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EX-32.01 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 906 - SBARRO INCdex3201.htm
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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x

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

 

For the quarterly period ended September 26, 2010

  Commission file number 333-142081

 

 

SBARRO, INC.

(Exact name of registrant as specified in its charter)

 

 

 

NEW YORK   11-2501939
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)
401 Broad Hollow Road, Melville, New York   11747-4714
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (631) 715-4100

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No   ¨

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

Yes  ¨    No   ¨

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

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

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

The number of shares of Common Stock of the registrant outstanding as of November 10, 2010 was 100.

 

 


Table of Contents

 

SBARRO, INC.

FORM 10-Q INDEX

 

       PAGES   

PART I. FINANCIAL INFORMATION

  

Item 1.

  Consolidated Financial Statements (unaudited):   
 

Balance Sheets (unaudited)—September 26, 2010 and December 27, 2009

     3-4   
 

Statements of Operations (unaudited)—Nine months ended September 26, 2010 and September 27, 2009 and the quarter ended September 26, 2010 and September 27, 2009

     5-6   
 

Statement of Shareholders’ Deficit (unaudited)—Nine months ended September 26, 2010

     7   
 

Statements of Cash Flows (unaudited)—Nine months ended September 26, 2010 and September 27, 2009

     8   
 

Notes to Unaudited Consolidated Financial Statements

     9   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      28   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      37   

Item 4.

  Controls and Procedures      37   

PART II. OTHER INFORMATION

  

Item 1.

  Legal Proceedings      38   

Item 1A.

  Risk Factors      38   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      38   

Item 3.

  Defaults Upon Senior Securities      38   

Item 4.

  (Removed and Reserved)      38   

Item 5.

  Other Information      38   

Item 6.

  Exhibits      39   

 

2


Table of Contents

 

Part I – Financial Information

 

Item 1. Consolidated Financial Statements

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

(UNAUDITED)

(In thousands)

 

     September 26, 2010      December 27, 2009  

Current assets:

     

Cash and cash equivalents

   $ 12,670       $ 26,863   

Receivables, net of allowance for doubtful accounts of $1,457 and $1,805 at September 26, 2010 and December 27, 2009, respectively:

     

Franchise

     1,881         2,237   

Other

     2,585         2,916   
                 
     4,466         5,153   

Inventories

     2,845         2,907   

Prepaid expenses

     3,402         1,771   
                 

Total current assets

     23,383         36,694   

Property and equipment, net

     51,758         56,148   

Intangible assets:

     

Goodwill

     194,786         194,786   

Trademarks

     157,400         173,100   

Other intangible assets

     18,850         19,650   

Deferred financing costs, net

     7,809         8,977   

Other assets

     1,567         1,068   
                 

Total assets

   $ 455,553       $ 490,423   
                 

See Notes to Unaudited Consolidated Financial Statements.

 

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SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

LIABILITIES & SHAREHOLDERS’ (DEFICIT) EQUITY

(UNAUDITED)

(In thousands except share data)

(CONTINUED)

 

     September 26, 2010     December 27, 2009  

Current liabilities:

    

Accounts payable

   $ 7,426      $ 9,032   

Accrued expenses

     19,164        22,631   

Accrued interest payable

     3,399        7,935   
                

Total current liabilities

     29,989        39,598   

Deferred rent

     7,466        6,482   

Deferred tax liability

     70,645        76,941   

Due to former shareholders and other liabilities

     13,258        12,508   

Accrued interest payable

     6,372        3,048   

Long-term debt

     341,802        336,095   

Commitments and contingencies

    

Shareholders’ (deficit) equity:

    

Common stock

    

Authorized 1,000 shares; $.01 par value issued and outstanding 100 shares at September 26, 2010 and December 27, 2009

     —          —     

Additional paid-in capital

     139,340        139,340   

Currency translation adjustments

     (60     200   

Advances to MidOcean SBR Holdings

     (305     (305

Accumulated deficit

     (155,146     (125,838
                

Total shareholders’ (deficit) equity

     (16,171     13,397   

Noncontrolling interests

     2,192        2,354   
                

Total shareholders’ (deficit) equity, including noncontrolling interests

     (13,979     15,751   
                

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

   $ 455,553      $ 490,423   
                

See Notes to Unaudited Consolidated Financial Statements.

 

4


Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands)

 

     For The Nine  Months
Ended
September 26, 2010
    For The Nine  Months
Ended
September 27, 2009
 

Revenues:

    

Restaurant sales

   $ 228,658      $ 235,083   

Franchise related income

     10,427        10,162   
                

Total revenues

     239,085        245,245   

Costs and expenses:

    

Cost of food and paper products

     48,006        48,117   

Payroll and other employee benefits

     64,476        66,047   

Other operating costs

     91,881        89,915   

Other income, net

     (2,846     (2,885

Depreciation and amortization

     10,981        12,297   

General and administrative

     23,033        22,612   

Goodwill and other intangible asset impairment

     15,700        31,474   

Asset impairment, restaurant closings/remodels

     1,457        2,305   
                

Total costs and expenses, net

     252,688        269,882   
                

Operating loss

     (13,603     (24,637
                

Other (expense) income:

    

Interest expense

     (22,902     (20,747

Write-off of deferred financing costs

     —          (423

Interest income

     1        33   
                

Net other expense

     (22,901     (21,137
                

Loss before income taxes and equity investments

     (36,504     (45,774

Income tax benefit

     (5,955     (9,480
                

Loss before equity investments

     (30,549     (36,294

Loss from equity investments

     (174     (162
                

Net loss

     (30,723     (36,456

Less: Net loss (income) attributable to noncontrolling interests

     1,415        (244
                

Net loss attributable to Sbarro, Inc.

   $ (29,308   $ (36,700
                

See Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

(UNAUDITED)

(In thousands)

 

     For The Three  Months
Ended
September 26, 2010
    For The Three  Months
Ended
September 27, 2009
 

Revenues:

    

Restaurant sales

   $ 80,467      $ 82,141   

Franchise related income

     3,538        3,388   
                

Total revenues

     84,005        85,529   

Costs and expenses:

    

Cost of food and paper products

     17,360        16,988   

Payroll and other employee benefits

     22,628        23,260   

Other operating costs

     30,880        30,341   

Other income, net

     (1,059     (865

Depreciation and amortization

     3,888        3,830   

General and administrative

     7,704        6,786   

Goodwill and other intangible asset impairment

     —          31,474   

Asset impairment, restaurant closings/remodels

     339        309   
                

Total costs and expenses, net

     81,740        112,123   
                

Operating income (loss)

     2,265        (26,594
                

Other expense:

    

Interest expense

     (7,796     (7,414
                

Other expense

     (7,796     (7,414
                

Loss before income taxes and equity investments

     (5,531     (34,008

Income tax expense (benefit)

     125        (9,752
                

Loss before equity investments

     (5,656     (24,256

Loss from equity investments

     (54     (54
                

Net loss

     (5,710     (24,310

Less: Net loss (income) attributable to noncontrolling interests

     428        (211
                

Net loss attributable to Sbarro, Inc.

