- --------------------------------------------------------------------------------
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 first quarterly period ended MARCH 31, 2006
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 mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.).
Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.) [ ] Yes [X] No
- --------------------------------------------------------------------------------
On March 31, 2006, there were 18,918,847 shares of Common Stock outstanding.
- --------------------------------------------------------------------------------
SPAR GROUP, INC.
Index
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets
as of March 31, 2006, and December 31, 2005....................3
Consolidated Statements of Operations for the three
months ended March 31, 2006, and 2005..........................4
Consolidated Statements of Cash Flows for the
three months ended March 31, 2006, and 2005................... 5
Notes to Consolidated Financial Statements.....................6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations...........................16
Item 3: Quantitative and Qualitative Disclosures about Market Risk....23
Item 4: Controls and Procedures.......................................24
PART II: OTHER INFORMATION
Item 1: Legal Proceedings.............................................25
Item 1A: Risk Factors..................................................25
Item 2: Unregistered Sales of Equity Securities and Use of Proceeds...25
Item 3: Defaults upon Senior Securities...............................25
Item 4: Submission of Matters to a Vote of Security Holders...........25
Item 5: Other Information.............................................26
Item 6: Exhibits ....................................................26
SIGNATURES....................................................................27
2
PART I:.FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
SPAR GROUP, INC.
Consolidated Balance Sheets
(In thousands, except share and per share data)
MARCH 31, DECEMBER 31,
2006 2005
------------- -------------
(Unaudited) (Note)
ASSETS
Current assets:
Cash and cash equivalents $ 1,312 $ 1,914
Accounts receivable, net 11,577 10,656
Prepaid expenses and other current assets 565 702
------------- -------------
Total current assets 13,454 13,272
Property and equipment, net 1,018 1,131
Goodwill 798 798
Other assets 172 216
------------- -------------
Total assets $ 15,442 $ 15,417
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,697 $ 1,597
Accrued expenses and other current liabilities 2,368 2,639
Accrued expenses due to affiliates 1,630 1,190
Restructuring charges 99 99
Customer deposits 798 1,658
Lines of credit 2,687 2,969
------------- -------------
Total current liabilities 9,279 10,152
Other long-term liabilities 10 10
Minority interest 421 405
------------- -------------
Total liabilities 9,710 10,567
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 -
18,918,847- March 31, 2006
18,916,847 - December 31, 2005 189 189
Treasury stock (1) (1)
Accumulated other comprehensive (loss) gain (19) 17
Additional paid-in capital 11,200 11,059
Accumulated deficit (5,637) (6,414)
------------- -------------
Total stockholders' equity 5,732 4,850
------------- -------------
Total liabilities and stockholders' equity $ 15,442 $ 15,417
============= =============
Note: The Balance Sheet at December 31, 2005, 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 MARCH 31,
------------------------------
2006 2005
----------- -----------
Net revenue $ 15,850 $ 14,521
Cost of revenue 9,854 8,651
----------- -----------
Gross profit 5,996 5,870
Selling, general and administrative expenses 5,071 4,256
Depreciation and amortization 213 279
----------- -----------
Operating income 712 1,335
Interest expense 51 40
Other income 178 -
----------- -----------
Income before provision for income taxes and
minority interest 839 1,295
Provision for income taxes 45 15
----------- -----------
Income before minority interest 794 1,280
Minority interest 17 111
----------- -----------
Net Income $ 777 $ 1,169
=========== ===========
Basic/diluted net income per common share:
Net income- basic/diluted $ 0.04 $ 0.06
=========== ===========
Weighted average common shares - basic 18,918 18,859
=========== ===========
Weighted average common shares - diluted 19,071 19,004
=========== ===========
See accompanying notes.
4
SPAR GROUP, INC.
Consolidated Statements of Cash Flows
(in thousands) (unaudited)
THREE MONTHS ENDED MARCH 31,
------------------------------
2006 2005
---------- ----------
OPERATING ACTIVITIES
Net cash (used in) provided by operating activities (184) 2,455
INVESTING ACTIVITIES
Purchases of property and equipment (100) (106)
---------- ----------
Net cash used in investing activities (100) (106)
FINANCING ACTIVITIES
Net payments on lines of credit (282) (2,832)
Other long-term liabilities - (97)
Proceeds from employee stock purchase plan and exercised
options - 30
---------- ----------
Net cash used in financing activities (282) (2,899)
Translation loss (36) (60)
Net change in cash and cash equivalents (602) (610)
Cash and cash equivalents at beginning of period 1,914 887
---------- ----------
Cash and cash equivalents at end of period $ 1,312 $ 277
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ 44 $ 48
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 2005 on Form 10-K for the year ended December 31,
2005, as filed with the Securities and Exchange Commission on April 3, 2006 (the
"Company's Annual Report for 2005 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, radio frequency identification
("RFID") services, technology services 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
and marketing services, in-store event staffing, product sampling, RFID
services, technology services and marketing research to manufacturers and
retailers in the United States. The various services are primarily performed in
mass merchandisers, electronics store chains, drug store chains, and convenience
and grocery stores. The International Merchandising Services Division,
established in July 2000, currently provides similar merchandising and marketing
services through a wholly owned subsidiary in Canada, through 51% owned joint
venture subsidiaries in Turkey, South Africa, India and Romania and through 50%
owned joint ventures in Japan and China. In September 2005, the Company
established a 51% owned joint venture subsidiary in Lithuania, which began
operations in April 2006. In April 2006, the Company also announced the
establishment of a 51% owned joint venture subsidiary in Australia, which is
projected to begin operations in the second quarter of 2006. The Company
continues to focus on expanding its merchandising and marketing services
business throughout the world.
