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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, 2005
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 for the transition period from ______ to ___________
Commission file number: 0-27824
SPAR GROUP, INC.
(Exact name of registrant as specified in its charter)
Delaware 33-0684451
State of Incorporation IRS Employer Identification No.
580 White Plains Road, 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, 2005, 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, 2005, and December 31, 2004.................... 3
Consolidated Statements of Operations for the three months
ended March 31, 2005, and 2004..................................4
Consolidated Statements of Cash Flows for the
three months ended March 31, 2005, and 2004.................... 5
Notes to Consolidated Financial Statements......................6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations............................17
Item 3: Quantitative and Qualitative Disclosures about Market Risk.....26
Item 4: Controls and Procedures........................................27
Item 5: Other Information..............................................27
PART II: OTHER INFORMATION
Item 1: Legal Proceedings..............................................28
Item 2: Changes in Securities and Use of Proceeds......................28
Item 3: Defaults upon Senior Securities................................28
Item 4: Submission of Matters to a Vote of Security Holders............28
Item 5: Other Information..............................................28
Item 6: Exhibits and Reports on Form 8-K .............................28
SIGNATURES....................................................................30
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,
2005 2004
---------------------- --------------------
(Unaudited) (Note)
ASSETS
Current assets:
Cash and cash equivalents $ 277 $ 887
Accounts receivable, net 9,851 11,307
Prepaid expenses and other current assets 400 657
---------------------- --------------------
Total current assets 10,528 12,851
Property and equipment, net 1,363 1,536
Goodwill 798 798
Other assets 541 636
---------------------- --------------------
Total assets $ 13,230 $ 15,821
====================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,346 $ 2,158
Accrued expenses and other current liabilities 2,527 2,391
Accrued expenses due to affiliates 1,020 987
Restructuring charges 99 250
Customer deposits 1,029 1,147
Lines of credit 2,124 4,956
---------------------- --------------------
Total current liabilities 8,145 11,889
Other long-term liabilities 15 12
Minority interest 217 206
---------------------- --------------------
Total liabilities 8,377 12,107
Commitments and contingencies (Note - 12)
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, 2005
18,858,972 - December 31, 2004 189 189
Treasury stock (3) (108)
Accumulated other comprehensive loss (146) (86)
Additional paid-in capital 10,936 11,011
Accumulated deficit (6,123) (7,292)
---------------------- --------------------
Total stockholders' equity 4,853 3,714
---------------------- --------------------
Total liabilities and stockholders' equity $ 13,230 $ 15,821
====================== ====================
Note: The Balance Sheet at December 31, 2004, 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
2005 2004
------------------------------------
Net revenues $ 14,521 $ 12,803
Cost of revenues 8,651 8,694
------------------------------------
Gross profit 5,870 4,109
Selling, general and administrative expenses 4,256 4,967
Depreciation and amortization 279 362
------------------------------------
Operating income (loss) 1,335 (1,220)
Interest expense 40 35
------------------------------------
Income (loss) before provision for income taxes and 1,295 (1,255)
minority interest
Provision (benefit) for income taxes 15 (465)
------------------------------------
Net income (loss) before minority interest 1,280 (790)
Minority interest 111 -
------------------------------------
Net income (loss) $ 1,169 $ (790)
====================================
Basic/diluted net income (loss) per common share:
Net income (loss)- basic/diluted $ 0.06 $ (0.04)
====================================
Weighted average common shares - basic 18,859 18,859
====================================
Weighted average common shares - diluted 19,004 18,859
====================================
See accompanying notes.
4
SPAR GROUP, INC.
Consolidated Statements of Cash Flows
(unaudited) (in thousands)
THREE MONTHS ENDED
MARCH 31 MARCH 31,
2005 2004
------------------------------------
OPERATING ACTIVITIES
Net income (loss) $ 1,169 $ (790)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Minority interest earnings in subsidiaries 111 -
Depreciation 279 362
Changes in operating assets and liabilities:
Accounts receivable 1,456 2,541
Prepaid expenses and other assets 352 (821)
Accounts payable, accrued expenses, other current
liabilities and customer deposits (794) (996)
Accrued expenses due to affiliates 33 580
Restructuring charges (151) -
------------------------------------
Net cash provided by operating activities 2,455 876
INVESTING ACTIVITIES
Purchases of property and equipment (106) (301)
Acquisition of businesses - (453)
------------------------------------
Net cash used in investing activities (106) (754)
FINANCING ACTIVITIES
Net payments on lines of credit (2,832) (195)
Other long-term liabilities (97) 5
Proceeds from employee stock purchase plan and exercised
options 30 68
------------------------------------
Net cash used in financing activities (2,899) (122)
Translation loss (60) -
Net change in cash and cash equivalents (610) -
Cash and cash equivalents at beginning of period 887 -
------------------------------------
Cash and cash equivalents at end of period $ 277 $ -
====================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Interest paid $ 48 $ 35
====================================
See accompanying notes.
5
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited, consolidated financial statements of SPAR
Group, Inc., a Delaware corporation ("SGRP"), and its subsidiaries (together
with SGRP, collectively, the "Company" or the "SPAR Group") have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included in these interim financial
statements. However, these interim financial statements should be read in
conjunction with the annual consolidated financial statements and notes thereto
for the Company as contained in the Company's Annual Report for 2004 on Form
10-K for the year ended December 31, 2004, as filed with the Securities and
Exchange Commission on April 12, 2005 (the "Company's Annual Report for 2004 on
Form 10-K"). The Company's results of operations for the interim periods are not
necessarily indicative of its operating results for the entire year.
2. BUSINESS AND ORGANIZATION
The Company is a supplier of merchandising and other marketing services
throughout the United States and internationally. The Company also provides
database marketing, technology services, teleservices and marketing research.
The Company's operations are divided into two divisions: the Domestic
Merchandising Services Division and the International Merchandising Services
Division. The Domestic Merchandising Services Division provides merchandising
services, in-store product demonstrations, product sampling, database marketing,
technology services, teleservices and marketing research to manufacturers and
retailers in the United States. The various services are primarily performed in
mass merchandisers, drug store chains, convenience and grocery stores. The
International Merchandising Services Division, established in July 2000,
currently provides merchandising services through a wholly owned subsidiary in
Canada, through 51% owned joint venture subsidiaries in Turkey, South Africa,
India and through a 50% owned joint venture in Japan. The Company is scheduled
to start operations in Romania in the second quarter of 2005 through a 51% owned
joint venture subsidiary. In February 2005, the Company announced the
establishment of a 50% owned joint venture in China. The Company's Chinese joint
venture is currently awaiting government approval and expects to begin
operations late in the third quarter of 2005.
