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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
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(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, 2005
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the
transition period from to
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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)
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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
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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, 2005, there were 18,916,847 shares of Common Stock
outstanding.
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SPAR Group, Inc.
Index
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets
as of September 30, 2005, and December 31, 2004...............3
Consolidated Statements of Operations for the three
months and nine months ended September 30, 2005, and 2004.....4
Consolidated Statements of Cash Flows for the
nine months ended September 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...29
Item 4: Controls and Procedures......................................30
Item 5: Other Information............................................30
PART II: OTHER INFORMATION
Item 1: Legal Proceedings............................................31
Item 2: Changes in Securities and Use of Proceeds....................31
Item 3: Defaults upon Senior Securities..............................31
Item 4: Submission of Matters to a Vote of Security Holders..........31
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)
September 30, December 31,
2005 2004
------------- ------------
(Unaudited) (Note)
Assets
Current assets:
Cash and cash equivalents $ 1,813 $ 887
Accounts receivable, net 8,758 11,307
Prepaid expenses and other current assets 662 657
-------- --------
Total current assets 11,233 12,851
Property and equipment, net 1,112 1,536
Goodwill 798 798
Other assets 89 636
-------- --------
Total assets $ 13,232 $ 15,821
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,592 $ 2,158
Accrued expenses and other current liabilities 2,635 2,391
Accrued expenses due to affiliates 770 987
Restructuring charges 99 250
Customer deposits 1,523 1,147
Lines of credit 2,418 4,956
-------- --------
Total current liabilities 9,037 11,889
Other long-term liabilities 53 12
Minority interest 209 206
-------- --------
Total liabilities 9,299 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 -
18,916,847 - September 30, 2005
18,858,972 - December 31, 2004 189 189
Treasury stock (1) (108)
Accumulated other comprehensive loss (184) (86)
Additional paid-in capital 11,077 11,011
Accumulated deficit (7,148) (7,292)
-------- --------
Total stockholders' equity 3,933 3,714
-------- --------
Total liabilities and stockholders' equity $ 13,232 $ 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 Nine Months Ended
-------------------------------- --------------------------------
September 30, September 30, September 30, September 30,
2005 2004 2005 2004
---- ---- ---- ----
Net revenues $ 11,060 $ 10,683 $ 38,381 $ 35,418
Cost of revenues 7,595 6,963 24,414 24,474
-------- -------- -------- --------
Gross profit 3,465 3,720 13,967 10,944
Selling, general and administrative expenses 4,214 4,028 12,712 14,471
Impairment charges - - - 8,141
Depreciation and amortization 261 275 812 1,005
-------- -------- -------- --------
Operating (loss) income (1,010) (583) 443 (12,673)
Interest expense 29 29 102 127
Other income - 773 14 764
-------- -------- -------- --------
(Loss) income before provision for income taxes
and minority interest (1,039) 161 355 (12,036)
Provision for income taxes 15 15 45 783
-------- -------- -------- --------
(Loss) income before minority interest (1,054) 146 310 (12,819)
Minority interest 88 (64) 166 (64)
-------- -------- -------- --------
Net (loss) income $ (1,142) $ 210 $ 144 $(12,755)
======== ======== ======== ========
Basic/diluted net (loss) income per common share:
Net (loss) income- basic/diluted $ (0.06) $ 0.01 $ 0.01 $ (0.68)
======== ======== ======== ========
Weighted average common shares - basic 18,899 18,859 18,876 18,859
======== ======== ======== ========
Weighted average common shares - diluted 18,899 19,026 19,388 18,859
======== ======== ======== ========
See accompanying notes.
4
SPAR Group, Inc.