3. PRINCIPLES OF CONSOLIDATION
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 in accordance with
Financial Accounting Standards Board Interpretation Number 46, as revised
December 2003, Consolidation of Variable Interest Entities ("FIN 46(R)").
During 2005, the Japan joint venture changed from a fiscal year ending
September 30 to a calendar year ending December 31. The Japan joint ventures'
operating results for the calendar fourth quarter of 2005 are included in the
three months ending March 31, 2006.
All significant intercompany accounts and transactions have been
eliminated.
6
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
4. NEW ACCOUNTING STANDARDS
In May 2005, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 154, "Accounting
Changes and Error Conditions, a replacement of APB No. 20 and FASB Statement No.
3 ("SFAS No. 154"). SFAS No. 154 requires retrospective application to prior
periods' financial statements of a voluntary change in accounting principle
unless it is impracticable. APB Opinion No. 20 "Accounting Changes," previously
required that most voluntary changes in accounting principle be recognized by
including in net income of the period of the change the cumulative effect of
changing to the new accounting principle. This Statement is effective for the
Company as of January 1, 2006. The Company does not expect the adoption of SFAS
No. 154 will have a significant impact on the manner of display of its results
of operations or financial position.
In December 2004, the FASB issued SFAS No. 123(R), "Share-Based
Payment", which replaces SFAS No. 123, "Accounting for Share-based
Compensation", and supersedes Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25"). The Statement
requires that the calculated cost resulting from all share-based payment
transactions be recognized in the financial statements. The Statement also
establishes fair value as the measurement objective in accounting for
share-based payment arrangements and requires all entities to apply a
fair-value-based measurement method in accounting for share-based payment
transactions with employees, except for equity instruments held by employee
share ownership plans. The Statement was effective for the Company beginning
January 1, 2006. The "modified prospective" method was required upon adoption;
accordingly, results of prior periods have not been restated. Under the modified
prospective method, the Statement applies to new awards and to awards modified,
repurchased or cancelled after the effective date. Additionally, compensation
cost for the unvested portion of awards as of the effective date is required to
be recognized after the effective date as the awards vest. As of January 1,
2006, the Company implemented SFAS No. 123(R), with share-based compensation
expense now reflected in the Company's interim statements of operations. See
Note 9 - Stock-Based Compensation below for additional information regarding the
adoption of SFAS No. 123(R).
5. RESTRUCTURING CHARGES
In July 2004, as a result of the loss of several significant clients and
the pending sale of the Company's largest client, 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. At March 31, 2006, 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.
7
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
6. EARNINGS PER SHARE
The following table sets forth the computations of basic and diluted
earnings per share (in thousands, except per share data):
THREE MONTHS ENDED MARCH 31,
--------------------------------
2006 2005
------------ ------------
Numerator:
Net income $ 777 $ 1,169
Denominator:
Shares used in basic earnings per share calculation 18,918 18,859
Effect of diluted securities:
Employee stock options 153 145
------------ ------------
Shares used in diluted earnings per share calculation 19,071 19,004
============ ============
Basic and diluted earnings per common share $ 0.04 $ 0.06
============ ============
7. LINES OF CREDIT
In January 2003, the Company and Webster Business Credit Corporation,
then known as Whitehall Business Credit Corporation ("Webster"), entered into
the Third Amended and Restated Revolving Credit and Security Agreement (as
amended, collectively, the "Credit Facility").
In January 2006, the Credit Facility was amended to extend its maturity
to January 2009 and to reset the Minimum Fixed Charge Coverage Ratio, and
Minimum Net Worth covenants. It further stipulated that should the Company meet
its covenants for the year ended December 31, 2005, which it has, Webster would
release Mr. Robert Brown and Mr. William Bartels from their obligation to
provide personal guarantees totaling $1.0 million and certain discretionary
reserves. The Credit Facility also limits certain expenditures, including, but
not limited to, capital expenditures and other investments.
The basic interest rate under the Credit Facility is Webster's
"Alternative Base Rate" plus 0.75% per annum (a total of 8.5% per annum at March
31, 2006), which automatically changes with each change made by Webster in such
Alternate Base Rate. The Company at its option, subject to certain conditions,
may elect to have portions of its loans under the Credit Facility bear interest
at various LIBOR rates plus 3.25% per annum based on fixed periods of one, two,
three or six months. The actual average interest rate under the Credit Facility
was 8.2% per annum for the quarter ending March 31, 2006. The Credit Facility is
secured by all of the assets of the Company and its domestic subsidiaries.
The Company was not in violation of any covenants at March 31, 2006, and
does not expect to be in violation at future measurement dates. However, there
can be no assurances that the Company will not be in violation of certain
covenants in the future. Should the Company be in violation, there are no
assurances that Webster will issue such waivers in the future.