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
venture where the Company is the primary beneficiary because the Company
believes this presentation is fairer and more meaningful. Rule 3A-02 of
Regulation S-X, Consolidated Financial Statements of the Registrant and its
6
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
Subsidiaries, states that consolidated statements are presumed to be more
meaningful, that majority owned subsidiaries (more than 50%) generally should be
consolidated, and that circumstances may require consolidation of other
subsidiaries to achieve a fairer presentation of its financial condition and
results of operations. In addition, the Company has determined that under
Financial Accounting Standards Board Interpretation Number 46, as revised
December 2003, Consolidation of Variable Interest Entities ("FIN 46(R)"), the
Company is the primary beneficiary of its 51% owned joint venture subsidiaries
and its 50% owned joint ventures, which accordingly requires consolidation of
those entities into the Company's financial statements. All significant
intercompany accounts and transactions have been eliminated.
4. MANAGEMENT'S PLANS CONCERNING CASH FLOW
Management believes that based upon the Company's current level of
earnings and the existing credit facilities, funding will be sufficient to
support ongoing operations over the next twelve months. The Company is and has
been in violation of certain covenants of its Credit Facility (see Note 7 -
Lines of Credit) and expects to violate such covenants in the future. The
Company's bank, Webster Business Credit Corporation, has issued waivers for past
covenant violations; however, there can be no assurances that Webster will
continue to issue such waivers in the future.
5. RESTRUCTURING CHARGES
In July 2004, as a result of the loss of several significant customers
and the pending sale of the Company's largest customer, the Company entered into
a plan to restructure and reduce its field force, as well as, its selling,
general and administrative cost structure to reflect its lower revenue base.
These reductions consisted of personnel reductions, personnel related expenses
and office closings. As a result of the July restructuring, the Company expensed
approximately $480,000 in the quarter ended September 30, 2004, approximately
$230,000 for severance benefits and approximately $250,000 for office leases
that the Company ceased using. At March 31, 2005, the Company had approximately
$99,000 reserved for future restructure payments that are expected to be paid in
2005. The Company records restructure expenses in the selling, general and
administrative section of its consolidated operating statements.
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 (loss) per share (in thousands, except per share data):
THREE MONTHS ENDED
-------------------------------------
MARCH 31, MARCH 31,
2005 2004
------------------ ------------------
Numerator:
Net income (loss) $ 1,169 $ (790)
Denominator:
Shares used in basic earnings
(loss) per share calculation 18,859 18,859
Effect of diluted securities:
Employee stock options 145 -
------------------ ------------------
Shares used in diluted earnings
(loss) per share calculation 19,004 18,859
================== ==================
Basic and diluted earnings (loss)
per common share:
Net income (loss) - basic and
diluted $ 0.06 $ (0.04)
================== ==================
The computation of dilutive loss per share excluded anti-dilutive stock
options to purchase approximately 501,000 shares for the three months ended
March 31, 2004.
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"). The Credit Facility provides a
$7.0 million revolving credit facility that matures on January 23, 2006. The
Company may borrow up to $7.0 million based upon a borrowing base formula as
defined in the agreement (principally 85% of "eligible" accounts receivable).
The Credit Facility bears interest at a rate based in part upon the earnings
before interest, taxes, depreciation and amortization and depending upon the
type of borrowing, is calculated based upon Webster's "Alternative Base Rate" or
the London Inter Bank Offering Rate ("LIBOR"). At March 31, 2005 there were no
LIBOR based loans and the interest rate calculated at Webster's Alternative Base
Rate plus 0.75% totaled 6.5% per annum. The average interest rate for the three
months ended March 31, 2005 was 6.1% per annum. The Credit Facility is secured
by all of the
8
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
assets of the Company and its domestic subsidiaries. In addition, Mr. Robert
Brown, a Director, the Chairman, President and Chief Executive Officer and a
major stockholder of the Company and Mr. William Bartels, a Director, the Vice
Chairman and a major stockholder of the Company, provide personal guarantees
totaling $1.0 million to Webster. The Credit Facility requires the Company
satisfy certain financial covenants, including a minimum "Net Worth", a minimum
"Fixed Charge Coverage Ratio", a capital expenditure limitation and a minimum
"EBITDA", as such terms are defined in the Credit Facility. The Credit Facility
also limits certain expenditures by the Company, including capital expenditures
and other investments.
The Company was in violation of certain covenants at March 31, 2005, and
expects to be in violation at future measurement dates. Webster issued a waiver
for the March 31, 2005 covenant violations. However, there can be no assurances
that Webster will issue such waivers in the future.
The revolving loan balances outstanding under the Credit Facility were
$1.2 million and $4.1 million at March 31, 2005, and December 31, 2004,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $700,000 at March 31, 2005, and December 31, 2004. As of March
31, 2005, the SPAR Group had unused availability under the Credit Facility of
$2.3 million out of the remaining maximum $5.1 million unused revolving line of
credit after reducing the borrowing base by outstanding loans and letters of
credit.
In 2001, the Japanese joint venture SPAR FM Japan, Inc. entered into a
revolving line of credit arrangement with Japanese banks for 300 million yen or
$2.7 million (based upon the exchange rate at December 31, 2004). At December
31, 2004, SPAR FM Japan, Inc. had 100 million yen or approximately $900,000 loan
balance outstanding under the line of credit. The line of credit is effectively
guarantied by the Company and the joint venture partner, Paltac Corporation. The
average interest rate on the borrowings under the Japanese line of credit for
its short-term bank loans at December 31, 2004 was 1.375% per annum.
8. RELATED-PARTY TRANSACTIONS
Mr. Robert G. Brown, a Director, the Chairman, President and Chief
Executive Officer and a major stockholder of the Company, and Mr. William H.
Bartels, a Director, the Vice Chairman and a major stockholder of the Company,
are executive officers and the sole stockholders and directors of SPAR Marketing
Services, Inc. ("SMS"), SPAR Management Services, Inc. ("SMSI"), and SPAR
Infotech, Inc. ("SIT").
