-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FuQpSCn0WaLU8m8mmK/l/M+xUS5lE+PsrXW+76j724aYz2CsL8T+OnD4uUX6mZ08 LKvrD7lIs0kFjkYsCi4kOA== 0000766004-98-000001.txt : 19980330 0000766004-98-000001.hdr.sgml : 19980330 ACCESSION NUMBER: 0000766004-98-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971228 FILED AS OF DATE: 19980327 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SBARRO INC CENTRAL INDEX KEY: 0000766004 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] IRS NUMBER: 112501939 STATE OF INCORPORATION: NY FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-08881 FILM NUMBER: 98576833 BUSINESS ADDRESS: STREET 1: 763 LARKFIELD RD CITY: COMMACK STATE: NY ZIP: 11725 BUSINESS PHONE: 5168640200 10-K 1 _______________________________________________________________ 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 28, 1997 __ / / 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 1-8881 SBARRO, INC. (Exact name of Registrant as specified in its charter) NEW YORK 11-2501939 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 763 Larkfield Road, Commack, New York 11725 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (5l6) 864-0200 Securities registered pursuant to Section 12(b) of the Act: Name of each Exchange on Title of each class which Registered Common Stock, par value $.01 per share New York Stock Exchange 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 aggregate market value of Common Stock held by non-affiliates of the registrant as of March 20, 1998 was approximately $390,832,000. The number of shares of Common Stock of the registrant outstanding as of March 20, 1998 was 20,517,311. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement to be used in connection with the registrant's 1998 Annual Meeting of Shareholders are incorporated by reference into Part III of this report. SBARRO, INC. PART I 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. The Company has become a leading operator and franchisor of family-style Italian restaurants, with 862 restaurants worldwide. In addition, since 1995, the Company has created, through joint ventures, other concepts for the purpose of developing growth opportunities in addition to its Sbarro restaurants. (See ``New Ventures'', below.) As used in this Report, the terms "Company" and ``Sbarro'' refers to Sbarro, Inc. and its consolidated subsidiaries, unless the context indicates otherwise. ___________________ Recent Developments The Company has received a proposal from Mario Sbarro, Joseph Sbarro, Anthony Sbarro and the Trust of Carmela Sbarro (the ``Sbarro Family'') for the merger of the Company with a company to be owned by the Sbarro Family pursuant to which shareholders of the Company, other than the Sbarro Family, would receive $28.50 per share in cash, or an aggregate of approximately $380 million for the approximately 13.4 million shares (approximately 65% of the outstanding shares) of the Company's Common Stock not owned by the Sbarro Family. The proposal is subject, among other things, to (i) entering into a definitive merger agreement, (ii) approval of the transaction by the special committee of the Board, the full Board of Directors and the Company's shareholders, (iii) receipt of satisfactory financing for the transaction, (iv) the immediate suspension of dividends by the Company and (v) receipt of a fairness opinion from the financial advisor to the special committee of the Board stating that the proposed transaction is fair, from a financial point of view, to the public shareholders. The Sbarro Family has advised the Company that they have received a letter from an investment banking firm which indicates that, subject to certain conditions, the firm was highly confident that financing for the transaction could be obtained. The Sbarro Family also advised the Company that they are not interested in selling their interests in the Company. The Board of Directors has appointed a special committee to evaluate and consider the proposal. Seven lawsuits have been instituted by purported shareholders of the Company alleging, with respect to the proposed transaction, in general, a breach of fiduciary duties by the directors of the Company and members of the Sbarro Family, -2- that the proposed price per share to be paid to public shareholders is inadequate and that the proposal serves no legitimate business purpose of the Company. (See ``Legal Proceedings''in Item 3 of this Report.) On February 11, 1998, the Company's Board of Directors deferred consideration of the Company's quarterly cash dividend pending consideration of the proposed transaction. (See ``Market for Registrant's Common Equity and Related Shareholder Matters'' in Item 5 of this Report.) General The Company develops and operates or franchises an international chain of family-style Italian restaurants principally under the "Sbarro" and "Sbarro The Italian Eatery" names (``Sbarro restaurants''). Sbarro restaurants are family- oriented cafeteria-style restaurants featuring 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. As of December 28, 1997, there were 862 Sbarro restaurants, located in 48 states throughout the United States, the District of Columbia and in Aruba, Australia, the Bahamas, Belgium, Canada, Chile, Cyprus, France, Israel, Japan, Korea, Kuwait, Lebanon, New Zealand, the Philippines, Puerto Rico, Russia, Saudi Arabia, and the United Kingdom. At that date, the Company owned and operated 623 restaurants and franchised 239 Sbarro restaurants. In addition, since 1995, the Company has created and operated, through joint ventures, other concepts for the purpose of developing growth opportunities in addition to its Sbarro restaurants. Restaurant Expansion The Company has expanded significantly in recent years, growing from 123 restaurants at the time of the Company's initial public offering of Common Stock in 1985 to 587 restaurants at the beginning of 1993 to 862 at the end of 1997. During 1997, 77 new Sbarro restaurants were opened, of which 30 were Company-owned and 47 were franchised. During 1998, the Company plans to open approximately 80 restaurants, of which approximately 35 are expected to be Company-owned and the balance are expected to be franchised. The actual number of openings will depend on the availability of appropriate sites, as well as other factors. While most Sbarro restaurants are located in shopping malls, in recent years the Company has been expanding the basic Sbarro concept outside the shopping mall environment by adding Company and franchise restaurants in downtown areas in major -3- United States cities, such as Boston, Chicago, New York and Philadelphia, as well as on toll roads, in strip shopping centers, hospitals, convention centers, universities, casinos, hotels and airports. In addition, kiosks have been introduced in certain selected markets. The following table indicates the number of Company- owned and franchised restaurants (excluding non-mall new venture restaurants) during each of the years from 1993 through 1997. Fiscal Year 1997 1996 1995 1994 1993 Company-owned Sbarro restaurants: Opened during period (*) 30 29 44 53 59 Acquired from franchisees during period 4 1 - 2 7 Closed during period (**) [8] [4] [40] [3] [7] Open at end of period 623 597 571 567 515 Franchised Sbarro restaurants: Opened during period 47 36 40 38 24 Sold to Company during period [4] [1] - [2] [7] Closed or terminated during period [23] [16] [2] [8] [14] Open at end of period 239 219 200 162 134 All Sbarro restaurants: Opened during period 77 65 84 91 83 Closed or terminated during period [31] [20] [42] [11] [21] Open at end of period 862 816 771 729 649 Kiosks (all franchised) 7 7 8 7 7 (*) Includes, in 1997 and 1996, two and three mall locations, respectively, of a joint venture which operates as Umberto of New Hyde Park. (**) In December 1995, the Company announced the planned closing of 40 Company-owned Sbarro restaurants. The costs associated with the closing of these restaurants was provided for in the 1995 financial statements. See Note A to "Selected Financial Data" in Item 6 of this Report. Concept and Menu Sbarro restaurants are family oriented, offering quick, efficient, friendly cafeteria and buffet style service designed to minimize customer waiting time and facilitate table turnover. The decor of a Sbarro restaurant incorporates booth and table seating (for "in-line" restaurants), with a contemporary motif that blends with the characteristics of the surrounding area. -4- As of December 28, 1997, there were 260 ``in-line'' Sbarro restaurants and 597 ``food court'' Sbarro restaurants. In addition, franchisees operated five free-standing Sbarro restaurants, including two in the Middle East and one in each of the Bahamas, Puerto Rico and Minnesota. "In-line" restaurants, which are self-contained restaurants, usually occupy approximately 1,500-3,000 square feet, contain the space and furniture to seat approximately 60-120 people and employ 10-40 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 approximately 500-1,000 square feet and contain only kitchen and service areas. They frequently have a more limited menu than an "in-line" restaurant and employ 6-30 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. 