Because of the requirement to maintain a lock box arrangement with
Webster and Webster's ability to invoke a subjective acceleration clause at its
discretion, borrowings under the Credit Facility are classified as current at
8
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
March 31, 2006, and December 31, 2005, in accordance with EITF 95-22, Balance
Sheet Classification of Borrowings Outstanding Under Revolving Credit Agreements
That Include Both a Subjective Acceleration Clause and a Lock-Box Agreement.
The revolving loan balances outstanding under the Credit Facility were
$2.1 million and $2.4 million at March 31, 2006, and December 31, 2005,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $552,000 at March 31, 2006, and December 31, 2005. As of March
31, 2006, the SPAR Group had unused availability under the Credit Facility of
$1.7 million out of the remaining maximum $4.3 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
$2.6 million (based upon the exchange rate at March 31, 2006). At March 31,
2006, SPAR FM Japan, Inc. had a 70 million Yen or approximately $600,000 loan
balance outstanding under the line of credit (based upon the exchange rate at
that date). The average interest rate at March 31, 2006 and 2005 was 1.4%.
8. RELATED-PARTY TRANSACTIONS
Mr. Robert G. Brown, a Director, the Chairman, President and Chief
Executive Officer and a major stockholder of SGRP, and Mr. William H. Bartels, a
Director, the Vice Chairman and a major stockholder of SGRP, 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 domestic
merchandising specialists in the field (through its independent contractor field
force) for both the three months ended March 31, 2006 and 2005, and
approximately 86% and 92% of the Company's domestic field management at a total
cost to the Company of approximately $5.8 million for both the three months
ended March 31, 2006, and 2005, 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 merchandising specialist field force of
approximately 5,500 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 44 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. Total net
premiums (4% of SMS and SMSI costs) paid to SMS and SMSI for services rendered
were approximately $235,000 and $220,000 for the three months ended March 31,
2006, and 2005, 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 and are 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 purchased by the Company at a total cost of approximately $187,000 and
$210,000 for the three months ended March 31, 2006, and 2005, respectively. SIT
provided approximately 6,400 and 6,700 hours of Internet computer programming
services to the Company for the three months ended March 31, 2006, and 2005,
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 $29.07 and $31.27 for the three months ended March 31, 2006, and 2005,
respectively. The Company has been advised that no hourly charges or business
expenses for Messrs. Brown and Bartels were charged
9
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
to the Company by SIT for the three months ended March 31, 2006, and 2005,
respectively. However, since SIT is a "Subchapter S" corporation and is 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"). In May 2005, the Company and SMS amended the lease agreements reducing
the total monthly payment. Each lease, as amended, 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 and marketing services in the United States
and has a monthly payment of $17,891. 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
and marketing services in Canada and has a monthly payment of $2,972. These
handheld computers had an original purchase price of $105,000. The monthly
payments, as amended, 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 MARCH 31,
----------------------------------------
2006 2005
----------------- -----------------
Services provided by affiliates:
Independent contractor services (SMS) $ 4,820 $ 4,781
================= =================
Field management services (SMSI) $ 951 $ 954
================= =================
Handheld computer leases (SMS) $ 70 $ 63
================= =================
Internet and software program consulting services (SIT) $ 187 $ 210
================= =================
Accrued expenses due to affiliates (in thousands): MARCH 31, DECEMBER 31,
2006 2005
----------------- -----------------
SPAR Marketing Services, Inc. $ 1,630 $ 1,190
================= =================
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 Chairman/CEO and Vice Chairman own,
through SMSI, a minority (less than 5%) equity interest in Affinity.
10
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
9. STOCK-BASED COMPENSATION
As of January 1, 2006, SFAS No. 123(R) became effective and applicable
to the Company's accounting for its employee options. The Company had previously
followed APB No. 25 and related interpretations in accounting for such options.
Under APB No. 25 no compensation expense was recognized by the Company when
employee stock options were granted, as the exercise price of the Company's
employee stock options equaled the market price of the underlying stock on the
date of grant. Under SFAS No. 123(R), compensation expense is now recognized in
the Company's financial statements when employee stock options are granted.
Share-based compensation cost is measured on the grant date, based on the fair
value of the award calculated at that date, and is recognized over the
employee's requisite service period, which generally is the options' vesting
period. Fair value is calculated using the Black-Scholes option pricing model.
The Black-Scholes calculation was performed for the three months ended March 31,
2006, utilizing the methodology and assumptions consistent with those used in
prior periods under SFAS No. 123, which were disclosed in the Company's
previously filed Annual Report on Form 10-K for the year ended December 31,
2005.
Share-based compensation expense totaled approximately $84,000 for the
three months ended March 31, 2006. Basic and diluted earnings per share impacted
by approximately $0.004 for the three month period ended March 31, 2006.
In 2005, under the disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation, as amended by SFAS 148, no compensation
cost was recognized for the stock option grants to Company employees for the
three months ended March 31, 2005. If compensation cost for the three month
ended March 31, 2005, had been recognized by the Company under the fair value
method, the Company's net income and pro forma net income per share would have
been reduced to the adjusted amounts indicated below (in thousands, except per
share data):
THREE MONTHS
ENDED MARCH 31,
--------------------
2005
--------------------
Net income, as reported $ 1,169
Stock based employee compensation expense
per the fair market value method 25
Pro forma net income --------------------
$ 1,144
====================
Basic and diluted net income per share, as reported $ 0.06
Basic and diluted net income per share, pro forma $ 0.06
Under the provision of SFAS No. 123 dealing with non-employee stock
option grants awarded to the employees of the Company's affiliates, the Company
recorded an expense for the three months ended March 31, 2006 and 2005, of
approximately $57,000 and $14,000 respectively.
