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SGRP > SEC Filings for SGRP > Form 10-K on 2-Apr-2013All Recent SEC Filings

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Form 10-K for SPAR GROUP INC


2-Apr-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources

Statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" include "forward-looking statements" within the meaning of the Securities Laws and are based on the Company's best estimates and determinations. You can identify forward-looking statements in such information by the Company's use of terms such as "may", "will", "expect", "intend", "believe", "estimate", "anticipate", "continue" or similar words or variations or negatives of those words. You should carefully consider all such information and the other risks and cautions noted in this Annual Report (including those incorporated by reference from the 2013 Proxy Statement) and the Company's other filings under applicable Securities Laws (including this Annual Report and the 2013 Proxy Statement, each a "SEC Report") that could cause the Company's actual assets, business, capital, cash flow, credit, expenses, financial condition, income, liabilities, liquidity, locations, marketing, operations, prospects, sales, strategies, taxation or other achievement, results, risks or condition to differ materially from those anticipated by the Company and described in the information in the Company's forward-looking statements, whether express or implied, as the Company's anticipations are based upon the Company's plans, intentions, expectations and estimates and (although the Company believe them to be reasonable) involve known and unknown risks, uncertainties and other factors that could cause them to fail to occur or be realized or to be materially and adversely different from those the Company anticipated.

Although the Company believes that its plans, intentions, expectations and estimates reflected or implied in such forward-looking statements are reasonable, the Company cannot assure you that such plans, intentions, expectations or estimates will be achieved in whole or in part, that the Company has identified all potential risks, or that the Company can successfully avoid or mitigate such risks in whole or in part. You should carefully review the risk factors described above (See Item 1A - Risk Factors, above) and any other cautionary statements contained or incorporated by reference in this Annual Report. All forward-looking and other statements attributable to the Company or persons acting on its behalf are expressly subject to and qualified by all such risk factors and other cautionary statements.

You should not place undue reliance on the Company's forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond its control. The Company's forward-looking statements, risk factors and other cautionary statements (whether contained in this Annual Report, the 2013 Proxy Statement or any other applicable SEC Report) are based on the information currently available to the Company and speak only as of the date specifically referenced, or if no date is referenced, then as of December 31, 2012, in the case of this Annual Report or the 2013 Proxy Statement or the last day of the period covered by any other applicable SEC Report. New risks and uncertainties arise from time to time, and it is impossible for the Company to predict these matters or how they may arise or affect the Company. Over time, the Company's actual assets, business, capital, cash flow, credit, expenses, financial condition, income, liabilities, liquidity, locations, marketing, operations, prospects, sales, strategies, taxation or other achievements, results, risks or condition will likely differ from those expressed or implied by the Company's forward-looking statements, and such difference could be significant and materially adverse to the Company and the value of your investment in the Company's Common Stock.

The Company does not intend or promise, and the Company expressly disclaims any obligation, to publicly update or revise any forward-looking statements, risk factors or other cautionary statements (in whole or in part), whether as a result of new information, future events or recognition or otherwise, except as and to the extent required by applicable law.

Overview

SPAR Group, Inc. ("SGRP"), and its subsidiaries (together with SGRP, the "SPAR Group" or the "Company"), is a diversified international merchandising and marketing services company and provides a broad array of services worldwide to help companies improve their sales, operating efficiency and profits at retail locations. The Company provides merchandising and other marketing services to manufacturers, distributors and retailers worldwide, primarily in mass merchandisers, office supply, grocery, drug store, independent, convenience and electronics stores, as well as providing furniture and other product assembly services in stores, homes and offices. The Company has supplied these project and product services in the United States since certain of its predecessors were formed in 1979 and internationally since the Company acquired its first international subsidiary in Japan in May of 2001. Today the Company operates in 10 countries that encompass approximately 50% of the total world population through operations in the United States, Canada, Japan, South Africa, India, Romania, China, Australia, Mexico and Turkey.

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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 Consolidated Financial Statements. These policies have been consistently applied in all material respects and address such matters as revenue recognition, depreciation methods, asset impairment recognition, consolidation of subsidiaries and other companies. 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 internal use software development costs.

