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  **SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D. C. 20549****FORM 10-K**(Mark One)   þ **Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934******For the fiscal year ended June 24, 2007.****   o **Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934****For the transition period from                      to                     .****Commission File Number 0-12919****PIZZA INN, INC.**(Exact name of registrant as specified in its charter)   **Missouri** **47-0654575****(State or jurisdiction of** **(I.R.S. Employer****incorporation or organization)** **Identification No.)**   **3551 Plano Parkway**  **The Colony, Texas** **75056**(Address of principal executive offices) (Zip Code)Registrant’s telephone number, including area code: **(469) 384-5000**Securities registered pursuant to Section 12(b) of the Act:   Title of class Name of each exchange on which registered**Common stock, par value $.01 each** **NASDAQ Capital Market**Securities registered pursuant to Section 12(g) of the Act: **None**     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule405 of the Securities Act. Yes o No þ     Indicate by check mark if the registrant is not required to file reports pursuant to Section13 or Section 15(d) of the Act. Yes o No þ     Indicate by check mark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes þ No o     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. o     Indicate by check mark whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer” and “large acceleratedfiler” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer o      Accelerated filer o      Non-accelerated filer þ     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 ofthe Act). Yes o No þ     As of December 22, 2006, the last business day of the registrant’s most recently completedsecond fiscal quarter, the aggregate market value of the voting and non-voting common equity heldby non-affiliates was $18,350,674 computed by reference to the closing price at which the commonequity was last sold, or the average bid and asked price of such common equity, as of the lastbusiness day of the registrant’s most recently completed second fiscal quarter.     As of September 21, 2007, there were 10,155,189 shares of the registrant’s common stockoutstanding.**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 in connection with the registrant’s annual meeting of shareholdersscheduled for December 13, 2007, have been incorporated by reference in Part III of this report.  
 

 
TABLE OF CONTENTS     **PART I**    ITEM 1. BUSINESS    ITEM 1A. RISK FACTORS    ITEM 1B. UNRESOLVED STAFF COMMENTS    ITEM 2. PROPERTIES    ITEM 3. LEGAL PROCEEDINGS    ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS         **PART II**    ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY RELATED STOCKHOLDER MATTERS. AND ISSUER PURCHASE OF EQUITY SECURITIES    ITEM 6. SELECTED FINANCIAL DATA    ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.    ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA    ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE    ITEM 9A. CONTROLS AND PROCEDURES    ITEM 9B. OTHER INFORMATION         **PART III**    ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT    ITEM 11. EXECUTIVE COMPENSATION    ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS    ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS    ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES         **PART IV**    ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES         SIGNATURES     Notice of Termination of the Executive Employment Agreement Second Amendment to Financing Agreement Consent of Independent Registered Public Accounting Firm Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer Section 1350 Certification of Principal Executive Officer Section 1350 Certification of Principal Financial Officer
 

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**PART I****ITEM 1. BUSINESS.****General**     Pizza Inn, Inc. and its subsidiaries (collectively referred to as the “Company”, “Pizza Inn”or in the first person notations of “we”, “us” and “our”) operate and franchise pizza buffet,delivery/carry-out and express restaurants domestically and internationally under the trademark“Pizza Inn.” Through our Norco Restaurant Services Company (“Norco”) division, and throughagreements with third party distributors, we provide or facilitate food, equipment and supplydistribution to our domestic and international system of restaurants.     On June 24, 2007, the Pizza Inn system consisted of 353 restaurants, including threeCompany-owned restaurants, and 350 franchised restaurants. The domestic restaurants are comprisedof 166 buffet restaurants, 42 delivery/carry-out restaurants and 68 express restaurants. Theinternational franchised restaurants are comprised of 18 buffet restaurants, 49 delivery/carry-outrestaurants and 10 express restaurants. Domestic restaurants are located predominantly in thesouthern half of the United States, with Texas, North Carolina, Arkansas and Mississippi accountingfor approximately 35%, 15%, 8% and 8%, respectively, of the total number of domestic restaurants.**Our History**     Pizza Inn has offered consumers affordable, high quality pizza since 1958, when the firstPizza Inn restaurant opened in Dallas, Texas. We awarded our first franchise in 1963 and openedour first buffet restaurant in 1969. We began franchising the Pizza Inn brand internationally inthe late 1970s. In 1993, our stock began trading on the NASDAQ Stock Market, and presently tradeson the NASDAQ Capital Market (formerly called the “NASDAQ SmallCap Market”) under the ticker symbol“PZZI.”**Our Concepts**     We offer three concepts: buffet, delivery/carry-out and express. Each is designed to enhancethe smooth flow of food ordering, preparation and service, and we believe that the overallconfiguration of each results in simplified operations, lower training and labor costs, increasedefficiency and improved consistency and quality of our food products. Our restaurants may beconfigured to adapt to a variety of building shapes and sizes, offering the flexibility necessaryfor our concepts to be operated at any number of otherwise suitable locations.     Our focused menu is designed to present an appealing variety of high quality pizza and sideitems to our customers. Our basic buffet restaurant menu offers three main crusts (Original ThinCrust, New York Pan and Italian), with standard toppings and special combinations of toppings.Buffet restaurants also offer pasta, salad, sandwiches, appetizers, desserts and beverages,including beer and wine in some locations, in an informal, family-oriented atmosphere. Weoccasionally offer other items on a limited promotional basis. Delivery/carryout restaurantstypically offer the three main crusts and some combination of side items. We believe that ourfocus on three main crust types creates a better brand identity among customers, improves operatingefficiency and maintains food quality and consistency.     Our buffet and delivery/carry-out concepts feature crusts that are hand-made from dough madefresh in the restaurant each day. We do not use a centralized commissary for mass production ofdough and our dough is never frozen (with the exception of certain dough products used in theexpress concept for pizza, discussed below). Pizza Inn pizzas are made from a proprietaryall-in-one flour mixture, real mozzarella cheese and a proprietary mix of classic pizza spices.Domestically, all ingredients and toppings can be purchased from Norco which makes deliveries toeach domestic restaurant in our system at least once per week. Beginning in November 2006, twoauthorized third party distributors, each of which has delivery responsibilities for differentgeographical regions of our system, began providing certain of the warehousing and deliveryservices that were previously provided by Norco. In international markets, the menu mix oftoppings and side items is occasionally adapted to local tastes.     Buffet Restaurants     Buffet restaurants offer dine-in, carryout and catering service and, in many cases, also offerdelivery service (“Buffet Units”). They are generally located in free standing buildings orin-line locations in retail developments in close proximity to offices, shopping centers andresidential areas. The current standard Buffet
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Units are between 2,100 and 4,500 square feet in size and seat 80 to 185 customers. The interiordecor is designed to promote a casual, lively, contemporary, family-style atmosphere.     The buffet is typically offered at prices from $4.29 to $5.99, and the average ticket priceper meal, including a drink, is approximately $6.38 per person for fiscal year 2007. Theseaverages are slightly higher in restaurants offering beer and wine.     We have implemented an updated image for our domestic Buffet Units. The new image includessignificant exterior and interior changes in signage, color schemes and dining area configuration,including the addition of a back-fed buffet bar offering an attractive and efficient presentation.The interior features vibrant colors, graphic accents, contemporary furnishings and updated signageand logos. Some Buffet Units feature game rooms that offer a range of electronic gameentertainment for the entire family. Interiors feature selected memorabilia capturing some of themilestones in our nearly 50 years of operation. Additionally, some Buffet Units offer guests theconvenience of curbside service. The new image has been introduced in new Company-owned BuffetUnits, as well as in several new franchised Buffet Units and existing, remodeled franchise BuffetUnits.     Delivery/Carryout Restaurants     Delivery/carryout restaurants offer delivery and carryout service only and are typicallylocated in shopping centers or other in-line retail developments (“Delco Units”). These relativelysmall restaurants, occupying approximately 1,000 square feet, are primarily production facilitiesand, in most instances, do not offer seating. Because Delco Units do not typically offer dine-inareas, they usually do not require expensive real estate leasehold or ownership costs and arerelatively less expensive to build and equip. The decor of the Delco Unit is designed to be brightand highly visible and feature neon, lighted displays and awnings. We have attempted to locateDelco Units strategically to facilitate timely delivery service and to provide easy access forcarryout service.     Express Restaurants     Express restaurants serve our customers through a variety of non-traditional points of sale.Express restaurants are typically located in a convenience store, food court, college campus,airport terminal, athletic facility or other commercial facility (“Express Units”). They havelimited or no seating and solely offer quick carryout service of a limited menu of pizza and otherfoods and beverages. An Express Unit typically occupies approximately 200 to 400 square feet andis commonly operated by the same person who owns the commercial host facility or who is licensed atone or more locations within the facility. We have developed a high-quality pre-prepared crustthat is topped and cooked on-site, allowing this concept to offer a lower initial investment andreduced labor and operating costs while maintaining product quality and consistency. Like DelcoUnits, Express Units are primarily production-oriented facilities and, therefore, do not requireall of the equipment, labor, real estate or square footage of the Buffet Unit.**Site Selection**     We consider the restaurant site selection process critical to a restaurant’s long-term successand devote significant resources to the investigation and evaluation of potential sites. The siteselection process includes a review of trade area demographics and other competitive factors. Wealso rely on the franchisee’s knowledge of the trade area and market characteristics when selectinga location for a franchised restaurant. A member of our development team will visit each potentialdomestic Company-owned restaurant location. We try to locate franchised and Company-ownedrestaurants in retail strip centers or freestanding buildings offering visibility, curb appeal andaccessibility.**Development and Operations**     We intend to continue our expansion domestically in markets with significant long-term growthpotential and where we believe that we can use our competitive strengths to establish brandrecognition and gain local market share. We believe our franchise-oriented business model willallow us to expand our franchised restaurant base with limited capital expenditures and workingcapital requirements. While we plan to expand our domestic restaurant base primarily throughopening new franchised restaurants, we also will continue to evaluate our mix of Company-owned andfranchised restaurants and may strategically develop Company-owned restaurants, acquire franchisedrestaurants and re-franchise Company-owned restaurants. We also believe that our most promisingdevelopment and system growth opportunities lie with experienced, well-capitalized,multi-restaurant operators.
