Sbarro files for Chapter 11 Bankruptcy | March 10, 2014
Sbarro, LLC and certain of its affiliates filed for Chapter 11 under the United States Bankruptcy Code. The Debtor has filed a prepackaged plan and has requested a confirmation hearing to be held on April 22, 2014. The case is currently pending in the Bankruptcy Court for the Southern District of New York under Case No. 14-10557 (together with the jointly administered cases described below). [download_link link=”http://chapter11dallas.com/wp-content/uploads/2014/03/Sbarro-Corporate-Structure.pdf” variation=”green”]Sbarro Corporate Structure[/download_link]
Overview of Sbarro Bankruptcy
Carolyn Spatafora, is the Chief Financial Officer (and prior Senior Vice President) of Sbarro LLC. In her affidavit filed in connection with the Chapter 11 filing, she discusses the rationale of the filing:
“Following negotiation with their secured creditors, the Debtors have commenced these chapter 11 cases to obtain access to $20 million in new money debtor-in-possession financing and to implement a pre-packaged restructuring designed to eliminate approximately $128 million (more than 85 percent) of prepetition funded debt. With their prepackaged plan serving as a baseline restructuring alternative, the Debtors intend to subject the plan to an overbid process to maximize creditor recoveries and, toward that end, have proposed bid procedures and a plan confirmation timeline designed to allow the Debtors to emerge expeditiously from chapter 11 as a smaller, more profitable, well-capitalized, and more competitive company, better equipped for growth in accordance with their revised business plan.
“As described further below, the Debtors are a global operator of Italian quick service and casual table dining restaurants, operating 217 company-owned restaurants nationally and 582 franchised restaurants nationally and internationally, employing more than 2,700 employees, and with annual revenues in excess of $38 million. With a strategy premised on offering delicious, fresh, and authentic Italian food items and excellent customer service, the Debtors are the largest mall-focused Italian restaurant concept in the world and have earned substantial credibility within the national food service and restaurant industry.
“Like other retail businesses and restaurant operators, however, the Debtors’ financial performance is sensitive to volatility in commodity prices and consumer discretionary spending, which have negatively impacted the Debtors since the global economic downturn that commenced in 2007 and 2008. Price surges for the Debtors’ key raw materials (cheese and flour) coupled with unprecedented declines in mall traffic during the height of the economic recession resulted in continued underperformance through 2010, resulting in the Debtors and their predecessors filing chapter 11 cases in April 2011. Eight months after the 2011 chapter 11 filing, the Debtors emerged from bankruptcy having reduced their total debt from approximately $400 million to $130 million, secured $35 million in new money commitments, closed certain unprofitable locations, and successfully negotiated amendments to numerous leases with key landlords. The significant financial and operational restructurings undertaken in connection with their 2011 chapter 11 cases, however, have not been sufficient to compensate for trends that have negatively affected the Debtors’ businesses and the overall economy since the Debtors’ adopted their current capital structure.
“Since November 2011, the Debtors have continued to face reduced consumer demand due to an even further decline in mall foot traffic, as well as increased pressure from innovative competitors in a fragmented market. While the Debtors have launched initiatives to diversify their offerings and venue types and reposition the Sbarro brand as one of freshness and handmade quality, these efforts could not overcome the slow-recovering economic climate. National mall traffic has continued to decline, contributing to negative same store sales measures in both 2012 and 2013. Compared to projections for 2012 and 2013 EBITDA of approximately $25 and $31 million, respectively (adjusted EBITDA of $30 and $36 million, respectively), the Debtors’ EBITDA fell to $15 million in 2012 and under $4 million in 2013. With these severe economic headwinds and financial underperformance, the Debtors developed a portfolio optimization plan to reduce their national footprint (and associated costs) by shedding a significant number of unprofitable store locations to focus on key, profitable restaurants. The Debtors also began exploring solutions for a comprehensive restructuring solution to address the reality that enterprise value is significantly less than the amount of the Debtors’ secured debt.
“In December 2013, Sbarro engaged Moelis as its investment banker, Loughlin as its financial advisor, and K&E as its restructuring counsel to advise the Debtors on a potential restructuring. Following a comprehensive analysis of the Debtors’ debt service requirements and operations, the Debtors and their advisors determined that the Debtors could not continue to service their existing secured debt and concluded that an accelerated financial and operational restructuring would be necessary to preserve the valuable brand, implement an appropriate store closure plan, and continue operations as a going concern.