Consolidated Statements of Cash Flows
(unaudited) (in thousands)
Nine Months Ended
-------------------------------
September 30, September 30,
2005 2004
---- ----
Operating activities
Net cash provided by operating activities 3,676 2,708
Investing activities
Purchases of property and equipment (388) (1,014)
Acquisition of businesses - (399)
------- -------
Net cash used in investing activities (388) (1,413)
Financing activities
Net payments on lines of credit (2,538) (1,275)
Other long-term liabilities 3 206
Proceeds from employee stock purchase plan and exercised
options 173 10
------- -------
Net cash used in financing activities (2,362) (1,059)
Net change in cash and cash equivalents 926 236
Cash and cash equivalents at beginning of period 887 -
------- -------
Cash and cash equivalents at end of period $ 1,813 $ 236
======= =======
Supplemental disclosure of cash flows information
Interest paid $ 104 $ 124
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 electronic 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. In September 2005, the Company also announced the
establishment of a 51% owned joint venture in Lithuania. The Company's joint
ventures in China and Lithuania are 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. The Japan joint venture's fiscal year ends
6
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
September 30. Accordingly, the consolidation of the Company's financial
statements include the results of the Japan joint venture for the nine months
ended June 30, 2005. In the corresponding period in 2004, the Japan joint
venture was accounted for on the equity method. All significant intercompany
accounts and transactions have been eliminated.
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 September 30, 2005, the Company had
approximately $99,000 reserved for future restructure payments that are expected
to be paid in 2006. 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
(loss) earnings per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
--------------------------------- -----------------------------
September 30, September 30, September 30, September 30,
------------- ------------- ------------- -------------
2005 2004 2005 2004
---- ---- ---- ----
Numerator:
Net (loss) income $ (1,142) $ 210 $ 144 $(12,755)
Denominator:
Shares used in basic (loss) earnings
per share calculation 18,899 18,859 18,876 18,859
Effect of diluted securities:
Employee stock options - 167 512 -
-------- -------- -------- --------
Shares used in diluted (loss) earnings
per share calculation 18,899 19,026 19,388 18,859
======== ======== ======== ========
Basic and diluted earnings (loss)
per common share:
Net (loss) income - basic and
diluted $ (0.06) $ 0.01 $ 0.01 $ (0.68)
======== ======== ======== ========
7
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
The computation of dilutive loss per share excluded anti-dilutive stock
options to purchase approximately 830,000 shares for the three months ended
September 30, 2005, and approximately 591,000 shares for the nine months ending
September 30, 2004.
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 of
its domestic subsidiaries). 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
September 30, 2005, there were no LIBOR based loans and the interest rate
calculated at Webster's Alternative Base Rate plus 0.75% which totaled 7.5% per
annum. The average interest rate for the nine months ended September 30, 2005,
was 6.65% 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 September 30, 2005,
and Webster has issued a waiver for those violations. The Company is currently
negotiating with Webster to amend the existing covenants and extend the Credit
Facility. 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
$1.7 million and $4.1 million at September 30, 2005, and December 31, 2004,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $700,000 at September 30, 2005, and December 31, 2004. As of
September 30, 2005, the SPAR Group had unused availability under the Credit
Facility of $1.6 million out of the remaining maximum $4.6 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
8
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
June 30, 2005). At June 30, 2005, SPAR FM Japan, Inc. had 80 million Yen or
approximately $724,000 loan balance outstanding under the line of credit (based
upon the exchange rate at that date). 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 nine months ended September 30, 2005, was 1.375% per annum.
