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 29, 1997. 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.) 5050 QUORUM DRIVE SUITE 500 DALLAS, TEXAS 75240 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (972) 701-9955 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) At September 8, 1997, there were 12,768,685 shares of the registrant's Common Stock outstanding, and the aggregate market value of registrant's Common Stock held by non-affiliates was $41,366,347, based upon the average of the bid and ask prices. 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 APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 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 DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement, to be filed pursuant to Section 14(a) of the Securities Exchange Act of 1934 in connection with the registrant's annual meeting of shareholders in December 1997, have been incorporated by reference in Part III of this report. PART I ITEM 1 - BUSINESS GENERAL 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 trade name "Pizza Inn" . On September 8, 1997, the Pizza Inn system consisted of 494 units, including five Company operated units (which are used for product testing and franchisee training, in addition to serving customers) and 489 franchised units. The domestic units are comprised of 323 full service units, 35 delivery/carry-out units and 71 Express units. The international units are comprised of 33 full service units, 12 delivery/carry-out units and 20 Express units. Pizza Inn units are currently located in 18 states and 19 foreign countries. Domestic units are located predominantly in the southern half of the United States, with Texas, North Carolina and Arkansas accounting for approximately 30%, 15% and 11%, respectively, of the total. Norco Manufacturing and Distributing Company ("Norco"), a division of the Company, distributes food products, equipment, and other supplies to units in the United States and, to the extent feasible, in other countries. PIZZA INN RESTAURANTS Full service restaurants ("Full-Service") offer dine-in and carry-out service and, in most cases, also offer delivery service. These restaurants serve pizza on three different crusts (The Original Thin Crust, New York Pan, and Italian Crust, with standard toppings and special combinations of toppings. They also offer pasta, salad, sandwiches, desserts and beverages, including beer and wine in some locations. They are generally located in free standing buildings in close proximity to offices, shopping centers and residential areas. The current standard Full-Service units are between 3,300 and 4,400 square feet in size and seat 130 to 180 customers. The interior decor is designed to promote a contemporary, family style atmosphere. Restaurants that offer delivery and carry-out service only ("Delcos") are growing in popularity and number. Delcos typically are located in shopping centers or other in-line arrangements, occupy approximately 1,000 square feet, and offer limited or no seating. Delcos generally offer the same menu as Full-Service units, except for buffet and dine-in service. The decor of these units is designed to be bright and highly visible, featuring neon, lighted displays and awnings. A third version, Pizza Inn Express units ("Express"), are typically located in a convenience store, college campus, airport terminal or other commercial facility. They have limited or no seating and offer quick carry-out service of a limited menu of pizza and other foods and beverages. An Express unit typically occupies approximately 200 to 400 square feet and is operated by the same person who owns the commercial facility or who is licensed at one or more locations within the facility. FRANCHISING The Pizza Inn concept was first franchised in 1963. Since that time, industry franchising concepts and development strategies have changed, so that present franchise relationships are evidenced by a variety of contractual forms. Common to those forms are provisions which: (i) provide an initial franchise term of 20 years 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) prohibit the development of one unit within a specified distance from another. The Company's current form of franchise agreement provides for: (i) a franchise fee of $20,000 for a Full-Service unit, $7,500 for a Delco and $3,500 for an Express unit, (ii) an initial franchise term of 20 years for a Full- Service unit, 10 years for a Delco, plus a renewal term of 10 years in both cases, and an initial term of five years for an Express unit, plus a renewal term of five years, (iii) contributions equal to 1% of gross sales to the Pizza Inn Advertising Plan or to the Company, discussed below, (iv) royalties equal to 4% of gross sales for a Full-Service or Delco and 5% of gross sales for an Express unit, and (v) required advertising expenditures of at least 4% of gross sales for a Full-Service unit, 5% for a Delco and 2% for an Express unit. The Company has adopted a franchising strategy which has three major components: continued development within existing Pizza Inn market areas, development of selected new domestic territories, and continued growth in the international arena. As a cornerstone of this approach, the Company offers, to certain experienced restaurant operators, area developer rights in both new and existing domestic markets. An area developer pays a negotiated fee to purchase the right to operate or develop, along with the Company, Pizza Inn restaurants within a defined territory, typically for a term of 20 years plus renewal options for 10 years. The area developer agrees to a new store development schedule and assists the Company in local franchise service and quality control. In return, half of the franchise fees and royalties earned on all units within the territory are retained by the area developer during the term of the agreement. The Company offers similar master franchise rights to develop Pizza Inn restaurants in certain foreign countries, with negotiated fees, development schedules and ongoing royalties. As with area developers, 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 foreign territory, typically for a term of 20 years plus renewal options for ten years. The master licensee agrees to a new store development schedule and the Company trains the master licensee to monitor and assist franchisees in their territory with local franchise service and quality control, with support from the Company. In return, the master licensee typically retains half the franchise fees and approximately half the royalties on all units within the territory during the term of the agreement. While all Pizza Inn restaurants opened in an area developer's territory enter into franchise agreements with the Company, a master licensee may open restaurants owned and operated by the master licensee, or they may open sub-franchised restaurants owned and operated by third parties through agreement with the master licensee. In July 1997, the Company repurchased the area developer rights for the majority Tennessee and portions of Kentucky for approximately $986,000. Restaurants operating or developed in the repurchased territory will now pay all royalties and franchisee fees directly to Pizza Inn, Inc. FOOD AND SUPPLY DISTRIBUTION The Company's Norco division offers substantially all of the food and paper products, equipment and other supplies necessary to operate a Pizza Inn restaurant. Franchisees are required to purchase from Norco certain food products which are proprietary to the Pizza Inn system. The vast majority of franchisees also purchase other supplies and equipment from Norco. Norco operates its central distribution facility six days per week, and it delivers to all domestic units on a weekly basis, utilizing a fleet of refrigerated tractor-trailer units operated by Company drivers and independent owner-operators. Norco also ships products and equipment to international franchisees. The food, equipment, and other supplies distributed by Norco are generally available from several sources, and 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. The Company does not anticipate any difficulty in obtaining supplies in the foreseeable future. ADVERTISING The Pizza Inn Advertising Plan ("PIAP") is a non-profit corporation which creates and produces print advertisements, television and radio commercials, and promotional materials for use by its members. Each operator of a domestic Full-Service or Delco unit, including the Company, is entitled to membership in PIAP. Nearly all of the Company's existing franchise agreements for Full-Service and Delco units require the franchisees to become members of PIAP. Members contribute 1% of their gross sales. PIAP is managed by a Board of Trustees, comprised 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. On September 8, 1997, the Company and substantially all of its domestic franchisees were members of PIAP. Operators of