SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 26, 2005.
Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _____ to _____.
COMMISSION FILE NUMBER 0-12919
PIZZA INN, INC.
(Exact name of registrant as specified in its charter)
MISSOURI 47-0654575
(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3551 PLANO PARKWAY
THE COLONY, TEXAS 75056
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (469) 384-5000
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 EACH
(Title of class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of December 26, 2004, the last business day of the registrant's most recently
completed second fiscal quarter, the aggregate market value of the voting and
non-voting common equity held by non-affiliates was $14,371,275, computed by
reference to the price at which the common equity was last sold, or the average
bid and asked price of such common equity, as of such date.
As of September 19, 2005, there were 10,108,494 shares of the registrant's
common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this report is incorporated by
reference from the registrant's definitive proxy statement required to be filed
pursuant to Regulation 14A in connection with the registrant's next annual
meeting of shareholders, which is expected to be held in December 2005.
PART I
ITEM 1 - BUSINESS
GENERAL
Pizza Inn, Inc. and its subsidiaries (collectively referred to as the
"Company", "Pizza Inn" or in the first person notations of "we", "us" and "our")
operate and franchise pizza buffet, delivery/carry-out and express restaurants
domestically and internationally under the trademark "Pizza Inn". Through our
Norco Restaurant Services Company ("Norco") division, we are also a food,
equipment and supply distributor to our domestic and international system of
restaurants.
On September 19, 2005, the Pizza Inn system consisted of 391 restaurants,
including four Company-owned restaurants, and 387 franchised restaurants. The
domestic franchised restaurants are comprised of 191 buffet restaurants, 50
delivery/carry-out restaurants and 71 express restaurants. The international
franchised restaurants are comprised of 17 buffet restaurants, 44
delivery/carry-out restaurants and 14 express restaurants. Domestic restaurants
are located predominantly in the southern half of the United States, with Texas,
North Carolina, and Arkansas accounting for approximately 35%, 14%, and 8%,
respectively, of the total number of domestic restaurants.
OUR HISTORY
Pizza Inn has offered consumers affordable, quality pizza since 1958, when
the first Pizza Inn restaurant opened in Dallas, Texas. We awarded our first
franchise in 1963 and opened our first buffet restaurant in 1969. We began
franchising the Pizza Inn brand internationally in the late 1970s. In 1993, our
stock began trading on the NASDAQ Stock Market, and presently trades on the
NASDAQ SmallCap Market under the ticker symbol "PZZI".
OUR CONCEPTS
We offer three concepts: buffet, delivery/carry-out and express. Each is
designed to enhance the smooth flow of food ordering, preparation and service,
and we believe that the overall configuration of each results in simplified
operations, lower training and labor costs, increased efficiency and improved
consistency and quality of our food products. Our restaurants may be configured
to adapt to a variety of building shapes and sizes, offering the flexibility
necessary for our concepts to be operated at any number of otherwise suitable
locations.
Our focused menu is designed to present an appealing variety of high
quality of pizza and side items to our customers. Our basic buffet restaurant
menu offers three main crusts (Original Thin Crust, New York Pan and Italian),
with standard toppings and special combinations of toppings. Buffet restaurants
also offer pasta, salad, sandwiches, appetizers, desserts and beverages,
including beer and wine in some locations, in an informal, family-oriented
atmosphere. We occasionally offer other items on a limited promotional basis.
Delivery/carryout restaurants usually offer the three main crusts and some
combination of side items. We believe that our focus on three main crust types
creates a better brand identity among customers, improves operating efficiency
and maintains food quality and consistency.
Our buffet and delivery/carry-out concepts feature crusts that are
hand-made from dough made fresh in the restaurant each day. We do not use a
centralized commissary for mass production of dough and our dough is never
frozen (with the exception of certain dough products used in the express concept
for pizza, discussed below). Pizza Inn pizzas are made from a proprietary
all-in-one flour mixture, real mozzarella cheese and a proprietary mix of
classic pizza spices. Domestically, all ingredients and toppings can be
purchased from Norco, which makes deliveries to each domestic restaurant in our
system at least once a week. In international markets, the menu mix of toppings
and side items is occasionally adapted to local tastes.
Buffet Restaurants
-------------------
These restaurants offer dine-in and carryout service and, in many cases,
also offer delivery service. They are generally located in free standing
buildings or in-line locations in retail developments in close proximity to
offices, shopping centers and residential areas. The current standard buffet
restaurants are between 3,000 and 5,000 square feet in size and seat 120 to 185
customers. The interior decor is designed to promote a casual, lively,
contemporary, family-style atmosphere. Buffet restaurants also offer catering
service.
The buffet is typically offered at prices from $4.29 to $5.99, and the
average ticket price per meal, including a drink, is approximately $6.38 per
person for fiscal year 2005. These averages are slightly higher in restaurants
offering beer and wine.
We are developing and implementing a new image and layout for our domestic
buffet concept, which we believe may increase retail sales and market share
through a stronger market presence, greater brand awareness and enhanced
customer satisfaction. This program involves significant exterior and interior
changes in signage, color schemes and work flow and dining area configuration,
including the addition of a back-fed buffet bar offering attractive and
efficient presentation, a greater variety of products and increased operating
efficiency. The design features vibrant colors, graphic accents, a contemporary
interior and updated signage and logos. Some restaurants will feature game
rooms, which will offer a range of electronic game entertainment for the entire
family. Interiors will feature selected memorabilia capturing some of the
milestones in our nearly 50 years of operation. Additionally, guests will enjoy
the convenience of curbside service. This new buffet concept is being
introduced in several new Company-owned restaurants, as well as in new and
certain existing franchised restaurants.
Delivery/Carryout Restaurants
------------------------------
These restaurants offer delivery and carryout service only and are
typically located in shopping centers or other in-line retail developments.
These relatively small restaurants, occupying approximately 1,000 square feet,
are primarily production facilities and, in most instances, do not offer
seating. Because these restaurants do not typically offer dine-in areas, they
usually do not require expensive real estate leasehold or ownership costs and
are relatively less expensive to build and equip. The decor of these
restaurants is designed to be bright and highly visible and feature neon,
lighted displays and awnings.
We attempt to locate these restaurants strategically to facilitate timely
delivery service and to provide easy access for carryout service. We believe
that there are continuing opportunities for strategic development for the
delivery/carry-out concept, whether as a primary means of market development in
carefully targeted areas, or as "in-fills" in buffet markets to serve an
identifiable customer segment and capture additional market share.
Express Restaurants
--------------------
These restaurants offer us the opportunity to serve our customers through a
variety of non-traditional points of sale. Express restaurants are typically
located in a convenience store, food court, college campus, airport terminal,
athletic facility or other commercial facility. They have limited or no seating
and solely offer quick carryout service of a limited menu of pizza and other
foods and beverages. An express restaurant typically occupies approximately 200
to 400 square feet and is commonly operated by the same person who owns the
commercial host facility or who is licensed at one or more locations within the
facility. We have developed a high-quality pre-prepared crust that is topped
and cooked on-site, allowing this concept to offer a lower initial investment
and reduced labor and operating costs while maintaining product quality and
consistency. Like the delivery/carry-out restaurants, express restaurants are
primarily production-oriented facilities and, therefore, do not require all of
the equipment, labor, real estate or square footage of a traditional buffet
restaurant.
SITE SELECTION
We consider the restaurant site selection process critical to the
restaurant's long-term success and devote significant resources to the
investigation and evaluation of potential sites. The site selection process
includes a review of trade area demographics and other competitive factors. We
also rely on the franchisee's knowledge of the trade area and market
characteristics when selecting a location for a franchised restaurant. A member
of the Company's development team will visit each potential domestic
Company-owned restaurant location. We try to locate franchised and
Company-operated restaurants in retail strip centers or freestanding buildings
offering visibility, curb appeal and accessibility.
DEVELOPMENT AND OPERATIONS
We intend to continue our expansion domestically in markets where we
believe there exists significant long-term earnings growth potential, and where
we believe that we can use our competitive strengths to establish brand
recognition and gain local market share. We believe our franchise-oriented
business model will allow us eventually to expand our franchised restaurant base
with limited capital expenditures and working capital requirements. While we
plan to expand our domestic restaurant base primarily through opening new
franchised restaurants, we also will continually evaluate our mix of
Company-operated and franchised restaurants and may strategically develop
Company-operated restaurants, acquire franchised restaurants and re-franchise
Company-operated restaurants. We believe that our most promising development
and system growth opportunities lie with experienced, well-capitalized,
multi-restaurant operators.
The specific rate at which we will be able to expand through franchise
development is determined in part by our success at selecting qualified
franchisees, by identifying satisfactory sites in appropriate markets and by our
ability to continue training and monitoring our franchisees.
Franchise Operations
---------------------
We have adopted a franchising strategy that has two major components:
continued development within our existing market areas and new development in
strategically targeted domestic territories. We also intend to continue to seek
appropriate international development opportunities.
Franchise and development agreements. Our current forms of franchise
agreements provide for: (i) a franchise fee of $20,000 for a buffet restaurant,
$7,500 for a delivery/carry-out restaurant and $5,000 for an express restaurant,
(ii) an initial franchise term of 20 years for a buffet restaurant and ten years
for a delivery/carry-out or express restaurant, plus a renewal term of ten years
for each concept, (iii) required contributions equal to 1% of gross sales to the
Pizza Inn Advertising Plan ("PIAP") or to the Company, as discussed below, (iv)
royalties equal to 4% of gross sales for a buffet or delivery/carry-out
restaurant, and 5% or 6%, as determined by the respective franchise agreements,
of gross sales for an express restaurant, and (v) required advertising
expenditures of at least 5% of gross sales for a buffet or delivery/carry-out
restaurant, and 2% for an express restaurant. From time to time, the Company
offers, to certain experienced restaurant operators, area developer rights in
new and existing domestic markets. An area developer pays a negotiated fee to
purchase the right to operate or develop restaurants within a defined territory.
The area developer typically agrees to multi-restaurant development schedule and
assists the Company in local franchise service and quality control in exchange
for half of the franchise fees and royalties from all restaurants within the
territory during the term of the agreement.
The Pizza Inn concept was first franchised in 1963. Since that time,
industry franchising concepts and development strategies have changed, and the
Company's present franchise relationships are evidenced by a variety of
contractual forms. Common to those forms are provisions that: (i) provide for
an initial franchise term of 20 years (except as described below) and a renewal
term, (ii) require the franchisee to follow the Pizza Inn system of restaurant
operation and management, (iii) require the franchisee to pay a franchise fee
and continuing royalties, and (iv) except for express restaurants, prohibit the
development of one restaurant within a specified distance from another.
Training. The Company offers numerous training programs for the benefit of
franchisees and their restaurant crew managers. The training programs, taught
by experienced Company employees, focus on food preparation, service, cost
control, sanitation, safety, local store marketing, personnel management and
other aspects of restaurant operation. The training programs include group
classes, supervised work in Company-operated restaurants and special field
seminars. Initial and some supplemental training programs are offered free of
charge to franchisees, who pay their own travel and lodging expenses.
Restaurant managers train their staff through on-the-job training, utilizing
videotapes and printed materials produced by the Company.
Standards. We enforce a variety of standards over franchise operations to
protect and enhance our brand. All franchisees are required to operate their
restaurants in compliance with written policies, standards and specifications,
which include matters such as menu items, ingredients, materials, supplies,
services, furnishings, decor and signs. Our efforts to maintain a consistent
level of operations may result from time to time in closing certain restaurants
that are not capable of achieving and maintaining a consistent level of quality
operations. Each franchisee has full discretion to determine the prices to be
charged to customers. We also provide ongoing support to our franchisees,
including training, marketing assistance and consultation to franchisees who
experience financial or operational difficulties.
Company Operations
-------------------
One of our long-term objectives is to continue to selectively expand the
number of Company-owned restaurants by identifying appropriate opportunities in
our targeted markets. We intend to concentrate our efforts in certain
identified markets by opening a limited number of restaurants at locations
developed by the Company or by selectively identifying opportunities to acquire
restaurants operated by franchisees at negotiated prices. We believe that
moving forward, our domestic network of Company- owned restaurants will play an
important strategic role in our predominately franchised operating structure.
In addition to generating revenues and earnings, we expect to use domestic
Company-owned restaurants as test sites for new products and promotions as well
as restaurant operational improvements and as a forum for training new managers
and franchisees. We also believe that as the number gradually increases, our
Company-owned restaurants may add to the economies of scale available for
advertising, marketing and other costs.
We currently operate one buffet restaurant and one delivery/carry-out
restaurant in the Dallas, Texas market. We are presently developing two
additional buffet restaurants in Houston, Texas that were recently acquired from
franchisees and we are constructing a new restaurant in Dallas, Texas. We
anticipate that these restaurants will be open late in the second quarter of
fiscal 2006. We are also considering opportunities to acquire select
franchisee-owned restaurants in other markets. We do not currently intend to
operate any delivery/carry-out restaurants or express restaurants other than the
one we currently own.
Our ability to open Company-owned restaurants is affected by a number of
factors, including, the terms of available financing, our ability to locate
suitable sites, negotiate acceptable lease or purchase terms, secure appropriate
local governmental permits and approvals and our capacity to supervise
construction and to recruit and train management personnel.
International Operations
-------------------------
From time to time we also offer master franchise rights to develop Pizza
Inn restaurants in certain foreign countries, with negotiated fees, development
schedules and ongoing royalties. A master licensee for a foreign country pays a
negotiated fee to purchase the right to develop and operate Pizza Inn
restaurants within a defined territory, typically for a term of 20 years, plus a
ten-year renewal option. The master licensee agrees to a multi-restaurant
development schedule and the Company trains the master licensee to monitor and
assist franchisees in their territory with local service and quality control,
with support from the Company. In return, the master licensee typically retains
half the franchise fees and half the royalties on all restaurants within the
territory during the term of the agreement. Master licensees may open
restaurants that they own and operate, or they may open sub-franchised
restaurants owned and operated by third parties through agreements with the
master licensee, but subject to our approval.
We opened our first restaurant outside of the United States in the late
1970s, and, as of June 26, 2005, there were 74 restaurants operating
internationally, with 43 of those restaurants operated or sub-licensed by our
franchisees in the United Arab Emirates and Saudi Arabia. Our master licensee
in Saudi Arabia has also developed several express restaurants at U. S. military
facilities.
Our ability to continue to develop select international markets is affected
by a number of factors, including our ability to locate experienced,
well-capitalized developers who can commit to an aggressive multi-restaurant
development schedule and achieve maximum initial market penetration with a
minimum of direct control by the Company.
FOOD AND SUPPLY DISTRIBUTION
We believe that Norco, our food and supply distribution system, results in
lower operating costs, improved food quality and increased customer
satisfaction. Norco is able to leverage the advantages of volume purchasing of
food, equipment and supplies for the franchisees' benefit in the form of a
concentrated, one-truck delivery system, pricing efficiencies and product
consistency. We negotiate directly with major suppliers to obtain competitive
prices. Operators are able to purchase all products and ingredients from Norco,
thereby reducing the logistical difficulties and added expense of maintaining
multiple inventory, purchasing and delivery records. In order to assure product
quality and consistency, our franchisees are required to purchase, from Norco,
certain food products that are proprietary to the Pizza Inn system, including
our flour mixture and spice blend. In addition, almost all franchisees purchase
other supplies from Norco. Franchisees may also purchase non-proprietary
products and supplies from other suppliers who meet our requirements for quality
and reliability.
Norco operates its central distribution facility six days per week, and
delivers to all domestic restaurants weekly, utilizing a fleet of refrigerated
tractor-trailers operated by Company drivers and independent owner-operators.
Norco also ships products and equipment to international franchisees.
Non-proprietary food and ingredients, equipment and other supplies distributed
by Norco are generally available from several qualified sources. With the
exception of several proprietary food products, the Company is not dependent
upon any one supplier or limited group of suppliers. The Company contracts with
established food processors for the production of its proprietary products.
We have not experienced any significant shortages of supplies or any delays
in receiving our food or beverage inventories, restaurant supplies or products,
and do not anticipate any difficulty in obtaining inventories or supplies in the
foreseeable future. Prices charged to us by our suppliers are subject to
fluctuation, and we may from time to time attempt to pass increased costs and
savings on to our franchisees. We do not engage in commodity hedging.
ADVERTISING
By communicating a common brand message at the regional, local market and
store levels, we believe we can create and reinforce a strong, consistent
marketing message to consumers and increase our market share. We offer or
facilitate a number of ways for the brand image and message to be promoted at
the local and regional levels.
PIAP is a Texas non-profit corporation that is responsible for creating and
producing print advertisements, television and radio commercials and in-store
promotional materials, along with related advertising services for use by its
members. Each operator of a buffet or delivery/carry-out restaurant, including
the Company, is entitled to membership in PIAP. Nearly all of the Company's
existing franchise agreements for buffet and delivery/carry-out restaurants
require the franchisees to become members of PIAP. Members contribute 1% of
their gross sales to PIAP. PIAP is managed by a board of trustees comprised
solely of franchisee representatives who are elected by the members each year.
The Company does not have any ownership interest in PIAP. The Company provides
certain administrative, marketing and other services to PIAP and is paid by PIAP
for such services. As of September 19, 2005, the Company-operated stores and
substantially all of our franchisees were members of PIAP. Operators of express
restaurants do not participate in PIAP; however, they contribute up to 1% of
their gross sales directly to the Company to help fund purchases of express
restaurant marketing materials and similar expenditures.
