-----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, QV/TcGLLQ6mDasodyaW3au1dyBQF4y0A5IBXSeeNjqfFLc7Vphi1SSOqGgywvIn0 kFsJNhbVMPW9rWOXj+99Cw== 0000910680-03-001007.txt : 20031119 0000910680-03-001007.hdr.sgml : 20031119 20031119164031 ACCESSION NUMBER: 0000910680-03-001007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20031005 FILED AS OF DATE: 20031119 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: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 002-96807 FILM NUMBER: 031013307 BUSINESS ADDRESS: STREET 1: 401 BROADHOLLOW ROAD CITY: MELVILLE STATE: NY ZIP: 11747 BUSINESS PHONE: 5168640200 MAIL ADDRESS: STREET 1: 401 BROADHOLLOW ROAD CITY: MELVILLE STATE: NY ZIP: 11747 10-Q 1 f10q-10052003.txt OCTOBER 5, 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 OCTOBER 5, 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 FILER (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES NO X ------------ ------------ THE NUMBER OF SHARES OF COMMON STOCK OF THE REGISTRANT OUTSTANDING AS OF NOVEMBER 13, 2003 WAS 7,064,328. ================================================================================ SBARRO, INC. FORM 10-Q INDEX --------------- PART I. FINANCIAL INFORMATION PAGES --------------------- ----- Consolidated Financial Statements: Balance Sheets - October 5, 2003 (unaudited) and December 29, 2002......3-4 Statements of Operations (unaudited) - Forty Weeks and Twelve Weeks ended October 5, 2003 and October 6, 2002.....................5-6 Statements of Cash Flows (unaudited) - Forty Weeks ended October 5, 2003 and October 6, 2002............................................7-8 Notes to Unaudited Consolidated Financial Statements-October 5, 2003...9-27 Management's Discussion and Analysis of Financial Condition and Results of Operations..........................................................28-38 Qualitative and Quantitative Disclosures of Market Risk.......................38 Controls and Procedures.......................................................39 PART II. OTHER INFORMATION................................................40 PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
(IN THOUSANDS, EXCEPT SHARE DATA) ------------------------------------------- OCTOBER 5, 2003 DECEMBER 29, 2002 --------------- ----------------- (UNAUDITED) CURRENT ASSETS: CASH AND CASH EQUIVALENTS $31,049 $55,150 RESTRICTED CASH FOR UNTENDERED SHARES 21 21 RECEIVABLES, NET OF ALLOWANCE FOR DOUBTFUL ACCOUNTS OF $488 IN 2003 AND $491 IN 2002: FRANCHISEE 1,717 2,059 OTHER 1,704 1,244 -------- -------- 3,421 3,303 INVENTORIES 2,299 3,285 PREPAID EXPENSES 8,945 2,362 CURRENT PORTION OF LOANS RECEIVABLE FROM SHAREHOLDERS 58 3,232 -------- -------- TOTAL CURRENT ASSETS 45,793 67,353 PROPERTY AND EQUIPMENT, NET 100,685 115,081 INTANGIBLE ASSETS: TRADEMARKS, NET 195,916 195,916 GOODWILL, NET 9,204 9,204 DEFERRED FINANCING COSTS AND OTHER, NET 5,806 6,632 LOANS RECEIVABLE FROM SHAREHOLDERS, LESS CURRENT PORTION 6,104 2,800 OTHER ASSETS 8,154 7,787 -------- -------- $371,662 $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) ------------------------------------------- OCTOBER 5, 2003 DECEMBER 29, 2002 --------------- ----------------- (UNAUDITED) CURRENT LIABILITIES: AMOUNTS DUE FOR UNTENDERED SHARES $21 $21 ACCOUNTS PAYABLE 13,801 10,279 ACCRUED EXPENSES 15,644 21,623 ACCRUED INTEREST PAYABLE 1,708 8,181 CURRENT PORTION OF MORTGAGE PAYABLE 205 154 -------- -------- TOTAL CURRENT LIABILITIES 31,379 40,258 DEFERRED RENT 8,885 8,474 LONG-TERM DEBT, NET OF ORIGINAL ISSUE DISCOUNT, LESS CURRENT PORTION 268,054 267,941 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 OCTOBER 5, 2003 AND DECEMBER 29, 2002 71 71 ADDITIONAL PAID-IN CAPITAL 10 10 RETAINED EARNINGS 63,263 88,019 -------- -------- 63,344 88,100 -------- -------- $371,662 $404,773 ======== ========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Page 4 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS) -------------- FOR THE FORTY WEEKS ENDED: -------------------------- OCTOBER 5, 2003 OCTOBER 6, 2002 --------------- --------------- REVENUES: RESTAURANT SALES $ 228,863 $254,454 FRANCHISE RELATED REVENUES 7,625 7,636 REAL ESTATE AND OTHER 4,448 4,334 ----------- -------- TOTAL REVENUES 240,936 266,424 ----------- -------- COSTS AND EXPENSES: RESTAURANT OPERATING EXPENSES: COST OF FOOD AND PAPER PRODUCTS 49,248 49,864 PAYROLL AND OTHER EMPLOYEE BENEFITS 66,357 71,867 OTHER OPERATING COSTS 85,790 89,152 DEPRECIATION AND AMORTIZATION 14,820 15,784 GENERAL AND ADMINISTRATIVE 20,122 17,985 ASSET IMPAIRMENT AND RESTAURANT CLOSING CHARGES, NET 4,467 2,911 ----------- -------- TOTAL COSTS AND EXPENSES 240,804 247,563 ----------- -------- OPERATING INCOME BEFORE MINORITY INTEREST 132 18,861 MINORITY INTEREST (22) (36) ----------- -------- OPERATING INCOME 110 18,825 ----------- -------- OTHER INCOME (EXPENSE): INTEREST EXPENSE (23,930) (23,905) INTEREST INCOME 569 390 EQUITY IN NET INCOME OF UNCONSOLIDATED AFFILIATES 270 692 INSURANCE RECOVERY, NET - 7,162 ----------- -------- NET OTHER EXPENSE (23,091) (15,661) ----------- -------- LOSS (INCOME) BEFORE INCOME TAXES (22,981) 3,164 INCOME TAXES 675 276 ----------- -------- NET (LOSS) INCOME $(23,656) $2,888 =========== ========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Page 5 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS) -------------- FOR THE TWELVE WEEKS ENDED: --------------------------- OCTOBER 5, 2003 OCTOBER 6, 2002 --------------- --------------- REVENUES: RESTAURANT SALES $72,109 $ 78,006 FRANCHISE RELATED REVENUES 2,295 2,561 REAL ESTATE AND OTHER 1,374 1,319 ------- ------ TOTAL REVENUES 75,778 81,886 ------- ------ COSTS AND EXPENSES: RESTAURANT OPERATING EXPENSES: COST OF FOOD AND PAPER PRODUCTS 15,701 15,010 PAYROLL AND OTHER EMPLOYEE BENEFITS 20,530 21,811 OTHER OPERATING COSTS 26,261 26,775 DEPRECIATION AND AMORTIZATION 4,411 3,872 GENERAL AND ADMINISTRATIVE 6,056 5,286 ASSET IMPAIRMENT AND RESTAURANT CLOSING CHARGES, NET 3,410 682 ------- ------ TOTAL COSTS AND EXPENSES 76,369 73,436 ------- ------ OPERATING (LOSS) INCOME BEFORE MINORITY INTEREST (591) 8,450 MINORITY INTEREST (12) ( 3) ------- ------ OPERATING (LOSS) INCOME (603) 8,447 ------- ------ OTHER INCOME (EXPENSE): INTEREST EXPENSE (7,167) (7,165) INTEREST INCOME 158 130 EQUITY IN NET (LOSS) INCOME OF UNCONSOLIDATED AFFILIATES (241) 147 INSURANCE RECOVERY, NET - 7,162 ------- ------ NET OTHER EXPENSE (7,250) 274 ------- ------ (LOSS) INCOME BEFORE INCOME TAXES (7,853) 8,721 INCOME TAXES 101 75 ------- ------ NET (LOSS) INCOME $(7,954) $8,646 ======== ======
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Page 6 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS) -------------- FOR THE FORTY WEEKS ENDED: -------------------------- OCTOBER 5, 2003 OCTOBER 6, 2002 --------------- --------------- OPERATING ACTIVITIES: NET (LOSS) INCOME $(23,656) $2,888 ADJUSTMENTS TO RECONCILE NET (LOSS) INCOME TO NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES: DEPRECIATION AND AMORTIZATION 15,938 16,939 ASSET IMPAIRMENT AND RESTAURANT CLOSING CHARGES 5,070 2,046 INCREASE IN DEFERRED RENT, NET 232 403 GAIN ON SALE OF OTHER CONCEPT UNIT (200) - LOSS ON SALE OF OTHER CONCEPT UNIT INCLUDED IN PRIOR YEAR ASSET IMPAIRMENT COSTS 250 - MINORITY INTEREST 22 36 EQUITY IN NET INCOME OF UNCONSOLIDATED AFFILIATES (270) (692) DIVIDENDS RECEIVED FROM UNCONSOLIDATED AFFILIATE 119 311 CHANGES IN OPERATING ASSETS AND LIABILITIES: DECREASE IN RECEIVABLES 351 881 DECREASE IN INVENTORIES 987 741 INCREASE IN PREPAID EXPENSES (6,371) (7,507) INCREASE IN OTHER ASSETS (105) (181) DECREASE IN ACCOUNTS PAYABLE AND ACCRUED EXPENSES (2,501) (6,012) DECREASE IN ACCRUED INTEREST PAYABLE (6,473) (6,473) -------- -------- NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (16,607) 3,380 -------- --------
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Page 7 SBARRO, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (UNAUDITED)
(IN THOUSANDS) -------------- FOR THE FORTY WEEKS ENDED: -------------------------- OCTOBER 5, 2003 OCTOBER 6, 2002 --------------- --------------- INVESTING ACTIVITIES: PURCHASES OF PROPERTY AND EQUIPMENT $(6,265) $(6,611) -------- -------- NET CASH USED IN INVESTING ACTIVITIES (6,265) (6,611) -------- -------- FINANCING ACTIVITIES: MORTGAGE PRINCIPAL REPAYMENTS (128) (117) TAX DISTRIBUTIONS RELATED TO THE PRIOR FISCAL YEAR (1,101) (3,125) -------- -------- NET CASH USED IN FINANCING ACTIVITIES (1,229) (3,242) -------- -------- DECREASE IN CASH AND CASH EQUIVALENTS (24,101) (6,473) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 55,150 36,952 -------- -------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $31,049 $30,479 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: CASH PAID DURING THE PERIOD FOR INCOME TAXES $378 $626 ==== ==== CASH PAID DURING THE PERIOD FOR INTEREST $29,250 $29,247 ======= =======
