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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, 2004
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934 for the transition period from ____________ to
_____________
Commission file number: 0-27824
SPAR Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware 33-0684451
State of Incorporation IRS Employer Identification No.
580 White Plains Road, Tarrytown, New York, 10591
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (914) 332-4100
Indicate by check whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: [ X ] Yes [ ] No
Indicate by check whether the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Exchange Act): [ ] Yes [ X ] No
On March 31, 2004, there were 18,858,972 shares of Common Stock outstanding.
SPAR Group, Inc.
Index
PART I: FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets
as of March 31, 2004 and December 31, 2003.......................................3
Consolidated Statements of Operations for the three
months ended March 31, 2004 and 2003.............................................4
Consolidated Statements of Cash Flows for the
three months ended March 31, 2004 and 2003.......................................5
Notes to Consolidated Financial Statements.......................................6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................13
Item 3: Quantitative and Qualitative Disclosures About Market Risk......................21
Item 4: Controls and Procedures.........................................................21
PART II: OTHER INFORMATION
Item 1: Legal Proceedings...............................................................23
Item 2: Changes in Securities and Use of Proceeds.......................................23
Item 3: Defaults upon Senior Securities.................................................23
Item 4: Submission of Matters to a Vote of Security Holders.............................23
Item 5: Other Information...............................................................23
Item 6: Exhibits and Reports on Form 8-K................................................24
SIGNATURES............................................................................................25
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,
2004 2003
-------- --------
(Unaudited) (Note)
Assets
Current assets:
Cash and cash equivalents $ - $ -
Accounts receivable, net 11,401 13,942
Prepaid expenses and other current assets 964 415
Deferred income taxes 1,873 1,305
-------- --------
Total current assets 14,238 15,662
Property and equipment, net 2,038 2,099
Goodwill 9,201 8,749
Deferred income taxes 434 434
Other assets 630 926
-------- --------
Total assets $ 26,541 $ 27,870
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 2,596 $ 1,445
Accrued expenses and other current liabilities 2,220 4,367
Accrued expenses, due to affiliates 1,576 996
Restructuring charges, current 685 685
Line of credit, short-term 3,889 4,084
-------- --------
Total current liabilities 10,966 11,577
Other long-term liabilities 275 270
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value:
Authorized shares - 3,000,000
Issued and outstanding shares - none - -
Common stock, $.01 par value:
Authorized shares - 47,000,000
Issued and outstanding shares -
18,858,972 - March 31, 2004 and
December 31, 2003 189 189
Treasury stock (242) (384)
Accumulated other comprehensive loss (8) (7)
Additional paid-in capital 11,175 11,249
Retained earnings 4,186 4,976
-------- --------
Total stockholders' equity 15,300 16,023
-------- --------
Total liabilities and stockholders' equity $ 26,541 $ 27,870
======== ========
Note: The Balance Sheet at December 31, 2003, has been derived from the
audited financial statements at that date but does not include any of
the information and footnotes required by accounting principles
generally accepted in the United States for complete financial
statements.
See accompanying notes.
3
SPAR Group, Inc.
Consolidated Statements of Operations
(unaudited)
(In thousands, except per share data)
Three Months Ended
--------------------
March 31, March 31,
2004 2003
-------- --------
Net revenues $ 12,803 $ 18,739
Cost of revenues 8,694 11,251
-------- --------
Gross profit 4,109 7,488
Selling, general and administrative expenses 4,967 4,943
Depreciation and amortization 362 378
-------- --------
Operating (loss) income (1,220) 2,167
Interest expense 34 68
Other expense 1 38
-------- --------
(Loss) income before income taxes (1,255) 2,061
(Benefit) provision for income taxes (465) 783
-------- --------
Net (loss) income $ (790) $ 1,278
======== ========
Basic/diluted net (loss) income per common share:
Net (loss) income - basic/diluted $ (0.04) $ 0.07
======== ========
Weighted average common shares - basic 18,859 18,841
======== ========
Weighted average common shares - diluted 18,859 19,443
======== ========
See accompanying notes.
4
SPAR Group, Inc.
Consolidated Statements of Cash Flows
(unaudited) (In thousands)
Three Months Ended
------------------
March 31, March 31,
2004 2003
------- -------
Operating activities
Net (loss) income $ (790) $ 1,278
Adjustments to reconcile net (loss) income to net cash provided
by operating activities:
Depreciation 362 378
Share of loss in joint venture 1 38
Changes in operating assets and liabilities:
Accounts receivable 2,541 (1,590)
Prepaid expenses, other assets and deferred taxes (821) (418)
Accounts payable, accrued expenses and other current
liabilities (996) 1,175
Accrued expenses due to affiliates 580 -
Restructuring charges - (816)
Other long-term liabilities 5 -
------- -------
Net cash provided by operating activities 882 45
Investing activities
Purchases of property and equipment (301) (421)
Acquisition of businesses (453) (38)
------- -------
Net cash used in investing activities (754) (459)
Financing activities
Net (payments) borrowings on line of credit (195) 3,469
Proceeds from employee stock purchase plan and exercised options 68 23
Payments to certain stockholders - (3,000)
Purchase of treasury stock - (78)
Translation (loss) (1) -
------- -------
Net cash (used in) provided by financing activities (128) 414
Net change in cash - -
Cash at beginning of period - -
------- -------
Cash at end of period $ - $ -
======= =======
Supplemental disclosure of cash flow information
Interest paid $ 35 $ 56
See accompanying notes.
