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EX-31.01 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 302 - SBARRO INCdex3101.htm
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EX-32.01 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 906 - SBARRO INCdex3201.htm
EX-31.02 - CERTIFICATION OF PRINCIPAL FINANCIAL-ACCOUNTING OFFICER PURSUANT TO SECTION 302 - SBARRO INCdex3102.htm
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarter ended June 27, 2010

   Commission file number 333-142081

 

 

SBARRO, INC.

(Exact name of registrant as specified in its charter)

 

NEW YORK   11-2501939
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The number of shares of Common Stock of the registrant outstanding as of August 11, 2010 was 100.

 

 


Table of Contents

SBARRO, INC.

FORM 10-Q INDEX

 

      PAGES

PART I. FINANCIAL INFORMATION

  

Item 1.

   Consolidated Financial Statements (unaudited):   
  

Balance Sheets (unaudited)—June 27, 2010 and December 27, 2009

   3-4
  

Statements of Operations (unaudited)—Six months ended June 27, 2010 and June 28, 2009 and the quarter ended June 27, 2010 and June 28, 2009

   5-6
  

Statement of Shareholders’ Equity (unaudited)—Six months ended June 27, 2010

   7
  

Statements of Cash Flows (unaudited)—Six months ended June 27, 2010 and June 28, 2009

   8
  

Notes to Unaudited Consolidated Financial Statements

   9

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    30

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    39

Item 4.

   Controls and Procedures    40

PART II. OTHER INFORMATION

  

Item 1.

   Legal Proceedings    41

Item 1A.

   Risk Factors    41

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    41

Item 3.

   Defaults Upon Senior Securities    41

Item 4.

   (Removed and Reserved)    41

Item 5.

   Other Information    41

Item 6.

   Exhibits    42

 

2


Table of Contents

Part I – Financial Information

 

Item 1. Consolidated Financial Statements

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

(UNAUDITED)

(In thousands)

 

     June 27, 2010    December 27, 2009

Current assets:

     

Cash and cash equivalents

   $ 12,057    $ 26,863

Receivables, net of allowance for doubtful accounts of $1,501 and $1,805 at June 27, 2010 and December 27, 2009, respectively:

     

Franchise

     1,540      2,237

Other

     3,566      2,916
             
     5,106      5,153

Inventories

     2,691      2,907

Prepaid expenses

     3,076      1,771
             

Total current assets

     22,930      36,694

Property and equipment, net

     53,657      56,148

Intangible assets:

     

Goodwill

     194,786      194,786

Trademarks

     157,400      173,100

Other intangible assets

     19,117      19,650

Deferred financing costs, net

     8,208      8,977

Other assets

     1,418      1,068
             

Total assets

   $ 457,516    $ 490,423
             

See Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

LIABILITIES & SHAREHOLDERS’ (DEFICIT) EQUITY

(UNAUDITED)

(In thousands except share data)

(CONTINUED)

 

     June 27, 2010     December 27, 2009  

Current liabilities:

    

Accounts payable

   $ 8,258      $ 9,032   

Accrued expenses

     19,025        22,631   

Accrued interest payable

     6,606        7,935   
                

Total current liabilities

     33,889        39,598   

Deferred rent

     7,122        6,482   

Deferred tax liability

     70,645        76,941   

Due to former shareholders and other liabilities

     13,008        12,508   

Accrued interest payable

     5,211        3,048   

Long-term debt

     336,277        336,095   

Commitments and contingencies

    

Shareholders’ (deficit) equity:

    

Common stock

    

Authorized 1,000 shares; $.01 par value issued and outstanding 100 shares at June 27, 2010 and December 27, 2009

     —          —     

Additional paid-in capital

     139,340        139,340   

Currency translation adjustments

     53        200   

Advances to MidOcean SBR Holdings

     (305     (305

Accumulated deficit

     (149,864     (125,838
                

Total shareholders’ (deficit) equity

     (10,776     13,397   

Noncontrolling interests

     2,140        2,354   
                

Total shareholders’ (deficit) equity, including noncontrolling interests

     (8,636     15,751   
                

Total liabilities and shareholders’ (deficit) equity, Sbarro, Inc.

   $ 457,516      $ 490,423   
                

See Notes to Unaudited Consolidated Financial Statements.

 

4


Table of Contents

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands)

 

     For The Six Months
Ended
June 27, 2010
    For The Six Months
Ended
June 28, 2009
 

Revenues:

    

Restaurant sales

   $ 148,191      $ 152,942   

Franchise related income

     6,889        6,774   
                

Total revenues

     155,080        159,716   

Costs and expenses:

    

Cost of food and paper products

     30,646        31,129   

Payroll and other employee benefits

     41,848        42,787   

Other operating costs

     61,001        59,574   

Other income, net

     (1,787     (2,020

Depreciation and amortization

     7,093        8,467   

General and administrative

     15,329        15,826   

Goodwill and other intangible asset impairment

     15,700        —     

Asset impairment, restaurant closings/remodels

     1,118        1,996   
                

Total costs and expenses, net

     170,948        157,759   
                

Operating (loss) income

     (15,868     1,957   
                

Other (expense) income:

    

Interest expense

     (15,106     (13,333

Write-off of deferred financing costs

     —          (423

Interest income

     1        33   
                

Net other expense

     (15,105     (13,723
                

Loss before income taxes and equity investments

     (30,973     (11,766

Income tax (benefit) expense

     (6,080     272   
                

Loss before equity investments

     (24,893     (12,038

Loss from equity investments

     (120     (108
                

Net loss

     (25,013     (12,146

Less: Net loss (income) attributable to noncontrolling interests

     987        (33
                

Net loss attributable to Sbarro, Inc.

   $ (24,026   $ (12,179
                

See Notes to Unaudited Consolidated Financial Statements.

 

5


Table of Contents

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

(UNAUDITED)

(In thousands except share data)

 

     For The Three  Months
Ended
June 27, 2010
    For The Three  Months
Ended

June 28, 2009
 

Revenues:

    

Restaurant sales

   $ 72,964      $ 76,659   

Franchise related income

     3,132        3,475   
                

Total revenues

     76,096        80,134   

Costs and expenses:

    

Cost of food and paper products

     15,323        15,631   

Payroll and other employee benefits

     20,590        21,548   

Other operating costs

     30,989        29,730   

Other income, net

     (941     (844

Depreciation and amortization

     3,719        4,266   

General and administrative

     7,729        7,424   

Goodwill and other intangible asset impairment

     15,700        —     

Asset impairment, restaurant closings/remodels

     1,118        1,117   
                

Total costs and expenses, net

     94,227        78,872   
                

Operating (loss) income

     (18,131     1,262   
                

Other (expense) income:

    

Interest expense

     (7,657     (7,492

Interest income

     1        1   
                

Net other expense

     (7,656     (7,491
                

Loss before income taxes and equity investments

     (25,787     (6,229

Income tax (benefit) expense

     (6,192     168   
                

Loss before equity investments

     (19,595     (6,397

Loss from equity investments

     (58     (53
                

Net loss

     (19,653     (6,450

Less: Net loss (income) attributable to noncontrolling interests

     824        (19
                

Net loss attributable to Sbarro, Inc.

   $ (18,829   $ (6,469
                

See Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS DEFICIT

(UNAUDITED)

(In thousands)

 

     Common Stock    Additional
paid-in
capital
   Advances to
MidOcean
SBR
Holdings
          Accumulated
Other
Comprehensive
Income (b)
             
     Number of
Shares
   Amount         Accumulated
Deficit
      Noncontrolling
Interest
    Total  

Balance at December 27,

2009

   100    $ —      $ 139,340    $ (305   $ (125,838   $ 200      $ 2,354      $ 15,751   

Components of comprehensive loss:

                   

Net loss

   —        —        —        —          (24,026     —          (987     (25,013

Currency translation adjustments

   —        —        —        —          —          (147     191        44   
                         

Comprehensive loss (a)

                      (24,969

Capital contribution from noncontrolling interest

   —        —        —        —          —          —          971        971   

Distribution of earnings and return of capital

   —        —        —        —          —          —          (563     (563

Proceeds from loan - noncontrolling interest

   —        —        —        —          —          —          174        174   
                                                           

Balance at June 27, 2010

   100    $ —      $ 139,340    $ (305   $ (149,864   $ 53      $ 2,140      $ (8,636
                                                           

 

(a)

The components of comprehensive loss are as follows:

 

     Six Months Ended
June  27, 2010
    Six Months Ended
June 28, 2009
 

Net loss (including noncontrolling interests)

   $ (25,013   $ (12,146

Currency translation adjustments

     44        72   
                
     (24,969     (12,074

Less: comprehensive (loss) income attributable to noncontrolling interests

     (796     63   
                

Comprehensive loss - Sbarro, Inc.

   $ (24,173   $ (12,137
                

 

(b)

The components of accumulated other comprehensive income are as follows:

 

     June 27, 2010    Dec 27, 2009  

Currency translation adjustments

   $ 229    $ 185   

Less: noncontrolling interests - currency translation adjustments

     176      (15
               

Accumulated other comprehensive income - Sbarro, Inc.

   $ 53    $ 200   
               

See Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

     For The Six  Months
Ended

June 27, 2010
    For The Six  Months
Ended

June 28, 2009
 

Operating Activities:

    

Net loss

   $ (25,013   $ (12,146

Adjustments to reconcile net loss to net cash used in operating activities:

    

Goodwill and other intangible asset impairment

     15,700        —     

Depreciation and amortization

     7,093        8,467   

Amortization of deferred financing costs

     951        724   

Provision for doubtful accounts receivable

     20        616   

Increase in deferred rent, net of tenant allowance

     817        938   

Asset impairment and restaurant closings/remodels

     903        873   

Change in deferred income taxes, net

     (6,296     —     

Write-off of deferred financing costs

     —          423   

Equity in net loss of unconsolidated affiliates

     120        108   

Changes in operating assets and liabilities

    

Decrease in receivables

     91        695   

Decrease in inventories

     217        452   

(Increase) decrease in prepaid expenses

     (1,305     247   

Increase in other assets

     (344     (65

Decrease in accounts payable, accrued expenses & other liabilities

     (4,276     (9,703

Increase (decrease) in accrued interest payable

     834        (36
                

Net cash used in operating activities

     (10,488     (8,407
                

Investing Activities:

    

Purchases of property and equipment

     (4,953     (4,630

Investment in joint ventures

     —          (245
                

Net cash used in investing activities

     (4,953     (4,875
                

Financing Activities:

    

Capital contribution from noncontrolling interests

     971        313   

Proceeds from (repayment of) short term loan from (to) noncontrolling interests

     174        (382

Distribution of earnings to noncontrolling interests

     (510     (653

Proceeds from second lien

     —          25,000   

Debt issuance and credit agreement costs

     —          (1,798

Repayment of secured term loan and revolver

     —          (32,958
                

Net cash provided by (used in) financing activities

     635        (10,478
                

Decrease in cash and cash equivalents

     (14,806     (23,760

Cash and cash equivalents at beginning of period

     26,863        38,286   
                

Cash and cash equivalents at end of period

   $ 12,057      $ 14,526   
                

See Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

1. Basis of Financial Statement Presentation:

On January 31, 2007, entities controlled by MidOcean Partners III, LP, a private equity firm, and certain of its affiliates (“MidOcean”) acquired Sbarro, Inc. (“we,” “us,” “Sbarro” or the “Company”), pursuant to an agreement and plan of merger (“Merger Agreement”). MidOcean SBR Acquisition Corp., a wholly-owned subsidiary of Sbarro Holdings, LLC, merged with and into the Company (the “Merger”), with the Company surviving the Merger. Sbarro Holdings, LLC is a wholly-owned subsidiary of MidOcean SBR Holdings, LLC (“Holdings”). Sbarro Holdings, LLC owns 100% of our outstanding common stock and Holdings owns 100% of the limited liability company interests of Sbarro Holdings, LLC.

