SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(MARK ONE)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 26, 2006.
----------------
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
COMMISSION FILE NUMBER 0-12919
PIZZA INN, INC.
(EXACT NAME OF REGISTRANT IN ITS CHARTER)
MISSOURI 47-0654575
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3551 PLANO PARKWAY
THE COLONY, TEXAS 75056
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES,
INCLUDING ZIP CODE)
(469) 384-5000
(REGISTRANT'S TELEPHONE NUMBER,
INCLUDING AREA CODE)
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 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 IS A LARGE ACCELERATED
FILER, AN ACCELERATED FILER, OR A NON-ACCELERATED FILER. SEE DEFINITION OF
"ACCELERATED FILER AND LARGE ACCELERATED FILER" IN RULE 12B-2 OF THE EXCHANGE
ACT. (CHECK ONE)
LARGE ACCELERATED FILER [ ] ACCELERATED FILER [ ] NON-ACCELERATED FILER [X}
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS
DEFINED IN RULE 12 B-2 OF THE EXCHANGE ACT). YES [ ] NO [X]
AS OF MAY 1, 2006, AN AGGREGATE OF 10,138,494 SHARES OF THE ISSUER'S COMMON
STOCK WERE OUTSTANDING.
PIZZA INN, INC.
Index
-----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
- ------- -------------------- ----
Condensed Consolidated Statements of Operations for the three months and
nine months ended March 26, 2006 and March 27, 2005 (unaudited) 3
Condensed Consolidated Statements of Comprehensive Income for the three
months and nine months ended March 26, 2006 and March 27, 2005 (unaudited) 3
Condensed Consolidated Balance Sheets at March 26, 2006 (unaudited)
and June 26, 2005 4
Condensed Consolidated Statements of Cash Flows for the three months and
nine months ended March 26, 2006 and March 27, 2005 (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 7
Management's Discussion and Analysis of
---------------------------------------
Item 2. Financial Condition and Results of Operations 14
- ------ ---------------------------------------------
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
- ------ ----------------------------------------------------------
Item 4. Controls and Procedures 22
- ------- -----------------------
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
- ------- -----------------
Item 2. Unregistered Sales of Equity Securities and the Use of Proceeds 29
- ------- ---------------------------------------------------------------
Item 3. Defaults Upon Senior Securities 29
- ------- -------------------------------
Item 4. Submission of Matters to a Vote of Security Holders 29
- ------ ---------------------------------------------------
Item 5. Other Information 30
- ------- -----------------
Item 6. Exhibits 30
- ------- --------
Signatures 31
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------
PIZZA INN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------- -------------------
MARCH 26, MARCH 27, MARCH 26, MARCH 27,
REVENUES: 2006 2005 2006 2005
-------------------- ----------- ------------------- -----------
Food and supply sales $ 11,131 $ 11,859 $ 33,654 $ 36,981
Franchise revenue 1,200 1,319 3,579 3,884
Restaurant sales 512 223 1,069 721
-------------------- ----------- ------------------- -----------
12,843 13,401 38,302 41,586
-------------------- ----------- ------------------- -----------
COSTS AND EXPENSES:
Cost of sales 11,225 11,241 33,451 35,125
Franchise expenses 783 723 2,384 2,044
General and administrative expenses 1,363 1,311 4,461 3,497
-------------------- ----------- ------------------- -----------
13,371 13,275 40,296 40,666
-------------------- ----------- ------------------- -----------
OPERATING (LOSS) INCOME (528) 126 (1,994) 920
Gain on sale of asset 2 - 149 -
Interest expense (211) (157) (579) (431)
-------------------- ----------- ------------------- -----------
(LOSS) INCOME BEFORE
INCOME TAXES (737) (31) (2,424) 489
Provision for income taxes (260) (11) (856) 173
-------------------- ----------- ------------------- -----------
NET (LOSS) INCOME $ (477) $ (20) $ (1,568) $ 316
==================== =========== =================== ===========
BASIC (LOSS) EARNINGS
'PER COMMON SHARE $ (0.05) $ - $ (0.15) $ 0.03
==================== =========== =================== ===========
DILUTED (LOSS) EARNINGS
' PER COMMON SHARE $ (0.05) $ - $ (0.15) $ 0.03
==================== =========== =================== ===========
WEIGHTED AVERAGE
' COMMON SHARES 10,138 10,089 10,118 10,109
==================== =========== =================== ===========
WEIGHTED AVERAGE COMMON
AND POTENTIAL DILUTIVE
COMMON SHARES 10,188 10,117 10,164 10,142
==================== =========== =================== ===========
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
MARCH 26, MARCH 27, MARCH 26, MARCH 27,
2006 2005 2006 2005
---- ---- ---- ----
Net (loss) income $ (477) $ (20) $ (1,568) $ 316
Interest rate swap gain (loss) - (net
of tax benefit (expense) of ($11) and $56
and ($59) and $70, respectively) 31 (109) 133 (137)
---------- ------- --------- --------
Comprehensive (loss) income $ (446) $ (129) $ (1,435) $ 179
========== ======== ========= ========
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements.
PIZZA INN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
MARCH 26, JUNE 26,
2006 2005
--------------------- ---------------------
(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 190 $ 173
Accounts receivable,
less allowance for doubtful
accounts of $209 and $360
respectively 2,894 3,419
Accounts receivable - related parties 465 622
Notes receivable, current
portion, less allowance
for doubtful accounts
of $0 and $11, respectively 63 -
Inventories 1,996 1,918
Property held for sale - 301
Deferred tax assets, net 1,011 193
Prepaid expenses and other 353 355
--------------------- ---------------------
Total current assets 6,972 6,981
LONG-TERM ASSETS
Property, plant and equipment, net 13,340 12,148
Property under capital leases, net - 12
Long-term receivable 10 -
Long-term receivable - related party 313 314
Goodwill 153 -
Reacquired development territory 479 623
Deposits and other 196 177
--------------------- ---------------------
$ 21,463 $ 20,255
==================== =====================
LIABILITIES AND
SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable - trade $ 2,558 $ 1,962
Accrued expenses 1,896 1,374
Current portion of long-term debt 8,648 406
Current portion of capital
lease obligations - 11
--------------------- ---------------------
Total current liabilities 13,102 3,753
LONG-TERM LIABILITIES
Long-term debt - 7,297
Long-term capital
lease obligations - 13
Deferred tax liability, net - 3
Other long-term liabilities 523 283
--------------------- ---------------------
13,625 11,349
--------------------- ---------------------
COMMITMENTS AND
CONTINGENCIES
SHAREHOLDERS' EQUITY
Common Stock, $.01 par value;
authorized 26,000,000
shares; issued 15,090,319 and
15,046,319 shares, respectively;
outstanding 10,138,494 and
10,094,494 shares, respectively 151 150
Additional paid-in capital 8,371 8,005
Retained earnings 19,014 20,582
Accumulated other comprehensive loss (54) (187)
Treasury stock at cost
Shares in treasury: 4,951,825
and 4,951,825, respectively (19,644) (19,644)
--------------------- ---------------------
Total shareholders' equity 7,838 8,906
--------------------- ---------------------
$ 21,463 $ 20,255
===================== =====================
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements.
PIZZA INN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
-----------------
MARCH 26, MARCH 27,
2006 2005
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (1,568) $316
Adjustments to reconcile net (loss) income to
cash provided by operating activities:
Depreciation and amortization 884 861
Gain on property held for sale (159) -
Provision for bad debt 100 30
Utilization of deferred taxes - (20)
Stock compensation expense 285 -
Deferred rent 32 -
Changes in assets and liabilities:
Notes and accounts receivable 491 (358)
Inventories (79) (435)
Accounts payable - trade 596 786
Accrued expenses (166) (711)
Prepaid expenses and other 158 51
----------- -------
CASH PROVIDED BY OPERATING ACTIVITIES 574 520
----------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets 589 -
Capital expenditures (2,165) (721)
----------- -------
CASH USED FOR INVESTING ACTIVITIES (1,576) (721)
----------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term bank debt and capital lease
obligations (110) (102)
Borrowings of bank debt 1,047 -
Stock repurchase - (160)
Proceeds from exercise of stock options 82 16
----------- -------
CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 1,019 (246)
----------- -------
Net increase (decrease) in cash and cash equivalents 17 (447)
Cash and cash equivalents, beginning of period 173 617
----------- -------
Cash and cash equivalents, end of period $ 190 $ 170
=========== =======
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements.
PIZZA INN, INC.
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
------------------
MARCH 26, MARCH 27,
2006 2005
------------------ ----------
CASH PAYMENTS FOR:
Interest $ 580 $ 433
Income taxes - 420
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements.
PIZZA INN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) The accompanying condensed consolidated financial statements of Pizza
Inn, Inc. (the "Company") have been prepared without audit pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and footnote disclosures normally included in the financial statements have been
omitted pursuant to such rules and regulations. The condensed consolidated
financial statements should be read in conjunction with the notes to the
Company's audited condensed consolidated financial statements in its Form 10-K
for the fiscal year ended June 26, 2005. Certain prior year amounts have been
reclassified to conform with current year presentation.
In the opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments necessary to fairly present the
Company's financial position and results of operations for the interim periods.
All adjustments contained herein are of a normal recurring nature.
In December 2004, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment
("FAS 123R"). This Statement requires companies to expense the estimated fair
value of stock options and similar equity instruments issued to employees over
the requisite service period. FAS 123R eliminates the alternative to use the
intrinsic method of accounting provided for in Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), which
generally resulted in no compensation expense recorded in the financial
statements related to the grant of stock options to employees if certain
conditions were met. Additionally, the pro forma impact from recognition of the
estimated fair value of stock options granted to employees has been disclosed in
our footnotes as required under previous accounting rules.
Effective June 27, 2005, the Company adopted FAS 123R using the modified
prospective method, which requires us to record compensation expense for all
awards granted after the date of adoption, and for the unvested portion of
previously granted awards that remain outstanding at the date of adoption.
Accordingly, prior period amounts presented herein have not been restated to
reflect the adoption of FAS 123R.
