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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED OCTOBER 5, 2003 COMMISSION FILE NUMBER 333-90817
SBARRO, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
NEW YORK 11-2501939
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER I.D. NO.)
INCORPORATION OR ORGANIZATION)
401 BROAD HOLLOW ROAD, MELVILLE, NEW YORK 11747
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (631) 715-4100
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 12 MONTHS, AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS.
YES NO
------------ ------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT).
YES NO X
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THE NUMBER OF SHARES OF COMMON STOCK OF THE REGISTRANT OUTSTANDING AS OF
NOVEMBER 13, 2003 WAS 7,064,328.
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SBARRO, INC.
FORM 10-Q INDEX
---------------
PART I. FINANCIAL INFORMATION PAGES
--------------------- -----
Consolidated Financial Statements:
Balance Sheets - October 5, 2003 (unaudited) and December 29, 2002......3-4
Statements of Operations (unaudited) - Forty Weeks and Twelve
Weeks ended October 5, 2003 and October 6, 2002.....................5-6
Statements of Cash Flows (unaudited) - Forty Weeks ended October 5,
2003 and October 6, 2002............................................7-8
Notes to Unaudited Consolidated Financial Statements-October 5, 2003...9-27
Management's Discussion and Analysis of Financial Condition and Results
of Operations..........................................................28-38
Qualitative and Quantitative Disclosures of Market Risk.......................38
Controls and Procedures.......................................................39
PART II. OTHER INFORMATION................................................40
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
(IN THOUSANDS, EXCEPT SHARE DATA)
-------------------------------------------
OCTOBER 5, 2003 DECEMBER 29, 2002
--------------- -----------------
(UNAUDITED)
CURRENT ASSETS:
CASH AND CASH EQUIVALENTS $31,049 $55,150
RESTRICTED CASH FOR UNTENDERED SHARES 21 21
RECEIVABLES, NET OF ALLOWANCE FOR DOUBTFUL
ACCOUNTS OF $488 IN 2003 AND $491 IN 2002:
FRANCHISEE 1,717 2,059
OTHER 1,704 1,244
-------- --------
3,421 3,303
INVENTORIES 2,299 3,285
PREPAID EXPENSES 8,945 2,362
CURRENT PORTION OF LOANS RECEIVABLE FROM SHAREHOLDERS 58 3,232
-------- --------
TOTAL CURRENT ASSETS 45,793 67,353
PROPERTY AND EQUIPMENT, NET 100,685 115,081
INTANGIBLE ASSETS:
TRADEMARKS, NET 195,916 195,916
GOODWILL, NET 9,204 9,204
DEFERRED FINANCING COSTS AND OTHER, NET 5,806 6,632
LOANS RECEIVABLE FROM SHAREHOLDERS, LESS CURRENT PORTION 6,104 2,800
OTHER ASSETS 8,154 7,787
-------- --------
$371,662 $404,773
======== ========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page 3
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
LIABILITIES AND SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
-------------------------------------------
OCTOBER 5, 2003 DECEMBER 29, 2002
--------------- -----------------
(UNAUDITED)
CURRENT LIABILITIES:
AMOUNTS DUE FOR UNTENDERED SHARES $21 $21
ACCOUNTS PAYABLE 13,801 10,279
ACCRUED EXPENSES 15,644 21,623
ACCRUED INTEREST PAYABLE 1,708 8,181
CURRENT PORTION OF MORTGAGE PAYABLE 205 154
-------- --------
TOTAL CURRENT LIABILITIES 31,379 40,258
DEFERRED RENT 8,885 8,474
LONG-TERM DEBT, NET OF ORIGINAL ISSUE
DISCOUNT, LESS CURRENT PORTION 268,054 267,941
CONTINGENCIES
SHAREHOLDERS' EQUITY:
PREFERRED STOCK, $1 PAR VALUE; AUTHORIZED 1,000,000 SHARES;
NONE ISSUED - -
COMMON STOCK, $.01 PAR VALUE; AUTHORIZED 40,000,000 SHARES;
ISSUED AND OUTSTANDING 7,064,328 SHARES AT OCTOBER 5,
2003 AND DECEMBER 29, 2002 71 71
ADDITIONAL PAID-IN CAPITAL 10 10
RETAINED EARNINGS 63,263 88,019
-------- --------
63,344 88,100
-------- --------
$371,662 $404,773
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SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page 4
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS)
--------------
FOR THE FORTY WEEKS ENDED:
--------------------------
OCTOBER 5, 2003 OCTOBER 6, 2002
--------------- ---------------
REVENUES:
RESTAURANT SALES $ 228,863 $254,454
FRANCHISE RELATED REVENUES 7,625 7,636
REAL ESTATE AND OTHER 4,448 4,334
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TOTAL REVENUES 240,936 266,424
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COSTS AND EXPENSES:
RESTAURANT OPERATING EXPENSES:
COST OF FOOD AND PAPER PRODUCTS 49,248 49,864
PAYROLL AND OTHER EMPLOYEE BENEFITS 66,357 71,867
OTHER OPERATING COSTS 85,790 89,152
DEPRECIATION AND AMORTIZATION 14,820 15,784
GENERAL AND ADMINISTRATIVE 20,122 17,985
ASSET IMPAIRMENT AND RESTAURANT CLOSING CHARGES, NET 4,467 2,911
----------- --------
TOTAL COSTS AND EXPENSES 240,804 247,563
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OPERATING INCOME BEFORE MINORITY INTEREST 132 18,861
MINORITY INTEREST (22) (36)
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OPERATING INCOME 110 18,825
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OTHER INCOME (EXPENSE):
INTEREST EXPENSE (23,930) (23,905)
INTEREST INCOME 569 390
EQUITY IN NET INCOME OF UNCONSOLIDATED AFFILIATES 270 692
INSURANCE RECOVERY, NET - 7,162
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NET OTHER EXPENSE (23,091) (15,661)
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LOSS (INCOME) BEFORE INCOME TAXES (22,981) 3,164
INCOME TAXES 675 276
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NET (LOSS) INCOME $(23,656) $2,888
=========== ========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page 5
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS)
--------------
FOR THE TWELVE WEEKS ENDED:
---------------------------
OCTOBER 5, 2003 OCTOBER 6, 2002
--------------- ---------------
REVENUES:
RESTAURANT SALES $72,109 $ 78,006
FRANCHISE RELATED REVENUES 2,295 2,561
REAL ESTATE AND OTHER 1,374 1,319
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TOTAL REVENUES 75,778 81,886
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COSTS AND EXPENSES:
RESTAURANT OPERATING EXPENSES:
COST OF FOOD AND PAPER PRODUCTS 15,701 15,010
PAYROLL AND OTHER EMPLOYEE BENEFITS 20,530 21,811
OTHER OPERATING COSTS 26,261 26,775
DEPRECIATION AND AMORTIZATION 4,411 3,872
GENERAL AND ADMINISTRATIVE 6,056 5,286
ASSET IMPAIRMENT AND RESTAURANT CLOSING CHARGES, NET 3,410 682
------- ------
TOTAL COSTS AND EXPENSES 76,369 73,436
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OPERATING (LOSS) INCOME BEFORE MINORITY INTEREST (591) 8,450
MINORITY INTEREST (12) ( 3)
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OPERATING (LOSS) INCOME (603) 8,447
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OTHER INCOME (EXPENSE):
INTEREST EXPENSE (7,167) (7,165)
INTEREST INCOME 158 130
EQUITY IN NET (LOSS) INCOME OF UNCONSOLIDATED AFFILIATES (241) 147
INSURANCE RECOVERY, NET - 7,162
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NET OTHER EXPENSE (7,250) 274
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(LOSS) INCOME BEFORE INCOME TAXES (7,853) 8,721
INCOME TAXES 101 75
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NET (LOSS) INCOME $(7,954) $8,646
======== ======
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page 6
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
--------------
FOR THE FORTY WEEKS ENDED:
--------------------------
OCTOBER 5, 2003 OCTOBER 6, 2002
--------------- ---------------
OPERATING ACTIVITIES:
NET (LOSS) INCOME $(23,656) $2,888
ADJUSTMENTS TO RECONCILE NET (LOSS) INCOME TO NET CASH (USED IN)
PROVIDED BY OPERATING ACTIVITIES:
DEPRECIATION AND AMORTIZATION 15,938 16,939
ASSET IMPAIRMENT AND RESTAURANT CLOSING CHARGES 5,070 2,046
INCREASE IN DEFERRED RENT, NET 232 403
GAIN ON SALE OF OTHER CONCEPT UNIT (200) -
LOSS ON SALE OF OTHER CONCEPT UNIT INCLUDED IN PRIOR YEAR
ASSET IMPAIRMENT COSTS 250 -
MINORITY INTEREST 22 36
EQUITY IN NET INCOME OF UNCONSOLIDATED AFFILIATES (270) (692)
DIVIDENDS RECEIVED FROM UNCONSOLIDATED AFFILIATE 119 311
CHANGES IN OPERATING ASSETS AND LIABILITIES:
DECREASE IN RECEIVABLES 351 881
DECREASE IN INVENTORIES 987 741
INCREASE IN PREPAID EXPENSES (6,371) (7,507)
INCREASE IN OTHER ASSETS (105) (181)
DECREASE IN ACCOUNTS PAYABLE AND ACCRUED EXPENSES (2,501) (6,012)
DECREASE IN ACCRUED INTEREST PAYABLE (6,473) (6,473)
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NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (16,607) 3,380
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SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page 7
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
(IN THOUSANDS)
--------------
FOR THE FORTY WEEKS ENDED:
--------------------------
OCTOBER 5, 2003 OCTOBER 6, 2002
--------------- ---------------
INVESTING ACTIVITIES:
PURCHASES OF PROPERTY AND EQUIPMENT $(6,265) $(6,611)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (6,265) (6,611)
-------- --------
FINANCING ACTIVITIES:
MORTGAGE PRINCIPAL REPAYMENTS (128) (117)
TAX DISTRIBUTIONS RELATED TO THE PRIOR FISCAL YEAR (1,101) (3,125)
-------- --------
NET CASH USED IN FINANCING ACTIVITIES (1,229) (3,242)
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (24,101) (6,473)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 55,150 36,952
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $31,049 $30,479
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
CASH PAID DURING THE PERIOD FOR INCOME TAXES $378 $626
==== ====
CASH PAID DURING THE PERIOD FOR INTEREST $29,250 $29,247
======= =======
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page 8
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions for Form 10-Q and
Regulation S-X related to interim period financial statements and,
therefore, do not include all information and footnotes required by
generally accepted accounting principles. However, in the opinion of
our management, all adjustments (consisting of normal recurring
adjustments and accruals) considered necessary for a fair presentation
of our consolidated financial position at October 5, 2003, our
consolidated results of operations for the forty and twelve week
periods ended October 5, 2003 and October 6, 2002 and cash flows for
the forty week periods then ended have been included. The results of
operations for interim periods are not necessarily indicative of the
results that may be expected for the entire year. Reference should be
made to the annual financial statements, including footnotes thereto,
included in our Annual Report on Form 10-K for the fiscal year ended
December 29, 2002.
