| PIZZA INN INC /MO/ ITEM 1A RISK FACTORS In addition to the other information contained in this report, the following risks may affect us |
| Our business, financial condition, cash flows or results of operations could be materially and adversely affected by any of these risks |
| Risks Associated with Ongoing Operations As a result of losses in recent quarters, our financial condition has been materially weakened and our liquidity has decreased |
| We have incurred losses of dlra490cmam000, dlra601cmam000, dlra477cmam000, and dlra4cmam421cmam000 in the first, second, third, and fourth quarters, respectively, of the fiscal year ended June 25, 2006 |
| As a result, our financial condition has been materially weakened and our liquidity diminished, and we remain vulnerable both to unexpected events (such as a sudden spike in block cheese prices or fuel prices) and to general declines in our operating environment (such as that resulting from significantly increased competition) |
| We are in default under our loan agreement, which has reduced available borrowing capacity under our revolving credit line and resulted in diminished liquidity |
| Since September 2005 we have been in default of our loan agreement with Wells Fargo Bank for on-going violations of certain financial ratio covenants in the loan agreement |
| As a result, Wells Fargo has reduced the availability of revolving credit loans under the loan agreement from dlra6cmam000cmam000 to dlra2cmam250cmam000 |
| The reduction in available borrowing capacity may diminish our cash flow and liquidity positions and adversely affect our ability to (i) meet our new restaurant development goals, and (ii) effectively address competitive challenges and adverse operating and economic conditions |
| On August 14, 2006, we entered into a limited forbearance agreement, with Wells Fargo under which Wells Fargo agreed to forbear until October 1, 2006 from exercising its rights and remedies as a result of our existing defaults under the revolving credit loan agreement, provided that the aggregate principal amount of all such revolving credit loans does not exceed dlra2cmam250cmam000 at any one time |
| Wells Fargo and we entered into the forbearance agreement to provide us with time to pursue discussions with Wells Fargo regarding various possible options for refinancing our indebtedness and liabilities to Wells Fargo under the revolving credit loan agreement |
| The limited forbearance agreement has not been extended beyond October 1, 2006 |
| As of September 20, 2006, our consolidated long-term indebtedness was dlra7dtta9 million, the full amount of which has been reclassified on our balance sheet as current debt since December 25, 2005 as a result of our on-going loan default |
| Our indebtedness and the fact that a portion of our reduced cash flow from operations must be used to make principal and interest payments on our indebtedness could have important consequences to us |
| For example, they could: • make it more difficult for us to satisfy our obligations with respect to our loan agreement; • increase our vulnerability to general adverse economic and industry conditions; • reduce the availability of our cash flow for other purposes; • limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, thereby placing us at a competitive disadvantage compared to our competitors that may have less debt; and • limit, by the financial and other restrictive covenants in our loan agreement, our ability to borrow additional funds |
| Payments we are required to make under a settlement agreement with our former president and chief executive officer could result in diminished liquidity and cash flow positions |
| On September 24, 2006, we entered into a settlement agreement with Ronald W Parker, our former president and chief executive officer, relating to the arbitration actions filed by the Company and Mr |
| Under the settlement agreement, we are obligated to pay Mr |
| Parker dlra2dtta8 million through a structured payment schedule beginning on the date of the settlement with the final payment of dlra2dtta05 million to be paid within 180 days of the date of the settlement |
| All payments under the settlement agreement would automatically and immediately become due and payable upon any sale lease-back transaction involving our corporate headquarters office and distribution facilities |
| These payments will reduce the availability of our cash flow for other purposes, limit our flexibility in planning for, or reacting to, changes in our business and industry, and alter or postpone implementation of our growth strategy |
| We expect to be able to fund the payments under the settlement agreement by utilizing available equity in our corporate headquarters office and distribution facilities to refinance existing mortgage debt on that property and/or engage in a sale lease-back transaction for that property |
| We may not be able to realize sufficient value from our real estate assets or otherwise be able to fund the payments under the settlement agreement |
| If we are not able to fund the payments under the settlement agreement or obtain financing, or enter into a sale lease-back transaction, on terms reasonably satisfactory to us, then our liquidity, financial condition, business, and results of operations may be materially adversely affected |
| If we do not prevail in litigation with a former beverage supplier, we could be liable for significant monetary damages |