The Company determines the fair value of the options granted to
employees and non-employees using the Black-Scholes valuation model and recovers
amounts previously expensed or expenses that vest 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.
11
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
10. CUSTOMER DEPOSITS
Customer deposits at March 31, 2006, were approximately $798,000
(approximately $405,000 from domestic operations and approximately $393,000 from
international operations) compared to approximately $1,658,000 at December 31,
2005 (approximately $1,246,000 from domestic operations and approximately
$412,000 from international operations). The decrease is primarily due to the
termination of a customer service agreement in March 2006.
11. COMMITMENTS AND CONTINGENCIES
INTERNATIONAL COMMITMENTS
The Company's international business model is to partner with local
merchandising companies and combine the Company's proprietary software and
expertise in the merchandising and marketing services 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,
Romania and China. In September 2005, the Company also announced the
establishment of a 51% owned joint venture subsidiary in Lithuania which began
operations in April 2006. In April 2006, the Company announced the establishment
of a 51% owned joint venture subsidiary in Australia, which is projected to
begin operations in the second quarter of 2006.
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 PIA Merchandising
Co., Inc. ("PIA Co."), a wholly owned subsidiary of SGRP, Pivotal Sales Company
("Pivotal"), a wholly owned subsidiary of PIA Co., and SGRP in Alameda Superior
Court, case no. 2001028498 on October 24, 2001, Safeway subsequently amended
their Complaint twice, dropping various causes of action for breach of trust and
breach of fiduciary duties. Safeway's remaining two claims are for breach of
contract and breach of implied contract. Safeway has most recently alleged
monetary damages in principal and interest of $6,400,000 (an increase of
$1,900,000 from the amount previously claimed) 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 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. Trial commenced in March 2006, and is
expected to conclude in late May or early June 2006. 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 in its claims and PIA Co. and Pivotal lose on their
cross-claims that result could have a material adverse effect on the Company.
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
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
12. GEOGRAPHIC DATA
A summary of the Company's net revenue, operating income and long lived
assets by geographic area for the three months ended March 31, 2006, and 2005,
respectively, and at March 31, 2006, and December 31, 2005, are as follows (in
thousands):
THREE MONTHS ENDED MARCH 31,
-------------------------------------
2006 2005
------------- -------------
Net revenue:
------------
United States $ 10,818 $ 10,800
International 5,032 3,721
------------- -------------
Total net revenue $ 15,850 $ 14,521
============= =============
THREE MONTHS ENDED MARCH 31,
-------------------------------------
2006 2005
------------- -------------
Operating income (loss):
------------------------
United States $ 716 $ 895
International (4) 440
------------- -------------
Total operating income $ 712 $ 1,335
============= =============
MARCH 31, DECEMBER 31,
------------- -------------
Long lived assets: 2006 2005
------------- -------------
United States $ 1,726 $ 1,799
International 262 346
------------- -------------
Total long lived assets $ 1,988 $ 2,145
============= =============
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 ventures. During 2005, the
Japan joint venture changed from a fiscal year ending September 30 to a calendar
year ending December 31. Due to the change of their fiscal year, the operating
results reported by the Japan joint venture for the first quarter ending March
31, 2006, included not only the operating results for the quarter, but also the
operating results for the calendar fourth quarter of 2005. The inclusion of the
fourth quarter operating results increased net revenue and operating income by
$1.3 million and $13,000, respectively. The joint venture in Japan contributed
17% and 9% of the consolidated net revenue of the Company for the three months
ended March 31, 2006, and 2005, respectively. For the three months ended March
31, 2006, and 2005, the wholly owned Canadian subsidiary contributed 7% of the
consolidated net revenue of the Company for both periods. The joint venture
subsidiary in South Africa contributed 5% and 9% to the consolidated net revenue
of the Company for the three months ended March 31, 2006, and 2005,
respectively. The remaining foreign joint venture subsidiaries contributed 4%
and 0.5% to the consolidated net revenue for the three month period ending March
31, 2006, and 2005, respectively.
13
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
13. SUPPLEMENTAL BALANCE SHEET INFORMATION
MARCH 31, DECEMBER 31,
------------ ------------
Accounts receivable, net, consists of the following (in thousands): 2006 2005
------------ ------------
Trade $ 7,201 $ 7,666
Unbilled 4,578 3,461
Non-trade 346 145
------------ ------------
12,125 11,272
Less allowance for doubtful accounts (548) (616)
------------ ------------
$ 11,577 $ 10,656
============ ============
MARCH 31, DECEMBER 31,
------------ ------------
Property and equipment consists of the following (in thousands): 2006 2005
------------ ------------
Equipment $ 5,181 $ 5,202
Furniture and fixtures 594 570
Leasehold improvements 568 568
Capitalized software development costs 1,318 1,228
------------ ------------
7,661 7,568
Less accumulated depreciation and amortization (6,643) (6,437)
------------ ------------
$ 1,018 $ 1,131
============ ============
Accrued expenses and other current liabilities consist of the MARCH 31, DECEMBER 31,
following (in thousands): 2006 2005
------------ ------------
Accrued medical and worker compensation expenses $ 193 $ 296
Taxes payable 160 490
Accrued accounting and legal expense 492 286
Accrued salaries payable 974 937
Other 549 630
------------ ------------
$ 2,368 $ 2,639
============ ============
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 ventures. In the three months ended March 31, 2006,
these exposures were primarily concentrated in the Canadian dollar, South
African Rand and Japanese Yen. At March 31, 2006, international assets totaled
approximately $4.2 million and international liabilities totaled approximately
$6.8 million. For the three months ended March 31, 2006, international revenues
totaled $5.0 million and there was an international net loss of $44,000.