2. NEW ACCOUNTING PRONOUNCEMENTS:
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses
accounting for restructuring and similar costs. SFAS No. 146 supersedes
previous accounting guidance, principally EITF Issue No. 94-3
"Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 requires that the liability for costs
associated with an exit or disposal activity be recognized when the
liability is incurred. Under EITF No. 94-3, a liability for an exit
cost was recognized at the date of a company's commitment for an exit
plan. SFAS No. 146 also establishes that the liability should initially
be measured and recorded at fair value. SFAS 146 changes the timing of
expense recognition for certain costs we incur while closing
restaurants or undertaking other exit or disposal activities; however,
the timing difference is not typically significant length. Adoption of
SFAS 146 did not have a material impact on our financial statements for
the quarter and year to date ended October 5, 2003.
In November 2002, the FASB issued Financial Interpretation (`FIN") No.
45, "Guarantor's Accounting and Disclosure Requirements for Guarantees
including Indirect Guarantees of Indebtedness of Others" which
addresses the accounting for and disclosure by guarantors regarding
obligations relating to the issuance of certain guarantees. FIN No. 45
requires that, for all guarantees issued or modified after December 31,
2002, a liability for the fair value of the obligation undertaken be
recorded at the inception of a guarantee. No revision of or restatement
of accounting for guarantees issued or modified prior to December 31,
2002 is allowed. The disclosure requirements of Interpretation No. 45
were effective with our 2002 financial statements. As described in the
Notes to the
Page 9
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Consolidated Financial Statements included in our Annual Report on Form
10-K for the year ended December 29, 2002, we have provided certain
guarantees that would require recognition upon issuance or modification
under the provisions of FIN 45. While the nature of our business will
include in the issuance of certain guarantees in the future, we do not
anticipate that FIN 45 will have a material impact on our financial
position or results of operations.
FIN 46, "Consolidation of Variable Interest Entities," is effective
immediately for all enterprises with variable interests in variable
interest entities created after January 31, 2003. The provisions of FIN
46 must be applied to interests in variable interest entities created
before February 1, 2003 beginning with the first reporting period after
December 15, 2003, which will be our 2003 fiscal year end. If an entity
is determined to be a variable interest entity, it must be consolidated
by the enterprise that absorbs the majority of the entity's expected
losses if they occur, receives a majority of the entity's expected
residual returns if they occur, or both. Where it is reasonably
possible that the enterprise will consolidate or disclose information
about a variable interest entity, the enterprise must disclose the
nature, purpose, size and activity of the variable interest entity and
the enterprise's maximum exposure to loss as a result of its
involvement with the variable interest entity in all financial
statements issued after January 31, 2003. On October 9, 2003, the FASB
issued FASB Staff Position No. FIN 46-6 "Effective Date of FASB
Interpretation No. 46, Consolidation of Variable Interest Entities,"
which defers the implementation date for public entities that hold an
interest in a variable interest entity or potential variable interest
entity from the first fiscal year or interim period beginning after
June 15, 2003 to the end of the first interim or annual period ending
after December 15, 2003. This deferral applies only if (1) the variable
interest entity was created before February 1, 2003 and (2) the public
entity has not issued financial statements reporting that variable
interest entity in accordance with FIN 46, other than disclosures
required by paragraph 26 of FIN 46. As of the date of this filing, we
understand the FASB is in the process of further modifying and/or
clarifying certain provisions of FIN 46. These modifications, when
finalized, could impact our analysis of the applicability of FIN 46 to
entities that are our franchisees. We are aware of certain
interpretations by some parties of the provisions of FIN 46, given its
continuing evolution, which could have applicability when certain
conditions exist that are not representative of a typical franchise
relationship. These conditions include the franchisor possessing an
equity interest in or providing significant levels of financial support
to a franchisee, including lease guarantees. We do not possess any
ownership interests in our franchisees and we do not provide financial
support to franchisees in our typical franchise relationship with the
exception of non-cancelable operating lease guarantees for
approximately 30 franchise locations. While we continue to monitor and
analyze developments regarding FIN 46 that would impact its
applicability to franchise relationships, at this time we do not
believe that the required consolidation of franchise entities, if any,
would materially impact our financial statements.
Page 10
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
We have also reviewed our corporate relationships for possible coverage
under FIN 46 and have determined that they will not have a material
effect on our disclosures and our financial position or results of
operations.
The required disclosures for any variable interest entity have been
included in our Form 10-K for the fiscal year ended December 29, 2002
3. LONG-TERM DEBT:
Our credit agreement required that we maintain a minimum ratio of
consolidated earnings before interest, taxes and depreciation and
amortization ("EBITDA") to consolidated interest expense and a maximum
ratio of consolidated senior debt to consolidated EBITDA. We have not
been in compliance with the required ratios, as amended, during 2003.
Our bank waived compliance with these covenants but we would not have
been able to borrower under this arrangement. We requested, and the
bank agreed, to terminate the bank's lending commitment. We had not
made any borrowings under the line of credit since its inception,
except for a required one day borrowing upon the activation of the
credit agreement and except with respect to letters of credit that have
been issued by the bank under the sublimit of the line. The termination
of the bank's lending commitment eliminates our obligation to pay a
commitment fee on the unused portion of the facility. Our obligations
under the credit agreement to reimburse the bank with respect to any
drawings that may be made under the approximately $1.7 million of
letters of credit that are outstanding as of November 19, 2003 will
remain in full force. We have agreed to either arrange for the
replacement of the letters of credit or to cash collateralize them by
January 9, 2004. The credit agreement will remain in effect until such
time as outstanding letters of credit shall have been drawn upon in
full, expired or otherwise terminate, except for our ability to borrow
or obtain letters of credit and except that compliance with our
financial and certain other covenants has been waived until the
termination date of the credit agreement. We are in the process of
negotiating for an uncommitted line of credit from other banks in a
presently undetermined amount, but there can be no assurance that we
will be able to obtain the line.
We are subject to various covenants under the indenture under which our
senior notes are issued. One of the covenants limits our ability to
borrow funds (except under specifically permitted arrangements, such as
up to $75.0 million of revolving credit loans) unless our consolidated
interest ratio coverage (as defined), after giving pro forma effect to
the interest on the new borrowing, for the four most recently ended
fiscal quarters is at least 2.5 to 1. Another covenant limits our
ability to make "restricted payments," including, among other things,
dividend payments (other than as distributions pursuant to our tax
payment agreement with our shareholders related to Subchapter S
distributions) and investments in, among other things, unrestricted
subsidiaries, to specified amounts determined under a formula contained
in the indenture provided that (except with respect to certain
permitted investments and tax distributions) our interest coverage
ratio is at
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SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
least 2.0 to 1 after giving pro forma effect to the restricted payment.
For the four fiscal quarters ended October 5, 2003, our consolidated
interest coverage ratio was 1.1 to 1. As a result, we are not presently
able to borrow funds (other than the specifically permitted
indebtedness). Additionally, under the formula contained in the
indenture, we cannot make restricted payments, other than certain
permitted investments and tax distributions, until we increase the
restricted payment availability by approximately $18 million, and then
only to the extent of any excess over that amount.
We were in compliance, as of October 5, 2003, with the various
covenants contained in the indenture for our senior notes and our
mortgage.
4. EXECUTIVE EMPLOYMENT AGREEMENT:
On September 8, 2003, we entered into an employment agreement with
Michael O'Donnell, our new President and Chief Executive Officer, which
terminates December 31, 2006. The agreement provides, among other
things, for an annual salary of $450,000; an annual performance bonus
beginning in 2004 to be based upon the achievement of increases in
EBITDA and other objectives to be set forth in business plans and
budgets approved from time to time by our board, which bonus, for the
year ending December 31, 2004, will not be less than $112,500;
$1,000,000 of life insurance; certain relocation, travel and housing
expenses incurred by Mr. O'Donnell; and a special incentive award. The
special incentive award is designed to reward Mr. O'Donnell for
improvements in our adjusted EBITDA, cash position and long term debt
position over the term of the agreement, vests upon termination of Mr.
O'Donnell's employment, is reduced in the event of early termination of
employment and, when earned, is payable, with interest, in twelve equal
quarterly installments. Alternatively, in the event of a public
offering of our common stock, a change in control of Sbarro by merger,
sale of stock or sale of assets, or a liquidation or dissolution of
Sbarro, the special incentive award would be based on the per share
proceeds received by our shareholders in excess of a threshold amount.