MidOcean owns approximately 76% of Holdings and thus acquired control of the Company in the Merger. Certain of our senior managers acquired approximately 5% of the outstanding equity of Holdings in connection with the Merger, with the balance of the equity of Holdings being owned by other investors.

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 the fair presentation of the consolidated financial position of Sbarro and our subsidiaries at June 27, 2010, and our consolidated results of operations for the three and six months ended June 27, 2010 and June 28, 2009 and cash flows for the six months ended June 27, 2010 and June 28, 2009 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. Certain items in the prior year’s consolidated financial statements have been reclassified to conform to the fiscal 2010 presentation. Reference should be made to our annual financial statements, including footnotes thereto, included in our Annual Report on Form 10-K for the year ended December 27, 2009.

Liquidity

We are highly leveraged and a substantial portion of our liquidity needs arise from debt service on indebtedness incurred in connection with the Merger. Our other liquidity needs fund our costs of operations, working capital and capital expenditures. Cash flow generated during our fourth quarter is critical to achieving positive annual operating cash flow. Adverse macroeconomic factors, including reduced mall traffic during the holiday shopping season and a decline in consumer spending among other factors can negatively impact achieving our projected operating cash flow. Additionally, we experience pressures related to increasing commodity costs, particularly cheese and flour.

On March 26, 2009, we entered into an amendment to the Senior Credit Facilities. The amendment permitted the Company to refinance a portion of our Term Loan by entering into the new Second Lien Facility, permanently waived a breach of our total net leverage ratio covenant for the fiscal quarter ended December 28, 2008, and replaced our total net leverage ratio covenant and interest coverage ratio covenant with a minimum EBITDA covenant and a maximum capital expenditure covenant, increased the margin on our Term Loan and Revolving Facility by 200 basis points, required prepayment of $25.0 million of the Term Loan from the proceeds of the Second Lien Facility, required prepayment of $3.5 million of the Revolving Facility from cash on hand and simultaneously reduced the Revolving Facility’s amount outstanding and commitment to $21.5 million and restricted payment of MidOcean’s annual management fee so that such fee will accrue but not be paid until the Company’s EBITDA is at least $55.0 million and after such goal is obtained, a maximum of $2.0 million of such fees may be paid each year. Our ability to borrow funds under our revolver is subject to compliance with our debt covenant requirements. On July 1, 2010 we drew the remaining amount available under our Revolving Facility and have no additional availability under the Senior Credit Facilities.

EBITDA, as calculated in accordance with our Senior Credit Facilities (“bank credit agreement EBITDA”), was $44.7 million for fiscal 2009 and $41.7 million for the twelve months ending with the second quarter of 2010. The Company was in compliance with all covenants at June 27, 2010. Our ability to meet or exceed our third quarter minimum trailing twelve months bank credit agreement EBITDA covenant of $40.0 million relies significantly on our same store sales trend versus the prior year. In order to comply with our third quarter minimum EBITDA covenant, our third quarter same store sales trend versus prior year would need to improve relative to our second quarter same store sales trend, and at the same time, our costs would need to be favorable to the prior year. If we fail to achieve this mix of increased sales and lower costs, we may not comply with our minimum EBITDA covenants for the third quarter.

 

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Table of Contents

SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Our minimum trailing twelve month EBITDA covenant, as calculated in accordance with our amended bank credit agreement, increases at the end of the fourth quarter of 2010 by $3.0 million dollars to $43.0 million. Our ability to meet our fourth quarter minimum trailing twelve month EBITDA covenant relies significantly on our company owned same store sales trend versus prior year. Our comparable sales percentage change versus the prior year is highly dependent on the level of traffic in shopping malls during the fourth quarter holiday shopping season. Based on our recent trends, we would need a significant upturn in the general economy and a significant change to our second quarter trend to achieve positive same store sales versus prior year to satisfy the minimum trailing twelve month EBITDA covenant for the fourth quarter, and at the same time our costs would need to be favorable to the prior year. If we fail to achieve this mix of increased sales and lower costs, we may not comply with our minimum EBITDA covenants for the fourth quarter.

We are unable to control commodity costs which can impact our ability to satisfy our minimum EBITDA covenants. Specifically, commodity costs can also fluctuate with cheese and flour currently being the most volatile. For example, a $.20 variance in the price of block cheese or a $.10 variance in the price of a pound of flour would affect our costs by approximately $250 thousand and $300 thousand in the third and fourth quarters, respectively.

Our Senior Credit Facility provides for certain cures in the event of noncompliance with our minimum EBITDA covenants. Covenant violations can be cured with cash payments made by our principal shareholders. Such cure amounts are equal to the shortfall, provided the shortfall does not exceed ten percent of our last twelve months bank EBITDA, and can be added to our minimum twelve month EBITDA for the next four quarters. An equity cure can only be completed twice within each twelve month period. Our principal shareholders have no obligation to provide such funds.

Based upon our cash balance of $12.1 million at June 27, 2010, along with the $5.4 million borrowings drawn under our revolver in July 2010 and our revised 2010 forecast, we believe that cash flows generated from operations during 2010, along with our cash on hand, will be sufficient for us to meet our debt service requirements and fund working capital and capital expenditures for the next twelve months. It is possible that our actual results may differ materially from our revised 2010 forecast or that we are unable to obtain a waiver or cure an event of noncompliance with our minimum EBITDA covenants, and then we would not have sufficient cash to meet our obligations and substantial doubt would exist about our ability to continue as a going concern at that time.

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

2. Recent Accounting Pronouncements

In June 2009, the FASB issued “Amendments to FASB Interpretation No. 46(R).” This statement amends the consolidation guidance applicable to variable interest entities and is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2009. We adopted this new guidance specified in the “Consolidation” topic of the Accounting Standards Codification in our first quarter of 2010. The adoption of this statement did not have any material impacts on our consolidated financial statements as there were no changes in our consolidated entities.

3. Long Term Debt:

Indenture:

In 2007 we issued $150.0 million of senior notes at 10.375% due 2015 (“Senior Notes”). The interest is payable on February 1 and August 1 of each year.

The Senior Notes are senior unsecured obligations of ours and are guaranteed by all of our current and future domestic subsidiaries and rank equally in right of payment with all existing and future senior indebtedness of ours. The Senior Notes are effectively subordinated to all secured indebtedness of ours to the extent of the collateral securing such indebtedness, including the Senior Credit Facilities and Second Lien Facility (both defined below). In the event of any distribution or payment of our assets in any foreclosure, dissolution, winding-up, liquidation, reorganization, or other bankruptcy proceeding, holders of secured indebtedness will have prior claim to those of our assets that constitute their collateral. The Senior Notes are structurally subordinated to all existing and future

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

indebtedness, claims of holders of preferred stock and other liabilities of our subsidiaries that do not guarantee the Senior Notes. In the event of a bankruptcy, liquidation or reorganization of any of our non-guarantor subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled to payment of their claims in full from the assets of those subsidiaries before any assets are made available for distribution. The Senior Notes are senior in right of payment to any future subordinated obligations of ours.

The indenture governing the notes contains certain events of default and restrictive covenants which are customary with respect to non-investment grade debt securities, including limitations on the incurrence of additional indebtedness, dividends, repurchases of capital stock, sales of assets, liens, mergers and transactions with affiliates. In addition, the notes contain cross-acceleration provisions and cross-default provisions tied to the Senior Credit Facilities and the Second Lien Facility.

Senior Credit Facilities:

In 2007, we entered into senior secured credit facilities. The senior secured credit facilities originally provided for loans of $208.0 million under a $183.0 million senior secured term loan facility (the “Term Loan”) and a $25.0 million senior secured revolving facility (the “Revolving Facility,” and collectively with the Term Loan, the “Senior Credit Facilities”). The Revolving Facility also provides for the issuance of letters of credit not to exceed $10.0 million at any one time outstanding and swing-line loans not to exceed $5.0 million at any one time outstanding. In connection with the Merger, we borrowed the entire $183.0 million available under the Term Loan. On October 17, 2008 and November 18, 2008, we borrowed $8.0 million and $12.0 million, respectively, under the Revolving Facility. On July 1, 2010 the Company borrowed the remaining $5.4 million available under the Senior Credit Facilities. The Term Loan matures in 2014 and the Revolving Facility is scheduled to terminate and come due in 2013.

On March 26, 2009, we entered into an amendment to the Senior Credit Facilities. The amendment permitted the Company to refinance a portion of the Term Loan by entering into a new Second Lien Facility (defined and discussed below), permanently waived a breach of our total net leverage ratio covenant for the fiscal quarter ended December 28, 2008, permanently replaced our total net leverage ratio covenant and interest coverage ratio covenant with a minimum EBITDA covenant and a maximum capital expenditure covenant, increased the margin on our Term Loan and Revolving Facility by 200 basis points, required prepayment of $25.0 million of the Term Loan from the proceeds of the Second Lien Facility, required prepayment of $3.5 million of the Revolving Facility from cash on hand and simultaneously reduced the Revolving Facility’s amount outstanding and commitment to $21.5 million, and restricted payment of MidOcean’s annual management fee so that such fee will accrue but not be paid until the Company’s EBITDA is at least $55.0 million and after such goal is obtained, a maximum of $2.0 million of such fees may be paid each year. In the first quarter of 2009, we wrote off $0.4 million of deferred financing costs related to the prepayment of the Term Loan. There were $3.5 million of letters of credit outstanding as of June 27, 2010. The letters of credit were issued instead of cash security deposits under our operating leases or to guarantee construction costs of our locations, and for run-out claims under our medical plan. In July 2010 we borrowed the remaining $5.4 million available under the Senior Credit Facilities.

