10-K 1 form10k-12312004.txt DECEMBER 31, 2004 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _________________________ FORM 10-K FOR ANNUAL AND TRANSITIONAL REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 2004 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from to Commission file number 0-27824 SPAR GROUP, INC. (Exact name of registrant as specified in its charter) Delaware 33-0684451 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 580 White Plains Road, Tarrytown, New York 10591 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (914) 332-4100 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to section 12(g) of the Act: Common Stock, par value $.01 per share Indicate by check mark 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 twelve 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. YES [X] NO [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K . [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Rule 12b-2 of the Act.) YES [ ] NO [X] The aggregate market value of the Common Stock of the Registrant held by non-affiliates of the Registrant on June 30, 2004, based on the closing price of the Common Stock as reported by the Nasdaq Small Cap Market on such date, was approximately $4,799,006. The number of shares of the Registrant's Common Stock outstanding as of December 31, 2004, was 18,858,972 shares. DOCUMENTS INCORPORATED BY REFERENCE None. SPAR GROUP, INC. ANNUAL REPORT ON FORM 10-K INDEX PART I Page Item 1. Business 2 Item 2. Properties 14 Item 3. Legal Proceedings 15 Item 4. Submission of Matters to a Vote of Security Holders 15 PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 16 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 7A. Quantitative and Qualitative Disclosures about Market Risk 26 Item 8. Financial Statements and Supplementary Data 26 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 26 Item 9A. Controls and Procedures 26 Item 9B. Other Information 27 PART III Item 10. Directors and Executive Officers of the Registrant 28 Item 11. Executive Compensation and Other Information of SPAR Group, Inc. 31 Item 12. Security Ownership of Certain Beneficial Owners and Management 35 Item 13. Certain Relationships and Related Transactions 36 Item 14. Principal Accountant Fees and Services 37 Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 38 Signatures 43 PART I Statements contained in this Annual Report on Form 10-K 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 headings "Business" and "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 herein and any other cautionary statements contained in this Annual Report on Form 10-K. 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 this Annual Report on Form 10-K. 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. Item 1. Business. GENERAL The SPAR Group, Inc., a Delaware corporation ("SGRP"), and its subsidiaries (together with SGRP, the "SPAR Group" or the "Company"), is a supplier of merchandising and other marketing services throughout the United States and internationally. In 2002, the Company sold its Incentive Marketing Division, SPAR Performance Group, Inc. ("SPGI"). The Company's operations are divided into two divisions: the Domestic Merchandising Services Division and the International Merchandising Services Division. The Domestic Merchandising Services Division provides merchandising services, in-store event staffing, product sampling, database marketing, technology services, teleservices and marketing research to manufacturers and retailers in the United States. The various services are primarily performed in mass merchandisers, drug store chains, convenience and grocery stores. The International Merchandising Services Division established in July 2000, currently provides similar merchandising services through a wholly owned subsidiary in Canada, through 51% owned joint venture subsidiaries in India, South Africa and Turkey, and through a 50% owned joint venture in Japan. The Company recently established a 50% owned joint venture in China and a 51% owned joint venture subsidiary in Romania and expects to offer merchandising services in these countries in 2005. Continuing Operations 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 -2- 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. 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. In February 2005, the Company announced the establishment of a 50% owned joint venture headquartered in Hong Kong, China. Discontinued Operations Incentive Marketing Division As part of a strategic realignment in the fourth quarter of 2001, the Company made the decision to divest its Incentive Marketing Division, operating through its subsidiary, SPAR Performance Group, Inc. ("SPGI"). The Company explored various alternatives for the sale of SPGI and subsequently sold the business to SPGI's employees through the establishment of an employee stock ownership plan on June 30, 2002. In December of 2003, SPGI changed its name to STIMULYS, Inc. Technology Division In October 2002, the Company dissolved its Technology Division established in March 2000 for the purpose of marketing its proprietary Internet-based computer software. INDUSTRY OVERVIEW Domestic Merchandising Services Division According to industry estimates over two billion dollars are spent annually on domestic retail merchandising services. The merchandising services industry includes manufacturers, retailers, food brokers, and professional service merchandising companies. The Company believes there is a continuing trend for major manufacturers to move increasingly toward third parties to handle in-store merchandising. The Company also believes that its merchandising services bring added value to retailers, manufacturers and other businesses. Retail merchandising services enhance sales by making a product more visible and available to consumers. These services primarily include placing orders, shelf maintenance, display placement, reconfiguring products on store shelves, replenishing -3- products and providing in-store event staffing services. The Company provides other marketing services such as test market research, mystery shopping, teleservices, database marketing and promotion planning and analysis. The Company believes merchandising services previously undertaken by retailers and manufacturers have been increasingly outsourced to third parties. Historically, retailers staffed their stores as needed to ensure inventory levels, the advantageous display of new items on shelves, and the maintenance of shelf schematics. In an effort to improve their margins, retailers decreased their own store personnel and increased their reliance on manufacturers to perform such services. Initially, manufacturers attempted to satisfy the need for merchandising services in retail stores by utilizing their own sales representatives. However, manufacturers discovered that using their own sales representatives for this purpose was expensive and inefficient. Therefore, manufacturers have increasingly outsourced the merchandising services to third parties capable of operating at a lower cost by (among other things) serving multiple manufacturers simultaneously. Another significant trend impacting the merchandising segment is the tendency of consumers to make product purchase decisions once inside the store. Accordingly, merchandising services and in-store product promotions have proliferated and diversified. Retailers are continually remerchandising and remodeling entire stores to respond to new product developments and changes in consumer preferences. The Company estimates that these activities have increased in frequency over the last five years, such that most stores are re-merchandised or remodeled approximately every twenty-four months. Both retailers and manufacturers are seeking third parties to help them meet the increased demand for these labor-intensive services. International Merchandising Services Division The Company believes another current trend in business is globalization. As companies expand into foreign markets they will need assistance in marketing their products. As evidenced in the United States, retailer and manufacturer sponsored merchandising programs are both expensive and inefficient. The Company also believes that the difficulties encountered by these programs are only exacerbated by the logistics of operating in foreign markets. This environment has created an opportunity for the Company to exploit its Internet-based technology and business model that are successful in the United States. In July 2000, the Company established its International Merchandising Services Division to cultivate foreign markets, modify the necessary systems and implement the Company's business model worldwide by expanding its merchandising services business off shore. The Company formed an International Merchandising Services Division task force consisting of members of the Company's information technology, operations and finance groups to evaluate and develop foreign markets. In 2001, the Company and a leading Japanese based distributor established a joint venture to provide the latest in-store merchandising services to the Japanese market. In 2003, the Company expanded its international presence to Canada and Turkey by acquiring the business of a Canadian merchandising company and entering into a start-up joint venture subsidiary in Turkey. In 2004, the Company established 51% owned joint venture subsidiaries in South Africa, India and Romania and in early 2005 a 50% owned joint venture in China. Key to the Company's international strategy is the translation of several of its proprietary Internet-based logistical, communications and reporting software applications into the native language of any market the Company enters. As a result of this requirement for market penetration, the Company has developed translation software that can quickly convert its proprietary software into various languages. Through its computer facilities in Auburn Hills, Michigan, the Company provides worldwide access to its proprietary logistical, communications and reporting software. In addition, the Company maintains personnel in Greece and Australia to assist in its international efforts. The Company is actively pursuing expansion into various other markets. PIA ACQUISITION SPAR Acquisition, Inc., and its subsidiaries (the "SPAR Companies") are the original predecessor of the current Company and were founded in 1967. On July 8, 1999, the Company completed a reverse merger with the SPAR Companies (the "PIA Acquisition"), and then changed its name to SPAR Group, Inc., from PIA Merchandising Services, Inc. (prior to such merger, "PIA"). Pursuant to the PIA Acquisition, the SPAR Companies were deemed to have "acquired" PIA and its subsidiaries prior to the PIA Acquisition (the "PIA Companies") which was treated as a purchase of the PIA Companies for accounting purposes, with the books and records of the Company being adjusted to reflect the historical operating results of the SPAR Companies. -4- BUSINESS STRATEGY As the marketing services industry continues to grow, consolidate and expand both in the United States and internationally, large retailers and manufacturers are increasingly outsourcing their marketing needs to third-party providers. The Company believes that offering marketing services on a national and global basis will provide it with a competitive advantage. Moreover, the Company believes that successful use of and continuous improvements to a sophisticated technology infrastructure, including its proprietary Internet-based software, is key to providing clients with a high level of customer service while maintaining efficient, low cost operations. The Company's objective is to become an international retail merchandising and marketing service provider by pursuing its operating and growth strategy, as described below. Increased Sales Efforts: The Company is seeking to increase revenues by increasing sales to its current customers, as well as, establishing long-term relationships with new customers, many of which currently use other merchandising companies for various reasons. The Company believes its technology, field implementation and other competitive advantages will allow it to capture a larger share of this market over time. However, there can be no assurance that any increased sales will be achieved. New Products: The Company is seeking to increase revenues through the internal development and implementation of new products and services that add value to its customers' retail merchandising related activities, some of which have been identified and are currently being tested for feasibility and market acceptance. However, there can be no assurance that any new products of value will be developed or that any such new product can be successfully marketed. Acquisitions: The Company is seeking to acquire businesses or enter into joint ventures or other arrangements with companies that offer similar merchandising services both in the United States and worldwide. The Company believes that increasing its industry expertise, adding product segments, and increasing its geographic breadth will allow it to service its clients more efficiently and cost effectively. As part of its acquisition strategy, the Company is actively exploring a number of potential acquisitions, predominately in its core merchandising service businesses (which includes in-store event staffing services). Through such acquisitions, the Company may realize additional operating and revenue synergies and may leverage existing relationships with manufacturers, retailers and other businesses to create cross-selling opportunities. However, there can be no assurance that any of the acquisitions will occur or whether, if completed, the integration of the acquired businesses will be successful or the anticipated efficiencies and cross-selling opportunities will occur. In December of 2003, the Company entered into an agreement to purchase the business and certain assets of Bert Fife & Associates, Inc., and related Companies ("Fife"), which specialized in providing in-store product demonstrations. As part of the agreement the Company entered into a one year consulting agreement with the President of Fife. The purchase was completed in January 2004. In April 2004, the Company established a joint venture subsidiary in South Africa. The joint venture subsidiary is headquartered in Durban and is owned 51% by the Company. Also in April 2004, the Company announced the establishment of a joint venture subsidiary in India and started operations during the third quarter. The joint venture subsidiary is headquartered in New Delhi and is 51% owned by the Company. In January 2005, the Company announced the establishment of a joint venture subsidiary in Romania and is owned 51% by the Company. In February 2005, the Company announced the establishment of a joint venture in China which is 50% owned by the Company. Improve Operating Efficiencies: The Company will continue to seek greater operating efficiencies. The Company believes that its existing field force and technology infrastructure can support additional customers and revenue in the Domestic Merchandising Services Division. At the corporate level, the Company will continue to streamline certain administrative functions, such as accounting and finance, insurance, strategic marketing and legal support. -5- Leverage and Improve Technology: The Company intends to continue to utilize computer (including hand-held computers), Internet, and other technology to enhance its efficiency and ability to provide real-time data to its customers, as well as, maximize the speed of communication, and logistical deployment of its merchandising specialists. Industry sources indicate that customers are increasingly relying on marketing service providers to supply rapid, value-added information regarding the results of marketing expenditures on sales and profits. The Company (together with certain of its affiliates) has developed and owns proprietary Internet-based software technology that allows it to utilize the Internet to communicate with its field management, schedule its store-specific field operations more efficiently, receive information and incorporate the data immediately, quantify the benefits of its services to customers faster, respond to customers' needs quickly and implement programs rapidly. The Company has successfully modified and is currently utilizing certain of its software applications in connection with its international ventures. The Company believes that it can continue to improve, modify and adapt its technology to support merchandising and other marketing services for additional customers and projects in the United States and in other foreign markets. The Company also believes that its proprietary Internet-based software technology gives it a competitive advantage in the marketplace. DESCRIPTION OF SERVICES The Company currently provides a broad array of merchandising and other marketing services on a national, regional and local basis to leading home entertainment, general merchandise, consumer goods, food, and health and beauty care manufacturers and retail companies through its Domestic Merchandising Services Division. The Company currently operates internationally serving some of the world's leading companies. The Company believes its full-line capabilities provide fully integrated solutions that distinguish the Company from its competitors. These capabilities include the ability to develop plans at one centralized division headquarter location, effect chain wide execution, implement rapid, coordinated responses to its clients' needs and report on a real time Internet enhanced basis. The Company also believes its international presence, industry-leading technology, centralized decision-making ability, local follow-through, ability to recruit, train and supervise merchandisers, ability to perform large-scale initiatives on short notice, and strong retailer relationships provide the Company with a significant advantage over local, regional or other competitors. Domestic Merchandising Services Division The Company provides a broad array of merchandising services on a national, regional, and local basis to manufacturers and retailers in the United States. The Company provides its merchandising and other marketing services primarily on behalf of consumer product manufacturers at mass merchandiser, drug and retail grocery chains. The Company currently provides three principal types of merchandising and marketing services: syndicated services, dedicated services and project services. Syndicated Services Syndicated services consist of regularly scheduled, routed merchandising services provided at the retail store level for various manufacturers. These services are performed for multiple manufacturers, including, in some cases, manufacturers whose products are in the same product category. Syndicated services may include activities such as: o Reordering and replenishment of products o Ensuring that the clients' products authorized for distribution are in stock and on the shelf o Adding new products that are approved for distribution but not yet present on the shelf o Designing and implementing store planogram schematics o Setting product category shelves in accordance with approved store schematics o Ensuring that product shelf tags are in place o Checking for overall salability of the clients' products o Placing new product and promotional items in prominent positions Dedicated Services Dedicated services consist of merchandising services, generally as described above, which are performed for a specific retailer or manufacturer by a dedicated organization, including a management team working exclusively -6- for that retailer or manufacturer. These services include many of the above activities detailed in syndicated services, as well as, new store set-ups, store remodels and fixture installations. These services are primarily based on agreed-upon rates and fixed management fees. Project Services Project services consist primarily of specific in-store services initiated by retailers and manufacturers, such as new store openings, new product launches, special seasonal or promotional merchandising, focused product support, product recalls, in-store product demonstrations and in-store product sampling. The Company also performs other project services, such as new store sets and existing store resets, re-merchandising, remodels and category implementations, under annual or stand-alone project contracts or agreements. Other Marketing Services Other marketing services performed by the Company include: Event Staffing Services - Performing in-store product demonstrations or product sampling. Test Market Research - Testing promotion alternatives, new products and advertising campaigns, as well as packaging, pricing, and location changes, at the store level. Mystery Shopping - Calling anonymously on retail outlets (e.g. stores, restaurants, banks) to check on distribution or display of a brand and to evaluate products, service of personnel, conditions of store, etc. Database Marketing - Managing proprietary information to permit easy access, analysis and manipulation for use in direct marketing campaigns. Data Collection - Gathering sales and other information systematically for analysis and interpretation. Teleservices - Maintaining a teleservices center in its Auburn Hills, Michigan, facility that performs inbound and outbound telemarketing services, including those on behalf of certain of the Company's manufacturing clients. The Company believes that providing merchandising and other marketing services timely, accurately and efficiently, as well as, delivering timely and accurate reports to its clients, are two key components that will be critical to its success. The Company has developed Internet-based logistic deployment, communications, and reporting systems that improve the productivity of its merchandising specialists and provide timely data and reports to its customers. The Company's merchandising specialists use hand-held computers, personal computers and laptop computers to report the status of each store they service upon completion either through the Internet or using Interactive Voice Response ("IVR") through its Auburn Hills telecommunication center. Merchandising specialists report on a variety of issues such as store conditions (e.g. out of stocks, inventory, display placement) or they may scan and process new orders for products. This information is reported, analyzed and displayed in a variety of reports that can be accessed by both the Company and its customers via the Internet. These reports can depict the status of every merchandising project in real time. Through the Company's automated labor tracking system, its merchandising specialists communicate work assignment completion information via the Internet or telephone, enabling the Company to report hours, mileage, and other completion information for each work assignment on a daily basis and providing the Company with daily, detailed tracking of work completion. This technology allows the Company to schedule its merchandising specialists more efficiently, quickly quantify the benefits of its services to customers, rapidly respond to customers' needs and rapidly implement programs. The Company believes that its technological capabilities provide it with a competitive advantage in the marketplace. -7- International Merchandising Services Division The Company believes another current trend in business is globalization. As companies expand into foreign markets they will need assistance in marketing their products. As evidenced in the United States, retailer and manufacturer sponsored merchandising programs are both expensive and inefficient. The Company also believes that the difficulties encountered by these programs are only exacerbated by the logistics of operating in foreign markets. This environment has created an opportunity for the Company to exploit its Internet-based technology and business model that are successful in the United States. In July 2000, the Company established its International Merchandising Services Division to cultivate foreign markets, modify the necessary systems and implement the Company's business model worldwide by expanding its merchandising services business off shore. The Company formed an International Merchandising Services Division task force consisting of members of the Company's information technology, operations and finance groups to evaluate and develop foreign markets. In 2001, the Company and a leading Japanese based distributor established a joint venture to provide the latest in-store merchandising services to the Japanese market. In 2003, the Company expanded its international presence to Canada by acquiring a Canadian merchandising company and Turkey by entering into a start-up joint venture. In 2004, the Company established 51% owned joint venture subsidiaries in South Africa, India and Romania and in early 2005, a 50% owned joint venture in China. Key to the Company's international strategy is the translation of several of its proprietary Internet-based logistical, communications and reporting software applications into the native language of any market the Company enters. As a result of this requirement for market penetration, the Company has developed translation software that can quickly convert its proprietary software into various languages. Through its computer facilities in Auburn Hills, Michigan, the Company provides worldwide access to its proprietary logistical, communications and reporting software. In addition, the Company maintains personnel in Greece and Australia to assist in its international efforts. The Company is actively pursuing expansion into various other markets. SALES AND MARKETING Domestic Merchandising Services Division The Company's sales efforts within its Domestic Merchandising Services Division are structured to develop new business in national, regional and local