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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarter ended October 3, 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
November 5, 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 - October 3, 2004 (unaudited) and December 28, 2003.............................3-4
Statements of Operations (unaudited) - Forty and Twelve Weeks ended
October 3, 2004 and October 5, 2003........................................................5-6
Statements of Cash Flows (unaudited) - Forty Weeks ended
October 3, 2004 and October 5, 2003........................................................7-8
Notes to Unaudited Consolidated Financial Statements..........................................9-24
Management's Discussion and Analysis of Financial Condition and Results of
Operations........................................................................................25-34
Qualitative and Quantitative Disclosures of Market Risk..................................................35
Controls and Procedures..................................................................................35
PART II. OTHER INFORMATION...........................................................................36
Page 2
Part I - Financial Information
Item 1. Consolidated Financial Statements
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
--------------------------
ASSETS October 3, 2004 December 28, 2003
-------- --------
(unaudited)
Current assets:
Cash and cash equivalents $ 36,561 $ 56,409
Receivables, net of allowance for doubtful
accounts of $460 in 2004 and $488 in 2003:
Franchisees 1,927 1,700
Other 1,666 1,171
Inventories 2,516 2,707
Prepaid expenses 10,711 3,865
Current portion of loans receivable from officers 5,550 2,810
-------- --------
Total current assets 58,931 68,662
Property and equipment, net 89,641 96,604
Intangible assets:
Trademarks, net 195,916 195,916
Goodwill, net 9,204 9,204
Deferred financing costs and other, net 4,742 5,482
Loans receivable from officers, less current portion 102 3,347
Other assets 7,404 7,614
-------- --------
$365,940 $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 October 3, 2004 December 28, 2003
-------- --------
(unaudited)
Current liabilities:
Accounts payable $ 11,050 $ 13,734
Accrued expenses 18,343 18,795
Accrued interest payable 1,708 8,181
Current portion of mortgage payable 179 168
-------- --------
Total current liabilities 31,280 40,878
-------- --------
Deferred rent 9,024 8,711
-------- --------
Long-term debt, net 268,294 268,152
-------- --------
Commitments and 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 57,261 69,007
-------- --------
Total shareholders' equity 57,342 69,088
-------- --------
$365,940 $386,829
======== ========
See notes to unaudited consolidated financial statements.
Page 4
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands)
-----------------------------
For the forty weeks ended
-----------------------------
October 3, 2004 October 5, 2003
--------- ---------
Revenues:
Restaurant sales $ 233,587 $ 228,863
Franchise related income 8,885 7,625
Real estate and other 4,762 4,448
--------- ---------
Total revenues 247,234 240,936
--------- ---------
Costs and expenses:
Cost of food and paper products 52,015 49,248
Payroll and other employee benefits 66,109 66,357
Other operating costs 85,997 85,790
Depreciation and amortization 12,388 14,820
General and administrative costs 18,798 20,122
Asset impairment and restaurant closing charges, net 560 4,467
--------- ---------
Total costs and expenses 235,867 240,804
--------- ---------
Operating income 11,367 132
--------- ---------
Other (expense) income:
Interest expense (23,697) (23,930)
Interest income 468 569
Equity in net income of unconsolidated affiliates 678 270
--------- ---------
Net other (expense) (22,551) (23,091)
--------- ---------
(Loss) before minority interest (11,184) (22,959)
Minority interest (42) (22)
--------- ---------
(Loss) before income taxes (11,226) (22,981)
Income taxes 520 675
--------- ---------
Net (loss) ($ 11,746) ($ 23,656)
========= =========
See notes to unaudited consolidated financial statements.
Page 5
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands)
---------------------------
For the twelve weeks ended
---------------------------
October 3, 2004 October 5, 2003
-------- --------
Revenues:
Restaurant sales $ 74,057 $ 72,109
Franchise related income 2,894 2,295
Real estate and other 1,355 1,374
-------- --------
Total revenues 78,306 75,778
-------- --------
Costs and expenses:
Cost of food and paper products 16,069 15,701
Payroll and other employee benefits 20,258 20,530
Other operating costs 26,553 26,261
Depreciation and amortization 3,726 4,411
General and administrative costs 5,328 6,056
Asset impairment and restaurant closing costs, net 185 3,410
-------- --------
Total costs and expenses 72,119 76,369
-------- --------
Operating income (loss) 6,187 (591)
-------- --------
Other (expense) income:
Interest expense (7,114) (7,167)
Interest income 144 158
Equity in net loss of unconsolidated affiliates (70) (241)
-------- --------
Net other (expense) (7,040) (7,250)
-------- --------
(Loss) before minority interest (853) (7,841)
Minority interest (25) (12)
-------- --------
(Loss) before income taxes (878) (7,853)
Income taxes 151 101
-------- --------
Net (loss) ($ 1,029) ($ 7,954)
======== ========
See notes to unaudited consolidated financial statements.
