10-Q 1 april202003-10q.txt APRIL 20, 2003 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [ ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED APRIL 20, 2003 COMMISSION FILE NUMBER 333-90817 SBARRO, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) NEW YORK 11-2501939 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER I.D. NO.) INCORPORATION OR ORGANIZATION) 401 BROAD HOLLOW ROAD, MELVILLE, NEW YORK 11747 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (631) 715-4100 INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS, AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES NO --------------- ------------ INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED TITLE (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES NO X --------------- ------------ THE NUMBER OF SHARES OF COMMON STOCK OF THE REGISTRANT OUTSTANDING AS OF MAY 30, 2003 WAS 7,064,328. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SBARRO, INC. FORM 10-Q INDEX --------------- PART I. FINANCIAL INFORMATION PAGES --------------------- ----- Consolidated Financial Statements: Balance Sheets - April 20, 2003 (unaudited) and December 29, 2002........3-4 Statements of Operations (unaudited) - Sixteen Weeks ended April 20, 2003 and April 21, 2002.....................................................5 Statements of Cash Flows (unaudited) - Sixteen Weeks ended April 20, 2003 And April 21, 2002..............................................6-7 Notes to Unaudited Consolidated Financial Statements - April 20, 2003...8-22 Management's Discussion and Analysis of Financial Condition and Results of Operations..........................................................23-30 Qualitative and Quantitative Disclosures of Market Risk.......................31 Controls and Procedures.......................................................31 PART II. OTHER INFORMATION....................................................32 ----------------- Page 2 PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
(In thousands except share data) -------------------------------------- April 20, 2003 December 29, 2002 -------------- ----------------- (unaudited) Current assets: Cash and cash equivalents $38,785 $55,150 Restricted cash for untendered shares 21 21 Receivables, net of allowance for doubtful accounts of $265 in 2003 and $491 in 2002: Franchisee 1,802 2,059 Other 2,120 1,244 -------- -------- 3,922 3,303 Inventories 2,354 3,285 Prepaid expenses 7,064 2,362 Current portion of loans receivable from shareholders - 3,232 -------- -------- Total current assets 52,146 67,353 Property and equipment, net 110,533 115,081 Intangible assets: Trademarks, net 195,916 195,916 Goodwill, net 9,204 9,204 Deferred financing costs and other, net 6,303 6,632 Loans receivable from shareholders, less current portion 6,032 2,800 Other assets 8,243 7,787 -------- -------- $388,377 $404,773 ======== ========
See notes to unaudited consolidated financial statements Page 3 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED) LIABILITIES AND SHAREHOLDERS' EQUITY
(In thousands except share data) -------------------------------------- April 20, 2003 December 29, 2002 -------------- ----------------- (unaudited) Current liabilities: Amounts due for untendered shares $21 $21 Accounts payable 14,511 10,279 Accrued expenses 17,597 21,623 Accrued interest payable 2,787 8,181 Current portion of mortgage payable 171 154 Total current liabilities 35,087 40,258 -------- -------- Deferred rent 8,790 8,474 Long-term debt, net of original issue discount 267,990 267,941 Contingencies Shareholders' equity: Preferred stock, $1 par value; authorized 1,000,000 shares; none issued - - Common stock, $.01 par value; authorized 40,000,000 shares; issued and outstanding 7,064,328 shares at April 20, 2003 and December 29, 2002 71 71 Additional paid-in capital 10 10 Retained earnings 76,429 88,019 -------- -------- 76,510 88,100 -------- -------- $388,377 $404,773 ======== ========
See notes to unaudited consolidated financial statements Page 4 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands except share data) -------------------------------------- April 20, 2003 April 21, 2002 -------------- --------------- Revenues: Restaurant sales $88,509 $100,769 Franchise related income 2,939 2,743 Real estate and other 1,667 1,694 -------- -------- Total revenues 93,115 105,206 -------- -------- Costs and expenses: Restaurant operating expenses: Cost of food and paper products 19,304 20,008 Payroll and other employee benefits 26,211 28,489 Other operating costs 33,532 35,717 Depreciation and amortization 5,896 6,824 General and administrative 8,719 7,155 Provision for restaurant closings 529 124 -------- -------- Total costs and expenses 94,191 98,317 -------- -------- Operating (loss) income before minority interest (1,076) 6,889 Minority interest (5) (19) -------- -------- Operating (loss) income (1,081) 6,870 -------- -------- Other income (expense): Interest expense (9,583) (9,574) Interest income 214 154 Equity in net income of unconsolidated affiliates 281 261 -------- -------- Net other expense (9,088) (9,159) -------- -------- Loss before income taxes (10,169) (2,289) Income taxes 321 132 -------- -------- Net loss $(10,490) $(2,421) ======== ========
See notes to unaudited consolidated financial statements Page 5 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands except share data) ---------------------------------------- April 20, 2003 April 21, 2002 -------------- -------------- Operating activities: Net loss $(10,490) $(2,421) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 6,365 7,271 Increase in deferred rent, net 90 262 Loss on sale of other concept units included in prior year asset impairment costs 250 - Minority interest 5 19 Equity in net income of unconsolidated affiliates (281) (261) Dividends received from unconsolidated affiliate 119 311 Changes in operating assets and liabilities: (Increase) decrease in receivables (220) 154 Decrease in inventories 932 490 Increase in prepaid expenses (4,424) (2,147) Increase in other assets (195) - Increase (decrease) in accounts payable and accrued expenses 1,100 (7,786) Decrease in accrued interest payable (5,394) (5,394) ------ ------ Net cash used in operating activities (12,143) (9,502) ------- ------
See notes to unaudited consolidated financial statements Page 6 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (UNAUDITED)
(In thousands except share data) ---------------------------------------- April 20, 2003 April 21, 2002 -------------- -------------- Investing activities: Purchases of property and equipment $(3,071) $(1,721) ------- ------- Net cash used in investing activities (3,071) (1,721) ------- ------- Financing activities: Mortgage principal repayments (50) (46) Tax distributions related to the prior fiscal year (1,101) (3,125) ------ ------ Net cash used in financing activities (1,151) (3,171) ------ ------ Decrease in cash and cash equivalents (16,365) (14,394) Cash and cash equivalents at beginning of period 55,150 36,952 ------ ------ Cash and cash equivalents at end of period $38,785 $22,558 ======= ======= Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $119 $340 ==== ==== Cash paid during the period for interest $14,548 $14,497 ======= =======
