SPAR Group, Inc. - Quarter Report: 2016 September (Form 10-Q)

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		September 30, 2016				December 31, 2015
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	7,502			$	5,718
Accounts receivable, net			30,782				23,203
Deferred income taxes			532				529
Prepaid expenses and other current assets			898				661
Total current assets			39,714				30,111
Property and equipment, net			2,556				2,443
Goodwill			2,257				1,800
Intangible assets, net			2,154				2,551
Deferred income taxes			6,513				5,890
Other assets			2,290				611
Total assets		$	55,484			$	43,406
Liabilities and equity
Current liabilities:
Accounts payable		$	5,007			$	2,984
Accrued expenses and other current liabilities			12,628				7,082
Accrued expenses due to affiliates			989				78
Deferred income taxes			2,566				2,154
Customer deposits			955				503
Lines of credit and short-term loans			8,181				476
Total current liabilities			30,326				13,277
Long-term debt and other liabilities			12				5,731
Total liabilities			30,338				19,008
Commitments and Contingencies – See Note 8
Equity:
SPAR Group, Inc. equity
Preferred stock, $.01 par value:
Authorized and available shares– 2,445,598
Issued and outstanding shares–
None – September 30, 2016 and December 31, 2015			–				–
Common stock, $.01 par value:
Authorized shares – 47,000,000
Issued shares – 20,680,717 – September 30, 2016 and December 31, 2015			207				207
Treasury stock, at cost 42,177 shares – September 30, 2016 and 119,695 shares – December 31, 2015			(58	)			(169	)
Additional paid-in capital			16,041				15,871
Accumulated other comprehensive loss			(3,364	)			(2,869	)
Retained earnings			5,746				5,662
Total SPAR Group, Inc. equity			18,572				18,702
Non-controlling interest			6,574				5,696
Total equity			25,146				24,398
Total liabilities and equity		$	55,484			$	43,406

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		Three Months Ended September 30,								Nine Months Ended September 30,
		2016				2015				2016				2015
Net revenues		$	33,438			$	28,269			$	89,781			$	87,002
Cost of revenues			26,162				21,555				69,309				66,206
Gross profit			7,276				6,714				20,472				20,796
Selling, general and administrative expense			6,360				6,014				17,637				18,289
Depreciation and amortization			486				471				1,459				1,414
Operating income			430				229				1,376				1,093
Interest expense			51				47				111				187
Other (income), net			(78	)			(8	)			(183	)			(68	)
Income before income tax expense			457				190				1,448				974
Income tax (benefit) expense			(31	)			83				200				435
Net income			488				107				1,248				539
Net income attributable to non-controlling interest			(546	)			(199	)			(1,164	)			(676	)
Net (loss) income attributable to SPAR Group, Inc.		$	(58	)		$	(92	)		$	84			$	(137	)
Basic and diluted loss per common share:		$	–			$	–			$	–			$	(0.01	)
Weighted average common shares – basic			20,607				20,556				20,580				20,562
Weighted average common shares – diluted			20,607				20,556				21,299				20,562
Net income		$	488			$	107			$	1,248			$	539
Other comprehensive income (loss):
Foreign currency translation adjustments			206				(663	)			(495	)			(1,413	)
Comprehensive income (loss)			694				(556	)			753				(874	)
Comprehensive (income) attributable to non-controlling interest			(546	)			(199	)			(1,164	)			(676	)
Comprehensive income (loss) attributable to SPAR Group, Inc.		$	148			$	(755	)		$	(411	)		$	(1,550	)

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		Common Stock								Treasury Stock								Additional				Accumulated Other								Non-
		Shares				Amount				Shares				Amount				Paid-In Capital				Comprehensive Loss				Retained Earnings				Controlling Interest				Total Equity
Balance at January 1, 2016			20,681			$	207				120			$	(169	)		$	15,871			$	(2,869	)		$	5,662			$	5,696			$	24,398
Share-based compensation			–				–				–				–				271				–				–				–				271
Purchase of treasury shares			–				–				11				(12	)			–				–				–				–				(12	)
Reissued treasury shares – RSU's			–				–				(33	)			46				(46	)			–				–				–				–
Reissued treasury shares – Employee Stock Plan			–				–				(2	)			3				(3	)			–				–				–				–
Exercise of stock options			–				–				(54	)			74				(52	)			–				–				–				22
Distributions to non-controlling investors			–				–				–				–				–				–				–				(286	)			(286	)
Other comprehensive loss			–				–				–				–				–				(495	)			–				–				(495	)
Net income			–				–				–				–				–				–				84				1,164				1,248
Balance at September 30, 2016			20,681			$	207				42			$	(58	)		$	16,041			$	(3,364	)		$	5,746			$	6,574			$	25,146

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		Nine Months Ended September 30,
		2016				2015
Operating activities
Net income		$	1,248			$	539
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			1,459				1,414
Bad debt expense, net of recoveries			317				409
Share based compensation			271				306
Changes in operating assets and liabilities:
Accounts receivable			(4,643	)			4,244
Prepaid expenses and other assets			(105	)			(21	)
Accounts payable			1,000				(403	)
Accrued expenses, other current liabilities and customer deposits			2,548				(1,395	)
Net cash provided by operating activities			2,095				5,093
Investing activities
Purchases of property and equipment and capitalized software			(1,153	)			(1,238	)
Purchases of Brazil subsidiary, net of cash			(306	)			-
Net cash used in investing activities			(1,459	)			(1,238	)
Financing activities
Net borrowing (payments) on lines of credit			2,015				(473	)
Proceeds from stock options exercised			22				24
Proceeds from local Brazil			102				-
Payments on term debt			(21	)			(18	)
Purchase of treasury shares			(12	)			(109	)
Distribution to non-controlling investors			(286	)			(329	)
Net cash provided by (used in) financing activities			1,820				(905	)
Effect of foreign exchange rate changes on cash			(672	)			(1,122	)
Net change in cash and cash equivalents			1,784				1,828
Cash and cash equivalents at beginning of year			5,718				4,382
Cash and cash equivalents at end of period		$	7,502			$	6,210
Supplemental disclosure of cash flows information
Interest paid		$	108			$	176
Income taxes paid		$	126			$	114

