10-Q 1 doc1.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (MARK ONE) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 28, 2004. ---------------- 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 IN ITS CHARTER) MISSOURI 47-0654575 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 3551 PLANO PARKWAY THE COLONY, TEXAS 75056 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (469) 384-5000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12 B-2 OF THE EXCHANGE ACT). YES NO [X] INDICATE BY CHECK MARK WHETHER THE REGISTRANT HAS FILED ALL DOCUMENTS AND REPORTS REQUIRED TO BE FILED BY SECTIONS 12, 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 SUBSEQUENT TO THE DISTRIBUTION OF SECURITIES UNDER A PLAN CONFIRMED BY A COURT. YES [X} NO AT MAY 3, 2004, AN AGGREGATE OF 10,083,674 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE OF $.01 EACH (BEING THE REGISTRANT'S ONLY CLASS OF COMMON STOCK), WERE OUTSTANDING. PIZZA INN, INC. Index ----- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Page -------- --------------------- ---- Condensed Consolidated Statements of Operations for the three months and nine months ended March 28, 2004 and March 30, 2003 (unaudited) 3 Condensed Consolidated Statements of Comprehensive Income for the three months and nine months ended March 28, 2004 and March 30, 2003 (unaudited) 3 Condensed Consolidated Balance Sheets at March 28, 2004 (unaudited) and June 29, 2003 4 Condensed Consolidated Statements of Cash Flows for the three months and nine months ended March 28, 2004 and March 30, 2003 (unaudited) 5 Notes to Condensed Consolidated Financial Statements (unaudited) 7 Item 2. ------- Management's Discussion and Analysis of ------------------------------------------- Financial Condition and Results of Operations 13 --------------------------------------------- Item 3. ------- Quantitative and Qualitative Disclosures about Market Risk 18 ---------------------------------------------------------------- Item 4. Controls and Procedures 18 -------- ------------------------- PART II. OTHER INFORMATION Item 1. Legal Proceedings 18 -------- ------------------ Item 4. Submission of Matters to a Vote of Security Holders 19 -------- ----------------------------------------------------------- Item 5. Other Information 19 -------- ------------------ Item 6. Exhibits and Reports on Form 8-K 21 -------- ------------------------------------- Signatures 22 PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS -------------------------------
PIZZA INN, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) THREE MONTHS ENDED NINE MONTHS ENDED ------------------- ------------------ MARCH 28, MARCH 30, MARCH 28, MARCH 30, REVENUES: 2004 2003 2004 2003 ------------------- ------------------ ----------- ----------- Food and supply sales . . . . . . . . . . . . . . . . . . . $ 12,774 $ 12,311 $ 39,304 $ 39,114 Franchise revenue . . . . . . . . . . . . . . . . . . . . . 1,323 1,347 4,038 3,957 Restaurant sales. . . . . . . . . . . . . . . . . . . . . . 452 446 1,234 1,366 Other income. . . . . . . . . . . . . . . . . . . . . . . . 94 94 212 286 ------------------- ------------------ ----------- ----------- 14,643 14,198 44,788 44,723 ------------------- ------------------ ----------- ----------- COSTS AND EXPENSES: Cost of sales . . . . . . . . . . . . . . . . . . . . . . . 11,877 11,562 36,548 36,134 Franchise expenses. . . . . . . . . . . . . . . . . . . . . 851 972 2,393 2,515 General and administrative expenses . . . . . . . . . . . . 829 907 2,832 1,556 Interest expense. . . . . . . . . . . . . . . . . . . . . . 150 188 470 622 ------------------- ------------------ ----------- ----------- 13,707 13,629 42,243 40,827 ------------------- ------------------ ----------- ----------- INCOME BEFORE INCOME TAXES. . . . . . . . . . . . . . . . . . 936 569 2,545 3,896 Provision for income taxes. . . . . . . . . . . . . . . . . 319 193 866 1,325 ------------------- ------------------ ----------- ----------- NET INCOME. . . . . . . . . . . . . . . . . . . . . . . . . . $ 617 $ 376 $ 1,679 $ 2,571 =================== ================== =========== =========== BASIC EARNINGS PER COMMON SHARE . . . . . . . . . . . . . . . $ 0.06 $ 0.04 $ 0.17 $ 0.26 =================== ================== =========== =========== DILUTED EARNINGS PER COMMON SHARE . . . . . . . . . . . . . . $ 0.06 $ 0.04 $ 0.17 $ 0.26 =================== ================== =========== =========== WEIGHTED AVERAGE COMMON SHARES. . . . . . . . . . . . . . . . 10,079 10,059 10,070 10,058 =================== ================== =========== =========== WEIGHTED AVERAGE COMMON AND POTENTIAL DILUTIVE COMMON SHARES. . . . . . . . . . . . . . 10,132 10,064 10,114 10,061 =================== ================== =========== =========== CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (IN THOUSANDS) THREE MONTHS ENDED. . . . . . . . . . NINE MONTHS ENDED ----------------------------- ---------------------- MARCH 28, . . . . . MARCH 30, MARCH 28, MARCH 30, 2004 2003 2004 2003 ------------------- ------------------ ----------- ----------- Net Income. . . . . . . . . . . . . . . . . . . . . . . . . . $ 617 $ 376 $ 1,679 $ 2,571 Interest rate swap gain (loss) - (net of tax (expense) benefit of ($20) and ($15) and $75 and $130, respectively). . . . . . . . . . . . . . 