The agreement also provides for severance pay in the event of early
termination by us without "cause" (as defined) or by Mr. O'Donnell for
"good reason" (as defined). Since the ultimate amount of the special
incentive award is not known until termination of the agreement, the
special incentive award is subject to variable plan accounting. There
will be no charge to our earnings until our EBITDA, cash position
and/or long-term debt position improves or a special event occurs. No
compensation expense relating to the special incentive award was
recorded in the twelve or forty weeks ended October 5, 2003.
5. INCOME TAXES:
During the forty weeks ended October 5, 2003, we made a Subchapter S
tax distribution to our shareholders, based on our tax basis income for
fiscal 2002, that totaled $1.1 million compared to a $3.1 million of
Subchapter S tax distribution made during the forty weeks ended October
6, 2002 based on our tax basis income for fiscal 2001.
Page 12
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. RELATED PARTY TRANSACTIONS:
On April 6, 2003, loans of $3.23 million to certain of our shareholders
were extended to April 6, 2005. The notes bear interest at 4.63% per
annum.
On March 28, 2003, we extended a loan of $40,000 to Gennaro A. Sbarro,
Corporate Vice President and President of our Franchising and Licensing
Division, to March 28, 2004. The note bears interest at 2.69% per
annum.
Anthony Missano, Corporate Vice President and President of our Quick
Service Division, entered into a note dated June 15, 2003 in our favor
in the amount of $89,687, bearing interest at 2.96%, payable in five
equal annual installments commencing in June 2004, with respect to the
payment of royalties due us for 2001 and 2000 from a former franchisee
that was owned by Mr. Missano's wife, the daughter of Joseph Sbarro.
On March 3, 2003, a company in which Gennaro J. Sbarro, then our
Corporate Vice President and President of our Casual and Fine Dining
Division and the son of Joseph Sbarro, has a 50% interest (the other
50% is owned by an unaffiliated third party) entered into a franchise
agreement with us for a new location. The lease for the location was
entered into in September 2002 by one of our subsidiaries. Subsequent
to that date, we determined that the economics of the location would be
better suited for a franchise operator and, as such, we entered into
the franchise agreement and subleased the premises to this franchisee.
Payments under the sublease will be made directly to the landlord by
the franchisee. The franchise agreement is on terms and conditions
similar to those in other franchise arrangements we have entered into
in similar situations with unrelated third parties. The franchise
agreement provides for the payment of 5% of the location's sales as a
continuing royalty but does not provide for any initial franchise fee.
Future minimum rental payments under the lease for this location over
the term of the lease, which expires in 2018, aggregate approximately
$2.6 million. The location is expected to open in the first quarter of
fiscal 2004. As of October 31, 2003, Gennaro J. Sbarro resigned from
his positions as Corporate Vice - President and President of our Casual
and Fine Dining division. A corporation owned by Mr. Sbarro entered
into an eighteen month agreement to provide consulting services to our
quick service and casual dining division for $22,500 per month as well
as reimbursement for customary and usual expenses that may be incurred.
Mr. Sbarro has entered into a note for $54,538, that is repayable over
the same eighteen month period with no interest, to reimburse Sbarro
for costs advanced by Sbarro in connection with the franchise location.
In October 2003, we sold the assets of three Sbarro-owned locations
separately to each of three of Anthony Sbarro's sons. Two of the
locations, which had no remaining book value, were transferred for no
consideration while the third was sold for $0.3 million, that was paid
in full, and resulted in a gain to Sbarro of approximately $0.1
million. Two of
Page 13
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the locations were marginally profitable in fiscal 2002 while the third
had a small loss during that period. In connection with the sale of the
locations, their employment with Sbarro was terminated and we will
include total severance pay of approximately $60,000 in our fourth
quarter results of operations. The franchise agreements are on terms
and conditions similar to those other franchise arrangements we have
entered into in similar situation with unrelated third parties. The
agreements provide for the payment of 5% of the location's sales as a
continuing royalty but does not provide for any initial franchise fee.
In addition, we subleased two of the locations to two of the
franchisees. The third location is on a month-to-month basis any new
lease entered into by the franchisee will not be guaranteed or
subleased by Sbarro. Payments under the subleases are being made
directly to the landlord by the franchisees. Future minimum rental
payments under the leases for the two locations being subleased over
the terms of the leases, which expire in 2006 and 2016, aggregate
approximately $2.0 million. We will review the fair value of these
lease guarantees in accordance with FIN 45.
7. LITIGATION:
On December 20, 1999, fourteen current and former general managers of
Sbarro restaurants in California amended a complaint against us filed
in the Superior Court of California for Orange County. The complaint
alleges that the plaintiffs were improperly classified as exempt
employees under the California wage and hour law. The plaintiffs are
seeking actual damages, punitive damages and costs of the lawsuit,
including reasonable attorney's fees, each in unspecified amounts.
Plaintiffs filed a motion to certify the lawsuit as a class action, but
the Court denied the motion. The trial was concluded in April 2003, and
the parties have submitted post-trial briefs. The Court has not yet
issued a ruling.
On September 6, 2000, eight other current and former general managers
of Sbarro restaurants in California filed a complaint against us in the
Superior Court of California for Orange County alleging that the
plaintiffs were improperly classified as exempt employees under
California wage and hour law. The plaintiffs are seeking actual
damages, punitive damages and costs of the lawsuit, including
reasonable attorney's fees, each in unspecified amounts. Plaintiffs are
represented by the same counsel who is representing the plaintiffs in
the case discussed in the preceding paragraph. We have separately
settled with four of the plaintiffs in this action for immaterial
amounts. The parties to this case have agreed that it will be settled
upon the same terms and conditions that the court orders in connection
with its decision in the case discussed in the preceding paragraph.
On March 22, 2002, five former general managers of Sbarro restaurants
in California filed a complaint against us in the Superior Court of
California for Los Angeles County. The complaint alleges that the
plaintiffs were illegally required to perform labor services without
proper premium overtime compensation from at least May of 1999. The
plaintiffs
Page 14
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
are seeking actual damages, punitive damages and attorney's fees and
costs, each in unspecified amounts. In addition, plaintiffs have
requested class action status for all managerial employees who worked
overtime and/or were not otherwise paid regular wages due and owing
from May 1999 to present. This case is currently in the discovery
phase.
We believe that we have substantial defenses in each of the actions and
are vigorously defending these actions.
In addition to the above complaints, from time to time, we are a party
to certain claims and legal proceedings in the ordinary course of
business. In our opinion, the results of the complaints and other
claims and legal proceedings are not expected to have a material
adverse effect on our consolidated financial position or results of
operations.
8. PROVISION FOR ASSET IMPAIRMENT
During the third quarter of fiscal 2003, we recorded a $3.0 million for
impairment of property and equipment (based on the net book value of
the property and equipment).
9. GUARANTOR AND NON-GUARANTOR FINANCIAL STATEMENTS:
Certain subsidiaries have guaranteed amounts outstanding under our
senior notes and bank credit agreement. Each of the guaranteeing
subsidiaries is our direct or indirect wholly owned subsidiary and each
has fully and unconditionally guaranteed the senior notes and the
credit agreement on a joint and several basis.
The following condensed consolidating financial information presents:
(1) Condensed consolidating balance sheets as of October 5, 2003
(unaudited) and December 29, 2002 and statements of operations
for the forty and twelve weeks ended October 5, 2003 (unaudited)
and October 6, 2002 (unaudited) and cash flows for the forty
weeks ended October 5, 2003 (unaudited) and October 6, 2002
(unaudited) of (a) Sbarro, Inc., the parent, (b) the guarantor
subsidiaries as a group, (c) the nonguarantor subsidiaries as a
group and (d) Sbarro on a consolidated basis.
(2) Elimination entries necessary to consolidate Sbarro, Inc., the
parent, with the guarantor and nonguarantor subsidiaries.
The principal elimination entries eliminate intercompany balances and
transactions. Investments in subsidiaries are accounted for by the
parent on the cost method.