Page 6
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
---------------------------
For the forty weeks ended
---------------------------
October 3, 2004 October 5, 2003
-------- --------
Operating activities:
Net (loss) ($11,746) ($23,656)
Adjustments to reconcile net (loss) to net cash (used in) operating activities:
Depreciation and amortization 12,388 14,820
Accretion of original issue discount 292 292
Amortization of deferred financing costs 740 826
Asset impairment and restaurant closing costs, net 560 4,467
Increase in deferred rent, net 282 232
Loss on sale of other concept units - 50
Minority interest 42 22
Equity in net income of unconsolidated affiliates (678) (270)
Dividends received from unconsolidated affiliate 305 119
-------- --------
2,185 (3,098)
Changes in operating assets and liabilities:
Receivables (400) 351
Inventories 191 987
Prepaid expenses (6,770) (6,371)
Other assets 207 (105)
Accounts payable and accrued expenses (2,267) (1,898)
Accrued interest payable (6,473) (6,473)
-------- --------
Net cash (used in) operating activities (13,327) (16,607)
-------- --------
See notes to unaudited consolidated financial statements.
Page 7
SBARRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(CONTINUED)
(In thousands)
---------------------------
For the forty weeks ended
---------------------------
October 3, 2004 October 5, 2003
-------- --------
Investing activities:
Purchases of property and equipment ($ 6,206) ($ 6,265)
-------- --------
Net cash used in investing activities (6,206) (6,265)
-------- --------
Financing activities:
Mortgage principal repayments (139) (128)
Tax distributions (682) (1,10l)
Reduction in loans receivable from officers 506 -
-------- --------
Net cash used in financing activities (315) (1,229)
-------- --------
Decrease in cash and cash equivalents (19,848) (24,101)
Cash and cash equivalents at beginning of period 56,409 55,150
-------- --------
Cash and cash equivalents at end of period $ 36,561 $ 31,049
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes $ 285 $ 378
======== ========
Cash paid during the period for interest $ 29,138 $ 29,250
======== ========
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 October 3, 2004 and our consolidated results of operations and cash
flows for the forty and twelve week periods ended October 3, 2004 and
October 5, 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, reported in our
Annual Report on Form 10-K for the fiscal year ended December 28, 2003.
Certain items in the financial statements 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 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.
Under our senior notes indenture, there are various covenants that
limit our ability to borrow funds, other than certain permitted
indebtedness, to make "restricted payments" including, among other
things, dividend payments and to make investments in, among other
things, unrestricted subsidiaries. The indenture for the senior notes
permits us to make distributions to shareholders pursuant to a tax
payment agreement between us and our shareholders that contains 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.
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 October 3, 2004, that ratio was 1.4 to 1. As a
result, we are not presently able to borrow funds except for
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 $20.3 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 $.1 million. The outstanding principal balance of the loan
as of October 3, 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.
We were in compliance with all covenants in the indenture for the
senior notes and our mortgage as of October 3, 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 2003 tax basis income. Of such
amount, $1.1 million was paid in the first quarter of 2003 and $.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 plaintiffs 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
Page 11
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
which mechanics liens for the plaintiffs were bonded. The parties have
agreed to binding arbitration. We believe that our maximum liability
that would result from the binding arbitration should be approximately
$400,000 and we have included this amount in our financial statements.
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 included this amount in our financial
statements. 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 October 3, 2004
(unaudited) and December 28, 2003 and statements of operations
and cash flows for the forty and twelve weeks ended October 3,
2004 (unaudited) and October 5, 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 October 3, 2004
(In thousands except share data)
(Unaudited)
Guarantor Nonguarantor
ASSETS Parent Subsidiaries Subsidiaries Eliminations Consolidated
--------- --------- --------- --------- ---------
Current assets:
Cash and cash equivalents $ 31,839 $ 3,578 $ 1,144 $ 36,561