In general, borrowings under the Senior Credit Facilities bear interest based, at our option, at either the LIBOR rate or an alternate base rate (“ABR”), in each case plus a margin. Our rate of interest for borrowings under the Senior Credit Facilities, as amended, is LIBOR plus 4.50% or ABR plus 3.50%. In addition to paying interest on outstanding principal under the Senior Credit Facilities, we are required to pay an unused line fee to the lenders with respect to the unutilized revolving commitments at a rate that shall not exceed 50 basis points per annum.

Our obligations under the Senior Credit Facilities are unconditionally and irrevocably guaranteed by our domestic subsidiaries. In addition, the Senior Credit Facilities are secured by first priority perfected security interests in substantially all of our and our domestic subsidiaries’ capital stock, and up to 65% of the outstanding capital stock of our foreign subsidiaries.

The credit agreement governing the Senior Credit Facilities contains certain events of default and restrictive covenants which are customary with respect to facilities of this type, including limitations on the incurrence of additional indebtedness, dividends, investments, repayment of certain indebtedness, sales of assets, liens, mergers and transactions with affiliates. In addition, the credit agreement, as amended, requires compliance with certain financial and operating covenants, including a minimum EBITDA covenant and a maximum capital expenditure covenant.

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Second Lien Facility:

On March 26, 2009, we entered into a new Second Lien Facility. The Second Lien Facility provides for a $25.5 million secured term loan facility. The loan under the Second Lien Facility was made by Column Investments S.a.r.l., an affiliate of MidOcean. In connection with closing the Second Lien Facility, we borrowed the entire $25.5 million available under the facility which provided for cash proceeds of $25.0 million (representing a 1.96% discount). The Second Lien Facility matures in 2014.

Borrowings under the Second Lien Facility bear interest at 15% per annum payable quarterly in arrears. The Second Lien Facility requires no principal payments until maturity. Interest is payable quarterly as follows: (i) prior to the third anniversary, interest is only payable in kind and (ii) after the third anniversary, interest is payable in cash so long as the Senior Credit Facilities leverage ratio is less than or equal to 2.75:1.00.

Our obligations under the Second Lien Facility are unconditionally and irrevocably guaranteed by our domestic subsidiaries. In addition, the Second Lien Facility is secured by a second priority perfected security interest in substantially all of our and our domestic subsidiaries’ capital stock, and up to 65% of the outstanding capital stock of our foreign subsidiaries.

The credit agreement governing the Second Lien Facility contains certain events of default and restrictive covenants which are customary with respect to facilities of this type, including limitations on the incurrence of indebtedness, dividends, investments, prepayment of certain indebtedness, sales of assets, liens, mergers and transactions with affiliates. In addition, the credit agreement contains (i) cross-acceleration provisions tied to the Senior Credit Facilities and cross-default provisions tied to the Senior Notes and (ii) compliance with certain financial and operating covenants, including a minimum EBITDA covenant and a maximum capital expenditure covenant, which are based on the covenants contained in the Senior Credit Facilities with less restrictive thresholds by approximately 15%. The credit agreement also contains a make-whole provision for any prepayment prior to the scheduled maturity date.

In connection with the closing of the Second Lien Facility, Holdings issued immediately exercisable warrants to certain MidOcean entities to acquire 5% of Holdings’ units issued and outstanding on the dates of exercise. The fair value of the warrants issued in connection with the credit agreement governing the Second Lien Facility was $6.3 million and was recorded as paid-in capital with the offset recorded as a discount on the Second Lien Facility.

In connection with the amendment to the Senior Credit Facilities and entry into the new Second Lien Facility, we recorded deferred financing costs of $2.3 million.

Long-term debt of $12.5 million is scheduled to mature in 2013, $180.3 million in 2014 and $150.0 million is scheduled to mature in 2015 and thereafter. Refer to Note 6 “Fair Value Measurement” for the gross balance, net book value and fair value of our long-term debt at June 27, 2010.

4. Intangibles (in thousands):

Goodwill

We have two reporting units (Company-owned and Franchise) for the purposes of evaluating goodwill for impairment. The carrying value of goodwill was allocated to each of our reporting units based upon the fair value of the reporting units at the date of the Merger.

Testing for impairment must be performed annually, or on an interim basis upon the occurrence of a triggering event or circumstances that would more likely than not reduce the carrying amount of a reporting unit below its fair value. The Company last performed its annual test for impairment as of December 27, 2009 and was scheduled to do so again in the fourth quarter of 2010. However, with the continuing economic challenges affecting our five year financial forecasts, management believed that there were circumstances evident to warrant impairment testing as of May 23, 2010.

Goodwill impairment testing is a two-step process. Step 1 involves comparing the fair value of the Company’s reporting units to their carrying amount. If the fair value of the reporting unit is greater than its carrying amount, there is no impairment. If the reporting unit’s carrying amount is greater than the fair value, Step 2 must be completed to measure the amount of impairment, if any. Step 2 calculates the implied fair value of goodwill by deducting the fair value of all tangible and intangible net assets, excluding goodwill,

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

of the reporting unit from the fair value of the reporting unit as determined in Step 1. The implied fair value of goodwill determined in this step is compared to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss is recognized equal to the difference.

Consistent with previous tests, we considered the results of both an income approach and a market approach in determining the fair value of the reporting units.

For the income approach we assumed that the current economic downturn would continue domestically in 2010, followed by moderate growth in future years consistent with our growth prior to the recent downturn in the economy. Internationally, we assumed the continued downturn in the economy in 2010 with slight improvements in future years. We applied gross margin assumptions consistent with the Company’s current trends and used a 5.6% growth factor. Discounting the projected cash flows at 15.0% we determined a fair value for the reporting units.

We calculated the fair value of the reporting units’ equity using a market approach based on option pricing principles. This method estimates the fair value of the Company’s equity using inputs such as current debt, future expected interest payments over term, expected volatility and risk-free rate. For purposes of our analysis, we used a three year term with an expected volatility of 40.0% and risk-free rate of 1.2%. Volatility assumptions were based on published estimates of the Company’s industry peer group.

The Company considered each alternative in determining fair value of the reporting units, and in doing so concluded that given the current environment, the market-based equity pricing model was most appropriate. As the carrying value of the Company-owned segment was negative as of the triggering event date, no further assessment of impairment on goodwill could be made. At the point in which equity becomes positive, the equity of the reporting unit will be compared to the fair value of the reporting unit pursuant to applicable guidance. No goodwill impairment was recorded for the Company-owned reporting segment.

Other Intangibles

In connection with the impairment testing of the Company’s goodwill, impairment testing was also performed on our trademarks and other indefinite lived intangible assets. We completed this test to determine any impairment value on trademarks, franchise relationships and franchise rights acquired by using the income approach which projects the present value of future cash flows attributable to these assets using the Relief from Royalty method.

The following table presents trademark, franchise relationships, franchise rights acquired and franchise agreements, net and the activity for the periods shown:

 

     Trademark     Franchise
Relationships
    Franchise Rights
Acquired
    Franchise
Agreements, net
 

December 28, 2008

   $ 195,000      $ 17,300      $ 1,351      $ 4,888   

Additions

     —          —          250        —     

Impairment

     (21,900     (2,900     —          —     

Amortization

     —          —          —          (1,239
                                

December 27, 2009

   $ 173,100      $ 14,400      $ 1,601      $ 3,649   

Impairment

     (15,700     —          —          —     

Amortization

     —          —          (8     (525
                                

June 27, 2010

   $ 157,400      $ 14,400      $ 1,593      $ 3,124   
                                

For purposes of establishing inputs for the fair value calculations described above related to indefinite lived intangible assets, we assumed that the current economic downturn would continue domestically through 2010, followed by moderate growth in future years consistent with our growth prior to the recent downturn in the economy. Internationally, we assumed the continued downturn in the economy in 2010 with slight improvements in future years.

 

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Notes to Unaudited Consolidated Financial Statements

(Continued)

 

We applied gross margin assumptions consistent with the Company’s current trends and used a 4.4% growth factor. Discounting the projected cash flows of these indefinite lived intangible assets at 15.0%, we determined a value of $157.4 million for our trademarks and accordingly, we impaired $15.7 million of trademarks during the quarter ended June 27, 2010. The fair value of the franchise relationships and franchise rights acquired exceeded their carrying value and as such no impairment charge was required. If the terminal growth rate, which has the largest impact on fair value, used in the fair value calculation for trademarks was decreased by 1%, the impairment charge would have increased by $6.5 million. If the discount rate used in the fair value calculation for trademarks was increased by 1%, the impairment charges would have increased by $13.9 million.

Franchise rights acquired and franchise agreements are definite lived assets and amortized over the life of the agreements. Amortization expense of $0.5 million and $0.6 million was recorded in the six months ended June 27, 2010 and June 28, 2009, respectively. At June 27, 2010 and December 27, 2009, accumulated amortization was $4.9 million and $4.4 million, respectively.

5. Income Taxes:

We provide for income taxes using the liability method. Deferred taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting and income tax purposes as determined under enacted tax laws and rates. The effect of changes in tax laws or rates is accounted for in the period of enactment.

In accounting for uncertainty in income taxes, for a tax benefit to be recognized, a tax position must be more likely than not to be sustained upon examination by the taxing authorities.

In assessing the realizability of the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax asset will be realized. Ultimately, the realization of the deferred tax asset is dependent upon the generation of sufficient future taxable income during those periods in which temporary differences become deductible and/or net operating loss and tax credit carryforwards can be utilized. Management considers the level of historical taxable income, scheduled reversal of taxable temporary differences, projected future taxable income and impairment of other assets.

Based on these considerations and the uncertainty surrounding the future economic climate, management believes that it is more likely than not that our net operating loss carryforward, foreign tax credit carryforward, and other deferred tax assets will not be realized. During the first six months of 2010 we recorded an addition to our valuation allowance against these deferred tax assets of $5.3 million. The valuation allowance was $45.0 million as of June 27, 2010.

The income tax benefit of $6.2 million and $6.1 million for the three and six month periods ended June 27, 2010, respectively, was primarily the result of a $6.3 million decrease in the Company’s deferred tax liability related to impairment charges. Refer to Note 4 “Intangibles” for further information regarding the impairment charges recorded.

6. Fair Value Measurement

Current accounting guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs create the following fair value hierarchy:

 

   

Level 1 – Quoted prices for identical instruments in active markets.

 

   

Level 2 – Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations in which all significant inputs are observable in active markets.

 

   

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

In addition, the guidance requires disclosures about the use of fair value to measure assets and liabilities to enable the assessment of inputs used to develop fair value measures, and for unobservable inputs to determine the effects of the measurements on earnings.

The fair values of cash and cash equivalents, accounts receivables-net, and accounts payable approximate carrying amounts because of the short maturities of these instruments.