Page 15
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEET
AS OF OCTOBER 5, 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
Current assets:
Cash and cash equivalents $26,958 $3,302 $789 $31,049
Restricted cash for untendered 21 - - 21
shares
Receivables net of allowance for
doubtful accounts of $488:
Franchise 1,717 - - 1,717
Other 133 822 749 1,704
------ ----- ----- ------
1,850 822 749
3,421
Inventories 1,013 1,156 130q 2,299
Prepaid expenses 6,627 2,119 199 8,945
Current portion of loans receivable
from shareholders 58 - - - 58
------ ----- ----- ------
Total current assets 36,527 7,399 1,867 45,793
Intercompany receivables 6,440 312,612 - $(319,052) -
Investment in subsidiaries 65,469 - - (65,469) -
Property and equipment, net 35,628 59,845 5,212 -
100,685
Intangible assets, net:
Trademarks, net 195,916 - - - 195,916
Goodwill, net 9,324 - - (120) 9,204
Deferred financing costs and other, net 5,565 241 - - 5,806
Loans receivable from shareholders 6,104 - - - 6,104
Other assets 9,472 1,833 (794) (2,357) 8,154
----------- ----------- ---------- --------- --------
$370,445 $381,930 $6,285 $(386,998) $371,662
======== ======== ====== ========== ========
Page 16
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEET
AS OF OCTOBER 5, 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
LIABILITIES AND SHAREHOLDERS' EQUITY
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
Current liabilities:
Amounts due for untendered shares $21 $21
Accounts payable 12,959 $255 $587 13,801
Accrued expenses 12,207 1,379 2,058 15,644
Accrued interest payable 1,708 - - 1,708
Current portion of mortgage payable - 205 - 205
----------- ----------- ---------- --------
Total current liabilities 26,895 1,839 2,645 31,379
Intercompany payables 312,614 2,958 3,480 $(319,052) -
Deferred rent
8,170 - 715 - 8,885
Long-term debt, net of
original issue discount 252,740 15,314 - - 268,054
Shareholders' equity (deficit):
Preferred stock, $1 par value;
authorized 1,000,000 shares; none
issued - - - - -
Common stock, $.01 par value;
authorized 40,000,000 shares;
issued and outstanding 7,064,328
shares 71 - - - 71
Additional paid-in capital 10 65,469 2,477 (67,946) 10
Retained earnings (deficit) (230,055) 296,350 (3,032) - 63,263
----------- ----------- ---------- --------- --------
(229,974) 361,819 (555) (67,946) 63,344
----------- ----------- ---------- --------- --------
$370,445 $381,930 $6,285 $(386,998) $371,662
======== ======== ====== ========== ========
Page 17
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 29, 2002
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
Current assets:
Cash and cash equivalents $47,636 $6,539 $975 $55,150
Restricted cash for untendered
shares 21 - - 21
Receivables net of allowance for
doubtful accounts of $491:
Franchise 2,059 - 2,059
Other 69 1,088 87 1,244
-------- -------- ------- --------
2,128 1,088 87 3,303
Inventories 1,417 1,725 143 3,285
Prepaid expenses 2,677 (342) 27 2,362
Current portion of loans receivable
from shareholders 3,232 - - 3,232
-------- -------- ------- --------
Total current assets 57,111 9,010 1,232 67,353
Intercompany receivables 8,505 313,877 - $(322,382) -
Investment in subsidiaries 65,469 - - (65,469) -
Property and equipment, net 42,762 65,726 6,593 - 115,081
Intangible assets:
Trademarks, net 195,916 - - - 195,916
Goodwill, net 9,324 - - (120) 9,204
Deferred financing costs, net 6,361 271 - - 6,632
Loans receivable from shareholders,
less current portion 2,800 - - - 2,800
Other assets 8,742 1,705 (303) (2,357) 7,787
-------- -------- ------- ---------- --------
$396,990 $390,589 $7,522 $(390,328) $404,773
======== ======== ====== ========= ========
Page 18
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 29, 2002
(IN THOUSANDS, EXCEPT SHARE DATA)
LIABILITIES AND SHAREHOLDERS' EQUITY
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
Current liabilities:
Amounts due for untendered shares $21 $21
Accounts payable 9,503 $212 $564 10,279
Accrued expenses 17,887 1,560 2,176 21,623
Accrued interest payable 8,181 - - 8,181
Current portion of
mortgage payable - 154 - 154
-------- -------- ------ --------
Total current liabilities 35,592 1,926 2,740 40,258
Intercompany payables 313,877 3,308 5,197 $(322,382) -
-------- -------- ------ --------- --------
Deferred rent 7,793 - 681 - 8,474
-------- -------- ------ --------- --------
Long-term debt, net of original issue
discount 252,449 15,492 - - 267,941
-------- -------- ------ --------- --------
Shareholders' equity (deficit):
Preferred stock, $1 par value;
authorized 1,000,000 shares; None
issued - - - - -
Common stock, $.01 par value;
authorized 40,000,000 shares;
issued and outstanding 7,064,328
shares 71 - - - 71
Additional paid-in capital 10 65,469 2,477 (67,946) 10
Retained earnings (deficit) (212,802) 304,394 (3,573) - 88,019
-------- -------- ------ --------- --------
(212,721) 369,863 (1,096) (67,946) 88,100
-------- -------- ------ --------- --------
$396,990 $390,589 $7,522 $(390,328) $404,773
========= ======== ====== ========== ========
Page 19
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE FORTY WEEKS ENDED OCTOBER 5, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
REVENUES:
- ---------
Restaurant sales $98,078 $119,528 $11,257 $228,863
Franchise related revenues 7,625 - - 7,625
Real estate and other 2,170 2,217 61 4,448
Intercompany charges 7,841 - - $(7,841) -
-------- ------- ----- -------- -------
Total revenues 115,714 121,745 11,318 (7,841) 240,936
-------- ------- ----- -------- -------
Cost and expenses:
Restaurant operating expenses:
Cost of food and paper products 20,105 26,180 2,963 - 49,248
Payroll and other employee
Benefits 27,300 35,218 3,839 - 66,357
Other operating costs 39,048 43,682 3,060 - 85,790
Depreciation and amortization 6,727 7,328 765 - 14,820
General and administrative 11,959 8,176 (13) - 20,122
Asset impairment and restaurant
closing charges, net 4,310 - 157 - 4,467
Intercompany charges - 7,841 - (7,841) -
-------- ------- ----- -------- -------
Total costs and expenses 109,449 128,425 10,771 (7,841) 240,804
-------- ------- ----- -------- -------
Operating income (loss) before
minority interest 6,265 (6,680) 547 - 132
Minority interest - - (22) - (22)
-------- ------- ----- -------- -------
Operating income (loss) 6,265 (6,680) 525 - 110
-------- ------- ----- -------- -------
Other (expense) income:
Interest expense (22,810) (1,120) - - (23,930)
Interest income 569 - - - 569
Equity in net income of
unconsolidated affiliates 270 - - - 270
-------- ------- ----- -------- -------
Net other expense (21,971) (1,120) - - (23,091)
-------- ------- ----- -------- -------
(Loss) income before income taxes (15,706) (7,800) 525 - (22,981)
Income tax provision (benefit) 447 244 (16) - 675
-------- ------- ----- -------- -------
Net (loss) income $(16,153) $(8,044) $541 - $(23,656)
========= ======== ==== ======= =========
Page 20
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE FORTY WEEKS ENDED OCTOBER 6, 2002
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
Revenues:
Restaurant sales $106,043 $130,493 $17,918 $254,454
Franchise related revenues 7,636 - - 7,636
Real estate and other 2,115 2,910 - $(691) 4,334
Intercompany charges - 11,091 - (11,091) -
-------- ------- ----- ---------- -------
Total revenues 115,794 144,494 17,918 (11,782) 266,424
-------- ------- ----- ---------- -------
Cost and expenses:
Restaurant operating expenses:
Cost of food and paper products 19,614 25,419 4,831 - 49,864
Payroll and other employee
benefits 28,110 37,233 6,524 - 71,867
Other operating costs 37,388 45,970 5,794 - 89,152
Depreciation and amortization 6,823 8,032 929 - 15,784
General and administrative 9,301 9,028 347 (691) 17,985
Asset impairment and restaurant
closing charges, net 2,770 - 141 - 2,911
Intercompany charges
11,091 - - (11,091) -
-------- ------- ----- ---------- -------
Total costs and expenses 115,097 125,682 18,566 (11,782) 247,563
-------- ------- ----- ---------- -------
Operating income (loss) before minority
interest 697 18,812 (648) - 18,861
Minority interest - - (36) - (36)
-------- ------- ----- ---------- -------
Operating income (loss) 697 18,812 (684) - 18,825
-------- ------- ----- ---------- -------
Other (expense) income:
Interest expense (22,774) (1,131) - - (23,905)
Interest income 390 - - - 390
Equity in net income of
unconsolidated affiliates
692 - - - 692
Insurance recovery, net 7,162 - - 7,162
-------- ------- ----- ---------- -------
Net other expense (14,530) (1,131) - - (15,661)
-------- ------- ----- ---------- -------
(Loss) income before income taxes (13,833) 17,681 (684) - 3,164
Income tax (benefit) provision (1,352) 1,690 (62) - 276
-------- ------- ----- ---------- -------
Net (loss) income $(12,481) $15,991 $(622) $ - $2,888
========= ======== ==== ========== =======
Page 21
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE TWELVE WEEKS ENDED OCTOBER 5, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
REVENUES:
- ---------
Restaurant sales $31,445 $37,267 $3,397 $72,109
Franchise related revenues 2,295 - - 2,295
Real estate and other 682 666 26 1,374
Intercompany charges 2,349 - - $(2,349) -
-------- ------- ----- ---------- -------
Total revenues 36,771 37,933 3,423 (2,349) 75,778
-------- ------- ----- ---------- -------
Cost and expenses:
Restaurant operating expenses:
Cost of food and paper products 6,526 8,267 908 - 15,701
Payroll and other employee
benefits 8,434 10,973 1,123 - 20,530
Other operating costs 12,029 13,302 930 - 26,261
Depreciation and amortization 2,029 2,155 227 - 4,411
General and administrative 3,505 2,470 81 - 6,056
Asset impairment and restaurant
closing charges, net 3,410 - - - 3,410
Intercompany charges - 2,349 - (2,349) -
-------- ------- ----- ---------- -------
Total costs and expenses 35,933 39,516 3,269 (2,349) 76,369
-------- ------- ----- ---------- -------
Operating income (loss) before
minority interest 838 (1,583) 154 - (591)
Minority interest - - (12) - (12)
-------- ------- ----- ---------- -------
Operating income (loss) 838 (1,583) 142 - (603)
-------- ------- ----- ---------- -------
Other (expense) income:
Interest expense (6,832) (335) - - (7,167)
Interest income 158 - - - 158
Equity in net loss of
unconsolidated affiliates (241) - - - (241)
-------- ------- ----- ---------- -------