Receivables less allowance for doubtful
accounts of $460
Franchisees 1,927 - - 1,927
Other 73 1,052 541 1,666
Inventories 1,039 1,334 143 2,516
Prepaid expenses 8,139 2,212 360 10,711
Current portion of loans receivable from
officers 5,550 - - 5,550
--------- --------- --------- ---------
Total current assets 48,567 8,176 2,188 58,931
Intercompany receivables 2,687 310,892 - ($313,579) -
Investment in subsidiaries 65,469 - - (65,469) -
Property and equipment, net 33,941 51,586 4,114 - 89,641
Intangible assets:
Trademarks, net 195,916 - - - 195,916
Goodwill, net 9,101 - - 103 9,204
Deferred financing costs and other, net 4,539 203 - - 4,742
Loans receivable from officers, less current
portion 102 - - - 102
Other assets 8,277 1,752 (654) (1,971) 7,404
--------- --------- --------- --------- ---------
$ 368,599 $ 372,609 $ 5,648 ($380,916) $ 365,940
========= ========= ========= ========= =========
Page 13
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Balance Sheet
As of October 3, 2004
(In thousands except share data)
(Unaudited)
Guarantor Nonguarantor
LIABILITIES & SHAREHOLDERS' EQUITY Parent Subsidiaries Subsidiaries Eliminations Consolidated
--------- --------- --------- --------- ---------
Current liabilities:
Accounts payable $ 9,822 $ 224 $ 395 $ 609 $ 11,050
Accrued expenses 14,997 1,636 1,710 - 18,343
Accrued interest payable 1,708 - - - 1,708
Current portion of mortgage payable - 179 - - 179
--------- --------- --------- --------- ---------
Total current liabilities 26,527 2,039 2,105 609 31,280
--------- --------- --------- --------- ---------
Intercompany payables 310,892 - 2,687 (313,579) -
--------- --------- --------- --------- ---------
Deferred rent 8,378 - 646 - 9,024
--------- --------- --------- --------- ---------
Long-term debt, net 253,119 15,175 - - 268,294
--------- --------- --------- --------- ---------
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) (230,398) 289,926 (2,267) - 57,261
--------- --------- --------- --------- ---------
Total shareholders' equity (deficit) (230,317) 355,395 210 (67,946) 57,342
--------- --------- --------- --------- ---------
$ 368,599 $ 372,609 $ 5,648 ($380,916) $ 365,940
========= ========= ========= ========= =========
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 9,101 - - 103 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 7,137 1,822 (212) (1,133)
--------- --------- --------- --------- ---------
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 forty weeks ended October 3, 2004
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
--------- --------- --------- --------- ---------
Revenues:
Restaurant sales $ 101,279 $ 121,128 $ 11,180 $ 233,587
Franchise related income 8,885 - 8,885
Real estate and other 2,569 2,193 - 4,762
Intercompany charges 8,319 - - ($ 8,319) -
--------- --------- --------- --------- ---------
Total revenues 121,052 123,321 11,180 (8,319) 247,234
--------- --------- --------- --------- ---------
Cost and expenses:
Cost of food and paper products 21,064 27,898 3,053 - 52,015
Payroll and other employee benefits 26,389 35,968 3,752 - 66,109
Other operating costs 39,812 43,041 3,144 - 85,997
Depreciation and amortization 5,345 6,346 697 - 12,388
General and administrative costs 11,148 7,626 24 - 18,798
Restaurant closing charges, net 560 - - - 560
Intercompany charges - 8,319 - (8,319) -
--------- --------- --------- --------- ---------
Total costs and expenses 104,318 129,198 10,670 (8,319) 235,867
--------- --------- --------- --------- ---------
Operating income (loss) 16,734 (5,877) 510 - 11,367
--------- --------- --------- --------- ---------
Other (expense) income:
Interest expense (22,588) (1,109) - - (23,697)
Interest income 468 - - - 468
Equity in net income of
unconsolidated affiliates 678 - - - 678
--------- --------- --------- --------- ---------
Net other (expense) (21,442) (1,109) - - (22,551)
--------- --------- --------- --------- ---------
(Loss) income before minority interest (4,708) (6,986) 510 - (11,184)
Minority interest - - (42) - (42)
--------- --------- --------- --------- ---------
(Loss) income before income taxes (4,708) (6,986) 468 - (11,226)
Income taxes (benefit) 231 310 (21) - 520
--------- --------- --------- --------- ---------
Net (loss) income ($ 4,939) ($ 7,296) $ 489 - ($ 11,746)
========= ========= ========= ========= =========
Page 17
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Statement of Operations
For the forty weeks ended October 5, 2003
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
--------- --------- --------- --------- ---------
Revenues:
Restaurant sales $ 98,078 $ 119,528 $ 11,257 $ 228,863
Franchise related income 7,625 - - 7,625
Real estate and other 2,170 2,217 61 4,448
Intercompany charges 7,841 - - ($ 7,841) -
--------- --------- --------- --------- ---------
Total revenues 115,714 121,745 11,318 (7,841) 240,936
--------- --------- --------- --------- ---------
Cost and expenses:
Cost of food and paper products 20,105 26,180 2,963 - 49,248