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     The specific rate at which we will be able to expand through franchise development isdetermined in part by our success at selecting qualified franchisees, by identifying satisfactorysites in appropriate markets and by our ability to continue training and monitoring ourfranchisees.     Franchise Operations     We have adopted a franchising strategy that has two major components: continued developmentwithin our existing market areas and new development in strategically targeted domesticterritories. We also intend to continue to seek appropriate international developmentopportunities.     *Franchise and development agreements.*Our current forms of franchise agreements provide for:(i) an initial franchise fee of $25,000 for a Buffet Unit, $7,500 for a Delco Unit and $5,000 foran Express Unit, (ii) an initial franchise term of 20 years for a Buffet Unit and ten years for aDelco Unit or Express Unit, plus a renewal term of ten years for each concept, (iii) requiredcontributions equal to 1% of gross sales to the Pizza Inn Advertising Plan (“PIAP”) or to us, asdiscussed below, (iv) royalties equal to 4% of gross sales for a Buffet Unit or Delco Unit, and 5%of gross sales for an Express Unit, and (v) required advertising expenditures of at least 5% ofgross sales for a Buffet Unit or Delco Unit, and 2% for an Express Unit. We have offered, tocertain experienced restaurant operators, area developer rights in new and existing domesticmarkets. An area developer typically pays a negotiated fee to purchase the right to operate ordevelop restaurants within a defined territory and typically agrees to a multi-restaurantdevelopment schedule and to assist us in local franchise service and quality control in exchangefor half of the franchise fees and royalties from all restaurants within the territory during theterm of the agreement.     Since the Pizza Inn concept was first franchised in 1963, industry franchising concepts anddevelopment strategies have changed, and our present franchise relationships are evidenced by avariety of contractual forms. Common to those forms are provisions that: (i) require thefranchisee to follow the Pizza Inn system of restaurant operation and management, (ii) require thefranchisee to pay a franchise fee and continuing royalties, and (iii) except for Express Units,prohibit the development of one restaurant within a specified distance from another.     *Training.*We offer numerous training programs for the benefit of franchisees and theirrestaurant crew managers. The training programs, taught by experienced Company employees, focus onfood preparation, service, cost control, sanitation, safety, local store marketing, personnelmanagement and other aspects of restaurant operation. The training programs include group classes,supervised work in Company-owned restaurants and special field seminars. Initial and certainsupplemental training programs are offered free of charge to franchisees, who pay their own traveland lodging expenses. Restaurant managers train their staff through on-the-job training, utilizingvideo and printed materials produced by us.     *Standards.*We require adherence to a variety of standards designed to ensure properoperations and to protect and enhance our brand. All franchisees are required to operate theirrestaurants in compliance with these written policies, standards and specifications, which includematters such as menu items, ingredients, materials, supplies, services, furnishings, decor andsigns. Our efforts to maintain consistent operations may result from time to time in closingcertain restaurants that have not achieved and maintained a consistent standard of quality oroperations. We also provide ongoing support to our franchisees to support education andadherence to our standards through our franchise business consultants, who are deployed locally inmarkets where our franchisees are located.     Company Operations     One of our long-term objectives is to selectively expand the number of Company-ownedrestaurants by identifying appropriate opportunities. We believe that moving forward, our domesticnetwork of Company-owned restaurants will play an important strategic role in our predominatelyfranchised operating structure. In addition to generating revenues and earnings, we expect to usedomestic Company-owned restaurants as test sites for new products and promotions as well asrestaurant operational improvements and as a forum for training new managers and franchisees. Wealso believe that as the number of Company-owned restaurants increases, they may add to theeconomies of scale available for advertising, marketing and other costs for the entire system.     As of June 24, 2007, we operated one Buffet Unit in the Dallas, Texas market and two BuffetUnits in the Houston, Texas market. We closed the two Buffet Units in the Houston, Texas market inJuly and August of 2007 and the Company is currently considering alternatives including sub-leasingthe units to new or existing franchisees or unrelated third-party tenants and selling the equipmentwithin the units to new or existing franchisees. From
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time to time, we also consider opportunities to acquire select franchisee-owned restaurants inother markets. We do not currently intend to operate any Delco Units or Express Units.     Our ability to open Company-owned restaurants is affected by a number of factors, including,the terms of available financing, our ability to locate suitable sites, negotiate acceptable leaseor purchase terms, secure appropriate local governmental permits and approvals and our capacity tosupervise construction and to recruit and train management personnel.     International Operations     We also offer master franchise rights to develop Pizza Inn restaurants in certain foreigncountries, with negotiated fees, development schedules and ongoing royalties. A master licenseefor a foreign country pays a negotiated fee to purchase the right to develop and operate Pizza Innrestaurants within a defined territory, typically for a term of 20 years, plus a ten-year renewaloption. The master licensee agrees to a multi-restaurant development schedule and we train themaster licensee to monitor and assist franchisees in their territory with local service and qualitycontrol, with support from us. In return, the master licensee typically retains half the franchisefees and half the royalties on all restaurants within the territory during the term of theagreement. Master licensees may open restaurants that they own and operate, or they may opensub-franchised restaurants owned and operated by third parties through agreements with the masterlicensee, but subject to our approval.     Our first franchised restaurant outside of the United States opened in the late 1970s, and, asof June 24, 2007, there were 77 restaurants operating internationally, with 49 of those restaurantsoperated or sub-licensed by our franchisees in the United Arab Emirates and Saudi Arabia. Ourmaster licensee in Saudi Arabia has also developed several express restaurants at U. S. militaryfacilities in the Middle East.     Our ability to continue to develop select international markets is affected by a number offactors, including our ability to locate experienced, well-capitalized developers who can commit toan aggressive multi-restaurant development schedule and achieve maximum initial market penetrationwith a minimal of supervision by us.**Food and Supply Distribution**     On August 28, 2006, we entered into distribution service agreements with two reputable andexperienced restaurant distribution companies. Under these agreements, The SYGMA Network (“SYGMA”)and The Institutional Jobbers Company (“IJ”) began making deliveries to all restaurants on November5, 2006, with delivery territories and responsibilities for each determined according togeographical region. Norco retained product sourcing, purchasing, quality assurance, research anddevelopment, franchisee order and billing services, and logistics support functions. We continueto own a significant majority of the inventory warehoused and delivered by SYGMA and IJ, andfranchisees are expected to continue to purchase such products from Norco. We believe thisdivision of responsibilities for our purchasing, franchisee support and distribution systems mayresult in lower operating costs, logistical efficiencies and increased customer satisfaction.Norco is able to leverage the advantages of direct vendor negotiations and volume purchasing offood, equipment and supplies for the franchisees’ benefit in the form of a concentrated, one-truckdelivery system, competitive pricing and product consistency. Operators are able to purchase allproducts and ingredients from Norco and have them delivered by experienced and efficientdistributors. In order to assure product quality and consistency, our franchisees are required topurchase, from Norco, certain food products that are proprietary to the Pizza Inn system, includingour flour mixture and spice blend. In addition, almost all franchisees purchase other suppliesfrom Norco. Franchisees may also purchase non-proprietary products and supplies from othersuppliers who meet our requirements for quality and reliability.     Under its agreement with us, SYGMA agreed to lease Norco’s warehouse and distribution facilityin The Colony, Texas, from which it provides distribution services to restaurants in the westernareas of the franchise system. The initial term of the lease agreement begins on November 1, 2006and continues for thirty-five months. On December 19, 2007, the Company completed a sale-leasebacktransaction with Vintage Interests, L.P. (“Vintage”) and sold the real estate, corporate officebuilding and distribution facility located at 3551 Plano Parkway, The Colony, Texas forapproximately $11.5 million. Under the terms of the Sale-Leaseback Agreement, the Companyassigned to Vintage, the three-year lease agreement for the distribution facility entered intobetween the Company and The SYGMA Network on August 25, 2006.     IJ will service eastern restaurants from its distribution center in Tennessee. Norco willcontinue to ship products and equipment to international franchisees. Non-proprietary food andingredients, equipment and other supplies distributed by SYGMA and IJ are generally available fromseveral qualified sources. With the exception of several proprietary food products, such as cheeseand dough flour, we are not dependent upon any one supplier or