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1.     Basis of Presentation

 

The unaudited, interim condensed consolidated financial statements of SPAR Group, Inc., a Delaware corporation ("SGRP"), and its subsidiaries (together with SGRP, collectively, the "Company" or the "SPAR Group"), accompanying this Quarterly Report on Form 10-Q for the quarter ended September 30, 2016 (this "Quarterly Report"), have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The condensed consolidated balance sheet as of December 31, 2015 has been compiled from the Company’s audited consolidated balance sheet as of such date. In the opinion of management, all normal and recurring adjustments considered necessary for a fair presentation have been included in these interim financial statements. However, these interim financial statements should be read in conjunction with the annual consolidated financial statements and notes thereto for the Company as contained in the SGRP's Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission (the "SEC") on March 30, 2016 (the "2015 Annual Report"), and SGRP's Proxy Statement for its 2016 Annual Meeting of Stockholders as filed with the SEC on April 27, 2016 (the "2016 Proxy Statement"). Particular attention should be given to Items 1 and 1A of the 2015 Annual Report respecting the Company's Business and Risk Factors, respectively, and the following parts of SGRP's 2016 Proxy Statement: (i) SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, (ii) CORPORATE GOVERNANCE, (iii) EXECUTIVE OFFICERS, COMPENSATION, DIRECTORS AND OTHER INFORMATION and (iv) EXECUTIVE COMPENSATION, EQUITY AWARDS AND OPTIONS. The Company's results of operations for the interim period are not necessarily indicative of its operating results for the entire year.

 

2.     Business and Organization

 

The Company is a supplier of merchandising and other marketing services throughout the United States and internationally. The Company also provides in-store event staffing, product sampling, audit services, furniture and other product assembly services, technology services and marketing research services. Assembly services are performed in stores, homes and offices while those other services are primarily performed in mass merchandisers, office supply, grocery, drug store, home improvement, independent, convenience, value channel and electronics stores.

  

Merchandising services primarily consist of regularly scheduled, special project and other product services provided at the store level, and the Company may be engaged by either the retailer or the manufacturer. Those services may include restocking and adding new products, removing spoiled or outdated products, resetting categories "on the shelf" in accordance with client or store schematics, confirming and replacing shelf tags, setting new sale or promotional product displays and advertising, replenishing kiosks, providing in-store event staffing and providing assembly services in stores, homes and offices. Other merchandising services include whole store or departmental product sets or resets, including new store openings, new product launches and in-store demonstrations, audit services, special seasonal or promotional merchandising, focused product support and product recalls. The Company also provides technology services and marketing research services.

 

As of September 30, 2016, the Company operates in 10 countries and divides its operations into two reportable segments: its Domestic Division, which provides those services in the United States of America since certain of its predecessors were formed in 1979, and its International Division, which began operations in May 2001 and provides similar merchandising, marketing, audit and in-store event staffing services in Japan, Canada, South Africa, India, China, Australia, Mexico, Turkey and Brazil.

 

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3.     Earnings Per Share

 

The following table sets forth the computations of basic and diluted net income per share (in thousands, except per share data):

 

 

For the three month period ended September 30, 2016, 696,000 vested and non-vested stock options were not included in the calculation because they would have had an anti-dilutive effect. For the three and nine months ended September 30, 2015, 1,008,000 and 1,016,000 vested and non-vested options were not included due to their anti-dilutive effect.

 

4.     Credit Facilities

 

Sterling Credit Facility:

 

SGRP and certain of its US and Canadian subsidiaries, (namely SPAR Marketing Force, Inc., SPAR Assembly & Installation, Inc. (f/k/a SPAR National Assembly Services, Inc.), SPAR Group International, Inc., SPAR Trademarks, Inc., SPAR Acquisition, Inc., SPAR Canada, Inc. and SPAR Canada Company) (together with SGRP, the "Borrowers"), are parties to a Revolving Loan and Security Agreement dated as of July 6, 2010, as amended (as amended, the "Sterling Loan Agreement"), with Sterling National Bank (the "Lender"), and their Secured Revolving Loan Note in the amended maximum principal amounts of $8.5 million (see below) to Sterling National Bank (as amended, the "Sterling Note"), to document and govern their credit facility with the Lender (including such agreement and note, the "Sterling Credit Facility"). The Sterling Credit Facility as amended effective September 28, 2015 currently is scheduled to expire and the Borrowers' loans thereunder will become due on July 6, 2017 (with no early termination fee).

 

The Sterling Loan Agreement currently requires the Borrowers to pay interest on the loans thereunder equal to the Agent's floating Prime Rate (as defined in such agreement) minus one half of one percent (0.5%) per annum, and a fee on the maximum unused line thereunder equal to one-eighth of one percent (0.125%) per annum.