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 Company-owned restaurants open a full year, average sales in 1997 and 1996 were $693,000 and $698,000, respectively, for "in-line" restaurants and $493,000 and $486,000, respectively, 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, some of the larger restaurants serve beer and wine, although alcoholic beverage sales are not emphasized. All food products are prepared fresh daily in each restaurant according to special recipes developed by the Sbarro family. Emphasis is placed on serving generous portions of quality Italian-style food at value prices. Entree selections, excluding pizza, generally range in price from $2.99 to $5.29. The Company believes that pizza, which is sold predominantly by the slice, accounts for approximately one-half of Sbarro restaurant sales. The Company's ``signature'' cheesecakes are prepared in its original kitchen located in Brooklyn, New York. Substantially all of the food ingredients and related restaurant supplies used by the restaurants are purchased from a national independent wholesale food distributor, while breads, pastries, produce, fresh dairy and certain meat products are purchased locally for each restaurant. The Company requires that the distributor adhere to established product specifications for all -5- food products sold to its restaurants. The Company believes that there are other distributors who would be able to service the Company's needs and that satisfactory alternative sources of supply are generally available for all items regularly used in the restaurants. Restaurant Management Each Sbarro restaurant is managed by one General Manager and one or two Co-Managers or Assistant Managers. Managers are required to participate in Company 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. The Company has a Restaurant Management Bonus Program which provides the management teams of Company-owned Sbarro restaurants with the opportunity to receive a percentage of restaurant sales in cash bonuses based on certain performance - related criteria. The Company also employs 70 - 75 Area Directors, each of whom is typically responsible for the operations of 7 - 15 Company-owned Sbarro restaurants in a given area. Before each new restaurant opening, the Company assigns an Area Director to coordinate opening procedures. Each Area Director reports to one of the nine Regional Directors. The Regional Directors recruit and supervise the managerial staff of all Company-owned Sbarro restaurants and report to one of the five Regional Vice Presidents. The Regional Vice Presidents coordinate the activities of the Regional Directors assigned to their areas of responsibility and report to one of two Corporate Vice Presidents. The Corporate Vice Presidents have total responsibility for their geographic areas. Franchise Development While the Company continues to emphasize expansion through Company-owned units, growth in franchise operations is also anticipated through the establishment of new Sbarro restaurants by new franchisees and by existing franchisees capable of multi-unit operations. The Company relies principally upon its reputation and the strength of its existing restaurants to attract new franchisees. As of December 28, 1997, the Company had 239 franchised Sbarro restaurants operated by 73 franchisees in 30 states as well as Aruba, Australia, the Bahamas, Belgium, Canada, Chile, Cyprus, France, Israel, Japan, Korea, Kuwait, Lebanon, New Zealand, the Philippines, Puerto Rico, Russia, Saudi Arabia and the United Kingdom. The Company is presently considering -6- additional franchise opportunities in the United States and other countries. In certain instances, franchise locations have been established through territorial agreements under which the Company granted, for specified time periods, exclusive rights to enter into franchise agreements for restaurant units in certain geographic areas, primarily in foreign countries, or for specified non-mall locations (such as for certain toll roads or airports) in the United States or foreign countries. The Company's basic franchise agreement generally requires payment of an initial license fee of $35,000 and requires continuing payments of royalty fees of 5% - 7% of gross revenues. Franchise agreements entered into prior to 1988 generally have an initial term of 15 years with the franchisee having a year renewal option, provided that the agreement has not been previously terminated by either party for specified reasons. Since 1988, the Company has required the franchise agreements to be coterminous with the underlying lease, but generally not less than ten nor more than twenty years. Since 1990, the Company has granted a renewal option in the Franchise Agreement subject to certain conditions, including a remodel or image enhancement requirement. Franchise agreements granted under territorial agreements contain negotiated terms and conditions other than those contained in the Company's basic franchise agreement. The agreements also provide the Company 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. New Ventures During 1995, the Company entered into joint venture arrangements for the purpose of developing three new restaurant concepts. The first venture is a casual dining chain in a Rocky Mountain steakhouse motif. This venture, in which the Company has a 40% interest, presently operates four restaurants under the name Boulder Creek Steaks & Saloon, with one additional restaurant under construction. The second venture, in which the Company has a 70% interest, is a moderately priced, table service restaurant chain featuring an Italian Mediterranean menu under the names Bice Med Grille, Salute and Cafe Med. Two restaurants in New York City and one on Long Island, New York are currently operating. During 1997, the joint venture determined to closed two other restaurants, located on Long Island, resulting in a $3,300,000 before tax ($2,046,000 or $.10 basic and diluted earnings per share after tax) charge to the Company's earnings. The third venture is a family restaurant concept under the name Umberto of New Hyde Park, featuring pizza and other Italian-style foods, in which the Company has an 80% interest. This venture currently operates three restaurants in strip shopping centers on -7- Long Island and Brooklyn, New York, with two additional restaurants under construction, and five food court units in regional shopping malls in Chicago, Las Vegas, White Plains and Long Island, New York. The Company continues to monitor the results of these three concepts for the purpose of evaluating their potential future growth. Employees As of December 28, 1997, the Company (exclusive of joint ventures to which the Company is a party) employed approximately 7,500 persons, of whom approximately 2,700 were full-time field and restaurant personnel, 4,600 were part-time restaurant personnel and 200 were headquarters office personnel. None of the Company's employees are covered by collective bargaining agreements. The Company believes its employee relations are satisfactory. Competition The restaurant business is highly competitive with respect to price, service, location and food quality, and is often affected by changes in consumer tastes, economic conditions, population and traffic patterns. There is active competition for management personnel and attractive commercial shopping mall, center city and other locations suitable for restaurants. The Company competes in each market in which it operates with locally-owned restaurants as well as with national and regional restaurant operations. Trademarks The 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. The Company has also registered or filed applications to register "Sbarro" and "Sbarro The Italian Eatery" in several other countries. The Company believes that these marks continue to be materially important to the Company's business. The joint ventures to which the Company is a party, have also applied for United States trademarks covering trade names used by them. Governmental Regulation The Company is subject to various Federal, state and local laws affecting its business. The restaurants of the Company and its franchisees are subject to a variety of regulatory provisions relating to wholesomeness of food, sanitation, health, safety and, in certain cases, licensing of the sale of alcoholic beverages. The Company is also subject to a substantial number of state laws and regulations governing the -8- offer and sale of franchises. Such laws impose registration and disclosure requirements on franchisors in the offer and sale of franchises and may also apply substantive standards to the relationship between franchisor and franchisee. The Company is also subject to Federal Trade Commission regulations governing disclosure requirements in the sale of franchises. In addition, the Fair Labor Standards Act, governing such matters as minimum wage requirements, overtime, employment of minors and other working conditions, is applicable to the Company. The Company believes it is in compliance with such laws in all material aspects. (See ``Legal Proceedings'' in Item 3 of this Report.) ITEM 2. PROPERTIES All Sbarro restaurants are operated in leased premises. As of December 28, 1997, the Company leased 641 restaurants, of which 34 were subleased to franchisees under terms which cover all obligations of the Company under the lease. The remaining franchisees directly lease their restaurant spaces. Most of the Company's 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. Leases to which the Company were a party at December 28, 1997 have initial terms expiring as follows: Years Initial Lease Number of Company- Number of Franchised Terms Expire owned Restaurants Restaurants 1998 26 4 1999 - 2003 336 25 2004 - 2008 239 5 2009 - 2012 6 0 Since May 1986, the Company's headquarters have been located in a two-story 20,000 square foot office building located in Commack, New York, which is subleased for a period of fifteen years from a partnership owned by certain shareholders of the Company at a current annual base rental of $337,000. In addition, the Company pays real estate taxes, utilities, insurance and certain other expenses for the facility. In March 1994, the Company purchased a 100,000 square foot office building in Melville, New York, for $5,350,000. The Company is in the process of renovating the building at an estimated additional cost of approximately $15 million (of which approximately $10 million has been expended through fiscal 1997) and intends to occupy approximately 25% of the building in 1998 as its corporate headquarters and lease the remainder of the building. Leases with unaffiliated third parties to occupy, upon completion of construction, approximately 40% of the total space in the facility have been entered into. -9- ITEM 3. LEGAL PROCEEDINGS Following the Company's announcement of a proposal for the merger of the Company with a company to be owned by the Sbarro Family (see ``Business - Recent Developments'' in Item 1 of this Report), seven lawsuits were instituted against the Company, certain directors and/or