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Page 8 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION: The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Regulation S-X related to interim period financial statements and, therefore, do not include all information and footnotes required by generally accepted accounting principles. However, in the opinion of our management, all adjustments (consisting of normal recurring adjustments and accruals) considered necessary for a fair presentation of our consolidated financial position at October 5, 2003, our consolidated results of operations for the forty and twelve week periods ended October 5, 2003 and October 6, 2002 and cash flows for the forty week periods then ended 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 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. SFAS 146 changes the timing of expense recognition for certain costs we incur while closing restaurants or undertaking other exit or disposal activities; however, the timing difference is not typically significant length. Adoption of SFAS 146 did not have a material impact on our financial statements for the quarter and year to date ended October 5, 2003. In November 2002, the FASB issued Financial Interpretation (`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 Page 9 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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 include 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. FIN 46, "Consolidation of Variable Interest Entities," is effective immediately for all enterprises with variable interests in variable interest entities created after January 31, 2003. The provisions of FIN 46 must be applied to interests in variable interest entities created before February 1, 2003 beginning with the first reporting period after December 15, 2003, which will be our 2003 fiscal year end. If an entity is determined to be a variable interest entity, it must be consolidated by the enterprise that absorbs the majority of the entity's expected losses if they occur, receives a majority of the entity's expected residual returns if they occur, or both. Where it is reasonably possible that the enterprise will consolidate or disclose information about a variable interest entity, the enterprise must disclose the nature, purpose, size and activity of the variable interest entity and the enterprise's maximum exposure to loss as a result of its involvement with the variable interest entity in all financial statements issued after January 31, 2003. On October 9, 2003, the FASB issued FASB Staff Position No. FIN 46-6 "Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities," which defers the implementation date for public entities that hold an interest in a variable interest entity or potential variable interest entity from the first fiscal year or interim period beginning after June 15, 2003 to the end of the first interim or annual period ending after December 15, 2003. This deferral applies only if (1) the variable interest entity was created before February 1, 2003 and (2) the public entity has not issued financial statements reporting that variable interest entity in accordance with FIN 46, other than disclosures required by paragraph 26 of FIN 46. As of the date of this filing, we understand the FASB is in the process of further modifying and/or clarifying certain provisions of FIN 46. These modifications, when finalized, could impact our analysis of the applicability of FIN 46 to entities that are our franchisees. We are aware of certain interpretations by some parties of the provisions of FIN 46, given its continuing evolution, which could have applicability when certain conditions exist that are not representative of a typical franchise relationship. These conditions include the franchisor possessing an equity interest in or providing significant levels of financial support to a franchisee, including lease guarantees. We do not possess any ownership interests in our franchisees and we do not provide financial support to franchisees in our typical franchise relationship with the exception of non-cancelable operating lease guarantees for approximately 30 franchise locations. While we continue to monitor and analyze developments regarding FIN 46 that would impact its applicability to franchise relationships, at this time we do not believe that the required consolidation of franchise entities, if any, would materially impact our financial statements. Page 10 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) We have also reviewed our corporate relationships for possible coverage under FIN 46 and have determined that they will not have a material effect on our disclosures and our financial position or results of operations. The required disclosures for any variable interest entity have been included in our Form 10-K for the fiscal year ended December 29, 2002 3. LONG-TERM DEBT: Our credit agreement required that we maintain a minimum ratio of consolidated earnings before interest, taxes and depreciation and amortization ("EBITDA") to consolidated interest expense and a maximum ratio of consolidated senior debt to consolidated EBITDA. We have not been in compliance with the required ratios, as amended, during 2003. Our bank waived compliance with these covenants but we would not have been able to borrower under this arrangement. We requested, and the bank agreed, to terminate the bank's lending commitment. We had not made any borrowings under the line of credit since its inception, except for a required one day borrowing upon the activation of the credit agreement and except with respect to letters of credit that have been issued by the bank under the sublimit of the line. The termination of the bank's lending commitment eliminates our obligation to pay a commitment fee on the unused portion of the facility. Our obligations under the credit agreement to reimburse the bank with respect to any drawings that may be made under the approximately $1.7 million of letters of credit that are outstanding as of November 19, 2003 will remain in full force. We have agreed to either arrange for the replacement of the letters of credit or to cash collateralize them by January 9, 2004. The credit agreement will remain in effect until such time as outstanding letters of credit shall have been drawn upon in full, expired or otherwise terminate, except for our ability to borrow or obtain letters of credit and except that compliance with our financial and certain other covenants has been waived until the termination date of the credit agreement. We are in the process of negotiating for an uncommitted line of credit from other banks in a presently undetermined amount, but there can be no assurance that we will be able to obtain the line. We are subject to various covenants under the indenture under which our senior notes are issued. 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 (except with respect to certain permitted investments and tax distributions) our interest coverage ratio is at Page 11 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) least 2.0 to 1 after giving pro forma effect to the restricted payment. For the four fiscal quarters ended October 5, 2003, our consolidated interest coverage ratio was 1.1 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 cannot make restricted payments, other than certain permitted investments and tax distributions, until we increase the restricted payment availability by approximately $18 million, and then only to the extent of any excess over that amount. We were in compliance, as of October 5, 2003, with the various covenants contained in the indenture for our senior notes and our mortgage. 