5
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited)
1. Basis of Presentation
The accompanying unaudited, consolidated financial statements of SPAR
Group, Inc., a Delaware corporation ("SGRP"), and its subsidiaries (together
with SGRP, collectively, the "Company" or the "SPAR Group") have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included in these interim financial
statements. However, these interim financial statements should be read in
conjunction with the annual consolidated financial statements and notes thereto
for the Company as contained in Company's Annual Report for 2003 on Form 10-K
for the year ended December 31, 2003, as filed with the Securities Exchange
Commission on March 30, 2004 (the "Company's Annual Report for 2003 on Form
10-K"). The Company's results of operations for the interim periods are not
necessarily indicative of its operating results for the entire year.
2. Restructuring Charges
In 1999, the Company's Board of Directors approved a plan to
restructure the operations of the PIA Companies. Restructuring costs were
composed of committed costs required to integrate the SPAR Companies' and the
PIA Companies' field organizations and the consolidation of administrative
functions to achieve beneficial synergies and costs savings. (For the specific
definitions of those terms, see Item 1 - Business - GENERAL - Continuing
Operations - Merchandising Services Division in the Company's Annual Report for
2003 on Form 10-K.)
The restructuring reserve relates to equipment and office lease
settlements and remains unchanged from the December 31, 2003 balance of
$685,000.
6
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
3. Net (Loss) Income Per Share
The following table sets forth the computations of basic and diluted
(loss) income per share (in thousands, except per share data):
Three Months Ended
----------------- ---------------------
March 31, March 31,
2004 2003
----------------- ---------------------
Numerator:
Net (loss) income $ (790) $ 1,278
Denominator:
Shares used in basic (loss) income per
share calculation 18,859 18,841
Effect of diluted securities:
Employee stock options - 602
----------------- ---------------------
Shares used in diluted (loss) income per
share calculation 18,859 19,443
================= =====================
Basic and diluted (loss) income per common share:
Net (loss) income - basic $ (0.04) $ 0.07
- diluted $ (0.04) $ 0.07
The computation of dilutive loss per share excluded anti-dilutive stock
options to purchase 501,000 shares as of March 31, 2004.
4. Line of Credit and Long-Term Liabilities
In January 2003, the Company and Webster Business Credit Corporation,
then known as Whitehall Business Credit Corporation ("Webster"), entered into
the Third Amended and Restated Revolving Credit and Security Agreement (as
amended, collectively, the "Credit Facility"). The Credit Facility provides a
$15.0 million revolving credit facility that matures on January 23, 2006. The
Credit Facility allows the Company to borrow up to $15.0 million based upon a
borrowing base formula as defined in the agreement (principally 85% of
"eligible" accounts receivable). The Credit Facility bears interest at Webster's
"Alternative Base Rate" plus one-half percent (a total of 4.5% per annum at
March 31, 2004), or LIBOR plus three percent, and is secured by all the assets
of the Company and its subsidiaries.
7
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
The Credit Facility contains certain financial covenants that must be
met by the Company on a consolidated basis, among which are a minimum "Net
Worth", a minimum "Fixed Charge Coverage Ratio", a capital expenditure
limitation and a minimum EBITDA, as such terms are defined in the Credit
Facility. The Company was in compliance with such financial covenants at March
31, 2004, except for the minimum "Fixed Charge Coverage Ratio" and minimum
EBITDA. On May 17, 2004, the Company secured a waiver from Webster for these
covenant violations. As consideration for the waiver, among other things, the
Company has agreed to reduce the revolving credit facility to $10.0 million from
$15.0 million.
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, 2004, and December 31, 2003, in accordance with EITF 95-22.
The revolving loan balances outstanding under the Credit Facility were
$3.9 million and $4.1 million at March 31, 2004, and December 31, 2003,
respectively. There were letters of credit outstanding under the Credit Facility
of $0.7 million at March 31, 2004 and December 31, 2003. As of March 31, 2004,
the SPAR Group had unused availability under the Credit Facility of $1.1 million
out of the remaining maximum $11.1 million unused revolving line of credit after
reducing the borrowing base by the outstanding loans and letters of credit.
5. Related-Party Transactions
Mr. Robert G. Brown, a Director, the Chairman, President and Chief
Executive Officer and a major stockholder of the Company, and Mr. William H.
Bartels, a Director, the Vice Chairman and a major stockholder of the Company
(collectively, the "SMS Principals"), are executive officers and the sole
stockholders and directors of SPAR Marketing Services, Inc. ("SMS"), SPAR
Management Services, Inc. ("SMSI"), and SPAR Infotech, Inc. ("SIT").
As consideration for Webster's waiver as of March 31, 2004 (See Note 4
- - Line of Credit and Long-Term Liabilities), the SMS Principals have provided
personal guarantees to Webster that the Company's obligations will be paid in
accordance with the terms of the Credit Facility. However, the guarantees from
the SMS Principals are limited to a maximum of $1.0 million, with Mr. Brown
limited to $600,000 and Mr. Bartels limited to $400,000. These guarantees will
remain in effect until the Company has achieved certain financial criteria.