Prior to the adoption of FAS 123R, the Company reported all tax benefits
resulting from the exercise of stock options as operating cash flows in our
consolidated statements of cash flows. In accordance with FAS 123R, for the
period beginning with first quarter of fiscal 2006, the Company will report the
excess tax benefits from the exercise of stock options as financing cash flows.
Such benefits are presented as a component of operating cash flows for periods
prior to the first quarter of 2006.
The fair value concepts were not changed significantly in FAS 123R; however, in
adopting this Standard, companies must choose among alternative valuation models
and amortization assumptions. After assessing alternative valuation models and
amortization assumptions, the Company will continue using both the Black-Scholes
valuation model and straight-line amortization of compensation expense over the
requisite service period for each separately vesting portion of the grant. The
Company will reconsider use of this model if additional information becomes
available in the future that indicates another model would be more appropriate
for us, or if grants issued in future periods have characteristics that cannot
be reasonably estimated using this model. The Company had previously estimated
forfeitures in the expense calculation for pro forma footnote disclosure and no
change in that methodology was made upon adoption of FAS 123R.
Amortization of the fair value of the stock option grants has been included in
our results since the grant date and totaled approximately $88,000 and $285,000
for the quarter and nine months ended March 26, 2006, respectively. The current
period expense related to the unvested portion of previously granted awards that
remain outstanding at the date of adoption and one grant of options to a
director in the current year. Similar amounts for these options are expected to
be expensed in future quarters.
The previously disclosed pro forma effects of recognizing the estimated fair
value of stock-based compensation for the first nine months of fiscal 2005 are
presented below.
MARCH 27,
2005
----------
Net income, as reported $ 316
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects -
----------
Pro forma net income $ 316
Earnings per share
Basic-as reported $ 0.03
Basic-pro forma $ 0.03
Diluted-as reported $ 0.03
Diluted-pro forma $ 0.03
(2) The Company entered into an agreement on August 29, 2005, effective June
26, 2005 (the "Revolving Credit Agreement"), with Wells Fargo to provide a $6.0
million revolving credit line that will expire October 1, 2007, replacing a
$3.0 million line that was due to expire December 23, 2005. The agreement
provides, among other terms, for modifications to certain financial covenants.
Interest is provided for at a rate equal to a range of Prime less an interest
rate margin of 0.75% to Prime plus an interest rate margin of 1.75% or, at the
Company's option, at the LIBOR rate plus an interest rate margin of 1.25% to
3.75%. The interest rate margin is based on the Company's performance under
certain financial ratio tests. An annual commitment fee is payable on any
unused portion of the revolving credit line at a rate from 0.35% to 0.50% based
on the Company's performance under certain financial ratio tests. As of March
26, 2006 and March 27, 2005, the variable interest rates were 9.25% and 6.0%,
using a Prime interest rate basis. Amounts outstanding under the revolving
credit line as of March 26, 2006 and March 27, 2005 were $2,215,000 and
$1,411,000, respectively. Property, plant and equipment, inventory and accounts
receivable have been pledged for the Revolving Credit Agreement.
The Company entered into an agreement effective December 28, 2000, as
amended (the "Term Loan Agreement"), with Wells Fargo to provide up to $8.125
million of financing for the construction of the Company's new headquarters,
training center and distribution facility. The construction loan converted to a
term loan effective January 31, 2002 with the unpaid principal balance to mature
on December 28, 2007. The term loan amortizes over a term of twenty years, with
principal payments of $34,000 due monthly. Interest on the term loan is also
payable monthly. Interest is provided for at a rate equal to a range of Prime
less an interest rate margin of 0.75% to Prime plus an interest rate margin of
1.75% or, at the Company's option, at the LIBOR rate plus an interest rate
margin of 1.25% to 3.75%. The interest rate margin is based on the Company's
performance under certain financial ratio tests. The Company, to fulfill the
requirements of Wells Fargo, fixed the interest rate on the term loan by
utilizing an interest rate swap agreement. The $8.125 million Term Loan
Agreement had an outstanding balance of $6,433,000 at March 26, 2006 and
$6,838,000 at March 27, 2005. Property, plant and equipment, inventory and
accounts receivable have been pledged for the Term Loan Agreement.
On October 18, 2005, the Company notified Wells Fargo Bank, N.A. that, as of
September 25, 2005 the Company was in violation of certain financial ratio
covenants in the Revolving Credit Agreement and that, as a result, an event of
default exists under the Loan Agreement. As a result of the continuing event of
default as of March 26, 2006 all outstanding principal of the Company's
obligations under the Revolving Credit Agreement were reclassified as a current
liability on the Company's balance sheet.
On November 28, 2005 Wells Fargo notified the Company that as a result of
the default Wells Fargo would continue to make Revolving Credit Loans (as
defined in the Revolving Credit Agreement) to the Company in accordance with the
terms of the Revolving Credit Agreement, provided that the aggregate principal
amount of all such Revolving Credit Loans does not exceed $3,000,000 at any one
time. Additionally, Wells Fargo notified the Company that the LIBOR rate margin
and the prime rate margin have been adjusted, effective as of October 1, 2005,
according to the pricing rate grid set forth in the Revolving Credit Agreement.
(3) The Company entered into an interest rate swap effective February 27,
2001, as amended, designated as a cash flow hedge, to manage interest rate risk
relating to the financing of the construction of the Company's new headquarters
and to fulfill bank requirements. The swap agreement has a notional principal
amount of $8.125 million with a fixed pay rate of 5.84%, which began November 1,
2001 and will end November 19, 2007. The swap's notional amount amortizes over
a term of twenty years to parallel the terms of the Term Loan Agreement.
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" requires that for cash flow hedges, which
hedge the exposure to variable cash flow of a forecasted transaction, the
effective portion of the derivative's gain or loss be initially reported as a
component of other comprehensive income in the equity section of the balance
sheet and subsequently reclassified into earnings when the forecasted
transaction affects earnings. Any ineffective portion of the derivative's gain
or loss is reported in earnings immediately. As of March 26, 2006, there was no
hedge ineffectiveness. The Company's expectation is that the hedging
relationship will be highly effective at achieving offsetting changes in cash
flows.
(4) On December 11, 2004, the Board of Directors of the Company terminated
the Executive Compensation Agreement dated December 16, 2002 between the Company
and its then Chief Executive Officer, Ronald W. Parker ("Parker Agreement").
Mr. Parker's employment was terminated following ten days written notice to Mr.
Parker of the Company's intent to discharge him for cause as a result of
violations of the Parker Agreement. Written notice of termination was
communicated to Mr. Parker on December 13, 2004. The nature of the cause
alleged was set forth in the notice of intent to discharge and based upon
Section 2.01(c) of the Parker Agreement, which provides for discharge for "any
intentional act of fraud against the Company, any of its subsidiaries or any of
their employees or properties, which is not cured, or with respect to which
Executive is not diligently pursuing a cure, within ten (10) business days of
the Company giving notice to Executive to do so." Mr. Parker was provided with
an opportunity to cure as provided in the Parker Agreement as well as the
opportunity to be heard by the Board of Directors prior to the termination.
On January 12, 2005, the Company instituted an arbitration proceeding
against Mr. Parker with the American Arbitration Association in Dallas, Texas
pursuant to the Parker Agreement seeking declaratory relief that Mr. Parker is
not entitled to severance payments or any other further compensation from the
Company. In addition, the Company is seeking compensatory damages,
consequential damages and disgorgement of compensation paid to Mr. Parker under
the Parker Agreement. On January 31, 2005, Mr. Parker filed claims against the
Company for breach of the Parker Agreement, seeking the severance payment
provided for in the Parker Agreement for a termination of Mr. Parker by the
Company for reason other than for cause (as defined in the Parker Agreement),
plus interest, attorney's fees and costs. The arbitration hearing is scheduled
to begin September 11, 2006.
Due to the preliminary stages of the arbitration proceeding and the general
uncertainty surrounding the outcome of this type of legal proceeding, it is not
possible for the Company to provide any certain or meaningful analysis,
projections or expectations at this time regarding the outcome of this matter.
Although the ultimate outcome of the arbitration proceeding cannot be projected
with certainty at this time, the Company intends to vigorously defend against
Mr. Parker's claims and to pursue all relief to which it may be entitled. An
adverse outcome to the proceeding could materially affect the Company's
financial position and results of operations. In the event the Company is
unsuccessful, it could be liable to Mr. Parker for approximately $5.4 million
under the Parker Agreement plus accrued interest and legal expenses. No accrual
for any amount has been made as of March 26, 2006.
(5) On June 15, 2004, B. Keith Clark provided the Company with notice of his
intent to resign as Senior Vice President - Corporate Development, Secretary and
General Counsel of the Company effective as of July 7, 2004. By letter dated
June 24, 2004, Mr. Clark notified the Company that he reserved his right to
assert that the election of Ramon D. Phillips and Robert B. Page to the Board of
Directors of the Company at the February 11, 2004 annual meeting of shareholders
constituted a "change of control" of the Company under his executive
compensation agreement (the "Clark Agreement"). As a result of the alleged
"change of control" under the Clark Agreement, Clark claimed that he was
entitled to terminate the Clark Agreement within 12 months of February 11, 2004
for "good reason" (as defined in the Clark Agreement) and is entitled to
severance. On August 6, 2004, the Company instituted an arbitration proceeding
against Mr. Clark with the American Arbitration Association in Dallas, Texas
pursuant to the Clark Agreement seeking declaratory relief that Mr. Clark is not
entitled to severance payments or any other further compensation from the
Company. On January 18, 2005, the Company amended its claims against Mr. Clark
to include claims for compensatory damages, consequential damages and
disgorgement of compensation paid to Mr. Clark under the Clark Agreement. Mr.
Clark filed claims against the Company for breach of the Clark Agreement,
seeking the severance payment provided for in the Clark Agreement plus a bonus
payment for 2003 of approximately $12,500. On November 8, 2005 the parties
entered into a confidential settlement agreement and release of claims, which
provided, among other things, that the Company paid Mr. Clark $150,000, the
parties dismissed with prejudice all claims in the pending arbitration action
and each party bore its or his own costs and expenses.