markets. The Company's corporate business development team directs its efforts toward the senior management of prospective clients. Sales strategies developed at the Company's headquarters are communicated to the Company's sales force for execution. The sales force, located nationwide, work from both Company and home offices. In addition, the Company's corporate account executives play an important role in the Company's new business development efforts within its existing manufacturer and retailer client base. As part of the retailer consolidation, retailers are centralizing most administrative functions, including operations, procurement and category management. In response to this centralization and the growing importance of large retailers, many manufacturers have reorganized their selling organizations around a retailer team concept that focuses on a particular retailer. The Company has responded to this emerging trend and currently has retailer teams in place at select retailers. The Company's business development process includes a due diligence period to determine the objectives of the prospective client, the work required to satisfy those objectives and the market value of such work to be performed. The Company employs a formal cost development and proposal process that determines the cost of each element of work required to achieve the prospective client's objectives. These costs, together with an analysis of market rates, are used in the development of a formal quotation that is then reviewed at various levels within the organization. The pricing of this internal proposal must meet the Company's objectives for profitability, which are established as part of the business planning process. After approval of this quotation, a detailed proposal is presented to and approved by the prospective client. -8- International Merchandising Services Division The Company's marketing efforts within its International Merchandising Services Division are three fold. First, the Company endeavors to develop new markets through acquisitions. The Company's international acquisition team, whose primary focus is to seek out and develop acquisitions throughout the world, consists of personnel located in the United States, Greece and Australia. Personnel from information technology, field operations, client services and finance support the international acquisition team. Second, the Company offers global merchandising solutions to customers that have worldwide distribution. This effort is spearheaded out of the Company's headquarters in the United States. Third the Company develops local markets through various joint ventures or subsidiaries throughout the world. CUSTOMERS Domestic Merchandising Services Division In its Domestic Merchandising Services Division, the Company currently represents numerous manufacturers and /or retail clients in a wide range of retail outlets in the United States including: o Mass Merchandisers o Drug o Grocery o Other retail trade groups (e.g. Discount, Home Centers) The Company also provides database, research and other marketing services to the consumer packaged goods industry. One customer accounted for 14%, 8%, and 6% of the Company's net revenues for the years ended December 31, 2004, 2003, and 2002, respectively. This customer also accounted for approximately 29%, 13%, and 4% of accounts receivable at December 31, 2004, 2003, and 2002, respectively. In addition, approximately 16%, 17%, and 24% of net revenues for the years ended December 31, 2004, 2003, and 2002, respectively, resulted from merchandising services performed for manufacturers and others in stores operated by Kmart. These customers also accounted for approximately 22% of accounts receivable at December 31, 2004. While the Company's customers and the resultant contractual relationships are with various manufacturers and not Kmart, a significant reduction of this retailer's stores or cessation of this retailer's business would negatively impact the Company. Another customer, a division of a major retailer, accounted for 26%, 30%, and 26% of the Company's net revenues for the years ended December 31, 2004, 2003, and 2002, respectively. This customer also accounted for approximately 4%, 30%, and 43% of accounts receivable at December 31, 2004, 2003, and 2002, respectively. On August 2, 2004, this customer was sold by its parent. International Merchandising Services Division The Company believes that the potential international customers for this division have similar profiles to its Domestic Merchandising Services Division customers. The Company is currently operating in Japan, Canada, Turkey, South Africa and India. The Company announced the establishment of a 51% owned joint venture subsidiary in Romania in late 2004 and a 50% owned joint venture in China in early 2005. The Company is actively pursuing expansion into Europe and other markets. -9- COMPETITION The marketing services industry is highly competitive. The Company's competition in the Domestic and International Merchandising Services Divisions arises from a number of large enterprises, many of which are national or international in scope. The Company also competes with a large number of relatively small enterprises with specific client, channel or geographic coverage, as well as with the internal marketing and merchandising operations of its clients and prospective clients. The Company believes that the principal competitive factors within its industry include development and deployment of technology, breadth and quality of client services, cost, and the ability to execute specific client priorities rapidly and consistently over a wide geographic area. The Company believes that its current structure favorably addresses these factors and establishes it as a leader in the mass merchandiser and chain drug store channels of trade. The Company also believes it has the ability to execute major national and international in-store initiatives and develop and administer national and international retailer programs. Finally, the Company believes that, through the use and continuing improvement of its proprietary Internet software, other technological efficiencies and various cost controls, the Company will remain competitive in its pricing and services. TRADEMARKS The Company has numerous registered trademarks. Although the Company believes its trademarks may have value, the Company believes its services are sold primarily based on breadth and quality of service, cost, and the ability to execute specific client priorities rapidly and consistently over a wide geographic area. See "Industry Overview" and "Competition". EMPLOYEES Worldwide the Company utilizes a labor force of approximately 7,700 people. As of December 31, 2004, the Company's Domestic Merchandising Services Division's labor force consisted of approximately 6,500 people. Approximately 150 were full-time employees and 15 were part-time employees of the Company. Of the 150 full-time Company employees, 143 were engaged in operations and 7 were engaged in sales. The Company's Domestic Merchandising Services Division utilizes the services of its affiliate, SPAR Management Services, Inc. ("SMSI"), to schedule and supervise its field force, which consists of the independent contractors furnished by another affiliate SPAR Marketing Services, Inc. ("SMS") (see Item 13 - Certain Relationships and Related Transactions, below) as well as the Company's field employees. Approximately 6,300 independent contractors and approximately 50 full-time field managers are furnished principally through SMS and SMSI, respectively. As of December 31, 2004, the Company's International Merchandising Services Division's labor force consisted of approximately 1,200 people. Approximately 50 full-time employees were engaged in operations and 3 were engaged in sales. The International Division's field force consisted of approximately 700 full time employees, 70 part time employees and approximately 380 independent contractors. The Company currently utilizes certain of its Domestic Merchandising Services Division's employees, as well as, the services of certain employees of its affiliates, SMSI and SPAR Infotech, Inc. ("SIT"), to support the International Merchandising Services Division. However, dedicated employees will be added to that division as the need arises. The Company's affiliate, SIT, also provides programming and other assistance to the Company's various divisions (see Item 13 - Certain Relationships and Related Transactions, below). The Company, SMS, SMSI and SIT consider their relations with their respective employees and independent contractors to be good. CERTAIN RISK FACTORS There are various risks associated with the Company's growth and operating strategy. Certain (but not all) of these risks are discussed below. -10- Dependency on Largest Customers As discussed above in Customers, the Company does a significant amount of business with one customer and performs a significant amount of services in Kmart. The loss of this customer or the loss of Kmart related business and the failure to attract new large customers, could significantly decrease the Company's revenues and such decreased revenues could have a material adverse effect on the Company's business, results of operations and financial condition. Dependence on Trend Toward Outsourcing The business and growth of the Company depends in large part on the continued trend toward outsourcing of marketing services, which the Company believes has resulted from the consolidation of retailers and manufacturers, as well as, the desire to seek outsourcing specialists and reduce fixed operation expenses. There can be no assurance that this trend in outsourcing will continue, as companies may elect to perform such services internally. A significant change in the direction of this trend generally, or a trend in the retail, manufacturing or business services industry not to use, or to reduce the use of, outsourced marketing services such as those provided by the Company, could significantly decrease the Company's revenues and such decreased revenues could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Failure to Successfully Compete The marketing services industry is highly competitive and the Company has competitors that are larger (or part of larger holding companies) and may be better financed. In addition, the Company competes with: (i) a large number of relatively small enterprises with specific customer, channel or geographic coverage; (ii) the internal marketing and merchandising operations of its customers and prospective customers; (iii) independent brokers; and (iv) smaller regional providers. Remaining competitive in the highly competitive marketing services industry requires that the Company monitor and respond to trends in all industry sectors. There can be no assurance that the Company will be able to anticipate and respond successfully to such trends in a timely manner. If the Company is unable to successfully compete, it could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. If certain competitors were to combine into integrated marketing services companies, or additional marketing service companies were to enter into this market, or existing participants in this industry were to become more competitive, it could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Variability of Operating Results and Uncertainty in Customer Revenue The Company has experienced and, in the future, may experience fluctuations in quarterly operating results. Factors that may cause the Company's quarterly operating results to vary and from time to time and may result in reduced revenue include: (i) the number of active customer projects; (ii) seasonality of customer products; (iii) customer delays, changes and cancellations in projects; (iv) the timing requirements of customer projects; (v) the completion of major customer projects; (vi) the timing of new engagements; (vii) the timing of personnel cost increases; and (viii) the loss of major customers. In particular, the timing of revenues is difficult to forecast for the home entertainment industry because timing is dependent on the commercial success of particular product releases. In the event that a particular release is not widely accepted by the public, the Company's revenue could be significantly reduced. In addition, the Company is subject to revenue uncertainties resulting from factors such as unprofitable customer work and the failure of customers to pay. The Company attempts to mitigate these risks by dealing primarily with large credit-worthy customers, by entering into written or oral agreements with its customers and by using project budgeting systems. These revenue fluctuations could materially and adversely affect the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Failure to Develop New Products A key element of the Company's growth strategy is the development and sale of new products. While several new products are under current development, there can be no assurance that the Company will be able to successfully develop and market new products. The Company's inability or failure to devise useful merchandising or marketing -11- products or to complete the development or implementation of a particular product for use on a large scale, or the failure of such products to achieve market acceptance, could adversely affect the Company's ability to achieve a significant part of its growth strategy and the absence of such growth could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Inability to Identify, Acquire and Successfully Integrate Acquisitions Another key component of the Company's growth strategy is the acquisition of businesses across the United States and worldwide that offer similar merchandising or marketing services. The successful implementation of this strategy depends upon the Company's ability to identify suitable acquisition candidates, acquire such businesses on acceptable terms, finance the acquisition and integrate their operations successfully with those of the Company. There can be no assurance that such candidates will be available or, if such candidates are available, that the price will be attractive or that the Company will be able to identify, acquire, finance or integrate such businesses successfully. In addition, in pursuing such acquisition opportunities, the Company may compete with other entities with similar growth strategies, these competitors may be larger and have greater financial and other resources than the Company. Competition for these acquisition targets could also result in increased prices of acquisition targets and/or a diminished pool of companies available for acquisition. The successful integration of these acquisitions also may involve a number of additional risks, including: (i) the inability to retain the customers of the acquired business; (ii) the lingering effects of poor customer relations or service performance by the acquired business, which also may taint the Company's existing businesses; (iii) the inability to retain the desirable management, key personnel and other employees of the acquired business; (iv) the inability to fully realize the desired efficiencies and economies of scale: (v) the inability to establish, implement or police the Company's existing standards, controls, procedures and policies on the acquired business; (vi) diversion of management attention; and (vii) exposure to customer, employee and other legal claims for activities of the acquired business prior to acquisition. In addition, any acquired business could perform significantly worse than expected. The inability to identify, acquire, finance and successfully integrate such merchandising or marketing services business could have a material adverse effect on the Company's growth strategy and could limit the Company's ability to significantly increase its revenues and profits. Uncertainty of Financing for, and Dilution Resulting from, Future Acquisitions The timing, size and success of acquisition efforts and any associated capital commitments cannot be readily predicted. Future acquisitions may be financed by issuing shares of the Company's Common Stock, cash, or a combination of Common Stock and cash. If the Company's Common Stock does not maintain a sufficient market value, or if potential acquisition candidates are otherwise unwilling to accept the Company's Common Stock as part of the consideration for the sale of their businesses, the Company may be required to obtain additional capital through debt or equity financings. To the extent the Company's Common Stock is used for all or a portion of the consideration to be paid for future acquisitions, dilution may be experienced by existing stockholders. There can be no assurance that the Company will be able to obtain the additional financing it may need for its acquisitions on terms that the Company deems acceptable. Failure to obtain such capital would materially adversely affect the Company's ability to execute its growth strategy. Reliance on the Internet The Company relies on the Internet for the scheduling, coordination and reporting of its merchandising and marketing services. The Internet has experienced, and is expected to continue to experience, significant growth in the numbers of users and amount of traffic as well as increased attacks by hackers and other saboteurs. To the extent that the Internet continues to experience increased numbers of users, frequency of use or increased bandwidth requirements of users, there can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on the Internet by this continued growth or that the performance or reliability of the Internet will not be adversely affected. Furthermore, the Internet has experienced a variety of outages and other delays as a result of accidental and intentional damage to portions of its infrastructure, and could face such outages and delays in the future of similar or greater effect. Any protracted disruption in Internet service would increase the Company's costs of operation and reduce efficiency and performance, which could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. -12- Economic and Retail Uncertainty The markets in which the Company operates are cyclical and subject to the effects of economic downturns. The current political, social and economic conditions, including the impact of terrorism on consumer and business behavior, make it difficult for the Company, its vendors and its customers to accurately forecast and plan future business activities. Substantially all of the Company's key customers are either retailers or those seeking to do product merchandising at retailers. If the retail industry experiences a significant economic downturn, a reduction in product sales could significantly decrease the Company's revenues. The Company also has risks associated with its customers changing their business plans and/or reducing their marketing budgets in response to economic conditions, which could also significantly decrease the Company's revenues. Such revenue decreases could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Significant Stockholders: Voting Control and Market Illiquidity Mr. Robert G. Brown, founder, director, Chairman, President and Chief Executive Officer of the Company, beneficially owns approximately 45.5% of the Company's outstanding Common Stock, and Mr. William H. Bartels, founder, director, and Vice Chairman of the Company beneficially owns approximately 29.4% of the Company's outstanding Common Stock. These stockholders have, should they choose to act together, and under certain circumstances Mr. Brown acting alone has, the ability to control all matters requiring stockholder approval, including the election of directors and the approval of mergers and other business combination transactions. In addition, although the Company Common Stock is quoted on the Nasdaq Small Cap Market, the trading volume in such stock may be limited and an investment in the Company's securities may be illiquid because the founders own a significant amount of the Company's stock. Dependence Upon and Potential Conflicts in Services Provided by Affiliates The success of the Company's domestic business is dependent upon the successful execution of its field services by SPAR Marketing Services, Inc. ("SMS"), and SPAR Management Services, Inc. ("SMSI"), as well as the programming services provided by SPAR Infotech, Inc. ("SIT"), each of which is an affiliate, but not a subsidiary, of the Company, and none of which is consolidated in the Company's financial statements. SMS provides substantially all of the field representatives used by the Company in conducting its domestic business (87% of field expense in 2004), and SMSI provides substantially all of the field management services used by the Company in conducting its business. These services provided to the Company by SMS and SMSI are on a cost-plus basis pursuant to contracts that are cancelable on 60 days notice prior to December 31 of each year, commencing in 1997, or with 180 days notice at any other time. SIT provides substantially all of the Internet programming services and other computer programming needs used by the Company in conducting its business (see Item 13 - Certain Relationships and Related Transactions, below), which are provided to the Company by SIT on an hourly charge basis pursuant to a contract that is cancelable on 30 days notice. The Company has determined that the services provided by SMS, SMSI and SIT are at rates favorable to the Company. SMS, SMSI and SIT (collectively, the "SPAR Affiliates") are owned solely by Mr. Robert G. Brown, founder, director, Chairman, President and Chief Executive Officer of the Company, and Mr. William H. Bartels, founder, director, and Vice Chairman of the Company, each of whom are also directors and executive officers of each of the SPAR Affiliates (see Item 13 - Certain Relationships and Related Transactions, below). In the event of any dispute in the business relationships between the Company and one or more of the SPAR Affiliates, it is possible that Messrs. Brown and Bartels may have one or more conflicts of interest with respect to those relationships and could cause one or more of the SPAR Affiliates to renegotiate or cancel their contracts with the Company or otherwise act in a way that is not in the Company's best interests. While the Company's relationships with SMS, SMSI and SIT are excellent, there can be no assurance that the Company could (if necessary under the circumstances) replace the field representatives and management currently provided by SMS and SMSI, respectively, or replace the Internet and other computer programming services provided by SIT, in sufficient time to perform its customer obligations or at such favorable rates in the event the SPAR Affiliates no longer performed those services. Any cancellation, other nonperformance or material pricing increase under those affiliate contracts could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. -13- The Company has not paid and does not intend to pay cash Dividends The Company has not paid dividends in the past, intends to retain any earnings or other cash resources to finance the expansion of its business and for general corporate purposes, and does not intend to pay dividends in the future. In addition, the Company's Credit Facility with Webster Business Credit Corporation ("Webster") (see Note 5 to the Financial Statements - Lines of Credit) restricts the payment of dividends without Webster's prior consent. Risks Associated with International Joint Ventures While the Company endeavors to limit its exposure for claims and losses in any international joint ventures through contractual provisions, insurance and use of single purpose entities for such ventures, there can be no assurance that the Company will not be held liable for the claims against and losses of a particular international joint venture under applicable local law or local interpretation of any joint venture or insurance provisions. If any such claims and losses should occur, be material in amount and be successfully asserted against the Company, such claims and losses could have a material adverse effect on the Company's business, results of operations and financial condition or the desired increases in the Company's business, revenues and profits. Risks Associated with Foreign Currency The Company also has foreign currency exposure associated with its international joint venture subsidiaries and joint ventures. In 2004, these exposures are primarily concentrated in the Canadian dollar, Japanese yen and South African rand. Risks Associated with International Business The Company's expansion strategy includes expansion into various countries around the world. While the Company endeavors to limit its exposure by entering only countries where the political, social and economic environments are conducive to doing business in that country there can be no assurances that the respective business environments will remain favorable. Item 2. Properties. The Company maintains its corporate headquarters in approximately 6,000 square feet of leased office space located in Tarrytown, New York, under a lease with a term expiring in May 2006. The Company leases certain office and storage facilities for its corporate headquarters, divisions and subsidiaries under operating leases, which expire at various dates during the next five years. Most of these leases require the Company to pay minimum rents, subject to periodic adjustments, plus other charges, including utilities, real estate taxes and common area maintenance. -14- The following is a list of the locations where the Company maintains leased facilities for its division offices and subsidiaries:
Location Office Use Approximate Square Footage -------------------------- -------------------------------------- --------------------------------- Domestic: Tarrytown, NY Corporate Headquarters 6,000 Auburn Hills, MI Regional Office and Warehouse 27,000 Cincinnati, OH Regional Office 5,300 International: Canada Toronto, Ontario Headquarters 4,000 Japan Osaka Headquarters 1,200 Tokyo Regional Office 1,000 Nagoya Regional Office 600 Hukuoka Regional Office 400 Turkey Istanbul Headquarters 4,600 South Africa Durban Headquarters 3,100 Port Elizabeth Regional Office 900 Western Cape Regional Office 2,900 Johannesburg Regional Office 2,000 India New Delhi Headquarters 4,300
Although the Company believes that its existing facilities are adequate for its current business, new facilities may be added should the need arise in the future. Item 3. Legal Proceedings. Safeway Inc. ("Safeway"), filed a Complaint against the PIA Merchandising Co., Inc. ("PIA Co."), a wholly owned subsidiary of the Company, 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 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 probable interest of $1,000,000 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. Item 4. Submission of Matters to a Vote of Security Holders. None. -15- PART II Item 5. Market for Registrant's Common Equity and Related Shareholder Matters. Price Range of Common Stock The following table sets forth the reported high and low sales prices of the Common Stock for the quarters indicated as reported on the Nasdaq Small Cap Market. 2004 2003 ------------------------ ------------------------- High Low High Low First Quarter $ 3.44 $ 2.30 $ 3.60 $ 2.42 Second Quarter 2.33 0.85 5.55 3.05 Third Quarter 1.50 0.75 5.32 3.17 Fourth Quarter 1.80 0.36 4.57 3.00 As of December 31, 2004, there were approximately 700 beneficial shareholders of the Company's Common Stock. Dividends The Company has never declared or paid any cash dividends on its capital stock and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. The Company currently intends to retain future earnings to finance its operations and fund the growth of the business. Any payment of future dividends will be at the discretion of the Board of Directors of the Company and will depend upon, among other things, the Company's earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions in respect to the payment of dividends and other factors that the Company's Board of Directors deems relevant. The Company's Credit Facility with Webster Business Credit Corporation (see Note 5 to the Financial Statements - Lines of Credit) restricts the payment of dividends without Webster's prior consent. Item 6. Selected Financial Data. The following selected condensed consolidated financial data sets forth, for the periods and the dates indicated, summary financial data of the Company and its subsidiaries. The selected financial data have been derived from the Company's financial statements. -16- SPAR Group, Inc. Condensed Consolidated Statements of Operations ----------------------------------------------- (In thousands, except per share data)
Year Ended December 31, --------------------------------------------------------------------- 2004 2003 2002 2001 2000 --------------------------------------------------------------------- STATEMENT OF OPERATIONS DATA: Net revenues $ 51,370 $ 64,859 $ 69,612 $ 70,891 $ 81,459 Cost of revenues 33,644 42,338 40,331 40,883 50,278 --------------------------------------------------------------------- Gross profit 17,726 22,521 29,281 30,008 31,181 Selling, general and administrative expenses 20,222 20,967 18,804 19,380 24,761 Impairment charges 8,141 - - - - Depreciation and amortization 1,399 1,529 1,844 2,682 2,383 --------------------------------------------------------------------- Operating (loss) income (12,036) 25 8,633 7,946 4,037 Other (income) expense (754) 237 (26) 107 (790) Interest expense 220 269 363 561 1,326 --------------------------------------------------------------------- (Loss) income from continuing operations before provision for income taxes and minority interest (11,502) (481) 8,296 7,278 3,501 Income tax provision 853 58 2,998 3,123 780 --------------------------------------------------------------------- (Loss) income from continuing operations before minority interest (12,355) (539) 5,298 4,155 2,721 --------------------------------------------------------------------- Minority interest 87 - - - - Discontinued operations: Loss from discontinued operations net of tax benefits of $935 and $858, respectively - - - (1,597) (1,399) Estimated loss on disposal of discontinued operations, including provision of $1,000 for losses during phase-out period and disposal costs net of tax benefit of $2,618 - - - (4,272) - --------------------------------------------------------------------- Net (loss) income $ (12,268) $ (539) $ 5,298 $ (1,714) $ 1,322 ===================================================================== Basic/diluted net (loss) income per common share: Net (loss) income from continuing operations $ (0.65) $ (0.03) $ 0.28 $ 0.23 $ 0.15 --------------------------------------------------------------------- Discontinued operations: Loss from discontinued operations - - - (0.09) (0.08) Estimated loss on disposal of discontinued operations - - - (0.23) - --------------------------------------------------------------------- Net loss from discontinued operations - - - (0.32) (0.08) --------------------------------------------------------------------- Basic/diluted net (loss) income $ (0.65) $ (0.03) $ 0.28 $ (0.09) $ 0.07 ===================================================================== Weighted average shares outstanding - basic 18,859 18,855 18,761 18,389 18,185 - diluted 18,859 18,855 19,148 18,467 18,303
-17-
December 31, ------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------- --------- ----------- ----------- ----------- BALANCE SHEET DATA: Working capital (deficiency) $ 962 $ 4,085 $ 6,319 $ 8,476 $ (2,273) Total assets $ 15,821 $ 28,137 $ 28,800 $ 41,155 $ 48,004 Lines of credit, current $ 4,956 $ 4,084 $ - $ 57 $ 1,143 Lines of credit and other long-term debt(1) $ 218 $ 270 $ 383 $ 13,287 $ 10,093 Total stockholders' equity $ 3,714 $ 16,023 $ 16,592 $ 10,934 $ 12,240
(1) Prior to 2003, the Company's lines of credit were charged to long-term liabilities (net of current portion). -18- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 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 established a 50% owned joint venture in China. In 2004, the Company consolidated Canada, Turkey, South Africa, India and Japan into the Company's financial statements. Romania did not have operations in 2004. In December 2001, the Company decided to divest its Incentive Marketing Division and recorded an estimated loss on disposal of SPAR Performance Group, Inc., now called STIMULYS, Inc. ("SPGI"), of approximately $4.3 million, net of taxes, including a $1.0 million reserve recorded for the anticipated cost to divest SPGI and any anticipated losses through the divestiture date. On June 30, 2002, SPAR Incentive Marketing, Inc. ("SIM"), a wholly owned subsidiary of the Company, entered into a Stock Purchase and Sale Agreement with Performance Holdings, Inc. ("PHI"), a Delaware corporation headquartered in Carrollton, Texas. Pursuant to that agreement, SIM sold all of the stock of SPGI, its subsidiary, to PHI for $6.0 million. As a condition of the sale, PHI issued and contributed 1,000,000 shares of its common stock to Performance Holdings, Inc. Employee Stock Ownership Plan, which became the only shareholder of PHI. SIM's results (including those of SPGI) were reclassified as discontinued operations for all periods presented. The results of operations of the discontinued business segment are shown separately below net income from continuing operations. Accordingly, the 2002 consolidated statements of operations of the Company have been prepared, and its 2001 and 2000 consolidated statement of operations have been restated, to report the results of discontinued operations of SIM (including those of SPGI) separately from the continuing operations of the Company (see Item 6 - Selected Financial Data, above). Critical Accounting Policies & Estimates ---------------------------------------- The Company's critical accounting policies, including the assumptions and judgments underlying them, are disclosed in the Note 2 to the Financial Statements. These 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. -19- 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 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 $761,000 and $515,000 at December 31, 2004 and 2003, respectively. The Company also recorded a reserve for sales allowances for potential customer credits of $448,000 at December 31, 2003. Bad debt and sales allowance expenses were $366,000, $825,000, and $262,000 in 2004, 2003, and 2002, 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 $559,000, $1,004,000, and $772,000 of costs related to software developed for internal use in 2004, 2003, and 2002, respectively. The Company also recorded a net impairment charge of capitalized software related to lost clients totaling approximately $442,000 in 2004. Results of operations The following table sets forth selected financial data and such data as a percentage of net revenues for the periods indicated.
Year Ended Year Ended Year Ended December 31, 2004 December 31, 2003 December 31, 2002 -------------------------------------------------------------------------------- (dollars in millions) Dollars % Dollars % Dollars % -------------- ----------- ----------- ----------- ----------- ----------- Net revenues $ 51.4 100.0% $ 64.9 100.0% $ 69.6 100.0% Cost of revenues 33.6 65.5 42.3 65.3 40.3 57.9 Selling, general & administrative expenses 20.2 39.4 21.0 32.3 18.8 27.0 Impairment charges 8.1 15.8 - - - - Depreciation & amortization 1.4 2.7 1.5 2.3 1.8 2.6 Other (income) expenses, net (0.4) (1.0) 0.5 0.8 0.4 0.6 -------------- ----------- ----------- ----------- ----------- ----------- (Loss) income before income tax provision (11.5) (22.4) (0.4) (0.7) 8.3 11.9 Provision for income taxes 0.9 1.7 0.1 0.1 3.0 4.3 -------------- ----------- ----------- ----------- ----------- ----------- (Loss) income before minority interest (12.4) (24.1)% (0.5) (0.8)% 5.3 7.6% Minority interest 0.1 0.2 - - - - -------------- ----------- ----------- Net (loss) income $ (12.3) (23.9)% $ (0.5) (0.8)% $ 5.3 7.6% ============== =========== ===========
-20- Results from continuing operations for the twelve months ended December 31, -------------------------------------------------------------------------------- 2004, compared to twelve months ended December 31, 2003 ------------------------------------------------------- Net Revenues Net revenues from operations for the twelve months ended December 31, 2004, were $51.4 million, compared to $64.9 million for the twelve months ended December 31, 2003, a decrease of $13.5 million or 20.8%. The decrease of $13.5 million in net revenues consists of a decrease in domestic revenue of $21.1 million or 32.9% partially offset by increases in international revenue of $7.7 million. The decrease in domestic revenue is a result of the loss of several significant customers partially offset by revenue from new customers in 2004. The international revenue increase of $7.7 million was primarily a result of the South African acquisition, the Japan consolidation and a full year of Canadian operations. 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 decreased by $8.7 million in 2004 and as a percentage of net revenues was 65.5% for the twelve months ended December 31, 2004, which was consistent with 65.3% for the twelve months ended December 31, 2003. Approximately 87% and 85% of the field services were purchased from the Company's affiliate, SMS, in 2004 and 2003, respectively (see Item 13 - Certain Relationships and Related Transactions, below). SMS's increased share of field services resulted from its more favorable cost structure Operating Expenses Operating expenses include selling, general and administrative expenses, impairment charges, depreciation and amortization. Selling, general and administrative expenses include corporate overhead, project management, information technology, executive compensation, human resource, legal and accounting expenses. The following table sets forth the operating expenses as a percentage of net revenues for the time periods indicated:
Year Ended Year Ended Increase December 31, 2004 December 31, 2003 (decrease) ---------------------------- ------------------------------ ------------- (dollars in millions) Dollars % Dollars % % -------------- ------------ --------------- ------------- ------------- Selling, general & administrative $ 20.2 39.4% $ 21.0 32.3% (3.6)% Impairment charges 8.1 15.8 - - - Depreciation and amortization 1.4 2.8 1.5 2.3 (8.5)% -------------- ------------ --------------- ------------- Total operating expenses $ 29.7 58.0% $ 22.5 34.6% 32.3% ============== ============ =============== =============
Selling, general and administrative expenses decreased by $0.8 million, or 3.6%, for the twelve months ended December 31, 2004, to $20.2 million compared to $21.0 million for the twelve months ended December 31, 2003. Domestic selling, general and administrative expenses totaled $16.7 million for 2004 and were reduced $3.3 million from $19.9 million in 2003. The reduction of 16.1% was a result of cost reduction programs initiated in 2004 as a result of the loss of certain large customers partially offset by restructure costs of $480,000 expensed in 2004 compared to no expense in 2003. Restructure costs included office lease and employee severance costs. The domestic cost reductions were partially offset by increases of $2.5 million in international selling, general and administrative expenses resulting from the consolidation of Japan, the acquisition of South Africa, and a full year of Canadian operations, as well as, the Turkey and India joint venture startups. Impairment charges were $8.1 million for 2004 (see Note 3 to the Financial Statements -Impairment Charges). Impairment charges resulting from the loss of certain large customers consisted of $7.6 million of goodwill impairment, $1.2 million for the impairment of other assets partially offset by the reduction of $1.4 million (net of taxes) of other liabilities related to the PIA Acquisition. In addition there was approximately $700,000 of goodwill impairment associated with the Canadian subsidiary. Depreciation and amortization charges of $1.4 million in 2004 was consistent with $1.5 million in 2003. -21- Other Income/Other Expense Other income was approximately $754,000 for 2004 versus other expense of $237,000 for 2003. In 2004, other income consisted of approximately $640,000 resulting from the release of specific reserves related to the refinancing of the SPGI notes and approximately $114,000 of foreign currency translation gains. In 2003, other expense consisted primarily of the Company's share of its 50% owned Japan joint venture losses accounted for on the equity method. In 2004, the Japan joint venture was consolidated into the Company's financial statements. Interest Expense Interest expense totaled $220,000 for 2004 and was consistent with interest expense of $269,000 for 2003. Income Taxes The provision for income taxes was $853,000 and $58,000 for 2004 and 2003, respectively. During 2004, 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 recorded a full valuation allowance against its net deferred tax assets resulting in a charge totaling approximately $750,000. The 2004 tax provision of $853,000 consists of the valuation allowance and minimum state taxes of approximately $103,000. The tax provision for 2003 reflects minimum tax requirements for state filings. Net (Loss) Income The SPAR Group had a net loss of approximately $12.3 million or $0.65 per basic and diluted share for 2004, compared to a net loss of approximately $539,000 or $0.03 per basic and diluted shares for 2003. Off Balance Sheet Arrangements None. -22- Results from continuing operations for the twelve months ended December 31, -------------------------------------------------------------------------------- 2003, compared to twelve months ended December 31, 2002 ------------------------------------------------------- Net Revenues Net revenues from operations for the twelve months ended December 31, 2003, were $64.9 million, compared to $69.6 million for the twelve months ended December 31, 2002, a 6.8% decrease. The decrease of 6.8% in net revenues is primarily attributed to decreased business in mass merchandiser chains. The decrease in net revenues was caused by decreased per unit fee revenue resulting from lower retail sales of customer products and the loss of a particular client, partially offset by increases in service fee revenue. 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 increased by $2.0 million in 2003 and as a percentage of net revenues was 65.3% for the twelve months ended December 31, 2003, compared to 57.9% for the twelve months ended December 31, 2002, a 5.0% increase. Approximately 85% and 76% of the field services were purchased from the Company's affiliate, SMS, in 2003 and 2002, respectively (see Item 13 - Certain Relationships and Related Transactions, below). SMS's increased share of field services resulted from its more favorable cost structure. The increase in cost as a percentage of net revenues is primarily a result of a decrease in per unit fee revenues that do not have a proportionate decrease in cost. As discussed above under Critical Accounting Policies/Revenue Recognition, the Company's revenue consists of: (1) service fee revenue, which is earned when the merchandising services are performed and, therefore, has proportionate costs in the period the services are performed; and (2) per unit fee revenue, which is earned when the client's product is sold to the consumer at retail, not when the services are performed and, therefore, does not have proportionate costs in the period the revenue is earned. Since the merchandising service and the related costs associated with per unit fee revenue are normally performed prior to the retail sale, and the retail sales of client products are influenced by numerous factors including consumer tastes and preferences, and not solely by the merchandising service performed, in any given period, the cost of per unit fee revenues may not be directly proportionate to the per unit fee revenue. Operating Expenses Operating expenses include selling, general and administrative expenses as well as depreciation and amortization. Selling, general and administrative expenses include corporate overhead, project management, information systems, executive compensation, human resource, legal and accounting expenses. The following table sets forth the operating expenses as a percentage of net revenues for the time periods indicated:
Year Ended Year Ended Increase December 31, 2003 December 31, 2002 (decrease) ---------------------------- ------------------------------ ------------- (dollars in millions) Dollars % Dollars % % -------------- ------------ --------------- ------------- ------------- Selling, general & administrative $ 21.0 32.3% $ 18.8 27.0% 12.0% Depreciation and amortization 1.5 2.3 1.8 2.6 (17.1)% -------------- ------------ --------------- ------------- Total operating expenses $ 22.5 34.6% $ 20.6 29.6% 9.4% ============== ============ =============== =============
Selling, general and administrative expenses increased by $2.2 million, or 12.0%, for the twelve months ended December 31, 2003, to $21.0 million compared to $18.8 million for the twelve months ended December 31, 2002. This increase was due primarily to increases in travel related expense of $0.4 million, postage and material expense of $0.6 million, stock option expense for non-employees of $0.4 million and increase in bad debt expense of $0.6 million. Depreciation and amortization decreased by $315,000 for the twelve months ended December 31, 2003, primarily due to older, higher priced assets becoming fully depreciated. -23- Interest Expense Interest expense decreased $94,000 to $269,000 for the twelve months ended December 31, 2003, from $363,000 for the twelve months ended December 31, 2002, due to decreased average debt levels as well as decreased interest rates in 2003. Income Taxes The provision for income taxes was $58,000 and $3.0 million for the twelve months ended December 31, 2003 and December 31, 2002, respectively. The tax provision for 2003 reflects minimum tax requirements for state filings. The effective tax rate was 36.1% for 2002. Net (Loss) Income The SPAR Group had a net loss of approximately $539,000 or $0.03 per basic and diluted share for the twelve months ended December 31, 2003, compared to a net income of approximately $5.3 million or $0.28 per basic and diluted shares for the twelve months ended December 31, 2002 because of the factors described above. Off Balance Sheet Arrangements None. Liquidity and Capital Resources In 2004, the Company had a net loss of $12.3 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, $1.4 million for depreciation and $0.1 million for minority interests in losses of subsidiaries. Net cash provided by operating activities for 2004, was $1.4 million, compared with net cash provided by operations of $3.4 million for 2003. The decrease of $2.0 million in cash provided by operating activities is primarily due to net operating losses offset by decreases in deferred taxes and restructuring charges. Net cash used in investing activities for 2004, was $1.3 million, compared with net cash used of $2.9 million for 2003. The decrease in net cash used in investing activities resulted was a result of fewer acquisitions of new businesses and lower purchases of property and equipment in 2004. Net cash provided by financing activities for 2004, was $0.9 million, compared with net cash used in financing activities of $0.5 million for 2003. The increase in net cash provided by financing activities in 2004 was primarily a result of the consolidation of our Japan joint venture into the Company's financial statements in 2004. The above activity resulted in a change in cash and cash equivalents for 2004 of $0.9 million. At December 31, 2004, the Company had positive working capital of $1.0 million as compared to $4.1 million at December 31, 2003. The decrease in working capital is due to decreases in accounts receivable and deferred taxes, increases in accounts payable, customer deposits and lines of credit, partially offset by increases in cash and decreases in accrued expenses and other current liabilities, accrued expenses due to affiliates and restructuring charges. The Company's current ratio was 1.08 and 1.34 at December 31, 2004 and 2003, respectively. 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 reserves against collateral. The amendment provides for interest to be charged at a rate based in part upon the earnings before interest, taxes, depreciation and amortization. The average interest rate for 2004 was 5.1%. At December 31, 2004, the Credit Facility bears interest at Webster's "Alternative Base Rate" plus 0.75% (a total of 6.0% per annum), or LIBOR plus 3.25%. The Credit Facility is secured by all of the assets of the Company and its domestic subsidiaries. In connection with the May 17, 2004, amendment, Mr. Robert Brown, a -24- Director, the Chairman, President and Chief Executive Officer and a major stockholder of theCompany 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, reduced the revolving credit facility from $10.0 million to $7.0 million, changed the covenant compliance testing for certain covenants from quarterly to monthly and reduced certain advance rates. On November 15, 2004, the Credit Facility was further amended to delete any required minimum Net Worth and minimum Fixed Charge Coverage Ratio covenant levels for the period ending December 31, 2004. The amendments did not change the future covenant levels. The Credit Facility also limits certain expenditures including, but not limited to, capital expenditures and other investments. The Company was in violation of certain monthly covenants at December 31, 2004, and expects to be in violation at future measurement dates. Webster issued a waiver for the December 31, 2004 covenant violations. However, there can be no assurances that Webster will issue such waivers in the future. Because of the requirement to maintain a lock box arrangement with Webster, Webster's ability to invoke a subjective acceleration clause at its discretion and the expected future covenant violations, borrowings under the Credit Facility are classified as current at December 31, 2004, and December 31, 2003, in accordance with EITF 95-22. Balance Sheet Classification of Borrowings Outstanding Under Revolving Credit Agreements That Include Both a Subjective Acceleration Clause and a Lock-Box Agreement. The revolving loan balances outstanding under the Credit Facility were $4.1 million at December 31, 2004, and December 31, 2003. There were letters of credit outstanding under the Credit Facility of $0.7 million at December 31, 2004, and December 31, 2003. As of December 31, 2004, the Company had unused availability under the Credit Facility of $1.4 million out of the remaining maximum $2.2 million unused revolving line of credit after reducing the borrowing base by outstanding loans and letters of credit. In 2001, the Japanese joint venture SPAR FM Japan, Inc. entered into a revolving line of credit arrangement with Japanese banks for 300 million yen or $2.7 million (based upon the exchange rate at September 30, 2004). At September 30, 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 rates on the borrowings under the Japanese line of credit for its short-term bank loans at September 30, 2004 and 2003 were 1.375% and 1.375% per annum, respectively. 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 and India. The Company also announced the establishment of joint ventures in Romania and China. 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- Certain Contractual Obligations The following table contains a summary of certain of the Company's contractual obligations by category as of December 31, 2004 (in thousands).