SMS and SMSI provided approximately 99% of the Company's field
representatives (through its independent contractor field force) and
approximately 92% of the Company's field management at a total cost of
approximately $5.8 million and $7.7 million for the three months ended March 31,
2005, and 2004, respectively. Pursuant to the terms of the Amended and Restated
Field Service Agreement dated as of January 1, 2004, SMS provides the services
of SMS's field force of approximately 6,300 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 50 full-time
national,
9
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
regional and district managers to the Company. For those services, the Company
has agreed to reimburse SMS and SMSI for all of their costs of providing those
services and to pay SMS and SMSI each a premium equal to 4% of their respective
costs, except that for 2004 SMSI agreed to concessions that reduced the premium
paid by approximately $145,000 for the three months ended March 31, 2004. Total
net premiums (4% of SMS and SMSI costs less 2004 concessions) paid to SMS and
SMSI for services rendered were approximately $233,000 and $162,000 for the
three months ended March 31, 2005, and 2004, respectively. The Company has been
advised that Messrs. Brown and Bartels are not paid any salaries as officers of
SMS or SMSI so there were no salary reimbursements for them included in such
costs or premium. However, since SMS and SMSI are "Subchapter S" corporations
owned by Messrs. Brown and Bartels, they benefit from any income of such
companies allocated to them.
SIT provided substantially all of the Internet computer programming
services to the Company at a total cost of approximately $210,000 and $380,000
for the three months ended March 31, 2005, and 2004, respectively. SIT provided
approximately 6,700 and 10,000 hours of Internet computer programming services
to the Company for the three months ended March 31, 2005, and 2004,
respectively. Pursuant to the Amended and Restated Programming and Support
Agreement dated as of January 1, 2004, SIT continues to provide programming
services to the Company for which the Company has agreed to pay SIT competitive
hourly wage rates for time spent on Company matters and to reimburse the related
out-of-pocket expenses of SIT and its personnel. The average hourly billing rate
was $31.27 and $36.62 for the three months ended March 31, 2005, and 2004,
respectively. The Company has been advised that no hourly charges or business
expenses for Messrs. Brown and Bartels were charged to the Company by SIT for
the three months ended March 31, 2005, and 2004, respectively. However, since
SIT is a "Subchapter S" corporation owned by Messrs. Brown and Bartels, they
benefit from any income of such company allocated to them.
In November 2004 and January 2005, the Company entered into separate
operating lease agreements between SMS and the Company's wholly owned
subsidiaries, SPAR Marketing Force, Inc. ("SMF") and SPAR Canada Company ("SPAR
Canada"). Each lease has a 36 month term and representations, covenants and
defaults customary for the leasing industry. The SMF lease is for handheld
computers to be used by field merchandisers in the performance of various
merchandising services in the United States and had a monthly payment of
$20,318. These handheld computers had an original purchase price of $632,200.
The SPAR Canada lease is also for handheld computers to be used by field
merchandisers in the performance of various merchandising services in Canada and
had a monthly payment of $3,326. These handheld computers had an original
purchase price of $105,000. In May 2005, the Company and SMS amended the lease
agreements reducing the total monthly payment from $20,318 to $17,891 for SMF
and from $3,326 to $2,972 for SPAR Canada. The amended monthly payments are
based upon a lease factor of 2.83%.
In March 2005, SMF entered into an additional 36 month lease with SMS
for handheld computers. The lease factor is 2.83% and the monthly payment is
$2,341. These handheld computers had an original purchase price of $82,727.
10
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
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,
-------------------------------------------
2005 2004
-------------------------------------------
Services provided by affiliates:
Independent contractor services (SMS) $ 4,844 $ 6,361
===========================================
Field management services (SMSI) $ 939 $ 1,354
===========================================
Handheld computer leases (SMSI) $ 63 $ -
===========================================
Internet and software program
consulting services (SIT) $ 210 $ 381
===========================================
Accrued expenses due to affiliates (in thousands): MARCH 31, DECEMBER 31,
2005 2004
---------------------------------
SPAR Marketing Services, Inc. $ 1,020 $ 987
=================================
In addition to the above, through the services of Affinity Insurance,
Ltd., the Company purchases insurance coverage for its casualty and property
insurance risk. The Company's CEO and Vice Chairman own, through SMSI, a
minority (less than 5%) equity interest in Affinity.
9. STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting
for Stock Based Compensation, requires disclosure of the fair value method of
accounting for stock options and other equity instruments. Under the fair value
method, compensation cost is measured at the grant date based on the fair value
of the award and is recognized over the service period, which is usually the
vesting period. The Company has chosen, under the provisions of SFAS No. 123, to
continue to account for employee stock-based transactions under Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.
11
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
Under the disclosure-only provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS 148, no compensation cost has been
recognized for the stock option grants to Company employees. Compensation cost
for the Company's option grants to Company employees has been determined based
on the fair value at the grant date consistent with the provisions of SFAS No.
123. If compensation cost had been recognized, the Company's net income (loss)
and pro forma net income (loss) per share from continuing operations would have
been reduced to the adjusted amounts indicated below (in thousands, except per
share data):
THREE MONTHS ENDED MARCH 31,
---------------------------------------
2005 2004
---------------------------------------
Net income (loss), as reported $ 1,169 $ (790)
Stock based employee compensation expense
under the fair market value method 25 156
---------------------------------------
Pro forma net income (loss) $ 1,144 $ (946)
Basic and diluted net income (loss) per share, as
reported $ 0.06 $ (0.04)
Basic and diluted net income (loss) per share,
pro forma $ 0.06 $ (0.05)
The pro forma effect on net income (loss) is not representative of the
pro forma effect on net income (loss) in future years because the options vest
over several years and additional awards may be made in the future.
Under the provision of SFAS No. 123 dealing with non-employee stock
option grants awarded to the employees of the Company's affiliates, for the
three months ended March 31, 2005, the Company recorded an expense of
approximately $14,000. For the three months ended March 31, 2004, as a result of
the decrease in the market price of the Company's stock from December 31, 2003
to March 31, 2004, there was no expense under the provision of SFAS No. 123. The
Company determines the fair value of the options granted to non-employees using
the Black-Scholes valuation model and recovers amounts previously expensed or
expenses that value over the service period. Until an option is vested, the fair
value of the option continues to be updated through the vesting date. The
options granted have a ten (10) year life and vest over four-year periods at a
rate of 25% per year, beginning on the first anniversary of the date of grant.
10. TREASURY STOCK
The Company initiated a share repurchase program in 2002, which allowed
for the repurchase of up to 100,000 shares. In 2003, the Board of Directors
authorized the repurchase of an additional 122,000 shares increasing the total
to 222,000 shares.
12
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
The following table summarizes the Company's treasury stock activity
from January 1, 2005 to March 31, 2005.