   $ (5,282   $ (24,521
                

See Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

 

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ DEFECIT

(UNAUDITED)

(In thousands)

 

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

Balance at December 27, 2009

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

Components of comprehensive loss:

                   

Net loss

     —           —           —           —          (29,308     —          (1,415     (30,723

Currency translation adjustments

     —           —           —           —          —          (260     193        (67
                         

Comprehensive loss (a)

                      (30,790

Capital contribution from noncontrolling interest

     —           —           —           —          —          —          1,186        1,186   

Distribution of earnings and return of capital

     —           —           —           —          —          —          (296     (296

Proceeds from loan - noncontrolling interest

     —           —           —           —          —          —          170        170   
                                                                   

Balance at September 26, 2010

     100       $ —         $ 139,340       $ (305   $ (155,146   $ (60   $ 2,192      $ (13,979
                                                                   

 

(a)

The components of comprehensive loss are as follows:

 

     Nine Months Ended
September 26, 2010
    Nine Months Ended
September 27, 2009
 

Net loss (including noncontrolling interests)

   $ (30,723   $ (36,456

Currency translation adjustments

     (67     16   
                
     (30,790     (36,440

Less: comprehensive (loss) income attributable to noncontrolling interests

     (1,222     223   
                

Comprehensive loss - Sbarro, Inc.

   $ (29,568   $ (36,663
                

 

(b)

The components of accumulated other comprehensive (loss) income are as follows:

 

     September 26, 2010     Dec 27, 2009  

Currency translation adjustments

   $ 118      $ 185   

Less: noncontrolling interests - currency translation adjustments

     178        (15
                

Accumulated other comprehensive (loss) income - Sbarro, Inc.

   $ (60   $ 200   
                

See Notes to Unaudited Consolidated Financial Statements.

 

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CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

     For The Nine  Months
Ended
September 26, 2010
    For The Nine  Months
Ended
September 27, 2009
 

Operating Activities:

    

Net loss

   $ (30,723   $ (36,456

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

    

Goodwill and other intangible asset impairment

     15,700        31,474   

Depreciation and amortization

     10,981        12,297   

Amortization of deferred financing costs

     1,475        1,084   

Provision for doubtful accounts receivable

     92        916   

Increase in deferred rent, net of tenant allowance

     1,248        1,404   

Asset impairment and restaurant closings/remodels

     1,129        1,100   

Change in deferred income taxes, net

     (6,296     (9,915

Write-off of deferred financing costs

     —          423   

Equity in net loss of unconsolidated affiliates

     174        162   

Changes in operating assets and liabilities

    

Decrease in receivables

     659        54   

Decrease in inventories

     62        495   

Increase in prepaid expenses

     (1,013     (350

Increase in other assets

     (1,110     (86

Decrease in accounts payable, accrued expenses & other liabilities

     (4,983     (8,278

Decrease in accrued interest payable

     (1,212     (1,941
                

Net cash used in operating activities

     (13,817     (7,617
                

Investing Activities:

    

Purchases of property and equipment

     (6,863     (6,277

Investment in joint ventures

     —          (283
                

Net cash used in investing activities

     (6,863     (6,560
                

Financing Activities:

    

Proceeds from revolver loan

     5,400        —     

Proceeds from second lien

     —          25,000   

Debt issuance and credit agreement costs

     —          (1,834

Repayment of secured term loan and revolver

     —          (32,958

Capital contribution from noncontrolling interests

     1,186        394   

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

     170        (374

Distribution of earnings to noncontrolling interests

     (269     (881
                

Net cash provided by (used in) financing activities

     6,487        (10,653
                

Decrease in cash and cash equivalents

     (14,193     (24,830

Cash and cash equivalents at beginning of period

     26,863        38,286   
                

Cash and cash equivalents at end of period

   $ 12,670      $ 13,456   
                

 

See Notes to Unaudited Consolidated Financial Statements.

 

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Table of Contents

 

SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

1. Basis of Financial Statement Presentation:

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

MidOcean owns approximately 76% of Holdings and thus acquired control of the Company in the Merger, with the balance of the equity of Holdings being owned by other investors.

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Regulation S-X related to interim period financial statements and, therefore, do not include all information and footnotes required by generally accepted accounting principles. However, in the opinion of our management, all adjustments (consisting of normal recurring adjustments and accruals) considered necessary for the fair presentation of the consolidated financial position of Sbarro and our subsidiaries at September 26, 2010, and our consolidated results of operations for the three and nine months ended September 26, 2010 and September 27, 2009 and cash flows for the nine months ended September 26, 2010 and September 27, 2009 have been included. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the entire year. Certain items in the prior year’s consolidated financial statements have been reclassified to conform to the fiscal 2010 presentation. Reference should be made to our annual financial statements, including footnotes thereto, included in our Annual Report on Form 10-K for the year ended December 27, 2009.

Liquidity

We are highly leveraged and a substantial portion of our liquidity needs arise from our debt service obligations. Our other liquidity needs fund our costs of operations, working capital and capital expenditures. Cash flow generated during the fourth quarter is critical to achieving positive annual operating cash flow. While many factors affect our results, some are outside our control, and their impact in the fourth quarter (and on overall liquidity) can be particularly significant, because the fourth quarter accounts for a disproportionate amount of our annual cash flow. Adverse macroeconomic factors, including reduced mall traffic during the holiday shopping season and a decline in consumer spending, can negatively impact our fourth quarter results and our ability to achieve positive operating cash flow for the year. Additionally, we face pressure related to increasing commodity costs, particularly cheese and flour.

At September 26, 2010, we were in compliance with all of our debt covenants under the terms of the Senior Credit Facilities. The most restrictive covenant is trailing 12 month minimum EBITDA which was required to be at least $40 million for the 12 months ended September 26, 2010. Our trailing 12 month EBITDA (as calculated based upon the terms of the Senior Credit Facilities, which we refer to as “bank credit agreement EBITDA”) was $40.4 million for that trailing 12 month period.

