==============================================================================
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 April 18, 2004 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 11747-4714
(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
----------- -----------
The number of shares of Common Stock of the registrant outstanding as of May 17,
2004 was 7,064,328.
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SBARRO, INC.
FORM 10-Q INDEX
PART I. FINANCIAL INFORMATION PAGES
--------------------- -----
Consolidated Financial Statements:
Balance Sheets - April 18, 2004 (unaudited) and December 28, 2003..............................3-4
Statements of Operations (unaudited) - Sixteen Weeks ended April 18, 2004
and April 20, 2003...........................................................................5
Statements of Cash Flows (unaudited) - Sixteen Weeks ended April 18, 2004 and
April 20, 2003............................................................................6-7
Notes to Unaudited Consolidated Financial Statements..........................................8-22
Management's Discussion and Analysis of Financial Condition and Results
of Operations.....................................................................................23-32
Qualitative and Quantitative Disclosures of Market Risk..................................................33
Controls and Procedures..................................................................................33
PART II. OTHER INFORMATION...........................................................................34
Page 2
Part I - Financial Information
Item 1. Consolidated Financial Statements
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS April 18, December 28,
2004 2003
-------- --------
(unaudited)
Current assets:
Cash and cash equivalents $ 40,822 $ 56,409
Restricted cash for untendered shares 21 21
Receivables, net of allowance for doubtful
accounts of $461 in 2004 and $488 in 2003:
Franchisee 2,036 1,700
Other 806 1,171
-------- --------
2,842 2,871
Inventories 2,802 2,707
Prepaid expenses 6,547 3,844
Current portion of loans receivable from officers 2,588 2,810
-------- --------
Total current assets 55,622 68,662
Property and equipment, net 93,477 96,604
Intangible assets:
Trademarks, net 195,916 195,916
Goodwill, net 9,204 9,204
Deferred financing costs and other, net 5,186 5,482
Loans receivable from officers, less current portion 3,065 3,347
Other assets 7,453 7,614
-------- --------
$369,923 $386,829
======== ========
See notes to unaudited consolidated financial statements.
Page 3
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
LIABILITIES & SHAREHOLDERS' EQUITY April 18, December 28,
2004 2003
-------- --------
(unaudited)
Current liabilities:
Amounts due for untendered shares $ 21 $ 21
Accounts payable 11,804 13,734
Accrued expenses 15,214 18,774
Accrued interest payable 2,787 8,181
Current portion of mortgage payable 173 168
-------- --------
Total current liabilities 29,999 40,878
-------- --------
Deferred rent 8,787 8,711
-------- --------
Long-term debt, net of original issue
discount 268,210 268,152
-------- --------
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 71 71
Additional paid-in capital 10 10
Retained earnings 62,846 69,007
-------- --------
Total shareholders equity 62,927 69,088
-------- --------
$369,923 $386,829
======== ========
See notes to unaudited consolidated financial statements.
Page 4
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands)
April 18, 2004 April 20, 2003
-------- --------
Revenues:
Restaurant sales $ 90,846 $ 88,509
Franchise related income 3,404 2,939
Real estate and other 1,961 1,667
-------- --------
Total revenues 96,211 93,115
-------- --------
Costs and expenses:
Restaurant operating expenses:
Cost of food and paper products 20,009 19,304
Payroll and other employee benefits 26,147 26,211
Other operating costs 33,807 33,532
Depreciation and amortization 4,984 5,896
General and administrative costs 8,126 8,719
Provision for restaurant closings 175 529
-------- --------
Total costs and expenses 93,248 94,191
-------- --------
Operating income (loss) 2,963 (1,076)
-------- --------
Other (expense) income:
Interest expense (9,477) (9,583)
Interest income 196 214
Equity in net income of unconsolidated affiliates 398 281
-------- --------
Net other expense (8,883) (9,088)
-------- --------
Loss before minority interest (5,920) (10,164)
Minority interest - (5)
-------- --------
Loss before income taxes (5,920) (10,169)
Income taxes 241 321
-------- --------
Net loss $ (6,161) $(10,490)
======== ========
See notes to unaudited consolidated financial statements.
Page 5
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
April 18, 2004 April 20, 2003
-------- --------
Operating activities:
Net loss $ (6,161) $(10,490)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 5,421 6,365
Increase in deferred rent, net 93 90
Loss on sale of other concept units - 250
Restaurant closing costs 175 529
Minority interest - 5
Equity in net income of unconsolidated affiliates (398) (281)
Dividends received from unconsolidated affiliate 305 119
-------- --------
(565) (3,413)
Changes in operating assets and liabilities:
Receivables 228 (220)
Inventories (95) 932
Prepaid expenses (2,703) (4,424)
Other assets 48 (195)
Accounts payable and accrued expenses (4,549) 571
Accrued interest payable (5,394) (5,394)
-------- --------
Net cash used in operating activities (13,030) (12,143)
-------- --------
See notes to unaudited consolidated financial statements.
Page 6
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
April 18, April 20,
2004 2003
-------- --------
Investing activities:
Purchases of property and equipment $ (2,324) $ (3,071)
-------- --------
Net cash used in investing activities (2,324) (3,071)
-------- --------
Financing activities:
Mortgage principal repayments (54) (50)
Tax distributions (682) (1,101)
Repayment of loans receivable from officers 503 -
-------- --------
Net cash used in financing activities (233) (1,151)
-------- --------
Decrease in cash and cash equivalents (15,587) (16,365)
Cash and cash equivalents at beginning of period 56,409 55,150
-------- --------
Cash and cash equivalents at end of period $ 40,822 $ 38,785
======== ========
Supplemental disclosure of cash flow
information:
Cash paid during the period for income taxes $ 204 $ 119
======== ========
Cash paid during the period for interest $ 14,458 $ 14,548
======== ========
See notes to unaudited consolidated financial statements.
