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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 second quarterly period ended June 30, 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 June 30, 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 June 30, 2004 and December 31, 2003....................................... 3
Consolidated Statements of Operations for the three
months and six months ended June 30, 2004 and 2003...............................4
Consolidated Statements of Cash Flows for the
six months ended June 30, 2004 and 2003......................................... 5
Notes to Consolidated Financial Statements.......................................6
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................16
Item 3: Quantitative and Qualitative Disclosures About Market Risk......................28
Item 4: Controls and Procedures.........................................................28
PART II: OTHER INFORMATION
Item 1: Legal Proceedings...............................................................29
Item 2: Changes in Securities and Use of Proceeds.......................................29
Item 3: Defaults upon Senior Securities.................................................29
Item 4: Submission of Matters to a Vote of Security Holders.............................29
Item 5: Other Information...............................................................29
Item 6: Exhibits and Reports on Form 8-K................................................29
SIGNATURES............................................................................................31
2
PART I:.FINANCIAL INFORMATION
Item 1: Financial Statements
SPAR Group, Inc.
Consolidated Balance Sheets
(In thousands, except share and per share data)
June 30, December 31,
2004 2003
-------- --------
(Unaudited) (Note)
Assets
Current assets:
Accounts receivable, net $ 7,743 $ 13,942
Prepaid expenses and other current assets 310 415
Deferred income taxes - 1,305
-------- --------
Total current assets 8,053 15,662
Property and equipment, net 1,751 2,099
Goodwill 798 8,749
Deferred income taxes - 434
Other assets 448 926
-------- --------
Total assets $ 11,050 $ 27,870
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 2,083 $ 1,445
Accrued expenses and other current liabilities 1,192 4,350
Accrued expenses, due to affiliates 1,296 996
Restructuring charges, current - 685
Customer deposits 932 17
Line of credit, short-term 1,856 4,084
-------- --------
Total current liabilities 7,359 11,577
Other long-term liabilities 513 270
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 - June 30, 2004 and
December 31, 2003 189 189
Treasury stock (213) (384)
Accumulated other comprehensive loss (3) (7)
Additional paid-in capital 11,197 11,249
Accumulated (deficit) retained earnings (7,992) 4,976
-------- --------
Total stockholders' equity 3,178 16,023
-------- --------
Total liabilities and stockholders' equity $ 11,050 $ 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 Six Months Ended
--------------------- ---------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
-------- -------- -------- --------
Net revenues $ 11,933 $ 17,351 $ 24,736 $ 36,090
Cost of revenues 8,716 11,146 17,411 22,397
-------- -------- -------- --------
Gross profit 3,217 6,205 7,325 13,693
Selling, general and administrative expenses 5,577 4,768 10,545 9,711
Impairment charges 8,141 - 8,141 -
Depreciation and amortization 369 399 730 777
-------- -------- -------- --------
Operating (loss) income (10,870) 1,038 (12,091) 3,205
Interest expense 64 72 98 140
Other expense (income) 7 (10) 8 28
-------- -------- -------- --------
(Loss) income before provision for income taxes (10,941) 976 (12,197) 3,037
Provision for income taxes 1,236 368 771 1,151
-------- -------- -------- --------
Net (loss) income $(12,177) $ 608 $(12,968) $ 1,886
======== ======== ======== ========
Basic/diluted net (loss) income per common share:
Net (loss) income - basic/diluted $ (0.65) $ 0.03 $ (0.69) $ 0.10
======== ======== ======== ========
Weighted average common shares - basic 18,859 18,858 18,859 18,850
======== ======== ======== ========
Weighted average common shares - diluted 18,859 19,538 18,859 19,447
======== ======== ======== ========
See accompanying notes.
4
SPAR Group, Inc.
Consolidated Statements of Cash Flows
(unaudited) (In thousands)
Six Months Ended
---------------------
June 30, June 30,
2004 2003
-------- --------
Operating activities
Net (loss) income $(12,968) $ 1,886
Adjustments to reconcile net (loss) income to net cash provided
by (used in) operating activities:
Impairment charges 8,141 -
Deferred tax asset adjustments 729 -
Depreciation 730 777
Changes in operating assets and liabilities:
Accounts receivable 6,199 (2,089)
Prepaid expenses and other assets 515 (630)
Accounts payable, accrued expenses, other current
liabilities and customer deposits (561) (332)
Accrued expenses due to affiliates 300 577
Restructuring charges - (817)
-------- --------
Net cash provided by (used in) operating activities 3,085 (628)
Investing activities
Purchases of property and equipment (824) (966)
Acquisition of businesses (399) (436)
-------- --------
Net cash used in investing activities (1,223) (1,402)
Financing activities
Net (payments) borrowings on line of credit (2,228) 6,500
Other long-term liabilities 243 -
Proceeds from employee stock purchase plan and exercised options 119 32
Payments to certain stockholders - (3,951)
Purchase of treasury stock - (551)
Translation gain 4 -
-------- --------
Net cash (used in) provided by financing activities (1,862) 2,030
Net change in cash - -
Cash at beginning of period - -
-------- --------
Cash at end of period $ - $ -
======== ========
Supplemental disclosure of cash flow information
Interest paid $ 103 $ 111
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 2003 on Form
10-K for the 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"). The Company's results of operations for the interim periods are not
necessarily indicative of its operating results for the entire year.