 

Revolving loans of up to $8.5 million are available to the Borrowers under the Sterling Credit Facility based upon the borrowing base formula defined in the Sterling Loan Agreement (principally 85% of "eligible" US and Canadian accounts receivable less certain reserves). The Sterling Credit Facility is secured by substantially all of the assets of the Borrowers (other than the Company's non-Canadian foreign subsidiaries, certain designated domestic subsidiaries, and those subsidiaries' respective equity and assets).

 

The amendment to the Sterling Credit Facility effective as of September 28, 2015, among other things, extended the scheduled term of the Sterling Credit Facility to July 6, 2017 (with no early termination fee), increased the maximum principal amounts of Sterling's commitment under the Sterling Loan Agreement to $8.5 million, and provided for the amendment and restatement of the Sterling Note with a new $8.5 million note from the Borrowers in replacement of the old notes and made other changes to its covenant and collateral formulas.

 

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

The Sterling Loan Agreement requires the Borrowers to maintain certain financial covenants, including maintenance by the Borrowers of a minimum combined tangible net worth of $3.4 million and minimum consolidated tangible net worth of $4.8 million, with those figures increasing by at least 50% of combined and consolidated net profit each year, respectively. In addition, the Borrowers and the Company must not exceed a maximum combined indebtedness to tangible net worth ratio of 3.0 to 1.0, and the Borrowers must maintain a minimum fixed charge coverage ratio of 1.5 to 1.0. Also, capital expenditures for the Borrowers cannot exceed $2.0 million during any fiscal year, and, on a consolidated basis, the Company's year-end operations may not result in a loss or deficit, as determined in accordance with GAAP. The Company was not in compliance with the Fixed Charge Ratio covenant at September 30, 2016, however a waiver was obtained from Sterling Bank on November 18, 2016.   

  

International Credit Facilities: 

 

SPARFACTS Australia Pty. Ltd., has a secured line of credit facility with Oxford Funding Pty Ltd. for $1.2 million (Australian) or approximately $916,000 USD (based upon the exchange rate at September 30, 2016). 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 is on a month to month basis at the Company's request. The outstanding balance at September 30, 2016, was approximately $448,000 (Australian) or $342,000 USD (based on the exchange rate at September 30, 2016).

 

On March 7, 2011, the Japanese subsidiary, SPAR FM Japan, Inc., a wholly owned subsidiary, secured a term loan with Mizuho Bank in the amount of approximately 20.0 million Yen (Japanese) or $198,000 USD. The loan is payable in monthly installments of 238,000 Yen or $2,400 USD at an interest rate of 0.1% per annum with a maturity date of February 28, 2018. The outstanding balance at September 30, 2016, was approximately 4.1 million Yen or $40,000 USD (based upon the exchange rate at September 30, 2016).

 

SPAR Todopromo has secured a line of credit facility with BBVA Bancomer Bank for 5.0 million pesos or approximately $257,000 USD (based upon the exchange rate at September 30, 2016). The revolving line of credit was secured on March 15, 2016 with a contract for 24 months. The variable interest rate is TIIE (Interbank Interest Rate) +4% which results in an actual interest rate of 8.5% at the end of September. The outstanding balance at September 30, 2016 was 5.0 million pesos or $257,000 USD.

 

The Company had scheduled future maturities of loans as of September 30, 2016, approximately as follows (dollars in thousands):

 

 

 

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

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.

 

5.     Related-Party Transactions

 

SGRP's policy respecting approval of transactions with related persons, promoters and control persons is contained in the SPAR Group Code of Ethical Conduct for its Directors, Senior Executives and Employees Amended and Restated (as of) August 13, 2015 (the "Ethics Code"). The Ethics Code is intended to promote and reward honest, ethical, respectful and professional conduct by each Covered Person (as defined in the Ethics Code in his or her position with the Company anywhere in the world, including (among other things) serving each customer, dealing with each vendor and treating each other with integrity and respect, and behaving honestly, ethically and professionally with each customer, each vendor, each other and the Company. Article II of the Ethics Code specifically prohibits various forms of self-dealing and collusion and Article V of the Ethics Code generally prohibits each "Covered Person" (including SGRP's officers and directors) from engaging in any business activity that conflicts with his or her duties to the Company, and directs each "Covered Person" to avoid any activity or interest that is inconsistent with the best interests of the SPAR Group, in each case except for any "Approved Activity" (as such terms are defined in the Ethics Code). Examples of violations include (among other things) having any ownership interest in, acting as a director or officer of or otherwise personally benefiting from business with any competitor, customer or vendor of the Company other than pursuant to any Approved Activity. Approved Activities include (among other things) any contract with an affiliated person (each an "Approved Affiliate Contract") or anything else disclosed to and approved by SGRP's Board of Directors (the "Board"), its Governance Committee or its Audit Committee, as the case may be, as well as the ownership, board, executive and other positions held in and services and other contributions to affiliates of SGRP and its subsidiaries by certain directors, officers or employees of SGRP, any of its subsidiaries or any of their respective family members. The Company's senior management is generally responsible for monitoring compliance with the Ethics Code and establishing and maintaining compliance systems, including conflicting relationships and transactions, subject to the review and oversight of SGRP's Governance Committee as provided in clause IV.11 of the Governance Committee's Charter, and SGRP's Audit Committee as provided in clause I.2(l) of the Audit Committee's Charter. The Governance Committee and Audit Committee each consist solely of independent outside directors.