Groups of franchisees in some of the Pizza Inn system's market areas have
formed local advertising cooperatives. These cooperatives, which may be formed
voluntarily or may be required by the Company under the franchise agreements,
establish contributions to be made by their members and direct the expenditure
of these contributions on local media advertising using materials developed by
PIAP and/or the Company. Franchisees are required to conduct independent
marketing efforts in addition to their participation in PIAP and local
cooperatives.
We provide Company-operated and franchised restaurants with catalogs for
the purchase of marketing and promotional items and pre-approved print and radio
marketing materials. We have also developed an internet-based system, Pizza Inn
Inn-tranet, by which all of our restaurants may communicate with us and place
orders for marketing and promotional products.
TRADEMARKS AND QUALITY CONTROL
The Company owns various trademarks, including the name "Pizza Inn," that
are used in connection with the restaurants and have been registered with the
United States Patent and Trademark Office. The duration of our trademarks is
unlimited, subject to periodic renewal and continued use. In addition, the
Company has obtained trademark registrations in several foreign countries and
has periodically re-filed and applied for registration in others. We believe
that we hold the necessary rights for protection of the trademarks essential to
our business and it is our regular policy to monitor the use of our trademarks
around the world.
The Company requires all restaurants to satisfy certain quality standards
governing the products and services offered through use of the Company's
trademarks.
GOVERNMENT REGULATION
We and our franchisees are subject to various federal, state and local laws
affecting the operation of our restaurants. Each Pizza Inn restaurant is
subject to licensing and regulation by a number of governmental authorities,
which include health, safety, sanitation, wage and hour, building and fire
agencies in the state or municipality in which the restaurant is located.
Difficulties in obtaining, or the failure to obtain, required licenses or
approvals could delay or prevent the opening of a new restaurant or require the
temporary or permanent closing of existing restaurants in a particular area.
Our distribution center is subject to regulation by state and local health and
fire codes, and the operation of our trucks is subject to U.S. Department of
Transportation regulations. We are also subject to state and federal
environmental regulations.
We are subject to Federal Trade Commission ("FTC") regulation and to
various state laws regulating the offer and sale of franchises. Several state
laws also regulate the substantive aspects of the franchisor-franchisee
relationship. The FTC requires us to furnish to prospective franchisees a
franchise offering circular containing prescribed information. Substantive
state laws that regulate the franchisor-franchisee relationship presently exist
in a number of states, and bills have been introduced in Congress from time to
time that would provide for further federal regulation of the
franchisor-franchisee relationship in certain respects. Some foreign countries
also have disclosure requirements and other laws regulating franchising and the
franchisor-franchisee relationship. Further government initiatives, such as
proposed minimum wage rate increases, could adversely affect Pizza Inn as well
as the restaurant industry in general.
EMPLOYEES
As of September 19, 2005, we had approximately 167 employees, including 56
in our corporate office, 70 at our Norco division and 17 full-time and 24
part-time employees at the Company-operated restaurants. None of the Company's
employees are currently covered by collective bargaining agreements. We believe
that our employee relations are excellent.
INDUSTRY AND COMPETITION
The restaurant industry is intensely competitive with respect to price,
service, location and food quality, and there are many well-established
competitors with substantially greater brand recognition and financial and other
resources than Pizza Inn. Competitors include a large number of international,
national and regional restaurant chains, as well as local restaurants and pizza
operators. Some of our competitors may be better established in the markets
where our restaurants are located or may be located. Within the pizza segment
of the restaurant industry, we believe that our primary competitors are national
pizza chains and several regional chains, including chains executing a "take and
bake" concept. A change in the pricing or other market strategies of one or
more of our competitors could have an adverse impact on our sales and earnings.
With respect to the sale of franchises, we compete with many franchisors of
restaurants and other business concepts. We believe that the principal
competitive factors affecting the sale of franchises are product quality and
price, value, consumer acceptance, franchisor experience and support and the
quality of the relationship maintained between the franchisor and its
franchisees. In general, there is also active competition for management
personnel and attractive commercial real estate sites suitable for our
restaurants.
Our Norco division competes with both national and local distributors of
food, equipment and other restaurant suppliers. The distribution industry is
very competitive. The Company believes that the principal competitive factors
in the distribution industry are product quality, customer service and price.
Norco is the sole authorized supplier of certain proprietary products that all
Pizza Inn restaurants are required to use.
AVAILABLE INFORMATION
The Company files reports, including reports on Form 10-Q and Form 10-K,
with the Securities and Exchange Commission ("SEC"). The public may read and
copy any materials we file with the SEC at the SEC's Public Reference Room at
100 F Street, N.E. Washington, DC 20549. The public may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
The SEC maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC. The address of that site is http://www.sec.gov.
------------------
We make available free of charge on or through our Internet website
(http://www.pizzainn.com) our annual report on Form 10-K, quarterly reports on
-----------------
Form 10-Q, current reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the SEC. We voluntarily will provide electronic or paper copies
of our filings free of charge upon written request to: Corporate Secretary,
Pizza Inn, Inc., 3551 Plano Parkway, The Colony, TX 75056.
FORWARD-LOOKING STATEMENTS
This Form 10-K contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995 (the "PSLRA"), including
information within Management's Discussion and Analysis of Financial Condition
and Results of Operations. The following cautionary statements are being made
pursuant to the provisions of the PSLRA and with the intention of obtaining the
benefits of the "safe harbor" provisions of the PSLRA. Although we believe that
our expectations are based upon reasonable assumptions, actual results may
differ materially from those in the forward-looking statements as a result of
various factors, including, but not limited to, the factors discussed in this
Form 10-K under the heading "Risk Factors".
RISK FACTORS
Investing in our common stock involves a high degree of risk. You should
carefully consider the following factors, as well as other information contained
in this report, before deciding to invest in shares of our common stock. These
risks could materially adversely affect our business, financial condition or
results of operations. The trading price of our common stock could also be
materially adversely affected by any of these risks.
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 have been in existence for a substantially
longer period than we have and 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, and convenience and concept.
We compete within the food service market and the restaurant industry not
only for customers, but also 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.
IF WE ARE NOT ABLE TO IMPLEMENT OUR GROWTH STRATEGY SUCCESSFULLY, WHICH
INCLUDES OPENING NEW DOMESTIC AND INTERNATIONAL RESTAURANTS 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 is opening new domestic and
international franchise restaurants. 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.
The opening of additional franchise restaurants and our reimaging program also
depends, in part, upon the availability of prospective franchisees who meet our
criteria. Our reimaging program may require considerable management time as
well as start-up expenses for market development before any significant revenues
and earnings are generated.
Accordingly, there can be no assurance that we will be able to meet planned
growth targets, open restaurants in markets now targeted for expansion or
operate in existing markets profitably. 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 SUPPLY OR 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. Shortages or interruptions in the supply
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.
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 in favor of foods
that are perceived as more healthy, our business and operating results would be
harmed. Moreover, because we are primarily dependent on a single product, if
consumer demand for pizza should decrease, our business would suffer more than
if we had a more diversified menu, as many other food service businesses do.
HEALTH CONCERNS OR DISEASE-RELATED DISRUPTIONS ABOUT COMMODITIES THAT WE
USE TO MAKE PIZZA COULD MATERIALLY ADVERSELY AFFECT THE AVAILABILITY AND COST OF
SUCH COMMODITIES.
Health- or disease-related disruptions or consumer concerns about the
commodity supply could materially adversely impact the availability and/or cost
of such commodities, thereby materially adversely impacting restaurant
operations and our financial results.
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.
A significant number of hourly personnel employed by our franchisees and by us
are paid at rates related to the federal minimum wage. Accordingly, further
increases in the federal minimum wage or the enactment of additional state or
local wage proposals may increase labor costs for our systemwide operations.
Additionally, labor shortages in various markets could result in higher required
wage rates.
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. Additionally,
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.
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. Our domestic restaurants
purchase substantially all food and related products from our distribution
division. Accordingly, both our Company-operated and franchised restaurants
could be harmed by any prolonged disruption in the supply of products from
Norco. Additionally, 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 could adversely affect the
financial results of our distribution operation.
OUR INTERNATIONAL AND DOMESTIC OPERATIONS COULD BE MATERIALLY ADVERSELY
AFFECTED BY SIGNIFICANT CHANGES IN INTERNATIONAL, REGIONAL, AND LOCAL ECONOMIC
AND POLITICAL CONDITIONS.
Our international and domestic operations are subject to many factors,
including currency regulations and fluctuations, culture and consumer
preferences, diverse government regulations and structures, availability and the
cost of land and construction, ability to source ingredients and other
commodities in a cost-effective manner and differing interpretation of the
obligations established in franchise agreements with international franchisees.
Accordingly, there can be no assurance that our operations will achieve or
maintain profitability or meet planned growth rates.
EACH OF THE FOREGOING RISK FACTORS THAT COULD AFFECT RESTAURANT SALES OR
COSTS COULD DISPROPORTIONATELY AFFECT THE FINANCIAL VIABILITY OF NEWLY OPENED
RESTAURANTS AND FRANCHISEES IN UNDER-PENETRATED OR EMERGING MARKETS AND,
CONSEQUENTLY, OUR OVERALL RESULTS OF OPERATIONS.
A decline in or failure to improve financial performance for this group of
restaurants or franchisees could lead to an inability to successfully recruit
new franchisees and open new restaurants and lead to restaurant closings at
greater than anticipated levels and therefore impact contributions to marketing
funds, our royalty stream, our distribution operations and support services
efficiencies and other system-wide results of operations.
WE 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.
For example, an adverse outcome to the proceedings involving Ronald W.
Parker, the Company's former President and Chief Executive Officer, and B. Keith
Clark, the Company's former Senior Vice President Secretary and General Counsel,
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 and for
approximately $775,000 under Mr. Clark's employment agreement plus accrued
interest and legal expenses. No accrual for any amount has been made as of June
26, 2005. See the discussion under "Legal Proceedings" in this report.
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, and their
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 store personnel. If they do not, our image and reputation may suffer, and
revenues could decline. While we try to ensure that our franchisees maintain
the quality of our brand and branded products, 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 our 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, AND INSURANCE PREMIUMS
FOR SUCH COVERAGE 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.
OUR ANNUAL AND QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT
FLUCTUATIONS DEPENDING ON VARIOUS FACTORS, MANY OF WHICH ARE BEYOND OUR CONTROL,
AND IF WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR
SHARE PRICE MAY DECLINE SIGNIFICANTLY.
Our sales and operating results can vary significantly from quarter to
quarter and year to year depending on various factors, many of which are beyond
our control. These factors include variations in the timing and volume of our
sales and our franchisees' sales; the timing of expenditures in anticipation of
future sales; sales promotions by us and our competitors; changes in competitive
and economic conditions generally; and changes in the cost or availability of
our ingredients (including cheese), fuel or labor. As a result, our results of
operations may decline quickly and significantly in response to changes in order
patterns or rapid decreases in demand for our products. We anticipate that
fluctuations in operating results will continue in the future.
ITEM 2 - PROPERTIES
The Company owns a 40,000 square foot facility housing its corporate office
and training center and a 100,000 square foot warehouse and distribution
facility. These buildings were constructed on approximately 11 acres of land in
The Colony, Texas in 2001.
The Company currently owns two Pizza Inn restaurants in the Dallas, Texas
area. One Company-owned restaurant, a buffet, is operated from a leased
location of approximately 3,865 square feet. Annual lease payments are
approximately $14.00 per square foot. The lease expires in 2007 but has
continuous three-year renewal options. The other Company-owned restaurant, a
delivery/carry-out restaurant, was constructed on land the Company purchased
north of Dallas, in Little Elm, Texas, in June 2003.
In July 2005, the Company acquired the assets of two existing buffet
restaurants from Houston, Texas-area franchisees. We are in the process of
remodeling these restaurants and anticipate reopening them in October 2005.
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.
In July 2005, the Company leased approximately 4,100 square feet of space
in a retail development in Dallas, Texas for the operation of a buffet
restaurant at an annual rate of approximately $30.00 per square foot. We are
currently in the process of finishing out the space and expect to have the
restaurant operating in October 2005. The lease has a five-year term with
multiple renewal options.
We also own property in Prosper, Texas that was purchased in August 2004
with the intention of constructing and operating a buffet restaurant. We have
decided not to pursue development at that location and currently have the
property under contract to sell to a third party.
ITEM 3 - LEGAL PROCEEDINGS
We are subject to claims and legal actions in the ordinary course of our
business. With the possible exception of the matters set forth below, we
believe that all such claims and actions currently pending against us are either
adequately covered by insurance or would not have a material adverse effect on
the Company's annual results of operations or financial condition if decided in
a manner that is unfavorable to us.
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. The arbitration hearing is scheduled
to begin on November 8, 2005.
The Company disagrees with Mr. Clark's claim that a "change of control" has
occurred under the Clark Agreement or that he is entitled to terminate the Clark
Agreement for "good reason." On May 4, 2004, the Board of Directors obtained a
written legal opinion that the "change of control" provision in the Clark
Agreement was not triggered by the results of the February 11, 2004 annual
meeting. Due to the nature of 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, the Company believes that its
claims against Mr. Clark are well founded and intends to vigorously 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. Clark for the
severance payment of approximately $762,000, the $12,500 bonus payment and costs
and fees. No accrual for any such amounts has been made as of June 26, 2005.
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 believes that its claims against Akin Gump and Mr.
Menges are well founded and 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 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. No date for an arbitration hearing has
been set.
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 believes that its claims against Mr.
Parker are well founded and intends to vigorously 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 June 26, 2005.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to a vote of security holders during
the fourth quarter of the Company's fiscal year 2005 at the Company's 2004
Annual Meeting of Shareholders on June 23, 2005.
Item 1. Election of Class I Directors.
Elected Directors For Against Abstain
- -------------------- --------- ------- -------
Bobby L. Clairday . 8,577,823 102,628 35,426
John D. Harkey, Jr. 8,164,874 17,877 533,126
Timothy P. Taft . . 8,179,874 2,877 533,126
Mark E. Schwarz . . 8,130,825 51,926 533,126
Continuing Directors
- --------------------
Robert B. Page
Ramon D. Phillips
Steven J. Pully
Item 2. Approval of adoption of a stock award plan for non-employee directors
as a successor plan to the 1993 Outside Directors Stock Award Plan that expired
in 2003.
For. . Against Abstain
--------- ------- -------
5,313,541 779,115 5,371
Item 3. Approval of adoption of an incentive stock award plan for employees as a
successor plan to the 1993 Employee Stock Award Plan that expired in 2003.
For. . Against Abstain
--------- ------- -------
5,849,542 245,990 2,495
Item 4. Approval of an amendment to the Company's Restated Articles of
Incorporation to declassify the board of directors.
For. . Against Abstain
--------- ------- -------
8,664,039 42,924 8,913
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of September 19, 2005, there were approximately 2,045 stockholders of
record of the Company's common stock.
The Company's common stock is listed on the SmallCap Market of the National
Association of Securities Dealers Automated Quotation ("NASDAQ") system under
the symbol "PZZI". The following table shows the highest and lowest actual trade
executed price per share of the common stock during each quarterly period within
the two most recent fiscal years, as reported by the National Association of
Securities Dealers. Such prices reflect inter-dealer quotations, without
adjustment for any retail markup, markdown or commission.
Actual Trade
Executed Price
High Low
--------------- -----
2005
First Quarter Ended 9/26/2004 . $ 3.25 $2.39
Second Quarter Ended 12/26/2004 3.26 2.63
Third Quarter Ended 3/27/2005 . 2.95 2.25
Fourth Quarter Ended 6/26/2005. 3.00 2.30
2004
First Quarter Ended 9/28/2003 . $ 3.95 $1.80
Second Quarter Ended 12/28/2003 3.06 2.50
Third Quarter Ended 3/28/2004 . 3.07 2.70
Fourth Quarter Ended 6/27/2004. 3.09 2.58
Under the Company's bank loan agreement, the Company is currently limited
in its ability to pay dividends or make other distributions on its common stock
and the Company believes that the loan agreement is likely to limit the
Company's ability to take such actions in the future.
The Company did not pay any dividends on its common stock during the fiscal
years ended June 26, 2005 and June 27, 2004. Any determination to pay cash
dividends in the future will be at the discretion of the Company's Board of
Directors and will be dependent upon the Company's results of operations,
financial condition, capital requirements, contractual restrictions and other
factors deemed relevant. Currently, there is no intention to pay any dividends
on its common stock.
EQUITY COMPENSATION PLAN INFORMATION
A summary of equity compensation under all of the Company's equity compensation
plans follows:
Number of Securities to Weighted-average Number of Securities
be issued upon exercise exercise price of remaining available for
Plan. . . . . . . . . of outstanding options, outstanding options, future issuance under
Category. . . . . . . warrants, and rights warrants, and rights equity compensation plans
- --------------------- ----------------------- --------------------- -------------------------
Equity Compensation
plans approved by
security holders. . . 310,958 $ 3.10 1,457,142
Equity compensation
plans not approved by
security holders. . . 500,000 $ 2.50 -
----------------------- --------------------- -------------------------
Total . . . . . . . . 810,958 $ 2.73 1,457,142
======================= ===================== =========================
Additional information regarding equity compensation can be found in the notes
to the consolidated financial statements.
ITEM 6 - SELECTED FINANCIAL DATA
The following table contains certain selected financial data for the
Company for each of the last five fiscal years through June 26, 2005, and should
be read in conjunction with the financial statements and schedules in Item 8 of
this report.