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 86% of the Company's field management at a total cost to the
Company of approximately $15.5 million and $19.5 million for the nine months
ended September 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 $470,000
for the nine months ended September 30, 2004. Total net premiums (4% of SMS and
SMSI costs less 2004 concessions) paid to SMS and SMSI for services rendered
were approximately $596,000 and $750,000 for the nine months ended September 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 $610,000 and $953,000
for the nine months ended September 30, 2005, and 2004, respectively. SIT
provided approximately 20,000 and 27,000 hours of Internet computer programming
services to the Company for the nine months ended September 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 $30.53 and $34.90 for the nine months ended September 30, 2005, and 2004,
respectively. The Company has
9
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
been advised that no hourly charges or business expenses for Messrs. Brown and
Bartels were charged to the Company by SIT for the nine months ended September
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. ("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 September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Services provided by affiliates:
Independent contractor services
(SMS) $ 3,567 $ 4,183 $12,721 $15,941
======= ======= ======= =======
Field management services (SMSI) $ 906 $ 946 $ 2,785 $ 3,561
======= ======= ======= =======
Handheld computer leases (SMS) $ 72 $ - $ 199 $ -
======= ======= ======= =======
Internet and software program
consulting services (SIT) $ 186 $ 238 $ 610 $ 953
======= ======= ======= =======
10
Accrued expenses due to affiliates (in thousands): September 30, December 31,
2005 2004
---- ----
SPAR Marketing Services, Inc. $770 $987
==== ====
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):
Nine Months Ended
September 30,
-----------------
2005 2004
Net income (loss), as reported $ 144 $(12,755)
Stock based employee compensation expense
under the fair market value method 341 367
-------- --------
Pro forma net (loss) $ (197) $(13,122)
Basic and diluted net income (loss) per share, as
reported $ 0.01 $ (0.68)
Basic and diluted net (loss) per share, pro forma $ (0.01) $ (0.70)
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.
11
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
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 nine
months ended September 30, 2005, the Company recorded an expense of
approximately $90,000. For the nine months ended September 30, 2004, as a result
of the decrease in the market price of the Company's stock from December 31,
2003 to September 30, 2004, there was a recovery of amounts previously expensed
of approximately $114,000 under the provision of SFAS 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
of authorized and repurchased shares to 222,000.
The following table summarizes the Company's treasury stock activity
from January 1, 2005, to September 30, 2005.
Quantity Amount
-------- ------
Treasury Stock, January 1, 2005 21,908 $ 108,100
Used to fulfill options exercised (21,654) (106,888)
------- --------
Treasury Stock, September 30, 2005 254 $ 1,212
======= ========
10. Customer Deposits
Customer deposits at September 30, 2005, were approximately $1.5
million; $1.1 million from domestic operations and approximately $400,000 from
international operations. Approximately $870,000 of the $1.1 million from
domestic operations is associated with a non-refundable deposit received by the
Company in June 2004 from one customer. The deposit is to be applied to future
invoices if services are 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.
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
12
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
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.
In February 2005, the Company announced the establishment of a 50% owned joint
venture in China. In September 2005, the Company also announced the
establishment of a 51% owned joint venture in Lithuania. The Company's joint
ventures in China and Lithuania are expected to be operational before the end of
2005.
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 is 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 2006.
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 nine months ended
September 30, 2005, and 2004, respectively, and at September 30, 2005, and
December 31, 2004, are as follows (in thousands):
13
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Net revenue:
------------
United States $ 7,467 $ 9,236 $ 27,446 $ 32,467
International 3,593 1,447 10,935 2,951
-------- -------- -------- --------
Total net revenue $ 11,060 $ 10,683 $ 38,381 $ 35,418
======== ======== ======== ========
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
2005 2004 2005 2004
---- ---- ---- ----
Operating (loss) income:
------------------------
United States $ (1,145) $ (260) $ (249) $(10,821)
International 135 (323) 692 (1,852)
-------- -------- -------- --------
Total operating (loss) income $ (1,010) $ (583) $ 443 $(12,673)
======== ======== ======== ========
September 30, December 31,
------------- ------------
Long lived assets: 2005 2004
---- ----
United States $1,811 $2,484
International 188 486
------ ------
Total long lived assets $1,999 $2,970
====== ======
International revenues disclosed above were based upon revenues reported
by the Company's 100% owned foreign subsidiary, its 51% owned foreign joint
venture subsidiaries and its 50% owned foreign joint venture. The joint venture
in Japan contributed 11% of the consolidated net revenue of the Company for the
nine months ended September 30 , 2005. In 2004, the joint venture in Japan was
accounted for on the equity method. For the nine months ended September 30,
2005, and 2004, the wholly owned Canadian subsidiary contributed 8% and 2%
respectively of the consolidated net revenue of the Company. The joint venture
subsidiary in South Africa contributed 7% and 7%, to the consolidated net
revenue of the Company for the nine months ended September 30, 2005, and 2004,
respectively. Each of the remaining foreign joint venture subsidiaries
contributed less than 5% to the consolidated net revenue for the nine month
period ending September 30, 2005, and 2004.