members of the Sbarro Family. While each of the complaints varies, in general, they allege a breach of fiduciary duties by the directors and members of the Sbarro Family, that the proposed price per share to be paid to Public Shareholders is inadequate and that the proposal serves no legitimate business purpose of the Company. Although varying, the complaints seek, generally, a declaration of class action status, damages in unspecified amounts alleged to be caused to the plaintiffs, and other relief (including injunctive relief, rescission if the transaction is consummated, including rescissory damages), costs and disbursements, including a reasonable allowance for counsel fees and expenses. The actions, which are presently pending in the Supreme Court in New York and Suffolk County, New York, are in the process of being consolidated into one action. The defendants intend to vigorously defend these actions. On June 18, 1997, an action entitled Kenneth Hoffman and Gloria Curtis, on behalf of themselves and all others similarly situated v. Sbarro, Inc., was filed in the United States District Court for the Southern District of New York. The plaintiffs, former restaurant level management employees, allege that the company required general managers and co-managers to reimburse the Company for cash and certain other shortages sustained by the Company and thereby lost their status as managerial employees exempt from the overtime compensation provisions of the Fair Labor Standards Act (the ``FLSA''). The plaintiffs seek unpaid overtime compensation, as well as liquidated damages in an amount equal to any overtime compensation awarded, reasonable attorney's fees, costs and expenses. The plaintiffs seek such further and general legal and/or suitable relief to which they may be entitled. The action also seeks to join similarly situated past and present employees in the lawsuit. The Company believes that it has substantial defenses to the claims, including that it has availed itself of a ``window of correction'' which, the Company believes, under applicable regulations of the FLSA and court decisions, preserves employees' exempt status and, thus, precludes any overtime liability. On October 22, 1997, the Court granted plaintiffs' request to send notices to determine whether similarly situated past and present employees of the Company wished to join the lawsuit. The Company intends to continue vigorously definding this action. -10- From time to time the Company is also a party to certain claims and legal proceedings in the ordinary course of business, none of which, in the opinion of the Company, would have a material adverse effect on the Company's financial position or results of operations. 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 The Company's Common Stock is listed on the New York Stock Exchange under the symbol ``SBA'', the range of high and low sales prices of which for the last two fiscal years is as follows: 1997 1996 Quarter Ended High Low Quarter Ended High Low April 20 $28.63 $25.13 April 21 $27.00 $21.38 July 13 $29.75 $26.25 July 14 $28.13 $24.13 October 5 $29.44 $26.06 October 6 $26.00 $22.88 December 28 $29.75 $26.00 December 29 $27.50 $24.25 As of March 16, 1998, there were approximately 529 holders of record of the Company's Common Stock, exclusive of shareholders whose shares were held by brokerage firms, depositories and other institutional firms in "street name" for their customers. In 1997 and 1996, the Company declared quarterly dividends of $.27 per share and $.23 per share, respectively, aggregating $1.08 per share and $.92 per share for the respective years. On February 11, 1998, the Company announced that its Board of Directors had deferred consideration of the Company's quarterly cash dividend pending consideration of a proposed merger of the Company with a Company to be owned by the Sbaro Family (see ``Business - Recent Developments'' in Item 1 of this Report). The proposal was conditioned upon, among other things, the immediate suspension of dividends by the Company and obtaining financing therefor. -11- ITEM 6. SELECTED FINANCIAL DATA The following Selected Financial Data should be read in conjunction with Management's Discussion and Analysis included in Item 7 of this Report and the consolidated financial statements of the Company 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. Years Ended Dec. 28, Dec. 29,Dec. 31, Jan. 1, Jan. 2, Income Statement Data: 1997 1996 1995 1995 1994 (In thousands, except share and per share data) Revenues: Restaurant sales $337,723 $319,315 $310,132 $288,808 $259,213 Franchise related income 7,360 6,375 5,942 5,234 4,758 Interest income 4,352 3,798 3,081 1,949 1,579 349,435 329,488 319,155 295,991 265,550 Costs and expenses: Cost of food and paper products 69,469 68,668 67,361 61,877 55,428 Restaurant operating expenses: Payroll & other employee benefits 84,910 78,258 78,342 70,849 64,653 Occupancy & other expenses 93,528 85,577 84,371 76,353 68,241 Depreciation and amortization23,922 22,910 23,630 21,674 18,599 General and administrative 17,762 14,940 16,089 13,319 12,913 Provision for unit closings (Note A) 3,300 - 16,400 - - Other income (1,653) (1,171) (1,359) (1,351) (1,244) 291,238 269,182 284,834 242,721 218,590 Income before income taxes and cumulative effect of change in method of accounting for income taxes 58,197 60,306 34,321 53,270 46,960 Income taxes 22,115 22,916 13,042 20,244 18,612 Income before cumulative effect of accounting change 36,082 37,390 21,279 33,026 28,348 Cumulative effect of change in method of accounting for income taxes - - - - 1,010 Net income (Note A) $36,082 $37,390 $21,279 $33,026 $29,358 Per share data: Basic earnings per share before cumulative effect of change in method of accounting for income taxes $1.77 $1.84 $1.05 $1.63 $1.40 Cumulative effect of change in method of accounting for income taxes - - - - .05 Basic earnings per share (Notes A and B) $1.77 $1.84 $1.05 $1.63 $1.45 -12- Income Statement Data: (continued) Basic number of shares used in the computation (Note B) 20,426,678 20,369,128 20,336,809 20,310,283 20,280,816 Diluted earnings per share before cumulative effect of change in method of accounting for income taxes $1.76 $1.83 $1.04 $1.62 $1.39 Cumulative effect of change in method of accounting for income taxes - - - - .05 Diluted earnings per share $1.76 $1.83 $1.04 $1.62 $1.44 Diluted number of shares used in the computation 20,504,303 20,404,620 20,396,704 20,355,275 20,339,945 Dividends declared $1.08 $0.92 $0.76 $0.64 $0.52 Dec. 28, Dec. 29,Dec. 31, Jan. 1, Jan. 2, Balance Sheet Data: 1997 1996 1995 1995 1994 (In thousands) Total assets $278,649 $258,659 $242,730 $232,051 $207,733 Working capital 88,006 73,619 57,645 43,271 45,218 Shareholders' equity 220,439 205,200 185,666 179,580 159,037 Number of Restaurants at End of Period: Company-owned and operated (Note A) 623 597 571 567 515 Franchised 239 219 200 162 134 Total (Note C) 862 816 771 729 649 Note A: In 1997, a provision of $3,300,000 before tax ($2,046,000 or $.10 basic and diluted earnings per share after tax) relating to the Company's investment in one of its joint ventures was established for the closing of certain joint venture units. Had the provision not been made, 1997 net income would have been $38,128,000 or $1.87 basic earnings per share and $1.86 diluted earnings per share. In 1995, a provision of $16,400,000 before tax ($10,168,000 or $0.50 basic and diluted per share after tax) was established for the closing of approximately 40 under-performing restaurants. Had the provision not been made, 1995 net income would have been $31,447,000 or $1.55 basic earnings per share and $1.54 diluted earnings per share. -13- Note B: All share and per share data have been restated to give effect to Statement of Financial Accounting Standards (``SFAS'') No. 128 which became effective for the Company at the end of 1997 and have been adjusted to give effect to a 3-for-2 stock split in the form of a 50% stock dividend distributed on September 22, 1994 to shareholders of record on September 9, 1994. Note C: Excludes kiosks operated by franchisees and restaurants owned and operated by joint ventures to which the Company is a party (other than five mall locations of a joint venture which are included in the table as Company-owned and operated units). ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations 1997 Compared to 1996 Restaurant sales from Company-owned units and consolidated joint venture units increased 5.8% to $337,723,000 in 1997 from $319,315,000 in 1996. The increase resulted from a higher number of units in operation in the current fiscal year and the effect of a full year of selective menu price increases of approximately .5% and 1%, which became effective in mid April 1996 and mid July 1996 offset, in part, by a decrease in comparable unit sales of .4%. Comparable unit sales decreased to $305,195,000 in 1997 from $306,313,000 in 1996. Comparable restaurant sales are made up of sales at locations that were open during the entire current year and entire prior fiscal year. Franchise related income increased 15.5% to $7,360,000 in 1997 from $6,375,000 in 1996. This increase resulted from a higher number of units in operation in the current year than in 1996 and an increase in initial franchise and development fees due to the opening of more franchise units in 1997 than in 1996. During the year ended December 28, 1997, 23 units were closed by franchisees. These units did not produce material levels of sales and, consequently, did not generate material amounts of royalty income to the Company. In addition, four franchise units were purchased by the Company. Comparable sales at franchise locations did not change significantly in fiscal 1997 from fiscal 1996. Interest income increased to $4,352,000 in 1997 from $3,798,000 in 1996. This increase was due to higher amounts of cash available for investment in 1997 than in 1996 at comparable interest rates. Cost of food and paper products decreased as a percentage of restaurant sales to 20.6% in 1997 from 21.5% in 1996. This improvement resulted from lower food prices, primarily of cheese from the fourth quarter