14
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 March 31, 2006, the Company's outstanding debt
totaled approximately $2.7 million, which consisted of domestic variable-rate
(8.5% per annum at that date) debt of $2.1 million and international variable
rate (1.4% per annum at that date) debt of $600,000. Based on the three months
ending March 31, 2006, average outstanding borrowings under variable-rate debt,
a one-percentage point per annum increase in interest rates would have
negatively impacted pre-tax earnings and cash flows for the three months ended
March 31, 2006, by approximately $7,000.
15
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 THREE
MONTHS ENDED MARCH 31, 2006 (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) THAT ARE BASED ON THE
COMPANY'S BEST ESTIMATES. IN PARTICULAR AND WITHOUT LIMITATION, THIS
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS" CONTAINS SUCH FORWARD-LOOKING STATEMENTS, WHICH ARE INCLUDED IN
(AMONG OTHER PLACES) THE DISCUSSIONS RESPECTING NET REVENUES FROM SIGNIFICANT
CLIENTS, SIGNIFICANT CHAIN WORK AND INTERNATIONAL JOINT VENTURES, FEDERAL TAXES
AND NET OPERATING LOSS CARRYFORWARDS, COMMENCEMENT OF OPERATIONS AND FUTURE
FUNDING OF INTERNATIONAL JOINT VENTURES, CREDIT FACILITIES AND COVENANT
COMPLIANCE, COST SAVINGS INITIATIVES, LIQUIDITY AND SOURCES OF CASH
AVAILABILITY. 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",
"LIKELY", "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 CONTAINING CAUTIONARY STATEMENTS OR IDENTIFYING
IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
THOSE PROVIDED IN THE FORWARD-LOOKING STATEMENTS.
YOU SHOULD CAREFULLY REVIEW THIS MANAGEMENT DISCUSSION AND ANALYSIS
TOGETHER WITH THE RISK FACTORS AND OTHER CAUTIONARY STATEMENTS CONTAINED IN THE
COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31,
2005, AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 3, 2006 (THE
"COMPANY'S ANNUAL REPORT FOR 2005 ON FORM 10-K"), INCLUDING THE RISK FACTORS
DESCRIBED IN ITEM 1 OF THAT ANNUAL REPORT UNDER THE CAPTION "CERTAIN RISK
FACTORS" AND THE CHANGES (IF ANY) IN SUCH RISK FACTORS DESCRIBED IN ITEM IA OF
PART II OF THIS QUARTERLY REPORT (COLLECTIVELY, "RISK FACTORS"), AS WELL AS 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 AND OTHER CAUTIONARY STATEMENTS IN THIS
QUARTERLY REPORT AND IN THE COMPANY'S ANNUAL REPORT FOR 2005 ON FORM 10-K, WHICH
ARE INCORPORATED BY REFERENCE INTO THIS QUARTERLY REPORT. 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. THE
COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY
FORWARD-LOOKING STATEMENTS, OR ANY RISK FACTORS OR OTHER CAUTIONARY STATEMENTS,
WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE, EXCEPT AS
REQUIRED BY LAW.
OVERVIEW
- --------
In the United States, the Company provides merchandising and marketing
services to manufacturers and retailers principally in mass merchandiser,
electronics, drug store, grocery, and other retail trade classes through its
Domestic Merchandising Services Division. Internationally, the Company provides
similar in-store merchandising and marketing services through a wholly owned
subsidiary in Canada, 51% owned joint venture subsidiaries in Turkey, South
Africa, India and Romania and 50% owned joint ventures in Japan and China. In
September 2005, the Company established a 51% owned joint venture subsidiary in
Lithuania, which began operations in April 2006. In April 2006, the Company also
announced the establishment of a 51% owned joint venture subsidiary in
Australia,
16
SPAR GROUP, INC.
which is projected to begin operations in the second quarter of 2006. For the
three months ended March 31, 2006, the Company consolidated Canada, Turkey,
South Africa, India, Romania, China and Japan into the Company's financial
statements.
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, electronic
store chains, drug store chains and grocery stores. Included in its clients are
home entertainment, general merchandise, health and beauty care, consumer goods
and food product companies in the United States.
Merchandising and marketing 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 or
distributors. 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 or
distributors, and include new store openings and existing store resets,
re-merchandising, remodels and category implementations,, new product launches,
special seasonal or promotional merchandising, focused product support and
product recalls. The Company also provides in-store product demonstrations,
in-store product sampling and other in-store event staffing services, RFID
services, technology services 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 and
marketing services business worldwide. The Company has expanded its
international business as follows:
Percent Ownership in
Date Subsidiary or Joint
Established 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
In April 2006, the Company also announced the establishment of a 51%
owned joint venture subsidiary in Australia, which is projected to begin
operations in the second quarter of 2006.
