10-K 1 edgar10k2000.txt 10K 2000 -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K |X|Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2000 |_| Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ________ to ________ Commission file number 333-90817 SBARRO, INC. (Exact name of Registrant as specified in its charter) NEW YORK 11-2501939 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 401 Broad Hollow Road, Melville, New York 11747 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (631) 715-4100 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None 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 requirement for the past 90 days. Yes X No ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ X ]. The registrant's common stock is not publicly-held nor publicly traded. The number of shares of Common Stock of the registrant outstanding as of March 15, 2001 was 7,064,328. DOCUMENTS INCORPORATED BY REFERENCE None -------------------------------------------------------------------------------- SBARRO, INC. Unless the context otherwise requires, all references to "we", "us", "our", "Sbarro" or the "Company" include Sbarro, Inc. and our subsidiaries. PART I Forward-Looking Statements This report contains certain forward-looking statements about our financial condition, results of operations, future prospects and business. These statements appear in a number of places in the report and include statements regarding our intent, belief, expectation, strategies or projections at that time. These statements generally contain words such as "may", "should", "seeks", "believes", "expects", "intends", "plans", "estimates", "projects", "strategy" and similar expressions or the negative of those words. Forward-looking statements are subject to a number of known and unknown risks and uncertainties that could cause actual results to differ materially from those projected, expressed or implied in the forward-looking statements. These risks and uncertainties, many of which are not within our control, include but are not limited to, general economic, weather and business conditions; 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; our ability to continue to attract franchisees; the success of the our present, and any future, joint ventures and other expansion opportunities; the availability of food (particularly cheese and tomatoes) and paper products at current prices; our ability to pass along cost increases to our customers; no material increase occurring 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 and principal under our senior notes and credit agreement; the effects which restrictions imposed on us under the Indenture for the senior notes and the credit agreement may have on our ability to operate our business; and our ability to repurchase Senior Notes to the extent required and make repayments under our credit agreement to the extent required in the event we make certain asset sales or experience a change of control. You are cautioned not to place undue reliance on these statements, which speak only as of the date of the report. We do not undertake any responsibility to release publicly any revisions to these forward-looking statements to take into account events or circumstances that occur after the date of this report, other than as required by law. 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. 2 ITEM 1. BUSINESS Sbarro, Inc., a New York corporation, was organized in 1977 and is the successor to a number of family food and restaurant businesses developed and operated by the Sbarro family. Today, we are a leading owner, operator and franchisor of quick-service restaurants, serving a wide variety of Italian specialty foods with 939 restaurants worldwide at December 31, 2000. In addition since 1995, we have created, primarily through joint ventures, other restaurant concepts for the purpose of developing growth opportunities in addition to the Sbarro restaurants. We presently operate 34 new concept units through joint ventures or wholly owned subsidiaries. (See "New Concept Development", below.) Going Private Transaction On September 28, 1999, members of the Sbarro family (who prior thereto owned approximately 34.4% of our common stock) became the holders of 100% of our issued and outstanding common stock as a result of a merger in which (i) a company owned by the members of the Sbarro family merged with and into us, (ii) our shareholders (other than the members of the Sbarro family and the company owned by them) received the right to receive $28.85 per share in cash in exchange for the approximately 13.5 million shares of our common stock not owned by the members of the Sbarro family, and (iii) all outstanding stock options, including stock options held by the members of the Sbarro family, were terminated in exchange for a cash payment equal to the number of shares subject to the options multiplied by the excess, if any, of $28.85 over the applicable option exercise price. The cost of the merger, including fees and expenses, was funded through the use of substantially all of the our cash on hand and the placement of $255.0 million of 11.0% Senior Notes due September 15, 2009 (the "Senior Notes") sold at a price of 98.514% of par to yield 11.25% per annum. The Senior Notes were issued under an Indenture dated September 28, 1999 (the "Indenture"). We also entered into a five year, $30 million unsecured senior revolving bank credit facility under a Credit Agreement dated as of September 23, 1999 (the "Credit Agreement"). The Credit Agreement provides an unsecured senior revolving credit facility which enables us to borrow, on a revolving basis from time to time during its five-year term, up to $30.0 million, including a $10.0 million sublimit for standby letters of credit. Our payment obligations under the Senior Notes and the Credit Agreement are jointly, severally, unconditionally and irrevocably guaranteed by all of our current Restricted Subsidiaries (as defined in the Indenture) and is to be similarly guaranteed by our future Restricted Subsidiaries. See "Selected Financial Data" included in Item 6 of this report, "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of this report, "Financial Statements and Supplementary Data" included in Item 8 of the report and "Certain Relationships and Related Transactions" included in Item 13 of this report. 3 General We are a leading owner, operator and franchisor of quick service restaurants, serving a wide variety of Italian specialty foods. Under the "Sbarro" and "Sbarro The Italian Eatery" names, we developed one of the first quick-service concepts that extended beyond offering one primary specialty item, such as pizza or hamburgers. Our diverse menu offering includes pizza, pasta and other hot and cold Italian entrees, salads, sandwiches, cheesecake and other desserts and beverages. All of our entrees are prepared fresh daily in each restaurant using special recipes developed by us. We focus on serving our customers generous portions of high quality Italian-style food at attractive prices. We believe that the Sbarro concept is unlike other quick-service Italian restaurants due to its diverse menu selection and its fast, cafeteria-style service. Since our inception in 1959, we have focused on high customer traffic venues due to the large number of captive customers who base their eating decision primarily on impulse and convenience. We therefore do not have to incur the significant advertising and promotional expenditures that certain of our competitors incur to attract customers to their destination restaurants. These factors, combined with adherence to strict cost controls, provide us with high and stable operating margins. Over the past ten years, we have extended the Sbarro concept from downtown locations and enclosed shopping malls to other high customer traffic venues, including toll roads, airports, sports arenas, hospitals, convention centers, university campuses and casinos. We believe the opportunity to open additional Sbarro units in these and other new venues should continue to increase as companies, municipalities and others seek to outsource their non-core food operations to companies with an established brand name. In addition, since 1995, we have created and operated, through joint ventures, other casual and fine dining concepts for the purpose of developing growth opportunities in addition to our Sbarro restaurants. As of December 31, 2000, we operated 939 quick service restaurants, consisting of 636 Company-owned and 303 franchised restaurants located in 48 States, the District of Columbia, the Commonwealth of Puerto Rico, certain United States territories and 21 countries throughout the world, and, with our joint venture partners or in wholly owned subsidiaries, 33 casual and fine dining restaurants featuring varying cuisines. Restaurant Expansion We have grown from 103 Sbarro-owned or franchised quick service restaurants at the time of our initial public offering in 1985 to 939 as of December 31, 2000 excluding 33 new concept units. During 2000, 49 new Sbarro restaurants were opened, of which 13 were Company-owned and 36 were franchised, 16 Company-owned and 18 franchised units were closed and one unit that had been a franchise unit became a Company-owned unit. In addition, we and joint ventures in which we participate opened seven casual and fine dining units in 2000. (See "New Concept Development" below). 4 The following table summarizes the number of Sbarro-owned and franchised quick service restaurants in operation during each of the years from 1996 through 2000:
Fiscal Year ------------------------------- 2000 1999 1998 1997 1996 Company-owned Sbarro restaurants: Opened during period (1) 13 24 25 28 26 (Sold to) acquired from franchisees during period 1 (1) 1 4 1 Closed during period (2) (16) (9) (20) (8) (4) ---- --- ---- --- --- Open at end of period (3) 636 638 624 618 594 Franchised Sbarro restaurants: Opened during period 36 49 43 47 36 Acquired from (sold to) Company during period (1) 1 (1) (4) (1) Closed or terminated during period (18) (32) (13) (23) (16) ---- ---- ---- ---- ---- Open at end of period 303 286 268 239 219 All Sbarro restaurants: Opened during period (1) 49 73 68 75 62 Closed or terminated during period (2) (34) (41) (33) (31) (20) ---- ---- ---- ---- ---- Open at end of period (3) 939 924 892 857 813 Kiosks (all franchised) open at end of year 5 4 8 7 7
(1) Excludes 7, 7, 7, 5 and 7 new concept units opened during the respective fiscal years. (2) See Note (3) to "Selected Financial Data" in Item 6 of this Report for information with respect to charges in 1998, 1997 and 1995 relating to the closing and planned closing of certain Company-owned units. (3) Excludes 33, 26, 19, 14 and 8 new concept units at the end of the respective fiscal years. Traditional Quick Service Concept and Menu Sbarro quick service restaurants are family oriented, offering quick, efficient, cafeteria and buffet style service designed to minimize customer waiting time and facilitate table turnover. The decor of a Sbarro restaurant incorporates a contemporary motif that blends with the characteristics of the surrounding area. 5 As of December 31, 2000, there were 256 "in-line" Sbarro restaurants and 676 "food court" Sbarro quick service restaurants. In addition, franchisees operated seven freestanding Sbarro restaurants. "In-line" restaurants, which are self-contained restaurants, usually occupy between 1,500 and 3,000 square feet, contain the space and furniture to seat approximately 60 to 120 people and employ 10 to 40 persons, including part-time personnel. "Food court" restaurants are primarily located in areas of shopping malls designated exclusively for restaurant use and share a common dining area provided by the mall. These restaurants generally occupy between 500 and 1,000 square feet and contain only kitchen and service areas. They frequently have a more limited menu than an "in-line" restaurant and employ 6 to 30 persons, including part-time personnel. Sbarro restaurants are generally open seven days a week serving lunch, dinner and, in a limited number of locations, breakfast, with hours conforming to those of the major department stores or other large retailers in the mall or trade area in which they are located. Typically, mall restaurants are open to serve customers 10 to 12 hours a day, except on Sunday, when mall hours may be more limited. For Sbarro - owned restaurants open a full year, average sales in fiscal 2000 were $0.7 million for "in-line" restaurants and $0.5 million for "food court" restaurants. Sbarro restaurants feature a menu of popular Italian food, including pizza with a variety of toppings, a selection of pasta dishes and other hot and cold Italian entrees, salads, sandwiches, cheesecake and other desserts. In addition to soft drinks, a limited number of the larger restaurants serve beer and wine. All of our entrees are prepared fresh daily in each restaurant according to special recipes developed by us. We place emphasis on serving generous portions of quality Italian-style food at attractive prices. Entree selections, excluding pizza, generally range in price from $2.79 to $6.69. We believe that pizza, which is sold predominantly by the slice, accounts for approximately 50% of Sbarro restaurant sales. Substantially all of the food ingredients and related restaurant supplies used by the restaurants are purchased from a national independent wholesale food distributor which is required to adhere to established product specifications for all food products sold to our restaurants. Breads, pastries, produce, fresh dairy and certain meat products are purchased locally for each restaurant. Soft drink mixes are purchased from major beverage producers under national contracts. We believe that there are other distributors who would be able to service our needs and that satisfactory alternative sources of supply are generally available for all items regularly used in our restaurants. Restaurant Management Each Sbarro restaurant is managed by one general manager and one or two co-managers or assistant managers, depending upon the size of the location. Managers are required to participate in Sbarro training sessions in restaurant management and operations prior to the assumption of their duties. In addition, each restaurant manager is required to comply with an extensive operations manual containing procedures for assuring uniformity of operations and consistent high quality of products. We have a restaurant management bonus program that provides the management teams of Sbarro-owned restaurants with the opportunity to receive cash bonuses based on certain performance-related criteria of their location. 6 We employ area and regional directors, each of whom is typically responsible for the operations of 6 to 14 Sbarro-owned restaurants in a given area. Before each new restaurant opening, we assign an area or regional director to coordinate opening procedures. Area and regional directors recruit and supervise the managerial staff of all Sbarro-owned restaurants and report to one of the four regional vice presidents. The regional vice presidents coordinate the activities of the area and regional directors assigned to their areas of responsibility and report to the President of our Quick Service Division. Franchise Development Growth in franchise operations occurs through the establishment of new Sbarro restaurants by new franchisees and existing franchisees who have multi-unit franchise agreements. We rely principally upon our reputation and the strength of our existing restaurants, as well as to participation in national franchise conventions, to attract new franchisees. As of December 31, 2000, we had 303 franchised Sbarro restaurants operated by 79 franchisees in 37 states of the United States as well as its territories and in 24 countries throughout the world. We are presently considering additional franchise opportunities in the United States and other countries. In certain instances, we have established franchise locations under territorial agreements in which we have granted, for specified time periods, exclusive rights to enter into franchise agreements for restaurant units in certain geographic areas (primarily foreign countries) or venues (primarily specified non-mall locations such as for certain toll roads or airports). In order to obtain a franchise, we generally require payment of an initial fee and continuing royalties at rates of 3.5% to 10.0% of gross revenues. Franchise agreements entered into prior to 1988 generally have an initial term of 15 years with the franchisee having a renewal option provided that the agreement has not been previously terminated by either party for specified reasons. Since 1988, we have required the franchise agreements to end at the same time as the underlying lease, but generally in not less than ten nor more than twenty years. Since 1990, the renewal option has also been subject to conditions, including a remodel or image enhancement requirement. Franchise agreements granted under territorial agreements and those for non-traditional sites are at negotiated fees, royalty rates and terms and conditions other than those contained in our basic franchise agreement. The franchise and territorial agreements provide us with the right to terminate a franchisee for a variety of reasons, including insolvency or bankruptcy, failure to operate its restaurant according to standards, understatement of gross receipts, failure to pay fees, or material misrepresentation on an application for a franchise. We presently employ fourteen management level individuals responsible for overseeing the operations of franchise units and for developing new units. These employees report to the President of our Franchising and Licensing Division. 7 New Concept Development Since 1995, we have entered into several joint ventures to develop new restaurant concepts and established two concepts on our own to provide growth opportunities that leverage our restaurant management and financial expertise. Our joint ventures and other new concepts presently operate 33 restaurants. We have chosen to develop the joint ventures with restaurateurs experienced in the particular food area and we are actively involved in the day-to-day operations of each venture. These concepts are in various stages of development and expansion and we are considering additional concepts for potential development. The following is a summary of our existing joint ventures and other new concepts: o We have a 100% interest in a new concept that presently operates one moderately priced casual dining restaurant serving Italian food under the name "Mama Sbarro's" in a strip center location. The format is both quick-service and table service with take-out service available. We are planning to open additional sites of this concept. o We have a 100% interest in a concept that presently operates three moderately priced casual dining restaurants serving Italian food under the name "Tony and Bruno's" in strip center locations. The restaurants primarily provide table service and cater to families. Take-out service is also available. We are not planning to open additional sites of this concept. o We have a 100% interest in a joint venture that presently operates moderately priced casual family restaurants serving Italian food under the name "Umberto of New Hyde Park" in six mall and eight strip center locations. The format is both quick-service and table service. In the non-mall locations, take-out service is also available. One non-mall location was closed in 1998. In March 2001, we acquired the ownership interests of our 20% partner in this venture as of December 31, 2000 in connection with the settlement of litigation against this partner. See "Legal Proceedings" in Item 3 of this report for further discussion of the action. We do not plan to open any additional restaurants under this brand name at this time. o We have a 40% interest in a joint venture that presently operates six casual dining restaurants with a Rocky Mountain steakhouse motif under the name "Boulder Creek Steaks & Saloon." This venture also operates three fine dining steak restaurants under the names "Rothmann's Steakhouse" and "Burton & Doyle". We are planning to open additional sites of each type of restaurant. o We have a 70% interest in two moderately priced, table service restaurants featuring an Italian Mediterranean menu that operate under the names "Salute" and "Cafe Med" which are located in New York City. During 1997, this venture closed two other restaurants, resulting in a $3.3 million before tax, or $2.0 million after tax, charge to our earnings. An additional $1.0 million charge to earnings before tax, or $0.6 million after tax, was recorded in 1999 when we subsequently agreed to absorb a portion of our joint venture partners' losses on these units upon their disposition. We do not plan to open any additional restaurants in this group at this time. 8 o We have a 100% interest in two moderately priced, table service restaurants featuring an Italian Mediterranean menu that operate under the names "BICE Ristorante" in Las Vegas and "The Grill on the Park" in New York City, each of which opened in the latter portion of 2000. There currently is another restaurant under construction in New York City that will be part of this venture. No further restaurants are planned in this group at this time. o We have a 50% interest in a joint venture which, in June 1999, acquired two Mexican style restaurants operating in strip centers under the name "Baja Grill". We are currently evaluating whether to expand this concept. o We have a 25% interest in a joint venture that was formed in 1999 that has operated one seafood restaurant under the name "Vincent's Clam Bar". There are no plans to open more restaurants under this name at this time. All joint venture restaurants, except four Umberto of New Hyde Park mall units and one restaurant in Las Vegas, are presently located in the New York City metropolitan area. We are continually evaluating the operating performance of these ventures to assess their feasibility and future growth potential. We intend to seek to expand our existing ventures, if appropriate, and to develop new restaurant concepts either independently or through existing or new joint ventures. There can be no assurance as to the performance of the existing joint ventures or our ability to successfully identify and develop new concepts. All of our new concepts presently operate through unrestricted subsidiaries which do not guarantee our Senior Notes and obligations under our Credit Agreement. As such, we have certain restrictions as to the financing we can provide to these new concepts and these entities are not subject to the restrictions contained in the Indenture and our Credit Agreement. Ventures in which we have a 50% or less interest are accounted for under the equity method of accounting. As of December 31, 2000, we had an aggregate investment in these unrestricted subsidiaries and joint ventures of approximately $33.8 million, which does not include guarantees of indebtedness and reimbursement obligations in respect of letters of credit in the aggregate amount of approximately $8.9 million and guarantees of certain real property lease obligations of these subsidiaries and related joint ventures. In addition, we have also sublet locations to, guaranteed all or portions of joint venture location leases and provided other credit enhancements for these joint ventures. 