13. Supplemental Balance Sheet Information
September 30, December 31,
------------- ------------
Accounts receivable, net, consists of the following (in thousands): 2005 2004
---- ----
Trade $ 6,253 $ 8,178
Unbilled 2,991 3,600
Non-trade 245 290
-------- --------
9,489 12,068
Less allowance for doubtful accounts (731) (761)
-------- --------
$ 8,758 $ 11,307
======== ========
14
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
September 30, December 31,
------------- ------------
Prepaid expenses and other current assets consist of the 2005 2004
following (in thousands): ---- ----
Prepaid insurance $ 282 $ 214
Tax refund due 62 62
Prepaid rents 49 49
Other 269 332
------ ------
$ 662 $ 657
====== ======
September 30, December 31,
------------- ------------
Property and equipment consists of the following (in thousands): 2005 2004
---- ----
Equipment $5,517 $5,397
Furniture and fixtures 547 547
Leasehold improvements 138 138
Capitalized software development costs 1,906 1,629
------ ------
8,108 7,711
Less accumulated depreciation and amortization 6,996 6,175
------ ------
$1,112 $1,536
====== ======
September 30, December 31,
------------- ------------
Accrued expenses and other current liabilities consist of the 2005 2004
following (in thousands): ---- ----
Merger related payables $ 450 $ 450
Accrued medical expenses 225 225
Taxes payable 332 345
Accrued accounting and legal expense 338 192
Accrued salaries payable 392 328
Other 898 851
------ ------
$2,635 $2,391
====== ======
14. 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 nine months ended September 30, 2005,
these exposures were primarily concentrated in the Canadian dollar, South
African Rand and Japanese Yen. At September 30, 2005, international assets
totaled approximately $2.9 million and international liabilities totaled
approximately $2.6 million. For the nine months ended September 30, 2005,
international revenues totaled $10.9 million and the Company's share of the net
income was approximately $489,000.
15
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
15. Interest Rate Fluctuations
The Company is exposed to market risk related to the variable interest
rates on its lines of credit. At September 30, 2005, the Company's outstanding
debt totaled approximately $2.4 million, which consisted of domestic
variable-rate (7.5%) debt of $1.7 million and international variable rate (1.4%)
debt of $0.7 million. Based on the nine months ending September 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 nine months ended September 30, 2005, by approximately $20,000.
16. 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 nine
months ended September 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. In September 2005, the
17
SPAR Group, Inc.
Company also announced the establishment of a 51% owned joint venture in
Lithuania. For the nine months ended September 30, 2005, the Company
consolidated Canada, Turkey, South Africa, India, Romania and Japan into the
Company's financial statements. While China and Lithuania did not have
operations for the nine months ended September 30, 2005, they are both projected
to be operational by the end of 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 electronic chains and grocery stores. Included in its customers are home
entertainment, general merchandise, electronic, health and beauty care, consumer
goods and food product 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
Establishment 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
September 2005 51% Siauliai, Lithuania
18
SPAR Group, Inc.
The China and Lithuania joint ventures are expected to be operational before the
end of 2005.
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
19
stated at the amount that management expects to collect from the
outstanding balances. The Company provides for probable uncollectible
amounts through a charge to earnings and a credit to bad debt allowance
based on management's assessment of the current status of individual
accounts. Based on management's assessment, the Company established an
allowance for doubtful accounts of $731,000 and $761,000 at September
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 $276,000 and $298,000 of costs related to
software developed for internal use in the nine months ended September
30, 2005, and 2004, respectively and amortized capitalized software of
approximately $416,000 and $221,000 in the nine months ended September
30, 2005, and 2004, respectively.