Net other expense (6,915) (335) - - (7,250)
-------- ------- ----- ---------- -------
(Loss) income before income taxes (6,077) (1,918) 142 - (7,853)
Income tax provision (benefit) 73 30 (2) - 101
-------- ------- ----- ---------- -------
Net (loss) income $(6,150) $(1,948) $144 - $(7,954)
======== ======== ==== ========== =======
Page 22
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE TWELVE WEEKS ENDED OCTOBER 6, 2002
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
Revenues:
Restaurant sales $33,246 $39,588 $5,172 $78,006
Franchise related revenues 2,561 - - 2,561
Real estate and other 651 875 - $(207) 1,319
Intercompany charges - 3,651 - (3,651) -
-------- ------- ----- ---------- -------
Total revenues 36,458 44,114 5,172 (3,858) 81,886
-------- ------- ----- ---------- -------
Cost and expenses:
Restaurant operating expenses:
Cost of food and paper products 6,786 6,733 1,491 - 15,010
Payroll and other employee
benefits 8,018 11,919 1,874 - 21,811
Other operating costs 12,392 12,738 1,645 - 26,775
Depreciation and amortization 1,706 1,875 291 - 3,872
General and administrative 2,604 2,742 147 (207) 5,286
Asset impairment and restaurant
closing charges, net 700 - (18) - 682
Intercompany charges 3,651 - - (3,651) -
-------- ------- ----- ---------- -------
Total costs and expenses 35,857 36,007 5,430 (3,858) 73,436
-------- ------- ----- ---------- -------
Operating income (loss) before minority
Interest 601 8,107 (258) - 8,450
Minority interest - - (3) - (3)
-------- ------- ----- ---------- -------
Operating income (loss) 601 8,107 (261) - 8,447
-------- ------- ----- ---------- -------
Other (expense) income:
Interest expense (6,827) (338) - - (7,165)
Interest income 130 - - - 130
Equity in net income of
unconsolidated affiliates
147 - - - 147
Insurance recovery, net 7,162 - - - 7,162
-------- ------- ----- ---------- -------
Net other income (expense) 612 (338) - - 274
-------- ------- ----- ---------- -------
Income (loss) before income taxes 1,213 7,769 (261) - 8,721
Income tax (benefit) provision (1,209) 1,331 (47) - 75
-------- ------- ----- ---------- -------
Net income (loss) $2,422 $6,438 $(214) $ - $8,646
====== ====== ====== ========== ======
Page 23
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE FORTY WEEKS ENDED OCTOBER 5, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
OPERATING ACTIVITIES:
- ---------------------
Net (loss) income $(16,153) $(8,044) $541 - $(23,656)
Adjustments to reconcile net (loss)
income to net cash (used in)
provided by operating activities:
Depreciation and amortization 8,304 6,872 762 - 15,938
Asset impairment and restaurant
closing charges 5,070 - - - 5,070
Increase (decrease) in deferred rent 230 (33) 35 - 232
Gain on sale of other concept unit - - (200) - (200)
Loss on sale of other concept units
included in prior year asset
impairment costs - - 250 - 250
Minority interest - - 22 - 22
Equity in net income of
unconsolidated affiliates (270) - - - (270)
Dividends received from
unconsolidated affiliates 119 - - - 119
Changes in operating assets and
liabilities:
Decrease (increase) in receivables 149 264 (62) - 351
Decrease in inventories 405 569 13 - 987
Increase in prepaid expenses (3,805) (2,394) (172) - (6,371)
(Increase) decrease in other assets (573) (24) 492 - (105)
Increase (decrease) in accounts
payable and accrued expenses (3,160) 776 (117) - (2,501)
Decrease in accrued interest
payable (6,473) - - - (6,473)
-------- ------- ----- ------- ---------
Net cash (used in) provided by
operating activities (16,157) (2,014) 1,564 - (16,607)
-------- ------- ----- ------- ---------
Investing activities:
- ---------------------
Purchase of property and equipment (4,219) (1,875) (171) - (6,265)
-------- ------- ----- ------- ---------
Net cash used in investing activities (4,219) (1,875) (171) - (6,265)
-------- ------- ----- ------- ---------
Page 24
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE FORTY WEEKS ENDED OCTOBER 5, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
FINANCING ACTIVITIES:
- ---------------------
Mortgage principal repayments - (128) - - (128)
Tax distribution (1,101) - - - (1,101)
Intercompany balances 799 780 (1,579) - -
-------- --------- ------- ------- --------
Net cash (used in) provided by
financing activities (302) 652 (1,579) - (1,229)
-------- --------- ------- ------- --------
Decrease in cash and
cash equivalents (20,678) (3,237) (186) - (24,101)
Cash and cash equivalents at
beginning of period 47,636 6,539 975 - 55,150
-------- --------- ------- ------- --------
Cash and cash equivalents at
end of period $26,958 $3,302 $789 - $31 049
======== ========= ======= ========
Supplemental disclosure of cash flow
Information:
Cash paid during the period for
income taxes $280 $85 $13 $ - $378
======== ========= ======= ======= ========
Cash paid during the period for
Interest $28,159 $1,091 $ - $ - $29,250
======== ========= ======= ======= ========
Page 25
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE FORTY WEEKS ENDED OCTOBER 6, 2002
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
OPERATING ACTIVITIES: PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
- --------------------- ------ ------------ ------------ ------------ -----
Net (loss) income $(12,481) $15,991 $(622) $2,888
Adjustments to reconcile net (loss)
income to net cash (used in)
provided by operating activities:
Depreciation and amortization 7,816 8,194 929 16,939
Provision for restaurant closings 2,046 - - 2,046
Increase in deferred rent, net 495 (120) 28 403
Minority interest - - 36 36
Equity in income of
unconsolidated affiliates (692) - - (692)
Dividends received from
unconcolidated affiliates 311 - - 311
Changes in operating assets
and liabilities:
Decrease (increase) in receivables 1,355 (425) (49) 881
Decrease (increase) in inventories 328 383 30 741
Increase in prepaid assets (4,707) (2,398) (402) (7,507)
(Increase) decrease in other
assets (406) 262 83 $(120) (181)
(Decrease) increase in accounts
payable and accrued expenses (3,149) (1,027) (1,956) 120 (6,012)
Decrease in accrued interest
payable (6,473) - - - (6,473)
------- ------- ------- ------ -------
Net cash (used in) provided by
operating activities (15,557) 20,860 (1,923) - 3,380
-------- ------- ------- ------ -------
Investing activities:
Purchases of property and equipment (4,795) (1,629) (187) - (6,611)
------- ------- ------- ------ -------
Net cash used in investing activities (4,795) (1,629) (187) - (6,611)
------- ------- ------- ------ -------
Page 26
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE FORTY ENDED OCTOBER 6, 2002
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------ ------------ ------------ ------------ -----
Financing activities:
- ---------------------
Mortgage principal repayments - (117) - - (117)
Distributions to shareholders (3,125) - - - (3,125)
Intercompany balances 18,643 (19,728) 1,085 - -
------ ------- ----- ------ -------
Net cash provided by
(used in) financing activities 15,518 (19,845) 1,085 - (3,242)
------ ------- ----- ------ -------
Decrease in cash and
cash equivalents (4,834) (614) (1,025) - (6,473)
Cash and cash equivalents at
beginning of period 29,673 5,437 1,842 - 36,952
------ ------- ----- ------ -------
Cash and cash equivalents at
end of period $24,839 $4,823 $817 $ - $30,479
======= ======= ===== ======= ========
Supplemental disclosure of cash flow
information:
Cash paid during the period for
income taxes $375 $250 $ 1 $ - $626
======= ======= ===== ======= ========
Cash paid during the period for $28,139 $1,108 $ - $ - $29,247
interest ======= ======= ===== ======= ========
Page 27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
The following table provides information concerning the number of Company-owned
and franchised restaurants in operation during each indicated period:
40 WEEKS 40 WEEKS 12 WEEKS 12 WEEKS FISCAL YEAR
ENDED ENDED ENDED ENDED --------------
10/05/03 10/06/02 10/05/03 10/06/02 2002 2001
-------- -------- -------- -------- ---- ----
Sbarro-owned restaurants:
Opened during period 3 8 2 5 13 9
Acquired from (sold to)
franchisees during period-net (7) (4) (1) (3) (6) -
Closed during period (19) (41) (3) (22) (51) (43)
--- --- --- --- --- ---
Open at end of period (1) 535 565 535 565 558 602
Franchised restaurants:
Opened during period 25 28 3 13 42 42
Purchased from (sold to)
Sbarro during period-net 7 4 1 3 6 -
Closed or terminated during
period (15) (18) (2) (5) (20) (20)
--- --- --- --- --- ---
Open at end of period 370 339 370 339 353 325
All restaurants:
Opened during period 28 36 5 18 55 51
Closed or terminated during
period (34) (59) (5) (27) (71) (63)
--- --- --- --- --- ---
Open at end of period (1) 905 904 905 904 911 927
Kiosks (all franchised) open at
end of period 3 4 3 4 3 4
- ------------------------------------
(1) Excludes 31, 34, 32 and 37 other concept units as of October 5, 2003 and
October 6, 2002, the end of fiscal 2002 and the end of fiscal 2001,
respectively.
Page 28
Our business is subject to seasonal fluctuations, the effect of weather and
economic conditions. Earnings have been highest in our fourth fiscal quarter due
primarily to increased volume in shopping malls during the holiday shopping
season but fluctuates due to the length of the holiday shopping period between
Thanksgiving and New Year's Day and the number of weeks in our fourth quarter.
In recent years, our fourth quarter income has also been significantly effected
due to a number of additional factors, including the adverse effect of the
general economic downturn, the continuing effect of the events of September 11,
2001 and significant year-end adjustments relating to asset impairment and store
closing costs. Due to the seasonality of our business, we perform the annual
testing for impairment on our trademarks and goodwill as required by SFAS 142
after our fourth quarter is completed and more information is available to us.
The evaluation of impairment of long-lived assets, as required by SFAS 144, is
also made when events or circumstances indicate that the carrying amount of the
assets may not be recoverable and considers many factors, in addition to
seasonality. If impairment factors are present earlier than year-end, we record
any adjustments as determined necessary through interim testing at that time.