Beginning with the fourth quarter of 2010 (which ends on January 2, 2011), our minimum trailing 12 month EBITDA covenant increases by $3 million to $43 million. Based upon our results to date and management’s projections for the fourth quarter of 2010 and first quarter of fiscal 2011, we believe it is probable that we will not achieve the minimum level of EBITDA required by the covenant in either the fourth quarter of 2010 or the first quarter of fiscal 2011.

Our Senior Credit Facilities provide for certain cures in the event we do not meet our minimum EBITDA covenant requirement. Covenant violations can be cured with cash payments made by our principal shareholders (referred to as an “equity cure”). Such cure amounts would be required to equal the amount of the EBITDA shortfall, below the minimum level required by the covenant, provided the shortfall does not exceed ten percent of the amount of our trailing 12 month bank credit agreement EBITDA. The cure amount would then be added to our minimum 12 month EBITDA for the quarter requiring the cure, and for the subsequent three quarters. An equity cure can only be completed twice within each twelve month period. Our principal shareholders have no obligation to fund any cure amount even if an equity cure right is available to us. Based upon our results to date and management’s projections for the fourth quarter of 2010, we believe our EBITDA shortfall could exceed ten percent of the amount of our trailing 12 month bank credit agreement EBITDA. In such event, we would not be able to utilize an equity cure to remedy an EBITDA covenant violation. We are currently exploring options to address our capital structure in light of our forecasts and the terms of our outstanding indebtedness, including discussions with our lenders regarding altering the terms of our debt and/or modifying our capital structure.

 

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Table of Contents

SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

 

Absent any waiver from or other agreement with the lenders under our Senior Credit Facilities, a violation of our minimum EBITDA covenants that is not remedied will give those lenders the right to accelerate the maturity of our outstanding indebtedness under the Senior Credit Facilities, so that the loans would become immediately due and payable. If this were to occur, we would be required by GAAP to reclassify all of our outstanding indebtedness from long-term to current liabilities on our balance sheet at January 2, 2011. If the lenders under our Senior Credit Facilities were to accelerate the maturity of our outstanding indebtedness, the lenders under our Second Lien Facility and the holders of our Senior Notes would have the right to declare all amounts owed to them immediately due and payable.

Based upon our cash balance of $12.7 million at September 26, 2010 and our current forecasts, our cash flows generated from operations, along with cash on hand, may not provide us with sufficient liquidity to meet our debt service requirements, fund working capital and limited capital expenditures for the next twelve months when we take into account economic uncertainty, the lack of any availability under our existing debt facilities and funding necessary for any debt restructuring or refinancing that may be undertaken along with related advisory fees and expenses. All of the above raises substantial doubt regarding the Company’s ability to continue as a going concern.

2. Recent Accounting Pronouncements

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

3. Long Term Debt:

Indenture:

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

The Senior Notes are senior unsecured obligations of ours and are guaranteed by all of our current and future domestic subsidiaries and rank equally in right of payment with all existing and future senior indebtedness of ours. The Senior Notes are effectively subordinated to all secured indebtedness of ours to the extent of the collateral securing such indebtedness, including the Senior Credit Facilities and Second Lien Facility (both defined below). In the event of any distribution or payment of our assets in any foreclosure, dissolution, winding-up, liquidation, reorganization, or other bankruptcy proceeding, holders of secured indebtedness will have prior claim to those of our assets that constitute their collateral. The Senior Notes are structurally subordinated to all existing and future indebtedness, claims of holders of preferred stock and other liabilities of our subsidiaries that do not guarantee the Senior Notes. In the event of a bankruptcy, liquidation or reorganization of any of our non-guarantor subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled to payment of their claims in full from the assets of those subsidiaries before any assets are made available for distribution. The Senior Notes are senior in right of payment to any future subordinated obligations of ours.

The indenture governing the notes contains certain events of default and restrictive covenants which are customary with respect to non-investment grade debt securities, including limitations on the incurrence of additional indebtedness, dividends, repurchases of

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

capital stock, sales of assets, liens, mergers and transactions with affiliates. In addition, the notes contain cross-acceleration provisions tied to any of our indebtedness in excess of $10 million, including the Senior Credit Facilities and the Second Lien Facility.

Senior Credit Facilities:

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

On March 26, 2009, we entered into an amendment to the Senior Credit Facilities. The amendment permitted the Company to refinance a portion of the Term Loan by entering into a new Second Lien Facility (defined and discussed below), permanently waived a breach of our total net leverage ratio covenant for the fiscal quarter ended December 28, 2008, permanently replaced our total net leverage ratio covenant and interest coverage ratio covenant with a minimum EBITDA covenant and a maximum capital expenditure covenant, increased the margin on our Term Loan and Revolving Facility by 200 basis points, required prepayment of $25.0 million of the Term Loan from the proceeds of the Second Lien Facility, required prepayment of $3.5 million of the Revolving Facility from cash on hand and simultaneously reduced the Revolving Facility’s amount outstanding and commitment to $21.5 million, and restricted payment of MidOcean’s annual management fee so that such fee will accrue but not be paid until the Company’s EBITDA is at least $55.0 million and after such goal is obtained, a maximum of $2.0 million of such fees may be paid each year. In the first quarter of 2009, we wrote off $0.4 million of deferred financing costs related to the prepayment of the Term Loan. There were $3.0 million of letters of credit outstanding as of September 26, 2010. The letters of credit were issued instead of cash security deposits under our operating leases or to guarantee construction costs of our locations, and for run-out claims under our medical plan. In July 2010 we borrowed $5.4 million from the Senior Credit Facilities. As of September 26, 2010 our remaining borrowing availability under the Senior Credit Facilities was $0.6 million.

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

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

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

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

 

Second Lien Facility:

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

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

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

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

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

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

Long-term debt of $17.9 million is scheduled to mature in 2013, $180.3 million in 2014 and $150.0 million is scheduled to mature in 2015. Refer to Note 6 “Fair Value Measurement” for the gross balance, net book value and fair value of our long-term debt at September 26, 2010.

4. Intangibles (in thousands):

Goodwill

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

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

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

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

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

Consistent with previous tests, we considered the results of both an income approach and a market approach in determining the fair value of the reporting units during the second quarter of 2010.

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

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

The Company considered each alternative in determining fair value of the reporting units, and in doing so concluded that given the current environment, the market-based equity pricing model was most appropriate. As the carrying value of the Company-owned segment was negative as of May 23, 2010, the triggering event date, no further assessment of impairment on goodwill could be made. At the point in which equity becomes positive, the equity of the reporting unit will be compared to the fair value of the reporting unit pursuant to applicable guidance. No goodwill impairment was recorded for the Company-owned reporting segment.