Page 7
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
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 the consolidated financial position of Sbarro and our subsidiaries
at April 18, 2004 and our consolidated results of operations and cash
flows for the first quarter which includes the sixteen week periods
ended April 18, 2004 and April 20, 2003 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 28, 2003.
2. Recent accounting pronouncements:
Financial Accounting Standards Board ("FASB") Interpretation ("FIN") No
46, "Consolidation of Variable Interest Entities," was effective
immediately upon its issuance during fiscal 2003 for all enterprises
with variable interests in entities created after January 31, 2003. In
December 2003, the FASB staff issued FIN No. 46(R) which changes the
effective date for interests in variable interest entities created
before February 1, 2003 beginning with the first interim reporting
period after March 15, 2004. 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. The FASB has specifically exempted traditional
franchise arrangements from the evaluations required under FIN No. 46.
We have also reviewed our corporate relationships for possible coverage
under FIN No. 46. The application of FIN No. 46 did not have a material
effect on our disclosures and our financial position or results of
operations. We have several variable interest entities, for which we
have provided certain required disclosures in our Form 10-K. However,
we are not the primary beneficiary and therefore do not need to
consolidate these entities.
Page 8
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
3. Debt:
In March 2004, we obtained an uncommitted line of credit to replace our
former revolving credit facility. Under the new line, we currently have
the ability, subject to bank approval, to borrow up to $3 million,
including outstanding letters of credit.
The new line of credit contains no financial covenants or unused line
fees. Interest applicable to the loans under the new line of credit is
at the bank's prime rate at the time of any borrowings. The line
expires in May 2005. There currently are $1.7 million of letters of
credit outstanding and we have $1.3 million of undrawn availability.
Under our senior notes indenture, there are various covenants that
limit our ability to borrow funds, in addition to lending arrangements
that existed at the date the indenture was entered into and
replacements of those arrangements, to make "restricted payments"
including, among other things, dividend payments (other than as
distributions pursuant to the tax payment agreement), and to make
investments in, among other things, unrestricted subsidiaries.
Among other covenants, the indenture requires that, in order for us to
borrow, our consolidated interest ratio coverage (as defined in the
indenture), after giving pro forma effect to the interest on the new
borrowing, for the four most recently ended fiscal quarters must be at
least 2.5 to 1. As of April 18, 2004, that ratio was 1.36 to 1. As a
result, we are not presently able to borrow funds except for the
specifically permitted indebtedness, of up to $75.0 million of
revolving credit loans.
In order to make restricted payments, that ratio must be at least 2.0
to 1, after giving pro forma effect to the restricted payment and, in
any event, is limited in dollar amount pursuant to a formula contained
in the indenture. We refer to the amount that is available for us to
make dividends and other restricted payments as the "restricted payment
availability." We cannot make restricted payments (other than
distributions pursuant to the tax payment agreement) until we increase
the restricted payment availability by approximately $17.8 million, and
then only to the extent of any excess over that amount.
In March 2000, one of our subsidiaries obtained a $16.0 million, 8.4%
loan due in 2010, secured by a mortgage on our corporate headquarters
building. The loan is payable in monthly installments of principal and
interest of $0.1 million. The outstanding principal balance of the loan
as of April 18, 2004 was $15.3 million. The mortgage agreement contains
various covenants, including a requirement that the subsidiary maintain
a minimum ratio of EBITDA to annual debt service of at least 1.2 to
1.0.
We were in compliance with all covenants in the indenture for the
senior notes and our mortgage as of April 18, 2004.
Page 9
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
4. Income taxes:
We made Subchapter S tax distributions in the amount of $1.8 million to
our shareholders related to our fiscal 2002 tax basis income. Of such
amount, $1.1 million was paid in the first quarter of 2003 and $0.7
million was paid in the first quarter of 2004.
5. Litigation:
On December 20, 1999, Antonio Garcia and thirteen current and former
general managers of Sbarro restaurants in California amended a
complaint 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 court issued a ruling in December 2003
which was unfavorable to us but did not set the amount of damages. We
are appealing the ruling due to errors that we believe were made by the
trial judge.
On September 6, 2000, Manuel Jimenez and seven other current and former
general managers of Sbarro restaurants in California filed a complaint
against Sbarro 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 two of the managers for immaterial amounts. The
remaining 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 Sbarro in the Superior Court of
California for Los Angeles County. The complaint alleges that the
plaintiffs were required to perform labor services without proper
premium overtime compensation from at least May of 1999. The plaintiffs
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. The case is currently in the discovery phase.
Page 10
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
In August 2002, a subcontractor and the general contractor, pursuant to
a construction contract to build a joint venture location that we
closed in fiscal 2002 and is also the subject of the lawsuit discussed
below, filed a complaint against the limited liability joint venture
company alleging that they are owed approximately $800,000, plus
interest. We are a defendant in the suit by reason of the fact that we
guaranteed the bonds under which mechanics liens for the plaintiffs
were bonded. The parties to the lawsuit have orally agreed to enter
into settlement discussions. Should those discussions not result in an
agreed upon settlement, the parties have agreed to binding arbitration.
We believe that our maximum liability that would result from the
settlement discussions or binding arbitration would be approximately
$400,000.
In May 2002, the landlord of the joint venture described above filed a
complaint against Sbarro in the Supreme Court of the New York for
Westchester County alleging that we were obligated to it, pursuant to a
Guaranty Agreement we executed for all rent during the remaining lease,
based on an alleged breach of the lease by the tenant, a subsidiary of
the joint venture. We believed that our guarantee was limited in amount
while the landlord alleged that the guarantee covered all amounts that
would become due during the remaining lease term. The court issued a
ruling in November 2003 which established our liability at $500,000 and
we have accrued for this amount. The landlord has appealed this
decision.
We believe that we have substantial defenses in each of these actions
and we 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.