20
SPAR Group, Inc.
Results of Operations
Three months ended September 30, 2005, compared to three months ended September
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
-------------------------------------------------------------------------------
September 30, 2005 September 30, 2004
------------------ ------------------
Increase
Dollars % Dollars % (decrease) %
------- - ------- - ------------
Net revenues $ 11,060 100.0% $ 10,683 100.0% 3.5%
Cost of revenues 7,595 68.7 6,963 65.2 9.1
Selling, general and administrative
expense 4,214 38.1 4,028 37.7 4.6
Depreciation and amortization 261 2.4 275 2.6 (4.8)
Interest expense 29 0.3 29 0.2 (2.1)
Other income - - 773 7.2 (100.0)
-------- ----- -------- -----
(Loss) income before provision for
income taxes and minority interest (1,039) (9.5) 161 1.5 -
Provision for income taxes 15 0.1 15 0.1 -
-------- ----- -------- -----
Net (loss) income before minority
interest (1,054) (9.6) 146 1.4 -
Minority interest 88 0.8 (64) (0.6) -
-------- ----- -------- -----
Net (loss) income $ (1,142) (10.4)% $ 210 2.0% -
======== ===== ======== =====
Net Revenues
Net revenues for the three months ended September 30, 2005, were $11.1
million, compared to $10.7 million for the three months ended September 30,
2004, an increase of 3.5%. For the third quarter domestic revenue decreased $1.7
million or 19.2% to $7.5 million, compared to $9.2 million a year ago. The
decrease in domestic revenue is a result of the loss of several significant
customers partially offset
21
SPAR Group, Inc.
by revenue from new customers. Internationally, revenue for the third quarter
increased to $3.6 million from $1.4 million last year. The increase in revenue
reflects $1.4 million of revenues resulting from the consolidation of the joint
venture in Japan that was accounted for on the equity method in 2004, as well as
continued revenue increases in Canada of $0.8 million and India of $0.4 million,
slightly offset by a revenue decrease of $0.6 million in South Africa.
One customer accounted for 13% and 14% of the Company's net revenue for
the three months ended September 30, 2005, and 2004, respectively. This customer
also accounted for approximately 19% and 29% of accounts receivable at September
30, 2005, and December 31, 2004, respectively.
Approximately 9% and 17% of the Company's net revenues for the three
months ended September 30, 2005, and 2004, respectively, resulted from
merchandising services performed for customers at Kmart. These customers also
accounted for approximately 9% and 22% of accounts receivable at September 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 10% of the Company's net revenue for the
three months ended September 30, 2005, resulted from merchandising services
performed for customers at Circuit City. These customers also accounted for
approximately 4% and 16% of accounts receivable at September 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.
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 68.7% for the three months ended
September 30, 2005, compared to 65.2% for the three months ended September 30,
2004. For the third quarter domestic cost of revenues as a percentage of net
revenues was 71.7% and 63.3% for the three months ended September 30, 2005, and
2004, respectively. The increase is primarily attributed to the mix of business
with higher cost project revenue accounting for a greater portion of revenue in
the current period. Internationally, cost of revenues as a percentage of net
revenues was 62.4% and 77.1% for the three months ended September 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.
Approximately 83.5% and 87.7% of the Company's domestic cost of revenue
in the three months ended September 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.
22
SPAR Group, 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 increased by $0.2 million,
or 4.6%, for the three months ended September 30, 2005, to $4.2 million compared
to $4.0 million for the three months ended September 30, 2004. Domestic selling,
general and administrative expenses decreased by $0.4 million to $3.0 million
for 2005 from $3.4 million in 2004. The reduction of 11% 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 $0.6 million to $1.2 million for 2005 from
approximately $0.6 million in 2004. The increase of 89.2% was primarily due to
the consolidation of the Japan joint venture.