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following table presents the gross balance, net book value and fair value of our long-term debt as of June 27, 2010 (in thousands):

 

     June 27, 2010
     Gross
Balance
   Net Book
Value
   Fair Value

Senior Notes

   $ 150,000    $ 150,000    $ 117,000

Senior Credit Facility

     167,298      167,298      148,895

Second Lien Facility

     25,500      18,979      22,255
                    

Total

   $ 342,798    $ 336,277    $ 288,150
                    

The estimated fair value of our Senior Notes is based on the quoted market price and trades (level 1 input). Fair value of the Senior Credit Facility was obtained from an independent source of composite bid prices from multiple dealers (level 2 input). Fair value of the Second Lien Facility was obtained from an independent source based on broker quotes, as well as consideration of peer group credit spread analysis (level 1 input). Fair value of the warrants issued in connection with the credit agreement governing the Second Lien Facility was $6.3 million.

7. Business Segment Information:

We operate our business through two segments. Our company-owned restaurant segment is comprised of the operating activities of our company-owned Quick Service Restaurants (“QSR’s”) and other concept restaurants. Our franchise restaurant segment is comprised of our franchised restaurants which offer opportunities worldwide for qualified operators to conduct business under the Sbarro name and other trade names owned by Sbarro. Revenue from our franchised restaurant segment is generated from initial franchise fees, ongoing royalties and other franchising revenue. We do not allocate indirect corporate charges to our operating segments. Such costs are managed on an entity-wide basis, and the information to reasonably allocate such costs is not readily available. We do not allocate assets by segment because our chief operating decision makers do not review the assets by segment to assess performance, as the assets are managed on an entity-wide basis. Our operating segments are discussed in Note 1—Summary of Significant Accounting Policies and Note 13—Business Segment Information to our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 27, 2009.

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following table sets forth the information concerning the revenue and operating (loss) income before unallocated costs of each of our company-owned and franchised restaurant segments (in thousands):

 

     Company-
Owned
Restaurants
    Franchised
Restaurants
   Totals  

2nd Quarter 2010

       

Total revenue

   $ 72,964      $ 3,132    $ 76,096   
                       

Operating (loss) income before unallocated costs

   $ (13,538   $ 2,185    $ (11,353
                 

Unallocated costs and expenses (1)

          6,778   
             

Operating loss

        $ (18,131
             

2nd Quarter 2009

       

Total revenue

   $ 76,659      $ 3,475    $ 80,134   
                       

Operating income before unallocated costs

   $ 5,294      $ 2,028    $ 7,322   
                 

Unallocated costs and expenses (1)

          6,060   
             

Operating income

        $ 1,262   
             

YTD 2nd Quarter 2010

       

Total revenue

   $ 148,191      $ 6,889    $ 155,080   
                       

Operating (loss) income before unallocated costs

   $ (7,428   $ 5,058    $ (2,370
                 

Unallocated costs and expenses (1)

          13,498   
             

Operating loss

        $ (15,868
             

YTD 2nd Quarter 2009

       

Total revenue

   $ 152,942      $ 6,774    $ 159,716   
                       

Operating income before unallocated costs

   $ 11,259      $ 4,127    $ 15,386   
                 

Unallocated costs and expenses (1)

          13,429   
             

Operating income

        $ 1,957   
             

 

(1)

Represents certain general and administrative expenses that are not allocated by segment.

Geographic Information

The Company recorded revenues of $149.8 million and $5.3 million and $155.8 million and $3.9 million in the United States and all other foreign countries in the first six months of 2010 and 2009, respectively, and $73.6 million and $2.5 million and $78.1 million and $2.0 million in the United States and all other foreign countries in the second quarter of 2010 and 2009, respectively.

 

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Notes to Unaudited Consolidated Financial Statements

(Continued)

 

8. Guarantor and non-guarantor financial statements:

Certain subsidiaries have guaranteed amounts outstanding under our credit facilities. Each of the guaranteeing subsidiaries is a direct or indirect wholly-owned subsidiary of the Company and each has fully and unconditionally guaranteed the Senior Notes, the Senior Credit Facilities, and the Second Lien Facility on a joint and several basis.

The following condensed consolidating financial information presents:

 

  (1)

Condensed unaudited consolidating balance sheets as of June 27, 2010 and December 27, 2009 and unaudited statements of operations for the three and six months ended June 27, 2010 and June 28, 2009 and our unaudited statement of cash flows for the six months ended June 27, 2010 and June 28, 2009: (a) Sbarro, (“the Parent”), (b) the guarantor subsidiaries as a group, (c) the nonguarantor subsidiaries as a group, and (d) Sbarro on a consolidated basis.

 

  (2)

Elimination entries necessary to consolidate the Parent with the guarantor and nonguarantor subsidiaries.

The principal elimination entries eliminate intercompany balances and transactions. Investments in subsidiaries are accounted for by the Parent on the equity method.

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of June 27, 2010

ASSETS

(In thousands)

 

     Parent     Guarantor
Subsidiaries
   Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total

Current assets:

           

Cash and cash equivalents

   $ 7,915      $ 2,880    $ 1,262      $ —        $ 12,057

Receivables

           

Franchise

     1,540        —        —          —          1,540

Other

     3,139        172      255        —          3,566
                                     
     4,679        172      255        —          5,106

Inventories

     1,012        1,564      115        —          2,691

Prepaid expenses

     2,102        485      489        —          3,076
                                     

Total current assets

     15,708        5,101      2,121        —          22,930

Intercompany receivables

     (42,422     45,324      (3,698     796        —  

Investment in subsidiaries

     74,280        —        2,307        (76,587     —  

Property and equipment, net

     17,515        34,004      2,369        (231     53,657

Goodwill

     194,786        —        —          —          194,786

Trademarks

     157,400        —        —          —          157,400

Other intangible assets

     19,117        —        —          —          19,117

Deferred financing costs, net

     8,208        —        —          —          8,208

Other assets

     160        202      1,056        —          1,418
                                     

Total assets

   $ 444,752      $ 84,631    $ 4,155      $ (76,022   $ 457,516
                                     

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of June 27, 2010

LIABILITIES AND SHAREHOLDER’S DEFICIT

(In thousands)

(Continued)

 

     Parent     Guarantor
Subsidiaries
   Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Current liabilities:

           

Accounts payable

   $ 6,167      $ 197    $ 1,894      $ —        $ 8,258   

Accrued expenses

     15,105        2,546      1,604        (230     19,025   

Accrued interest payable

     6,606        —        —          —          6,606   
                                       

Total current liabilities

     27,878        2,743      3,498        (230     33,889   

Deferred rent

     2,065        4,986      71        —          7,122   

Deferred tax liability

     70,645        —        —          —          70,645   

Due to former shareholders & other liabilities

     13,008        —        —          —          13,008   

Accrued interest payable

     5,211        —        —          —          5,211   

Long-term debt

     336,277        —        —          —          336,277   

Commitment and contingencies

           

Shareholders’ (deficit) equity:

           

Common stock

           

Authorized 1,000 shares; $.01 par value issued and outstanding 100 shares at June 27, 2010

     —          —        1,478        (1,478     —     

Additional paid in capital

     139,340        68,302      2,267        (70,569     139,340   

Currency translation adjustment

     53        —        180        (180     53   

Advances to MidOcean SBR Holding

     (305     —        —          —          (305

(Accumulated deficit) retained earnings

     (149,864     7,110      (3,545     (3,565     (149,864
                                       

Total shareholder’s (deficit) equity

     (10,776     75,412      380        (75,792     (10,776

Noncontrolling interests

     444        1,490      206        —          2,140   
                                       

Total shareholder’s (deficit) equity, including noncontrolling interests

     (10,332     76,902      586        (75,792     (8,636
                                       

Total liabilities & stockholders’ (deficit) equity, Sbarro, Inc.

   $ 444,752      $ 84,631    $ 4,155      $ (76,022   $ 457,516   
                                       

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of December 27, 2009

ASSETS

(In thousands)

 

     Parent     Guarantor
Subsidiaries
   Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total

Current assets:

           

Cash and cash equivalents

   $ 23,713      $ 2,464    $ 686      $ —        $ 26,863

Receivables

           

Franchise

     2,237        —        —          —          2,237

Other

     2,549        304      63        —          2,916
                                     
     4,786        304      63        —          5,153

Inventories

     1,152        1,643      112        —          2,907

Prepaid expenses

     1,094        533      144        —          1,771
                                     

Total current assets

     30,745        4,944      1,005        —          36,694

Intercompany receivables

     (43,062     45,250      (2,472     284        —  

Investment in subsidiaries

     73,468        —        1,240        (74,708     —  

Property and equipment, net

     19,358        36,415      605        (230     56,148

Goodwill

     194,786        —        —          —          194,786

Trademarks

     173,100        —        —          —          173,100

Other intangible assets

     19,650        —        —          —          19,650

Deferred financing costs, net

     8,977        —        —          —          8,977

Other assets

     1,745        201      848        (1,726     1,068
                                     

Total Assets

   $ 478,767      $ 86,810    $ 1,226      $ (76,380   $ 490,423
                                     

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of December 27, 2009

LIABILITIES AND SHAREHOLDER’S EQUITY

(In thousands)

(Continued)

 

     Parent     Guarantor
Subsidiaries
   Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Current liabilities:

           

Accounts payable

   $ 8,730      $ 164    $ 138      $ —        $ 9,032   

Accrued expenses

     19,329        2,599      933        (230     22,631   

Accrued interest payable

     7,935        —        —          —          7,935   
                                       

Total current liabilities

     35,994        2,763      1,071        (230     39,598   

Deferred rent

     139        6,343      —          —          6,482   

Deferred tax liability

     76,941        —        —          —          76,941   

Due to former shareholders & other liabilities

     12,508        —        —          —          12,508   

Accrued interest payable

     3,048        —        —          —          3,048   

Long-term debt

     336,095        —        —          —          336,095   

Shareholders’ equity (deficit):

           

Common stock, $.01 par value, 1000 shares authorized, 100 issued & outstanding at December 27, 2009

     —          —        484        (484     —     

Additional paid-in capital

     139,340        68,302      1,910        (70,212     139,340   

Currency translation adjustments

     200        —        255        (255     200   

Advances to MidOcean SBR Holding

     (305     —        —          —          (305

(Accumulated deficit) retained earnings

     (125,838     7,509      (2,310     (5,199     (125,838
                                       

Total shareholders’ equity (deficit)

     13,397        75,811      339        (76,150     13,397   

Noncontrolling interest

     645        1,893      (184     —          2,354   
                                       

Total shareholders’ equity (deficit), including noncontrolling interests

     14,042        77,704      155        (76,150     15,751   
                                       

Total liabilities and shareholders’ equity (deficit), Sbarro, Inc.