For the 3-month period ended March 31, 2004, SMS provided approximately
92% of the Company's field representatives (through its independent contractor
field force), and SMSI provided approximately 95% of the Company's field
management. Pursuant to the Amended and Restated Field Service Agreement dated
as of January 1, 2004 (the "Field Service Agreement"), SMS provides the services
of approximately 6,000 field representatives to the Company at its request from
time to time, for which the Company has agreed to reimburse SMS for all of its
costs of providing those services and to pay SMS a premium equal to 4% of such
costs. Pursuant to the terms of the Amended and Restated Field Management
Agreement dated as of January 1, 2004 (the "Field Management Agreement"), SMSI
provides approximately 70 full-time national, regional and district managers to
the Company at its request, from time to time, for which the Company has agreed
to reimburse SMSI for all of its costs of providing those services and to pay
SMSI a premium equal to 4% of such costs, except that for 2004 SMSI agreed (as
an accommodation to the Company) to not be paid for certain administrative costs
(which concession saved the Company approximately $145,000 for the 3-month
period ended March 31, 2004). The SMS Principals were not paid any salaries as
officers of SMS or SMSI for the 3-month period ended March 31, 2004, so there
were no salary reimbursements for them included in such costs or
8
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
premium. However, since SMS and SMSI are "Subchapter S" corporations, the SMS
Principals benefit from any income of such companies allocated to them.
SIT provided substantially all of the Internet computer programming
services to the Company for the 3-month period ended March 31, 2004. Pursuant to
the Amended and Restated Programming and Support Agreement dated as of January
1, 2004 (the "Programming and Support Agreement"), SIT continues to provide
programming services to the Company at its request, from time to time, for which
the Company has agreed to pay SIT competitive hourly wage rates for time spent
on Company matters and to reimburse the related out-of-pocket expenses of SIT
and its personnel. No hourly charges or business expenses for the SMS Principals
were charged to the Company for the 3-month period ended March 31, 2004.
However, since SIT is a "Subchapter S" corporation, the SMS Principals benefit
from any income of such company allocated to them.
Through arrangements with the Company, SMS, SMSI and SIT participate in
various benefit plans, insurance policies and similar group purchases by the
Company, for which the Company charges them their allocable shares of the costs
of those group items and the actual costs of all items paid specifically for
them.
The following transactions occurred between the SPAR Companies and the
above affiliates (in thousands):
Three Months Ended
------------------
March 31, March 31,
2004 2003
------------------
Services provided by affiliates:
SMS: Independent contractor field services $6,361 $7,697
====== ======
SMSI: Field management services $1,354 $1,759
====== ======
SIT: Internet and computer programming services $ 381 $ 406
====== ======
Reimbursed costs from affiliates $ 263 $ 97
====== ======
Accrued expenses due to affiliates (in thousands):
March 31,
2004 2003
------------------
SMS $1,576 $2,030
====== ======
9
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
6. Stock Options
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting
for Stock Based Compensation, requires disclosure of the fair value method of
accounting for stock options and other equity instruments. Under the fair value
method, compensation cost is measured at the grant date based on the fair value
of the award and is recognized over the service period, which is usually the
vesting period. The Company has chosen, under the provisions of SFAS No. 123, to
continue to account for employee stock-based transactions under Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.
Under the disclosure-only provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS 148, no compensation cost has been
recognized for the stock option grants to Company employees. Compensation cost
for the Company's option grants to Company employees has been determined based
on the fair value at the grant date consistent with the provisions of SFAS No.
123, the Company's net (loss) income and pro forma net (loss) income per share
from operations would have been reduced to the adjusted amounts indicated below
(in thousands, except per share data):
Three Months Ended
-------------------
March 31, March 31,
2004 2003
------ ------
Net (loss) income, as reported $ (790) $1,278
Stock based employee compensation expense
under the fair market value method 156 315
------ ------
Adjusted pro forma net (loss) income $ (946) $ 963
Basic and diluted net (loss) income per share, as reported $(0.04) $ 0.07
Basic and diluted adjusted pro forma net (loss) income $(0.05) $ 0.05
per share, after adjustment for stock based
employee compensation expense under the fair market
value method
The pro forma effect on net (loss) income is not representative of the
pro forma effect on net (loss) income in future years because the options vest
over several years and additional awards may be made in the future.
10
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
For the three months ended March 31, 2004, there was no expense under
the provision of SFAS No. 123 dealing with stock options to non-employees for
stock option grants that were awarded to the employees of the Company's
affiliates resulting from the decrease in the market price from December 31,
2003 to March 31, 2004. The Company determines the fair value of the options
granted to non-employees using the Black-Scholes valuation model and expenses
that value over the service period. Until an option is vested, the fair value of
the option continues to be updated through the vesting date. The options granted
have a ten (10) year life and vest over four-year periods at a rate of 25% per
year, beginning on the first anniversary of the date of grant.
7. Treasury Stock
As of March 31, 2004, the Company has 48,806 shares of treasury stock
at a cost of $242,504. During the three months ended March 31, 2004, the Company
utilized 27,250 shares of treasury stock for the issuance of common stock
resulting from the exercise of stock options. During the three months ended
March 31, 2003, the Company repurchased 22,899 shares of its common stock for
$78,327. Currently, the Company has no stock repurchase program in place.