| An adverse outcome in our litigation with PepsiCo, Inc |
| could result in a liability of approximately dlra2dtta6 million, which could materially adversely affect our liquidity, financial position and results of operation |
| No accrual for any amount of potential liability for this matter has been made as of June 25, 2006 |
| We also face risks of litigation from customers, franchisees, employees and others in the ordinary course of business, which diverts our financial and management resources |
| Any adverse litigation or publicity may negatively impact our financial condition and results of operations |
| Claims of illness or injury relating to food quality or food handling are common in the food service industry |
| In addition to decreasing our sales and profitability and diverting our management resources, adverse publicity or a substantial judgment against us could negatively impact our financial condition, results of operations and brand reputation, hindering our ability to attract and retain franchisees and grow our business |
| Further, we may be subject to employee, franchisee and other claims in the future based on, among other things, discrimination, harassment, wrongful termination and wage, rest break and meal break issues, including those relating to overtime compensation |
| If one or more of these claims were to be successful or if there is a significant increase in the number of these claims, our business, financial condition and operating results could be harmed |
| 9 _________________________________________________________________ [44]Table of Contents If we are not able to implement our growth strategy successfully, which includes opening new domestic Buffet Units and reimaging existing restaurants, our ability to increase our revenues and operating profits could be materially adversely affected |
| A significant component of our growth strategy for developing new domestic franchised and Company-owned restaurants is the implementation of our new prototype Buffet Unit concept |
| We and our franchisees face many challenges in opening new restaurants, including, among other things, selection and availability of suitable restaurant locations and suitable employees, increases in food, paper, labor, utilities, fuel, employee benefits, insurance and similar costs, negotiation of suitable lease or financing terms, constraints on permitting and construction of restaurants, higher than anticipated construction costs, the hiring, training and retention of management and other personnel and securing required domestic or foreign governmental permits and approvals |
| The opening of additional franchise restaurants also depends, in part, upon the availability of prospective franchisees who meet our criteria |
| Our new concept development program may require considerable management time as well as start-up expenses for franchisee recruitment and training and market development before any significant revenues and earnings are generated |
| Accordingly, we may not be able to meet planned growth targets, open restaurants in markets now targeted for expansion or operate profitably in existing markets |
| In addition, even if we are able to continue to open new restaurants, we may not be able to keep restaurants from closing at a faster rate than we are able to open restaurants |
| An increase in the cost of cheese or other commodities, including fuel and labor, could adversely affect our profitability and operating results |
| An increase in our operating costs could adversely affect our profitability |
| Factors such as inflation, increased food costs, increased labor and employee benefit costs and increased energy costs may adversely affect our operating costs |
| Most of the factors affecting costs are beyond our control and, in many cases, we may not be able to pass along these increased costs to our customers or franchisees even if we attempted to do so |
| Most ingredients used in our pizza, particularly cheese, are subject to significant price fluctuations as a result of seasonality, weather, availability, demand and other factors |
| Sustained increases in fuel and utility costs could adversely affect the profitability of our restaurant and distribution businesses |
| Labor costs are largely a function of the minimum wage for a majority of our restaurant and distribution center personnel and, generally, are a function of the availability of labor |
| Further government initiatives, such as proposed minimum wage rate increases, could adversely affect us as well as the restaurant industry in general |
| Shortages or interruptions in the delivery of food products could adversely affect our operating results |
| We, and our franchisees, are dependent on frequent deliveries of food products that meet our specifications |
| Our Company-owned domestic restaurants purchase substantially all food and related products from our distribution division, Norco |
| Domestic franchisees are only required to purchase the flour mixture, spice blend and certain other items from Norco, and changes in purchasing practices by domestic franchisees as a result of delivery disruptions or otherwise could adversely affect the financial results of our distribution operation |