2. Impairment Charges
Goodwill:
In April 2004, the Company's largest customer announced that they signed
definitive agreements for the sale of its business to two purchasers. The sale
was completed on August 2, 2004. This customer accounted for 35.9% and 32.7% of
the Company's net revenues for the six months ended June 30, 2004 and 2003,
respectively and 29.9% of the Company's revenues for the year ended December 31,
2003. This customer was the last remaining profitable business that resulted
from the PIA acquisition on July 9, 1999.
At March 31, 2004, the Company had $7.6 million of goodwill related to the
acquisition of PIA. As a result of the loss of this major client, the Company
has recorded an impairment of the PIA related goodwill resulting in a non-cash
charge of $7.6 million to the results of operations for the three months ending
June 30, 2004. Also, in connection with the PIA acquisition, certain deferred
tax assets related to PIA net operating loss carry forward benefits were
recognized as an adjustment to goodwill. The Company also recorded as an
impairment charge, a $750,000 valuation allowance on these deferred tax assets.
At March 31, 2004, the Company had approximately $2.1 million accrued for
restructure costs and PIA merger related costs. As a result of the PIA business
impairment, the Company evaluated these accruals and determined that only $0.4
million is required. The Company applied the $1.7 million ($1.4 million net of
the tax effect) reduction in PIA related acquisition liabilities against
impairment charges during the quarter ended June 30, 2004.
6
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
In June 2003, the Company acquired its Canadian operations. In connection
with the acquisition, the Company recorded goodwill of $712,000. At the time of
acquisition, it was expected that the Canadian subsidiary would be profitable.
However, the Canadian subsidiary has operated at a loss since its acquisition.
It is also expected that the Canadian subsidiary will incur a loss for the year
ending December 31, 2004. As a result of the continued losses and the failure to
attract new customers the Company has recorded an impairment of the related
goodwill resulting in a non-cash charge of $712,000 for the three months ending
June 30, 2004.
Capitalized Internal Use Software Development Costs:
Historically, the Company has capitalized costs of computer software
developed for internal use. Some of the costs capitalized were associated with
certain clients to whom the Company no longer provides merchandising services.
As a result of the loss of these clients, the Company recorded an impairment
charge for the net book value of internally developed software costs of
approximately $442,000 for the three months ended June 30, 2004.
Other Assets:
In addition to the above, the Company has recorded impairment of other
assets totaling $68,000 for the three months ending June 30, 2004.
3. Management's Plans Concerning Cash Flow
Management believes that based upon the Company's cost saving initiatives
(outlined in Note 4 Restructuring Charges) 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 6 Line 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.
4. Restructuring Charges
In 1999, in connection with the PIA merger, 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.) At March 31, 2004, the Company had previously
recorded PIA related restructuring reserves for equipment and office lease
settlements totaling $685,000. At June 30, 2004, the Company evaluated its
restructuring reserves and determined that the restructuring reserves were no
longer necessary (See Note 2 Impairment Charges).
7
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
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 consist of personnel reductions and related expenses, office
closings and restructuring or abandoning of equipment leases. In July 2004, the
Company implemented several of the savings initiatives and will continue to
implement certain others over the next several months. As a result of the July
restructuring, the Company estimates it will incur charges of approximately
$200,000 for severance benefits and approximately $500,000 for equipment and
office leases that the Company will cease using in the quarter ending September
30, 2004 or thereafter. The Company will continue to evaluate cost saving
opportunities and expects to incur additional restructuring costs in the future.
5. Earnings Per Share
The following table sets forth the computations of basic and diluted
earnings (loss) per share (in thousands, except per share data):
Three Months Ended Six Months Ended
----------------------- -----------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
-------- -------- -------- --------
Numerator:
Net (loss) income $(12,177) $ 608 $(12,968) $ 1,886
Denominator:
Shares used in basic earnings
(loss) per share calculation 18,859 18,858 18,859 18,850
Effect of diluted securities:
Employee stock options - 680 - 597
-------- -------- -------- --------
Shares used in diluted earnings
(loss) per share calculation 18,859 19,538 18,859 19,447
======== ======== ======== ========
Basic and diluted earnings (loss)
per common share:
Net (loss) income - basic and $ (0.65) $ 0.03 $ (0.69) $ 0.10
diluted
======== ======== ======== ========
The computation of dilutive loss per share excluded anti-dilutive stock
options to purchase 370,000 shares and 795,000 shares for three months and six
months ending June 30, 2004, respectively.