 

SGRP's Audit Committee has the specific duty and responsibility to review and approve the overall fairness of all material related-party transactions. The Audit Committee receives affiliate contracts and amendments thereto for its review and approval (to the extent approval is given), and these contracts are periodically (often annually) again reviewed, in accordance with the Audit Committee Charter, the Ethics Code, the rules of the Nasdaq Stock Market, Inc. ("Nasdaq"), and other applicable law to ensure that the overall economic and other terms will be (or continue to be) no less favorable to the Company than would be the case in an arms-length contract with an unrelated provider of similar services (i.e., its overall fairness to the Company including pricing and the ability to provide services at comparable performance levels). The Audit Committee periodically reviews all of the related party relationships, agreements and transactions described below.

 

Domestic Related Party Services:

 

SPAR Business Services, Inc. ("SBS"), SPAR Administrative Services, Inc. ("SAS"), and SPAR InfoTech, Inc. ("SIT"), are affiliates of SGRP but are not part of the consolidated Company. Mr. Robert G. Brown, a Director, the Chairman and a major stockholder of SGRP, and Mr. William H. Bartels, a Director and the Vice Chairman of the Company and a major stockholder of SGRP, are the sole stockholders of SBS. Mr. Brown is the sole stockholder of SIT. Mr. Brown is a director and officer of SBS and SIT. Mr. Bartels is a director and officer of SAS. The stockholders of SAS were Mr. Bartels and Mr. Brown, and as of January 1, 2015, Mr. Brown had transferred all of his ownership to parties related to Mr. Brown, each of whom are considered affiliates of the Company for related party purposes because of their family relationships with Mr. Brown.

 

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

The Company had expenses of $19.7 million and $18.9 million for the nine months ended September 30, 2016 and 2015, respectively (each "Total Domestic Field Cost"), for the execution of the field merchandising, auditing, assembly and other specialists (each a "Field Specialist") who execute the services provided by the Company to its domestic clients. SBS, through the use as needed of approximately 6,000 of its available Field Specialists in the U.S.A., provided a majority of all of the domestic Field Specialists used by the Company (which amounted to approximately 78% and 83% of the Company's Total Domestic Field Cost for the nine months ended September 30, 2016 and 2015, respectively). SAS, through the use of its 59 full-time national, regional and district administrators, provided substantially all of the domestic field administrative services used by the Company (which amounted to approximately 92% and 90% of the Company's total domestic field administrative service cost for the nine months ended September 30, 2016 and 2015, respectively).

 

Pursuant to the terms of the Amended and Restated Field Service Agreement with SBS dated as of January 1, 2004, as amended in 2011, and the Amended and Restated Field Management Agreement with SAS dated as of January 1, 2004 (each a "Prior Agreement"), defined reimbursable expenses and established the "Cost Plus Fee" arrangement where the Company paid SBS and SAS for their costs of providing those services plus a fixed percentage of such reimbursable expenses (the "Cost Plus Fee"). The parties have had negotiations respecting replacement agreements since the Prior Agreements expired on November 30, 2014.

 

The Company and SBS have agreed in principle to a Cost Plus Fee to 2.96% of SBS's reimbursable expenses as noted above. This agreement in principle went into effect on and has applied since December 1, 2014. A new SBS agreement is being prepared, which will be subject to contractual terms and provisions reasonably acceptable to the parties.

 

No SBS compensation for Mr. Brown has been reimbursed to date by the Company, and no such salary reimbursements were made under SBS's Prior Agreement. Although recently requested by SBS, those reimbursements have not been agreed upon or authorized by the Company. However, since SBS is a "Subchapter S" corporation and owned by Messrs. Brown and Bartels, all income from SBS is allocated to them.

 

On June 14, 2016, SAS and SMF entered into a new Field Administration Agreement (the "SAS Agreement"), a copy of which was filed with the Company's Current Report on Form 8-K as filed with the SEC on June 20, 2016. In order to provide continuity with SAS' Prior Agreement, the SAS Agreement is effective and governs the relationship of the parties as of December 1, 2014, and amends, restates and completely replaces SAS' Prior Agreement. The SAS Agreement more clearly defines reimbursable expenses, exclusions and procedures and continues the indemnifications and releases provided by SAS' Prior Agreement (which indemnifications and releases were and are comparable to those applicable to SGRP's directors and executive officers under its By-Laws and applicable law). Significantly, the SAS Agreement reduced the Cost Plus Fee from 4% to 2% effective as of June 1, 2016.

 

SGRP's Audit Committee has approved the SAS Agreement pursuant to its specific duty and responsibility to review and approve the overall fairness of all material related-party transactions, as more fully provided above in this Note 5 to the Company's Condensed Consolidated Financial Statements.

 

No salary reimbursements for Mr. Bartels have been included in such SAS reimbursable expenses or Cost Plus Fee, as such salary reimbursements were not made under the SAS's Prior Agreement and have not been included in the new SAS Agreement approved by the Audit Committee (as required under related party transaction rules). However, since SAS is a "Subchapter S" corporation and owned by Mr. Bartels and relatives of Mr. Brown, all income from SAS is allocated to them.

  

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

SBS renders the services of independent contractors to provide field merchandising, auditing, assembly and other services (such as “Field Specialist”). The appropriateness of SBS's treatment of its Field Specialists as independent contractors has been periodically subject to challenge (both currently and historically) by various states and others, and SBS's expenses of defending those challenges and other litigation have been paid by the Company (consistent with the Prior Agreements and to endeavor to manage related potential risks). See Note 8 to the Condensed Consolidated Financial Statements – Commitments and Contingencies, below. The Company paid SBS for its legal expenses in defending all of its litigation in the amounts of $143,920 and $116,635 for the three month periods ended September 30, 2016 and 2015, respectively, and $586,836 and $383,971 for the nine month periods ended September 30, 2016, and 2015, respectively.