Express units do not participate in PIAP; however, they contribute up to 1% of their gross sales to the Company to help fund Express unit marketing materials and similar expenditures. International operators do not participate in PIAP; however, like all other franchisees, they are required to conduct local area advertising. The Company works with foreign master licensees on local advertising and reserves the right to review all such advertising before publication or broadcast. Groups of franchisees in many 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 advertising and promotions using materials developed by PIAP and the Company. The Company and its franchisees conduct independent marketing efforts in addition to their participation in PIAP and local cooperatives. TRADEMARKS AND QUALITY CONTROL The Company owns various trademarks, including the name "Pizza Inn", which are used in connection with the restaurants and have been registered with the United States Patent and Trademark Office. The duration of such trademarks is unlimited, subject to continued use. In addition, the Company has obtained trademark registrations in several foreign countries and has applied for registration in others. The Company believes that it holds the necessary rights for protection of the trademarks essential to its business. The Company requires all units to satisfy certain quality standards governing the products and services offered through use of the Company's trademarks. The Company has a staff of field representatives, whose responsibilities include periodic visits to provide advice in operational, sales building and cost control activities and to evaluate compliance with the Company's quality standards. TRAINING The Company offers training programs for the benefit of franchisees and their restaurant managers. The training programs, taught by experienced Company employees, focus on food preparation, service, cost control, sanitation, local store marketing, personnel management, and other aspects of restaurant operation. The training programs include group classes, supervised work in Company operated units and the Company's training center, and special field seminars. 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 video tapes and printed materials produced by the Company. WORKING CAPITAL PRACTICES The Company's Norco division maintains a sufficient inventory of food and other consumable supplies which it distributes to Pizza Inn units on a weekly basis, plus certain other items ordered on an irregular basis. The Company's accounts receivable consist primarily of receivables from food and supply sales and accrued franchise royalties. GOVERNMENT REGULATION The Company is subject to registration and disclosure requirements and other restrictions under federal and state franchise laws. The Company's Norco division is subject to various federal and state regulations, including those regarding transportation of goods, food labeling and distribution, and vehicle licensing. The development and operation of Pizza Inn units are subject to federal, state and local regulations, including those pertaining to zoning, public health, and alcoholic beverages, where applicable. Some restaurant employees are paid at rates related to the minimum wage established by federal and state law. Increases in the federal minimum wage can result in higher labor costs for the Company and its franchisees, which may be partially offset by price increases or operational efficiencies. EMPLOYEES On September 8, 1997, the Company had approximately 274 employees, including 64 in the Company's corporate office, 79 at its Norco division, and 57 full-time and 74 part-time employees at the Company operated restaurants. None of the Company's employees are currently covered by collective bargaining agreements. The Company believes that its employee relations are excellent. COMPETITION The restaurant business is highly competitive. The Company and its franchisees compete with other national and regional pizza chains, independent pizza restaurants, and other restaurants which serve moderately priced foods. The Company believes that Pizza Inn units compete primarily on the basis of the quality and overall value of their menu, the consistency and level of service, and the location and attractiveness of their restaurant facilities. Because of the importance of brand awareness, the Company has increased its emphasis on market penetration and cooperative advertising by franchisees. The Company's Norco division competes with both national and local distributors of food, equipment and other restaurant supplies. The distribution industry is very competitive. The Company believes that the principal competitive factors in the distribution industry are quality, service and price. Norco is the sole authorized supplier of certain proprietary products which are required to be used by all Pizza Inn units. In the sale of franchises, the Company competes with franchisors of other restaurant concepts and franchisors of a variety of other products and services. The Company believes that the principal competitive factors affecting the sale of franchises are product quality and value, consumer acceptance, franchisor experience and support, and the relationship maintained between the franchisor and its franchisees. SEASONALITY Historically, sales at Pizza Inn restaurants have been somewhat higher during the warmer months and somewhat lower during the colder months of the year. The Company believes that the increasing popularity of delivery service and expansion into the high impulse buying market of Express units should lessen the seasonal impact on future chainwide sales. ITEM 2 - PROPERTIES The Company leases 23,402 square feet in Dallas, Texas for its corporate office and 76,700 square feet in Grand Prairie, Texas for its Norco warehouse and office facilities. The leases expire in 2003 and 2001, respectively. The Company also leases 2,736 square feet in Addison, Texas for its training facility with a term expiring in 2001. On September 8, 1997, all five of the Company operated Pizza Inn restaurants (all located in Texas) were leased. The Company also owns one restaurant property which it leases to a former franchisee. The Company operated units range in size from approximately 1,000 to 4,000 square feet and incur annual minimum rent between $6.80 and $20.00 per square foot. Most of the leases require payment of additional rent based upon a percentage of gross sales and require the Company to pay for repairs, insurance and real estate taxes. ITEM 3 - LEGAL PROCEEDINGS On September 21, 1989, the Company, Pizza Inn, Inc. (a Delaware corporation) and Memphis Pizza Inns, Inc. filed for protection under the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. The plan of reorganization, as confirmed by the court, became effective on September 5, 1990. The court retained jurisdiction to help ensure that the plan of reorganization was carried out and to hear any disputes that arose during the five year term of the plan. In May 1996, the court issued its final order finding that the proceedings have been completed and closing the bankruptcy cases. On August 5, 1997, the Company entered into a settlement agreement regarding a lawsuit against Choyung International, Inc. ("Choyung") in the Seoul District Court in Korea. Pursuant to the terms of the settlement, Choyung agreed to comply with its post-termination obligations of returning all trademarks to the Company and de-identifying all former Pizza Inn restaurant locations. The Company and Choyung also entered into mutual releases and dismissed all pending litigation. Certain other pending legal proceedings exist against the Company which the Company believes are not material or have arisen in the ordinary course of its business. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the Company's fiscal year 1997.
PART II ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS On September 8, 1997, there were 3,016 stockholders of record of the Company's Common Stock. The Company's Common Stock is listed on the Small-Cap Market of the National Association of Securities Dealers Automated Quotation ("NASDAQ") system under the symbol "PZZI". The following table shows the highest and lowest bid 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. <TABLE> <CAPTION> Bid ------------------ High Low -------- ------- <S> <C> <C> 1996 First Quarter Ended 9/24/95 4 1/16 3 3/16 Second Quarter Ended 12/24/95 4 1/2 3 5/8 Third Quarter Ended 3/24/96 4 7/8 3 3/4 Fourth Quarter Ended 6/30/96 5 3/16 4 1/8 1997 First Quarter Ended 9/29/96 4 13/16 3 11/16 Second Quarter Ended 12/29/96 5 4 1/4 Third Quarter Ended 3/30/97 4 7/8 3 7/8 Fourth Quarter Ended 6/29/97 4 1/4 3 1/4 </TABLE> On August 21, 1997 the Board of Directors of the Company declared a quarterly cash dividend of $.06 per share payable October 24 to shareholders of record on October 10, 1997. 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.