“The proposed Plan, which received near unanimous support from the Debtors’ prepetition secured lenders, with holders of approximately 98% of the outstanding Prepetition Secured Claims voting to accept the Plan,5 provides for a standalone restructuring based on a $35 million credit bid of Prepetition Secured Claims and $20 million in debtor-in-possession financing that will convert to an Exit Facility upon consummation of the proposed Plan. If confirmed on a standalone basis, the Plan will: (a) reduce the Debtors’ total funded debt (including interest) by approximately 85%, from approximately $148.2 million as of March 5, 2014 to approximately $20 million under an Exit Facility; (b) provide the Debtors with long-term financing to support their go-forward business needs and increase free cash flow through significant annual interest expense savings; (c) allow for the efficient implementation of the Debtors’ portfolio optimization plan; and (d) allow the company to maintain going-concern operations for the benefit of its more than 2,700 employees while further executing against its turnaround plan to position for long-term success.
”Under the Credit Bid incorporated in the Plan there is no distributable value beyond the Prepetition Secured Lender Claims (which claims are themselves significantly impaired) and, therefore, no recovery for general unsecured creditors.6 To ensure creditor recoveries are maximized, however, the Plan expressly contemplates an overbid process to allow any strategic or financial investor to “top”the Plan. To facilitate the overbid process, the Debtors intend to seek approval of bidding procedures that will set the framework and timeline for the submission of overbids.
“At the same time, the Debtors are cognizant of the costs associated with the Chapter 11 Cases and the urgent need to recapitalize the business, right-size the debt burden, and ensure sufficient liquidity for investments in the Debtors’ operational strategy. Therefore, the Debtors believe that confirming the proposed Plan as expeditiously as possible — in the absence of any qualifying overbids — will maximize value for their estates. Toward that end, the Debtors are requesting that the Court establish a hearing date for approval of the Disclosure Statement and confirmation of the Plan as early as April 22, 2014. In the event the Debtors receive qualifying overbids, they may adjourn the confirmation hearing to accommodate the overbid process. The Debtors believe that their proposed timeline and bidding procedures appropriately balance the Debtors’ urgent need to restructure with the goal of maximizing value and potential recoveries for all of their stakeholders.
“In sum, the Debtors, with the near unanimous support of their Prepetition Secured Lenders, have created a holistic restructuring solution that will enable the Debtors to promptly emerge from chapter 11 well-positioned to execute on their revised business plan and to compete successfully in the competitive food service and restaurant market. For the reasons described herein, I believe that the compromise contemplated by the Plan is fair and equitable, provides the best recovery available to the Debtors’ stakeholders, and will position the Debtors to achieve their financial and operating plan.
“In the 58 years since the Sbarro family opened their first Italian restaurant in Brooklyn, New York, Sbarro, together with its Debtor and non-debtor affiliates, has grown into a leading owner, operator, and franchisor of Italian quick service restaurants (“QSRs”) and the largest mall-focused restaurant concept in the world — with over 2,700 employees and a global base of approximately 800 restaurants in 35 countries. Under various brand names, the Debtors and their non-debtor affiliates developed one of the first quick-service restaurant concepts that extended beyond offering one primary specialty item, such as pizza or hamburgers.
“In 1985, with a base of 83 company-owned stores and 53 franchised restaurants, Sbarro went public, offering shares of its common stock on The New York Stock Exchange, and began a period of rapid growth correlating with the expansion of shopping malls. On September 28, 1999, members of the Sbarro family (who owned approximately 34.4 percent of Sbarro’s common stock) obtained 100 percent of the issued and outstanding common stock through a “going-private”transaction.
“In January 2007, entities controlled by MidOcean Partners III, L.P. and certain of its affiliates, a leading private equity investment firm, acquired Sbarro and its affiliates from the Sbarro family. As described above, the economic downturn of 2007 and 2008 severely impacted Sbarro’s performance, and in April 2011 Sbarro filed chapter 11 cases. Upon emergence from the prior restructuring, certain senior lenders took ownership of the company through conversion of the second lien and unsecured bond debt to equity as part of the restructuring. The timeline below generally outlines the sequence of events described above.
1956 Opening of original Sbarro in Brooklyn, NY.
1967 First mall-based location at King’s Plaza.
1977 Sbarro, Inc. organized.
1985 IPO with 83 company-owned and 53 franchised units.
1999 Take-private transaction by the Sbarro family.
2007 Acquisition by MidOcean.
2011 Filed chapter 11 cases, consummated by fully consensual chapter 11 plan that reduced funded debt by nearly 70%.
Prepetition Capital Structure.
“As of the Petition Date, the Debtors have outstanding funded debt for borrowed money in the aggregate principal amount of approximately $148.2 million. … The annual interest expense under the Prepetition Secured Credit Agreement is approximately $17 million.