-------------------------------------------------------------------------------------------------------------------- Contractual Obligations Payments due by Period -------------------------------------------------------------------------------------------------------------------- Total Less than 1 1-3 years 3-5 years More than 5 year years -------------------------------------------------------------------------------------------------------------------- Credit Facilities $ 4,956 $ 4,956 $ - $ - $ - -------------------------------------------------------------------------------------------------------------------- Operating Lease Obligations 1,468 776 651 41 - -------------------------------------------------------------------------------------------------------------------- Total $ 6,424 $ 5,732 $ 651 $ 41 $ - --------------------------------------------------------------------------------------------------------------------
In addition to the above table, at December 31, 2004, the Company had $737,337 in outstanding Letters of Credit. Item 7A. 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. As of December 31, 2004, the variable interest rate on the Company's lines of credit were 6.0% on its domestic line of credit and 1.4% on its Japanese line of credit. The Company has foreign currency exposure associated with its international 100% owned subsidiary, its 51% owned joint venture subsidiaries and its 50% owned joint ventures. In 2004, these exposures are primarily concentrated in the Canadian dollar, Japanese yen and South African rand. At December 31, 2004, international assets totaled $2.8 million and international liabilities totaled $3.8 million. For 2004, international revenues totaled $8.2 million and the Company's share of the net losses was approximately $500,000. Investment Portfolio The Company has no derivative financial instruments or derivative commodity instruments in its cash and cash equivalents and investments. Domestically, excess cash is normally used to pay down its revolving line of credit. Internationally, excess cash is used to fund operations. Item 8. Financial Statements and Supplementary Data. See Item 15 of this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. Item 9A. 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. -26- There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls during the twelve months covered by this report or from the end of the reporting period to the date of this Form 10-K. The Company has established a plan and has begun to document and test its internal controls over financial reporting required by Section 404 of the Sarbanes-Oxley Act of 2002. Item 9B. Other Information. 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 has representations, covenants and defaults customary for the leasing industry. The leases are for handheld computers to be used by field merchandisers in the performance of various merchandising services in the United States and Canada (see Item 13 - Certain Relationships and Related Transactions). -27- PART III Item 10. Directors and Executive Officers of the Registrant. Directors and Executive Officers -------------------------------- The following table sets forth certain information in connection with each person who is or was at December 31, 2004, an executive officer and/or director for the Company. Name Age Position with SPAR Group, Inc. ---- --- ------------------------------ Robert G. Brown. . . . . . . . 62 Chairman, Chief Executive Officer, President and Director William H. Bartels . . . . . . 61 Vice Chairman and Director . . Robert O. Aders (1). . . . . . 77 Director, Chairman Governance Committee Jack W. Partridge (1) . . . . . 59 Director, Chairman Compensation Committee Jerry B. Gilbert (1) . . . . . 70 Director Lorrence T. Kellar (1) . . . . 67 Director, Chairman Audit Committee Charles Cimitile. . . . . . . . 50 Chief Financial Officer, Treasurer and Secretary Kori G. Belzer . . . . . . . . . 39 Chief Operating Officer Patricia Franco. . . . . . . . . 44 Chief Information Officer James R. Segreto . . . . . . . . 56 Vice President, Controller __________________________ (1) Member of the Board's Governance, Compensation and Audit Committees Robert G. Brown serves as the Chairman, Chief Executive Officer, President and a Director of SGRP and has held such positions since July 8, 1999, the effective date of the merger of the SPAR Marketing Companies with PIA Merchandising Services, Inc. (the "Merger"). Mr. Brown served as the Chairman, President and Chief Executive Officer of the SPAR Marketing Companies (SPAR/Burgoyne Retail Services, Inc. ("SBRS") since 1994, SPAR, Inc. ("SINC") since 1979, SPAR Marketing, Inc. ("SMNEV") since November 1993, and SPAR Marketing Force, Inc. ("SMF") since 1996). William H. Bartels serves as the Vice Chairman and a Director of SGRP and has held such positions since July 8, 1999 (the effective date of the Merger). Mr. Bartels served as the Vice Chairman, Secretary, Treasurer and Senior Vice President of the SPAR Marketing Companies (SBRS since 1994, SINC since 1979, SMNEV since November 1993 and SMF since 1996). Robert O. Aders serves as a Director of SGRP and has done so since July 8, 1999. He has served as the Chairman of the Governance Committee since May 9, 2003. Mr. Aders has served as Chairman of The Advisory Board, Inc., an international consulting organization since 1993, and also as President Emeritus of the Food Marketing Institute ("FMI") since 1993. Immediately prior to his election to the Presidency of FMI in 1976, Mr. Aders was Acting Secretary of Labor in the Ford Administration. Mr. Aders was the Chief Executive Officer of FMI from 1976 to 1993. He also served in The Kroger Co., in various executive positions from 1957 to 1974 and was Chairman of the Board from 1970 to 1974. Mr. Aders also serves as a Director of Checkpoint Systems, Inc., Sure Beam Corporation and Telepanel Systems, Inc. -28- Jack W. Partridge serves as a Director of SGRP and has done so since January 29, 2001. He has served as the Chairman of the Compensation Committee of SGRP since May 9, 2003. Mr. Partridge is President of Jack W. Partridge & Associates. He previously served as Vice Chairman of the Board of The Grand Union Company from 1998 to 2000. Mr. Partridge's service with Grand Union followed a distinguished 23-year career with The Kroger Company, where he served as Group Vice President, Corporate Affairs, and as a member of the Senior Executive Committee, as well as various other executive positions. Mr. Partridge has been a leader in industry and community affairs for over two decades. He has served as Chairman of the Food Marketing Institute's Government Relations Committee, the Food and Agriculture Policy Task Force, and as Chairman of the Board of The Ohio Retail Association. He has also served as Vice Chairman of the Cincinnati Museum Center and a member of the boards of the United Way of Cincinnati, the Childhood Trust, Second Harvest and the Urban League. Jerry B. Gilbert serves as a Director of SGRP and has done so since June 4, 2001. Mr. Gilbert served as Vice President of Customer Relations for Johnson & Johnson's Consumer and Personal Care Group of Companies from 1989 to 1997. Mr. Gilbert joined Johnson & Johnson in 1958 and from 1958 to 1989 held various executive positions. Mr. Gilbert also served on the Advisory Boards of the Food Marketing Institute, the National Association of Chain Drug Stores and the General Merchandise Distributors Council (GMDC) where he was elected the first President of the GMDC Educational Foundation. He was honored with lifetime achievement awards from GMDC, Chain Drug Review, Drug Store News and the Food Marketing Institute. He is the recipient of the prestigious National Association of Chain Drug Stores (NACDS) Begley Award, as well as the National Wholesale Druggists Association (NWDA) Tim Barry Award. In June 1997, Mr. Gilbert received an Honorary Doctor of Letters Degree from Long Island University. Lorrence T. Kellar serves as a Director and the Chairman of the Audit Committee of SGRP and has done so since April 2, 2003. Mr. Kellar had a 31-year career with The Kroger Co., where he served in various financial capacities, including Group Vice President for real estate and finance, and earlier, as Corporate Treasurer. He was responsible for all of Kroger's real estate activities, as well as facility engineering, which coordinated all store openings and remodels. Mr. Kellar subsequently served as Vice President, real estate, for Kmart. He currently is Vice President of Continental Properties Company, Inc. Mr. Kellar also serves on the boards of Frisch's Restaurants and Multi-Color Corporation and is a trustee of the Acadia Realty Trust. He also is a major patron of the arts and has served as Chairman of the Board of the Cincinnati Ballet. Charles Cimitile serves as the Chief Financial Officer, Secretary and Treasurer of SGRP and has done so since November 24, 1999. Mr. Cimitile served as Chief Financial Officer for GT Bicycles from 1996 to 1999 and Cruise Phone, Inc. from 1995 through 1996. Prior to 1995, he served as the Vice President Finance, Secretary and Treasurer of American Recreation Company Holdings, Inc. and its predecessor company. Kori G. Belzer serves as the Chief Operating Officer of SGRP and has done so since January 1, 2004. Ms. Belzer also serves as Chief Operating Officer of SPAR Management Services, Inc. ("SMSI"), and SPAR Marketing Services, Inc. ("SMS"), each an affiliate of SGRP (see Item 13 - Certain Relationships and Related Transactions, below), and has done so since 2000. The Audit Committee determined that Ms. Belzer also served during 2003 as the de facto chief operating officer of SGRP through her position as Chief Operating Officer of SMSI and SMS. Prior to 2000, Ms. Belzer served as Vice President Operations of SMS from 1997 to 2000, and as Regional Director of SMS from 1995 to 1997. Prior to 1995, she served as Client Services Manager for SPAR/Servco, Inc. -29- Patricia Franco serves as the Chief Information Officer of SGRP and President of the SPAR International Merchandising Services Division and has done so since January 1, 2004. Ms. Franco also serves as Senior Vice President of SPAR Infotech, Inc. ("SIT"), an affiliate of SGRP (see Item 13 - Certain Relationships and Related Transactions, below), and has done so since January 1, 2003. The Audit Committee determined that Ms. Franco also served during 2003 as the de facto chief information officer of SGRP as well as, the de facto President of the SPAR International Merchandising Services Division, through her position as Senior Vice President of SIT. Prior to 2003, Ms. Franco served in various management capacities with SIT, SMS and their affiliates. James R. Segreto serves as Vice President, Controller of SGRP and has done so since July 8, 1999, the effective date of the Merger. From 1997 through the Merger, he served in the same capacity for SMS. Mr. Segreto served as Chief Financial Officer for Supermarket Communications Systems, Inc. from 1992 to 1997 and LM Capital, LLP from 1990 to 1992. Prior to 1992, he served as Controller of Dorman Roth Foods, Inc. Audit Committee Composition and Financial Expert The Audit Committee currently consists of Messrs. Kellar (its Chairman), Aders, Gilbert and Partridge, each of whom has been determined by the Governance Committee and the Board to meet the independence requirements for audit committee members under Nasdaq Rule 4200(a)(14). In connection with his re-nomination as a Director, the Governance Committee and the Board re-determined that Mr. Kellar was qualified to be the "audit committee financial expert" as required by applicable law and the SEC Rules. Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of the Exchange Act ("Section 16(a)") requires the Company's directors and certain of its officers and persons who own more than 10% of the Company's Common Stock (collectively, "Insiders"), to file reports of ownership and changes in their ownership of the Company's Common Stock with the Commission. Insiders are required by Commission regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it for the year ended December 31, 2004, or written representations from certain reporting persons for such year, the Company believes that its Insiders complied with all applicable Section 16(a) filing requirements for such year, with the exception that Robert G. Brown, William H. Bartels, Jack W. Partridge and Robert O. Aders untimely filed certain Statements of Changes in Beneficial Ownership on Form 4. Kori Belzer and Patricia Franco became filers in March of 2004. All such Section 16(a) filing requirements have since been completed by each of the aforementioned individuals. Ethics Codes The Company has adopted codes of ethical conduct applicable to all of its directors, officers and employees, as approved and recommended by the Audit Committee and Governance Committee and adopted by the Board on May 3, 2004, in accordance with Nasdaq Rules. These codes of conduct consist of: (1) the SPAR Group Code of Ethical Conduct for its Directors, Senior Executives and Employees Dated (as of) May 1, 2004; and (2) the SPAR Group Statement of Policy Regarding Personal Securities Transaction in SGRP Stock and Non-Public Information Dated, Amended and Restated as of May 1, 2004, which amends, restates and completely replaces its existing similar statement of policy. Both Committees were involved because authority over ethics codes shifted from the Audit Committee to the Governance Committee with the adoption of the committee charters on May 18, 2004. Copies of these codes and policies are posted and available to stockholders and the public on the Company's web site (www.SPARinc.com). -30- Item 11. Executive Compensation and Other Information of SPAR Group, Inc. Executive Compensation ---------------------- The following table sets forth all compensation received for services rendered to the Company in all capacities for the years ended December 31, 2004, 2003, and 2002 (except for amounts paid to SMS, SMSI and SIT, see Item 13 - Certain Relationships and Related Transactions, below) (i) by the Company's Chief Executive Officer, and (ii) each of the other four most highly compensated executive officers of the Company and its affiliates who were serving as executive officers of the Company or performing equivalent functions for the Company through an affiliate, at December 31, 2004 (collectively, the "Named Executive Officers"). Summary Compensation Table
Long Term Annual Compensation Compensation Awards ------------------- ------------------- Securities Underlying All Other Options Compensation Name and Principal Positions Year Salary ($) Bonus ($) (#)(1) ($)(2) ---------------------------- ---- ---------- --------- ------ ------ Robert G. Brown 2004 114,000 (3) -- -- 1,800 Chief Executive Officer, Chairman of the 2003 180,000 (3) -- -- 2,200 Board, President, and Director 2002 164,340 (3) -- -- 2,040 William H. Bartels 2004 114,000 (3) -- -- 1,620 Vice Chairman and Director 2003 180,000 (3) -- -- 2,007 2002 164,340 (3) -- -- 2,040 Charles Cimitile 2004 220,000 -- 25,000 1,800 Chief Financial Officer, Treasurer and 2003 221,700 20,000 20,000 2,200 Secretary 2002 215,564 15,000 20,000 2,040 Kori G. Belzer 2004 147,990 -- 25,000 1,495 Chief Operating Officer 2003 147,067 19,000 26,750 1,843 Patricia Franco 2004 147,900 10,000 25,000 1,493 Chief Information Officer 2003 145,875 20,000 37,500 1,718
________________________ (1) In June 2004, Mr. Brown and Mr. Bartels voluntarily surrendered for cancellation their options for the purchase of the following shares of common stock under the 2000 Plan: 382,986 and 235,996, respectively. In September 2004, Mr. Cimitile, Ms. Belzer and Ms. Franco voluntarily surrendered for cancellation their options for the purchase of the following shares of common stock under the 2000 Plan: 55,000, 76,140 and 87,500 respectively. Also in September 2004, Ms. Franco voluntarily surrendered for cancellation her options for the purchase 10,000 shares of common stock under the 1995 Plan. (2) Other compensation represents the Company's 401k contribution. (3) Does not include amounts paid to SMS, SMSI, SIT and Affinity Insurance Ltd. (see Item 13 - Certain Relationships and Related Transactions, below) -31- Stock Option Grants in Last Fiscal Year The following table sets forth information regarding each grant of stock options made during the year ended December 31, 2004, to each of the Named Executive Officers. No stock appreciation rights ("SAR's") were granted during such period to such person.
Individual Grants ---------------------------------------------------------- Number of Percent of Securities Total Options Underlying Granted to Potential Realizable Value at Options Employees in Exercise Expiration Assumed Annual Rates of Stock Name Granted(2)(#) Period (%) Price ($/Sh) Date Price Appreciation for Option(1) ---- ------------------------------------------------------------------------------------------ 5% ($) 10% ($) ------------------------------------------------------------------------------------------ Charles Cimitile 25,000 16.1 2.39 3/31/14 37,596 95,226 Kori G. Belzer 25,000 16.1 2.39 3/31/14 37,596 95,226 Patricia Franco 25,000 16.1 2.39 3/31/14 37,596 95,226
____________ (1) The potential realizable value is calculated based upon the term of the option at its time of grant. It is calculated by assuming that the stock price on the date of grant appreciates at the indicated annual rate, compounded annually for the entire term of the option. (2) These options vest over four-year periods at a rate of 25% per year, beginning on the first anniversary of the date of grant. Aggregated Stock Option Exercises in Last Fiscal Year and Fiscal Year End Option Values The following table sets forth the number of shares of Common Stock of the Company purchased by each of the Named Executive Officers in the exercise of stock options during the year ended December 31, 2004, the value realized in the purchase of such shares (the market value at the time of exercise less the exercise price to purchase such shares), and the number of shares that may be purchased and value of the exercisable and unexercisable options held by each of the Named Executive Officers at December 31, 2004.