8. Line of Credit and Advances due from SPAR Performance Group, Inc. (now
called STIMULYS, Inc.); Inability to Consolidate under FIN 46
In connection with the sale of SPAR Performance Group, Inc. ("SPGI"),
on June 30, 2002, the Company sold all of the stock of its subsidiary, SPGI. In
connection with the sale, SPGI entered into a term loan agreement with the
Company under which SPGI borrowed $6.0 million in term loans, which due to their
speculative nature have been fully reserved.
In connection with such sale, the Company also agreed to provide a
discretionary revolving line of credit to SPGI not to exceed $2.0 million
through September 30, 2005 (the "SPGI Revolver"). The SPGI Revolver is secured
by a pledge of all the assets of SPGI and is guarantied by its parent,
Performance Holdings, Inc. Under the SPGI Revolver terms, SPGI is required to
deposit all of its cash into the Company's lock box with Webster. The SPGI
Revolver provided for advances in excess of the borrowing base through September
30, 2003. As of October 1, 2003, the SPGI Revolver includes a borrowing base
calculation (principally 85% of "eligible" accounts receivable). In September
2003, SPGI requested and the Company agreed to provide advances of up to $1.0
million in excess of SPGI's borrowing base through September 30, 2004. In
December of 2003, SPAR Performance Group, Inc. changed its name to STIMULYS,
Inc.
At March 31, 2004, there was approximately $1.2 million advanced under
the SPGI Revolver and $70,000 in outstanding letters of credit, while the
borrowing base was approximately $0.4 million. Due to the speculative nature of
the SPGI Revolver, the Company has a reserve of approximately $800,000 against
the SPGI Revolver at March 31, 2004. The amount due under the SPGI Revolver, net
of the reserve, is included in other current assets.
11
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
In accordance with FASB Interpretation No. 46 - Consolidation of
Variable Interest Entities (FIN 46), as a result of the term loans and revolving
advances, the Company has concluded that it is the primary beneficiary of SPGI
and is, therefore, required to consolidate SPGI in its financial statements.
However, the Company has been unable to perform certain accounting procedures
necessary to include SPGI in the consolidated financial statements, as required
by FIN 46, and has been unable to obtain the necessary permission from SPGI to
include that organization in the Company's consolidated financial statements. At
March 31, 2004, the Company's maximum loss exposure is $470,000, which
represents the amounts outstanding under the revolving line of credit in excess
of the $800,000 reserve. The Company's maximum potential loss exposure resulting
from the revolving line of credit agreement with SPGI is limited to $1.2
million, which is the $2.0 million revolving line of credit less the $800,000
reserve.
12
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, 2004 (this "Quarterly Report"), of SPAR Group, Inc.
("SGRP", and together with its subsidiaries, the "SPAR Group" or the "Company"),
include "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act, including, in particular and
without limitation, the statements contained in the discussions under the
heading "Management's Discussion and Analysis of Financial Condition and Results
of Operations". Forward-looking statements involve known and unknown risks,
uncertainties and other factors that could cause the Company's actual results,
performance and achievements, whether expressed or implied by such
forward-looking statements, to not occur or be realized or to be less than
expected. Such forward-looking statements generally are based upon the Company's
best estimates of future results, performance or achievement, current conditions
and the most recent results of operations. Forward-looking statements may be
identified by the use of forward-looking terminology such as "may", "will",
"expect", "intend", "believe", "estimate", "anticipate", "continue" or similar
terms, variations of those terms or the negative of those terms. You should
carefully consider such risks, uncertainties and other information, disclosures
and discussions which contain cautionary statements identifying important
factors that could cause actual results to differ materially from those provided
in the forward-looking statements.
Although the Company believes that its plans, intentions and
expectations reflected in or suggested by such forward-looking statements are
reasonable, it cannot assure that such plans, intentions or expectations will be
achieved in whole or in part. You should carefully review the risk factors
described and any other cautionary statements contained in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2003, as filed with
the Securities and Exchange Commission on March 30, 2004 (the "Company's Annual
Report for 2003 on Form 10-K"), and the cautionary statements contained in this
Quarterly Report. All forward-looking statements attributable to the Company or
persons acting on its behalf are expressly qualified by the risk factors (see
Item 1 - Certain Risk Factors) and other cautionary statements in the Company's
Annual Report for 2003 on Form 10-K and in this Quarterly Report. The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
Overview
The Company's operations are divided into two divisions: the
Merchandising Services Division and the International Division. The
Merchandising Services Division provides merchandising services, product
demonstrations, product sampling, database marketing, teleservices and marketing
research to manufacturers and retailers with product distribution primarily in
mass merchandisers, drug chains and grocery stores in the United States. The
International Division, established in July 2000, currently provides
merchandising services in Japan, Canada, Turkey and India.
13
SPAR Group, Inc.
Merchandising Services Division
The Company provides nationwide merchandising and other marketing
services to general merchandise, health and beauty care, consumer goods, home
entertainment, PC software and food products companies in drug chains, mass
merchandisers and retail grocery stores in the United States. Merchandising
services primarily consist of regularly scheduled dedicated routed services and
special projects provided at the store level for a specific retailer or multiple
manufacturers primarily under single or multi-year contracts or agreements.