Quantity Amount
-----------------------------------
Treasury Stock, January 1, 2005 21,908 $ 108,100
Used to fulfill options exercised (21,654) (104,617)
-----------------------------------
TREASURY STOCK, MARCH 31, 2005 254 $ 3,483
===================================
11. CUSTOMER DEPOSITS
In June 2004, the Company received a non-refundable deposit of
approximately $900,000 from a customer. The deposit is to be applied to future
invoices for services that will be provided by the Company under a master
service agreement through December 31, 2006. Each invoice will be reduced by 20%
until the deposit is depleted. As of March 31, 2005, the outstanding balance was
approximately $870,000.
12. COMMITMENTS AND CONTINGENCIES
INTERNATIONAL COMMITMENTS
The Company's international model is to partner with local merchandising
companies and combine their knowledge of the local market with the Company's
proprietary software and expertise in the merchandising business. In 2001, the
Company established its first joint venture and has continued this strategy. As
of this filing, the Company is currently operating in Japan, Canada, Turkey,
South Africa, India and Romania. The Company also announced the establishment of
a joint venture in China. The Company's Chinese joint venture is currently
awaiting government approval and expects to begin operations late in the third
quarter of 2005.
Certain of these joint ventures and joint venture subsidiaries are
marginally profitable while others are operating at a loss. None of these
entities have excess cash reserves. In the event of continued losses, the
Company may be required to provide additional cash infusions into these joint
ventures and joint venture subsidiaries.
LEGAL MATTERS
Safeway Inc. ("Safeway"), filed a Complaint against the PIA
Merchandising Co., Inc. ("PIA Co."), a wholly owned subsidiary of SGRP, and
Pivotal Sales Company ("Pivotal"), a wholly owned subsidiary of PIA Co., and
SGRP in Alameda Superior Court, case no. 2001028498 on October 24, 2001, and has
subsequently amended it. Safeway alleges causes of action for breach of
contract, breach of implied
13
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
contract, breach of fiduciary duty, conversion, constructive fraud, breach of
trust, unjust enrichment, and accounting fraud. Safeway has most recently
alleged monetary damages in the principal sum of $3,000,000 and alleged interest
of $1,500,000 and has also demanded unspecified costs. PIA Co., Pivotal and SGRP
filed cross-claims against Safeway on or about March 11, 2002, and amended them
on or about October 15, 2002, alleging causes of action by them against Safeway
for breach of contract, interference with economic relationship, unfair trade
practices and unjust enrichment and seeking damages and injunctive relief.
Mediation between the parties occurred in 2004, but did not result in a
settlement. PIA Co., Pivotal and SGRP are vigorously defending Safeway's
allegations. It is not possible at this time to determine the likelihood of the
outcome of this lawsuit. However, if Safeway prevails respecting its
allegations, and PIA Co., Pivotal and SGRP lose on their cross-claims and
counterclaims, that result could have a material adverse effect on the Company.
The Company anticipates that this matter will be resolved in 2005.
In addition to the above, the Company is a party to various other legal
actions and administrative proceedings arising in the normal course of business.
In the opinion of Company's management, disposition of these other matters are
not anticipated to have a material adverse effect on the financial position,
results of operations or cash flows of the Company.
13. GEOGRAPHIC DATA
A summary of the Company's net revenue, operating income (loss) and long
lived assets by geographic area for the three months ended March 31, 2005 and
2004, respectively, and as of March 31, 2005, and December 31, 2004, is as
follows (in thousands):
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2005 2004
----------------------------------------
Net revenue:
------------
United States $ 10,800 $ 12,664
International 3,721 139
----------------------------------------
Total net revenue $ 14,521 $ 12,803
========================================
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2005 2004
----------------------------------------
Operating income (loss):
------------------------
United States $ 895 $ (890)
International 440 (330)
----------------------------------------
Total operating income (loss) $ 1,335 $ (1,220)
========================================
MARCH 31, DECEMBER 31,
----------------------------------------
Long lived assets: 2005 2004
----------------------------------------
United States $ 2,281 $ 2,484
International 421 486
----------------------------------------
Total long lived assets $ 2,702 $ 2,970
========================================
14
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
International revenues disclosed above were based upon revenues reported
by the Company's foreign subsidiaries and joint ventures. For the three months
ended March 31, 2005, both the joint venture subsidiaries in Japan and South
Africa each contributed 9% to the consolidated net revenue of the Company. The
wholly-owned Canadian subsidiary contributed 7% of the consolidated net revenue
of the Company.
14. SUPPLEMENTAL BALANCE SHEET INFORMATION
Accounts receivable, net, consists of the following (in thousands):
MARCH 31, DECEMBER 31,
------------------------------------
2005 2004
------------------------------------
Trade $ 5,990 $ 8,178
Unbilled 4,365 3,600
Non-trade 172 290
------------------------------------
10,527 12,068
Less:
Allowance for doubtful accounts (676) (761)
------------------------------------
$ 9,851 $ 11,307
====================================
Property and equipment consists of the following (in thousands):
MARCH 31, DECEMBER 31,
------------------------------------
2005 2004
------------------------------------
Equipment $ 5,406 $ 5,397
Furniture and fixtures 547 547
Leasehold improvements 138 138
Capitalized software development costs 1,726 1,629
------------------------------------
7,817 7,711
Less accumulated depreciation and amortization 6,454 6,175
------------------------------------
$ 1,363 $ 1,536
====================================
MARCH 31, DECEMBER 31,
-------------------------------------
Prepaid expenses and other current assets (in thousands): 2005 2004
-------------------------------------
Prepaid insurance $ 197 $ 214
Tax refund due 62 62
Prepaid rents 49 49
Other 92 332
------------------------------------
$ 400 $ 657
====================================
15
SPAR GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (CONTINUED)
15. ISSUANCE OF OPTIONS
On April 12, 2005, the Company issued non-qualified stock options to
various employees and affiliates to acquire 500,030 shares of stock of SGRP at
$1.26 per share, with the normal four year vesting provisions.
16. FOREIGN CURRENCY RATE FLUCTUATIONS
The Company has foreign currency exposure associated with its
international 100% owned subsidiary, its 51% owned joint venture subsidiaries
and its 50% owned joint venture. In the first quarter of 2005, these exposures
are primarily concentrated in the Canadian dollar, Japanese yen and South
African rand. For the three months ended March 31, 2005, international assets
totaled $3.2 million and international liabilities totaled $5.8 million. For
three months ended March 31, 2005, international revenues totaled $3.7 million
and the Company's share of the net income was approximately $300,000.