During the third quarter of fiscal 2003, a review of the impairment factors
determined that the carrying amount of certain store assets may not be
recoverable through the estimated undiscounted future cash flows resulting from
the use of those assets and an asset impairment charge of $3.0 million was
recorded in the twelve and forty weeks periods ended October 5, 2003.
Our consolidated EBITDA for the forty weeks ended October 5, 2003 was $15.2
million compared to $42.5 million for the forty weeks ended October 6, 2002. Our
consolidated EBITDA for the twelve weeks ended October 5, 2003 was $3.6 million
compared to $19.6 million for the twelve weeks ended October 6, 2002. EBITDA for
the forty and twelve weeks ended October 6, 2002 included an insurance recovery
of $7.2 million, net, relating to the events of September 11, 2001. Excluding
this item, EBITDA for the forty and twelve weeks ended October 6, 2002 was $35.3
million and $12.5 million, respectively. EBITDA represents earnings before
interest income, interest expense, taxes, depreciation and amortization. EBITDA
should not be considered in isolation from, or as a substitute for, net income,
cash flow from operations or other cash flow statement data prepared in
accordance with generally accepted accounting principles ("GAAP") in the United
States or as a measure of a company's profitability or liquidity. Rather, we
believe that EBITDA provides relevant and useful information for analysts and
investors in our senior notes in that EBITDA is one of the factors in the
calculation of our compliance with the ratios in the indenture under which our
senior notes are issued. We also internally use EBITDA as one of the measures to
determine whether to continue or close restaurant units since it provides us
with a measurement of whether we are receiving an adequate cash return on our
cash investment. Our calculation of EBITDA may not be comparable to a similarly
titled measure reported by other companies, since all companies do not calculate
this non-GAAP measure in the same manner. Our EBITDA calculations are not
intended to represent cash provided by (used in) operating activities since they
do not include interest and taxes and changes in operating assets and
liabilities, nor are they intended to represent a net increase in cash since
they do not include cash provided by (used in) investing and financing
activities. The following table reconciles EBITDA to our net loss, which we
believe is the most direct comparable financial measure to EBITDA, for each of
the forty and twelve week periods presented (in thousands):
Page 29
Forty weeks ended: Twelve weeks ended:
10/05/03 10/06/02 10/05/03 10/06/02
-------- -------- -------- --------
EBITDA $15,200 $42,463 $3,567 $19,628
Interest expense (23,930) (23,905) (7,167) (7,165)
Interest income 569 390 158 130
Income taxes (675) (276) (101) (75)
Depreciation and amortization (14,820) (15,784) (4,411) (3,872)
-------- -------- ------- -------
Net (loss) income $(23,656) $2,888 $(7,954) $8,646
========= ====== ======== ======
Restaurant sales by Sbarro-owned quick service units and consolidated other
concept units decreased 10.1% to $228.9 million for the forty weeks ended
October 5, 2003 from $254.5 million in the forty weeks ended October 6, 2002 and
decreased 7.6% to $72.1 million for the twelve weeks ended October 5, 2003 from
$78.0 million in the twelve weeks ended October 6, 2002.
The decrease in sales for the forty weeks ended October 5, 2003 reflects $18.9
million (8.0%) of lower sales of Sbarro quick service units and $6.7 million
(37.2%) of lower sales of consolidated other concept units. The decrease in
sales for the twelve weeks ended October 5, 2003 reflects $4.1 million (5.7%) of
lower sales of Sbarro quick service units and $1.8 million (34.3%) of lower
sales of consolidated other concept units. Declines in comparable sales of $10.3
million (4.6% to $211.4 million) in the forty week and $1.6 million (2.4% to
$67.3 million) in the twelve week periods of fiscal 2003 from the comparable
periods in fiscal 2002 was the primary reason for the decline in quick service
restaurant sales. We believe that these declines were attributable to a
reduction in shopping mall traffic related to the general economic downturn in
the United States and, additionally with respect to the forty week period, the
effects of the threatened and then actual military action in Iraq during the
first quarter of fiscal 2003. Comparable restaurant sales are made up of sales
at locations that were open during the entire current and prior fiscal years.
Since the end of fiscal 2001, we closed 67 (including 23 units closed, net of
openings during the first forty weeks of fiscal 2003) more units than we opened,
causing the remaining $8.6 and $2.5 million net reduction in Sbarro quick
service unit sales for the forty and twelve weeks ended October 5, 2003,
respectively. The units closed since the end of fiscal 2001 were generally low
volume units that did not have a material impact on our results of operations.
Of the decline in consolidated other concept unit sales, for the forty weeks
ended October 5, 2003, approximately $0.6 million resulted from a 5.3% decrease
in comparable unit sales to $11.1 million. For the twelve-week period ended
October 5, 2003, there was a $0.1 million or 3.9% decrease in comparable
consolidated other concept unit sales to $3.4 million. We believe that these
declines were attributable to the same factors that affected Sbarro quick
service locations. In addition, since the end of fiscal 2001, eight consolidated
other concept units have been closed, resulting in a net sales reduction from
sales at those locations of $6.1 million for the
Page 30
forty weeks ended October 5, 2003 and $1.7 million for the twelve weeks ended
October 5, 2003. These units were either unprofitable or marginally profitable
and were part of ventures that we determined to discontinue.
Franchise related revenues was nominally ($11,000) lower in the reported forty
week period and $0.3 million (10.3%) lower in the twelve week period of fiscal
2003 than in fiscal 2002 because of an accrual for a potential need to refund
certain royalty payments previously made to us by our Russian franchisee.
Excluding the effect of this $0.2 million accrual, franchise related revenues
increased by approximately $0.2 million (2.8%) to $7.8 million for the forty
weeks ended October 5, 2003 despite a $0.1 million (1.7%) decrease to $2.5
million for the twelve weeks ended October 5, 2003, in each case from the
comparable period ended October 6, 2002. Initial and ongoing royalties earned
from locations opened during fiscal 2003 and 2002 were offset, in part, by 3.8%
and 0.5% reductions in comparable unit sales at both domestic and international
locations in the forty and twelve weeks periods ended October 5, 2003,
respectively, from the comparable period ended October 6, 2002. During the
twelve weeks ended October 5, 2003, our Russian franchisee advised us that sales
and other income taxes that were remitted to their local government were
erroneously included in their previously reported sales upon which its ongoing
royalty fees were calculated. Subject to final confirmation and review, we have
reduced our royalty revenues by approximately $0.2 million for this potential
overpayment for the twelve and forty week periods ended October 5, 2003.
Real estate and other revenues were relatively unchanged for both the forty and
twelve weeks periods ended October 5, 2003 from the respective periods ended
October 6, 2002.
Cost of food and paper products as a percentage of restaurant sales increased to
21.5% for the forty weeks ended October 5, 2003 from 19.6% for the comparable
2002 fiscal period and to 21.8% for the twelve weeks ended October 5, 2003 from
19.2% for the same twelve weeks in fiscal 2002. The cost of sales percentage in
both the forty and twelve week periods of fiscal 2003 were negatively impacted
by the decrease in comparable unit sales. In addition, without changing the
effect on the final product, we modified our pizza and pasta sauce recipes to
utilize ready made sauce instead of crushed tomatoes as the base raw material to
facilitate the consistency in product in each restaurant unit and reduce labor
needed to prepare our products. We estimate that this has added approximately
3/4 of 1 percentage point to our cost of food. The increase in cheese prices
that began at the end of the second quarter resulted in significantly higher
cheese costs in the third quarter of fiscal 2003 compared to the similar period
in fiscal 2002 causing a 1.2% and 0.4% increase in cost of sales for the twelve
and forty week periods, respectively, ended October 5, 2003. Cheese prices to
date in the fourth quarter of fiscal 2003 have moderated somewhat but continue
to be approximately 40% higher than the comparable time in fiscal 2002. In early
fiscal 2003, we replaced our then national independent wholesale distributor,
which declared bankruptcy, with another national independent wholesale
distributor. There has not been a material impact on the cost of food and paper
products from this new distribution arrangement as the majority of the products
used in our restaurants are proprietary and we are involved in negotiating their
cost to the wholesaler. However, the cost of sales
Page 31
percentage in the first quarter of 2003, effecting the forty week period (but
not a factor in the increase in cost of sales in the second or third quarters)
of fiscal 2003 was impacted by the cost of purchases of product from third
parties until the new distribution contract was effective.
Payroll and other employee benefits decreased by $5.5 million but as a
percentage of restaurant sales, increased to 29.0% in the forty weeks ended
October 5, 2003 from 28.2% of restaurant sales in the forty weeks ended October
6, 2002. For the twelve week period ended October 5, 2003, these costs decreased
by $1.3 million but increased to 28.5% from 28.0% as a percentage of restaurant
sales when compared to the comparable twelve week period in fiscal 2002. The
dollar decrease was primarily due to fewer units in operation while the
percentage of sales increase was due to the reduction in comparable unit sales.
Other operating expenses decreased by $3.4 million but increased to 37.5% of
restaurant sales in the forty weeks ended October 5, 2003 from 35.0% in the
forty weeks ended October 6, 2002. These expenses decreased $0.5 million but
increased to 36.4% from 34.3% of restaurant sales in the twelve weeks ended
October 5, 2003 and October 6, 2002, respectively. The lower dollar level of
other operating expenses resulted primarily from the fewer number of units in
operation. The increases as a percentage of restaurant sales were primarily due
to increases in rent and other occupancy related expenses resulting from the
renewal of existing leases at the end of their terms at higher rental rates,
compounded by the reduced level of sales. In addition, we are continuing to
experience increases in our repair and maintenance costs due to the number of
years that the majority of our locations have been operating and the effects of
the long-term utilization on their equipment.