38 29 (145) (252) ------------------- ------------------ ----------- ----------- Comprehensive Income. . . . . . . . . . . . . . . . . . . . . $ 655 $ 405 $ 1,534 $ 2,319 =================== ================== =========== =========== See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) MARCH 28, JUNE 29, ASSETS 2004 2003 ----------- ---------- (UNAUDITED) CURRENT ASSETS Cash and cash equivalents. . . . . . . . . . . . . . . . . . . $ 212 $ 399 Accounts receivable, less allowance for doubtful accounts of $308 and $722, respectively. . . . . . . . . . . 3,991 3,730 Notes receivable, current portion, less allowance for doubtful accounts of $54 and $175, respectively. . . . . 244 260 Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . 1,811 1,511 Deferred taxes, net. . . . . . . . . . . . . . . . . . . . . . 265 585 Prepaid expenses and other . . . . . . . . . . . . . . . . . . 481 533 ----------- ---------- Total current assets . . . . . . . . . . . . . . . . . . . 7,004 7,018 Property, plant and equipment, net . . . . . . . . . . . . . . . 12,889 13,126 Property under capital leases, net . . . . . . . . . . . . . . . 60 120 Deferred taxes, net. . . . . . . . . . . . . . . . . . . . . . . 196 382 Long-term notes receivable, less allowance for doubtful accounts of $8 and $19, respectively. . . . . . . . . - 41 Deposits and other . . . . . . . . . . . . . . . . . . . . . . . 1,023 109 ----------- ---------- $ 21,172 $ 20,796 =========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable - trade . . . . . . . . . . . . . . . . . . . $ 2,140 $ 1,217 Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . 2,229 1,950 Current portion of long-term debt. . . . . . . . . . . . . . . 510 1,448 Current portion of capital lease obligations . . . . . . . . . 45 109 ----------- ---------- Total current liabilities. . . . . . . . . . . . . . . . . . 4,924 4,724 LONG-TERM LIABILITIES Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . 8,165 9,643 Long-term capital lease obligations. . . . . . . . . . . . . . 26 33 Other long-term liabilities. . . . . . . . . . . . . . . . . . 767 989 ----------- ---------- 13,882 15,389 ----------- ---------- SHAREHOLDERS' EQUITY Common Stock, $.01 par value; authorized 26,000,000 shares; issued 14,981,319 and 14,956,319 shares, respectively; outstanding 10,083,674 and 10,058,674 shares, respectively. 150 150 Additional paid-in capital . . . . . . . . . . . . . . . . . . 7,875 7,825 Loans to officers. . . . . . . . . . . . . . . . . . . . . . . (560) (569) Retained earnings. . . . . . . . . . . . . . . . . . . . . . . 19,815 18,135 Accumulated other comprehensive loss . . . . . . . . . . . . . (506) (650) Treasury stock at cost Shares in treasury: 4,897,645 and 4,897,645 respectively . . (19,484) (19,484) ----------- ---------- Total shareholders' equity . . . . . . . . . . . . . . . . . 7,290 5,407 ----------- ---------- $ 21,172 $ 20,796 =========== ========== See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED ------------------- MARCH 28, MARCH 30, 2004 2003 ------------------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,679 $ 2,571 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization. . . . . . . . . . . . . . . . . . . 827 1,103 Non-cash settlement of accounts receivable . . . . . . . . . . . . (281) - Recovery of bad debt, net. . . . . . . . . . . . . . . . . . . . . (249) (1,830) Utilization of deferred taxes. . . . . . . . . . . . . . . . . . . 467 445 Utilization of pre-reorganization net operating loss carryforwards - 1,131 Changes in assets and liabilities: Notes and accounts receivable. . . . . . . . . . . . . . . . . . . (236) (115) Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . (300) (182) Accounts payable - trade . . . . . . . . . . . . . . . . . . . . . 923 173 Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . 279 (525) Prepaid expenses and other . . . . . . . . . . . . . . . . . . . . 330 163 ------------------- ----------- CASH PROVIDED BY OPERATING ACTIVITIES. . . . . . . . . . . . . . . 3,439 2,934 ------------------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sale of assets . . . . . . . . . . . . . . . . . . . . 38 - Reacquisition of area development territory. . . . . . . . . . . . . (682) - Capital expenditures . . . . . . . . . . . . . . . . . . . . . . . . (554) (261) ------------------- ----------- CASH USED FOR INVESTING ACTIVITIES . . . . . . . . . . . . . . . . (1,198) (261) ------------------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings of long-term bank debt. . . . . . . . . . . . . . . . . . 127 500 Repayments of long-term bank debt and capital lease obligations. . . (2,614) (5,710) Officer loan payment . . . . . . . . . . . . . . . . . . . . . . . . 9 1,951 Proceeds from exercise of stock options. . . . . . . . . . . . . . . 50 - ------------------- ----------- CASH USED FOR FINANCING ACTIVITIES . . . . . . . . . . . . . . . . (2,428) (3,259) ------------------- ----------- Net decrease in cash and cash equivalents. . . . . . . . . . . . . . . (187) (586) Cash and cash equivalents, beginning of period . . . . . . . . . . . . 399 770 ------------------- ----------- Cash and cash equivalents, end of period . . . . . . . . . . . . . . . $ 212 $ 184 ------------------- ----------- See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED ------------------ MARCH 28, MARCH 30, 2004 2003 ------------------ ---------- CASH PAYMENTS FOR: Interest . . . . . . . . . . . . . . . . . $ 478 $ 627 Income taxes . . . . . . . . . . . . . . . 309 - NON-CASH FINANCING AND INVESTING ACTIVITIES: Non-cash settlement of accounts receivable $ 281 $ - See accompanying Notes to Consolidated Financial Statements.