4. EXECUTIVE EMPLOYMENT AGREEMENT: On September 8, 2003, we entered into an employment agreement with Michael O'Donnell, our new President and Chief Executive Officer, which terminates December 31, 2006. The agreement provides, among other things, for an annual salary of $450,000; an annual performance bonus beginning in 2004 to be based upon the achievement of increases in EBITDA and other objectives to be set forth in business plans and budgets approved from time to time by our board, which bonus, for the year ending December 31, 2004, will not be less than $112,500; $1,000,000 of life insurance; certain relocation, travel and housing expenses incurred by Mr. O'Donnell; and a special incentive award. The special incentive award is designed to reward Mr. O'Donnell for improvements in our adjusted EBITDA, cash position and long term debt position over the term of the agreement, vests upon termination of Mr. O'Donnell's employment, is reduced in the event of early termination of employment and, when earned, is payable, with interest, in twelve equal quarterly installments. Alternatively, in the event of a public offering of our common stock, a change in control of Sbarro by merger, sale of stock or sale of assets, or a liquidation or dissolution of Sbarro, the special incentive award would be based on the per share proceeds received by our shareholders in excess of a threshold amount. The agreement also provides for severance pay in the event of early termination by us without "cause" (as defined) or by Mr. O'Donnell for "good reason" (as defined). Since the ultimate amount of the special incentive award is not known until termination of the agreement, the special incentive award is subject to variable plan accounting. There will be no charge to our earnings until our EBITDA, cash position and/or long-term debt position improves or a special event occurs. No compensation expense relating to the special incentive award was recorded in the twelve or forty weeks ended October 5, 2003. 5. INCOME TAXES: During the forty weeks ended October 5, 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 of Subchapter S tax distribution made during the forty weeks ended October 6, 2002 based on our tax basis income for fiscal 2001. Page 12 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. 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 28, 2003, we extended a loan of $40,000 to Gennaro A. Sbarro, Corporate Vice President and President of our Franchising and Licensing Division, to March 28, 2004. The note bears interest at 2.69% per annum. Anthony Missano, Corporate Vice President and President of our Quick Service Division, entered into a note dated June 15, 2003 in our favor in the amount of $89,687, bearing interest at 2.96%, payable in five equal annual installments commencing in June 2004, with respect to the payment of royalties due us for 2001 and 2000 from a former franchisee that was owned by Mr. Missano's wife, the daughter of Joseph Sbarro. On March 3, 2003, a company in which Gennaro J. Sbarro, then our Corporate Vice President and President of our Casual and Fine Dining Division and the son of Joseph Sbarro, has a 50% interest (the other 50% is owned by an unaffiliated third party) entered into a franchise agreement with us for a new location. 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, we entered into the franchise agreement and subleased the premises to this franchisee. Payments under the sublease will be made directly to the landlord by the franchisee. The franchise agreement is on terms and conditions similar to those in other franchise arrangements we have entered into in similar situations with unrelated third parties. The franchise agreement provides for the payment of 5% of the location's sales as a continuing royalty but does not provide for any initial franchise fee. Future minimum rental payments under the lease for this location over the term of the lease, which expires in 2018, aggregate approximately $2.6 million. The location is expected to open in the first quarter of fiscal 2004. As of October 31, 2003, Gennaro J. Sbarro resigned from his positions as Corporate Vice - President and President of our Casual and Fine Dining division. A corporation owned by Mr. Sbarro entered into an eighteen month agreement to provide consulting services to our quick service and casual dining division for $22,500 per month as well as reimbursement for customary and usual expenses that may be incurred. Mr. Sbarro has entered into a note for $54,538, that is repayable over the same eighteen month period with no interest, to reimburse Sbarro for costs advanced by Sbarro in connection with the franchise location. In October 2003, we sold the assets of three Sbarro-owned locations separately to each of three of Anthony Sbarro's sons. Two of the locations, which had no remaining book value, were transferred for no consideration while the third was sold for $0.3 million, that was paid in full, and resulted in a gain to Sbarro of approximately $0.1 million. Two of Page 13 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) the locations were marginally profitable in fiscal 2002 while the third had a small loss during that period. In connection with the sale of the locations, their employment with Sbarro was terminated and we will include total severance pay of approximately $60,000 in our fourth quarter results of operations. The franchise agreements are on terms and conditions similar to those other franchise arrangements we have entered into in similar situation with unrelated third parties. The agreements provide for the payment of 5% of the location's sales as a continuing royalty but does not provide for any initial franchise fee. In addition, we subleased two of the locations to two of the franchisees. The third location is on a month-to-month basis any new lease entered into by the franchisee will not be guaranteed or subleased by Sbarro. Payments under the subleases are being made directly to the landlord by the franchisees. Future minimum rental payments under the leases for the two locations being subleased over the terms of the leases, which expire in 2006 and 2016, aggregate approximately $2.0 million. We will review the fair value of these lease guarantees in accordance with FIN 45. 7. 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 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 ruling. 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. The parties to this case have agreed that it will be settled upon the same terms and conditions that the court orders in connection with its decision in the case discussed in the preceding paragraph. On March 22, 2002, five former general managers of Sbarro restaurants in California filed a complaint against 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 Page 14 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. This case is currently in the discovery phase. 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. 8. PROVISION FOR ASSET IMPAIRMENT During the third quarter of fiscal 2003, we recorded a $3.0 million for impairment of property and equipment (based on the net book value of the property and equipment). 9. 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 October 5, 2003 (unaudited) and December 29, 2002 and statements of operations for the forty and twelve weeks ended October 5, 2003 (unaudited) and October 6, 2002 (unaudited) and cash flows for the forty weeks ended October 5, 2003 (unaudited) and October 6, 2002 (unaudited) of (a) 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 15 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING BALANCE SHEET AS OF OCTOBER 5, 2003 (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED) ASSETS
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Current assets: Cash and cash equivalents $26,958 $3,302 $789 $31,049 Restricted cash for untendered 21 - - 21 shares Receivables net of allowance for doubtful accounts of $488: Franchise 1,717 - - 1,717 Other 133 822 749 1,704 ------ ----- ----- ------ 1,850 822 749 3,421 Inventories 1,013 1,156 130q 2,299 Prepaid expenses 6,627 2,119 199 8,945 Current portion of loans receivable from shareholders 58 - - - 58 ------ ----- ----- ------ Total current assets 36,527 7,399 1,867 45,793 Intercompany receivables 6,440 312,612 - $(319,052) - Investment in subsidiaries 65,469 - - (65,469) - Property and equipment, net 35,628 59,845 5,212 - 100,685 Intangible assets, net: Trademarks, net 195,916 - - - 195,916 Goodwill, net 9,324 - - (120) 9,204 Deferred financing costs and other, net 5,565 241 - - 5,806 Loans receivable from shareholders 6,104 - - - 6,104 Other assets 9,472 1,833 (794) (2,357) 8,154 ----------- ----------- ---------- --------- -------- $370,445 $381,930 $6,285 $(386,998) $371,662 ======== ======== ====== ========== ========