(6) On October 5, 2004 the Company filed a lawsuit against the law firm
Akin, Gump, Strauss, Hauer & Feld, ("Akin Gump") and J. Kenneth Menges, one of
the firm's partners. Akin Gump served as the Company's principal outside lawyers
from 1997 through May 2004, when the Company terminated the relationship. The
petition alleges that during the course of representation of the Company, the
firm and Mr. Menges, as the partner in charge of the firm's services for the
Company, breached certain fiduciary responsibilities to the Company by giving
advice and taking action to further the personal interests of certain of the
Company's executive officers to the detriment of the Company and its
shareholders. Specifically, the petition alleges that the firm and Mr. Menges
assisted in the creation and implementation of so-called "golden parachute"
agreements, which, in the opinion of the Company's current counsel, provided for
potential severance payments to those executives in amounts greatly
disproportionate to the Company's ability to pay, and that, if paid, could
expose the Company to significant financial liability which could have a
material adverse effect on the Company's financial position. This matter is in
its preliminary stages, and the Company is unable to provide any meaningful
analysis, projections or expectations at this time regarding the outcome of this
matter. However, the Company intends to vigorously pursue all relief to which
it may be entitled. On January 25, 2005, Akin Gump filed a motion with the
court asking for this matter to be abated pending a determination in the Clark
and Parker arbitrations. The court denied the motion but ruled that it would
not set a trial date until after completion of the Clark and Parker arbitration
hearings.
(7) On April 22, 2005, the Company provided PepsiCo, Inc. ("PepsiCo")
written notice of PepsiCo's breach of the beverage marketing agreement the
parties had entered into in May 1998 (the "Beverage Agreement"). In the notice,
the Company alleged that PepsiCo had not complied with the terms of the Beverage
Agreement by failing to (i) provide account and equipment service, (ii) maintain
and repair fountain dispensing equipment, (iii) make timely and accurate account
payments, and by providing the Company beverage syrup containers that leaked in
storage and in transit. The notice provided PepsiCo 90 days within which to
cure the instances of default. On May 18, 2005 the parties entered into a
"standstill" agreement under which the parties agreed to a 60-day extension of
the cure period to attempt to renegotiate the terms of the Beverage Agreement
and for PepsiCo to complete its cure.
The parties were unable to renegotiate the Beverage Agreement, and the Company
contends that PepsiCo did not cure each of the instances of default set forth in
the Company's April 22, 2005 notice of default. On September 15, 2005, the
Company provided PepsiCo notice of termination of the Beverage Agreement. On
October 11, 2005, PepsiCo served the Company with a Petition in the matter of
PepsiCo, Inc. v. Pizza Inn Inc., filed in District Court in Collin County,
Texas. In the Petition, PepsiCo alleges that the Company breached the Beverage
Agreement by terminating it without cause. PepsiCo seeks damages of
approximately $2.6 million, an amount PepsiCo believes represents the value of
gallons of beverage products that the Company is required to purchase under the
terms of the Beverage Agreement, plus return of any marketing support funds that
PepsiCo advanced to the Company but that the Company has not earned. The
Company has filed a counterclaim against PepsiCo for amounts earned by the
Company under the Beverage Agreement but not yet paid by PepsiCo, and for
damages for business defamation and tortuous interference with contract based
upon statements and actions of the PepsiCo account representative servicing the
Company's account.
The Company believes that it had good reason to terminate the Beverage Agreement
and that it terminated the Beverage Agreement in good faith and in compliance
with its terms. The Company further believes that under such circumstances it
has no obligation to purchase additional quantities of beverage products. Due
to the preliminary nature of this matter and the general uncertainty surrounding
the outcome of any form of legal proceeding, it is not possible for the Company
to provide any certain or meaningful analysis, projection or expectation at this
time regarding the outcome of this matter. Although the outcome of the legal
proceeding cannot be projected with certainty, the Company believes that
PepsiCo's allegations are without merit. The Company intends to vigorously
defend against such allegations and to pursue all relief to which it may be
entitled. An adverse outcome to the proceeding could materially affect the
Company's financial position and results of operation. In the event the Company
is unsuccessful, it could be liable to PepsiCo for approximately $2.6 million
plus costs and fees. No accrual for such amounts has been made as of March 26,
2006. This matter is set for trial beginning on September 4, 2006.
(8) The following table shows the reconciliation of the numerator and
denominator of the basic EPS calculation to the numerator and denominator of the
diluted EPS calculation (in thousands, except per share amounts).
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------ ------------- -----------
THREE MONTHS ENDED MARCH 26, 2006
BASIC EPS
Income Available to Common Shareholders $ (477) 10,138 $ (0.05)
Effect of Dilutive Securities - Stock Options 50
-------------
DILUTED EPS
Income Available to Common Shareholders
& Assumed Conversions $ (477) 10,188 $ (0.05)
============ ============= ===========
THREE MONTHS ENDED MARCH 27, 2005
BASIC EPS
Income Available to Common Shareholders $ (20) 10,089 $ (0.00)
Effect of Dilutive Securities - Stock Options 28
-------------
DILUTED EPS
Income Available to Common Shareholders
& Assumed Conversions $ (20) 10,117 $ (0.00)
============ ============= ===========
NINE MONTHS ENDED MARCH 26, 2006
BASIC EPS
Income Available to Common Shareholders (1,568) 10,118 $ (0.15)
Effect of Dilutive Securities - Stock Options 46
-------------
DILUTED EPS
Income Available to Common Shareholders
& Assumed Conversions $ (1,568) 10,164 $ (0.15)
============ ============= ===========
NINE MONTHS ENDED MARCH 27, 2005
BASIC EPS
Income Available to Common Shareholders $ 316 10,109 $ 0.03
Effect of Dilutive Securities - Stock Options 33
-------------
DILUTED EPS
Income Available to Common Shareholders
& Assumed Conversions $ 316 10,142 $ 0.03
============ ============= ===========
(8) Summarized in the following tables are net sales and operating revenues,
depreciation and amortization, interest expense, operating (loss) income and
geographic information (revenues) for the Company's reportable segments for the
three month and nine month periods ended March 26, 2006 and March 27, 2005 (in
thousands).
THREE MONTHS ENDED NINE MONTHS ENDED
------------------- ------------------
MARCH 26, MARCH 27, MARCH 26, MARCH 27,
2006 2005 2006 2005
----------- ----------- ----------- -----------
NET SALES AND OPERATING REVENUES:
Food and Equipment Distribution $ 11,131 $ 11,859 $ 33,654 $ 36,981
Franchise and Other 1,712 1,542 4,648 4,605
Intersegment revenues 386 80 881 255
----------- ----------- ----------- -----------
Combined 13,229 13,481 39,183 41,841
Less intersegment revenues (386) (80) (881) (255)
----------- ----------- ----------- -----------
Consolidated revenues $ 12,843 $ 13,401 $ 38,302 $ 41,586
=========== =========== =========== ===========
DEPRECIATION AND AMORTIZATION:
Food and Equipment Distribution $ 128 $ 129 $ 394 $ 381
Franchise and Other 106 71 253 214
----------- ----------- ----------- -----------
Combined 234 200 647 595
Corporate administration and other 84 81 237 266
----------- ----------- ----------- -----------
Depreciation and amortization $ 318 $ 281 $ 884 $ 861
=========== =========== =========== ===========
INTEREST EXPENSE:
Food and Equipment Distribution $ 118 $ 87 $ 323 $ 240
Franchise and Other 1 1 3 2
----------- ----------- ----------- -----------
Combined 119 88 326 242
Corporate administration and other 92 69 253 189
----------- ----------- ----------- -----------
Interest Expense $ 211 $ 157 $ 579 $ 431
=========== =========== =========== ===========
OPERATING (LOSS) INCOME:
Food and Equipment Distribution (1) $ (188) $ 41 $ (996) $ 576
Franchise and Other (1) 271 563 817 1,754
Intersegment profit 63 24 153 70
----------- ----------- ----------- -----------
Combined 146 628 (26) 2,400
Less intersegment profit (63) (24) (153) (70)
Corporate administration and other (611) (478) (1,815) (1,410)
----------- ----------- ----------- -----------
Operating (loss) income $ (528) $ 126 $ (1,994) $ 920
=========== =========== =========== ===========
GEOGRAPHIC INFORMATION (REVENUES):
United States $ 12,578 $ 13,060 $ 37,532 $ 40,593
Foreign countries 265 341 770 993
----------- ----------- ----------- -----------
Consolidated total $ 12,843 $ 13,401 $ 38,302 $ 41,586
=========== =========== =========== ===========
<FN>
(1) Does not include full allocation of corporate administration.
(10) On February 27, 2006 the Company sold the Company's Dallas, Texas
buffet unit to an existing franchisee for $115,000.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
consolidated financial statements, accompanying notes and selected financial
data appearing elsewhere in this Quarterly Report on Form 10-Q and in our Annual
Report on Form 10-K and may contain forward-looking statements that are based on
current management expectations. Generally, verbs in the future tense and the
words "believe," "expect," "anticipate," "estimate," "intends," "opinion,"
"potential" and similar expressions identify forward-looking statements.
Forward-looking statements in this report include, without limitation,
statements relating to the strategies underlying our business objectives, our
customers and our franchisees, our liquidity and capital resources, the impact
of our historical and potential business strategies on our business, financial
condition, and operating results and the expected effects of potentially adverse
litigation outcomes. Our actual results could differ materially from our
expectations. Further information concerning our business, including additional
risk factors and uncertainties that could cause actual results to differ
materially from the forward-looking statements contained in this Quarterly
Report on Form 10-Q, are set forth below under the heading "Risk Factors."
These risks and uncertainties should be considered in evaluating forward-looking
statements and undue reliance should not be placed on such statements. The
forward-looking statements contained herein speak only as of the date of this
Quarterly Report on Form 10-Q and, except as may be required by applicable law
and regulation, we do not undertake, and specifically disclaim any obligation
to, publicly update or revise such statements to reflect events or circumstances
after the date of such statements or to reflect the occurrence of anticipated or
unanticipated events.