Year Ended
-----------
June 26, June 27, June 29, June 30, June 24,
2005 2004 2003 2002 2001
----------- --------- --------- --------- ----------
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA:
Total revenues . . . . . . . . . . . . $ 55,269 $ 59,988 $ 58,471 $ 65,388 $ 64,739
Income before taxes. . . . . . . . . . 359 3,648 4,643 1,723 3,921
Net income . . . . . . . . . . . . . . 204 2,243 3,093 1,137 2,480
Basic earnings per common share. . . . 0.02 0.22 0.31 0.11 0.23
Diluted earnings per common share. . . 0.02 0.22 0.31 0.11 0.23
Dividends declared per common share. . - - - - 0.12
SELECTED BALANCE SHEET DATA:
Total assets . . . . . . . . . . . . . 20,255 20,906 20,796 24,318 (1) 19,576
Long-term debt and
capital lease obligations . . . . 7,310 7,960 9,676 15,227 11,161
(1) Total assets in 2002 include a prior period adjustment of $296,000 to
properly reflect deferred tax asset and liability balances. See Note A to the
consolidated financial statements for further discussion.
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 Annual Report on Form 10-K and may contain
certain 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 Annual Report on Form 10-K, are set forth above
under Item 1 and 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 Annual Report on
Form 10-K 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.
FISCAL 2005 COMPARED TO FISCAL 2004
OVERVIEW
We are a franchisor and food and supply distributor to a system of
restaurants operating under the trademark "Pizza Inn". At June 26, 2005, there
were 398 Pizza Inn restaurants, consisting of two Company-owned restaurants and
396 franchised restaurants. At June 26, 2005, domestic restaurants were
operated as: (i) 199 buffet restaurants that offer dine-in, carry-out and, in
many cases, delivery services; (ii) 52 restaurants that offer delivery/carry-out
services only; and (iii) 73 express restaurants that are typically located
within a convenience store, college campus building, airport terminal or other
commercial facility and offer quick carry-out service from a limited menu. The
324 domestic restaurants were located in 18 states predominately situated in the
southern half of the United States. Additionally, we had 74 international
restaurants located in nine foreign countries.
Diluted earnings per share decreased 91% to $0.02 from $0.22 in the prior
year. Net income decreased 91% to $204,000 from $2,243,000 in the prior year,
on revenues of $55,269,000 in the current year and $59,988,000 in the prior
year. Pre-tax income decreased 90% to $359,000 from $3,648,000. The decrease
in net income is the result of lower food and supply sales created by lower
restaurant sales combined with product cost inflation not passed on to the
franchisees and planned reductions in prices on products sold to franchisees.
The retention in cost inflation and the reduction in some pricing was designed
to improve the store level economics and strengthen the system. In addition,
legal fees increased $1,454,000, which included the prior-year reversal of
$567,000 in legal reserves relating to the settlement of a previously resolved
legal matter and for on going litigation and related matters.
Results of operations for fiscal 2005 and 2004 both include fifty-two weeks.
REVENUES
Our revenues are primarily derived from sales of food, paper products and
equipment and supplies by Norco to franchisees, franchise royalties, franchise
fees and 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 product 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 is 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 materials and other distribution revenues. Food and supply sales
decreased 7%, or $3,911,000, to $49,161,000 from $53,072,000 compared to the
comparable period last year. The decrease is partially due to lower sales
prices, reduced to improve the store level economics, on certain key
ingredients, including dough products and tomato tidbits, which negatively
impacted revenues by approximately $997,000. Cheese product sales were
approximately $799,000 lower than the comparable period in the prior year due to
the lower retail sales and were partially offset by higher overall cheese
prices. Also contributing to the revenue decrease for the year was lower
equipment sales of approximately $758,000 due to fewer store openings.
Additionally, a decline of 2.6% in overall chainwide retail sales negatively
impacted non-cheese, dough and tidbit sales by approximately $737,000. The
sale of restaurant-level marketing materials to franchisees decreased $624,000.
FRANCHISE REVENUE
Franchise revenue, which includes income from royalties, license fees and
area development and foreign master license sales, decreased 4% or $238,000
compared to the comparable period last year primarily due to higher
international royalties for the comparable period in the previous year as a
result of the collection of international royalties previously deemed
uncollectible. Additionally, domestic franchise fees were lower compared to the
comparable period last year due to fewer store openings. The following chart
summarizes the major components of franchise revenue (in thousands):
Twelve Months Ended
------------------
June 26, June 27,
2005 2004
-------------------- ---------
Domestic royalties . . . . . . . . . . . . . . . $ 4,624 $ 4,557
International royalties. . . . . . . . . . . . . 365 380
Collection of international royalties previously
deemed uncollectible . . . . . . . . . . . . . - 173
Domestic franchise fees. . . . . . . . . . . . . 173 278
International development fees . . . . . . . . . - 12
-------------------- ---------
Franchise revenue. . . . . . . . . . . . . . . . $ 5,162 $ 5,400
==================== =========
RESTAURANT SALES
Restaurant sales, which consist of revenue generated by Company-owned
stores, decreased 38% or $570,000 compared to the comparable period of the prior
year. The decrease is the result of the sale of one buffet restaurant, which
was replaced by a smaller, lower sales volume delivery/carry-out restaurant, and
lower comparable sales at the other Company-owned buffet restaurant. The
following chart details the revenues at the respective Company-owned restaurants
(in thousands):
Twelve Months Ended
--------------------
June 26, June 27,
2005 2004
-------------------- ---------
Buffet restaurant . . . . . . . . . . . . . . . . . $ 574 $ 647
Buffet restaurant - sold February 2004. . . . . . . - 616
Delivery/carry-out restaurant - opened January 2004 372 253
-------------------- ---------
Restaurant sales. . . . . . . . . . . . . . . . . . $ 946 $ 1,516
==================== =========
COSTS AND EXPENSES
COST OF SALES
Cost of sales decreased 5% or $2,409,000 compared to the comparable period
in the prior year. This decrease is the result of lower chainwide retail sales
and lower payroll costs as a result of earlier staff reductions. Cost of sales,
as a percentage of food and supply sales and restaurant sales, increased to 93%
from 90% for the comparable period last year. This percentage increase is
primarily due to higher product costs of approximately 3.3% offset partially by
payroll savings of $1,001,000 resulting from earlier staff reductions. Although
the Company does not currently intend to raise prices to compensate for the
increases in product costs referenced, in part, because we do not believe that
we would be able to successfully do so as a result of the competitive
environment in which we operate, it may become necessary to increase prices in
the future. The Company experiences fluctuations in commodity prices (most
notably, block cheese prices), increases in transportation costs (particularly
in the price of diesel fuel), fluctuations in interest rates 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 year 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
(primarily wages and travel expenses) directly related to the sale and
continuing service of franchises and Territories. These expenses decreased 12%
or $384,000 compared to the comparable period last year. This decrease is
primarily the result of lower payroll and related expenses resulting from
earlier staff reductions and are partially offset by higher product research
expenses.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased 31% or $1,127,000 compared to
the comparable period last year. The following chart summarizes the primary
variances in general and administrative expenses (in thousands):
Twelve Months Ended
--------------------
June 26, June 27,
2005 2004
-------------------- ----------
Legal fees. . . . . . . . . . . $ 1,257 $ (197)
Payroll . . . . . . . . . . . . 758 1,122
Consulting fees . . . . . . . . 126 33
Other . . . . . . . . . . . . . 113 -
Proxy solicitation. . . . . . . 69 238
-------------------- ----------
Primary variances in general
and administrative expenses $ 2,323 $ 1,196
==================== ==========
Legal fees in the prior year included the reversal of $567,000 in legal
reserves relating to the settlement of a previously resolved legal matter. In
addition, the current year includes legal expenses related to ongoing litigation
and related matters described previously. The Company anticipates a higher level
of legal expenses from the ongoing litigation and related matters described
previously, until all such matters are resolved. The higher legal fees in the
current year were partially offset by proxy solicitation expenses in the prior
year of $190,000 and lower payroll and related expenses from earlier staff
reductions.
INTEREST EXPENSE
Interest expense decreased 4% or $23,000 for the period ended June 26,
2005, compared to the comparable period of the prior year due to lower debt
balances offset by higher interest rates.
PROVISION FOR INCOME TAX
Provision for income taxes decreased 89% or $1,250,000 compared to the
comparable period in the prior year due to lower income in the current year.
The effective tax rate was 43% compared to 39% in the previous year. The change
in the effective tax rate is primarily due to the effect of permanent
differences on lower net income in the current year as compared to the prior
year.
RESTAURANT OPENINGS AND CLOSINGS
During fiscal 2005 a total of 29 new Pizza Inn franchise restaurants
opened, including 22 domestic and 7 international. Domestically, 36 restaurants
were closed by franchisees or terminated by the Company, typically because of
unsatisfactory standards of operation or performance. No 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 units that were closed during fiscal 2005 and (ii) these closed units were
lower volume units whose financial impact on our business as a whole was
immaterial. For those units that are anticipated to close or 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 store activity for the periods
ended June 26, 2005 compared to the comparable period in the prior year:
Twelve months ending June 26, 2005
Beginning Concept End of
of Period Opened Closed Change Period
--------- ------- ------ ------- ------
Buffet . . . . . . . . . . . . . . 212 8 18 (3) 199
Delivery/carry-out . . . . . . . . 53 6 8 1 52
Express. . . . . . . . . . . . . . 73 8 10 2 73
International. . . . . . . . . . . 67 7 - - 74
--------- ------- ------ ------- ------
Total. . . . . . . . . . . . . . . 405 29 36 - 398
========= ======= ====== ======= ======
Twelve months ending June 27, 2004
Beginning Concept End of
of Period Opened Closed Change Period
--------- ------- ------ ------- ------
Buffet . . . . . . . . . . . . . . 220 12 20 - 212
Delivery/carry-out . . . . . . . . 56 4 8 1 53
Express. . . . . . . . . . . . . . 75 10 11 (1) 73
International. . . . . . . . . . . 59 8 - - 67
--------- ------- ------ ------- ------
Total. . . . . . . . . . . . . . . 410 34 39 - 405
========= ======= ====== ======= ======
FISCAL 2004 COMPARED TO FISCAL 2003
OVERVIEW
Diluted earnings per share decreased 29% to $0.22 from $0.31 in the prior
year. Net income decreased 27% to $2,243,000 from $3,093,000 in the prior year,
on revenues of $59,988,000 in the current year and $58,471,000 in the prior
year. Pre-tax income decreased 21% to $3,648,000 from $4,643,000. The decrease
in net income was primarily attributable to the reversal of a pretax charge in
the prior year of approximately $1.9 million, which was originally recorded in
June 2002, to reserve for a note receivable owed to the Company from C. Jeffrey
Rogers, the Company's former Chief Executive Officer. The Company received
payment in full for the note receivable in December 2002. See "Transactions
with Related Parties."
Results of operations for fiscal 2004 and 2003 both include fifty-two
weeks.
REVENUES
FOOD AND SUPPLY SALES
Food and supply sales by Norco include food and paper products, equipment,
marketing materials and other distribution revenues. Total food and supply
sales increased 3% to $53,072,000 from $51,556,000 in the prior year due
primarily to higher cheese prices.
FRANCHISE REVENUE
Franchise revenue, which includes royalties, license fees and income from
area development and foreign master license (collectively, "Territory") sales,
increased 5% or $265,000 in fiscal 2004 primarily due to higher international
royalties, including the collection of previously unrecorded past due royalties
which were offset by lower international development fees.
RESTAURANT SALES
Restaurant sales, which consist of revenue generated by Company-operated stores,
decreased 15% or $264,000 compared to the same period of the prior year. The
Company opened a new delivery/carry-out restaurant on January 9, 2004. The
Company also sold an existing buffet restaurant effective March 1, 2004. The
year-to-date decrease is primarily the result of lower comparable sales.
COSTS AND EXPENSES
COST OF SALES
Cost of sales increased 4% to $49,194,000 from $47,420,000 in the prior
year. The increase in cost of sales is primarily the result of higher cheese
prices. Block cheese prices averaged $1.61 per pound in fiscal 2004 vs. $1.13
per pound in fiscal 2003. This increase in cheese cost was partially offset by
lower depreciation and amortization expenses and lower transportation costs. As
a percentage of sales, cost of sales increased to 90.1% from 88.9% compared to
the prior year.
FRANCHISE EXPENSES
Franchise expenses include selling, general and administrative expenses
(primarily wages and travel expenses) directly related to the sale and service
of franchises and Territories. These expenses decreased 2.5% or $81,000
compared to last year primarily due to a departmental restructuring offset by
added amortization costs from the reacquisition of area development rights for
certain counties in Kentucky and Tennessee.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased 13.7% or $571,000 in fiscal
2004. This is primarily the result of lower legal fees due to settlement of
litigation for less than the previously accrued amount and lower amortization of
a leasehold property and computer system implementation. These savings were
partially offset by higher proxy solicitation expenses.
INTEREST EXPENSE
Interest expense decreased 22% or $176,000 in the current year due to lower
average interest rates and debt levels in the current year.
PROVISION FOR INCOME TAX
Provision for income taxes decreased 9% or $145,000 due to a decrease in
income as mentioned above. The effective tax rate was 39% compared to 33% in
the prior year. The increase in the effective tax rate is primarily due to a
provision made for state income tax and an increase in permanent differences.
RESTAURANT OPENINGS AND CLOSINGS
During fiscal 2004 a total of 34 new Pizza Inn franchise restaurants
opened, including 26 domestic and 8 international restaurants. Domestically, 39
restaurants were closed by franchisees or terminated by the Company typically
because of unsatisfactory standards of operation or performance. No
international restaurants were closed.
Twelve months ending June 27, 2004
Beginning Concept End of
of Period Opened Closed Change Period
--------- ------- ------ ------- ------
Buffet . . . . . . . . . . . . . . 220 12 20 - 212
Delco. . . . . . . . . . . . . . . 56 4 8 1 53
Express. . . . . . . . . . . . . . 75 10 11 (1) 73
International. . . . . . . . . . . 59 8 - - 67
--------- ------- ------ ------- ------
Total. . . . . . . . . . . . . . . 410 34 39 - 405
========= ======= ====== ======= ======
Twelve months ending June 29, 2003
Beginning Concept End of
of Period Opened Closed Change Period
--------- ------- ------ ------- ------
Buffet . . . . . . . . . . . . . . 233 5 17 (1) 220
Delco. . . . . . . . . . . . . . . 54 7 8 3 56
Express. . . . . . . . . . . . . . 82 6 11 (2) 75
International. . . . . . . . . . . 60 6 7 - 59
--------- ------- ------ ------- ------
Total. . . . . . . . . . . . . . . 429 24 43 - 410
========= ======= ====== ======= ======
LIQUIDITY AND CAPITAL RESOURCES
Cash flows from operating activities are generally the result of net income
adjusted for deferred taxes, depreciation and amortization and changes in
working capital. In fiscal 2005, the Company generated cash flows of $1,088,000
from operating activities as compared to $3,512,000 in fiscal 2004 and
$4,021,000 in fiscal 2003. Cash provided by operations was primarily used for
capital expenditures and to pay down debt. Reduction in cash flows from
operating activities for the fiscal year ending June 26, 2005 as compared to the
prior year resulted primarily from a decrease in net income of $2,039,000 to
$204,000 at June 26, 2005, from $2,243,000 at June 27, 2004, with the remaining
reduction from normal changes in working capital.
Cash flows from investing activities primarily reflect the Company's capital
expenditure strategy. In fiscal 2005, the Company used cash of $753,000 for
investing activities as compared to $1,299,000 in fiscal 2004 and $470,000 in
fiscal 2003. Cash flow used for investing activities during fiscal 2005
consisted primarily of the capital expenditures relating to land purchased in
Prosper, Texas and the enlargement of the Norco parking lot. In the prior year,
the Company used $682,000 to re-acquire an area development territory and
$655,000 in the prior year primarily used to fund the new delivery/carry-out
restaurant in Little Elm, Texas.
Cash flows from financing activities generally reflect changes in the
Company's net repayments of borrowings during the period, together with treasury
stock purchases and exercise of stock options. Net cash used for financing
activities was $779,000 in fiscal 2005 as compared to cash used for financing
activities of $1,995,000 in fiscal 2004 and cash used for financing activities
of $3,922,000 in fiscal 2003. The Company used cash flow from operations to
decrease its net bank borrowings and capital lease obligations by $649,000 to
$7,727,000 at June 26, 2005 from $8,376,000 at June 27, 2004.
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 $116,000 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's prior net operating loss carryforwards and alternative
minimum tax carryforwards have now been fully utilized and the Company began
making estimated quarterly tax payments in January 2004.
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 amendment
provides, among other terms, for modifications to certain financial covenants,
which would have resulted in an Event of Default had the Company not entered
into the new Revolving Credit Agreement. 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 June 26, 2005 and June 27, 2004, the
variable interest rates were 6.50% and 2.35%, using a Prime and the LIBOR
interest rate basis, respectively. Amounts outstanding under the revolving
credit line as of June 26, 2005 and June 27, 2004 were $966,000 and $1.2
million, respectively. Property, plant and equipment, inventory and accounts
receivable have been pledged for the above referenced loan 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 had an
outstanding balance of $6.7 million at June 26, 2005 and $7.1 million at June
27, 2004. Property, plant and equipment, inventory and accounts receivable have
been pledged for the above referenced loan agreement.
The Company is in arbitration proceedings with Messrs. Parker and Clark and
has filed a lawsuit against the law firm Akin, Gump, Strauss, Hauer and Feld, as
previously described. Although the ultimate outcome of the arbitration and
legal proceedings cannot be projected with certainty at this time, the Company
believes that its claims against Messrs. Parker and Clark and Akin Gump are well
founded and intends to vigorously pursue all relief to which it may be entitled.