   

National Merchandising Services, LLC ("NMS"), is a consolidated domestic subsidiary of the Company and is owned jointly by SGRP through its indirect ownership of 51% of the NMS membership interests and by National Merchandising of America, Inc. ("NMA"), through its ownership of the other 49% of the NMS membership interests. Mr. Edward Burdekin is the Chief Executive Officer and President and a director of NMS and also is an executive officer and director of NMA and the sole member and manager of National Retail Source, LLC ("NRS"). Ms. Andrea Burdekin, Mr. Burdekin's wife, is the sole stockholder and a director of NMA and a director of NMS. NRS and NMA are affiliates of the Company but are not consolidated with the Company. NMS commenced operations as of September 1, 2012.

 

NRS provided a substantial amount of the domestic merchandising specialist field force used by NMS during 2015. Pursuant to the terms of the Master Field Services Agreement dated as of August 1, 2013 (the "NRS Services Agreement"), NMS received merchandising services from NRS through the use of field merchandising specialists during 2015. For those services, the Company had agreed to reimburse NRS for its total costs of providing those services and to pay NRS a fee equal to 2% of its total costs (the "Plus 2% Fee"). Those costs included all field and administrative costs and expenses (effectively including workers compensation insurance expenses) of NRS but exclude certain legal and other administrative expenses. Accordingly, no salary reimbursement for Mr. Burdekin or Ms. Burdekin were included in such reimbursable costs or Plus 2% Fee.

 

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

In 2015, NRS provided a substantial amount of the domestic merchandising specialist field force used by NMS and 5% of all of the domestic merchandising specialist field force used by the Company for the nine months ended September 30, 2015. The total Plus 1% Fee earned by NRS for services rendered was approximately $20,000 for the nine months ended September 30, 2015. As of December 2015, NMS no longer uses NRS but uses field merchandising services from a non-affiliated third-party provider, but NMS could once again use NRS in the future.

 

International Related Party Services:

 

SGRP Meridian (Pty), Ltd. ("Meridian") is a consolidated international subsidiary of the Company and is owned 51% by SGRP and 49% by the following individuals: Mr. Brian Mason, Mr. Garry Bristow, and Mr. Adrian Wingfield. Mr. Mason is President and a director and Mr. Bristow is an officer and director of Meridian. Mr. Mason is also an officer and director and shareholder of Merhold Property Trust ("MPT"). Mr. Mason and Mr. Bristow are both officers and directors and both are shareholders of Merhold Cape Property Trust ("MCPT"). Mr. Mason, Mr. Bristow and Mr. Wingfield are all officers and shareholders of Merhold Holding Trust ("MHT") which provides similar services like MPT. MPT owns the building where Meridian is headquartered and also owns two vehicles both of which are subleased to Meridian. MCPT provides a fleet of 126 vehicles to Meridian under a 4 year lease program. These leases are provided to Meridian at local market rates included in the summary table below.

 

SGRP NDS Tanitim Ve Danismanlik A.S. ("NDS") is a consolidated international subsidiary of the Company and is owned 51% by SGRP and 49% by Mr. Medet Yilmaz and Ms. Nurgül Yilmaz. Mr. Yilmaz is President and a director and Ms. Yilmaz is an officer and director of NDS. They are both officers and directors of NDS Tanitim Danismanlik Hizmetleri Gida Tekstil Turizm Pazarlama Ticaret Limited Sirketi ("NDS Tanitim") and NDS Reklam Tanitim Ve Danismanlik Hizmetleri Pazarlama Ticaret Limited Sirketi ("NDS Reklam"). Mr. and Ms. Yilmaz are shareholders of NDS Tanitim and NDS Reklam. NDS Tanitim provided NDS field administration services while NDS Reklam provided NDS field merchandising services both at local market rates through May 2015 at which time NDS assumed these service responsibilities.

 

SPAR Todopromo is a consolidated international subsidiary of the Company and is owned 51% by SGRP and 49% by the following individuals: Mr. Juan F. Medina Domenzain, Mr. Juan Medina Staines, Mr. Julio Cesar Hernandez Vanegas, and Mr. Jorge Medina Staines. Mr. Juan F. Medina Domenzain is an officer and director of SPAR Todopromo and is also majority shareholder of CONAPAD ("CON") which supplies administrative and operational consulting support to SPAR Todopromo.

 

At the end of August, Mr. Juan F. Medina Domenzain ("JFMD"), partner in SPAR Todopromo, purchased a warehouse that was leased by SPAR Todopromo. He is leasing the use of the warehouse to SPAR Todopromo for the same amount per month as the prior warehouse owner. He currently has a rental contract for the rest of the year with SPAR Todopromo and a new contract is expected to be signed in January, 2017 at current market rates.