Depreciation and Amortization
Depreciation and amortization charges of $0.3 million for the three
months ended September 30, 2005, was consistent with $0.3 million in the same
period for 2004.
Income Taxes
The Company recorded an income tax provision of $15,000 for the three
months ended September 30, 2005. The provision was primarily for minimum state
taxes. There was no provision for federal tax for the three months ended
September 30, 2005, since the Company expects to utilize net operating loss
carryforwards which are available to offset any federal taxes due.
The Company recorded an income tax provision of $15,000 for the three
months ended September 30, 2004.
Minority Interest
Minority interest of approximately $88,000 and approximately ($64,000)
resulted from the operating profits and losses of the 51% owned joint venture
subsidiaries and the 50% owned Japanese joint venture for the three months ended
September 30, 2005, and 2004, respectively.
Net (Loss) Income
The Company had a net loss of $1.1 million for the three months ended
September 30, 2005, or $0.06 per diluted share, compared to a net income of $0.2
million, or $0.01 per diluted share, for the corresponding period last year.
23
Results of Operations
Nine months ended September 30, 2005, compared to nine months ended September
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).
Nine Months Ended
-------------------------------------------------------------------------------
September 30, 2005 September 30, 2004
------------------ ------------------
Increase
Dollars % Dollars % (decrease) %
------- - ------- - ------------
Net revenues $ 38,381 100.0% $ 35,418 100.0% 8.4%
Cost of revenues 24,414 63.6 24,474 69.1 (0.2)
Selling, general and administrative
expense 12,712 33.1 14,471 40.9 (12.2)
Impairment charges - - 8,141 23.0 (100.0)
Depreciation and amortization 812 2.1 1,005 2.8 (19.2)
Interest expense 102 0.3 127 0.4 (20.0)
Other income 14 - 764 2.2 (98.2)
-------- ----- -------- -----
Income (loss) before provision for
income taxes and minority interest 355 0.9 (12,036) (34.0) -
Provision for income taxes 45 0.1 783 2.2 -
-------- ----- -------- -----
Net income (loss) before minority
interest 310 0.8 (12,819) (36.2) -
Minority interest 166 0.3 (64) (0.2) -
-------- ----- -------- -----
Net income (loss) $ 144 0.5% $(12,755) (36.0)% -
======== ===== ======== =====
Net Revenues
Net revenues for the nine months ended September 30, 2005, were $38.4
million, compared to $35.4 million for the nine months ended September 30, 2004,
an increase of $3.0 million or 8.4%. For
24
SPAR Group, Inc.
the nine month period, domestic revenue decreased $5.0 million or 15.5% to $27.4
million, compared to $32.4 million in 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 nine
months increased to $11.0 million from $3.0 million last year. The increase in
revenue for the nine months ended September 30, 2005 reflects $4.3 million of
revenue resulting from the consolidation of the joint venture in Japan that was
accounted for on the equity method in 2004, as well as continued revenue
increases in Canada of $2.5 million, India of $0.7 million and South Africa of
$0.3 million.
One customer accounted for 17% and 12% of the Company's net revenue for
the nine months ended September 30, 2005, and 2004, respectively. This customer
also accounted for approximately 19% and 29% of accounts receivable at September
30, 2005, and December 31, 2004, respectively.
A second customer accounted for 9% and 30% of the Company's net revenues
for the nine months ended September 30, 2005, and 2004, respectively. This
customer also accounted for approximately 2% and 4% of accounts receivable at
September 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 various projects that resulted in $3.4 million of
revenue for this customer.
In addition, approximately 10% of the Company's net revenue for the nine
months ended September 30, 2005, resulted from merchandising services performed
for customers at Circuit City. These customers also accounted for approximately
4% and 16% of accounts receivable at September 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 15% of the Company's net revenues for the nine
months ended September 30, 2005, and 2004, respectively, resulted from
merchandising services performed for customers at Kmart. These customers also
accounted for approximately 9% and 22% of accounts receivable at September 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 63.6% for the nine months ended
September 30, 2005, compared to 69.1% for the nine months ended September 30,
2004. For the nine months ended September 30, 2005 and 2004, domestic cost of
revenues as a percentage of net revenues was 64.8% and 68.3% 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 60.5% and 78.2% for the nine months ended
September
25
SPAR Group, Inc.