Number of Securities Underlying Value of Unexercised Unexercised Options at Fiscal In-the-Money Options at Fiscal Year-End (#) Year-End ($) ---------------------------------- -------------------------------- Shares Acquired Value Name on Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable ---- ----------------- --------------- ---------------- ---------------- -------------- ---------------- Robert G. Brown -- -- -- 95,746 -- -- William H. Bartels -- -- -- 58,999 -- -- Charles Cimitile -- -- 25,000 85,000 10,625 -- Kori G. Belzer -- -- 11,500 94,500 4,513 88 Patricia Franco -- -- 11,500 79,500 4,513 88
Stock Option and Purchase Plans The Company has four stock option plans: the Amended and Restated 1995 Stock Option Plan ("1995 Plan"), the 1995 Director's Plan ("Director's Plan"), the Special Purpose Stock Option Plan (the "Special Purpose Plan"), and the 2000 Stock Option Plan ("2000 Plan"). The 1995 Plan provided for the granting of either incentive or nonqualified stock options to specific employees, consultants, and directors of the Company for the purchase of up to 3,500,000 shares of the Company's common stock. The options had a term of ten years from the date of issuance, except in the case of incentive stock options granted to greater than 10% stockholders for which the term was five years. The exercise price of nonqualified stock options must have been equal to at least 85% of the fair market value of the Company's common stock at the date of grant. Since 2000, the Company has not granted any new options under this plan. During 2004, 1,500 options to purchase shares of the Company's common stock were exercised and options to purchase 26,625 shares of the Company's stock were cancelled -32- under this plan. At December 31, 2004, options to purchase 15,125 shares of the Company's common stock remain outstanding under this plan. The 1995 Plan was superseded by the 2000 Plan with respect to all new options issued. The Director's Plan was a stock option plan for non-employee directors and provided for the purchase of up to 120,000 shares of the Company's common stock. Since 2000, the Company has not granted any new options under this plan. During 2004, no options to purchase shares of the Company's common stock were exercised under this plan. At December 31, 2004, 20,000 options to purchase shares of the Company's common stock remained outstanding under this plan. The Director's Plan has been replaced by the 2000 Plan with respect to all new options issued. On July 8, 1999, in connection with the merger, the Company established the Special Purpose Plan of PIA Merchandising Services, Inc. to provide for the issuance of substitute options to the holders of outstanding options granted by SPAR Acquisition, Inc. There were 134,114 options granted at $0.01 per share. Since July 8, 1999, the Company has not granted any new options under this plan. During 2004, 21,000 options to purchase shares of the Company's common stock were exercised under this plan. At December 31, 2004, options to purchase 4,750 shares of the Company's common stock remain outstanding under this plan. On December 4, 2000, the Company adopted the 2000 Plan, as the successor to the 1995 Plan and the Director's Plan with respect to all new options issued. The 2000 Plan provides for the granting of either incentive or nonqualified stock options to specified employees, consultants, and directors of the Company for the purchase of up to 3,600,000 (less those options still outstanding under the 1995 Plan or exercised after December 4, 2000 under the 1995 Plan). The options have a term of ten years, except in the case of incentive stock options granted to greater than 10% stockholders for whom the term is five years. The exercise price of nonqualified stock options must be equal to at least 85% of the fair market value of the Company's common stock at the date of grant (although typically the options are issued at 100% of the fair market value), and the exercise price of incentive stock options must be equal to at least the fair market value of the Company's common stock at the date of grant. During 2004, options to purchase 476,417 shares of the Company's common stock were granted, options to purchase 53,302 shares of the Company's common stock were exercised and options to purchase 1,345,542 shares of the Company's stock were voluntarily surrendered and cancelled under this plan. At December 31, 2004, options to purchase 1,251,383 shares of the Company's common stock remain outstanding under this plan and options to purchase 1,618,719 shares of the Company's common stock were available for grant under this plan. In 2001, SGRP adopted its 2001 Employee Stock Purchase Plan (the "ESP Plan"), which replaced its earlier existing plan, and its 2001 Consultant Stock Purchase Plan (the "CSP Plan"). These plans were each effective as of June 1, 2001. The ESP Plan allows employees of the Company, and the CSP Plan allows employees of the affiliates of the Company (see Item 13 - Certain Relationships and Related Transactions, below), to purchase SGRP's Common Stock from SGRP without having to pay any brokerage commissions. On August 8, 2002, SGRP's Board approved a 15% discount for employee purchases of Common Stock under the ESP Plan and recommended that its affiliates pay a 15% cash bonus for affiliate consultant purchases of Common Stock under the CSP Plan. Compensation of Directors The Company's Compensation Committee administers the compensation plan for its outside Directors as well as the compensation for its executives. Each member of the Company's Board who is not otherwise an employee or officer of the Company or any subsidiary or affiliate of the Company (each, an "Eligible Director") is eligible to receive the compensation contemplated under such plan. In January 2001, SGRP adopted the Director Compensation Plan for its outside Directors, as approved by the Board, as amended (the "Directors Compensation Plan"). SGRP's Compensation Committee administers the Directors Compensation Plan as well as the compensation for SGRP's executives. Under the Directors Compensation Plan, each member of SGRP's Board who is not otherwise an employee or officer of SGRP or any subsidiary or affiliate of SGRP (each, a "Non-Employee Director") is eligible to receive director's fees of $30,000 per annum (plus an additional $5,000 per annum for the Audit Committee Chairman), payable quarterly. Each quarterly installment of such director's fees ($7,500 plus an additional $1,250 for the Audit Committee Chairman) is paid half in cash and half in stock options to purchase shares of SGRP's common stock. Prior to May 2004, SGRP issued such stock options with an exercise price of $0.01 per share. The number of option shares issued was calculated by dividing the amount of compensation to be paid in stock options by the closing stock price at the end of each quarter. In May 2004, the Compensation Committee approved and recommended and the Board adopted a change in this policy to instead issue such stock options for the purchase of common stock with an exercise price equal to 100% of the fair -33- market value of SGRP's common stock at the end of each quarter. The number of option shares to be issued will be equal to three times the quotient of the amount of compensation to be paid in stock options divided by the closing stock price at the end of each quarter. The Compensation Committee and the Board determined that this revised policy more fairly compensated the Non-Employee Directors. In addition upon acceptance of the directorship, each Non-Employee Director receives options to purchase 10,000 shares of SGRP's common stock with an exercise price equal to 100% of the fair market value of SGRP's common stock at the date of grant, options to purchase 10,000 additional shares of SGRP's common stock with an exercise price equal to 100% of the fair market value of SGRP's common stock at the date of grant after one year of service and options to purchase 10,000 additional shares of SGRP's common stock with an exercise price equal to 100% of the fair market value of SGRP's common stock at the date of grant for each additional year of service thereafter. All of those options to Non-Employee Directors have been and will be granted under the 2000 Plan described above, under which each member of the Board is eligible to participate. Non-Employee Directors will be reimbursed for all reasonable expenses incurred during the course of their duties. There is no additional compensation for committee participation, phone meetings, or other Board activities. Severance Agreements The Company has entered into a Change of Control Severance Agreement with each of Patricia Franco, the Company's Chief Information Officer, and Kori G. Belzer, the Company's Chief Operating Officer, each providing for a lump sum severance payment and other accommodations from the Company to the employee under certain circumstances if, pending or following a change in control, the employee leaves for good reason or is terminated other than in a termination for cause. The payment is equal to the sum of the employee's monthly salary times a multiple equal to 24 months less the number of months by which the termination of employment followed the change in control plus the maximum bonus that would have been paid to the employee (not to exceed 25% of the employee's annual salary). Compensation Committee Interlocks and Insider Participation No member of the Board's Compensation Committee was at any time during the year ended December 31, 2004, or at any other time an officer or employee of the Company. No executive officer or board member of the Company serves as a member of the board of directors or compensation committee of any other entity, that has one or more executive officers serving as a member of the Company's Board or Compensation Committee, except for the positions of Messrs. Brown and Bartels as directors and officers of the Company (including each of its subsidiaries) and each of its affiliates, including SMS, SMSI and SIT (see Item 13 - Certain Relationships and Related Transactions, below). -34- Item 12. Security Ownership of Certain Beneficial Owners and Management. Security Ownership of Certain Beneficial Owners of the Company The following table sets forth certain information regarding beneficial ownership of the Company's common stock as of March 15, 2005 by: (i) each person (or group of affiliated persons) who is known by the Company to own beneficially more than 5% of the Company's common stock; (ii) each of the Company's directors; (iii) each of the Named Executive Officers in the Summary Compensation Table; and (iv) the Company's directors and such Named Executive Officers as a group. Except as indicated in the footnotes to this table, the persons named in the table, based on information provided by such persons, have sole voting and sole investment power with respect to all shares of common stock shown as beneficially owned by them, subject to community property laws where applicable.
Number of Shares Title of Class Name and Address of Beneficial Owner Beneficially Owned Percentage Common Shares Robert G. Brown (1) 8,622,407 (2) 45.5% Common Shares William H. Bartels (1) 5,549,842 (3) 29.4% Common Shares Robert O. Aders (1) 134,543 (4) * Common Shares Jack W. Partridge (1) 78,633 (5) * Common Shares Jerry B. Gilbert (1) 71,974 (6) * Common Shares Lorrence T. Kellar (1) 68,602 (7) * Common Shares Charles Cimitile (1) 107,500 (8) * Common Shares Kori G. Belzer (1) 97,951 (9) * Common Shares Patricia Franco (1) 141,998 (10) * Common Shares Richard J. Riordan (11) 300 South Grand Avenue, Suite 2900 Los Angeles, California 90071 1,209,922 6.4% Common Shares Heartland Advisors, Inc. (12) 790 North Milwaukee Street Milwaukee, Wisconsin 53202 1,300,000 6.9% Common Shares Executive Officers and Directors 14,873,450 79.0%
* Less than 1% (1) The address of such owners is c/o SPAR Group, Inc. 580 White Plains Road, Tarrytown, New York 10591. (2) Includes 1,800,000 shares held by a grantor trust for the benefit of certain family members of Robert G. Brown over which Robert G. Brown, James R. Brown, Sr. and William H. Bartels are trustees. Includes 95,747 shares issuable upon exercise of options. (3) Excludes 1,800,000 shares held by a grantor trust for the benefit of certain family members of Robert G. Brown over which Robert G. Brown, James R. Brown, Sr. and William H. Bartels are trustees, beneficial ownership of which are disclaimed by Mr. Bartels. Includes 58,999 shares issuable upon exercise of options. (4) Includes 62,889 shares issuable upon exercise of options. (5) Includes 67,665 shares issuable upon exercise of options. (6) Includes 71,974 shares issuable upon exercise of options. (7) Includes 62,454 shares issuable upon exercise of options. (8) Includes 107,500 shares issuable upon exercise of options. (9) Includes 96,000 shares issuable upon exercise of options. (10) Includes 88,500 shares issuable upon exercise of options. (11) Share ownership was confirmed with the Company's stock transfer agent and the principal. (12) All information regarding share ownership is taken from and furnished in reliance upon the Schedule 13G (Amendment No. 9), filed by Heartland Advisors, Inc. with the Securities and Exchange Commission on December 31, 2004. -35- Equity Compensation Plans The following table contains a summary of the number of shares of Common Stock of the Company to be issued upon the exercise of options, warrants and rights outstanding at December 31, 2004, the weighted-average exercise price of those outstanding options, warrants and rights, and the number of additional shares of Common Stock remaining available for future issuance under the plans as at December 31, 2004.
Equity Compensation Plan Information ----------------------------- -------------------------- ------------------------- ------------------------- Number of securities to Weighted average Number of securities be issued upon exercise exercise price of remaining available for of outstanding options, outstanding options, future issuance of warrants and rights (#) warrants and rights ($) options, warrants and Plan category rights (#) ----------------------------- -------------------------- ------------------------- ------------------------- Equity compensation plans 1,291,258 $1.66 1,618,719 approved by security holders ----------------------------- -------------------------- ------------------------- ------------------------- Equity compensation plans not approved by security holders -- -- -- ----------------------------- -------------------------- ------------------------- ------------------------- Total 1,291,258 $1.66 1,618,719 ----------------------------- -------------------------- ------------------------- -------------------------
Item 13. Certain Relationships and Related 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 $24.0 million, $36.0 million, and $30.5 million for 2004, 2003, and 2002, 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, 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 $640,000 for 2004. Total net premiums (4% of SMS and SMSI costs less 2004 concessions) paid to SMS and SMSI for services rendered were approximately $320,000, $1,350,000, and $1,100,000 for 2004, 2003, and 2002, 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, Messrs. Brown and Bartels 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 $1,170,000, $1,610,000, and $1,630,000 for 2004, 2003, and 2002, respectively. SIT provided approximately 34,000, 47,000, and 46,000 hours of Internet computer programming services to the Company for 2004, 2003, and 2002, 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 $34.71, $34.24, and $35.10 for 2004, 2003, and 2002, 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 2004. However, since SIT is a "Subchapter S" corporation, Messrs. Brown and Bartels 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 has representations, covenants and defaults customary for the leasing industry. The SMF lease has a monthly payment of $20,318 and is for handheld computers to be used by field merchandisers in the performance of various merchandising services in the United States. These handheld computers had an original purchase price of $632,200. The SPAR Canada lease has a monthly payment of $3,326 and is for handheld -36- computers to be used by field merchandisers in the performance of various merchandising services in Canada. These handheld computers had an original purchase price of $105,000. The Company's agreements with SMS, SMSI and SIT are periodically reviewed by the Company's Audit Committee, which includes an examination of the overall fairness of the arrangements. In February 2004, the Audit Committee approved separate amended and restated agreements with each of SMS, SMSI and SIT, effective as of January 1, 2004. The restated agreements extend the contract maturities for four years, strengthened various contractual provisions in each agreement and continued the basic economic terms of the existing agreements, except that the restated agreement with SMSI provides for temporary concessions to the Company by SMSI totalling approximately $640,000 for 2004. In July 1999, SMF, SMS and SIT entered into a Software Ownership Agreement with respect to Internet job scheduling software jointly developed by such parties. In addition, SPAR Trademarks, Inc. ("STM"), SMS and SIT entered into trademark licensing agreements whereby STM has granted non-exclusive royalty-free licenses to SIT, SMS and SMSI for their continued use of the name "SPAR" and certain other trademarks and related rights transferred to STM, a wholly owned subsidiary of the Company. Messrs. Brown and Bartels also collectively own, through SMSI, a minority (less than 5%) equity interest in Affinity Insurance Ltd., which provides certain insurance to the Company. In April 2003, all previously outstanding amounts due certain stockholders under certain notes were paid in full. In the event of any material dispute in the business relationships between the Company and SMS, SMSI, or SIT, it is possible that Messrs. Brown or Bartels may have one or more conflicts of interest with respect to these relationships and such dispute could have a material adverse effect on the Company. Item 14. Principal Accountant Fees and Services. On October 4, 2004, Ernst & Young LLP ("E&Y") resigned as the independent registered public accounting firm for the Company and its subsidiaries. The resignation was effective upon completion of E&Y's review of the interim financial information for the Company's third fiscal quarter ended September 30, 2004, and the filing of the Company's quarterly report on Form 10-Q for such period. In January 2005, the Company, with the approval of the Company's Audit Committee, appointed Rehmann Robson ("Rehmann") as its independent registered public accounting firm to audit the financial statements of the Company for its year ending December 31, 2004. The Company and its subsidiaries did not engage Rehmann or E&Y to provide advice regarding financial information systems design or implementation, but did engage E&Y for tax consulting services related to the PHI/SPGI ESOP in 2003 (for which E&Y was paid $3,778), due diligence services for the IMS acquisition during 2003 (for which E&Y was paid $14,334) and for tax services in 2003 (for which E&Y was paid $2,295). No other non-audit services were performed by Rehmann or E&Y in 2004 or 2003. Since 2003, as required by law, each non-audit service performed by the Company's auditor either (i) was approved in advance on a case-by-case basis by the Company's Audit Committee, or (ii) fit within a pre-approved "basket" of non-audit services of limited amount, scope and duration established in advance by the Company's Audit Committee. In connection with the standards for independence of the Company's independent public accountants promulgated by the Securities and Exchange Commission, the Audit Committee considers (among other things) whether the provision of such non-audit services would be compatible with maintaining the independence of Rehmann or E&Y. Audit Fees During the Company's fiscal year ended December 31, 2004 and 2003, respectively, fees billed by E&Y for all audit services rendered to the Company and its subsidiaries were $100,203 and $179,362, respectively. Audit services principally include fees for the Company's audits and 10-Q filing reviews. Since 2003, as required by law, the choice of the Company's auditor and the audit services to be performed by it have been approved in advance by the Company's Audit Committee. -37- PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) 1. Index to Financial Statements filed as part of this report: Reports of Independent Registered Public Accounting Firms - Rehmann Robson. F-1 - Ernst & Young LLP. F-2 Consolidated Balance Sheets as of December 31, 2004, and December 31, 2003. F-3 Consolidated Statements of Operations for the years ended December 31, 2004, December 31, 2003, and December 31, 2002. F-4 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2004, December 31, 2003, and December 31, 2002. F-5 Consolidated Statements of Cash Flows for the years ended December 31, 2004, December 31, 2003, and December 31, 2002. F-6 Notes to Financial Statements. F-7 2. Financial Statement Schedules. Schedule II - Valuation and Qualifying Accounts for the three years ended December 31, 2004. F-30 3. Exhibits. Exhibit Number Description ------ ----------- 3.1 Certificate of Incorporation of SPAR Group, Inc. (referred to therein under its former name PIA), as amended (incorporated by reference to the Company's Registration Statement on Form S-1 (Registration No. 33-80429), as filed with the Securities and Exchange Commission ("SEC") on December 14, 1995 (the "Form S-1")), and the Certificate of Amendment filed with the Secretary of State of the State of Delaware on July 8, 1999 (which, among other things, changes the Company's name to SPAR Group, Inc.) (incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q for the 3rd Quarter ended September 30, 1999). 3.2 Amended and Restated By-Laws of SPAR Group, Inc. adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 3.3 Amended and Restated Charter of the Audit Committee of the Board of Directors of SPAR Group, Inc., adopted May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 3.4 Charter of the Compensation Committee of the Board of Directors of SPAR Group, Inc. adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 3.5 Charter of the Governance Committee of the Board of Directors of SPAR Group, Inc. adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 3.6 SPAR Group, Inc. Statement of Policy Respecting Stockholder Communications with Directors, adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). -38- 3.7 SPAR Group, Inc. Statement of Policy Regarding Director Qualifications and Nominations, adopted on May 18, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 27, 2004). 4.1 Registration Rights Agreement entered into as of January 21, 1992, by and between RVM Holding Corporation, RVM/PIA, a California Limited Partnership, The Riordan Foundation and Creditanstalt-Bankverine (incorporated by reference to the Form S-1). 