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limited group of suppliers. We contract with established food processors for the productionof our proprietary products.     We have not experienced any significant shortages of supplies or any delays in receiving ourfood or beverage inventories, restaurant supplies or products, and do not anticipate any difficultyin obtaining inventories or supplies in the foreseeable future. Prices charged to us by oursuppliers are subject to fluctuation, and we may from time to time attempt to pass increased costsand savings on to our franchisees. We do not engage in commodity hedging.**Advertising**     By communicating a common brand message at the regional, local market and restaurant levels,we believe we can create and reinforce a strong, consistent marketing message to consumers andincrease our market share. We offer or facilitate a number of ways for the brand image and messageto be promoted at the local and regional levels.     PIAP is a Texas non-profit corporation that is responsible for creating and producing printadvertisements, television and radio commercials and in-store promotional materials, along withrelated advertising services for use by its members. Each operator of a Buffet Unit or Delco Unit,including us, is entitled to membership in PIAP. Nearly all of our existing franchise agreementsfor Buffet Units and Delco Units require the franchisees to become members of PIAP. Memberscontribute 1% of their gross sales to PIAP. PIAP is managed by a board of trustees comprisedsolely of franchisee representatives who are elected by the members each year. We do not have anyownership interest in PIAP. We provide certain administrative, marketing and other services toPIAP and are paid by PIAP for such services. As of June 24, 2007, the Company-owned Buffet Unitsand substantially all of our franchisees were members of PIAP. Operators of Express Units do notparticipate in PIAP; however, they contribute up to 1% of their gross sales directly to us to helpfund purchases of Express Unit marketing materials and similar expenditures.     Groups of franchisees, that are also participants of PIAP, in some of our market areas haveformed local advertising cooperatives. These cooperatives, which may be formed voluntarily or maybe required by us under the franchise agreements, establish contributions to be made by theirmembers and direct the expenditure of these contributions on local media advertising usingmaterials developed by PIAP and/or us. Franchisees are required to conduct independent marketingefforts in addition to their participation in PIAP and local cooperatives.     We provide Company-owned and franchised restaurants with catalogs for the purchase ofmarketing and promotional items and pre-approved print and radio marketing materials. We have alsodeveloped an internet-based system, The Pizza Inn *Inn*-tranet, by which all of our restaurants maycommunicate with us and place orders for marketing and promotional products.**Trademarks and Quality Control**     We own various trademarks, including the name “Pizza Inn,” that are used in connection withthe restaurants and have been registered with the United States Patent and Trademark Office. Theduration of our trademarks is unlimited, subject to periodic renewal and continued use. Inaddition, we have obtained trademark registrations in several foreign countries and haveperiodically re-filed and applied for registration in others. We believe that we hold thenecessary rights for protection of the trademarks essential to our business.**Government Regulation**     We and our franchisees are subject to various federal, state and local laws affecting theoperation of our restaurants. Each restaurant is subject to licensing and regulation by a numberof governmental authorities, which include health, safety, sanitation, wage and hour, alcoholicbeverage, building and fire agencies in the state or municipality in which the restaurant islocated. Difficulties in obtaining, or the failure to obtain, required licenses or approvals coulddelay or prevent the opening of a new restaurant or require the temporary or permanent closing ofexisting restaurants in a particular area.     We are subject to Federal Trade Commission (“FTC”) regulation and to various state lawsregulating the offer and sale of franchises. Several state laws also regulate the substantiveaspects of the franchisor-franchisee relationship. The FTC requires us to furnish to prospectivefranchisees a franchise offering circular containing prescribed information. Substantive statelaws that regulate the franchisor-franchisee relationship presently exist in a number of states,and bills have been introduced in Congress from time to time that would provide for further
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federal regulation of the franchisor-franchisee relationship in certain respects. Some foreigncountries also have disclosure requirements and other laws regulating franchising and thefranchisor-franchisee relationship.**Employees**     As of September 21, 2007, we had approximately 75 employees, including 53 in our corporateoffice of which 8 are part of our Norco division, and 5 full-time and 17 part-time employees at theCompany-owned restaurant. None of our employees are currently covered by collective bargainingagreements.**Industry and Competition**     The restaurant industry is intensely competitive with respect to price, service, location andfood quality, and there are many well-established competitors with substantially greater brandrecognition and financial and other resources than Pizza Inn. Competitors include a large numberof international, national and regional restaurant and pizza chains, as well as local restaurantsand pizza operators. Some of our competitors may be better established in the markets where ourrestaurants are located or may be located. Within the pizza segment of the restaurant industry, webelieve that our primary competitors are national pizza chains and several regional chains,including chains executing a “take and bake” concept. A change in the pricing or other marketstrategies of one or more of our competitors could have an adverse impact on our sales andearnings.     With respect to the sale of franchises, we compete with many franchisors of restaurants andother business concepts. We believe that the principal competitive factors affecting the sale offranchises are product quality and price, value, consumer acceptance, franchisor experience andsupport and the quality of the relationship maintained between the franchisor and its franchisees.In general, there is also active competition for management personnel and attractive commercialreal estate sites suitable for our restaurants.     Our Norco division competes with both national and local distributors of food, equipment andother restaurant suppliers. The distribution industry is very competitive. We believe that theprincipal competitive factors in the distribution industry are product quality, customer serviceand price. Norco or its designees are the sole authorized suppliers of certain proprietaryproducts that all Pizza Inn restaurants are required to use.**Available Information**     We file reports, including reports on Form 10-Q and Form 10-K, with the Securities andExchange Commission (“SEC”). The public may read and copy any materials we file with the SEC atthe SEC’s Public Reference Room at 100 F Street, N.E. Washington, DC 20549. The public may obtaininformation on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.The SEC maintains an Internet site that contains reports, proxy and information statements, andother information regarding issuers that file electronically with the SEC. The address of thatsite is http://www.sec.gov.     We make available, free of charge on or through our Internet website(http://www.pizzainn.com), our annual report on Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act as soon as reasonably practicable after we electronically file suchmaterial with, or furnish it to, the SEC. We will provide electronic or paper copies of ourfilings free of charge upon written request to: Corporate Secretary, Pizza Inn, Inc., 3551 PlanoParkway, The Colony, TX 75056.     Our “Code of Business Conduct and Ethics” is also available on our website. We intend tosatisfy the disclosure requirements regarding amendments to, or waivers from, a provision of theCode of Business Conduct and Ethics by posting such information on our Website.**Forward-Looking Statements**     This Form 10-K contains forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995 (the “PSLRA”), including information within Management’sDiscussion and Analysis of Financial Condition and Results of Operations. The following cautionarystatements are being made pursuant to the provisions of the PSLRA and with the intention ofobtaining the benefits of the “safe harbor” provisions of the PSLRA. Although we believe that ourexpectations are based upon reasonable assumptions, actual results may differ materially from thosein the forward-looking statements as a result of various factors, including, but not limited to,the factors discussed in this Form 10-K under the heading “Risk Factors.”