8
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
6. Line 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 provided a $15.0
million revolving credit facility that matures on January 23, 2006. The Credit
Facility allowed 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). On May 17, 2004, the Credit Facility was
amended to among other things, reduce the revolving credit facility from $15.0
million to $10.0 million, change the interest rate and increase certain reserves
against collateral. The amendment provides for interest to be charged at a rate
based in part upon the earnings before interest, tax, depreciation and
amortization. At June 30, 2004, the Credit Facility bears interest at Webster's
"Alternative Base Rate" plus 0.75% (a total of 5.25% per annum), or LIBOR plus
3.25%. The Credit Facility is secured by all of the assets of the Company and
its subsidiaries. In connection with the May 17, 2004 amendment, Mr. Robert
Brown, a Director, the Chairman, President, 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, provided personal guarantees
totaling $1.0 million to Webster. On August 20, 2004 the Credit Facility was
further amended in connection with the waiver of certain covenant violations
(see below). The amendment, among other things, reduces the revolving credit
facility from $10.0 million to $7.0 million, changes the covenant compliance
testing for certain covenants from quarterly to monthly and reduces certain
advance rates. The amendment does not change the future covenant levels.
Therefore, the Company expects to be in violation of certain covenants in the
future. Webster has issued waivers for past covenant violations, however, there
can be no assurances that Webster will issue such waivers in the future.
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. Except for the
capital expenditure limitation, the Company was not in compliance with such
financial covenants at June 30, 2004. The Company has secured a waiver from
Webster for those items of non-compliance (see above).
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
June 30, 2004, and December 31, 2003, in accordance with EITF 95-22.
The revolving loan balances outstanding under the Credit Facility were
$1.9 million and $4.1 million at June 30, 2004, and December 31, 2003,
respectively. There were letters of credit outstanding under the Credit Facility
of $0.7 million at June 30, 2004 and December 31, 2003. As of June 30, 2004, the
SPAR Group had unused availability under the Credit Facility of $2.0 million out
of the remaining maximum $4.2 million unused revolving line of credit (as
adjusted by the August 20, 2004 amendment) after reducing the borrowing base by
the outstanding loans and letters of credit.
9
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
7. Related-Party Transactions
Mr. Robert G. Brown, a Director, the Chairman, President and Chief
Executive Officer and a major stockholder of the Company, and Mr. William H.
Bartels, a Director, the Vice Chairman and a major stockholder of the Company
(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").
SMS provided approximately 99% of the Company's field representatives in
the United States (through its independent contractor field force), and SMSI
provided approximately 92% of the Company's field management in the United
States at June 30, 2004. 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 6,200 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 62 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 to concessions that reduced the Company's costs
by approximately $89,000 and $234,000 for the three and six month periods ended
June 30, 2004, respectively. The SMS Principals 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, 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 three and six month periods ended June 30, 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 three and six month
periods ended June 30, 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.
10
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
The following transactions occurred between the SPAR Companies and the
above affiliates (in thousands):
Three Months Ended Six Months Ended
-------------------- --------------------
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
------- ------- ------- -------
Services provided by affiliates:
SMS: Independent contractor field
services $ 5,397 $ 7,257 $11,758 $14,954
======= ======= ======= =======
SMSI: Field management services $ 1,280 $ 1,859 $ 2,634 $ 3,775
======= ======= ======= =======
SIT: Internet and computer
programming services $ 334 $ 476 $ 715 $ 882
======= ======= ======= =======
Reimbursed costs from affiliates: $ 27 $ 52 $ 63 $ 108
======= ======= ======= =======
Accrued expenses due to affiliates (in thousands):
June 30,
-------------------
2004 2003
------- ------
SMS $ 1,296 $1,535
======= ======
8. 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.
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. For disclosure
purposes, the compensation cost for the Company's option grants that were
awarded 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):
Six Months Ended
-----------------------
June 30, June 30,
2004 2003
-------- --------
Net (loss) income, as reported $(12,968) $ 1,886
-------- --------
Stock based employee compensation expense
under the fair market value method $ 342 $ 907
-------- --------
Adjusted pro forma net (loss) income $(13,310) $ 979
Basic and diluted net (loss) income per share, as reported $ (0.69) $ 0.10
Basic and diluted adjusted pro forma net (loss) income $ (0.71) $ 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.
For the six months ended June 30, 2004, there was a recovery of amounts
previously expensed of approximately $60,000 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 of the stock from December 31, 2003 to June 30, 2004. 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.