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 29, 1997, and should be read in conjunction with the financial statements and schedules in Item 8 of this report. <TABLE> <CAPTION> Year Ended ---------------------------------------------------------------- June 29, June 30, June 25, June 26, June 27, 1997 1996 1995 1994 1993 --------- --------- --------- --------- ---------- (In thousands, except per share amounts) <S> <C> <C> <C> <C> <C> <C> <C> SELECTED INCOME STATEMENT DATA: Total revenues $ 69,123 $ 69,441 $ 62,044 $ 57,378 $ 53,468 Income before income taxes and extraordinary item 6,860 5,921 4,845 3,899 2,444 Income before extraordinary item 4,528 3,908 3,198 2,573 1,406 Income before extraordinary item per common share .33 .28 .22 .18 .11 Net income 4,528 3,908 3,198 2,573 2,186 (1) Income per common share .33 .28 .22 .18 .17 SELECTED BALANCE SHEET DATA: Total assets 24,310 24,419 25,803 27,234 26,018 Long-term debt and capital 7,789 7,902 11,039 14,538 15,600 lease obligations Redeemable Preferred Stock - - - - (2) 3,371 <FN> (1) Includes an extraordinary gain of $780,000 from the utilization of operating loss carryforwards. (2) During fiscal 1994, the Company redeemed all outstanding shares of Redeemable Preferred Stock in exchange for Common Stock and cash. </TABLE> ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS FISCAL 1997 COMPARED TO FISCAL 1996 Earnings per share for fiscal year ended June 29, 1997 grew 18% to $.33 from $.28. Net income increased 16% to $4.5 million from $3.9 million in the prior year. Pre-tax income also increased 16% to $6.9 million from $5.9 million. The Company considers pre-tax income to be the best measure of its performance due to the significant benefit of its net operating loss carryforwards. These carryforwards, which total $20.6 million at June 29, 1997, reduce the income taxes paid by the Company from the 34% rate expensed on its statements of operations to approximately 2%. Results of operations for fiscal 1997 include 52 weeks versus 53 weeks for fiscal 1996. The effect of the additional week on prior year revenues and net income was an increase of approximately 2%. Food and supply sales by the Company's distribution division were up slightly from last year. Increased market share on the sale of non- proprietary food, supplies and equipment offset the decrease resulting from the additional week in the prior fiscal year. Franchise revenue, which includes royalties, license fees and income from area development and foreign master license (collectively, "Territory") sales, decreased 9% or $662,000 in fiscal 1997. This was primarily due to lower income from Territory sales in the current year. Proceeds from Territory sales vary depending on size, demographics and current market development in the Territories. The timing and recognition of Territory sales may vary significantly from year to year. Current year sales include partial recognition of proceeds from the sale of new Territory rights for South Korea, the Philippines, Brazil, the Palestinian territories and Puerto Rico. Current year royalties also decreased 5% or $270,000, primarily due to the effect of the additional week of operations in fiscal 1996, as well as the closure during fiscal 1996 of all 39 units in Korea upon termination of the Company's agreement with its former master licensee. Restaurant sales, which consist of sales from Company operated training units, decreased 8% or $238,000 during the current year. This was primarily the result of the closing during the third quarter of fiscal 1996 of one of the Company operated units. Cost of sales decreased 1% during fiscal 1997. While product purchases increased as a result of slightly higher food and supply sales to the Company's franchises, this was offset by cost efficiencies in other areas. Fleet modernization and improvements in routing have reduced transportation costs, warehouse productivity is up, and the Company continues to find opportunities to improve the purchasing process. 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 costs have remained at the same level as last year. General and administrative expenses decreased 9% or $474,000 in the current year. In fiscal 1997 the Company incurred fewer legal fees related to international litigation. In addition, fiscal 1996 included a one-time charge of $95,000 to write down assets to market value at two Company operated units. Interest expense decreased 24% or $213,000 in fiscal 1997, as the result of lower debt balances and lower average interest rates. During fiscal 1997, a total of 67 new Pizza Inn franchise units were opened for business. Domestically, 31 units were closed by franchisees or terminated by the Company typically because of unsatisfactory standards of operation or performance. In addition, 20 international units were closed, including all 19 units operated by the Company's former licensee in Taiwan. FISCAL 1996 COMPARED TO FISCAL 1995 Net income for fiscal year ended June 30, 1996 increased 22% to $3.9 million from $3.2 million in the prior year. Earnings per share grew 27% to $.28 from $.22. Excluding the effect of a prior year non-recurring gain, net income increased 37% and earnings per share grew 40%. Pre-tax income increased 22% to $5.9 million from $4.8 million in the prior year. Results of operations for fiscal 1996 include fifty-three weeks versus fifty-two weeks for fiscal 1995. The effect of the additional week on fiscal 1996 revenues and net income was an increase of approximately 2%. Revenues for fiscal 1996 were up 12% to $69.4 million from $62 million in fiscal 1995. Food and supply sales grew 14% in fiscal 1996. This was partially the result of continued growth in domestic chainwide retail sales, which grew 5%. Additional factors contributing to growth in food and supply sales were increased market share on sales of non-proprietary food ingredients and equipment, as well as increases in the market price of certain commodities. Franchise revenue, which includes royalties, license fees and income from area development and foreign master license (collectively, "Territory") sales, increased 8% or $523,000 in fiscal 1996 due to higher royalties and Territory sales, partially offset by lower license fees. Fiscal 1996 Territory sales include installments on the sale of Territory rights for Arkansas, portions of Missouri, North Carolina and South Carolina, as well as the Philippines. Revenue from royalties was up due to growth in domestic retail sales and international store openings at higher effective royalty rates than existing units. The increase in revenue occurred despite the closing during fiscal 1996 of all units in Korea, which paid less than $150,000 in annual royalties. Fiscal 1996 license fees were down because more stores opened in Territories. Restaurant sales decreased $219,000 in fiscal 1996 as a result of closing one of the Company operated units that was not required for training or other purposes. Other income consists primarily of interest income and non-recurring revenue items. Other income increased because fiscal 1996 includes a lawsuit settlement and a gain on the sale of a sublease. Cost of sales increased 11% or $5.4 million in fiscal 1996. This increase is directly related to the growth in food and supply sales to the Company's franchisees. It includes the direct cost of increased product volume, as well as proportionate increases in direct transportation and warehouse costs. As a percentage of food and supply sales, cost of sales is slightly lower during fiscal 1996 due to cost improvements achieved through fleet modernization and routing efficiencies, increased labor productivity and improved buying power through volume purchasing. Franchise expenses include selling, general and administrative expenses directly related to the sale and service of franchises and Territories. These costs increased 10% or $282,000 in fiscal 1996. This increase reflects investments in additional training and field service personnel and increases in related costs of providing services to franchisees. General and administrative expenses increased 11% in fiscal 1996. This was due to the implementation of a new computer system, which resulted in additional expenses related to hardware, software, programming and support. Expenses for fiscal 1996 also include a one-time charge of $95,000 to write down assets to market value at two Company operated units. During fiscal 1995, certain sales and property tax liabilities were settled for amounts lower than estimated in previous years. A one-time credit of $531,000 ($350,000 net of tax) reflects the adjustment of the excess tax accrual. Interest expense decreased 32% or $417,000 during fiscal 1996. Average debt balances were 25% lower as the Company made $2.1 million in scheduled principal payments and $1.4 million in voluntary principal payments. The average interest rate was also slightly lower in fiscal 1996. During fiscal 1996, a total of 73 new Pizza Inn franchise units were opened for business, an 11% increase over the 66 locations opened during fiscal 1995. A total of 32 units were closed by franchisees or terminated by the Company in fiscal 1996, typically because of unsatisfactory standards of operation or poor performance, compared to 33 units in fiscal 1995. In addition, all 39 units operated by the Company's former licensee in Korea were closed during fiscal 1996, after the Company terminated the license following extensive efforts to resolve problems by mutual agreement. In September 1996, the Company granted a new license to a Seoul, Korea-based firm to be the Company's exclusive operator and subfranchisor in Korea. FINANCIAL CONDITION Cash and cash equivalents increased $1.4 million in fiscal 1997, as the Company generated cash flow from operations beyond that required for debt repayment, capital expenditures and open market purchases of the Company's own common stock. Scheduled debt payments of $2 million in the current year reduced debt from $8.9 million to $6.9 million at June 29, 1997. During fiscal 1997, the Company also used $1.9 million in working capital to acquire 421,700 shares of its own common stock at prevailing prices on the open market. At June 28, 1993, upon adoption of SFAS 109, the Company recorded a net deferred tax asset of $15.4 million, primarily representing the benefit of pre-reorganization net operating loss carryforwards which expire in 2005. The net deferred tax asset was recorded as a reduction of intangibles to the extent available ($13.7 million), and then as an increase in additional paid-in capital ($1.7 million). At June 29, 1997, the net deferred tax asset balance was $8.5 million. 