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**ITEM 1A. RISK FACTORS.**     In addition to the other information contained in this report, the following risks may affectus. Among the risks are: (i) risks associated with our business, (ii) risks associated with ourcommon stock and (iii) risks associated with our industry. Our business, financial condition, cashflows or results of operations could be materially and adversely affected by any of these risks.**Risks Associated with Our Business**     **If we are not able to implement our growth strategy successfully, which includes opening newdomestic Buffet Units and reimaging existing restaurants, our ability to increase our revenues andoperating profits could be materially adversely affected.**     A significant component of our growth strategy for developing new domestic franchised andCompany-owned restaurants is the implementation of our new prototype Buffet Unit concept. We andour franchisees face many challenges in opening new restaurants, including, among other things,selection and availability of suitable restaurant locations and suitable employees, increases infood, paper, labor, utilities, fuel, employee benefits, insurance and similar costs, negotiation ofsuitable lease or financing terms, constraints on permitting and construction of restaurants,higher than anticipated construction costs, the hiring, training and retention of management andother personnel and securing required domestic or foreign governmental permits and approvals.     The opening of additional franchise restaurants also depends, in part, upon the availabilityof prospective franchisees who meet our criteria. Our new concept development program may requireconsiderable management time as well as start-up expenses for franchisee recruitment and trainingand market development before any significant revenues and earnings are generated.     Accordingly, we may not be able to meet planned growth targets, open restaurants in marketsnow targeted for expansion or operate profitably in existing markets. In addition, even if we areable to continue to open new restaurants, we may not be able to keep restaurants from closing at afaster rate than we are able to open restaurants.     **Our earnings and business growth strategy depends on the success of our franchisees, and wemay 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 franchisedrestaurants. Franchisees are independent operators whose employees are not our employees. Weprovide limited training and support to franchisees, but the quality of franchised restaurantoperations 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 andrequirements, or may not hire and train qualified managers and other store personnel. If they donot, our image and reputation may suffer, and revenues could decline. Our franchisees may takeactions that adversely affect the value of our intellectual property or reputation. Our domesticand international franchisees may not operate their franchises successfully. If one or more of ourkey franchisees were to become insolvent or otherwise were unable or unwilling to pay us ourroyalties, our business and results of operations would be adversely affected.     **Loss of key personnel or our inability to attract and retain new qualified personnel couldhurt 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 keymanagement personnel. We may not be able to retain our executive officers and key personnel orattract additional qualified management. Our success also will depend on our ability to attractand retain qualified personnel to oversee our restaurants, distribution operations andinternational operations. The loss of these employees or any inability to recruit and retainqualified personnel could have a material adverse effect on our operating results.     **We face risks of litigation from customers, franchisees, employees and others in the ordinarycourse of business, which diverts our financial and management resources. Any adverse litigationor 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 foodservice industry. In addition to decreasing our sales and profitability and diverting ourmanagement resources, adverse
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publicity or a substantial judgment against us could negatively impact our financialcondition, results of operations and brand reputation, hindering our ability to attract and retainfranchisees 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 mealbreak issues, including those relating to overtime compensation. If one or more of these claimswere to be successful or if there is a significant increase in the number of these claims, ourbusiness, financial condition and operating results could be harmed.          **Shortages or interruptions in the delivery of food products could adversely affect ouroperating results.**          We, and our franchisees, are dependent on frequent deliveries of food products that meet ourspecifications. Our Company-owned domestic restaurants purchase substantially all food and relatedproducts from our distribution division, Norco. Domestic franchisees are only required to purchasethe flour mixture, spice blend and certain other items from Norco, and changes in purchasingpractices by domestic franchisees as a result of delivery disruptions or otherwise could adverselyaffect the financial results of our distribution operation. Interruptions in the delivery of foodproducts caused by unanticipated demand, problems in production or distribution by Norco, oursuppliers, or our distribution service providers, inclement weather (including hurricanes and othernatural disasters) or other conditions could adversely affect the availability, quality and cost ofingredients, which would adversely affect our operating results.          **An increase in the cost of cheese or other commodities, including fuel and labor, couldadversely affect our profitability and operating results.**          An increase in our operating costs could adversely affect our profitability. Factors such asinflation, increased food costs, increased labor and employee benefit costs and increased energycosts may adversely affect our operating costs. Most of the factors affecting costs are beyond ourcontrol and, in many cases, we may not be able to pass along these increased costs to our customersor franchisees even if we attempted to do so. Most ingredients used in our pizza, particularlycheese, are subject to significant price fluctuations as a result of seasonality, weather,availability, demand and other factors. Sustained increases in fuel and utility costs couldadversely affect the profitability of our restaurant and distribution businesses. Labor costs arelargely a function of the minimum wage for a majority of our restaurant and distribution centerpersonnel and, generally, are a function of the availability of labor. Further governmentinitiatives, such as proposed minimum wage rate increases, could adversely affect us as well as therestaurant industry in general.          **If we are not able to continue purchasing our key pizza ingredients from our current suppliersor find suitable replacement suppliers our financial results could be materially adverselyaffected.**          We are dependent on a few suppliers for our some of our key ingredients. Domestically, werely upon sole suppliers for our cheese and flour mixture which are key ingredients. Alternativesources for these ingredients may not be available on a timely basis to supply these keyingredients or be available on terms as favorable to us as under our current arrangements. Anydisruptions in our supply of key ingredients could adversely affect our operations.          **We are subject to extensive government regulation, and any failure to comply with existing orincreased regulations could adversely affect our business and operating results.**          We are subject to numerous federal, state, local and foreign laws and regulations, includingthose 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 togovernmental or judicial fines or sanctions. In addition, our capital expenditures could increasedue to remediation measures that may be required if we are found to be noncompliant with any ofthese laws or regulations.
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     We are also subject to a Federal Trade Commission rule and to various state and foreign lawsthat govern the offer and sale of franchises. These laws regulate various aspects of the franchiserelationship, including terminations and the refusal to renew franchises. The failure to complywith these laws and regulations in any jurisdiction or to obtain required government approvalscould 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 ourbusiness and operating results.     **Our current insurance coverage may not be adequate, our insurance premiums may increase and wemay 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 ourbusiness. In addition, in the future our insurance premiums may increase and we may not be able toobtain similar levels of insurance on reasonable terms, or at all. Any such inadequacy of, orinability to obtain, insurance coverage could have a material adverse effect on our business,financial condition and results of operations.**Risks Associated With Our Common Stock**     **Even though our common stock is currently traded on the Nasdaq Capital Market, it has lessliquidity than the stock of many other companies quoted on the NASDAQ Stock Market’s Global Marketor on a national securities exchange.**     The trading volume in our common stock on the Nasdaq Capital Market has been relatively lowwhen compared with larger companies listed on the Nasdaq Global Market or the other stockexchanges. Shareholders, therefore, may experience difficulty selling a substantial number ofshares for the same price at which shareholders could sell a smaller number of shares. We cannotpredict the effect, if any, that future sales of our common stock in the market, or theavailability of shares of common stock for sale in the market, will have on the market price of ourcommon stock. Sales of substantial amounts of common stock in the market, or the potential forlarge amounts of sales in the market, may cause the price of our common stock to declineor 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 maybe unrelated to our performance.**     General market price declines or overall market volatility in the future could adverselyaffect the price of our common stock, and the current market price may not be indicative of futuremarket prices.**Risks Associated With Our Industry**     **If we are not able to compete effectively, our business, sales and earnings could bematerially adversely affected.**     The restaurant industry in general, as well as the pizza segment of the industry, is intenselycompetitive, both internationally and domestically, with respect to price, service, location andfood quality. We compete against many regional and local businesses. There are manywell-established competitors with substantially greater brand awareness and financial and otherresources than we have. Some of these competitors may be better established in markets whererestaurants we operate or that are operated by our franchisees are, or may be, located. Experiencehas shown that a change in the pricing or other marketing or promotional strategies, including newproduct and concept developments, of one or more of our major competitors can have an adverseimpact on sales and earnings and our chainwide restaurant operations.     We could also experience increased competition from existing or new companies in the pizzasegment of the restaurant industry. If we are unable to compete, we could experience downwardpressure on prices, lower demand for our products, reduced margins, the inability to take advantageof new business opportunities and the loss of market share, all of which would have a materialadverse effect on our operating results.     We also compete on a broader scale with quick service, fast casual and other international,national, regional and local restaurants. The overall food service market and the quick servicerestaurant sector are intensely competitive with respect to food quality, price, service,convenience and concept. We also compete within the food service market and the restaurantindustry for management and hourly employees, suitable real estate sites and qualified franchisees.