Payroll and other employee benefits 27,300 35,218 3,839 - 66,357
Other operating costs 39,048 43,682 3,060 - 85,790
Depreciation and amortization 6,727 7,328 765 - 14,820
General and administrative costs 11,959 8,176 (13) - 20,122
Asset impairment and restaurant closing
charges, net 4,310 - 157 - 4,467
Intercompany charges - 7,841 - (7,841) -
--------- --------- --------- --------- ---------
Total costs and expenses 109,449 128,425 10,771 (7,841) 240,804
--------- --------- --------- --------- ---------
Operating income (loss) 6,265 (6,680) 547 - 132
Other (expense) income:
Interest expense (22,810) (1,120) - - (23,930)
Interest income 569 - - - 569
Equity in net income of unconsolidated
affiliates 270 - - - 270
--------- --------- --------- --------- ---------
Net other expense (21,971) (1,120) - - (23,091)
--------- --------- --------- --------- ---------
(Loss) income before minority interest (15,706) (7,800) 547 - (22,959)
Minority interest - - (22) - (22)
--------- --------- --------- --------- ---------
(Loss) income before income taxes (15,706) (7,800) 525 - (22,981)
--------- --------- --------- --------- ---------
Income taxes (benefit) 447 244 (16) - 675
--------- --------- --------- --------- ---------
Net (loss) income ($ 16,153) ($ 8,044) $ 541 - ($ 23,656)
========= ========= ========= ========= =========
Page 18
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Statement of Operations
For the twelve weeks ended October 3, 2004
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- -------- -------- -------- --------
Revenues:
Restaurant sales $ 32,627 $ 37,980 $ 3,450 $ 74,057
Franchise related income 2,894 - - 2,894
Real estate and other 705 650 - 1,355
Intercompany charges 3,334 - - ($ 3,334) -
-------- -------- -------- -------- --------
Total revenues 39,560 38,630 3,450 (3,334) 78,306
-------- -------- -------- -------- --------
Cost and expenses:
Cost of food and paper products 6,650 8,506 913 - 16,069
Payroll and other employee benefits 8,054 11,078 1,126 - 20,258
Other operating costs 12,535 13,045 973 - 26,553
Depreciation and amortization 1,584 1,931 211 - 3,726
General and administrative costs 3,846 1,609 (127) - 5,328
Restaurant closing charges, net 185 - - - 185
Intercompany charges - 3,334 - (3,334) -
-------- -------- -------- -------- --------
Total costs and expenses 32,854 39,503 3,096 (3,334) 72,119
-------- -------- -------- -------- --------
Operating (loss) income 6,706 (873) 354 - 6,187
-------- -------- -------- -------- --------
Other (expense) income:
Interest expense (6,788) (326) - - (7,114)
Interest income 144 - - - 144
Equity in net income of
unconsolidated affiliates (70) - - - (70)
-------- -------- -------- -------- --------
Net other (expense) (6,714) (326) - - (7,040)
-------- -------- -------- -------- --------
(Loss) income before minority interest (8) (1,199) 354 - (853)
Minority interest - - (25) - (25)
-------- -------- -------- -------- --------
(Loss) income before income taxes (8) (1,199) 329 - (878)
Income taxes (benefit) 63 104 (16) - 151
-------- -------- -------- -------- --------
Net (loss) income $ (71) $ (1,303) $ 345 - $ (1,029)
======== ======== ======== ======== ========
Page 19
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Statement of Operations
For the twelve weeks ended October 5, 2003
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- -------- -------- -------- --------
Revenues:
Restaurant sales $ 31,445 $ 37,267 $ 3,397 $ 72,109
Franchise related income 2,295 - - 2,295
Real estate and other 682 666 26 1,374
Intercompany charges 2,349 - - ($ 2,349) -
-------- -------- -------- -------- --------
Total revenues 36,771 37,933 3,423 (2,349) 75,778
-------- -------- -------- -------- --------
Cost and expenses:
Cost of food and paper products 6,526 8,267 908 - 15,701
Payroll and other employee benefits 8,434 10,973 1,123 - 20,530
Other operating costs 12,029 13,302 930 - 26,261
Depreciation and amortization 2,029 2,155 227 - 4,411
General and administrative costs 3,505 2,470 81 - 6,056
Asset impairment and restaurant closing
charges, net 3,410 - - - 3,410
Intercompany charges - 2,349 - (2,349) -
-------- -------- -------- -------- --------
Total costs and expenses 35,933 39,516 3,269 (2,349) 76,369
-------- -------- -------- -------- --------
Operating income (loss) 838 (1,583) 154 - (591)
-------- -------- -------- -------- --------
Other (expense) income:
Interest expense (6,832) (335) - - (7,167)
Interest income 158 - - - 158
Equity in net income of
unconsolidated affiliates (241) - - - (241)
-------- -------- -------- -------- --------
(6,915) (335) - - (7,250)
-------- -------- -------- -------- --------
(Loss) income before minority interest (6,077) (1,918) 154 - (7,841)
Minority interest - - (12) - (12)
-------- -------- -------- -------- --------
(Loss) income before income taxes (6,077) (1,918) 142 - (7,853)
Income taxes (benefit) 73 30 (2) - 101
-------- -------- -------- -------- --------