6. Guarantor and non-guarantor financial statements:
Certain subsidiaries have guaranteed amounts outstanding under our
senior notes and new line of credit. 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.
Page 11
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
The following condensed consolidating financial information presents:
(1) Condensed consolidating balance sheets as of April 18, 2004
(unaudited) and December 28, 2003 and statements of operations
and cash flows for the fiscal quarters ended April 18, 2004
(unaudited) and April 20, 2003 (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 12
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Balance Sheet
As of April 18, 2004
(In thousands except share data)
(Unaudited)
Unrestricted
Guarantor Subsidiaries Consolidated
ASSETS Parent Subsidiaries (as a group) Eliminations Total
---------- ---------- -------- ------------ ----------
Current assets:
Cash and cash equivalents $ 35,638 $ 3,694 $ 1,490 $ 40,822
Restricted cash for untendered shares 21 - - 21
Receivables less allowance for doubtful
accounts of $461
Franchisee 2,036 - - 2,036
Other (558) 1,070 294 806
---------- ---------- -------- ------------ ----------
1,478 1,070 294 2,842
Inventories 1,193 1,471 138 2,802
Prepaid expenses 5,542 951 54 6,547
Current portion of loans receivable from
officers 2,588 - - 2,588
---------- ---------- -------- ------------ ----------
Total current assets 46,460 7,186 1,976 55,622
Intercompany receivables 2,546 315,807 $ (318,353) -
Investment in subsidiaries 65,469 - (65,469)
Property and equipment, net 35,171 53,833 4,473 93,477
Intangible assets:
Trademarks, net 195,916 - - - 195,916
Goodwill, net 9,101 - - 103 9,204
Deferred financing costs and other, 4,965 221 - - 5,186
net
Loans receivable from officers, less
current portion 3,065 - - - 3,065
Other assets 8,078 1,802 (426) (2,001) 7,453
---------- ---------- -------- ------------ ----------
$ 370,771 $ 378,849 $ 6,023 $ (385,720) $ 369,923
========== ========== ======== ============ ==========
Page 13
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Balance Sheet
As of April 18, 2004
(In thousands except share data)
(Unaudited)
Guarantor Unrestricted Consolidated
LIABILITIES & SHAREHOLDERS' EQUITY Parent Subsidiaries Subsidiaries Eliminations Total
---------- ---------- -------- ----------- ----------
Current liabilities:
Amounts due for untendered shares $ 21 $21
Accounts payable 10,665 $172 $388 $579 11,804
Accrued expenses 12,209 1,322 1,683 - 15,214
Accrued interest payable 2,787 - - - 2,787
Current portion of mortgage payable - 173 - - 173
---------- ---------- -------- ----------- ----------
Total current liabilities 25,682 1,667 2,071 579 29,999
---------- ---------- -------- ----------- ----------
Intercompany payables 312,725 2,208 3,420 (318,353) -
---------- ---------- -------- ----------- ----------
Deferred rent 8,096 - 691 - 8,787
---------- ---------- -------- ----------- ----------
Long-term debt, net of original issue
discount 252,945 15,265 - - 268,210
---------- ---------- -------- ----------- ----------
Shareholders' equity (deficit):
Preferred stock, $1 par value;
authorized 1,000,000 shares;
none issued - - - - -
Common stock, $.01 per 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) (228,758) 294,240 (2,636) - 62,846
---------- ---------- -------- ----------- ----------
Total shareholders' equity
(deficit) (228,677) 359,709 (159) (67,946) 62,927
---------- ---------- -------- ----------- ----------
$ 370,771 $ 378,849 $ 6,023 $ (385,720) $ 369,923
========== ========== ======== =========== ==========
Page 14
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Balance Sheet
As of December 28, 2003
(In thousands except share data)
Guarantor Nonguarantor Consolidated
ASSETS Parent Subsidiaries Subsidiaries Eliminations Total
-------- -------- ------- ---------- --------
Current assets:
Cash and cash equivalents $49,515 $5,595 $1,299 $56,409
Restricted cash for untendered 21 - - 21
shares
Receivables less allowance for
doubtful accounts of $488
Franchisee 1,700 - - 1,700
Other (191) 966 396 1,171
-------- -------- ------- ---------- --------
1,509 966 396 2,871
Inventories 1,177 1,387 143 2,707
Prepaid expenses 4,018 (227) 53 3,844
Current portion of loans receivable
from officers 2,810 - - 2,810
-------- -------- ------- ---------- --------
Total current assets 59,050 7,721 1,891 68,662
Intercompany receivables 6,697 317,237 - $(323,934) -
Investment in subsidiaries 65,469 - - (65,469) -
Property and equipment, net 36,189 55,706 4,709 96,604
Intangible assets:
Trademarks, net 195,916 - - - 195,916
Goodwill, net 9,204 - - - 9,204
Deferred financing costs and 5,369 233 - (120) 5,482
other, net
Loans receivable from officers, less
current portion 3,347 - - - 3,347
Other assets 7,034 1,822 (212) (1,030) 7,614
-------- -------- ------- ---------- --------
$388,275 $382,719 $6,388 $(390,553) $386,829
======== ======== ====== ========== ========
Page 15
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Balance Sheet
As of December 28, 2003
(In thousands except share data)
Guarantor Nonguarantor Consolidated
LIABILITIES & SHAREHOLDERS' EQUITY Parent Subsidiaries Subsidiaries Eliminations Total
--------- --------- --------- --------- ---------
Current liabilities:
Amounts due for untendered shares $ 21 $ 21
Accounts payable 11,859 $ 129 $ 419 $ 1,327 13,734
Accrued expenses 15,521 1,447 1,806 - 18,774
Accrued interest payable 8,181 - - - 8,181
Current portion of mortgage payable - 168 - - 168
--------- --------- --------- --------- ---------
Total current liabilities 35,582 1,744 2,225 1,327 40,878
--------- --------- --------- --------- ---------
Intercompany payables 317,236 2,958 3,740 (323,934) -