Other Intangibles

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

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

 

     Trademark     Franchise
Relationships
    Franchise  Rights
Acquired
    Franchise
Agreements,  net
 

December 28, 2008

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

Additions

     —          —          250        —     

Impairment

     (21,900     (2,900     —          —     

Amortization

     —          —          —          (1,239
                                

December 27, 2009

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

Impairment

     (15,700     —          —          —     

Amortization

     —          —          (12     (788
                                

September 26, 2010

   $ 157,400      $ 14,400      $ 1,589      $ 2,861   
                                

For purposes of establishing inputs for the fair value calculations described above related to indefinite lived intangible assets, we assumed that the current economic downturn would continue domestically through 2010, followed by moderate growth in future years

consistent with our growth prior to the recent downturn in the economy. Internationally, we assumed the continued downturn in the economy in 2010 with slight improvements in future years.

 

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Notes to Unaudited Consolidated Financial Statements

(Continued)

 

 

We applied gross margin assumptions consistent with the Company’s current trends and used a 4.4% growth factor. Discounting the projected cash flows of these indefinite lived intangible assets at 15.0%, we determined a value of $157.4 million for our trademarks as of May 23, 2010, the triggering event date, and accordingly, we impaired $15.7 million of trademarks during the quarter ended June 27, 2010. The fair value of the franchise relationships and franchise rights acquired exceeded their carrying value and as such no impairment charge was required. If the terminal growth rate, which has the largest impact on fair value, used in the fair value calculation for trademarks was decreased by 1%, the impairment charge would have increased by $6.5 million. If the discount rate used in the fair value calculation for trademarks was increased by 1%, the impairment charges would have increased by $13.9 million.

Franchise rights acquired and franchise agreements are definite lived assets and amortized over the life of the agreements. Amortization expense of $0.8 million and $0.9 million was recorded in the nine months ended September 26, 2010 and September 27, 2009, respectively. At September 26, 2010 and December 27, 2009, accumulated amortization was $5.2 million and $4.4 million, respectively.

5. Income Taxes:

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

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

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

Based on these considerations and the uncertainty surrounding the future economic climate, management believes that it is more likely than not that our net operating loss carryforward, foreign tax credit carryforward, and all other deferred tax assets will not be realized. During the first nine months of 2010 we recorded an addition of $10.0 million to our full valuation allowance against these deferred tax assets. The valuation allowance was $49.7 million as of September 26, 2010.

The income tax benefit of $6.0 million recognized for the first nine months of 2010 was primarily the result of a $6.3 million benefit recorded in the second quarter of 2010 due to the decrease in our deferred tax liability related to intangible asset impairment charges. Refer to Note 4 “Intangibles” for further information regarding the impairment charges recorded.

6. Fair Value Measurement

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

 

   

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

 

   

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

 

   

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

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

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

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

 

The following table presents the gross balance, net book value and fair value of our long-term debt as of September 26, 2010 (in thousands):

 

     September 26, 2010  
     Gross
Balance
     Net Book
Value
     Fair Value  

Senior Notes

   $ 150,000       $ 150,000       $ 88,500   

Senior Credit Facility

     172,698         172,698         157,725   

Second Lien Facility

     25,500         19,104         23,438   
                          

Total

   $ 348,198       $ 341,802       $ 269,663   
                          

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

7. Business Segment Information:

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

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

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

 

     Company-
Owned

Restaurants
    Franchised
Restaurants
     Totals  

3rd Quarter 2010

       

Total revenue

   $ 80,467      $ 3,538       $ 84,005   
                         

Operating income before unallocated costs

   $ 6,375      $ 2,591       $ 8,966   
                   

Unallocated costs and expenses (1)

          6,701   
             

Operating income

        $ 2,265   
             

3rd Quarter 2009

       

Total revenue

   $ 82,141      $ 3,388       $ 85,529   
                         

Operating (loss) income before unallocated costs

   $ (23,195   $ 2,150       $ (21,045
                   

Unallocated costs and expenses (1)

          5,549   
             

Operating loss

        $ (26,594
             

YTD 3rd Quarter 2010

       

Total revenue

   $ 228,658      $ 10,427       $ 239,085   
                         

Operating (loss) income before unallocated costs

   $ (1,053   $ 7,648       $ 6,595   
                   

Unallocated costs and expenses (1)

          20,198   
             

Operating loss

        $ (13,603
             

YTD 3rd Quarter 2009

       

Total revenue

   $ 235,083      $ 10,162       $ 245,245   
                         

Operating (loss) income before unallocated costs

   $ (11,936   $ 6,277       $ (5,659
                   

Unallocated costs and expenses (1)

          18,978   
             

Operating loss

        $ (24,637
             

 

(1)

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

Geographic Information

The Company recorded revenues of $230.2 million and $8.9 million and $239.2 million and $6.0 million in the United States and all other foreign countries in the first nine months of 2010 and 2009, respectively, and $80.4 million and $3.6 million and $83.4 million and $2.1 million in the United States and all other foreign countries in the third quarter of 2010 and 2009, respectively.

 

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SBARRO INC. AND SUBSIDIARIES

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

8. Guarantor and non-guarantor financial statements:

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

The following condensed consolidating financial information presents:

 

  (1)

Condensed unaudited consolidating balance sheets as of September 26, 2010 and December 27, 2009 and unaudited statements of operations for the three and nine months ended September 26, 2010 and September 27, 2009 and our unaudited statement of cash flows for the nine months ended September 26, 2010 and September 27, 2009 of: (a) Sbarro, (“the Parent”), (b) the guarantor subsidiaries as a group, (c) the nonguarantor subsidiaries as a group, and (d) Sbarro on a consolidated basis.