| Interruptions in the delivery of food products caused by unanticipated demand, problems in production or distribution by Norco, our suppliers, or our distribution service providers, inclement weather (including hurricanes and other natural disasters) or other conditions could adversely affect the availability, quality and cost of ingredients, which would adversely affect our operating results |
| If we are not able to continue purchasing our key pizza ingredients from our current suppliers or find suitable replacement suppliers our financial results could be materially adversely affected |
| We are dependent on a few suppliers for our key ingredients |
| Domestically, we rely upon sole suppliers for our cheese, flour mixture and certain other key ingredients |
| Alternative sources for these ingredients may not be available on a timely basis to supply these key ingredients or be available on terms as favorable to us as under our current arrangements |
| Any disruptions in our supply of key ingredients could adversely affect our operations |
| 10 _________________________________________________________________ [45]Table of Contents We are subject to extensive government regulation, and any failure to comply with existing or increased regulations could adversely affect our business and operating results |
| We are subject to numerous federal, state, local and foreign laws and regulations, including those relating to: • the preparation and sale of food; • building and zoning requirements; • minimum wage, citizenship, overtime and other labor requirements; • compliance with the Americans with Disabilities Act; and • working and safety conditions |
| If we fail to comply with existing or future laws and regulations, we may be subject to governmental or judicial fines or sanctions |
| In addition, our capital expenditures could increase due to remediation measures that may be required if we are found to be noncompliant with any of these laws or regulations |
| We are also subject to a Federal Trade Commission rule and to various state and foreign laws that govern the offer and sale of franchises |
| These laws regulate various aspects of the franchise relationship, including terminations and the refusal to renew franchises |
| The failure to comply with these laws and regulations in any jurisdiction or to obtain required government approvals could result in a ban or temporary suspension on future franchise sales, fines or other penalties, or require us to make offers of rescission or restitution, any of which could adversely affect our business and operating results |
| Our earnings and business growth strategy depends on the success of our franchisees, and we may be harmed by actions taken by our franchisees that are outside of our control |
| A significant portion of our earnings comes from royalties generated by our franchised restaurants |
| Franchisees are independent operators whose employees are not our employees |
| We provide limited training and support to franchisees, but the quality of franchised restaurant operations may be diminished by any number of factors beyond our control |
| Consequently, franchisees may not successfully operate restaurants in a manner consistent with our standards and requirements, or may not hire and train qualified managers and other store personnel |
| If they do not, our image and reputation may suffer, and revenues could decline |
| Our franchisees may take actions that adversely affect the value of our intellectual property or reputation |
| Our domestic and international franchisees may not operate their franchises successfully |
| If one or more of our key franchisees were to become insolvent or otherwise were unable or unwilling to pay us our royalties, our business and results of operations would be adversely affected |
| Loss of key personnel or our inability to attract and retain new qualified personnel could hurt our business and inhibit our ability to operate and grow successfully |
| Our success will depend to a significant extent on our leadership team and other key management personnel |
| We may not be able to retain our executive officers and key personnel or attract additional qualified management |
| Our success also will depend on our ability to attract and retain qualified personnel to oversee our restaurants, distribution operations and international operations |
| The loss of these employees or any inability to recruit and retain qualified personnel could have a material adverse effect on our operating results |
| Our current insurance coverage may not be adequate, our insurance premiums may increase and we may not be able to obtain insurance at acceptable rates, or at all |
| Our insurance policies may not be adequate to protect us from liabilities that we incur in our business |
| In addition, in the future our insurance premiums may increase and we may not be able to obtain similar levels of insurance on reasonable terms, or at all |
| Any such inadequacy of, or inability to obtain, insurance coverage could have a material adverse effect on our business, financial condition and results of operations |
| 11 _________________________________________________________________ [46]Table of Contents The Company’s management has concluded that the Company’s disclosure controls and procedures are not effective, and that a material weakness in financial reporting existed at June 25, 2006 as a result of recent turnover in its accounting staff and reassignment of responsibilities among remaining staff, which may affect the Company’s ability to accurately and timely complete and file its financial statements |