An adverse outcome to the proceedings 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 and Mr. Clark for
approximately $6.2 million under the Parker Agreement and the Clark Agreement
plus accrued interest and legal expenses. The Company maintains that it does
not owe Messrs. Parker and Clark severance payments or any other compensation,
but it believes it has the ability to make any payments required by an adverse
determination. No accrual for any amount has been made as of June 26, 2005.
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 Pizza Inn
buffet restaurants from Houston, Texas-area franchises and is currently in the
process of remodeling those restaurants with the objective of reopening and
operating them as Company-owned restaurants. We anticipate opening these
restaurants in October 2005. 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 is expected to range between $965,000 and $1,050,000.
In July 2005 the Company leased approximately 4,100 square feet of space in
a retail development in Dallas, Texas at a rate of approximately $30.00 per
square foot for the operation of a buffet concept. We are currently in the
process of finishing out the space and expect to have the restaurant operating
in October 2005. The lease has a five-year term with multiple renewal options.
The cost of finishing out the space is expected to range between $450,000 and
$500,000.
We also own property in Prosper, Texas that was purchased in August 2004
with the intention of constructing and operating a buffet restaurant. We have
decided not to pursue development at that location and currently have the
property under contract to sell to a third party.
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 June 26, 2005 (in thousands):
Fiscal Year Fiscal Years Fiscal Years After Fiscal
Total 2006 2007- 2008 2009 - 2010 Year 2010
--------- ------- ------------ ------------ ------------
Bank debt (1) . . . . . . . . . . . $ 7,703 $ 406 $ 7,297 $ - $ -
Operating lease obligations . . . . 2,223 947 862 282 132
Employment Agreements . . . . . . . 761 386 375 - -
Capital lease obligations (1) . . . 24 11 13 - -
--------- ------- ------------ ------------ ------------
Total contractual cash obligations. $ 10,711 $ 1,750 $ 8,547 $ 282 $ 132
========== ========= ========== ========== ============
1) Does not include amount representing interest.
TRANSACTIONS WITH RELATED PARTIES
Two directors of the Company are franchisees.
One of the director franchisees currently operates a total of 10
restaurants located in Arkansas. Purchases by this franchisee comprised 6.3%
and 6.0% of the Company's total food and supply sales in fiscal 2005 and fiscal
2004, respectively. Royalties and license fees and area development sales from
this franchisee comprised 3.4% and 3.2% of the Company's total franchise
revenues in fiscal 2005 and fiscal 2004, respectively. As of June 26, 2005 and
June 27, 2004, his accounts and note payable to the Company were $898,000 and
$923,000, respectively. As franchised units, his restaurants pay royalties to
the Company and purchase a majority of their food and supplies from Norco.
The other director franchisee currently operates one restaurant in
Oklahoma. Purchases by this franchisee comprised 0.4% and 0.5% of the Company's
total food and supply sales in fiscal 2005 and fiscal 2004, respectively.
Royalties from this franchisee comprised 0.5% and 0.5% of the Company's total
franchise revenues in fiscal 2005 and fiscal 2004, respectively. As of June 26,
2005 and June 27, 2004, his accounts payable to the Company was $39,000 and
$42,000, respectively. As a franchised unit, his restaurant pays royalties to
the Company and purchases a majority of its food and supplies from the Company's
distribution division.
The Company believes that the above transactions were at the same prices
and on the same payment terms available to non-related parties, with one
exception. This exception relates to the enforcement of the personal guarantee
by a director of the $314,000 debt of a franchise of which he is the President
and sole shareholder. The debt relates to food and equipment purchases and
royalty payments for the franchise during a period when the director had
transferred his interest in the franchise, and prior to his later reacquisition
of the franchise. The director has affirmed his guarantee and confirmed that the
debt will be paid in full.
In October 1999, the Company loaned $1,949,698 to then Chief Executive
Officer C. Jeffery Rogers in the form of a promissory note due in June 2004 to
acquire 700,000 shares of the Company's common stock through the exercise of
vested stock options previously granted to him in 1995 by the Company. The note
bore interest at the same floating interest rate the Company pays on its
revolving credit line with Wells Fargo and was collateralized by a second lien
in certain real property and existing Company stock owned by C. Jeffrey Rogers.
The first lien on both the real property and Company stock pledged by Mr. Rogers
was held by Wells Fargo, Mr. Rogers' primary lender. The Board determined that
doubt existed regarding the collectibility of the note as of June 30, 2002, and
recorded a pre-tax charge of approximately $1.9 million to fully reserve for the
expected non-payment of the debt by Mr. Rogers. In December 2002, the Company's
loan to Mr. Rogers was paid in full. The reserve for the note receivable was
reversed in the quarter ended December 29, 2002.
In October 1999, the Company loaned $557,056 to then Chief Operating
Officer Ronald W. Parker in the form of a promissory note due in June 2004 to
acquire 200,000 shares of the Company's common stock through the exercise of
vested stock options previously granted to him in 1995 by the Company. The note
bore interest at the same floating interest rate the Company pays on its
revolving credit line with Wells Fargo and was collateralized by certain real
property and existing Company stock owned by Ronald W. Parker. The note was
reflected as a reduction to shareholders' equity. As of June 27, 2004, the
note balance was paid in full.
In July 2000, the Company also loaned $302,581 to Ronald W. Parker in the
form of a promissory note due in June 2004, in conjunction with a cash payment
of $260,000 from Mr. Parker, to acquire 200,000 shares of the Company's common
stock through the exercise of vested stock options previously granted in 1995 by
the Company. The note bore interest at the same floating interest rate the
Company pays on its revolving credit line with Wells Fargo and was
collateralized by certain real property and existing Company stock owned by
Ronald W. Parker. The note was reflected as a reduction to shareholders'
equity. As of June 27, 2004, the note balance was paid in full.
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.
Notes receivable primarily consist of notes from franchisees for trade
receivables, franchise fees and equipment purchases. These notes generally have
terms ranging from one to five years and interest rates of 6% to 12%. 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 a 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.
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.
Re-acquired development franchise rights are recorded at lower of cost or
fair value based upon estimated cash flows from existing franchises operating in
the region. When circumstances warrant, the Company assesses the fair value of
these assets based on estimated, undiscounted future cash flows, to determine if
impairment in the value has occurred and an adjustment is necessary. If an
adjustment is required, a discounted cash flow analysis would be performed and
an impairment loss would be recorded.
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 the
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.
NEW PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4" ("SFAS 151"). SFAS 151 clarifies the
accounting for abnormal amounts of idle facility expense, freight, handling
costs and wasted material. Additionally, SFAS 151 requires that allocation of
fixed production overhead to inventory be based on the normal capacity of the
production facilities. The provisions of SFAS 151 are applicable to inventory
costs incurred during fiscal years beginning after June 15, 2005. The adoption
of this statement is not expected to have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
In December 2004, the FASB issued the revised SFAS No. 123 ("SFAS 123R"),
which addresses the accounting for share-based payment transactions in which the
Company obtains employee services in exchange for (a) equity instruments of the
Company or (b) liabilities that are based on the fair value of the Company's
equity instruments or that may be settled by the issuance of such equity
instruments. This statement eliminates the ability to account for employee
share-based payment transactions using APB No. 25 and requires instead that such
transactions be accounted for using the grant-date fair value based method. SFAS
123R is effective for public companies that are not small business issuers as of
the first interim period or fiscal year beginning after June 15, 2005. SFAS
123R will require the Company to record compensation charges for share-based
transactions in the Statement of Operations. The adoption of this statement is
not expected to have a material effect on the Company's consolidated financial
position, results of operations or cash flows.
On December 2004, FASB issued Statement of Financial Accounting Standards
No. 153, "Exchanges of Nonmonetary Assets, an amendment to APB Opinion No. 29"
("SFAS 153"). The Statement eliminates the exception to measure exchanges at
fair value for exchanges of similar productive assets and replaces it with a
general exception for exchange transactions that do not have commercial
substance. SFAS 153 is effective for nonmonetary exchanges in fiscal periods
beginning after June 15, 2005. The adoption of this statement is not expected to
have a material effect on the Company's consolidated financial position, results
of operations or cash flows.
In March 2005, the FASB issued FASB Interpretation ("FIN") No.
47,"Accounting for Conditional Asset Retirement Obligations." FIN No. 47
clarifies the meaning of the term CONDITIONAL ASSET RETIREMENT OBLIGATION as
used in SFAS 143, "Accounting for Asset Retirement Obligations" and clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. This interpretation is effective no
later than the end of fiscal years ending after December 15, 2005 (December 31,
2005 for calendar-year companies). Retrospective application of interim
financial information is permitted but is not required. The adoption of FIN No.
47 is not expected to have a material effect on the Company's consolidated
financial position, results of operations or cash flows.
On May 5, 2005, the FASB issued Statement No. 154, Accounting Changes and
Error Corrections ("SFAS 154"), a replacement of APB Opinion No. 20 and FASB
Statement No. 3. The Statement applies to all voluntary changes in accounting
principles, and changes the requirements for accounting for and reporting of a
change in accounting principle. SFAS 154 requires retrospective application to
prior periods' financial statements of a voluntary change in accounting
principle unless it is impracticable. SFAS 154 requires that a change in method
of depreciation, amortization, or depletion for long-lived, nonfinancial assets
be accounted for as a change in accounting estimate that is effected by a change
in accounting principle. Opinion 20 previously required that such a change be
reported as a change in accounting principle. The requirements of SFAS 154 are
effective for accounting changes made in fiscal years beginning after December
15, 2005. The adoption of this statement is not expected to have a material
effect on the Company's consolidated financial position, results of operations
or cash flows.
RISK FACTORS
Investing in our common stock involves a high degree of risk. You should
carefully consider the following factors, as well as other information contained
in this report, before deciding to invest in shares of our common stock. These
risks could materially adversely affect our business, financial condition or
results of operations. The trading price of our common stock could also be
materially adversely affected by any of these risks.
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 have been in existence for a substantially
longer period than we have and 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 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, and convenience and concept.
We compete within the food service market and the restaurant industry not
only for customers, but also 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.
IF WE ARE NOT ABLE TO IMPLEMENT OUR GROWTH STRATEGY SUCCESSFULLY, WHICH
INCLUDES OPENING NEW DOMESTIC AND INTERNATIONAL RESTAURANTS 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 is opening new domestic and
international franchise stores. We and our franchisees face many challenges in
opening new stores, including, among other things, selection and availability of
suitable restaurant locations and suitable franchisees, 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.
The opening of additional franchise restaurants and our reimaging program also
depends, in part, upon the availability of prospective franchisees who meet our
criteria. Our reimaging program may require considerable management time as
well as start-up expenses for market development before any significant revenues
and earnings are generated.
Accordingly, there can be no assurance that we will be able to meet planned
growth targets, open restaurants in markets now targeted for expansion or
operate in existing markets profitably. 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 SUPPLY OR 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. Shortages or interruptions in the supply
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.
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 in favor of foods
that are perceived as more healthy, our business and operating results would be
harmed. Moreover, because we are primarily dependent on a single product, if
consumer demand for pizza should decrease, our business would suffer more than
if we had a more diversified menu, as many other food service businesses do.
HEALTH CONCERNS OR DISEASE-RELATED DISRUPTIONS ABOUT COMMODITIES THAT WE
USE TO MAKE PIZZA COULD MATERIALLY ADVERSELY AFFECT THE AVAILABILITY AND COST OF
SUCH COMMODITIES.
Health- or disease-related disruptions or consumer concerns about the
commodity supply could materially adversely impact the availability and/or cost
of such commodities, thereby materially adversely impacting restaurant
operations and our financial results.
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.
A significant number of hourly personnel employed by our franchisees and by us
are paid at rates related to the federal minimum wage. Accordingly, further
increases in the federal minimum wage or the enactment of additional state or
local wage proposals may increase labor costs for our systemwide operations.
Additionally, labor shortages in various markets could result in higher required
wage rates.
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. Additionally,
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.
IF WE ARE NOT ABLE TO CONTINUE TO PURCHASE 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. Our domestic restaurants
purchase substantially all food and related products from our distribution
division. Accordingly, both our Company-operated and franchised restaurants
could be harmed by any prolonged disruption in the supply of products from
Norco. Additionally, 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 could adversely affect the
financial results of our distribution operation.
OUR INTERNATIONAL AND DOMESTIC OPERATIONS COULD BE MATERIALLY ADVERSELY
AFFECTED BY SIGNIFICANT CHANGES IN INTERNATIONAL, REGIONAL, AND LOCAL ECONOMIC
AND POLITICAL CONDITIONS.
Our international and domestic operations are subject to many factors,
including currency regulations and fluctuations, culture and consumer
preferences, diverse government regulations and structures, availability and the
cost of land and construction, ability to source ingredients and other
commodities in a cost-effective manner and differing interpretation of the
obligations established in franchise agreements with international franchisees.
Accordingly, there can be no assurance that our operations will achieve or
maintain profitability or meet planned growth rates.
EACH OF THE FOREGOING RISK FACTORS THAT COULD AFFECT RESTAURANT SALES OR
COSTS COULD DISPROPORTIONATELY AFFECT THE FINANCIAL VIABILITY OF NEWLY OPENED
RESTAURANTS AND FRANCHISEES IN UNDER-PENETRATED OR EMERGING MARKETS AND,
CONSEQUENTLY, OUR OVERALL RESULTS OF OPERATIONS.
A decline in or failure to improve financial performance for this group of
restaurants or franchisees could lead to an inability to successfully recruit
new franchisees and open new restaurants and lead to restaurant closings at
greater than anticipated levels and therefore impact contributions to marketing
funds, our royalty stream, our distribution operations and support services
efficiencies and other system-wide results of operations.
WE 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.
For example, an adverse outcome to the proceedings involving Ronald W.
Parker, the Company's former Chief Executive Officer, and B. Keith Clark, the
Company's former Senior Vice President and General Counsel, 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 and for approximately $775,000 under
Mr. Clark's employment agreement plus accrued interest and legal expenses. No
accrual for any amount has been made as of June 26, 2005. See the discussion
under "Legal Proceedings" in this report.
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, and their
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 store personnel. If they do not, our image and reputation may suffer, and
revenues could decline. While we try to ensure that our franchisees maintain
the quality of our brand and branded products, 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 operate our restaurants, distribution centers and international
operations. The loss of these employees or our 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, AND INSURANCE PREMIUMS
FOR SUCH COVERAGE 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.
OUR ANNUAL AND QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT
FLUCTUATIONS DEPENDING ON VARIOUS FACTORS, MANY OF WHICH ARE BEYOND OUR CONTROL,
AND IF WE FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS, OUR
SHARE PRICE MAY DECLINE SIGNIFICANTLY.
Our sales and operating results can vary significantly from quarter to
quarter and year to year depending on various factors, many of which are beyond
our control. These factors include variations in the timing and volume of our
sales and our franchisees' sales; the timing of expenditures in anticipation of
future sales; sales promotions by us and our competitors; changes in competitive
and economic conditions generally; and changes in the cost or availability of
our ingredients (including cheese), fuel or labor. As a result, our results of
operations may decline quickly and significantly in response to changes in order
patterns or rapid decreases in demand for our products. We anticipate that
fluctuations in operating results will continue in the future.
ITEM 7A - 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.
As of June 26, 2005, the Company had approximately $7.7 million of variable
rate debt obligations outstanding with a weighted average interest rate of 4.69%
for the year ending June 26, 2005. A hypothetical 10% change in the effective
interest rate for these borrowings, assuming debt levels at June 26, 2005, would
change interest expense by approximately $31,000.
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. 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 June 26, 2005, 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 exposed to market risks from changes in commodity prices.
During the normal course of business, the Company purchases cheese and certain
other food products that are affected by changes in commodity prices and, as a
result, the Company is subject to volatility in our food sales and cost of
sales. Management actively monitors this exposure, however, we do not enter
into financial instruments to hedge commodity prices. The block price per pound
of cheese averaged $1.56 in fiscal 2005. The estimated change in sales from a
hypothetical $0.20 change in the average cheese block price per pound would have
been approximately $1.3 million in fiscal 2005.
PIZZA INN, INC.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Schedule:
FINANCIAL STATEMENTS PAGE NO.
Report of Independent Registered Public Accounting Firm. 32
Report of Independent Registered Public Accounting Firm. 33
Consolidated Statements of Operations for the years ended
June 26, 2005, June 27, 2004, and June 29, 2003. 34
Consolidated Statements of Comprehensive Income for the years ended
June 26, 2005, June 27, 2004, and June 29, 2003. 34
Consolidated Balance Sheets at June 26, 2005 and June 27, 2004. 35
Consolidated Statements of Shareholders' Equity for the years
ended June 26, 2005, June 27, 2004, and June 29, 2003. 36
Consolidated Statements of Cash Flows for the years ended June 26, 2005,
June 27, 2004, and June 29, 2003. 37
Notes to Consolidated Financial Statements. 39
FINANCIAL STATEMENT SCHEDULE
Schedule II - Consolidated Valuation and Qualifying Accounts 57
All other schedules are omitted because they are not applicable, not
required or because the required information is included in the
consolidated financial statements or notes thereto.
SIGNATURES 62
REPORT OF REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Pizza Inn, Inc.
We have audited the accompanying consolidated balance sheets of Pizza Inn, Inc.
as of June 26, 2005 and June 27, 2004 and the related consolidated statements of
operations and comprehensive income, stockholders' equity, and cash flows for
the years then ended. We have also audited the schedule listed in the
accompanying index for the years ended June 26, 2005 and June 27, 2004. These
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan and perform the audits to obtain reasonable assurance about whether the
financial statements and schedule are free of material misstatement. An audit
includes consideration of internal control over financial reporting as a basis
for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the
Company's internal controls over financial reporting. Accordingly, we express
no such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements and schedule,
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall presentation of the financial
statements and schedule. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Pizza Inn, Inc. at
June 26, 2005 and June 27, 2004, and the results of its operations and its cash
flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America.