--------- --------- --------- --------- ---------
Deferred rent 8,009 - 702 - 8,711
--------- --------- --------- --------- ---------
Long-term debt, net of original issue discount 252,827 15,325 - - 268,152
--------- --------- --------- --------- ---------
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) (225,460) 297,223 (2,756) - 69,007
--------- --------- --------- --------- ---------
Total shareholders' equity (deficit) (225,379) 362,692 (279) (67,946) 69,088
--------- --------- --------- --------- ---------
$ 388,275 $ 382,719 $ 6,388 $(390,553) $ 386,829
========= ========= ========= ========= =========
Page 16
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Statement of Operations
For the sixteen weeks ended April 18, 2004
(In thousands)
(Unaudited)
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------- -------- -------- -------- --------
Revenues:
Restaurant sales $ 38,982 $ 47,512 $ 4,352 $ 90,846
Franchise related income 3,404 - - 3,404
Real estate and other 1,010 951 - 1,961
Intercompany charges 2,524 - - $ (2,524) -
-------- -------- -------- -------- --------
Total revenues 45,920 48,463 4,352 (2,524) 96,211
-------- -------- -------- -------- --------
Cost and expenses:
Restaurant operating expenses
Cost of food and paper products 8,037 10,790 1,182 - 20,009
Payroll and other employee
benefits 10,447 14,203 1,497 - 26,147
Other operating costs 15,545 17,034 1,228 - 33,807
Depreciation and amortization 2,144 2,562 278 - 4,984
General and administrative 4,298 3,776 52 - 8,126
Provision for restaurant closings 175 - - - 175
Intercompany charges - 2,524 - (2,524) -
-------- -------- -------- -------- --------
Total costs and expenses 40,646 50,889 4,237 (2,524) 93,248
-------- -------- -------- -------- --------
Operating income (loss) 5,274 (2,426) 115 - 2,963
Other (expense) income
Interest expense (9,032) (445) - - (9,477)
Interest income 196 - - - 196
Equity in net income of
unconsolidated affiliates 398 - - - 398
-------- -------- -------- -------- --------
Net other expense (8,438) (445) - - (8,883)
-------- -------- -------- -------- --------
(Loss) income before minority interest (3,164) (2,871) 115 - (5,920)
Minority interest - - - - -
-------- -------- -------- -------- --------
Income (loss) before income taxes (3,164) (2,871) 115 - (5,920)
Income taxes (benefit) 134 112 (5) - 241
-------- -------- -------- -------- --------
Net income (loss) $ (3,298) (2,983) $ 120 $ - $ (6,161)
======== ======== ======== ======== ========
Page 17
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Statement of Operations
For the sixteen weeks ended April 20, 2003
(In thousands)
(Unaudited)
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------- -------- -------- -------- --------
Revenues:
Restaurant sales $ 37,415 $ 46,595 $ 4,499 $ 88,509
Franchise related income 2,939 - - 2,939
Real estate and other 780 887 - 1,667
Intercompany charges - 3,160 - $ (3,160) -
-------- -------- -------- -------- --------
Total revenues 41,134 50,642 4,499 (3,160) 93,115
-------- -------- -------- -------- --------
Cost and expenses:
Restaurant operating expenses:
Cost of food and paper products 7,798 10,324 1,182 - 19,304
Payroll and other employee
benefits 10,831 13,794 1,586 - 26,211
Other operating costs 14,938 17,337 1,257 - 33,532
Depreciation and amortization 2,645 2,940 311 - 5,896
General and administrative 4,999 3,626 94 - 8,719
Provision for restaurant closings 399 - 130 - 529
Intercompany charges 3,160 - - (3,160) -
-------- -------- -------- -------- --------
Total costs and expenses 44,770 48,021 4,560 (3,160) 94,191
-------- -------- -------- -------- --------
Operating (loss) income (3,636) 2,621 (61) - (1,076)
-------- -------- -------- -------- --------
Other (expense) income:
Interest expense (9,131) (452) - - (9,583)
Interest income 214 - - - 214
Equity in net income of
unconsolidated affiliates
281 - - - 281
-------- -------- -------- -------- --------
Net other expense (8,636) (452) - - (9,088)
-------- -------- -------- -------- --------
(Loss) income before minority interest (12,272) 2,169 (61) - (10,164)
Minority interest - - (5) - (5)
-------- -------- -------- -------- --------
(Loss) income before income taxes (12,272) 2,169 (66) - (10,169)
Income taxes 188 131 2 - 321
-------- -------- -------- -------- --------
Net (loss) income $(12,460) $ 2,038 $ (68) $ - $(10,490)
======== ======== ======== ======== ========
Page 18
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Statement of Cash Flows
For the sixteen weeks ended April 18, 2004
(In thousands)
(Unaudited)
Guarantor Unrestricted Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------- -------- -------- -------- --------
Operating Activities:
Net (loss) income $ (3,298) $ (2,983) $ 120 $ (6,161)
Adjustments to reconcile net (loss) income
to net cash (used in) provided by
operating activities:
Depreciation and amortization 2,244 2,900 277 5,421
Increase in deferred rent, net 89 3 1 93
Loss on sale of other concept units
Restaurant closing costs 175 - - 175
Minority interest - - - -
Equity in income of unconsolidated
affiliates (398) - - (398)
Dividends received from unconsolidated
affiliates 305 - - 305
-------- -------- -------- --------
(883) (80) 398 (565)
Changes in operating assets and liabilities:
Receivables 229 (104) 103 228
Inventories (16) (84) 5 (95)
Prepaid expenses (1,524) (1,178) (1) (2,703)
Other assets (919) 17 202 $ 748 48
Accounts payable and accrued expenses (3,564) (82) (155) (748) (4,549)
Accrued interest payable (5,394) - - - (5,394)
-------- -------- -------- -------- --------
Net cash (used in) provided by
operating activities (12,071) (1,511) 552 - (13,030)
-------- -------- -------- -------- --------