17. INTEREST RATE FLUCTUATIONS
The Company is exposed to market risk related to the variable interest
rate on its lines of credit. At March 31, 2005, the Company's outstanding debt
totaled $2.1 million, which consisted of domestic variable-rate (6.5%) debt of
$1.2 million and international variable rate (1.4%) debt of $0.9 million. Based
on the three months ending March 31, 2005, average outstanding borrowings under
variable-rate debt, a one-percentage point increase in interest rates would
negatively impact pre-tax earnings and cash flows for the three months ended
March 31, 2005 by approximately $6,000.
16
SPAR GROUP, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
- --------------------------
STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q FOR THE THREE
MONTHS ENDED MARCH 31, 2005 (THIS "QUARTERLY REPORT"), OF SPAR GROUP, INC.
("SGRP", AND TOGETHER WITH ITS SUBSIDIARIES, THE "SPAR GROUP" OR THE "COMPANY"),
INCLUDE "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE
SECURITIES ACT AND SECTION 21E OF THE EXCHANGE ACT, INCLUDING, IN PARTICULAR AND
WITHOUT LIMITATION, THE STATEMENTS CONTAINED IN THE DISCUSSIONS UNDER THE
HEADING "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS". FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS,
UNCERTAINTIES AND OTHER FACTORS THAT COULD CAUSE THE COMPANY'S ACTUAL RESULTS,
PERFORMANCE AND ACHIEVEMENTS, WHETHER EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS, TO NOT OCCUR OR BE REALIZED OR TO BE LESS THAN
EXPECTED. SUCH FORWARD-LOOKING STATEMENTS GENERALLY ARE BASED UPON THE COMPANY'S
BEST ESTIMATES OF FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENT, CURRENT CONDITIONS
AND THE MOST RECENT RESULTS OF OPERATIONS. FORWARD-LOOKING STATEMENTS MAY BE
IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "MAY", "WILL",
"EXPECT", "INTEND", "BELIEVE", "ESTIMATE", "ANTICIPATE", "CONTINUE" OR SIMILAR
TERMS, VARIATIONS OF THOSE TERMS OR THE NEGATIVE OF THOSE TERMS. YOU SHOULD
CAREFULLY CONSIDER SUCH RISKS, UNCERTAINTIES AND OTHER INFORMATION, DISCLOSURES
AND DISCUSSIONS, WHICH CONTAIN CAUTIONARY STATEMENTS IDENTIFYING IMPORTANT
FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROVIDED
IN THE FORWARD-LOOKING STATEMENTS.
ALTHOUGH THE COMPANY BELIEVES THAT ITS PLANS, INTENTIONS AND EXPECTATIONS
REFLECTED IN OR SUGGESTED BY SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, IT
CANNOT ASSURE THAT SUCH PLANS, INTENTIONS OR EXPECTATIONS WILL BE ACHIEVED IN
WHOLE OR IN PART. YOU SHOULD CAREFULLY REVIEW THE RISK FACTORS DESCRIBED AND ANY
OTHER CAUTIONARY STATEMENTS CONTAINED IN THE COMPANY'S ANNUAL REPORT ON FORM
10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004, AS FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION ON APRIL 12, 2005 (THE "COMPANY'S ANNUAL REPORT FOR 2004
ON FORM 10-K"), AND THE CAUTIONARY STATEMENTS CONTAINED IN THIS QUARTERLY
REPORT. ALL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS
ACTING ON ITS BEHALF ARE EXPRESSLY QUALIFIED BY THE RISK FACTORS (SEE ITEM 1 -
CERTAIN RISK FACTORS) AND OTHER CAUTIONARY STATEMENTS IN THE COMPANY'S ANNUAL
REPORT FOR 2004 ON FORM 10-K AND IN THIS QUARTERLY REPORT. THE COMPANY
UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING
STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.
OVERVIEW
- --------
In the United States, the Company provides merchandising services to
manufacturers and retailers principally in mass merchandiser, drug store,
grocery, and other retail trade classes through its Domestic Merchandising
Services Division. Internationally, the Company provides in-store merchandising
services through a wholly owned subsidiary in Canada, 51% owned joint venture
subsidiaries in Turkey, South Africa and India and a 50% owned joint venture in
Japan. In December 2004, the Company established a 51% owned joint venture
subsidiary in Romania. In February 2005, the Company
17
SPAR GROUP, INC.
established a 50% owned joint venture in China. For the three months ended March
31, 2005, the Company consolidated Canada, Turkey, South Africa, India and Japan
into the Company's financial statements. Romania and China did not have
operations for the three months ended March 31, 2005.
DOMESTIC MERCHANDISING SERVICES DIVISION
The Company's Domestic Merchandising Services Division provides
nationwide merchandising and other marketing services primarily on behalf of
consumer product manufacturers and retailers at mass merchandisers, drug store
chains and grocery stores. Included in its customers are home entertainment,
general merchandise, health and beauty care, consumer goods and food products
companies in the United States.
Merchandising services primarily consist of regularly scheduled
dedicated routed services and special projects provided at the store level for a
specific retailer or single or multiple manufacturers primarily under single or
multi-year contracts or agreements. Services also include stand-alone
large-scale implementations. These services may include sales enhancing
activities such as ensuring that client products authorized for distribution are
in stock and on the shelf, adding new products that are approved for
distribution but not presently on the shelf, setting category shelves in
accordance with approved store schematics, ensuring that shelf tags are in
place, checking for the overall salability of client products and setting new
and promotional items and placing and/or removing point of purchase and other
related media advertising. Specific in-store services can be initiated by
retailers or manufacturers, and include new store openings, new product
launches, special seasonal or promotional merchandising, focused product support
and product recalls. The Company also provides in-store event staffing services,
database marketing, technology services, teleservices and marketing research
services.
INTERNATIONAL MERCHANDISING SERVICES DIVISION
In July 2000, the Company established its International Merchandising
Services Division, operating through a wholly owned subsidiary, SPAR Group
International, Inc. ("SGI"), to focus on expanding its merchandising services
business worldwide. The Company has expanded its international business as
follows:
May 2001, the Company entered Japan through a 50% owned joint venture
headquartered in Osaka.
June 2003, the Company entered Canada by acquiring an existing business
through its wholly-owned Canadian subsidiary headquartered in Toronto.
July 2003, the Company entered Turkey through a 51% owned joint venture
subsidiary headquartered in Istanbul.
April 2004, the Company entered South Africa through a 51% owned joint
venture subsidiary headquartered in Durban.
18
SPAR GROUP, INC.
April 2004, the Company entered India through a 51% owned joint venture
subsidiary headquartered in New Delhi.