   $ 478,767      $ 86,810    $ 1,226      $ (76,380   $ 490,423   
                                       

 

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Table of Contents

SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Statement of Operations

For The Three Months Ended June 27, 2010

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations    Consolidated
Total
 

Revenues:

           

Restaurant sales

   $ 30,391      $ 41,564      $ 1,009      $ —      $ 72,964   

Franchise related income

     3,132        —          —          —        3,132   
                                       

Total revenues

     33,523        41,564        1,009        —        76,096   

Costs and expenses:

           

Cost of food and paper products

     7,498        7,474        351        —        15,323   

Payroll and other employee benefits

     8,201        12,029        360        —        20,590   

Other operating costs

     12,468        17,283        1,238        —        30,989   

Other income, net

     (204     (724     (13     —        (941

Depreciation and amortization

     1,735        1,918        66        —        3,719   

General and administrative

     7,843        (11     (103     —        7,729   

Intercompany charges

     (4,325     4,223        102        —        —     

Goodwill & other intangible asset impairment

     15,700        —          —          —        15,700   

Asset impairment, restaurant closings/remodels

     112        975        31        —        1,118   
                                       

Total costs and expenses, net

     49,028        43,167        2,032        —        94,227   
                                       

Operating loss

     (15,505     (1,603     (1,023     —        (18,131

Other (expense) income:

           

Interest expense

     (7,657     —          —          —        (7,657

Interest income

     1        —          —          —        1   
                                       

Net other (expense) income

     (7,656     —          —          —        (7,656
                                       

Equity in loss of subsidiaries

     (1,964     —          —          1,964      —     
                                       

(Loss) income before income taxes and equity investments

     (25,125     (1,603     (1,023     1,964      (25,787

Income tax benefit

     (6,192     —          —          —        (6,192
                                       

(Loss) income before equity investments

     (18,933     (1,603     (1,023     1,964      (19,595

Loss from equity investments

     —          —          (58     —        (58
                                       

Net (loss) income

     (18,933     (1,603     (1,081     1,964      (19,653

Less: Net loss attributable to noncontrolling interests

     104        —          720        —        824   
                                       

Net (loss) income attributable to Sbarro, Inc.

   $ (18,829   $ (1,603   $ (361   $ 1,964    $ (18,829
                                       

 

23


Table of Contents

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Operations

For The Three Months Ended June 28, 2009

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations    Consolidated
Total
 

Revenues:

           

Restaurant sales

   $ 32,568      $ 43,662      $ 429      $ —      $ 76,659   

Franchise related income

     3,475        —          —          —        3,475   
                                       

Total revenues

     36,043        43,662        429        —        80,134   
                                       

Costs and expenses:

           

Cost of food and paper products

     7,783        7,706        142        —        15,631   

Payroll and other employee benefits

     8,716        12,659        173        —        21,548   

Other operating costs

     12,357        17,064        309        —        29,730   

Other income, net

     (117     (663     (64     —        (844

Depreciation and amortization

     1,980        2,267        19        —        4,266   

General and administrative

     7,423        1        —          —        7,424   

Intercompany charges

     (5,816     5,780        36        —        —     

Asset impairment, restaurant closings

     664        453        —          —        1,117   
                                       

Total costs and expenses, net

     32,990        45,267        615        —        78,872   
                                       

Operating income (loss)

     3,053        (1,605     (186     —        1,262   

Other (expense) income:

           

Interest expense

     (7,492     —          —          —        (7,492

Interest income

     1        —          —          —        1   
                                       

Net other (expense) income

     (7,491     —          —          —        (7,491
                                       

Equity in loss of subsidiaries

     (1,831     —          —          1,831      —     
                                       

(Loss) income before income taxes and equity investments

     (6,269     (1,605     (186     1,831      (6,229

Income tax expense

     168        —          —          —        168   
                                       

(Loss) income before equity investments

     (6,437     (1,605     (186     1,831      (6,397

Loss from equity investments

     —          —          (53     —        (53
                                       

Net (loss) income

     (6,437     (1,605     (239     1,831      (6,450

Less: Net (income) loss attributable to noncontrolling interests

     (32     (60     73        —        (19
                                       

Net (loss) income attributable to Sbarro, Inc.

   $ (6,469   $ (1,665   $ (166   $ 1,831    $ (6,469
                                       

 

24


Table of Contents

SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Statement of Operations

For The Six Months Ended June 27, 2010

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations    Consolidated
Total
 

Revenues:

           

Restaurant sales

   $ 61,197      $ 85,368      $ 1,626      $ —      $ 148,191   

Franchise related income

     6,889        —          —          —        6,889   
                                       

Total revenues

     68,086        85,368        1,626        —        155,080   

Costs and expenses:

           

Cost of food and paper products

     14,936        15,175        535        —        30,646   

Payroll and other employee benefits

     16,612        24,665        571        —        41,848   

Other operating costs

     24,782        34,353        1,866        —        61,001   

Other income, net

     (285     (1,485     (17     —        (1,787

Depreciation and amortization

     3,363        3,646        84        —        7,093   

General and administrative

     14,872        —          457        —        15,329   

Intercompany charges

     (8,599     8,438        161        —        —     

Goodwill & other intangible asset impairment

     15,700        —          —          —        15,700   

Asset impairment, restaurant closings/remodels

     112        975        31        —        1,118   
                                       

Total costs and expenses, net

     81,493        85,767        3,688        —        170,948   
                                       

Operating loss

     (13,407     (399     (2,062     —        (15,868

Other (expense) income:

           

Interest expense

     (15,106     —          —          —        (15,106

Interest income

     1        —          —          —        1   
                                       

Net other (expense) income

     (15,105     —          —          —        (15,105
                                       

Equity in loss of subsidiaries

     (1,634     —          —          1,634      —     
                                       

(Loss) income before income taxes and equity investments

     (30,146     (399     (2,062     1,634      (30,973

Income tax benefit

     (6,080     —          —          —        (6,080
                                       

(Loss) income before equity investments

     (24,066     (399     (2,062     1,634      (24,893

Loss from equity investments

     —          —          (120     —        (120
                                       

Net (loss) income

     (24,066     (399     (2,182     1,634      (25,013

Less: Net (income) loss attributable to noncontrolling interests

     40        —          947        —        987   
                                       

Net (loss) income attributable to Sbarro, Inc.

   $ (24,026   $ (399   $ (1,235   $ 1,634    $ (24,026
                                       

 

25


Table of Contents

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Operations

For The Six Months Ended June 28, 2009

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations    Consolidated
Total
 

Revenues:

           

Restaurant sales

   $ 64,424      $ 87,701      $ 817      $ —      $ 152,942   

Franchise related income

     6,774        —          —          —        6,774   
                                       

Total revenues

     71,198        87,701        817        —        159,716   
                                       

Costs and expenses:

           

Cost of food and paper products

     15,331        15,517        281        —        31,129   

Payroll and other employee benefits

     17,220        25,210        357        —        42,787   

Other operating costs

     25,191        33,748        635        —        59,574   

Other income, net

     (222     (1,704     (94     —        (2,020

Depreciation and amortization

     3,777        4,657        33        —        8,467   

General and administrative

     15,825        1        —          —        15,826   

Intercompany charges

     (12,212     12,140        72        —        —     

Asset impairment, restaurant closings

     1,033        963        —          —        1,996   
                                       

Total costs and expenses, net

     65,943        90,532        1,284        —        157,759   
                                       

Operating income (loss)

     5,255        (2,831     (467     —        1,957   

Other (expense) income:

           

Interest expense

     (13,333     —          —          —        (13,333

Write-off of deferred financing costs

     (423     —          —          —        (423

Interest income

     33        —          —          —        33   
                                       

Net other (expense) income

     (13,723     —          —          —        (13,723
                                       

Equity in loss of subsidiaries

     (3,406     —          —          3,406      —     
                                       

(Loss) income before income taxes and equity investments

     (11,874     (2,831     (467     3,406      (11,766

Income tax expense

     272        —          —          —        272   
                                       

(Loss) income before equity investments

     (12,146     (2,831     (467     3,406      (12,038

Loss from equity investments

     —          —          (108     —        (108
                                       

Net (loss) income

     (12,146     (2,831     (575     3,406      (12,146

Net (income) loss attributable to noncontrolling interests

     (33     (190     190        —        (33
                                       

Net (loss) income attributable to Sbarro, Inc.

   $ (12,179   $ (3,021   $ (385   $ 3,406    $ (12,179
                                       

 

26


Table of Contents

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Cash Flows

For The Six Months Ended June 27, 2010

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 
Operating Activities:           

Net (loss) income

   $ (24,066   $ (399   $ (2,182   $ 1,634      $ (25,013

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

          

Goodwill and intangible asset impairment charges

     15,700        —          —          —          15,700   

Depreciation and amortization

     3,363        3,646        84        —          7,093   

Amortization of deferred financing costs

     951        —          —          —          951   

Provision for doubtful accounts receivable

     20        —          —          —          20   

Increase in deferred rent, net of tenant allowance

     234        575        8        —          817   

Asset impairment & restaurant closings/remodels

     —          872        31        —          903   

Change in deferred income taxes, net

     (6,296     —          —          —          (6,296

Equity in net loss of unconsolidated affiliates

     —          —          120        —          120   

Changes in operating assets and liabilities:

          

Decrease (increase) in receivables

     151        132        (192     —          91   

Decrease (increase) in inventories

     141        79        (3     —          217   

(Increase) decrease in prepaid expenses

     (1,008     48        (345     —          (1,305

Increase in other assets

     (344     —          —          —          (344

Decrease (increase) in accounts payable, accrued expenses & other liabilities

     (6,529     (45     2,298        —          (4,276

Increase in accrued interest payable

     834        —          —          —          834   
                                        

Net cash (used in) provided by operating activities

     (16,849     4,908        (181     1,634        (10,488
                                        
Investing Activities:           

Purchases of property and equipment

     (967     (1,802     (2,184     —          (4,953
                                        

Net cash used in investing activities

     (967     (1,802     (2,184     —          (4,953
                                        
Financing Activities:           

Capital contribution from noncontrolling interests

     —          —          971        —          971   

Proceeds from short term loan to noncontrolling interests

     —          —          174        —          174   

Distribution of earning to noncontrolling interests

     (510     —          —          —          (510

Intercompany balances

     2,528        (2,690     1,796        (1,634     —     
                                        

Net cash provided by (used in) financing activities

     2,018        (2,690     2,941        (1,634     635   
                                        

(Decrease) increase in cash and cash equivalents

     (15,798     416        576        —          (14,806

Cash and cash equivalents at beginning of period

     23,713        2,464        686        —          26,863   
                                        

Cash and cash equivalents at end of period

   $ 7,915      $ 2,880      $ 1,262      $ —        $ 12,057   
                                        

 