of fiscal 1996 into -14- 1997 Compared to 1996 (Continued) the fourth quarter of fiscal 1997, lower prices of various paper products and the effect of a full year of the selective menu price increases implemented in mid 1996. Cheese prices have risen since the middle of the fourth quarter of fiscal 1997 and currently remain at prices higher than those in the comparable prior year period. Restaurant operating expenses - payroll and other employee benefits increased to 25.1% of restaurant sales in 1997 from 24.5% of restaurant sales in 1996. This percentage increase was attributable to the higher costs of providing benefits to employees and, to a lesser extent, the effects of the two increases in the Federal minimum wage which became effective in September 1997 and 1996, as well as the decrease in comparable unit sales in fiscal 1997. Restaurant operating expenses - occupancy and other expenses increased to 27.7% of restaurant sales in 1997 from 26.8% of restaurant sales in 1996. This percentage increase was primarily attributable to rent and rent related charges increasing at a faster rate than sales. Depreciation and amortization expenses increased to $23,922,000 in 1997 from $22,910,000 in 1996. This increase was primarily the result of additional Company owned units in operation during 1997 over the number of units in operation during 1996. General and administrative expenses were $17,762,000 in 1997 or 5.1% of revenues and $14,940,000 in 1996 or 4.5% of revenues. This increase was due to hiring additional personnel in anticipation of the Company's development plans, and increases in executive compensation and legal fees. General and administrative expenses in 1998 may be affected by costs associated with the proposal made by certain members of the Sbarro Family for the merger of the Company with a company to be owned by them, which would be expensed if the merger does not take place and by potential additional costs associated with pending litigation against the Company. (See Note 6 of Notes to Consolidated Financial Statements.) In 1997, a provision of $3,300,000 before tax ($2,046,000 or $.10 after tax) relating to the Company's investment in one of its joint ventures was established for the closing of certain joint venture units. The effective income tax rate was 38.0% for 1997 and 1996. 1996 Compared to 1995 Restaurant sales from Company-owned units increased 3.0% to $319,315,000 in 1996 from $310,132,000 in 1995. The -15- increase resulted from the higher contribution to sales in 1996 than in 1995 from units opened during 1995 together with the contribution to sales from units opened during 1996 offset, in part, by the loss of sales from underperforming units closed at the end of 1995. Another factor affecting sales was the selective menu price increases of approximately .5% and 1% in mid April 1996 and mid July 1996. Comparable unit sales remained relatively unchanged at $292,088,000 in 1996 and $292,622,000 in 1995. Comparable restaurant sales are made up of sales at locations that were open during the entire current year and entire prior fiscal year. Franchise related income increased 7.3% to $6,375,000 in 1996 from $5,942,000 in 1995. This increase resulted from higher royalties due principally to a larger number of franchise units in operation in the current year than in 1995, offset somewhat by lower initial franchise licensing fees due to less unit openings. Comparable sales at franchise locations did not change significantly. Interest income increased to $3,798,000 in 1996 from $3,081,000 in 1995. This increase was primarily due to larger amounts of cash invested, offset somewhat by slightly lower yields on cash equivalents and marketable securities for the fiscal year. Cost of food and paper products decreased as a percentage of restaurant sales to 21.5% in 1996 from 21.7% in 1995. This improvement resulted principally from the effects of the closing of underperforming units in late 1995, which had higher food cost relationships than more typical Company locations, lower prices of various paper products and food items and, to a limited extent, the selective menu price increases, offset by higher cheese prices during the second and third quarters of 1996, which increased food costs by approximately $1,800,000. Restaurant operating expenses - payroll and other employee benefits decreased to 24.5% of restaurant sales in 1996 from 25.3% of restaurant sales in 1995. Restaurant operating expenses - occupancy and other expenses decreased to 26.8% of restaurant sales in 1996 from 27.2% of restaurant sales in 1995. These improvements were principally due to the Company's program of closing underperforming units which had higher payroll and other restaurant cost relationships, improved supervision and controls over costs and, to a limited extent, the impact of menu price increases. Depreciation and amortization expenses decreased to $22,910,000 in 1996 from $23,630,000 in 1995. This decrease was principally due to the closing of underperforming units in late 1995, offset somewhat from new unit openings in 1996. -16- 1996 Compared to 1995 (Continued) General and administrative expenses were $14,940,000 in 1996 or 4.5% of revenues and $16,089,000 in 1995 or 5.0% of revenues. The decrease in dollars was principally due to improved controls in supervising and administering restaurants. The decrease in this category of expenses as a percentage of revenues was, in addition to the dollar decrease, favorably impacted by the spreading of non-variable costs over a larger revenue base. The effective income tax rate was 38.0% for 1996 and 1995. Impact of Inflation Food, labor, 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 the Company's control that may reduce available supply and increase the price of food stuff and paper products. Seasonality The Company's business is subject to seasonal fluctuations, the effects of weather and economic conditions. Earnings have been highest in its fourth fiscal quarter due primarily to increased volume in shopping malls during the holiday shopping season. The fourth fiscal quarter normally accounts for approximately 40% of net income for the year. In 1997, the fourth fiscal quarter accounted for 38% of net income for the year (prior to the provision in 1997 for the closing of certain joint venture units). The length of the holiday shopping period between Thanksgiving and Christmas and the number of weeks in the fourth quarter produce changes in the fourth quarter earnings relationship from year to year. (See also, ``Accounting Period'' .) Accounting Period The Company's fiscal year ends on the Sunday nearest to December 31, with fiscal quarters of sixteen weeks in the first quarter and twelve weeks in each succeeding quarter (except in a 53 week year, which has a thirteen week fourth quarter). The Company's 1997, 1996 and 1995 fiscal years each contained 52 weeks. Fiscal 1998 will contain 53 weeks. -17- Potential Effect of AICPA Exposure Draft Statement of Position The Accounting Standards Executive Committee of the American Institute of Certified Public Accountants has issued an Exposure Draft Statement of Position (SOP) which, if adopted in its current form, would require all companies which capitalize pre-opening and similar costs to write off all existing such costs, net of tax benefit, as a ``cumulative effect of accounting change'' and to expense all such costs as incurred in the future. The exposure draft, if enacted, would be effective beginning with the Company's 1999 fiscal year. The Company does not expect this proposal to materially affect future operating income except that the Company would be required to write off the accumulated costs ($1,219,000 at December 28, 1997) which would be reflected as a cumulative effect of accounting change ($756,000 after tax at December 28, 1997). Liquidity and Capital Resources During 1997, operating activities contributed $61.0 million to cash flow resulting primarily from net income of $36.1 million, non-cash expenses of $23.9 million for depreciation and amortization, a $3.3 million provision for unit closings and an increase in accounts payable and accrued expenses ($3.5 million), which were somewhat offset by increases in deferred charges ($1.6 million) and other assets ($.8 million). During the year, the Company expended approximately $28.6 million for the acquisition of property and equipment related primarily, to opening 30 Company-owned restaurants, construction costs related to joint venture operations and the renovation of the Company's new headquarters building. In addition, $21.2 million was used to pay four quarterly cash dividends to the Company's shareholders. At December 28, 1997, the Company had cash, cash equivalents and marketable securities of approximately $127.3 million (compared to $114.8 million at the end of fiscal 1996) and its working capital was approximately $88.0 million. The Company anticipates that approximately 35 Company- owned and operated units will be opened during 1998 and that its capital expenditures (including approximately $5.0 million to complete the renovation and equipping of the Company's new headquarters building) will approximate $28.0 million in 1998. The Company does not anticipate making material expenditures for remodeling of Company-owned restaurants during 1998. From time to time, the Company has the opportunity to contract for and secure price protection for certain of its raw ingredients. Such situations may require the advance outlay of funds for inventories of these items. In 1997, the Company declared quarterly dividends of $0.27 per share aggregating $1.08 per share (or $22,068,000) for the year. On February 11, 1998, the Company announced that its -18- Liquidity and Capital Resources (Continued) Board of Directors had deferred consideration of the Company's quarterly cash dividend pending consideration of a transaction that has been proposed by members of the Sbarro Family to merge the Company with a Company owned by them in which all of the shares of the Company not owned by such members of the Sbarro Family would be exchanged for cash. The proposal was conditioned upon, among other things, the immediate