See notes to unaudited consolidated financial statements Page 7 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION: The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Regulation S-X related to interim period financial statements and, therefore, do not include all information and footnotes required by generally accepted accounting principles. However, in the opinion of our management, all adjustments (consisting of normal recurring adjustments and accruals) considered necessary for a fair presentation of the consolidated financial position of Sbarro and our subsidiaries at April 20, 2003 and our consolidated results of operations and cash flows for the sixteen week periods ended April 20, 2003 and April 21, 2002 have been included. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the entire year. Reference should be made to the annual financial statements, including footnotes thereto, included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2002. 2. NEW ACCOUNTING PRONOUNCEMENTS: In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64. Amendment of FASB Statement No. 13 and Technical Corrections." This statement eliminates the prior requirement that gains and losses on debt extinguishment must be classified as extraordinary items in the income statement and contains other nonsubstantive corrections to authoritative accounting literature in SFAS No. 4, 44 and 64. The changes in SFAS No. 145 related to debt extinguishment were effective for us at the beginning of our 2003 fiscal year and the other changes were effective for us beginning with transactions after May 15, 2002. Adoption of this standard has not had a material effect on our financial position and results of operations. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses accounting for restructuring and similar costs. SFAS No. 146 supersedes previous accounting guidance, principally EITF Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of a company's commitment for an exit plan. SFAS No. 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS No. 146 may affect the timing of recognizing future restructuring costs (including our future accounting for restaurant closing costs) as well as the amount recognized. We adopted the provisions of SFAS No. 146 for restructuring activities Page 8 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) initiated after December 29, 2002. The adoption of SFAS No. 146 has not had a material effect on our financial position or results of operations. In November 2002, the FASB issued FIN No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees including Indirect Guarantees of Indebtedness of Others" which addresses the accounting for and disclosure by guarantors regarding obligations relating to the issuance of certain guarantees. FIN No. 45 requires that, for all guarantees issued or modified after December 31, 2002, a liability for the fair value of the obligation undertaken be recorded at the inception of a guarantee. No revision of or restatement of accounting for guarantees issued or modified prior to December 31, 2002 is allowed. The disclosure requirements of Interpretation No. 45 were effective with our 2002 financial statements. As described in the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 29, 2002, we have provided certain guarantees that would require recognition upon issuance or modification under the provisions of FIN 45. While the nature of our business will likely result in the issuance of certain guarantees in the future, we do not anticipate that FIN 45 will have a material impact on our financial position or results of operations. 3. LONG-TERM DEBT: We have received a waiver of compliance for the first quarter of fiscal 2003 from certain ratios required to be maintained under our bank credit agreement, as had been amended in March 2003. Our credit agreement requires that we maintain a minimum ratio of consolidated EBITDA to consolidated interest expense (in each case with the guaranteeing subsidiaries, the same entities as our Restricted Subsidiaries under the indenture) of at least 1.4 to 1.0 beginning December 30, 2002 and 1.5 to 1.0 beginning December 28, 2003 for the four quarters ended April 20, 2003, this ratio was 1.36 to 1. We are also required to maintain a maximum ratio of consolidated senior debt to consolidated EBITDA (in each case with the guaranteeing subsidiaries) of 6.5 to 1.0 beginning December 30, 2002 and 6.0 to 1.0 beginning December 28, 2003. For the four quarters ended April 20, 2003, this ratio was 6.67 to 1. We are subject to various covenants under the indenture under which our senior notes are issued and under our bank credit agreement. One of the covenants limits our ability to borrow funds (except under specifically permitted arrangements, such as up to $75.0 million of revolving credit loans) unless our consolidated interest ratio coverage (as defined), after giving pro forma effect to the interest on the new borrowing, for the four most recently ended fiscal quarters is at least 2.5 to 1. Another covenant limits our ability to make "restricted payments," including, among other things, dividend payments (other than as distributions pursuant to our tax payment agreement with our shareholders related to Subchapter S distributions) and investments in, among other things, unrestricted subsidiaries, to specified amounts determined under a formula contained in the indenture Page 9 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) provided that that ratio is at least 2.0 to 1 after giving pro forma effect to the restricted payment. For the four fiscal quarters ended April 20, 2003, our consolidated interest coverage ratio was 1.59 to 1. As a result, we are not presently able to borrow funds (other than the specifically permitted indebtedness). Additionally, under the formula contained in the indenture, we may not presently make restricted payments other than certain permitted investments and tax distributions. We cannot make restricted payments until we increase the restricted payment availability by approximately $10.8 million, and then only to the extent of any excess over that amount. We were in compliance with the various covenants in the indenture for our senior notes, and our mortgage as of April 20, 2003. 4. INCOME TAXES: During the first quarter of fiscal 2003, we made a Subchapter S tax distribution to our shareholders, based on our tax basis income for fiscal 2002, that totaled $1.1 million compared to a $3.1 million Subchapter S tax distribution made, during the first quarter of fiscal 2002 based on our tax basis income for fiscal 2001. 5. RELATED PARTY TRANSACTIONS: On April 6, 2003, loans of $3.23 million to certain of our shareholders were extended to April 6, 2005. The notes bear interest at 4.63% per annum. On March 3, 2003, a company in which Gennaro J. Sbarro, who is a Corporate Vice President and President of our Casual and Fine Dining Division, has a 50% interest, signed a franchise agreement with us for a new location. The terms of the franchise agreement are similar to those in agreements entered into by us with unrelated franchisees. The lease for the location was entered into in September 2002 by one of our subsidiaries. Subsequent to that date, we determined that the economics of the location would be better suited for a franchise operator and, as such, it was subsequently subleased to this franchisee. Payments under the sublease will be made directly to the landlord by the franchisee. Future minimum rental payments under the lease for this location over the term of the lease, which expires in 2018, are approximately $2.6 million. The location is expected to open in the second quarter of fiscal 2003. 