27


Table of Contents

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Cash Flows

For The Six Months Ended June 28, 2009

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 
Operating Activities:           

Net (loss) income

   $ (12,146   $ (2,831   $ (575   $ 3,406        (12,146

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

          

Depreciation and amortization

     3,777        4,657        33        —          8,467   

Amortization of deferred financing costs

     724        —          —          —          724   

Provision for doubtful accounts receivable

     616        —          —          —          616   

Increase in deferred rent, net of tenant allowance

     352        569        17        —          938   

Asset impairment, restaurant closings/remodels

     457        416        —          —          873   

Equity in net loss of unconsolidated affiliates

     —          —          108        —          108   

Write-off of deferred financing costs

     423        —          —          —          423   

Changes in operating assets and liabilities:

          

Decrease (increase) in receivables

     447        251        (193     190        695   

Decrease in inventories

     193        248        11        —          452   

(Increase) decrease in prepaid expenses

     (137     88        296        —          247   

Increase in other assets

     (65     —          —          —          (65

(Decrease) increase in accounts payable and accrued expenses

     (8,998     (708     469        (466     (9,703

Decrease in accrued interest payable

     (36     —          —          —          (36
                                        

Net cash (used in) provided by operating activities

     (14,393     2,690        166        3,130        (8,407
                                        
Investing Activities:           

Purchases of property and equipment

     (612     (3,923     (95     —          (4,630

Investment in joint ventures

     (245     —          —          —          (245
                                        

Net cash used in investing activities

     (857     (3,923     (95     —          (4,875
                                        
Financing Activities:           

Proceeds from second lien

     25,000        —          —          —          25,000   

Repayment of secured term loan and revolver

     (32,958     —          —          —          (32,958

Debt issue costs

     (1,798     —          —          —          (1,798

Capital contribution from noncontrolling interests

     —          —          313        —          313   

Repayment of short term loan to noncontrolling interests

     —          —          (382     —          (382

Distribution of earnings to noncontrolling interests

     (653     —          —          —          (653

Intercompany balances

     4,073        (702     (241     (3,130     —     
                                        

Net cash used in financing activities

     (6,336     (702     (310     (3,130     (10,478
                                        

Decrease in cash and cash equivalents

     (21,586     (1,935     (239     —          (23,760

Cash and cash equivalents at beginning of period

     34,249        3,468        569        —          38,286   
                                        

Cash and cash equivalents at end of period

   $ 12,663      $ 1,533      $ 330      $ —        $ 14,526   
                                        

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

9. Subsequent Events

On July 1, 2010 the Company borrowed the remaining $5.4 million available under the Senior Credit Facilities.

Effective July 28, 2010 Peter Beaudrault stepped down as the President and Chief Executive Officer of Holdings and the Company and as Chairman of the Board and a Director of the Company. Under the terms of the letter agreement (defined and discussed below) he will remain with the Company in a consulting capacity while the Company’s Board of Directors (the “Board”) undertakes a search for a new Chief Executive Officer.

Mr. Beaudrault, the Company and Holdings entered into a Letter Agreement on July 28, 2010 (the “Letter Agreement”) to address certain transitional matters. Pursuant to the terms of the Letter Agreement, Mr. Beaudrault agreed to remain an employee of the Company and Holdings in order to provide certain transitional services until the earliest of (i) December 31, 2010, (ii) the thirtieth (30th) day following the commencement of employment of the Company’s and Holdings’ new full-time (rather than acting or interim) Chief Executive Officer in such capacity, and (iii) such other date as may be mutually agreed upon by the parties. In consideration for these services, Mr. Beaudrault continues to receive salary and benefits in accordance with the terms of his Employment Agreement with the Company and Holdings, dated January 31, 2007 (the “Employment Agreement”). At the conclusion of Mr. Beaudrault’s employment pursuant to the terms of the Letter Agreement, Mr. Beaudrault will receive severance payments and continued medical benefits for a period of twelve months in accordance with the terms of the Employment Agreement.

Dennis Malamatinas, an existing Director of Holdings and the Company, replaced Mr. Beaudrault as Chairman of the Board, and Nicholas McGrane, an existing Director of Holdings and the Company will serve as Interim President and Chief Executive Officer of the Company and Holdings until the Board appoints a new Chief Executive Officer. In this capacity, Mr. McGrane serves as the Company’s and Holdings’ principal executive officer.

Mr. Malamatinas will receive a fee of $100,000 per year for his service as Chairman of the Board, in lieu of the fee he currently receives as a Director. Mr. McGrane, who is Managing Director of MidOcean, will not receive any compensation from the Company or Holdings for his service as Interim President and Chief Executive Officer.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

We make statements in this Quarterly Report that are considered forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended. The words “anticipate,” “believe,” “estimate,” “intend,” “may,” “will,” “expect” and similar words often indicate that a statement is a “forward-looking statement.” Statements about non-historic results also are considered to be forward-looking statements. None of these forward-looking statements are guarantees of future performance or events, and they are subject to numerous risks, uncertainties and other factors. These risks, uncertainties and other factors include, but are not limited to:

 

   

general economic, inflation, national security, weather and business conditions;

 

   

decrease in mall traffic, and other events arising from the downturn in the economy;

 

   

the availability of suitable restaurant sites in appropriate regional shopping malls and other locations on reasonable rental terms;

 

   

changes in consumer tastes;

 

   

changes in population and traffic patterns, including the effects that military action and terrorism or other events may have on the willingness of consumers to frequent malls, airports or downtown areas which are the predominant areas in which our restaurants are located;

 

   

our ability to continue to attract franchisees;

 

   

the success of our present, and any future, joint ventures and other expansion opportunities;

 

   

changes in commodity and commodity related prices (particularly cheese and flour), beverage and paper products;

 

   

our ability to pass along cost increases to our customers;

 

   

increases in the Federal minimum wage;

 

   

the continuity of services of members of our senior management team;

 

   

our ability to attract and retain competent restaurant and executive managerial personnel;

 

   

competition;

 

   

the level of, and our ability to comply with, government regulations;

 

   

our ability to generate sufficient cash flow to make interest payments under our borrowing agreements;

 

   

our ability to comply with financial covenants and ratios and the effects the restrictions imposed by those financial covenants and ratios may have on our ability to operate our business; and

 

   

our ability to repurchase and/or repay amounts under our borrowing agreements to the extent required in the event of certain circumstances as defined in our borrowing agreements.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this 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.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited consolidated financial statements, the notes thereto and other data and information appearing elsewhere in this report.

Executive Overview

For the purposes of management’s discussion and analysis, the year to date second quarter of 2010 is the twenty six weeks ended June 27, 2010 and the year to date second quarter of 2009 is the twenty six weeks ended June 28, 2009. The second quarter of 2010 is the thirteen weeks ended June 27, 2010 and the second quarter of 2009 is the thirteen weeks ended June 28, 2009.

We are the world’s leading Italian Quick Service Restaurant (“QSR”) concept and the largest shopping mall-focused restaurant concept in the world. We have a global base of 1,041 units in 41 countries, with 482 company-owned units, 536 franchised units and 23 joint venture units. Sbarro restaurants feature a menu of popular Italian food, including pizza, a selection of pasta dishes and other hot and cold Italian entrees, salads, sandwiches, drinks and desserts.

 

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We operate our business through two segments. Our company-owned restaurant segment is comprised of the operating activities of our company-owned QSR’s and other concept restaurants. Our franchised restaurant segment is comprised of our franchised restaurants which offer opportunities worldwide for qualified operators to conduct business under the Sbarro name and other trade names owned by Sbarro. Revenue from our franchised restaurant segment is generated from initial franchise fees, ongoing royalties and other franchising revenue. We do not allocate indirect corporate charges to our operating segments. Such costs are managed on an entity-wide basis, and the information to reasonably allocate such costs is not readily available. We do not allocate assets by segment because our chief operating decision makers do not review the assets by segment to assess performance, as the assets are managed on an entity-wide basis. Our operating segments are discussed in Note 1—Summary of Significant Accounting Policies and Note 13—Business Segment Information to our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 27, 2009.

Our Restaurant Expansion

The following table summarizes the number of company-owned, franchised, and joint venture restaurants in operation during each indicated period:

 

     Three Months Ended
June 27, 2010
    Three Months Ended
June 28, 2009
    Six Months Ended
June 27, 2010
    Six Months Ended
June 28, 2009
 

Company-owned Sbarro restaurants:

        

Open at beginning of period

   484      490      484      509   

Opened during period

   1      1      4      5   

Closed during period

   (3   (6   (6   (29
                        

Open at end of period

   482      485      482      485   
                        

Franchised Sbarro restaurants:

        

Open at beginning of period

   550      566      555      566   

Opened during period

   9      13      17      36   

Closed during period

   (23   (19   (36   (42
                        

Open at end of period

   536      560      536      560   
                        

Joint venture Sbarro restaurants:

        

Open at beginning of period

   21      16      17      16   

Opened during period

   2      1      6      1   
                        

Open at end of period

   23      17      23      17   
                        

All restaurants:

        

Open at beginning of period

   1,055      1,072      1,056      1,091   

Opened during period

   12      15      27      42   

Closed during period

   (26   (25   (42   (71
                        

Open at end of period

   1,041      1,062      1,041      1,062   
                        

Seasonality

Revenues are highest in our fourth quarter due primarily to increased traffic in shopping malls during the holiday shopping season. Our annual revenues and earnings can fluctuate due to the length of the holiday shopping period between Thanksgiving and New Year’s Day.

Goodwill and Other Intangible Assets

Due to the seasonality of our business, we perform our annual test for impairment on our goodwill and intangible assets with indefinite lives as required by the accounting for goodwill and other intangible assets and fully evaluate the impairment of long-lived assets as required by the accounting for the impairment and disposal of long-lived assets in the fourth quarter of our fiscal year. Any required adjustments are recorded at that time unless our assumptions regarding forecasted revenue or margin growth rates are not achieved, then we may be required to record an impairment charge prior to that if any such change constitutes a triggering event outside of the quarter from when the annual goodwill impairment test is performed. Refer to Note 4 “Intangibles” to our Unaudited Consolidated Financial Statements for further information regarding impairment testing performed during the second quarter of 2010 and the impairment charges recorded during the second quarter of 2010.

 

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Noncontrolling Interests

We present minority interests as noncontrolling interests in the equity section of our consolidated balance sheet as a separate net loss attributable to noncontrolling interests in our consolidated statement of operations, and as a distribution to/from noncontrolling interests in the consolidated statements of cash flows.