suspension of dividends by the Company and obtaining financing therefor (such financing could adversely affect the Company's liquidity after becoming privately owned). The Company believes, based on current projections, that its liquid assets presently on hand, together with funds expected to be generated from operations, should be sufficient for its presently contemplated operations, the investment in property and equipment for the opening of additional restaurant locations, as well as the completion of the renovation and equipping of the Company's new headquarters building. Year 2000 In July, 1996, the Emerging Issues Task Force of the FASB reached a consensus on Issue 96-14, ``Accounting for the Costs Associated with Modifying Computer Software for the Year 2000,''which requires that costs associated with modifying computer software for the Year 2000 be expensed as incurred. The Company does not believe, based upon its internal reviews and other factors, that future external and internal costs to be incurred relating to the modification of internal-use software for the Year 2000 will have a material effect on the Company's results of operations or financial position. In addition, the Company has addressed the Year 2000 issue with its principal suppliers and has been assured that they will be timely Year 2000 compliant. Forward Looking Statement Certain statements contained in this Report are forward-looking statements which are subject to a number of known and unknown risks and uncertainties that could cause the Company's actual results and performance to differ materially from those described or implied in the forward-looking statements. These risks and uncertainties, many of which are not within the Company's 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; ability to continue to attract franchisees; the success of its present, and any future, joint ventures and other expansion opportunities; the availability of food (particularly -19- cheese and tomatoes) and paper products at reasonable prices; no material increase occurring in the Federal minimum wage; and the Company's ability to attract competent restaurant and executive managerial personnel. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Annexed hereto starting on Page F-1. ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III The information called for by Part III (Items 10, 11, 12 and 13) of Form 10-K is incorporated herein by reference to such information which will be contained in the Company's definitive Proxy Statement to be used in connection with the Company's 1998 Annual Meeting. -20- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) and (a) (2) and (d) Financial Statements and Financial Statement Schedule Financial Statements Page Report of Independent Public Accountants F-1 Consolidated Balance Sheets at December 28, 1997 and December 29, 1996 F-2 Consolidated Statements of Income for each of the years in the three-year period ended December 28, 1997 F-4 Consolidated Statements of Shareholders' Equity for each of the years in the three-year period ended December 28, 1997 F-5 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 28, 1997 F-6 Notes to Consolidated Financial Statements F-8 Financial Statement Schedule Report of Independent Public Accountants on Schedule S-1 II - Valuation and Qualifying Accounts S-2 Information required by other schedules called for under Regulation S-X is either not applicable or is included in the consolidated financial statements or notes thereto. (b) Reports on Form 8-K No Reports on Form 8-K were filed by the Company during the fourth quarter of the Company's fiscal year ended December 28, 1997. (c) Exhibits: * 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) -21- (c) Exhibits (continued): * 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 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 21, 1996, File No. 1-8881) *10.01 Commack, New York Corporate Headquarters Sublease. (Exhibit 10.04 to the Company's Registration Statement on Form S-1, File No. 2-96807) + *10.02(a) 1985 Incentive Stock Option Plan, as amended. (Exhibit 10.1 to Company's Quarterly Report on Form 10-Q for the quarter ended October 6, 1996, File No. 33-4380) + *10.02(b) 1991 Stock Incentive Plan, as amended. (Exhibit 10.1 to the Company's Quarterly Report on Form 10- Q for the quarter ended April 20, 1997, File No. 1-8881) + *10.02(c) Form of Stock Option Agreement dated May 30, 1990 between the Company and each of Anthony Sbarro, Joseph Sbarro and Mario Sbarro, together with a schedule, pursuant to Instruction 2 to Item 601 of Regulation S-K, identifying the details in which the actual agreements differ from the exhibit filed herewith. (Exhibit 10.02(c) to the Company's Annual Report on Form 10-K for the year ended December 30, 1990, File No. 1-8881) -22- + *10.02(d) 1993 Non-Employee Director Stock Option Plan, as amended. (Exhibit 10.2 (d) to the Company's Quarterly Report on Form 10-Q for the quarter ended April 20, 1997, File No. 1-8881) + *10.02(e) The Company's Performance Incentive Plan. (Exhibit A to the Company's Proxy Statement dated April 29, 1997, File No. 1-8881) + *10.03 Consulting Agreement (including option) dated June 3, 1985 between the Company and Bernard Zimmerman & Company, Inc. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1-8881) + *10.04 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) *21.01 List of subsidiaries. 23.01 Consent of Arthur Andersen LLP. 27.01 Financial Data Schedule. _____________________________ * Incorporated by reference to the document indicated. + Management contract or compensatory plan. -23- 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 27, 1998. SBARRO, INC. By: /s/MARIO SBARRO Mario Sbarro, Chairman of the Board -24- 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 27, 1998 Mario Sbarro (Principal Executive Officer) and Director /s/ROBERT S. KOEBELE Vice President-Finance March 27, 1998 Robert S. Koebele (Chief Financial and Accounting Officer) /s/JOSEPH SBARRO Director March 27, 1998 Joseph Sbarro /s/ANTHONY SBARRO Director March 27, 1998 Anthony Sbarro /s/HAROLD KESTENBAUM Director March 27, 1998 Harold Kestenbaum /s/RICHARD A. MANDELL Director March 27, 1998 Richard A. Mandell /s/CARMELA SBARRO Director March 27, 1998 Carmela Sbarro -25- Signature Title Date /s/PAUL A. VATTER Director March 27, 1998 Paul A. Vatter /s/TERRY VINCE Director March 27, 1998 Terry Vince /s/BERNARD ZIMMERMAN Director March 27, 1998 Bernard Zimmerman -26- ARTHUR ANDERSEN LLP REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Sbarro, Inc.: We have audited the accompanying consolidated balance sheets of Sbarro, Inc. (a New York corporation) and subsidiaries as of December 28, 1997 and December 29, 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 28, 1997. 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 generally accepted auditing standards. 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 28, 1997 and December 29, 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 1997, in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP New York, New York February 11, 1998 F-1 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS (In thousands) December 28, December 29, 1997 1996 Current assets: Cash and cash equivalents $119,810 $104,818 Marketable securities 7,500 2,500 Receivables: Franchisees 810 743 Other 1,565 1,122 2,375 1,865 Inventories 2,962 2,841 Prepaid expenses 1,768 1,409 Total current assets 134,415 113,433 Marketable securities - 7,500 Property and equipment, net (Notes 3 and 9) 136,798 130,993 Other assets: Deferred charges, net of accumulated amortization of $1,269,000 at December 28, 1997 and $1,436,000 at December 29, 1996 1,596 1,633 Other, net 5,840 5,100 7,436 6,733 $278,649 $258,659 (continued) F-2 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) LIABILITIES AND SHAREHOLDERS' EQUITY (In thousands) December 28, December 29, 1997 1996 Current liabilities: Accounts payable $10,086 $7,173 Accrued expenses (Note 4) 26,025 22,663 Dividend payable 5,521 4,691 Income taxes (Note 5) 4,777 5,287 Total current liabilities 46,409 39,814 Deferred income taxes (Note 5) 11,801 13,645 Commitments and contingencies (Note 6) Shareholders' equity (Note 8): 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 20,446,654 shares at December 28, 1997 and 20,392,909 shares at December 29, 1996 204 204 Additional paid-in capital 32,444 31,219 Retained earnings 187,791 173,777 220,439 205,200 $278,649 $258,659 See notes to consolidated financial statements F-3 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except share data) For the Years Ended December 28, December 29, December 31, 1997 1996 1995 Revenues: Restaurant sales $337,723 $319,315 $310,132 Franchise related income 7,360 6,375 5,942 Interest income 4,352 3,798 3,081 Total revenues 349,435 329,488 319,155 Costs and expenses: Cost of food and paper products 69,469 68,668 67,361 Restaurant operating expenses: Payroll and other employee benefits 84,910 78,258 78,342 Occupancy and other expenses 93,528 85,577 84,371 Depreciation and amortization 23,922 22,910 23,630 General and administrative 17,762 14,940 16,089 Provision for unit closings (Note 9) 3,300 16,400 Other income (1,653) (1,171) (1,359) Total costs and expenses 291,238 269,182 284,834 Income before income taxes 58,197 60,306 34,321 Income taxes (Note 5) 22,115 22,916 13,042 Net income $36,082 $37,390 $21,279 Per share information: Net income per share: Basic $1.77 $1.84 $1.05 Diluted $1.76 $1.83 $1.04 Shares used in computing net income per share: Basic 20,426,678 20,369,128 20,336,809 Diluted 20,504,303 20,404,620 20,396,704 Dividends declared (Note 10) $1.08 $0.92 $0.76 See notes to consolidated financial statements F-4 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except share data) Common stock Additional Number of paid-in Retained shares Amount capital earnings Total Balance at January 1, 1995 20,328,981 $203 $30,066 $149,311 $179,580 Exercise of stock options 16,502 264 264 Net income 21,279 21,279 Dividends declared (15,457) (15,457) Balance at December 31, 1995 20,345,483 203 30,330 155,133 185,666 Exercise of stock options 47,426 1 