December 2004, the Company established a 51% owned joint venture
subsidiary headquartered in Bucharest, Romania. Operations are expected to start
in the second quarter of 2005.
In February 2005, the Company announced the establishment of a 50% owned
joint venture headquartered in Hong Kong. The Company's Chinese joint venture is
currently awaiting government approval, and operations are expected to start in
the third quarter of 2005.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The Company's critical accounting policies have been consistently applied
in all material respects and address such matters as revenue recognition,
depreciation methods, asset impairment recognition, business combination
accounting, and discontinued business accounting. While the estimates and
judgments associated with the application of these policies may be affected by
different assumptions or conditions, the Company believes the estimates and
judgments associated with the reported amounts are appropriate in the
circumstances. Four critical accounting policies are consolidation of
subsidiaries, revenue recognition, allowance for doubtful accounts and sales
allowances, and internal use software development costs:
CONSOLIDATION OF SUBSIDIARIES
The Company consolidates its 100% owned subsidiaries. The Company also
consolidates its 51% owned joint venture subsidiaries and its 50% owned
joint ventures where the Company is the primary beneficiary because the
Company believes this presentation is fairer and more meaningful. Rule
3A-02 of Regulation S-X, Consolidated Financial Statements of the
Registrant and its Subsidiaries, states that consolidated statements are
presumed to be more meaningful, that majority owned subsidiaries (more
than 50%) generally should be consolidated, and that circumstances may
require consolidation of other subsidiaries to achieve a fairer
presentation of its financial condition and results. In addition, the
Company has determined that under Financial Accounting Standards Board
Interpretation Number 46, as revised December 2003, Consolidation of
Variable Interest Entities ("FIN 46(R)"), the Company is the primary
beneficiary of its 51% owned joint venture subsidiaries and its 50% owned
joint ventures, which accordingly requires consolidation of those
entities into the Company's financial statements.
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.
19
SPAR GROUP, INC.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND SALES ALLOWANCES
The Company continually monitors the validity of its accounts receivable
based upon current customer credit information and financial condition.
Balances that are deemed to be uncollectible after the Company has
attempted reasonable collection efforts are written off through a charge
to the bad debt allowance and a credit to accounts receivable. Accounts
receivable balances are stated at the amount that management expects to
collect from the outstanding balances. The Company provides for probable
uncollectible amounts through a charge to earnings and a credit to bad
debt allowance based on management's assessment of the current status of
individual accounts. Based on management's assessment, the Company
established an allowance for doubtful accounts of $676,000 and $761,000
at March 31, 2005, and December 31, 2004, respectively.
INTERNAL USE SOFTWARE DEVELOPMENT COSTS
In accordance with SOP 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, the Company capitalizes
certain costs associated with its internally developed software.
Specifically, the Company capitalizes the costs of materials and services
incurred in developing or obtaining internal use software. These costs
include but are not limited to the cost to purchase software, write
program code and payroll, related benefits and travel expenses for those
employees who are directly involved with and who devote time to its
software development projects. Capitalized software development costs are
amortized over three years.
The Company capitalized $97,000 and $184,000 of costs related to software
developed for internal use in the three months ended March 31, 2005 and
2004, respectively.
20
SPAR GROUP, INC.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2005, COMPARED TO THREE MONTHS ENDED MARCH 31, 2004
- --------------------------------------------------------------------------------
The following table sets forth selected financial data and data as a
percentage of net revenues for the periods indicated (in thousands, except
percent data).
Three Months Ended
--------------------------------------------------------------------------------
March 31, 2005 March 31, 2004
Increase
Amount % Amount % (decrease)%
------ - ------ - ----------
Net revenues $ 14,521 100.0% $ 12,803 100.0% 13.4%
Cost of revenues 8,651 59.6 8,694 67.9 (0.5)
Selling, general and administrative expense 4,256 29.3 4,967 38.8 (14.3)
Depreciation and amortization 279 1.9 362 2.8 (23.0)
Interest expense 40 0.3 35 0.3 17.7
---------------- --------------- ----------------- ----------------
Income (loss) before provision for income taxes
and minority interest 1,295 8.9 (1,255) (9.8) -
Provision (benefit) for income tax 15 0.1 (465) (3.6) -
---------------- --------------- ----------------- ----------------
Net income (loss) before minority interest 1,280 8.8 (790) (6.2) -
Minority interest 111 0.8 - - -
---------------- --------------- ----------------- ----------------
Net income (loss) $ 1,169 8.0% $ (790) (6.2)% -
================ =============== ================= ================
NET REVENUES
Net revenues for the three months ended March 31, 2005, were $14.5
million, compared to $12.8 million for the three months ended March 31, 2004, an
increase of 13.4%. For the first quarter domestic revenue decreased $1.9 million
or 14.7% to $10.8 million, compared to $12.7 million a year ago. The decrease in
domestic revenue is a result of the loss of several significant customers
partially offset by revenue from new customers. Internationally, revenue for the
first quarter increased to $3.7 million from $139,000 last year, primarily as a
result of the Japan consolidation, the South African acquisition and a stronger
performance from our Canadian operations.
21
SPAR GROUP, INC.
One customer accounted for 17% and 7% of the Company's net revenue for
the three months ended March 31, 2005, and 2004, respectively. This customer
also accounted for approximately 25% and 29% of accounts receivable at March 31,
2005, and December 31, 2004, respectively.
A second customer accounted for 16% and 44% of the Company's net revenues
for the three months ended March 31, 2005 and 2004, respectively. This customer
also accounted for approximately 12% and 4% of accounts receivable at March 31,
2005 and December 31, 2004, respectively. In 2004, this customer was a division
of a major retailer. This customer was sold by its parent on August 2, 2004. In
the first quarter of 2005 the Company performed a project that resulted in $1.9
million of revenue for this customer. Even with this project revenue, the
Company saw a significant decline in net revenue from this customer and expects
the decline to continue in 2005.
Approximately 10% and 15% of the Company's net revenues for the three
months ended March 31, 2005, and 2004, respectively, resulted from merchandising
services performed for customers at Kmart. These customers also accounted for
approximately 11% and 22% of accounts receivable at March 31, 2005 and December
31, 2004, respectively. While the contractual relationships or agreements are
with various customers and not Kmart, a significant reduction of this retailer's
stores or cessation of this retailer's business would negatively impact the
Company.