6. LITIGATION: On December 20, 1999, fourteen current and former general managers of Sbarro restaurants in California amended a complaint against us filed in the Superior Court of California for Orange County. The complaint alleges that the plaintiffs were improperly classified as exempt employees under the California wage and hour law. The plaintiffs are seeking actual damages, punitive damages and costs of the lawsuit, including Page 10 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) as a class action, but the Court denied the motion. The trial was reasonable attorney's fees, each in unspecified amounts. Plaintiffs filed a motion to certify the lawsuit concluded in April 2003, and the parties have submitted post-trial briefs. The Court has not yet issued a judgment. On September 6, 2000, eight other current and former general managers of Sbarro restaurants in California filed a complaint against us in the Superior Court of California for Orange County alleging that the plaintiffs were improperly classified as exempt employees under California wage and hour law. The plaintiffs are seeking actual damages, punitive damages and costs of the lawsuit, including reasonable attorney's fees, each in unspecified amounts. Plaintiffs are represented by the same counsel who is representing the plaintiffs in the case discussed in the preceding paragraph. We have separately settled with four of the plaintiffs in this action for immaterial amounts. On March 22, 2002, five former general managers of Sbarro restaurants in California filed a complaint against us in the Superior Court of California for Los Angeles County. The complaint alleges that the plaintiffs were illegally required to perform labor services without proper premium overtime compensation from at least May of 1999. The plaintiffs are seeking actual damages, punitive damages and attorney's fees and costs, each in unspecified amounts. In addition, plaintiffs have requested class action status for all managerial employees who worked overtime and/or were not otherwise paid regular wages due and owing from May 1999 to present. We believe that we have substantial defenses in each of the actions and are vigorously defending these actions. In addition to the above complaints, from time to time, we are a party to certain claims and legal proceedings in the ordinary course of business. In our opinion, the results of the complaints and other claims and legal proceedings are not expected to have a material adverse effect on our consolidated financial position or results of operations. 7. GUARANTOR AND NON-GUARANTOR FINANCIAL STATEMENTS: Certain subsidiaries have guaranteed amounts outstanding under our senior notes and bank credit agreement. Each of the guaranteeing subsidiaries is our direct or indirect wholly owned subsidiary and each has fully and unconditionally guaranteed the senior notes and the credit agreement on a joint and several basis. The following condensed consolidating financial information presents: (1) Condensed consolidating balance sheets as of April 20, 2003 (unaudited) and December 29, 2002 and statements of operations and cash flows for the fiscal quarters ended April 20, 2003 (unaudited) and April 21, 2002 (unaudited) of (a) Page 11 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Sbarro, Inc., the parent, (b) the guarantor subsidiaries as a group, (c) the nonguarantor subsidiaries as a group and (d) Sbarro on a consolidated basis. (2) Elimination entries necessary to consolidate Sbarro, Inc., the parent, with the guarantor and nonguarantor subsidiaries. The principal elimination entries eliminate intercompany balances and transactions. Investments in subsidiaries are accounted for by the parent on the cost method. Page 12 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING BALANCE SHEET AS OF APRIL 20, 2003 (IN THOUSANDS EXCEPT SHARE DATA) (UNAUDITED) ASSETS
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Current assets: Cash and cash equivalents $33,863 $3,907 $1,015 $38,785 Restricted cash for untendered shares 21 - - 21 Receivables less allowance for Doubtful accounts of $265: Franchise 1,802 - - 1,802 Other 926 709 485 2,120 -------- -------- ------ -------- 2,728 709 485 3,922 Inventories 998 1,220 136 2,354 Prepaid expenses 6,220 623 221 7,064 -------- -------- ------ -------- Total current assets 43,830 6,459 1,857 52,146 Intercompany receivables 4,323 319,850 - $(324,173) - Investment in subsidiaries 65,469 - - (65,469) - Property and equipment, net 41,508 63,447 5,578 - 110,533 Intercompany receivables - long term 3,158 - - (3,158) - Intangible assets, net: Trademarks, net 195,916 - - - 195,916 Goodwill, net 9,204 - - - 9,204 Deferred financing costs and others, net 6,043 260 - - 6,303 Loans receivable from shareholders 6,032 - - - 6,032 Other assets 9,319 2,155 (754) (2,477) 8,243 -------- -------- ------ --------- -------- $384,802 $392,171 $6,681 $(395,277) $388,377 ======== ======== ====== ========= ========
Page 13 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING BALANCE SHEET AS OF APRIL 20, 2003 (IN THOUSANDS EXCEPT SHARE DATA) (UNAUDITED) LIABILITIES AND SHAREHOLDERS' EQUITY
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Current liabilities: Amounts due for untendered shares $21 $21 Accounts payable 13,351 $224 $936 14,511 Accrued expenses 14,398 1,293 1,906 17,597 Accrued interest payable 2,787 - - 2,787 Current portion of mortgage payable - 171 - 171 -------- -------- ------ -------- Total current liabilities 30,557 1,688 2,842 35,087 Intercompany payables 319,850 - 4,323 $(324,173) - Deferred rent 8,110 - 680 - 8,790 Long-term debt, net of original issue discount 252,565 15,425 - - 267,990 Intercompany payables - long term - 3,158 - (3,158) - Shareholders' equity (deficit): Preferred stock, $1 par value; authorized 1,000,000 shares; none issued - - - - - Common stock, $.01 par value: authorized 40,000,000 shares; issued and outstanding 7,064,328 shares 71 - - - 71 Additional paid-in capital 10 65,469 2,477 (67,946) 10 Retained earnings (deficit) (226,361) 306,431 (3,641) - 76,429 -------- -------- ------ --------- -------- (226,280) 371,900 (1,164) (67,946) 76,510 -------- -------- ------ --------- -------- $384,802 $392,171 $6,681 $(395,277) $388,377 ======== ======== ====== ========= ========
Page 14 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING BALANCE SHEET AS OF DECEMBER 29, 2002 (IN THOUSANDS EXCEPT SHARE DATA) ASSETS
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Current assets: Cash and cash equivalents $47,636 $6,539 $975 $55,150 Restricted cash for untendered shares 21 - - 21 Receivables less allowance for doubtful accounts of $491: Franchise 2,059 - 2,059 Other 69 1,088 87 1,244 ------ ----- ----- ------ 2,128 1,088 87 3,303 Inventories 1,417 1,725 143 3,285 Prepaid expenses 2,677 (342) 27 2,362 Current portion of loans receivable from shareholders 3,232 - - 3,232 ------ ----- ----- ------ Total current assets 57,111 9,010 1,232 67,353 Intercompany receivables 5,197 313,877 - $(319,074) - Investment in subsidiaries 65,469 - - (65,469) - Property and equipment, net 42,762 65,726 6,593 - 115,081 Intercompany receivables - long term 3,308 - - (3,308) - Intangible assets: Trademarks, net 195,916 - - - 195,916 Goodwill, net 9,324 - - (120) 9,204 Deferred financing costs, net 6,361 271 - - 6,632 Loans receivable from shareholders, less current portion 2,800 - - - 2,800 Other assets 8,742 1,705 (303) (2,357) 7,787 ----- ----- ---- ------ ----- $396,990 $390,589 $7,522 $(390,328) $404,773 ======== ======== ====== ========== ========
Page 15 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING BALANCE SHEET AS OF DECEMBER 29, 2002 (IN THOUSANDS EXCEPT SHARE DATA) LIABILITIES AND SHAREHOLDERS' EQUITY
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Current liabilities: Amounts due for untendered shares $21 $21 Accounts payable 9,503 $212 $564 10,279 Accrued expenses 17,887 1,560 2,176 21,623 Accrued interest payable 8,181 - - 8,181 Current portion of mortgage payable - 154 - 154 -------- ------- ------ ------ Total current liabilities 35,592 1,926 2,740 40,258 -------- ------- ------ ------ Intercompany payables 313,877 - 5,197 $(319,074) - -------- ------- ------ ---------- ------ Deferred rent 7,793 - 681 - 8,474 -------- ------- ------ ------- ------ Long-term debt, net of original issue discount 252,449 15,492 - - 267,941 -------- ------- ------ ------- ------ Intercompany payables - long term - 3,308 - (3,308) - -------- ------- ------ ------- ------ Shareholders' equity (deficit): Preferred stock, $1 par value; authorized 1,000,000 shares; None issued - - - - - Common stock, $.01 par value: authorized 40,000,000 shares; issued and outstanding 7,064,328 shares 71 - - - 71 Additional paid-in capital 10 65,469 2,477 (67,946) 10 Retained earnings (deficit) (212,802) 304,394 (3,573) - 88,019 -------- ------- ------ ------- ------ (212,721) 369,863 (1,096) (67,946) 88,100 -------- ------- ------ ------- ------ $396,990 $390,589 $7,522 $(390,328) $404,773 ======== ======== ====== ========== ========