Net (loss) income ($ 6,150) ($ 1,948) $ 144 - ($ 7,954)
======== ======== ======== ======== ========
Page 20
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Statement of Cash Flows
For the forty weeks ended October 3, 2004
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- -------- -------- -------- --------
Operating Activities:
- ---------------------
Net (loss) income ($ 4,939) ($ 7,296) $ 489 ($11,746)
Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating
activities:
Depreciation and amortization 5,258 6,433 697 12,388
Accretion of original issue discount 292 - - 292
Amortization of deferred financial costs 711 29 - 740
Asset impairment and restaurant closing
charges, net 560 - - 560
Increase in deferred rent, net 272 66 (56) 282
Minority interest - - 42 42
Equity in net income of unconsolidated
affiliates (678) - - (678)
Dividends received from unconsolidated
affiliates 305 - - 305
-------- -------- -------- --------
1,781 (768) 2,185 1,172
-------- -------- -------- --------
Changes in operating assets and liabilities:
Receivables (169) (86) (145) (400)
Inventories 138 53 - 191
Prepaid expenses (4,024) (2,439) (307) (6,770)
Other assets (951) - 336 $ 822 207
Accounts payable and accrued expenses
(1,654) 287 (163) (737) (2,267)
Accrued interest payable (6,473) - - - (6,473)
-------- -------- -------- -------- --------
Net cash (used in) provided by operating activities (11,352) (2,953) 893 85 (13,327)
-------- -------- -------- -------- --------
Page 21
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Statement of Cash Flows
For the forty weeks ended October 3, 2004
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- -------- -------- -------- --------
Investing activities:
- ---------------------
Purchases of property and equipment ($ 3,368) ($ 2,737) ($ 101) ($ 6,206)
-------- -------- -------- --------
Net cash used in investing activities (3,368) (2,737) (101) (6,206)
-------- -------- -------- --------
Financing activities:
- ---------------------
Mortgage principal repayments - (139) - (139)
Tax distribution (682) - - (682)
Reduction in loans receivable from
officers 506 - - 506
Intercompany balances (2,780) 3,812 (947) ($ 85) -
-------- -------- -------- -------- --------
Net cash provided by (used in)
financing activities (2,956) 3,673 (947) (85) (315)
-------- -------- -------- -------- --------
Decrease in cash and cash equivalents (17,676) (2,017) (155) - (19,848)
Cash and cash equivalents at beginning
of period 49,515 5,595 1,299 - 56,409
-------- -------- -------- -------- --------
Cash and cash equivalents at end of
period $ 31,839 $ 3,578 $ 1,144 - $ 36,561
======== ======== ======== ======== ========
Supplemental disclosure of cash flow
information:
Cash paid during the period for income
taxes $ 117 $ 141 $ 27 - $ 285
======== ======== ======== ======== ========
Cash paid during the period for interest $ 28,058 $ 1,080 - - $ 29,138
======== ======== ======== ======== ========
Page 22
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Statement of Cash Flows
For the forty weeks ended October 5, 2003
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- -------- -------- ------ --------
Operating Activities:
- ---------------------
Net (loss) income ($16,153) ($ 8,044) $ 541 - ($23,656)
Adjustments to reconcile net (loss) income to
net cash (used in) provided by operating
activities:
Depreciation and amortization 7,215 6,843 762 - 14,820
Amortization of deferred financing costs 797 29 - - 826
Accretion of original issue discount 292 - - - 292
Asset impairment and restaurant closing
charges, net 4,467 - - - 4,467
Increase in deferred rent, net 230 (33) 35 - 232
Loss on sale of other concept units - - 50 - 50
Minority interest - - 22 - 22
Equity in net income of unconsolidated
affiliates (270) - - - (270)
Dividends received from unconsolidated
affiliates 119 - - - 119
-------- -------- -------- ------ --------
(3,303) (1,205) (1,410) - (3,098)
Changes in operating assets and liabilities:
Receivables 149 264 (62) - 351
Inventories 405 569 13 - 987
Prepaid expenses (3,805) (2,394) (172) - (6,371)
Other assets (573) (24) 492 - (105)
Accounts payable and accrued expenses (2,557) 776 (117) - (1,898)
Accrued interest payable (6,473) - - - (6,473)
-------- -------- -------- ------ --------
Net cash (used in) provided by operating activities (16,157) (2,014) 1,564 - (16,607)
-------- -------- -------- ------ --------
Page 23
SBARRO, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Consolidating Statement of Cash Flows
For the forty weeks ended October 5, 2003
(In thousands)
(Unaudited)
Guarantor Nonguarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
-------- -------- -------- --------- --------
Investing activities:
- ---------------------
Purchase of property and equipment ($ 4,219) ($ 1,875) ($ 171) - ($ 6,265)
-------- -------- -------- --------- --------
Net cash used in investing activities (4,219) (1,875) (171) - (6,265)
-------- -------- -------- --------- --------