Page 19
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Statement of Cash Flows
For the sixteen weeks ended April 18, 2004
(In thousands)
(Unaudited)
Guarantor Unrestricted Elimin Consolidated
Parent Subsidiaries Subsidiaries ations Total
-------- -------- -------- -- --------
Investing activities:
Purchases of property and equipment $ (1,031) $ (1,252) $ (41) $ (2,324)
-------- -------- -------- --------
Net cash (used in) provided by
investing activities (1,031) (1,252) (41) (2,324)
-------- -------- -------- --------
Financing activities:
Mortgage principal repayments - (54) - (54)
Tax distribution (682) - - (682)
Repayment of loans receivable from
officers 503 - - 503
Intercompany balances (596) 916 (320) -
-------- -------- -------- --------
Net cash provided by (used in)
financing activities (775) 862 (320) (233)
-------- -------- -------- --------
(Decrease) increase in cash and
cash equivalents (13,877) (1,901) 191 (15,587)
Cash and cash equivalents at beginning
of Period 49,515 5,595 1,299 56,409
-------- -------- -------- --------
Cash and cash equivalents at end of
period $ 35,638 $ 3,694 $ 1,490 $ 40,822
======== ======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for income
taxes $ 106 $ 95 $ 3 $- $ 204
======== ======== ======== == ========
Cash paid during the period for interest $ 14,025 $ 433 $ - $- $ 14,458
======== ======== ======== == ========
Page 20
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Statement of Cash Flows
For the sixteen weeks ended April 20, 2003
(In thousands)
(Unaudited)
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------- -------- -------- -------- --------
Operating Activities:
Net (loss) income $(12,460) $ 2,038 $ (68) $(10,490)
Adjustments to reconcile net (loss) income
to net cash (used in) provided by
operating activities
Depreciation and amortization 3,499 2,557 309 6,365
Increase in deferred rent, net 109 (19) - 90
Loss on sale of other concept units - - 250 250
Restaurant closing costs 529 - - 529
Minority interest - - 5 5
Equity in net income of unconsolidated
affiliates (281) - - (281)
Dividends received from unconsolidated
affiliates 119 - - 119
-------- -------- -------- --------
(8,485) 4,576 496 (3,413)
Changes in operating assets and liabilities:
Receivables (600) 379 1 (220)
Inventories 419 506 7 932
Prepaid expenses (3,334) (896) (194) (4,424)
Other assets (286) (360) 451 (195)
Accounts payable and accrued expenses 247 231 93 571
Accrued interest payable (5,394) - - (5,394)
-------- -------- -------- --------
Net cash (used in) provided by operating
activities (17,433) 4,436 854 (12,143)
-------- -------- -------- --------
Page 21
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Continued)
Consolidating Statement of Cash Flows
For the sixteen weeks ended April 20, 2003
(In thousands)
(Unaudited)
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------- ------- ----- ------ --------
Investing activities:
Purchase of property and $ (2,233) $ (755) $ (83) $ (3,071)
equipment -------- ------- ----- --------
Net cash used in investing activities (2,233) (755) (83) (3,071)
-------- -------- -------- --------
Financing activities:
Mortgage principal repayments - (50) - (50)
Tax distribution (1,101) - - (1,101)
Intercompany balances 6,994 (6,263) (731) -
-------- -------- -------- --------
Net cash provided by
(used in) financing activities 5,893 (6,313) (731) (1,151)
-------- -------- -------- --------
(Decrease) increase in cash and
cash equivalents (13,773) (2,632) 40 (16,365)
Cash and cash equivalents at
beginning of period 47,636 6,539 975 55,150
-------- -------- -------- --------
Cash and cash equivalents at
end of period $ 33,863 $ 3,907 $ 1,015 $ 38,785
======== ======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for
income taxes $ 91 $ 15 $ 13 $ 119
======== ======== ======== ========
Cash paid during the period for
interest $ 14,110 $ 438 $ - $ - $ 14,548
======== ======== ======== ====== ========
Page 22
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:
16 Weeks 16 Weeks
Ended Ended Fiscal Year
04/18/04 04/20/03 2003 2002
-------- -------- ---- ----
Company-owned restaurants:
Opened during period 2 - 4 13
Sold to franchisees during period-net (2) (4) (12) (6)
Closed during period (12) (9) (22) (51)
Open at end of period (1) 516 545 528 558
Franchised restaurants:
Opened during period 9 10 39 42
Purchased from Company during
period-net 2 4 12 6
Closed or terminated during period (5) (8) (17) (20)
Open at end of period 393 359 387 353
All restaurants:
Opened during period 11 10 43 55
Closed or terminated during period (17) (17) (39) (71)
Open at end of period (1) 909 904 915 911
Kiosks (all franchised) open at
end of period 3 3 3 3
- ----------
(1) Excludes 29, 30, 29 and 32 other concept units as of April 18, 2004 and
April 20, 2003, the end of fiscal 2003 and the end of fiscal 2002,
respectively.
Page 23
Our business is subject to seasonal fluctuations, and the effects 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. As a result, our annual earnings can fluctuate 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
fluctuated significantly due to a number of other factors, including the adverse
effect of the general economic downturn and significant year end adjustments
relating to asset impairment and store closing costs. Due to the seasonality of
our business, until after our fourth quarter is completed, we are not able to
perform the testing for impairment on our goodwill and intangible assets with
indefinite lives acquired prior to July 1, 2001 as required by SFAS No. 142,
"Goodwill and Other Intangible Assets." Any required adjustments are recorded at
that time unless impairment factors are present earlier.