Page 16 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING BALANCE SHEET AS OF OCTOBER 5, 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 12,959 $255 $587 13,801 Accrued expenses 12,207 1,379 2,058 15,644 Accrued interest payable 1,708 - - 1,708 Current portion of mortgage payable - 205 - 205 ----------- ----------- ---------- -------- Total current liabilities 26,895 1,839 2,645 31,379 Intercompany payables 312,614 2,958 3,480 $(319,052) - Deferred rent 8,170 - 715 - 8,885 Long-term debt, net of original issue discount 252,740 15,314 - - 268,054 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) (230,055) 296,350 (3,032) - 63,263 ----------- ----------- ---------- --------- -------- (229,974) 361,819 (555) (67,946) 63,344 ----------- ----------- ---------- --------- -------- $370,445 $381,930 $6,285 $(386,998) $371,662 ======== ======== ====== ========== ========
Page 17 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 net of 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 8,505 313,877 - $(322,382) - Investment in subsidiaries 65,469 - - (65,469) - Property and equipment, net 42,762 65,726 6,593 - 115,081 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 18 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 3,308 5,197 $(322,382) - -------- -------- ------ --------- -------- Deferred rent 7,793 - 681 - 8,474 -------- -------- ------ --------- -------- Long-term debt, net of original issue discount 252,449 15,492 - - 267,941 -------- -------- ------ --------- -------- 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 19 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS FOR THE FORTY WEEKS ENDED OCTOBER 5, 2003 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL REVENUES: - --------- Restaurant sales $98,078 $119,528 $11,257 $228,863 Franchise related revenues 7,625 - - 7,625 Real estate and other 2,170 2,217 61 4,448 Intercompany charges 7,841 - - $(7,841) - -------- ------- ----- -------- ------- Total revenues 115,714 121,745 11,318 (7,841) 240,936 -------- ------- ----- -------- ------- Cost and expenses: Restaurant operating expenses: Cost of food and paper products 20,105 26,180 2,963 - 49,248 Payroll and other employee Benefits 27,300 35,218 3,839 - 66,357 Other operating costs 39,048 43,682 3,060 - 85,790 Depreciation and amortization 6,727 7,328 765 - 14,820 General and administrative 11,959 8,176 (13) - 20,122 Asset impairment and restaurant closing charges, net 4,310 - 157 - 4,467 Intercompany charges - 7,841 - (7,841) - -------- ------- ----- -------- ------- Total costs and expenses 109,449 128,425 10,771 (7,841) 240,804 -------- ------- ----- -------- ------- Operating income (loss) before minority interest 6,265 (6,680) 547 - 132 Minority interest - - (22) - (22) -------- ------- ----- -------- ------- Operating income (loss) 6,265 (6,680) 525 - 110 -------- ------- ----- -------- ------- Other (expense) income: Interest expense (22,810) (1,120) - - (23,930) Interest income 569 - - - 569 Equity in net income of unconsolidated affiliates 270 - - - 270 -------- ------- ----- -------- ------- Net other expense (21,971) (1,120) - - (23,091) -------- ------- ----- -------- ------- (Loss) income before income taxes (15,706) (7,800) 525 - (22,981) Income tax provision (benefit) 447 244 (16) - 675 -------- ------- ----- -------- ------- Net (loss) income $(16,153) $(8,044) $541 - $(23,656) ========= ======== ==== ======= =========
Page 20 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS FOR THE FORTY WEEKS ENDED OCTOBER 6, 2002 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Revenues: Restaurant sales $106,043 $130,493 $17,918 $254,454 Franchise related revenues 7,636 - - 7,636 Real estate and other 2,115 2,910 - $(691) 4,334 Intercompany charges - 11,091 - (11,091) - -------- ------- ----- ---------- ------- Total revenues 115,794 144,494 17,918 (11,782) 266,424 -------- ------- ----- ---------- ------- Cost and expenses: Restaurant operating expenses: Cost of food and paper products 19,614 25,419 4,831 - 49,864 Payroll and other employee benefits 28,110 37,233 6,524 - 71,867 Other operating costs 37,388 45,970 5,794 - 89,152 Depreciation and amortization 6,823 8,032 929 - 15,784 General and administrative 9,301 9,028 347 (691) 17,985 Asset impairment and restaurant closing charges, net 2,770 - 141 - 2,911 Intercompany charges 11,091 - - (11,091) - -------- ------- ----- ---------- ------- Total costs and expenses 115,097 125,682 18,566 (11,782) 247,563 -------- ------- ----- ---------- ------- Operating income (loss) before minority interest 697 18,812 (648) - 18,861 Minority interest - - (36) - (36) -------- ------- ----- ---------- ------- Operating income (loss) 697 18,812 (684) - 18,825 -------- ------- ----- ---------- ------- Other (expense) income: Interest expense (22,774) (1,131) - - (23,905) Interest income 390 - - - 390 Equity in net income of unconsolidated affiliates 692 - - - 692 Insurance recovery, net 7,162 - - 7,162 -------- ------- ----- ---------- ------- Net other expense (14,530) (1,131) - - (15,661) -------- ------- ----- ---------- ------- (Loss) income before income taxes (13,833) 17,681 (684) - 3,164 Income tax (benefit) provision (1,352) 1,690 (62) - 276 -------- ------- ----- ---------- ------- Net (loss) income $(12,481) $15,991 $(622) $ - $2,888 ========= ======== ==== ========== =======
Page 21 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS FOR THE TWELVE WEEKS ENDED OCTOBER 5, 2003 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- REVENUES: - --------- Restaurant sales $31,445 $37,267 $3,397 $72,109 Franchise related revenues 2,295 - - 2,295 Real estate and other 682 666 26 1,374 Intercompany charges 2,349 - - $(2,349) - -------- ------- ----- ---------- ------- Total revenues 36,771 37,933 3,423 (2,349) 75,778 -------- ------- ----- ---------- ------- Cost and expenses: Restaurant operating expenses: Cost of food and paper products 6,526 8,267 908 - 15,701 Payroll and other employee benefits 8,434 10,973 1,123 - 20,530 Other operating costs 12,029 13,302 930 - 26,261 Depreciation and amortization 2,029 2,155 227 - 4,411 General and administrative 3,505 2,470 81 - 6,056 Asset impairment and restaurant closing charges, net 3,410 - - - 3,410 Intercompany charges - 2,349 - (2,349) - -------- ------- ----- ---------- ------- Total costs and expenses 35,933 39,516 3,269 (2,349) 76,369 -------- ------- ----- ---------- ------- Operating income (loss) before minority interest 838 (1,583) 154 - (591) Minority interest - - (12) - (12) -------- ------- ----- ---------- ------- Operating income (loss) 838 (1,583) 142 - (603) -------- ------- ----- ---------- ------- Other (expense) income: Interest expense (6,832) (335) - - (7,167) Interest income 158 - - - 158 Equity in net loss of unconsolidated affiliates (241) - - - (241) -------- ------- ----- ---------- ------- Net other expense (6,915) (335) - - (7,250) -------- ------- ----- ---------- ------- (Loss) income before income taxes (6,077) (1,918) 142 - (7,853) Income tax provision (benefit) 73 30 (2) - 101 -------- ------- ----- ---------- ------- Net (loss) income $(6,150) $(1,948) $144 - $(7,954) ======== ======== ==== ========== =======
Page 22 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF OPERATIONS FOR THE TWELVE WEEKS ENDED OCTOBER 6, 2002 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Revenues: Restaurant sales $33,246 $39,588 $5,172 $78,006 Franchise related revenues 2,561 - - 2,561 Real estate and other 651 875 - $(207) 1,319 Intercompany charges - 3,651 - (3,651) - -------- ------- ----- ---------- ------- Total revenues 36,458 44,114 5,172 (3,858) 81,886 -------- ------- ----- ---------- ------- Cost and expenses: Restaurant operating expenses: Cost of food and paper products 6,786 6,733 1,491 - 15,010 Payroll and other employee benefits 8,018 11,919 1,874 - 21,811 Other operating costs 12,392 12,738 1,645 - 26,775 Depreciation and amortization 1,706 1,875 291 - 3,872 General and administrative 2,604 2,742 147 (207) 5,286 Asset impairment and restaurant closing charges, net 700 - (18) - 682 Intercompany charges 3,651 - - (3,651) - -------- ------- ----- ---------- ------- Total costs and expenses 35,857 36,007 5,430 (3,858) 73,436 -------- ------- ----- ---------- ------- Operating income (loss) before minority Interest 601 8,107 (258) - 8,450 Minority interest - - (3) - (3) -------- ------- ----- ---------- ------- Operating income (loss) 601 8,107 (261) - 8,447 -------- ------- ----- ---------- ------- Other (expense) income: Interest expense (6,827) (338) - - (7,165) Interest income 130 - - - 130 Equity in net income of unconsolidated affiliates 147 - - - 147 Insurance recovery, net 7,162 - - - 7,162 -------- ------- ----- ---------- ------- Net other income (expense) 612 (338) - - 274 -------- ------- ----- ---------- ------- Income (loss) before income taxes 1,213 7,769 (261) - 8,721 Income tax (benefit) provision (1,209) 1,331 (47) - 75 -------- ------- ----- ---------- ------- Net income (loss) $2,422 $6,438 $(214) $ - $8,646 ====== ====== ====== ========== ======