Consolidation of Subsidiaries

The Company consolidates its 100% owned subsidiaries. The Company also consolidates all of its 51% owned subsidiaries as the Company believes it is the primary beneficiary and controls the economic activities in accordance with Accounting Standards Codification (ASC) 810-10, Consolidation of Variable Interest Entity.

Revenue Recognition

The Company's services are provided to its clients under contracts or agreements. The Company bills its clients based upon service fee and per unit fee billing arrangements. Revenues under service fee billing 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.

Allowance for Doubtful Accounts

The Company continually monitors the validity of its accounts receivable based upon current client credit information and financial condition. Balances that are deemed to be uncollectible after the Company has attempted reasonable collection efforts are written off through a charge to the bad debt allowance and a credit to accounts receivable. Accounts receivable balances, net of any applicable reserves or allowances, 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 in part 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 $216,000 and $57,000 at December 31, 2012, and 2011, respectively. Bad debt expense was $72,000, for the year ended December 31, 2012. In 2011, the Company had minimal write offs of accounts receivable resulting in recovery of $55,000 for the year ended December 31, 2011.

Internal Use Software Development Costs

In accordance with ASC-350-10-720, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the Company capitalizes certain costs associated with its internally developed software. Specifically, the Company capitalizes the costs of materials and services incurred in developing or obtaining internal use software. These costs include (but are not limited to) the cost to purchase software, the cost to write program code, payroll and related benefits and travel expenses for those employees who are directly involved with and who devote time to the Company's software development projects. Capitalized software development costs are amortized over three years on a straight-line basis.

The Company capitalized $824,000 and $722,000 of costs related to software developed for internal use in 2012, and 2011, respectively, and recognized approximately $638,000 and $595,000 of amortization of capitalized software for the years ended December 31, 2012, and 2011, respectively.

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Results of Operations

The following table sets forth selected financial data and such data as a percentage of net revenues for the years indicated (in millions).

                                                       Year Ended December 31,
                                         2012             %              2011            %
Net revenues                          $    102.8           100.0 %    $     73.5          100.0 %
Cost of revenues                            75.5            73.5            51.0           69.4
Selling, general & administrative
expense                                     22.1            21.5            18.5           25.1
Depreciation & amortization                  1.2             1.1             1.1            1.5
Interest expense, net                        0.1             0.1             0.2            0.3
Other income                                (0.1 )          (0.1 )             -              -

Income before income tax provision
and non-controlling interest                 4.0             3.9             2.7            3.7
Provision for income taxes                   0.6             0.5             0.4            0.5

Net income                                   3.4             3.4             2.3            3.2
Net income attributable to non-
controlling interest                        (0.5 )          (0.5 )          (0.1 )         (0.2 )
Net income attributable to SPAR
Group, Inc.                           $      2.9             2.9 %    $      2.2            3.0 %

Results of operations for the year ended December 31, 2012, when compared to the same period in 2011

Net Revenues

Net revenues for the year ended December 31, 2012, were $102.8 million, compared to $73.5 million for the year ended December 31, 2011, an increase of $29.3 million or 39.7%.

Domestic net revenues totaled $43.1 million in the year ended December 31, 2012, compared to $37.8 million for the same period in 2011. Domestic net revenues increased by $5.3 million or 14% primarily attributable to continued growth from the Company's syndicated services and assembly businesses, increased project work and the acquisition of a competitive company in the later part of the year.

International net revenues totaled $59.7 million for the year ended December 31, 2012, compared to $35.7 million for the same period in 2011, an increase of $24.0 million or 67%. The increase in 2012 international net revenues was primarily due to additional revenue from the newly integrated acquisitions acquired in the fourth quarter of 2011 in Mexico of $10 million and Turkey of $3.5, and 2012 acquisitions in Romania of $4.1 million, and South Africa of $2.4 million, as well as, continued organic growth in South Africa of $3.1 and Japan of $2 million.