Page 16 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS FOR THE SIXTEEN WEEKS ENDED APRIL 20, 2003 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- REVENUES: --------- Restaurant sales $37,415 $46,595 $4,499 $88,509 Franchise related income 2,939 - - 2,939 Real estate and other 780 887 - - 1,667 Intercompany charges - 3,160 - $(3,160) - -------- -------- ------- --------- -------- Total revenues 41,134 50,642 4,499 (3,160) 93,115 -------- -------- ------- --------- -------- Cost and expenses: Restaurant operating expenses: Cost of food and paper products 7,798 10,324 1,182 - 19,304 Payroll and other employee benefits 10,831 13,794 1,586 - 26,211 Other operating costs 14,938 17,337 1,257 - 33,532 Depreciation and amortization 2,645 2,940 311 - 5,896 General and administrative 4,999 3,626 94 - 8,719 Provision for restaurant closings 399 - 130 - 529 Intercompany charges 3,160 - - (3,160) - -------- -------- ------- --------- -------- Total costs and expenses 44,770 48,021 4,560 (3,160) 94,191 -------- -------- ------- --------- -------- Operating income (loss) before minority interest (3,636) 2,621 (61) - (1,076) Minority interest - - (5) - (5) -------- -------- ------- --------- -------- Operating (loss) income (3,636) 2,621 (66) - (1,081) -------- -------- ------- --------- -------- Other (expense) income: Interest expense (9,131) (452) - - (9,583) Interest income 214 - - - 214 Equity in net income of Unconsolidated affiliates 281 - - - 281 -------- -------- ------- --------- -------- Net other expense (8,636) (452) - - (9,088) -------- -------- ------- --------- -------- (Loss) income before income taxes (12,272) 2,169 (66) - (10,169) Income taxes 188 131 2 - 321 -------- -------- ------- --------- -------- Net (loss) income $(12,460) $2,038 $(68) $ - $(10,490) ========= ====== ==== ========== =========
Page 17 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS FOR THE SIXTEEN WEEKS ENDED APRIL 21, 2002 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- REVENUES: --------- Restaurant sales $41,413 $52,203 $7,153 $100,769 Franchise related income 2,743 - - 2,743 Real estate and other 809 1,161 - $(276) 1,694 Intercompany charges - 4,050 - (4,050) - ------- ------ -------- ---------- ------- Total revenues 44,965 57,414 7,153 (4,326) 105,206 ------- ------ -------- ---------- ------- Cost and expenses: Restaurant operating expenses: Cost of food and paper products 7,378 10,754 1,876 - 20,008 Payroll and other employee benefits 10,722 15,170 2,597 - 28,489 Other operating costs 14,781 18,417 2,519 - 35,717 Depreciation and amortization 2,927 3,532 365 - 6,824 General and administrative 3,600 3,728 103 (276) 7,155 Provision for restaurant closings 100 - 24 - 124 Intercompany charges 4,050 - - (4,050) - ------- ------ -------- ---------- ------- Total costs and expenses 43,558 51,601 7,484 (4,326) 98,317 ------- ------ -------- ---------- ------- Operating income (loss) before minority interest 1,407 5,813 (331) - 6,889 Minority interest - - (19) - (19) ------- ------ -------- ---------- ------- Operating income (loss) 1,407 5,813 (350) - 6,870 ------- ------ -------- ---------- ------- Other (expense) income: Interest expense (9,121) (453) - - (9,574) Interest income 154 - - - 154 Equity in net income of unconsolidated affiliates 261 - - - 261 ------- ------ -------- ---------- ------- Net other expense (8,706) (453) - - (9,159) ------- ------ -------- ---------- ------- Income (loss) before income taxes (7,299) 5,360 (350) - (2,289) Income taxes (benefit) (158) 309 (19) - 132 ------- ------ -------- ---------- ------- Net income (loss) $(7,141) $5,051 $(331) $ - $(2,421) ======== ====== ===== ========== ========
Page 18 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE SIXTEEN WEEKS ENDED APRIL 20, 2003 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- OPERATING ACTIVITIES: --------------------- Net (loss) income $(12,460) $2,038 $(68) $(10,490) Adjustments to reconcile net (loss) income to net cash used in operating activities: Depreciation and amortization 3,499 2,557 309 6,365 Loss on sale of other concept units included in prior year asset impairment costs - - 250 250 Increase in deferred rent, net 109 (19) - 90 Minority interest - - 5 5 Equity in net income of unconsolidated affiliates (281) - - (281) Dividends received from unconsolidated affiliates 119 - - 119 Changes in operating assets and liabilities: (Increase) decrease in receivables (600) 379 1 (220) Decrease in inventories 419 506 7 932 Increase in prepaid expenses (3,334) (896) (194) (4,424) (Increase) decrease in other assets (286) (360) 451 (195) Increase in accounts payable and accrued expenses 776 231 93 1,100 Decrease in accrued interest payable (5,394) - - (5,394) ------- -------- -------- --------- Net cash (used in) provided by operating activities (17,433) 4,436 854 (12,143) ------- -------- -------- --------- Investing activities: Purchase of property and equipment (2,233) (755) (83) (3,071) ------- -------- -------- --------- Net cash used in investing activities (2,233) (755) (83) (3,071) ------- -------- -------- ---------
Page 19 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE SIXTEEN WEEKS ENDED APRIL 20, 2003 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- FINANCING ACTIVITIES: --------------------- Mortgage principal repayments $(50) $(50) Tax distribution $(1,101) - (1,101) Intercompany balances 6,994 (6,263) $(731) - ------- ------- ------- ------- Net cash provided by (used in) financing activities 5,893 (6,313) (731) (1,151) ------- ------- ------- ------- (Decrease) increase in cash and cash equivalents (13,773) (2,632) 40 (16,365) Cash and cash equivalents at Beginning of period 47,636 6,539 975 55,150 ------- ------- ------- ------- Cash and cash equivalents at end of period $33,863 $3,907 $1,015 $38,785 ======= ======= ====== ======= Supplemental disclosure of cash flow Information: Cash paid during the period for income taxes $91 $15 $13 $119 === === === ==== Cash paid during the period for Interest $14,110 $438 $ - $14,548 ======= ==== ====== =======
Page 20 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE SIXTEEN WEEKS ENDED APRIL 21, 2002 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- OPERATING ACTIVITIES: --------------------- Net (loss) income $(7,141) $5,051 $(331) $(2,421) Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization 3,362 3,544 365 7,271 Increase in deferred rent, net 272 (54) 44 262 Minority interest - - 19 19 Equity in income of Unconsolidated affiliates (261) - - (261) Dividends received from Unconsolidated affiliates 311 - - 311 Changes in operating assets and liabilities: Decrease (increase) in receivables 187 (13) (20) 154 Decrease in inventories 246 186 58 490 Increase in prepaid assets (755) (1,153) (239) (2,147) (Increase) decrease in other assets (183) 264 39 $(120) - (Decrease) increase in accounts Payable and accrued expenses (5,854) (1,162) (890) 120 (7,786) Decrease in accrued interest Payable (5,394) - - - (5,394) -------- -------- ------ ------ -------- Net cash (used in) provided by operating activities (15,210) 6,663 (955) - (9,502) -------- -------- ------ ------ -------- Investing activities: --------------------- Purchases of property and equipment (1,347) (416) 42 - (1,721) -------- -------- ------ ------ -------- Net cash (used in) provided by investing activities (1,347) (416) 42 - (1,721) -------- -------- ------ ------ --------