12
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
9. Treasury Stock
The Company utilized 33,148 of repurchased shares to issue stock for the
exercise of stock options during the six months ended June 30, 2004. As of June
30, 2004, the Company has 42,908 shares of treasury stock, which it acquired at
a cost of approximately $213,000. Currently, the Company has no stock repurchase
program in place.
10. 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.
Also in connection with the sale, 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. In December
of 2003, SPGI changed its name to STIMULYS, Inc. On April 30, 2004, as a result
of various defaults by STIMULYS, the Company amended the discretionary line of
credit by eliminating advances in excess of STIMULYS' borrowing base and
reducing the maximum amount of the revolving line to the greater of $1.0 million
or the borrowing base. Under the SPGI Revolver terms, STIMULYS is required to
deposit all of its cash receipts to the Company's lock box.
At June 30, 2004, there was approximately $0.9 million advanced under the
SPGI Revolver and $70,000 in outstanding letters of credit, while the borrowing
base was approximately $0.9 million. Due to the speculative nature of the SPGI
Revolver, the Company has a reserve of approximately $750,000 against the SPGI
Revolver at June 30, 2004.
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
STIMULYS and is, therefore, required to consolidate STIMULYS in its financial
statements. However, the Company has been unable to perform accounting
procedures necessary to include STIMULYS in the consolidated financial
statements, as required by FIN 46, and has been unable to obtain the necessary
permission from STIMULYS to include that organization in the Company's
consolidated financial statements. At June 30, 2004, the Company's maximum loss
exposure is $220,000, which represents the amounts outstanding under the
revolving line of credit and the letter of credit in excess of the $750,000
reserve. The Company's maximum potential loss exposure resulting
13
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
from the revolving line of credit agreement with STIMULYS is limited to
$250,000, which is the $1.0 million revolving line of credit less the $750,000
reserve.
11. Income Taxes
As a result of the loss of several significant clients, current year losses and
the lack of certainty of a return to profitability in the next twelve months,
the Company has reversed the $465,000 tax benefit recorded in the quarter ended
March 31, 2004. In addition, the Company has recorded a full valuation allowance
against its net deferred tax assets resulting in a charge totaling approximately
$729,000 for the three months ending June 30, 2004.
12. Customer Deposits
In June 2004, the Company received a non-refundable deposit of $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.
13. Contingencies/Joint Venture Guarantee
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 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 June 30, 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 June 30,
2004 would be 50 million Yen or approximately $0.5 million. The Company has
recorded approximately $0.3 million in long-term liabilities for its share of
the cumulative losses associated with this joint venture.
Legal Matters
On October 24, 2001, Safeway Inc., a former customer of the PIA Merchandising
Co., Inc. and Pivotal Sales Company, filed a complaint alleging damages of
approximately $3.6 million plus interest and costs and alleged punitive damages
in an unspecified amount against the Company in Alameda County Superior Court,
California, Case No. 2001028498 with respect to (among other things) alleged
breach of contract. On or about December 30, 2002, the Court approved the filing
of Safeway Inc.'s Second Amended Complaint, which alleges causes of action for
(among other things) breach of contract against the Company, PIA Merchandising
Co., Inc. and Pivotal Sales Company. The Second Amended Complaint was filed with
the Court on January 13, 2003, and does not specify the amount of monetary
damages sought. No punitive or exemplary damages are sought in Safeway Inc.'s
Second Amended Complaint. This case is being vigorously contested by the
Company.
14
SPAR Group, Inc.
Notes to Consolidated Financial Statements
(unaudited) (continued)
The Company is a party to various legal actions and administrative proceedings
arising in the normal course of business. In the opinion of Company management,
disposition of these matters are not anticipated to have a material adverse
effect on the financial position, results of operations or cash flows of the
Company.
14. Geographic Data
A summary of the Company's net revenue, operating income and long lived assets
by geographic area for the three and six month periods ending June 30, 2004 is
as follows (in thousands):
Three Months Ending Six Months Ending
-------- --------
June 30, June 30,
2004 2004
-------- --------
Net revenue:
United States $ 10,568 $ 23,231
International $ 1,365 $ 1,505
Operating income:
United States $(10,395) $(11,258)
International $ (475) $ (833)
Long lived assets as of June 30, 2004:
United States $ 1,555
International $ 196
No one international geographic market is greater than 10% of consolidated net
revenue.
15
SPAR Group, Inc.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
Statements contained in this Quarterly Report on Form 10-Q for the six
months ended June 30, 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, convenience stores and grocery stores in the
United States. The International Division, established in July 2000, currently
provides merchandising services in Japan, Canada, Turkey and South Africa.
16
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, convenience stores 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, 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. 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 established a joint venture in South Africa. The joint venture
is headquartered in Durban and is owned 51% by the Company. In April 2004, the
Company announced the establishment of a joint venture in India with plans to
start operations during the third quarter. 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 capitalized internal
use software development costs:
17
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 $589,000 and $515,000 at June 30, 2004 and December 31,
2003, respectively. The Company also recorded a sales allowance of $37,000 and
$448,000 at June 30, 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 $362,808 and $541,042 of costs related to
software developed for internal use in the six months ended June 30, 2004 and
2003, respectively.