RESULTS OF OPERATIONS
OVERVIEW
We are a franchisor and food and supply distributor to a system of
restaurants operating under the trade name "Pizza Inn". Our distribution
division is Norco Restaurant Services Company ("Norco"). At March 26, 2006,
there were 381 Pizza Inn restaurants, consisting of four Company-owned
restaurants and 377 franchised restaurants. Domestic restaurants are operated
as: (i) 185 buffet restaurants ("Buffet Units") that offer dine-in, carry-out,
and, in many cases, delivery services; (ii) 50 restaurants that offer delivery
and carry-out services only ("Delco Units"); and (iii) 72 express units
("Express Units") typically located within a convenience store, college campus
building, airport terminal, or other commercial facility that offers quick
carry-out service from a limited menu. The 307 domestic restaurants were
located in 18 states predominately situated in the southern half of the United
States. Additionally, we have 74 international restaurants located in 9
foreign countries.
Diluted earnings per share decreased $0.05 to ($0.05) from $0.00 for the
three month period ended March 26, 2006 and decreased $0.18 to ($0.15) from
$0.03 for the nine month period ended March 26, 2006 compared to the comparable
periods in the prior year, respectively. Net loss for the three month period
ended March 26, 2006 increased $457,000 to ($477,000) from ($20,000) in the
prior year, on revenues of $12,812,000 in the current year and $13,401,000 in
the prior year. Net income for the nine month period ended March 26, 2006
decreased $1,884,000 to ($1,568,000) from $316,000 in the prior year, on
revenues of $38,271,000 in the current year and $41,586,000 in the prior year.
The decrease in net income is primarily the result of lower food and supply
sales and royalties resulting from lower overall chainwide retail sales and
fewer net restaurants. In addition to lower revenues, year-to-date energy costs
increased $446,000 due to higher rates for diesel fuel and electricity and legal
fees increased $419,000 for ongoing litigation and related matters.
REVENUES
Our revenues are primarily derived from sales of food, paper products, and
equipment and supplies by Norco to franchisees, initial franchise license fees
and ongoing royalties and, from time to time, the sale of area development
rights. Management believes that key performance indicators in evaluating
financial results include chainwide retail sales, the number and type of
operating restaurants and the percentage of products and supplies such
restaurants purchase from Norco. Our financial results are dependent in large
part upon the pricing and cost of these products and supplies to franchisees,
and the level of chainwide retail sales, which are driven by changes in same
store sales and restaurant count.
FOOD AND SUPPLY SALES
Food and supply sales by Norco include food and paper products, equipment,
marketing material and other distribution revenues. Food and supply sales for
the three month period ended March 26, 2006 decreased 6%, or $728,000, to
$11,131,000 from $11,859,000 compared to the same period last year. The
decrease in sales for the three month period ended March 26, 2006 compared to
the three month period ended March 27, 2005 is primarily due to a decline of
2.6% in overall domestic chainwide retail sales which negatively impacted Norco
product sales by approximately $482,000; lower cheese prices, which decreased
sales by $255,000; $119,000 lower equipment sales and $100,000 lower
international sales. These sales decreases were partially offset by $226,000
higher backhaul and storage revenues. Food and supply sales for the nine month
period ended March 26, 2006 decreased 9%, or $3,327,000 to $33,654,000 from
$36,981,000 compared to the same period last year. The decrease for the nine
month period ending March 26, 2006 is primarily due to a decline of 4.5% in
overall domestic chainwide retail sales, which negatively impacted Norco product
sales by approximately $2,141,000; lower non-cheese prices, which negatively
impacted sales by $545,000; $414,000 lower Norco product sales due to lower
market penetration and lower non-cheese price variances; $225,000 lower
international sales; $184,000 lower marketing material sales; and $119,000 lower
equipment sales. The sales decreases were partially offset by $452,000 higher
backhaul and storage revenues and a $86,000 fuel surcharge.
FRANCHISE REVENUE
Franchise revenue, which includes income from royalties, license fees and
area development and foreign master license sales, decreased 9%, or $119,000 to
$1,200,000 from $1,319,000 for the three month period ended March 26, 2006
compared to the same period last year, due to the impact on royalty income as a
result of the decline of 2.6% in overall domestic chainwide retail sales. In
addition, the prior year included collections of $102,000 in unrecorded
royalties. Franchise revenue decreased 8%, or $305,000 to $3,579,000 from
$3,884,000 for the nine month period ended March 26, 2006 compared to the same
period last year, primarily due to the impact on royalties as a result of the
decline of 4.5% in overall domestic chainwide retail sales and the collections
of $102,000 in unrecorded royalty income in the prior year. The following chart
summarizes the major components of franchise revenue (in thousands):
Three Months Ended Nine Months Ended
------------------- ------------------
March 26, March 27, March 26, March 27,
2006 2005 2006 2005
---------- ---------- ---------- ----------
Domestic royalties $ 1,065 $ 1,208 $ 3,186 $ 3,475
International royalties 116 92 275 269
Domestic franchise fees 19 19 118 140
---------- ---------- ---------- ----------
Franchise revenue $ 1,200 $ 1,319 $ 3,579 $ 3,884
========== ========== ========== ==========
RESTAURANT SALES
Restaurant sales, which consist of revenue generated by Company-owned
restaurants, increased 130%, or $289,000 to $512,000 from $223,000 for the three
month period ended March 26, 2006 compared to the same period of the prior year
due to three new Buffet Units opening during the current year. This increase
was partially offset by lower comparable sales Company-owned Delco Unit and the
sale of one Company-owned Buffet Unit on February 27, 2006. Restaurant sales
increased 48%, or $348,000 to $1,069,000 from $721,000 for the nine month period
ended March 27, 2006 compared to the same period of the prior year. The
following chart summarizes the sales by Company owned restaurants (in
thousands):
Three Months Ended Nine Months Ended
------------------- ------------------
March 26, March 27, March 26, March 27,
2006 2005 2006 2005
---------- ---------- ---------- ----------
Buffet Units $ 439 $ 140 $ 833 $ 437
Delco Unit 73 83 236 284
---------- ---------- ---------- ----------
Restaurant sales $ 512 $ 223 $ 1,069 $ 721
========== ========== ========== ==========
COSTS AND EXPENSES
COST OF SALES
Cost of sales decreased $16,000 to $11,225,000 from $11,241,000 for the three
month period ended March 26, 2006 compared to the same period in the prior year
and decreased 5%, or $1,674,000 to $33,451,000 from $35,125,000 for the nine
month period ended March 26, 2006 compared to the same period in the prior year.
These decreases are primarily the result of lower food and supply sales
resulting from lower retail sales as previously discussed. Cost of sales, as a
percentage of food and supply and restaurant sales for the three month and nine
month periods ended March 26, 2006 increased to 96% from 93% for the same
periods last year. This percentage increase is primarily due to higher energy
costs and to pre-opening expenses, including payroll, rent and utilities for the
three new Company-owned Buffet Units under development in the first two quarters
of the current year. The Company experiences fluctuations in commodity prices
(most notably, block cheese prices), increases in transportation costs
(particularly in the price of diesel fuel) and net gains or losses in the number
of restaurants open in any particular period, among other things, all of which
have impacted operating margins over the past several quarters to some extent.
Future fluctuations in these factors are difficult for the Company to
meaningfully predict with any certainty.
FRANCHISE EXPENSES
Franchise expenses include selling, general and administrative expenses
directly related to the sale and continuing service of domestic and
international franchises. These costs increased 8%, or $60,000 to $783,000 from
$723,000 for the three month period ended March 26, 2006 compared to the same
period last year and 17%, or $340,000 to $2,384,000 from $2,044,000 for the nine
month period ended March 26, 2006 compared to the same period in the prior year.
These increases are primarily the result of higher payroll expenses due to
additional staffing levels, higher travel costs relating primarily to the
construction and opening of the three new Company-owned Buffet Units, and
increased field market research.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased 4%, or $52,000 to $1,363,000
from $1,311,000 for the three month period ended March 26, 2006 compared to the
same period last year and increased 28%, or $964,000 to $4,461,000 from
$3,497,000 for the nine month period ended March 26, 2006 compared to the same
period in the prior year. The following chart summarizes the major components
of general and administrative expenses (in thousands):
Three Months Ended Nine Months Ended
------------------- ------------------
March 26, March 27, March 26, March 27,
2006 2005 2006 2005
---------- ---------- ---------- ----------
Payroll $ 744 $ 539 $ 1,924 $ 1,696
Legal fees 180 482 1,237 818
Bad debt 100 - 100 30
Stock compensation 88 - 285 -
Other 251 290 915 953
---------- ---------- ---------- ----------
Total general and
administrative expense $ 1,363 $ 1,311 $ 4,461 $ 3,497
========== ========== ========== ==========
The current year includes legal expenses related to ongoing litigation and
related matters described previously, bad debt expense, and increased payroll
amounts due to increased staffing levels and severance payments made in the
third quarter. The Company anticipates that higher than normal legal expenses
will continue until all such matters are resolved. Stock compensation expense
is the result of the implementation of FAS 123R as previously discussed.
INTEREST EXPENSE
Interest expense increased 34%, or $54,000 to $211,000 from $157,000 for
the three month period ended March 26, 2006 compared to the same period of the
prior year and 34%, or $148,000 to $579,000 from $431,000 for the nine month
period ended March 26, 2006 compared to the same period in the prior year, due
to higher interest rates and higher debt balances under the Revolving Credit
Agreement.
PROVISION FOR INCOME TAX
Provision for income taxes decreased $249,000 for the three month period
ended March 26, 2006 compared to the same period in the prior year and
$1,029,000 for the nine month period ended March 26, 2006 compared to the same
period in the prior year due to lower income for the three month and nine month
periods in the current year compared to the same periods in the prior year. The
effective tax rate was 35% for the three month and nine month periods ending
March 26, 2006 and March 27, 2005. The majority of the current loss can be
carried back against prior taxes paid.