Relevant Financial Information
Sixteen weeks ended
----------------------------------------
April 18, 2004 April 21, 2004
----------------------------------------
(in millions except number of locations)
----------------------------------------
Comparable Sbarro - owned quick service sales (1) $ 85.8 $ 80.5
Comparable Sbarro - owned quick service sales
- change for period (1) 6.6% (5.9)%
Number of Sbarro - owned quick service locations closed and
locations sold to franchisees during the period 14 13
Franchise location sales $ 71.9 $ 61.5
Franchise revenues $ 3.4 $ 3.0
Cost of food and paper products as a percentage of restaurant
sales 22.0% 21.8%
Payroll and other benefits as a percentage of restaurant sales 28.8% 29.6%
Other operating expenses as a percentage of restaurant sales 37.2% 37.9%
General and administrative costs as a percentage of revenues 8.4% 9.4%
Provision for restaurant closings $ 0.2 $ 0.5
EBITDA $ 8.3 $ 5.1
(1) Comparable Sbarro-owned quick service sales dollar and annual percentage
changes are based on locations that were comparable as of April 18, 2004 in each
of the periods presented based on locations opened prior to December 29, 2002.
Page 24
Our consolidated EBITDA for the sixteen weeks ended April 18, 2004 was $8.3
million compared to $5.1 million for the sixteen weeks ended April 20, 2003.
EBITDA represents earnings (losses) 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") of the United States 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 operating 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 for the sixteen week periods presented which we believe
is the most direct comparable GAAP financial measure to EBITDA (in thousands):
2004 2003
---- ----
EBITDA $ 8,345 $ 5,096
Interest expense (9,477) (9,583)
Interest income 196 214
Income taxes (241) (321)
Depreciation and amortization (4,984) (5,896)
------- ----------
Net loss $(6,161) $(10,490)
======== =========
Page 25
Restaurant sales from the Sbarro-owned quick service business and consolidated
other concepts increased 2.6% to $90.8 million for the sixteen weeks ended April
18, 2004 from $88.5 million in the sixteen weeks ended April 20, 2003. The
increase in sales reflects $2.5 million of higher sales of the Sbarro quick
service business partially offset by $0.2 million of lower sales of consolidated
other concepts. The increase in Sbarro quick service business resulted from an
approximate $5.3 million (6.6%) increase in comparable sales to $85.8 million.
We believe that the increase in comparable sales is primarily due to the
improvement in the economy partially offset by the loss of $2.8 million of
sales, from the closure, since the end of the first quarter of 2003, of
generally low volume locations that did not have a material impact on our
operations (including 12 unites closed in the first quarter of fiscal 2004). The
6.6% increase in comparable sales includes approximately 1.5% attributable to
price increases in the fourth quarter of 2003. In addition, there were selective
price increases that became effective during the last half of the first fiscal
quarter of 2004 which did not have a material impact on the first quarter of
2004.
The decline in consolidated other concept unit sales was primarily a result of
the closing of two unprofitable or marginally profitable locations in early
2003.
Franchise related income increased 15.8 % to $3.4 million for the first quarter
of 2004 from $2.9 million in the first quarter of 2003. Increases in royalties
from comparable locations that were a result of sales increases of 19.9% for
international locations and 2.6% for domestic locations and from royalties from
locations opened during the first quarter of 2004 and 2003 contributed to the
increase in the franchise related income during the first quarter of fiscal
2004.
Real estate and other revenues increased 17.6% in the first quarter of fiscal
2004 from the same period in fiscal 2003 primarily due to variations in certain
vendor rebates.
Cost of food and paper products as a percentage of restaurant sales increased to
22.0% for the sixteen weeks ended April 18, 2004 from 21.8% for the comparable
2003 fiscal period. The cost of food and paper products percentage for the first
fiscal quarter of 2004 was positively impacted by the increase in comparable
unit sales and the price increase implemented late in the first quarter of 2004.
Cheese prices, which increased beginning at the end of the second quarter of
fiscal 2003 and declined at the end of the fourth quarter of fiscal 2003 through
early 2004, continued to increase to record high levels at the first quarter of
fiscal 2004. These increases in cheese prices resulted in a 1.0% increase in the
cost of food and paper products when compared to the first quarter of fiscal
2003. Cheese prices in the second quarter have moderated from the historically
high first quarter amounts. In the first quarter of fiscal 2003, we purchased
product from third parties, increasing our cost of food and paper products
during that quarter, until our current distribution contract became effective
after the bankruptcy of our former distributor.
Payroll and other employee benefits decreased to 28.8% in the first quarter of
2004 from 29.6% of restaurant sales in the first quarter of 2003. The dollar
decrease was primarily due to increased restaurant sales as a result of both
unit sales and price increases as well as the elimination of locations with
higher payroll costs.
Page 26
Other operating expenses increased by $0.3 million but decreased to 37.2% of
restaurant sales in the first quarter of 2004 from 37.9% in the first quarter of
2003. The dollar increase was primarily due to increases in rent and other
occupancy related expenses resulting from the renewal of existing leases at
higher rental rates. As a percentage of restaurant sales, these costs improved
primarily as a result of the higher level of sales.
Depreciation and amortization expense decreased by $0.9 million for the first
quarter of fiscal year 2004 from the same period in fiscal year 2003. Of the
reduction, $0.3 million was due to fewer numbers of units in operation in fiscal
2004, $0.3 million was for locations that had been included in the provision for
asset impairment in fiscal 2003 for which no depreciation was taken in fiscal
2004, $0.2 million related to locations that became fully depreciated during
fiscal 2003 and of $0.1 million related to our administrative office building
that was closed in May 2004.