Depreciation and amortization expense decreased by $1.0 million and increased by
$0.5 million for the forty and twelve weeks, respectively, of fiscal 2003 from
the comparable periods in fiscal 2002. The reductions were due to fewer numbers
of units in operation in fiscal 2003 ($1.0 million and $0.4 million,
respectively), the absence in 2003 of depreciation of locations that had been
included in the provision for asset impairment in fiscal 2002 as a result of
which, no depreciation was taken on these units in fiscal 2003 and for locations
that became fully depreciated during fiscal 2002. These reductions were offset,
in part, primarily by depreciation of our upgraded computer system in 2003 and
included a correction of $0.3 million due to a calculation error reflected in
the third quarter of fiscal 2002.
General and administrative expenses were $20.1 million, or 8.4% of total
revenues, for the forty weeks ended October 5, 2003, compared to $18.0 million,
or 6.8% of total revenues, for the forty weeks ended October 6, 2002. Those
costs were $6.1 million, or 8.0% of total revenues, for the twelve weeks ended
October 5, 2003, as compared to $5.3 million, or 6.5% of total revenues, for the
twelve weeks ended October 6, 2002. The principal factors contributing to the
increases in the forty week period were $0.2 million of legal fees incurred in
connection with a lawsuit, a $0.2 million allowance for doubtful accounts
receivable recorded with respect to our franchisee in Spain that declared
bankruptcy and bonuses of $0.7 million that were granted to certain executive
officers, all in the first fiscal quarter of 2003, a $0.2 million allowance
against the collectibility of
Page 32
amounts owed by our Israeli franchisee and $0.2 million of costs and expenses
related to the hiring of our new President and Chief Executive Officer during
the third fiscal quarter and higher quick-service field management travel and
related costs.
During the forty weeks ended October 5, 2003, we recorded a provision for asset
impairment and for restaurant closing charges of $4.5 million. For the same
forty week period ended October 6, 2002, we recorded a provision for restaurant
closing charges of $2.9 million. The similar provisions for the twelve-week
periods ended October 5, 2003 and October 6, 2002 were $3.4 million and $0.7
million, respectively. The provisions include a charge for asset impairment of
$3.0 million in the forty and twelve weeks ended October 5, 2003 that resulted
from our evaluation of impairment indicators which determined that the carrying
amount of certain store assets may not be recoverable through the estimated
undiscounted future cash flows resulting from the use of those assets. The
remaining portion of the fiscal 2003 provision related to charges for closed
locations. The provisions in fiscal 2002 related, for the most part, to the
planned closing of up to thirty low volume, unprofitable Sbarro quick service
locations during the third and fourth quarter of fiscal 2002, for which the
provision was recorded primarily in the second quarter of fiscal 2002.
Minority interest represents the share of the minority holders' interests in the
earnings or loss of a joint venture in which we have a majority interest. In
early fiscal 2002, we closed one of the two locations owned by this joint
venture. The closed unit had a nominal operating loss in the first quarter of
fiscal 2002.
Interest expense of $23.9 million and $7.2 million for each of the forty weeks
and twelve weeks, respectively, ended October 5, 2003 and October 6, 2002,
relates to the 11%, $255.0 million senior notes we issued to finance our going
private transaction in September 1999 ($21.6 million and $6.5 million in both
the forty and twelve weeks of fiscal 2003 and 2002), the 8.4%, $16.0 million
mortgage loan on our corporate headquarters in 2001 ($1.1 million and $0.3
million in the respective periods) and fees for unused borrowing capacity under
our credit agreement that we terminated in the fourth quarter of fiscal 2003
($0.1 million in the respective periods). In addition, $0.7 million and $0.4
million in the forty weeks and twelve weeks, respectively, of fiscal 2003 and
2002 represents non-cash charges for the accretion of the original issue
discount on our senior notes and the amortization of deferred financing costs on
the senior notes, credit agreement and the mortgage loan.
Interest income for the forty week period ended October 5, 2003 was $0.6 million
versus $0.4 million for the forty week period ended October 6, 2002. Interest
income was $0.2 million and $0.1 million for the third quarter of fiscal 2003
and 2002, respectively. Higher average cash available for investment in each
period presented in fiscal 2003 compared to the similar periods in fiscal 2002
was partially offset by the lower prevailing interest rates in effect. The
indenture under which our senior notes are issued limits the types of
investments which we may make. In addition, we earned approximately $0.05
million of interest income that was included in an
Page 33
income tax refund received in the second quarter of fiscal 2003 related to a
year in which we were a Subchapter C corporation.
Equity in the net income (loss) of unconsolidated affiliates represents our
proportionate share of earnings and losses in those other concepts in which we
have a 50% or less ownership interest. Included in our equity in the net loss of
unconsolidated affiliates in the third quarter of fiscal 2003 was our
proportionate share ($0.5 million) of the losses from the sale of our Vincent's
Clam Bar location and one of our steakhouse joint venture locations. These
losses were offsets against our equity in the net operational net income of
unconsolidated affiliates of approximately $0.8 million and $0.3 million in for
the forty and twelve weeks ended October 5, 2003, respectively, compared to $0.7
million and $0.1 million, respectively, in our equity for the same periods
ending October 6, 2002. We have determined that we will continue, to the extent
agreed with our joint venture partners, to develop and expand the steakhouse
joint venture locations but do not intend to expand our other joint venture
operations.
The insurance recovery credit to our earnings for the forty and twelve weeks
ended October 6, 2002 of $7.2 million represents the settlement, net of related
expenses, to reimburse us for the lost income under our business interruption
insurance coverage related to the events of September 11, 2001.
We have elected to be taxed under the provisions of Subchapter S of the Internal
Revenue Code and, where applicable and permitted, under similar state and local
income tax provisions beginning January 3, 2000. Under the provisions of
Subchapter S, substantially all taxes on our income are paid by our shareholders
rather than us. Our tax expense was $0.7 million and $0.3 million for the forty
week periods, and $0.1 million and $0.1 million for the twelve-week periods,
ended October 5, 2003 and October 6, 2002, respectively. The expense was for
taxes owed by us (rather than our shareholders) to jurisdictions that do not
recognize S corporation status or that tax entities based on factors other than
income.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
We have historically not required significant working capital to fund our
existing operations and have financed our capital expenditures and investments
in our joint ventures through cash generated from operations. At October 5,
2003, we had unrestricted cash and cash equivalents of $31.0 million and working
capital of $14.4 million compared to unrestricted cash and cash equivalents of
$30.5 million and working capital of $19.5 million at October 6, 2002.
Net cash used in operating activities was $16.6 million for the forty weeks
ended October 5, 2003 compared to $3.4 million provided by operating activities
during the forty weeks ended October 6, 2002. The $20.0 million change resulted
primarily from a $26.7 million change (from a profit of $2.9 million in the
fiscal 2002 period to a loss of $23.7 million in the fiscal 2003 period) in our
results of operations. This change was reduced, in part, by an increase in
non-cash expenses in the fiscal 2003 period from the fiscal 2002 period, with a
$3.0 million charge for
Page 34
asset impairment in fiscal 2003 being offset, in part, by a $1.0 million
reduction in depreciation and amortization. Also, less cash was used during the
fiscal 2003 period than the fiscal 2002 period to support changes in operating
assets and liabilities, primarily as a result of an increase (a decrease of $2.5
million in fiscal 2003, compared to a $6.0 million decrease in fiscal 2002) in
accounts payable and accrued expenses and a $1.1 million lower increase in
fiscal 2003 in prepaid expenses (the prepaid balances at the end of the third
fiscal quarters of both 2003 and 2002 being similar). Of the increase in
accounts payable, approximately $2.6 million relates to the amount accrued for,
but unpaid to, our bankrupt former national independent wholesale distributor.
We are in negotiations with its creditors' committee with regard to the amount,
if any, owed as we incurred significant additional costs after the bankruptcy
filing date due to the bankruptcy. In addition, there was a decrease of $0.2
million in the dividend received from our unconsolidated affiliate.
Net cash used in investing activities has historically been primarily for
capital expenditures, including investments made by our consolidated other
concepts. Net cash used in investing activities decreased from $6.6 million for
the forty weeks ended October 6, 2002 to $6.3 million for the forty weeks ended
October 5, 2003. Investing activities in the forty weeks ended October 5, 2003
reflect higher remodel activity than during the forty weeks ended October 6,
2002. These investing activities also include $1.0 million and $1.3 million,
respectively, paid as part of previously committed costs of $2.9 million
relating to an upgrade of our computer systems.
Net cash used in financing activities was $1.2 million for the twenty-eight
weeks ended July 13, 2003 compared to $3.2 million in the comparable 2002 period
The reduction was due to a $2.0 million decrease in tax distributions to
shareholders.
We incur annual cash interest expense of approximately $29.7 million under our
senior notes and mortgage loan and may incur additional interest expense for
borrowings that may be made if we are able to secure an uncommitted line of
credit to replace the credit agreement that we terminated. In addition to debt
service, we expect that our other liquidity needs will relate to capital
expenditures, working capital, investments in other ventures, distributions to
shareholders (to the extent permitted under the indenture for the senior notes)
and for general corporate purposes. We anticipate that aggregate restaurant
capital expenditures and our investments in joint ventures during the next
twelve months will approximate the fiscal 2002 levels.
We expect our primary sources of liquidity to meet these needs will be our
existing cash and cash flow from operations.