9 Employees As of December 31, 2000, we employed approximately 6,800 persons, excluding employees of new concepts, of whom approximately 3,000 were full-time field and restaurant personnel, approximately 3,500 were part-time restaurant personnel and 300 were corporate administrative personnel. None of our employees are covered by collective bargaining agreements. We believe our employee relations are satisfactory. Competition The restaurant business is highly competitive. Many of our direct competitors operate within the pizza restaurant segment. We believe we compete on the basis of menu selection, price, service, location and food quality. Factors that affect our and our franchisees' business operations include changes in consumer tastes, national, regional and local economic conditions, population, traffic patterns, changes in discretionary spending priorities, demographic trends, consumer confidence in food wholesomeness, handling and safety, weather conditions, the type, number and location of competing restaurants and other factors. There is also active competition for management personnel and attractive commercial shopping mall, center city and other locations suitable for restaurants. We compete in each market in which we operate with locally-owned restaurants, as well as with national and regional restaurant chains. Factors such as inflation and increased food, beverage, labor, occupancy and other costs could also adversely affect us and others in the restaurant industry. Although we believe we are well positioned to compete in the quick-service Italian specialty food business because of our leading market position, focus, expertise and strong national brand name recognition, we could experience increased competition from existing or new companies and loss of market share, which could have an adverse effect on our operations. Trademarks Our Sbarro restaurants operate principally under the "Sbarro" and "Sbarro The Italian Eatery" service marks, which are registered with the United States Patent and Trademark Office for terms presently expiring in 2004 and 2001, respectively. Registered service marks may continually be renewed for 10 year periods. We have also registered or filed applications to register "Sbarro" and "Sbarro The Italian Eatery" in several other countries. We believe that these marks continue to be materially important to our business. The joint ventures to which we are a party have also applied for United States trademarks covering trade names used by them. Governmental Regulation We are subject to various federal, state and local laws affecting our businesses, as are our franchisees. Each of our restaurants and those owned by our franchisees and joint ventures are subject to a variety of licensing and governmental regulatory provisions relating to wholesomeness of food, sanitation, health, safety and, in certain cases, licensing of the sale of alcoholic beverages. Difficulties in obtaining, or the failure to obtain, required licenses or approvals can delay or prevent the opening of a new restaurant in any particular area. Our operations and those of our franchisees and joint ventures are also subject to federal laws, such as minimum wage laws, the Fair Labor Standards Act and the Immigration Reform and Control Act of 1986. They are also subject to state laws governing such matters as wages, working conditions, employment of minors, citizenship requirements and overtime. Some states have set minimum wage requirements higher than the federal level. 10 We are also subject to Federal Trade Commission regulations and various state laws regulating the offer and sale of franchises. The FTC and various state laws require us to furnish to prospective franchisees a franchise offering circular containing prescribed information. We are currently registered to offer and sell franchises in six states and are currently exempt from the franchise registration requirements in five states based upon "large franchisor" exemptions, which are based upon our experience and meeting certain size tests, generally requiring a net worth of at least $5 to $15 million (depending on the state). The states in which we are registered, and a number of states in which we may franchise, require registration of a franchise offering circular or a filing with state authorities. Substantive state laws that regulate the franchisor-franchisee relationship presently exist in a substantial number of states, and bills have been introduced in Congress from time to time which provide for federal regulation of the franchisor-franchisee relationship in certain respects. The state laws often limit, among other things, the duration and scope of non-competition provisions and the ability of a franchisor to terminate or refuse to renew a franchise. Although alcoholic beverage sales are not emphasized in our Sbarro quick service restaurants, our new concepts serve alcoholic beverages and some of our larger restaurants serve beer and wine. Sales of beer and wine contributed less than 1% of our total revenues during fiscal 2000. We submitted timely applications where appropriate to amend our liquor license applications to reflect the going private transaction and have received approvals in all jurisdictions except California. While we do not anticipate the denial of our application in California, there can be no assurance thereof. We believe that we are in compliance in all material respects with the laws to which we are subject. ITEM 2. PROPERTIES All Sbarro restaurants are typically leased under ten-year leases that often do not include an option to renew the lease. We have historically been able to renew or extend leases on existing sites. As of December 31, 2000, we leased 653 restaurants, of which 24 were subleased to franchisees under terms which cover all of our obligations under the lease. The remaining franchisees directly lease their restaurant spaces. Most of our restaurant leases provide for the payment of base rents plus real estate taxes, utilities, insurance, common area charges and certain other expenses, as well as contingent rents generally ranging from 8% to 10% of net restaurant sales in excess of stipulated amounts. 11 Leases to which we were a party at December 31, 2000 have initial terms expiring as follows: Years Initial Lease Number of Sbarro- Number of Franchised Terms Expire owned Restaurants Restaurants ------------ ----------------- ----------- 2001.................... 37 4 2002.................... 50 4 2003.................... 73 3 2004.................... 49 2 2005.................... 68 2 Thereafter.............. 352 9 We own a four-story office building in Melville, New York with approximately 100,000 square feet and a cafeteria style restaurant operated by us. This building was purchased and renovated at a total cost of approximately $21.5 million. Approximately 73% of the rentable square feet is currently under lease to unaffiliated third parties. One floor of the building is occupied by us as our principal executive offices. On March 3, 2000, we obtained a ten year, 8.4%, $16.0 million mortgage loan on this property. We also occupy a two-story 20,000 square foot office building for administrative support functions located in Commack, New York. We have leased the building since May 1986 from a partnership owned by some of our shareholders at an annual base rental of $0.3 million for the remainder of the lease term, which expires in 2011. In addition, we pay real estate taxes, utilities, insurance and certain other expenses for the facility. See "Certain Relationships and Related Transactions" in Item 13 of this Report for a description of the lease. In addition, our new restaurant concepts, including joint ventures, own one facility and lease 35 facilities. ITEM 3. LEGAL PROCEEDINGS In February 1999, the Umberto of New Hyde Park joint venture companies, in which we have an 80% interest, began an action in the U.S. District Court for the Eastern District of New York against Umberto Corteo, who owns the remaining 20% interest in the joint venture companies, and against three other restaurants controlled by Mr. Corteo. We alleged, among other things, that Mr. Corteo engaged in unfair trade practices and in trademark infringement, thereby breaching the joint venture agreements. We were seeking an accounting, compensatory and punitive damages and injunctive relief. The answer filed by Mr. Corteo and his co-defendants denied our claims and further alleged that non-competition restrictions against Mr. Corteo in the joint venture agreements are unenforceable. Mr. Corteo and his co-defendants had also counterclaimed against us alleging misappropriation of trademark rights and failure to perform administrative duties that amounted to a breach of the agreements. In March 2001, we acquired the 20% interest owned in this venture by Mr. Corteo in final settlement of this litigation. The terms of the settlement agreement do not have a material impact upon either our financial condition or results of operations. 12 On November 17, 1999, an action entitled Shan Wanli, Basem Tawil, Abdul Hamid v. Sbarro, Inc. was filed in the Superior Court of the State of Washington for King County. The plaintiffs allege that they served as store managers, general managers, assistant managers or co-managers in our restaurants in the State of Washington at various times since November 17, 1996 and that, in connection with their employment, we violated the overtime pay provisions of the State of Washington's Minimum Wage Act by treating them as overtime exempt employees, breached alleged employment agreements and statutory provisions by failing to record and pay for hours worked at the contract rates and/or statutory minimum wage rates and failed to provide statutorily required meal breaks and rest periods. The plaintiffs represent substantially all of our restaurant managers employed for any period of time on or after November 9, 1996 in the State of Washington. We currently own and operate 18 restaurants in the State of Washington. The plaintiffs seek actual damages, exemplary damages and costs of the lawsuit, including reasonable attorney's fees, each in unspecified amounts, and injunctive relief. A settlement agreement has been approved by the court and will not have a material impact upon either our financial condition or results of operations. On December 20, 1999, Antonio Garcia and eleven other current and former general managers of Sbarro restaurants in California amended a complaint filed in the Superior Court of California for Orange County. The complaint alleges that the plaintiffs were improperly classified as exempt employees under the California wage and hour law. The plaintiffs are seeking actual damages, punitive damages and costs of the lawsuit, including reasonable attorney's fees, each in unspecified amounts. Plaintiff's filed a motion to certify the lawsuit as a class action, but the motion was denied by the court. We believe that we have substantial defenses to the claims and are vigorously defending this action. On September 6, 2000, Manuel Jimenez and seven other current and former general managers of Sbarro restaurants in California filed a complaint against Sbarro in the Superior Court of California for Orange County alleging that the plaintiffs were improperly classified as exempt employees under California wage and hour law. Plaintiffs are represented by the same counsel who is representing the plaintiffs in the Garcia case. We believe that we have substantial defenses to the claims and are vigorously defending this action. From time to time, we are a party to certain claims and legal proceedings in the ordinary course of business, none of which, in our opinion, would have a material adverse effect on our financial position or results of operations. 13 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS As a result of the going private transaction, our Common Stock is not publicly-held nor publicly traded. We currently have six shareholders of record. (See Item 12 "Security Ownership of Certain Beneficial Owners and Management"). During 2000, we declared dividends to our shareholders of $22.1 million, of which $3.8 million were in the form of tax distributions pursuant to the Tax Agreement with our shareholders (see Item 13, "Certain Relationships and Related Transactions - Tax Payment Agreement"). Amount Date Per Share Total Type March 15, 2000 $2.548 $18,000,000 General Distribution December 15, 2000 0.046 327,870 General Distribution ------- ----------- 2.594 18,327,870 ------- ---------- April 17, 2000 0.072 511,156 Tax Distribution (1) June 13, 2000 0.457 3,229,743 Tax Distribution (1) September 15, 2000 0.009 59,096 Tax Distribution (1) ----- ------------ 0.538 3,799,995 ----- --------- $3.132 $22,127,865 (1) ====== =========== In addition, on January 15, 2001, we declared dividends to our shareholders as follows: Amount Date Per Share Total Type January 15, 2001 $0.50 $3,562,937 Tax Distribution (1) ===== ========== (1) For tax distributions pursuant to the Tax Payment Agreement between us and our shareholders (see "Certain Relationships and Related Party Transactions" in Item 13 "Executive Compensation"). 14 The Indenture under which our Senior Notes are issued and our Credit Agreement contain various covenants that may limit our ability to make "restricted payments" including, among other things, dividend payments (other than as distributions pursuant to the Tax Payment Agreement). As of December 31, 2000, $14.9 million was available to make restricted payments. Among other covenants, the Indenture requires that, in order to make a restricted payment, our consolidated interest ratio coverage (as defined in the Indenture), after giving pro forma effect to the restricted payment, for the four most recently ended fiscal quarters must be at least 2.0 to 1. As of December 31, 2000 that ratio was 2.56 to 1. In addition, our Credit Agreement requires us to maintain a ratio of EBITDA to consolidated interest expense (as defined in the Credit Agreement) of at least 2.0 to 1. As of December 31, 2000 that ratio was 2.64 to 1. In 1997 and 1996, we declared dividends of $22.1 million and $18.7 million, respectively. Dividends were thereafter suspended pending our consideration of the original proposals which resulted in the going private transaction. 15 ITEM 6. SELECTED FINANCIAL DATA The following Selected Financial Data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of this report and our consolidated financial statements and the related notes included in Item 8 of this report, which consolidated financial statements have been audited and reported on by Arthur Andersen LLP, independent public accountants.
Fiscal Year (Dollars in thousands) 2000 1999 1998(1) 1997 1996 ---- ---- ------- ---- ---- System Sales (unaudited) $569,260 $543,219 $524,572 $473,716 $439,802 ======== ======== ======== ======== ======== Income Statement Data: Revenues: Restaurant sales $382,365 $375,514 $370,101 $344,190 $323,544 Franchise related income 11,231 8,688 8,284 7,175 6,229 Real estate and other 5,812 5,495 3,402 1,764 1,366 --------- -------- -------- --------- ---------- Total revenues 399,408 389,697 381,787 353,129 331,139 Costs and expenses: Restaurant operating expenses: Costs of food and paper products 74,405 75,956 78,603 70,994 69,644 Payroll and other employee benefits 101,553 97,336 93,338 85,021 79,346 Other operating costs 114,122 108,599 102,927 94,468 84,437 Depreciation and amortization(2) 29,039 25,712 22,784 24,357 23,092 General and administrative costs 30,882 28,854 23,999 21,241 17,952 Provision for unit closings(3) -- 1,013 2,515 3,300 -- Terminated transaction costs(4) -- -- 986 -- -- Litigation settlement and related costs(5) -- -- 3,544 -- -- Loss on land to be sold(6) -- -- 1,075 -- -- --------- -------- ---------- --------- Total costs and expenses 350,001 337,470 329,771 299,381 274,471 Operating income before minority interest 49,407 52,227 52,016 53,748 56,668 Minority interest (46) 266 (101) 208 35 ------------ ---------- ----------- --------- ---------- Operating income 49,361 52,493 51,915 53,956 56,703 ---------- --------- -------- -------- -------- Other (expense) income: Interest expense (30,243) (7,899) -- -- -- Interest income 949 3,828 5,120 4,352 3,798 Equity in net income (loss) of unconsolidated affiliates 303 423 (296) (111) (195) --------- ---------- --------- ---------- -------- Net other (expense) income (28,991) (3,648) 4,824 4,241 3,603 -------- ------- ----- ----- ----- Income before income taxes and cumulative effect of change in method of accounting for start-up costs 20,370 48,845 56,739 58,197 60,306 Income taxes (credit) (7) (5,075) 19,322 21,547 22,115 22,916 ------- ------ -------- -------- -------- Income before cumulative effect of change in method of accounting for start-up costs 25,445 29,523 35,192 36,082 37,390 Cumulative effect of change in method of accounting for start-up costs, net of income taxes of $504 -- -- (858) -- -- ------ ------ --------- ------- ------- Net income $25,445 $ 29,523 $ 34,334 $ 36,082 $ 37,390 ======= ======== ======== ======== ========
16
2000 1999 1998(1) 1997 1996 ---- ---- ------- ---- ---- (Dollars in thousands) Other Financial and Restaurant Data: Net cash provided by operating activities(8) $48,329 $62,282 $59,199 $61,939 $55,716 Net cash used in investing activities(8) (31,158) (25,227) (20,661) (27,020) (27,200) Net cash used in financing activities(8) (8,606) (158,356) (3,377) (20,012) (17,030) EBITDA (9) 78,703 78,628 74,403 78,202 79,600 EBITDA margin(9) 19.7% 20.2% 19.5% 22.1% 24.0% Capital expenditures(10) $31,193 $25,282 $28,213 $29,758 $ 27,792 Ratio of earnings to fixed charges(11) 1.4x 2.6x 3.8x 4.1x 4.6x Number of restaurants at end of period: Company-owned (12) 636 638 624 618 594 Franchised 303 286 268 239 219 --- ---------- ------- ------- ------- Total number of restaurants 939 924 892 857 813 === ========== ======= ======= ======= Balance Sheet Data (at end of period): Total assets $428,555 $417,543 $308,251 $278,811 $ 258,817 Working capital (deficiency) 9,217 (1,935) 126,619 93,464 78,214 Total long-term obligations 274,269 263,090 14,902 17,270 18,856 Shareholders' equity 113,597 110,280 256,918 220,439 205,207
17 (1) Our fiscal year ends on the Sunday nearest December 31. Our 1998 fiscal year contained 53 weeks. All other fiscal years presented contained 52 weeks. As a result, our 1998 fiscal year benefited from one additional week of operations over the other reported fiscal years. The additional week contributed revenues, net income and EBITDA of approximately $8.6 million, $1.7 million and $2.7 million, respectively. (2) Includes amortization of the excess purchase price over the book value of assets acquired as a result of the going private transaction on September 28, 2000 of $4.8 million and $2.0 million in fiscal 2000 and 1999, respectively. In fiscal 2000, we finalized our allocation of the purchase price from the going private transaction based on an evaluation of our net assets at September 29, 1999 resulting in lower annual amortization expense than originally estimated. (3) Represents provisions of (a) a special allocation of losses in fiscal 1999 which arose as a result of the final disposition of two joint venture unit closings recorded in 1997, (b) $2.5 million for the closing of 20 restaurants in fiscal 1998 and (c) $3.3 million for the closing of two joint venture units in fiscal 1997. (4) Represents a charge for costs associated with the termination of a prior going private proposal by the Sbarro family. (5) Represents a charge in connection with the settlement of a lawsuit. (6) Represents a write down of the carrying cost on a parcel of undeveloped land that we own. (7) A credit of $5.6 million was recorded in 2000 to write-off deferred income taxes as a result of electing to be taxed under the provisions of Subchapter S of the Internal Revenue Code and, where applicable and permitted, under similar state and local income tax provisions beginning in fiscal 2000. For a discussion of the distributions that we are permitted to make to our shareholders to pay taxes on our income, see "Certain Relationships and Related Transactions - Tax Agreement" in Item 13 of this report. (8) For a more detailed presentation of our cash flow data, see our audited consolidated financial statements and related notes for the year ended December 31, 2000 included in Item 8 of this Report. In 2000, net cash provided by operating activities before the change in deferred taxes caused by the conversion to Subchapter S status and the change in accrued interest payable was $53.5 million. In 1999, net cash provided by operating activities before the change in accrued interest payable was $53.8 million. 18 (9) EBITDA represents earnings before cumulative effect of change in accounting method, interest income, interest expense, taxes, depreciation and amortization. EBITDA includes the effect of the unusual charges included in notes 3, 4, 5 and 6 above. EBITDA margin represents EBITDA divided by total revenues. EBITDA should not be considered in isolation from, or as a substitute for, net income, cash flow from operations or other cash flow statement data prepared in accordance with generally accepted accounting principles or as a measure of a company's profitability or liquidity. Rather, EBITDA is presented because it is a widely accepted supplemental financial measure, and we believe that it provides relevant and useful information. 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. (10) The following amounts related to the construction of our headquarters are included as capital expenditures: $4.2 million in fiscal 1996, $5.0 million in fiscal 1997, which opened in late 1998, $4.8 million in fiscal 1998, $1.6 million in fiscal 1999 and $0.4 million in fiscal 2000. (11) The ratio of earnings to fixed charges has been determined by dividing the total fixed charges into the sum of income before income taxes, cumulative effect of change in method of accounting for start-up costs and before minority interest and equity in net income (loss) of unconsolidated affiliates and fixed charges. Fixed charges consist of interest expense and one-third of rental expense, which we deem to be a reasonable approximation of the interest factor of this expense. (12) Excludes 33, 26, 19, 14 and 8 for new concept units opened at the end of fiscal 2000, 1999, 1998, 1997 and 1996 respectively. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements, the notes thereto and other data and information appearing elsewhere in this report. Results of Operations Our fiscal year ends on the Sunday nearest to December 31. Our 1998 fiscal year, which ended on January 3, 1999, contained 53 weeks, while all other reported fiscal years contained 52 weeks. As a result, our 1998 fiscal year benefited from one additional week of operations. The additional week in fiscal 1998 produced revenues of $8.6 million, EBITDA of $2.7 million and net income of $1.7 million. The going private transaction, including the purchase price allocation and certain other related transactions described in the notes to the consolidated financial statements, have affected the comparability of the interest income, depreciation and amortization, interest expense and income tax line items in our consolidated statements of operations for fiscal 2000 as compared to fiscal 1999 and fiscal 1999 compared to fiscal 1998. 19 Fiscal 2000 Compared to Fiscal 1999 Our consolidated EBITDA for the fiscal year ended December 31, 2000 was $78.7 million and our EBITDA margin was 19.7%, compared to $78.6 million and 20.2%, respectively, for the fiscal year ended January 2, 2000. EBITDA represents earnings before cumulative effect of change in accounting method, interest income, interest expense, taxes, depreciation and amortization. EBITDA margin represents EBITDA divided by total revenues. EBITDA should not be considered in isolation from, or as a substitute for, net income, cash flow from operations or other cash flow statement data prepared in accordance with generally accepted accounting principles or as a measure of a company's profitability or liquidity. Rather, EBITDA is presented because it is a widely accepted supplemental financial measure, and we believe that it provides relevant and useful information. 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. Restaurant sales from Sbarro-owned quick service units and consolidated new concept units increased by $6.9 million or 1.8% to $382.4 million for fiscal 2000 from $375.5 million in fiscal 1999. Sales from new concept units contributed $5.1 million of the increase in restaurant sales. Revenues from new quick service units did not offset the loss of revenues from closed quick service units as we closed two more units than we opened in 2000, including two high volume units (one of which is being replaced in fiscal 2001). Comparable Sbarro quick service unit sales increased 0.2% during fiscal 2000. Comparable restaurant sales are made up of sales at locations that were open during the entire current and prior fiscal year. Franchise related income increased 29.3% to $11.2 million for the fiscal year ended December 31, 2000 from $8.7 million for the fiscal year ended January 2, 2000. The increase resulted from greater continuing royalties due to a higher number of franchise units in operation, higher area development and higher initial franchise fees in fiscal 2000 than in fiscal 1999, particularly from international markets, and approximately $1.5 million recognized in fiscal 2000 related to the termination of our development agreement and the closing of all Sbarro locations in Japan. In fiscal 2000, we entered into area development agreements in specific domestic and international venues and markets with two major food service operators. We believe these agreements will increase the rate of future growth in our franchise operations. Real estate and other revenues increased by $0.3 million to $5.8 million for the fiscal year ended December 31, 2000 from fiscal 1999 due to the full year impact from leasing a majority of our corporate headquarters building not occupied by Sbarro to third parties in 1999. Cost of food and paper products as a percentage of restaurant sales improved to 19.5% for fiscal 2000 from 20.2% in the 1999 fiscal year. This improvement was primarily due to lower average cheese prices during fiscal 2000. Cheese prices to date in the first quarter of fiscal 2001 have been higher than comparable period in 2000. Payroll and other employee benefits increased to 26.6% of restaurant sales for the year ended December 31 2000 from 25.9% of restaurant sales in the year ended January 2, 2000. This increase was primarily due to the tight labor market, resulting in pressures on wages and salaries and associated increases in amounts paid for payroll taxes. 