Also, in our opinion, the schedule for the years ended June 26, 2005 and June
27, 2004 presents fairly, in all material respects, the information set forth
therein.
/s/ BDO Seidman, LLP
Dallas, TX
August 16, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
and Shareholders of Pizza Inn, Inc.
In our opinion, the consolidated financial statements listed in the accompanying
index, after the restatement described in Note A, present fairly, in all
material respects, the results of operations and cash flows of Pizza Inn, Inc.
and its subsidiaries for the year ended June 29, 2003 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audit. We conducted our audit of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
As described in Note A to the consolidated financial statements, the Company has
restated its financial statements as of June 30, 2002 to adjust beginning
retained earnings and deferred tax assets.
/s/ PRICEWATERHOUSECOOPERS LLP
Dallas, Texas
September 25, 2003
PIZZA INN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED
----------------------------------------------------------------
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
-------------------- ---------------------- --------------------
REVENUES:
Food and supply sales . . . . . . . . . . . . . . . . . $ 49,161 $ 53,072 $ 51,556
Franchise revenue . . . . . . . . . . . . . . . . . . . 5,162 5,400 5,135
Restaurant sales. . . . . . . . . . . . . . . . . . . . 946 1,516 1,780
-------------------- ---------------------- --------------------
55,269 59,988 58,471
-------------------- ---------------------- --------------------
COSTS AND EXPENSES:
Cost of sales . . . . . . . . . . . . . . . . . . . . . 46,785 49,194 47,420
Franchise expenses. . . . . . . . . . . . . . . . . . . 2,791 3,175 3,256
General and administrative expenses . . . . . . . . . . 4,714 3,587 4,158
Provision for (recovery of) bad debt (see Note J) . . . 30 (229) (1,795)
Interest expense. . . . . . . . . . . . . . . . . . . . 590 613 789
-------------------- ---------------------- --------------------
54,910 56,340 53,828
-------------------- ---------------------- --------------------
INCOME BEFORE INCOME TAXES. . . . . . . . . . . . . . . . 359 3,648 4,643
Provision for income taxes. . . . . . . . . . . . . . . 155 1,405 1,550
-------------------- ---------------------- --------------------
NET INCOME. . . . . . . . . . . . . . . . . . . . . . . . $ 204 $ 2,243 $ 3,093
==================== ====================== ====================
BASIC EARNINGS PER COMMON SHARE . . . . . . . . . . . . . $ 0.02 0.22 $ 0.31
==================== ====================== ====================
DILUTED EARNINGS PER COMMON SHARE . . . . . . . . . . . . $ 0.02 0.22 $ 0.31
==================== ====================== ====================
WEIGHTED AVERAGE COMMON SHARES. . . . . . . . . . . . . . 10,105 10,076 10,058
==================== ====================== ====================
WEIGHTED AVERAGE COMMON AND
POTENTIALLY DILUTIVE COMMON SHARES. . . . . . . . . . . 10,142 10,117 10,061
==================== ====================== ====================
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
YEAR ENDED
----------------------------------------------------------------
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
-------------------- ---------------------- --------------------
Net Income. . . . . . . . . . . . . . . . . . . . . . $ 204 $ 2,243 $ 3,093
Interest rate swap gain (loss) (net of tax (expense)
benefit of ($59), ($179), and $168, respectively) 115 348 (326)
-------------------- ---------------------- --------------------
Comprehensive Income. . . . . . . . . . . . . . . . . $ 319 $ 2,591 $ 2,767
==================== ====================== ====================
See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
JUNE 26, JUNE 27,
ASSETS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2005 2004
--------------------- ---------------------
CURRENT ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . $ 173 $ 617
Accounts receivable, less allowance for doubtful
accounts of $360 and $310, respectively . . . . . . . . . . . 3,419 3,113
Accounts receivable - related parties . . . . . . . . . . . . . . 622 577
Notes receivable, current portion, less allowance
for doubtful accounts of $11 and $59, respectively. . . . . . - 50
Notes receivable - related parties. . . . . . . . . . . . . . . . - 54
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,918 1,713
Property held for resale. . . . . . . . . . . . . . . . . . . . . 301 -
Deferred tax assets, net. . . . . . . . . . . . . . . . . . . . . 193 183
Prepaid expenses and other. . . . . . . . . . . . . . . . . . . . 355 415
--------------------- ---------------------
Total current assets. . . . . . . . . . . . . . . . . . . . . 6,981 6,722
LONG-TERM ASSETS
Property, plant and equipment, net. . . . . . . . . . . . . . . . 12,148 12,756
Property under capital leases, net. . . . . . . . . . . . . . . . 12 18
Deferred tax assets, net. . . . . . . . . . . . . . . . . . . . . - 105
Long-term notes receivable, less allowance
for doubtful accounts of $0 and $3, respectively. . . . . . . - -
Long-term receivable - related party . . . . . . . . . . . . . . 314 335
Re-acquired development territory, net. . . . . . . . . . . . . . 623 866
Deposits and other. . . . . . . . . . . . . . . . . . . . . . . . 177 104
--------------------- ---------------------
$ 20,255 $ 20,906
===================== =====================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable - trade. . . . . . . . . . . . . . . . . . . . . $ 1,962 $ 1,246
Accrued expenses. . . . . . . . . . . . . . . . . . . . . . . . . 1,374 2,109
Current portion of long-term debt . . . . . . . . . . . . . . . . 406 406
Current portion of capital lease obligations. . . . . . . . . . . 11 10
--------------------- ---------------------
Total current liabilities . . . . . . . . . . . . . . . . . . 3,753 3,771
LONG-TERM LIABILITIES
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . . . . 7,297 7,937
Long-term capital lease obligations . . . . . . . . . . . . . . . 13 23
Deferred tax liability, net . . . . . . . . . . . . . . . . . . . 3 -
Other long-term liabilities . . . . . . . . . . . . . . . . . . . 283 458
--------------------- ---------------------
11,349 12,189
--------------------- ---------------------
COMMITMENTS AND CONTINGENCIES (See Notes D and I)
SHAREHOLDERS' EQUITY
Common Stock, $.01 par value; authorized 26,000,000
shares; issued 15,046,319 and 15,031,319 shares, respectively;
outstanding 10,094,494 and 10,133,674 shares, respectively. . . 150 150
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . 8,005 7,975
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . 20,582 20,378
Accumulated other comprehensive loss. . . . . . . . . . . . . . . (187) (302)
Treasury stock at cost
Shares in treasury: 4,951,825 and 4,897,645, respectively . . . (19,644) (19,484)
--------------------- ---------------------
Total shareholders' equity. . . . . . . . . . . . . . . . . . 8,906 8,717
--------------------- ---------------------
$ 20,255 $ 20,906
===================== =====================
See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
ACCUM.
OTHER
COMP. TREASURY
COMMON STOCK PAID-IN LOANS TO RETAINED (LOSS) STOCK
-------------
SHARES AMOUNT CAPITAL OFFICERS EARNINGS GAIN AT COST Total
-------- ------- ------- --------- ---------- --------- ------ ------
BALANCE, JUNE 30, 2002,. . . . 10,058 $ 150 $ 7,824 $ (575) $ 15,042 $ (324) $(19,484) $ 2,633
-------- ------- ------- --------- ---------- --------- ------ ------
as restated
Employee incentive shares.. 1 - 1 - - - - 1
Principal repayment of loans
by officers. . . . . . . - - - 1,756 - - - 1,756
Reversal of allowance for
doubtful accounts. . . . - - - (1,750) - - - (1,750)
Interest rate swap loss
(net of tax benefit of $168) - - - - - (326) - (326)
Net income . . . . . . . . . . . - - - - 3,093 - - 3,093
-------- ------- ------- --------- ---------- --------- ------ ------
BALANCE, JUNE 29, 2003 . . . . 10,059 $ 150 $ 7,825 $ (569) $ 18,135 $ (650) $(19,484)$5,407
-------- ------- ------- --------- ---------- --------- ------ ------
Employee incentive shares. . 75 - 150 - - - - 150
Principal repayment of loans
by officers . . . . . . - - - 569 - - - 569
Interest rate swap gain
(net of tax expense of $179) - - - - - 348 - 348
Net income . . . . . . . . . . . - - - - 2,243 - - 2,243
-------- ------- ------- --------- ---------- --------- ------ ------
BALANCE, JUNE 27, 2004 . . . 10,134 $ 150 $ 7,975 $ - $ 20,378 $ (302) $(19,484) $8,717
-------- ------- ------- --------- ---------- --------- ------ ------
Employee incentive shares . . 15 - 30 - - - - 30
Stock repurchase
(54,180 shares) . . . . . (54) - - - - - (160) (160)
Interest rate swap gain
(net of tax expense of $59) - - - - - 115 - 115
Net income . . . . . . . . . . . - - - - 204 - - 204
-------- ------- ------- --------- ---------- --------- ------ -- ---
BALANCE, JUNE 26, 2005 .. . . . 10,095 $ 150 $ 8,005 $ - $ 20,582 $ (187) $(19,644) $8,906
======== ======== ======== ========== ========== ======= ========= =====
See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED
-----------------------
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
----------------------- ----------------------- -----------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . $ 204 $ 2,243 $ 3,093
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization. . . . . . . . . 1,143 1,133 1,403
Non cash settlement of accounts receivable . . - (281) -
Provision for (recovery of) bad debt, net. . . 30 (229) (1,795)
Deferred income taxes. . . . . . . . . . . . . 39 500 1,381
Changes in assets and liabilities:
Notes and accounts receivable. . . . . . . . . (256) (270) 204
Inventories. . . . . . . . . . . . . . . . . . (205) (202) 15
Accounts payable - trade . . . . . . . . . . . 716 29 (310)
Accrued expenses . . . . . . . . . . . . . . . (711) 163 (527)
Deferred franchise revenue . . . . . . . . . . (24) (4) (52)
Prepaid expenses and other . . . . . . . . . . 152 430 609
----------------------- ----------------------- -----------------------
CASH PROVIDED BY OPERATING ACTIVITIES. . . . . 1,088 3,512 4,021
----------------------- ----------------------- -----------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets . . . . . . . . . . - 38 6
Capital expenditures . . . . . . . . . . . . . . (753) (655) (476)
Re-acquisition of area development territory . . - (682) -
----------------------- ----------------------- -----------------------
CASH USED IN INVESTING ACTIVITIES. . . . . . . (753) (1,299) (470)
----------------------- ----------------------- -----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term bank debt and
capital lease obligations. . . . . . . . . . . (415) (1,534) (1,337)
Borrowings of long-term debt . . . . . . . . . . - - 500
Line of credit, net. . . . . . . . . . . . . . . (234) (1,300) (5,042)
Proceeds from exercise of stock options. . . . . 30 150 -
Officer loan payment . . . . . . . . . . . . . . - 689 1,957
Purchases of treasury stock. . . . . . . . . . . (160) - -
----------------------- ----------------------- -----------------------
CASH USED IN FINANCING ACTIVITIES. . . . . . . (779) (1,995) (3,922)
----------------------- ----------------------- -----------------------
Net increase (decrease) in cash and cash equivalents (444) 218 (371)
Cash and cash equivalents, beginning of period . . . 617 399 770
----------------------- ----------------------- -----------------------
Cash and cash equivalents, end of period . . . . . . 173 617 399
======================= ======================= =========================
See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC.
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
(IN THOUSANDS)
YEAR ENDED
-----------
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
----------- --------- ---------
CASH PAYMENTS FOR:
Interest. . . . . . . . . . . $ 589 $ 624 $ 810
Income taxes. . . . . . . . . 633 635 -
See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
DESCRIPTION OF BUSINESS:
Pizza Inn, Inc. (the "Company"), a Missouri corporation incorporated in
1983, is the successor to a Texas company of the same name, which was
incorporated in 1961. The Company is the franchisor and food and supply
distributor to a system of restaurants operating under the trademark "Pizza
Inn."
On June 26, 2005 the Pizza Inn system consisted of 398 locations, including
two Company-operated restaurants and 396 franchised restaurants. On June 26,
2005 the Company had franchises in 18 states and nine foreign countries.
Domestic restaurants are located predominantly in the southern half of the
United States, with Texas, North Carolina and Arkansas accounting for
approximately 35%, 15%, and 8%, respectively, of the total. Norco Restaurant
Services ("Norco"), a division of the Company, distributes food products,
equipment and other supplies to restaurants in the United States and, to the
extent feasible, in other countries.
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All appropriate inter-company balances and
transactions have been eliminated. Certain prior year amounts have been
reclassified to conform with current year presentation.
CASH AND CASH EQUIVALENTS:
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
INVENTORIES:
Inventories, which consist 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. Provision is made for obsolete
inventories.
PROPERTY HELD FOR RESALE:
Assets that are to be disposed of by sale are recognized in the financial
statements at the lower of carrying amount or fair value, less cost to sell, and
are not depreciated after being classified as held for sale. In order for an
asset to be classified as held for sale, the asset must be actively marketed, be
available for immediate sale and meet certain other specified criteria.
PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment, including property under capital leases, are
stated at cost less accumulated depreciation and amortization. Repairs and
maintenance are charged to operations as incurred; major renewals and
betterments are capitalized. Internal and external costs incurred to develop or
purchase internal-use computer software during the application development
stage, including upgrades and enhancements, are capitalized. Upon the sale or
disposition of a fixed asset, the asset and the related accumulation
depreciation or amortization are removed from the accounts and the gain or loss
is included in operations. The Company capitalizes interest on borrowings
during the active construction period of major capital projects. Capitalized
interest is added to the cost of the underlying asset and amortized over the
useful life of the asset.
Depreciation and amortization is computed on the straight-line method over
the useful lives of the assets or, in the case of leasehold improvements, over
the term of the lease including any reasonably assured renewal periods, if
shorter. The useful lives of the assets range from three to thirty-nine years.
It is the Company's policy to periodically review the net realizable value of
its long-lived assets when certain indicators exist through an assessment of the
estimated gross future cash flows related to such assets. In the event that
assets are found to be carried at amounts that are in excess of estimated gross
future cash flows then the assets will be adjusted for impairment to a level
commensurate with a discounted cash flow analysis of the underlying assets. The
Company believes no impairment of long-lived assets exists at June 26, 2005.
ACCOUNTS RECEIVABLE:
Accounts receivable consist primarily of receivables from food and supply
sales 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, customer credit
worthiness and current economic trends. After all attempts to collect a
receivable have failed, the receivable is written off against the allowance.
NOTES RECEIVABLE:
Notes receivable primarily consist of notes from franchisees for the
purchase of area development and master license territories and the refinancing
of existing trade receivables. These notes generally have terms ranging from
one to five years, with interest rates of 6% to 12%. 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, customer creditworthiness and current economic trends. After all
attempts to collect a receivable have failed, the receivable is written off
against the allowance.
RE-ACQUIRED DEVELOPMENT TERRITORY:
Re-acquired development franchise rights are recorded at lower of cost or
fair value based upon estimated cash flows from existing franchises operating in
the region. When circumstances warrant, the Company assesses the fair value of
these assets based on estimated, undiscounted future cash flows, to determine if
impairment in the value has occurred and an adjustment is necessary. If an
adjustment is required, a discounted cash flow analysis would be performed and
an impairment loss would be recorded.
The Company has one re-acquired territory at June 26, 2005. The territory
was re-acquired in December 2003, and is being amortized against incremental
cash flows received, which is estimated to be approximately five years. The
following chart summarizes the amortization expense for fiscal year ending June
26, 2005 and June 27, 2004 and the estimated amortization to be expensed in
fiscal year 2006 through 2009.
Re-Acquired Territory
Fiscal Year End Net Book
Amortization Accumulated Amortization Value
--------------------- ------------------------ -----
December 2003 . . . . . . . $ 962
For the Fiscal Year Ending
2004 (Actual) . . . . . . . $ 96 $ 96 866
2005 (Actual) . . . . . . . 192 288 674
2006 (Estimate) . . . . . . 192 480 482
2007 (Estimate) . . . . . . 192 672 290
2008 (Estimate) . . . . . . 192 864 98
2009 (Estimate) . . . . . . 98 962 $ -
INCOME TAXES:
Income taxes are accounted for using the asset and liability method
pursuant to Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes" ("SFAS 109"). Deferred taxes are recognized for the tax
consequences of "temporary differences" by applying enacted statutory tax rates
applicable to future years to differences between the financial statement and
carrying amounts and the tax bases of existing assets and liabilities. The
effect on deferred taxes for a change in tax rates is recognized in income in
the period that includes the enactment date. The Company recognizes future tax
benefits to the extent that realization of such benefits is more likely than
not.
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 impacted by changes in future taxable income and the results of tax
strategies.
During the fourth quarter of fiscal 2003, the Company determined that a prior
period adjustment was required to properly state its deferred tax asset and
liability balances. The Company identified approximately $296,000 in
adjustments to these balances, primarily relating to temporary differences for
fixed assets and the allowance for doubtful accounts, which related to fiscal
years ended 1997 and earlier. These adjustments are summarized as follows (in
thousands):
AS PRESENTED ADJUSTMENT RESTATED
------------- ------------ ---------
JUNE 30, 2002:
Deferred taxes, net - current asset . . $ 1,297 $ 10 $ 1,307
Deferred taxes, net - non-current asset 1,347 (306) 1,041
Total assets. . . . . . . . . . . . . . 24,614 (296) 24,318
Total shareholders' equity. . . . . . . 2,929 (296) 2,633
JUNE 25, 2000:
Beginning retained earnings . . . . . . 13,163 (296) 12,867
REVENUE RECOGNITION:
The Company's Norco division sells food, supplies and equipment to
franchisees on trade accounts under terms common in the industry. Revenue from
such sales is recognized upon shipment. Title and risk of loss for products we
sell transfer upon delivery. Revenue has been historically recognized upon
shipment, which approximates the results of recognition upon delivery to within
an insignificant degree. This occurs because the product shipment and delivery
cycle (the length of time between loading an order on our trucks and receipt by
franchisee) is relatively short and consistent between reporting periods.