The Company also recorded a net impairment charge of capitalized
software related to lost clients totaling approximately $442,000 in the
three-month period ending June 30, 2004.
18
SPAR Group, Inc.
Results of Operations
Three months ended June 30, 2004, compared to three months ended June 30, 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
--------------------------------------------------------------------
June 30, 2004 June 30, 2003
----------------------- -----------------------
(Decrease)
Amount % Amount % Increase %
--------- --------- --------- --------- ---------
Net revenues $ 11,933 100.0% $ 17,351 100.0% (31.2)%
Cost of revenues 8,716 73.0 11,146 64.2 (21.8)
Selling, general and administrative expense 5,577 46.7 4,768 27.4 17.0
Impairment charges 8,141 68.2 - - -
Depreciation and amortization 369 3.1 399 2.3 (7.5)
Interest expense 64 0.6 72 0.4 (11.1)
Other expense (income) 7 0.1 (10) (0.1) (170.0)
--------- --------- --------- ---------
(Loss) income before provision for income taxes (10,941) (91.7) 976 5.6 (1,221.0)
Provision for income tax 1,236 10.4 368 2.1 235.9
--------- --------- --------- ---------
Net (loss) income $(12,177) (102.0)% $ 608 3.5% (2,102.8)%
========= ========= ========= =========
Net revenues for the three months ended June 30, 2004, were $11.9
million, compared to $17.4 million for the three months ended June 30, 2003, a
decrease of 31.2%. The decrease in net revenues resulted primarily from reduced
business from the Company's largest customer, which was in the process of being
sold during the quarter, as well as the loss of two other large clients.
One customer, a division of a major retailer, accounted for 27.5% and
36.9% of the Company's net revenues for the three months ended June 30, 2004 and
2003, respectively. This customer also accounted for approximately 18.0% and
41.2% of accounts receivable at June 30, 2004 and 2003, respectively. In April
2004, the customer's parent company announced that they signed definitive
agreements for the sale
19
SPAR Group, Inc.
of this business to two purchasers. The sale was completed on August 2, 2004.
The loss of this business will have a material adverse effect on the Company's
business, results of operations and financial condition.
For the three months ended June 30, 2004, a second customer accounted
for 10.3% of net revenue. This customer also accounted for approximately 18.9%
of accounts receivable at June 30, 2004.
For the three months ended June 30, 2003, a third and fourth customer
accounted for 8.0% and 4.8% respectively of net revenue. The Company no longer
provides services to these customers.
In addition, approximately 15% of the Company's net revenues for the
three months ended June 30, 2004 and 2003 resulted from merchandising services
performed for manufacturers and others at Kmart. Kmart filed for protection
under the U.S. Bankruptcy Code in January 2002 and emerged from bankruptcy in
May 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 or agreements 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.
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 73.0% for the
three months ended June 30, 2004, compared to 64.2% for the three months ended
June 30, 2003. The increase is primarily a result of additional costs associated
with its per unit fee revenue programs and reduced pricing to a large customer.
The Company is currently in the process of reducing its field structure to
reflect its reduction of business.
Approximately 76.3% and 81.8% of the Company's cost of revenue in the
three months ended June 30, 2004 and 2003, respectively, resulted from in-store
independent contractor and field management services purchased from the
Company's affiliates, SPAR Marketing Services, Inc. ("SMS"), and SPAR Management
Services, Inc. ("SMSI"), respectively (see Note 7 to the Financial Statements in
this Quarterly Report).
Operating expenses include selling, general and administrative
expenses, impairment charges and 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):
20
Three Months Ended
---------------------------------------------------------------------------
Increase
June 30, 2004 June 30, 2003 (Decrease)
--------------------------- -------------------------- --------------
Amount % Amount % %
------ - ------ - -
Selling, general and administrative $ 5.6 46.7% $ 4.8 27.4% 17.0%
Impairment charges 8.1 68.2% - - -
Depreciation and amortization 0.4 3.1% 0.4 2.3% (7.5)%
Selling, general and administrative expenses were $5.6 million for the
three months ended June 30, 2004, compared to $4.8 million for the three months
ended June 30, 2003, an increase of $0.8 million or 17.0%. The increase of $0.8
million consists of a one-time charge of $0.5 million resulting from the
settlement of a client claim and approximately $0.6 million of international
selling, general and administrative costs acquired in 2004, offset by domestic
reductions of $0.3 million. The Company is currently in the process of reducing
its selling, general and administrative cost structure to reflect its reduction
of business.