Financing activities:
- ---------------------
Mortgage principal repayments - (128) - - (128)
Tax distribution (1,101) - - - (1,101)
Intercompany balances 799 780 (1,579) - -
-------- -------- -------- --------- --------
Net cash (used in) provided by
financing activities (302) 652 (1,579) - (1,229)
Decrease in cash and
cash equivalents (20,678) (3,237) (186) - (24,101)
Cash and cash equivalents at
beginning of period 47,636 6,539 975 - 55,150
-------- -------- -------- --------- --------
Cash and cash equivalents at $ 26,958 $ 3,302 $ 789 - $ 31,049
end of period ======== ======== ======== ========= ========
Supplemental disclosure of cash flow
information:
Cash paid during the period for
income taxes $ 280 $ 85 $ 13 $ - $ 378
======== ======== ======== ========= ========
Cash paid during the period for
interest $ 28,159 $ 1,091 $ - $ - $ 29,250
======== ======== ======== ========= ========
Page 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:
40 Weeks 40 Weeks 12 Weeks 12 Weeks Fiscal Year
Ended Ended Ended Ended ---------------
10/3/04 10/5/03 10/3/04 10/5/03 2003 2002
------- ------- ------- ------- ---- ----
Company-owned restaurants:
Open at beginning of period 528 558 513 537 558 602
Opened during period 2 3 - 2 4 13
Acquired from (sold to)
franchisees during period, net (2) (7) - (1) (12) (6)
Closed during period (19) (19) (4) (3) (22) (51)
---- ---- ---- ---- ---- ----
Open at end of period (1) 509 535 509 535 528 558
==== ==== ==== ==== ==== ====
Franchised restaurants:
Open at beginning of period 387 353 407 368 353 325
Opened during period 40 25 17 3 39 42
Purchased from (sold to)
Company during period, net 2 7 - 1 12 6
Closed or terminated during period (8) (15) (3) (2) (17) (20)
---- ---- ---- ---- ---- ----
Open at end of period 421 370 421 370 387 353
==== ==== ==== ==== ==== ====
All restaurants:
Open at beginning of period 915 911 920 905 911 927
Opened during period 42 28 17 5 43 55
Closed or terminated during period (27) (34) (7) (5) (39) (71)
---- ---- ---- ---- ---- ----
Opened at end of period (1) 930 905 930 905 915 911
==== ==== ==== ==== ==== ====
Kiosks (all franchised) open at end
of period 3 3 3 3 3 3
==== ==== ==== ==== ==== ====
- ----------
(1) Excludes 28, 31, 29 and 32 other concept units as of October 3, 2004
and October 5, 2003, the end of fiscal 2003 and the end of fiscal 2002,
respectively.
Page 25
SBARRO, INC. AND SUBSIDIARIES
Seasonality
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
- ------------------------------
Forty weeks ended Twelve weeks ended
October 3, October 5, October 3, October 5,
2004 2003 2004 2003
---- ---- ---- ----
(in millions)
Comparable Sbarro - owned quick service sales (1) $220 $209 $70 $67
Franchise location sales $189 $176 $62 $56
Franchise revenues $ 9 $ 8 $ 3 $ 2
Provision for asset impairment and restaurant
closings $ 1 $ 5 - $ 3
EBITDA $ 24 $ 15 $10 $ 4
Comparable Sbarro - owned quick service sales -
percentage change (1) 5.2% (3.5%) 4.7% (1.2%)
Cost of food and paper products as a percentage
of restaurant sales 22.3% 21.5% 21.7% 21.8%
Payroll and other benefits as a percentage of
restaurant sales 28.3% 29.0% 27.4% 28.5%
Other operating expenses as a percentage of
restaurant sales 36.8% 37.5% 35.9% 36.4%
General and administrative costs as a percentage
of restaurant sales 8.0% 8.8% 7.2% 8.4%
(1) Comparable Sbarro-owned quick service sales dollar and annual
percentage changes are based on locations that were in operation at all
times since December 29, 2002.
Page 26
SBARRO, INC. AND SUBSIDIARIES
Our consolidated EBITDA for the first three quarters of 2004 was $24.4 million
compared to $15.2 million for the first three quarters of 2003. Our consolidated
EBITDA for the third quarter of 2004 was $9.8 million compared to $3.6 million
for the third 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):
Forty weeks ended Twelve weeks ended
10/3/2004 10/5/2003 10/3/2004 10/5/2003
--------- --------- --------- ---------
EBITDA $24,391 $15,200 $9,818 $3,567
Interest expense (23,697) (23,930) (7,114) (7,167)
Interest income 468 569 144 158
Income taxes (520) (675) (151) (101)
Depreciation and amortization (12,388) (14,820) (3,726) (4,411)
========= ========== ======== --------
Net loss ($11,746) ($23,656) ($1,029) ($7,954)
========= ========== ======== ========
Page 27
SBARRO, INC. AND SUBSIDIARIES
Restaurant sales increased $4.7 million, or 2.1%, to $233.6 million for the
first three quarters of fiscal 2004 from $228.9 million for the first three
quarters of fiscal 2003. The increase in sales resulted from $4.8 million of
higher sales of the quick service business offset by $.1 million of lower sales
of consolidated other restaurant concepts. The increase in quick service
business resulted from an approximate $10.8 million (5.2%) increase in
comparable sales offset by the loss of approximately $8.8 million of sales from
the closure, since the first quarter of 2003, of generally low volume locations.