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 $1.4 million related to the potential expiration of certain tax credit carryforwards. Future taxable income at the same level as fiscal 1997 would be more than sufficient for full realization of the net tax asset. Management believes that, based on recent growth trends and future projections, maintaining current levels of taxable income is achievable. Expansion of the Company's franchise base, through the sale of new franchises and Territories with agreements containing minimum required development schedules,is expected to cause future growth in the Company's royalties, franchise fees and distribution sales. These factors are expected to contribute to growth in future taxable income and should be more than sufficient to enable the Company to realize its deferred tax asset without reliance on material, non-routine income. While the Company expects to realize substantial benefit from the utilization of its net operating loss carryforwards (which currently total $20.6 million and expire in 2005) to reduce its federal tax liability, current accounting standards dictate that this benefit can not be reflected in the Company's results of operations. Carryforwards resulting from losses incurred after the Company's reorganization in September 1990 were reflected as an extraordinary item, reducing a portion of income tax expense on the statement of operations for the first three quarters of fiscal 1993. When post-reorganization carryforwards were exhausted, the Company began utilizing its pre-reorganization carryforwards, which require a different accounting treatment. In accordance with SFAS 109, these carryforwards, when utilized, are reflected as a reduction of the deferred tax asset rather than a reduction of income tax expense. Beginning in the last quarter of fiscal 1993, this has caused the Company to reflect an amount for federal income tax expense at the corporate rate of 34% on its statement of operations. This rate is significantly different from the alternative minimum tax that it actually pays (approximately 2% of taxable income). Historically, the differences between pre-tax earnings for financial reporting purposes and taxable income for tax purposes have consisted of temporary differences arising from the timing of depreciation, deductions for accrued expenses and deferred revenues, as well as permanent differences as a result of goodwill amortization deducted for financial reporting purposes but not for income tax purposes. Under the Internal Revenue Code, the utilization of net operating loss and credit carryforwards could be limited if certain changes in ownership of the Company's Common Stock were to occur. The Company's Articles of Incorporation contain certain restrictions which are intended to reduce the likelihood that such changes in ownership would occur. LIQUIDITY AND CAPITAL RESOURCES Cash provided by operations totaled $5.4 million in fiscal 1997 and was used primarily to service debt, to acquire the Company's common stock, and to fund capital expenditures. The Company reduced its term loan balance from $8.9 million at June 30, 1996 to $6.9 million at June 29, 1997. In August 1997, the Company signed an agreement with its current lender to refinance its existing debt under a new revolving credit facility. The new $9.5 million revolving credit line combines the Company's existing $6.9 million term loan with its $1 million revolving credit line, plus an additional $1.6 million revolving credit commitment. The new agreement extends through August 1999. During fiscal 1997, the Company purchased 421,700 shares of its own common stock on the open market for a total price of $1.9 million, bringing the number of shares purchased over the last three years to 1,790,416, including 662,094 shares purchased on favorable terms from a former lender. All reacquired shares will be held as treasury stock until retired. Capital expenditures during fiscal 1997 included remodels for several Company operated training restaurants, leasehold improvements for a new corporate training center and testing facility, and updating the distribution division offices. During fiscal 1997, the Company entered into leases for five new distribution trailers, which were classified as operating leases, and retired five older trailers. The Company's future requirements for cash relate primarily to debt repayment, the periodic purchase of its own common stock, capital expenditures and payment of dividends on its common stock. Although the new loan agreement does not require the Company to make any scheduled debt reductions, the Company plans to continue using excess cash to retire debt. The Company currently considers its common stock to be undervalued, and plans to continue purchasing its own shares on the open market. Anticipated capital expenditures include warehouse improvements and information systems updates. In August 1997, the Board of Directors of the Company declared a quarterly dividend on the Company's common stock. The dividends are payable in October 1997 and will require approximately $800,000 or $0.06 per share in cash. Declaration of future dividends will be at the discretion of the Board of Directors. In July 1997, the Company repurchased the area developer rights for the majority of Tennessee and Kentucky for approximately $986,000 in cash. Restaurants operating or developed in the repurchased territory will now pay all royalties and franchise fees directly to Pizza Inn, Inc. The Company's primary sources of cash are royalties, license fees and Territory sales, as well as sales from the distribution division. Existing area development and master license agreements contain development commitments that should result in future chainwide growth. Related growth in royalties and distribution sales are expected to provide adequate working capital to supply the needs described above. The signing of any new area development or master license agreements, which cannot be predicted with certainty, would also provide significant infusions of cash. ECONOMIC FACTORS The costs of operations, including labor, supplies, utilities, financing and rental costs, to the Company and its franchisees, are significantly affected by inflation and other economic factors. Increases in any such costs would result in higher costs to the Company and its franchisees, which may be partially offset by price increases and increased efficiencies in operations. The Company's revenues are also affected by local economic trends in Texas and other markets where units are concentrated. The Company intends to pursue franchise development in new markets in the United States and other countries, which would mitigate the impact of local economic factors. "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains certain projections and other forward-looking statements that are not historical facts and are subject to various risks and uncertainties, 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.
PIZZA INN, INC. ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Financial Statements and Schedules: FINANCIAL STATEMENTS PAGE NO. Report of Independent Accountants. 15 Consolidated Statements of Operations for the years ended June 29, 1997, June 30, 1996, and June 25, 1995. 16 Consolidated Balance Sheets at June 29, 1997 and June 30, 1996. 17 Consolidated Statements of Shareholders' Equity for the years ended June 29, 1997, June 30, 1996, and June 25, 1995. 18 Consolidated Statements of Cash Flows for the years ended June 29, 1997, June 30, 1996, and June 25, 1995. 19 Notes to Consolidated Financial Statements. 21 FINANCIAL STATEMENT SCHEDULES Schedule II - Consolidated Valuation and Qualifying Accounts 32 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.
REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Pizza Inn, Inc. In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Pizza Inn, Inc. (the "Company") and its subsidiaries at June 29, 1997 and June 30, 1996, and the results of their operations and their cash flows for each of the three years in the period ended June 29, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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 audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Dallas, Texas August 21, 1997
PIZZA INN, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share amounts) <TABLE> <CAPTION> Year Ended ---------------------------------- June 29, June 30, June 25, 1997 1996 1995 --------- ------------ --------- <S> <C> <C> <C> REVENUES: Food and supply sales $ 59,557 $ 58,823 $ 51,820 Franchise revenue 6,750 7,412 6,889 Restaurant sales 2,696 2,934 3,153 Other income 120 272 182 --------- ------------ --------- 69,123 69,441 62,044 --------- ------------ --------- COSTS AND EXPENSES: Cost of sales 53,744 54,273 48,881 Franchise expenses 2,978 3,019 2,737 General and administrative expenses 4,879 5,353 4,820 Non-recurring gain - - (531) Interest expense 662 875 1,292 --------- ------------ --------- 62,263 63,520 57,199 --------- ------------ --------- INCOME BEFORE INCOME TAXES 6,860 5,921 4,845 Provision for income taxes 2,332 2,013 1,647 --------- ------------ --------- NET INCOME $ 4,528 $ 3,908 $ 3,198 ========= ============ ========= NET INCOME PER COMMON SHARE $ 0.33 $ 0.28 $ 0.22 ========= ============ ========= <FN> See accompanying Notes to Consolidated Financial Statements </TABLE>