PIZZA INN, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) The accompanying condensed consolidated financial statements of Pizza Inn, Inc. (the "Company") have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in the financial statements have been omitted pursuant to such rules and regulations. The condensed consolidated financial statements should be read in conjunction with the notes to the Company's audited condensed consolidated financial statements in its Form 10-K for the fiscal year ended June 29, 2003. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the Company's financial position and results of operations for the interim periods. All adjustments contained herein are of a normal recurring nature. 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 No. 123. 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):
NINE MONTHS ENDED ------------------- MARCH 28, MARCH 30, 2004 2003 ------------------- ----------- Net income, as reported. . . . . . . . . . . $ 1,679 $ 2,571 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects. . . . . . . . . . . . (1) (15) ------------------- ----------- Pro forma net income . . . . . . . . . . . . $ 1,678 $ 2,556 Earnings per share Basic-as reported. . . . . . . . . . . . . $ 0.17 $ 0.26 Basic-pro forma. . . . . . . . . . . . . . $ 0.17 $ 0.25 Diluted-as reported. . . . . . . . . . . . $ 0.17 $ 0.26 Diluted-pro forma. . . . . . . . . . . . . $ 0.17 $ 0.25
The effects of applying SFAS No. 123 in this 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. (2) The Company entered into an agreement effective March 28, 2004 with its current lender to provide a $4.0 million revolving credit line that will expire October 1, 2005, replacing a $7.0 million line that was due to expire December 31, 2004. Interest on the revolving credit line is payable monthly. Interest is provided for at a rate equal to prime less an interest rate margin from 1.0% to 0.5% or, at the Company's option, at the LIBOR rate plus 1.25% to 1.75%. The interest rate margin is based on the Company's performance under certain financial ratio tests. A 0.375% to 0.5% annual commitment fee is payable on any unused portion of the revolving credit line. As of March 28, 2004 and March 30, 2003, the variable interest rates were 2.59% and 3.06%, respectively, using a LIBOR rate basis. Amounts outstanding under the revolving credit line as of March 28, 2004 and March 30, 2003 were $1.3 million and $2.7 million, respectively. The Company entered into a term note effective March 31, 2000 with its current lender. The $5,000,000 term note had outstanding balances of $104,000 and $1.4 million at March 28, 2004 and March 30, 2003, respectively. The term note requires monthly principal payments of $104,000 with the balance maturing on March 31, 2004. Interest on the term loan is also payable monthly. Interest is provided for at a rate equal to prime less an interest rate margin of 0.75% or, at the Company's option, at the LIBOR rate plus 1.5%. As of March 28, 2004 and March 30, 2003, the variable interest rates were 2.63% and 2.81%, respectively. The Company entered into an agreement effective December 28, 2000, as amended, with its current lender 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. This term loan will amortize over a term of twenty years, with principal payments of $34,000 due monthly. Interest on this term loan is also payable monthly. Interest is provided for at a rate equal to prime less an interest rate margin of 0.75% or, at the Company's option, to the LIBOR rate plus 1.5%. As of March 28, 2004 and March 30, 2003, the variable interest rates were 2.59% and 2.78%, respectively. The Company, to fulfill bank requirements, has caused the outstanding principal amount to be subject to a fixed interest rate by utilizing an interest rate swap agreement as discussed below. The $8.125 million term loan had an outstanding balance of $7.2 million at March 28, 2004 and $7.6 million at March 30, 2003. (3) The Company entered into an interest rate swap effective February 27, 2001, as amended, designated as a cash flow hedge, to manage interest rate risk relating to the financing of the construction of the Company's new headquarters and to fulfill bank requirements. The swap agreement has a notional principal amount of $8.125 million with a fixed pay rate of 5.84% which began November 1, 2001 and will end November 19, 2007. The swap's notional amount amortizes over a term of twenty years to parallel the terms of the term loan. 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 March 28, 2004 there was no hedge ineffectiveness. The Company's expectation is that the hedging relationship will continue to be highly effective at achieving offsetting changes in cash flows. (4) 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"). 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 against actual incremental cash flows received, which is estimated to be approximately five years. (5) On January 18, 2002 the Company was served with a lawsuit filed by Blakely-Witt & Associates, Inc. alleging Pizza Inn sent, or caused to be sent, unsolicited facsimile advertisements. The plaintiff has requested this matter be certified as a class action. We are vigorously defending our position in this litigation. We cannot assure you that we will prevail in this lawsuit and our defense could be costly and consume the time of our management. We are unable to predict the outcome of this case. However, an adverse resolution of this matter could materially affect our financial position and results of operations. All of the parties to this matter have entered into a settlement agreement under which the Company would pay an amount that would not materially affect our financial performance. Final approval of this settlement agreement is subject to court approval and no assurances can be given that such approval will be obtained. The settlement terms currently agreed to and pending court approval, have been provided for in the Company's financial statements. (6) On April 21, 2004 the Company's board of directors, following the recommendation of the shareholders at its annual meeting held February 11, 2004, approved the reimbursement of expenses for Newcastle Partners' proxy solicitation efforts related to matters presented for a vote at the Company's annual shareholder meeting. The Company has established a reserve during its fiscal third quarter of approximately $176,000 to fund reimbursement of these expenses. (7) In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51," ("FIN 46"). FIN 