| If the Company is not able to accurately and timely complete its financial statements and file the reports required under Section 13 or 15(d) of the Exchange Act, the Company could face SEC or NASDAQ inquiries, its stock price may decline, and/or its financial condition could be materially adversely affected |
| The Company’s management has concluded that its disclosure controls and procedures were not effective as of the end of the period covered by this report and that this ineffectiveness, which created a material weakness, resulted primarily from recent, significant turnover in the Company’s accounting staff, including in the positions of chief financial officer and controller, and reassignment of responsibilities among remaining accounting staff, during the fiscal year ended June 25, 2006 |
| The Company believes that the accounting staff turnover and reassignment of responsibilities, and the resulting ineffectiveness of the Company’s disclosure controls and procedures, may adversely affect the Company’s ability to accurately and timely complete its financial statements |
| Risks Associated With Our Common Stock Even though our common stock is currently traded on the Nasdaq Capital Market, it has less liquidity than the stock of many other companies quoted on the NASDAQ Stock Market’s Global Market or on a national securities exchange |
| The trading volume in our common stock on the Nasdaq Capital Market has been relatively low when compared with larger companies listed on the Nasdaq Global Market or the other stock exchanges |
| Shareholders, therefore, may experience difficulty selling a substantial number of shares for the same price at which shareholders could sell a smaller number of shares |
| We cannot predict the effect, if any, that future sales of our common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of our common stock |
| Sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, may cause the price of our common stock to decline or impair our future ability to raise capital through sales of our common stock |
| The market price of our common stock may fluctuate in the future, and these fluctuations may be unrelated to our performance |
| General market price declines or overall market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices |
| Risks Associated With Our Industry If we are not able to compete effectively, our business, sales and earnings could be materially adversely affected |
| The restaurant industry in general, as well as the pizza segment of the industry, is intensely competitive, both internationally and domestically, with respect to price, service, location and food quality |
| We compete against many regional and local businesses |
| There are many well-established competitors with substantially greater brand awareness and financial and other resources than we have |
| Some of these competitors may be better established in markets where restaurants we operate or that are operated by our franchisees are, or may be, located |
| Experience has shown that a change in the pricing or other marketing or promotional strategies, including new product and concept developments, of one or more of our major competitors can have an adverse impact on sales and earnings and our chainwide restaurant operations |
| We could also experience increased competition from existing or new companies in the pizza segment of the restaurant industry |
| If we are unable to compete, we could experience downward pressure on prices, lower demand for our products, reduced margins, the inability to take advantage of new business opportunities and the loss of market share, all of which would have a material adverse effect on our operating results |
| 12 _________________________________________________________________ [47]Table of Contents We also compete on a broader scale with quick service, fast casual and other international, national, regional and local restaurants |
| The overall food service market and the quick service restaurant sector are intensely competitive with respect to food quality, price, service, convenience and concept |
| We also compete within the food service market and the restaurant industry for management and hourly employees, suitable real estate sites and qualified franchisees |
| Norco is also subject to competition from outside suppliers |
| If other suppliers who meet our qualification standards were to offer lower prices or better service to our franchisees for their ingredients and supplies and, as a result, our franchisees chose not to purchase from Norco, our financial condition, business and results of operations would be adversely affected |
| Changes in consumer preferences and perceptions could decrease the demand for our products, which would reduce sales and harm our business |
| Restaurant businesses are affected by changes in consumer tastes, national, regional and local economic conditions, demographic trends, disposable purchasing power, traffic patterns and the type, number and location of competing restaurants |
| For example, if prevailing health or dietary preferences cause consumers to avoid pizza and other products we offer, or quick service restaurant offerings generally, in favor of foods that are perceived as more healthy, our business and operating results would be harmed |