Services also include stand-alone, large-scale implementations such as new store
openings, new product launches, special seasonal or promotional merchandising,
focused product support and product recalls. These services may include sales
enhancing activities such as ensuring that client products authorized for
distribution are in stock and on the shelf, adding new products that are
approved for distribution but not presently on the shelf, setting category
shelves in accordance with approved store schematics, ensuring that shelf tags
are in place, checking for the overall salability of client products and setting
new and promotional items, placing and/or removing point of purchase and other
related media advertising. Specific in-store services can be initiated by
retailers or manufacturers, and include new store openings, new product
launches, special seasonal or promotional merchandising, focused product support
and product recalls. In 2003, the Company added in-store product demonstration
and in-store product sampling services to its merchandising service offerings.
Marketing services consist of database marketing, teleservices and marketing
research.
International Division
In July 2000, the Company established its International Division,
through a wholly owned subsidiary, SPAR Group International, Inc. ("SGI"), to
focus on expanding its merchandising services business worldwide. In May 2001,
the Company entered into a 50% owned joint venture with a large Japanese
distributor to provide merchandising services in Japan. In June 2003, the
Company expanded its merchandising services into Canada through a wholly owned
subsidiary. In July 2003, the Company established a 51% owned joint venture
based in Istanbul to provide merchandising services throughout Turkey.
In April 2004, the Company announced the establishment of a joint
venture in India. The joint venture is headquartered in New Delhi and is owned
51% by the Company.
Critical Accounting Policies
The Company's critical accounting policies have been consistently
applied in all material respects and address such matters as revenue
recognition, depreciation methods, asset impairment recognition, business
combination accounting, and discontinued business accounting. While the
estimates and judgments associated with the application of these policies may be
affected by different assumptions or conditions, the Company believes the
estimates and judgments associated with the reported amounts are appropriate in
the circumstances. Three critical accounting policies are revenue recognition,
allowance for doubtful accounts and sales allowance, and internal use software
development costs.
14
SPAR Group, Inc.
Revenue Recognition
The Company's services are provided under contracts or agreements that
consist primarily of service fees and per unit fee arrangements. Revenues under
service fee arrangements are recognized when the service is performed. The
Company's per unit contracts or agreements provide for fees to be earned based
on the retail sales of client's products to consumers. The Company recognizes
per unit fees in the period such amounts become determinable and are reported to
the Company.
Allowance for Doubtful Accounts and Sales Allowance
The Company continually monitors the collectability of its accounts
receivable based upon current customer credit information and other information
available. Utilizing this information, the Company has established an allowance
for doubtful accounts of $531,000 and $515,000 at March 31, 2004 and December
31, 2003, respectively. The Company also recorded a sales allowance of $788,000
and $448,000 at March 31, 2004 and December 31, 2003, respectively, to reflect
potential customer credits.
Internal Use Software Development Costs
Under the rules of SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, the Company capitalizes certain
costs incurred in connection with developing or obtaining internal use software.
Capitalized software development costs are amortized over three years.
The Company capitalized $184,651 and $212,896 of costs related to
software developed for internal use in the three months ended March 31, 2004 and
2003, respectively.
15
SPAR Group, Inc.
Results of Operations
Three months ended March 31, 2004 compared to three months ended March 31, 2003
The following table sets forth selected financial data and data as a
percentage of net revenues for the periods indicated (in thousands except
percent data).
Three Months Ended
-----------------------------------------------------------------
March 31, 2004 March 31, 2003
---------------------- ---------------------
(Decrease)
Amount % Amount % Increase %
-------- ----- -------- ----- ----------
Net revenues $ 12,803 100.0% $ 18,739 100.0% (31.7)%
Cost of revenues 8,694 67.9% 11,251 60.0% (22.7)%
Selling, general and administrative expense 4,967 38.8% 4,943 26.4% 0.5%
Depreciation and amortization 362 2.8% 378 2.0% (4.2)%
Interest expense 34 0.3% 68 0.4% (50.0)%
Other expense 1 0.0% 38 0.2% (97.3)%
-------- ----- -------- -----
(Loss) income before income taxes (1,255) (9.8)% 2,061 11.0% (160.9)%
(Benefit) provision for income taxes (465) (3.6)% 783 4.2% (159.4)%
-------- ----- -------- -----
Net (loss) income $ (790) (6.2)% $ 1,278 6.8% (161.8)%
======== ===== ======== =====
Net revenues for the three months ended March 31, 2004, were $12.8
million, compared to $18.7 million for the three months ended March 31, 2003, a
decrease of 31.7%. The decrease in net revenues resulted primarily from
decreased project revenue from a particular client, reduced business from the
Company's second largest customer for whom the Company will no longer provide
service subsequent to March 31, 2004 and reduced per unit fee revenue primarily
resulting from the loss of a certain customer.
16
SPAR Group, Inc.
One customer, a division of a major retailer, accounted for 44% and 28%
of the Company's net revenues for the three months ended March 31, 2004 and
2003, respectively. This customer also accounted for approximately 47% and 42%
of accounts receivable at March 31, 2004 and 2003, respectively. In April of
2004, the customer's parent company announced that they have signed definitive
agreements for the sale of this business. There can be no assurances that the
purchasers will continue to use the services of the Company. The loss of this
business could have a material adverse effect on the Company's business, results
of operations and financial condition.