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     Norco is also subject to competition from outside suppliers. If other suppliers who meet ourqualification standards were to offer lower prices or better service to our franchisees for theiringredients and supplies and, as a result, our franchisees chose not to purchase from Norco, ourfinancial 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 localeconomic conditions, demographic trends, disposable purchasing power, traffic patterns and thetype, number and location of competing restaurants. For example, if prevailing health or dietarypreferences cause consumers to avoid pizza and other products we offer, or quick service restaurantofferings generally, in favor of foods that are perceived as more healthy, our business andoperating results would be harmed.**ITEM 1B. UNRESOLVED STAFF COMMENTS.**Not applicable**ITEM 2. PROPERTIES.**     The Company currently owns one Buffet Unit in the Dallas, Texas area. It is operated from aleased location of approximately 4,100 square feet. Annual lease payments are approximately $22.00per square foot. The lease has a five-year term with multiple renewal options. At June 24, 2007the Company also operated two Buffet Units in the Houston, Texas market. One location hasapproximately 4,347 square feet and the other has approximately 2,760 square feet. Both are leasedat annual rates of approximately $13.00 and $18.00 per square foot, respectively. The Houstonleases expire in 2015 and each has at least one renewal option. We closed the two Buffet Units inthe Houston, Texas market in July and August of 2007 and the Company is currently consideringalternatives such as sub-leasing the units to new or existing franchisees or unrelated third-partytenants and selling the equipment within the units to new or existing franchisees. The Companyalso leases its corporate office facility from Vintage Interests, L.P. pursuant to thesale-leaseback transaction completed on December 19, 2006 at an annual rate of approximately $10.00per square foot. This lease began on December 19, 2006 and has a ten year term.     The Company also owns property in Little Elm, Texas that was purchased in June 2003 for$127,000 from which the Company previously operated a Delco Unit. Finish out and improvements forthe Delco Unit totaled approximately $440,000. The Company has listed the property with a brokerfor sale to a third party. This property is classified as “held for sale” at June 24, 2007.**ITEM 3. LEGAL PROCEEDINGS.**     The Company is subject to claims and legal actions in the ordinary course of its business.With the possible exception of the matters set forth below, the Company believes that all suchclaims and actions currently pending against it are either adequately covered by insurance or wouldnot have a material adverse effect on the Company’s annual results of operations, cash flows orfinancial condition if decided in a manner that is unfavorable to the Company.     On October 5, 2004 the Company filed a lawsuit against the law firm Akin, Gump, Strauss, Hauer& Feld, (“Akin Gump”) and J. Kenneth Menges, one of the firm’s partners. Akin Gump served as theCompany’s principal outside lawyers from 1997 through May 2004, when the Company terminated therelationship. The petition alleges that during the course of representation of the Company, thefirm and Mr. Menges, as the partner in charge of the firm’s services for the Company, breachedcertain fiduciary responsibilities to the Company by giving advice and taking action to further thepersonal interests of certain of the Company’s executive officers to the detriment of the Companyand its shareholders. Specifically, the petition alleges that the firm and Mr. Menges assisted inthe creation and implementation of so-called “golden parachute” agreements, which, in the opinionof the Company’s current counsel, provided for potential severance payments to those executives inamounts greatly disproportionate to the Company’s ability to pay, and that, if paid, could exposethe Company to significant financial liability which could have a material adverse effect on theCompany’s financial position. The Company is unable to provide any meaningful analysis,projections or expectations at this time regarding the outcome of this matter. However, theCompany believes that its claims against Akin Gump and Mr. Menges are well founded and intends tovigorously pursue all relief to which it may be entitled.
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     On December 11, 2004, the Board of Directors of the Company terminated the ExecutiveCompensation Agreement dated December 16, 2002 between the Company and its then Chief ExecutiveOfficer, Ronald W. Parker (“Parker Agreement”). Mr. Parker’s employment was terminated followingten days written notice to Mr. Parker of the Company’s intent to discharge him for cause as aresult of violations of the Parker Agreement. Written notice of termination was communicated toMr. Parker on December 13, 2004. The nature of the cause alleged was set forth in the notice ofintent to discharge and based upon Section 2.01(c) of the Parker Agreement, which provides fordischarge for “any intentional act of fraud against the Company, any of its subsidiaries or any oftheir employees or properties, which is not cured, or with respect to which Executive is notdiligently pursuing a cure, within ten (10) business days of the Company giving notice to Executiveto do so.” Mr. Parker was provided with an opportunity to cure as provided in the Parker Agreementas well as the opportunity to be heard by the Board of Directors prior to the termination.     On January 12, 2005, the Company instituted an arbitration proceeding against Mr. Parker withthe American Arbitration Association in Dallas, Texas pursuant to the Parker Agreement seekingdeclaratory relief that Mr. Parker was not entitled to severance payments or any other furthercompensation from the Company. In addition, the Company was seeking compensatory damages,consequential damages and disgorgement of compensation paid to Mr. Parker under the ParkerAgreement. On January 31, 2005, Mr. Parker filed claims against the Company for allegeddefamation, alleged wrongful termination, and recovery of amounts allegedly due under the ParkerAgreement. Mr. Parker had originally sought in excess of $10.7 million from the Company, includingapproximately (i) $7.0 million for severance payments plus accrued interest, (ii) $0.8 million inlegal expenses, and (iii) $2.9 million in other alleged damages.     On September 24, 2006, the parties entered into a compromise and settlement agreement (the“Parker Settlement Agreement”) relating to the arbitration actions filed by the Company and Mr.Parker (collectively, the “Parker Arbitration”). Pursuant to the Settlement Agreement, each of theCompany and Mr. Parker (i) denied wrongdoing and liability, (ii) agreed to mutual releases ofliability, and (iii) agreed to dismiss all pending claims with prejudice. The Company also agreedto pay Mr. Parker $2,800,000 through a structured payment schedule to resolve all claims assertedby Mr. Parker in the Parker Arbitration, with the entire amount to be paid within six months of thedate of the Parker Settlement Agreement. In addition, all payments under the Parker SettlementAgreement automatically and immediately became due upon the completion of the sale-leasebacktransaction involving our corporate headquarters office and distribution facility on December 19,2006. Following the completion of the sale-leaseback transaction, the Company paid off the entireamount of remaining payments due under the Parker Settlement Agreement. At June 24, 2007, therewere no remaining amounts due to Mr. Parker under the Parker Settlement Agreement.     On April 22, 2005, the Company provided PepsiCo, Inc. (“PepsiCo”) written notice of PepsiCo’sbreach of the beverage marketing agreement the parties had entered into in May 1998 (the “BeverageAgreement”). In the notice, the Company alleged that PepsiCo had not complied with the terms ofthe Beverage Agreement by failing to (i) provide account and equipment service, (ii) maintain andrepair fountain dispensing equipment, (iii) make timely and accurate account payments, and byproviding to the Company beverage syrup containers that leaked in storage and in transit. Thenotice provided PepsiCo 90 days within which to cure the instances of default. On May 18, 2005 theparties entered into a “standstill” agreement under which the parties agreed to a 60-day extensionof the cure period to attempt to renegotiate the terms of the Beverage Agreement and for PepsiCo tocomplete its cure.     The parties were unable to renegotiate the Beverage Agreement, and the Company contended thatPepsiCo did not cure each of the instances of default set forth in the Company’s April 22, 2005notice of default. On September 15, 2005, the Company provided PepsiCo notice of termination ofthe Beverage Agreement. On October 11, 2005, PepsiCo served the Company with a petition in thematter of *PepsiCo, Inc. v. Pizza Inn Inc.,*filed in District Court in Collin County, Texas. In thepetition, PepsiCo alleged that the Company breached the Beverage Agreement by terminating itwithout cause. PepsiCo was seeking damages of approximately $2.6 million, an amount PepsiCobelieved represents the value of gallons of beverage products that the Company was required topurchase under the terms of the Beverage Agreement, plus return of any marketing support funds thatPepsiCo advanced to the Company but that the Company had not earned. The Company filed acounterclaim against PepsiCo for amounts earned by the Company under the Beverage Agreement but notyet paid by PepsiCo, and for damage for business defamation and tortuous interference with contractbased upon statements and actions of the PepsiCo account representative servicing the Company’saccount.     On December 14, 2006, the Company and PepsiCo entered into a compromise settlement agreement(the “PepsiCo Settlement Agreement”) and an agreed final judgment fully resolving all claims atissue in the litigation between the parties. Under the terms of the PepsiCo Settlement Agreement,among other things, (i) each party