“Sbarro employs all of the Debtors’ employees and is responsible for all corporate overhead and support functions, including legal, accounting, marketing, finance, purchasing and information technology activities, and is also party to the vast majority of the Debtors’ operating leases, supply agreements, and franchise agreements. The subsidiary operating entities are generally organized around certain branded restaurant “concepts”(as further described below) and/or to hold certain operating leases or liquor licenses in states that require separate incorporation for such purposes.
“The Debtors are predominantly domiciled in New York. Notably, 23 of the 34 Debtors, including Sbarro LLC, are either incorporated or formed (as limited liability companies) in the state of New York. The stock certificates for 28 of the Debtors’ entities are also held in the Prepetition Agent’s vault in Manhattan, New York. In addition, the Debtors operate several restaurants in Manhattan, New York.
Current Businesses and Operations
“The Debtors are an Italian QSR concept and the largest shopping-mall focused restaurant concept, with approximately 217 QSR locations and 582 franchised locations. The Debtors’ global QSR and casual dining restaurant brands are organized under two business segments: (1) the company-owned restaurant segment, which consists of wholly-owned QSRs, casual-dining restaurants, and certain new concept restaurants (the “Company Segment”); and (2) the franchise restaurant segment which consists entirely of franchisee-owned domestic and international QSRs (the “Franchise Segment”).
A. Company Segment.
“The Company Segment comprises the Debtors’ core domestic QSR business, which includes approximately 217 stores, all located in high pedestrian traffic locations within North America, spanning 39 states in the United States, the District of Columbia, and Canada. The Debtors are currently investing in two new concepts: Pizza Cucinova, a premium Neapolitan style made-to-order pizza concept, and Brooklyn Fresh, a fast casual Italian concept featuring made-to-order New York style pizza, pasta, and salads.
B. Franchise Segment.
“As noted above, the Franchise Segment currently represents a majority of the Debtors’ global store base with 582 franchised restaurants, including 176 domestic restaurants and 406 international restaurants. Internationally, the Debtors partner with experienced local operators who have the infrastructure and resources to grow the brand. Sbarro’s key international markets include Russia, Turkey, the Philippines, Mexico, and India. Sbarro’s international franchises are relatively vibrant, with approximately 60 new international franchises having opened during 2013.
“The majority of domestic franchised QSRs are operated by institutional food service companies and restaurant operators that manage entire food courts in high-pedestrian- traffic locations such as airports, universities, and travel plazas. In addition, Sbarro has a large number of smaller individual franchisees who operate one or two locations, primarily in malls. The Debtors do not provide deficit or any other financing to their franchised restaurants. The Debtors derive revenues from franchised locations from initial payments and continuing royalty payments based on a percentage of sales.
C. Standard Restaurant Operations.
“The Debtors’ family-oriented restaurants offer cafeteria and buffet-style quick service designed to minimize customer waiting time. The Debtors’ various restaurant concepts feature a diverse menu of popular Italian cuisine, including, pizza, pasta dishes, salads, sandwiches, beverages, and desserts that offers a compelling alternative to traditional fast food. The Debtors’ entrees generally range in cost between price from $3.29 for a slice of pizza to $7.99 with the average check generally being $8.75 per customer transaction. Pizza — which is sold predominately by the slice — accounts for just over half of food sales.
“The Debtors’ approximately 799 company-owned and franchised restaurants are generally open seven days a week for 10-to-12 hours a day. To ensure that they are able to provide customers with the freshest and highest quality products each day, the Debtors rely on a national distributor and also a network of regional and local food and beverage suppliers to make timely deliveries (multiple times per week, and sometimes daily) to each of the Debtors’ restaurants.
“The Debtors’ lease space and locate their restaurants in high-pedestrian-traffic locations, such as shopping malls, airports, casinos, universities and travel plazas to ensure they reach the greatest number of potential customers. The Debtors’ restaurant locations are relatively concentrated with a handful of major national landlords. Approximately two-thirds of the Debtors’ restaurants are leased with six major landlords, and leases with just two major landlords account for approximately 40% of the Debtors’ restaurant base.
“The Debtors are current on all of their insurance obligations, with no outstanding amounts due on account of their insurance policies. The Debtors intend to maintain appropriate insurance coverage during the pendency of the chapter 11 cases.