Page 21 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE SIXTEEN WEEKS ENDED APRIL 21, 2002 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- FINANCING ACTIVITIES: --------------------- Mortgage principal repayments - (46) - - (46) Tax distribution (3,125) - - - (3,125) Intercompany balances 6,939 (7,574) 635 - - ------- ------ -------- ------- ------- Net cash (used in) provided by financing activities 3,814 (7,620) 635 - (3,171) ------- ------ -------- ------- ------- Decrease in cash and cash equivalents (12,743) (1,373) (278) - (14,394) Cash and cash equivalents at beginning of period 29,673 5,437 1,842 - 36,952 ------- ------ -------- ------- ------- Cash and cash equivalents at end of period $16,930 $4,064 $1,564 $ - $22,558 ======= ====== ======== ======= ======= Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $233 $107 $ - $ - $340 ======= ==== ======== ======= ======= Cash paid during the period for interest $14,055 $442 $ - $ - $14,497 ======= ==== ======== ======= =======
Page 22 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS --------------------- The following table provides information concerning the number of Company-owned and franchised restaurants in operation during each indicated period:
16 WEEKS 16 WEEKS FISCAL YEAR ENDED ENDED ---------------------- 04/20/03 04/21/02 2002 2001 -------- -------- ---- ---- Company-owned restaurants: Opened during period - 2 13 9 Acquired from (sold to) franchisees during period-net (4) - (6) - Closed during period (9) (11) (51) (43) --- --- --- --- Open at end of period (1) 545 593 558 602 Franchised restaurants: Opened during period 10 7 42 42 Purchased from (sold to) Company during period-net 4 - 6 - Closed or terminated during period (8) (8) (20) (20) --- --- --- --- Open at end of period 359 324 353 325 All restaurants: Opened during period 10 9 55 51 Closed or terminated during period (17) (19) (71) (63) --- --- --- --- Open at end of period (1) 904 917 911 927 Kiosks (all franchised) open at end of period 3 4 3 4
-------------------- (1) Excludes 30, 34, 32 and 37 other concept units as of April 20, 2003 and April 21, 2002, the end of fiscal 2002 and the end of fiscal 2001, respectively. Page 23 Our business is subject to seasonal fluctuations, the effect of weather and economic conditions. Earnings have been highest in our fourth fiscal quarter due primarily to increased volume in shopping malls during the holiday shopping season but fluctuates due to the length of the holiday shopping period between Thanksgiving and New Year's Day and the number of weeks in our fourth quarter. In recent years, our fourth quarter income has also fluctuated significantly due to a number of additional factors, including the adverse effect of the general economic downturn, the continuing effect of the events of September 11, 2001 and significant year end adjustments relating to asset impairment and store closing costs. Due to the seasonality of our business, we perform the annual testing for impairment on our trademarks and goodwill as required by SFAS 142 after our fourth quarter is completed and more information is available to us. The evaluation of impairment of long-lived assets as required by SFAS 144 is made when events or circumstances indicate that the carrying amount of the assets may not be recoverable and considers many factors, in addition to seasonality. If impairment factors are present earlier than year-end, we record any adjustments as determined necessary through interim testing at that time. Our consolidated EBITDA for the sixteen weeks ended April 20, 2003 was $5.0 million compared to $14.0 million for the sixteen weeks ended April 21, 2002. EBITDA represents earnings before interest income, interest expense, taxes, depreciation and amortization. EBITDA should not be considered in isolation from, or as a substitute for, net income, cash flow from operations or other cash flow statement data prepared in accordance with generally accepted accounting principles ("GAAP") of the United States measure of a company's profitability or liquidity. Rather, we believe that EBITDA provides relevant and useful information for analysts and investors in our senior notes in that EBITDA is one of the factors in the calculation of our compliance with the ratios in the indenture under which our senior notes are issued and bank credit agreement and to determine the commitment fee we pay on the unused portion of our credit facility. We also internally use EBITDA as one of the measures to determine whether to continue or close restaurant units since it provides us with a measurement of whether we are receiving an adequate cash return on our cash investment. Our calculation of EBITDA may not be comparable to a similarly titled measure reported by other companies, since all companies do not calculate this non-GAAP measure in the same manner. Our EBITDA calculations are not intended to represent cash provided by (used in) operating activities since they do not include interest and taxes and changes in operating assets and liabilities, nor are they intended to represent a net increase in cash since they do not include cash provided by (used in) investing and financing activities. The following table reconciles EBITDA to our net loss which we believe is the most direct comparable financial measure to EBITDA, for each of the sixteen week periods presented (in thousands): 2003 2002 ---- ---- EBITDA $5,096 $13,955 Interest expense (9,583) (9,574) Interest income 214 154 Income taxes (321) (132) Depreciation and amortization (5,896) (6,824) -------- ------- Net loss $(10,490) $(2,421) ======== ======= Page 24 Restaurant sales from Sbarro-owned quick service units and consolidated other concept units decreased 12.2% to $88.5 million for the sixteen weeks ended April 20, 2003 from $100.8 million in the sixteen weeks ended April 21, 2002. The decrease in sales reflects $9.6 million of lower sales of Sbarro quick service units and $2.6 million of lower sales of consolidated other concept units. Of the decline in Sbarro quick service unit restaurant sales, approximately $6.3 million resulted from a 7.1% decrease in comparable unit sales to $84.6 million. We believe this decline was attributable to a reduction in shopping mall traffic related to the general economic downturn in the United States, the continuing impact of the events of September 11, 2001 and the effects of the threatened and then actual military action in Iraq during the first quarter of fiscal 2003. Comparable restaurant sales are made up of sales at locations that were open during the entire current and prior fiscal years. Since the end of fiscal 2001, we closed 47 more units than we opened (including nine units closed during the first quarter of fiscal 2003), causing the remaining $3.3 million net reduction in Sbarro quick service unit sales. The units closed since the end of fiscal 2001, were generally low volume units that did not have a material impact on our results of operations. Of the decline in consolidated other concept unit sales, approximately $0.7 million resulted from a 14.4% decrease in comparable unit sales to $4.2 million. We believe that this decline was attributable to the same factors that affected Sbarro quick service locations. In addition, since the end of fiscal 2001, eight consolidated other concept units have been closed, which resulted in a net sales reduction of $1.9 million from sales at those locations in the first quarter of fiscal 2003. Franchise related income increased 7.1% to $2.9 million for the sixteen weeks ended April 20, 2003 from $2.7 million in the sixteen-week period ended April 21, 2002. This increase was from royalties earned from locations opened during fiscal 2003 and 2002 offset, in part, by a 4.7% reduction in comparable unit sales at both domestic and international locations in the first quarter of fiscal 2003. Real estate and other revenues decreased 1.6% in the first fiscal quarter of 2003 from the same period in fiscal 2002 primarily due to changes in certain vendor rebates. Cost of food and paper products as a percentage