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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 JULY 11, 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
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THE NUMBER OF SHARES OF COMMON STOCK OF THE REGISTRANT OUTSTANDING AS OF AUGUST
13, 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 - July 11, 2004 (unaudited) and December 28, 2003....3-4
Statements of Operations (unaudited) - Twenty Eight and Twelve
Weeks ended July 11, 2004 and July 13, 2003.....................5-6
Statements of Cash Flows (unaudited) - Twenty Eight Weeks ended
July 11, 2004 and July 13, 2003.................................7-8
Notes to Unaudited Consolidated Financial Statements...............9-24
Management's Discussion and Analysis of Financial Condition and Results of
Operations.............................................................25-35
Qualitative and Quantitative Disclosures of Market Risk.......................36
Controls and Procedures.......................................................36
PART II. OTHER INFORMATION................................................37
Page 2
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
--------------
ASSETS July 11, 2004 December 28, 2003
------------- -----------------
(unaudited)
Current assets:
Cash and cash equivalents $39,265 $56,409
Receivables, net of allowance for doubtful
accounts of $455 in 2004 and $488 in 2003:
Franchisees 2,192 1,700
Other 1,268 1,171
Inventories 2,931 2,707
Prepaid expenses 10,126 3,865
Current portion of loans receivable from officers 2,589 2,810
---------- -----------
Total current assets 58,371 68,662
---------- -----------
Property and equipment, net 91,571 96,604
Intangible assets:
Trademarks, net 195,916 195,916
Goodwill, net 9,204 9,204
Deferred financing costs and other, net 4,964 5,482
Loans receivable from officers, less current portion 3,062 3,347
Other assets 7,654 7,614
---------- -----------
$370,742 $386,829
========== ===========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
Page 3
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(CONTINUED)
(In thousands except share data)
--------------------------------
LIABILITIES & SHAREHOLDERS' EQUITY July 11, 2004 December 28, 2003
------------- -----------------
(unaudited)
Current liabilities:
Accounts payable $11,600 $13,734
Accrued expenses 14,128 18,795
Accrued interest payable 9,260 8,181
Current portion of mortgage payable 176 168
--------- ----------
Total current liabilities 35,164 40,878
--------- ----------
Deferred rent 8,955 8,711
--------- ----------
Long-term debt, net 268,252 268,152
--------- ----------
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 58,290 69,007
--------- ----------
Total shareholders' equity 58,371 69,088
--------- ----------
$370,742 $386,829
========= ==========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
Page 4
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands)
--------------
For the twenty eight weeks ended
July 11, 2004 July 13, 2003
------------- -------------
Revenues:
Restaurant sales $159,530 $156,754
Franchise related income 5,991 5,330
Real estate and other 3,407 3,074
----------- ----------
Total revenues 168,928 165,158
----------- ----------
Costs and expenses:
Cost of food and paper products 35,946 33,547
Payroll and other employee benefits 45,851 45,827
Other operating costs 59,444 59,529
Depreciation and amortization 8,674 10,409
General and administrative costs 13,458 14,066
Provision for restaurant closings 375 1,057
----------- ----------
Total costs and expenses 163,748 164,435
----------- ----------
Operating income 5,180 723
----------- ----------
Other (expense) income:
Interest expense (16,583) (16,763)
Interest income 324 411
Equity in net income of unconsolidated affiliates 748 511
----------- ----------
Net other (expense) (15,511) (15,841)
----------- ----------
(Loss) before minority interest (10,331) (15,118)
Minority interest (17) (10)
----------- ----------
(Loss) before income taxes (10,348) (15,128)
Income taxes 369 574
----------- ----------
Net (loss) ($10,717) ($15,702)
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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
July 11, 2004 July 13, 2003
------------- -------------
Revenues:
Restaurant sales $68,684 $68,245
Franchise related income 2,587 2,391
Real estate and other 1,446 1,407
----------- ----------
Total revenues 72,717 72,043
----------- ----------
Costs and expenses:
Cost of food and paper products 15,937 14,243
Payroll and other employee benefits 19,704 19,816
Other operating costs 25,637 25,797
Depreciation and amortization 3,678 4,513
General and administrative costs 5,344 5,347
Provision for restaurant closings 200 528
----------- ----------
Total costs and expenses 70,500 70,244
----------- ----------
Operating income 2,217 1,799
----------- ----------
Other (expense) income:
Interest expense (7,106) (7,180)
Interest income 128 197
Equity in net income of unconsolidated affiliates 350 230
----------- ----------
Net other (expense) (6,628) (6,753)
----------- ----------
(Loss) before minority interest (4,411) (4,954)
Minority interest (17) (5)
----------- ----------
(Loss) before income taxes (4,428) (4,959)
Income taxes 128 253
----------- ----------
Net (loss) ($4,556) ($5,212)
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SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page 6
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
--------------