10.1 2000 Stock Option Plan, as amended, (incorporated by reference to the Company's Proxy Statement for the Company's Annual meeting held on August 2, 2001, as filed with the SEC on July 12, 2001). 10.2 2001 Employee Stock Purchase Plan (incorporated by reference to the Company's Proxy Statement for the Company's Annual meeting held on August 2, 2001, as filed with the SEC on July 12, 2001). 10.3 2001 Consultant Stock Purchase Plan (incorporated by reference to the Company's Proxy Statement for the Company's Annual meeting held on August 2, 2001, as filed with the SEC on July 12, 2001). 10.4 Amended and Restated Field Service Agreement dated and effective as of January 1, 2004, by and between SPAR Marketing Services, Inc., and SPAR Marketing Force, Inc. (incorporated by reference to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2004, as filed on May 21, 2004). 10.5 Amended and Restated Field Management Agreement dated and effective as of January 1, 2004, by and between SPAR Management Services, Inc., and SPAR Marketing Force, Inc. (incorporated by reference to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2004, as filed on May 21, 2004). 10.6 Amended and Restated Programming and Support Agreement dated and effective as of January 1, 2004, by and between SPAR InfoTech, Inc., and SPAR Marketing Force, Inc. (incorporated by reference to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 2004, as filed on May 21, 2004). 10.7 Trademark License Agreement dated as of July 8, 1999, by and between SPAR Marketing Services, Inc., and SPAR Trademarks, Inc. (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2002). 10.8 Trademark License Agreement dated as of July 8, 1999, by and between SPAR Infotech, Inc., and SPAR Trademarks, Inc. (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2002). 10.9 Stock Purchase and Sale Agreement by and among Performance Holdings, Inc. and SPAR Incentive Marketing, Inc., effective as of June 30, 2002 (incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 2002). 10.10 Revolving Credit, Guaranty and Security Agreement by and among Performance Holdings, Inc. and SPAR Incentive Marketing, Inc., effective as of June 30, 2002 (incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 2002). 10.11 Term Loan, Guaranty and Security Agreement by and among Performance Holdings, Inc. and SPAR Incentive Marketing, Inc., effective as of June 30, 2002 (incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 2002). 10.12 Promissory Note in the principal amount of $764,271.00 by STIMULYS, Inc., in favor of SPAR Incentive Marketing, Inc., dated as of September 10, 2004, as filed herewith. -39- 10.13 Payoff and Release Letter by and between STIMULYS, Inc., and SPAR Incentive Marketing, Inc., dated as of September 10, 2004, as filed herewith. 10.14 Sales Proceeds Agreement by and between STIMULYS, Inc. and SPAR Incentive Marketing, Inc., dated as of September 10, 2004, as filed herewith. 10.15 Third Amended and Restated Revolving Credit and Security Agreement by and among Whitehall Business Credit Corporation (the "Lender") with SPAR Marketing Force, Inc., SPAR Group, Inc., SPAR, Inc., SPAR/Burgoyne Retail Services, Inc., SPAR Incentive Marketing, Inc., SPAR Trademarks, Inc., SPAR Marketing, Inc. (DE), SPAR Marketing, Inc. (NV), SPAR Acquisition, Inc., SPAR Group International, Inc., SPAR Technology Group, Inc., SPAR/PIA Retail Services, Inc., Retail Resources, Inc., Pivotal Field Services Inc., PIA Merchandising Co., Inc., Pacific Indoor Display Co. and Pivotal Sales Company (collectively, the "Existing Borrowers"), dated as of January 24, 2003 (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2002). 10.16 Waiver And Amendment No. 3 To Third Amended And Restated Revolving Credit And Security Agreement entered into as of March 26, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 26, 2004). 10.17 Joinder, Waiver And Amendment No. 4 To Third Amended And Restated Revolving Credit And Security Agreement entered into as of May 17, 2004 (incorporated by reference to the Company's report on Form 8-K, as filed on May 26, 2004). 10.18 Waiver and Amendment to Third Amended and Restated Revolving Credit and Security Agreement by and among the Lender and the Borrowers dated as of January 2004 (incorporated by reference to the Company's report on Form 10-K/A for the year ended December 31, 2003, as filed on June 28, 2004). 10.19 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 (incorporated by reference to the Company's quarterly report of the quarter ended June 30, 2004, as filed on August 23, 2004). 10.20 Waiver and Amendment No. 6 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 November 12, 2004 (incorporated by reference to the Company's quarterly report for the quarter ended September 30, 2004, filed November 17, 2004). 10.21 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, 2004, as filed herewith. 10.22 Consent, Joinder, Release and Amendment Agreement dated as of October 31, 2003, by and among the Lender, the Existing Borrowers and SPAR All Store Marketing, Inc., as a Borrower (incorporated by reference to the Company's Form 10-K for the fiscal year ended December 31, 2003). 10.23 Change in Control Severance Agreement between Kori Belzer and SPAR Group, Inc., dated as of August 12, 2004 (incorporated by reference to the Company's quarterly report of the quarter ended June 30, 2004, as filed on August 23, 2004). 10.24 Change in Control Severance Agreement between Patricia Franco and SPAR Group, Inc., dated as of August 12, 2004 (incorporated by reference to the Company's quarterly report of the quarter ended June 30, 2004, as filed on August 23, 2004). -40- 10.25 Master Lease Agreement by and between SPAR Marketing Services, Inc. and SPAR Marketing Force, Inc. dated as of November 2004 relating to lease of handheld computer equipment, as filed herewith. 10.26 Master Lease Agreement by and between SPAR Marketing Services, Inc. and SPAR Canada Company dated as of January 2005 relating to lease of handheld computer equipment, as filed herewith. 10.27 Joint Venture Agreement dated as of March 26, 2004, by and between Solutions Integrated Marketing Services Ltd. and SPAR Group International, Inc. as filed herewith. 10.28 Joint Venture Shareholders Agreement between Friedshelf 401 (Proprietary) Limited, SPAR Group International, Inc., Derek O'Brien, Brian Mason, SMD Meridian CC, Meridian Sales & Mnrechandisign (Western Cape) CC, Retail Consumer Marketing CC, Merhold Holding Trust in respect of SGRP Meridian (Proprietary) Limited, dated as of June 25, 2004, as filed herewith. 10.29 Joint Venture Agreement dated as of July 21, 2003, by and between CEO Produksiyon Tanitim ve Arastirma Hizmetleri Ltd Sti and SPAR Group International, Inc., as filed herewith. 10.30 Joint Venture Agreement dated as of May 1, 2001, by and between Paltac Corporation and SPAR Group, Inc., as filed herewith. 10.31 Agreement on Amendment dated as of August 1, 2004, by and between SPAR Group, Inc. and SPAR FM Japan, Inc., as filed herewith. 10.32 Joint Venture Agreement dated as of January 26, 2005, by and between Best Mark Investments Holdings Ltd and SPAR International Ltd. as filed herewith. 10.33 Joint Venture Agreement dated as of December 14, 2004, by and between Field Insights S.R.L. and SPAR Group International, Inc., as filed herewith. 14.1 Code of Ethical Conduct for the Directors, Senior Executives and Employees, of SPAR Group, Inc., dated May 1, 2004 (incorporated by reference to the Company's Form 8-K filed on May 5, 2004). 14.2 Statement of Policy Regarding Personal Securities Transaction in Company Stock and Non-Public Information, as amended and restated on May 1, 2004 (incorporated by reference to the Company's Form 8-K filed on May 5, 2004). 21.1 List of Subsidiaries. 23.1 Consent of Rehmann Robson. 23.2 Consent of Ernst & Young LLP. 31.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, and filed herewith. 31.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, and filed herewith. 32.1 Certification of the CEO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and filed herewith. -41- 32.2 Certification of the CFO pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and filed herewith. (b) Reports on Form 8-K. Form 8-K - Changes in Registrant's Certifying Accountant filed on October 8, 2004, respecting the resignation of Ernst & Young LLP as the Company's Independent Auditors. Form 8-K - Results of Operations and Financial Condition filed on November 12, 2004, attaching press release respecting financial results for the third quarter ended September 30, 2004. Form 8-K - Unscheduled Material Events filed on February 4, 2005 respecting, appointment of Rehmann Robson as the Company's Independent Auditors. -42- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to the report to be signed on its behalf by the undersigned, thereunto duly authorized. SPAR Group, Inc. By: /s/ Robert G. Brown -------------------------------------- Robert G. Brown President, Chief Executive Officer and Chairman of the Board Date: April 12, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this amendment to the report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. SIGNATURE TITLE /s/ Robert G. Brown President, Chief Executive Officer, Director, ----------------------- and Chairman of the Board Robert G. Brown Date: April 12, 2005 /s/ William H. Bartels Vice Chairman and Director ----------------------- William H. Bartels Date: April 12, 2005 /s/ Robert O. Aders Director ----------------------- Robert O. Aders Date: April 12, 2005 /s/ Jack W. Partridge Director ----------------------- Jack W. Partridge Date: April 12, 2005 /s/ Jerry B. Gilbert Director ----------------------- Jerry B. Gilbert Date: April 12, 2005 /s/ Lorrence T. Kellar Director ----------------------- Lorrence T. Kellar Date: April 12, 2005 /s/ Charles Cimitile Chief Financial Officer, Treasurer and ----------------------- Secretary (Principal Financial and Charles Cimitile Accounting Officer) Date: April 12, 2005 -43- Report of Registered Public Accounting Firm The Board of Directors and Stockholders SPAR Group, Inc. and Subsidiaries Tarrytown, New York We have audited the consolidated balance sheet of SPAR Group, Inc. and Subsidiaries as of December 31, 2004, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. Our audit also included the financial statement schedule (2004 information only) listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule (2004 information only) based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, based on our audit, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SPAR Group, Inc. and Subsidiaries as of December 31, 2004, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial schedule (2004 information only), when considered in relation to the consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein. /s/ Rehmann Robson Troy, Michigan February 28, 2005 F-1 Report of Registered Public Accounting Firm The Board of Directors and Stockholders SPAR Group, Inc. and Subsidiaries Tarrytown, New York We have audited the consolidated balance sheet of SPAR Group, Inc. and Subsidiaries, as of December 31, 2003 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SPAR Group, Inc. and Subsidiaries at December 31, 2003, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. As discussed in Note 2, the Company adopted Statement of Accounting Standards No. 142 effective January 1, 2002. /s/ Ernst & Young LLP Minneapolis, Minnesota February 13, 2004 F-2 SPAR Group, Inc. and Subsidiaries Consolidated Balance Sheets (In thousands, except share and per share data)
December 31, -------------------------------------------- 2004 2003 ---------------------- -------------------- Assets Current assets: Cash and cash equivalents $ 887 $ 24 Accounts receivable, net 11,307 13,942 Prepaid expenses and other current assets 657 658 Deferred income taxes - 1,305 ---------------------- -------------------- Total current assets 12,851 15,929 Property and equipment, net 1,536 2,099 Goodwill 798 8,749 Deferred income taxes - 434 Other assets 636 926 ---------------------- -------------------- Total assets $ 15,821 $ 28,137 ====================== ==================== Liabilities and stockholders' equity Current liabilities: Accounts payable $ 2,158 $ 1,373 Accrued expenses and other current liabilities 2,391 4,081 Accrued expenses due to affiliates 987 1,091 Restructuring charges 250 685 Customer deposits 1,147 530 Lines of credit 4,956 4,084 ---------------------- -------------------- Total current liabilities 11,889 11,844 Other long-term liabilities 12 270 Minority interest 206 - ---------------------- -------------------- Total liabilities 12,107 12,114 Commitments and contingencies (Note - 7) 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 - 2004 and 2003 189 189 Treasury stock (108) (384) Accumulated other comprehensive loss (86) (7) Additional paid-in capital 11,011 11,249 Accumulated (deficit) retained earnings (7,292) 4,976 ---------------------- -------------------- Total stockholders' equity 3,714 16,023 ---------------------- -------------------- Total liabilities and stockholders' equity $ 15,821 $ 28,137 ====================== ====================
See accompanying notes. F-3 SPAR Group, Inc. and Subsidiaries Consolidated Statements of Operations (In thousands, except per share data)
Year Ended December 31, ------------------------------------------------------ 2004 2003 2002 ------------------------------------------------------ Net revenues $ 51,370 $ 64,859 $ 69,612 Cost of revenues 33,644 42,338 40,331 ------------------------------------------------------ Gross profit 17,726 22,521 29,281 Selling, general and administrative expenses 20,222 20,967 18,804 Impairment charges 8,141 - - Depreciation and amortization 1,399 1,529 1,844 ------------------------------------------------------ Operating (loss) income (12,036) 25 8,633 Interest expense 220 269 363 Other (income) expense (754) 237 (26) ------------------------------------------------------ (Loss) income before provision for income taxes and (11,502) (481) 8,296 minority interest Provision for income taxes 853 58 2,998 ------------------------------------------------------ Net (loss) income before minority interest (12,355) (539) 5,298 Minority interest 87 - - ------------------------------------------------------ Net (loss) income $ (12,268) $ (539) $ 5,298 ====================================================== Basic/diluted net (loss) income per common share: Net (loss) income - basic/diluted $ (0.65) $ (0.03) $ 0.28 ====================================================== Weighted average common shares - basic 18,859 18,855 18,761 ====================================================== Weighted average common shares - diluted 18,859 18,855 19,148 ======================================================
See accompanying notes. F-4 SPAR Group, Inc. and Subsidiaries Consolidated Statement of Stockholders' Equity (In thousands)
Common Stock ----------------------------------- Accumulated Additional Other Total Treasury Paid-In Earnings Comprehensive Stockholders' Shares Amount Stock Capital Retained (Loss) Equity ------------------------------------------------------------------------------------------ Balance at January 31, 2002 18,583 $ 186 $ - $ 10,531 $ - $ - $ 10,934 - 217 Stock options exercised and employee stock purchase plan purchases 242 2 - 388 - 390 Purchase of treasury stock - - (30) - - (30) Net income - - - - 5,298 5,298 ------------------------------------------------------------------------------------------ Balance at December 31, 2002 18,825 188 (30) 10,919 5,515 - 16,592 Stock options exercised and employee stock purchase plan purchases 34 1 570 (86) - - 485 Issuance of stock options to non- employees for services - - - 416 - - 416 Purchase of treasury stock - - (924) - - - (924) Comprehensive loss: Foreign currency translation loss (7) (7) Net loss (539) (539) -------------- Comprehensive loss (546) ------------------------------------------------------------------------------------------ Balance at December 31, 2003 18,859 189 (384) 11,249 4,976 (7) 16,023 Stock options exercised and employee stock purchase plan purchases - - 276 (316) - - (40) Issuance of stock options to non- employees for services - - - 78 - - 78 Comprehensive loss: Foreign currency translation loss (79) (79) Net loss (12,268) (12,268) -------------- Comprehensive loss (12,347) ------------------------------------------------------------------------------------------ Balance at December 31, 2004 18,859 $ 189 $ (108) $ 11,011 $ (7,292) $ (86) $ 3,714 ==========================================================================================
See accompanying notes. F-5 SPAR Group, Inc. and Subsidiaries Consolidated Statements of Cash Flows (In thousands)
Year Ended December 31, ------------------------------------------------------ 2004 2003 2002 ------------------------------------------------------ Operating activities Net (loss) income $ (12,268) $ (539) $ 5,298 Adjustments to reconcile net (loss) income to net cash provided by operating activities: Impairment charges 8,141 - - Minority interest earnings in subsidiaries (87) - - Share of loss in joint venture - 270 - Deferred tax asset adjustments 710 (131) 2,022 Depreciation 1,399 1,529 1,844 Issuance of stock options for service 78 416 - Changes in operating assets and liabilities: Accounts receivable 2,635 2,516 4,686 Prepaid expenses and other assets (126) (330) (354) Accounts payable, accrued expenses, other current liabilities and customer deposits 756 422 (538) Accrued expenses due to affiliates (104) 133 347 Restructuring charges 250 (904) (593) ------------------------------------------------------ Net cash provided by operating activities 1,384 3,382 12,712 Investing activities Purchases of property and equipment (1,260) (1,456) (1,172) Deposit related to acquisition 350 (350) - Acquisition of businesses (399) (1,091) - ------------------------------------------------------ Net cash used in investing activities (1,309) (2,897) (1,172) Financing activities Net borrowings (payments) on lines of credit 872 3,936 (11,139) Other long-term liabilities 35 - (57) Proceeds from employee stock purchase plan and exercised options (40) 485 390 Payments to certain stockholders - (3,951) (704) Purchase of treasury stock - (924) (30) ------------------------------------------------------ Net cash provided by (used in) financing activities 867 (454) (11,540) Translation loss (79) (7) - Net change in cash 863 24 - Cash at beginning of period 24 - - ------------------------------------------------------ Cash at end of period $ 887 $ 24 $ - ====================================================== Supplemental disclosure of cash flows information Interest paid $ 180 $ 241 $ 686 ====================================================== Income taxes paid $ 86 $ 578 $ 200 ======================================================
See accompanying notes. F-6 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements December 31, 2004 1. Business and Organization The SPAR Group, Inc., a Delaware corporation ("SGRP"), and its subsidiaries (together with SGRP, the "SPAR Group" or 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. SPAR Acquisition, Inc., and its subsidiaries (the "SPAR Companies") are the original predecessor of the Company and were founded in 1967. On July 8, 1999, SGRP completed a reverse merger with the SPAR Companies (the "PIA Acquisition"), and then changed its name to SPAR Group, Inc., from PIA Merchandising Services, Inc. (prior to such merger, "PIA"). Pursuant to the PIA Acquisition, the SPAR Companies were deemed to have "acquired" PIA and its subsidiaries prior to the PIA Acquisition (the "PIA Companies"), which was treated as a purchase of the PIA Companies for accounting purposes, with the books and records of the Company being adjusted to reflect the historical operating results of the SPAR Companies. In 2002, the Company sold its Incentive Marketing Division, SPAR Performance Group, Inc. ("SPGI"). The Company's continuing operations are now 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 Romania and through 50% owned joint ventures in Japan and China. The Company continues to focus on expanding its merchandising services business throughout the world. 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 retail 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 product demonstration and in-store product sampling services, database marketing, technology services, teleservices and marketing research services. F-7 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 1. Business and Organization (continued) International Merchandising Services Division In July 2000, the Company established its International Merchandising Services Division, through a wholly owned subsidiary, SPAR Group International, Inc. ("SGI"), to focus on expanding its merchandising services business worldwide 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. 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. In February 2005, the Company announced the establishment of a 50% owned joint venture headquartered in Hong Kong, China. Discontinued Operations - Incentive Marketing Division In the fourth quarter of 2001, the Company made the decision to divest its interest in SPGI. On June 30, 2002, SPAR Incentive Marketing, Inc. ("SIM"), a wholly-owned subsidiary of the Company, entered into a Stock Purchase Agreement with Performance Holdings, Inc. ("PHI"), a Delaware corporation headquartered in Carrollton, Texas. SIM sold all of the stock of its subsidiary, SPGI, to PHI for $6.0 million. As a condition of the sale, PHI issued and contributed 1,000,000 shares of its common stock to Performance Holdings, Inc. Employee Stock Ownership Plan, which became the only shareholder of PHI. The $6.0 million sales price was evidenced by two Term Loans, an Initial Term Loan totaling $2.5 million and an Additional Term Loan totaling $3.5 million (collectively the "Term Loans"). The Term Loans were guarantied by SPGI and secured by pledges of all assets of PHI and SPGI. The Term Loans had interest rates of 12% per annum through December 31, 2003. On January 1, 2004 the interest rate changed to 8.9% per annum. Because the collection of the notes depended on the future operations of PHI, the $6.0 million notes were 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 was secured by a pledge of all the assets of SPGI and was 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 F-8 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 1. Business and Organization (continued) 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 ("STIMULYS"). 