Equipment that is sold requires installation prior to acceptance. Recognition
of revenue occurs upon installation of such equipment. Norco sales are
reflected under the caption "food and supply sales." Shipping and handling
costs billed to customers are recognized as revenue.
Franchise revenue consists of income from license fees, royalties, and area
development and foreign master license (collectively, "Territory") sales.
License fees are recognized as income when there has been substantial
performance of the agreement by both the franchisee and the Company, generally
at the time the restaurant is opened. Royalties are recognized as income when
earned. For the years ended June 26, 2005, June 27, 2004 and June 29, 2003, 97%,
95% and 92%, respectively, of franchise revenue was comprised of recurring
royalties.
Territory sales are the fees paid by selected experienced restaurant
operators to the Company for the right to develop Pizza Inn restaurants in
specific geographical territories. The Company recognizes the fee to the extent
its obligations are fulfilled and of cash received. Territory fees recognized
as income for the years ended June 26, 2005, June 27, 2004 and June 29, 2003
were $0, $12,500 and $180,000, respectively.
STOCK OPTIONS:
As allowed by SFAS 123, "Accounting for Stock-Based Compensation" (SFAS No.
123), the Company elected to follow APB No. 25, and related Interpretations in
accounting for employee stock options because the alternative fair value
accounting provided for under SFAS No. 123, "Accounting for Stock Based
Compensation," requires use of option valuation models that were not developed
for use in valuing employee stock options. Under APB No. 25, because the
exercise price of our employee stock options equals or exceeds the fair value of
the underlying stock on the date of grant, no compensation expense is
recognized.
Pro forma information regarding net income and earnings per share is
required to be determined as if the Company had accounted for its stock options
granted subsequent to June 25, 1995 under the fair value method of SFAS 123,
"Accounting for Stock-Based Compensation." The fair value of options granted in
fiscal 2005, 2004 and 2003 was estimated at the grant date using a Black-Scholes
option pricing model. The following weighted average assumptions were used in
fiscal 2005: risk-free interest rates ranging from 4.09% to 4.50%, expected
volatility of 40.5% to 40.9%, expected dividends yield of 0% and expected lives
of six to nine years. Assumptions used in fiscal years 2004 and 2003 were as
follows: risk-free interest rates ranging from 1.9% to 2.8%, expected
volatility of 42.2% to 42.5%, expected dividend yield of 0% and expected lives
of two years.
For purposes of pro forma disclosures, the estimated fair value of the stock
options is amortized over the option vesting periods. The Company's pro forma
information follows (in thousands, except for earnings per share information):
June 26, 2005 June 27, 2004 June 29, 2003
-------------- -------------- --------------
As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma
-------------- -------------- -------------- ---------- ------------ ----------
Net income . . . . . . . . $ 204 $ 80 $ 2,243 $ 2,241 $ 3,093 $ 3,075
Basic earnings per share . $ 0.02 $ 0.01 $ 0.22 $ 0.22 $ 0.31 $ 0.31
Diluted earnings per share $ 0.02 $ 0.01 $ 0.22 $ 0.22 $ 0.31 $ 0.31
The effects of applying SFAS 123 in the pro forma disclosure are not indicative
of future amounts as the pro forma amounts above do not include the impact of
additional awards anticipated in future years.
In December 2004, the FASB issued the revised SFAS No. 123 ("SFAS 123R"), which
addresses the accounting for share-based payment transactions in which the
Company obtains employee services in exchange for (a) equity instruments of the
Company or (b) liabilities that are based on the fair value of the Company's
equity instruments or that may be settled by the issuance of such equity
instruments. This statement eliminates the ability to account for employee
share-based payment transactions using APB No. 25 and requires instead that such
transactions be accounted for using the grant-date fair value based method. SFAS
123R is effective for public companies that are not small business issuers as of
the first interim period or fiscal year beginning after June 15, 2005. The
Company anticipates that the adoption of SFAS 123R will not have an adverse
material impact on the Company's financial position and results of operations.
SFAS 123R will require the Company to record compensation charges for
share-based transactions in the Statement of Operations. The adoption of
this statement is not expected to have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amounts of short-term investments, accounts and notes
receivable, and debt approximate fair value. The fair value of the Company's
interest rate swap is based on pricing models using current market rates.
USE OF MANAGEMENT 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 other various assumptions that we believe
are reasonable under the circumstances. Estimates and assumptions are reviewed
periodically. Actual results could differ materially from estimates.
FISCAL YEAR:
The Company's fiscal year ends on the last Sunday in June. Fiscal years
ending June 26, 2005 and June 27, 2004 and June 29, 2003 all contained 52 weeks.
NEW PRONOUNCEMENTS:
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4" ("SFAS 151"). SFAS 151 clarifies the
accounting for abnormal amounts of idle facility expense, freight, handling
costs and wasted material. Additionally, SFAS 151 requires that allocation of
fixed production overhead to inventory be based on the normal capacity of the
production facilities. The provisions of SFAS 151 are applicable to inventory
costs incurred during fiscal years beginning after June 15, 2005. The adoption
of this statement is not expected to have a material effect on the Company's
consolidated financial position, results of operations or cash flows.
In December 2004, FASB issued Statement of Financial Accounting Standards
No. 153, "Exchanges of Nonmonetary Assets, an amendment to APB Opinion No. 29"
("SFAS 153"). The Statement eliminates the exception to measure exchanges at
fair value for exchanges of similar productive assets and replaces it with a
general exception for exchange transactions that do not have commercial
substance. SFAS 153 is effective for nonmonetary exchanges in fiscal periods
beginning after June 15, 2005. The adoption of this statement is not expected to
have a material effect on the Company's consolidated financial position, results
of operations or cash flows.
In March 2005, the FASB issued FASB Interpretation ("FIN") No. 47, "Accounting
for Conditional Asset Retirement Obligations." FIN No. 47 clarifies the meaning
of the term CONDITIONAL ASSET RETIREMENT OBLIGATION as used in SFAS 143,
"Accounting for Asset Retirement Obligations" and clarifies when an entity would
have sufficient information to reasonably estimate the fair value of an asset
retirement obligation. This interpretation is effective no later than the end of
fiscal years ending after December 15, 2005 (December 31, 2005 for calendar-year
companies). Retrospective application of interim financial information is
permitted but is not required. The adoption of this statement is not expected
to have a material effect on the Company's consolidated financial position,
results of operations or cash flows.
On May 5, 2005, the FASB issued Statement No. 154, Accounting Changes and
Error Corrections ("SFAS 154"), a replacement of APB Opinion No. 20 and FASB
Statement No. 3. The Statement applies to all voluntary changes in accounting
principles, and changes the requirements for accounting for and reporting of a
change in accounting principle. SFAS 154 requires retrospective application to
prior periods' financial statements of a voluntary change in accounting
principle unless it is impracticable. SFAS 154 requires that a change in method
of depreciation, amortization, or depletion for long-lived, nonfinancial assets
be accounted for as a change in accounting estimate that is effected by a change
in accounting principle. Opinion 20 previously required that such a change be
reported as a change in accounting principle. The requirements of SFAS 154 are
effective for accounting changes made in fiscal years beginning after December
15, 2005. The adoption of this statement is not expected to have a material
effect on the Company's consolidated financial position, results of operations
or cash flows.
NOTE B - PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment and property under capital leases consist of
the following (in thousands):
USEFUL JUNE 26, JUNE 27,
LIVES . 2005 2004
- --------------------------------- -------------------- ------------------------
Property, plant and equipment:
Equipment, furniture and fixtures 3 - 7 yrs $ 5,681 $ 5,504
Building. . . . . . . . . . . . . 5 - 39 yrs 11,023 10,875
Land. . . . . . . . . . . . . . . - 2,071 2,087
Construction in progress. . . . . - 18 10
Leasehold improvements. . . . . . 7 yrs or lease term
if shorter. . 579 670
-------------------- -----------------------
19,372 19,146
Less: accumulated depreciation . (7,224) (6,390)
-------------------- -----------------------
$ 12,148 $ 12,756
======================== =======================
Property under capital leases:
Real estate . . . . . . . . . . . 20 yrs $ 118 $ 118
Equipment . . . . . . . . . . . . 3 - 7 yrs - 3
------------------------ -----------------------
118 121
Less: accumulated amortization . (106) (103)
----------------------- ------------------------
12 18
======================== =======================
Depreciation expense was $936,000, $1,024,000 and $1,218,000 for the years ended
June 26, 2005, June 27, 2004 and June 29, 2003, respectively.
The Company owns land in Prosper, Texas that was purchased in August 2004 with
the intention of constructing and operating a buffet restaurant. We have
decided not to pursue development at this location and currently have the
property under contract to sell to a third party.
NOTE C - ACCRUED EXPENSES:
Accrued expenses consist of the following (in thousands):
JUNE 26, JUNE 27,
2005 2004
--------------------- ---------------------
Compensation . . . . . . . . . . . . . . . $ 586 $ 653
Taxes. . . . . . . . . . . . . . . . . . . 221 713
Legal reserves and other professional fees 216 154
Other. . . . . . . . . . . . . . . . . . . 351 589
--------------------- ---------------------
1,374 2,109
===================== =====================
NOTE D - LONG-TERM DEBT:
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 amendment
provides, among other terms, for modifications to certain financial covenants,
which would have resulted in an Event of Default had the Company not entered
into the new Revolving Credit Agreement. 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 June 26, 2005 and June 27, 2004, the
variable interest rates were 6.50% and 2.35%, using a Prime and the LIBOR
interest rate basis, respectively. Amounts outstanding under the revolving
credit line as of June 26, 2005 and June 27, 2004 were $966,000 and $1.2
million, respectively. Property, plant and equipment, inventory and accounts
receivable have been pledged for the above referenced loan 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 as discussed below. The $8.125
million term loan had an outstanding balance of $6.7 million at June 26, 2005
and $7.1 million at June 27, 2004. Property, plant and equipment, inventory and
accounts receivable have been pledged for the above referenced loan 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 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. SFAS 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. At June 26, 2005
there was no hedge ineffectiveness.
PIBCO, Ltd., a wholly-owned insurance subsidiary of the Company, in the
normal course of operations, arranged for the issuance of a letter of credit for
$230,000 to reinsurers to secure loss reserves. At June 26, 2005 and June 27,
2004 this letter of credit was secured under the Company's revolving line of
credit. Loss reserves for approximately the same amount have been recorded by
PIBCO, Ltd. and are reflected as current liabilities in the Company's financial
statements.
The following chart summarizes all of the Company's debt obligations to
make future payments under debt agreements as of June 26, 2005 (in thousands):
Fiscal Year
- ---------------------
2006. . . . . . . . . $ 406
2007. . . . . . . . . 406
2008. . . . . . . . . 6,891
---------------------
Total debt obligation 7,703
=====================
NOTE E - INCOME TAXES:
Provision for income taxes consist of the following (in thousands):
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
---------------------- --------------------- ---------------------
Federal. . . . . . . . . . $ 134 $ 637 $ -
State. . . . . . . . . . . 7 246 -
Deferred . . . . . . . . . 14 522 1,550
---------------------- --------------------- ---------------------
Provision for income taxes 155 1,405 1,550
====================== ===================== =====================
The effective income tax rate varied from the statutory rate for the years
ended June 26, 2005, June 27, 2004 and June 29, 2003 as reflected below (in
thousands):
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
------------------------ ---------------------- ----------------------
Federal income taxes based on 34%
of book income $ 111 $ 1,157 $ 1,579
State income tax 7 246 -
Permanent adjustments 26 18 21
Change in valuation allowance (21) (16) (72)
Expired credits 32 - 22
--------------- -------------- ---------------------
$ 155 $ 1,405 $ 1,550
=============== ============== ======================
The tax effects of temporary differences that give rise to the net deferred
tax assets (liabilities) consisted of the following (in thousands):
JUNE 26, JUNE 27,
2005 2004
----------------------- -----------------------
Reserve for bad debt. . . . $ 131 $ 126
Depreciable assets. . . . . (244) (128)
Deferred fees . . . . . . . 24 31
Other reserves and accruals 123 33
Interest rate swap loss . . 96 155
Credit carryforwards. . . . 176 208
----------------------- -----------------------
Gross deferred tax asset. . $ 306 $ 425
Valuation allowance . . . . (116) (137)
----------------------- -----------------------
Net deferred tax asset. . . 190 288
======================= =======================
As of June 26, 2005, the Company had $176,000 of foreign tax credit
carryforwards expiring between 2006 and 2007. The valuation allowance was
established under SFAS 109, since it is more likely than not that a portion of
the foreign tax credit carryforwards will expire before they can be utilized.
NOTE F - LEASES:
The real property and premises occupied by a Company-operated restaurant is
leased for an initial term of ten years with renewal options of three years
each. The lease agreement contains either provisions requiring additional rent
if sales exceed specified amounts or an escalation clause based upon a
predetermined multiple.
The Company's distribution division currently leases a significant portion
of its transportation equipment under operating leases with terms from five to
seven years. Some of the leases include fair market value purchase options at
the end of the term.
Future minimum rental payments under non-cancelable leases with initial or
remaining terms of one year or more at June 26, 2005 are as follows (in
thousands):
CAPITAL OPERATING
LEASES LEASES
------------------------ ---------
2006. . . . . . . . . . . . . . . . . . . $ 12 $ 947
2007. . . . . . . . . . . . . . . . . . . 12 611
2008. . . . . . . . . . . . . . . . . . . 2 251
2009. . . . . . . . . . . . . . . . . . . - 149
2010. . . . . . . . . . . . . . . . . . . - 133
Thereafter. . . . . . . . . . . . . . . . - 132
--------------- -------
$ 26 $ 2,223
==========
Less amount representing interest . . . . (2)
-------------
Present value of total obligations under
capital leases. . . . . . . . . . . . 24
Less current portion. . . . . . . . . . . (11)
-------------
Long-term capital lease obligations . . . $ 13
=============
Rental expense consisted of the following (in thousands):
YEAR ENDED YEAR ENDED YEAR ENDED
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
----------------------- ---------------------- ----------------------
Minimum rentals. . $ 1,040 $ 1,135 $ 1,143
Contingent rentals - 1 14
Sublease rentals . (75) (94) (97)
----------------------- ---------------------- ----------------------
$ 965 $ 1,042 $ 1,060
======================= ====================== ======================
NOTE G - EMPLOYEE BENEFITS:
The Company has a tax advantaged savings plan that is designed to meet the
requirements of Section 401(k) of the Internal Revenue Code (the "Code"). The
current plan is a modified continuation of a similar savings plan established by
the Company in 1985. Employees who have completed six months of service and are
at least 21 years of age are eligible to participate in the plan. Effective
January 1, 2002, as amended by the Economic Growth and Tax Relief Reconciliation
Act (EGTRRA), the plan provides that participating employees may elect to have
between 1% - 15% of their compensation deferred and contributed to the plan
subject to certain IRS limitations. Effective January 1, 2001 through June 30,
2004, the Company contributed on behalf of each participating employee an amount
equal to 50% of up to 4% of the employee's contribution. Effective July 1, 2004
through June 26, 2005, the Company elected to temporarily suspend its matching
contribution to the plan. Effective June 27, 2005, the Company contributes on
behalf of each participating employee an amount equal to 50% of up to 4% of the
employee's contribution. Separate accounts are maintained with respect to
contributions made on behalf of each participating employee. Employer matching
contributions and earnings thereon are invested in common stock of the Company.
The plan is subject to the provisions of the Employee Retirement Income Security
Act, as amended, and is a profit sharing plan as defined in Section 401 of the
Code. The Company is the administrator of the plan.
For the years ended June 26, 2005, June 27, 2004 and June 29, 2003, total
matching contributions to the tax advantaged savings plan by the Company on
behalf of participating employees were $0, $94,200 and $82,576, respectively.
NOTE H - STOCK OPTIONS:
In January 1994, the 1993 Stock Award Plan ("the 1993 Plan") was approved
by the Company's shareholders with a plan effective date of October 13, 1993.
Officers and employees of the Company were eligible to receive stock options
under the 1993 Plan. Options were granted at market value of the stock on the
date of grant, and were subject to various vesting periods ranging from six
months to three years with exercise periods up to eight years, and could have
been designated as incentive options (permitting the participant to defer
resulting federal income taxes). Originally, a total of two million shares of
common stock were authorized to be issued under the 1993 Plan. In December
1996, 1997 and 1998, the Company's shareholders approved amendments that
increased the 1993 Plan by 500,000 shares in each year. In December 2000, the
Company's shareholders approved amendments that increased the 1993 Plan by
100,000 shares. The 1993 Plan expired on October 13, 2003 and no further
options may be granted pursuant to it.
The 1993 Outside Directors Stock Award Plan (the "1993 Directors Plan") was
also adopted by the Company effective as of October 13, 1993 as approved by the
shareholders. Elected directors not employed by the Company were eligible to
receive stock options under the 1993 Directors Plan. Options for common stock
equal to twice the number of shares of common stock acquired during the previous
fiscal year were granted, up to 20,000 shares per year, to each outside
director. Options were granted at market value of the stock on the first day of
each fiscal year, which was also the date of grant, and with various vesting
periods ranging from one to four years with exercise periods up to nine years.