RESTAURANT OPENINGS AND CLOSINGS
A total of 17 new Pizza Inn franchise restaurants opened, including ten
domestic and seven international, during the nine month period ended March 26,
2006. Domestically, 27 restaurants were closed by franchisees or terminated by
the Company, typically because of unsatisfactory standards of operation or
performance. Additionally, seven international restaurants were closed. We do
not believe that these closings had any material impact on collectibility of any
outstanding receivables and royalties due to us because (i) these amounts have
been previously reserved for by us with respect to restaurants that were closed
during fiscal 2005 and (ii) these closed restaurants were generally lower volume
restaurants. For those restaurants that are anticipated to close or are
exhibiting signs of financial distress, credit terms are typically restricted,
weekly food orders are required to be paid for on delivery and/or with certified
funds and royalty and advertising fees are collected as add-ons to the delivered
price of weekly food orders. The following chart summarizes restaurant activity
for the period ended March 26, 2006 compared to the same period in the prior
year:
Nine months ending March 26, 2006
Beginning Concept End of
--------- --------
of Period Opened Closed Change Period
Buffet Units 199 4 18 - 185
Delco 52 3 5 - 50
Express Units 73 3 4 - 72
International 74 7 7 - 74
--------- ------ ------ -------- ------
Total 398 17 34 - 381
========= ====== ====== ======== ======
Nine months ending March 27, 2005
Beginning Concept End of
--------- --------
of Period Opened Closed Change Period
--------- ------ ------ -------- ------
Buffet Units 212 7 9 (3) 207
Delco 53 4 2 1 56
Express Units 73 6 6 2 75
International 67 6 - - 73
--------- ------ ------ -------- ------
Total 405 23 17 - 411
========= ====== ====== ======== ======
LIQUIDITY AND CAPITAL RESOURCES
Cash flows from operating activities are generally the result of net loss
adjusted for deferred taxes, depreciation and amortization, stock compensation
and changes in working capital. In the nine month period ending March 26, 2006
the Company generated cash flows of $574,000 from operating activities as
compared to $520,000 in cash flows for the same period in the prior year. The
increase in cash flows for the nine months ended March 26, 2006 as compared to
the prior year was primarily related to normal changes in working capital
partially offset by a decrease in net income of $1,884,000 to ($1,568,000) for
the nine month period ended March 26, 2006 from $316,000 for the same period in
the prior year.
Cash flows from investing activities primarily reflect the Company's
capital expenditure strategy. In the first nine months of fiscal 2006,
$1,576,000 cash was used for investing activities as compared to cash used for
investing activities of $721,000 for the same period in fiscal 2005. Cash used
was primarily for costs associated with development of the three new
Company-owned Buffet Units and purchase of warehouse equipment that was
partially offset from the proceeds from the sale of land in Prosper, Texas.
Cash flows from financing activities generally reflect changes in the
Company's borrowings, treasury stock transactions and exercise of stock options
during the period. Net cash provided by financing activities was $1,019,000 in
the first nine months of fiscal 2006 as compared to cash used for financing
activities of $246,000 for the same period in fiscal 2005. The increase of net
cash from financing activities is primarily the result of increased borrowing of
the revolving credit line. As of March 26, 2006, the Company had utilized
$2,200,000 of the $3,000,000 revolving credit line.
Management believes that future operations will generate sufficient taxable
income, along with the reversal of temporary differences, to fully realize the
deferred tax asset, net of a valuation allowance of $138,000 primarily related
to the potential expiration of certain foreign tax credit carryforwards.
Additionally, management believes that taxable income based on the Company's
existing franchise base should be more than sufficient to enable the Company to
realize its net deferred tax asset without reliance on material non-routine
income.
The Company entered into an agreement on August 29, 2005, effective June
26, 2005 (the "Revolving Credit Agreement"), with Wells Fargo to provide a $6.0
million revolving credit line that will expire October 1, 2007, replacing a $3.0
million line that was due to expire December 23, 2005. The agreement provides,
among other terms, for modifications to certain financial covenants. Interest
is provided for at a rate equal to a range of Prime less an interest rate margin
of 0.75% to Prime plus an interest rate margin of 1.75% or, at the Company's
option, at the LIBOR rate plus an interest rate margin of 1.25% to 3.75%. The
interest rate margin is based on the Company's performance under certain
financial ratio tests. An annual commitment fee is payable on any unused
portion of the revolving credit line at a rate from 0.35% to 0.50% based on the
Company's performance under certain financial ratio tests. As of March 26, 2006
and March 27, 2005, the variable interest rates were 9.25% and 6.0%, using a
Prime interest rate basis. Amounts outstanding under the revolving credit line
as of March 26, 2006 and March 27, 2005 were $2,215,000 and $1,411,000,
respectively. Property, plant and equipment, inventory and accounts receivable
have been pledged for the Revolving Credit Agreement.
The Company entered into an agreement effective December 28, 2000, as
amended (the "Term Loan Agreement"), with Wells Fargo to provide up to $8.125
million of financing for the construction of the Company's new headquarters,
training center and distribution facility. The construction loan converted to a
term loan effective January 31, 2002 with the unpaid principal balance to mature
on December 28, 2007. The term loan amortizes over a term of twenty years, with
principal payments of $34,000 due monthly. Interest on the term loan is also
payable monthly. Interest is provided for at a rate equal to a range of Prime
less an interest rate margin of 0.75% to Prime plus an interest rate margin of
1.75% or, at the Company's option, at the LIBOR rate plus an interest rate
margin of 1.25% to 3.75%. The interest rate margin is based on the Company's
performance under certain financial ratio tests. The Company, to fulfill the
requirements of Wells Fargo, fixed the interest rate on the term loan by
utilizing an interest rate swap agreement. The Term Loan Agreement had an
outstanding balance of $6.4 million at March 26, 2006 and $6.8 million at March
27, 2005. Property, plant and equipment, inventory and accounts receivable have
been pledged for the Term Loan Agreement.
On October 18, 2005, the Company notified Wells Fargo Bank, N.A. that, as
of September 25, 2005 the Company was in violation of certain financial ratio
covenants in the Revolving Credit Agreement and that, as a result, an event of
default exists under the Loan Agreement. As a result of the continuing event of
default as of December 25, 2005 all outstanding principal of the Company's
obligations under the Revolving Credit Agreement were reclassified as a current
liability on the Company's balance sheet.
On November 28, 2005 Wells Fargo notified the Company that as a result of
the default Wells Fargo would continue to make Revolving Credit Loans (as
defined in the Revolving Credit Agreement) to the Company in accordance with the
terms of the Revolving Credit Agreement, provided that the aggregate principal
amount of all such Revolving Credit Loans does not exceed $3,000,000 at any one
time. Additionally, Wells Fargo notified the Company that the LIBOR rate margin
and the Prime rate margin under the Revolving Credit Agreement had been
adjusted, effective as of October 1, 2005, according to the pricing rate grid
set forth in the Revolving Credit Agreement.
The Company entered into an interest rate swap effective February 27, 2001,
as amended, designated as a cash flow hedge, to manage interest rate risk
relating to the financing of the construction of the Company's new headquarters
and to fulfill bank requirements. The swap agreement has a notional principal
amount of $8.125 million with a fixed pay rate of 5.84%, which began November 1,
2001 and will end November 19, 2007. The swap's notional amount amortizes over
a term of twenty years to parallel the terms of the Term Loan Agreement.
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" requires that for cash flow hedges, which
hedge the exposure to variable cash flow of a forecasted transaction, the
effective portion of the derivative's gain or loss be initially reported as a
component of other comprehensive income in the equity section of the balance
sheet and subsequently reclassified into earnings when the forecasted
transaction affects earnings. Any ineffective portion of the derivative's gain
or loss is reported in earnings immediately. As of March 26, 2006, there was no
hedge ineffectiveness. The Company's expectation is that the hedging
relationship will be highly effective at achieving offsetting changes in cash
flows.
The Company is in an arbitration proceeding with Mr. Parker as
previously described. Although the ultimate outcome of the arbitration
proceeding cannot be projected with certainty at this time, the Company intends
to vigorously defend against Mr. Parker's claims and pursue all relief to which
it may be entitled. An adverse outcome to the proceeding could materially
affect the Company's financial position, results of operations and liquidity.
In the event the Company is unsuccessful, it could be liable to Mr. Parker for
approximately $5.4 million under the Parker Agreement plus accrued interest and
legal expenses. The Company maintains that it does not owe Mr. Parker severance
payments or any other compensation, however it is possible that the Company
might not have sufficient borrowing capacity or available cash or assets to make
all payments required by a determination granting Mr. Parker all or
substantially all of the amounts he demands. No accrual for any amount has
been made as of March 26, 2006. We are also a party to a lawsuit brought
against us by PepsiCo, as previously described. We believe that the allegations
made against the Company by PepsiCo are unfounded, although the ultimate outcome
of the lawsuit cannot be predicted with certainty at this time. We intend to
vigorously contest all of PepsiCo's claims and to pursue all relief to which we
may be entitled. However, in the event the Company is unsuccessful, it could be
liable to PepsiCo for approximately $2.6 million plus fees and costs. It is
possible that the Company might not have sufficient borrowing capacity or
available cash or assets to make all payments required by a determination
granting PepsiCo all or substantially all of the amount demanded. No accrual
has been made as of March 26, 2006. The Company anticipates a higher level of
legal expenses from the ongoing litigation and related matters described
previously, until all such matters are resolved.
In July 2005 the Company acquired the assets of two existing Buffet Units
from Houston, Texas area franchisees. These restaurants have been remodeled and
one opened in December 2005 and the other restaurant opened in February 2006.
One location has approximately 4,100 square feet and the other has approximately
2,750 square feet. Both are leased at rates of approximately $18.00 per square
foot. The leases expire in 2015 and each has at least one renewal option. The
cost of acquiring and remodeling these restaurants was approximately $1,152,000.
In July 2005 the Company leased approximately 4,100 square feet of space in
a retail development in Plano, Texas for the operation of a Buffet Unit at a
lease rate of approximately $30.00 per square foot. The restaurant opened
October 28, 2005. The lease has a five-year term with multiple renewal options.
The cost of finishing out the space, including equipment, was approximately
$678,000.