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 was required to deposit all of its cash receipts to the Company's lock box. On September 10, 2004, in consideration for a new Promissory Note totaling $764,271 (which represented the amount outstanding under the SPGI Revolver at that time) and in the event of a change in control of STIMULYS, a share in the net proceeds resulting from such change in control, the Company terminated the SPGI Revolver and the Term Loans. SPAR also released its security interest in any collateral previously pledged by STIMULYS. The first payment due under the Promissory Note was received on October 29, 2004. Due to the collection risk associated with the Promissory Note, the Company has established a reserve for the remaining amount due, including interest of approximately $355,000 at December 31, 2004. As a result of the termination of the SPGI Revolver, the reserve for collection of advances and accrued interest under the SPGI Revolver previously established by the Company totaling approximately $984,000 was no longer required. The release of this reserve, net of the new reserve required for the Promissory Note, resulted in Other Income totaling approximately $640,000 for 2004. 2. Summary of Significant Accounting Policies Principles of Consolidation The Company consolidates its 100% owned subsidiaries. The Company also consolidates its 51% owned joint venture subsidiaries and its 50% owned joint ventures where the Company is the primary beneficiary 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. All significant intercompany accounts and transactions have been eliminated. In 2004, due to the amendment of a royalty agreement between the Company and its 50% owned Japanese joint venture, the Company has determined that in accordance with FIN 46(R) it is the primary beneficiary of the Japanese joint venture, and has consolidated the Japanese financial results for 2004 in accordance with the provisions of FIN 46(R). The Japanese joint venture's fiscal year ended on September 30, 2004 and accordingly its financial statements were audited as of that date. In connection with the consolidation the Company began reporting the Japanese joint venture's financial results as of and for the period ending September 30, 2004. Therefore, for 2004, the Company's consolidated financial statements only include the Japanese joint venture financial results for nine months ended September 30, 2004. In 2004, the Japanese joint venture recorded revenue of approximately $2.6 million, total assets of approximately $822,000, total liabilities of approximately $1.2 million and a deficit of approximately $445,000. In 2003 and 2002, prior F-9 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) to the amendment of the royalty agreement, the investment in the Japanese joint venture was accounted for using the equity method based upon the Company's 50% ownership. At December 31, 2004, international assets totaled $2.8 million and international liabilities totaled $3.8 million. For 2004, international revenues totaled $8.2 million and the Company's share of the net losses was approximately $500,000. Cash Equivalents The Company considers all highly liquid short-term investments with maturities of three months or less at the time of acquisition to be cash equivalents. Cash equivalents are stated at a cost, which approximates fair value. Revenue Recognition The Company's services are provided under contracts or agreements. The Company bills its clients based upon service fee or unit fee arrangements. Revenues under service fee arrangements are recognized when the service is performed. The Company's per unit fee arrangements provide for fees to be earned based on the retail sales of a client's products to consumers. The Company recognizes per unit fees in the period such amounts become determinable and are reported to the Company. Unbilled Accounts Receivable Unbilled accounts receivable represent services performed but not billed. Doubtful Accounts, Sales Allowances and Credit Risks 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 $761,000 and $515,000 at December 31, 2004 and 2003, respectively. The Company also recorded a reserve for sales allowances for potential customer credits of $448,000 at December 31, 2003. Bad debt and sales allowance expenses were $366,000, $825,000, and $262,000 in 2004, 2003, and 2002, respectively. Property and Equipment Property and equipment, including leasehold improvements, are stated at cost. Depreciation is calculated on a straight-line basis over estimated useful lives of the related assets, which range from three to seven years. Leasehold improvements are depreciated over the shorter of their estimated useful lives or lease term, using the straight-line method. F-10 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) Internal Use Software Development Costs In accordance with SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes certain costs associated with its internally developed software. Specifically, the Company capitalizes the costs of materials and services incurred in developing or obtaining internal use software. These costs include but are not limited to the cost to purchase software, the cost to write program code, payroll, payroll related benefits and travel expenses for those employees who are directly involved with and who devote time to the Company's software development projects. Capitalized software development costs are amortized over three years. The Company capitalized $559,000, $1,004,000, and $772,000 of costs related to software developed for internal use in 2004, 2003, and 2002, respectively. In 2004, the Company recorded an impairment charge against capitalized software costs due to the loss of certain clients during the year (see Note 3 - Impairment Charges). Impairment of Long-Lived Assets The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that an assets's carrying amount may be higher than its fair value. If an asset is considered to be impaired, the impairment charge recognized is the excess of the asset's carrying value over the asset's fair value (see Note 3 - Impairment Charges). Fair Value of Financial Instruments The Company's balance sheets include the following financial instruments: accounts receivable, accounts payable and a lines of credit. The Company considers the carrying amounts of current assets and liabilities in the 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 or payment. The carrying amount of the lines of credit approximates fair value because the obligations bear interest at a floating rate. The carrying amount of long-term debt to certain stockholders approximated fair value because the then current effective interest rates reflected the market rate for unsecured debt with similar terms and remaining maturities. Excess Cash The Company's domestic cash balances are generally utilized to pay its bank line of credit. International cash balances are maintained in liquid cash accounts and are utilized to fund daily operations. Major Customers One customer accounted for 14%, 8%, and 6% of the Company's net revenues for the years ended December 31, 2004, 2003, and 2002, respectively. This customer also accounted for approximately 29%, 13%, and 4% of accounts receivable at December 31, 2004, 2003, and 2002, respectively. In addition, approximately 16%, 17%, and 24% of net revenues for the years ended December 31, 2004, 2003, and 2002, respectively, resulted from merchandising services performed for manufacturers and others in stores operated by Kmart. These customers also accounted for approximately 22% of accounts receivable at December 31, 2004. While the Company's customers and the resultant contractual F-11 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) relationships are with various manufacturers and not Kmart, a significant reduction of this retailer's stores or cessation of this retailer's business would negatively impact the Company. Another customer, a division of a major retailer, accounted for 26%, 30%, and 26% of the Company's net revenues for the years ended December 31, 2004, 2003, and 2002, respectively. This customer also accounted for approximately 4%, 30%, and 43% of accounts receivable at December 31, 2004, 2003, and 2002, respectively. On August 2, 2004, this customer was sold by its parent. As discussed above, the Company does a significant amount of business with one customer and performs a significant amount of services in Kmart. The loss of this customer or the loss of Kmart related business and the failure to attract new large customers, could significantly decrease the Company's revenues and such decreased revenues could have a material adverse effect on the Company's business, results of operations and financial condition. Foreign Currency Rate Fluctuations The Company has foreign currency exposure associated with its international wholly owned subsidiaries, 51% owned joint venture subsidiaries and 50% owned joint ventures. In 2004, these exposures are primarily concentrated in the Canadian dollar, South African rand and Japanese yen. At December 31, 2004, international assets totaled $2.8 million and international liabilities totaled $3.8 million. For 2004, international revenues totaled $8.2 million and the Company's share of the net losses was approximately $500,000. Interest Rate Fluctuations At December 31, 2004 the Company's outstanding debt totaled $5.0 million, which consisted of domestic variable-rate (6.0%) debt of $4.1 million and international variable rate (1.4%) debt of $0.9 million. Based on 2004 average outstanding borrowings under variable-rate debt, a one-percentage point increase in interest rates would negatively impact annual pre-tax earnings and cash flows by approximately $50,000. Income Taxes Deferred tax assets and liabilities represent the future tax return consequences of certain timing differences that will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes are also recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future income taxes. In the event the future consequences of differences between the financial reporting basis and the tax basis of the Company's assets and liabilities result in a net deferred tax asset, an evaluation is required of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance is provided when it is more likely than not that some portion or the entire deferred tax asset will not be realized. 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 F-12 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) transactions under Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Under the disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS 148, no compensation cost has been recognized for the stock option grants to Company employees. Compensation cost for the Company's option grants to Company employees has been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net (loss) income and pro forma net (loss) income per share from continuing operations would have been reduced to the adjusted amounts indicated below (in thousands, except per share data):
Twelve Months Ended December 31, ---------------------------------------------- 2004 2003 2002 ---------------------------------------------- Net (loss) income, as reported $ (12,268) $ (539) $ 5,298 Stock based employee compensation expense under the fair market value method 454 1,005 1,844 ---------------------------------------------- Pro forma net (loss) income $ (12,722) $ (1,544) $ 3,454 Basic and diluted net (loss) income per share, as reported $ (0.65) $ (0.03) $ 0.28 Basic and diluted net (loss) income per share, pro forma $ (0.67) $ (0.08) $ 0.18
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. The fair value of each option grant is estimated based on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: dividend yield of 0% for all years; volatility factor of expected market price of common stock of 150%, 154%, and 172% for 2004, 2003, and 2002, respectively; risk-free interest rate of 4.23%, 4.27%, and 4.03%; and expected lives of six years. Net (Loss) Income Per Share Basic net (loss) income per share amounts are based upon the weighted average number of common shares outstanding. Diluted net (loss) income per share amounts are based upon the weighted average number of common and potential common shares outstanding except for periods in which such potential common shares are anti-dilutive. Potential common shares outstanding include stock options and are calculated using the treasury stock method. Use of Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-13 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) Goodwill The Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, in the first quarter of 2002. Therefore, goodwill is no longer amortized but is subject to annual impairment tests in accordance with that Statement. At June 30, 2004, the Company performed the required impairment test discussed in FAS 142. The Company calculated the fair value of each business unit for which goodwill was recorded to determine if there was an impairment. The fair value of each unit was based upon the estimate of the discounted cash flow generated by the respective business unit. As a result of these calculations, it was determined that there were impairments to the goodwill associated with the PIA Acquisition on July 8, 1999 and acquisition of the Company's Canadian subsidiary in June 2003. Therefore, the Company recorded an impairment charge of approximately $8.4 million (see Note 3 - Impairment Charges). Changes to goodwill for the years ended December 31, 2004, 2003, and 2002 were as follows:
2004 2003 2002 --------------- ---------------- ---------------- Beginning of the year $ 8,749 $ 7,858 $ 8,357 Impairment charges (8,350) - - Changes in deferred tax assets related to use of PIA net operating losses acquired - - (499) Adjustment to merger related and restructure liabilities - (89) - Acquisitions 399 980 - --------------- ---------------- ---------------- End of the year $ 798 $ 8,749 $ 7,858 =============== ================ ================
Translation of Foreign Currencies The financial statements of the foreign entities consolidated into SPAR Group, Inc. consolidated financial statements were translated into United States dollar equivalents at exchange rates as follows: balance sheet accounts for assets and liabilities at year-end rates and equity and the income statement accounts at average exchange rates for the year. The resulting translation gains and losses are reflected in accumulated other comprehensive gain or losses in the statement of stockholders' equity. Foreign currency transaction gains and losses are reflected in net earnings. Recently Issued Accounting Standards In December 2004, the FASB issued SFAS 123 (revised 2004), Share-Based Payment, (SFAS 123R). SFAS 123R addresses the accounting for share-based payments to employees, including grants of employee stock options. Under the new standard, companies will no longer be able to account for share-based compensation transactions using the intrinsic method in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees. Instead, the Company will be required to account for such transactions using a fair-value method and recognize the expense in the consolidated statement of income. SFAS 123R will be effective for periods beginning after June 15, 2005 and allows, but does not require, the Company to restate the full fiscal year of 2005 to reflect the impact of expensing share-based payments under SFAS 123R. The Company has not yet determined which fair-value method and transitional provision it will follow. See Note 2 - Stock-Based Compensation for the pro forma impact on net income and net income per share from calculating stock-based compensation costs under the fair value alternative of SFAS F-14 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 2. Summary of Significant Accounting Policies (continued) 123. However, the calculation of compensation cost for share-based payment transactions after the effective date of SFAS 123R may be different from the calculation of compensation cost under SFAS 123, but such differences have not yet been quantified. Reclassifications Certain reclassifications have been made to the prior years' financial statements to conform to the 2004 presentation. 3. Impairment Charges Goodwill During 2004, in accordance with the requirements of SFAS 142, the Company determined that there were impairments of the goodwill amounts associated with certain of its reporting entities. 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 26%, 30%, and 26% of the Company's net revenues for the twelve months ended December 31, 2004, 2003, and 2002, respectively and was the last remaining profitable business related to the PIA Acquisition on July 8, 1999. At June 30, 2004, the Company had $7.6 million of goodwill remaining that was related to the PIA Acquisition. As a result of the loss of this major client, the Company does not expect a positive cash flow from this business unit. Therefore, 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 the operations for 2004. In June 2003, the Company began its Canadian operations through the acquisition of substantially all of the business and assets of Impulse Marketing Services, Inc. In connection with this acquisition, the Company recorded goodwill of $712,000. At the time of the acquisition, it was expected that the Canadian subsidiary would be profitable. However, the Canadian subsidiary has operated at a loss since its acquisition. As a result of the continued losses and the failure to attract new customers the Company does not expect to receive positive cash flow from this unit. Therefore, the Company has recorded an impairment of the related goodwill resulting in a non-cash charge of $712,000 for 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 2004. Other Assets and Liabilities Also, in connection with the PIA Acquisition, certain tax deferred assets related to the PIA net operating loss carry forward benefits were recognized. The Company also recorded as an impairment charge, a $750,000 valuation allowance on these deferred tax assets. F-15 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 3. Impairment Charges (continued) The Company had approximately $2.1 million accrued for restructure costs and PIA Acquisition 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 tax effect) reduction in PIA related acquisition liabilities against the related goodwill thereby reducing the impairment charges recognized for 2004. In addition to the above, the Company has recorded an impairment of other assets totaling $68,000 for 2004. The above net impairment of $8.1 million is shown in the accompanying consolidated statement of operations in 2004 as "Impairment charges". 4. Supplemental Balance Sheet Information Accounts receivable, net, consists of the following (in thousands):
December 31, ------------------------------------ 2004 2003 ------------------------------------ Trade $ 8,178 $ 10,333 Unbilled 3,600 4,551 Non-trade 290 21 ------------------------------------ 12,068 14,905 Less: Allowance for doubtful accounts (761) (515) Sales allowances - (448) ------------------------------------ $ 11,307 $ 13,942 ==================================== Property and equipment consists of the following (in thousands): December 31, ------------------------------------ 2004 2003 ------------------------------------ Equipment $ 5,397 $ 4,784 Furniture and fixtures 547 550 Leasehold improvements 138 141 Capitalized software development costs 1,629 2,128 ------------------------------------ 7,711 7,603 Less accumulated depreciation and amortization 6,175 5,504 ------------------------------------ $ 1,536 $ 2,099 ==================================== December 31, ------------------------------------- Prepaid expenses and other current assets (in thousands): 2004 2003 ------------------------------------- Prepaid insurance $ 214 $ 245 Tax refund due 62 244 Prepaid rents 49 70 Other 332 99 ----------------------------------- $ 657 $ 658 =====================================
F-16 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 4. Supplemental Balance Sheet Information (continued) December 31, ------------------------------------- Accrued expenses and other current liabilities (in thousands): 2004 2003 ------------------------------------- Merger related payables $ 450 $ 1,495 STIMULYS cash deposits - 794 SPGI Revolver - 740 Accrued medical expenses 225 100 Taxes payable 345 139 Accrued accounting and legal expenses 192 219 Accrued salaries payable 328 241 Other 851 353 ------------------------------------- $ 2,391 $ 4,081 =====================================
5. 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 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 reserves against collateral. The amendment provides for interest to be charged at a rate based in part upon the earnings before interest, taxes, depreciation and amortization. The average interest rate for 2004 was 5.1%. At December 31, 2004, the Credit Facility bears interest at Webster's "Alternative Base Rate" plus 0.75% (a total of 6.0% per annum), or LIBOR plus 3.25%. The Credit Facility is secured by all of the assets of the Company and its domestic 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, reduced the revolving credit facility from $10.0 million to $7.0 million, changed the covenant compliance testing for certain covenants from quarterly to monthly and reduced certain advance rates. On November 15, 2004, the Credit Facility was further amended to delete any required minimum Net Worth and minimum Fixed Charge Coverage Ratio covenant levels for the period ending December 31, 2004. The amendments did not change the future covenant levels. The Credit Facility also limits certain expenditures including, but not limited to, capital expenditures and other investments. The Company was in violation of certain monthly covenants at December 31, 2004, and expects to be in violation at future measurement dates. Webster issued a waiver for the December 31, 2004 covenant violations. However, there can be no assurances that Webster will issue such waivers in the future. Because of the requirement to maintain a lock box arrangement with Webster, Webster's ability to invoke a subjective acceleration clause at its discretion, and the expected future covenant violations, borrowings under the Credit Facility are classified as current at December 31, 2004 and 2003, in accordance with EITF 95-22. Balance Sheet Classification of Borrowings Outstanding Under Revolving Credit Agreements That Include Both a Subjective Acceleration Clause and a Lock-Box Agreement. F-17 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 5. Lines of Credit (continued) The revolving loan balances outstanding under the Credit Facility were $4.1 million at December 31, 2004, and December 31, 2003. There were letters of credit outstanding under the Credit Facility of $0.7 million at December 31, 2004, and December 31, 2003. As of December 31, 2004, the SPAR Group had unused availability under the Credit Facility of $1.4 million out of the remaining maximum $2.2 million unused revolving line of credit after reducing the borrowing base by outstanding loans and letters of credit. In 2001, the Japanese joint venture SPAR FM Japan, Inc. entered into a revolving line of credit arrangement with Japanese banks for 300 million yen or $2.7 million (based upon the exchange rate at September 30, 2004). At September 30. 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 rates on the borrowings under the Japanese line of credit for its short-term bank loans at September 30, 2004 and 2003 were 1.375% and 1.375% per annum, respectively. 6. Income Taxes The provision for income tax expense from continuing operations is summarized as follows (in thousands):