Page 23 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE FORTY WEEKS ENDED OCTOBER 5, 2003 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- OPERATING ACTIVITIES: - --------------------- Net (loss) income $(16,153) $(8,044) $541 - $(23,656) Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization 8,304 6,872 762 - 15,938 Asset impairment and restaurant closing charges 5,070 - - - 5,070 Increase (decrease) in deferred rent 230 (33) 35 - 232 Gain on sale of other concept unit - - (200) - (200) Loss on sale of other concept units included in prior year asset impairment costs - - 250 - 250 Minority interest - - 22 - 22 Equity in net income of unconsolidated affiliates (270) - - - (270) Dividends received from unconsolidated affiliates 119 - - - 119 Changes in operating assets and liabilities: Decrease (increase) in receivables 149 264 (62) - 351 Decrease in inventories 405 569 13 - 987 Increase in prepaid expenses (3,805) (2,394) (172) - (6,371) (Increase) decrease in other assets (573) (24) 492 - (105) Increase (decrease) in accounts payable and accrued expenses (3,160) 776 (117) - (2,501) Decrease in accrued interest payable (6,473) - - - (6,473) -------- ------- ----- ------- --------- Net cash (used in) provided by operating activities (16,157) (2,014) 1,564 - (16,607) -------- ------- ----- ------- --------- Investing activities: - --------------------- Purchase of property and equipment (4,219) (1,875) (171) - (6,265) -------- ------- ----- ------- --------- Net cash used in investing activities (4,219) (1,875) (171) - (6,265) -------- ------- ----- ------- ---------
Page 24 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE FORTY WEEKS ENDED OCTOBER 5, 2003 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- FINANCING ACTIVITIES: - --------------------- Mortgage principal repayments - (128) - - (128) Tax distribution (1,101) - - - (1,101) Intercompany balances 799 780 (1,579) - - -------- --------- ------- ------- -------- Net cash (used in) provided by financing activities (302) 652 (1,579) - (1,229) -------- --------- ------- ------- -------- Decrease in cash and cash equivalents (20,678) (3,237) (186) - (24,101) Cash and cash equivalents at beginning of period 47,636 6,539 975 - 55,150 -------- --------- ------- ------- -------- Cash and cash equivalents at end of period $26,958 $3,302 $789 - $31 049 ======== ========= ======= ======== Supplemental disclosure of cash flow Information: Cash paid during the period for income taxes $280 $85 $13 $ - $378 ======== ========= ======= ======= ======== Cash paid during the period for Interest $28,159 $1,091 $ - $ - $29,250 ======== ========= ======= ======= ========
Page 25 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE FORTY WEEKS ENDED OCTOBER 6, 2002 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED OPERATING ACTIVITIES: PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL - --------------------- ------ ------------ ------------ ------------ ----- Net (loss) income $(12,481) $15,991 $(622) $2,888 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities: Depreciation and amortization 7,816 8,194 929 16,939 Provision for restaurant closings 2,046 - - 2,046 Increase in deferred rent, net 495 (120) 28 403 Minority interest - - 36 36 Equity in income of unconsolidated affiliates (692) - - (692) Dividends received from unconcolidated affiliates 311 - - 311 Changes in operating assets and liabilities: Decrease (increase) in receivables 1,355 (425) (49) 881 Decrease (increase) in inventories 328 383 30 741 Increase in prepaid assets (4,707) (2,398) (402) (7,507) (Increase) decrease in other assets (406) 262 83 $(120) (181) (Decrease) increase in accounts payable and accrued expenses (3,149) (1,027) (1,956) 120 (6,012) Decrease in accrued interest payable (6,473) - - - (6,473) ------- ------- ------- ------ ------- Net cash (used in) provided by operating activities (15,557) 20,860 (1,923) - 3,380 -------- ------- ------- ------ ------- Investing activities: Purchases of property and equipment (4,795) (1,629) (187) - (6,611) ------- ------- ------- ------ ------- Net cash used in investing activities (4,795) (1,629) (187) - (6,611) ------- ------- ------- ------ -------
Page 26 SBARRO, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE FORTY ENDED OCTOBER 6, 2002 (IN THOUSANDS) (UNAUDITED)
GUARANTOR NONGUARANTOR CONSOLIDATED PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL ------ ------------ ------------ ------------ ----- Financing activities: - --------------------- Mortgage principal repayments - (117) - - (117) Distributions to shareholders (3,125) - - - (3,125) Intercompany balances 18,643 (19,728) 1,085 - - ------ ------- ----- ------ ------- Net cash provided by (used in) financing activities 15,518 (19,845) 1,085 - (3,242) ------ ------- ----- ------ ------- Decrease in cash and cash equivalents (4,834) (614) (1,025) - (6,473) Cash and cash equivalents at beginning of period 29,673 5,437 1,842 - 36,952 ------ ------- ----- ------ ------- Cash and cash equivalents at end of period $24,839 $4,823 $817 $ - $30,479 ======= ======= ===== ======= ======== Supplemental disclosure of cash flow information: Cash paid during the period for income taxes $375 $250 $ 1 $ - $626 ======= ======= ===== ======= ======== Cash paid during the period for $28,139 $1,108 $ - $ - $29,247 interest ======= ======= ===== ======= ========
Page 27 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS - --------------------- The following table provides information concerning the number of Company-owned and franchised restaurants in operation during each indicated period:
40 WEEKS 40 WEEKS 12 WEEKS 12 WEEKS FISCAL YEAR ENDED ENDED ENDED ENDED -------------- 10/05/03 10/06/02 10/05/03 10/06/02 2002 2001 -------- -------- -------- -------- ---- ---- Sbarro-owned restaurants: Opened during period 3 8 2 5 13 9 Acquired from (sold to) franchisees during period-net (7) (4) (1) (3) (6) - Closed during period (19) (41) (3) (22) (51) (43) --- --- --- --- --- --- Open at end of period (1) 535 565 535 565 558 602 Franchised restaurants: Opened during period 25 28 3 13 42 42 Purchased from (sold to) Sbarro during period-net 7 4 1 3 6 - Closed or terminated during period (15) (18) (2) (5) (20) (20) --- --- --- --- --- --- Open at end of period 370 339 370 339 353 325 All restaurants: Opened during period 28 36 5 18 55 51 Closed or terminated during period (34) (59) (5) (27) (71) (63) --- --- --- --- --- --- Open at end of period (1) 905 904 905 904 911 927 Kiosks (all franchised) open at end of period 3 4 3 4 3 4
- ------------------------------------ (1) Excludes 31, 34, 32 and 37 other concept units as of October 5, 2003 and October 6, 2002, the end of fiscal 2002 and the end of fiscal 2001, respectively. Page 28 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 been significantly effected 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 also 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. During the third quarter of fiscal 2003, a review of the impairment factors determined that the carrying amount of certain store assets may not be recoverable through the estimated undiscounted future cash flows resulting from the use of those assets and an asset impairment charge of $3.0 million was recorded in the twelve and forty weeks periods ended October 5, 2003. Our consolidated EBITDA for the forty weeks ended October 5, 2003 was $15.2 million compared to $42.5 million for the forty weeks ended October 6, 2002. Our consolidated EBITDA for the twelve weeks ended October 5, 2003 was $3.6 million compared to $19.6 million for the twelve weeks ended October 6, 2002. EBITDA for the forty and twelve weeks ended October 6, 2002 included an insurance recovery of $7.2 million, net, relating to the events of September 11, 2001. Excluding this item, EBITDA for the forty and twelve weeks ended October 6, 2002 was $35.3 million and $12.5 million, respectively. 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") in the United States or as a measure of a company's profitability or liquidity. Rather, we believe that EBITDA provides relevant and useful information for analysts and investors in our senior notes in that EBITDA is one of the factors in the calculation of our compliance with the ratios in the indenture under which our senior notes are issued. We also internally use EBITDA as one of the measures to determine whether to continue 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 forty and twelve week periods presented (in thousands): Page 29