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agreed to dismiss all claims between the parties; (ii) the parties released and dischargedeach other from all pending and possible claims arising out of or in connection with the BeverageAgreement; (iii) the Company agreed to pay to PepsiCo $410,000 on or before December 29, 2006 andentered into the agreed final judgment to secure the Company’s payment obligations; and (iv) eachparty bears its own attorneys’ fees and court costs. The Company paid to PepsiCo the $410,000settlement amount on December 29, 2006 and the parties subsequently entered the agreed joint motionwith the court to dismiss the case. As of December 24, 2006, the Company had accrued the fullamount paid to PepsiCo. As a result of the terms of the PepsiCo Settlement Agreement, the Companyreduced to zero $108,000 of accounts payable to PepsiCo related to beverage product previouslypurchased from PepsiCo, which resulted in a reduction of the provision for litigation costs by thatamount during the fiscal second quarter ended December 24, 2006. As of June 24, 2007, there wereno remaining payments due under the PepsiCo Settlement Agreement.     On August 31, 2006, the Company was served with notice of a lawsuit filed against it by aformer franchisee and its guarantors who operated one restaurant in the Harlingen, Texas market in2003. The former franchisee and guarantor allege generally that the Company intentionally andnegligently misrepresented costs associated with development and operation of the Company’sfranchise, and that as a result they sustained business losses that ultimately led to the closingof the restaurant. They seek damages of approximately $768,000, representing amounts the formerfranchisees claim to have lost in connection with their development and operation of therestaurant. In addition, they seek unspecified punitive damages, and recovery of attorneys’ feesand court costs. The Eastern District of Texas magistrate recently ruled in the Company’s favor totransfer this action to the Northern District of Texas pursuant to the forum selection clause inthe franchise agreement. Due to the preliminary nature of this matter and the general uncertaintysurrounding the outcome of any form of legal proceeding, it is not practicable for the Company toprovide any certain or meaningful analysis, projection or expectation at this time regarding theoutcome of this matter. Although the outcome of the legal proceeding cannot be projected withcertainty, the Company believes that the plaintiff’s allegations are without merit. The Companyintends to vigorously defend against such allegations and to pursue all relief to which it may beentitled, including pursuing a counterclaim for recovery of past due amounts, future lost royaltiesand attorneys’ fees and costs. An adverse outcome to the proceeding could materially affect theCompany’s financial position and results of operation. The Company has not made any accrual forsuch amounts as of June 24, 2007.     On April 12, 2006, Pizza Inn filed a verified complaint and application for injunctive reliefagainst James Minick. Minick was a Georgia franchisee with four (4) franchise agreements, whichhad been terminated for non-renewal of the franchise agreement, past due fees, and failure tocomply with Pizza Inn’s standards, policies, and procedures. At the time of filing the VerifiedComplaint, Pizza Inn had terminated and sought relief under only one of the franchise agreements(“The Eastman Franchise Agreement”). Minick failed to answer or otherwise respond by May 22, 2006.Pizza Inn moved for an entry of default against Minick. After the clerk entered the entry ofdefault, Pizza Inn analyzed Minick’s defaults under all the agreements and filed an amendedverified complaint, asserting claims under two additional franchise agreements (“The Baxley andDublin Franchise Agreements”). Pizza Inn also amended its application for preliminary injunction,to enjoin Minick from using Pizza Inn’s marks without authorization and maintaining “Minick’sPizza” restaurants in violation of the covenant not to compete.     On November 9, 2006, the Court issued a preliminary injunction against Minick, restrainingMinick from (1) operating pizza restaurants, while the Swainsboro Franchise Agreement is effective,(2) operating pizza restaurants within ten miles of the former Eastman and Dublin locations for aperiod of two years from the date of the order, and (3) using Pizza Inn’s marks, trade names, andlogos without authorization. On December 18, 2006, Pizza Inn filed its amended motion for defaultjudgment against Minick, since Minick still failed to answer or otherwise respond. On December 20,2006, the Court entered a Final Judgment against Minick. The Court granted damages in theprincipal sum of $238,375, plus $32,691 in attorney fees, and $3,310 in expenses. The Courtordered that Pizza Inn recover prejudgment interest on these sums at the rate allowed by law andpost-judgment interest at the rate of 4.95% per annum. Furthermore, the Court issued a permanentinjunction on the same terms as the preliminary injunction. On or about April 5, 2007, the UnitedStates Marshal in Georgia served Minick with the Final Judgment. The receipts and return ofprocess were filed with the Court on April 10, 2007. Pizza Inn has registered the Final Judgmentwith the Georgia courts and has filed abstracts to record the Final Judgment in the deed records ofeach county in which Minick is believed to have real property. Pizza Inn also has the option toinitiate a sheriff’s sale of real properties in Georgia.**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.**Not applicable
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**PART II****ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY RELATED STOCKHOLDER MATTERS.AND ISSUER PURCHASE OF EQUITY SECURITIES.**     As of September 21, 2007, there were approximately 1,991 stockholders of record of theCompany’s common stock.     The Company had no sales of unregistered securities during fiscal 2007, 2006 or 2005.     The Company’s common stock is listed on the Capital Market (formerly called the “NASDAQSmallCap Market”) of the NASDAQ Stock Market, LLC (“NASDAQ”) exchange under the symbol “PZZI”. Thefollowing table shows the highest and lowest daily closing price per share of the common stockduring each quarterly period within the two most recent fiscal years, as reported by NASDAQ. Suchprices reflect inter-dealer quotations, without adjustment for any retail markup, markdown orcommission.               Actual Trade    Executed Price    High Low2007            First Quarter Ended 9/24/2006 $2.90  $1.85   Second Quarter Ended 12/24/2006  2.25   1.51   Third Quarter Ended 3/25/2007  2.53   1.77   Fourth Quarter Ended 6/24/2007  3.22   2.24            2006            First Quarter Ended 9/25/2005 $2.97  $2.50   Second Quarter Ended 12/25/2005  2.90   2.50   Third Quarter Ended 3/26/2006  2.93   2.59   Fourth Quarter Ended 6/25/2006  3.35   2.63      Under the Company’s bank loan agreement (the “CIT Credit Facility”), the Company is allowed topay dividends or make other distributions on its common stock up to an aggregate amount of$3,000,000.     The Company did not pay any dividends on its common stock during the fiscal years ended June24, 2007 and June 25, 2006. Any determination to pay cash dividends in the future will be at thediscretion of the Company’s Board of Directors and will be dependent upon the Company’s results ofoperations, financial condition, capital requirements, contractual restrictions and other factorsdeemed relevant. Currently, there is no intention to pay any dividends on its common stock.     On May 23, 2007, our board of directors approved a stock purchase plan (the “2007 StockPurchase Plan”) authorizing the purchase on our behalf of up to 1,016,000 shares of our commonstock in the open market or in privately negotiated transactions. Although no repurchases weremade in any month within the fourth quarter of the fiscal year covered by this report, 16,004shares of our common stock were purchased, in the open market, and are being held by us as treasuryshares, pursuant to the 2007 Stock Purchase Plan subsequent to June 24, 2007. The following tablefurnishes information for purchases made subsequent to June 24, 2007:
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**ISSUER PURCHASES OF EQUITY SECURITIES**                           **Total Number of**  **Maximum Number of**           **Shares Purchased as**  **Shares that May Yet**   **Total Number of**      **Part of Publicly**  **Be Purchased Under**   **Shares**  **Average Price Paid**  **Announced Plans or**  **the Plans or** **Period** **Purchased**  **per Share**  **Programs**  **Programs** **Month #1**                (June 25, 2007 –July 29, 2007)  **0**   **—**   **—**   **1,016,000** **Month #2**                (July 30, 2007 –August 26, 2007)  **2,924**  **$****2.31**   **2,924**   **1,013,076** **Month #3**                (August 27, 2007 –September 20, 2007)  **13,080**  **$****2.19**   **13,080**   **999,996**              **Total:**  **16,004**  **$****2.21**   **16,004****(1)**  **999,996**               (1) These shares were purchased pursuant to the 2007 Stock Purchase Plan. The 2007Stock Purchase Plan was announced on May 23, 2007. Our board of directors approved the purchase ofup to 1,016,000 shares of our common stock pursuant to the 2007 Stock Purchase Plan. The 2007Stock Purchase Plan does not have any expiration date.     Our ability to purchase shares of our common stock is subject to various laws, regulations andpolicies as well as the rules and regulations of the Securities and Exchange Commission. We intendto make further purchases under the 2007 Stock Purchase Plan. We may also purchase shares of ourcommon stock other than pursuant to the 2007 Stock Purchase Plan and other than pursuant to apublicly announced plan or program.**Equity Compensation Plan Information**     A summary of equity compensation under all of the Company’s equity compensation plans follows:               Number of Securities to Weighted-average Number of Securities  be issued upon exercise exercise price of remaining available forPlan of outstanding options, outstanding options, future issuance underCategory warrants, and rights warrants, and rights equity compensation plansEquity Compensationplans approved bysecurity holders  88,358  $2.77   1,433,759  Equity Compensationplans not approved bysecurity holders  500,000  $2.50   —               Total  588,358  $2.54   1,433,759              Additional information regarding equity compensation can be found in the notes to the consolidatedfinancial statements.