20 Other operating expenses increased to 29.8% for fiscal 2000 from 28.9% of restaurant sales for fiscal 1999 primarily due to increases in rent, utility and other occupancy related expenses. Depreciation and amortization expense increased by $3.3 million for fiscal 2000 over fiscal 1999. Depreciation and amortization expense includes $4.8 and $2.0 million in fiscal 2000 and 1999, respectively, for amortization of the excess of the purchase price over the cost of net assets acquired in connection with the completion of the going private transaction on September 28, 1999 representing a full year in 2000 compared to three months in 1999. In fiscal 2000, we finalized our allocation of the purchase price from the going private transaction based on an evaluation of our net assets at September 29, 1999 resulting in lower annual amoritzation expense than originally estimated. General and administrative costs were $30.9 million, or 7.7% of total revenues, for fiscal 2000, compared to $28.9 million, or 7.4% of total revenues, for fiscal 1999. These increases were primarily due to higher payroll costs , costs incurred in expanding franchise and new concept operations and increases in various professional fees, including litigation expenses. These expenses include the cost of operating our corporate headquarters building. The provision for unit closings is the result of a special allocation of losses in fiscal 1999 of $1.0 million in connection with the final disposition of two joint venture unit closings recorded in 1997. Minority interest represents the share of the minority holders' interests in the combined income in fiscal 2000 and combined loss in fiscal 1999 of the joint ventures in which we have a majority interest. Interest expense of $30.2 million for fiscal 2000 relates to the 11%, $255.0 million Senior Notes issued to finance our going private transaction on September 28, 1999, the 8.4%, $16.0 million mortgage loan on our corporate headquarters in 2000 and line fees for unused borrowing capacity under our Credit Agreement. Results for fiscal 1999 included interest only from the date of the going private transaction through the end of the 1999 fiscal year of $7.9 million for the Senior Notes and Credit Agreement line fees. Of these amounts, $1.5 and $0.4 million for fiscal 2000 and 1999, respectively, represented non-cash charges for the accretion of the original issue discount on our Senior Notes and the amortization of deferred financing costs on the Senior Notes, Credit Agreement and, in 2000, the mortgage loan. Interest income was approximately $0.9 million and $3.8 million for the fiscal years 2000 and 1999, respectively. We used substantially all of our available cash on September 28, 1999 in order to fund the going private transaction. Therefore, we had a substantial reduction in our interest income for fiscal 2000. We will not realize the level of interest income as we have in the past unless and until we rebuild our cash position. 21 Equity in the net income (loss) of unconsolidated affiliates represents our share of earnings and losses in those new concepts in which the Company has a 50% or less ownership interest. We have elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code and, where applicable and permitted, under similar state and local income tax provisions beginning January 3, 2000. As required by Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes", we recognized a $5.6 million credit associated with the reversal of our deferred tax liabilities upon conversion to S corporation status in the first quarter of fiscal 2000. Under the provisions of Subchapter S, substantially all taxes on our income is now paid by our shareholders rather than us. Our tax expense for the fiscal 2000 included $0.5 million for taxes owed to jurisdictions that do not recognize S corporation status or that tax entities based on factors other than income. Fiscal 1999 Compared to Fiscal 1998 Our 1998 fiscal year benefited from one additional week of operations compared to fiscal year. The additional week in fiscal 1998 produced revenues of $8.6 million, EBITDA of $2.7 million and net income of $1.7 million. Our consolidated EBITDA for our 1999 fiscal year, ended January 2, 2000, was $78.6 million and our EBITDA margin was 20.2%, compared to $74.4 million and 19.5%, respectively, for our 1998 fiscal year, ended January 3, 1999. Restaurant sales from Sbarro-owned units and consolidated new concept units increased $5.4 million or 1.5% to $375.5 million from $370.1 million in the 1998 fiscal year. Sales from new concept units contributed $2.6 million of the increase in restaurant revenues. Sales for 1998 included $8.6 million generated in the 53rd week of the 1998 fiscal year. The increase in quick service revenues resulted primarily from a higher number of units in operation in fiscal 1999 than the comparable period in 1998 and selective menu price increases of approximately 2.8%, 1.4% and .7% at Sbarro-owned units which became effective in September 1999, September 1998 and February 1998, respectively. Comparable unit sales increased 0.8% in the fiscal 1999 year from the first 52 weeks of the 1998 fiscal year primarily as a result of the menu price increases. Comparable quick service restaurant sales are made up of sales at locations that were open during the entire current and prior fiscal year. Franchise related income increased 4.9% to $8.7 million in fiscal 1999 from $8.3 million in fiscal 1998. The increase resulted primarily from greater continuing royalties due to a higher number of franchise units in operation in fiscal 1999 than in the 1998 fiscal year partially offset by lower area development and initial franchise fees in fiscal 1999. Real estate and other revenues increased by $2.1 million to $5.5 million for the 1999 fiscal year compared to the 1998 fiscal year primarily as a result of leasing a majority of our corporate headquarters building not occupied by us to third parties. 22 Cost of food and paper products as a percentage of restaurant sales improved to 20.2% for fiscal 1999 compared to 21.2% for the 1998 fiscal year. This improvement was primarily due to lower average cheese prices during fiscal 1999 and the impact of the menu price increases described above. Payroll and other benefits increased to 25.9% of restaurant sales in fiscal 1999 from 25.2% of restaurant sales in fiscal 1998. This increase was primarily due to the tight labor market, resulting in pressures on wages and salaries and associated increases in amounts paid for payroll taxes. Other restaurant operating expenses increased to 28.9% for fiscal 1999 from 27.8% of restaurant sales for fiscal 1998 primarily as a result of increases in rent and other occupancy costs. Depreciation and amortization expense increased by $2.9 million in fiscal 1999 over fiscal 1998 primarily as a result of an increase in depreciation and amortization of our new headquarters building that was completed in the fourth quarter of fiscal 1998 and amortization of the excess of the purchase price over the cost of net assets acquired in connection with the going private transaction. General and administrative costs were $28.9 million, or 7.4% of total revenues, for the 1999 fiscal year, compared to $24.0 million, or 6.3% of total revenues, for the 1998 fiscal year. The increase was primarily due to higher payroll costs and costs associated with the administration of additional Sbarro-owned restaurants, costs incurred in expanding joint venture operations, higher litigation costs, increases in various field training and human resource functions and costs associated with a full year of operations of our headquarters building, which was completed during the fourth quarter of fiscal 1998. Minority interests represent the share of the minority holders' interests in the combined loss in fiscal 1999 and the combined income in fiscal 1998 of the joint ventures in which we have a majority interest. Interest expense of $7.9 million in fiscal 1999 relates to the accrual of interest, accretion of original issue discount and the amortization of deferred financing charges with respect to the Senior Notes for the period subsequent to their issuance on September 28, 1999 in financing the going private transaction and the cost of the unused line of credit and the amortization of deferred financing charges with respect to the bank credit agreement entered into at that time. The provision for unit closings is the result of a special allocation of losses in fiscal 1999 of $1.0 million in connection with the final disposition of two joint venture unit closings recorded in 1997. Results for fiscal 1998 include one-time charges to operating income of $2.5 million before tax, or $1.6 million after tax, for the closing of 20 Sbarro-owned restaurants and $1.0 million before tax, or $0.6 million after tax, for costs associated with the terminated negotiations of the initial going private proposal by the Sbarro family. The 1998 fiscal year results also include a provision of $3.5 million before tax, or $2.2 million after tax, for costs associated with the settlement approved and finalized in December 1998 of a lawsuit under the Fair Labor Standards Act and a charge of $1.1 million before tax, or $0.7 million after tax, for the difference between the carrying cost and proposed selling price of a parcel of land sold by us. 23 Interest income was approximately $3.8 million for fiscal 1999 compared to $5.1 million in fiscal 1998. We used substantially all of our available cash in order to fund the going private transaction. Therefore, we generated a minimal amount of interest income for the period from September 28, 1999, the date of the going private transaction, to the end of the fiscal year. Equity in the net income (loss) of unconsolidated affiliates represents our share of earnings and losses in those new concepts in which the Company has a 50% or less ownership interest. The effective income tax rate was 39.6% and 38.0% for fiscal 1999 and fiscal 1998, respectively. The increase in the effective income tax rate was primarily a result of the non-deductible amortization expenses incurred as a result of the going private transaction. The cumulative effect of the change in method of accounting in fiscal 1998 resulted from Sbarro's implementation of Statement of Position 98-5 of the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants which required companies that had capitalized pre-opening and similar costs to write off all those existing costs as a "cumulative effect of accounting change" and to expense all those costs as incurred in the future. In accordance with the early application provisions, we implemented SOP 98-5 as of the beginning of our 1998 fiscal year and incurred a one-time charge of $0.9 million, net of an income tax benefit of $0.5 million, to write off all start-up costs existing as of the beginning of that year. Impact of Inflation and Other Factors Food, labor, rent, construction and equipment costs are the items most affected by inflation in the restaurant business. Although for the past several years inflation has not been a significant factor, there can be no assurance that this trend will continue. In addition, food and paper product costs may be temporarily or permanently affected by weather, economic and other factors beyond our control that may reduce the availability and increase the cost of these items. Historically, the price of cheese has fluctuated more than our other food ingredients and related restaurant supplies. Seasonality 24 Seasonality Our business is subject to seasonal fluctuations, and the effects of weather and economic conditions. Earnings have been highest in our fourth fiscal quarter due primarily to increased volume in shopping malls during the holiday shopping season. Historically, the fourth fiscal quarter normally accounts for approximately 40% of annual operating net income before the effect of additional amortization associated with the going private transaction ("adjusted operating income") and fluctuates due to the length of the holiday shopping period between Thanksgiving and New Year's Day and the number of weeks in our fourth quarter. Adjusted operating income for the fourth quarter of 2000 and 1999 would have been approximately 37% and 39%, respectively, of adjusted operating income for the respective fiscal year. The 1998 fiscal year, which contained 53 weeks, had a 13 week fourth quarter. Excluding the impact of the thirteenth week, the fourth quarter of fiscal 1998 would have accounted for 38% of our adjusted operating income, which is consistent with the comparable prior year period. Accounting Period Our fiscal year ends on the Sunday nearest to December 31. The fiscal year which ended on January 3, 1999 contained 53 weeks. All other reported fiscal years contained 52 weeks. Liquidity and Capital Resources We have historically not required significant working capital to fund our existing operations and have financed our capital expenditures and investments in our joint ventures through cash generated from operations. At December 31, 2000, we had unrestricted cash and cash equivalents of $42.3 million and working capital of $9.2 million compared to unrestricted cash and cash equivalents of $33.8 million and a working capital deficiency of $1.9 million as of January 2, 2000. As part of the going private transaction, we sold $255.0 million of 11% Senior Notes (at a price of 98.514% of par to yield 11.25% per annum), the net proceeds of which, together with substantially all of our then existing cash, was used to finance the transaction, and entered into a $30.0 million Credit Agreement. We have $26.9 million of undrawn availability under our Credit Agreement, net of outstanding letters of credit and guarantees of reimbursement obligations currently aggregating approximately $3.1 million. Net cash provided by operating activities was $48.3 million and $62.3 million for the fiscal years ended December 31, 2000 and January 2, 2000, respectively. The $14.0 million reduction was primarily due to a $22.3 million increase in interest expense related to the issuance of our Senior Notes to finance the going private transaction and the mortgage on our headquarters building offset by the $5.6 million reversal of previously recorded net deferred taxes as a result of our election to be treated as a Subchapter S corporation. Net cash provided by operating activities before the change in accrued interest payable and the reversal of deferred tax liabilities in 2000 upon conversion to Subchapter S status was $53.5 and $54.8 million for fiscal 2000 and 1999, respectively. 25 Net cash used in investing activities primarily relates to capital expenditures, including investments made by our consolidated joint ventures. Net cash used in investing activities was $31.1 million for 2000 compared $25.2 million for fiscal 1999. Net cash used in financing activities was $8.6 million for the fiscal year ended December 31, 2000 compared to $158.4 million of cash used by financing activities for the comparable period in 1999. Cash used in financing activities for fiscal 2000 resulted primarily from $22.1 million of distributions to shareholders including tax distributions of $3.8 million (see below) and a $2.0 million loan to our Chairman, President and CEO offset by $15.6 million of net proceeds from a $16.0 million 8.4% ten year loan secured by a mortgage on our corporate headquarters. Cash used in financing activities for the comparable period of 1999 resulted primarily from $410.0 million of cash used (net of accrued or previously paid going private costs) to pay the going private consideration and related going private and financing costs offset, in part, by approximately $251.2 million of net proceeds raised through the private placement of the Senior Notes. In March 2000, we elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code and, where applicable and permitted, under similar state and local income tax provisions beginning January 3, 2000. Under the provisions of Subchapter S, substantially all taxes on our income are paid by our shareholders. We and our shareholders had a tax liability of approximately 46% of our taxable income in 2000. This tax rate is higher than our historical effective tax rate prior to 2000 due to (i) differences in tax rates between individual and corporate taxpayers, (ii) the timing differences previously accounted for as deferred taxes in our financial statements (which deferred taxes were eliminated upon our conversion to S corporation status) and (iii) the effect of double taxation in those state and local jurisdictions that do not recognize S corporation status. The Indenture for the Senior Notes and the Credit Agreement permit us to make distributions to shareholders for taxes on our earnings. We made tax distributions of $3.8 million in fiscal 2000 and $3.6 million in January 2001 and we expect to make an additional $4.0 million of tax distributions in 2001 related to 2000 earnings. We will incur annual cash interest expense of approximately $29.7 million under the Senior Notes and mortgage loan and may incur additional interest expense for borrowings under our Credit Agreement. In addition to debt service, we expect that our other liquidity needs will relate to capital expenditures, working capital, investments in joint ventures, distributions to shareholders as permitted under the Indenture for the Senior Notes and the Credit Agreement and general corporate purposes. We expect our primary sources of liquidity to meet these needs will be cash flow from operations and availability under our Credit Agreement. We believe that aggregate restaurant capital expenditures and our investments in joint ventures during the next twelve months will be moderately lower than levels in fiscal 2000. Unpaid capital expenditure commitments aggregated approximately $4.6 million at December 31, 2000. We do not have any principal repayment obligations under the Senior Notes or our Credit Agreement until September 2009 and September 2004, respectively. We were in compliance with the various covenants in the Indenture for the Senior Notes, the Credit Agreement and the Mortgage as of December 31, 2000. 26 Recent Accounting Pronouncements The Financial Accounting Standards Board issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" as amended by SFAS No. 137 and SFAS No. 138, which is effective for fiscal years beginning after June 15, 2000. Presently, we do not use derivative instruments and therefore SFAS No. 133, while effective in fiscal 2001, is not currently applicable. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides guidance on the recognition, presentation and disclosure of revenues in financial statements and requires adoption no later than the fourth quarter of fiscal 2001. The Company has evaluated the impact of SAB 101 and the interpretations thereunder and determined that it did not have a material effect on the Company's consolidated financial position and results of operations. ITEM 7-A. QUALITATIVE AND QUANTITATIVE DISCLOSURES OF MARKET RISK We have historically invested our cash on hand in short term, fixed rate, highly rated and highly liquid instruments which are reinvested when they mature throughout the year. The indenture under which our Senior Notes are issued limits us to similar investments. Although our existing investments are not considered at risk with respect to changes in interest rates or markets for these instruments, our rate of return on short-term investments could be affected at the time of reinvestment as a result of intervening events. Our borrowings under our credit facility will be subject to fluctuations in interest rates. However, we do not expect to enter into any interest rate swaps or other instruments to hedge our borrowings under our credit facility. We have not purchased future, forward, option or other instruments to hedge against fluctuations in the prices of the commodities we purchase. As a result, our future commodities purchases are subject to changes in the prices of such commodities. All of our transactions with foreign franchisees have been denominated in, and all payments have been made in, United States dollars, reducing the risks attendant in changes in the values of foreign currencies. As a result, we have not purchased future contracts, options or other instruments to hedge against changes in values of foreign currencies. 27 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Sbarro, Inc.: We have audited the accompanying consolidated balance sheets of Sbarro, Inc. (a New York corporation) and subsidiaries as of December 31, 2000 and January 2, 2000, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three fiscal years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sbarro, Inc. and subsidiaries as of December 31, 2000 and January 2, 2000, and the results of their operations and their cash flows for each of the three fiscal years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ Arthur Andersen LLP New York, New York March 29, 2001 28 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
December 31, 2000 January 2, 2000 (In thousands except share date) Current assets: Cash and cash equivalents $42,319 $33,754 Restricted cash for untendered shares (Note 2) 153 298 Receivables, net of allowance for doubtful accounts of $211 in 2000 and $419 in 1999 Franchise 1,350 1,429 Other 1,554 1,343 --------------- ------------ 2,904 2,772 Inventories 3,531 3,717 Prepaid expenses 999 1,697 ------------- ------------ Total current assets 49,906 42,238 Property and equipment, net (Note 4) 152,468 138,951 Excess of purchase price over the cost of net assets acquired, net of accumulated amortization of $2,000 (Notes 2 and 5) - 220,681 Intangible assets: Franchise system and trademarks, net (Notes 2 and 5) 201,044 432 Deferred financing costs and other, net (Notes 2 and 5) 16,635 10,168 Loan receivable from officer (Note 10) 2,000 - Other assets 6,502 5,073 ------------ ------------- $428,555 $417,543 =========== ==========
29 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) LIABILITIES AND SHAREHOLDERS' EQUITY
December 31, 2000 January 2, 2000 ----------------- --------------- (In thousands except share data) Current liabilities: Amounts due for untendered shares (Note 2) $ 153 $ 298 Accounts payable 10,284 8,749 Accrued expenses (Note 6) 21,941 26,914 Accrued interest payable (Note 8) 8,181 7,480 Current portion of mortgage payable (Note 8) 130 - Income taxes payable (Note 7) - 732 ------------ --------- Total current liabilities 40,689 44,173 Deferred rent 6,791 6,151 Deferred income taxes (Note 7) - 5,629 Long-term debt, net of original issue discount (Note 8) 267,478 251,310 Commitments and contingencies (Note 9) Shareholders' equity (Notes 2 and 12): Preferred stock, $1 par value; authorized 1,000,000 shares; none issued - - Common stock, $.01 par value; authorized 40,000,000 shares; issued and outstanding 7,064,328 shares at December 31, 2000 and January 2, 2000 71 71 Additional paid-in capital 10 10 Retained earnings 113,516 110,199 --------- ------------- 113,597 110,280 ----------- ------------- $428,555 $417,543 ============ ============
See notes to consolidated financial statements 30 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