Our credit agreement required that we maintain a minimum ratio of consolidated
earnings before interest, taxes and depreciation and amortization ("EBITDA") to
consolidated interest expense and a maximum ratio of consolidated senior debt to
consolidated EBITDA. We have not been in compliance with the required ratios, as
amended, during 2003. Our bank waived compliance with these covenants but we
would not have been able to borrower under this arrangement. We requested, and
the bank agreed, to terminate the bank's lending commitment. We had not made
Page 35
any borrowings under the line of credit since its inception, except for a
required one day borrowing upon the activation of the credit agreement and
except with respect to letters of credit that have been issued by the bank under
the sublimit of the line. The termination of the bank's lending commitment
eliminates our obligation to pay a commitment fee on the unused portion of the
facility. Our obligations under the credit agreement to reimburse the bank with
respect to any drawings that may be made under the approximately $1.7 million of
letters of credit that are outstanding as of November 19, 2003 will remain in
full force. We have agreed to either arrange for the replacement of the letters
of credit or to cash collateralize them by January 9, 2004. The credit agreement
will remain in effect until such time as outstanding letters of credit shall
have been drawn upon in full, expired or otherwise terminate, except for our
ability to borrow or obtain letters of credit and except that compliance with
our financial and certain other covenants has been waived until the termination
date of the credit agreement. We are in the process of negotiating for an
uncommitted line of credit from other banks in a presently undetermined amount,
but there can be no assurance that we will be able to obtain the line.
We are subject to various covenants under the indenture under which our senior
notes are issued. One of the covenants limits our ability to borrow funds
(except under specifically permitted arrangements, such as up to $75.0 million
of revolving credit loans) unless our consolidated interest ratio coverage (as
defined), after giving pro forma effect to the interest on the new borrowing,
for the four most recently ended fiscal quarters is at least 2.5 to 1. Another
covenant limits our ability to make "restricted payments," including, among
other things, dividend payments (other than as distributions pursuant to our tax
payment agreement with our shareholders related to Subchapter S distributions)
and investments in, among other things, unrestricted subsidiaries, to specified
amounts determined under a formula contained in the indenture provided (except
with respect to certain permitted investments and tax distributions) that our
interest coverage ratio is at least 2.0 to 1 after giving pro forma effect to
the restricted payment. For the four fiscal quarters ended October 5, 2003, our
consolidated interest coverage ratio was 1.1 to 1. As a result, we are not
presently able to borrow funds (other than the specifically permitted
indebtedness). Additionally, under the formula contained in the indenture, we
cannot make restricted payments other than certain permitted investments and tax
distributions until we increase the restricted payment availability by
approximately $16 million, and then only to the extent of any excess over that
amount.
The Tax Payment Agreement was entered into as part of our election that our
shareholders, rather than us, be taxed on our taxable income pursuant to
Subchapter S of the Internal Revenue Code and, where applicable and permitted,
under similar state and local tax provisions. The Tax Payment Agreement permits
us, regardless of whether we can make restricted payments, to make periodic tax
distributions to our shareholders in amounts intended to approximate the income
taxes, including estimated taxes, that would be payable by them if their only
income were their pro rata share of our taxable income and that income was taxed
at the highest applicable Federal and New York state marginal income tax rates.
Page 36
OFF-BALANCE SHEET FINANCING
- ---------------------------
The Company has no off-balance sheet contractual arrangements, as that term is
defined in Item 304(a)(4) of Regulation S-K.
CONTRACTUAL OBLIGATIONS
- -----------------------
Our contractual obligations arrangements with respect to both our Sbarro quick
service and our other concepts (both those in which we have a majority or
minority interest) do not differ materially from the information disclosed in
Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended
December 29, 2002.
CRITICAL ACCOUNTING POLICIES AND JUDGMENTS
- ------------------------------------------
Accounting policies are an integral part of the preparation of our financial
statements in accordance with accounting principles generally accepted in the
United States of America. Understanding these policies, therefore, is a key
factor in understanding our reported results of operations and financial
position. Certain critical accounting policies require us to make estimates and
assumptions that affect the amounts of assets, liabilities, revenues and
expenses reported in the financial statements. Due to their nature, estimates
involve judgments based upon available information. Therefore, actual results or
amounts could differ from estimates and the difference could have a material
impact on our consolidated financial statements. During the forty weeks ended
October 5, 2003, there have been no material changes in the accounting policies
whose application may have a significant effect on our reported results of
operations and financial position and that can require judgments by management
that can affect their application from the matters discussed under the heading
"Critical Accounting Policies and Judgments" in Part II, Item 7 of our Annual
Report on Form 10-K for the fiscal year ended December 29, 2002.
FORWARD LOOKING STATEMENTS
- --------------------------
This report contains certain forward-looking statements about our financial
condition, results of operations, future prospects and business. These
statements appear in a number of places in the report and include statements
regarding our intent, belief, expectation, strategies or projections at that
time. These statements generally contain words such as "may," "should," "seeks,"
"believes," "in our opinion," "expects," "intends," "plans," "estimates,"
"projects," "strategy" and similar expressions or the negative of those words.
Forward-looking statements are subject to a number of known and unknown risks
and uncertainties that could cause actual results to differ materially from
those projected, expressed or implied in the forward-looking statements. These
risks and uncertainties, many of which are not within our control, include but
are not limited to:
o general economic, weather and business conditions;
Page 37
o the availability of suitable restaurant sites in appropriate regional
shopping malls and other locations on reasonable rental terms;
o changes in consumer tastes;
o changes in population and traffic patterns, including the effect that
military action and terrorism or other events may have on the willingness
of consumers to frequent shopping malls, airports or downtown areas that
are the predominant areas in which our restaurants are located;
o our ability to continue to attract franchisees;
o the success of our present, and any future, joint ventures and other
expansion opportunities;
o the availability of food (particularly cheese and tomatoes) and paper
products at current prices;
o our ability to pass along cost increases to our customers;
o no material increase occurring in the Federal minimum wage;
o the continuity of services of members of our senior management team;
o our ability to attract and retain competent restaurant and executive
managerial personnel;
o competition;
o the level of, and our ability to comply with, government regulations;
o our ability to generate sufficient cash flow to make interest payments and
principal under our senior notes;
o our ability to obtain a bank line of credit that would enable us to meet
any unanticipated operational needs;
o our ability to comply with covenants contained in the indenture under which
the senior notes are issued, and the effects which the restrictions imposed
by those covenants may have on our ability to operate our business; and
o our ability to repurchase senior notes to the extent required in the event
we make certain asset sales or experience a change of control.
You are cautioned not to place undue reliance on these statements, which speak
only as of the date of the report. We do not undertake any responsibility to
release publicly any revisions to these forward-looking statements to take into
account events or circumstances that occur after the date of this report.
Additionally, we do not undertake any responsibility to update you on the
occurrence of any unanticipated events which may cause actual results to differ
from those expressed or implied by the forward-looking statements contained in
this report.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES OF MARKET RISK
We have historically invested our cash on hand in short term, fixed rate, highly
rated and highly liquid instruments which are reinvested when they mature
throughout the year. The indenture under which our senior notes are issued
limits the investments we may make. Although our existing investments are not
considered at risk with respect to changes in interest rates or markets for
these instruments, our rate of return on short-term investments could be
affected at the time of reinvestment as a result of intervening events.
Page 38
Future borrowings under any line of credit we may be able to obtain is likely to
be at rates that float with the market and, therefore, will be subject to
fluctuations in interest rates. Our $255.0 million senior notes bear a fixed
interest rate of 11.0%. We are not a party to, and do not expect to enter into
any interest rate swaps or other instruments to hedge interest rates.
We have not, and do not expect to, purchase future, forward, option or other
instruments to hedge against fluctuations in the prices of the commodities we
purchase. As a result, our future commodities purchases are subject to changes
in the prices of such commodities.
All of our transactions with foreign franchisees have been denominated in, and
all payments have been made in, United States dollars, reducing the risks
attendant in changes in the values of foreign currencies. As a result, we have
not purchased future contracts, options or other instruments to hedge against
changes in values of foreign currencies.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, our management, with the
participation of our President and Chief Executive Officer and our Vice
President, Controller and principal accounting officer (the person presently
performing the function of our principal financial officer), evaluated the
effectiveness of our "disclosure controls and procedures," as defined in Rule
15d-15(e) under the Securities Exchange Act of 1934. Based on that evaluation,
these officers concluded that, as of the date of their evaluation, our
disclosure controls and procedures were effective to provide reasonable
assurance that information required to be disclosed in our periodic filings
under the Exchange Act is accumulated and communicated to our management,
including those officers, to allow timely decisions regarding required
disclosure.
During the period covered by this report, there were no changes in our internal
control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
Page 39
PART II. OTHER INFORMATION
--------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits:
31.01 Certification of Principal Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.02 Certification of Vice President, Controller and Principal Accounting
Officer, the person performing the function of our principal financial
officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.01 Certification of Principal Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.02 Certification of Vice President, Controller and Principal Accounting
Officer, the person performing the function of our principal financial
officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
A Report on Form 8-K was filed by Sbarro dated (date of earliest event
reported) September 8, 2003, reporting under Item 5, Other Events, and
Item 7, Financial Statements and Exhibits. No financial statements were
filed with that Report.
Page 40
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
SBARRO, INC.
---------------------------------------------
Registrant
Date: November 19, 2003 By: /s/ MICHAEL O'DONNELL
----------------- -----------------------------------------
Michael O'Donnell
President and Chief Executive Officer
(Principal Executive Officer)
Date: November 19, 2003 By: /s/ STEVEN B. GRAHAM
----------------- ----------------------------------------
Steven B. Graham
Vice President and Controller (Principal
Accounting Officer)
Page 41
EXHIBIT INDEX
-------------
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
31.01 Certification of Principal Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.02 Certification of Vice President, Controller and Principal Accounting
Officer, the person performing the function of our principal financial
officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.01 Certification of Principal Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.02 Certification of Vice President, Controller, Principal Accounting
Officer, the person performing the function of our principal financial
officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Page 42