General and administrative expenses were $8.1 million, or 8.4% of total
revenues, for the first quarter of 2004, compared to $8.7 million, or 9.4% of
total revenues, for the first quarter of 2003. Factors contributing to the
decrease in the general and administrative costs included lower costs of
approximately $0.7 million due to the reduction in work force, $0.2 million due
to a reduction in legal fees and a $0.2 million decrease in the bad debt
expense, bonuses of $0.7 million granted to certain executive officers in the
first quarter of 2003 which were not granted in the first quarter of 2004
offset, in part, by $0.7 million of severance and other costs related to the
reduction in work force, and $0.2 million of costs related to new executives.
The annual effect of our reduction in work force on our administrative and
general costs is estimated at $3.1 million.
Interest expense of $9.5 million and $9.6 million for the first quarter of 2004
and 2003, respectively, relates to the 11%, $255.0 million senior notes issued
to finance our going private transaction ($8.6 million) and the 8.4%, $16.0
million mortgage loan on our corporate headquarters in 2001 ($0.5 million). In
addition, $0.4 million and $0.5 million in the first quarter of fiscal 2004 and
2003, respectively, represents non-cash charges for the total of the accretion
of the original issue discount on our senior notes and the amortization of
deferred financing costs on the senior notes, credit agreement (for the line of
credit that was terminated in the fourth quarter of fiscal 2003) and the
mortgage loan.
Interest income was approximately $0.2 million for each of the first quarters of
fiscal 2004 and 2003. The indenture under which our senior notes are issued and
our credit agreement limit the types of investments which we may make.
Equity in the net income 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. The $0.1 million increase in our share of
the equity in the net income of unconsolidated affiliates was primarily as a
result of an improvement in the performance of our steakhouse joint venture.
There currently are two steakhouses under construction, both of which are
expected to be completed during the fourth quarter of fiscal 2004. We do not
have any further expansion plans for this venture.
Page 27
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 approximately $0.2 million and $0.3 million
for the first fiscal quarter of fiscal 2004 and 2003, 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 and for taxes withheld at the source of payment on foreign franchise
income related payments.
Liquidity and Capital Resources
Cash Requirements
Our liquidity requirements relate to debt service, capital expenditures, working
capital, investments in other ventures, distributions to shareholders when
permitted under the indenture for the senior notes and to repay any borrowings
we may make under our line of credit agreement and general corporate purposes.
We incur annual cash interest expense of approximately $29.5 million under the
senior notes and mortgage loan and may incur additional interest expense for
borrowings under our line of credit. We are not required to make principal
payments, absent the occurrence of certain events, on our senior notes until
they mature in September 2009. We believe that aggregate restaurant capital
expenditures and our investments in joint ventures during fiscal 2004 will
approximate the fiscal 2003 level of $8.5 million. Our $3.0 million line of
credit which expires in May 2005 is uncommitted. Therefore, our lender could
refuse to lend to us at any time. Unpaid capital expenditure commitments
aggregated approximately $0.8 million at April 18, 2004.
We expect our primary source of liquidity to meet these needs will be cash flow
from operations. We do not presently expect to borrow under our line of credit
in fiscal 2004.
Contractual Obligations and Off-Balance Sheet Arrangements
Our contractual obligations and off balance sheets arrangements with respect to
Sbarro owned and franchised restaurants as well as those for our other concept
arrangements (both those in which we have a majority or minority interest) do
not materially differ from the information disclosed in Part II, Item 7 of our
Annual Report on Form 10-K for the 2003 fiscal year.
Page 28
Sources and Uses of Cash
The following table summarizes our cash and cash equivalents and working capital
as at the end of the first fiscal quarters of 2004 and 2003 and the uses of our
cash flows during those two fiscal quarters:
Fiscal Quarter Ended
--------------------
April 18, 2004 April 20, 2003
-------------- --------------
(in millions)
Liquidity at the end of period
------------------------------
Cash and cash equivalents $ 40.8 $38.8
Working capital 25.6 17.1
Net cash flows for the period
-----------------------------
Used in operating activities (13.1) (12.1)
Used in investing activities (2.3) (3.1)
Used in financing activities (0.2) (1.2)
Net decrease in cash (15.6) (16.4)
We have historically not required significant working capital to fund our
existing operations and have financed our capital expenditures and investments
in joint ventures through cash generated from operations.
Net cash used in operating activities was $13.1 million for the sixteen weeks
ended April 18, 2004 compared to $12.1 million used during the sixteen weeks
ended April 20, 2003. The $1.0 million increase was primarily due to the effect
of the decrease in the loss from operations, as adjusted for non-cash items, in
the first quarter of 2004 compared to the same calculation for the first quarter
of 2003 of approximately $2.8 million, income tax refunds received of
approximately $0.3 million, contractual payments of $0.2 million related to
prior year sales of other concept locations, a $1.7 million increase in cash as
a result of the timing of payments in fiscal 2004 for our insurance policy
renewal as the 2003 policy renewals were financed, offset by an increase of
approximately $0.8 million in the inventory value due to increases in product
costs, primarily cheese, and by a decrease of approximately $5.1 million in
accounts payable and accrued expense between the comparable 2004 and 2003
periods due to the change in the level of sales just prior to the beginning of
each of those fiscal periods.
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 $3.1 million for
the sixteen weeks ended April 20, 2003 to $2.3 million for the sixteen weeks
ended April 18, 2004 primarily due to an decrease in quick service renovation
activity and $0.6 million that was expended in the first quarter of fiscal 2003
relating to an upgrade of our computer system.
Page 29
Net cash used in financing activities was $0.2 million in the first quarter of
fiscal 2004 compared to $1.2 million for the first quarter of fiscal 2003. Cash
used in financing activities in both years resulted primarily from tax
distributions to our shareholders. In March 2000, we 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. The indenture for the
senior notes permits us to make distributions to shareholders under a formula
that is designed to approximate the income taxes, including estimated taxes,
that would be payable by our shareholders if their only income were their
pro-rata share of our taxable income and such income were taxed at the highest
applicable federal and New York State marginal income tax rates. There are
differences in the book and tax treatments of the provision for asset
impairment, tax credits and in book and tax depreciation. The tax distributions
in the first quarter of both fiscal years were made with respect to our taxable
income for fiscal 2002. The $0.7 million distribution made in the first quarter
of 2004 was declared in November 2003. We do not expect to make tax
distributions in 2004 related to the 2003 results of operations. In addition,
there were payments of $0.5 million that reduced the loan receivable from
officers during the first quarter of 2004.