889 890 Net income 37,390 37,390 Dividends declared (18,746) (18,746) Balance at December 29, 1996 20,392,909 204 31,219 173,777 205,200 Exercise of stock options 53,745 1,225 1,225 Net income 36,082 36,082 Dividends declared (22,068) (22,068) Balance at December 28, 1997 20,446,654 $204 $32,444 $187,791 $220,439 See notes to consolidated financial statements F-5 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) For the Years Ended December 28, December 29,December 31, 1997 1996 1995 Operating activities: Net income $36,082 $37,390 $21,279 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 23,922 22,910 23,630 Decrease in deferred income taxes (1,844) (442) (5,183) Provision for unit closings 3,300 16,400 Changes in operating assets and liabilities: (Increase) decrease in receivables (510) 739 58 (Increase) decrease in inventories (121) (78) 29 (Increase) decrease in prepaid expenses (359) 268 (292) Increase in deferred charges (1,624) (1,298) (1,400) Increase in other assets (844) (1,750) (2,425) Increase (decrease) in accounts payable and accrued expenses 3,534 (4,309) 2,638 Increase (decrease) in income taxes payable (510) 579 (154) Net cash provided by operating activities 61,026 54,009 54,580 (continued) F-6 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (In thousands) For the Years Ended December 28, December 29,December 31, 1997 1996 1995 Investing activities: Proceeds from maturities of marketable securities 2,500 28,618 Purchases of property and equipment (28,556) (25,928) (17,513) Proceeds from disposition of property and equipment 34 266 34 Net cash (used in) provided by investing activities (26,022) (25,662) 11,139 Financing activities: Proceeds from exercise of stock options 1,225 890 264 Cash dividends paid (21,237) (17,920) (14,844) Net cash used in financing activities (20,012) (17,030) (14,580) Increase in cash and cash equivalents 14,992 11,317 51,139 Cash and cash equivalents at beginning of year 104,818 93,501 42,362 Cash and cash equivalents at end of year $119,810 $104,818 $93,501 See notes to consolidated financial statements F-7 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. and its wholly-owned subsidiaries (together, the "Company") and the accounts of its joint ventures. All intercompany accounts and transactions have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that may affect the amounts reported in the financial statements and accompanying notes. 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. Marketable securities: The Company classifies its investments in marketable securities as ``held to maturity''. These investments are stated at amortized cost, which approximates market, and are comprised primarily of direct obligations of the U.S. Government and its agencies. 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 and depreciation: Property and equipment are stated at cost. Depreciation is provided for by the straight-line method over the estimated useful lives of the assets. 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. F-8 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Summary of significant accounting policies (continued): Deferred charges: Certain costs and expenses incurred which are directly related to new restaurant openings (primarily crew payroll costs and travel expenses incurred prior to opening) are deferred and amortized on a straight-line basis over a twenty-four month period. One-half year of amortization is recorded in the year in which the restaurant commences operations. The Accounting Standards Executive Committee of the American Institute of Certified Public Accountants has issued an Exposure Draft Statement of Position (SOP) which, if adopted in its current form, would require all companies which capitalize pre-opening and similar costs to write off all existing such costs, net of tax benefit, as a ``cumulative effect of accounting change'' and to expense all such costs as incurred in the future. The exposure draft, if enacted, would be effective beginning with the Company's 1999 fiscal year. The Company does not expect this proposal to materially affect future operating income except that the Company would be required to write off the accumulated costs ($1,219,000 at December 28, 1997) which would be reflected as a cumulative effect of accounting change ($756,000 after tax at December 28, 1997). Deferred income: Deferred income relates to vendor cash advances for allowances to be based on product usage. Franchise related income: Initial franchise fees are recorded as income as restaurants are opened by the franchisee and all services have been substantially performed by the Company. Development fees are amortized over the number of restaurant openings covered under each development 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. F-9 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Summary of significant accounting policies (continued): Stock based compensation plans: In accordance with Accounting Principles Board Opinion (``APB'') No. 25, ``Accounting for Stock Issued to Employees,'' and related interpretations, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. (See Note 8). Income taxes: The Company files a consolidated Federal income tax return. Deferred income taxes result primarily from differences between financial and tax reporting of depreciation and amortization. Accounting period: The Company's fiscal year ends on the Sunday nearest to December 31, with fiscal quarters of sixteen weeks in the first quarter and twelve weeks in each succeeding quarter (except in a 53 week year, which has a thirteen week fourth quarter). The Company's 1997, 1996 and 1995 fiscal years each contained 52 weeks. The Company's 1998 fiscal year will contain 53 weeks, with 13 weeks in the fourth quarter. Per share data: The provisions of Statement of Financial Accounting Standards (`` SFAS'') No. 128, ``Earnings Per Share'' became effective as to the Company for the quarter and year ended December 28, 1997. SFAS No. 128 requires the presentation of both basic and diluted earnings per share on the face of the income statement. SFAS 128 replaces primary and fully diluted earnings per share with basic and diluted earnings per share, respectively. Earnings per share is calculated using the weighted average number of shares of common stock outstanding for the period, with basic earnings per share excluding, and diluted earnings per share including, potentially dilutive securities, such as stock options that could result in the issuance of common stock. The number of shares of common stock subject to stock options included in diluted earnings per share were 77,625 in 1997, 35,492 in 1996 and 59,895 in 1995. As required by SFAS 128, all prior period amounts have been restated to conform to the new presentation. F-10 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. Summary of significant accounting policies (continued): Long-Lived Assets: SFAS No. 121, `` Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,'' requires that long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and used be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable. The adoption of SFAS No. 121 in fiscal 1997 did not have a material effect on the Company's results of operations or financial position. Supplemental disclosures of cash flow information: (In thousands) For the Years Ended December 28, December 29,December 31, 1997 1996 1995 Cash paid for: Income taxes $24,297 $23,143 $18,880 2. Description of business: The Company and 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 United States and overseas, principally in shopping malls and other high traffic locations. The following sets forth the number of units in operation as of: December 28, December 29,December 31, 1997 1996 1995 Company-owned 623 597 571 Franchised 239 219 200 862 816 771 F-11 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. Property and equipment: (In thousands) December 28, December 29, 1997 1996 Leasehold improvements $168,581 $154,507 Furniture, fixtures and equipment 97,688 91,644 Construction-in-progress * 20,096 14,139 286,365 260,290 Less accumulated depreciation and amortization 149,567 129,297 $136,798 $130,993 (*) Includes $15,651 in 1997 and $10,609 in 1996 related to the acquisition and improvement of the Company's new corporate headquarters. 4. Accrued expenses: (In thousands) December 28, December 29, 1997 1996 Compensation $5,051 $4,392 Payroll and sales taxes 3,494 3,672 Rent 6,699 6,427 Provision for unit closings (Note 9) 4,351 1,922 Other 6,430 6,250 $26,025 $22,663 5. Income taxes: (In thousands) For the Years Ended December 28, December 29,December 31, 1997 1996 1995 Federal: Current $19,868 $19,216 $14,897 Deferred (1,557) (322) (4,158) 18,311 18,894 10,739 State and local: Current 4,091 4,142 3,328 Deferred (287) (120) (1,025) 3,804 4,022 2,303 $22,115 $22,916 $13,042 F-12 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. Income taxes: (Continued) Deferred income taxes are comprised of the following: (In thousands) December 28, December 29, 1997 1996 Depreciation and amortization $15,782 $16,427 Deferred charges 475 448 Other 60 55 Gross deferred tax liabilities 16,317 16,930 Accrued expenses (2,431) (1,620) Deferred income (1,949) (1,580) Other (136) (85) Gross deferred tax assets (4,516) (3,285) $11,801 $13,645 Actual tax expense differs from `` expected'' tax expense (computed by applying the Federal corporate rate of 35% for the years ended December 28, 1997, December 29, 1996 and December 31, 1995) as follows: (In thousands) For the Years Ended December 28, December 29, December 31, 1997 1996 1995 Computed "expected" tax expense $ 20,369 $21,108 $12,012 Increase (reduction) in income taxes resulting from: State and local income taxes, net of Federal income tax benefit 2,429 2,614 1,497 Tax exempt interest income (59) (63) (311) Other, net (624) (743) (156) $22,115 $22,916 $13,042 F-13 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. 