PIZZA INN, INC. CONSOLIDATED BALANCE SHEETS (In thousands) <TABLE> <CAPTION> June 29, June 30, 1997 1996 --------- --------- <S> <C> <C> ASSETS - ---------------------------------------------------- CURRENT ASSETS Cash and cash equivalents $ 2,037 $ 653 Restricted cash and short-term investments, (including $0 and $230, respectively, pledged as collateral for certain letters of credit) 295 360 Accounts receivable, less allowance for doubtful accounts of $939 and $781, respectively 6,711 5,875 Notes receivable, less allowance for doubtful accounts of $60 and $119, respectively 593 777 Inventories 2,224 1,919 Prepaid expenses and other 452 536 --------- --------- Total current assets 12,312 10,120 PROPERTY, PLANT AND EQUIPMENTS, net 2,044 1,866 PROPERTY UNDER CAPITAL LEASES, net 934 1,107 DEFERRED TAXES, net 8,492 10,687 OTHER ASSETS Long-term notes receivable, less allowance for doubtful accounts of $122 and $63, respectively 149 149 Deposits and other 379 490 --------- --------- $ 24,310 $ 24,419 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY - ---------------------------------------------------- CURRENT LIABILITIES Current portion of long-term debt $ - $ 2,000 Current portion of capital lease obligations 115 109 Accounts payable - trade 1,482 2,331 Accrued expenses 2,917 3,158 --------- --------- Total current liabilities 4,514 7,598 LONG-TERM LIABILITIES Long-term debt 6,910 6,910 Long-term capital lease obligations 879 992 Other long-term liabilities 786 813 COMMITMENTS AND CONTINGENCIES (See Note I) SHAREHOLDERS' EQUITY Common Stock, $.01 par value; 26,000,000 shares authorized; outstanding 12,713,562 and 12,876,801 shares, respectively (after deducting shares in treasury: 1997 - 1,790,416; 1996 - 1,360,567) 127 129 Additional paid-in capital 4,061 3,684 Retained earnings 7,033 4,293 --------- --------- Total shareholders' equity 11,221 8,106 --------- --------- $ 24,310 $ 24,419 ========= ========= <FN> See accompanying Notes to Consolidated Financial Statements </TABLE>
PIZZA INN, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands) <TABLE> <CAPTION> Retained Additional Earnings Common Stock Paid-In (Accumulated Shares Amount Capital Deficit) Total ------- -------- ------------ -------------- -------- <S> <C> <C> <C> <C> <C> BALANCE, JUNE 26, 1994 13,807 138 4,749 256 5,143 Stock options exercised 121 1 177 - 178 Management shares issued 18 - 49 - 49 Purchase of treasury stock (419) (4) (1,001) (161) (1,166) Net income - - - 3,198 3,198 ------- -------- ------------ -------------- -------- BALANCE, JUNE 25, 1995 13,527 135 3,974 3,293 7,402 Stock options exercised 291 3 491 - 494 Purchases of treasury stock (941) (9) (781) (2,908) (3,698) Net income - - - 3,908 3,908 ------- -------- ------------ -------------- -------- BALANCE, JUNE 30, 1996 12,877 $ 129 $ 3,684 $ 4,293 $ 8,106 Stock options exercised 267 2 503 - 505 Purchases of treasury stock (430) (4) (126) (1,788) (1,918) Net income - - - 4,528 4,528 ------- -------- ------------ -------------- --------- BALANCE, JUNE 29, 1997 12,714 $ 127 $ 4,061 $ 7,033 $11,221 ======= ======== ============ ============== ========= <FN> See accompanying Notes to Consolidated Financial Statements </TABLE>
PIZZA INN, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) <TABLE> <CAPTION> Year Ended --------------------------------------- June 29, June 30, June 25, 1997 1996 1995 ---------- ------------ ---------- <S> <C> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 4,528 $ 3,908 $ 3,198 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 707 595 500 Provision for doubtful accounts and notes receivable 110 - - Utilization of pre-reorganization net operating loss carryforwards 2,195 1,895 1,550 Non-recurring gain - - (531) Changes in assets and liabilities: Restricted cash and other short-term investments 65 (7) (64) Notes and accounts receivable (762) (1,002) (495) Inventories (305) (329) 196 Accounts payable - trade (849) 1,147 (333) Accrued expenses (94) (83) (238) Deferred franchise revenue (147) (100) (901) Prepaid expenses and other (23) 195 (125) ---------- ---------- ---------- Cash provided by operating activities 5,425 6,219 2,757 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (628) (639) (955) Proceeds from sales of assets - 84 420 ---------- ---------- ---------- Cash used for investing activities (628) (555) (535) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayments of debt (2,000) (3,479) (2,487) Proceeds from exercise of stock options 505 494 179 Purchases of treasury stock (1,918) (3,698) (1,166) ---------- ----------- ---------- Cash used for financing activities (3,413) (6,683) (3,474) ---------- ----------- ---------- Net increase (decrease) in cash and cash equivalents 1,384 (1,019) (1,252) Cash and cash equivalents, beginning of period 653 1,672 2,924 ---------- ---------- ---------- Cash and cash equivalents, end of period $ 2,037 $ 653 $ 1,672 ========== ========== ========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Year Ended ------------------------------------ June 29, June 30, June 25, 1997 1996 1995 ---------- ------------ ---------- <S> <C> <C> <C> CASH PAYMENTS FOR: Interest $ 612 $ 880 $ 1,320 Income taxes 150 110 60 NONCASH FINANCING AND INVESTING ACTIVITIES: Notes received upon sale of assets and area - - 511 development territories Capital lease obligations incurred - 477 659 <FN> See accompanying Notes to Consolidated Financial Statements </TABLE>
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 trade name "Pizza Inn ". On June 29, 1997 the Pizza Inn system consisted of 484 locations, including five Company operated units and 479 franchised units. They are currently franchised in 18 states and 19 foreign countries. Domestic units are located predominantly in the southern half of the United States, with Texas, North Carolina and Arkansas accounting for approximately 30%, 15%, and 11%, respectively, of the total. Norco Manufacturing and Distributing Company ("Norco"), a division of the Company, distributes food products, equipment, and other supplies to units 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 intercompany 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. RESTRICTED CASH AND OTHER SHORT-TERM INVESTMENTS: PIBCO, Ltd., a wholly owned insurance subsidiary of the Company, in the normal course of operations, arranged for the issuance of letters of credit to reinsurers to secure unearned premium and loss reserves. At June 29, 1997, these letters of credit were secured under the Company's revolving line of credit. At June 30, 1996, time deposits and short-term investments in the amount of $230,000 were pledged as collateral for these letters of credit. Unearned premium and 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. 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. PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment, including property under capital leases, is stated at cost less accumulated depreciation. Depreciation 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, if shorter. The useful lives of the assets range from seven to eight years. ACCOUNTS RECEIVABLE: Accounts receivable consist primarily of receivables from food and supply sales and accrued franchise royalties. The Company records a provision for doubtful receivables to allow for any amounts which may be unrecoverable. For the year ended June 29, 1997, a provision of $110,000 was included in cost of sales in the statement of operations. No provision was recorded for the years ended June 30, 1996 and June 25, 1995. 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 8% to 12%. The carrying amount of notes receivable currently approximates fair value. The Company records a provision for doubtful receivables to allow for any amounts which may be unrecoverable. No provision was recorded for the years ended June 29, 1997, June 30, 1996 and June 25, 1995. INCOME TAXES: Under SFAS 109, deferred tax assets and liabilities result from differences between the financial statement carrying amounts of existing assets and liabilities compared to their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are projected to be recovered. TREASURY STOCK: The excess of the cost of shares acquired for the treasury over par value is allocated to additional paid-in capital based on the per share amount of additional capital for all shares in the same issue, with any difference charged to retained earnings. All reacquired shares will be held in treasury until retired. DISTRIBUTION DIVISION OPERATIONS: 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." FRANCHISE 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 unit is opened. Royalties are recognized as income when earned. For the years ended June 29, 1997, June 30, 1996 and June 25, 1995, 78%, 75%, and 79%, 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. 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. Territory fees recognized as income for the years ended June 29, 1997, June 30, 1996 and June 25, 1995 were $1,154,000, $1,630,000 and $1,054,000 respectively. NON-RECURRING GAIN: During the year ended June 25, 1995, the Company settled certain sales and property tax liabilities for amounts lower than previously estimated. The excess tax accruals, which had been classified as other long-term liabilities, were reversed and recorded as a non-recurring gain in the statement of operations. NET INCOME PER COMMON SHARE: Net income per common share is computed based on the weighted average number of common and equivalent shares outstanding during each period. Common stock equivalents include shares issuable upon exercise of the Company's stock options. For the years ended June 29, 1997, June 30, 1996, and June 25, 1995, the weighted average number of shares considered to be outstanding were 13,707,249 and 14,007,380 and 14,234,431, respectively. Fully diluted earnings per share is not presented because the effect of considering any potentially dilutive securities is immaterial. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS: The carrying amounts of short-term investments, accounts and notes receivable, and debt approximate fair value. USE OF MANAGEMENT ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and related revenues and expenses and disclosure of gain and loss contingencies at the date of the financial statements. Actual results could differ from those estimates. FISCAL YEAR: The Company's fiscal year ends on the last Sunday in June. Fiscal year ended June 29, 1997 contained 52 weeks, fiscal year ended June 30, 1996 contained 53 weeks, and fiscal year ended June 25, 1995 contained 52 weeks. NEW PRONOUNCEMENTS: In June 1997, the Financial Accounting Standards Board issued SFAS 130, "Reporting Comprehensive Income", and SFAS 131, "Disclosures About Segments of an Enterprise and Related Information", which are effective for fiscal years beginning after December 15, 1997. The adoption of these pronouncements is not expected to have a significant effect on the Company.