17
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 in
accordance with Financial Accounting Standards Board Interpretation
Number 46, as revised December 2003, Consolidation of Variable Interest
Entities ("FIN 46(R)").
REVENUE RECOGNITION
The Company's services are provided under contracts or agreements. The
Company bills its clients based upon service fees and per unit fee
arrangements. Revenues under service fee arrangements are recognized
when the service is performed. The Company's per unit fee arrangement
provides for fees to be earned based on the retail sales of client's
products to consumers. The Company recognizes per unit fees in the
period such amounts become determinable and are reported to the Company.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES ALLOWANCES
The Company continually monitors the validity of its accounts receivable
based upon current client 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 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 $548,000 and $616,000
at March 31, 2006, and December 31, 2005, 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, the cost to write program code, payroll and 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 $90,000 and $97,000 of costs related to software
developed for internal use in the three months ended March 31, 2006, and
2005, respectively and amortized capitalized software of approximately
$102,000 and $139,000 in the three months ended March 31, 2006, and
2005, respectively.
18
SPAR GROUP, INC.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2006, COMPARED TO THREE MONTHS ENDED MARCH 31, 2005
- --------------------------------------------------------------------------------
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 March 31,
----------------------------------------------------------------------
Increase
2006 % 2005 % (decrease)%
---------- ------ ---------- ------ -----------
Net revenues $ 15,850 100.0% $ 14,521 100.0% 9.2%
Cost of revenues 9,854 62.2 8,651 59.6 13.9
Selling, general & administrative expense 5,071 32.0 4,256 29.3 19.2
Depreciation and amortization 213 1.3 279 1.9 (23.7)
Interest expense 51 0.3 40 0.3 26.1
Other income 178 1.1 - - -
---------- ------ ---------- ------
Income before income tax provision and
minority interest 839 5.3 1,295 8.9 (35.2)
Provision for income taxes 45 0.3 15 0.1 198.0
---------- ------ ---------- ------
Income before minority interest 794 5.0 1,280 8.8 (38.0)
Minority interest 17 0.1 111 0.8 (84.8)
---------- ------ ---------- ------
Net income $ 777 4.9% $ 1,169 8.0% (33.5)
========== ====== ========== ======
NET REVENUES
Net revenues for the three months ended March 31, 2006, were $15.9
million, compared to $14.5 million for the three months ended March 31, 2005, an
increase of 9.2%. Domestic net revenue for the three months ended March 31,
2006, was $10.9 million (including $770,000 in non-recurring revenues from the
termination of a service agreement), and was consistent with the $10.8 million
for the prior year period. International net revenue for the three months ended
March 31, 2006, increased $1.3 million to $5.0 million from $3.7 million for the
prior year period. The increase in International net revenue of $1.3 million was
due to the inclusion of the calendar year fourth quarter 2005 net revenue
totaling $1.3 million as a result of the change in the year end reporting for
the Japan joint venture. Changes in net revenue from the remaining international
joint ventures were a net increase of approximately $2,000, consisting of an
increase in net revenue in India of approximately $391,000, a decrease of
approximately $563,000 in South Africa due to the loss of a client in 2005, and
all other joint ventures posting an increase of $174,000.
One domestic client accounted for 13% and 16% of the Company's net
revenue for the three months ended March 31, 2006, and 2005, respectively. This
client also accounted for approximately 15% and 1% of accounts receivable at
March 31, 2006, and December 31, 2005, respectively.
A second domestic client accounted for 12% and 17% of the Company's net
revenue for the three months ended March 31, 2006, and 2005, respectively. This
client also accounted for approximately 4% and 10% of accounts receivable at
March 31, 2006, and December 31, 2005, respectively.
Approximately 10% of the Company's net revenue for both the three months
ended March 31, 2006, and 2005, resulted from merchandising services performed
for clients at a leading domestic electronics chain. Services performed for
these clients in that electronics chain also accounted for approximately 7% and
8% of accounts
19
SPAR GROUP, INC.
receivable at March 31, 2006, and December 31, 2005, respectively. The Company's
contractual relationships or agreements are with various clients and not that
retail electronics chain.
Approximately 8% and 10% of the Company's net revenues for the three
months ended March 31, 2006, and 2005, respectively, resulted from merchandising
services performed for domestic clients at a leading mass merchandising chain.
Services performed for these clients in that chain also accounted for
approximately 5% and 8% of accounts receivable at March 31, 2006, and December
31, 2005, respectively. The Company's contractual relationships or agreements
are with various clients and not that retail mass merchandising chain.
The loss of these clients, the loss of the ability to provide
merchandising and marketing services in those chains, or the failure to attract
new large clients could significantly decrease the Company's revenues and such
decreased revenues could have a material adverse effect on the Company's
business, results of operations and financial condition.