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 Years Ended December 28,December 29,December 31, 1997 1996 1995 Depreciation and amortization $(1,824) $(1,397) $(2,781) Accrued expenses (624) 1,791 (2,482) Other 604 (836) 80 $(1,844) $(442) $(5,183) 6. Commitments and contingencies: Commitments: The Company conducts all of its operations in leased facilities. Most of the Company's 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, are as follows: (In thousands) For the Years Ended December 28, December 29, December 31, 1997 1996 1995 Minimum rentals $40,365 $36,383 $35,142 Common area charges 12,541 11,303 10,846 Contingent rentals 2,910 2,819 3,082 $55,816 $50,505 $49,070 F-14 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. Commitments and contingencies (continued): Commitments (continued): Future minimum rental and other payments required under non- cancelable operating leases for Company-operated restaurants that were open on December 28, 1997 and the existing corporate office are as follows (in thousands): Years ending: January 3, 1999 $57,982 January 2, 2000 55,970 January 1, 2001 53,678 December 31, 2001 50,101 December 30, 2002 45,032 Later years 106,000 $368,763 The Company is the principal lessee under operating leases for certain franchised restaurants which are subleased to the individual franchisees. Franchisees pay rent and related expenses directly to the landlord. Future minimum rental payments required under these non-cancelable operating leases for franchised restaurants that were open as of December 28, 1997 are as follows (in thousands): Years ending: January 3, 1999 $1,884 January 2, 2000 1,717 January 1, 2001 1,382 December 31, 2001 1,123 December 30, 2002 779 Later years 1,167 $8,052 As of February 11, 1998, future minimum rental payments required under non-cancelable operating leases for restaurants which had not as yet opened as of December 28, 1997 are as follows (in thousands): Years ending: January 3, 1999 $857 January 2, 2000 1,091 January 1, 2001 1,098 December 31, 2001 1,137 December 30, 2002 1,158 Later years 6,195 $11,536 F-15 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. Commitments and contingencies (continued): Commitments (continued): The Company is a party to contracts aggregating $1,734,000 with respect to the construction of restaurants and approximately $1 million with respect to the Company's new corporate headquarters building to be opened in 1998. Payments of approximately $246,000 have been made on those contracts as of December 28, 1997. One of the joint ventures in which the Company is a partner has entered into a contract to purchase the land on which a restaurant is located, at the end of its five year lease on such property in 2002, for $950,000. Contingencies: The Company has received a proposal from Mario Sbarro, Joseph Sbarro, Anthony Sbarro and the Trust of Carmela Sbarro (the ``Sbarro Family'') for the merger of the Company with a company to be owned by the Sbarro Family pursuant to which shareholders of the Company, other than the Sbarro Family, would receive $28.50 per share in cash, or an aggregate of approximately $380 million for the approximately 13.4 million shares (approximately 65% of the outstanding shares) of the Company's Common Stock not owned by the Sbarro Family. The proposal is subject, among other things, to (i) entering into a definitive merger agreement, (ii) approval of the transaction by the special committee of the Board, the full Board of Directors and the Company's shareholders, (iii) receipt of satisfactory financing for the transaction, (iv) the immediate suspension of dividends by the Company and (v) receipt of a fairness opinion from the financial advisor to the special committee of the Board stating that the proposed transaction is fair, from a financial point of view, to the public shareholders. Following the Company's announcement of a proposal for the merger of the Company with a company to be owned by the Sbarro Family, seven lawsuits were instituted against the Company, certain directors and/or members of the F-16 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. Commitments and contingencies (continued): Contingencies (continued): Sbarro Family. While each of the complaints varies, in general, they allege a breach of fiduciary duties by the directors and members of the Sbarro Family, that the proposed price per share to be paid is inadequate and that the proposal serves no legitimate business purpose of the Company. Although varying, the complaints seek, generally, a declaration of class action status, damages in unspecified amounts alleged to be caused to the plaintiffs, and other relief (including injunctive relief, rescission if the transaction is consummated, including rescissory damages), costs and disbursements, including a reasonable allowance for counsel fees and expenses. The actions, which are presently pending in the Supreme Court in New York and Suffolk County, New York, are in the process of being consolidated into one action. The defendants intend to vigorously defend these actions. On June 18, 1997, an action entitled Kenneth Hoffman and Gloria Curtis, on behalf of themselves and all others similarly situated v. Sbarro, Inc., was filed in the United States District Court for the Southern District of New York. The plaintiffs, former restaurant level management employees, allege that the Company required general managers and co-managers to reimburse the Company for cash and certain other shortages sustained by the Company and thereby lost their status as managerial employees exempt from the overtime compensation provisions of the Fair Labor Standards Act (the ``FLSA''). The plaintiffs seek unpaid overtime compensation, as well as liquidated damages in an amount equal to any overtime compensation awarded, reasonable attorney's fees, costs and expenses. The plaintiffs seek such further and general legal and/or suitable relief to which they may be entitled. The action also seeks to join similarly situated past and present employees in the lawsuit. The Company believes that it has substantial defenses to the claims, including that it has availed itself of a `` window of correction'' which, the Company believes, under applicable regulations of the FLSA and court decisions, preserves employees' exempt status and, thus, precludes any overtime liability. On October 22, 1997, the Court granted plaintiffs' request to send notices to determine whether similarly situated past and present employees of the Company wished to join the lawsuit. The Company intends to continue vigorously definding this action. F-17 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. Transactions with related parties: In May 1986, the Company entered into a fifteen year sublease with a partnership owned by certain shareholders of the Company for its present corporate headquarters office building. In each of 1996 and 1995, the Company incurred rent expense for such building of $298,000. For 1997 and for each of the remaining years of the lease the rent expense is $337,000 per year. Management believes that such rents are comparable to the rents that would be charged by an unaffiliated third party. A member of the Board of Directors acts as a consultant to the Company for which he received $116,400 in 1997, $106,100 in 1996 and $96,000 in 1995. 8. Stock options: The Company's Board of Directors has adopted and shareholders have approved the 1991 Stock Incentive Plan (the `` 1991 Plan''), which replaced the Company's 1985 Incentive Stock Option Plan, and a 1993 Non-Employee Director Stock Option Plan (the ``1993 Plan''). Under the 1991 Plan, the Company may grant, until February 2001, incentive stock options and non-qualified stock options, alone or in tandem with stock appreciation rights (``SARS''), to employees and consultants of the Company and its subsidiaries. Options and SARs may not be granted at exercise prices of less than 100% of the fair market value of the Company's common stock on the date of grant. The Board of Directors and the Board's Committee administering the 1991 Plan are empowered to determine, within the limits of the 1991 Plan, the number of shares subject to each option and SAR, the exercise price, and the time period (which may not exceed ten years) and terms under which each may be exercised. The 1993 Plan provides for the automatic grant to each non- employee director of an option to purchase 3,750 shares of common stock following each annual shareholders' meeting. Each option has a ten year term and is exercisable in full commencing one year after grant at 100% of the fair market value of the Company's common stock on the date of grant. In 1997, 1996 and 1995, each of the five (six in 1995) non- employee directors were granted options to purchase 3,750 shares at $28.88, $26.88, and $21.50 per share, respectively. In 1997, 11,250 options of one former director were exercised at $23.05, $23.71 and $21.50, respectively. F-18 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. Stock options: (Continued) A summary of the status of the Company's option plans is presented in the table below: 1997 1996 1995 Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price Options outstanding, beginning of period 934,836 $25.57 717,712 $24.97 765,958 $24.75 Granted 777,750 $25.96 378,750 $25.55 37,500 $22.53 Exercised (53,745)$22.78 (47,426)$18.24 (16,502)$15.97 Canceled or expired (20,502)$24.66(114,200)$24.84 (69,244)$21.44 Options outstanding, end of period 1,638,339 $25.85 934,836 $25.57 717,712 $24.97 Options exercisable, end of period 573,880 $26.05 534,214 $25.89 463,962 $25.89 Of the options outstanding at December 28, 1997, options to purchase 106,839 shares had exercise prices ranging between $15.17 and $22.75, with a weighted average exercise price of $21.34 and a weighted average remaining contractual life of 6.23 years, of which 77,463 were exercisable, with a weighted average exercise price of $21.28. The remaining options to purchase 1,531,500 shares had exercise prices between $23.05 and $28.88, with a weighted average exercise price of $26.17 and a weighted average remaining contractual life of 7.21 years, of which 496,417 are exercisable, with a weighted average exercise price of $26.79. At December 28, 1997, there were an aggregate of 2,061,452 shares available for option grants under the 1991 and 1993 Plans. F-19 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. Stock options: (Continued) The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: 1997 1996 1995 Expected life (years) 1.5 4 4 Interest rate 5.82% 6.53% 6.51% Volatility 21% 28% 28% Dividend yield 4.00% 3.50% 3.50% Weighted average fair value of options granted $2.79 $5.75 $5.30 The Company has adopted the pro forma disclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123, `` Accounting for Stock-Based Compensation''. Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's stock option plans been determined under SFAS No. 123, the Company's net income and earnings per share would approximate the pro forma amounts below: (In thousands, except per share data) Net Income: 1997 1996 1995 As Reported 36,082 37,390 21,279 Pro Forma 35,089 37,160 21,258 Per share information: Net income per share (as reported): Basic $1.77 $1.84 $1.05 Diluted $1.76 $1.83 $1.04 Net income per share (pro forma): Basic $1.72 $1.82 $1.05 Diluted $1.71 $1.82 $1.04 The foregoing table includes options granted in 1997 under the 1991 Plan to the Company's Chairman of the Board and President to purchase 100,000 and 150,000 shares at $25.13 and $28.88 per share, respectively, and to the Company's Vice Chairman of the Board and Senior Executive Vice President to purchase 100,000 and 100,000 shares, respectively, at $25.13 per share; options granted in 1996 to the Company's Chairman of the Board and President and Senior Executive Vice President to purchase 100,000 and F-20 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. Stock options: (Continued) 50,000 shares, respectively, at $24.75 per share; options granted in 1993 under the 1991 Plan to the Company's Chairman of the Board and President, Vice Chairman of the Board and Senior Executive Vice President and one non- employee director to purchase 120,000, 90,000, 75,000 and 37,500 shares, respectively, at $27.09 per share. Each such option was granted at an exercise price equal to the fair market value of the Company's common stock on the date of grant and is exercisable for 10 years from the date of grant. Such options remain unexercised. In addition to the foregoing, in 1990, shareholder approved options were granted to the Company's Chairman of the Board and President, Vice Chairman of the Board and Senior Executive Vice President to purchase 150,000, 75,000 and 75,000 shares, respectively, at $20.67 per share, the fair market value of the Company's common stock on the date of grant, for a period of 10 years from the date of grant. Such options remain unexercised. 9. Provision for unit closings: A provision for restaurant closings in the amount of $3,300,000 ($2,046,000 or $.10 basic and diluted earnings per share after tax) relating to the Company's investment in one of its joint ventures was established in 1997 for the closing of certain of the joint venture's units. A provision for restaurant closings in the amount of $16,400,000 ($10,168,000 or $0.50 basic and diluted earnings per share after tax) was established in 1995 for the closing of approximately 40 under-performing restaurants. 10. Dividends: In 1997 and 1996, the Company declared quarterly dividends of $0.27 per share and $0.23 per share, respectively, aggregating $1.08 per share and $0.92 per share for the respective years. On February 11, 1998, the Company announced that its Board of Directors had deferred consideration of the Company's quarterly cash dividend pending consideration of a transaction that has been proposed by the Sbarro Family which would result in the acquisition at $28.50 per share in cash of all of the shares of the Company not owned by the Sbarro Family. The proposal is conditioned upon, among other things, the immediate suspension of dividends by the Company. (See Note 6) F-21 SBARRO, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. Quarterly financial information (unaudited): (In thousands, except share data) First Second Third Fourth Quarter Quarter Quarter Quarter Fiscal year 1997 Revenues $95,364 $75,301 $82,678 $96,092 Gross profit (a) 73,324 57,976 63,314 73,640 Net income (b) 7,885 6,733 9,206 12,258 Per share information: Net income per share: Basic $.39 $.33 $.45 $.60 Diluted $.39 $.33 $.45 $.60 Shares used in computation of net income per share: Basic 20,401,538 20,428,711 20,440,596 20,444,678 Diluted 20,454,534 20,599,676 20,526,757 20,529,233 Fiscal year 1996 Revenues $88,057 $71,128 $78,421 $91,882 Gross profit (a) 66,722 53,560 59,284 71,081 Net income 6,975 6,642 9,188 14,585 Per share information: Net income per share: Basic $.34 $.33 $.45 $.72 Diluted $.34 $.33 $.45 $.71 Shares used in computation of net income per share: Basic 20,348,179 20,363,607 20,379,932 20,391,774 Diluted 20,383,628 20,406,051 20,404,755 20,431,626 (a) Gross profit represents the difference between restaurant sales and the cost of food and paper products. (b) See Note 9. F-22 ARTHUR ANDERSEN LLP REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE To the Board of Directors and Shareholders of Sbarro, Inc.: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Sbarro, Inc. and subsidiaries, included in this filing and have issued our report thereon dated February 11, 1998. 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 February 11, 1998 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 Deductions Balance at Beginning Costs and Accounts Describe End of Description of Period Expenses Describe (1) Period December 28, 1997 Accumulated amortization of of deferred charges $1,436 $1,495 $(1,662) $1,269 Accumulated amortization of Canadian development rights (2) 424 57 481 Accumulated amortization of purchased leasehold rights (2) 943 213 (1,060) 96 $2,803 $1,765 $(2,722) $1,846 December 29, 1996: Accumulated amortization of deferred charges $1,573 $1,432 $(1,569) $1,436 Accumulated amortization of Canadian development rights (2) 368 56 424 Accumulated amortization of purchased leasehold rights (2) 764 179 943 $2,705 $1,667 $(1,569) $2,803 S-2 SBARRO, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS (In thousands) FOR THE THREE YEARS ENDED (Continued) December 31, 1995: Accumulated amortization of deferred charges $1,548 $1,507 $(1,482) $1,573 Accumulated amortization of Canadian development rights (2) 311 57 368 Accumulated amortization of purchased leasehold rights (2) 586 178 764 $2,445 $1,742 $(1,482) $2,705 (1) Write-off of fully amortized deferred charges (2) Included in other assets S-3 EXHIBIT INDEX Exhibit Number Description * 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 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 21, 1996, File No. 1-8881) *10.01 Commack, New York Corporate Headquarters Sublease. (Exhibit 10.04 to the Company's Registration Statement on Form S-1, File No. 2-96807) + *10.02(a) 1985 Incentive Stock Option Plan, as amended. (Exhibit 10.1 to Company's Quarterly Report on Form 10-Q for the quarter ended October 6, 1996, File No. 33-4380) + *10.02(b) 1991 Stock Incentive Plan, as amended. (Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended April 20, 1997, File No. 1- 8881) __________________________ Exhibit Index (continued): Exhibit Number Description + *10.02(c) Form of Stock Option Agreement dated May 30, 1990 between the Company and each of Anthony Sbarro, Joseph Sbarro and Mario Sbarro, together with a schedule, pursuant to Instruction 2 to Item 601 of Regulation S-K, identifying the details in which the actual agreements differ from the exhibit filed herewith. (Exhibit 10.02(c) to the Company's Annual Report on Form 10-K for the year ended December 30, 1990, File No. 1-8881) + *10.02(d) 1993 Non-Employee Director Stock Option Plan, as amended. (Exhibit 10.2 (d) to the Company's Quarterly Report on Form 10-K for the year ended April 20, 1997, File No. 1-8881) + *10.02(e) The Company's Performance Incentive Plan. (Exhibit A to the Company's Proxy Statement dated April 29, 1997, File No. 1-8881.) + *10.03 Consulting Agreement (including option) dated June 3, 1985 between the Company and Bernard Zimmerman & Company, Inc. (Exhibit 10.04 to the Company's Annual Report on Form 10-K for the year ended January 1, 1989, File No. 1-8881) + *10.04 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) 21.01 List of subsidiaries. 23.01 Consent of Arthur Andersen LLP. 27.01 Financial Data Schedule. _____________________________ * Incorporated by reference to the document indicated. + Management contract or compensatory plan. EX-23 2 EXHIBIT No. 23.01 ARTHUR ANDERSEN LLP CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated February 11, 1998, included in this Form 10-K, into Sbarro, Inc.'s previously filed Registration Statements on Form S-3 (File No. 33- 39637) and Form S-8 (File Nos. 33-4380, 33-39636 and 33- 68486). It should be noted that we have performed no audit procedures subsequent to February 11, 1998, the date of our report. Furthermore, we have not audited any financial statements of Sbarro, Inc. as of any date or for any period subsequent to December 28, 1997. /s/ Arthur Andersen LLP New York, New York March 5, 1998 EX-27 3
5 1,000 YEAR JAN-03-1999 DEC-28-1997 119,810 7,500 2,375 0 2,962 134,415 286,365 149,567 278,649 46,409 0 0 0 204 220,235 278,649 337,723 349,435 69,469 181,738 0 0 0 58,197 22,115 36,082 0 0 0 36,082 $1.77 $1.76
EX-21 4 EXHIBIT 21.01 NAME OF SUBSIDIARY STATE OF PERCENTAGE (1)(2) INCORPORATION OWNERSHIP Sbarro of Virginia, Inc. Virginia 100 Sbarro America, Inc. New York 100 Sbarro's of Texas, Inc. Texas 49(3) Italian Food Franchising, Inc. New York 100 Corest Management, Inc. New York 100 Franrest Management, Inc. New York 100 Larkfield Equipment Corp. New York 100 Sbarro of Roosevelt Field Inc. New York 100 Melville Advertising Agency, Inc. New York 100 401 Broadhollow Realty Corp. New York 100 (1) Excludes subsidiaries which, if considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary (within the meaning of Rule 1- 02(v) of Regulation S-X) as of the end of the fiscal year covered by this report. (2) Indentation indicates the direct parent of an indirect subsidiary. (3) Sbarro America, Inc. beneficially owns 100% of the outstanding shares of the indicated subsidiary. -----END PRIVACY-ENHANCED MESSAGE-----