For the twenty eight weeks ended
July 11, 2004 July 13, 2003
------------- -------------
Operating activities:
Net (loss) ($10,717) ($15,702)
Adjustments to reconcile net (loss) to net cash used
in operating activities:
Depreciation and amortization 8,674 10,409
Accretion of original issue discount 204 204
Amortization of deferred financing costs 518 579
Increase in deferred rent, net 165 212
Loss on sale of other concept units - 50
Restaurant closing costs 375 71
Minority interest 17 10
Equity in net income of unconsolidated affiliates (748) (511)
Dividends received from unconsolidated affiliate 305 119
----------- -----------
(1,207) (4,559)
Changes in operating assets and liabilities:
Receivables (289) 422
Inventories (224) 1,005
Prepaid expenses (6,147) (5,694)
Other assets 70 (130)
Accounts payable and accrued expenses (5,942) 1,160
Accrued interest payable 1,079 1,079
----------- -----------
Net cash used in operating activities (12,660) (6,717)
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SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
Page 7
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(CONTINUED)
(In thousands)
--------------
For the twenty eight weeks ended
July 11, 2004 July 13, 2003
------------- -------------
Investing activities:
Purchases of property and equipment ($4,211) ($4,739)
----------- ----------
Net cash used in investing activities (4,211) (4,739)
----------- ----------
Financing activities:
Mortgage principal repayments (96) (88)
Tax distributions (682) (1,10l)
Reduction in loans receivable from officers 505 -
----------- ----------
Net cash used in financing activities (273) (1,189)
----------- ----------
Decrease in cash and cash equivalents (17,144) (12,645)
Cash and cash equivalents at beginning of period 56,409 55,150
----------- ----------
Cash and cash equivalents at end of period $39,265 $42,505
========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $223 $330
========== ==========
Cash paid during the period for interest $14,796 $14,867
========== ==========
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 the consolidated financial position of Sbarro and our subsidiaries
at July 11, 2004 and our consolidated results of operations and cash
flows for the twenty-eight and twelve week periods ended July 11, 2004
and July 13, 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.
Certain items in the financial statement presented have been
reclassified to conform to the fiscal 2004 presentation.
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(R). We have also reviewed our corporate relationships for possible
coverage under FIN No. 46(R). The application of FIN No. 46(R) 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 provide disclosures. However, we are not the primary
beneficiary and therefore do not need to consolidate these entities.
Page 9
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 July 11, 2004, that ratio was 1.3 to 1. As a
result, we are not presently able to borrow funds except for the
specifically permitted indebtedness, including up to $75 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 $20.5 million, and
then only to the extent of any excess over that amount.
In March 2000, one of our subsidiaries obtained a $16 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 July 11, 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 July 11, 2004.
Page 10
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
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 filed a complaint
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 but failed to specify 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 sought
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.
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 have agreed to binding
Page 11
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
arbitration. We believe that our maximum liability that would result
from the binding arbitration could 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 State of 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 believe that our guarantee is
limited in amount, while the landlord alleges 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.
The following condensed consolidating financial information presents:
(1) Condensed consolidating balance sheets as of July 11, 2004
(unaudited) and December 28, 2003 and statements of operations
and cash flows for the twenty-eight and twelve weeks ended July
11, 2004 (unaudited) and July 13, 2003 (unaudited) of (a) Sbarro,
Inc., the parent, (b) the guarantor subsidiaries as a group, (c)
the non-guarantor 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 non guarantor 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
CONSOLIDATING BALANCE SHEET
AS OF JULY 11, 2004
(IN THOUSANDS EXCEPT SHARE DATA)
(UNAUDITED)
GUARANTOR NONGUARANTOR
ASSETS PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
- ------ ------ ------------ ------------ ------------ ------------
Current assets:
Cash and cash equivalents $34,548 $3,594 $1,123 $39,265
Receivables less allowance for doubtful
accounts of $455
Franchisees 2,192 - - 2,192
Other (228) 1,127 369 1,268
Inventories 1,229 1,557 145 2,931
Prepaid expenses 8,110 1,629 387 10,126
Current portion of loans receivable from
officers 2,589 - 2,589
---------- ----------- --------- -----------
Total current assets 48,440 7,907 2,024 58,371
Intercompany receivables 2,948 311,057 - ($314,005) -
Investment in subsidiaries 65,469 - - (65,469) -
Property and equipment, net 34,703 52,606 4,262 91,571