December 31, ---------------------------------------------------------- 2004 2003 2002 ----------------- ------------------ ------------------- Current $ 103 $ 189 $ 476 Deferred 750 (131) 2,522 ----------------- ------------------ ------------------- $ 853 $ 58 $ 2,998 ================= ================== ===================
The provision for income taxes from continuing operations is different from that which would be obtained by applying the statutory federal income tax rate to income before income taxes. The items causing this difference are as follows (in thousands):
December 31, -------------------------------------------------------- 2004 2003 2002 --------------- ---------------- ---------------- (Benefit) provision for income taxes at federal statutory rate $ (3,911) $ (77) $ 2,821 State income taxes, net of federal benefit 117 95 175 Permanent differences 1,613 41 (48) Change in valuation allowance 3,013 - - Other 21 (1) 50 --------------- ---------------- ---------------- Provision for income taxes $ 853 $ 58 $ 2,998 =============== ================ ================
F-18 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 6. Income Taxes (continue) Deferred taxes consist of the following (in thousands):
December 31, ------------------------------------ 2004 2003 ------------------------------------ Deferred tax assets: Net operating loss carryforwards $ 5,230 $ 3,876 Restructuring 266 309 Deferred revenue 384 - SIM reserve against loan commitment 135 304 Allowance for doubtful accounts and other receivable 288 323 Other 455 559 Valuation allowance (6,139) (3,126) ------------------------------------ Total deferred tax assets 619 2,245 Deferred tax liabilities: Capitalized software development costs 619 506 ------------------------------------ Total deferred tax liabilities 619 506 ------------------------------------ Net deferred tax assets $ - $ 1,739 ====================================
At December 31, 2004, the Company has net operating loss carryforwards (NOLs) of $10.2 million, related to the PIA Acquisition available to reduce future federal taxable income. The $10.2 million PIA related net operating loss carryforwards begin to expire in the year 2012. Section 382 of the Internal Revenue Code restricts the annual utilization of the NOLs incurred prior to a change in ownership. Such a change in ownership had occurred in 1999, thereby restricting the NOL's prior to such date available to the Company to approximately $657,500 per year. In addition, the Company has NOLs related to its current losses totaling $4.1 million. The $4.1 million net operating loss carryfowards begin to expire in the year 2023. As a result of the loss of several significant clients, current year losses and the lack of certainty of a return to profitably in the next twelve months, the Company has established a valuation allowance equal to the total of its net deferred tax assets of $6.1 million. The Company does not provide for U.S. income taxes on the undistributed earnings of its foreign subsidiaries since, at the present time, management considers them to be permanently invested in the subsidiary. F-19 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 7. Commitments and Contingencies Lease Commitments The Company leases equipment and certain office space in several cities, under non-cancelable operating lease agreements. Certain leases require the Company to pay its share of any increases in operating expenses and real estate taxes. Rent expense was approximately $1.0 million, $0.9 million, and $1.0 million for 2004, 2003, and 2002, respectively. At December 31, 2004, future minimum commitments under all non-cancelable operating lease arrangements are as follows (in thousands): 2005 $ 776 2006 569 2007 82 2008 40 2009 1 ------------------ Total $ 1,468 =================== 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 and India. The Company also announced the establishment of joint ventures in Romania and China. 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 the Company, 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 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 probable interest of $1,000,000 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 F-20 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 7. Commitments and Contingencies (continued) 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. 8. Treasury Stock The Company initiated a share repurchase program in 2002, which allowed for 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. The following table summarizes the Company's treasury stock activity for the years 2004 and 2003. Quantity Amount ------------------------------------ Treasury Stock, January 1, 2003 9,783 $ 30,073 Purchases 211,315 923,714 Used to fulfill: Employee Stock Purchases (9,848) (30,297) Options Exercised (135,194) (539,383) ------------------------------------ Treasury Stock, December 31, 2003 76,056 384,107 Used to fulfill: Options Exercised (54,148) (276,007) ------------------------------------ Treasury Stock, December 31, 2004 21,908 $ 108,100 ==================================== 9. Employee Benefits Stock Purchase Plans The Company has Employee and Consultant Stock Purchase Plans (the "SP Plans"). The SP Plans allow employees and consultants of the Company to purchase common stock without having to pay any commissions on the purchases. On August 8, 2002, the Company's Board of Directors approved a 15% discount for employee purchases and recommended that its affiliates (see Note 10 - Related-Party Transactions) approve a 15% cash bonus for affiliate consultant purchases. The maximum amount that any employee or consultant can contribute to the SP Plans per quarter is $6,250, and the total number of shares reserved by the Company for purchase under the SP Plans is 500,000. Shares purchased by employees and consultants under the SP Plans were 43,023, 22,561, and 10,104 for 2004, 2003, and 2002, respectively. The Company's expense as a result of the 15% discount offered to employees and consultants were approximately $10,000, $11,000, and $4,000 for 2004, 2003, and 2002, respectively. Retirement/Pension Plans The Company has a 401(k) Profit Sharing Plan covering substantially all eligible employees. Employer contributions were approximately $97,000, $87,000, and $117,000 for 2004, 2003, and 2002, respectively. F-21 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 9. Employee Benefits (continued) In 2003 and 2002, certain of the Company's employees were covered by union-sponsored, collectively bargained, multi-employer pension plans. Pension expense related to these plans was approximately $32,000 and $60,000 for the years ended December 31, 2003 and 2002, respectively. There were no employees under union contract in 2004. 10. 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 $24.0 million, $36.0 million, and $30.5 million for 2004, 2003, and 2002, 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, 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 $640,000 for 2004. Total net premiums (4% of SMS and SMSI costs less 2004 concessions) paid to SMS and SMSI for services rendered were approximately $320,000, $1,350,000, and $1,100,000 for 2004, 2003, and 2002, 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, Messrs. Brown and Bartels 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 $1,170,000, $1,610,000, and $1,630,000 for 2004, 2003, and 2002, respectively. SIT provided approximately 34,000, 47,000, and 46,000 hours of Internet computer programming services to the Company for 2004, 2003, and 2002, 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 $34.71, $34.24, and $35.10 for 2004, 2003, and 2002, 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 2004. However, since SIT is a "Subchapter S" corporation, Messrs. Brown and Bartels benefit from any income of such company allocated to them. F-22 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 10. Related-Party Transactions (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):
Twelve Months Ended December 31, ------------------------------------------------- 2004 2003 2002 ------------------------------------------------- Services provided by affiliates: Independent contractor services (SMS) $ 19,944 $ 28,411 $ 23,262 ================================================= Field management services (SMSI) $ 4,502 $ 7,600 $ 7,280 ================================================= Internet and software program consulting services (SIT) $ 1,172 $ 1,607 $ 1,626 ================================================= Accrued expenses due to affiliates (in thousands): December 31, 2004 2003 --------------------------------- SPAR Marketing Services, Inc. $ 987 $ 1,091 =================================
In addition to the above, through the services of Affinity Insurance, Ltd., the Company purchased insurance coverage for its casualty and property insurance risk for approximately $1.1 million for each of the three years ended December 31, 2004, 2003, and 2002. The Company's CEO and Vice Chairman own, through SMSI, a minority (less than 5%) equity interest in Affinity. 11. Stock Options The Company has four stock option plans: the Amended and Restated 1995 Stock Option Plan ("1995 Plan"), the 1995 Director's Plan ("Director's Plan"), the Special Purpose Stock Option Plan ("Special Purpose Plan"), and the 2000 Stock Option Plan ("2000 Plan"). The 1995 Plan provided for the granting of either incentive or nonqualified stock options to specific employees, consultants, and directors of the Company for the purchase of up to 3,500,000 shares of the Company's common stock. The options had a term of ten years from the date of issuance, except in the case of incentive stock options granted to greater than 10% stockholders for which the term was five years. The exercise price of nonqualified stock options must have been equal to at least 85% of the fair market value of the Company's common stock at the date of grant. Since 2000, the Company has not granted any new options under this plan. During 2004, 1,500 options to purchase shares of the Company's common stock were exercised and options to purchase 26,625 shares of the Company's stock were cancelled under this plan. At December 31, 2004, options to purchase 15,125 shares of the Company's common stock remain outstanding under this plan. The 1995 Plan was superseded by the 2000 Plan with respect to all new options issued. F-23 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 11. Stock Options (continued) The Director's Plan was a stock option plan for non-employee directors and provided for the purchase of up to 120,000 shares of the Company's common stock. Since 2000, the Company has not granted any new options under this plan. During 2004, no options to purchase shares of the Company's common stock were exercised under this plan. At December 31, 2004, 20,000 options to purchase shares of the Company's common stock remained outstanding under this plan. The Director's Plan has been replaced by the 2000 Plan with respect to all new options issued. On July 8, 1999, in connection with the merger, the Company established the Special Purpose Plan of PIA Merchandising Services, Inc. to provide for the issuance of substitute options to the holders of outstanding options granted by SPAR Acquisition, Inc. There were 134,114 options granted at $0.01 per share. Since July 8, 1999, the Company has not granted any new options under this plan. During 2004, 21,000 options to purchase shares of the Company's common stock were exercised under this plan. At December 31, 2004, options to purchase 4,750 shares of the Company's common stock remain outstanding under this plan. On December 4, 2000, the Company adopted the 2000 Plan, as the successor to the 1995 Plan and the Director's Plan with respect to all new options issued. The 2000 Plan provides for the granting of either incentive or nonqualified stock options to specified employees, consultants, and directors of the Company for the purchase of up to 3,600,000 (less those options still outstanding under the 1995 Plan or exercised after December 4, 2000 under the 1995 Plan). The options have a term of ten years, except in the case of incentive stock options granted to greater than 10% stockholders for whom the term is five years. The exercise price of nonqualified stock options must be equal to at least 85% of the fair market value of the Company's common stock at the date of grant (although typically the options are issued at 100% of the fair market value), and the exercise price of incentive stock options must be equal to at least the fair market value of the Company's common stock at the date of grant. During 2004, options to purchase 476,417 shares of the Company's common stock were granted, options to purchase 53,302 shares of the Company's common stock were exercised and options to purchase 1,345,542 shares of the Company's stock were voluntarily surrendered and cancelled under this plan. At December 31, 2004, options to purchase 1,251,383 shares of the Company's common stock remain outstanding under this plan and options to purchase 1,618,719 shares of the Company's common stock were available for grant under this plan. F-24 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 11. Stock Options (continued) The following table summarizes stock option activity under the Company's plans:
Weighted Average Shares Exercise Price ---------------------------------------- Options outstanding, December 31, 2001 2,483,727 $ 1.42 Granted 332,792 $ 2.01 Exercised (230,463) 1.23 Canceled or expired (487,875) 5.05 --------------------- Options outstanding, December 31, 2002 2,098,181 $ 1.52 Granted 401,020 $ 3.51 Exercised (143,641) 1.17 Canceled or expired (92,750) 2.38 --------------------- Options outstanding, December 31, 2003 2,262,810 $ 1.85 Granted 476,417 $ 1.47 Exercised (75,802) 0.49 Canceled or expired (1,372,167) 6.18 --------------------- Options outstanding, December 31, 2004 1,291,258 $ 1.66 Option price range at end of year $0.01 to $14.00 2004 2003 2002 -------------------------------------------------- Grant Date weighted average fair value of options granted during the year $ 1.43 $ 2.33 $ 1.60
F-25 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 11. Stock Options (continued) The following table summarizes information about stock options outstanding at December 31, 2004:
Options Outstanding Options Exercisable ---------------------------------------------------- -------------------------------- Weighted Number Average Weighted Number Outstanding at Remaining Average Exercisable at Weighted Range of December 31, 2004 Contractual Life Exercise December 31, Average Exercise Prices Price 2004 Exercise Price -------------------- ---------------------------------------------------- -------------------------------- Less than $1.00 273,536 8.1 years $ 0.71 230,336 $ 0.70 $1.01 - $2.00 783,347 7.0 years 1.31 697,972 1.30 $2.01 - $4.00 192,875 8.4 years 2.75 61,196 2.88 Greater than $4.00 41,500 5.1 years 9.37 41,126 9.42 ------------------ ----------------- Total 1,291,258 1,030,630 ================== =================
In 2004, the Company recorded an expense of approximately $103,000 under the provision of SFAS No. 123 dealing with stock option grants to non-employees for stock option grants that were awarded to the employees of the Company's affiliates. The Company determines the fair value of the options granted to non-employees using the Black-Scholes valuation model and expenses that value over the service period. Until an option is vested, the fair value of the option continues to be updated through the vesting date. The options granted have a ten (10) year life and vest over four-year periods at a rate of 25% per year, beginning on the first anniversary of the date of grant. 12. Notes Payable to Certain Stockholders In April 2003, all previously outstanding amounts due certain stockholders under certain notes bearing interest at 8.0% were paid in full. 13. Geographic Data A summary of the Company's net revenue, operating (loss) income and long lived assets by geographic area as of and for the year ended December 31, is as follows (in thousands): Twelve Months Ended December 31, ---------------------------------------------- 2004 2003 2002 ---------------------------------------------- Net revenue: United States $ 43,163 $ 64,305 $ 69,612 International 8,207 554 - ---------------------------------------------- Total net revenue $ 51,370 $ 64,859 $ 69,612 ============================================== F-26 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 13. Geographic Data (continued)
Twelve Months Ended December 31, ---------------------------------------------- 2004 2003 2002 ---------------------------------------------- Operating (loss) income: United States $ (10,559) $ 893 $ 9,100 International (1,477) (868) (467) ---------------------------------------------- Total operating (loss) income $ (12,036) $ 25 $ 8,633 ============================================== December 31, ------------------------------------- Long lived assets: 2004 2003 ------------------------------------- United States $ 2,484 $ 11,632 International 486 576 ------------------------------------- Total long lived assets $ 2,970 $ 12,208 =====================================
International revenues disclosed above were based upon revenues reported by the Company's foreign subsidiaries and joint ventures. No one international geographic market is greater than 10% of consolidated net revenue for the twelve months ended December 31, 2004. 14. Restructuring Charges In 1999, in connection with the PIA Acquisition, 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. At June 30, 2004, the Company evaluated its restructuring reserves and determined that certain restructuring reserves were no longer necessary (see Note 3 - Impairment 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 consist 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 ending September 30, 2004, approximately $230,000 for severance benefits and approximately $250,000 for office leases that the Company ceased using. At December 31, 2004, the Company had approximately $250,000 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. F-27 SPAR Group, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) December 31, 2004 14. Restructuring Charges (continued) The following table displays a roll forward of the liabilities for restructuring charges from January 1, 2001 to December 31, 2004 (in thousands):
Equipment Office Employee Lease Lease Separation Settlements Settlements Total --------------- ---------------- ---------------- -------------- January 1, 2001 balance $ 487 $ 2,770 $ 544 $ 3,801 Adjustments in restructuring charges (132) - - (132) 2001 payments (355) (1,008) (124) (1,487) --------------- ---------------- ---------------- -------------- December 31, 2001 balance $ - $ 1,762 $ 420 $ 2,182 2002 payments - (593) - (593) --------------- ---------------- ---------------- -------------- December 31, 2002 balance $ - $ 1,169 $ 420 $ 1,589 Adjustments in restructuring charges - 98 (185) (87) 2003 payments (817) (817) --------------- ---------------- ---------------- -------------- December 31, 2003, balance $ - $ 450 $ 235 $ 685 Impairment charge (see Note 3 - Impairment Charges) - (450) (235) (685) 2004 restructure plan 230 - 250 480 2004 payments (230) - - (230) --------------- ---------------- ---------------- -------------- December 31, 2004, balance $ - $ - $ 250 $ 250 =============== ================ ================ ==============
15. Net (Loss) Income Per Share The following table sets forth the computations of basic and diluted net (loss) income per share (in thousands, except per share data):
Twelve Months Ended December 31, -------------------------------------------------- 2004 2003 2002 -------------------------------------------------- Numerator: Net (loss) income $ (12,268) $ (539) $ 5,298 Denominator: Shares used in basic net (loss) income per share calculation 18,859 18,855 18,761 Effect of diluted securities: Employee stock options - - 387 -------------------------------------------------- Shares used in diluted net (loss) income per share calculations 18,859 18,855 19,148 ================================================== Basic and diluted net (loss) income per common share: $ (0.65) $ (0.03) $ 0.28
The computation of dilutive loss per share excluded anti-dilutive stock options to purchase approximately 430,000 and 657,000 shares as of December 31, 2004 and 2003, respectively. F-28 16. Quarterly Financial Data (Unaudited) Quarterly data for 2004 and 2003 was as follows (in thousands, except earnings per share data):
Quarter ------------------------------------------------------------- First Second Third Fourth ------------------------------------------------------------- Year Ended December 31, 2004: Net revenues $ 12,803 $ 11,932 $ 10,683 $ 15,952 Gross profit 4,109 3,115 3,720 6,782 ------------------------------------------------------------- Net (loss) income $ (790) $ (12,177) $ 210 $ 489 ============================================================= Basic/diluted net (loss) income per common share $ (0.04) $ (0.65) $ 0.01 $ 0.03 ============================================================= Year Ended December 31, 2003: Net revenues $ 18,738 $17,351 $ 16,615 $ 12,155 Gross profit 7,487 6,205 5,235 3,594 ------------------------------------------------------------- Net income (loss) $ 1,278 $ 608 $ (345) $ (2,080) ============================================================= Basic/diluted net income (loss) per common share $ 0.07 $ 0.03 $ (0.02) $ (0.11) =============================================================
2004 The lost business and subsequent impairment charges were the primary factors for the losses incurred in the first two quarters of 2004. However, primarily as a result of the restructure plan initiated in the third quarter, the Company was profitable in the second half of 2004. 2003 In the fourth quarter 2003, the Company experienced certain charges to revenue and cost of sales that did not occur in 2004. These charges accounted for approximately 50% of the loss in 2003 fourth quarter. The Company also experienced lower revenues from per unit fee contracts in the fourth quarter resulting from decreased retail sales of some of the Company's larger clients' products, as well as the loss of a particular client earlier in the year. F-29 SPAR Group, Inc. and Subsidiaries Schedule II - Valuation and Qualifying Accounts (In thousands)
Balance at Charged to Beginning of Costs and Balance at End Period Expenses Deductions of Period ----------------------------------------------------------------- Year ended December 31, 2004: Deducted from asset accounts: Allowance for doubtful accounts $ 515 $ 366 $ 120 (1) $ 761 Sales allowances $ 448 $ - $ 448 $ - Year ended December 31, 2003: Deducted from asset accounts: Allowance for doubtful accounts $ 301 $ 377 $ 163 (1) $ 515 Sales allowances $ - $ 448 $ - $ 448 Year ended December 31, 2002: Deducted from asset accounts: Allowance for doubtful accounts $ 325 $ 262 $ 286 (1) $ 301
(1) Uncollectible accounts written off, net of recoveries F-30