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**ITEM 6. SELECTED FINANCIAL DATA.**     The following table contains certain selected financial data for the Company for each of thelast five fiscal years through June 24, 2007, and should be read in conjunction with theconsolidated financial statements and schedules in Item 8 of this report.                       For The Year Ended  June 24, June 25, June 26, June 27, June 29,  2007 2006 2005 2004 2003  *(In thousands, except per share amounts)*SELECTED INCOME STATEMENT DATA:                    Total revenues $47,136  $50,459  $55,269  $59,988  $58,471                      Income (loss) before taxes  206   (7,018)  359   3,648   4,643 Net income (loss)  206   (5,989)  204   2,243   3,093 Basic earnings (loss) per common share  0.02   (0.59)  0.02   0.22   0.31 Diluted earnings (loss) per common share  0.02   (0.59)  0.02   0.22   0.31                      SELECTED BALANCE SHEET DATA:                    Total assets  8,194   19,001   20,255   20,906   20,796 Total debt andcapital lease obligations  —   8,044   7,727   8,376   11,233 In thefiscal 2006 the Company adopted SFAS No. 123(R) that requirescompensation expense for most equity-based awards be recognized overthe requisite service period. Year ended June 24, 2007 and June 25,2006 compensation reversal/expense was ($14,000) and $341,000,respectively.
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**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.****Results of Operations**     *The following discussion should be read in conjunction with the consolidated financialstatements, accompanying notes and selected financial data appearing elsewhere in this AnnualReport on**Form 10-K**and may contain certain forward-looking statements that are based on currentmanagement expectations. Generally, verbs in the future tense and the words “believe,” “expect,”“anticipate,” “estimate,” “intends,” “opinion,” “potential” and similar expressions identifyforward-looking statements. Forward-looking statements in this report include, without limitation,statements relating to the strategies underlying the Company’s business objectives, its customersand its franchisees, its liquidity and capital resources, the impact of its historical andpotential business strategies on the Company’s business, financial condition, and operating resultsand the expected effects of potentially adverse litigation outcomes. The Company’s actual resultscould differ materially from its expectations. Further information concerning the Company’sbusiness, including additional risk factors and uncertainties that could cause actual results todiffer materially from the forward-looking statements contained in this Annual Report on**Form 10-K**,are set forth above under Item 1 and below under the heading “Risk Factors.” These risks anduncertainties should be considered in evaluating forward-looking statements and undue relianceshould not be placed on such statements. The forward-looking statements contained herein speakonly as of the date of this Annual Report on**Form 10-K**and, except as may be required by applicablelaw and regulation, the Company does not undertake, and specifically disclaims any obligation to,publicly update or revise such statements to reflect events or circumstances after the date of suchstatements or to reflect the occurrence of anticipated or unanticipated events.****Fiscal 2007 Compared to Fiscal 2006*****Overview**     The Company is a franchisor and food and supply distributor to a system of restaurantsoperating under the trademark “Pizza Inn”. At June 24, 2007, there were 353 Pizza Inn restaurants,consisting of three Company-owned restaurants and 350 franchised restaurants. At June 24, 2007,the domestic restaurants were operated as: (i) 166 Buffet Units; (ii) 42 Delco Units; and (iii) 68Express Units. The 276 domestic restaurants were located in 18 states predominately situated inthe southern half of the United States. Additionally, the Company had 77 internationalrestaurants located in nine foreign countries.     Diluted earnings per common share were $0.02 as compared to a diluted loss of $0.59 per sharein the prior year. Net income was $206,000 as compared to net loss of ($5,989,000) in the prioryear, on revenues of $47,136,000 in the current year and $50,459,000 in the prior year. Pre-taxincome was $206,000 as compared to a pre-tax loss of ($7,018,000) in the prior year.     Results of operations for fiscal 2007 and 2006 both include fifty-two weeks.