We also owned property in Prosper, Texas that was purchased in August
2004 with the intention of constructing and operating a Buffet Unit. We decided
not to pursue development at that location and sold the property to a third
party on September 23, 2005 for $301,000, realizing a gain of $147,000 on the
sale.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following chart summarizes all of the Company's material obligations
and commitments to make future payments under contracts such as debt and lease
agreements as of March 26, 2006 (in thousands):
Fiscal Year Fiscal Years Fiscal Years After Fiscal
Total 2006 2007 - 2008 2009 - 2010 Year 2010
------- ------------ ------------- ------------- -------------
Bank debt (1) $ 8,648 $ 8,648 $ - $ - $ -
Operating lease obligations 3,591 1,045 925 629 992
Employee contracts 517 142 375 - -
------- ------------ ------------- ------------- -------------
Total contractual obligations $12,756 $ 9,835 $ 1,300 $ 629 $ 992
======= ============ ============= ============= =============
(1) Does not include amounts representing interest. The bank debt includes
a variable rate $3.0 million revolving credit line with a balance of $2.2
million as of March 26, 2006. At March 26, 2006, the variable interest rate on
the revolving credit line was 9.25%. Also included in the bank debt is a
variable rate term loan of $8.125 million with a balance of $6.4 million as of
March 26, 2006. The Company fixed the interest rate at 5.84% on the term loan
by utilizing an interest rate swap agreement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires our management to make estimates and
assumptions that affect our reported amounts of assets, liabilities, revenues,
expenses and related disclosure of contingent liabilities. We base our
estimates on historical experience and various other assumptions that we believe
are reasonable under the circumstances. Estimates and assumptions are reviewed
periodically. Actual results could differ materially from estimates.
The Company believes the following critical accounting policies require
estimates about the effect of matters that are inherently uncertain, are
susceptible to change, and therefore require subjective judgments. Changes in
the estimates and judgments could significantly impact our results of operations
and financial conditions in future periods.
Accounts receivable consist primarily of receivables generated from food
and supply sales to franchisees and franchise royalties. The Company records a
provision for doubtful receivables to allow for any amounts which may be
unrecoverable and is based upon an analysis of the Company's prior collection
experience, general customer creditworthiness, and the franchisee's ability to
pay, based upon the franchisee's sales, operating results, and other general and
local economic trends and conditions that may affect the franchisee's ability to
pay. Actual realization of amounts receivable could differ materially from our
estimates. Beginning January 1, 2006, the Company began charging a finance
charge on all receivables past due more than thirty days.
Inventory, which consists primarily of food, paper products, supplies and
equipment located at the Company's distribution center, are stated at the lower
of FIFO (first-in, first-out), cost or market. The valuation of inventory
requires us to estimate the amount of obsolete and excess inventory. The
determination of obsolete and excess inventory requires us to estimate the
future demand for our products within specific time horizons, generally six
months or less. If the Company's demand forecast for specific products is
greater than actual demand and the Company fails to reduce purchasing
accordingly, the Company could be required to write down additional inventory,
which would have a negative impact on our gross margin.
The Company has recorded a valuation allowance to reflect the estimated
amount of deferred tax assets that may not be realized based upon the Company's
analysis of existing tax credits by jurisdiction and expectations of the
Company's ability to utilize these tax attributes through a review of estimated
future taxable income and establishment of tax strategies. These estimates
could be materially impacted by changes in future taxable income and the results
of tax strategies.
The Company assesses its exposures to loss contingencies including legal
and income tax matters based upon factors such as the current status of cases
and consultations with external counsel and provides for an exposure by accruing
an amount if it is judged to be probable and can be reasonably estimated. If
the actual loss from a contingency differs from management's estimate, operating
results could be impacted.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
The Company has market risk exposure arising from changes in interest
rates. The Company's earnings are affected by changes in short-term interest
rates as a result of borrowings under its credit facilities, which bear interest
based on floating rates.
At March 26, 2006, the Company had approximately $8.6 million of variable
rate debt obligations outstanding with a weighted average interest rate of 7.0%.
A hypothetical 10% increase in the effective interest rate for these borrowings,
assuming debt levels at March 26, 2006, would have increased interest expense by
approximately $11,000 for the nine month period ending March 26, 2006. As
discussed previously, the Company has entered into an interest rate swap
designed to manage the interest rate risk relating to $6.4 million of the
variable rate debt.
ITEM 4. CONTROLS AND PROCEDURES
- ------------------------------------
The Company's management, including the Company's principal executive
officer and principal accounting officer, has evaluated the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
Quarterly Report on Form 10-Q. Based upon that evaluation, the Company's
principal executive officer and principal accounting officer have concluded that
the disclosure controls and procedures were effective as of the end of the
period covered by this Quarterly Report on Form 10-Q.
There were no changes in the Company's internal control over financial
reporting that occurred during the Company's last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- ----------------------------
On December 11, 2004, the Board of Directors of the Company terminated
the Executive Compensation Agreement dated December 16, 2002 between the Company
and its then Chief Executive Officer, Ronald W. Parker ("Parker Agreement").
Mr. Parker's employment was terminated following ten days written notice to Mr.
Parker of the Company's intent to discharge him for cause as a result of
violations of the Parker Agreement. Written notice of termination was
communicated to Mr. Parker on December 13, 2004. The nature of the cause
alleged was set forth in the notice of intent to discharge and based upon
Section 2.01(c) of the Parker Agreement, which provides for discharge for "any
intentional act of fraud against the Company, any of its subsidiaries or any of
their employees or properties, which is not cured, or with respect to which
Executive is not diligently pursuing a cure, within ten (10) business days of
the Company giving notice to Executive to do so." Mr. Parker was provided with
an opportunity to cure as provided in the Parker Agreement as well as the
opportunity to be heard by the Board of Directors prior to the termination.
On January 12, 2005, the Company instituted an arbitration proceeding
against Mr. Parker with the American Arbitration Association in Dallas, Texas
pursuant to the Parker Agreement seeking declaratory relief that Mr. Parker is
not entitled to severance payments or any other further compensation from the
Company. In addition, the Company is seeking compensatory damages,
consequential damages, and disgorgement of compensation paid to Mr. Parker under
the Parker Agreement. On January 31, 2005, Mr. Parker filed claims against the
Company for breach of the Parker Agreement, seeking the severance payment
provided for in the Parker Agreement for a termination of Mr. Parker by the
Company for reason other than for cause (as defined in the Parker Agreement),
plus interest, attorney's fees and costs. The arbitration hearing is scheduled
to begin September 11, 2006.
Due to the preliminary stages of the arbitration proceeding and the
general uncertainty surrounding the outcome of this type of legal proceeding, it
is not possible for the Company to provide any certain or meaningful analysis,
projections, or expectations at this time regarding the outcome of this matter.
Although the ultimate outcome of the arbitration proceeding cannot be projected
with certainty at this time, the Company intends to vigorously defend against
Mr. Parker's claims and to pursue all relief to which it may be entitled. An
adverse outcome to the proceeding could materially affect the Company's
financial position and results of operations. In the event the Company is
unsuccessful, it could be liable to Mr. Parker for approximately $5.4 million
under the Parker Agreement plus accrued interest and legal expenses. No accrual
for any amount has been made as of March 26, 2006.
On June 15, 2004, B. Keith Clark provided the Company with notice of
his intent to resign as Senior Vice President - Corporate Development, Secretary
and General Counsel of the Company effective as of July 7, 2004. By letter
dated June 24, 2004, Mr. Clark notified the Company that he reserved his right
to assert that the election of Ramon D. Phillips and Robert B. Page to the Board
of Directors of the Company at the February 11, 2004 annual meeting of
shareholders constituted a "change of control" of the Company under his
executive compensation agreement (the "Clark Agreement"). As a result of the
alleged "change of control" under the Clark Agreement, Clark claims that he was
entitled to terminate the Clark Agreement within twelve (12) months of February
11, 2004 for "good reason" (as defined in the Clark Agreement) and is entitled
to severance. On August 6, 2004, the Company instituted an arbitration
proceeding against Mr. Clark with the American Arbitration Association in
Dallas, Texas pursuant to the Clark Agreement seeking declaratory relief that
Mr. Clark is not entitled to severance payments or any other further
compensation from the Company. On January 18, 2005, the Company amended its
claims against Mr. Clark to include claims for compensatory damages,
consequential damages and disgorgement of compensation paid to Mr. Clark under
the Clark Agreement. Mr. Clark has filed claims against the Company for breach
of the Clark Agreement, seeking the severance payment provided for in the Clark
Agreement plus a bonus payment for 2003 of approximately $12,500. On November
8, 2005 the parties entered into a confidential settlement agreement and release
of claims, which provided, among other things, that the Company paid Mr. Clark
$150,000, the parties dismissed with prejudice all claims in the pending
arbitration action and each party will bore its or his own costs and expenses.
On October 5, 2004 the Company filed a lawsuit against the law firm Akin,
Gump, Strauss, Hauer & Feld, ("Akin Gump") and J. Kenneth Menges, one of the
firm's partners. Akin Gump served as the Company's principal outside lawyers
from 1997 through May 2004, when the Company terminated the relationship. The
petition alleges that during the course of representation of the Company, the
firm and Mr. Menges, as the partner in charge of the firm's services for the
Company, breached certain fiduciary responsibilities to the Company by giving
advice and taking action to further the personal interests of certain of the
Company's executive officers to the detriment of the Company and its
shareholders. Specifically, the petition alleges that the firm and Mr. Menges
assisted in the creation and implementation of so-called "golden parachute"
agreements, which, in the opinion of the Company's current counsel, provided for
potential severance payments to those executives in amounts greatly
disproportionate to the Company's ability to pay, and that, if paid, could
expose the Company to significant financial liability which could have a
material adverse effect on the Company's financial position. This matter is in
its preliminary stages, and the Company is unable to provide any meaningful
analysis, projections or expectations at this time regarding the outcome of this
matter. However, the Company intends to vigorously pursue all relief to which
it may be entitled. On January 25, 2005, Akin Gump filed a motion with the
court asking for this matter to be abated pending a determination in the Clark
and Parker arbitrations. The court denied the motion but ruled that it would
not set a trial date until after completion of the Clark and Parker arbitration
hearings.
On April 22, 2005, the Company provided PepsiCo, Inc. ("PepsiCo") with
written notice of PepsiCo's breach of the beverage marketing agreement the
parties had entered into in May 1998 (the "Beverage agreement"). In the notice,
the Company alleged that PepsiCo had not complied with the terms of the Beverage
Agreement by failing to (i) provide account and equipment service, (ii) maintain
and repair fountain dispensing equipment, (iii) make timely and accurate account
payments, and by providing the Company with beverage syrup containers that
leaked in storage and in transit. The notice provided PepsiCo 90 days with
which to cure the instances of default. On May 18, 2005 the parties entered
into a "standstill" agreement under which the parties agreed to a 60-day
extension of the cure period to attempt to renegotiate the terms of the Beverage
Agreement and for PepsiCo to complete its cure.