In addition, approximately 10% of the Company's net revenue for the three
months ended March 31, 2005 resulted from merchandising services performed for
customers at Circuit City. These customers also accounted for approximately 12%
and 16% of accounts receivable at March 31, 2005 and December 31, 2004,
respectively. While the contractual relationships or agreements are with various
customers and not Circuit City, a significant reduction of this retailer's
stores or cessation of this retailer's business would negatively impact the
Company.
Failure to attract new large customers could significantly impede the
growth of the Company's revenues, which could have a material adverse effect on
the Company's future business, results of operations and financial condition.
COST OF REVENUES
Cost of revenues 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 59.6% for the
three months ended March 31, 2005, compared to 67.9% for the three months ended
March 31, 2004. The decrease is primarily a result of the Company restructuring
its domestic field force to reflect its reduction of business.
Approximately 88% and 89% of the Company's domestic cost of revenue in
the three months ended March 31, 2005, and 2004, respectively, resulted from
in-store independent contractor and field management services purchased from the
Company's affiliates, SPAR Marketing Services, Inc. ("SMS"), and SPAR Management
Services, Inc. ("SMSI"), respectively (see Note 8 - Related-Party Transactions).
22
SPAR GROUP, INC.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses include corporate overhead,
project management, information technology, executive compensation, human
resource, legal and accounting expenses.
Selling, general and administrative expenses decreased by $0.7 million,
or 14.3%, for the three months ended March 31, 2005, to $4.3 million compared to
$5.0 million for the three months ended March 31, 2004. Domestic selling,
general and administrative expenses totaled $3.2 million for 2005 and were
reduced $1.4 million from $4.6 million in 2004. The reduction of 30.2% was
primarily due to cost reduction programs initiated in 2004 as a result of the
loss of certain large customers. The domestic cost reductions were partially
offset by increases of $0.7 million in international selling, general and
administrative expenses resulting from the consolidation of Japan, and the
operations of South Africa, Turkey and India joint venture subsidiaries that did
not have operations last year.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization charges of $0.3 million for the three
months ended March 31, 2005 was consistent with $0.4 million in the same period
for 2004.
INCOME TAXES
The Company recorded an income tax provision of $15,000 for the three
months ended March 31, 2005. The provision was primarily for minimum state
taxes. There was no provision for federal tax for the three months ended March
31, 2005 since the Company expects to utilize net operating loss carryforwards
previously reserved to offset any federal taxes due. For the three months ended
March 31, 2004, the income tax benefit represents a combined federal and state
income tax rate of 37%.
MINORITY INTEREST
Minority interest of approximately $111,000 resulted from the operations
of the 51% owned joint venture subsidiaries and the 50% owned joint venture for
the three months ended March 31, 2005.
NET INCOME
The Company had a net income of $1.2 million for the three months ended
March 31, 2005, or $0.06 per diluted share, compared to a net loss of $0.8
million, or $0.04 per share, for the corresponding period last year.
23
SPAR GROUP, INC.
LIQUIDITY AND CAPITAL RESOURCES
In the three months ended March 31, 2005, the Company had a net income of
$1.2 million.
Net cash provided by operating activities for the three months ended
March 31, 2005, was $2.5 million, compared to net cash provided by operating
activities of $0.9 million for the three months ended March 31, 2004. The
increase of $1.6 million in cash provided by operating activities is primarily
due to net operating income, reductions in prepaid expenses and other assets
partially offset by lower reductions in accounts receivables, as well as,
restructuring payments.
Net cash used in investing activities for the three months ended March
31, 2005, was $0.1 million compared to net cash used in investing activities of
$0.8 million for the three months ended March 31, 2004. The decrease in net cash
used in investing activities was a result of no acquisitions and lower purchases
of property and equipment in 2005.
Net cash used in financing activities for the three months ended March
31, 2005, was $2.9 million, compared to net cash used in financing activities of
$0.1 million for the three months ended March 31, 2004. The increase of net cash
used in financing activities was primarily a result of higher net payments on
the lines of credit.
The above activity resulted in a reduction in cash and cash equivalents
for the three months ended March 31, 2005 of $0.6 million.
At March 31, 2005, the Company had positive working capital of $2.4
million, as compared to a positive working capital of $1.0 million at December
31, 2004. The increase in working capital is due primarily to reductions in
accounts payable and lines of credit, partially offset by reduced accounts
receivable. The Company's current ratio was 1.29 at March 31, 2005 and 1.08 at
December 31, 2004.
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
$7.0 million revolving credit facility that matures on January 23, 2006. The
Company may borrow up to $7.0 million based upon a borrowing base formula as
defined in the agreement (principally 85% of "eligible" accounts receivable).
The Credit Facility bears interest at a rate based in part upon the earnings
before interest, taxes, depreciation and amortization and depending upon the
type of borrowing, is calculated based upon Webster's "Alternative Base Rate" or
the London Inter Bank Offering Rate ("LIBOR"). At March 31, 2005 there were no
LIBOR based loans and the interest rate calculated at Webster's Alternative Base
Rate plus 0.75% totaled 6.5% per annum. The average interest rate for the three
months ended March 31, 2005 was 6.1% per annum. The Credit Facility is secured
by all of the assets of the Company and its domestic subsidiaries. In addition,
Mr. Robert Brown, a Director, the Chairman, President and Chief Executive
Officer and a major stockholder of the Company and Mr. William Bartels, a
Director, the Vice Chairman and a major stockholder of the Company, provide
personal guarantees totaling $1.0 million to Webster. The Credit Facility
requires the Company satisfy certain financial covenants, including a minimum
"Net Worth", a minimum "Fixed Charge Coverage Ratio", a capital expenditure
limitation and a minimum "EBITDA", as such terms are defined in the
24
SPAR GROUP, INC.
Credit Facility. The Credit Facility also limits certain expenditures by the
Company, including capital expenditures and other investments.
The Company was in violation of certain covenants at March 31, 2005, and
expects to be in violation at future measurement dates. Webster issued a waiver
for the March 31, 2005 covenant violations. However, there can be no assurances
that Webster will issue such waivers in the future.
The revolving loan balances outstanding under the Credit Facility were
$1.2 million and $4.1 million at March 31, 2005, and December 31, 2004,
respectively. There were letters of credit outstanding under the Credit Facility
of approximately $700,000 at March 31, 2005, and December 31, 2004. As of March
31, 2005, the SPAR Group had unused availability under the Credit Facility of
$2.3 million out of the remaining maximum $5.1 million unused revolving line of
credit after reducing the borrowing base by outstanding loans and letters of
credit.