For the three months ended March 31, 2003, a second customer accounted
for 14% of net revenue as a result of a particular project. This project did not
recur in 2004 and, as a result, this customer's net revenues were less than 10%
of total net revenues for the three months ended March 31, 2004. A third
customer accounted for 11% of the Company's net revenue for the three months
ended March 31, 2003. This customer's net revenues were significantly reduced
and fell before 10% of total net revenues for the three months ended March 31,
2004. Subsequent to March 31, 2004, the Company will no longer provide service
to this customer.
In addition, approximately 15% and 16% of the Company's net revenues
for the three months ended March 31, 2004 and 2003, respectively, resulted from
merchandising services performed for manufacturers at Kmart retail stores. Kmart
filed for protection under the U.S. Bankruptcy Code in January of 2002 and
emerged from bankruptcy in May of 2003. During its time in bankruptcy, Kmart
closed a number of stores in the United States. While the Company's customers
and the resultant contractual relationships are with various manufacturers and
not Kmart, a significant reduction of this retailer's stores or cessation of
this retailer's business would negatively impact the Company. As of August 31,
2003, one customer discontinued its merchandising programs with the Company.
Some, but not all, of these programs were performed at Kmart stores. This
customer accounted for 15% of the business generated from Kmart for the three
months ended March 31, 2003.
Failure to attract new large customers could significantly impede the
growth of the Company's revenues, which could have a material adverse effect on
the Company's future business, results of operations and financial condition.
Cost of revenues from operations consists of in-store labor and field
management wages, related benefits, travel and other direct labor-related
expenses. Cost of revenues as a percentage of net revenues was 67.9% for the
three months ended March 31, 2004, compared to 60.0% for the three months ended
March 31, 2003. The increase is primarily a result of certain fixed field costs
that did not decrease with the lower volume as well as higher cost programs.
Approximately 89% and 84% of cost of revenues were purchased from the
Company's affiliate, SMS, in the three months ended March 31, 2004 and 2003,
respectively, and substantially all of the field management services were
purchased from the Company's affiliate, SMSI, during those periods (See note 5
to the Financial Statements in this Quarterly Report).
17
SPAR Group, Inc.
Operating expenses include selling, general and administrative expenses
as well as depreciation and amortization. Selling, general and administrative
expenses include corporate overhead, project management, information technology,
executive compensation, human resource expenses, legal and accounting expenses.
The following table sets forth the operating expenses as a percentage of net
revenues for the time periods indicated (in millions except percent data):
Three Months Ended
---------------------------------------------------------
Increase
March 31, 2004 March 31, 2003 (Decrease)
---------------- ---------------- --------------
Amount % Amount % %
------ ---- ------ ---- --------------
Selling, general and administrative $ 4.9 38.8% $ 4.9 26.4% 0.5%
Depreciation and amortization $ 0.4 2.8% $ 0.4 2.0% (4.2)%
Selling, general and administrative expenses were $4.9 million for the
three months ended March 31, 2004 and 2003, respectively. For the three months
ended March 31, 2004, the Company reduced selling, general and administrative
costs by $450,000 versus the same period in 2003. These savings were offset by
the selling, general and administrative costs associated with acquisitions
during 2003. As a result, selling, general and administrative costs for the
three months ending March 31, 2004 were consistent with the prior period.
Other Expense
Other expense represents the Company's share in the Japanese joint
venture loss totaling approximately $1,000 and $38,000 for the three months
ended March 31, 2004 and 2003, respectively.
Income Taxes
The income tax (benefit) provision represents a combined federal and
state income tax rate of 37% and 38% for the three months ended March 31, 2004
and 2003, respectively.
Net Income
The Company had a net loss of $0.8 million for the three months ended
March 31, 2004, or $0.04 per diluted share, compared to net income of $1.3
million, or $0.07 per diluted share, for the corresponding period last year.
Liquidity and Capital Resources
In the three months ended March 31, 2004, the Company had a net loss of
$0.8 million. Net cash provided by operating activities for the three months
ended March 31, 2004, was $0.9 million, compared with net cash provided by
operations of $45,000 for the three months ended March 31, 2003. The cash
provided by operating activities in 2004 was primarily a result of decreases in
accounts
18
SPAR Group, Inc.
receivable and increases in accrued expenses due to affiliates significantly
offset by net operating losses, increases in prepaid expenses, other assets and
deferred taxes and decreases in accounts payable, accrued expenses and other
current liabilities.
Net cash used in investing activities for the three months ended March
31, 2004, was $0.8 million, compared with net cash used in investing activities
of $0.5 million for the three months ended March 31, 2003. The cash used in
investing activities in 2004 resulted from the acquisition of businesses and
purchases of property and equipment.
Net cash used in financing activities for the three months ended March
31, 2004, was $0.1 million, compared with net cash provided by financing
activities of $0.4 million for the three months ended March 31, 2003. The cash
used in financing activities in 2004 was primarily a result of net payments on
the line of credit.