For the Fiscal Years Ended Dec. 31, 2000 Jan. 2, 2000 Jan. 3, 1999 ------------- ------------ ------------ (52 weeks) (52 weeks) (53 weeks) (In thousands) Revenues: Restaurant sales $382,365 $375,514 $370,101 Franchise related income 11,231 8,688 8,284 Real estate and other 5,812 5,495 3,402 ---------- ---------- --------- Total revenues 399,408 389,697 381,787 Costs and expenses: Restaurant operating expenses: Cost of food and paper products 74,405 75,956 78,603 Payroll and other employee benefits 101,553 97,336 93,338 Other operating costs 114,122 108,599 102,927 Depreciation and amortization 29,039 25,712 22,784 General and administrative 30,882 28,854 23,999 Provision for unit closings (Note 11) - 1,013 2,515 Terminated transaction costs (Note 2) - - 986 Litigation settlement and related costs (Note 9) - - 3,544 Loss on land to be sold (Note 4) - - 1,075 ------------- ------------ -------- Total costs and expenses 350,001 337,470 329,771 Operating income before minority interest 49,407 52,227 52,016 Minority interest (46) 266 (101) ---------- --------- ---------- Operating income 49,361 52,493 51,915 -------- ------- ------- Other (expense) income: Interest expense (Note 8) (30,243) (7,899) - Interest income 949 3,828 5,120 Equity in net income (loss) of unconsolidated affiliates 303 423 (296) --------- --------- -------- Net other (expense) income (28,991) (3,648) 4,824 -------- ------- ----- Income before income taxes and cumulative effect of change in method of accounting for start-up costs 20,370 48,845 56,739 Income taxes (credit) (Note 7) (5,075) 19,322 21,547 ------- ------ ------ Income before cumulative effect of change in method of accounting 25,445 29,523 35,192 Cumulative effect of change in method of accounting for start-up costs, net of income taxes of $504 (Note 1) - - (858) ---------- ---------- ---------------- Net income $25,445 $29,523 $34,334 ======= ======= =======
See notes to consolidated financial statements 31 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Number of Additional shares of paid-in Retained common stock Amount capital earnings Total -------------------------------------------- ------ ------- -------- ---------- (In thousands, except share data) Balance at December 29, 1997 20,446,654 $204 $32,444 $187,791 $220,439 Exercise of stock options 84,989 1 2,143 2,144 Net income 34,334 34,334 ----------- --------- ------------ ---------- -------- Balance at January 3, 1999 20,531,643 205 34,587 222,125 256,917 Exercise of stock options 17,337 - 426 - 426 Net income 29,523 29,523 Shares repurchased and retired in going private transaction (Note 2) (13,484,652) (134) (35,003) - (35,137) Adjustment to original cost basis of continuing shareholders (Note 2) - - - (141,449) (141,449) --------------- -------- --------- ----------- ----------- Balance at January 2, 2000 7,064,328 71 10 110,199 110,280 Net income 25,445 25,445 Distributions to shareholders - - - (22,128) (22,128) --------------- -------- ----------- --------- -------- Balance at December 31, 2000 7,064,328 $7l $10 $113,516 $113,597 ========= === === ======== ========
See notes to consolidated financial statements 32 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Fiscal Years Ended December 31, January 2, January 3, 2000 2000 1999 ---- ---- ---- (52 weeks) (52 weeks) (53 weeks) (In thousands) Operating activities: Net income $25,445 $29,523 $34,334 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of change in method of accounting for start-up costs - - 858 Depreciation and amortization 30,489 26,088 22,784 Increase (decrease) in deferred income taxes - 710 (2,078) Increase (decrease) in deferred rent, net 180 (107) 214 Provision for unit closings - 1,013 2,515 Loss on land to be sold - - 1,075 Minority interest 46 (266) 101 Equity in net (income) loss of unconsolidated affiliates (303) (423) 296 Dividends received from unconsolidated affiliates 156 - 75 Changes in operating assets and liabilities: (Increase) decrease in receivables (132) 770 (1,147) Decrease (increase) in inventories 186 (554) (163) Decrease (increase) in prepaid expenses 698 (408) 488 Decrease (increase) in other assets 304 (2,898) (935) (Decrease) increase in accounts payable and accrued expenses (3,080) 2,762 1,413 Decrease in income taxes payable (732) (1,408) (631) --------- ---------- ---------- Net cash provided by operating activities before change in accrued interest payable and effect of conversion to Subchapter S status 53,257 54,802 59,199 -- Change in deferred taxes due to conversion to Subchapter S status (5,629) - - Increase in accrued interest payable 701 7,480 - -------- ------- ---------- Net cash provided by operating activities 48,329 62,282 59,199 ------ ------ ------
(continued) 33 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For the Fiscal Years Ended December 31, January 2, January 3, 2000 2000 1999 ---- ---- ---- (52 weeks) (52 weeks) (53 weeks) (In thousands) Investing activities: Purchases of property and equipment (31,193) (25,282) (28,213) Proceeds from disposition of property and equipment 35 55 52 Proceeds from maturities of marketable securities - - 7,500 ----------- ----------- ------- Net cash used in investing activities (31,158) (25,227) (20,661) - ------- ------ -- ------ Financing activities: Proceeds from mortgage 16,000 - - Mortgage principal repayments (81) - - Cost of mortgage (397) - - Loan to officer (2,000) - - Proceeds from long-term debt - 251,211 - Cost of Merger and related financing - (411,000) - Accrued and previously paid Merger costs - 1,007 - Proceeds from exercise of stock options - 426 2,144 Distributions to shareholders (22,128) - (5,521) --- --------- ------------- -------- Net cash used in financing activities (8,606) (158,356) (3,377) ------------- ---------- -- ----- Increase (decrease) in cash and cash equivalents 8,565 (121,301) 35,161 Cash and cash equivalents at beginning of year 33,754 155,055 119,894 ---------- --------- ---------- Cash and cash equivalents at end of year $42,319 $33,754 $155,055 ======= ======= ========
See notes to consolidated financial statements 34 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of significant accounting policies: Basis of financial statement presentation: The consolidated financial statements include the accounts of Sbarro, Inc., its wholly owned subsidiaries and the accounts of its majority-owned joint ventures (together, "we", "our", "us", or "Sbarro"). All significant intercompany accounts and transactions have been eliminated. Minority interest includes the interests held by our partners in certain of our majority-owned joint ventures. The minority interests at the end of fiscal 2000 and 1999 were not material. The preparation of our financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that may affect the amounts reported in the financial statements and accompanying notes. Our actual results could differ from those estimates. Cash equivalents: All highly liquid debt instruments with a maturity of three months or less at the time of purchase are considered to be cash equivalents. Inventories: Inventories, consisting primarily of food, beverages and paper supplies, are stated at cost, which is determined by the first-in, first-out method. Property and equipment: Property and equipment are stated at cost, less accumulated amortization and depreciation. Depreciation of equipment and amortization of leasehold improvements is provided for by the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter. One-half year of depreciation and amortization is recorded in the year in which the restaurant commences operations. Intangible assets: Intangible assets consist of our franchise system and trademarks, goodwill and deferred financing costs. Franchise system and trademark values and goodwill were determined based on an allocation of the purchase price from the going private transaction (see Note 2) 35 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Summary of significant accounting policies (continued): Intangible assets (continued): and are being amortized on a straight line basis over 40 years. Deferred financing costs were incurred as a result of the going private transaction (see Note 2) and the mortgage on the corporate headquarters building (see Note 8) and are being amortized as additional interest expense over the respective lives of the related debt instrument. Equity investments: The Company accounts for its investments in 50% or less owned joint ventures under the equity method of accounting. The equity in the net income (loss) of these unconsolidated affiliates is recorded in the accompanying consolidated statements of income. Deferred charges: We account for pre-opening and similar costs in accordance with Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-up Activities", of the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants, which required companies to write off all such costs, net of tax benefit, as a "cumulative effect of accounting change" upon our adoption of the SOP and to expense all of those costs as incurred in the future. In accordance with its early application provisions, we implemented the SOP as of the beginning of our 1998 fiscal year which resulted in a charge at that time of $1.4 million before tax, or $0.9 million after tax. Comprehensive income: We observe the provisions of Statement of Financial Accounting Standards ("SFAS") 130, "Reporting Comprehensive Income", which establishes rules for the reporting of comprehensive income and its components. The adoption of this statement had no impact on our net income or shareholders' equity. For all years presented, our operations did not give rise to items includible in comprehensive income which were not already included in net income. Therefore, our comprehensive income is the same as our net income for all periods presented. 36 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Summary of significant accounting policies (continued): Franchise related income: Initial franchise fees are recorded as income as restaurants are opened by the franchisee and we have performed substantially all services. Development fees are recognized over the number of restaurant openings covered under each development agreement, with any remaining balance recognized at the end of the term of the agreement. Royalty and other fees from franchisees are accrued as earned. Revenues and expenses related to construction of franchised restaurants are recognized when contractual obligations are completed and the restaurants are opened. Deferred rent: The majority of our lease agreements provide for scheduled rent increases during the lease term. Provision has been made for the excess of operating lease rental expense over cash rentals paid, computed on a straight-line basis over the lease terms. Income taxes: In March 2000, we elected to be taxed, beginning January 3, 2000, under the provisions of Subchapter S of the Internal Revenue Code of 1986, and, where applicable and permitted, under similar state and local income tax provisions. With certain limited exceptions, we no longer pay federal, state and local income taxes for periods for which we are treated as an S corporation. Rather, our shareholders include their pro-rata share of our taxable income on their individual income tax returns and thus are required to pay taxes on their respective share of our taxable income, whether or not it is distributed to them. We file a consolidated federal income tax return for informational purposes. Minority interest includes no provision or liability for income taxes as any tax liability related to their interest is the responsibility of the minority partners. In accordance with SFAS No. 109, "Accounting for Income Taxes", we reversed our net deferred taxes upon our conversion to S corporation status. This resulted in a credit to income taxes of $5.6 million in the first quarter fiscal 2000. 37 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Summary of significant accounting policies (continued): Accounting period: Our fiscal year ends on the Sunday nearest to December 31. Our 1998 fiscal year ended January 3, 1999 and contained 53 weeks. All other reported fiscal years contained 52 weeks. Long-lived assets: Impairment losses are recorded on long-lived assets on a restaurant by restaurant basis whenever impairment factors are determined to be present, the undiscounted cash flows estimated to be generated by those assets are less than the carrying value of such assets and events or changes in circumstances indicate that the carrying amount may not be recoverable. Additionally, the Company periodically reviews the values assigned to goodwill and other intangibles which resulted from the going private transaction to determine if they have been permanently impaired by adverse conditions. Derivative instruments and hedging activities: The Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 137 and SFAS No. 138, which is effective for fiscal years beginning after June 15, 2000. Presently, we do not use derivative instruments and therefore SFAS No. 133, while effective in fiscal 2001, is not currently applicable. Segment Reporting: We have no material reportable segments under SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information", other than our primary quick service restaurant business. Reclassifications: Certain items in the financial statements presented have been reclassified to conform to the fiscal 2000 presentation. 38 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Summary of significant accounting policies (continued): Supplemental disclosures of cash flow information:
For The Fiscal Years Ended ------------------------------------------------------------------------------------------------------------ December 31, January 2, January 3, 2000 2000 1999 ---- ---- ---- (In thousands) ------------------------------------------------------------------------------------------------------------ Cash paid for: ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ Income taxes $ 3,949 $20,129 $24,617 ======== ======= ======= ------------------------------------------------------------------------------------------------------------ Interest $28,104 $ 30 $ - ======= ======== ===============
2. Going private transaction: On September 28, 1999, members of the Sbarro family (who prior thereto owned approximately 34.4% of the Sbarro's common stock) became the holders of 100% of our issued and outstanding common stock as a result of a "going private" merger. The cost of the merger, including fees and expenses, was funded through the use of substantially all of our then cash on hand and the placement of $255.0 million of 11.0% Senior Notes due September 15, 2009 sold at a price of 98.514% of par to yield 11.25% per annum. In April 2000, we exchanged these Senior Notes for Senior Notes having the same terms, except that the new Senior Notes ("Senior Notes") were registered under the Securities Act of 1933. The old senior notes and the Senior Notes were issued under an Indenture dated September 28, 1999 (the "Indenture"). We also entered into a five year, $30 million unsecured senior revolving bank credit facility under a Credit Agreement dated as of September 23, 1999 (the "Credit Agreement"). The Credit Agreement provides an unsecured senior revolving credit facility which enables us to borrow, on a revolving basis from time to time during its five-year term, up to $30.0 million, including a $10.0 million sublimit for standby letters of credit. Our payment obligations under the Senior Notes and the Credit Agreement are jointly, severally, unconditionally and irrevocably guaranteed by all of our current Restricted Subsidiaries (as defined in the Indenture) and is to be similarly guaranteed by our future Restricted Subsidiaries. As of December 31, 2000, there was $0.2 million remaining on deposit with a third party 39 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. Going private transaction (continued): paying agent for untendered shares to be redeemed as part of the merger consideration. That amount is shown as restricted cash and amounts due for untendered shares in the consolidated balance sheet. Funds for the untendered shares are being returned to us to be held until claimed or escheated to the appropriate jurisdictions. In accordance with Emerging Issues Task Force Issue 88-16, "Basis in Leveraged Buyout Transactions", the acquisition of all the outstanding shares of common stock not owned by the Sbarro family and all outstanding stock options have been accounted for under the purchase method of accounting. As a result, the remaining shares of common stock owned by the Sbarro family are presented in shareholder's equity at their original basis in the accompanying consolidated balance sheet. During fiscal 2000, we finalized an allocation of the purchase price from the going private transaction based on an evaluation of the Company at September 29, 1999. As a result, property and equipment and intangible assets were increased by $7.0 million and $216.0 million, respectively, and annual depreciation and amortization expense was lower than originally estimated due to the allocation to assets with different remaining useful lives (See Note 13). All stock option plans that were in effect as of the date of the going private transaction were terminated on September 29, 1999. Summarized below are our unaudited pro forma results of operations for the fiscal years ended January 2, 2000 and January 3, 1999 as if the merger had taken place as of the beginning of that year. Adjustments have been made for the amortization of the excess of the purchase price over the cost basis of net assets acquired, interest expense, including interest on the $16 million mortgage issued subsequent to fiscal 1999 to one of the guaranteeing subsidiaries (Note 14) and related changes in income tax expense. For the Fiscal Years Ended January 2, 2000 January 3, 1999 --------------- --------------- (In thousands) Pro Forma: Revenues $389,697 $381,787 ======== ======== Income before cumulative effect of accoun $ 6,662 $4,597 ========== ====== Net incom $ 6,662 $3,767 ========= ====== These pro forma results of operations are not necessarily indicative of the actual results of 40 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. Going private transaction (continued): operations that would have occurred had the merger taken place at the beginning of the periods presented or of results which may occur in the future. In connection with the termination of negotiations for the initial proposal of our acquisition of all shares of common stock not owned by such members of the Sbarro family, we recorded a charge of $1.0 million before tax, or $0.6 million after tax, in fiscal 1998. 3. Description of business: We and our franchisees develop and operate family oriented cafeteria style Italian restaurants principally under the "Sbarro" and "Sbarro The Italian Eatery" names. The restaurants are located throughout the world, principally in shopping malls and other high traffic locations. The following sets forth the number of restaurants in operation as of:
----------------------------- ---------------------- ---------------------- -------------------- December 31, January 2, January 3, 2000 2000 1999 ---- ---- ---- ----------------------------- ---------------------- ---------------------- -------------------- ----------------------------- ---------------------- ---------------------- -------------------- ----------------------------- ---------------------- ---------------------- -------------------- ----------------------------- ---------------------- ---------------------- -------------------- Sbarro-owned (a) 636 638 624 ----------------------------- ---------------------- ---------------------- -------------------- ----------------------------- ---------------------- ---------------------- -------------------- Franchised 303 286 268 --- --- --- ----------------------------- ---------------------- ---------------------- -------------------- ----------------------------- ---------------------- ---------------------- -------------------- 939 924 892 === === ===
(a) Excludes 33, 26, and 19 new concept units as of the end of the respective fiscal years. 4. Property and equipment, net:
December 31, January 2, 2000 2000 ---- ---- ------------------------------------------------------------------------------------------------------------ --------------------------------------------------------------------(In thousands)------------------------- Land and improvements (a) $ 3,781 $ 3,364 ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ Leasehold improvements 165,627 204,478 ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ Furniture, fixtures and equipment 78,237 112,087 ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ Construction-in-progress 717 3,157 ------ ----- ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ 248,362 323,086 ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ Less accumulated depreciation and 95,894 184,135 ------- ------- amortization (b) ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ $152,468 $138,951 ======== ======== ------------------------------------------------------------------------------------------------------
41 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. Property and equipment, net (continued): (a) During 1998, we recorded a charge of $1.1 million before tax, $0.7 million after tax, for the difference between the carrying cost and proposed selling price of a parcel of land which is being offered for sale. (b) Depreciation and amortization of property and equipment was $24.0, $23.9 and $22.5 million in fiscal 2000, 1999 and 1998 respectively. In connection with the going private transaction, an allocation of the purchase price resulted in certain increases in the property and equipment, and changes in accumulated depreciation and amortization during fiscal 2000. See Note 2. 5. Intangible assets:
-------------------------------------------------------------------------------------------------------- December 31, January 2, 2000 2000 ---- ---- -------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- (In thousands) -------------------------------------------------------------------------------------------------- Franchise system and trademarks $207,529 $560 Goodwill 8,520 Deferred financing costs 9,694 9,830 Other - 1,388 ----------- ----- 225,743 11,778 Less accumulated amortization 8,064 1,178 ------- -------- $217,679 $10,600
6. Accrued expenses: -------------------------------------------------------------------------------------------------------- December 31, January 2, 2000 2000 ---- ---- (In thousands) -------------------------------------------------------------------------------------------------- Compensation $5,265 $6,234 -------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- Payroll and sales taxes 3,413 5,265 -------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- Rent and related cost 3,625 2,438 -------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- Provision for unit closings (Note 11) 50 863 -------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- Other 9,588 12,114 ----- ------ -------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- $21,941 $26,914 ======= =======
7. Income taxes: In March 2000, we elected to be taxed, beginning January 3, 2000, under the provisions of Subchapter S of the Internal Revenue Code of 1986, and, where applicable and permitted, 42 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. Income taxes (continued): under similar state and local income tax provisions. With certain limited exceptions, we no longer pay federal, state and local income taxes for periods for which we are treated as an S corporation. Rather, our shareholders include their pro-rata share of our taxable income on their individual income tax returns and thus are required to pay taxes on their respective share of our taxable income, whether or not it is distributed to them. In connection with the going private transaction and the related financing, we have entered into a tax payment agreement with our shareholders. The tax payment agreement permits us to make periodic tax distributions to our shareholders in amounts that are intended to approximate the income taxes, including estimated taxes, that would be payable by our shareholders if their only income were their pro-rata share of our taxable income and that income was taxed at the highest applicable federal and New York State marginal income tax rates. We may only make the tax distributions with respect to periods in which we are treated as an S corporation for income tax purposes. We made distributions to our shareholders in accordance with the tax payment agreement of $3.8 million in fiscal 2000 and $3.6 million in January 2001 and estimate that an additional $4.0 million of distributions will be made in 2001 related to 2000 earnings. In accordance with SFAS No. 109, "Accounting for Income Taxes", we reversed our net deferred taxes upon our conversion to S corporation status. This resulted in a credit to income taxes of $5.6 million in the first quarter of fiscal 2000.