Summary Financial Information (dollars in millions)

 

     Three Months
Ended
June 27, 2010
    Three Months
Ended
June 28, 2009
    Six Months
Ended
June 27, 2010
    Six Months
Ended
June 28, 2009
 

Comparable sales-percentage change vs. prior comparable period (1):

        

QSR-owned locations

     -6.2     -5.1     -3.7     -4.9

Franchise locations:

        

Domestic Franchise

     -0.9     -4.5     -3.0     -4.3

International Franchise:

        

Local Currency

     4.1     -4.5     5.8     -6.8

Foreign Currency Impact

     3.9     -18.7     7.0     -18.1
                                

International Franchise, net

     8.0     -23.2     12.8     -24.9

Cost of food and paper products as a percentage of restaurant sales

     21.0     20.4     20.7     20.4

Payroll and other benefits as a percentage of restaurant sales

     28.2     28.1     28.2     28.0

Other operating expense as a percentage of restaurant sales

     42.5     38.8     41.2     39.0

General and administrative costs as a percentage of revenues

     10.2     9.3     9.9     9.9

Bank credit agreement EBITDA (2)

   $ 6,316      $ 8,220      $ 14,341      $ 17,348   

 

(1)

Comparable and annual percentage changes are based on locations that were open during the entire period within the periods presented.

(2)

Bank credit agreement EBITDA includes certain adjustments to EBITDA disclosed in our Senior Credit Facilities. EBITDA represents earnings before interest income, interest expense, taxes, depreciation and amortization. EBITDA should not be considered in isolation from, or as a substitute for, net income, cash flow from operations or other cash flow statement data prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) or as a measure of a company’s profitability or liquidity. Rather, we believe that EBITDA and bank credit agreement EBITDA provide relevant and useful information for analysts and investors in our Senior Notes in that the Senior Credit Facilities and the Second Lien Facility each contain a minimum bank credit agreement EBITDA covenant. We also internally use EBITDA to determine whether or not to continue operating restaurant units since it provides us with a measurement of whether we are receiving an adequate cash return on our 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.

 

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The following table reconciles our net loss to EBITDA and bank credit agreement EBITDA for each of the periods presented. EBITDA and bank credit agreement EBITDA are non-GAAP financial measures. We believe net loss is the most direct comparable GAAP financial measure to EBITDA and bank credit agreement EBITDA, (dollars in thousands):

 

     Three  Months
Ended
June 27, 2010
    Three  Months
Ended
June 28, 2009
    Six  Months
Ended
June 27, 2010
    Six  Months
Ended
June 28, 2009
 

Net loss attributable to Sbarro, Inc.

   $ (18,829   $ (6,469   $ (24,026   $ (12,179

Interest Expense

     7,657        7,492        15,106        13,333   

Interest Income

     (1     (1     (1     (33

Income Tax (Benefit) Expense

     (6,192     168        (6,080     272   

Depreciation and Amortization

     3,719        4,266        7,093        8,467   
                                

EBITDA attributable to Sbarro, Inc.

     (13,646     5,456        (7,908     9,860   

Goodwill & other intangible asset impairment

     15,700        —          15,700        —     
                                

EBITDA attributable to Sbarro, Inc. exclusive of goodwill & other intangible asset impairment

   $ 2,054      $ 5,456      $ 7,792      $ 9,860   

Adjustments:

        

Non-cash charges

     1,326        1,205        1,816        2,820   

Management fees and related expenses

     297        248        595        957   

Restructuring related expenses, store closing costs and severance

     1,481        1,084        2,016        2,989   

Preopening, joint venture operations and taxes in lieu of income tax

     1,158        227        2,122        722   
                                

Bank Credit Agreement EBITDA

   $ 6,316      $ 8,220      $ 14,341      $ 17,348   
                                

 

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The following table sets forth the information concerning the revenue and operating (loss) income before unallocated costs of each of our company-owned and franchised restaurant segments (in thousands):

 

     Company-
Owned
Restaurants
    Franchised
Restaurants
   Totals  

2nd Quarter 2010

       

Total revenue

   $ 72,964      $ 3,132    $ 76,096   
                       

Operating (loss) income before unallocated costs

   $ (13,538   $ 2,185    $ (11,353
                 

Unallocated costs and expenses (1)

          6,778   
             

Operating loss

        $ (18,131
             

2nd Quarter 2009

       

Total revenue

   $ 76,659      $ 3,475    $ 80,134   
                       

Operating income before unallocated costs

   $ 5,294      $ 2,028    $ 7,322   
                 

Unallocated costs and expenses (1)

          6,060   
             

Operating income

        $ 1,262   
             

YTD 2nd Quarter 2010

       

Total revenue

   $ 148,191      $ 6,889    $ 155,080   
                       

Operating (loss) income before unallocated costs

   $ (7,428   $ 5,058    $ (2,370
                 

Unallocated costs and expenses (1)

          13,498   
             

Operating loss

        $ (15,868
             

YTD 2nd Quarter 2009

       

Total revenue

   $ 152,942      $ 6,774    $ 159,716   
                       

Operating income before unallocated costs

   $ 11,259      $ 4,127    $ 15,386   
                 

Unallocated costs and expenses (1)

          13,429   
             

Operating income

        $ 1,957   
             

 

(1)

Represents certain general and administrative expenses that are not allocated by segment.

Second Quarter 2010 versus Second Quarter 2009

Sales by QSR and consolidated other concept restaurants were $73.0 million for the second quarter of 2010 compared to $76.7 million for the second quarter of 2009. The decrease in sales is due to a decrease in comparable unit sales of $4.5 million, or 6.2%, in our QSR restaurants and lost sales from stores strategically closed of $1.4 million partially offset by sales generated by new stores opened, remodeled or relocated in 2010 and 2009 of $1.9 million. The decrease in comparable unit sales primarily reflects the reduction in consumer spending throughout the United States as a result of the current economic environment.

Franchise related revenues were $3.1 million in the second quarter of 2010 compared to $3.5 million for the second quarter of 2009. This resulted from a decrease in international development fee income and lost royalties from stores closed.

 

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Cost of food and paper products as a percentage of restaurant sales increased to 21.0% for the second quarter of 2010 as compared to 20.4% for the second quarter of 2009. The cost of cheese in the second quarter of 2010 averaged $1.66 per pound compared to an average of $1.38 per pound for the second quarter of 2009. This $.28 per pound increase in cheese costs accounted for $0.4 million or 0.5% of restaurant sales. The cost of flour in both the second quarter of 2010 and 2009 averaged $.29 per pound.

Payroll and other employee benefits as a percentage of restaurant sales increased to 28.2% in the second quarter of 2010 from 28.1% in the second quarter of 2009.

Other operating costs were $31.0 million in the second quarter of 2010 compared to $29.7 million in the second quarter of 2009. As a percentage of restaurant sales, other operating costs increased to 42.5% in the second quarter of 2010 as compared to 38.8% in the second quarter of 2009 due to an increase in store opening costs related to our joint venture operations in the second quarter of 2010.

Other income, net increased to $0.9 million in the second quarter of 2010 from $0.8 million in the second quarter of 2009.

Depreciation and amortization decreased to $3.7 million in the second quarter of 2010 compared to $4.3 million in the second quarter of 2009 due to underperforming stores closed in 2009.

General and administrative expenses were $7.7 million in the second quarter of 2010 as compared to $7.4 million in the second quarter of 2009. The increase was primarily related to an increase in marketing research initiatives and joint venture expenses offset by a reduction in expenses for the bad debt provision and severance when compared to the prior year.

Goodwill and other intangible asset impairment totaled $15.7 million in the second quarter of 2010. There were no goodwill and other intangible asset impairment charges in the second quarter of 2009. This is discussed further in Note 4 – Intangibles to our Unaudited Consolidated Financial Statements included within this Report.

Asset impairment, restaurant closing and remodeling costs were $1.1 million in both the second quarter of 2010 and 2009. Included in the 2010 expense of $1.1 million was $0.9 million of non-cash fixed asset impairment charges.

Interest expense of $7.7 million in the second quarter of 2010 and $7.5 million for the second quarter of 2009 relates primarily to the Senior Notes, the Term Loans and Revolving Facility under our Senior Credit Facilities and our Second Lien Facility. Included in interest expense in both the second quarter of 2010 and 2009 was the amortization of deferred financing costs for the Senior Notes, Term Loan and Second Lien Facility of $0.4 million.

The income tax benefit of $6.2 million for the second quarter of 2010 was primarily the result of a $6.3 million decrease in our deferred tax liability related to intangible asset impairment charges and our effective tax rate was 24.8%. During the second quarter of 2010, we recorded a $3.7 million increase to the valuation allowance on our deferred tax assets increasing the valuation allowance to $45.0 million. The income tax expense was $0.2 million in the second quarter of 2009 and our effective tax rate was negative 2.7%. During the second quarter of 2009, we recorded a $2.5 million increase to the valuation allowance on our deferred tax assets.

Loss from equity investments relates to our joint venture in Beirut, an unconsolidated affiliate.

Net loss (income) attributable to noncontrolling interests relates to our joint ventures in India, Japan, China and certain partnerships.

Net loss attributable to Sbarro, Inc. was $18.8 million for the second quarter of 2010 as compared to a net loss attributable to Sbarro, Inc. of $6.5 million for the second quarter of 2009. Included in the second quarter of 2010 net loss were goodwill and other intangible asset impairment charges of $15.7 million offset by an income tax benefit of $6.2 million. Without impairment charges and taxes, the net loss would have been $9.3 million and $6.3 million in the second quarter of 2010 and 2009, respectively. This increase in net loss was due to the items discussed above, primarily the decrease in comparable unit sales and an increase in other operating costs offset by overall cost reductions related to cost savings initiatives.

Six Months Ended 2010 versus Six Months Ended 2009

Sales by QSR and consolidated other concept restaurants were $148.2 million for the first six months of 2010 compared to $152.9 million for the first six months of 2009. The decrease in sales is due to a decrease in comparable unit sales of $5.4 million, or 3.7%, in our QSR restaurants and lost sales from stores strategically closed of $3.6 million, partially offset by sales generated by new stores opened, remodeled or relocated in 2010 and 2009 of $3.9 million. The decrease in comparable unit sales primarily reflects the reduction in consumer spending throughout the United States as a result of the current economic environment.

 

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Franchise related revenues were $6.9 million in the first six months of 2010 compared to $6.8 million for the first six months of 2009. This resulted from an increase in international development fee income partially offset by lost royalties from stores closed.

Cost of food and paper products as a percentage of restaurant sales increased to 20.7% for the first six months of 2010 as compared to 20.4% for the first six months of 2009. The cost of cheese in the first six months of 2010 averaged $1.73 per pound compared to an average of $1.39 per pound for the first six months of 2009. This $.34 per pound increase in cheese costs accounted for $0.9 million or 0.6% of restaurant sales. The cost of flour in the first six months of both 2010 and 2009 averaged $.30 per pound.