A total of 200,000 shares of Company common stock were authorized to be issued
pursuant to the 1993 Directors Plan. The 1993 Directors Plan expired on October
13, 2003 and no further options may be granted pursuant to it.
On March 31, 2005 the Company and Tim Taft, the Company's President and
Chief Executive Officer, entered into a non-qualified stock option award
agreement as part of Mr. Taft's employment agreement. Pursuant to the agreement
Mr. Taft was awarded options to purchase 500,000 shares of the Company's common
stock at an exercise price of $2.50 per share, which was the market value of the
stock on that day. Options for 50,000 shares vested immediately upon execution
of the agreement and the remaining options vest incrementally over the next
three years.
In June 2005, the 2005 Employee Incentive Stock Option Award Plan (the
"2005 Employee Plan") was approved by the Company's shareholders with a plan
effective date of June 23, 2005. Under the 2005 Employee Plan, officers and
employees of the Company are eligible to receive options to purchase shares of
the Company's common stock. Options are granted at market value of the stock on
the date of grant, are subject to various vesting and exercise periods as
determined by the Compensation Committee of the Board of Directors, and may be
designated as incentive options (permitting the participant to defer resulting
federal income taxes). A total of one million shares of common stock are
authorized to be issued under the 2005 Employee Plan.
The shareholders also approved the 2005 Non-Employee Directors Stock Award
Plan (the "2005 Directors Plan") in June 2005, to be effective as of June 23,
2005. Directors not employed by the Company are eligible to receive stock
options under the 2005 Directors Plan. Options for common stock equal to twice
the number of shares of common stock acquired during the previous fiscal year
can be granted, up to 40,000 shares per year, to each non-employee director.
Options are granted at market value of the stock on the first day of each fiscal
year, which is also the date of grant, and with various vesting periods
beginning at a minimum of six months and with exercise periods up to ten years.
A total of 500,000 shares of Company common stock are authorized to be issued
pursuant to the 2005 Directors Plan.
SUMMARY OF STOCK OPTION TRANSACTIONS
A summary of stock option transactions under all of the Company's stock
option plans and information about fixed-price stock options follows:
June 26, 2005 June 27, 2004 June 29, 2003
--------------- -------------- ---------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------------- -------------- --------------- ------ ---------- ------
Outstanding at beginning of year 485,700 $ 3.40 806,150 $ 3.68 1,591,233 $ 3.76
Granted. . . . . . . . . . . . . 542,858 $ 2.53 5,000 $ 2.15 10,000 $ 1.28
Exercised. . . . . . . . . . . . (15,000) $ 2.00 (75,000) $ 2.00 - $ 0.00
Canceled/Expired . . . . . . . . (202,600) $ 3.86 (250,450) $ 4.69 (795,083) $ 3.81
--------------- -------------- --------------- ------ ---------- ------
Outstanding at end of year . . . 810,958 $ 2.73 485,700 $ 3.40 806,150 $ 3.68
=============== ============== =============== ====== ========== ======
Exercisable at end of year . . . 318,100 $ 3.00 480,700 $ 3.42 792,150 $ 3.72
Weighted-average fair value of
options granted during the year. $ 1.37 $ 0.53 $ 0.33
FIXED PRICE STOCK OPTIONS
The following table provides information on options outstanding and options
exercisable at June 26, 2005:
Options Outstanding Options Exercisable
------------------------------------- --------------------
Weighted-
Average
Shares Remaining Weighted- Shares Weighted-
Range of Outstanding Contractual Average Exercisable Average
Exercise Prices at June 26, 2005 Life (Years) Exercise Price at June 26, 2005 Exercise Price
- ---------------- ------------------- -------------------- --------------- ---------------- ---------------
1.28 - 3.25 . . 668,958 8.00 $ 2.46 176,100 $ 2.25
3.30 - 4.25 . . 99,000 1.31 $ 3.59 99,000 $ 3.59
4.38 - 5.50 . . 43,000 1.05 $ 5.00 43,000 $ 5.00
------------------- ----------------
1.28 - 5.50 . . 810,958 6.82 $ 2.73 318,100 $ 3.04
=================== ================
NOTE I - COMMITMENTS AND CONTINGENCIES:
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. The arbitration hearing is scheduled
to begin on November 8, 2005.
The Company disagrees with Mr. Clark's claim that a "change of control" has
occurred under the Clark Agreement or that he is entitled to terminate the Clark
Agreement for "good reason." On May 4, 2004, the Board of Directors obtained a
written legal opinion that the "change of control" provision in the Clark
Agreement was not triggered by the results of the February 11, 2004 annual
meeting. Due to the nature of 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, the Company believes that its
claims against Mr. Clark are well founded and intends to vigorously 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. Clark for the
severance payment of approximately $762,000, the $12,500 bonus payment and costs
and fees. No accrual for any such amounts has been made as of June 26, 2005.
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 believes that its claims against Akin Gump and Mr.
Menges are well founded and 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 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. No date for an arbitration hearing has
been set.
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 believes that its claims against Mr.
Parker are well founded and intends to vigorously 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 June 26, 2005.
The Company is also subject to other various claims and contingencies
related to employment agreements, lawsuits, taxes, food product purchase
contracts and other matters arising out of the normal course of business. With
the possible exception of the matters set forth above, management believes that
any such claims and actions currently pending against us are either covered by
insurance or would not have a material adverse effect on the Company's annual
results of operations or financial condition if decided in a manner that is
unfavorable to us.
On April 30, 1998, Mid-South Pizza Development, Inc. ("Mid-South") entered
into a promissory note whereby, among other things, Mid-South borrowed
$1,330,000 from a third party lender (the "Loan") with the Company acting as the
guarantor. The proceeds of the Loan, less transaction costs, were used by
Mid-South to purchase area developer rights from the Company for certain
counties in Kentucky and Tennessee. Effective December 28, 2003, the Company
reacquired all such area development rights from Mid-South. The Company paid
approximately $963,000 for these rights of which $682,000 was a cash payment,
and a non-cash settlement of accounts receivable of approximately $281,000. A
long-term asset was recorded for the same amount. Restaurants operating or
developed in the reacquired territory will now pay all royalties and franchise
fees directly to Pizza Inn, Inc. The asset will be amortized over the life of
the asset, which is estimated to be approximately five years.
NOTE J - RELATED PARTIES:
Two directors of the Company are franchisees.
One of the director franchisees currently operates a total of 10
restaurants located in Arkansas. Purchases by this franchisee comprised 6.3%
and 6.0% of the Company's total food and supply sales in fiscal 2005 and fiscal
2004, respectively. Royalties and license fees and area development sales from
this franchisee comprised 3.4% and 3.2% of the Company's total franchise
revenues in fiscal 2005 and fiscal 2004, respectively. As of June 26, 2005 and
June 27, 2004, his accounts and note payable to the Company were $898,000 and
$923,000, respectively. As franchised units, his restaurants pay royalties to
the Company and purchase a majority of their food and supplies from Norco.
The other director franchisee currently operates one restaurant in
Oklahoma. Purchases by this franchisee comprised 0.4% and 0.5% of the Company's
total food and supply sales in fiscal 2005 and fiscal 2004, respectively.
Royalties from this franchisee comprised 0.5% and 0.5% of the Company's total
franchise revenues in fiscal 2005 and fiscal 2004, respectively. As of June 26,
2005 and June 27, 2004, his accounts payable to the Company was $39,000 and
$42,000, respectively. As a franchised unit, his restaurant pays royalties to
the Company and purchases a majority of its food and supplies from the Company's
distribution division.
The Company believes that the above transactions were at the same prices
and on the same payment terms available to non-related parties, with one
exception. This exception relates to the enforcement of the personal guarantee
by a director of the $314,000 debt of a franchise of which he is the President
and sole shareholder. The debt relates to food and equipment purchases and
royalty payments for the franchise during a period when the director had
transferred his interest in the franchise, and prior to his later reacquisition
of the franchise. The director has affirmed his guarantee and confirmed that the
debt will be paid in full.
In October 1999, the Company loaned $1,949,698 to then Chief Executive
Officer C. Jeffrey Rogers in the form of a promissory note due in June 2004 to
acquire 700,000 shares of the Company's common stock through the exercise of
vested stock options previously granted to him in 1995 by the Company. The note
bore interest at the same floating interest rate the Company pays on its
revolving credit line with Wells Fargo and was collateralized by a second lien
in certain real property and existing Company stock owned by C. Jeffrey Rogers.
The first lien on both the real property and Company stock pledged by Mr. Rogers
was held by Wells Fargo, Mr. Rogers' primary lender. The Board determined that
doubt existed regarding the collectibility of the note as of June 30, 2002, and
recorded a pre-tax charge of approximately $1.9 million to fully reserve for the
expected non-payment of the debt by Mr. Rogers. In December 2002, the Company's
loan to Mr. Rogers was paid in full. The reserve for the note receivable was
reversed in the quarter ending December 29, 2002.
In October 1999, the Company also loaned $557,056 to then Chief Operating
Officer Ronald W. Parker in the form of a promissory note due in June 2004 to
acquire 200,000 shares of the Company's common stock through the exercise of
vested stock options previously granted to him in 1995 by the Company. The note
bore interest at the same floating interest rate the Company pays on its
revolving credit line with Wells Fargo and was collateralized by certain real
property and existing Company stock owned by Ronald W. Parker. The note was
reflected as a reduction to shareholders' equity. As of June 27, 2004, the
note balance is paid in full.
In July 2000, the Company loaned $302,581 to Ronald W. Parker in the form
of a promissory note due in June 2004, in conjunction with a cash payment of
$260,000 from Mr. Parker, to acquire 200,000 shares of the Company's common
stock through the exercise of vested stock options previously granted in 1995 by
the Company. The note bore interest at the same floating interest rate the
Company pays on its revolving credit line with Wells Fargo and was
collateralized by certain real property and existing Company stock owned by
Ronald W. Parker. The note was reflected as a reduction to shareholders'
equity. As of June 27, 2004, the note balance is paid in full.
NOTE K - TREASURY STOCK:
For the period of September 1995 through June 2005, the Company purchased
5,298,341 shares of its own Common stock from time to time on the open market at
a total cost of $21.6 million. In fiscal 2005, the Company purchased 54,180
shares of its own Common stock on the open market at a total cost of $160,000.
The purchases of common shares described above were primarily funded from
working capital, and reduced the Company's outstanding shares by approximately
34%.
NOTE L - EARNINGS PER SHARE:
The Company computes and presents earnings per share ("EPS") in
accordance with SFAS 128, "Earnings Per Share." Basic EPS excludes the effect
of potentially dilutive securities while diluted EPS reflects the potential
dilution that would occur if securities or other contracts to issue common stock
were exercised, converted or resulted in the issuance of common stock that then
shared in the earnings of the entity.
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
------------ ------------- ----------
YEAR ENDED JUNE 26, 2005
BASIC EPS
Income Available to Common Shareholders . . . $ 204 10,105 $ 0.02
Effect of Dilutive Securities - Stock Options 37
------------
DILUTED EPS
Income Available to Common Shareholders
& Potentially Dilutive Securities . . . . . . $ 204 10,142 $ 0.02
============ ============= ==========
YEAR ENDED JUNE 27, 2004
BASIC EPS
Income Available to Common Shareholders . . . $ 2,243 10,076 $ 0.22
Effect of Dilutive Securities - Stock Options 41
------------
DILUTED EPS
Income Available to Common Shareholders
& Potentially Dilutive Securities . . . . . . $ 2,243 10,117 $ 0.22
============ ============= ==========
YEAR ENDED JUNE 29, 2003
BASIC EPS
Income Available to Common Shareholders . . . $ 3,093 10,058 $ 0.31
Effect of Dilutive Securities - Stock Options 3
------------
DILUTED EPS
Income Available to Common Shareholders
& Potentially Dilutive Securities . . . . . . $ 3,093 10,061 $ 0.31
============ ============= ==========
Options to purchase 206,958 shares of common stock at exercise prices
ranging from $2.85 to $5.00 per share were outstanding at June 26, 2005 but were
not included in the computation of diluted EPS because the option's exercise
price was greater than the average market price of the common shares. Options to
purchase 391,650 and 796,150 shares of common stock during fiscal years 2004 and
2003, respectively, were not included in the computation of diluted EPS because
the option's exercise price was greater than the average market price of the
common share.
NOTE M - SUBSEQUENT EVENTS:
In July 2005 the Company acquired the assets of two existing Pizza Inn
buffet restaurants from Houston, Texas-area franchises and is currently in the
process of remodeling those restaurants with the objective of reopening and
operating them as Company-owned restaurants. We anticipate opening these
restaurants in October 2005. 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.
In July 2005 the Company leased approximately 4,100 square feet of space in
a retail development in Dallas, Texas at a rate of approximately $30.00 per
square foot for the operation of a buffet concept. We are currently in the
process of finishing out the space and expect to have the restaurant operating
in October 2005. The lease has a five-year term with multiple renewal options.
We also own property in Prosper, Texas that was purchased in August
2004 with the intention of constructing and operating a buffet restaurant. We
have decided not to pursue development at that location and currently have the
property under contract to sell to a third party.
NOTE N - SEGMENT REPORTING:
The Company has two reportable operating segments as determined by
management using the "management" approach as defined in SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." (1) Food
and Equipment Distribution, and (2) Franchise and Other. These segments are a
result of differences in the nature of the products and services sold.
Corporate administration costs, which include, but are not limited to, general
accounting, human resources, legal and credit and collections, are partially
allocated to the two operating segments. Other revenue consists of nonrecurring
items.
The Food and Equipment Distribution segment sells and distributes
proprietary and non-proprietary items to franchisees and to two company-owned
and operated stores. Inter-segment revenues consist of sales to the
company-owned stores. Assets for this segment include tractor/trailers,
equipment, furniture and fixtures.
The Franchise and Other segment include income from royalties, license fees
and area development and foreign master license sales. The Franchise and Other
segment include the company-owned stores, which are used as prototype and
training facilities. Assets for this segment include equipment, furniture and
fixtures for the company stores.
Corporate administration and other assets primarily include the deferred
tax asset, cash and short-term investments, as well as furniture and fixtures
located at the corporate office. All assets are located within the United
States.
Summarized in the following tables are net sales and operating revenues,
depreciation and amortization expense, interest expense, interest income,
operating profit, income tax expense, capital expenditures and assets for the
Company's reportable segments for the years ended June 26, 2005, June 27, 2004,
and June 29, 2003 (in thousands):
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
---------- ---------- ----------
NET SALES AND OPERATING REVENUES:
Food and equipment distribution . . $ 49,161 $ 53,072 $ 51,556
Franchise and other . . . . . . . . 6,108 6,916 6,915
Inter-segment revenues. . . . . . . 228 640 664
---------- ---------- ----------
Combined. . . . . . . . . . . . . 55,497 60,628 59,135
Less inter-segment revenues . . . . (228) (640) (664)
---------- ---------- ----------
Consolidated revenues . . . . . . $ 55,269 $ 59,988 $ 58,471
========== ========== ==========
DEPRECIATION AND AMORTIZATION:
Food and equipment distribution . . $ 516 $ 575 $ 806
Franchise and other . . . . . . . . 281 181 101
---------- ---------- ----------
Combined. . . . . . . . . . . . . 797 756 907
Corporate administration and other. 346 377 496
---------- ---------- ----------
Depreciation and amortization . . $ 1,143 $ 1,133 $ 1,403
========== ========== ==========
INTEREST EXPENSE:
Food and equipment distribution . . $ 329 $ 365 $ 464
Franchise and other . . . . . . . . 3 4 5
---------- ---------- ----------
Combined. . . . . . . . . . . . . 332 369 469
Corporate administration and other. 258 244 320
---------- ---------- ----------
Interest expense. . . . . . . . . $ 590 $ 613 $ 789
========== ========== ==========
OPERATING PROFIT:
Food and equipment distribution (1) $ 614 $ 3,066 $ 3,389
Franchise and other (1) . . . . . . 2,240 2,319 1,937
Inter-segment profit. . . . . . . . 91 170 197
---------- ---------- ----------
Combined. . . . . . . . . . . . . 2,945 5,555 5,523
Less inter-segment profit . . . . . (91) (170) (197)
Corporate administration and other. (2,495) (1,737) (683)
---------- ---------- ----------
Income before taxes . . . . . . . $ 359 $ 3,648 $ 4,643
========== ========== ==========
INCOME TAX EXPENSE:
Food and equipment distribution . . $ 265 $ 1,181 $ 1,131
Franchise and other . . . . . . . . 967 893 647
---------- ---------- ----------
Combined. . . . . . . . . . . . . 1,232 2,074 1,778
Corporate administration and other. (1,077) (669) (228)
---------- ---------- ----------
Income tax expense. . . . . . . . $ 155 $ 1,405 $ 1,550
========== ========== ==========
(1) Does not include full allocation of corporate administration
JUNE 26, JUNE 27, JUNE 29,
2005 2004 2003
--------- --------- ---------
CAPITAL EXPENDITURES:
Food and equipment distribution . . $ 353 $ 161 $ 62
Franchise and other . . . . . . . . 327 1,159 76
--------- --------- ---------
Combined. . . . . . . . . . . . . 680 1,320 138
Corporate administration and other. 73 17 338
--------- --------- ---------
Consolidated capital expenditures $ 753 $ 1,337 $ 476
========= ========= =========
ASSETS:
Food and equipment distribution . . $ 8,653 $ 12,186 $ 10,963
Franchise and other . . . . . . . . 1,941 1,280 1,049
--------- --------- ---------
Combined. . . . . . . . . . . . . . 10,594 13,466 12,012
Corporate administration and other. 9,661 7,440 8,784
--------- --------- ---------
Consolidated assets . . . . . . . . $ 20,255 $ 20,906 $ 20,796
========= ========= =========
GEOGRAPHIC INFORMATION (REVENUES):
United States . . . . . . . . . . . $ 54,059 $ 58,569 $ 57,402
Foreign countries . . . . . . . . . 1,210 1,419 1,069
--------- --------- ---------
Consolidated total. . . . . . . . $ 55,269 $ 59,988 $ 58,471
========= ========= =========
NOTE O - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):
The following summarizes the unaudited quarterly results of operations for the
fiscal years ended June 26, 2005 and June 27, 2004 (in thousands, except per
share amounts):
QUARTER ENDED
--------------------------
SEPTEMBER 26, DECEMBER 26, MARCH 27, JUNE 26,
2004 2004 2005 2005
-------------- ------------- ----------- ----------
FISCAL YEAR 2005
Revenues. . . . . . . . . . . . . . . . . $ 14,421 $ 13,768 $ 13,401 $ 13,679
Gross profit. . . . . . . . . . . . . . . 884 823 841 774
Net Income (loss) . . . . . . . . . . . . 285 51 (20) (112)
Basic earnings per share on net income. . 0.03 0.01 - (0.01)
Diluted earnings per share on net income. 0.03 0.01 - (0.01)
QUARTER ENDED
-----------------------------------------
SEPTEMBER 28, . DECEMBER 28, MARCH 28, JUNE 27,
2003 2003 2004 2004
-------------- ------------- ----------- ----------
FISCAL YEAR 2004
Revenues. . . . . . . . . . . . . . . . . $ 15,355 $ 14,672 $ 14,548 $ 15,413
Gross profit. . . . . . . . . . . . . . . 1,315 1,419 1,425 1,235
Net income. . . . . . . . . . . . . . . . 504 558 617 564
Basic earnings per share on net income. . 0.05 0.06 0.06 0.06
Diluted earnings per share on net income. 0.05 0.06 0.06 0.06
SCHEDULE II
PIZZA INN, INC.