46 requires the consolidation of entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. In October 2003, the FASB issued Staff Position No. 46-6, "Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities," ("FSP FIN 46-6") in which the FASB deferred, for public companies, the required effective dates to implement FIN 46 for interests held in a variable interest entity ("VIE") or potential VIE that was created before February 1, 2003. In December 2003, the FASB published a revision to FIN 46 to clarify some of the provisions and to exempt certain entities from its requirements. Under the new guidance, special effective date provisions apply to enterprises that have fully or partially applied FIN 46 prior to issuance of the revised interpretation. Otherwise, application of Interpretation 46R ("FIN 46R") is required in financial statements of public entities that have interests in structures that are commonly referred to as special-purpose entities ("SPEs") for periods ending after December 15, 2003. Application by public entities, other than small business issuers, for all other types of VIEs other than SPEs is required in financial statements for periods ending after March 15, 2004. The Company does not have any interests in structures commonly referred to as SPEs, typically has no equity ownership interests in its franchisees, and has not consolidated any of these entities in the Company's financial statements. The Company will continue to monitor developments regarding the Interpretation as they occur. Implementation of this pronouncement in the third fiscal quarter of 2004 did not have a material impact on the financial statements. (8) The proxy contest in connection with the Company's most recent annual meeting resulted in three nominees of Newcastle Partners, L.P. ("Newcastle") (i.e. Ramon D. Phillips, Robert B. Page, and Steven J. Pully) being elected as Class II members of the Board of Directors at the meeting. In Part II, Item 5 of the Company's report on Form 10-Q for the quarter ended September 28, 2003, filed with the Securities and Exchange Commission on November 12, 2003, the Company expressed concern that election of Newcastle's nominees might result in a "Change of Control" as defined in the employment agreements executed on December 16, 2002 between the Company and each of Ronald W. Parker, B. Keith Clark, Ward T. Olgreen and Shawn M. Preator. In the report, the Company summarized the issue as follows: Whether or not a Change of Control is deemed to have occurred is a function of whether or not two existing directors, Messrs. Schwarz and Pully, and a nominee director, Mr. Phillips, currently an advisory director, are incumbent directors, as that term is defined in the employment agreements. If a Change of Control were to occur and any or all of these executive officers were to terminate their employment for any reason (including the voluntary termination of employment by such officer) as provided in the employment agreements within twelve months after such Change of Control, the Company would be required to make a lump sum payment to such officer which would have a material adverse effect on the Company's financial position and results of operations. After filing its Form 10-Q for the quarter ended September 28, 2003, the Company sought a legal opinion on the "Change of Control" issue from its outside legal counsel, which delivered its opinion on November 26, 2003. The Company's definitive proxy statement, filed with the Securities and Exchange Commission on January 7, 2004, contained the following commentary regarding the "Change of Control" issue: Counsel to the Company has delivered to the Board its written legal opinion that, subject to the assumptions, limitations, qualifications and exceptions contained therein, it is of the opinion that a Texas court in a properly presented and argued case should conclude that Messrs. Schwarz, Pully, Phillips and Page would not constitute members of the Incumbent Board and therefore, if the Newcastle nominees are elected to the Board in connection with a proxy contest, a "Change of Control" as defined in the employment agreements discussed above would be deemed to occur. Counsel for Newcastle has informed counsel to the Company that they disagree with this opinion. Additionally, Messrs. Schwarz and Pully have informed the Board that they believe themselves to be incumbent directors. Newcastle's definitive proxy statement, filed with the Securities and Exchange Commission on January 2, 2004, expressed a different view of the "Change of Control" issue: We believe that Messrs. Schwarz and Pully are "Incumbent Directors" under a plain reading of the employment agreements as they were appointed by an agreement of a majority of the Pizza Inn Board and not due to an "actual or threatened solicitation of proxies." We also believe that Mr. Phillips should be deemed an "Incumbent Director" if elected by virtue of the fact that he was a director of the Company at the time the new employment agreements were adopted by the Pizza Inn Board. After the shareholder meeting, the newly constituted Audit Committee of the Board of Directors commenced an investigation to determine whether a "Change of Control" had occurred under the employment agreements as a result of the election of Newcastle's nominees. In connection with this investigation, the Audit Committee engaged independent legal counsel to advise the Audit Committee. On May 4, 2004, the Audit Committee's independent legal counsel delivered its legal opinion to the Audit Committee, opining that a Texas court in a properly presented and argued case should conclude that no Change of Control has occurred under the employment agreements of Messrs. Parker, Clark, Olgreen and Preator at any time since December 16, 2002. In addition to certain assumptions, limitations, qualifications and exceptions, the opinion was based on counsel's conclusion that Mr. Phillips is among the individuals constituting the Incumbent Board. Based on the opinion of the Audit Committee's independent legal counsel, the Audit Committee, on May 10, 2004, concluded that there has been no "Change of Control" and recommended that the Board of Directors reach the same conclusion. Based on such recommendation, the Board of Directors, on May 11, 2004, concluded that there has been no "Change of Control." (9) The following table shows the reconciliation of the numerator and denominator of the basic EPS calculation to the numerator and denominator of the diluted EPS calculation (in thousands, except per share amounts).
INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ----------- ------------- ------ THREE MONTHS ENDED MARCH 28, 2004 BASIC EPS Income Available to Common Shareholders $ 617 10,079 $ 0.06 Effect of Dilutive Securities - Stock Options 53 -- DILUTED EPS Income Available to Common Shareholders & Assumed Conversions $ 617 10,132 $ 0.06 ==================== ================= ========== THREE MONTHS ENDED MARCH 30, 2003 BASIC EPS Income Available to Common Shareholders $ 376 10,059 $ 0.04 Effect of Dilutive Securities - Stock Options 5 DILUTED EPS -- Income Available to Common Shareholders & Assumed Conversions $ 376 10,064 $ 0.04 ==================== ================= ========== NINE MONTHS ENDED MARCH 28, 2004 BASIC EPS Income Available to Common Shareholders $1,679 10,070 $ 0.17 Effect of Dilutive Securities - Stock Options 44 -- DILUTED EPS Income Available to Common Shareholders & Assumed Conversions $1,679 10,114 $ 0.17 ==================== ================= ========== NINE MONTHS ENDED MARCH 30, 2003 BASIC EPS Income Available to Common Shareholders $2,571 10,059 $ 0.26 Effect of Dilutive Securities - Stock Options 2 -- DILUTED EPS Income Available to Common Shareholders & Assumed Conversions $2,571 10,061 $ 0.26 ==================== ================= ==========
(10) Summarized in the following tables are net sales and operating revenues, operating profit, and geographic information (revenues) for the Company's reportable segments for the three month and nine month periods ended March 28, 2004 and March 30, 2003 (in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED ------------------- ------------------ MARCH 28, MARCH 30, MARCH 28, MARCH 30, 2004 2003 2004 2003 ----------- ----------- ----------- ----------- NET SALES AND OPERATING REVENUES: Food and Equipment Distribution . . $ 12,774 $ 12,311 $ 39,304 $ 39,114 Franchise and Other . . . . . . . . 1,775 1,793 5,272 5,323 Intersegment revenues . . . . . . . 173 164 536 515 ----------- ----------- ----------- ----------- Combined. . . . . . . . . . . . . 14,722 14,268 45,112 44,952 Other revenues. . . . . . . . . . . 94 94 212 286 Less intersegment revenues. . . . . (173) (164) (536) (515) ----------- ----------- ----------- ----------- Consolidated revenues . . . . . . $ 14,643 $ 14,198 $ 44,788 $ 44,723 =========== =========== =========== =========== OPERATING PROFIT: Food and Equipment Distribution (1) $ 952 $ 513 $ 2,237 $ 1,909 Franchise and Other (1) . . . . . . 487 528 1,727 1,928 Intersegment profit . . . . . . . . 51 47 142 143 ----------- ----------- ----------- ----------- Combined. . . . . . . . . . . . . 1,490 1,088 4,106 3,980 Other profit or loss. . . . . . . . 94 94 212 286 Less intersegment profit. . . . . . (51) (47) (142) (143) Corporate administration and other. (597) (566) (1,631) (227) ----------- ----------- ----------- ----------- Income before taxes . . . . . . . $ 936 $ 569 $ 2,545 $ 3,896 =========== =========== =========== =========== GEOGRAPHIC INFORMATION (REVENUES): United States . . . . . . . . . . . $ 14,295 $ 13,863 $ 43,723 $ 43,892 Foreign countries . . . . . . . . . 348 335 1,065 831 ----------- ----------- ----------- ----------- Consolidated total. . . . . . . . $ 14,643 $ 14,198 $ 44,788 $ 44,723 =========== =========== =========== =========== (1) Does not include full allocation of corporate administration.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND -------------------------------------------------------------------------------- RESULTS OF OPERATIONS ----------------------- CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's discussion and analysis is based on the Company's condensed consolidated financial statements and related footnotes contained within this report. The Company's critical accounting policies used in the preparation of those condensed consolidated financial statements are discussed below. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates made by management include the allowance for doubtful accounts, inventory valuation, deferred tax asset valuation allowances, and legal accruals. Actual results could differ from those estimates. 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. 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 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 unit is opened. Royalties are recognized as income when earned. 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. When the Company has no continuing substantive obligations of performance to the area developer or master licensee regarding the fee, the Company recognizes the fee to the extent of cash received. If continuing obligations exist, fees are recognized ratably during the performance of those obligations. 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 and is based upon management's assessment of the market conditions for its products. 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 creditworthiness, and current economic trends. Notes receivable primarily consist of notes from franchisees for the purchase of area development and master license territories, trade receivables and equipment purchases. These notes generally have terms ranging from one to five years and interest rates of 6% to 9%. 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. 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. 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 if it is judged to be probable and estimable. If the actual loss from a contingency differs from management's estimate, operating results could be impacted. RESULTS OF OPERATIONS QUARTER AND NINE MONTHS ENDED MARCH 28, 2004 COMPARED TO THE QUARTER AND NINE MONTHS ENDED MARCH 30, 2003. Earnings per share for the quarter were $0.06 versus $0.04 for the same period last year. Net income was $617,000 versus $376,000, on revenues of $14,643,000 versus $14,198,000 in the previous year. For the nine month period, earnings per share were $0.17 versus $0.26 last year. Net income was $1,679,000 compared to $2,571,000 on revenues of $44,788,000 versus $44,723,000 last year. The quarter that ended March 28, 2004 included a pretax adjustment of $285,000 to a previously recorded legal reserve. The Company and all other parties in the previously disclosed class-action fax litigation have entered into a settlement agreement, which is awaiting court approval. Excluding the above-described adjustment of approximately $188,000 (after-tax), or $0.02 per share, net income of $617,000, or $0.06 per share, for the quarter ended March 28, 2004 was $429,000 or $0.04 per share. Food and supply sales by the Company's Norco division include food and paper products, equipment, marketing material, and other distribution revenues. Food and supply sales for the quarter increased 4% or $463,000 to $12,774,000 from $12,311,000 compared to the same period last year. For the nine month period, food and supply sales increased less than 1% or $190,000, to $39,304,000 from $39,114,000. These increases are primarily due to higher chainwide retail sales for the quarter combined with higher cheese prices year-to-date. Franchise revenue, which includes income from royalties, license fees and area development and foreign master license (collectively, "Territory") sales, decreased 2% or $24,000 for the quarter compared to the same period last year and increased 2% or $81,000 for the nine month period. The decrease for the quarter is due to a reduction