Intangible assets:
Trademarks, net 195,916 - - 195,916
Goodwill, net 9,101 - 103 9,204
Deferred financing costs and other, net 4,752 212 - 4,964
Loans receivable from officers less current
portion 3,062 - - 3,062
Other assets 8,504 1,781 (649) (1,982) 7,654
---------- ----------- --------- ------------- -----------
$372,895 $373,563 $5,637 ($381,353) $370,742
========== =========== ========= ============= ===========
Page 13
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING BALANCE SHEET
AS OF JULY 11, 2004
(IN THOUSANDS EXCEPT SHARE DATA)
(UNAUDITED)
GUARANTOR NONGUARANTOR
LIABILITIES & SHAREHOLDERS' EQUITY PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
---------------------------------- ------ ------------ ------------ ------------ ------------
Current liabilities:
Accounts payable $10,485 $177 $340 $598 $11,600
Accrued expenses 11,023 1,293 1,812 14,128
Accrued interest payable 9,260 - - 9,260
Current portion of mortgage payable - 176 - - 176
---------- ----------- --------- ------------ ---------
Total current liabilities 30,768 1,646 2,152 598 35,164
---------- ----------- --------- ------------ ---------
Intercompany payables 311,057 - 2,948 (314,005) -
---------- ----------- --------- ------------ ---------
Deferred rent 8,284 - 671 8,955
--------- ---------- ------ ---------
Long-term debt, net 253,032 15,220 - 268,252
---------- ----------- --------- ---------
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) (230,327) 291,228 (2,611) - 58,290
---------- ----------- --------- ------------ ---------
(230,246) 356,697 (134) (67,946) 58,371
---------- ----------- --------- ------------ ---------
Total shareholders' equity (deficit) $372,895 $373,563 $5,637 ($381,353) $370,742
========== =========== ========= ============ =========
Page 14
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 28, 2003
(IN THOUSANDS)
GUARANTOR NONGUARANTOR
ASSETS PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
Current assets:
Cash and cash equivalents $49,515 $5,595 $1,299 $56,409
Receivables less allowance for
doubtful accounts of $488
Franchisees 1,700 - - 1,700
Other (191) 966 396 1,171
Inventories 1,177 1,387 143 2,707
Prepaid expenses 4,039 (227) 53 3,865
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 other, net 5,369 233 - (120) 5,482
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
CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 28, 2003
(IN THOUSANDS EXCEPT SHARE DATA)
GUARANTOR NONGUARANTOR
LIABILITIES & SHAREHOLDERS'EQUITY PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
Current liabilities:
Accounts payable $11,859 $129 $419 $1,327 $13,734
Accrued expenses 15,542 1,447 1,806 18,795
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 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
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE TWENTY EIGHT WEEKS ENDED JULY 11, 2004
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
Revenues:
Restaurant sales $68,652 $83,148 $7,730 $159,530
Franchise related income 5,991 - - 5,991
Real estate and other 1,865 1,542 - 3,407
Intercompany charges 4,985 - - $(4,985) -
--------- ------------ ------------ ------------ -------------
Total revenues 81,493 84,690 7,730 (4,985) 168,928
--------- ------------ ------------ ------------ -------------
Cost and expenses:
Cost of food and paper products 14,414 19,392 2,140 35,946
Payroll and other employee benefits 18,335 24,890 2,626 45,851
Other operating costs 27,277 29,996 2,171 59,444
Depreciation and amortization 3,773 4,415 486 8,674
General and administrative 7,290 6,017 151 13,458
Provision for restaurant closings 375 - - 375
Intercompany charges - 4,985 - (4,985) -
--------- ------------ ------------ ------------ -------------
Total costs and expenses 71,464 89,695 7,574 (4,985) 163,748
--------- ------------ ------------ ------------ -------------
Operating income (loss) 10,029 (5,005) 156 5,180
--------- ------------ ------------ -------------
Other (expense) income:
Interest expense (15,800) (783) (16,583)
Interest income 324 - 324
Equity in net income of
unconsolidated affiliates 748 - 748
--------- ------------ ------------ -------------
Net other expense (14,728) (783) (15,511)
--------- ------------ ------------ -------------
(Loss) income before minority interest (4,699) (5,788) 156 (10,331)
Minority interest - - (17) (17)
--------- ------------ ------------ -------------
(Loss) income before income taxes (4,699) (5,788) 139 (10,348)
Income taxes (benefit) 168 207 (6) 369
--------- ------------ ------------ -------------
Net (loss) income ($4,867) ($5,995) $145 ($10,717)
========= ============ ============ =============
Page 17
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE TWENTY EIGHT WEEKS ENDED JULY 13, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
Revenues:
Restaurant sales $66,633 $82,261 $7,860 $156,754
Franchise related income 5,330 - - 5,330
Real estate and other 1,489 1,551 34 3,074
Intercompany charges 5,492 - - $(5,492) -
------------- ------------ ---------- ----------- ------------
Total revenues 78,944 83,812 7,894 (5,492) 165,158
------------- ------------ ---------- ----------- ------------
Cost and expenses:
Restaurant operating expenses:
Cost of food and paper products 13,578 17,914 2,055 33,547
Payroll and other employee benefits 18,866 24,245 2,716 45,827
Other operating costs 27,024 30,378 2,127 59,529
Depreciation and amortization 4,697 5,173 539 10,409
General and administrative 8,454 5,706 (94) 14,066
Provision for restaurant closings 900 - 157 1,057