The parties did not reach an agreement regarding renegotiation of the
Beverage Agreement and the Company contends that PepsiCo did not cure each of
the instances of default set forth in the Company's original notice of default.
On September 15, 2005 the Company provided PepsiCo with notice of termination of
the Beverage Agreement effective immediately. On October 11, 2005 PepsiCo
served the Company with a Petition in the matter of PepsiCo, Inc. v. Pizza Inn,
Inc. filed in District Court in Collin County, Texas. In the Petition, PepsiCo
alleges that the Company breached the Beverage Agreement by terminating it
without cause. PepsiCo seeks damages of $2.6 million, an amount PepsiCo
believes represents the value of gallons of beverage products that the Company
is required to purchase under the terms of the Beverage Agreement, plus return
of any marketing support funds that PepsiCo advanced to the Company but that the
Company has not earned. The Company has filed a counterclaim against PepsiCo
for amounts earned by the Company under the Beverage Agreement but not yet paid
by PepsiCo, and for damages for business defamation and tortuous interference
with contract based upon statements and actions of the PepsiCo account
representative servicing the Company's account.
The Company believes that it had good reason to terminate the Beverage
Agreement and that it terminated the Beverage Agreement in good faith and in
compliance with its terms. The Company further believes that under such
circumstances it has no obligation to purchase additional quantities of beverage
products. Due to the preliminary nature of this matter and the general
uncertainty surrounding the outcome of any form of legal proceeding, it is not
possible for the Company to provide any certain or meaningful analysis,
projection, or expectation at this time regarding the outcome of this matter.
Although the outcome of the legal proceeding cannot be projected with certainty,
the Company believes that its actions in terminating the Beverage Agreement were
proper and that PepsiCo's allegations are without merit. The Company intends to
vigorously defend against such allegations and to pursue all relief to which it
may be entitled. An adverse outcome to the proceeding could materially affect
the Company's financial position and results of operation. In the event the
Company is unsuccessful, it could be liable to PepsiCo for gallons of beverage
products valued at approximately $2.6 million plus costs and fees. No accrual
for such amounts has been made as of March 26, 2006. This matter is set for
trial beginning on September 4, 2006.
- ------
ITEM 1A. RISK FACTORS
In addition to the other information contained in this report, the
following risk factors may affect us. Among the risk factors are: (i) risks
associated with our business and ongoing operations, (ii) risks associated with
an investment in our common stock and (iii) risks associated with our industry.
Our business, financial condition or results of operations could be materially
and adversely affected by any of these risks.
RISKS ASSOCIATED WITH OUR BUSINESS AND ONGOING OPERATIONS
AS A RESULT OF LOSSES IN RECENT QUARTERS, OUR FINANCIAL CONDITION HAS BEEN
MATERIALLY WEAKENED AND OUR LIQUIDITY HAS DECREASED.
We incurred losses of $601,000, $490,000, and $477,000 in the first, second
and third quarters, respectively, of the fiscal year ending June 25, 2006. As a
result, our financial condition has been materially weakened and our liquidity
diminished, and we remain vulnerable both to unexpected events (such as a sudden
spike in block cheese prices or fuel prices) and to general declines in our
operating environment (such as that resulting from significantly increased
competition).
WE ARE IN DEFAULT UNDER OUR REVOLVING CREDIT AGREEMENT, WHICH HAS REDUCED
AVAILABLE BORROWING CAPACITY UNDER OUR REVOLVING CREDIT AGREEMENT AND RESULTED
IN DIMINISHED LIQUIDITY.
Since September 2005, we have been in default of our loan agreement with
Wells Fargo Bank for ongoing violations of certain financial ratio covenants in
the Revolving Credit Agreement. As a result, Wells Fargo has reduced the
availability of revolving credit loans under the Revolving Credit Agreement from
$6,000,000 to $3,000,000. The reduction in available borrowing capacity may
diminish our cash flow and liquidity positions and adversely affect our ability
to (i) meet our new restaurant development goals, and (ii) effectively address
competitive challenges and adverse operating and economic conditions.
As a result of our default under the Revolving Credit Agreement we are also
in default under the Term Loan Agreement. According to the provisions of the
Term Loan Agreement, Wells Fargo has the right to require immediate payment of
the Real Estate Note (as defined in the Term Loan Agreement), which had a
principal balance of $6,433,000 as of March 26, 2006.
OUR SUBSTANTIAL INDEBTEDNESS COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS AND
LIMIT OUR ABILITY TO PLAN FOR OR RESPOND TO CHANGES IN OUR BUSINESS.
As of March 26, 2006, our substantial consolidated long-term indebtedness
was $8,615 million, the full amount of which has been reclassified on our
balance sheet as current debt since December 25, 2005 as a result of our
on-going loan default. Our indebtedness and the fact that a portion of our
reduced cash flow from operations must be used to make principal and interest
payments on our indebtedness could have important consequences to you. For
example, they could:
- - make it more difficult for us to satisfy our obligations with respect to
our loan agreement;
- - increase our vulnerability to general adverse economic and industry
conditions;
- - reduce the availability of our cash flow for other purposes;
- - limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate, thereby placing us at a
competitive disadvantage compared to our competitors that may have less debt;
and
- - limit, by the financial and other restrictive covenants in our loan
agreement, our ability to borrow additional funds.
IF WE DO NOT PREVAIL IN OUR ARBITRATION WITH OUR FORMER PRESIDENT AND CHIEF
EXECUTIVE OFFICER AND IN LITIGATION WITH A FORMER BEVERAGE SUPPLIER, WE COULD BE
LIABLE FOR SIGNIFICANT MONETARY DAMAGES.
An adverse outcome to the proceedings involving Ronald W. Parker, the
Company's former President and Chief Executive Officer, could materially affect
the Company's financial position and results of operations. In the event the
Company is unsuccessful, it could be liable to Mr. Parker for approximately $5.4
million under his employment agreement plus accrued interest and legal expenses.
Likewise, an unfavorable outcome in our litigation with PepsiCo, Inc. could
result in a liability of approximately $2.6 million. No accrual for any amount
of potential liability for either of these matters has been made as of March 26,
2006.
WE ALSO FACE RISKS OF LITIGATION FROM CUSTOMERS, FRANCHISEES, EMPLOYEES AND
OTHERS IN THE ORDINARY COURSE OF BUSINESS, WHICH DIVERTS OUR FINANCIAL AND
MANAGEMENT RESOURCES. ANY ADVERSE LITIGATION OR PUBLICITY MAY NEGATIVELY IMPACT
OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Claims of illness or injury relating to food quality or food handling are
common in the food service industry. In addition to decreasing our sales and
profitability and diverting our management resources, adverse publicity or a
substantial judgment against us could negatively impact our financial condition,
results of operations and brand reputation, hindering our ability to attract and
retain franchisees and grow our business.
Further, we may be subject to employee, franchisee and other claims in the
future based on, among other things, discrimination, harassment, wrongful
termination and wage, rest break and meal break issues, including those relating
to overtime compensation. If one or more of these claims were to be successful
or if there is a significant increase in the number of these claims, our
business, financial condition and operating results could be harmed.
IF WE ARE NOT ABLE TO IMPLEMENT OUR GROWTH STRATEGY SUCCESSFULLY, WHICH
INCLUDES OPENING NEW DOMESTIC BUFFET UNITS AND REIMAGING EXISTING RESTAURANTS,
OUR ABILITY TO INCREASE OUR REVENUES AND OPERATING PROFITS COULD BE MATERIALLY
ADVERSELY AFFECTED.
A significant component of our growth strategy for developing new domestic
franchised and Company-owned restaurants is the implementation of our new
prototype buffet restaurant concept. We and our franchisees face many
challenges in opening new restaurants, including, among other things, selection
and availability of suitable restaurant locations and suitable employees,
increases in food, paper, labor, utilities, fuel, employee benefits, insurance
and similar costs, negotiation of suitable lease or financing terms, constraints
on permitting and construction of restaurants, higher than anticipated
construction costs, the hiring, training and retention of management and other
personnel and securing required domestic or foreign governmental permits and
approvals. In addition to implementing our growth strategy through the sale of
franchised Buffet Units, we intend to gradually develop and operate
Company-owned Buffet Units in selected markets. The construction, finish-out,
and operation of Buffet Units will require more initial capital investment and
greater on-going expense and operating risk to the Company than normally
experienced through franchise development alone. As a result, we may experience
diminished liquidity, reduced cash flow, and increased risk of loss from
unprofitable Buffet Unit operations.
The opening of additional franchise restaurants also depends, in part, upon
the availability of prospective franchisees who meet our criteria. Our new
concept development program may require considerable management time as well as
start-up expenses for franchisee recruitment and training and market development
before any significant revenues and earnings are generated.
Accordingly, we may not be able to meet planned growth targets, open
restaurants in markets now targeted for expansion or operate profitably in
existing markets. In addition, even if we are able to continue to open new
restaurants, we may not be able to keep restaurants from closing at a faster
rate than we are able to open restaurants.
AN INCREASE IN THE COST OF CHEESE OR OTHER COMMODITIES, INCLUDING FUEL AND
LABOR, COULD ADVERSELY AFFECT OUR PROFITABILITY AND OPERATING RESULTS.
An increase in our operating costs could adversely affect our
profitability. Factors such as inflation, increased food costs, increased labor
and employee benefit costs and increased energy costs may adversely affect our
operating costs. Most of the factors affecting costs are beyond our control
and, in many cases, we may not be able to pass along these increased costs to
our customers or franchisees even if we attempted to do so. Most ingredients
used in our pizza, particularly cheese, are subject to significant price
fluctuations as a result of seasonality, weather, availability, demand and other
factors. Sustained increases in fuel and utility costs could adversely affect
the profitability of our restaurant and distribution businesses. Labor costs
are largely a function of the minimum wage for a majority of our restaurant and
distribution center personnel and, generally, are a function of the availability
of labor.