 

  (2)

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

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

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of September 26, 2010

ASSETS

(In thousands)

 

     Parent     Guarantor
Subsidiaries
     Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Current assets:

           

Cash and cash equivalents

   $ 9,605      $ 2,734       $ 331      $ —        $ 12,670   

Receivables:

           

Franchise

     1,881        —           —          —          1,881   

Other

     2,208        —           377        —          2,585   
                                         
     4,089        —           377        —          4,466   

Inventories

     1,043        1,533         269        —          2,845   

Prepaid expenses

     2,757        499         146        —          3,402   
                                         

Total current assets

     17,494        4,766         1,123        —          23,383   

Intercompany receivables

     (44,920     48,083         (3,512     349        —     

Investment in subsidiaries

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

Property and equipment, net

     16,696        33,363         1,929        (230     51,758   

Goodwill

     194,786        —           —          —          194,786   

Trademarks

     157,400        —           —          —          157,400   

Other intangible assets

     18,850        —           —          —          18,850   

Deferred financing costs, net

     7,809        —           —          —          7,809   

Other assets

     165        203         1,199        —          1,567   
                                         

Total assets

   $ 442,560      $ 86,415       $ 3,046      $ (76,468   $ 455,553   
                                         

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of September 26, 2010

LIABILITIES AND SHAREHOLDERS’ (DEFICIT) EQUITY

(In thousands)

(Continued)

 

     Parent     Guarantor
Subsidiaries
     Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Current liabilities:

           

Accounts payable

   $ 6,135      $ 284       $ 1,007      $ —        $ 7,426   

Accrued expenses

     14,838        2,060         2,496        (230     19,164   

Accrued interest payable

     3,399        —           —          —          3,399   
                                         

Total current liabilities

     24,372        2,344         3,503        (230     29,989   

Deferred rent

     1,885        5,510         71        —          7,466   

Deferred tax liability

     70,645        —           —          —          70,645   

Due to former shareholders & other liabilities

     13,258        —           —          —          13,258   

Accrued interest payable

     6,372        —           —          —          6,372   

Long-term debt

     341,802        —           —          —          341,802   

Commitment and contingencies

           

Shareholders’ (deficit) equity:

           

Common stock

           

Authorized 1,000 shares; $.01 par value issued and outstanding 100 shares at September 26, 2010

     —          —           1,891        (1,891     —     

Additional paid in capital

     139,340        68,302         2,196        (70,498     139,340   

Currency translation adjustment

     (60     —           175        (175     (60

Advances to MidOcean SBR Holding

     (305     —           —          —          (305

(Accumulated deficit) retained earnings

     (155,146     8,221         (4,547     (3,674     (155,146
                                         

Total shareholders’ (deficit) equity

     (16,171     76,523         (285     (76,238     (16,171

Noncontrolling interests

     397        2,038         (243     —          2,192   
                                         

Total shareholders’ (deficit) equity, including noncontrolling interests

     (15,774     78,561         (528     (76,238     (13,979
                                         

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

   $ 442,560      $ 86,415       $ 3,046      $ (76,468   $ 455,553   
                                         

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of December 27, 2009

ASSETS

(In thousands)

 

     Parent     Guarantor
Subsidiaries
     Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Current assets:

           

Cash and cash equivalents

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

Receivables:

           

Franchise

     2,237        —           —          —          2,237   

Other

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

Inventories

     1,152        1,643         112        —          2,907   

Prepaid expenses

     1,094        533         144        —          1,771   
                                         

Total current assets

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

Intercompany receivables

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

Investment in subsidiaries

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

Property and equipment, net

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

Goodwill

     194,786        —           —          —          194,786   

Trademarks

     173,100        —           —          —          173,100   

Other intangible assets

     19,650        —           —          —          19,650   

Deferred financing costs, net

     8,977        —           —          —          8,977   

Other assets

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

Total Assets

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

 

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SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Balance Sheet

As of December 27, 2009

LIABILITIES AND SHAREHOLDERS’ EQUITY

(In thousands)

(Continued)

 

     Parent     Guarantor
Subsidiaries
     Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Current liabilities:

           

Accounts payable

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

Accrued expenses

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

Accrued interest payable

     7,935        —           —          —          7,935   
                                         

Total current liabilities

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

Deferred rent

     139        6,343         —          —          6,482   

Deferred tax liability

     76,941        —           —          —          76,941   

Due to former shareholders & other liabilities

     12,508        —           —          —          12,508   

Accrued interest payable

     3,048        —           —          —          3,048   

Long-term debt

     336,095        —           —          —          336,095   

Shareholders’ equity:

           

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

     —          —           484        (484     —     

Additional paid-in capital

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

Currency translation adjustments

     200        —           255        (255     200   

Advances to MidOcean SBR Holding

     (305     —           —          —          (305

(Accumulated deficit) retained earnings

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

Total shareholders’ equity

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

Noncontrolling interest

     645        1,893         (184     —          2,354   
                                         

Total shareholders’ equity, including noncontrolling interests

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

Total liabilities and shareholders’ equity, Sbarro, Inc.

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

 

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Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Statement of Operations

For The Three Months Ended September 26, 2010

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Revenues:

          

Restaurant sales

   $ 33,649      $ 45,043      $ 1,775      $ —        $ 80,467   

Franchise related income

     3,538        —          —          —          3,538   
                                        

Total revenues

     37,187        45,043        1,775        —          84,005   

Costs and expenses:

          

Cost of food and paper products

     8,427        8,374        559        —          17,360   

Payroll and other employee benefits

     9,074        12,747        807        —          22,628   

Other operating costs

     12,545        17,654        681        —          30,880   

Other income, net

     (244     (766     (49     —          (1,059

Depreciation and amortization

     1,443        1,692        753        —          3,888   

General and administrative

     7,349        —          355        —          7,704   

Intercompany charges

     (4,293     4,126        167        —          —     

Goodwill and other intangible asset impairment

     —          —          —          —          —     

Asset impairment, restaurant closings/remodels

     122        105        112        —          339   
                                        

Total costs and expenses, net

     34,423        43,932        3,385        —          81,740   
                                        

Operating income (loss)

     2,764        1,111        (1,610     —          2,265   

Other expense:

          

Interest expense

     (7,796     —          —          —          (7,796
                                        

Other expense

     (7,796     —          —          —          (7,796
                                        

Equity in loss of subsidiaries

     109        —          —          (109     —     
                                        

(Loss) income before income taxes and equity investments

     (4,923     1,111        (1,610     (109     (5,531

Income tax expense

     125        —          —          —          125   
                                        

(Loss) income before equity investments

     (5,048     1,111        (1,610     (109     (5,656

Loss from equity investments

     —          —          (54     —          (54
                                        

Net (loss) income

     (5,048     1,111        (1,664     (109     (5,710

Less: Net (income) loss attributable to noncontrolling interests

     (234     —          662        —          428   
                                        

Net (loss) income attributable to Sbarro, Inc.