----------------------------------------------------------------------------------------------------------------- For the Fiscal Years Ended December 31, January 2, January 3, 2000 2000 1999 ---- ---- ---- (In thousands) Federal: Current $ - $14,758 $19,421 Deferred (4,589) 557 (2,209) -------- ------- ------- (4,589) 15,315 17,212 ------- ------ ------ State and local: Current 554 3,854 4,708 Deferred (1,040) 153 (373) -------- ------ ---- (486) 4,007 4,335 ----- ------- ------- $(5,075) $19,322 $21,547 ========= ======= ======= -----------------------------------------------------------------------------------------------------------
43 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. Income taxes (continued): Deferred income taxes as of January 2, 2000 were comprised of the following (in thousands): Depreciation and amortization $11,097 ------------------------------------------------------------ ------------------------------------------------------------ Deferred charges 11 ------------------------------------------------------------ ------------------------------------------------------------ Other 495 ------------------------------------------------------------ ------------------------------------------------------------ Gross deferred tax liabilities 11,603 ------ Accrued expenses (2,070) ------------------------------------------------------------- ------------------------------------------------------------- Deferred income (3,496) ------------------------------------------------------------- ------------------------------------------------------------- Other (408) ---- ------------------------------------------------------------- ------------------------------------------------------------- Gross deferred tax assets (5,974) ------- -------------------------------------------------- $5,629 -------------------------------------------------- Actual tax expense differed from "expected" tax expense (computed by applying the Federal corporate rate of 35% for the fiscal years ended January 2, 2000, and January 3, 1999) as follows: -----------------------------------------------------
For the Fiscal Years Ended January 2, January 3, 2000 1999 ---- ---- (In thousands) Computed "expected" tax expense $17,096 $19,382 --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- Increase (reduction) in income taxes resulting from: State and local income taxes, net of federal 2,605 2,725 income tax benefit --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- Tax exempt interest income and dividends received deduction (1,002) (1,198) Amortization of excess purchase price over the cost of net assets acquired 700 - Other, net (77) 638 ---- ----- $19,322 $21,547 ======== =======
44 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. Income taxes (continued): Deferred income taxes are provided for temporary differences between financial and tax reporting. These differences and the amount of the related deferred tax benefit are as follows (in thousands): ------------------------------------------------------------------- For the Fiscal Years Ended January 2, January 3, 2000 1999 ---- ---- Depreciation and amortization $(408) $(1,824) Accrued expenses 2,706 (624) Other (1,588) 604 ------- --- $ 710 $(1,844) 8. Long-term debt: (a) The cost of the merger, including fees and expenses, was funded through the use of substantially all of our cash on hand and the placement of $255 million of 11.0% senior notes due September 15, 2009 sold at a price of 98.514% of par to yield 11.25% per annum. In April 2000, we exchanged these senior notes for senior notes having the same terms, except that the new senior notes ("Senior Notes") were registered under the Securities Act of 1933. The old senior notes and the Senior Notes were issued under an Indenture dated September 28, 1999 (the "Indenture"). Interest on the Senior Notes is payable semi-annually on March 15 and September 15 of each year and commenced on March 15, 2000. Our payment obligations under the Senior Notes are jointly, severally, unconditionally and irrevocably guaranteed by all of Sbarro's current Restricted Subsidiaries (as defined in the Indenture) and is to be similarly guaranteed by our future Restricted Subsidiaries. The Senior Notes and the subsidiary guarantees are senior unsecured obligations of Sbarro and the guaranteeing subsidiaries, respectively, ranking pari passu in right of payment to all of our and their respective present and future senior debt, including amounts outstanding under the bank credit agreement discussed below. The Indenture permits redemption of the Senior Notes at our option at varying redemption prices and requires us to offer to purchase Senior Notes in the event of a Change of Control and in connection with certain Asset Sales (each as defined). The Indenture contains various covenants on our part and the guarantor subsidiaries, including, but not limited to, restrictions on our payment of dividends, stock repurchases, certain investments and other restricted payments, the incurrence of indebtedness and liens on our assets, affiliate transactions, asset sales and mergers. We were in compliance with the various covenants contained in the Indenture as of December 31, 2000. 45 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. Long-term debt (continued): The discount at which the Senior Notes were issued, an aggregate of approximately $3.8 million, is being accreted to the Senior Notes over the original ten year life of the Senior Notes. (b) On September 23, 1999, we entered into a Bank Credit Agreement (the "Credit Agreement") which provides us with an unsecured senior revolving credit facility that enables us to borrow, on a revolving basis from time to time during its five-year term, up to $30 million, including a $10 million sublimit for standby letters of credit. No amounts were outstanding under the credit facility as of December 31, 2000. Each of our current guaranteeing subsidiaries (the same entities as the Restricted Subsidiaries under the Indenture) have agreed to, and the future guaranteeing subsidiaries are to, unconditionally and irrevocably guarantee our obligations under the Credit Agreement on a joint and several basis. All borrowings under the Credit Agreement are repayable on September 28, 2004. In addition, we will be required to repay our loans and reduce the lenders' commitments under the Credit Agreement using the proceeds of certain asset sales and issuances of certain equity interests of, and sales of equity interests in, the guaranteeing subsidiaries. At our option, the interest rates applicable to loans under the Credit Agreement will be at either (i) the bank's prime rate (8.0% at March 28, 2001) plus a margin ranging from zero to 0.75% (the margin at March 28, 2001 was 0.50%) or (ii) reserve adjusted LIBOR (5.05% at March 28, 2001) plus a margin ranging from 1.5% to 2.5% (the margin at March 28, 2001 was 2.25%). In each case, the margin depends upon the ratio of our senior debt (as defined) to its earnings before interest, taxes and depreciation and amortization ("EBITDA"). We have agreed to pay certain fees in connection with the Credit Agreement, including an unused commitment fee at a rate per year that will vary from 0.25% of the undrawn amount of the facility to 0.45% of the undrawn amount of the facility per year, depending upon the ratio of our senior debt to EBITDA. The unused commitment fee at March 28, 2001 was 0.40% per year. The Credit Agreement contains various covenants on our part and on the part of the guaranteeing subsidiaries, including, but not limited to, restrictions on the payment of dividends and making stock repurchases, certain investments and other restricted payments, the incurrence of indebtedness, guarantees, other contingent obligations, liens on assets, affiliate transactions, asset sales and mergers, consolidations and acquisitions of stock or 46 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. Long-term debt (continued): assets by us and our guaranteeing subsidiaries. The Credit Agreement also contains provisions which, under certain circumstances, prohibit redemptions or repurchases of the Senior Notes, including repurchases that might otherwise be required pursuant to the terms of the Indenture, and imposes certain conditions on our amending or supplementing the Indenture. In addition, we are required to maintain a minimum ratio of consolidated EBITDA to consolidated interest expense (in each case with the guaranteeing subsidiaries) of at least 2.0 to 1.0 and a ratio of consolidated senior debt to consolidated EBITDA (in each case with the guaranteeing subsidiaries) ranging from 4.3 to 1.0 through December 29, 2001, 4.1 to 1 thereafter through December 28, 2002 and 3.9 to 1.0 beginning December 29, 2002. We were in compliance with the various covenants contained in the Credit Agreement as of December 31, 2000. (c) In March 2000, one of our Restricted Subsidiaries obtained a $16.0 million, 8.4% loan due in 2010, secured by a mortgage on our corporate headquarters building. The loan is payable in monthly installments of principal and interest of $0.1 million. The balance as of December 31, 2000 was $15.9 million. The mortgage agreement contains various covenants including a requirement that the Restricted Subsidiary maintain a minimum ratio of EBITDA to annual and quarterly debt service of at least 1.2 to 1.0. We were in compliance with the various covenants contained in the mortgage agreement as of December 31, 2000. Scheduled maturities of long-term debt are as follows (in thousands): Fiscal years ending: December 30, 2001 $130 December 29, 2002 141 December 28, 2003 155 January 2, 2005 168 January 1, 2006 182 Later years 270,142 ------- 270,918 Less: Current maturities (130) Unaccreted original issue discount (3,310) ------------- $267,478 47 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. Commitments and contingencies: Commitments: We conduct all of our operations in leased facilities. Most of our restaurant leases provide for the payment of base rents plus real estate taxes, utilities, insurance, common area charges and certain other expenses, as well as contingent rents generally ranging from 8% to 10% of net restaurant sales in excess of stipulated amounts. Rental expense under operating leases, including common area charges, other expenses and additional amounts based on sales, were as follows: For the Fiscal Years Ended December 31, January 2, January 3, 2000 2000 1999 ---- ---- ---- (In thousands) Minimum rentals $50,070 $47,627 $44,358 Common area charges 14,819 14,002 13,557 Contingent rentals 4,827 4,567 4,363 ---------- --------- --------- $69,716 $66,196 $62,278 ======= ======= ======= Future minimum rental and other payments required under non-cancelable operating leases for our restaurants that were open on December 31, 2000 and the existing leased administrative and support function office (Note 10) are as follows (in thousands): Fiscal Years Ending: December 30, 2001 $75,146 December 29, 2002 73,525 December 28, 2003 70,401 January 2, 2005 67,135 January 1, 2006 63,562 Later years $239,351 We are the principal lessee under operating leases for certain franchised restaurants which are subleased to the franchisee. Franchisees pay rent and related expenses directly to the landlord. Future minimum rental payments required under these non-cancelable operating 48 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. Commitments and contingencies: Contingencies (continued): leases for franchised restaurants that were open as of December 31, 2000 are as follows (in thousands): Fiscal Years Ending: December 30, 2001 $1,674 December 29, 2002 1,384 December 28, 2003 1,258 January 2, 2005 1,114 January 1, 2006 889 Later years $2,360 - As of March 28, 2001, future minimum rental payments required under non-cancelable operating leases for restaurants which had not as yet opened as of December 31, 2000 are as follows (in thousands): Fiscal Years Ending: December 30, 2001 $1,880 December 29, 2002 3,257 December 28, 2003 3,854 January 2, 2005 3,959 January 1, 2006 3,986 Later years $25,519 We are a party to contracts aggregating $12.8 million with respect to the construction of restaurants. Payments of approximately $8.2 million have been made on those contracts as of December 31, 2000. We are the guarantor of $3.1 million of letters of credit and up to $8.9 million for loans, a mortgage and a line of credit for certain of our joint ventures. Contingencies: In February 1999, the Umberto of New Hyde Park joint venture companies, in which we have an 80% interest, began an action in the U.S. District Court for the Eastern District of New York against Umberto Corteo, who owns the remaining 20% interest in the joint venture companies, and against three other restaurants owned by Mr. Corteo. We alleged, 49 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. Commitments and contingencies: Contingencies (continued): among other things, that Mr. Corteo engaged in unfair trade practices and in trademark infringement, thereby breaching the joint venture agreements. We were seeking an accounting, compensatory and punitive damages and injunctive relief. The answer filed by Mr. Corteo and his co-defendants denied our claims and further alleged that non-competition restrictions against Mr. Corteo in the joint venture agreements are unenforceable. Mr. Corteo and his co-defendants had also counterclaimed against us alleging misappropriation of trademark rights and failure to perform administrative duties that amounted to a breach of the agreements. In March 2001, we acquired the 20% interest owned in this venture by Mr. Corteo in final settlement of this litigation. The terms of the settlement agreement do not have a material impact upon either our financial condition or results of operations. On November 17, 1999, an action was instituted against us in which the plaintiffs allege that they served as store managers, general managers, assistant managers or co-managers in our restaurants in the State of Washington at various times since November 17, 1996 and that, in connection with their employment, we violated the overtime pay provisions of the State of Washington's Minimum Wage Act by treating them as overtime exempt employees, breached alleged employment agreements and statutory provisions by failing to record and pay for hours worked at the contract rates and/or statutory minimum wage rates and failed to provide statutorily required meal breaks and rest periods. The plaintiffs represent substantially all of our restaurant managers employed for any period of time on or after November 9, 1996 in the State of Washington. We currently own and operate 18 restaurants in the State of Washington. The plaintiffs seek actual damages, exemplary damages and costs of the lawsuit, including reasonable attorney's fees, each in unspecified amounts, and injunctive relief. A settlement agreement has been approved by the court for approval and will not have a material impact upon either our financial condition or results of operations. On December 20, 1999, twelve current and former general managers of Sbarro restaurants in California amended a complaint filed in the Superior Court of California for Orange County. The complaint alleges that the plaintiffs were improperly classified as exempt employees under the California wage and hour law. The plaintiffs are seeking actual damages, punitive damages and costs of the lawsuit, including reasonable attorney's fees, each in unspecified amounts. Plaintiffs filed a motion to certify the lawsuit as a class action, but the motion was denied by the court. We believe that we have substantial defenses to the claims and are vigorously defending this action. 50 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. Commitments and contingencies: Contingencies (continued): On September 6, 2000, eight other current and former general managers of Sbarro restaurants in California filed a complaint against Sbarro in the Superior Court of California for Orange County alleging that the plaintiffs were improperly classified as exempt employees under California wage and hour law. Plaintiffs are represented by the same counsel who is representing the plaintiffs in the case discussed in the preceding paragraph. We believe that we have substantial defenses to the claims and are vigorously defending this action. From time to time, we are a party to certain claims and legal proceedings in the ordinary course of business, none of which, in our opinion, would have a material adverse effect on our financial position or results of operations. 10. Transactions with related parties: We are the sole tenant of an administrative office building which is leased from a partnership owned by certain of Sbarro's shareholders. For each of the 2000, 1999 and 1998 fiscal years, the annual rent paid pursuant to the sublease was $0.3 million. The annual rent payable pursuant to the sublease is $0.3 million each year for the remainder of the lease term which expires in 2011. In addition, we are obligated to pay real estate taxes, utilities, insurance and certain other expenses for the facility. We believe that our rent is comparable to the rent that would be charged by an unaffiliated third party. In April 2000, we loaned our Chairman, President and Chief Executive Officer, $2.0 million, pursuant to a note due on April 4, 2002 bearing interest at 6.46%, payable annually. On January 2 and 3, 2001, we loaned three executive officers and directors, Mario, Anthony and Joseph Sbarro, $200,000, $300,000 and $200,000, respectively, which loans were repaid on January 15, 2001 with interest at our bank's prime rate in effect at that time. A member of our Board of Directors acts as a consultant to us for which he received $0.3 million, $0.5 million and $0.1 million in the 2000, 1999 and 1998 fiscal years, respectively. 51 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. Provision for unit closings: In connection with the final disposition of two joint venture units closings recorded in fiscal 1997, we agreed to a special allocation of losses which resulted in an additional $1.0 million charge before tax, or $0.6 million after tax, to earnings in fiscal 1999. A provision for restaurant closings of $2.5 million before tax, or $1.6 million after tax, was established in fiscal 1998 relating to the closing of 20 restaurant locations. 12. Dividends: During 2000, we made distributions to our shareholders totaling $22.1 million including $3.8 million for taxes pursuant to the tax payment agreement described in Note 7. 13. Quarterly financial information (unaudited):
First Second Third Fourth Quarter Quarter Quarter Quarter (In thousands) Fiscal year 2000 Revenues $111,423 $88,306 $91,562 $108,118 Gross profit (a) 86,028 67,036 70,324 84,572 Net income (b) 5,194 1,447 2,446 16,358 =========== ======= ======== ======== Fiscal year 1999 Revenues $106,942 $83,534 $91,456 $107,765 Gross profit (a) 81,345 64,213 69,570 84,430 Net income (b) 6,912 6,234 7,563 8,814 ========== ========== ========= ==========
(a) Gross profit represents the difference between restaurant sales and the cost of food and paper products. (b) See Notes 2 and 11 for information regarding unusual charges in the fourth quarter of fiscal 2000 and 1999. See Note 7 regarding a $5.6 million credit to income tax expense upon conversion to an S Corporation in the first quarter of 52 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. Quarterly financial information (unaudited) (continued): 2000. See Note 2 regarding a reduction of $2.4 million of depreciation and amortization recorded in the fourth quarter of 2000 upon finalization of the purchase price allocation from the going private transaction. 14. Guarantor and non-guarantor financial statements: Certain subsidiaries have guaranteed amounts outstanding under the Senior Notes and Credit Agreement. Each of the guaranteeing subsidiaries is our direct or indirect wholly owned subsidiary and each has fully and unconditionally guaranteed the Senior Notes and the Credit Agreement on a joint and several basis. The following condensed consolidating financial information presents: (1) Condensed consolidating balance sheets as of December 31, 2000 and January 2, 2000 and related statements of income and cash flows for the fiscal years ended December 31, 2000, January 2, 2000 and January 3, 1999 of (a) Sbarro, Inc., the parent, (b) the guarantor subsidiaries as a group, (c) the nonguarantor subsidiaries as a group and (d) the Company on a consolidated basis. (2) Elimination entries necessary to consolidate Sbarro, Inc., the parent, with the guarantor and nonguarantor subsidiaries. (3) Investments in subsidiaries are accounted for by the parent on the cost method. The principal elimination entries eliminate intercompany balances and transactions. 53 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Balance Sheet As of December 31, 2000 ASSETS
Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Current assets: Cash and cash equivalents $36,963 $4,232 $1,124 $42,319 Restricted cash for untendered shares 153 - - 153 Receivables less allowance for doubtful accounts of $211: Franchise 1,350 - - 1,350 Other 1,111 370 103 ($30) 1,554 ------- -------- ------- -------- ------- 2,461 370 103 (30) 2,904 Inventories 1,459 1,763 309 - 3,531 Prepaid expenses 836 136 27 - 999 ------- ------ ------ -------- ------- Total current assets 41,872 6,501 1,563 (30) 49,906 Intercompany receivables 20,318 195,470 - (215,788) - Investment in subsidiaries 65,469 - - (65,469) - Property and equipment, net 45,486 88,026 18,956 - 152,468 Intercompany receivables - long term 3,558 - - (3,558) - Intangible assets: Franchise system and trademarks, net 201,044 - - - 201,044 Deferred financing costs and other, net 16,262 373 - - 16,635 Loan receivable from officer 2,000 - - - 2,000 Other assets 10,788 52 (534) (3,804) 6,502 ---------- ------------ ----------- --------- ------- $406,797 $290,422 $ 19,985 ($288,649) $428,555 ======== ======== ======== ========== ========
54 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Balance Sheet As of December 31, 2000 LIABILITIES AND SHAREHOLDERS EQUITY
Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Current liabilities: Amounts due for untendered shares $153 $153 Accounts payable 9,593 $135 $556 10,284 Accrued expenses 20,025 (1,094) 3,010 21,941 Accrued interest payable 8,181 - - 8,181 Current portion of mortgage payable - 130 - - 130 --------- ------ --------- --------- ----- Total current liabilities 37,952 (829) 3,566 - 40,689 Intercompany payables 195,470 - 20,318 ($215,788) - Deferred rent 6,791 - - - 6,791 Long-term debt, net of original issue discount 251,689 15,789 - - 267,478 Intercompany payables - long term - 3,558 - (3,558) - Shareholders' equity (deficit): Preferred stock, $1 par value; authorized 1,000,000 shares; none issued - - - - - Common stock, $.01 par value: authorized 40,000,000 shares; issued and outstanding 7,064,328 shares 71 - - - 71 Additional paid-in capital 10 65,469 2,507 (67,976) 10 Retained earnings (deficit) (85,186) 206,435 (6,406) (1,327) 113,516 --------- --------- --------- --------- -------- (85,105) 271,904 (3,899) (69,303) 113,597 --------- --------- --------- --------- -------- $406,797 $290,422 $19,985 ($288,649) $428,555 ========= ========= ======== =========== =========
55 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Balance Sheet As of January 2, 2000 ASSETS
Guarantor Nonguarantor Consolidated Current assets: Parent Subsidiaries Subsidiaries Eliminations Total ------ ------------ ------------ ------------ ----- Cash and cash equivalents $27,853 $4,391 $1,510 $33,754 Restricted cash for untendered shares 298 - - 298 Receivables less allowance for doubtful accounts of $419 Franchise 1,429 - - 1,429 Other 1,280 16 77 ($30) 1,343 -------- -------- -------- ----------- --------- 2,709 16 77 (30) 2,772 Inventories 1,594 1,963 160 - 3,717 Prepaid expenses 2,013 (377) 61 - 1,697 ------- -------- -------- ----------- ------- Total current assets 34,467 5,993 1,808 (30) 42,238 Intercompany receivables 13,258 172,769 - (186,027) - Investment in subsidiaries 66,237 - - (66,237) - Property and equipment, net 47,570 82,216 9,165 - 138,951 Intercompany receivables - long term 19,897 - - (19,897) - Excess of purchase price over the cost of net assets acquired, net 220,681 - - - 220,681 Intangible assets: Franchise system and trademarks, net 432 - - - 432 Deferred financing costs and other, net 10,168 10,168 Other assets 6,263 706 (125) (1,771) 5,073 ----- --- ----- --------- -------- $418,973 $261,684 $10,848 $(273,962) $417,543 ========= ========= ======== =========== =========
56 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Balance Sheet As of January 2, 2000 LIABILITIES AND SHAREHOLDERS EQUITY
Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Current liabilities: Amounts due for untendered shares $298 $298 Accounts payable 8,013 $296 $440 8,749 Accrued expenses 25,452 (348) 1,810 26,914 Accrued interest payable 7,480 - - 7,480 Income taxes 984 (180) (72) 732 ------- --------- --------------------- -------- Total current liabilities 42,227 (232) 2,178 - 44,173 Intercompany payables 172,769 - 13,258 ($186,027) - Deferred rent 6,151 - - - 6,151 Deferred income taxes 5,629 - - - 5,629 Long-term debt, net of original issue discount 251,310 - - - 251,310 Intercompany payables - long term - 19,897 - (19,897) - Shareholders' equity (deficit): Preferred stock, $1 par value; authorized 1,000,000 shares; none issued - - - - - Common stock, $.01 par value: authorized 40,000,000 shares; issued and outstanding 7,064,328 shares 71 - - - 71 Additional paid-in capital 10 66,238 1,800 (68,038) 10 Retained earnings (deficit) (59,194) 175,781 (6,388) - 110,199 ---------- --------- --------- ------------ ---------- (59,113) 242,019 (4,588) (68,038) 110,280 ---------- --------- ---------- ---------- --------- $418,973 $261,684 $10,848 (273,962) $417,543 ========= ======== ======== ========== ========
57 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Statement of Income For the fiscal year ended December 31, 2000
Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Revenues: Restaurant sales $163,903 $194,797 $23,665 $382,365 Franchise related income 11,231 - - 11,231 Real estate and other 3,161 3,490 - ($839) 5,812 Intercompany charges - 16,991 - (16,991) - ------------ -------- ----------- --------- ------------- Total revenues 178,295 215,278 23,665 (17,830) 399,408 ------- ------- ------ ------- ------- Costs and expenses: Restaurant operating expenses: Cost of food and paper products 28,760 39,186 6,459 - 74,405 Payroll and other employee benefits 39,571 53,671 8,311 - 101,553 Other operating costs 46,929 60,667 6,526 - 114,122 Depreciation and amortization 14,894 13,112 1,033 - 29,039 General and administrative 18,173 12,497 1,051 (839) 30,882 Intercompany charges 16,991 - - (16,991) - ------ --------- ---------- --------- ---------- Total costs and expenses 165,318 179,133 23,380 (17,830) 350,001 -------- --------- -------- ----------- ------------ Operating income before minority interest 12,977 36,145 285 - 49,407 Minority interest - - (46) - (46) ---------- ---------- -------- ---------- -------- Operating income 12,977 36,145 239 - 49,361 Other (expense) income: Interest expense (29,244) (999) (1,612) 1,612 (30,243) Interest income 2,561 - - (1,612) 949 Equity in net income of unconsolidated affiliates 303 - - - 303 -------- ------------ ------------ ------------- ------ Net other (expense) income (26,380) (999) (1,612) - (28,991) Income (loss) before income taxes (13,403) 35,146 (1,373) - 20,370 Income taxes (benefit) (5,790) 743 (28) - (5,075) ---------- ------- --------- ---------- -------- Net income (loss) $(7,613) $34,403 $(1,345) $ - $25,445 ========== ======== ======== ========== ==========
58 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued):
Consolidating Statement of Income For the fiscal year ended January 2, 2000 Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Revenues: Restaurant sales $162,770 $194,105 $18,639 $375,514 Franchise related income 8,688 - - 8,688 Real estate and other 2,659 2,913 (77) 5,495 Intercompany charges - 19,864 - $(19,864) - ------------- ----------- ----------- ---------- ------------ Total revenues 174,117 216,882 18,562 (19,864) 389,697 -------- --------- ------- ---------- ------- Costs and expenses: Restaurant operating expenses: Cost of food and paper products 30,297 40,871 4,788 - 75,956 Payroll and other employee benefits 42,844 48,509 5,983 - 97,336 Other operating costs 43,198 60,325 5,076 - 108,599 Depreciation and amortization 12,210 12,703 799 - 25,712 General and administrative 14,548 12,393 1,913 - 28,854 Provision for store closing - - 1,013 - 1,013 Intercompany charges 19,864 - - (19,864) - -------- ------------ -------- ---------- ----------- Total costs and expenses 162,961 174,801 19,572 (19,864) 337,470 ------- ------- -------- -------- ---------- Operating income (loss) before minority interest 11,156 42,081 (1,010) - 52,227 Minority interest - - 266 - 266 ----------- ---------- ------ -------- -------- Operating income (loss) 11,156 42,081 (744) - 52,493 Other (expense) income: Interest expense (7,899) - (997) 997 (7,899) Interest income 4,825 - - (997) 3,828 Equity in net income of unconsolidated affiliates 423 - - - 423 --------- ------------ ------------ ------------- --------- Net other (expense) income (2,651) - (997) - (3,648) ------- ------------ -------- ------------- ------- Income (loss) before income taxes 8,505 4 2,081 (1,741) - 48,845 Income taxes 3,365 16,646 (689) - 19,322 -------- ------- --------- ----------- -------- Net income (loss) $5,140 $25,435 $(1,052) $ - $29,523 ======= ======= ========== ========== =======
59 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued):
Consolidating Statement of Income For the fiscal year ended January 3, 1999 Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Revenues: Restaurant sales $162,390 $192,127 $15,584 $370,101 Franchise related income 8,284 - - 8,284 Real estate and other 3,070 863 (531) 3,402 Intercompany charges - 21,176 - ($21,176) - --------- ------------ -------- --------- ---------- Total revenues 173,744 214,166 15,053 (21,176) 381,787 --------- ---------- ------- --------- --------- Costs and expenses: Restaurant operating expenses: Cost of food and paper products 32,279 42,279 4,045 - 78,603 Payroll and other employee benefits 38,192 50,398 4,748 - 93,338 Other operating costs 42,573 55,812 4,542 - 102,927 Depreciation and amortization 9,875 12,239 670 - 22,784 General and administrative 13,548 9,995 456 - 23,999 Provision for unit closings 2,515 - - - 2,515 Terminated transaction costs 986 - - - 986 Litigation settlement and related costs 3,544 - - - 3,544 Loss on land to be sold 1,075 - - - 1,075 Intercompany charges 21,176 - - (21,176) - --------- ---------- ---------- ----------- ------- Total costs and expenses 165,763 170,723 14,461 (21,176) 329,771 --------- ---------- -------- -------- --------- Operating income before minority interest 7,981 43,443 592 - 52,016 Minority interest - - (101) - (101) ----------- ----------- ------- --------- ----- Operating income 7,981 43,443 491 - 51,915 -------- ------- ------- --------- -------- Other (expense) income: Interest expense - - - - - Interest income 5,120 - - - 5,120 Equity in net loss of unconsolidated affiliates (296) - - - (296) --------- ------------ ----------- ------------- ----------- Net other income 4,824 - - - 4,824 ------- ------------ ----------- ------------- -------- Income before income taxes and cumulative effect of change in method of accounting for start-up costs 12,805 43,443 491 - 56,739 Income taxes (benefit) 4,813 16,509 225 - 21,547 ---------- --------- --------- -------- -------- Income before cumulative change of change in accounting method 7,992 26,934 266 - 35,192 Cumulative change in method of accounting for start-up costs, net of income taxes of $504 (682) - (176) - (858) ----------- ----------- ----------- ---------- ----------- Net income $7,310 $26,934 $90 $ - $34,334 ======== ======= =========== ========= ========
60 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Statement of Cash Flows For the fiscal year ended December 31, 2000
Guarantor Nonguarantor Consolidated Operating activities: Parent Subsidiaries Subsidiaries Eliminations Total Net income (loss) ($7,613) $34,403 $(1,345) $ - $25,445 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 17,324 12,131 1,034 - 30,489 Increase in deferred rent, net 180 - - - 180 Minority interest - - 46 - 46 Equity in income of unconsolidated affiliates (303) - - - (303) Dividends received from unconsolidated affiliates 156 - - - 156 Changes in operating assets and liabilities: Decrease(increase)in receivables 248 (354) (26) - (132) Decrease (increase) in inventories 134 201 (149) - 186 Decrease (increase)in prepaid expenses 1,177 (513) 34 - 698 (Increase) decrease in other assets (9,441) 242 2,443 7,060 304 (Increase) decrease in accounts (Decrease) increase in accounts payable and accrued expenses (3,912) (438) 1,270 - (3,080) (Decrease) increase in income taxes payable (985) 180 73 - (732) --------- --------- ------- ----------- ------- Net cash (used in) provided by operating activities before change in accrued interest payable and effect of conversion to Subchapter S status(3,035) 45,852 3,380 7,060 53,257 Change in deferred taxes due to Subchapter S conversion (5,629) - - - (5,629) Increase in accrued interest payable 701 - - - 701 --------- ---------- --------- --------- -------- Net cash (used in) provided by operating activities (7,963) 45,852 3,380 7,060 48,329 Investing activities: Purchases of property and equipment (7,628) (12,740) (10,825) - (31,193) Proceeds from disposition of property and equipment 35 - - - 35 --------- ------------- ------------- ------------- --------- Net cash used in investing activities (7,593) (12,740) (10,825) - (31,158) ------- -------- -------- ------------- --------
61 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Statement of Cash Flows For the fiscal year ended December 31, 2000
Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Financing activities: Proceeds from mortgage - 16,000 - - 16,000 Mortgage principal repayments - (81) - - (81) Cost of mortgage - (397) - - (397) Loan to officer (2,000) - - - (2,000) Distributions to shareholders (22,128) - - - (22,128) Intercompany balances 48,793 (48,793) 7,060 (7,060) - --------- -------- -------- -------- ------------ Net cash (used in) provided by financing activities 24,665 (33,271) 7,060 (7,060) (8,606) ----------- --------- -------- ------- ------- Increase (decrease) in cash and cash equivalents 9,109 (159) (385) - 8,565 Cash and cash equivalents at beginning of year 27,853 4,391 1,510 - 33,754 --------- ------- ------- ------- -------- Cash and cash equivalents at end of year $36,962 $4,232 $1,125 $ - $42,319 ======== ======== ======= ======== ========= Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $3,240 $676 $33 $ - $3,949 ====== ==== === ====== ====== Cash paid during the period for interest $27,152 $999 $ - $ - $28,151 ======= ==== ====== ====== =======
62 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Statement of Cash Flows For the fiscal year ended January 2, 2000
Guarantor Nonguarantor Consolidated Operating activities: Parent Subsidiaries Subsidiaries Eliminations Total Net income (loss) $5,140 $25,435 $(1,052) $29,523 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 13,017 12,269 802 26,088 Increase in deferred income taxes 710 - - 710 Decrease in deferred rent, net (107) - - (107) Provision for unit closings 1,013 - - 1,013 Minority interest - - (266) (266) Equity in income of unconsolidated affiliates (423) - - (423) Changes in operating assets and liabilities: (Increase) decrease in receivables 772 (11) 9 770 (Increase) decrease in inventories (247) (309) 2 (554) (Increase) decrease in prepaid expenses (413) 73 (68) (408) (Increase) decrease in other assets (6,629) (17) 333 $3,415 (2,898) Increase (decrease) in accounts payable and accrued expenses 2,967 (594) 389 - 2,762 (Decrease) increase in income taxes payable (1,264) (92) (52) - (1,408) --------- ------------ ----------- -------- --------- Net cash provided by operating activities before change in accrued interest payable 14,536 36,754 97 3,415 54,802 Increase in accrued interest payable 7,480 - - - 7,480 ----- - - - ----- Net cash provided by operating activities 22,016 36,754 97 3,415 62,282 ------ ------ -- ----- ----- Investing activities: Purchases of property and equipment (8,877) (13,750) (2,655) - (25,282) Proceeds from disposition of property and equipment 55 - - - 55 --------- ------------- ------------- ------------- ----------- Net cash used in investing activities (8,822) (13,750) (2,655) - (25,227) --------- -------- ------- ------------- --------
63 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Statement of Cash Flows For the fiscal year ended January 2, 2000
Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Financing activities: Proceeds from long-term debt 251,211 - - - 251,211 Cost of merger and related financing (411,000) - - - (411,000) Accrued and previously paid Merger costs 1,007 - - - 1,007 Proceeds from exercise of stock options 426 - - - 426 Intercompany balances 24 ,880 (24,880) 3,415 (3,415) - ----------- -------- -------- --------- ----------- Net cash used in financing activities (133,476) (24,880) 3,415 (3,415) (158,356) ------------ ----------- ------- -------- --------- (Decrease) increase in cash and cash equivalents (120,282) (1,876) 857 - (121,301) Cash and cash equivalents at beginning of year 148,134 6,268 653 - 155,055 ----------- ------ ---- ---------- -------------- Cash and cash equivalents at end of period $27,852 $4,392 $1,510 $ - $33,754 ========= ======== ====== =========== ========= Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $17,540 $2,544 $45 $ - $20,129 ======= ====== === ====== ======= Cash paid during the period for interest $30 $ - $ - $ - $30 === ====== ====== ====== ===
64 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Statement of Cash Flows For the fiscal year ended January 3, 1999
Guarantor Nonguarantor Consolidated Operating activities: Parent Subsidiaries Subsidiaries Eliminations Total Net income $7,310 $26,934 $90 $ - $34,334 Adjustments to reconcile net income to net cash provided by operating activities: Cumulative effect of change in method of accounting for start-up costs 682 - 176 - 858 Depreciation and amortization 10,105 12,007 672 - 22,784 (Decrease) in deferred income taxes (2,078) - - - (2,078) Increase in deferred rent, net 214 - - - 214 Provision for unit closings 2,515 - - - 2,515 Loss on land to be sold 1,075 - - - 1,075 Minority interest - - 101 - 101 Equity in loss of unconsolidated affiliates 296 - - - 296 Dividends received from unconsolidated affiliates 75 - - - 75 Changes in operating assets and liabilities: (Increase) decrease in receivables (1,160) (5) 18 (1,147) Increase in inventories (67) (74) (22) - (163) Decrease (increase) in prepaid expenses 480 (40) 48 - 488 Increase (decrease) in other assets (1,503) (480) 33 1,015 (935) Increase (decrease) in accounts payable and accrued expenses 1,330 (474) 557 - 1,413 Decrease in income taxes payable (615) (16) - - (631) --------- ------------ ----------- -------- ---------- Net cash provided by operating activities 18,659 37,852 1,673 1,015 59,199 -------- ---------- --------- ------- --------- Investing activities: Purchases of property and equipment (14,882) (10,959) (2,372) - (28,213) Proceeds from disposition of property and equipment 52 - - - 52 Proceeds from maturities of marketable securities 7,500 - - - 7,500 -------- ---------- ---------- ---------- ------- Net cash used in investing activities (7,330) (10,959) (2,372) - (20,661) ---------- -------- ------- ---------- --------
65 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. Guarantor and non-guarantor financial statements (continued): Consolidating Statement of Cash Flows For the fiscal year ended January 3, 1999
Guarantor Nonguarantor Consolidated Parent Subsidiaries Subsidiaries Eliminations Total Financing activities: Proceeds from exercise of stock options 2,144 - - - 2,144 Distribution to shareholders (5,521) - - - (5,521) Intercompany balances 25,116 (25,116) 1,015 (1,015) - ---------- -------- ------- ---------- ----------- Net cash used in financing activities 21,739 (25,116) 1,015 (1,015) (3,377) -------- ----------- ------- --------- --------- Increase in cash and cash equivalents 33,068 1,777 316 - 35,161 Cash and cash equivalents at beginning of year 115,066 4,491 337 - 119,894 --------- ------- ---- -------- -------------- Cash and cash equivalents at end of year $148,134 $6,268 $653 $ - $155,055 ======== ======= ===== ======== ========= Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $22,855 $1,750 $12 $ - $24,617 ======= ====== === ===== ======= Cash paid during the period for interest $ - $ - $ - $ - $ - ====== ====== ====== ====== ============