of restaurant sales increased to 21.8% for the sixteen weeks ended April 20, 2003 from 19.9% for the comparable 2002 fiscal period. In early fiscal 2003, we replaced our national independent wholesale distributor with another national independent wholesale distributor due to the bankruptcy of our then national wholesale food distributor. We do not believe there will be a material impact on the cost of food and paper products from this new distribution arrangement as the majority of the products used in our restaurants are proprietary and we are involved in negotiating their cost to the wholesaler. However, the cost of sales percentage in the first quarter of 2003 was impacted by the cost of purchases of product from third parties until the new distribution contract was effective as well as by the decrease in comparable sales. In addition, without changing the effect on the final product, we modified our pizza and pasta sauce recipes to utilize ready made sauce instead of crushed tomatoes as the base raw material. We estimate that this has added approximately .75% to our cost of food. The use of this product allows for more effective use of our restaurant staff in enhancing the overall guest experience at our quick-service locations. Changes in cheese prices did not have a significant effect on the change in cost of sales in the first quarter of fiscal 2003. Page 25 Cheese prices to date in the second quarter to date of fiscal 2003 have been slightly lower than in the comparable period in fiscal 2002. Payroll and other employee benefits decreased by $2.3 million, as a percentage of restaurant sales, increased to 29.6% in the sixteen weeks ended April 20, 2003 from 28.3% of restaurant sales in the sixteen weeks ended April 21, 2002. Both effects were primarily due to the reduced level of sales. Other operating expenses decreased by $2.2 million but increased to 37.9% of restaurant sales in the sixteen weeks ended April 20, 2003 from 35.4% in the sixteen weeks ended April 21, 2002 primarily due to increases in rent and other occupancy related expenses resulting from the renewal of existing leases at the end of their terms at higher rental rates, compounded, in the case of the percentage of restaurant sales, by the reduced level of sales. In addition, we are continuing to experience increases in our repair and maintenance costs due to the number of years that the majority of our locations have been operating and the results of the long-term utilization of their equipment. Depreciation and amortization expense decreased by $0.9 million for the first quarter of fiscal 2003 from the same period in fiscal 2002. The reduction was due to fewer numbers of units in operation in fiscal 2003 ($0.6 million) and for locations that had been included in the provision for asset impairment in fiscal 2002 for which no depreciation was taken in fiscal 2003 and decreases in depreciation and amortization for locations that became fully depreciated during fiscal 2002. General and administrative expenses were $8.7 million, or 9.4% of total revenues, for the sixteen weeks ended April 20, 2003, compared to $7.2 million, or 6.8% of total revenues, for the sixteen weeks ended April 21, 2002. Factors contributing to the increases were $0.2 million of legal fees incurred in connection with a lawsuit tried in fiscal 2003, a $0.2 million allowance for doubtful accounts receivable recorded with respect to our franchisee in Spain that declared bankruptcy during the first quarter of fiscal 2003, bonuses of $0.7 million that were granted to certain executive officers and higher quick-service field management travel and related costs relating to a number of regional field management meetings that were held in the beginning of fiscal 2003. During the first sixteen weeks of fiscal 2003 and 2002, we recorded provisions for restaurant closings of $0.5 million and $0.1 million, respectively. Minority interest represents the share of the minority holders' interests in the earnings or loss of a joint venture in which we have a majority interest. In early fiscal 2002, we closed one of the two locations owned by this joint venture. The closed unit had a nominal operating loss in the first quarter of fiscal 2002. Interest expense of $9.6 million for the first quarter of both fiscal 2003 and 2002 relates to the 11%, $255.0 million senior notes issued to finance our going private transaction ($8.6 million), the 8.4%, $16.0 million mortgage loan on our corporate headquarters in 2001 ($0.5 million) and fees for unused borrowing capacity under our credit agreement ($0.1 million). In addition, $0.4 million in each of the first quarter of fiscal 2003 and 2002 represents non-cash charges for the Page 26 total of the accretion of the original issue discount on our senior notes and the amortization of deferred financing costs on the senior notes, credit agreement and the mortgage loan. Interest income was approximately $0.2 million for each of the first quarters of fiscal 2003 and 2002. Higher cash available for investment in fiscal 2003 than in fiscal 2002 was offset by the lower prevailing interest rates in effect. The indenture under which our senior notes are issued and our credit agreement limit the types of investments which we may make. Equity in the net income of unconsolidated affiliates represents our proportionate share of earnings and losses in those other concepts in which we have a 50% or less ownership interest. The increase in our share of the equity in the net income of unconsolidated affiliates was primarily as a result of improved performance of our steakhouse joint venture. We have determined that we will continue, to the extent agreed with our joint venture partners, to develop and expand the steakhouse joint venture locations but do not intend to expand our other joint venture operations. We have elected to be taxed under the provisions of Subchapter S of the Internal Revenue Code and, where applicable and permitted, under similar state and local income tax provisions beginning January 3, 2000. Under the provisions of Subchapter S, substantially all taxes on our income are paid by our shareholders rather than us. Our tax expense for both the first quarter of fiscal 2003 and fiscal 2002 of approximately $0.3 million and $0.1 million, respectively, was for taxes owed to jurisdictions that do not recognize S corporation status or that tax entities based on factors other than income. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- We have historically not required significant working capital to fund our existing operations and have financed our capital expenditures and investments in our joint ventures through cash generated from operations. At April 20, 2003, we had unrestricted cash and cash equivalents of $38.8 million and working capital of $17.1 million compared to unrestricted cash and cash equivalents of $22.5 million and working capital of $8.5 million at April 21, 2002. Net cash used in operating activities was $12.1 million for the sixteen weeks ended April 20, 2003 compared to $9.5 million used during the sixteen weeks ended April 21, 2002. The $2.6 million increase in cash used resulted primarily from an $8.9 million reduction in EBITDA, an increase in prepaid expenses of approximately $2.3 million, primarily due to an increase in prepaid insurance in fiscal 2003 as compared to fiscal 2002, offset, in large part, by an $8.9 million increase in accounts payable and accrued expenses. Of the increase in accounts payable, approximately $2.6 million relates to the amount accrued for our bankrupt former national independent wholesale distributor. We are in negotiations with its creditors' committee with regard to the amount, if any, owed as we believe that significant additional costs were incurred after the bankruptcy filing date due to the bankruptcy. Accrued expenses for the first quarter of fiscal 2003 include the accrued