The above activity resulted in no change in cash and cash equivalents
for the three months ended March 31, 2004, as the Company utilizes excess cash
to pay down its line of credit.
At March 31, 2004, the Company had positive working capital of $3.3
million, as compared to a positive working capital of $4.1 million at December
31, 2003. The decrease in working capital is due primarily to decreases in
accounts receivable, increases in accounts payable and accrued expenses due to
affiliates, partially offset by increases in prepaid expenses and deferred taxes
and decreases in accrued expenses. The Company's current ratio was 1.32 at March
31, 2004, and 1.35 at December 31, 2003.
In January 2003, the Company and Webster Business Credit Corporation,
then known as Whitehall Business Credit Corporation ("Webster"), entered into
the Third Amended and Restated Revolving Credit and Security Agreement (as
amended, collectively, the "Credit Facility"). The Credit Facility provides a
$15.0 million revolving credit facility that matures on January 23, 2006. The
Credit Facility allows the Company to borrow up to $15.0 million based upon a
borrowing base formula as defined in the agreement (principally 85% of
"eligible" accounts receivable). The Credit Facility bears interest at Webster's
"Alternative Base Rate" plus one-half percent (a total of 4.5% per annum at
March 31, 2004), or LIBOR plus three percent, and is secured by all the assets
of the Company and its subsidiaries.
The Credit Facility contains certain financial covenants that must be
met by the Company on a consolidated basis, among which are a minimum "Net
Worth", a minimum "Fixed Charge Coverage Ratio", a capital expenditure
limitation and a minimum EBITDA, as such terms are defined in the Credit
Facility. The Company was in compliance with such financial covenants at March
31, 2004, except for the minimum "Fixed Charge Coverage Ratio" and minimum
EBITDA. On May 17, 2004, the Company secured a waiver from Webster for these
covenant violations. As consideration for the waiver, among other things, the
Company has agreed to reduce the revolving credit facility to $10.0 million from
$15.0 million.
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, 2004 and December 31, 2003, in accordance with EITF 95-22.
The revolving loan balance outstanding under the Credit Facility were
$3.9 million and $4.1 million at March 31, 2004 and December 31, 2003,
respectively. There were letters of credit outstanding under the Credit Facility
of $0.7 million at March 31, 2004 and December 31, 2003. As of March 31, 2004,
the SPAR Group had unused availability under the Credit Facility of
19
SPAR Group, Inc.
$1.1 million out of the remaining maximum $11.1 million unused revolving line of
credit after reducing the borrowing base by outstanding loans and letters of
credit.
Management believes that based upon the Company's current working
capital position and the existing credit facilities, funding 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 return to profitability, could have a
material adverse effect on the Company's cash resources and its ongoing ability
to fund operations.
In connection with the sale of SPGI on June 30, 2002, the Company
agreed to provide a discretionary revolving line of credit to SPGI not to exceed
$2.0 million (the "SPGI Revolver") through September 30, 2005. The SPGI Revolver
is secured by a pledge of all the assets of SPGI and is guarantied by SPGI's
parent, Performance Holdings, Inc. The SPGI Revolver provided for advances in
excess of the borrowing base through September 30, 2003. As of October 1, 2003,
the SPGI Revolver was adjusted, as per the agreement, to include a borrowing
base calculation (principally 85% of "eligible" accounts receivable). In
September 2003, SPGI requested and the Company agreed to provide advances of up
to $1.0 million in excess of the borrowing base through September 30, 2004. At
March 31, 2004, there was approximately $1.2 million borrowed under the SPGI
Revolver and $70,000 in outstanding letters of credit, while the borrowing base
was approximately $0.4 million. Under the SPGI Revolver terms, SPGI is required
to deposit all of its cash to the Company's lock box.
Certain Contractual Obligations
The following table contains a summary of certain of the Company's
contractual obligations by category as of March 31, 2004 (in thousands).
Contractual Obligations Payments due by Period
- --------------------------------------------------------------------------------------------------------------------
Total Less than 1 1-3 years 3-5 years More than 5
year years
- --------------------------------------------------------------------------------------------------------------------
New Credit Facility $3,889 $3,889 $ - $ - $ -
- --------------------------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,955 858 1,009 88 0
- --------------------------------------------------------------------------------------------------------------------
Total $5,844 $4,747 $1,009 $ 88 $ 0
- --------------------------------------------------------------------------------------------------------------------
In addition to the above table, the Company had agreed to provide a
discretionary line of credit to SPGI not to exceed $2.0 million through
September 30, 2005. Outstanding loans to SPGI under the discretionary line of
credit totaled $1.2 million at March 31, 2004. The Company also had $737,337 in
outstanding Letters of Credit at March 31, 2004.
In May 2001, the Company and Paltac, Inc. ("Paltac"), a large Japanese
distributor, entered into a joint venture to create a Japanese company, SPAR FM.