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.
Approximately 87.1% and 87.9% of the Company's domestic cost of revenue
in the nine months ended September 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 $1.8 million,
or 12.2%, for the nine months ended September 30, 2005, to $12.7 million
compared to $14.5 million for the nine months ended September 30, 2004. Domestic
selling, general and administrative expenses decreased by $3.5 million to $9.2
million for 2005 from $12.7 million in 2004. The reduction of 27.9% 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 $1.7 million to $3.5 million
for 2005 from $1.8 million in 2004. The increase of 103.9% was primarily due to
$1.3 million of expenses resulting from the consolidation of Japan and increases
of $0.3 million in Canada and $0.1 million in South Africa resulting from
increased operations.
Impairment Charges
The Company had no impairment charge for the nine months ended September
30, 2005, as compared to impairment of $8.1 million for the nine months ended
September 30, 2004. Impairment charges for the 2004 period 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 were $0.8 million for the nine
months ended September 30, 2005, a decrease of $0.2 million from $1.0 million in
the same period for 2004.
Income Taxes
The Company recorded an income tax provision of $45,000 for the nine
months ended September 30, 2005. The provision was primarily for minimum state
taxes. There was no provision for federal tax for the nine months ended
September 30, 2005, since the Company expects to utilize net operating loss
carryforwards which are available to offset any federal taxes due.
26
SPAR Group, Inc.
The Company recorded an income tax provision of $0.8 million for the
nine months ended September 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.
Minority Interest
Minority interest of approximately $166,000 and approximately ($64,000)
resulted from the operating profits and losses of the 51% owned joint venture
subsidiaries and the 50% owned joint venture for the nine months ended September
30, 2005, and 2004, respectively.
Net Income (Loss)
The Company had a net income of $0.1 million for the nine months ended
September 30, 2005, or $0.01 per diluted share, compared to a net loss of $12.8
million, or $0.68 per diluted share, for the corresponding period last year.
Liquidity and Capital Resources
In the nine months ended September 30, 2005, the Company had a net
income of $144,000.
Net cash provided by operating activities for the nine months ended
September 30, 2005, and 2004, was $3.7 million and $2.7 million, respectively.
Net cash used in investing activities for the nine months ended
September 30, 2005, was approximately $388,000 compared to net cash used in
investing activities of $1.4 million for the nine months ended September 30,
2004. The decrease in net cash used in investing activities was a result of no
business acquisitions and lower purchases of property and equipment in 2005.
Net cash used in financing activities for the nine months ended
September 30, 2005, was $2.4 million, compared to net cash used in financing
activities of $1.1 million for the nine months ended September 30, 2004. The
increase of net cash used in financing activities was primarily a result of
higher net payments on the lines of credit.
The above activity resulted in an increase in cash and cash equivalents
for the nine months ended September 30, 2005, of approximately $926,000.
At September 30, 2005, the Company had positive working capital of $2.2
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 1.24 at September 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
27
SPAR Group, Inc.
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 of its domestic subsidiaries). 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 September 30, 2005, there were no
LIBOR based loans and the interest rate calculated at Webster's Alternative Base
Rate plus 0.75% which totaled 7.5% per annum. The average interest rate for the
nine months ended September 30, 2005, was 6.65% 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 September 30, 2005,
and Webster has issued a waiver for the September 30, 2005, covenant violations.