 

The Company continues to purchase services from SBS, SAS, NRS, MPT, MCPT, MHT, NDS Tanitim, NDS Reklam, CON and JFMD because it believes the value of services it receives from them are at least as favorable to the Company as it could obtain from non-affiliated providers of similar services. The Company believes it is the largest and most important customer of SBS, SAS, NRS, MPT, MCPT, MHT, NDS Tanitim, NDS Reklam, CON and JFMD (and from time to time may be their only customer), and accordingly the Company generally has been able to negotiate better terms, receives more personal and responsive service and is more likely to receive credits and other financial accommodations from SBS, SAS, NRS, MPT, MCPT, MHT, NDS Tanitim, NDS Reklam, CON and JFMD than the Company could reasonably expect to receive from an unrelated service provider who has significant other customers and business. SBS, SAS and NRS affiliate contracts and arrangements are annually reviewed and considered for approval by SGRP's Audit Committee, subject to the ongoing negotiations as described above.

  

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

Summary of Related Party Services:

The following costs of affiliates were charged to the Company (in thousands):

 

 

 

Other Related Party Transactions and Arrangements

 

In July 1999, SPAR Marketing Force, Inc. ("SMF"), SBS and SIT entered into a perpetual software ownership agreement providing that each party independently owned an undivided share of and had the right to unilaterally license and exploit their "Business Manager" Internet job scheduling software (which had been jointly developed by such parties), and all related improvements, revisions, developments and documentation from time to time voluntarily made or procured by any of them at its own expense. Business Manager and its other proprietary software and applications are used by the Company for (among other things) the scheduling, tracking, coordination and reporting of its merchandising and marketing services and are accessible via the Internet or other applicable telecommunication network by the authorized representatives of the Company and its clients through their respective computers and mobile devices. In addition, SPAR Trademarks, Inc. ("STM"), SBS and SIT entered into separate perpetual trademark licensing agreements whereby STM has granted non-exclusive royalty-free licenses to SIT and SBS (and through them to their commonly controlled subsidiaries and affiliates by sublicenses, including SAS) for their continued use of the name "SPAR" and certain other trademarks and related rights of STM, a wholly owned subsidiary of SGRP. SBS and SAS provide services to the Company, as described above, SIT assisted in the Brazilian acquisition, as described below, and SIT no longer provides services to and does not compete with the Company.

 

Through arrangements with the Company, SBS, SAS and other companies owned by Mr. Brown or Mr. Bartels 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 such transactions between the Company and the above affiliates are paid and/or collected by the Company in the normal course of business.

 

In addition to the above, SAS purchases insurance coverage for worker compensation, casualty and property insurance risk for itself, SBS for its field merchandising specialists that require such insurance coverage and the Company from Affinity Insurance, Ltd. ("Affinity"). SAS owns a minority (less than 1%) of the common stock in Affinity. The Affinity insurance premiums for such coverage are ultimately charged to SAS, SBS (and through SBS to its covered field merchandising specialists) and the Company based on the contractual arrangements of the parties.

 

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

Related Party Transactions and Arrangements in the Brazil Acquisition

 

The following related party transactions occurred and arrangements established in connection with the Company's September 2016 acquisition in Brazil of the NM Companies (as defined and more fully described in Note 10 to Consolidated Financial Statements - Purchase of Interests in Subsidiaries, below).

 

On September 8, 2016, the Company (through its Cayman Islands subsidiary) acquired 100% ownership of SGRP Brasil Participações Ltda. ("SGRP Holdings"), a Brazilian limitada (which is a form of limited liability company), from its affiliate, SPAR Infotech, Inc. ("SIT") (see below), at cost (including approved expenses). SGRP Holdings then completed the formation and acquired a majority of the stock of SPAR Brasil Serviços de Merchandising e Tecnologia S.A., a Brazilian corporation ("SPAR BSMT").

 

SGRP Holdings, JK Consultoria Empresarial Ltda.-ME, a Brazilian limitada ("JKC"), and Earth Investments, LLC, a Nevada limited liability company ("EILLC"), entered into a Joint Venture Agreement respecting SPAR BSMT dated and effective as of September 13, 2016 (the "JV Agreement"). See below respecting the ownership and related party status of JKC and EILLC. The JV Agreement (among other things) provided for the NM Acquisition described (and defined) below, provided for the capitalization of and loans to SPAR BSMT to fund the NM Acquisition and its working capital, and established terms for the election of officers and directors and governance of SPAR BSMT. In addition, the JV Agreement provided for the issuance of shares by SPAR BSMT in the necessary amounts to give SGRP Holdings 51%, JKC 39% and EILLC 10% of the outstanding shares of SPAR BSMT's stock. Under the JV Agreement, SPAR BSMT has five directors, three of which are nominated by SGRP Holdings, one of which is nominated by JKC and one of which is nominated by EILLC.

 

JKC is owned by Mr. Jonathan Dagues Martins, a Brazilian citizen and resident ("JDM") and his sister, Ms. Karla Dagues Martins, a Brazilian citizen and resident. JDM is the Chief Executive Officer and President of each SPAR Brazil company pursuant to a Management Agreement between JDM and SPAR BSMT dated September 13, 2016. JDM also is a director of SPAR BSMT. Accordingly, JKC and JDM are each a related party in respect of the Company. JKC and SGRP Holdings are parties to separate Loan Agreements with SPAR BSMT dated September 14, 2016, pursuant to which SGRP Holdings loaned R$1,400,000 (approximately US$448,000) and JKC loaned R$453,673 (approximately US$145,175) to SPAR BMST as required by the JV Agreement. JKC funded that loan in part through a loan of R$120,423 (approximately US$38,700) to JKC from SGRP Holdings pursuant to a Loan Agreement between them dated September 14, 2016.