   $ (5,282   $ 1,111      $ (1,002   $ (109   $ (5,282
                                        

 

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Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Operations

For The Three Months Ended September 27, 2009

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Revenues:

          

Restaurant sales

   $ 35,431      $ 46,084      $ 626      $ —        $ 82,141   

Franchise related income

     3,388        —          —          —          3,388   
                                        

Total revenues

     38,819        46,084        626        —          85,529   
                                        

Costs and expenses:

          

Cost of food and paper products

     8,556        8,256        176        —          16,988   

Payroll and other employee benefits

     9,485        13,560        215        —          23,260   

Other operating costs

     12,975        17,000        366        —          30,341   

Other income, net

     (48     (806     (11     —          (865

Depreciation and amortization

     1,945        1,860        25        —          3,830   

General and administrative

     6,763        4        19        —          6,786   

Asset impairment, restaurant closings

     (1,766     1,753        13        —          —     

Goodwill and other intangible asset impairment

     31,474        —          —          —          31,474   

Intercompany charges

     199        110        —          —          309   
                                        

Total costs and expenses, net

     69,583        41,737        803        —          112,123   
                                        

Operating (loss) income

     (30,764     4,347        (177     —          (26,594

Other expense:

          

Interest expense

     (7,414     —          —          —          (7,414
                                        

Net other expense

     (7,414     —          —          —          (7,414
                                        

Equity in loss of subsidiaries

     3,802        —          —          (3,802     —     
                                        

(Loss) income before income taxes and equity investments

     (34,376     4,347        (177     (3,802     (34,008

Income tax benefit

     (9,752     —          —          —          (9,752
                                        

(Loss) income before equity investments

     (24,624     4,347        (177     (3,802     (24,256

Loss from equity investments

     —          —          (54     —          (54
                                        

Net (loss) income

     (24,624     4,347        (231     (3,802     (24,310

Less: Net loss (income) attributable to noncontrolling interests

     103        (393     79        —          (211
                                        

Net (loss) income attributable to Sbarro, Inc.

   $ (24,521   $ 3,954      $ (152   $ (3,802   $ (24,521
                                        

 

23


Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Consolidating Statement of Operations

For The Nine Months Ended September 26, 2010

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations      Consolidated
Total
 

Revenues:

           

Restaurant sales

   $ 94,846      $ 130,411      $ 3,401      $ —         $ 228,658   

Franchise related income

     10,427        —          —          —           10,427   
                                         

Total revenues

     105,273        130,411        3,401        —           239,085   

Costs and expenses:

           

Cost of food and paper products

     23,363        23,549        1,094        —           48,006   

Payroll and other employee benefits

     25,686        37,412        1,378        —           64,476   

Other operating costs

     37,327        52,007        2,547        —           91,881   

Other income, net

     (529     (2,251     (66     —           (2,846

Depreciation and amortization

     4,806        5,338        837        —           10,981   

General and administrative

     22,221        —          812        —           23,033   

Intercompany charges

     (12,892     12,564        328        —           —     

Goodwill and other intangible asset impairment

     15,700        —          —          —           15,700   

Asset impairment, restaurant closings/remodels

     234        1,080        143        —           1,457   
                                         

Total costs and expenses, net

     115,916        129,699        7,073        —           252,688   
                                         

Operating (loss) income

     (10,643     712        (3,672     —           (13,603

Other (expense) income:

           

Interest expense

     (22,902     —          —          —           (22,902

Interest income

     1        —          —          —           1   
                                         

Net other (expense) income

     (22,901     —          —          —           (22,901
                                         

Equity in loss of subsidiaries

     (1,525     —          —          1,525         —     
                                         

(Loss) income before income taxes and equity investments

     (35,069     712        (3,672     1,525         (36,504

Income tax benefit

     (5,955     —          —          —           (5,955
                                         

(Loss) income before equity investments

     (29,114     712        (3,672     1,525         (30,549

Loss from equity investments

     —          —          (174     —           (174
                                         

Net (loss) income

     (29,114     712        (3,846     1,525         (30,723

Less: Net (income) loss attributable to noncontrolling interests

     (194     —          1,609        —           1,415   
                                         

Net (loss) income attributable to Sbarro, Inc.

   $ (29,308   $ 712      $ (2,237   $ 1,525       $ (29,308
                                         

 

24


Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Operations

For The Nine Months Ended September 27, 2009

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Revenues:

          

Restaurant sales

   $ 99,855      $ 133,785      $ 1,443      $ —        $ 235,083   

Franchise related income

     10,162        —          —          —          10,162   
                                        

Total revenues

     110,017        133,785        1,443        —          245,245   
                                        

Costs and expenses:

          

Cost of food and paper products

     23,887        23,773        457        —          48,117   

Payroll and other employee benefits

     26,705        38,770        572        —          66,047   

Other operating costs

     38,166        50,748        1,001        —          89,915   

Other income, net

     (270     (2,510     (105     —          (2,885

Depreciation and amortization

     5,723        6,516        58        —          12,297   

General and administrative

     22,588        5        19        —          22,612   

Asset impairment, restaurant closings

     1,232        1,073        —          —          2,305   

Goodwill and other intangible asset impairment

     31,474        —          —          —          31,474   

Intercompany charges

     (13,979     13,893        86        —          —     
                                        

Total costs and expenses, net

     135,526        132,268        2,088        —          269,882   
                                        

Operating (loss) income

     (25,509     1,517        (645     —          (24,637

Other (expense) income:

          

Interest expense

     (20,747     —          —          —          (20,747

Write-off of deferred financing costs

     (423     —          —          —          (423

Interest income

     33        —          —          —          33   
                                        

Net other (expense) income

     (21,137     —          —          —          (21,137
                                        

Equity in loss of subsidiaries

     396        —          —          (396     —     
                                        

(Loss) income before income taxes and equity investments

     (46,250     1,517        (645     (396     (45,774

Income tax benefit

     (9,480     —          —          —          (9,480
                                        

(Loss) income before equity investments

     (36,770     1,517        (645     (396     (36,294

Loss from equity investments

     —          —          (162     —          (162
                                        

Net (loss) income

     (36,770     1,517        (807     (396     (36,456

Net loss (income) attributable to noncontrolling interests

     70        (583     269        —          (244
                                        

Net (loss) income attributable to Sbarro, Inc.