SPAR FM entered into a 300 million Yen Revolving Credit Agreement with a
Japanese bank. The bank required Paltac guarantee the outstanding balance on the
revolving credit facility. As part of the joint venture agreement, should Paltac
be required
20
SPAR Group, Inc.
to make a payment on its guarantee to the bank, then the Company has
agreed to remit to Paltac 50% of any such payment up to a maximum of 150 million
Yen or approximately $1.4 million. As of March 31, 2004, SPAR FM has borrowed
100 million Yen under its Revolving Credit Agreement. Therefore, the Company's
current exposure to Paltac respecting outstanding loans to SPAR FM at March 31,
2004 would be 50 million Yen or approximately $0.5 million.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risk related to the variable interest
rate on the line of credit and the variable yield on its cash and cash
equivalents. The Company's accounting policies for financial instruments and
disclosures relating to financial instruments require that the Company's
consolidated balance sheets include the following financial instruments: cash
and cash equivalents, accounts receivable, accounts payable and long term debt.
The Company considers carrying amounts of current assets and liabilities in the
consolidated financial statements to approximate their fair value because of the
relatively short period of time between their origination and their expected
realization. The Company monitors the risks associated with interest rates. The
Company's investment policy objectives require the preservation and safety of
the principal, and the maximization of the return on investment based upon the
safety and liquidity objectives.
Currently, the Company's international operations are not material and,
therefore, the risk related to foreign currency exchange rates is not material.
The Company has no derivative financial instruments or derivative
commodity instruments in its cash and cash equivalents and investments. Excess
cash is normally used to pay down its revolving line of credit.
Item 4. Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer
evaluated the effectiveness of the Company's disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) as of the end of the period
covering this report. Based on this evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures are effective to provide reasonable assurance that information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified by the Securities and Exchange Commission's rules and
forms. There were no material changes in the Company's internal control over
financial reporting during the first quarter of 2004.
21
SPAR Group, Inc.
CODES OF ETHICS
The Company has adopted codes of ethics that apply to its Directors,
Officers and Employees. They are contained in the SPAR Group Code of Ethical
Conduct for its Directors, Senior Executives and Employees Dated (as of) May 1,
2004 (the "Ethics Code"), and the SPAR Group Statement of Policy Regarding
Personal Securities Transactions in SGRP Stock Amended Non-Public Information
Dated, Amended and Restated as of May 1, 2004 (the "Securities Policy"). The
Company has filed copies of the Ethics Code and Securities Policy as Exhibits to
its Periodic Report on Form 8-K, dated May 1, 2004, filed with the U.S.
Securities and Exchange Commission on May 5, 2004.
22
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 2(d): Not applicable
Item 3: Defaults upon Senior Securities
Item 3(a): Defaults under Indebtedness: None.
Item 3(b): Defaults under Preferred Stock: Not Applicable.
Item 4: Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5: Other Information
In February 2004, the Company's Audit Committee approved the
Field Service Agreement, Field Management Agreement and
Programming and Support Agreement effective as of January 1,
2004, which amended, restated and completely replaced the
predecessor agreements pursuant to which SMS, SMSI and SIT had
previously provided their respective services to the Company. The
Company has filed copies of the Field Service Agreement, Field
Management Agreement and Programming and Support Agreement as
Exhibits 10.1, 10.2 and 10.3, respectively, to this quarterly
report on Form 10-Q for the fiscal quarter ending March 31, 2004.
These restated agreements extended the previous contract
maturities for four years, strengthened various contractual
provisions and continued the basic economic terms of the previous
agreements, except that the restated Field Management Agreement
provides for a temporary reduction in SMSI's fees for 2004 by
excluding certain administrative costs as described above. The
Company's agreements and other arrangements with SMS, SMSI and
SIT are periodically reviewed by the Company's Audit Committee,
which review includes an examination of the overall fairness of
the arrangements and the resulting income (if any) to the SMS
Principals.
23
SPAR Group, Inc.
Item 6: Exhibits And Reports On Form 8-K.
Exhibits.
10.1 Amended and Restated Field Service Agreement dated and
effective as of January 1, 2004, by and between SPAR Marketing
Services, Inc., SPAR Marketing Force, Inc., as filed herewith.
10.2 Amended and Restated Field Management Agreement dated and
effective as of January 1, 2004, by and between SPAR
Management Services, Inc., and SPAR Marketing Force, Inc., as
filed herewith.
10.3 Amended and Restated Programming and Support Agreement dated
and effective as of January 1, 2004, by and between SPAR
InfoTech, Inc., and SPAR Marketing Force, Inc., 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.
Reports On Form 8-K.
1. Periodic Report on Form 8-K, dated March 26, 2004 filed with
the U.S. Securities and Exchange Commission on March 26, 2004,
respecting the earnings press release for 2003.
2. Periodic Report on Form 8-K, dated May 1, 2004, filed with the
U.S. Securities and Exchange Commission on May 5, 2004,
respecting the adoption and filing of the SPAR Group Code of
Ethical Conduct for its Directors, Senior Executives and
Employees Dated (as of) May 1, 2004, and the SPAR Group
Statement of Policy Regarding Personal Securities Transactions
in SGRP Stock and Non-Public Information Dated, Amended and
Restated as of May 1, 2004.
3. Periodic Report on Form 8-K, dated May 14, 2004, filed with
the U.S. Securities and Exchange Commission on May 14, 2004,
respecting the earnings press release for the quarter ended
March 31, 2004.
24
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 18, 2004 SPAR Group, Inc., Registrant
By: /s/ Charles Cimitile
--------------------
Charles Cimitile
Chief Financial Officer and duly
authorized signatory
25