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 62.2% for the three months ended
March 31, 2006, compared to 59.6% for the three months ended March 31, 2005. For
the first quarter domestic cost of revenues as a percentage of net revenues was
61.9% and 59.8% for the three months ended March 31, 2006, and 2005,
respectively. The increase is primarily attributable to the mix of business with
higher cost project revenue accounting for a greater portion of revenue in the
three months ended March 31, 2006. Cost of revenues from International
Operations as a percentage of net revenues was 62.7% and 59.0% for the three
months ended March 31, 2006, and 2005, respectively. The international cost of
revenue percentage increase was primarily attributable to an increase in
competitive pricing pressures, particularly within the Canadian operations.
Approximately 59% and 66% of the Company's cost of revenue in the three
months ended March 31, 2006, and 2005, 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 8 - 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 approximately
$815,000, or 19.2%, for the three months ended March 31, 2006, to $5.1 million
compared to $4.3 million for the three months ended March 31, 2005. Domestic
selling, general and administrative expenses, while consistent at $3.2 million,
included litigation costs of approximately $350,000 and $57,000 for the three
months ended March 31, 2006, and 2005 respectively. Internationally, selling,
general and administrative expenses increased by approximately $793,000, or
75.2%, to $1.9 million for the three months ended March 31, 2006, from
approximately $1.1 million for the three months ended March 31, 2005. The
increase of approximately $793,000 was primarily due to the Japan joint venture;
approximately $554,000 resulting from the additional quarter of expense due to
the change in year-end reporting and approximately $232,000 from increased
spending due to a change in the joint ventures' cost structure. All other
International operations contributed a net increase of $7,000.
20
SPAR GROUP, INC.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization charges of approximately $213,000 for the
three months ended March 31, 2006, were consistent with approximately $279,000
for those charges in the same period for 2005.
OTHER INCOME
The Company recorded other income of $175,000 for the three months ended
March 31, 2006, resulting from the favorable settlement of a vendor lawsuit.
INCOME TAXES
The Company recorded an income tax provision of $45,000 for the three
months ended March 31, 2006. The provision was primarily for minimum state
taxes. There was no provision for federal tax for the three months ended March
31, 2006, since the Company expects to utilize net operating loss carry forwards
which are available to offset any federal taxes due.
MINORITY INTEREST
Minority interest of approximately $17,000 and $111,000 resulted from
the operating profits and losses of the 51% owned joint venture subsidiaries and
the 50% owned joint ventures for the three months ended March 31, 2006, and
2005, respectively.
NET INCOME
The Company had net income of $777,000 for the three months ended March
31, 2006, or $0.04 per diluted share, compared to a net income of $1.2 million,
or $0.06 per diluted share, for the corresponding period last year.
LIQUIDITY AND CAPITAL RESOURCES
In the three months ended March 31, 2006, the Company had a net income
of $777,000.
Net cash used by operating activities for the three months ended March
31, 2006, was $184,000 compared to net cash provided by operating activities for
the three months ended March 31, 2005 of $2.5 million. The decrease in net cash
provided in operating activities was a result of increased accounts receivable
and decreases in accrued expenses and customer deposits partially offset by
increases in accrued expenses due to affiliates and accounts payable.
Net cash used in investing activities was approximately $100,000 for the
three months ended March 31, 2006, and 2005.
Net cash used in financing activities for the three months ended March
31, 2006, was approximately $282,000, compared to net cash used in financing
activities of $2.9 million for the three months ended March 31, 2005. The
decrease of net cash used in financing activities was primarily a result of
lower net payments on lines of credit.
The above activity resulted in a decrease in cash and cash equivalents
for the three months ended March 31, 2006, of approximately $602,000.
At March 31, 2006, the Company had positive working capital of $4.2
million, as compared to a positive working capital of $3.1 million at December
31, 2005. 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 1.45 at March 31,
2006, and 1.31 at December 31, 2005.
21
SPAR GROUP, INC.
In January 2003, the Company and Webster Business Credit Corporation,
then known as Whitehall Business Credit Corporation ("Webster"), entered into
the Third Amended and Restated Revolving Credit and Security Agreement (as
amended, collectively, the "Credit Facility").
In January 2006, the Credit Facility was amended to extend its maturity
to January 2009 and to reset the Minimum Fixed Charge Coverage Ratio, and
Minimum Net Worth covenants. It further stipulated that should the Company meet
its covenants for the year ended December 31, 2005, which it has, Webster would
release Mr. Robert Brown and Mr. William Bartels from their obligation to
provide personal guarantees totaling $1.0 million and certain discretionary
reserves. The Credit Facility also limits certain expenditures, including, but
not limited to, capital expenditures and other investments.
The basic interest rate under the Credit Facility is Webster's
"Alternative Base Rate" plus 0.75% per annum (a total of 8.5% per annum at March
31, 2006), which automatically changes with each change made by Webster in such
Alternate Base Rate. The Company at its option, subject to certain conditions,
may elect to have portions of its loans under the Credit Facility bear interest
at various LIBOR rates plus 3.25% per annum based on fixed periods of one, two,
three or six months. The actual average interest rate under the Credit Facility
was 8.2% per annum for the quarter ending March 31, 2006. The Credit Facility is
secured by all of the assets of the Company and its domestic subsidiaries.
The Company was not in violation of any covenants at March 31, 2006, and
does not expect to be in violation at future measurement dates. However, there
can be no assurances that the Company will not be in violation of certain
covenants in the future. Should the Company be in violation, there are no
assurances that Webster will issue such waivers in the future.