Events Leading to the Commencement of These Chapter 11 Cases
“The Debtors have commenced these chapter 11 cases because they can no longer sustain the amount of their debt obligations under the Prepetition Secured Credit Agreement. The Debtors incurred these obligations at a time when their EBITDA was significantly higher than it is now. Specifically, the Debtors’ EBITDA fell to $15 million in 2012 and under $4 million in 2013, compared to 2011 EBITDA of approximately $22 million (before restructuring charges) and the Debtors’ projected EBITDA of approximately $25 million in 2012 and approximately $31 million in 2013 ($30 million and $36 million of adjusted EBITDA, respectively). As described above, this rapid decline has been driven primarily by reduced mall traffic. Indeed, mall traffic declined by 1.9% in 2012 and 1.6% in 2013. This trend has severely impacted restaurant businesses, like the Debtors, that rely on mall food court venues, resulting in negative same store sales in both 2012 and 2013. With these severe economic headwinds and financial underperformance, as well as a need to obtain additional liquidity and shed a significant number of unprofitable store locations, the Debtors determined they needed a comprehensive restructuring solution.
“The Debtors’ operational restructuring strategy centers on the need to deleverage their capital structure, optimize their lease portfolio to focus on profitable restaurants and close unprofitable locations, and introduce new concepts to improve the customer experience. At the beginning of 2014, the Debtors implemented a portfolio optimization plan in order to close underperforming locations and focus on key, profitable restaurants. To identify “keep” and “close” stores, the Debtors examined multiple factors, including historical financial performance, minimum EBITDA and revenue levels, occupancy costs, same store sales, management, and geographic location. As a result, the Debtors identified the profitable core restaurants it intends to keep, as well as more than 230 locations to close.9 The Debtors closed over 180 unprofitable stores prior to the Petition Date. The Debtors are also working with their landlords to obtain rent reductions on the remaining portfolio. The Debtors’ portfolio optimization plan, coupled with the proposed financial restructuring embodied in the Plan, is expected to provide a stable and adequate flow of EBITDA to enable the Debtors to pursue strategies that include new fast casual concepts to optimize the business.
“Although the Debtors expect to realize the full benefits of these initiatives, forecasting an improvement in EBITDA to $12 million by the end of 2014 and $13 million by 2016, these higher EBITDA levels would still be less than the Debtors’ current annual cash interest expense. Moreover, the Debtors have been facing significant liquidity pressure and require additional financing to fund losses and the capital expenditures required to implement their operational restructuring strategy. Finally, commencing these chapter 11 cases is necessary for the Debtors to implement their turnaround strategy, preserve value, and position the company for long-term success.
“I believe that the Plan will: (a) reduce the Debtors’ total funded debt (including interest) by approximately 85%, from approximately $148.2 million as of March 5, 2014 to approximately $20 million under the Exit Facility, assuming (i) the Payout Event does not occur and (ii) the original aggregate principal amount of the DIP Facility is converted into the Exit Facility; (b) allow for the efficient implementation of the Debtors’ portfolio optimization plan; and (c) preserve the value of the Debtors’ go-forward operations and allow them to further implement their turnaround plan and position the company for long-term success. I further believe that the terms of the Plan, together with the relief sought in the First Day Pleadings, will minimize the adverse effects of the commencement of these chapter 11 cases on the Debtors’ business operations and ensure the Debtors can maintain a business as usual environment in its remaining stores during the pendency of these chapter 11 cases.
Debtors in Chapter 11
The Debtors in these chapter 11 cases, along with the last four digits of each Debtor’s federal tax identification number, include: Sbarro LLC (1939); Carmela’s, LLC (8088); Carmela’s of Kirkman LLC (7703); Carmela’s of Kirkman Operating, LLC (1182); Corest Management, Inc. (9134); Cucinova Easton LLC (4874); Cucinova Holdings LLC (2698); Cucinova Kenwood LLC (9558); Cucinova Olentangy LLC (8264); Demefac Leasing Corp. (2379); Larkfield Equipment Corp. (7947); Las Vegas Convention Center LLC (7645); New Sbarro Finance, Inc. (6440); New Sbarro Intermediate Holdings, Inc. (9105); Sbarro America, Inc. (9130); Sbarro America Properties, Inc. (9540); Sbarro Blue Bell Express LLC (1419); Sbarro Commack, Inc. (4007); Sbarro Express LLC (0253); Sbarro Holdings, Inc. (7352); Sbarro New Hyde Park, Inc. (6185); Sbarro of Las Vegas, Inc. (2853); Sbarro of Longwood, LLC (0328); Sbarro of Virginia, Inc. (2309); Sbarro Pennsylvania, Inc. (3530); Sbarro Properties, Inc. (9541); Sbarro Venture, Inc. (3182); Sbarro’s of Texas, Inc. (5139); Umberto at the Source, LLC (8024); Umberto Deer Park, LLC (8728); Umberto Hauppauge, LLC (8245); Umberto Hicksville, LLC (0989); Umberto Huntington, LLC (8890); and Umberto White Plains, LLC (8159). The Debtors’ service address is: 401 Broadhollow Road, Melville, New York 11747.
Special thanks to Robert Dremluk for his contributions.