NOTE B - PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment and assets under capital leases consist of the following (in thousands): <TABLE> <CAPTION> June 29, June 30, 1997 1996 ---------- ---------- <S> <C> <C> Property, plant and equipment: Equipment, furniture and fixtures $ 3,732 $ 3,337 Leasehold improvements 1,224 992 ---------- ---------- 4,956 4,329 Less: accumulated depreciation (2,912) (2,463) ---------- ---------- $ 2,044 $ 1,866 ========== ========== Assets under capital leases: Real Estate $ 118 $ 118 Equipment 1,396 1,396 ---------- ---------- 1,514 1,514 Less: accumulated amortization (580) (407) ---------- ---------- $ 934 $ 1,107 ========== ========== </TABLE> Depreciation and amortization expense was $707,000, $595,000 and $508,000 for the years ended June 29, 1997, June 30, 1996, and June 25, 1995, respectively. NOTE C - ACCRUED EXPENSES: Accrued expenses consist of the following (in thousands): <TABLE> <CAPTION> June 29, June 30, 1997 1996 --------- --------- <S> <C> <C> Compensation $ 1,145 $ 1,295 Taxes other than income 206 222 Insurance loss reserves 183 239 Legal and other professional fees 309 241 Deferred franchise revenue 624 772 Other 450 389 --------- --------- $ 2,917 $ 3,158 ========= ========= </TABLE> NOTE D - LONG-TERM DEBT: The following table summarizes the components of long-term debt (in thousands): <TABLE> <CAPTION> June 29, June 30, 1997 1996 ---------- ---------- <S> <C> <C> Note payable under a term loan facility $ - $ 8,910 Note payable under a revolving line of credit 6,910 - ---------- ---------- $ 6,910 $ 8,910 Less current portion - ( 2,000) ---------- ---------- $ 6,910 $ 6,910 ========== ========== </TABLE> In December 1994, the Company entered into a loan agreement (the "Loan Agreement") with two banks, in which the Company refinanced its existing indebtedness of $14 million under a term loan facility which was to mature in November 1998. The Loan Agreement also provided for a $1 million revolving credit line, which was renewable in November 1997. Interest on both the term loan and the revolving credit line was payable monthly. Interest was provided for at a rate equal to prime plus an interest rate margin from 0.5% to 1.25% or, at the Company's option, at the Eurodollar rate plus 1.25% to 2.25%. The interest rate margin was based on the Company's performance under certain financial ratio tests. A 0.5% annual commitment fee was payable on any unused portion of the revolving credit line. As of June 29, 1997, the Company's effective interest rate was 6.94% (with a Eurodollar rate basis). Principal payments on the term loan were payable quarterly, with a balloon payment due at the end of the term. The Loan Agreement contained covenants which, among other things, required the Company to satisfy certain financial ratios and restricted additional debt and payment of dividends. As of June 29, 1997, the Company was in compliance with all of its debt covenants. The indebtedness was secured by essentially all of the Company's assets. In August 1997, the Company signed a new agreement (the "New Loan Agreement") with its current lender, Wells Fargo, to refinance its existing debt under a new revolving credit facility. The new $9.5 million revolving credit line combines the Company's existing $6.9 million term loan with its $1 million revolving credit line, plus an additional $1.6 million revolving credit commitment. The revolving credit note matures in August 1999 and is secured by essentially all of the Company's assets. Interest on the revolving credit line is payable monthly. Interest is provided for at a rate equal to prime plus an interest rate margin from -1.0% to 0.0% or, at the Company's option, at the Eurodollar rate plus 1.25% to 2.25%. The interest rate margin is based on the Company's performance under certain financial ratio tests. A 0.5% annual commitment fee is payable on any unused portion of the revolving credit line. The New Loan Agreement contains covenants which, among other things, require the Company to satisfy certain financial ratios and restrict additional debt. In accordance with SFAS 6, "Classification of Short-Term Obligations Expected to be Refinanced", the entire balance outstanding under the Loan Agreement at June 29, 1997 has been classified as long-term to reflect the provisions of the New Loan Agreement. NOTE E - INCOME TAXES: As discussed in Note A, the Company adopted SFAS 109, "Accounting for Income Taxes", effective June 28, 1993, which changed its method of accounting for income taxes from the deferred method to the liability method. The cumulative effect of adoption of SFAS 109 was a balance sheet benefit of $15.4 million. At June 29, 1997, the deferred tax asset balance was $8.5 million. Income tax expense for the three years ended June 29, 1997, June 30, 1996, and June 25, 1995, is computed by applying the applicable U.S. corporate income tax rate of 34% to net income before income taxes. Income tax expense consists of the following(in thousands): <TABLE> <CAPTION> Year Ended ------------------------------- June 29, June 30, June 25, 1997 1996 1995 --------- --------- --------- <S> <C> <C> <C> Federal: Current $ 137 $ 118 $ 97 Deferred 2,195 1,895 1,550 --------- --------- --------- Provision for income taxes $ 2,332 $ 2,013 $ 1,647 ========= ========= ========= </TABLE> The tax effects of temporary differences which give rise to the net deferred tax assets (liabilities) consisted of the following (in thousands): <TABLE> <CAPTION> Year Ended ------------------------ June 29, June 30, 1997 1996 ---------- ---------- <S> <C> <C> Reserve for bad debt $ 422 $ 368 Depreciable assets 423 378 PIBCO reserves 84 113 Deferred fees 204 261 Other reserves (221) (6) NOL carryforwards 7,013 9,130 Credit carryforwards 1,944 1,820 ---------- ---------- Gross deferred tax asset $ 9,869 $ 12,064 Valuation allowance (1,377) (1,377) ---------- ---------- Net deferred tax asset $ 8,492 $ 10,687 ========== ========== </TABLE> As of June 29, 1997, the Company had $20.6 million of net operating loss carryforwards that expire in 2005. The Company also had $1.5 million of general business credit carryforwards expiring between 1998 and 2001 and $444,000 of minimum tax credits that can be carried forward indefinitely. The valuation allowance was established upon adoption of SFAS 109, since it is more likely than not that a portion of the general business credit carryforwards will expire before they can be utilized. Under the Internal Revenue Code, the utilization of net operating loss and credit carryforwards could be limited if certain changes in ownership of the Company's Common Stock were to occur. The Company's Articles of Incorporation contain certain restrictions which are intended to reduce the likelihood that such changes in ownership would occur. NOTE F - LEASES: All of the real property occupied by the Company operated restaurants is leased for initial terms ranging from five to 25 years with renewal options ranging from five to 15 years. Most of the lease agreements contain either provisions requiring additional rent if sales exceed specified amounts, or escalation clauses based on changes in the Consumer Price Index. The Company leases 23,402 square feet in Dallas, Texas for its corporate office and 76,700 square feet in Grand Prairie, Texas for its Norco warehouse and office facilities. The leases expire in 2003 and 2001, respectively. The Company also leases 2,736 square feet in Addison, Texas for its training facility with a term expiring in 2001. The Company's distribution division currently leases a significant portion of its transportation equipment under 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 29, 1997 are as follows (in thousands): <TABLE> <CAPTION> Capital Operating Leases Leases --------- ---------- <S> <C> <C> 1998 $ 193 $ 806 1999 193 723 2000 193 712 2001 193 581 2002 310 475 Thereafter 222 480 --------- ---------- $ 1,304 $ 3,777 ========== Less amount representing interest (310) --------- Present value of total obligations under capital leases 994 Less current portion (115) --------- Long-term capital lease obligations $ 879 ========= </TABLE> Rental expense consisted of the following (in thousands): <TABLE> <CAPTION> Year Ended ------------------------------------- June 