Sales for locations that opened after December 29, 2002 comprised the remaining
$2.7 million increase in quick service sales.
Restaurant sales increased $1.9 million, or 2.7%, to $74.1 million for the third
quarter of fiscal 2004 from $72.1 million in the third quarter of 2003. This
increase in sales was primarily a result of higher sales of the quick service
business. The increase in the quick service business included an approximate
$3.2 million (4.7%) increase in comparable sales offset by the loss of
approximately $2.2 million of sales from the closure, since the first quarter of
2003, of generally low volume locations. Third quarter sales for locations that
were opened after December 29, 2002 comprised the remaining $.9 million increase
in quick service sales.
We believe that the increases in comparable sales in both 2004 reported periods
from the comparable 2003 periods was primarily due to economic trends, the
strengthening of operational management and training programs which generated
increased sales and 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 3% effect on sales on an annual basis.
Franchise related income increased 16.5% to $8.9 million for the first three
fiscal quarters of 2004 from $7.6 million in the first three fiscal quarters of
2003. The increase in franchise related income was comprised of increases in
royalties from comparable locations that resulted from sales increases of 9.0%
for international locations and 3.5% for domestic locations as well as royalty
income derived from locations that were opened after December 29, 2002. In
addition, during the third quarter of 2003, we reduced our royalty revenues by
approximately $.2 million for excess royalties that had been paid by our Russian
franchisee as it had erroneously included sales and other income taxes in its
reported sales.
Franchise related income increased 26.1% to $2.9 million for the third fiscal
quarter of 2004 from $2.3 million for the third quarter of 2003. The increase
was comprised of increases in royalties that resulted from sales increases from
comparable locations of 2.2% for international locations and 4.6% for domestic
locations as well as royalty income derived during the third quarter from
locations that were opened after December 29, 2002. The third quarter of 2003
was affected by the royalty reduction due to the earlier overpayment of $.2
million of royalties by our Russian franchisee.
Real estate and other revenues increased 7.1% for the first three quarters of
fiscal 2004 compared to the same period in fiscal 2003, primarily due to
variations in certain vendor rebates relating to franchisees and marketing
allowances. Real estate and other revenues were flat in the third quarter of
fiscal 2004 compared to the third quarter of fiscal 2003.
Page 28
SBARRO, INC. AND SUBSIDIARIES
Cost of food and paper products as a percentage of restaurant sales increased to
22.3% for the first three quarters of fiscal 2004 from 21.5% for the comparable
2003 fiscal period. An increase in cheese prices during the second fiscal
quarter of 2004 had a negative effect on the cost of food and paper products.
While cheese prices have moderated, the fluctuations in cheese prices resulted
in a 1.2%, as a percentage of restaurant sales, increase in the cost of food and
paper products in the first three quarters of fiscal 2004, when compared to the
same periods in fiscal 2003. The cost of food and paper products, as a
percentage of restaurant sales, in the 2004 period was positively impacted by
the increase in comparable unit sales. .
Cost of food and paper products as a percentage of restaurant sales decreased to
21.7% for the third quarter of 2004 from 21.8% for the comparable period in
2003. The improvement in the cost of sales percentage in the third quarter of
2004 was positively impacted by the increases in comparable unit sales. Cheese
prices during the third quarter of 2004 as compared to the third quarter of 2003
were relatively flat.
Payroll and other employee benefits decreased to 28.3% of restaurant sales for
the first three quarters of 2004 from 29.0% of restaurant sales in the first
three quarters of 2003. Payroll and other employee benefits decreased to 27.4%
of restaurant sales for the third quarter of fiscal 2004 from 28.5% of
restaurant sales for the third quarter of fiscal 2003. These percentage
decreases were primarily due to increased restaurant sales as well as the
elimination of locations with higher payroll costs as a percentage of restaurant
sales.
Other operating expenses decreased to 36.8% of restaurant sales in the first
three quarters of fiscal 2004 from 37.5% of restaurant sales in the first three
quarters of 2003. Other operating expenses decreased to 35.9% of restaurant
sales for the third quarter of 2004 from 36.4% of restaurant sales for the third
quarter of 2003. While the dollars in both periods presented were relatively
flat these costs, as a percentage of restaurant sales improved primarily as a
result of the higher level of sales.