Cost of Revenues

The Company's cost of revenues consists of its in-store labor and field management wages, related benefits, travel and other direct labor-related expenses and was 73.5% of net revenues for the year ended December 31, 2012, compared to 69.4% of net revenues for the year ended December 31, 2011.

Domestic cost of revenues was 67.6% of domestic net revenues for the year ended December 31, 2012, and 66.7% of domestic net revenues for the year ended December 31, 2011. The minor increase in domestic cost of revenues as a percentage of domestic net revenues of 1% was due primarily to an unfavorable mix within both syndicated and project work compared to the prior year. Approximately 86% and 88% of the Company's domestic cost of revenues in the year ended December 31, 2012 and 2011, respectively, resulted from in-store merchandiser specialist and field management services purchased from certain of the Company's affiliates, SPAR Marketing Services, Inc. ("SMS"), and SPAR Management Services, Inc. ("SMSI"), (See Item 13 - Certain Relationships and Related Transactions, and Director Independence and Note 10 to the Consolidated Financial Statements - Related-Party Transactions, below).

Internationally, cost of revenue as a percent of net revenue increased to 77.7% of international net revenues for the year ended December 31, 2012, compared to 72.3% of international net revenues for the year ended December 31, 2011. The international cost of revenue percentage increase of 8.3% was primarily due to higher cost margin business in the new markets in Mexico, Turkey and Romania and the mix of business in Canada, China and Japan.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses of the Company include its
corporate overhead, project management, information technology, executive
compensation, human resources, legal and accounting expenses. Selling, general
and administrative expenses were approximately $22.1 million and $18.5 million
for the years ended December 31, 2012 and 2011, respectively.

                                            Year Ended December 31,
                                     2012        %         2011        %

Selling, general & administrative   $ 22.1       21.5 %   $ 18.5       25.1 %
Depreciation and amortization          1.2        1.0        1.1        1.5

Total operating expenses            $ 23.3       22.5 %   $ 19.6       26.6 %

Domestic selling, general and administrative expenses totaled $9.8 million for the year ended December 31, 2012, compared to $8.9 million for the same period in 2011. The increase of approximately $900,000 was due primarily to payroll related expenses, legal and accounting services, as well as expenses from the newly acquired merchandising company.

International selling, general and administrative expenses totaled $12.3 million for the year ended December 31, 2012, compared to $9.6 million for the same period in 2011. The increase of approximately $2.7 million was primarily attributable to the new subsidiaries in Romania and South Africa, and a full year impact from fourth quarter 2011 acquisitions in Mexico and Turkey, partially offset by lower expenses in Australia and India.

Depreciation and Amortization

Depreciation and amortization expenses totaled $1.2 million for the year ended December 31, 2012, compared to $1.1 million for the same period in 2011. The increase was primarily due to higher capital expenditures related to software development compared to prior year.

Interest Expense, net

The Company's net interest expense was $129,000 and $197,000 for the years ended December 31, 2012 and 2011, respectively. The decrease in interest expense was directly attributable to reduced borrowings and lower interest rates.

Income Taxes

The income tax provision for the years ended December 31, 2012 and 2011 was $550,000 and $362,000, respectively. The tax provision resulted primarily from domestic state taxes and for tax provisions related to certain international profits. The Company recognizes minimum federal tax provisions as the Company anticipates utilizing operating loss carry forwards in 2012.

The Company has established over time and currently has a valuation allowance reserve of approximately $4.2 million against its deferred tax asset balance at December 31, 2012. The reduction of that reserve and the corresponding realization of these deferred tax assets is contingent upon the realization of future taxable profits over several years. The Company does not believe such future profits are certain, and thus the requirements of ASC 740-10 for reducing that reserve are not currently met, due to the subjective nature of forecasting profits and the risks the Company faces on a daily basis as noted in Item 1A of this report, including (without limitation) the risks related to dependence on the trend of both clients and retailers towards outsourcing merchandising and marketing services, the competitive nature of the this industry, economic and retail uncertainty, reliance on the Internet and dependence upon cost of services provided by affiliates.