Payroll and other employee benefits as a percentage of restaurant sales increased to 28.2% in the first six months of 2010 from 28.0% in the first six months of 2009. The increase is primarily due to the decrease in comparable unit sales in the first six months of 2010.

Other operating costs were $61.0 million in the first six months of 2010 compared to $59.6 million in the first six months of 2009. As a percentage of restaurant sales, other operating costs increased to 41.2% in the first six months of 2010 as compared to 39.0% in the first six months of 2009 due to an increase in store opening costs related to our joint venture operations in the first six months of 2010 partially offset by cost control initiatives implemented in 2009.

Other income, net decreased to $1.8 million in the first six months of 2010 from $2.0 million in the first six months of 2009.

Depreciation and amortization decreased to $7.1 million in the first six months of 2010 compared to $8.5 million in the first six months of 2009 due to underperforming stores closed in 2009.

General and administrative expenses were $15.3 million in the first six months of 2010 as compared to $15.8 million in the first six months of 2009. The decrease was primarily related to a reduction in severance expenses and the bad debt provision offset by costs associated with marketing research initiatives and joint venture expenses when compared to the prior year.

Goodwill and other intangible asset impairment totaled $15.7 million in the first six months of 2010. There were no goodwill and other intangible asset impairment charges in the first six months of 2009. This is discussed further in Note 4 – Intangibles to our Unaudited Consolidated Financial Statements included within this Report.

Asset impairment, restaurant closing and remodeling costs decreased to $1.1 million for the first six months of 2010 compared to $2.0 million for the first six months of 2009 as 29 stores were strategically closed in the prior year.

Interest expense of $15.1 million in the first six months of 2010 and $13.3 million for the first six months of 2009 relates primarily to the Senior Notes, the Term Loans and Revolving Facilities under our Senior Credit Facilities and our Second Lien Facility. Included in interest expense in the first six months of 2010 and 2009 was the amortization of deferred financing costs for the Senior Notes, Term Loan and Second Lien Facility of $0.8 million and $0.7 million, respectively.

Write-off of deferred financing costs of $0.4 million in the first six months of 2009 related to prepayment of the Senior Credit Facility.

The income tax benefit of $6.1 million for the first six months of 2010 was primarily the result of a $6.3 million decrease in our deferred tax liability related to intangible asset impairment charges and our effective tax rate was 20.3%. During the first six months of 2010, we recorded a $5.3 million increase to the valuation allowance on our deferred tax assets increasing the valuation allowance to $45.0 million. The income tax expense was $0.3 million in the first six months of 2009 and our effective tax rate was negative 2.3%. During the first six months of 2009, we recorded a $4.6 million increase to the valuation allowance on our deferred tax assets.

Loss from equity investments relates to our joint venture in Beirut, an unconsolidated affiliate.

Net loss (income) attributable to noncontrolling interests relates to our joint ventures in India, Japan, China and certain partnerships.

Net loss attributable to Sbarro, Inc. was $24.0 million for the first six months of 2010 as compared to a net loss attributable to Sbarro, Inc. of $12.2 million for the first six months of 2009. Included in the net loss for the first six months of 2010 were goodwill and other intangible asset impairment charges of $15.7 million offset by an income tax benefit of $6.1 million. Without impairment charges and taxes, the net loss would have been $14.4 million and $11.9 million in the first six months of 2010 and 2009, respectively. This increase in net loss was due to the items discussed above, primarily the decrease in comparable unit sales and an increase in other operating costs offset by a reduction in certain operating expenses due to cost savings initiatives.

 

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Liquidity and Capital Resources

Principal Cash Requirements and Sources

We are highly leveraged and a substantial portion of our liquidity needs arise from debt service on indebtedness incurred in connection with the Merger. Our other liquidity needs fund our costs of operations, working capital and capital expenditures. Cash flow generated during our fourth quarter is critical to achieving positive annual operating cash flow. Adverse macroeconomic factors, including reduced mall traffic during the holiday shopping season and a decline in consumer spending among other factors can negatively impact achieving our projected operating cash flow. Additionally, we experience pressures related to increasing commodity costs, particularly cheese and flour.

On March 26, 2009, we entered into an amendment to the Senior Credit Facilities. The amendment permitted the Company to refinance a portion of our Term Loan by entering into the new Second Lien Facility, permanently waived a breach of our total net leverage ratio covenant for the fiscal quarter ended December 28, 2008, and replaced our total net leverage ratio covenant and interest coverage ratio covenant with a minimum EBITDA covenant and a maximum capital expenditure covenant, increased the margin on our Term Loan and Revolving Facility by 200 basis points, required prepayment of $25.0 million of the Term Loan from the proceeds of the Second Lien Facility, required prepayment of $3.5 million of the Revolving Facility from cash on hand and simultaneously reduced the Revolving Facility’s amount outstanding and commitment to $21.5 million and restricted payment of MidOcean’s annual management fee so that such fee will accrue but not be paid until the Company’s EBITDA is at least $55.0 million and after such goal is obtained, a maximum of $2.0 million of such fees may be paid each year. Our ability to borrow funds under our revolver is subject to compliance with our debt covenant requirements. On July 1, 2010 we drew the remaining amount available under our Revolving Facility and have no additional availability under the Senior Credit Facilities.

EBITDA, as calculated in accordance with our Senior Credit Facilities (“bank credit agreement EBITDA”), was $44.7 million for fiscal 2009 and $41.7 million for the twelve months ending with the second quarter of 2010. The Company was in compliance with all covenants at June 27, 2010. Our ability to meet or exceed our third quarter minimum trailing twelve months bank credit agreement EBITDA covenant of $40.0 million relies significantly on our same store sales trend versus the prior year. In order to comply with our third quarter minimum EBITDA covenant, our third quarter same store sales trend versus prior year would need to improve relative to our second quarter same store sales trend, and at the same time, our costs would need to be favorable to the prior year. If we fail to achieve this mix of increased sales and lower costs, we may not comply with our minimum EBITDA covenants for the third quarter.

Our minimum trailing twelve month EBITDA covenant, as calculated in accordance with our amended bank credit agreement, increases at the end of the fourth quarter of 2010 by $3.0 million dollars to $43.0 million. Our ability to meet our fourth quarter minimum trailing twelve month EBITDA covenant relies significantly on our company owned same store sales trend versus prior year. Our comparable sales percentage change versus the prior year is highly dependent on the level of traffic in shopping malls during the fourth quarter holiday shopping season. Based on our recent trends, we would need a significant upturn in the general economy and a significant change to our second quarter trend to achieve positive same store sales versus prior year to satisfy the minimum trailing twelve month EBITDA covenant for the fourth quarter, and at the same time our costs would need to be favorable to the prior year. If we fail to achieve this mix of increased sales and lower costs, we may not comply with our minimum EBITDA covenants for the fourth quarter.

We are unable to control commodity costs which can impact our ability to satisfy our minimum EBITDA covenants. Specifically, commodity costs can also fluctuate with cheese and flour currently being the most volatile. For example, a $.20 variance in the price of block cheese or a $.10 variance in the price of a pound of flour would affect our costs by approximately $250 thousand and $300 thousand in the third and fourth quarters, respectively.

Our Senior Credit Facility provides for certain cures in the event of noncompliance with our minimum EBITDA covenants. Covenant violations can be cured with cash payments made by our principal shareholders. Such cure amounts are equal to the shortfall, provided the shortfall does not exceed ten percent of our last twelve months bank EBITDA, and can be added to our minimum twelve month EBITDA for the next four quarters. An equity cure can only be completed twice within each twelve month period. Our principal shareholders have no obligation to provide such funds.

Based upon our cash balance of $12.1 million at June 27, 2010, along with the $5.4 million borrowings drawn under our revolver in July 2010 and our revised 2010 forecast, we believe that cash flows generated from operations during 2010, along with our cash on hand, will be sufficient for us to meet our debt service requirements and fund working capital and capital expenditures for the next twelve months. It is possible that our actual results may differ materially from our revised 2010 forecast or that we are unable to obtain a waiver or cure an event of noncompliance with our minimum EBITDA covenants, and then we would not have sufficient cash to meet our obligations and substantial doubt would exist about our ability to continue as a going concern at that time.

 

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We estimate that our cash interest expense for the fiscal year under the Senior Notes and the Senior Credit Facilities will be approximately $26.2 million under the amended Senior Credit Facilities, assuming a 2% LIBOR rate. Borrowings under the Second Lien Facility bear interest at 15% per annum payable quarterly in arrears. The Second Lien Facility provides for no amortization of principal. Interest is payable quarterly as follows: (i) prior to the third anniversary, interest is only payable in kind and (ii) after the third anniversary, interest is payable in cash so long as the Senior Credit Facilities leverage ratio is less than or equal to 2.75:1.00.

The amended Senior Credit Facilities require us to prepay outstanding borrowings, subject to certain exceptions, with (a) 75% of our annual excess cash flow; (b) 100% of the net cash proceeds of certain asset sales or other dispositions of property (including casualty insurance and condemnations) if we do not commit to reinvest such proceeds in accordance with the terms of the Senior Credit Facilities within 365 days of the event giving rise thereto (or, to the extent we have entered into a commitment to reinvest such proceeds within such time period to the extent such amounts are actually reinvested, within six months of the expiration of such 365 days); and (c) 100% of the net cash proceeds of any incurrence of debt, other than debt permitted under the Senior Credit Facilities. The prepayment of $25.0 million of the Term Loan from the proceeds of the Second Lien Facility satisfied our quarterly obligation for further principal amortization payments on our Senior Credit Facilities. We are not required to make principal payments, absent the occurrence of certain events, on our Senior Notes until they mature in 2015. In July 2010 we borrowed the remaining $5.4 million available under our Senior Credit Facilities. We believe that aggregate capital expenditures for our domestic locations in 2010 will approximate $4.8 million, which we expect will be funded with operating cash. Based upon our projected cash requirements for operations, we believe we have adequate resources to fund operations, working capital needs, capital expenditures, debt servicing requirements and other cash needs for the next twelve months based upon current cash balances. If necessary, we may adjust the rate of capital expenditures, acquisitions, or the timing and magnitude of other controllable expenditures to meet such requirements.

Sources and Uses of Cash

The following table summarizes our cash and cash equivalents and working capital at June 27, 2010 and June 28, 2009 respectively, and the sources and uses of our cash flows for the six months ended June 27, 2010 and June 28, 2009, respectively (in millions):

 

     Six Months Ended
June 27, 2010
    Six Months Ended
June 28, 2009
 

Liquidity at the end of period

    

Cash and cash equivalents

   $ 12.1      $ 14.5   

Working capital

   $ (11.0   $ (9.3

Net cash flows

    

Used in operating activities

   $ (10.5   $ (8.4

Used in investing activities

   $ (4.9   $ (4.9

Provided by (used in) financing activities

   $ 0.6      $ (10.5