Forty weeks ended: Twelve weeks ended: 10/05/03 10/06/02 10/05/03 10/06/02 -------- -------- -------- -------- EBITDA $15,200 $42,463 $3,567 $19,628 Interest expense (23,930) (23,905) (7,167) (7,165) Interest income 569 390 158 130 Income taxes (675) (276) (101) (75) Depreciation and amortization (14,820) (15,784) (4,411) (3,872) -------- -------- ------- ------- Net (loss) income $(23,656) $2,888 $(7,954) $8,646 ========= ====== ======== ======
Restaurant sales by Sbarro-owned quick service units and consolidated other concept units decreased 10.1% to $228.9 million for the forty weeks ended October 5, 2003 from $254.5 million in the forty weeks ended October 6, 2002 and decreased 7.6% to $72.1 million for the twelve weeks ended October 5, 2003 from $78.0 million in the twelve weeks ended October 6, 2002. The decrease in sales for the forty weeks ended October 5, 2003 reflects $18.9 million (8.0%) of lower sales of Sbarro quick service units and $6.7 million (37.2%) of lower sales of consolidated other concept units. The decrease in sales for the twelve weeks ended October 5, 2003 reflects $4.1 million (5.7%) of lower sales of Sbarro quick service units and $1.8 million (34.3%) of lower sales of consolidated other concept units. Declines in comparable sales of $10.3 million (4.6% to $211.4 million) in the forty week and $1.6 million (2.4% to $67.3 million) in the twelve week periods of fiscal 2003 from the comparable periods in fiscal 2002 was the primary reason for the decline in quick service restaurant sales. We believe that these declines were attributable to a reduction in shopping mall traffic related to the general economic downturn in the United States and, additionally with respect to the forty week period, 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 67 (including 23 units closed, net of openings during the first forty weeks of fiscal 2003) more units than we opened, causing the remaining $8.6 and $2.5 million net reduction in Sbarro quick service unit sales for the forty and twelve weeks ended October 5, 2003, respectively. 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, for the forty weeks ended October 5, 2003, approximately $0.6 million resulted from a 5.3% decrease in comparable unit sales to $11.1 million. For the twelve-week period ended October 5, 2003, there was a $0.1 million or 3.9% decrease in comparable consolidated other concept unit sales to $3.4 million. We believe that these declines were 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, resulting in a net sales reduction from sales at those locations of $6.1 million for the Page 30 forty weeks ended October 5, 2003 and $1.7 million for the twelve weeks ended October 5, 2003. These units were either unprofitable or marginally profitable and were part of ventures that we determined to discontinue. Franchise related revenues was nominally ($11,000) lower in the reported forty week period and $0.3 million (10.3%) lower in the twelve week period of fiscal 2003 than in fiscal 2002 because of an accrual for a potential need to refund certain royalty payments previously made to us by our Russian franchisee. Excluding the effect of this $0.2 million accrual, franchise related revenues increased by approximately $0.2 million (2.8%) to $7.8 million for the forty weeks ended October 5, 2003 despite a $0.1 million (1.7%) decrease to $2.5 million for the twelve weeks ended October 5, 2003, in each case from the comparable period ended October 6, 2002. Initial and ongoing royalties earned from locations opened during fiscal 2003 and 2002 were offset, in part, by 3.8% and 0.5% reductions in comparable unit sales at both domestic and international locations in the forty and twelve weeks periods ended October 5, 2003, respectively, from the comparable period ended October 6, 2002. During the twelve weeks ended October 5, 2003, our Russian franchisee advised us that sales and other income taxes that were remitted to their local government were erroneously included in their previously reported sales upon which its ongoing royalty fees were calculated. Subject to final confirmation and review, we have reduced our royalty revenues by approximately $0.2 million for this potential overpayment for the twelve and forty week periods ended October 5, 2003. Real estate and other revenues were relatively unchanged for both the forty and twelve weeks periods ended October 5, 2003 from the respective periods ended October 6, 2002. Cost of food and paper products as a percentage of restaurant sales increased to 21.5% for the forty weeks ended October 5, 2003 from 19.6% for the comparable 2002 fiscal period and to 21.8% for the twelve weeks ended October 5, 2003 from 19.2% for the same twelve weeks in fiscal 2002. The cost of sales percentage in both the forty and twelve week periods of fiscal 2003 were negatively impacted by the decrease in comparable unit 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 to facilitate the consistency in product in each restaurant unit and reduce labor needed to prepare our products. We estimate that this has added approximately 3/4 of 1 percentage point to our cost of food. The increase in cheese prices that began at the end of the second quarter resulted in significantly higher cheese costs in the third quarter of fiscal 2003 compared to the similar period in fiscal 2002 causing a 1.2% and 0.4% increase in cost of sales for the twelve and forty week periods, respectively, ended October 5, 2003. Cheese prices to date in the fourth quarter of fiscal 2003 have moderated somewhat but continue to be approximately 40% higher than the comparable time in fiscal 2002. In early fiscal 2003, we replaced our then national independent wholesale distributor, which declared bankruptcy, with another national independent wholesale distributor. There has not been 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 Page 31 percentage in the first quarter of 2003, effecting the forty week period (but not a factor in the increase in cost of sales in the second or third quarters) of fiscal 2003 was impacted by the cost of purchases of product from third parties until the new distribution contract was effective. Payroll and other employee benefits decreased by $5.5 million but as a percentage of restaurant sales, increased to 29.0% in the forty weeks ended October 5, 2003 from 28.2% of restaurant sales in the forty weeks ended October 6, 2002. For the twelve week period ended October 5, 2003, these costs decreased by $1.3 million but increased to 28.5% from 28.0% as a percentage of restaurant sales when compared to the comparable twelve week period in fiscal 2002. The dollar decrease was primarily due to fewer units in operation while the percentage of sales increase was due to the reduction in comparable unit sales. Other operating expenses decreased by $3.4 million but increased to 37.5% of restaurant sales in the forty weeks ended October 5, 2003 from 35.0% in the forty weeks ended October 6, 2002. These expenses decreased $0.5 million but increased to 36.4% from 34.3% of restaurant sales in the twelve weeks ended October 5, 2003 and October 6, 2002, respectively. The lower dollar level of other operating expenses resulted primarily from the fewer number of units in operation. The increases as a percentage of restaurant sales were 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 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 effects of the long-term utilization on their equipment. Depreciation and amortization expense decreased by $1.0 million and increased by $0.5 million for the forty and twelve weeks, respectively, of fiscal 2003 from the comparable periods in fiscal 2002. The reductions were due to fewer numbers of units in operation in fiscal 2003 ($1.0 million and $0.4 million, respectively), the absence in 2003 of depreciation of locations that had been included in the provision for asset impairment in fiscal 2002 as a result of which, no depreciation was taken on these units in fiscal 2003 and for locations that became fully depreciated during fiscal 2002. These reductions were offset, in part, primarily by depreciation of our upgraded computer system in 2003 and included a correction of $0.3 million due to a calculation error reflected in the third quarter of fiscal 2002. General and administrative expenses were $20.1 million, or 8.4% of total revenues, for the forty weeks ended October 5, 2003, compared to $18.0 million, or 6.8% of total revenues, for the forty weeks ended October 6, 2002. Those costs were $6.1 million, or 8.0% of total revenues, for the twelve weeks ended October 5, 2003, as compared to $5.3 million, or 6.5% of total revenues, for the twelve weeks ended October 6, 2002. The principal factors contributing to the increases in the forty week period were $0.2 million of legal fees incurred in connection with a lawsuit, a $0.2 million allowance for doubtful accounts receivable recorded with respect to our franchisee in Spain that declared bankruptcy and bonuses of $0.7 million that were granted to certain executive officers, all in the first fiscal quarter of 2003, a $0.2 million allowance against the collectibility of Page 32 amounts owed by our Israeli franchisee and $0.2 million of costs and expenses related to the hiring of our new President and Chief Executive Officer during the third fiscal quarter and higher quick-service field management travel and related costs. During the forty weeks ended October 5, 2003, we recorded a provision for asset impairment and for restaurant closing charges of $4.5 million. For the same forty week period ended October 6, 2002, we recorded a provision for restaurant closing charges of $2.9 million. The similar provisions for the twelve-week periods ended October 5, 2003 and October 6, 2002 were $3.4 million and $0.7 million, respectively. The provisions include a charge for asset impairment of $3.0 million in the forty and twelve weeks ended October 5, 2003 that resulted from our evaluation of impairment indicators which determined that the carrying amount of certain store assets may not be recoverable through the estimated undiscounted future cash flows resulting from the use of those assets. The remaining portion of the fiscal 2003 provision related to charges for closed locations. The provisions in fiscal 2002 related, for the most part, to the planned closing of up to thirty low volume, unprofitable Sbarro quick service locations during the third and fourth quarter of fiscal 2002, for which the provision was recorded primarily in the second quarter of fiscal 2002. 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 $23.9 million and $7.2 million for each of the forty weeks and twelve weeks, respectively, ended October 5, 2003 and October 6, 2002, relates to the 11%, $255.0 million senior notes we issued to finance our going private transaction in September 1999 ($21.6 million and $6.5 million in both the forty and twelve weeks of fiscal 2003 and 2002), the 8.4%, $16.0 million mortgage loan on our corporate headquarters in 2001 ($1.1 million and $0.3 million in the respective periods) and fees for unused borrowing capacity under our credit agreement that we terminated in the fourth quarter of fiscal 2003 ($0.1 million in the respective periods). In addition, $0.7 million and $0.4 million in the forty weeks and twelve weeks, respectively, of fiscal 2003 and 2002 represents non-cash charges for the accretion of the original issue discount on our senior notes and the amortization of deferred financing costs on the senior notes, credit agreement and the mortgage loan. Interest income for the forty week period ended October 5, 2003 was $0.6 million versus $0.4 million for the forty week period ended October 6, 2002. Interest income was $0.2 million and $0.1 million for the third quarter of fiscal 2003 and 2002, respectively. Higher average cash available for investment in each period presented in fiscal 2003 compared to the similar periods in fiscal 2002 was partially offset by the lower prevailing interest rates in effect. The indenture under which our senior notes are issued limits the types of investments which we may make. In addition, we earned approximately $0.05 million of interest income that was included in an Page 33 income tax refund received in the second quarter of fiscal 2003 related to a year in which we were a Subchapter C corporation. Equity in the net income (loss) 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. Included in our equity in the net loss of unconsolidated affiliates in the third quarter of fiscal 2003 was our proportionate share ($0.5 million) of the losses from the sale of our Vincent's Clam Bar location and one of our steakhouse joint venture locations. These losses were offsets against our equity in the net operational net income of unconsolidated affiliates of approximately $0.8 million and $0.3 million in for the forty and twelve weeks ended October 5, 2003, respectively, compared to $0.7 million and $0.1 million, respectively, in our equity for the same periods ending October 6, 2002. 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. The insurance recovery credit to our earnings for the forty and twelve weeks ended October 6, 2002 of $7.2 million represents the settlement, net of related expenses, to reimburse us for the lost income under our business interruption insurance coverage related to the events of September 11, 2001. 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 was $0.7 million and $0.3 million for the forty week periods, and $0.1 million and $0.1 million for the twelve-week periods, ended October 5, 2003 and October 6, 2002, respectively. The expense was for taxes owed by us (rather than our shareholders) to jurisdictions that do not recognize S corporation status or that tax entities based on factors other than income. 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 October 5, 2003, we had unrestricted cash and cash equivalents of $31.0 million and working capital of $14.4 million compared to unrestricted cash and cash equivalents of $30.5 million and working capital of $19.5 million at October 6, 2002. Net cash used in operating activities was $16.6 million for the forty weeks ended October 5, 2003 compared to $3.4 million provided by operating activities during the forty weeks ended October 6, 2002. The $20.0 million change resulted primarily from a $26.7 million change (from a profit of $2.9 million in the fiscal 2002 period to a loss of $23.7 million in the fiscal 2003 period) in our results of operations. This change was reduced, in part, by an increase in non-cash expenses in the fiscal 2003 period from the fiscal 2002 period, with a $3.0 million charge for Page 34 asset impairment in fiscal 2003 being offset, in part, by a $1.0 million reduction in depreciation and amortization. Also, less cash was used during the fiscal 2003 period than the fiscal 2002 period to support changes in operating assets and liabilities, primarily as a result of an increase (a decrease of $2.5 million in fiscal 2003, compared to a $6.0 million decrease in fiscal 2002) in accounts payable and accrued expenses and a $1.1 million lower increase in fiscal 2003 in prepaid expenses (the prepaid balances at the end of the third fiscal quarters of both 2003 and 2002 being similar). Of the increase in accounts payable, approximately $2.6 million relates to the amount accrued for, but unpaid to, 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 incurred significant additional costs after the bankruptcy filing date due to the bankruptcy. In addition, there was a decrease of $0.2 million in the dividend received from our unconsolidated affiliate. 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 decreased from $6.6 million for the forty weeks ended October 6, 2002 to $6.3 million for the forty weeks ended October 5, 2003. Investing activities in the forty weeks ended October 5, 2003 reflect higher remodel activity than during the forty weeks ended October 6, 2002. These investing activities also include $1.0 million and $1.3 million, respectively, paid as part of previously committed costs of $2.9 million relating to an upgrade of our computer systems. Net cash used in financing activities was $1.2 million for the twenty-eight weeks ended July 13, 2003 compared to $3.2 million in the comparable 2002 period The reduction was due to a $2.0 million decrease 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 that may be made if we are able to secure an uncommitted line of credit to replace the credit agreement that we terminated. 