 

EILLC is owned by Mr. Peter W. Brown, a citizen and resident of the USA ("PWB"). PWB is an officer and employee of the Company's affiliate, SIT which is owned by SGRP's Chairman, Mr. Robert G. Brown, PWB is an official observer at the meetings of SGRP's Board, and PWB also is the nephew of Mr. Robert G. Brown. PWB also is a director of SPAR BSMT. Accordingly, PWB and EILLC are each a related party in respect of the Company. In consideration of PWB's efforts in finding and pursuing the NM Acquisition, the Company agreed to grant his company, EILLC, a 10% interest in SPAR BSMT, have SGRP Holdings take over and make the initial loans to SPAR BSMT that would otherwise have been required to have been made by EILLC (aggregating R$116,326 or approximately US$37,200). The Company also agreed to reimburse Infotech for PWB's approved expenses.

 

The NM Acquisition and associated related party transactions were reviewed and approved by the Audit Committee of SGRP's Board of Directors.

Company paid SBS for its legal expenses in defending all of its litigation in the amounts of $143,920 and $116,635 for the three month periods ended September 30, 2016 and 2015, respectively, and $586,836 and $383,971 for the nine month periods ended September 30, 2016, and 2015, respectively.

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6.      Preferred Stock

 

SGRP's certificate of incorporation authorizes it to issue 3,000,000 shares of preferred stock with a par value of $0.01 per share (the "SGRP Preferred Stock"), which may have such preferences and priorities over the SGRP Common Stock and other rights, powers and privileges as the Company's Board of Directors may establish in its discretion from time to time. The Company has created and authorized the issuance of a maximum of 3,000,000 shares of Series A Preferred Stock pursuant to SGRP's Certificate of Designation of Series "A" Preferred Stock (the "SGRP Series A Preferred Stock"), which have dividend and liquidation preferences, have a cumulative dividend of 10% per year, are redeemable at the Company's option and are convertible at the holder's option (and without further consideration) on a one-to-one basis into SGRP Common Stock. The Company issued 554,402 of SGRP shares to affiliated retirement plans which were all converted into common shares in 2011 (including dividends earned thereon), leaving 2,445,598 shares of remaining authorized preferred stock. At September 30, 2016, no shares of SGRP Series A Preferred Stock were issued and outstanding.

 

7.      Stock-Based Compensation and Other Plans

 

SGRP has granted restricted stock and stock option awards to its eligible directors, officers and employees and certain employees of its affiliates respecting shares of Common Stock issued by SGRP ("SGRP Shares") pursuant to SGRP's 2008 Stock Compensation Plan (as amended, the "2008 Plan"), which was approved by SGRP's stockholders in May of 2008 and 2009. The 2008 Plan provides for the granting of restricted SGRP shares, stock options to purchase SGRP shares (either incentive or nonqualified), and restricted stock units, stock appreciation rights and other awards based on SGRP shares ("Awards") to SGRP Directors and the Company's specified executives, employees and consultants (which are employees of certain of its affiliates), although to date SGRP has not issued any permissible form of Award other than stock option, restricted share awards, and performance stock units. As of September 30, 2016, approximately 700,000 SGRP shares were available for Award grants under the amended 2008 Plan. In the third quarter, there were 75,000 options awarded to officers, 50,000 options awarded to Peter W. Brown, a consultant and related party to the Company, and 400,000 options awarded to the new President and CEO of SPAR Group, Inc. In addition, the CEO was awarded 25,000 shares of restricted stock in the quarter.

 

The Company recognized $90,000 and $119,000 in stock-based compensation expense relating to stock option awards during the three month periods ended September 30, 2016 and 2015, respectively. The tax benefit available from stock based compensation expense related to stock option during the three months ended September 30, 2016 and 2015 was approximately $34,000 and $45,000 respectively. The Company recognized $232,000 and $290,000 in stock-based compensation expense relating to stock option Awards during the nine month periods ended September 30, 2016 and 2015, respectively. The tax benefit, available to the Company, from stock based compensation expense related to stock options during the nine months ended September 30, 2016 and 2015 was approximately $85,000 and $110,000, respectively. However, since the Company has NOL's available for the next several years, these tax benefits have not been realized as of this report. As of September 30, 2016, total unrecognized stock-based compensation expense related to stock options was $674,000.

 

During the three months ended September 30, 2016 and 2015, the Company recognized approximately $9,000 and $15,000, respectively of stock based compensation expense related to restricted stock. The tax benefit available to the Company from stock based compensation expense related to restricted stock during the three months ended September 30, 2016 and 2015 was approximately $3,500 and $5,600, respectively. During the nine months ended September 30, 2016 and 2015, the Company recognized approximately $39,000 and $35,000, respectively, of stock-based compensation expense related to restricted stock. The tax benefit, available to the Company, from stock based compensation expense related to restricted stock during the nine months ended September 30, 2016 and 2015 was approximately $14,800 and $13,500, respectively. However, since the Company has NOL's available for the next several years, these tax benefits have not been realized as of this report. As of September 30, 2016, total unrecognized stock-based compensation expense related to unvested restricted stock Awards was $118,000.

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8.     Commitments and Contingencies

 

The Company is a party to various legal actions and administrative proceedings arising in the normal course of business, and through its insurance programs, the Company endeavors to manage any underlying or related potential risk.