Non-controlling Interest

Net operating profits from the non-controlling interests, respecting the Company's 51% owned subsidiaries, resulted in a reduction of the Company's net income of $521,000 and $123,000 for the years ended December 31, 2012 and 2011, respectively.

Net Income

The Company reported a net income of $2.9 million for the year ended December 31, 2012, or $0.14 per diluted share, compared to a net income of $2.2 million, or $0.10 per diluted share, for the corresponding period last year, based on diluted shares outstanding of 21.6 million and 21.3 million at December 31, 2012, and 2011, respectively.

Off Balance Sheet Arrangements

None.

-28-

Liquidity and Capital Resources

The Company had net income before non-controlling interest of $3.5 million and $2.3 million for the years ended December 31, 2012, and December 31, 2011, respectively.

The Company's cash provided by operating activities for the year ended December 31, 2012, was $3.4 million, compared to net cash provided by operating activities of $3.5 million in 2011. The net cash provided by operating activities was primarily due to a reported net income, depreciation and an increase in accounts payable, accrued expenses and other liabilities, partially offset by an increase in accounts receivable.

Net cash used by the Company in investing activities was $1.8 million for the year ended December 31, 2012, and $1.3 million for the year ended December 31, 2011, respectively. The net cash used in investing activities was a result of capitalization of software development costs, the purchase of computer equipment, the purchase of non-controlling interest in new subsidiaries and the final payment for the purchase of the Mexican subsidiary.

Net cash used by the Company in financing activities for the year ended December 31, 2012, was $1.4 million compared with net cash used in financing activities of $1.5 million for the year ended December 31, 2011. The cash used in financing activities was primarily a result of the Company's net payments on its lines of credit.

The above activities resulted in an increase of $87,000 in the Company's cash and cash equivalents for the year ended December 31, 2012.

The Company had positive working capital of $9.7 million at December 31, 2012, compared to positive working capital of $7.2 million at December 31, 2011. The Company's current ratio was 1.7 at both December 31, 2012 and 2011. The increase in working capital was primarily due to increases in cash and accounts receivable and decreases in borrowings against lines of credit, partially offset by increased accounts payable and accrued expenses.

Credit Facilities:

Domestic Credit Facility

SGRP and certain of its domestic subsidiaries, namely SPAR Marketing Force, Inc., National Assembly Services, Inc., SPAR Group International, Inc., SPAR Trademarks, Inc., and SPAR Acquisition, Inc. (each a "Subsidiary Borrower", and together with SGRP, collectively, the "Borrowers"), entered into a Revolving Loan and Security Agreement dated as of July 6, 2010 (the "Loan Agreement"), with Sterling National Bank and Cornerstone Bank as the lenders (the "Lenders"), and issued their Secured Revolving Loan Notes in the original maximum principal amounts of $5.0 million to Sterling National Bank and $1.5 million to Cornerstone Bank (the "Notes"), to document and govern its new credit facility with them (the "Sterling Credit Facility"). In June 2011, the Lenders agreed to:
(1) reduce the personal guarantee limits to the amounts noted below, and (2) extend the maturity of the Sterling Credit Facility until July 2013. The Sterling Credit Facility was amended effective as of July 1, 2012 (the "Second Sterling Amendment"), to: (1) increase the maximum available revolving loan amount to $6.5 million from Sterling National Bank and remove Cornerstone Bank as a lender, (2) reduce the interest rate to prime plus three quarters of one percent (3/4%) per annum, and (3) release and discharge each Guarantor as noted below.

In addition, Mr. Robert G. Brown, a Director, the Chairman and a major stockholder of SGRP, and Mr. William H. Bartels, a Director, the Vice Chairman and a major stockholder of SGRP, provided personal guarantees of the Sterling Credit Facility totaling $1,250,000 pursuant to their Limited Continuing Guaranty in favor of the Lenders dated as of July 6, 2010, as amended in June 2011 (the "Limited Sterling Guaranty"). In the Second Sterling Amendment, Mr. Robert G. Brown and Mr. William H. Bartels were released and discharged by Sterling from their Limited Sterling Guaranty.