66 ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The directors and executive officers of the Company and their ages at March 15, 2001 are: Name Age Position Mario Sbarro 59 Chairman of the Board, President, Chief Executive Officer and Director Anthony Sbarro 54 Vice Chairman of the Board, Treasurer and Director Joseph Sbarro 60 Senior Executive Vice President, Secretary and Director Carmela Sbarro 79 Vice President and Director Anthony J. Missano 42 President -- Quick Service Division and Corporate Vice President Gennaro A. Sbarro 34 President-- Franchising and Licensing Division and Corporate Vice President Gennaro J. Sbarro 38 President -- Casual and Fine Dining Division and Corporate Vice President Robert G. Rooney 43 Senior Vice President and Chief Financial Officer Carmela N. Merendino 36 Vice President-- Administration Joseph A. Fallarino 48 Vice President-- Human Resources Henry G. Ciocca 54 Vice President and General Counsel John Bernabeo 44 Vice President-- Architecture and Engineering Donald A. Dziomba 52 Vice President-- Management Information Services Steven B. Graham 47 Vice President and Controller J. Peter Brown 49 Vice President-- Franchise Development Harold L. Kestenbaum 51 Director Richard A. Mandell 58 Director Terry Vince 72 Director Bernard Zimmerman 68 Director MARIO SBARRO has been an officer, a director and a principal shareholder of Sbarro since its organization in 1977, serving as Chairman of our board of directors and Chief Executive Officer for more than the past five years. Mr. Sbarro re-assumed the position as our President in May 1996 (a position he held for more than five years prior to December 1993). 67 ANTHONY SBARRO has been an officer, a director and a principal shareholder of Sbarro since its organization in 1977, serving as Vice Chairman of our board of directors since May 1996 and as President and Chief Operating Officer from December 1993 through May 1996. For more than five years prior to December 1993, Mr. Sbarro was an Executive Vice President. He has also served as our Treasurer for more than the past five years. JOSEPH SBARRO has been an officer, a director and a principal shareholder of Sbarro since its organization in 1977, serving as Senior Executive Vice President since December 1993. For more than five years prior thereto, Mr. Sbarro was an Executive Vice President. He has also served as our Secretary for more than the past five years. CARMELA SBARRO has been one of our Vice Presidents since March 1985. Mrs. Sbarro was a founder of Sbarro, together with her late husband, Gennaro Sbarro. Mrs. Sbarro devotes a substantial portion of her time to recipe and product development. Our board of directors elected Mrs. Sbarro as a director in January 1998. Mrs. Sbarro previously served as a director from March 1985 until December 1988, when she was elected director emeritus. ANTHONY J. MISSANO has been a Corporate Vice President since August 1996 and was elected President of our Quick Service Division in January 2000. From February 1995 until August 1996, he served as Vice President -- Operations (West), and from June 1992 until February 1995 he served as a Zone Vice President. GENNARO A. SBARRO has been a Corporate Vice President since August 1996 and was elected President of our Franchising and Licensing Division in January 2000. From February 1995 until August 1996 he served as Vice President -- Franchising, and for more than five years prior thereto Mr. Sbarro served in various capacities for us. GENNARO J. SBARRO has been a Corporate Vice President since August 1996 and was elected President of our Casual and Fine Dining Division in January 2000. From February 1995 until August 1996, he served as Vice President -- Operations (East), and from June 1992 until February 1995 he served as a Zone Vice President. ROBERT G. ROONEY was elected Senior Vice President and Chief Financial Officer in January 2000. From June 1999, when he joined us, until January 2000, Mr. Rooney served as Vice President-- Finance and Chief Financial Officer. From December 1996 until he joined us, Mr. Rooney was employed by Discovery Zone, Inc. (a national family entertainment center chain), serving as Senior Vice President, Chief Financial and Administrative Officer since February 1997. From March 1994 until September 1996, Mr. Rooney served as Senior Vice President and Chief Financial Officer of Victory Capital LLC (formerly Forschner Enterprises, Inc.), a venture capital firm, and, from September 1992 to February 1994, served as a director and consultant on behalf of various investors and investment funds affiliated with Forschner Enterprises, Inc. Discovery Zone, Inc., which had filed under Chapter 11 of the United States Bankruptcy Code prior to Mr. Rooney's joining that company, again filed under that law on April 20, 1999. Mr. Rooney has been a certified public accountant in New York for over 20 years. 68 CARMELA N. MERENDINO was elected Vice President-- Administration in October 1988. Ms. Merendino joined us in March 1985 and performed a variety of corporate administrative functions for us prior to her election as Vice President-- Administration. JOSEPH A. FALLARINO joined Sbarro in September 1998 and was elected Vice President -- Human Resources in November 1998. Prior to joining us, from April 1998 until September 1998, Mr. Fallarino served as Director of Human Resources of Ogden Corporation, an international diversified service corporation; from March 1996 until March 1998, he served as Senior Vice President -- Human Resources of Arbor Management LLC, a provider of financial services and healthcare services; and from January 1994 until February 1996, he served as Vice President -- Human Resources of AMS Corporation, a national outsourcing company. HENRY G. CIOCCA joined Sbarro in January 2000 and serves as Vice President and General Counsel. From August 1997 to April 1999, Mr. Ciocca was an advisor to the President of The Thomson Corporation, a worldwide information and publishing company. From September 1995 to June 1997, Mr. Ciocca was President, Chief Executive Officer and a Director of Markborough Properties, Inc., a publicly-traded commercial real estate company headquartered in Toronto; from June 1993 to August 1995, Mr. Ciocca was President and Chief Executive Officer of Markborough Development, a division of The Thomson Corporation that developed master planned communities in the United States; and from June 1987 to June 1993, Mr. Ciocca held various positions with The Thomson Corporation, including Executive Vice President and General Counsel. Mr. Ciocca is admitted to practice law in Connecticut, Florida and New York. JOHN BERNABEO joined Sbarro in August 1992 and served in various capacities prior to his election as Vice President -- Architecture and Engineering in May 1997. DONALD A. DZIOMBA was elected Vice President - Management Information Services in January 2000. Mr. Dziomba had served as our Director of Management Information Systems since joining Sbarro in November 1993. STEVEN B. GRAHAM was elected Vice President and Controller in January 2000. Mr. Graham has served as our Controller since joining Sbarro in April 1994. Mr. Graham has been a certified public accountant in New York for over 20 years. J. PETER BROWN jointed Sbarro in May 2000 as Vice President - Franchise Development From May 1996 until joining us, Mr. Brown served as Vice President of Business Development of Arby's Inc. (dba Triarc Restaurant Group), a subsidiary of Triarc Companies, Inc., a branded consumer products company in beverages and restaurant franchising. From July 1993 through April 1996 he served as Vice President Asset Development with Scott's Food Services, a subsidiary of Scott's Hospitality Inc., a food service and retail corporation. 69 HAROLD L. KESTENBAUM has been a practicing attorney in New York since 1976. He became a director of Sbarro in March 1985. Mr. Kestenbaum is also a director of Extravnet.com, Inc. RICHARD A. MANDELL, a private investor and financial consultant, was a Managing Director of BlueStone Capital Partners, L.P., an investment banking firm, from February until April 1998 and Vice President -- Private Investments of Clariden Asset Management (NY) Inc., a subsidiary of Clariden Bank, a private Swiss bank, from January 1996 until February 1998. From 1982 until June 1995, Mr. Mandell served as a Managing Director of Prudential Securities Incorporated, an investment banking firm. He became a director of Sbarro in March 1986. Mr. Mendel is also a director of Trend-Lines, Inc., U.S.A. Detergents, Inc. and Shells Seafood Restaurants, Inc. TERRY VINCE has been Chairman of the Board and President of Sovereign Hotels, Inc. a company that owns and manages hotels, since October 1991 and Chairman of the Board of Fame Corp., a food service management company, since January 1994. Mr. Vince became a director of Sbarro in December 1988. BERNARD ZIMMERMAN has been President of Bernard Zimmerman & Co., Inc. since October 1972 and was Senior Vice President of The Zimmerman Group, Inc. from January 1991 to November 1996, two financial and management consulting firms. Mr. Zimmerman also served as President and a director of Beacon Hill Management, Inc., an advisor to Beacon Hill Mutual Fund, Inc., from December 1994 until October 1996. From September 1986 until September 1993, Mr. Zimmerman also served as Chairman and President of St. Lawrence Seaway Corp., an owner and manager of agricultural properties. Mr. Zimmerman has been a certified public accountant in New York for more than the past thirty-five years. He became a director of Sbarro in March 1985. Our by-laws provide that the minimum number of directors that can constitute our board is six and the maximum number of directors that can constitute our board is twelve. Our officers are elected annually by the board of directors at its meeting held immediately after the annual meeting of our shareholders, and hold their respective offices until their successors are duly elected and qualified. Officers may be removed at any time by the board. Mario, Anthony and Joseph Sbarro are the sons of Carmela Sbarro. Carmela N. Merendino is the daughter, and Gennaro A. Sbarro is the son, of Mario Sbarro. Gennaro J. Sbarro is the son, and Anthony J. Missano is the son-in-law, of Joseph Sbarro. During fiscal 2000, the Company's officers, directors and shareholders were not required to file reports under Section 16(a) of the Securities Exchange Act of 1934. 70 ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table The following table sets forth information concerning the annual and long-term compensation of our chief executive officer and other five most highly compensated persons who were serving as executive officers at the end of our 2000 fiscal year for services in all capacities to us and our subsidiaries during our 2000, 1999 and 1998 fiscal years.
Annual Name and Compensation Other Principal Position Year Salary Bonus Compensation Mario Sbarro.......................................... 2000 $700,000 $ 300,000 -- Chairman of the Board, President and 1999 700,000 300,000 $2,221,987(1) Chief Executive Officer 1998 713,462 300,000 -- Anthony Sbarro........................................ 2000 300,000 200,000 -- Vice Chairman of the Board and Treasurer 1999 300,000 200,000 $1,145,242(1) 1998 305,769 200,000 -- Joseph Sbarro......................................... 2000 300,000 200,000 -- Senior Executive Vice President and 1999 300,000 200,000 $1,323,743(1) Secretary 1998 305,769 200,000 -- Anthony J. Missano.................................... 2000 200,000 150,000 -- President-- Quick Service Division 1999 200,000 150,000 $348,000(1) 1998 203,846 100,000 -- Gennaro A. Sbarro..................................... 2000 200,000 150,000 -- President-- and Licensing Division 1999 200,000 150,000 $389,168(1) 1998 203,846 100,000 -- Gennaro J. Sbarro..................................... 2000 200,000 150,000 -- President-- Casual and Fine Dining Division 1999 200,000 150,000 $348,000(1) 1998 203,846 100,000 --
-------------------- (1) All of the options held by each executive officer named in the Summary Compensation Table were terminated in the going private transaction in exchange for a cash payment equal to the number of shares subject to the options multiplied by the excess of $28.85 over the applicable option exercise price. All option plans were terminated upon the completion of the going private transaction. 71 Options/SAR Grants in Last Fiscal year. We did not grant any options to purchase our securities or any stock appreciation rights during fiscal 2000. Aggregated Option Exercises in Last Fiscal Year and Year End Values No options were exercised during fiscal 2000 and no options were outstanding at the end of fiscal 2000. Compensation of Directors Our non-employee directors currently receive a retainer at the rate of $16,000 per annum, $1,000 for each meeting of the Board attended and $500 for each meeting attended of a committee of the board on which they serve if the meeting is not held on the same day as a meeting of the board. Members of the board also are reimbursed for reasonable travel expenses incurred in attending board and committee meetings. Bernard Zimmerman & Company, Inc., of which Bernard Zimmerman is President and a majority shareholder, renders financial and consulting assistance to us, for which it received fees of $340,400 for services rendered during our 2000 fiscal year. Compensation Committee Interlocks and Insider Participation in Compensation Decisions Our board of directors does not presently have a Compensation Committee. Decisions regarding the compensation of executive officers are being made by our entire board. Accordingly, Mario Sbarro, Anthony Sbarro and Joseph Sbarro, executive officers and directors, as well as Bernard Zimmerman, a director and a consultant to us, may participate in deliberations of our board concerning executive officer compensation. See Item 13, "Certain Relationships and Related Transactions" in this report, for information concerning related party transactions. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information regarding the ownership of shares of our common stock as of March 15, 2000 with respect to (1) holders known to us to beneficially own more than five percent of our outstanding common stock, (2) each of our directors, (3) our Chief Executive Officer and our five next most highly compensated executive officers and (4) all of our directors and executive officers as a group. We understand that, except as noted below, each beneficial owner has sole voting and investment power with respect to all shares attributable to such owner. 72 Shares Beneficially Owned Beneficial Owner Number Percent ---------------- ------ ------- Mario Sbarro(1)............................ 1,524,730(2) 21.6% Anthony Sbarro(1).......................... 1,233,800 17.5% Joseph Sbarro(1)........................... 1,756,022(3) 25.6% Trust of Carmela Sbarro(1)................. 2,497,884(4) 35.3% Harold L. Kestenbaum....................... -- -- Richard A. Mandell......................... -- -- Terry Vince................................ -- -- Bernard Zimmerman.......................... -- -- Anthony J. Missano......................... 25,946(5) 0.4% Gennaro A. Sbarro.......................... -- -- Gennaro J. Sbarro.......................... 25,946 0.4% All directors and executive officers as a group (18 persons).................. 7,064,328 100.0% (1) The business address of each of Mario Sbarro, Joseph Sbarro, Anthony Sbarro and the Trust of Carmela Sbarro is 401 Broadhollow Road, Melville, New York 11747. (2) Excludes the 2,497,884 shares held by the Trust of Carmela Sbarro, of which trust Mario Sbarro serves as a co-trustee and as to which shares Mr. Sbarro may be deemed a beneficial owner with shared voting and dispositive power. (3) Excludes 25,946 shares beneficially owned by each of Mr. Sbarro's son, Gennaro J. Sbarro, reflected below, and daughter. Mr. Sbarro's daughter is the wife of Anthony J. Missano. (4) The trust was created by Carmela Sbarro for her benefit and for the benefit of her descendants, including Mario, Joseph and Anthony Sbarro. The trustees of the trust are Franklin Montgomery, whose business address is 90 Broad Street, 19th Floor, New York, New York 10274, and Mario Sbarro. As trustees, Franklin Montgomery and Mario Sbarro may be deemed to be the beneficial owners of these shares with shared voting and dispositive power. (5) Represents shares owned by Mr. Missano's wife. Mr. Missano disclaims beneficial ownership of these shares. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the caption "Compensation Committee Interlocks and Insider Participation in Compensation Decisions" in Item 11, "Executive Compensation", in this report for information concerning the participation of Mssrs. Mario Sbarro, Anthony Sbarro, Joseph Sbarro and Bernard Zimmerman in executive compensation determinations. 73 We are the sole tenant of an administrative office building, which is leased from Sbarro Enterprises, L.P. The annual rent payable pursuant to the sublease is $0.3 million each year for the remainder of the lease term, which expires in 2011. In addition, we are obligated to pay real estate taxes, utilities, insurance and certain other expenses for the facility. We believe that our rent is comparable to the rent that would be charged by an unaffiliated third party. The limited partners of Sbarro Enterprises, L.P. are Mario, Joseph, Anthony and Carmela Sbarro. We, our subsidiaries and the joint ventures in which we have an interest have purchased printing services from a corporation owned by a son-in-law of Mario Sbarro for which they paid, in the aggregate, $547,480 during fiscal 2000. We believe that these services were provided on terms comparable to those that would have been available from unrelated third parties. During fiscal 2000, we paid cash dividends to our shareholders totaling $22.1 million including $3.8 million of distributions made pursuant to the Tax Agreement described below. On April 4, 2000, we loaned $2.0 million to Mario Sbarro, our Chairman, President and Chief Executive Officer, under a note that is payable on April 4, 2002. The note bears interest at the rate of 6.46%, payable annually. We believe that the loan is on terms that are no less favorable to us than would have been obtained in a comparable transaction by us with an unrelated person. On January 2 and 3, 2001, we loaned $200,000 to Mario Sbarro, $300,000 to Joseph Sbarro and $200,000 to Anthony Sbarro which loans were repaid on January 15, 2001 with interest at the prime rate in effect from time to time at European American Bank. Companies owned by a son of Anthony Sbarro and a company owned by the daughter of Joseph Sbarro paid royalties to us under franchise agreements containing terms similar to those in agreements entered into by us with unrelated franchisees. Royalties paid to us aggregated $18,624 and $108,741, respectively, during fiscal 2000. Bernard Zimmerman & Company, Inc., of which Bernard Zimmerman is President and a majority shareholder, renders financial and consulting assistance to us, for which it received fees of $340,400 for services during our 2000 fiscal year. In addition to the compensation of Mario, Anthony, Joseph, Gennaro A. and Gennaro J. Sbarro and Anthony J. Missano: o Carmela Sbarro, the mother of Mario, Anthony and Joseph Sbarro, who was a co-founder of Sbarro and serves as Vice President and a director, received $100,000 from us for services rendered during fiscal 2000; and o Carmela N. Merendino, a daughter of Mario Sbarro, who serves as Vice President -- Administration, received $207,924 from us for services rendered during fiscal 2000. 