 

The Company executes the services it provides to its domestic clients through independent field merchandising, auditing, assembly and other specialists (each a "Field Specialist"), the vast majority of whom are provided by SBS. For affiliated relationships, contractual details, and payment amounts, see Note 5 to the Condensed Consolidated Financial Statements – Related Party Transactions - Domestic Related Party Services, in this Quarterly Report, above. The appropriateness of SBS's treatment of its Field Specialists as independent contractors has been periodically subject to challenge (both currently and historically) by various states and others, and SBS's expenses of defending those challenges and other litigation have been paid by the Company (consistent with their Prior Agreements and to endeavor to manage related potential risks). That treatment is being challenged currently in a California class action lawsuit where the State Court separated the issues of independent contractor status and damages, tried the status issue first, and ruled that the Field Specialists were employees because (among other things) they failed to sufficiently exercise their independence. The second stage of the trial will be the determination of damages, if any. When a decision has been reached on those damages, the liability and damage decisions can be appealed to a higher court. There can be no assurance that SBS will succeed in defending any such challenge, the legal expenses of prolonged litigation and appeals could continue to be (and have from time to time been) significant, and any adverse determination could increase the Company's costs of doing business.

 

The Company's management does not anticipate at this time that disposition of those matters would be likely to have a material adverse effect on the Company.

 

 

9.      Segment Information

 

The Company reports net revenues from continuing operations and operating income from continuing operations by reportable segment. Reportable segments are components of the Company for which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

 

The Company provides similar merchandising and marketing services throughout the world, operating within two reportable segments, its Domestic Division and its International Division. The Company uses those divisions to improve its administration and operational and strategic focuses, and it tracks and reports certain financial information separately for each of those divisions. The Company measures the performance of its Domestic and International Divisions and subsidiaries using the same metrics. The primary measurement utilized by management is operating profits, historically the key indicator of long-term growth and profitability, as the Company is focused on reinvesting the operating profits of each of its international subsidiaries back into its local markets in an effort to improve market share and continued expansion efforts.

 

 

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

Management evaluates performance as follows (in thousands): 

 

 

Note: There were no inter-company sales for the nine months ended September 30, 2016 or 2015.

 

 

 

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

Geographic Data (in thousands)

 

 

 

 

10. Purchase of Interests in Subsidiaries

 

After acquiring SGRP Brasil Participações Ltda. ("SGRP Holdings"), a Brazilian limitada (which is a form of limited liability company), and establishing SPAR Brasil Serviços de Merchandising e Tecnologia S.A., a Brazilian corporation ("SPAR BSMT"), in a series of related party transactions (See Note 5 to Condensed Consolidated Financial Statements - Related Party Transactions, above), SGRP Holdings and SPAR BSMT (the "Purchasers") entered into a Quota Purchase Agreement dated September 13, 2016 (the "NM QPA"), with Interservice Publicidade Sociedade Ltda., a Brazilian limitada, Momentum Promoções Ltda., a Brazilian limitada, and IPG Nederland B.V., a Netherlands company (collectively, the "Sellers"). The Sellers are subsidiaries of The Interpublic Group of Companies, Inc., a Delaware corporation ("Interpublic"), which is a global provider of advertising, media and other business services. The NM QPA provided for the acquisition by the Purchasers from the Sellers (the "NM Acquisition") of all of the equity shares (called "quotas") in New Momentum Ltda., a Brazilian limitada, and New Momentum Serviços Temporários Ltda., a Brazilian limitada (each a "NM Company" or collectively “the new Companies”), two of Interpublic's "In Store" companies in Brazil. SPAR BSMT acquired 99% of the quotas issued by each NM Company and SGRP Holdings acquired 1% of the quotas issued by each NM Company pursuant to the NM QPA. The closing of the acquisition of the NM Companies was completed with the disbursement of the purchase price to the Sellers on September 19, 2016, effective as of September 13, 2016.

 

The preliminary purchase price at closing for the NM Companies was R$1,163,263 (approximately US$358,000), based on a preliminary balance sheet as of July 31, 2016 which is subject to adjustment (upward or downward) based on the final closing balance sheet as of September 13, 2016. The Sellers have until December 12, 2016 to present the final closing balance sheet to the Company.

   

 

  

SPAR Group, Inc. and Subsidiaries

Notes to Condensed Consilidated Financial Statements

(unaudited) (continued)

 

Momentum Promoções Ltda., one of the Sellers, also agreed to provide certain transition services and continued use of certain existing office space to SPAR BSMT and each of the NM Companies (collectively, "SPAR Brazil"), pursuant to a Transition Services Agreement dated September 13, 2016 (the "Transition Agreement"), and a Sublease Agreement dated September 13, 2016 (the "Sublease"), respectively. The Sublease has an initial term of 12 months and requires monthly rent and back office support payments of R$205,417 (approximately US$65,700). The Transition Agreement has an initial term ending December 31, 2016, and requires various monthly service payments estimated to be in total R$74,534 (approximately US$23,850).

  

The Company has completed its preliminary calculation of the estimated fair value and related allocation of assets between goodwill and other. This valuation may be subject to change upon receipt of the final closing balance sheet as of September 13, 2016, which is expected by the end of this year at which time the Company will update its fair value allocation analysis. The Company expects to finalize the purchase price allocation as soon as practical, but no later than one year from acquisition date. A summary of assets acquired, goodwill and liabilities assumed and net of purchase price are as follows (in thousands);

 

 

The following table includes the amount of Brazil’s revenue and earnings included in the Company’s consolidated statement of income for the quarter ended September 30, 2016, and a pro forma calculation of the amounts that would have been included in the Company’s consolidated statements of income for the three and nine month periods ended September 30, 2016 and 2015 had the Brazil acquisition date been January 1, 2015, instead of September 14, 2016 (in thousands):

 

 

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