bonuses of $0.7 million for certain executive officers discussed above. The increase also reflects approximately $2.1 million related to the financing of our insurance policies in fiscal 2003. Although our policies were also financed in fiscal 2002, no amounts were accrued as the financing terms had yet been finalized. Page 27 Net cash used in investing activities has historically been primarily for capital expenditures, including investments made by our consolidated other concepts. Net cash used in investing activities increased from $1.7 million for the sixteen weeks ended April 21, 2002 to $3.1 million for the sixteen weeks ended April 20, 2003 primarily due to an increase in quick service and renovation activity. Net cash used in financing activities was $1.2 million for the sixteen weeks ended April 20, 2003 compared to $3.2 million in the comparable 2002 period, caused by a $2.0 million reduction in tax distributions to shareholders. We incur annual cash interest expense of approximately $29.7 million under our senior notes and mortgage loan and may incur additional interest expense for borrowings under our credit agreement. In addition to debt service, we expect that our other liquidity needs will relate to capital expenditures, working capital, investments in other ventures, distributions to shareholders permitted under the indenture for the senior notes and the credit agreement and general corporate purposes. We believe that aggregate restaurant capital expenditures and our investments in joint ventures during the next twelve months will approximate the fiscal 2002 levels. We expect our primary sources of liquidity to meet these needs will be cash flow from operations. Also at May 30, 2003, we had $28.1 million of undrawn availability under our bank credit agreement, net of outstanding letters of credit and guarantees of reimbursement obligations aggregating approximately $1.9 million. We are subject to various covenants under the indenture under which our senior notes are issued and under our bank credit agreement. One of the covenants limits our ability to borrow funds (except under specifically permitted arrangements, such as up to $75.0 million of revolving credit loans) unless our consolidated interest ratio coverage (as defined), after giving pro forma effect to the interest on the new borrowing, for the four most recently ended fiscal quarters is at least 2.5 to 1. Another covenant limits our ability to make "restricted payments," including, among other things, dividend payments (other than as distributions pursuant to our tax payment agreement with our shareholders related to Subchapter S distributions) and investments in, among other things, unrestricted subsidiaries, to specified amounts determined under a formula contained in the indenture provided that that ratio is at least 2.0 to 1 after giving pro forma effect to the restricted payment. For the four fiscal quarters ended April 20, 2003, our consolidated interest coverage ratio was 1.59 to 1. As a result, we are not presently able to borrow funds (other than the specifically permitted indebtedness). Additionally, under the formula contained in the indenture, we may not presently make restricted payments other than certain permitted investments and tax distributions. We cannot make restricted payments until we increase the restricted payment availability by approximately $10.8 million, and then only to the extent of any excess over that amount. The tax payment agreement was entered into as part of our election that our shareholders, rather than us, be taxed on our taxable income pursuant to Subchapter S of the Internal Revenue Code and, where applicable and permitted, under similar state and local tax provisions. The Tax Payment Agreement permits us, regardless of whether we can make restricted payments, to make Page 28 periodic tax distributions to our shareholders in amounts intended to approximate the income taxes, including estimated taxes, that would be payable by them if their only income were their pro rata share of our taxable income and that income was taxed at the highest applicable Federal and New York state marginal income tax rates. Our contractual obligations and off balance sheet arrangements with respect to both our Sbarro quick service and our other concepts (both those in which we have a majority or minority interest) do not differ materially from the information disclosed in Item 7, Part 2 of our Annual Report on Form 10-K for the 2002 fiscal year. We have received a waiver of compliance for the first quarter of fiscal 2003 from certain ratios required to be maintained under our bank credit agreement, as amended in March 2003. Our credit agreement requires that we maintain a minimum ratio of consolidated EBITDA to consolidated interest expense (in each case with the guaranteeing subsidiaries, the same entities as our Restricted Subsidiaries under the indenture) of at least 1.4 to 1.0 beginning December 30, 2002 and 1.5 to 1.0 beginning December 28, 2003 on the four quarters ended April 20, 2003, this ratio was 1.36 to 1. We are also required to maintain a maximum ratio of consolidated senior debt to consolidated EBITDA (in each case with the guaranteeing subsidiaries) of 6.5 to 1.0 beginning December 30, 2002 and 6.0 to 1.0 beginning December 28, 2003. For the four quarters ended April 20, 2003, this ratio was 6.67 to 1. CRITICAL ACCOUNTING POLICIES AND JUDGMENTS ------------------------------------------ Accounting policies are an integral part of the preparation of our financial statements in accordance with accounting principles generally accepted in the United States of America. Understanding these policies, therefore, is a key factor in understanding our reported results of operations and financial position. Certain critical accounting policies require us to make estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported in the financial statements. Due to their nature, estimates involve judgments based upon available information. Therefore, actual results or amounts could differ from estimates and the difference could have a material impact on our consolidated financial statements. During the sixteen weeks ending April 20, 2003, there have been no material changes in the accounting policies whose application may have a significant effect on our reported results of operations and financial position and that can require judgments by management that can affect their application from the matters discussed under the heading "Critical Accounting Policies and Judgments" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2002. FORWARD LOOKING STATEMENTS -------------------------- This report contains certain forward-looking statements about our financial condition, results of operations, future prospects and business. These statements appear in a number of places in the report and include statements regarding our intent, belief, expectation, strategies or projections at that time. These statements generally contain words such as "may," "should," "seeks," "believes," "in our opinion," "expects," "intends," "plans," "estimates," "projects," "strategy" and similar expressions or the negative of those words. Page 29 Forward-looking statements are subject to a number of known and unknown risks and uncertainties that could cause actual results to differ materially from those projected, expressed or implied in the forward-looking statements. These risks and uncertainties, many of which are not within our control, include but are not limited to: o general economic, weather and business conditions; o the availability of suitable restaurant sites in appropriate regional shopping malls and other locations on reasonable rental terms; o changes in consumer tastes; o changes in population and traffic patterns, including the effect that military action and terrorism or other events may have on the willingness of consumers to