Because of the requirement to maintain a lock box arrangement with
Webster and Webster's ability to invoke a subjective acceleration clause at its
discretion, borrowings under the Credit Facility are classified as current at
March 31, 2006, and December 31, 2005, in accordance with EITF 95-22, Balance
Sheet Classification of Borrowings Outstanding Under Revolving Credit Agreements
That Include Both a Subjective Acceleration Clause and a Lock-Box Agreement.
The revolving loan balances outstanding under the Credit Facility were
$2.1 million and $2.4 million at March 31, 2006, and December 31, 2005,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $552,000 at March 31, 2006, and December 31, 2005. As of March
31, 2006, the SPAR Group had unused availability under the Credit Facility of
$1.7 million out of the remaining maximum $4.3 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
$2.6 million (based upon the exchange rate at March 31, 2006). At March 31,
2006, SPAR FM Japan, Inc. had a 70 million Yen or approximately $600,000 loan
balance outstanding under the line of credit (based upon the exchange rate at
that date). The average interest rate at March 31, 2006 and 2005 was 1.4%.
The Company's international business model is to partner with local
merchandising companies and combine the Company's proprietary software and
expertise in the merchandising and marketing services 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,
Romania, China, Lithuania and Australia. In September 2005, the Company also
announced
22
SPAR GROUP, INC.
the establishment of a 51% owned joint venture subsidiary in Lithuania which
will begin operations in April 2006. In April 2006, the Company announced the
establishment of a 51% owned joint venture subsidiary in Australia, which is
projected to begin operations in the second quarter of 2006.
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 reduction in business from such clients, or the
inability to acquire new clients, or the Company's inability to remain
profitable, 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 March 31, 2006 (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 $2,687 $2,687 $ - $ - $ -
- --------------------------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,597 858 693 46 -
- --------------------------------------------------------------------------------------------------------------------
Total $4,284 $3,545 $ 693 $ 46 $ -
- --------------------------------------------------------------------------------------------------------------------
The Company also had approximately $552,000 in outstanding Letters of
Credit at March 31, 2006.
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 carries those current assets and liabilities at their stated or face
amounts in its consolidated financial statements, as the Company believes those
amounts approximate the fair value for these items because of the relatively
short period of time between origination of the instrument, asset or liability
and their expected realization or payment. The Company monitors the risks
associated with interest rates and financial instrument, asset and liability
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 March 31, 2006, the Company's outstanding debt
totaled approximately $2.7 million, which consisted of domestic variable-rate
(8.5% per annum at that date) debt of $2.1 million and international variable
rate (1.4% per annum at that date) debt of $600,000. Based on the three months
ending March 31, 2006, average outstanding borrowings under variable-rate debt,
a one-percentage point per annum increase in interest rates would have
negatively impacted pre-tax earnings and cash flows for the three months ended
March 31, 2006, by approximately $7,000.
23
SPAR GROUP, INC.
The Company has foreign currency exposure associated with its
international 100% owned subsidiary, its 51% owned joint venture subsidiaries
and its 50% owned joint ventures. In the three months ended March 31, 2006,
these exposures were primarily concentrated in the Canadian dollar, South
African Rand and Japanese Yen. At March 31, 2006, international assets totaled
approximately $4.2 million and international liabilities totaled approximately
$6.8 million. For the three months ended March 31, 2006, international revenues
totaled $5.0 million and there was an international net loss of $44,000.
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 three
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 for its domestic internal controls
over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of
2002 and has begun to document and test them.
24
SPAR GROUP, INC.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Safeway Inc. ("Safeway") filed a Complaint against PIA
Merchandising Co., Inc. ("PIA Co."), a wholly owned subsidiary of SGRP,
Pivotal Sales Company ("Pivotal"), a wholly owned subsidiary of PIA Co.,
and SGRP in Alameda Superior Court, case no. 2001028498 on October 24,
2001, Safeway subsequently amended their Complaint twice, dropping
various causes of action for breach of trust and breach of fiduciary
duties. Safeway's remaining two claims are for breach of contract and
breach of implied contract. Safeway has most recently alleged monetary
damages in principal and interest of $6,400,000 (an increase of
$1,900,000 from the amount previously claimed) 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 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. Trial commenced in March 2006, and is expected
to conclude in late May or early June 2006. 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 in its claims and PIA Co. and
Pivotal lose on their cross-claims that result could have a material
adverse effect on the Company.
There have been no other new reportable proceedings or material
developments in previously reported proceedings since the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2005,
as filed with the Securities and Exchange Commission on April 3, 2006
(the "Company's Annual Report for 2005 on Form 10-K").
ITEM 1A. RISK FACTORS
The Company's Annual Report for 2005 on Form 10-K describes
various risk factors applicable to the Company and its businesses in
Item 1 under the caption "Certain Risk Factors", which risk factors are
incorporated by reference into this Quarterly Report. There have been no
material changes in the Company's risk factors since the Company's
Annual Report for 2005 on Form 10-K.
ITEM 2: UNREGISTERED SALES OF EQUITY 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.
25
SPAR GROUP, INC.
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS
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.
26
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: May 15, 2006 SPAR Group, Inc., Registrant
By: /s/ Charles Cimitile
-----------------------------------
Charles Cimitile
Chief Financial Officer, Treasurer,
Secretary and duly authorized signatory
27