74 In addition, other members of the immediate families of Mario, Anthony, Joseph and Carmela Sbarro, who are our employees, earned an aggregate of $809,585 during fiscal 2000. Tax Agreement We have elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code of 1986, and, where applicable and permitted, under similar state and local income tax provisions, beginning in fiscal 2000. With certain limited exceptions, we do not pay federal and state and local income taxes for periods for which we are treated as an S corporation. Rather, our shareholders do include their pro-rata share of our taxable income on their individual income tax returns and thus are required to pay taxes with respect to their respective shares of our taxable income, whether or not it is distributed to them. We have entered into a tax payment agreement with our shareholders. The tax payment agreement permits us to make periodic tax distributions to our shareholders in amounts that are intended to approximate the income taxes, including estimated taxes, that would be payable by our shareholders if their only income were their pro-rata shares of our taxable income and that income was taxed at the highest applicable federal and New York State marginal income tax rates. We may only make the tax distributions with respect to periods in which we are treated as an S corporation. We made distributions of $3.8 million in fiscal 2000 and $3.6 million in January 2001 and we expect to make additional distributions in fiscal 2001 of approximately $4.0 million for fiscal 2000 earnings. The tax payment agreement provides for adjustments of the amount of tax distributions previously paid in respect of a year upon the filing of our federal income tax return for that year, upon the filing of an amended federal income tax return or as a result of an audit. In these circumstances, if it is determined that the amount of tax distributions previously made for the year was less than the amount computed based upon our federal income tax return, our amended federal return or as adjusted based on the results of the audit, we may make additional tax distributions which might include amounts to cover any interest or penalties. Conversely, if it is determined in these circumstances that the amount of tax distributions previously made for a year exceeded the amount computed based on our federal income tax return, our amended federal return or the results of an audit, as the case may be, our shareholders will be required to repay the excess, with, in certain circumstances, interest. In addition, our shareholders will be required to return, with interest, any tax distributions previously distributed with respect to any taxable year for which it is subsequently determined that we were not an S corporation. 75 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Consolidated Financial Statements The following consolidated financial statements of Sbarro, Inc. and the Report of Independent Auditors thereon are included in Item 8 above: Page Report of Independent Public Accountants 28 Consolidated Balance Sheets at December 31, 2000 and January 2, 2000 29 - 30 Consolidated Statements of Income for each of the fiscal years in the three-year period ended December 31, 2000 31 Consolidated Statements of Shareholders' Equity for each of the fiscal years in the three-year period ended December 31, 2000 32 Consolidated Statements of Cash Flows for each of the fiscal years in the three-year period ended December 31, 2000 33 - 34 Notes to Consolidated Financial Statements 35 - 66 (a) (2) Financial Statement Schedules The following financial statement schedule is filed as a part of this Report on Page S-2: Schedule II - Valuation and Qualifying Accounts for the three fiscal years ended December 31, 2000. All other schedules called for by Form 10-K are omitted because they are inapplicable or the required information is shown in the financial statements, or notes thereto, included herein. (a) (3) Exhibits Exhibits incorporated herein by reference are identified with an * or include a management contract or compensatory plan or arrangement are identified with an "+". 76 Exhibits: -------- *2.01 Agreement and Plan of Merger dated as of January 19, 1999 among the Company, Sbarro Merger LLC, a New York limited liability company, Mario Sbarro, Joseph Sbarro, Joseph Sbarro (1994) Family Limited Partnership, Anthony Sbarro, and Mario Sbarro and Franklin Montgomery, not individually but as trustees under that certain Trust Agreement dated April 28, 1984 for the benefit of Carmela Sbarro and her descendants. (Exhibit 2 to the Company Current Report on Form 8-K dated (date of earliest event reported) January 19, 1999, File No. 1-8881) * 3.01(a) Restated Certificate of Incorporation of the Company as filed with the Department of State of the State of New York on March 29, 1985. (Exhibit 3.01 to the Company's Registration Statement on Form S-1, File No. 2-96807) * 3.01(b) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on April 3, 1989. (Exhibit 3.01(b) to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1-8881) * 3.01(c) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on May 31, 1989. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 23, 1989, File No. 1-8881) * 3.01(d) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on June 1, 1990. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 22, 1990, File No. 1-8881) * 3.02 By-Laws of the Company, as amended. (Exhibit 3.1 to the Company's Registration Statement on Form S-4, File No. 333-90817) *4.01 Indenture dated as of September, 28, 1999 among the Company, the Restricted Subsidiaries of the Company named therein, as guarantors, and Firstar Bank, N.A., including the form of 11% Senior Notes of the Company to be issued upon consummation of the Exchange Offer and the form of Senior Guarantees of the Guarantors. (Exhibit 4.1 to the Company's Current Report on Form 8-K dated (date of earliest event reported) September 23, 1999, File No. 1-8881) *4.02 Credit Agreement dated as of September 23, 1999 among the Company, European American Bank, as agent, and the Lenders party thereto (Exhibit 4.2 to the Company's Current Report on Form 8-K dated (date of earliest event reported) September 23, 1999, File No. 1-8881) 77 *10.01(a) Commack, New York Corporate Headquarters Sublease. (Exhibit 10.04 to the Company's Registration Statement on Form S-1, File No. 2-96807) 10.01(b) Amendment dated May 4, 2000 to the Company's Commack, New York Corporate Headquarters Sublease + 10.02 Form of Indemnification Agreement between the Company and each of its directors and officers. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 1-8881) *10.03 Registration Rights Agreement dated as of September 28, 1999 among the Company, the Guarantors named therein and Bear, Stearns & Co. Inc. (Exhibit 10.1 to the Company's Current Report on Form 8-K dated (date of earliest event reported) September 23, 1999, File No. 1-8881) *10.04 Tax Payment Agreement dated as of September 28, 1999 among the Company, Mario Sbarro, Joseph Sbarro, Joseph Sbarro (1994) Family Limited Partnership, Anthony Sbarro, and Mario Sbarro and Franklin Montgomery, not individually but as Trustees under that certain Trust Agreement dated April 28, 1984 for the benefit of Carmela Sbarro and her descendants (Exhibit 10.6 to the Company's Registration Statement on Form S-4, File No. 333-90817) 12.01 Statement of computation of earnings to fixed charges *21.01 List of subsidiaries.(Exhibit 21.01 to the Company's Annual Report on Form 10-K for the year ended January 2, 2000, File No. 333-90817) ----------------------------- * Incorporated by reference to the document indicated. + Management contract or compensatory plan. (b) Reports on Form 8-K No Reports on form 8-K were filed by us during the fourth quarter of our fiscal year ended December 31, 2000. 78 UNDERTAKING We hereby undertake to furnish to the Securities and Exchange Commission, upon request, all constituent instruments defining the rights of holders of long-term debt of our us and our consolidated subsidiaries not filed with this Report. Those instruments have not been filed since none are, nor are being, registered under Section 12 of the Securities Exchange Act of 1934 and the total amount of securities authorized under any of those instruments does not exceed 10% of the total assets of us and our subsidiaries on a consolidated basis. 79 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 29, 2001. SBARRO, INC. By: /s/ MARIO SBARRO ----------------------------------- Mario Sbarro, Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/ MARIO SBARRO Chairman of the Board March 29, 2001 ----------------------------- Mario Sbarro (Principal Executive Officer) and Director /s/ ROBERT G. ROONE Senior Vice President and March 29, 2001 ------------------------------ Robert G. Rooney Chief Financial Officer (Principal Financial Officer) /s/ JOSEPH SBARRO Director March 29, 2001 --------------------------- Joseph Sbarro /s/ ANTHONY SBARRO Director March 29, 2001 ---------------------------- Anthony Sbarro 80 Signature Title Date /s/ STEVEN B. GRA Vice President and March 29, 2001 ------------------------------ Steven B. Graham Controller (Principal Accounting Officer) /s/ HAROLD L. KESTENBAU Director March 29, 2001 --------------------------------- Harold L. Kestenbaum /s/ RICHARD A. MANDELL Director March 29, 2001 --------------------------------- Richard A. Mandell /s/ CARMELA SBARRO Director March 29 2001 ------------------------------- Carmela Sbarro /s/ TERRY VINCE Director March 29, 2001 ------------------------------ Terry Vince /s/ BERNARD ZIMMERMAN Director March 29, 2001 ------------------------------ Bernard Zimmerman 81 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE To Sbarro, Inc.: We have audited, in accordance with auditing standards generally accepted in the United States, the consolidated financial statements of Sbarro, Inc. and subsidiaries included in this filing and have issued our report thereon dated March 29, 2001. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying schedule is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP New York, New York March 29, 2001 S-1 SCHEDULE II SBARRO, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (In thousands)
FOR THE THREE YEARS ENDED COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E ------ - -------- -------------- -------- -------- ADDITIONS Balance Charged Charged to at to Other Balance at Beginning Costs and Accounts Deductions End of Description of Period Expenses Describe Describe Period ----------- --------- -------- --------- --------------- ------ December 31, 2000 Allowance for doubtful ($120)(1) accounts receivable $419 60 (2) ($148)(2) $211 ==== ====== ====== ==== January 2, 2000: Allowance for doubtful accounts receivable $38 $381 $419 === ==== ==== January 3, 1999: Allowance for doubtful accounts receivable $38 $38 === ===
(1) Collection of previously reserved receivables (2) Write off of uncollectible accounts S-2 EXHIBIT INDEX Exhibit Number Description *2.01 Agreement and Plan of Merger dated as of January 19, 1999 among the Company, Sbarro Merger LLC, a New York limited liability company, Mario Sbarro, Joseph Sbarro, Joseph Sbarro (1994) Family Limited Partnership, Anthony Sbarro, and Mario Sbarro and Franklin Montgomery, not individually but as trustees under that certain Trust Agreement dated April 28, 1984 for the benefit of Carmela Sbarro and her descendants. (Exhibit 2 to the Company Current Report on Form 8-K dated (date of earliest event reported) January 19, 1999, File No. 1-8881) *3.01(a) Restated Certificate of Incorporation of the Company as filed with the Department of State of the State of New York on March 29, 1985. (Exhibit 3.01 to the Company's Registration Statement on Form S-1, File No. 2-96807) * 3.01(b) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on April 3, 1989. (Exhibit 3.01(b) to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1-8881) *3.01(c) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on May 31, 1989. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 23, 1989, File No. 1-8881) *3.01(d) Certificate of Amendment to the Company's Restated Certificate of Incorporation as filed with the Department of State of the State of New York on June 1, 1990. (Exhibit 4.01 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 22, 1990, File No. 1-8881) * 3.02 By-Laws of the Company, as amended. (Exhibit 3.1 to the Company's Registration Statement on Form S-4, File No. 333-90817) *4.01 Indenture dated as of September, 28, 1999 among the Company, the Restricted Subsidiaries of the Company named therein, as guarantors, and Firstar Bank, N.A., including the form of 11% Senior Notes of the Company to be issued upon consummation of the Exchange Offer and the form of Senior Guarantees of the Guarantors. (Exhibit 4.1 to the Company's Current Report on Form 8-K dated (date of earliest event reported) September 23, 1999, File No. 1-8881) *4.02 Credit Agreement dated as of September 23, 1999 among the Company, European American Bank, as agent, and the Lenders party thereto (Exhibit 4.2 to the Company's Current Report on Form 8-K dated (date of earliest event reported) September 23, 1999, File No. 1-8881) *10.01(a) Commack, New York Corporate Headquarters Sublease. (Exhibit 10.04 to the Company's Registration Statement on Form S-1, File No. 2-96807) 10.01(b) Amendment dated May 4, 2000 to the Company's Commack, New York Corporate Headquarters Sublease + *10.02 Form of Indemnification Agreement between the Company and each of its directors and officers. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 1-8881) *10.03 Registration Rights Agreement dated as of September 28, 1999 among the Company, the Guarantors named therein and Bear, Stearns & Co. Inc. (Exhibit 10.1 to the Company's Current Report on Form 8-K dated (date of earliest event reported) September 23, 1999, File No. 1-8881) *10.04 Tax Payment Agreement dated as of September 28, 1999 among the Company, Mario Sbarro, Joseph Sbarro, Joseph Sbarro (1994) Family Limited Partnership, Anthony Sbarro, and Mario Sbarro and Franklin Montgomery, not individually but as Trustees under that certain Trust Agreement dated April 28, 1984 for the benefit of Carmela Sbarro and her descendants (Exhibit 10.6 to the Company's Registration Statement on Form S-4, File No. 333-90817. 12.01 Statement of computation of earnings to fixed charges *21.01 List of subsidiaries. (Exhibit 21.01 to the Company's Annual Report on Form 10-K for the year ended January 2, 2000, File No. 333-90817) -------------------------- * Incorporated by reference to the document indicated. + Management contract or compensatory plan. EXHIBIT 10.01 (b) FIRST AMENDMENT TO BUILDING LEASE THIS AMENDMENT TO BUILDING LEASE (the "Amendment") dated this 4th day of May, 2000, by and between SBARRO ENTERPRISES, L.P., a Delaware limited partnership, having an address at 401 Broadhollow Road, Melville, New York 11747 ("Landlord"), and SBARRO, INC., a New York corporation, having an address at 401 Broadhollow Road, Melville, New York 11747 ("Tenant"). W I T N E S S E T H : WHEREAS, Landlord and Tenant's predecessor in interest, Sbarro Licensing, Inc., entered into a certain Lease (hereinafter referred to as the "Lease") pursuant to the terms of which Tenant leased from Landlord, subject to the terms and provisions of a Ground Lease, those certain premises in Commack, State of New York, known as 763 Larkfield Road, (said space being designated and more fully described in the Lease and hereinafter referred to as the "Property"); and WHEREAS, Landlord and Tenant desire to amend the Lease as hereinafter provided and to evidence Tenant's Assumption of all the obligation of said Lease. NOW, THEREFORE, Landlord and Tenant agree as follows: 1. Landlord and Tenant wish to confirm and document the original Commencement and Expiration Date under the Lease, as follows: The Commencement Date of the term of the Lease was June 1, 1986 and the Original Term thereunder expires on June 1, 2001. 2. Tenant hereby is electing to exercise the two (2) options to extend the Original Term of the Lease, and Landlord is consenting to same. Each option being for a term of five (5) years each, as granted by Landlord in Section 3.02 of the Lease. 3. Accordingly, the Lease term is hereby extended for an additional ten (10) years and shall now expire on the 1st day of June, 2011. 4. Section 15.01 of the Lease is deleted in favor of the following: Section 15.01(a) Subordination. This lease is subject and subordinate to all ground or underlying leases, if any, and to all mortgages which may now or hereinafter affect such leases or the real property of which demises premises are a part and to all renewals, modifications, consolidations, replacements and extensions of any such underlying leases and mortgages. This clause shall be self-operative and no further instrument of subordination shall be required by any ground or underlying lessor or by any mortgagee, affecting any lease or the real property of which the demised premises are a part. In confirmation of such subordination, Tenant shall execute promptly any certificate that Landlord may request. 5. Section 15.02 of the lease is deleted in favor of the following: Any first mortgage in Section 15.01 to which this lease is subordinate shall contain language, the substance of which provides: (a) that provided Mortgagee approves the assignment of this lease to any third party pursuant to the mortgage, and that third party is not in default under any obligations of this lease as assigned, any mortgagee upon foreclosure shall acquire and accept the premises subject to this lease provided, however, that such third party tenant hereby agrees to attorn to such purchaser upon foreclosure sale of said first mortgage and to recognize such purchaser as Landlord under this lease; and provided further that such purchaser, upon foreclosure sale of said first mortgage, shall not be obligated to accept this lease or the leasehold estate created hereby in the event such third party tenant is in default in the performance of any of the terms and provisions on tenant's part to be kept and performed under this lease (b) that so long as tenant shall not be in default under this lease, tenant shall be entitled to peaceful possession of the premises in accordance with the provisions hereof during the term of this lease, and this lease shall not be adversely affected or extinguished by the exercise of any remedy of the mortgagee or trust under the aforedescribed mortgage. 6. Tenant hereby assumes all of the obligation under the Lease. 7. Except as otherwise expressly modified by the terms of this Amendment, the Lease shall remain unchanged and in full force and effect. 8. This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors, heirs and assigns. IN WITNESS WHEREOF, Landlord and Tenant have executed this First Amendment as o the date first above written. LANDLORD: SBARRO ENTERPRISES, L.P. WITNESS __________________ By:_____________________________ SBARRO OF LARKFIELD, INC. General Partner By: Carmela Merendino, Vice President TENANT: SBARRO, INC. WITNESS: ___________________ By:________________________ Robert Rooney CFO EXHIBIT 12.01 Sbarro, Inc. Computation of Ratio of Earnings to Fixed Charges (Dollars in Thousands)
Fiscal Year 2000 1999 1998 1997 1996 Fixed charges: Interest expense $30,243 $7,899 $0 $0 $0 Rental expense 22,412 21,845 20,552 18,899 17,030 ------ ------ ------ ------ ------ Total fixed charges (1) $52,655 $29,744 $20,552 18,899 17,030 ======= ======= ======= ====== ====== Earnings available for fixed charges: Earnings (2) 20,113 48,156 57,136 58,100 60,466 Add fixed charges 52,655 29,744 20,552 18,899 17,030 ------ ------ ------ ------ ------ Total earnings available for fixed charges $72,768 $77,990 $77,688 76,999 $77,496 ======= ======= ======= ====== ======= Ratio of earnings to Fixed charges (3) 1.4 2.6 3.8 4.1 4.6 === === === === ===
(1) Total fixed charges consist of interest and one-third of rent expense (deemed to be a reasonable approximation of the interest factor). (2) Earnings represents income before income taxes, cumulative effect of change in method of accounting for start-up costs and before minority interest and equity in net income (loss) of unconsolidated affiliates. (3) The ratio of earnings to fixed charges has been computed based on dividing Total earnings available for fixed charges by Total fixed charges.