Intercompany charges - 5,492 - (5,492) -
------------- ------------ ---------- ----------- ------------
Total costs and expenses 73,519 88,908 7,500 (5,492) 164,435
------------- ------------ ---------- ----------- ------------
Operating income (loss) 5,425 (5,096) 394 723
------------- ------------ ---------- ------------
Other (expense) income:
Interest expense (15,978) (785) (16,763)
Interest income 411 - 411
Equity in net income of
Unconsolidated affiliates 511 - 511
------------- ------------ ------------
Net other expense (15,056) (785) (15,841)
------------- ------------ ------------
(Loss) income before minority interest (9,631) (5,881) 394 (15,118)
Minority interest - - (10) (10)
------------- ------------ ---------- ------------
(Loss) income before income taxes (9,631) (5,881) 384 (15,128)
Income taxes (benefit) 373 215 (14) 574
------------- ------------ ---------- ------------
Net (loss) income $(10,004) $(6,096) $398 $(15,702)
============= ============ ========== ============
Page 18
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE TWELVE WEEKS ENDED JULY 11, 2004
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
Revenues:
Restaurant sales $29,669 $35,636 $3,379 $68,684
Franchise related income 2,587 - - 2,587
Real estate and other 854 592 - 1,446
Intercompany charges 2,461 - - ($2,461) -
------------- ------------ ---------- --------- ------------
Total revenues 35,571 36,228 3,379 (2,461) 72,717
------------- ------------ ---------- --------- ------------
Cost and expenses:
Cost of food and paper products 6,377 8,602 958 15,937
Payroll and other employee benefits 7,888 10,687 1,129 19,704
Other operating costs 11,732 12,962 943 25,637
Depreciation and amortization 1,617 1,853 208 3,678
General and administrative 3,004 2,241 99 5,344
Provision for restaurant closings 200 - - 200
Intercompany charges - 2,461 - (2,461) -
------------- ------------ ---------- --------- ------------
Total costs and expenses 30,818 38,806 3,337 (2,461) 70,500
------------- ------------ ---------- --------- ------------
Operating (loss) income 4,753 (2,578) 42 2,217
------------- ------------ ---------- ------------
Other (expense) income:
Interest expense (6,768) (338) (7,106)
Interest income 128 - 128
Equity in net income of
unconsolidated affiliates 350 - 350
------------- ------------ ------------
Net other expense (6,290) (338) (6,628)
------------- ------------ ------------
(Loss) income before minority interest (1,537) (2,916) 42 (4,411)
Minority interest - - (17) (17)
------------- ------------ ---------- ------------
(Loss) income before income taxes (1,537) (2,916) 25 (4,428)
Income taxes 33 95 - 128
------------- ------------ ---------- ------------
Net (loss) income ($1,570) ($3,011) $25 ($4,556)
============= ============ =========== ============
Page 19
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE TWELVE WEEKS ENDED JULY 11, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
Revenues:
Restaurant sales $29,217 $35,667 $3,361 $68,245
Franchise related income 2,391 - - 2,391
Real estate and other 709 664 34 1,407
Intercompany charges 2,333 - - $(2,333) -
----------- --------- ----------- --------- -------------
Total revenues 34,650 36,331 3,395 (2,333) 72,043
----------- --------- ----------- --------- -------------
Cost and expenses:
Cost of food and paper products 5,780 7,590 873 14,243
Payroll and other employee benefits 8,235 10,451 1,130 19,816
Other operating costs 11,886 13,041 870 25,797
Depreciation and amortization 2,053 2,233 227 4,513
General and administrative 3,455 2,081 (189) 5,347
Provision for restaurant closings 500 - 28 528
Intercompany charges - 2,333 - (2,333) -
----------- --------- ----------- --------- -------------
Total costs and expenses 31,909 37,729 2,939 (2,333) 70,244
----------- --------- ----------- --------- -------------
Operating income (loss) 2,741 (1,398) 456 1,799
-------- -------- ------- --------
Other (expense) income:
Interest expense (6,847) (333) (7,180)
Interest income 197 - 197
Equity in net income of
unconsolidated affiliates 230 - 230
----------- --------- -------------
Net other expense (6,420) (333) (6,753)
----------- --------- -------------
(Loss) income before minority interest (3,679) (1,731) 456 (4,954)
Minority interest - - (5) (5)
----------- --------- ----------- -------------
(Loss) income before income taxes (3,679) (1,731) 451 (4,959)
Income taxes (benefit) 186 83 (16) 253
----------- --------- ----------- -------------
Net (loss) income $(3,865) $(1,814) $467 $(5,212)
=========== ========= =========== =============
Page 20
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE TWENTY EIGHT WEEKS ENDED JULY 11, 2004
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
- ---------------------
Net (loss) income ($4,866) ($5,995) $144 ($10,717)
Adjustments to reconcile net (loss)
income to net cash (used in)
provided by operating activities:
Depreciation and amortization 3,773 4,415 486 8,674
Accretion of original issue discount 204 - - 204
Amortization of deferred financial costs 498 20 518
Increase in deferred rent, net 160 36 (31) 165
Provision for restaurant closing 375 - - 375
Minority interest - - 17 17
Equity in net income of
unconsolidated affiliates (748) - - (748)
Dividends received from
unconsolidated affiliates 305 - - 305
-------- ------------- -------- ----------
(299) (1,524) 616 (1,207)
Changes in operating assets and liabilities:
Receivables (155) (161) 27 (289)
Inventories (52) (170) (2) (224)