Depreciation and amortization expense was $2.4 million lower for the first three
quarters of fiscal 2004 as compared to the same period in 2003. Depreciation and
amortization expense was $.7 lower for the third quarter of fiscal 2004, than in
the third quarter of fiscal 2003. The reductions were primarily due to the
reduction in depreciable assets as a result of restaurant closings, asset
impairments in 2003 and the consolidation of our administrative offices in 2003.
General and administrative expenses were $18.8 million, or 8.0% of restaurant
sales for the first three quarters of fiscal 2004 compared to $20.1 million, or
8.8% of restaurant sales for the first three quarters of fiscal 2003. The
improvement was primarily comprised of the reduction in work force and the
absence of bonuses paid to certain executive officers offset, in part, by the
cost of severance and the cost of the new members of our executive team. The
annual effect of our reduction in work force on our general and administrative
costs are estimated at $3.1 million.
General administrative expenses were $5.3 million or 7.2% of restaurant sales in
the third quarter of fiscal 2004 compared to $6.1 million or 8.4% of restaurant
sales for the third quarter of fiscal 2003. The reduction is primarily comprised
of the reduction in work force.
Page 29
SBARRO, INC. AND SUBSIDIARIES
Interest expense for the first three quarters of fiscal 2004 and 2003 was $23.7
million and $23.9 million, respectively, and $7.1 million and $7.2 million for
the third quarter of 2004 and 2003, respectively.
Equity in the net income of unconsolidated affiliates represents our
proportionate share of earnings and losses in those concepts in which we have a
50% or less ownership interest. The increase in our proportionate share was $.4
million for the first three quarters of fiscal 2004. The increase in our
proportionate share was $.2 million for the third quarter of 2004. The increases
were primarily due to the absence of losses incurred in 2003 from the sale of
two locations. There currently are two steakhouses under construction which are
expected to be completed by 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. Under the provisions of Subchapter S, substantially all
taxes on our income are paid by our shareholders rather than us. Our tax expense
was $.5 million and $.7 million for the first three quarters and $.2 million and
$0.1 million for the third 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, repayment of 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 our
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. There were no unpaid capital expenditure
commitments at October 3, 2004.
We expect our primary source of liquidity to meet current requirements 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
Page 30
SBARRO, INC. AND SUBSIDIARIES
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 third quarter of 2004 and 2003 and the uses of our cash
flows during the first three quarters of each of the respective fiscal years:
As at and for the Forty Weeks Ended
-----------------------------------
October 3, 2004 October 5, 2003
--------------- ---------------
(in millions)
-------------
Liquidity at the end of periods
- -------------------------------
Cash and cash equivalents $ 36.6 $ 31.0
Working capital 27.7 14.4
Net cash flows for the period
- -----------------------------
Used in operating activities (13.3) (16.6)
Used in investing activities (6.2) (6.3)
Used in financing activities (.3) (1.2)
Net decrease in cash (19.8) (24.1)
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 $13.3 million for the first three
quarters of 2004 compared to $16.6 million used during the first three quarters
of 2003. The decrease is primarily a result of improved operating results.
Net cash used in investing activities has historically been primarily for
capital expenditures. Net cash used in investing activities of $6.2 million for
the first three quarters of 2004 was approximately the same as the 2003 level.
Net cash used in financing activities was $.3 million in the first three
quarters of fiscal 2004 compared to $1.2 million for the first three quarters of
fiscal 2003. The decline in cash used in financing activities resulted from a
repayment of shareholder loans in 2004 as well as lower tax distributions. Cash
used in financing activities included tax distributions of $.7 million and $1.1
million to our shareholders in the fiscal 2004 and fiscal 2003, respectively.
The tax distributions in the first quarter of both fiscal years were made with
respect to our taxable income for fiscal 2002. The 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
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SBARRO, INC. AND SUBSIDIARIES
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.
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 than as distributions pursuant to the tax
payment agreement), and to make investments in, among other things, unrestricted
subsidiaries. The indenture for the senior notes permits us to make
distributions to shareholders pursuant to a tax payment agreement that contains
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.
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 October 3, 2004,
that ratio was 1.4 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 $20.3 million, and then only to the extent of any excess over that
amount.
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.
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 October 3, 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 October 3, 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.
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SBARRO, INC. AND SUBSIDIARIES
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.
Certain Relationships and Related Transactions
During the first three quarters 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;
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SBARRO, INC. AND SUBSIDIARIES
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 in our mortgage loan 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.
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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 forty weeks ended October 3, 2004 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.
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PART II. OTHER INFORMATION
Item 6. 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.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
SBARRO, INC.
-----------------------------------------------
Registrant
Date: November 12, 2004 By: /s/ MICHAEL O'DONNELL
----------------- -------------------------------------------
Michael O'Donnell
President and Chief Executive Officer
Date: November 12, 2004 By: /s/ ANTHONY J. PUGLISI
----------------- -------------------------------------------
Anthony J. Puglisi
Vice President; Chief Financial Officer and
Principal Accounting Officer
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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.