in foreign master license fees which was partially offset by higher domestic and international royalties. The increase for the nine month period is due primarily to higher international royalties, including the collection of previously unrecorded past due royalties. Restaurant sales, which consist of revenue generated by Company-owned training stores increased 1% or $6,000 for the quarter, compared to the same period of the prior year. For the nine month period, restaurant sales decreased 10% or $132,000. The Company opened a new Delco unit on January 9, 2004. The Company also sold an existing Buffet unit effective March 1, 2004. The year-to-date decrease is the result of lower comparable sales and one less month of operations due to the unit sale as described above. Other income consists primarily of interest income, third party commissions, and non-recurring revenue items. Other income remained unchanged for the quarter, compared to the same period of the prior year. For the nine month period, other income decreased 26% or $74,000, due to lower commissions and lower interest income. Cost of sales increased 3% or $315,000 for the quarter and increased 1% or $414,000 for the nine month period. These increases are due to higher cheese prices partially offset by lower depreciation and amortization expenses and lower transportation costs. Cost of sales, as a percentage of sales for the quarter decreased to 90% from 91% for the same period last year. Cost of sales, as a percentage of sales for the nine month period increased to 90% from 89% for the same period last year. Franchise expenses include selling, general and administrative expenses directly related to the sale and continuing service of franchises and Territories. These costs decreased 12% or $121,000 for the quarter and decreased 5% or $122,000 for the nine month period compared to the same period last year. These decreases are primarily the result of lower taxes on foreign revenues and lower payroll and related expenses. General and administrative expenses decreased 9% or $78,000 for the quarter and increased 82% or $1,276,000 for the nine month period, compared to the same periods last year. The quarterly decrease is due to the reversal of the previously recorded legal reserve as discussed above which was partially offset by a $176,000 reserve for the reimbursement of expenses for Newcastle Partners' proxy solicitation efforts. The nine month period increase is the result of the reversal of a previously recorded pre-tax charge of approximately $1,950,000 for bad debt in the prior year partially offset by lower payroll and related expenses. Interest expense decreased 20% or $38,000 for the quarter and 24% or $152,000 for the nine month period, compared to the same periods of the prior year due to lower debt balances and lower interest rates. Provision for income taxes increased 65% or $126,000 for the quarter, and decreased 35% or $459,000 for the nine month period compared to the same periods in the prior year. The effective tax rate was 34% for both the current and prior quarters and nine month periods. LIQUIDITY AND CAPITAL RESOURCES Cash flows from operating activities are generally the result of net income, deferred taxes, depreciation and amortization, and changes in working capital. In the first nine months of fiscal 2004, the company generated cash flows of $3,439,000 from operating activities as compared to $2,934,000 in fiscal 2003. Cash provided by operations was utilized primarily to pay down debt. Cash flows from investing activities primarily reflect the Company's capital expenditure strategy. During the first nine months of fiscal 2004, the Company used cash of $1,198,000 for investing activities as compared to $261,000 in fiscal 2003. The cash used during fiscal 2004 consisted primarily of the reacquisition of area development rights as described above, and costs associated with a Company-owned store which opened in January 2004. Cash flows from financing activities generally reflect changes in the Company's borrowings during the period, treasury stock transactions, and exercise of stock options. Net cash used for financing activities was $2,428,000 during the first nine months of fiscal 2004 as compared to cash used for financing activities of $3,259,000 in fiscal 2003. 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 $137,556 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 effective March 28, 2004 with its current lender to provide a $4.0 million revolving credit line that will expire October 1, 2005, replacing a $7.0 million line that was due to expire December 31, 2004. Interest on the revolving credit line is payable monthly. Interest is provided for at a rate equal to prime less an interest rate margin from 1.0% to 0.5% or, at the Company's option, at the LIBOR rate plus 1.25% to 1.75%. The interest rate margin is based on the Company's performance under certain financial ratio tests. A 0.375% to 0.5% annual commitment fee is payable on any unused portion of the revolving credit line. As of March 28, 2004 and March 30, 2003, the variable interest rates were 2.59% and 3.06%, respectively, using a LIBOR rate basis. Amounts outstanding under the revolving credit line as of March 28, 2004 and March 30, 2003 were $1.3 million and $2.7 million, respectively. The Company entered into a term note effective March 31, 2000 with its current lender. The $5,000,000 term note had outstanding balances of $104,000 and $1.4 million at March 28, 2004 and March 30, 2003, respectively. The term note requires monthly principal payments of $104,000 with the balance maturing on March 31, 2004. Interest on the term loan is also payable monthly. Interest is provided for at a rate equal to prime less an interest rate margin of 0.75% or, at the Company's option, at the LIBOR rate plus 1.5%. As of March 28, 2004 and March 30, 2003, the variable interest rates were 2.63% and 2.81%, respectively. The Company entered into an agreement effective December 28, 2000, as amended, with its current lender 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. This term loan will amortize over a term of twenty years, with principal payments of $34,000 due monthly. Interest on this term loan is also payable monthly. Interest is provided for at a rate equal to prime less an interest rate margin of 0.75% or, at the Company's option, to the LIBOR rate plus 1.5%. As of March 28, 2004 and March 30, 2003, the variable interest rates were 2.59% and 2.78%, respectively. The Company, to fulfill bank requirements, has caused the outstanding principal amount to be subject to a fixed interest rate by utilizing an interest rate swap agreement as discussed below. The $8.125 million term loan had an outstanding balance of $7.2 million at March 28, 2004 and $7.6 million at March 30, 2003. 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. 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 March 28, 2004 there was no hedge ineffectiveness. The Company's expectation is that the hedging relationship will continue to be highly effective at achieving offsetting changes in cash flows. 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"). 