   $ (36,700   $ 934      $ (538   $ (396   $ (36,700
                                        

 

25


Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Cash Flows

For The Nine Months Ended September 26, 2010

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 
Operating Activities:           

Net (loss) income

   $ (29,114   $ 712      $ (3,846   $ 1,525      $ (30,723

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

          

Goodwill and other intangible asset impairment charges

     15,700        —          —          —          15,700   

Depreciation and amortization

     4,806        5,338        837        —          10,981   

Amortization of deferred financing costs

     1,475        —          —          —          1,475   

Provision for doubtful accounts receivable

     92        —          —          —          92   

Increase in deferred rent, net of tenant allowance

     460        778        10        —          1,248   

Asset impairment & restaurant closings/remodels

     82        904        143        —          1,129   

Change in deferred income taxes, net

     (6,296     —          —          —          (6,296

Equity in net loss of unconsolidated affiliates

     —          —          174        —          174   

Changes in operating assets and liabilities:

          

Decrease (increase) in receivables

     669        304        (314     —          659   

Decrease (increase) in inventories

     109        110        (157     —          62   

(Increase) decrease in prepaid expenses

     (1,045     34        (2     —          (1,013

Decrease (increase) in other assets

     40        (2     (1,148     —          (1,110

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

     (6,665     (483     2,165        —          (4,983

Decrease in accrued interest payable

     (1,212     —          —          —          (1,212
                                        

Net cash (used in) provided by operating activities

     (20,899     7,695        (2,138     1,525        (13,817
                                        
Investing Activities:           

Purchases of property and equipment

     (1,604     (3,055     (2,204     —          (6,863
                                        

Net cash used in investing activities

     (1,604     (3,055     (2,204     —          (6,863
                                        
Financing Activities:           

Proceeds from revolver loan

     5,400        —          —          —          5,400   

Capital contribution from noncontrolling interests

     —          —          1,186        —          1,186   

Proceeds from short term loan from noncontrolling interests

     —          —          170        —          170   

Distribution of earnings to noncontrolling interests

     (269     —          —          —          (269

Intercompany balances

     3,264        (4,370     2,631        (1,525     —     
                                        

Net cash provided by (used in) financing activities

     8,395        (4,370     3,987        (1,525     6,487   
                                        

(Decrease) increase in cash and cash equivalents

     (14,108     270        (355     —          (14,193

Cash and cash equivalents at beginning of period

     23,713        2,464        686          26,863   
                                        

Cash and cash equivalents at end of period

   $ 9,605      $ 2,734      $ 331      $ —        $ 12,670   
                                        

 

26


Table of Contents

 

SBARRO, INC. AND SUBSIDIARIES

Notes To Unaudited Consolidated Financial Statements

Consolidating Statement of Cash Flows

For The Nine Months Ended September 27, 2009

(In thousands)

 

     Parent     Guarantor
Subsidiaries
    Nonguarantor
Subsidiaries
    Eliminations     Consolidated
Total
 

Operating Activities:

          

Net (loss) income

   $ (36,770   $ 1,517      $ (807   $ (396   $ (36,456

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

          

Goodwill and other intangible asset impairment charges

     31,474        —          —          —          31,474   

Depreciation and amortization

     5,723        6,516        58        —          12,297   

Amortization of deferred financing costs

     1,084        —          —          —          1,084   

Provision for doubtful accounts receivable

     916        —          —          —          916   

Increase in deferred rent, net of tenant allowance

     510        883        11        —          1,404   

Asset impairment, restaurant closings/remodels

     817        283        —          —          1,100   

Change in deferred income taxes, net

     (9,915     —          —          —          (9,915

Equity in net loss of unconsolidated affiliates

     —          —          162        —          162   

Write-off of deferred financing costs

     423        —          —          —          423   

Changes in operating assets and liabilities:

          

(Increase) decrease in receivables

     (189     251        363        (371     54   

Decrease in inventories

     213        271        11        —          495   

(Increase) decrease in prepaid expenses

     (726     129        247        —          (350

Increase in other assets

     (86     —          —          —          (86

(Decrease) increase in accounts payable and accrued expenses

     (7,747     (580     698        (649     (8,278

Decrease in accrued interest payable

     (1,941     —          —          —          (1,941
                                        

Net cash (used in) provided by operating activities

     (16,214     9,270        743        (1,416     (7,617
                                        
Investing Activities:           

Purchases of property and equipment

     (1,378     (4,424     (475     —          (6,277

Investment in joint ventures

     (283     —          —          —          (283
                                        

Net cash used in investing activities

     (1,661     (4,424     (475     —          (6,560
                                        
Financing Activities:           

Proceeds from second lien

     25,000        —          —          —          25,000   

Repayment of secured term loan and revolver

     (32,958     —          —          —          (32,958

Debt issue costs

     (1,834     —          —          —          (1,834

Capital contribution from noncontrolling interests

     —          —          394        —          394   

Repayment of short term loan to noncontrolling interests

     —          —          (374     —          (374

Distribution of earnings to noncontrolling interests

     (881     —          —          —          (881

Intercompany balances

     6,105        (6,868     (653     1,416        —     
                                        

Net cash (used in) provided by financing activities

     (4,568     (6,868     (633     1,416        (10,653
                                        

Decrease in cash and cash equivalents

     (22,443     (2,022     (365     —          (24,830

Cash and cash equivalents at beginning of period

     34,249        3,468        569        —          38,286   
                                        

Cash and cash equivalents at end of period

   $ 11,806      $ 1,446      $ 204      $ —        $ 13,456   
                                        

 

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

Forward-Looking Statements

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

 

   

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

 

   

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

 

   

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

 

   

changes in consumer tastes;

 

   

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

 

   

our ability to continue to attract franchisees;

 

   

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

 

   

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

 

   

our ability to pass along cost increases to our customers;

 

   

increases in the Federal minimum wage;

 

   

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

 

   

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

 

   

competition;

 

   

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

 

   

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

 

   

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

 

   

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

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report. We do not undertake any responsibility to release publicly any revisions to these forward-looking statements to take into account events or circumstances that occur after the date of this report. Additionally, we do not undertake any responsibility to update you on the occurrence of any unanticipated events which may cause actual results to differ from those expressed or implied by the forward-looking statements contained in this report.

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

Executive Overview

For the purposes of management’s discussion and analysis, the year to date third quarter of 2010 is the thirty-nine weeks ended September 26, 2010 and the year to date third quarter of 2009 is the thirty-nine weeks ended September 27, 2009. The third quarter of 2010 is the thirteen weeks ended September 26, 2010 and the third quarter of 2009 is the thirteen weeks ended September 27, 2009.

We are the world’s leading Italian Quick Service Restaurant (“QSR”) concept and the largest shopping mall-focused restaurant concept in the world. We have a global base of 1,032 units in 40 countries, with 476 company-owned units, 538 franchised units and 18 joint venture units. Sbarro restaurants feature a menu of popular Italian food, including pizza, a selection of pasta dishes and other hot and cold Italian entrees, salads, sandwiches, drinks and desserts.