frequent shopping malls, airports or downtown areas which are the predominant areas in which our restaurants are located; o our ability to continue to attract franchisees; o the success of the our present, and any future, joint ventures and other expansion opportunities; o the availability of food (particularly cheese and tomatoes) and paper products at current prices; o our ability to pass along cost increases to our customers; o no material increase occurring in the Federal minimum wage; o the continuity of services of members of our senior management team; o our ability to attract and retain competent restaurant and executive managerial personnel; o competition; o the level of, and our ability to comply with, government regulations; o our ability to generate sufficient cash flow to make interest payments and principal under our senior notes and credit agreement; o our ability to comply with covenants contained in the indenture under which the senior notes are issued and in our bank credit agreement, and the effects which the restrictions imposed by those covenants may have on our ability to operate our business; and o our ability to repurchase senior notes to the extent required and make repayments under our credit agreement to the extent required in the event we make certain asset sales or experience a change of control. You are cautioned not to place undue reliance on these statements, which speak only as of the date of the report. We do not undertake any responsibility to release publicly any revisions to these forward-looking statements to take into account events or circumstances that occur after the date of this report. Additionally, we do not undertake any responsibility to update you on the occurrence of any unanticipated events which may cause actual results to differ from those expressed or implied by the forward-looking statements contained in this report. Page 30 ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES OF MARKET RISK We have historically invested our cash on hand in short term, fixed rate, highly rated and highly liquid instruments which are reinvested when they mature throughout the year. The indenture under which our senior notes are issued limits the investments we may make. Although our existing investments are not considered at risk with respect to changes in interest rates or markets for these instruments, our rate of return on short-term investments could be affected at the time of reinvestment as a result of intervening events. Future borrowings under our credit facility (none are currently outstanding) will be at rates that float with the market and, therefore, will be subject to fluctuations in interest rates. Our $255.0 million senior notes bear a fixed interest rate of 11.0%. We are not a party to, and do not expect to enter into any interest rate swaps or other instruments to hedge interest rates. We have not, and do not expect to, purchase future, forward, option or other instruments to hedge against fluctuations in the prices of the commodities we purchase. As a result, our future commodities purchases are subject to changes in the prices of such commodities. All of our transactions with foreign franchisees have been denominated in, and all payments have been made in, United States dollars, reducing the risks attendant in changes in the values of foreign currencies. As a result, we have not purchased future contracts, options or other instruments to hedge against changes in values of foreign currencies. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures Within 90 days prior to the date of this report, an evaluation was carried out of the effectiveness of the design and operation of our "disclosure controls and procedures," as defined in, and pursuant to Rule 13a-14c of the Securities Exchange Act of 1934 by our Chairman of the Board, President and principal executive officer and Vice President, Controller and principal accounting officer (the person performing the function of our principal financial officer). Based on that evaluation these officers concluded that, as of the date of their evaluation, our disclosure controls and procedures were effective to ensure that material information relating to us and our subsidiaries is made known to them. (b) Changes in internal controls There were no significant changes in our internal controls or in other factors that could significantly affect these internal controls subsequent to the evaluation discussed above. Page 31 PART II. OTHER INFORMATION -------------------------- Item 1. Legal proceedings On December 20, 1999, fourteen current and former general managers of Sbarro restaurants in California amended a complaint against us filed in the Superior Court of California for Orange County. The complaint alleges that the plaintiffs were improperly classified as exempt employees under the California wage and hour law. The plaintiffs are seeking actual damages, punitive damages and costs of the lawsuit, including reasonable attorney's fees, each in unspecified amounts. Plaintiffs filed a motion to certify the lawsuit as a class action, but the Court denied the motion. The trial was concluded in April 2003, and the parties have submitted post-trial briefs. The Court has not yet issued a judgment. Item 6. Exhibits and Reports on Form 8-K. a) Exhibits: 4.02(d) Letter agreement dated May 30, 2003 with respect to the Credit Agreement dated as of September 23, 1999 between Sbarro, Inc. and Citibank N.A. as successor to European American Bank, as agent. 99.01 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.02 Certification of Vice President, Controller and Principal Accounting Officer, the person performing the function of our principal financial officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K: None Page 32 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. SBARRO, INC. ------------------------------------- Registrant Date: June 3, 2003 By: /s/ MARIO SBARRO --------------------- ------------------------------------- Mario Sbarro Chairman of the Board and President (Principal Executive Officer) Date: June 3, 2003 By: /s/ STEVEN B. GRAHAM --------------------- ------------------------------------- Steven B. Graham Vice President and Controller (Principal Accounting Officer) Page 33 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Mario Sbarro, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Sbarro, Inc.; 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Quarterly Report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and Page 34 b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: June 3, 2003 /s/ MARIO SBARRO ---------------------------------------- Mario Sbarro, Chairman of the Board and President (Principal Executive Officer) Page 35 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Steven B. Graham, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Sbarro, Inc.; 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Quarterly Report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors: a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and Page 36 report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: June 3, 2003 /s/ STEVEN B. GRAHAM ---------------------------------------- Steven B. Graham, Vice President and Controller (Principal Accounting Officer and person performing the function of our principal financial officer) Page 37 EXHIBIT INDEX ------------- EXHIBIT NUMBER DESCRIPTION -------------- ----------- 4.02(d) Letter agreement dated May 30, 2003 with respect to the Credit Agreement dated as of September 23, 1999 between Sbarro, Inc. and Citibank N.A. as successor to European American Bank, as agent. 99.01 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.02 Certification of Vice President, Controller, Principal Accounting Officer, the person performing the function of our principal financial officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.