Revolving Loans of up to $6.5 million are available to the Borrowers under the Sterling Credit Facility based upon the borrowing base formula defined in the Loan Agreement (principally 85% of "eligible" domestic accounts receivable less certain reserves). The Sterling Credit Facility is secured by substantially all of the assets of the Borrowers (other than SGRP's foreign subsidiaries, certain designated domestic subsidiaries, and their respective equity and assets).

As of the effective date of the Second Sterling Amendment, the basic interest rate under the Sterling Credit Facility was reduced by three quarters of one percent (3/4%) per annum to the sum of the fluctuating Prime Rate of interest published in the Wall Street Journal from time to time plus three quarters of one percent (3/4%) percent per annum, which automatically changes with each change in such rate.

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Effective January 1, 2013 the Sterling Credit Facility was amended (the "Third Sterling Amendment") to reduce the interest rate to the Prime Rate (as that term is defined in the Loan Agreement) plus one quarter of one percent (1/4%) per annum.

Due to the requirement to maintain a lock box arrangement with the Agent and the Lenders' ability to invoke a subjective acceleration clause at its discretion, borrowings under the Sterling Credit Facility will be classified as current.

The Sterling Credit Facility contains certain financial and other restrictive covenants and also limits certain expenditures by the Borrowers, including, but not limited to, capital expenditures and other investments. At December 31, 2012, the Company was in compliance with such covenants.

International Credit Facilities:

In October 2011, SPARFACTS Australia Pty. Ltd., replaced the Commonwealth Bank line of credit with a new receivables based secured line of credit facility with Oxford Funding Pty Ltd. for $1.2 million (Australian) or approximately $1.2 million (based upon the exchange rate at December 31, 2012). The facility provides for borrowing based upon a formula as defined in the agreement (principally 80% of eligible accounts receivable less certain deductions). The agreement expired on October 31, 2012. SPARFACTS is in the process of renegotiating a new agreement.

SPAR Canada Company, a wholly owned subsidiary, has a secured credit agreement with Royal Bank of Canada providing for a Demand Operating Loan for a maximum borrowing of $750,000 (Canadian) or approximately $753,000 (based upon the exchange rate at December 31, 2012). The Demand Operating Loan provides for borrowing based upon a formula as defined in the agreement (principally 75% of eligible accounts receivable less certain deductions) and a minimum total debt to tangible net worth covenant. The Company was in compliance with the minimum total debt to tangible net worth covenant under this line of credit at December 31, 2012.

On March 7, 2011, the Japanese subsidiary, SPAR FM Japan, Inc., a wholly owned subsidiary, secured a loan with Mizuho Bank in the amount of 20.0 million Yen (Japanese), or approximately $232,000. The loan is payable in monthly installments of 238,000 Yen or $2,800 at an interest rate of 0.1% per annum with a maturity date of February 28, 2018. The outstanding balance at December 31, 2012, was approximately 14.8 million Yen or $171,000 (based upon the exchange rate at December 31, 2012).

Summary of Company Credit and Other Debt Facilities: (in thousands)

                                                                    Average                                     Average
                                         December 31, 2012       Interest Rate       December 31, 2011       Interest Rate
Credit Facilities Loan Balance:
United States                           $             1,762                 4.3 %   $             2,621                 4.8 %
Australia                                               210                 9.4 %                   402                10.4 %
Canada                                                  421                 4.0 %                   618                 4.0 %
                                        $             2,393                         $             3,641

Other Debt Facility:
Japan Term Loan                         $               171                 0.1 %   $               227                 0.1 %



                        December 31, 2012               December 31, 2011
Unused Availability:
United States          $             4,248             $             2,671
Australia                            1,035                             818
Canada                                 331                             118
                       $             5,614             $             3,607

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Management believes that based upon the continuation of the Company's existing credit facilities, projected results of operations, vendor payment requirements and other financing available to the Company (including amounts due to affiliates), sources of cash availability should be manageable and sufficient to support ongoing operations over the next year. However, delays in collection of receivables due from any of the Company's major clients, or a significant reduction in business from such clients could have a material adverse effect on the Company's cash resources and its ongoing ability to fund operations.

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