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 against actual incremental cash flows received, which is estimated to be approximately five years. On January 18, 2002, the Company was served with a lawsuit filed by Blakely-Witt & Associates, Inc. alleging Pizza Inn sent or, caused to be sent, unsolicited facsimile advertisements. The plaintiff has requested this matter be certified as a class action. We are vigorously defending our position in this litigation. We cannot assure you that we will prevail in this lawsuit and our defense could be costly and consume the time of our management. We are unable to predict the outcome of this case. However, an adverse resolution of this matter could materially affect our financial position and results of operations. All of the parties to this matter have entered into a settlement agreement under which the Company would pay an amount that would not materially affect our financial performance. Final approval of this settlement agreement is subject to court approval and no assurances can be given that such approval will be obtained. The settlement terms currently agreed to and pending court approval, have been provided for in the Company's financial statements. On April 21, 2004 the Company's board of directors, following the recommendation of the shareholders at its annual meeting held February 11, 2004, approved the reimbursement of expenses for Newcastle Partners' proxy solicitation efforts related to matters presented for a vote at the Company's annual shareholder meeting. The Company has established a reserve during its fiscal third quarter of approximately $176,000 to fund reimbursement of these expenses. CONTRACTUAL OBLIGATIONS AND COMMITMENTS The following chart summarizes all of the Company's material obligations and commitments to make future payments under contracts such as debt and lease agreements as of March 28, 2004 (in thousands):
Less Than 1 1-3 4-5 After 5 Total. Year Years Years Years ----------------------------------- ------- ------ -------- ------ Bank debt . . . . . . . . . . . . . $ 8,675 $ 510 $ 2,545 $5,620 $ - Operating lease obligations . . . . 3,132 1,111 1,582 348 91 Capital lease obligations (1) . . . 71 45 22 4 - ------- ------ -------- ------ --- Total contractual cash obligations. $11,878 $1,666 $ 4,149 $5,972 $91 ======= ====== ======== ====== ===
(1) Does not include amount representing interest. FORWARD-LOOKING STATEMENT This report contains certain forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) relating to the Company that are based on the beliefs of the management of the Company, as well as assumptions and estimates made by and information currently available to the Company's management. When used in this report, the words "anticipate," "believe," "estimate," "expect," "intend" and similar expressions, as they relate to the Company or the Company's management, identify forward-looking statements. Such statements reflect the current views of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions relating to the operations and results of operations of the Company as well as its customers and suppliers, including as a result of competitive factors and pricing pressures, shifts in market demand, general economic conditions and other factors including but not limited to, changes in demand for Pizza Inn products or franchises, the impact of competitors' actions, changes in prices or supplies of food ingredients, and restrictions on international trade and business. Should one or more of these risks or uncertainties materialize, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK -------------------------------------------------------------------------- The Company has market risk exposure arising from changes in interest rates. The Company's earnings are affected by changes in short-term interest rates as a result of borrowings under its credit facilities which bear interest based on floating rates. At March 28, 2004 the Company has approximately $8.7 million of variable rate debt obligations outstanding with a weighted average interest rate of 2.63%. A hypothetical 10% change in the effective interest rate for these borrowings, assuming debt levels at March 28, 2004, would change interest expense by approximately $19,000 for the nine months ended March 28, 2004. As discussed previously, the Company has entered into an interest rate swap designed to manage the interest rate risk relating to $7.2 million of the variable rate debt. ITEM 4. CONTROLS AND PROCEDURES ------------------------------------ a) Evaluation of disclosure controls and procedures. Based on their evaluation as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Company's principal executive officer and principal financial officer have concluded that the Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the "Exchange Act")) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Our Chief Executive Officer and our Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report, and they have concluded that as of that date our disclosure controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in our reports filed under the Exchange Act. b) Changes in internal controls. There were no significant changes to our internal controls or in other factors that could significantly affect our internal controls subsequent to the date of their evaluation by our Chief Executive Officer and our Chief Financial Officer. There were no significant deficiencies or material weaknesses, and therefore there were no corrective actions taken. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS ---------------------------- On January 18, 2002, the Company was served with a lawsuit filed by Blakely-Witt & Associates, Inc. in the District Court, L-193rd Judicial District, Dallas County, Texas (Cause No. 01-11043). The suit alleges Pizza Inn sent, or caused to be sent, unsolicited facsimile advertisements to plaintiff and others in violation of (i) 47 U.S.C. Section 227(b)(1)(C) and (b)(3), the Telephone Consumer Protection Act, and (ii) Texas Business and Commerce Code Section 35.47. The plaintiff has requested this matter be certified as a class action. We are vigorously defending our position in this litigation. We cannot assure you that we will prevail in this lawsuit and our defense could be costly and consume the time of our management. We are unable to predict the outcome of this case. However, an adverse resolution of this matter could materially affect our financial position and results of operations. All of the parties to this matter have entered into a settlement agreement under which the Company would pay an amount that would not materially affect our financial performance. Final approval of this settlement agreement is subject to court approval and no assurances can be given that such approval will be obtained. The settlement terms currently agreed to and pending court approval, have been provided for in the Company's financial statements. ------ ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------------------------- At the Annual Meeting of Shareholders on February 11, 2004 five matters were submitted to a vote of shareholders. Those matters and the results of the vote for each are as follows: Item 1. Election of Class II Directors Nominee For Votes Withheld ------- --- -------------- Robert B. Page 5,506,809 14,025 Ramon D. Phillips 5,512,895 14,025 Steven J. Pully 6,198,964 112,207 Item 2. Approval to adopt a resolution to repeal the following amendment of the Amended and Restated Bylaws of the Company adopted on December 18, 2002: Amendment to Article III, Section 7 that eliminates the