Impairment charges were $8.1 million for the three months ended June
30, 2004. Impairment charges consisted of $9.0 million of goodwill impairment,
offset by adjustments to other liabilities of $1.0 million and restructuring
charges of $0.7 million, net of a $0.3 million tax effect, $0.4 million of net
impairment of software development costs previously capitalized and $0.1 million
for impairment of other assets.
Depreciation and amortization costs of $0.4 million for the three
months ended June 30, 2004, were consistent with the prior year.
Other Expense (Income)
Other expense represents the Company's share in the Japanese joint
venture loss totaling approximately $7,000 for the three months ended June 30,
2004.
Income Taxes
The Company recorded an income tax provision of $1.2 million for the
three months ended June 30, 2004. The provision was primarily a result of the
establishment of a valuation reserve for the deferred tax assets previously
recorded by the Company totaling $0.7 million, a reversal of the $0.5 million
tax benefit previously recorded in the quarter ending March 31, 2004 and
estimated minimum taxes due. For the three months ended June 30, 2003, the
income tax provision represents a combined federal and state income tax rate of
38%.
Net Income
The Company had a net loss of $12.2 million for the three months ended
June 30, 2004, or $(0.65) per diluted share, compared to net income of $0.6
million, or $0.03 per diluted share, for the corresponding period last year.
21
SPAR Group, Inc.
Results of Operations
Six months ended June 30, 2004, compared to six months ended June 30, 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):
Six Months Ended
--------------------------------------------------------------------------------
June 30, 2004 June 30, 2003
% Incr.
Amount % Amount % (Decr.)
---------------- --------------- ----------------- -----------------
Net revenues $ 24,736 100.0% $ 36,090 100.0% (31.5)%
Cost of revenues 17,411 70.4 22,397 62.1 (22.3)
Selling, general, and administrative expense 10,545 42.6 9,711 26.9 8.6
Impairment charges 8,141 32.9 - - -
Depreciation and amortization 730 3.0 777 2.1 (6.1)
Interest expense 98 0.4 140 0.4 (30.0)
Other expense (income) 8 0.0 28 0.1 (71.4)
---------------- --------------- ----------------- -----------------
(Loss) income before provision for income taxes (12,197) (49.3) 3,037 8.4 (501.6)
Provision for income taxes 771 3.1 1,151 3.2 33.0
---------------- --------------- ----------------- -----------------
Net (loss) income $ (12,968) (52.4)% $ 1,886 5.2% (787.6)%
================ =============== ================= =================
Net revenues from operations for the six months ended June 30, 2004,
were $24.7 million, compared to $36.1 million for the six months ended June 30,
2003, a decrease of 31.5%. The decrease in net revenues resulted primarily from
reduced business from the Company's largest customer, which was in the process
of being sold, decreased project revenue from another client and the loss of two
other large clients.
One customer accounted for 35.9% and 32.7% of the Company's net
revenues for the six months ended June 30, 2004 and 2003, respectively. This
customer also accounted for approximately 18.0% and 41.2% of accounts receivable
at June 30, 2004, and 2003, respectively. In April 2004, the customer's parent
company announced that they signed definitive agreements for the sale of this
business to two
22
SPAR Group, Inc.
purchasers. The sale was completed on August 2, 2004. The loss of this business
will have a material adverse effect on the Company's business, results of
operations and financial condition.
For the six months ended June 30, 2004, a second customer accounted for
8.4% of net revenue. This customer also accounted for approximately 18.9% of
accounts receivable at June 30, 2004. For the six months ended June 30, 2003, a
third and fourth customer accounted for 9.8% and 5.0% respectively of net
revenue. The Company no longer provides services to these customers.
Approximately 15% and 16% of the Company's net revenues for the six
months ended June 30, 2004, and 2003, respectively, resulted from merchandising
services performed at Kmart for various customers. Kmart filed for protection
under the U.S. Bankruptcy Code in January 2002 and emerged from bankruptcy in
May 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 or agreements are with various manufacturers and not this
retailer, a significant reduction of this retailer's stores or cessation of this
retailer's business would negatively impact the Company.
Cost of revenues consists of field 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 70.4% for the six months ended June
30, 2004, compared to 62.1% for the six months ended June 30, 2003. The increase
is primarily a result of additional costs associated with its per unit fee
revenue programs and reduced pricing to a large customer. The Company is
currently in the process of reducing its field structure to reflect its
reduction in business.
Approximately 82.7% and 83.6% of the Company's costs of revenue in the six
months ended June 30, 2004, and 2003, respectively, resulted from field in-store
independent contractor and field management services purchased from the
Company's affiliates, SMS, and SMSI, respectively (see Note 7 to the Financial
Statements in this Quarterly Report).
Operating expenses include selling, general and administrative
expenses, impairment charges and depreciation and amortization. Selling, general
and administrative expenses include corporate overhead, project management,
information technology, executive compensation, human resources 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):
Six Months Ended
------------------------------------------------------------------------
Incr.