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
ADDITIONS
------------
BALANCE AT CHARGED TO RECOVERED BALANCE
BEGINNING COST AND COST AND AT END
OF PERIOD EXPENSE EXPENSE DEDUCTIONS OF PERIOD
------------ ----------- ----------- ------------ -----------
ALLOWANCE FOR DOUBTFUL
ACCOUNTS AND NOTES RECEIVABLE
Year Ended June 26, 2005. . . . . . . . . . . . $ 372 $ 30 $ - $ (31) $ 371
Year Ended June 27, 2004. . . . . . . . . . . . $ 916 $ 35 $ (264) $ (315) $ 372
Year Ended June 29, 2003. . . . . . . . . . . . $ 2,953 $ 155 $ (1,950) $ (242) $ 916
VALUATION ALLOWANCE FOR
DEFERRED TAX ASSET
Year Ended June 26, 2005. . . . . . . . . . . . $ 137 $ - $ - $ - $ 137
Year Ended June 27, 2004. . . . . . . . . . . . $ 153 $ - $ - $ (16) $ 137
Year Ended June 29, 2003. . . . . . . . . . . . $ 225 $ - $ - $ (72) $ 153
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There are no events to report under this item.
ITEM 9A - CONTROLS AND PROCEDURES
The Company's management, including the Company's principal executive
officer and principal financial 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
report on Form 10-K. Based upon that evaluation, the Company's principal
executive officer and principal financial officer have concluded that the
disclosure controls and procedures were effective as of the end of the period
covered by this report on Form 10-K.
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.
ITEM 9B - OTHER INFORMATION
There is no information required to be disclosed under this item.
PART III
The information required by this Item is incorporated by reference
from the Company's definitive Proxy Statement to be filed pursuant to Regulation
14A in connection with the Company's next annual meeting of shareholders, which
is expected to be held in December 2005.
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is included in the Proxy Statement
and is incorporated herein by reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this Item is included in the Proxy Statement
and is incorporated herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this Item is included in the Proxy Statement
and is incorporated herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is included in the Proxy Statement
and is incorporated herein by reference.
ITEM 14- PRINCIPAL ACCOUNTANTS FEES AND SERVICES
The information required by this Item is included in the Proxy Statement
and is incorporated herein by reference.
PART IV
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. The financial statements filed as part of this report are listed in the
Index to Financial Statements and Supplemental Data under Part II, Item 8 of
this Form 10-K.
2. The financial statement schedule filed as part of this report are listed
in the Index to Financial Statements and Supplemental Dataunder Part II, Item 8
of this Form 10-K.
3. Exhibits:
3.1 Restated Articles of Incorporation as filed on September 5, 1990 and
amended on February 16,1993 (filed as Exhibit 3.1 to the Company's Annual Report
on Form 10-K for the fiscal year ended June 27, 1993 and incorporated herein by
reference).
3.2 Amended and Restated By-Laws as adopted by the Board of Directors on
July 11, 2000 (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K
for the fiscal year ended June 24, 2001 and incorporated herein by reference).
3.3 Amended and Restated By-Laws as adopted by the Board of Directors on
October 8, 2002 (filed as Item 9 on Form 8-K on October 9, 2002 and
incorporated herein by reference).
3.4 Amended and Restated By-Laws as adopted by the Board of Directors on
December 18, 2002 (filed as Item 5 on Form 8-K on December 23, 2002 and
incorporated herein by reference).
3.5 Amended and Restated By-Laws as adopted by the Board of Directors on
February 11, 2004 (filed as Item 5 on 8-K on February 11, 2004 and
incorporated herein by reference).
3.6 Restated Articles of Incorporation as filed on September 5,
1990 and amended on June 23, 2005.
4.1 Provisions regarding Common stock in Article IV of the
Restated Articles of Incorporation, as amended (filed as Exhibit 3.1 to the
Company's Annual Report on Form 10-K for the fiscal year ended June 27, 1999 and
incorporated herein by reference).
4.2 Provisions regarding Redeemable Preferred Stock in Article V of the
Restated Articles of Incorporation, as amended (filed as Exhibit 3.1 to this
Report and incorporated herein by reference).
10.1 Third amendment to Third Amended and Restated Loan Agreement
and Second Amendment to Real Estate Note dated August 29, 2005 but effective as
of June 26, 2005, between the Company and Wells Fargo Bank, N.A. (filed as item
1.01 on Form, 8-K on August 30, 2005 and incorporated herein by reference).
10.2 Second amended and Restated Loan Agreement between the Company and
Wells Fargo Bank (Texas), N.A. dated March 31, 2000 (filed as Exhibit 10.1 to
the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March
26, 2000 and incorporated herein by reference).
10.3 First Amendment to the Second Amendment and Restated Loan Agreement
between the Company and Wells Fargo Bank (Texas), N.A. dated December 28, 2000
(filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended December 24, 2000 and incorporated herein by reference).
10.4 Second Amendment to the Second Amended and Restated Loan Agreement
between the Company and Wells Fargo Bank (Texas), N.A. dated January 31, 2002,
but effective December 23, 2001 (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended December 23, 2001 and
incorporated herein by reference).
10.5 Third Amendment to the Second Amended and Restated Loan Agreement
between the Company and Wells Fargo Bank (Texas), N.A. dated September 26, 2002,
but effective June 30, 2002. (filed as Exhibit 10.4 to the Company's Annual
Report on Form 10-K for the fiscal year ended June 30, 2002 and incorporated
herein by reference).
10.6 Third Amended and Restated Loan Agreement between the Company and Wells
Fargo Bank (Texas), N.A. dated January 22, 2003, but effective December 29,
2002. (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for
the fiscal quarter ended December 29, 2002 and incorporated herein by
reference).
10.7 Construction Loan Agreement between the Company and Wells Fargo Bank
(Texas) N.A. dated December 28, 2000 (filed as Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the fiscal quarter ended December 24, 2000 and
incorporated herein by reference).
10.8 Promissory Note between the Company and Wells Fargo Bank (Texas) N.A.
dated December 28, 2000 (filed as Exhibit 10.3 to the Company's Quarterly Report
on Form 10-Q for the fiscal quarter ended December 24, 2000 and incorporated
herein by reference).
10.9 Promissory Note between the Company and Wells Fargo Bank (Texas), N.A.
dated January 31, 2002 (filed as Exhibit 10.2 to the Company's Quarterly Report
on Form 10-Q for the fiscal quarter ended December 23, 2001 and incorporated
herein by reference).
10.10 Stock Purchase Agreement between the Company and Kleinwort Benson
Limited dated April 28, 1995 (filed as Exhibit 10.14 to the Company's Quarterly
Report on Form 10-Q for the fiscal quarter ended March 26, 1995 and incorporated
herein by reference).
10.11 Redemption Agreement between the Company and Kleinwort Benson Limited
dated June 24, 1994 (filed as Exhibit 10.4 to the Company's Annual Report on
Form 10-K for the fiscal year ended June 26, 1994 and incorporated herein by
reference.)
10.12 Form of Executive Employment Contract (filed as Exhibit 10.3 to the
Company's Quarterly Report on Form 10-Q for the fiscal quarter ended December
29, 2002 and incorporated herein by reference).*
10.13 Employment Agreement between the Company and Ronald W. Parker dated
December 16, 2002 (filed as Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the fiscal quarter ended December 29, 2002 and incorporated herein
by reference).*
10.14 Severance agreement between the Company and C. Jeffrey Rogers dated
August 21, 2002. (filed as Exhibit 10.12 to the Company's Annual Report on Form
10-K for the fiscal year ended June 30, 2002 and incorporated herein by
reference). *
10.15 1993 Stock Award Plan of the Company (filed as Exhibit 10.9 to the
Company's Annual Report on Form 10-K for the fiscal year ended June 26, 1994 and
incorporated herein by reference).*
10.16 1993 Outside Directors Stock Award Plan of the Company (filed as
Exhibit 10.10 to the Company's Annual Report on Form 10-K for the fiscal year
ended June 26, 1994 and incorporated herein by reference).*
10.17 1992 Stock Award Plan of the Company (filed as Exhibit 10.6 to the
Company's Annual Report on Form 10-K for the fiscal year ended June 27, 1993 and
incorporated herein by reference).*
10.18 Letter Agreement dated February 9, 2005 the Company and Wells Fargo
Bank, N.A. (filed as Exhibit 10.1 on Form 10-Q for the quarterly period ended
December 26, 2004 and incorporated herein by reference).
10.19 Second Amendment to Third Amended and Restated Loan Agreement and
Amendment to Real Estate Note dated February 11, 2005 but effective as of
December 26, 2004, between the Company and Wells Fargo Bank, N.A. (filed as Item
10.2 on Form 10-Q for the quarterly period ended March 27, 2005 and incorporated
herein by reference).
10.20 Eighth Amended and Restated Revolving Credit Note Agreement dated
February 11, 2005 but effective as of December 26, 2004, between the Company and
Wells Fargo Bank, N.A. (filed as Item 10.3 on Form 10-Q for the quarterly period
ended March 27, 2005 and incorporated herein by reference).
10.21 Employment Agreement dated March 31, 2005 between the Company and
Timothy P. Taft (filed as Item 10.4 on Form 10-Q for the quarterly period ended
March 27, 2005 and incorporated herein by reference). *
10.22 Non-Qualified Stock Option Agreement dated March 31, 2005 between
the Company and Timothy P. Taft (filed as Item 10.5 on Form 10-Q for the
quarterly period ended March 27, 2005 and incorporated herein by reference).*
10.23 Executive Compensation Agreement dated April 22,2005 between the
Company and Ward T. Olgreen (filed as Item 10.6 on Form 10-Q for the quarterly
period ended March 27, 2005 and incorporated herein by reference).*
10.24 Executive Compensation Agreement dated April 22, 2005 between the
Company and Shawn M. Preator (filed as Item 10.7 on Form 10-Q for the quarterly
period ended March 27, 2005 and incorporated herein by reference).*
10.25 2005 Non-Employee Directors Stock Award Plan of the Company.*
10.26 2005 Employee Incentive Stock Option Award Plan of the Company.*
21.0 List of Subsidiaries of the Company (filed as Exhibit 21.0 to
the Company's Annual Report on Form 10-K for the fiscal year ended June 26, 1994
and incorporated herein by reference).
23.1 Consent of Independent Registered Public Accounting Firm.
23.2 Consent of Independent Registered Public Accounting Firm.
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 Financial 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 Financial Officer as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
* Denotes a management contract or compensatory plan or arrangement filed
pursuant to Item 15 (a) of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: September 23, 2005 By: /s/ Shawn M. Preator
Shawn M. Preator
Chief Financial Officer
Treasurer
(Principal Accounting Officer)
(Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
Name and Position Date
- ------------------- ----
/s/Mark E. Schwarz September 23, 2005
- --------------------
Mark E. Schwarz
Director and Chairman of the Board
/s/Ramon D. Phillips September 23, 2005
- ----------------------
Ramon D. Phillips
Director and Vice Chairman of the Board
/s/ Bobby L. Clairday September 23, 2005
- ------------------------
Bobby L. Clairday
Director
/s/ John D. Harkey, Jr. September 23, 2005
- ---------------------------
John D. Harkey, Jr.
Director
/s/Robert B. Page September 23, 2005
- -------------------
Robert B. Page
Director
/s/ Steven J. Pully September 23, 2005
- ----------------------
Steven J. Pully
Director
/s/ Tim P. Taft September 23, 2005
- ------------------
Tim P. Taft
President and Chief Executive Officer
(Principal Executive Officer)
Director
EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------
We hereby consent to the incorporation by reference in the Registration
Statements on Forms S-8 (Nos. 33-56590, 33-71700, as amended by Post-Effective
Amendments No. One and Two, 333-77617, and 333-76296) of Pizza Inn, Inc. of our
report dated September 25, 2003 relating to the consolidated financial
statements and financial statement schedule, which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Dallas, Texas
September 23, 2005
EXHIBIT 23.2
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------
Pizza Inn, Inc.
The Colony, Texas
We hereby consent to the incorporation by reference in the Registration
Statements on Forms S-8 (Nos. 33-56590, 33-71700, as amended by Post-Effective
Amendments No. One and Two, 333-77617, and 333-76296) of Pizza Inn, Inc. of our
report dated August 16, 2005 relating to the consolidated financial statements
and financial statement schedule, which appears in this Form 10-K.
/s/ BDP Seidman, LLP
BDO Seidman, LLP
Dallas, Texas
September 23, 2005
EXHIBIT 31.1
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO SECTION 3.22 OF THE SARBANES-OXLEY ACT OF 2002
I, Tim P. Taft certify that:
1. I have reviewed this annual report on Form 10-K of Pizza Inn, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
c. Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
/s/ Tim P. Taft
Date: September 23, 2005 By: Tim P. Taft
- --------------------------- President and Chief Executive Officer
(Principal Executive Officer)
Director
EXHIBIT 31.2
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Shawn M. Preator, certify that:
1. I have reviewed this annual report on Form 10-K of Pizza Inn, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a. Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities,
particularly during the period in which this report is being prepared;
b. Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
c. Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a. All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b. Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
/s/ Shawn M. Preator
Date: September 23, 2005 By: Shawn M. Preator
Principal Financial Officer
EXHIBIT 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Pizza Inn, Inc. (the "Company"), does hereby certify, to
such officer's knowledge, that:
The Annual Report on Form 10-K for the year ended June 26, 2005 (the "Form
10-K") of the Company fully complies with the requirements of Section 13(a) or
15(d), as applicable, of the Securities Exchange Act of 1934 and the information
contained in the Form 10-K fairly presents, in all material respects, the
financial condition and results of operations of the Company as of, and for, the
periods presented in the Form 10-K.
/s/ Tim P. Taft
Date: September 23, 2005 By: Tim P. Taft
President and Chief Executive Officer
(Principal Executive Officer)
Director
The foregoing certification is being furnished as an exhibit to the Form
10-K pursuant to Item 601(b)(32) of Regulation S-K and Section 906 of the
Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63
of Title 18, United States Code) and, accordingly, is not being filed as part of
the Form 10-K for purposes of Section 18 of the Securities Exchange Act of 1934,
as amended, and is not incorporated by reference into any filing of the Company,
whether made before or after the date hereof, regardless of any general
incorporation language in such filing.
EXHIBIT 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of Section 1350, Chapter 63 of Title 18, United States Code), the
undersigned officer of Pizza Inn, Inc. (the "Company"), does hereby certify, to
such officer's knowledge, that:
The Annual Report on Form 10-K for the year ended June 26, 2005 (the "Form
10-K") of the Company fully complies with the requirements of Section 13(a) or
15(d), as applicable, of the Securities Exchange Act of 1934 and the information
contained in the Form 10-K fairly presents, in all material respects, the
financial condition and results of operations of the Company as of, and for, the
periods presented in the Form 10-K.
/s/ Shawn M. Preator
Date: September 23, 2005 By: Shawn M. Preator
Principal Financial Officer
The foregoing certification is being furnished as an exhibit to the Form
10-K pursuant to Item 601(b)(32) of Regulation S-K and Section 906 of the
Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63
of Title 18, United States Code) and, accordingly, is not being filed as part of
the Form 10-K for purposes of Section 18 of the Securities Exchange Act of 1934,
as amended, and is not incorporated by reference into any filing of the Company,
whether made before or after the date hereof, regardless of any general
incorporation language in such filing.