Prepaid expenses (3,956) (1,857) (334) (6,147)
Other assets (1,176) 80 438 $728 70
Accounts payable and accrued expenses (5,018) (105) (91) (728) (5,942)
Accrued interest payable 1,079 - - 1,079
-------- ------------- -------- ----------
Net cash (used in) provided by operating
activities (9,577) (3,737) 654 (12,660)
-------- ------------- -------- ----------
Page 21
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE TWENTY EIGHT WEEKS ENDED JULY 11, 2004
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
INVESTING ACTIVITIES:
- ---------------------
Purchases of property and equipment (2,453) (1,720) (38) (4,211)
---------- --------- ----------- ---------
Net cash used in investing activities (2,453) (1,720) (38) (4,211)
---------- --------- ----------- ---------
FINANCING ACTIVITIES:
- ---------------------
Mortgage principal repayments - (96) - (96)
Tax distribution (682) - - (682)
Loans receivable from officers 505 - - 505
Intercompany balances (2,760) 3,552 (792) -
---------- --------- ----------- ---------
Net cash provided by (used in)
financing activities (2,937) 3,456 (792) (273)
---------- --------- ----------- ---------
Decrease in cash and cash equivalents (14,967) (2,001) (176) (17,144)
Cash and cash equivalents at beginning
of period 49,515 5,595 1,299 56,409
---------- --------- ----------- ---------
Cash and cash equivalents at end of
period $34,548 $3,594 $1,123 $39,265
========== ========= =========== =========
SS Supplemental disclosure of cash flow
information:
Cash paid during the period for income
taxes $112 $95 $16 $223
========== ========= =========== =========
Cash paid during the period for interest $14,025 $771 - $14,796
========== ========= =========== ==========
Page 22
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE TWENTY EIGHT WEEKS ENDED JULY 13, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
OPERATING ACTIVITIES:
- ---------------------
Net (loss) income ($10,004) ($6,096) $398 ($15,702)
Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating
activities:
Depreciation and amortization 4,697 5,173 539 10,409
Amortization of deferred financing costs 579 - - 579
Accretion of original issue discount 204 - - 204
Provision for restaurant closing 71 - - 71
Increase (decrease) in deferred rent 215 (27) 24 212
Loss on sale of other concept units - - 50 50
Minority interest - - 10 10
Equity in net income of unconsolidated
affiliates (511) - - (511)
Dividends received from unconsolidated
affiliates 119 - - 119
----------- ---------- --------- ------------
(4,630) (950) 1,021 (4,559)
Changes in operating assets and liabilities:
Receivables 88 355 (21) 422
Inventories 452 547 6 1,005
Prepaid expenses (3,711) (1,782) (201) (5,694)
Other assets (592) (27) 489 (130)
Accounts payable and accrued expenses 852 375 (67) 1,160
Accrued interest payable 1,079 - - 1,079
----------- ---------- --------- ------------
Net cash (used in) provided by operating
activities (6,462) (1,482) 1,227 (6,717)
----------- ---------- --------- ------------
Page 23
SBARRO, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE TWENTY EIGHT WEEKS ENDED JULY 13, 2003
(IN THOUSANDS)
(UNAUDITED)
GUARANTOR NONGUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
------ ------------ ------------ ------------ ------------
INVESTING ACTIVITIES:
- ---------------------
Purchase of property and equipment (3,080) (1,508) (151) (4,739)
----------- -------- ------- ---------
Net cash used in investing activities (3,080) (1,508) (151) (4,739)
----------- -------- ------- ---------
FINANCING ACTIVITIES:
- ---------------------
Mortgage principal repayments - (88) - (88)
Tax distribution (1,101) - - (1,101)
Intercompany balances 733 553 (1,286) -
----------- -------- ------- ---------
Net cash (used in) provided by
financing activities (368) 465 (1,286) (1,189)
----------- -------- ------- ---------
Decrease in cash and
cash equivalents (9,910) (2,525) (210) (12,645)
Cash and cash equivalents at
beginning of period 47,636 6,539 975 55,150
----------- -------- ------- ---------
Cash and cash equivalents at
end of period $37,726 $4,014 $765 $42,505
=========== ======== ======= =========
Supplemental disclosure of cash flow
information:
Cash paid during the period for
income taxes $244 $73 $13 $330
=========== ======== ======= =========
Cash paid during the period for
Interest $14,102 $765 - $14,867
=========== ======== ======= =========
Page 24
SBARRO, INC. AND SUBSIDIARIES
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:
28 WEEKS 28 WEEKS 12 WEEKS 12 WEEKS
--------- --------- --------- ---------
ENDED ENDED ENDED ENDED FISCAL YEAR
----- ----- ----- ----- -----------------
7/11/2004 7/13/03 7/11/04 7/13/03 2003 2002
Company-owned restaurants:
Opened during period 2 1 - 1 4 13
Acquired from (sold to)
franchisees during period, net (2) (6) - (2) (12) (6)
Closed during period (15) (16) (3) (7) (22) (51)
Open at end of period (1) 513 537 513 537 528 558
Franchised restaurants:
Opened during period 23 22 14 12 39 42
Purchased from (sold to)
Company during
period, net 2 6 - 2 12 6
Closed or terminated during period (5) (13) - (5) (17) (20)
Open at end of period 407 368 407 368 387 353
All restaurants:
Opened during period 25 23 14 13 43 55
Closed or terminated during period (20) (29) (3) (12) (39) (71)
Opened at end of period (1) 920 905 920 905 915 911
Kiosks (all franchised) open at
end of period 3 3 3 3 3 3
(1) Excludes 29, 31, 29 and 32 other concept units as of July 11, 2004 and July
13, 2003, the end of fiscal 2003 and the end of fiscal 2002, respectively.