June 30, 2004 June 30, 2003 (Decr.)
--------------------------- -------------------------- -----------
Amount % Amount % %
------ --- ------ --- ---
Selling, general and administrative $ 10.5 42.6% $ 9.7 26.9% 8.6%
Impairment charge 8.1 32.9% - - -
Depreciation and amortization 0.7 3.0% 0.8 2.1% (6.1)%
Selling, general and administrative expenses were $10.5 million for the
six months ended June 30, 2004, compared to $9.7 million for the six months
ended June 30, 2003, an increase of $0.8 million or 8.6%. The increase consists
of a one time charge of $0.5 million resulting from the settlement of a
23
SPAR Group, Inc.
client claim and approximately $0.7 million of international and $0.2 million of
in-store demonstration selling, general and administrative costs acquired in
2004, offset by domestic reductions of approximately $0.6 million. The Company
is currently in the process of reducing its selling, general and administrative
cost structure to reflect its reduction of business.
Impairment charges were $8.1 million for the six months ended June 30,
2004. Impairment charges consisted of $9.0 million of goodwill impairment,
offset by reductions to the other liabilities for PIA merger related costs of
$1.0 million and PIA restructuring charges of $0.7 million, net of a $0.3
million tax effect, $0.4 million of net impairment of software development costs
previously capitalized and $0.1 million for impairment of other assets.
Depreciation and amortization costs of $0.7 million for the first six
months ended June 30, 2004, were comparable to depreciation and amortization
costs of $0.8 million for the six months ended June 30, 2003.
Other Expense (Income)
Other expense represents the Company's share in the Japanese joint
venture loss totaling approximately $8,000 for the six months ended June 30,
2004.
Income Taxes
The Company recorded an income tax provision of $0.8 million for the
six months ended June 30, 2004. The provision was primarily a result of the
establishment of a valuation reserve for net deferred tax assets previously
recorded by the Company and estimated minimum taxes due. For the six months
ended June 30, 2003 the income tax provision represents a combined federal and
state income tax rate of 38%.
Net Income
The Company had a net loss of $13.0 million for the six months ended
June 30, 2004, or $(0.69) per diluted share compared to net income of $1.9
million or $0.10 per diluted share for the corresponding period last year.
Liquidity and Capital Resources
In the six months ended June 30, 2004, the Company had a net loss of
$13.0 million. Included in the net loss were non-cash charges of $8.1 million
for impairment, $0.7 million for deferred tax asset valuation adjustments and
$0.7 million for depreciation and amortization.
Net cash provided by operating activities for the six months ended June
30, 2004, was $3.1 million, compared with net cash used in operations of $0.6
million for the six months ended June 30, 2003. The increase in cash provided by
operating activities was primarily a result of decreases in accounts receivable,
prepaid expenses and other assets and increases in customer deposits and accrued
expenses due to affiliates
24
SPAR Group, Inc.
significantly offset, by net operating losses, decreases in accounts
payable, accrued expenses and other current liabilities.
Net cash used in investing activities of $1.2 million for the six
months ended June 30, 2004, was comparable to net cash used in investing
activities of $1.4 million for the six months ended June 30, 2003.
Net cash used in financing activities for the six months ended June 30,
2004, was $1.9 million, compared with net cash provided by financing activities
of $2.0 million for the six months ended June 30, 2003. The increase of net cash
used in financing activities 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 six months ended June 30, 2004, as the Company utilizes excess cash to
pay down its line of credit.
At June 30, 2004, the Company had positive working capital of $0.7
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 operating losses,
decreases in accounts receivable, accounts payable and accrued expenses. The
Company's current ratio was 1.09 at June 30, 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 provided a
$15.0 million revolving credit facility that matures on January 23, 2006. The
Credit Facility allowed 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). On May 17, 2004, the Credit Facility was
amended to among other things, reduce the revolving credit facility from $15.0
million to $10.0 million, change the interest rate and increase the reserves
against collateral. The amendment provides for interest to be charged at a rate
based in part upon the earnings before interest, tax, depreciation and
amortization. At June 30, 2004, the Credit Facility bears interest at Webster's
"Alternative Base Rate" plus 0.75% (a total of 5.25% per annum), or LIBOR plus
3.25%. The Credit Facility is secured by all of the assets of the Company and
its subsidiaries. In connection with the May 17, 2004 amendment, 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, provided personal guarantees
totaling $1.0 million to Webster. On August 20, 2004 the Credit Facility was
further amended in connection with the waiver of certain covenant violations
(see below). The amendment, among other things, reduces the revolving credit
facility from $10.0 million to $7.0 million, changes the covenant compliance
testing for certain covenants from quarterly to monthly and reduces certain
advance rates. The amendment does not change the future covenant levels.