The Company is currently negotiating with Webster to amend the existing
covenants and extend the Credit Facility. 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
$1.7 million and $4.1 million at September 30, 2005, and December 31, 2004,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $700,000 at September 30, 2005, and December 31, 2004. As of
September 30, 2005, the SPAR Group had unused availability under the Credit
Facility of $1.6 million out of the remaining maximum $4.6 million unused
revolving line of credit after reducing the borrowing base by outstanding loans
and letters of credit.
In 2001, the Japanese joint venture SPAR FM Japan, Inc. entered into a
revolving line of credit arrangement with Japanese banks for 300 million Yen or
$2.7 million (based upon the exchange rate at September 30, 2005). At September
30, 2005, SPAR FM Japan, Inc. had 80 million Yen or approximately $724,000 loan
balance outstanding under the line of credit (based upon the exchange rate at
that date). 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 September 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,
28
SPAR Group, Inc.
South Africa, India and Romania. In February 2005, the Company announced the
establishment of a joint venture in China. In September 2005, the Company
announced the establishment of a joint venture in Lithuania. The Company's
Chinese and Lithuanian joint ventures are expected to be operational before the
end of 2005.
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, each 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 September 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 $2,418 $2,418 $ - $ - $ -
- -------------------------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,481 969 512 - -
- -------------------------------------------------------------------------------------------------------------------
Total $3,899 $3,387 $ 512 $ - $ -
- -------------------------------------------------------------------------------------------------------------------
The Company also had approximately $700,000 in outstanding Letters of
Credit at September 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.
29
SPAR Group, Inc.
The Company is exposed to market risk related to the variable interest
rates on its lines of credit. At September 30, 2005, the Company's outstanding
debt totaled approximately $2.4 million, which consisted of domestic variable
rate (7.5%) debt of $1.7 million and international variable rate (1.4%) debt of
$0.7 million. Based on the nine months ending September 30, 2005, average
outstanding borrowings of approximately $1.5 million and approximately 93
million Yen under variable rate debt, a one-percentage point increase in
interest rates would negatively impact pre-tax earnings and cash flows for the
nine months ended September 30, 2005, by approximately $20,000.
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 nine months ended September 30,
2005, these exposures were primarily concentrated in the Canadian dollar, South
African Rand and Japanese Yen. At September 30, 2005, international assets
totaled approximately $4.5 million and international liabilities totaled
approximately $6.8 million. For the nine months ended September 30, 2005,
international revenues totaled $10.9 million and the Company's share of the net
income was approximately $489,000.
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 nine
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 as required by Section 404
of the Sarbanes-Oxley Act of 2002.
Item 5. Other Information.
None
30
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
SGRP held its Annual Meeting of Stockholders on August 10, 2005. The
meeting was held (1) to elect the Board of Directors and (2) to
ratify the appointment of Rehmann Robson as the Company's independent
auditors for the year ending December 31, 2005.
Proposal 1 - Election of Directors:
Name: For: Abstention:
-------------------------------------------------------------------
Robert G. Brown 17,426,619 3,710
-------------------------------------------------------------------
William H. Bartels 17,361,449 68,880
-------------------------------------------------------------------
Robert O. Aders 17,420,778 9,551
-------------------------------------------------------------------
Jack W. Partridge 17,419,778 10,551
-------------------------------------------------------------------
Jerry B. Gilbert 17,424,098 6,231
-------------------------------------------------------------------
Lorrence T. Kellar 17,418,697 11,632
-------------------------------------------------------------------
Each of the nominees was elected to the Board of Directors of SGRP.
Proposal Number 2 - Ratification of the appointment of Rehmann Robson
as the Company's independent public accountant for the fiscal year
ending December 31, 2005:
For: Against: Abstention:
-------------------------------------------------------------------
17,415,996 1,870 12,463
-------------------------------------------------------------------
31
SPAR Group, Inc.
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
November 10, 2005, with respect to the fiscal quarter ended
September 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: November 14, 2005 SPAR Group, Inc., Registrant
By: /s/ Charles Cimitile
---------------------------------------
Charles Cimitile
Chief Financial Officer, Treasurer,
Secretary and duly authorized signatory
33