Page 25
SBARRO, INC. AND SUBSIDIARIES
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, 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" until
after our fourth quarter is completed. Our annual impairment test is performed
at that time unless impairment factors are present earlier.
RELEVANT FINANCIAL INFORMATION
Twenty eight weeks ended Twelve weeks ended
July 11, 2004 July 13, 2003 July 11, 2004 July 13, 2003
------------- ------------- ------------- -------------
in millions except number of locations
Comparable Sbarro - owned quick service sales(1) $150.4 $142.8 $64.8 $62.6
Comparable Sbarro - owned quick service sales -
percentage change (1) 5.3% 4.5% 3.6% 2.6%
Franchise location sales $127.1 $120.4 $55.2 $54.5
Franchise revenues $6.0 $5.3 $2.6 $2.4
Cost of food and paper products as a percentage
of restaurant sales 22.5% 21.4% 23.2% 20.9%
Payroll and other benefits as a percentage of
restaurant sales 28.7% 29.2% 28.7% 29.0%
Other operating expenses as a percentage of
restaurant sales 37.3% 38.0% 37.3% 37.8%
General and administrative costs as a
percentage of revenues 8.0% 8.5% 7.4% 7.4%
Provision for asset impairment and restaurant
closings $0.4 $1.1 $0.2 $0.5
EBITDA $14.6 $11.6 $6.2 $6.5
(1) Comparable Sbarro-owned quick service sales dollar and annual percentage
changes are based on locations that were comparable as of July 11, 2004 in each
of the periods presented based on locations opened prior to December 29, 2002.
Page 26
SBARRO, INC. AND SUBSIDIARIES
Our consolidated EBITDA for the first half of 2004 was $14.6 million compared to
$11.6 million for the first half of 2003. Our consolidated EBITDA for the second
quarter of 2004 was $6.2 million compared to $6.5 million for the second quarter
of 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 of the United States ("GAAP") 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 each of the periods presented which we believe is the
most direct comparable GAAP financial measure to EBITDA (in thousands):
Twenty eight weeks ended: Twelve weeks ended:
7/11/2004 7/13/2003 7/11/2004 7/13/2003
--------- --------- --------- ---------
EBITDA $14,573 $11,633 $6,228 $6,537
Interest expense (16,583) (16,763) (7,106) (7,180)
Interest income 324 411 128 197
Income taxes (369) (574) (128) (253)
Depreciation and amortization (8,662) (10,409) (3,678) (4,513)
========== ========== =========== ========
Net loss ($10,717) ($15,702) ($4,556) ($5,212)
========== ========== =========== ========
Page 27
SBARRO, INC. AND SUBSIDIARIES
Restaurant sales increased $2.7 million, or 1.8%, to $159.5 million for the
first half of fiscal 2004 from $156.8 million for the first half of fiscal 2003.
The increase in sales included $2.9 million of higher sales of the quick service
business offset by $0.2 million of lower sales of consolidated other concepts.
The increase in quick service business included an approximate $7.6 million
(5.3%) increase in comparable sales offset by the loss of approximately $6.6
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
operating results. Sales for locations that opened during fiscal 2004 and an
increase in sales of the locations that were opened during the first half of
fiscal 2003 comprised the remaining $1.9 million increase in quick service
sales.
Restaurant sales increased $0.5 million, or 0.6%, to $68.7 million for the
second quarter of fiscal 2004 from $68.2 million in the second quarter of 2003.
This increase in sales is primarily a result of $0.5 million of higher sales of
the quick service business. The increase in the quick service business included
an approximate $2.2 million (3.6%) increase in comparable sales offset by the
loss of approximately $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 operating results. Second quarter sales for both
locations that opened during fiscal 2004 and the increase in sales of the
locations that were opened during the first half of fiscal 2003 comprised the
remaining $1.1 million increase in quick service sales.