SHORTAGES OR INTERRUPTIONS IN THE DELIVERY OF FOOD PRODUCTS COULD ADVERSELY
AFFECT OUR OPERATING RESULTS.
We, and our franchisees, are dependent on frequent deliveries of food
products that meet our specifications. Our Company-owned domestic restaurants
purchase substantially all food and related products from our distribution
division, Norco. Domestic franchisees are only required to purchase the flour
mixture, spice blend and certain other items from Norco, and changes in
purchasing practices by domestic franchisees as a result of delivery disruptions
or otherwise could adversely affect the financial results of our distribution
operation. Interruptions in the delivery of food products caused by
unanticipated demand, problems in production or distribution by Norco or
otherwise, inclement weather (including hurricanes and other natural disasters)
or other conditions could adversely affect the availability, quality and cost of
ingredients, which would adversely affect our operating results.
IF WE ARE NOT ABLE TO CONTINUE PURCHASING OUR KEY PIZZA INGREDIENTS FROM
OUR CURRENT SUPPLIERS OR FIND SUITABLE REPLACEMENT SUPPLIERS OUR FINANCIAL
RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.
We are dependent on a few suppliers for our key ingredients. Domestically,
we rely upon sole suppliers for our cheese, flour mixture and certain other key
ingredients. Alternative sources for these ingredients may not be available on
a timely basis to supply these key ingredients or be available on terms as
favorable to us as under our current arrangements. Any disruptions in our
supply of key ingredients could adversely affect our operations.
WE ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATION, AND ANY FAILURE TO
COMPLY WITH EXISTING OR INCREASED REGULATIONS COULD ADVERSELY AFFECT OUR
BUSINESS AND OPERATING RESULTS.
We are subject to numerous federal, state, local and foreign laws and
regulations, including those relating to:
- - the preparation and sale of food;
- - building and zoning requirements;
- - environmental protection;
- - minimum wage, citizenship, overtime and other labor requirements;
- - compliance with the Americans with Disabilities Act; and
- - working and safety conditions.
If we fail to comply with existing or future laws and regulations, we may
be subject to governmental or judicial fines or sanctions. In addition, our
capital expenditures could increase due to remediation measures that may be
required if we are found to be noncompliant with any of these laws or
regulations.
We are also subject to a Federal Trade Commission rule and to various state
and foreign laws that govern the offer and sale of franchises. These laws
regulate various aspects of the franchise relationship, including terminations
and the refusal to renew franchises. The failure to comply with these laws and
regulations in any jurisdiction or to obtain required government approvals could
result in a ban or temporary suspension on future franchise sales, fines or
other penalties or require us to make offers of rescission or restitution, any
of which could adversely affect our business and operating results.
OUR EARNINGS AND BUSINESS GROWTH STRATEGY DEPENDS ON THE SUCCESS OF OUR
FRANCHISEES, AND WE MAY BE HARMED BY ACTIONS TAKEN BY OUR FRANCHISEES THAT ARE
OUTSIDE OF OUR CONTROL.
A significant portion of our earnings comes from royalties generated by our
franchised restaurants. Franchisees are independent operators whose employees
are not our employees. We provide limited training and support to franchisees,
but the quality of franchised restaurant operations may be diminished by any
number of factors beyond our control. Consequently, franchisees may not
successfully operate restaurants in a manner consistent with our standards and
requirements, or may not hire and train qualified managers and other restaurant
personnel. If they do not, our image and reputation may suffer, and revenues
could decline. Our franchisees may take actions that adversely affect the value
of our intellectual property or reputation. Our domestic and international
franchisees may not operate their franchises successfully. If one or more of
our key franchisees were to become insolvent or otherwise were unable or
unwilling to pay us our royalties, our business and results of operations would
be adversely affected.
LOSS OF KEY PERSONNEL OR OUR INABILITY TO ATTRACT AND RETAIN NEW QUALIFIED
PERSONNEL COULD HURT OUR BUSINESS AND INHIBIT OUR ABILITY TO OPERATE AND GROW
SUCCESSFULLY.
Our success will depend to a significant extent on our leadership team and
other key management personnel. We may not be able to retain our executive
officers and key personnel or attract additional qualified management. Our
success also will depend on our ability to attract and retain qualified
personnel to oversee our restaurants, distribution center and international
operations. The loss of these employees or any inability to recruit and retain
qualified personnel could have a material adverse effect on our operating
results.
OUR CURRENT INSURANCE COVERAGE MAY NOT BE ADEQUATE, OUR INSURANCE PREMIUMS
MAY INCREASE AND WE MAY NOT BE ABLE TO OBTAIN INSURANCE AT ACCEPTABLE RATES, OR
AT ALL.
Our insurance policies may not be adequate to protect us from liabilities
that we incur in our business. In addition, in the future our insurance
premiums may increase and we may not be able to obtain similar levels of
insurance on reasonable terms, or at all. Any such inadequacy of, or inability
to obtain, insurance coverage could have a material adverse effect on our
business, financial condition and results of operations.
RISKS ASSOCIATED WITH AN INVESTMENT IN OUR COMMON STOCK
EVEN THOUGH OUR COMMON STOCK IS CURRENTLY TRADED ON THE NASDAQ SMALLCAP
MARKET, IT HAS LESS LIQUIDITY THAN THE STOCK OF MANY OTHER COMPANIES QUOTED ON
THE NASDAQ STOCK MARKET'S NATIONAL MARKET OR ON A NATIONAL SECURITIES EXCHANGE.
The trading volume in our common stock on the Nasdaq SmallCap Market has
been relatively low when compared with larger companies listed on the Nasdaq
National Market or the other stock exchanges. Shareholders, therefore, may
experience difficulty selling a substantial number of shares for the same price
at which shareholders could sell a smaller number of shares. We cannot predict
the effect, if any, that future sales of our common stock in the market, or the
availability of shares of common stock for sale in the market, will have on the
market price of our common stock. Sales of substantial amounts of common stock
in the market, or the potential for large amounts of sales in the market, may
cause the price of our common stock to decline or impair our future ability to
raise capital through sales of our common stock.
THE MARKET PRICE OF OUR COMMON STOCK MAY FLUCTUATE IN THE FUTURE, AND THESE
FLUCTUATIONS MAY BE UNRELATED TO OUR PERFORMANCE.
General market price declines or overall market volatility in the future
could adversely affect the price of our common stock, and the current market
price may not be indicative of future market prices.
RISKS ASSOCIATED WITH OUR INDUSTRY
IF WE ARE NOT ABLE TO COMPETE EFFECTIVELY, OUR BUSINESS, SALES AND EARNINGS
COULD BE MATERIALLY ADVERSELY AFFECTED.
The restaurant industry in general, as well as the pizza segment of the
industry, is intensely competitive, both internationally and domestically, with
respect to price, service, location and food quality. We compete against many
regional and local businesses. There are many well-established competitors with
substantially greater brand awareness and financial and other resources than we
have. Some of these competitors may be better established in markets where
restaurants we operate or that are operated by our franchisees are, or may be,
located. Experience has shown that a change in the pricing or other marketing
or promotional strategies, including new product and concept developments, of
one or more of our major competitors can have an adverse impact on sales and
earnings and our systemwide restaurant operations.
We could also experience increased competition from existing or new
companies in the pizza segment of the restaurant industry. If we are unable to
compete, we could experience downward pressure on prices, lower demand for our
products, reduced margins, the inability to take advantage of new business
opportunities and the loss of market share, all of which would have a material
adverse effect on our operating results.
We also compete on a broader scale with quick service, fast casual and
other international, national, regional and local restaurants. The overall food
service market and the quick service restaurant sector are intensely competitive
with respect to food quality, price, service, convenience and concept. We also
compete within the food service market and the restaurant industry for
management and hourly employees, suitable real estate sites and qualified
franchisees.
Norco is also subject to competition from outside suppliers. If other
suppliers who meet our qualification standards were to offer lower prices or
better service to our franchisees for their ingredients and supplies and, as a
result, our franchisees chose not to purchase from Norco, our financial
condition, business and results of operations would be adversely affected.
CHANGES IN CONSUMER PREFERENCES AND PERCEPTIONS COULD DECREASE THE DEMAND
FOR OUR PRODUCTS, WHICH WOULD REDUCE SALES AND HARM OUR BUSINESS.
Restaurant businesses are affected by changes in consumer tastes, national,
regional and local economic conditions, demographic trends, disposable
purchasing power, traffic patterns and the type, number and location of
competing restaurants. For example, if prevailing health or dietary preferences
cause consumers to avoid pizza and other products we offer or quick service
restaurant offerings generally in favor of foods that are perceived as more
healthy, our business and operating results would be harmed.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND THE USE OF PROCEEDS
- --------------------------------------------------------------------------------
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- --------------------------------------------
On October 18, 2005 the Company notified Wells Fargo that as of September
25, 2005 the Company was in violation of certain financial ratio covenants in
the Revolving Credit Agreement and that as a result an event of default existed
under the Revolving Credit Agreement. As a result of the continuing event of
default, as of March 26, 2006, all outstanding principal of the Company's
obligations under the Revolving Credit Agreement and Term Loan Agreement have
been reclassified as current liabilities on the Company's balance sheet.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ---------------------------------------------------------------------
Not applicable.
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ITEM 5. OTHER INFORMATION
- ----------------------------
Not applicable.
ITEM 6. EXHIBITS
- ------------------
3.1 Restated Articles of Incorporation as filed on September 5, 1990
and amended on June 23, 2005 (filed as Exhibit 3.6 to the Company's Annual
Report on Form 10-K for the fiscal year ended June 26, 2005 and incorporated
herein by reference).
3.2 Amended and Restated By-laws as adopted by the Board of Directors on
February 11, 2004 (filed as Item 5 on Form 8-K on February 11, 2004 and
incorporated herein by reference).
31.1 Certification of Chief Executive Officer as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Accounting Officer as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Principal Accounting Officer as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
------
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PIZZA INN, INC.
Registrant
By: /s/Timothy P. Taft
--------------------
Timothy P. Taft
Chief Executive Officer
By: /s/Kevin A. Kleiner
---------------------
Kevin A. Kleiner
Principal Accounting Officer
Dated: May 9, 2006