29, June 30, June 25, 1997 1996 1995 ------------ ------------ ------------ <S> <C> <C> <C> Minimum rentals $ 1,117 $ 1,068 $ 1,053 Contingent rentals 11 11 8 Sublease rentals (90) (127) (166) ------------ ------------ ------------ $ 1,038 $ 952 $ 895 ============ ============ ============ </TABLE> NOTE G - EMPLOYEE BENEFITS: The Company has a tax advantaged savings plan which is designed to meet the requirements of Section 401(k) of the Internal Revenue 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. The plan provides that participating employees may elect to have between 1% and 15% of their compensation deferred and contributed to the plan. Effective January 1, 1993, the Company contributes on behalf of each participating employee an amount equal to 50% of the first 3% and 25% of next 3% of the employee's contribution. Separate accounts are maintained with respect to contributions made on behalf of each participating employee. The plan is subject to the provisions of the Employee Retirement Income Security Act and is a profit sharing plan as defined in Section 401 of the Code. The Company is the administrator of the plan. Employees may direct investment of all contributions to a variety of funds or to purchase shares of Common Stock of the Company. For the years ended June 29, 1997, June 30, 1996 and June 25, 1995, total matching contributions to the tax advantaged savings plan by the Company on behalf of participating employees were $58,774, $60,394 and $56,738, respectively. NOTE H - STOCK OPTIONS: On September 1, 1992, the Company adopted the 1992 Stock Award Plan (the "1992 Plan"). All officers, employees and elected outside directors are eligible to participate. The Company's 1992 Plan is a combined nonqualified stock option and stock appreciation rights arrangement. A total of two million shares of Pizza Inn, Inc. Common Stock were originally authorized to be awarded under the 1992 Plan. A total of 973,073 options were actually granted under the 1992 Plan through December 1993. 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 are eligible to receive stock options under the 1993 Plan. Options are granted at market value of the stock on the date of grant, are subject to various vesting and exercise periods, and may be designated as incentive options (permitting the participant to defer resulting federal income taxes). A total of two million shares of Common Stock were originally authorized to be issued under the 1993 Plan. In December 1996, the Company's shareholders approved an amendment to the 1993 plan increasing by 500,000 shares the aggregate number of shares of common stock issuable under the plan. The 1993 Outside Directors Stock Award Plan (the "1993 Directors Plan") was also adopted by the Company effective as of October 13, 1993. Directors who are not employed by the Company are eligible to receive stock options under the 1993 Directors Plan. Options are granted, up to 20,000 shares per year, to each outside director who purchased a matching number of shares of Common Stock of the Company during the preceding year. Options are granted at market value of the stock on the first day of the fiscal year, which is also the date of grant, and are subject to various vesting and exercise periods. A total of 200,000 shares of Company Common Stock are authorized to be issued pursuant to the 1993 Directors Plan. During the year ended June 25, 1995, the Company canceled certain employee options and granted replacement options at the then current market value of the stock. In December 1994 and June 1995, 781,500 and 1,446,500 of these options, respectively, were canceled and an equal number were granted. These transactions are reflected in shares granted and in shares canceled in the schedule below. A summary of stock option transactions under both of the Company's stock option plans and information about fixed-price stock options follows: Summary of Stock Option Transactions <TABLE> <CAPTION> June 29, 1997 June 30, 1996 June 25, 1995 ------------------------ ----------------------- -------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ----------- ---------- ----------- ------------ ------------ ----------- <S> <C> <C> <C> <C> <C> <C> Outstanding at beginning of year 2,608,356 $ 2.82 2,181,073 $ 2.22 1,563,573 $ 2.68 Granted 876,783 3.56 781,283 4.06 3,053,500 2.68 Exercised (266,500) 1.90 (291,500) 1.70 (121,000) 1.47 Canceled (75,000) 3.74 (62,500) 2.50 (2,315,000) 3.18 ----------- ----------- ------------- Outstanding at end of year 3,143,639 $ 3.08 2,608,356 $ 2.82 2,181,073 $ 2.22 =========== ========== ========== =========== ============= ============ Exercisable at end of year 2,076,856 $ 2.84 1,625,856 $ 2.27 608,073 $ 1.41 Weighted-average fair value of options granted during the year $ .89 $ 1.21 Fixed Price Stock Options Options Outstanding Options Exercisable ----------------------------------------------- ------------------------------------ <S> <C> <C> <C> <C> <C> Weighted- Average Shares Remaining Weighted- Shares Weighted- Range of Outstanding Contractual Average Exercisable Average Exercise Prices at 6/29/97 Life(Years) Exercise Price at 6/29/97 Exercise Price - ------------------ ------------- -------------- ---------------- -------------- ----------------- <S> <C> <C> <C> <C> <C> $ 1.13 - $2.25 226,250 0.86 $ 1.26 226,250 $ 1.26 $ 1.75 - $3.94 20,323 2.48 3.87 20,323 3.87 $ 2.50 - $3.25 1,312,783 2.88 2.52 1,242,783 2.53 $ 2.69 - $4.13 707,500 5.52 4.09 587,500 4.08 $ 3.44 - $4.63 876,783 6.73 3.56 0 - ------------ -------------- $ 1.13 - $4.63 3,143,639 4.40 $ 3.08 2,076,856 $ 2.84 ============ ============== </TABLE> 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 1996 and 1997 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rates ranging from 5.5% to 6.5%, expected volatility of 43.9% to 50.8%, expected dividend yield of 5.2% to 8.9% and expected lives of 2 to 6 years. For purposes of pro forma disclosures, the estimated fair value of the stock options is amortized over the options vesting periods. The Company's pro forma information follows (in thousands except for earnings per share information): <TABLE> <CAPTION> June 29, 1997 June 30, 1996 ------------------------ ------------------------ As Reported Pro Forma As Reported Pro Forma ----------- --------- ----------- --------- <S> <C> <C> <C> <C> Net Income $ 4,528 $ 3,981 $ 3,908 $ 3,891 Earnings Per Share $ 0.33 $ 0.29 $ 0.28 $ 0.28 </TABLE> The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts as the pro forma amounts above do not include the impact of stock option awards granted prior to June 25, 1995, and additional awards are anticipated in future years. NOTE I - COMMITMENTS AND CONTINGENCIES: The Company is subject to various claims and contingencies related to employment agreements, lawsuits, taxes, food product purchase contracts and other matters arising in the normal course of business. Management believes that any liabilities arising from these claims and contingencies are either covered by insurance or would not have a material adverse effect on the Company's annual results of operations or financial condition. NOTE J - RELATED PARTIES: One of the individuals nominated by the Company and elected to serve on its Board of Directors is a franchisee. This franchisee currently operates a total of 20 restaurants located in Arkansas, Texas and Missouri. Purchases by this franchisee made up 7% of the Company's food and supply sales in fiscal 1997. Royalties and license fees from this franchisee made up 4% of the Company's franchise revenues in fiscal 1997. As franchised units, his restaurants pay royalties to the Company and purchase a majority of their food and supplies from the Company's distribution division. The Company believes the above transactions were at the same prices and on the same terms available to non-related third parties. NOTE K - TREASURY STOCK: In January 1995, the Company implemented an odd lot buy-back program, in which the Company offered to purchase its Common Stock for $3.50 per share from shareholders who owned less than 100 shares. The program was implemented in order to reduce future administrative costs related to small shareholder accounts. The program, which was completed in March 1995, resulted