We believe that the increases in comparable sales are primarily due to economic
trends, the strengthening of operational management and training programs which
generated operational efficiencies, as well as a series of selective price
increases that became effective during the second quarter of fiscal 2004 and
during the last half of the first quarter of 2004. We believe that the price
increases will have an approximate 2% effect on sales on an annual basis.
Franchise related income increased 12.4% to $6.0 million for the first half of
2004 from $5.3 million in the first half of fiscal 2003. The increase in
franchise related income is comprised of increases in royalties from comparable
locations that resulted from sales increases of 12.5% for international
locations and 3.1% for domestic locations as well as royalty income derived from
locations opened during the first and second quarters of 2004 and 2003.
Franchise related income increased 8.2% to $2.6 million for the second quarter
of 2004 from $2.4 million for the second quarter of 2003. The increase in
franchise related income is comprised of increases in royalties from comparable
locations that resulted from sales increases of 3.6% for international locations
and 3.7% for domestic locations as well as royalty income derived during the
second quarter from locations opened during the first and second quarters of
2004 and 2003.
Real estate and other revenues increased 10.8% and 2.8% in the first half and
second quarter of fiscal 2004 from the same periods in fiscal 2003,
respectively, primarily due to variations in certain vendor rebates relating to
franchises and marketing allowances.
Cost of food and paper products as a percentage of restaurant sales increased to
22.5% for the first half of fiscal 2004 from 21.4% for the comparable 2003
fiscal period. These costs increased to 23.2% for the second quarter of 2004
from 20.9% for the comparable period in 2003. While
Page 28
SBARRO, INC. AND SUBSIDIARIES
the cost of sales percentages in 2004 were positively impacted by operating
efficiencies resulting from the increase in comparable unit sales and the price
increases implemented during 2004, cheese prices increased to record high levels
during the second fiscal quarter of 2004 but moderated significantly during the
latter part of that quarter. These fluctuations in cheese prices resulted in
1.7% and 2.7% increases in the cost of sales in the first half and second
quarter of fiscal 2004, respectively, when compared to the same periods in
fiscal 2003.
Payroll and other employee benefits decreased to 28.7% of restaurant sales for
the first half of 2004 from 29.2% of restaurant sales in the first half of 2003.
Payroll and other employee benefits decreased to 28.7% of restaurant sales for
the second quarter of fiscal 2004 from 29.0% of restaurant sales for the second
quarter of fiscal 2003. These percentage decreases were primarily due to
increased revenues as a result of both unit sales and price increases as well as
the elimination of locations with higher payroll costs as a percentage of
restaurant sales.
Other operating expenses decreased to 37.3% of restaurant sales in the first
half of fiscal 2004 from 38.0% of restaurant sales in the first half of 2003.
Other operating expenses decreased to 37.3% of restaurant sales for the second
quarter of 2004 from 37.8% of restaurant sales for the second quarter of 2003.
As a percentage of restaurant sales, these costs improved primarily as a result
of the higher level of sales.
Depreciation and amortization expense was $1.7 million lower for the first half
and $0.8 million lower for the second quarter of fiscal 2004, as compared to the
same periods in 2003. Of the reduction in the first half of the year, $0.4
million was due to the reduction in the number of units in operation, $0.6
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,
$0.4 million related to locations that became fully depreciated during fiscal
2003 and $0.3 million related to depreciable assets at our former administrative
office building on which the lease was terminated May 2004. Of the reduction in
the second quarter of this year, $0.1 million was due to the reduction in the
number of units in operation, $0.2 million was for locations that had been
included in the provision for asset impairment in fiscal 2003, $0.2 million
related to locations that became fully depreciated during fiscal 2003 and $0.2
million related to depreciable assests at our former administrative office
building on which the lease was terminated May 2004.
General and administrative expenses were $13.5 million, or 8.0% of total
revenues, for the first half of fiscal 2004 compared to $14.1 million, or 8.5%
of total revenues, for the first half of 2003. Factors contributing to the
changes for the first half of 2004 included approximately $1.4 million of lower
costs due to the reduction in work force, a $0.2 million decrease in bad debt
expense recorded in the first quarter of fiscal 2003 and 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
recorded in the first quarter of fiscal 2004 of severance and other costs
related to the reduction in work force and $0.7 million of costs related to new
executives. In addition, general and administrative costs in the second quarter
of 2003 included a $0.3 million gain on the sale of an other concept location.
The annual effect of our reduction in work force on our administrative and
general costs is estimated at $3.1 million.
Page 29
SBARRO, INC. AND SUBSIDIARIES
General administrative expenses were $5.3 million in each second quarter, or
7.3% and 7.4% of total revenues, for the second quarter of fiscal 2004 and 2003,
respectively. For the second quarter of 2004, there were lower costs due to the
reduction in work force of approximately $0.7 million offset by costs of
approximately $0.3 million for new executives. General and administrative costs
in the second quarter of 2003 included a $0.3 million gain on the sale of an
other concept location.