Financing
As part of the transaction in which we became a privately-held company, we sold
$255.0 million of 11% senior notes (at a price of 98.514% of par to yield 11.25%
per annum), the net proceeds of which, together with substantially all of our
then existing cash, was used to finance the transaction. We also entered into a
$30.0 million credit agreement that we terminated in the fourth quarter of 2003,
except for the temporary continuation of outstanding standby letters of credit.
In March 2004, we obtained an uncommitted line of credit, which expires in May
2005, to replace our former revolving credit facility. We currently have the
ability, subject to bank approval, to borrow up to $3 million, including
outstanding letters of credit. We have $1.7 million of outstanding letters of
credit and $1.3 million of undrawn availability. The new line of credit contains
no financial covenants or unused line fees. Interest applicable to the loans
under the new line of credit is at the bank's prime rate at the time of any
borrowings.
Under our senior notes indenture, there are various covenants that limit our
ability to borrow funds, in addition to lending arrangements that existed at the
date that the indenture was entered into and replacements of those arrangements,
to make "restricted payments" including, among other things, dividend payments
(other than as distributions pursuant to the tax payment agreement), and to make
investments in, among other things, unrestricted subsidiaries.
Among other covenants, the indenture requires that, in order for us to borrow,
our consolidated interest ratio coverage (as defined in the Indenture), after
giving pro forma effect to the interest on the new borrowing, for the four most
recently ended fiscal quarters must be at least 2.5 to 1. As of April 18, 2004,
that ratio was 1.36 to 1. As a result, we are not presently able to borrow funds
except for the specifically permitted indebtedness of up to $75.0 million of
revolving credit
Page 30
loans. In order to make restricted payments, that ratio must be at least 2.0 to
1, after giving pro forma effect to the restricted payment and, in any event, is
limited in dollar amount pursuant to a formula contained in the indenture. We
refer to the amount that is available for us to make dividends and other
restricted payments as the "restricted payment availability." We cannot make
restricted payments (other than distributions pursuant to the tax payment
agreement) until we increase the restricted payment availability by
approximately $17.8 million, and then only to the extent of any excess over that
amount.
In March 2000, one of our subsidiaries obtained a $16.0 million, 8.4% loan due
in 2010, secured by a mortgage on our corporate headquarters building. The loan
is payable in monthly installments of principal and interest of $0.1 million.
The outstanding principal balance of the loan as of April 18, 2004 was $15.4
million. The mortgage agreement contains various covenants, including a
requirement that the subsidiary maintain a minimum ratio of EBITDA to annual
debt service of at least 1.2 to 1.0.
We were in compliance with all covenants in the indenture for the senior notes
and our mortgage as of April 18, 2004.
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. Accounting policies often 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 sixteen weeks ended April 18,
2004, there were no material changes in the accounting policies whose
application may have the most significant effect on our reported results of
operations and financial position and that require judgments estimates and
assumptions 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
28, 2003.
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 this
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.
Page 31
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;
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 which 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), beverage
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 and mortgage loan;
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.
Page 32
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 us to similar investments. 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.
Future borrowings under our uncommitted line of credit (none are currently
outstanding) will be at rates that float with the market and, therefore, will be
subject to fluctuations in interest rates. 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 to 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
Disclosure Controls and Procedures:
Our management, with the participation of our Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of our disclosure controls
and procedures (as such terms is defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of l934, as amended (the "Exchange Act") as of the
end of the period covered by this report. Based on such evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that, as of the end
of the period, our disclosure controls and procedures are effective.
Notwithstanding the foregoing, a control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that it will
detect or uncover failures within Sbarro to disclose material information
otherwise required to be set forth in our periodic reports.
Internal Control Over Financial Reporting:
There have not been any changes in our internal control over financial reporting
(as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange
Act) during the first quarter of 2004 that have materially affected, or are
reasonable likely to materially affect, our internal control over financial
reporting.
Page 33
PART II. OTHER INFORMATION
Item 1. Legal proceedings
None of the proceedings discussed in Item 3 of our Annual Report
on Form 10-K for our 2003 fiscal year have been terminated and
there have not been any material developments in those proceedings
during the first fiscal quarter of fiscal 2004 except that the
parties to the legal proceeding related to a construction contract
entered into to build a joint venture location that we closed in
fiscal 2002 have orally agreed to settlement discussions and,
should those fail to result in a settlement, binding arbitration
of the matter. See Note 5 of the Notes to Consolidated Financial
Statement contained elsewhere in this report for additional
information concerning this legal proceeding.
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits:
31.01 Certification of Principal Executive pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.02 Certification of Vice President, Chief Financial Officer and
Principal Accounting Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.01 Certification of Principal Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.02 Certification of Vice President, Chief Financial Officer and
Principal Accounting Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
We filed no reports on Form 8-K during the quarter covered by
this report.
Page 34
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: June 2, 2004 By: /s/ MICHAEL O'DONNELL
--------------------------- ---------------------
Michael O'Donnell
President and Chief Executive Officer
Date: June 2, 2004 By: /s/ ANTHONY J. PUGLISI
--------------------------- -------------------------------------------
Anthony J. Puglisi
Vice President; Chief Financial Officer
and Principal Accounting Officer
Page 35
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
31.01 Certification of Principal Executive pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.02 Certification of Vice President, Chief Financial Officer and Principal
Accounting Officer pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.01 Certification of Principal Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.02 Certification of Vice President, Chief Financial Officer and Principal
Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.