In 2001, the Japanese joint venture SPAR FM Japan, Inc. entered into a
revolving line of credit arrangement with Japanese banks for 300 million yen or
$2.7 million (based upon the exchange rate at December 31, 2004). At December
31, 2004, SPAR FM Japan, Inc. had 100 million yen or approximately $900,000 loan
balance outstanding under the line of credit. The line of credit is effectively
guarantied by the Company and the joint venture partner, Paltac Corporation. The
average interest rate on the borrowings under the Japanese line of credit for
its short-term bank loans at December 31, 2004 was 1.375% per annum.
The Company's international model is to partner with local merchandising
companies and combine their knowledge of the local market with the Company's
proprietary software and expertise in the merchandising business. In 2001, the
Company established its first joint venture in Japan and has continued this
strategy. As of this filing, the Company is currently operating in Japan,
Canada, Turkey, South Africa, India and Romania. In February 2005, the Company
announced the establishment of a joint venture in China. The Company's Chinese
joint venture is currently awaiting government approval, and operations are
expected to start in the third quarter of 2005.
Certain of these joint ventures and joint venture subsidiaries are
marginally profitable while others are operating at a loss. None of these
entities have excess cash reserves. In the event of continued losses, the
Company may be required to provide additional cash infusions into these joint
ventures and joint venture subsidiaries.
Management believes that based upon the results of Company's cost saving
initiatives and the existing credit facilities, sources of cash availability
will be sufficient to support ongoing operations over the next twelve months.
However, delays in collection of receivables due from any of the Company's major
clients, or a significant further reduction in business from such clients, or
the inability to acquire new clients, or the Company's inability to remain
profitable, or the inability to obtain bank waivers for future covenant
violations could have a material adverse effect on the Company's cash resources
and its ongoing ability to fund operations.
25
SPAR GROUP, INC.
CERTAIN CONTRACTUAL OBLIGATIONS
The following table contains a summary of certain of the Company's
contractual obligations by category as of March 31, 2005 (in thousands).
CONTRACTUAL OBLIGATIONS PAYMENTS DUE BY PERIOD
Total Less than 1 1-3 years 3-5 years More than 5
year years
Credit Facility $2,124 $2,124 $ - $ - $ -
Operating Lease Obligations 1,990 1,027 944 19 -
Total $4,114 $3,151 $ 944 $ 19 $ -
The Company also had approximately $700,000 in outstanding Letters of
Credit at March 31, 2005.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's accounting policies for financial instruments and
disclosures relating to financial instruments require that the Company's
consolidated balance sheets include the following financial instruments: cash
and cash equivalents, accounts receivable, accounts payable and lines of credit.
The Company considers carrying amounts of current assets and liabilities in the
consolidated financial statements to approximate the fair value for these
financial instruments because of the relatively short period of time between
origination of the instruments and their expected realization. The Company
monitors the risks associated with interest rates and financial instrument
positions. The Company's investment policy objectives require the preservation
and safety of the principal, and the maximization of the return on investment
based upon the safety and liquidity objectives.
The Company is exposed to market risk related to the variable interest
rate on its lines of credit. At March 31, 2005, the Company's outstanding debt
totaled $2.1 million, which consisted of domestic variable-rate (6.5%) debt of
$1.2 million and international variable rate (1.4%) debt of $0.9 million. Based
on the three months ending March 31, 2005, average outstanding borrowings under
variable-rate debt, a one-percentage point increase in interest rates would
negatively impact pre-tax earnings and cash flows for the three months ended
March 31, 2005 by approximately $6,000.
The Company has foreign currency exposure associated with its
international 100% owned subsidiary, its 51% owned joint venture subsidiaries
and its 50% owned joint venture. In the first quarter of 2005, these exposures
are primarily concentrated in the Canadian dollar, Japanese yen and South
African rand. For the three months ended March 31, 2005, international assets
totaled $3.2 million and international liabilities totaled $5.8 million. For
three months ended March 31, 2005, international revenues totaled $3.7 million
and the Company's share of the net income was approximately $300,000.
26
SPAR GROUP, INC.
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 and has begun to document and test its
domestic internal controls over financial reporting required by Section 404 of
the Sarbanes-Oxley Act of 2002.
ITEM 5. OTHER INFORMATION.
None
27
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
Not applicable.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS.
10.1 Amended and Restated Equipment Leasing Schedule 001 to Master
Lease Agreement by and between SPAR Marketing Services, Inc.,
and SPAR Marketing Force, Inc., dated as of November 1, 2004,
relating to lease of handheld computer equipment, as filed
herewith.
10.2 Amended and Restated Equipment Leasing Schedule 002 to Master
Lease Agreement by and between SPAR Marketing Services, Inc.,
and SPAR Marketing Force, Inc., dated as of January 4, 2005,
relating to lease of handheld computer equipment, as filed
herewith.
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SPAR GROUP, INC.
10.3 Amended and Restated Equipment Leasing Schedule 003 to Master
Lease Agreement by and between SPAR Marketing Services, Inc.,
and SPAR Marketing Force, Inc., dated as of January 31, 2005,
relating to lease of handheld computer equipment, as filed
herewith.
10.4 Amended and Restated Equipment Leasing Schedule 001 to Master
Lease Agreement by and between SPAR Marketing Services, Inc.,
and SPAR Canada Company dated as of January 4, 2005, relating
to lease of handheld computer equipment, as filed herewith.
10.5 Equipment Leasing Schedule 004 to Master Lease Agreement by
and between SPAR Marketing Services, Inc., and SPAR Marketing
Force, Inc., dated as of March 24, 2005, relating to lease of
handheld computer equipment, as filed herewith.
10.6 Waiver to the Third Amended and Restated Revolving Credit and
Security Agreement among Webster Business Credit Corporation,
SPAR Group, Inc., and certain of its subsidiaries dated as of
March 31, 2005, as filed herewith.
10.7 Waiver to the Third Amended and Restated Revolving Credit and
Security Agreement among Webster Business Credit Corporation,
SPAR Group, Inc., and certain of its subsidiaries dated as of
May 11, 2005, as filed herewith.
31.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, as filed herewith.
31.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002, as filed herewith.
32.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, as filed herewith.
32.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, as filed herewith.
REPORTS ON FORM 8-K.
1. Periodic Report on Form 8-K, dated May 5, 2005 filed with the
U.S. Securities and Exchange Commission on May 10, 2005,
respecting the earnings press release for the first quarter
ended March 31, 2005.
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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, 2005 SPAR Group, Inc., Registrant
By: /s/ Charles Cimitile
---------------------------------------
Charles Cimitile
Chief Financial Officer, Treasurer,
Secretary and duly authorized signatory
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