Interest expense for the first half of fiscal 2004 and 2003 was $16.6 million
and $16.8 million, respectively, and $7.1 million and $7.2 million for the
second quarter of 2004 and 2003, respectively. Interest costs were incurred for
the 11%, $255 million senior notes issued to finance our going private
transaction in 1999 and the 8.4%, $16 million mortgage loan on our corporate
headquarters in 2001. In addition, interest expense includes 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 and the mortgage
loan and, for 2003, the credit agreement that was terminated in the fourth
quarter of fiscal 2003.
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 $0.2 million and $0.1 million
increase in the first half and second quarter of 2004, respectively, 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 which are
expected to be completed by the end of fiscal 2004 or early in fiscal 2005. We
do not have any further expansion plans for our unconsolidated joint ventures.
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 $0.4 million and approximately $0.6 million
for the first halves and $0.1 million and $0.3 million for the second quarters
of 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, 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
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SBARRO, INC. AND SUBSIDIARIES
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. There were no unpaid capital expenditure commitments at July 11, 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 except for required letters of credit.
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.
SOURCES AND USES OF CASH
The following table summarizes our cash and cash equivalents and working capital
as at the end of the second quarter of 2004 and 2003 and the uses of our cash
flows during the first half of each of the respective fiscal years:
As at and for the Six Months Ended
----------------------------------
July 11, 2004 July 13, 2003
------------- -------------
(in millions)
-------------
Liquidity at the end of periods
- -------------------------------
Cash and cash equivalents $ 39.3 $42.5
Working capital 23.2 15.6
Net cash flows for the period
- -----------------------------
Used in operating activities (12.7) (6.7)
Used in investing activities (4.2) (4.7)
Used in financing activities (0.3) (1.2)
Net decrease in cash (17.2) (12.6)
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 $12.7 million for the first half of
2004 compared to $6.7 million used during the first half of 2003. The $5.9
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 half of 2004
compared to the same calculation for the first half of 2003 of approximately
$3.3 million, income tax refunds received of approximately $0.3 million,
contractual payments of $0.2
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SBARRO, INC. AND SUBSIDIARIES
million related to prior year sales of other concept locations and a $2.4
million increase in the use of 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 $1.2 million in inventory value
due to increases in product costs, primarily cheese, a reduction in franchise
related collections during fiscal 2004 of approximately $1.2 million and a
decrease of approximately $4.7 million in accounts payable and accrued expenses
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 years.
Net cash used in investing activities has historically been primarily for
capital expenditures. Net cash used in investing activities decreased from $4.7
million for the first half of 2003 to $4.2 million for the first half of 2004
primarily due to $0.6 million that was expended in the first half of fiscal 2003
relating to an upgrade of our computer system.
Net cash used in financing activities was $0.3 million in the first half of
fiscal 2004 compared to $1.2 million for the first half 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 operation.
FINANCING
As part of the transaction in which we became a privately-held company in 1999,
we sold $255 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. At that time, we
also entered into a $30 million credit agreement that we terminated in the
fourth quarter of 2003.
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 to make "restricted payments" including, among other
things, dividend payments (other
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SBARRO, INC. AND SUBSIDIARIES
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 July 11, 2004,
that ratio was 1.3 to 1. As a result, we are not presently able to borrow funds
except for specifically permitted indebtedness, including 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 $20.5 million, and then only to the extent of any excess over that
amount.
In March 2000, one of our subsidiaries obtained a $16 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 July 11, 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 July 11, 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 first half of fiscal 2004, there
were no material changes in the accounting policies, the application of which
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.
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SBARRO, INC. AND SUBSIDIARIES
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- ----------------------------------------------
During the first half of fiscal 2004 there were no changes in the matters
discussed under the heading "Certain Relationships and Related Transactions" in
Part II, Item 13 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.
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, energy prices 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.
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SBARRO, INC. AND SUBSIDIARIES
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.
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SBARRO, INC. AND SUBSIDIARIES
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 are 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 that 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 twenty eight weeks ended July 11, 2004 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
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SBARRO, INC. AND SUBSIDIARIES
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 second fiscal quarter of fiscal 2004.
Item 6. Exhibits and Reports on Form 8-K.
a) Exhibits:
31.01 Certification of Principal Executive Officer 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.
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SBARRO, INC. AND SUBSIDIARIES
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: August 17, 2004 By: /s/ MICHAEL O'DONNELL
--------------------- ----------------------------------------
Michael O'Donnell
President and Chief Executive Officer
Date: August 17, 2004 By: /s/ ANTHONY J. PUGLISI
--------------------- ----------------------------------------
Anthony J. Puglisi
Vice President; Chief Financial Officer and
Principal Accounting Officer
Page 38
EXHIBIT INDEX
-------------
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
31.01 Certification of Principal Executive Officer 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.