in the purchase of 18,898 shares from 675 shareholders, at a total cost of $66,143. On April 28, 1995, the Company signed an agreement to purchase 662,094 shares of its Common Stock held by a former lender. Under the terms of the agreement, the Company paid $1,100,000 to purchase 400,000 of the shares on April 28, 1995. The Company had the option to purchase the remaining 262,094 shares for a price of $596,285 on or before June 30, 1995, or for a price of $720,758 between July 1 and September 30, 1995. On June 30, 1995, the Company exercised its option to purchase the remaining 262,094 shares for a price of $596,285. These common shares had been issued to the former lender in September 1993, in exchange for 1,655,235 shares of the Company's redeemable preferred stock. The redeemable preferred stock had been issued during the period of September 1990 through August 1992, in lieu of $1,655,235 in interest payments on the Company's term loan. In July 1996, in order to further reduce future administrative costs related to small shareholder accounts, the Company implemented another odd lot buy-back program to purchase Common Stock for $5.25 per share from shareholders who own less than 100 shares. Under this program, the Company purchased 8,149 shares at a total cost of $42,782. For the period of September 1995 through June 1997, the Company purchased 1,100,700 shares of its own Common Stock from time to time on the open market at a total cost of $5 million. The purchases of common shares described above were funded from working capital, and reduced the Company's outstanding shares by approximately 12%. The Company plans to retire the shares at the earliest opportunity. NOTE L - EARNINGS PER SHARE: In February 1997, the Financial Accounting Standards Board issued SFAS 128, "Earnings per Share", which is effective for financial statements issued for periods ending after December 15, 1997, including interim periods. Effective December 28, 1997, the Company will adopt SFAS 128, which establishes standards for computing and presenting earnings per share (EPS). The statement requires dual presentation of basic and diluted EPS on the face of the income statement for entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation, to the numerator and denominator of the diluted EPS calculation. 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 into or resulted in the issuance of common stock that then shared in the earnings of the entity. The pro forma EPS amounts shown below have been calculated assuming the Company had already adopted the provisions of this statement. <TABLE> <CAPTION> Year Ended ---------------------------------------- June 29, June 30, June 25, 1997 1996 1995 ------------ ------------ ------------ <S> <C> <C> <C> Basic EPS $ .35 $ .30 $ .24 Diluted EPS .33 .28 .22 </TABLE> NOTE M - SUBSEQUENT EVENTS (UNAUDITED): In July 1997, the Company repurchased the area development rights for the majority of Tennessee and Kentucky, for a cash price of $986,000. Restaurants operating or developed in the repurchased territory will now pay all royalties and franchise fees directly to Pizza Inn, Inc. In August 1997, the Company's Board of Directors declared a quarterly dividend of $0.06 per share on the Company's common stock, payable October 24, 1997 to shareholders of record on October 10, 1997. NOTE N - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED): The following summarizes the unaudited quarterly results of operations for the fiscal years ended June 29, 1997 and June 30, 1996 (in thousands, except per share amounts): <TABLE> <CAPTION> Quarter Ended ---------------------------------------------------- September 29, December 29, March 30, June 29, 1996 1996 1997 1997 -------------- ------------- ---------- --------- <S> <C> <C> <C> <C> FISCAL YEAR 1997 Revenues $ 17,734 $ 17,559 $ 16,503 $ 17,327 Gross Profit 2,140 2,077 2,159 2,133 Net Income 996 1,165 1,076 1,291 Primary earnings per share 0.07 0.08 0.08 0.10 on net income Quarter Ended ---------------------------------------------------- September 24, December 24, March 24, June 30, 1995 1995 1996 1996 -------------- ------------- ---------- --------- <S> <C> <C> <C> <C> FISCAL YEAR 1996 Revenues $ 16,152 $ 16,894 $ 16,557 $ 19,838 Gross Profit 1,629 1,758 1,788 2,309 Net Income 793 975 920 1,220 Primary earnings per share 0.06 0.07 0.07 0.09 on net income </TABLE>
<TABLE> SCHEDULE II PIZZA INN, INC. CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS (In thousands) <CAPTION> Additions ----------------------- Balance at Charged to Charged to Balance at beginning cost and other end of period expense accounts Deductions (1) of period ----------- ----------- ----------- --------------- ----------- <S> <C> <C> <C> <C> <C> YEAR ENDED JUNE 29, 1997 Allowance for doubtful $ 963 $ 110 $ - $ (48) $ 1,121 accounts and notes YEAR ENDED JUNE 30, 1996 Allowance for doubtful 1,318 - - 355 $ 963 accounts and notes YEAR ENDED JUNE 25, 1995 Allowance for doubtful 1,386 - - 68 $ 1,318 accounts and notes <FN> (1) Write-off of receivables, net of recoveries. </TABLE>
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There are no events to report under this item. PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is included in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A in connection with the Company's annual meeting of shareholders to be held in December 1997 (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 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.
PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON 8-K 1. The financial statements filed as part of this report are listed in the Index to Financial Statements and Schedules under Part II, Item 8 of this Form 10-K. 2. The financial statement schedules filed as part of this report are listed in the Index to Financial Statements and Schedules under 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 30, 1993 (filed as Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended June 27,1993 and incorporated herein by reference). 4.1 Provisions regarding Common Stock in Article IV of the Restated Articles of Incorporation, as amended (filed as Exhibit 3.1 to this Report 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 Loan Agreement among the Company and Wells Fargo (Texas), N.A. dated August 28, 1997. 10.2 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). 10.3 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). 10.4 Employment Agreement between the Company and C. Jeffrey Rogers dated July 1, 1994 (filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K for the fiscal year ended June 26, 1994 and incorporated herein by reference).* 10.5 Form of Executive Compensation Agreement between the Company and certain executive officers (filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended June 26, 1994 and incorporated herein by reference).* 10.6 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).* 10.7 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).* 10.8 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).* 11.0 Computation of Net Income Per Share. 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). 23.0 Consent of Independent Accountants. * Denotes a management contract or compensatory plan or arrangement filed pursuant to Item 14 (c) of this report. (b) No reports were filed on Form 8-K during the fourth quarter of the Company's fiscal year 1997.
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 26, 1997 By: /s/ Elizabeth D. Reimer Elizabeth D. Reimer Controller and Treasurer (Principal Accounting 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/Steve A. Ungerman September 26, 1997 Steve A. Ungerman Director and Chairman of the Board /s/C. Jeffrey Rogers September 26, 1997 C. Jeffrey Rogers Director, Vice Chairman, President and Chief Executive Officer (Principal Executive Officer) /s/Don G. Navarro September 26, 1997 Don G. Navarro Director /s/Ramon D. Phillips September 26, 1997 Ramon D. Phillips Director /s/F. Jay Taylor September 26, 1997 F. Jay Taylor Director /s/Bobby L. Clairday September 26, 1997 Bobby L. Clairday Director /s/Ronald W. Parker September 26, 1997 Ronald W. Parker Director, Executive Vice President and Chief Operating Officer (Principal Financial Officer)