 

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

Our Restaurant Expansion

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

 

     Three Months  Ended
September 26, 2010
    Three Months  Ended
September 27, 2009
    Nine Months  Ended
September 26, 2010
    Nine Months  Ended
September 27, 2009
 

Company-owned Sbarro restaurants:

        

Open at beginning of period

     482        485        484        509   

Opened during period

     —          2        4        7   

Closed during period

     (6     (2     (12     (31
                                

Open at end of period

     476        485        476        485   
                                

Franchised Sbarro restaurants:

        

Open at beginning of period

     536        560        555        566   

Opened during period

     16        13        33        49   

Closed during period

     (14     (19     (50     (61
                                

Open at end of period

     538        554        538        554   
                                

Joint venture Sbarro restaurants:

        

Open at beginning of period

     23        17        17        16   

Opened during period

     —          —          6        1   

Closed during period

     (5     —          (5     —     
                                

Open at end of period

     18        17        18        17   
                                

All restaurants:

        

Open at beginning of period

     1,041        1,062        1,056        1,091   

Opened during period

     16        15        43        57   

Closed during period

     (25     (21     (67     (92
                                

Open at end of period

     1,032        1,056        1,032        1,056   
                                

Seasonality

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

Goodwill and Other Intangible Assets

Due to the seasonality of our business, we perform our annual test for impairment on our goodwill and intangible assets with indefinite lives as required by the accounting for goodwill and other intangible assets and fully evaluate the impairment of long-lived assets as required by the accounting for the impairment and disposal of long-lived assets in the fourth quarter of our fiscal year. Any required adjustments are recorded at that time unless our assumptions regarding forecasted revenue or margin growth rates are not achieved, then we may be required to record an impairment charge prior to that if any such change constitutes a triggering event

 

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outside of the quarter from when the annual goodwill impairment test is performed. Refer to Note 4 “Intangibles” to our Unaudited Consolidated Financial Statements for further information regarding impairment testing performed during the second quarter of 2010 and the impairment charges recorded during the second quarter of 2010.

Noncontrolling Interests

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

Summary Financial Information (dollars in thousands)

 

    Three Months
Ended
September 26, 2010
    Three Months
Ended
September 27, 2009
    Nine Months
Ended
September 26, 2010
    Nine Months
Ended
September 27, 2009
 

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

       

QSR-owned locations

    -3.5     -5.2     -3.1     -5.0

Franchise locations:

       

Domestic Franchise

    -2.4     -7.1     -3.4     -5.4

International Franchise:

       

Local Currency

    6.1     -12.9     6.1     -9.2

Foreign Currency Impact

    0.8     -14.4     4.8     -16.7
                               

International Franchise, net

    6.9     -27.3     10.9     -25.9

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

    21.6     20.7     21.0     20.5

Payroll and other benefits as a percentage of restaurant sales

    28.1     28.3     28.2     28.1

Other operating expense as a percentage of restaurant sales

    38.4     36.9     40.2     38.2

General and administrative costs as a percentage of revenues

    9.2     7.9     9.6     9.2

Bank credit agreement EBITDA (2)

  $ 9,076      $ 10,206      $ 23,716      $ 27,728   

 

(1)

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

(2)

Bank credit agreement EBITDA includes certain adjustments to EBITDA disclosed in our Senior Credit Facilities. EBITDA represents earnings before interest income, interest expense, taxes, depreciation and amortization. EBITDA should not be considered in isolation from, or as a substitute for, net income, cash flow from operations or other cash flow statement data prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) or as a measure of a company’s profitability or liquidity. Rather, we believe that EBITDA and bank credit agreement EBITDA provide relevant and useful information for analysts and investors in our Senior Notes in that the Senior Credit Facilities and the Second Lien Facility each contain a minimum bank credit agreement EBITDA covenant. We also internally use EBITDA to determine whether or not to continue operating restaurant units since it provides us with a measurement of whether we are receiving an adequate cash return on our investment. Our calculation of EBITDA may not be comparable to a similarly titled measure reported by other companies, since all companies do not calculate this non-GAAP measure in the same manner. Our EBITDA calculations are not intended to represent cash provided by (used in) operating activities since they do not include interest and taxes and changes in operating assets and liabilities, nor are they intended to represent a net increase in cash since they do not include cash provided by (used in) investing and financing activities.

 

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

 

    Three Months
Ended
September 26, 2010
    Three Months
Ended
September 27, 2009
    Nine Months
Ended
September 26, 2010
    Nine Months
Ended
September 27, 2009
 

Net loss attributable to Sbarro, Inc.

  $ (5,282   $ (24,521   $ (29,308   $ (36,700

Interest Expense

    7,796        7,414        22,902        20,747   

Interest Income

    —          —          (1     (33

Income Tax Expense (Benefit)

    125        (9,752     (5,955     (9,480

Depreciation and Amortization

    3,888        3,830        10,981        12,297   
                               

EBITDA attributable to Sbarro, Inc.

    6,527        (23,029     (1,381     (13,169

Goodwill and other intangible asset impairment

    —          31,474        15,700        31,474   
                               

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

  $ 6,527      $ 8,445      $ 14,319      $ 18,305   

Adjustments:

       

Non-cash charges

    1,644        420        3,459        3,239   

Management fees and related expenses

    295        311        889        1,290   

Restructuring related expenses, store closing costs and severance

    398        722        2,714        3,864   

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

    212        308        2,335        1,030   
                               

Bank Credit Agreement EBITDA

  $ 9,076      $ 10,206      $ 23,716      $ 27,728   
                               

 

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

 

<
     Company-
Owned
Restaurants
    Franchised
Restaurants
     Totals  

3rd Quarter 2010

       

Total revenue

   $ 80,467      $ 3,538       $ 84,005   
                         

Operating income before unallocated costs

   $ 6,375      $ 2,591       $ 8,966   
                   

Unallocated costs and expenses (1)

          6,701   
             

Operating income

        $ 2,265   
             

3rd Quarter 2009

       

Total revenue

   $ 82,141      $ 3,388       $ 85,529   
                         

Operating (loss) income before unallocated costs

   $ (23,195   $ 2,150       $ (21,045
                   

Unallocated costs and expenses (1)

          5,549   
             

Operating loss

        $ (26,594
             

YTD 3rd Quarter 2010

       

Total revenue

   $ 228,658      $ 10,427       $ 239,085   
                         

Operating (loss) income before unallocated costs

   $ (1,053   $ 7,648       $ 6,595   
                   

Unallocated costs and expenses (1)

          20,198   
             

Operating loss

        $ (13,603
             

YTD 3rd Quarter 2009