ability of shareholders to call a special meeting of shareholders. Votes for 5,648,318 Votes against 655,894 Abstain 20,884 Item 3. Approval to adopt a resolution to repeal the following amendment of the Amended and Restated Bylaws of the Company adopted on December 18, 2002: New Article III, Section 13 that requires shareholders to comply with certain procedures in order to bring business before a shareholders meeting. Votes for 5,693,889 Votes against 606,963 Abstain 23,884 Item 4. Approval to adopt a resolution to repeal the following amendment of the Amended and Restated Bylaws of the Company adopted on December 18, 2002: New Article IV, Section 6 that requires shareholders to comply with certain procedures in order to nominate directors. Votes for 5,700,154 Votes against 600,706 Abstain 23,836 Item 5. Approval to adopt a resolution recommending to the Board of Directors of the Company that the Company reimburse Newcastle Partners, L.P. for all expenses it incurs in connection with its solicitation of proxies for the Annual Meeting. Votes for 5,871,073 Votes against 809,953 Abstain 83,670 ITEM 5. OTHER INFORMATION ---------------------------- The proxy contest in connection with the Company's most recent annual meeting resulted in three nominees of Newcastle Partners, L.P. ("Newcastle") (i.e. Ramon D. Phillips, Robert B. Page, and Steven J. Pully) being elected as Class II members of the Board of Directors at the meeting. In Part II, Item 5 of the Company's report on Form 10-Q for the quarter ended September 28, 2003, filed with the Securities and Exchange Commission on November 12, 2003, the Company expressed concern that election of Newcastle's nominees might result in a "Change of Control" as defined in the employment agreements executed on December 16, 2002 between the Company and each of Ronald W. Parker, B. Keith Clark, Ward T. Olgreen and Shawn M. Preator. In the report, the Company summarized the issue as follows: Whether or not a Change of Control is deemed to have occurred is a function of whether or not two existing directors, Messrs. Schwarz and Pully, and a nominee director, Mr. Phillips, currently an advisory director, are incumbent directors, as that term is defined in the employment agreements. If a Change of Control were to occur and any or all of these executive officers were to terminate their employment for any reason (including the voluntary termination of employment by such officer) as provided in the employment agreements within twelve months after such Change of Control, the Company would be required to make a lump sum payment to such officer which would have a material adverse effect on the Company's financial position and results of operations. After filing its Form 10-Q for the quarter ended September 28, 2003, the Company sought a legal opinion on the "Change of Control" issue from its outside legal counsel, which delivered its opinion on November 26, 2003. The Company's definitive proxy statement, filed with the Securities and Exchange Commission on January 7, 2004, contained the following commentary regarding the "Change of Control" issue: Counsel to the Company has delivered to the Board its written legal opinion that, subject to the assumptions, limitations, qualifications and exceptions contained therein, it is of the opinion that a Texas court in a properly presented and argued case should conclude that Messrs. Schwarz, Pully, Phillips and Page would not constitute members of the Incumbent Board and therefore, if the Newcastle nominees are elected to the Board in connection with a proxy contest, a "Change of Control" as defined in the employment agreements discussed above would be deemed to occur. Counsel for Newcastle has informed counsel to the Company that they disagree with this opinion. Additionally, Messrs. Schwarz and Pully have informed the Board that they believe themselves to be incumbent directors. Newcastle's definitive proxy statement, filed with the Securities and Exchange Commission on January 2, 2004, expressed a different view of the "Change of Control" issue: We believe that Messrs. Schwarz and Pully are "Incumbent Directors" under a plain reading of the employment agreements as they were appointed by an agreement of a majority of the Pizza Inn Board and not due to an "actual or threatened solicitation of proxies." We also believe that Mr. Phillips should be deemed an "Incumbent Director" if elected by virtue of the fact that he was a director of the Company at the time the new employment agreements were adopted by the Pizza Inn Board. After the shareholder meeting, the newly constituted Audit Committee of the Board of Directors commenced an investigation to determine whether a "Change of Control" had occurred under the employment agreements as a result of the election of Newcastle's nominees. In connection with this investigation, the Audit Committee engaged independent legal counsel to advise the Audit Committee. On May 4, 2004, the Audit Committee's independent legal counsel delivered its legal opinion to the Audit Committee, opining that a Texas court in a properly presented and argued case should conclude that no Change of Control has occurred under the employment agreements of Messrs. Parker, Clark, Olgreen and Preator at any time since December 16, 2002. In addition to certain assumptions, limitations, qualifications and exceptions, the opinion was based on counsel's conclusion that Mr. Phillips is among the individuals constituting the Incumbent Board. Based on the opinion of the Audit Committee's independent legal counsel, the Audit Committee, on May 10, 2004, concluded that there has been no "Change of Control" and recommended that the Board of Directors reach the same conclusion. Based on such recommendation, the Board of Directors, on May 11, 2004, concluded that there has been no "Change of Control." ------ ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ----------------------------------------------- (a) Exhibits: 10.1 First amendment to third amended and restated loan agreement between the Company and Wells Fargo Bank (Texas), N.A. dated April 22, 2004 but effective March 28, 2004. 10.2 Seventh amended and restated revolving credit note agreement between the Company and Wells Fargo Bank (Texas), N.A. dated April 22, 2004 but effective March 28, 2004. 31.1 Certification of Chief Executive Officer as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Chief 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 Chief Financial Officer as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Form 8-K On January 23, 2004 the Company filed a report on Form 8-K, reporting a press release with respect to earnings for the second quarter ended December 28, 2003. On February 8, 2004 the Company filed a report on Form 8-K, reporting management performance from August 2002 to December 2003. On February 11, 2004 the Company filed a report on Form 8-K, announcing the results of its annual shareholder meeting. On April 23, 2004 the Company filed a report on Form 8-K, reporting a press release with respect to earnings for the third quarter ended March 28, 2004. ------ SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. PIZZA INN, INC. Registrant By: /s/Ronald W. Parker --------------------- Ronald W. Parker President and Chief Executive Officer By: /s/Shawn M. Preator --------------------- Shawn M. Preator Chief Financial Officer Dated: May 12, 2004