Therefore, the Company expects to be in violation of certain covenants in the
future. Webster has issued waivers for past covenant violations, however, there
can be no assurances that Webster will issue such waivers in the future.
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
25
SPAR Group, Inc.
Facility. Except for the capital expenditure limitation, the Company was not in
compliance with such financial covenants at June 30, 2004. The Company has
secured a waiver from Webster for those items of non-compliance (see above).
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
June 30, 2004, and December 31, 2003, in accordance with EITF 95-22.
The revolving loan balances outstanding under the Credit Facility were
$1.9 million and $4.1 million at June 30, 2004 and December 31, 2003,
respectively. There were letters of credit outstanding under the Credit Facility
of $0.7 million at June 30, 2004, and December 31, 2003. As of June 30, 2004,
the SPAR Group had unused availability under the Credit Facility of $2.0 million
out of the remaining maximum $4.2 million unused revolving line of credit (as
adjusted by the August 20, 2004 amendment) after reducing the borrowing base by
outstanding loans and letters of credit.
Management believes that based upon the Company's cost saving
initiatives 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, 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.
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. In
December 2003, SPGI changed its name to STIMULYS, Inc. On April 30, 2004, as a
result of various defaults by STIMULYS, the Company amended the discretionary
line of credit by eliminating advances in excess of STIMULYS' borrowing base and
reducing the maximum amount of the revolving line to the greater of $1.0 million
or the borrowing base. At June 30, 2004, there was approximately $0.9 million
borrowed under the SPGI Revolver and $70,000 in outstanding letters of credit.
Under the SPGI Revolver terms, STIMULYS is required to deposit all of its cash
receipts to the Company's lock box.
26
SPAR Group, Inc.
Certain Contractual Obligations
The following table contains a summary of certain of the Company's
contractual obligations by category as of June 30, 2004 (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 $1,856 $1,856 $ - $ - $ -
- --------------------------------------------------------------------------------------------------------------------
Operating Lease Obligations 1,751 828 884 39 -
- --------------------------------------------------------------------------------------------------------------------
Total $3,607 $2,684 $884 $ 39 $ -
- --------------------------------------------------------------------------------------------------------------------
In addition to the above table, the Company had agreed to provide a
discretionary line of credit to STIMULYS not to exceed the greater of $1.0
million or the borrowing base through September 30, 2005. Outstanding loans to
SPGI under the discretionary line of credit totaled approximately $0.9 million
at June 30, 2004.
The Company also had $0.7 in outstanding Letters of Credit at June 30,
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 to make a payment on its guarantee to the bank, 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 June 30, 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 June 30,
2004, would be 50 million Yen or approximately $0.5 million.
27
SPAR Group, Inc.
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 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.
Currently, the Company does not believe the risk related to foreign
currency exchange rates is 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 second quarter of 2004.
28
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 Waiver and Amendment No. 5 to Third Amended and Restated
Revolving Credit and Security Agreement among Webster Business
Credit Corporation, SPAR Group, Inc., and certain of its
subsidiaries dated as of August 20, 2004, as filed herewith.
10.2 Change in Control Severance Agreement between Kori Belzer and
SPAR Group, Inc., dated as of August 12, 2004, as filed
herewith.
10.3 Change in Control Severance Agreement between Patricia Franco
and SPAR Group, Inc., dated as of August 12, 2004, 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.
29
SPAR Group, Inc.
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 May 26, 2004,
respecting the Waiver And Amendment No. 3 To Third Amended And
Restated Revolving Credit And Security Agreement entered into
as of March 26, 2004, and the Joinder, Waiver And Amendment
No. 4 to Third Amended and Restated Revolving Credit And
Security Agreement entered into as of May 17, 2004.
2. Periodic Report on Form 8-K, dated May 18, 2004, filed with
the U.S. Securities and Exchange Commission on May 27, 2004,
respecting the adoption of each of (i) the Amended and
Restated By-Laws of the Company; (ii) the Amended and Restated
Charter of the Audit Committee of the Board of Directors of
the Company; (iii) the Charter of the Compensation Committee
of the Board of Directors of the Company; (iv) the Charter of
the Governance Committee of the Board of Directors of the
Company; (v) the SPAR Group, Inc. Statement of Policy
Respecting Stockholder Communications with Directors; and (vi)
the SPAR Group, Inc. Statement of Policy Regarding Director
Qualifications and Nominations.
3. Periodic Report on Form 8-K, dated August 23, 2004, filed with
the U.S. Securities and Exchange Commission on August 23,
2004, respecting the earnings press release for the second
quarter ended June 30, 2004.
30
SPAR Group, Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 23, 2004 SPAR Group, Inc., Registrant
By: /s/ Charles Cimitile
---------------------------------------
Charles Cimitile
Chief Financial Officer and duly
authorized signatory
31