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 (to the extent permitted under the indenture for the senior notes) and for general corporate purposes. We anticipate 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 our existing cash and cash flow from operations. Our credit agreement required that we maintain a minimum ratio of consolidated earnings before interest, taxes and depreciation and amortization ("EBITDA") to consolidated interest expense and a maximum ratio of consolidated senior debt to consolidated EBITDA. We have not been in compliance with the required ratios, as amended, during 2003. Our bank waived compliance with these covenants but we would not have been able to borrower under this arrangement. We requested, and the bank agreed, to terminate the bank's lending commitment. We had not made Page 35 any borrowings under the line of credit since its inception, except for a required one day borrowing upon the activation of the credit agreement and except with respect to letters of credit that have been issued by the bank under the sublimit of the line. The termination of the bank's lending commitment eliminates our obligation to pay a commitment fee on the unused portion of the facility. Our obligations under the credit agreement to reimburse the bank with respect to any drawings that may be made under the approximately $1.7 million of letters of credit that are outstanding as of November 19, 2003 will remain in full force. We have agreed to either arrange for the replacement of the letters of credit or to cash collateralize them by January 9, 2004. The credit agreement will remain in effect until such time as outstanding letters of credit shall have been drawn upon in full, expired or otherwise terminate, except for our ability to borrow or obtain letters of credit and except that compliance with our financial and certain other covenants has been waived until the termination date of the credit agreement. We are in the process of negotiating for an uncommitted line of credit from other banks in a presently undetermined amount, but there can be no assurance that we will be able to obtain the line. We are subject to various covenants under the indenture under which our senior notes are issued. 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 (except with respect to certain permitted investments and tax distributions) that our interest coverage ratio is at least 2.0 to 1 after giving pro forma effect to the restricted payment. For the four fiscal quarters ended October 5, 2003, our consolidated interest coverage ratio was 1.1 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 cannot make restricted payments other than certain permitted investments and tax distributions until we increase the restricted payment availability by approximately $16 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 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. Page 36 OFF-BALANCE SHEET FINANCING - --------------------------- The Company has no off-balance sheet contractual arrangements, as that term is defined in Item 304(a)(4) of Regulation S-K. CONTRACTUAL OBLIGATIONS - ----------------------- Our contractual obligations 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 Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 29, 2002. 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 forty weeks ended October 5, 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. 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; Page 37 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 that are the predominant areas in which our restaurants are located; o our ability to continue to attract franchisees; o the success of our present, and any future, joint ventures and other expansion opportunities; o the availability of food (particularly cheese and tomatoes) 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; o our ability to obtain a bank line of credit that would enable us to meet any unanticipated operational needs; o our ability to comply with covenants contained in the indenture under which the senior notes are issued, and the effects which the restrictions imposed by those covenants may have on our ability to operate our business; and o our ability to repurchase senior notes to the extent required in the event we make certain asset sales or experience a change of control. You are cautioned not to place undue reliance on these statements, which speak only as of the date of the report. We do not undertake any responsibility to release publicly any revisions to these forward-looking statements to take into account events or circumstances that occur after the date of this report. Additionally, we do not undertake any responsibility to update you on the occurrence of any unanticipated events which may cause actual results to differ from those expressed or implied by the forward-looking statements contained in this report. 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. Page 38 Future borrowings under any line of credit we may be able to obtain is likely to 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 As of the end of the period covered by this report, our management, with the participation of our President and Chief Executive Officer and our Vice President, Controller and principal accounting officer (the person presently performing the function of our principal financial officer), evaluated the effectiveness of our "disclosure controls and procedures," as defined in Rule 15d-15(e) under the Securities Exchange Act of 1934. Based on that evaluation, these officers concluded that, as of the date of their evaluation, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our periodic filings under the Exchange Act is accumulated and communicated to our management, including those officers, to allow timely decisions regarding required disclosure. During the period covered by this report, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Page 39 PART II. OTHER INFORMATION -------------------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. a) Exhibits: 31.01 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.02 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 302 of the Sarbanes-Oxley Act of 2002. 32.01 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. 32.02 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: A Report on Form 8-K was filed by Sbarro dated (date of earliest event reported) September 8, 2003, reporting under Item 5, Other Events, and Item 7, Financial Statements and Exhibits. No financial statements were filed with that Report. Page 40 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. SBARRO, INC. --------------------------------------------- Registrant Date: November 19, 2003 By: /s/ MICHAEL O'DONNELL ----------------- ----------------------------------------- Michael O'Donnell President and Chief Executive Officer (Principal Executive Officer) Date: November 19, 2003 By: /s/ STEVEN B. GRAHAM ----------------- ---------------------------------------- Steven B. Graham Vice President and Controller (Principal Accounting Officer) Page 41 EXHIBIT INDEX ------------- EXHIBIT NUMBER DESCRIPTION - -------------- ----------- 31.01 Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.02 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 302 of the Sarbanes-Oxley Act of 2002. 32.01 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. 32.02 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. Page 42 EX-31 3 exhb31-01.txt 31.01 EXHIBIT 31.01 CERTIFICATION ------------- I, Michael O'Donnell, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Sbarro, Inc.; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 19, 2003 /s/ MICHAEL O'DONNELL - ------------------------------------ Michael O'Donnell, President and Chief Executive Officer (Principal Executive Officer) EX-31 4 exhb31-02.txt 31.02 EXHIBIT 31.02 CERTIFICATION ------------- 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 19, 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) EX-32 5 exhb32-01.txt 32.01 Exhibit 32.01 I, Michael O'Donnell, 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. Date: November 19, 2003 /s/ MICHAEL O'DONNELL - ------------------------------------- Michael O'Donnell President and Chief Executive Officer (Principal Executive Officer) A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906 HAS BEEN PROVIDED TO SBARRO, INC. AND WILL BE RETAINED BY SBARRO, INC. AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST. EX-32 6 exhb32-02.txt 32.02 Exhibit 32.02 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. Date: November 19, 2003 /s/ STEVEN B. GRAHAM - --------------------------- Steven B. Graham, Vice President and Controller (Principal Accounting Officer) A SIGNED ORIGINAL OF THIS WRITTEN STATEMENT REQUIRED BY SECTION 906 HAS BEEN PROVIDED TO SBARRO, INC. AND WILL BE RETAINED BY SBARRO, INC. AND FURNISHED TO THE SECURITIES AND EXCHANGE COMMISSION OR ITS STAFF UPON REQUEST. -----END PRIVACY-ENHANCED MESSAGE-----