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     Management believes that key performance indicators in evaluating financial results includechain-wide retail sales and the number and type of operating restaurants. The following tablesummarizes these key performance indicators.           Fiscal Year Ended  June 24, June 25,  2007 2006Chainwide retail sales Buffet Units (in thousands) $114,083  $119,369 Chainwide retail sales Delco Units (in thousands) $12,576  $13,765 Chainwide retail sales Express Units (in thousands) $7,175  $8,579 Average number of Buffet Units  171   186 Average number of Delco Units  46   51 Average number of Express Units  67   69 ***Revenues***     Revenues are primarily derived from sales of food, paper products and equipment and suppliesby Norco to franchisees, franchise royalties and franchise fees. Financial results are dependentin large part upon the pricing and cost of these products and supplies to franchisees, and thelevel of chainwide retail sales, which is driven by changes in same store sales and restaurantcount.**Food and Supply Sales**     Food and supply sales by Norco include food and paper products, equipment, marketing materialsand other distribution revenues. Food and supply sales decreased 7%, or $3,173,000, to $41,029,000from $44,202,000 compared to the comparable period last year. The decline in food and supply saleswas due primarily to an overall decline in domestic chain wide sales, driven primarily by thestrategic closure of underperforming franchise restaurants that were typically not compliant withCompany operating standards, which accounted for $2,108,000 of the sales decline. The Companyclosed 33 domestic franchise restaurants during the year, or 9% of the total domestic franchiselocations. Freight and storage revenue declined $557,000 due to outsourcing certain warehousemanagement and delivery services. In addition, the sale of restaurant-level marketing materials tofranchisees decreased $365,000 primarily as a result of the Company’s decision to discontinue thesale of such materials to franchisees.**Franchise Revenue**     Franchise revenue, which includes income from royalties and franchise fees, decreased 4% or$177,000 compared to the comparable period last year primarily due to lower royalties for thecomparable period in the previous year as a result of lower retail sales. International royaltiesincreased 14% due primarily to increased retail sales and more locations. The following chartsummarizes the major components of franchise revenue (in thousands):           Fiscal Year Ended   June 24,  June 25,   2007  2006 Domestic royalties $3,963  $4,229 International royalties  423   370 Domestic franchise fees  191   147 International development fees  45   53        Franchise revenue $4,622  $4,799        
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**Restaurant Sales**     Restaurant sales, which consist of revenue generated by Company-owned restaurants,increased 2%, or $27,000, compared to the comparable period of the prior year. The increaseis the result of opening three newBuffet Units in fiscal 2006, which replaced one Buffet Unit that was sold to a franchiseeand one Delco Unit that was closed. The following chart details the revenues at Company-ownedrestaurants (in thousands):           Fiscal Year Ended   June 24,  June 25,   2007  2006 New Buffet Units — opened partial in Fiscal 2006 $1,485  $855 Buffet Unit — sold February 2006  —   354 Delco Unit — closed April 2006  —   249        Total Restaurant sales $1,485  $1,458        **Cost of Sales**     Cost of sales decreased 8% or $3,661,000 compared to the comparable period in the prioryear. This decrease is the primarily the result of lower food and supply sales. In addition,the Company’s commencement of the outsourcing of certain of its warehouse management anddelivery services for the distribution of food product to restaurants has resulted in adecreased cost of sales. Cost of sales, as a percentage of food and supply sales andrestaurant sales, decreased to 94% from 96% for the comparable period last year.**Franchise Expenses**     Franchise expenses include selling, general and administrative expenses (primarily wagesand travel expenses) directly related to the sale and continuing service of franchises andterritories. These expenses decreased 16% or $493,000 compared to the comparable period lastyear. This decrease is primarily the result of lower payroll, administrative and travelexpenses which were offset slightly by higher research and development and promotion expenses.**General and Administrative Expenses**     General and administrative expenses decreased 28% or $1,529,000 compared to the comparableperiod last year. The following chart summarizes the variances in general and administrativeexpenses (in thousands):           Fiscal Year Ended   June 24,  June 25,   2007  2006 Legal and Other Professional Fees $1,829  $1,850 Payroll  418   834 Stock Compensation  (14)  341 Occupancy Costs  622   833 Administrative Expenses and Other  416   662 Depreciation and Amortization  155   330 Information Technology  210   269 Utilities  189   216 Company Store Marketing  102   118 Repairs and Maintenance  75   78        Total general and administrative expenses $4,002  $5,531        
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     The decrease in payroll is primarily due to lower head count and a year end adjustment to thebonus accrual. The reduction of the stock compensation expense is a result of forfeitures associated with the resignation of the Company’s President and CEO and options thatbecame fully expensed in fiscal 2006. Occupancy costs decreased due to lower property tax and insurance costs which were slightly offset by rent expense. Administrative expensesand other include refunds on property taxes and insurance in the current year and lower expenses related to the Product Purchasing Committee. Depreciation and amortization is lower as aresult of the sale of the corporate office and the impairment of two restaurants in Houston during fiscal year 2006. Prior year Information Technology expenses included the write-offof capitalized software development costs associated with a proprietary on-line ordering system that was under development for the Company by a third party and that had been intendedto serve as an ordering and communication platform for franchisees placing orders with Norco. Travel costs were lower in fiscal 2007 as a result of lower head count as mentioned above.**Gain on Sale of Assets**     The current year includes the net gain on the sale of the corporate office and warehousefacility and various warehouse equipment and trailers the Company no longer needed, ofapproximately $570,000. A $261,000 deferred gain was also recognized as a result of the saleof the office building and is being recognized ratably over the ten-year term of the officelease. Prior year included the gain on sale of property in Prosper, Texas of approximately$149,000.**Impairment of Long-lived Assets and Goodwill**     In the fourth quarter of fiscal 2007, the Company recognized additional impairment ofapproximately $48,000 to certain property held for sale to value these assets at theirapproximate net realizable value and additional impairment of approximately $46,000 related toequipment and other fixed assets at the two Company-owned Houston area Buffet units based onmanagement’s decision to close these stores in the first quarter of fiscal 2008.     In the fourth quarter of fiscal 2006, the Company incurred impairment charges ofapproximately $152,000 to the goodwill related to the Company-owned stores and impairmentcharges of approximately $1,166,000 to the equipment and improvements related to the twoCompany-owned Buffet Units in the Houston, Texas market and one Company-owned Delco Unit inLittle Elm, Texas. The impairments were recognized due to the underperformance of theseCompany-owned stores and the Company’s determination that it was more likely than not that theCompany-owned restaurants in Houston, Texas and Little Elm, Texas would be sold prior to theend of their useful lives.**Litigation Settlement Accrual**     The prior year included a $2,800,000 expense to accrue future payments (paid in fiscal2007) to be made pursuant to an agreement to settle litigation with the Company’s formerpresident and chief executive officer. The current year includes a net settlement with PepsiCofor $302,000.**Other (Income) Expense**     Other income consisted primarily of rental income of $175,000 on the corporate warehouseprior to the sale of the building in the second quarter of fiscal year 2007.**Interest Expense**     Interest expense decreased 39% or $310,000 for the period ended June 24, 2007, compared tothe comparable period of the prior year due to the payoff of the Revolving Line of Credit withWells Fargo in December of 2006.
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**Provision for Bad Debt**     Bad debt provision related to accounts receivable from franchisees decreased by $205,000to $96,000. The Company believes that most of the restaurant closings in fiscal year 2007 didnot have a material impact on collectibility of any outstanding receivables and royalties dueto us because the vast majority of these closed restaurants were lower volume restaurants whosefinancial impact on its business as a whole was immaterial. For those restaurants that areanticipated to close or exhibiting signs of financial distress, credit terms are typicallyrestricted, weekly food orders are required to be paid for on delivery and/or with certifiedfunds and royalty and advertising fees are collected as add-ons to the delivered price ofweekly food orders.**Provision for Income Tax**     There was no provision for income taxes for the year ended June 24, 2007 compared to thebenefit of $1,029,000 for the prior year due to lower income in the prior year. The effectivetax rate was 0% compared to 15% in the previous year. The change in the effective tax rate isprimarily due to the effect of state net operating loss, foreign tax credit and the change inthe valuation allowance. The 2006 loss was carried back against prior taxes paid, and theCompany received a refund of approximately $680,000, in February 2007, for a portion of priortaxes paid.**Restaurant Openings and Closings**     During fiscal 2007 a total of 15 new franchise restaurants opened, including 8 domesticand 7 international restaurants. Domestically, 33 restaurants were closed by franchisees orterminated by the Company, typically because of unsatisfactory standards of operation orperformance. In addition, 4 international restaurants were closed. The following chartsummarizes restaurant openings and closings for the periods ended June 24, 2007 compared to thecomparable period in the prior year:Fiscal year ended June 24, 2007                       Beginning         Concept End ofDomestic of Period Opened Closed Change PeriodBuffet Units  182   3   20   1   166 Delco Units  49   1   8   —   42 Express Units  70   4   5   (1)  68 International Units  74   7   4   —   77                      Total  375   15   37   —   353                      Fiscal year ended June 25, 2006                       Beginning         Concept End ofDomestic of Period Opened Closed Change PeriodBuffet Units  199   4   21   —   182 Delco Units  52   4   7   —   49 Express Units  73   5   8   —   70 International Units  74   11   11   —   74                      Total  398   24   47   —   375                      
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***Fiscal 2006 Compared to Fiscal 2005*****Overview**     At June 25, 2006, there were 375 Pizza Inn restaurants, consisting of three Company-ownedrestaurants and 372 franchised restaurants. At June 25, 2006, the domestic restaurants wereoperated as: (i) 182 Buffet Units; (ii) 49 Delco Units; and (iii) 70 Express Units. The 301domestic restaurants were located in 18 states predominately situated in the southern half of theUnited States. Additionally, the Company had 74 international restaurants located in nine foreigncountries.     Diluted loss per common share was ($0.59) as compared to $0.02 of diluted income per share inthe prior year. Net loss was ($5,989,000) as compared to net income of $204,000 in the prior year,on revenues of $50,459,000 in the current year and $55,269,000 in the prior year. Pre-tax loss was($7,018,000) as compared to pre-tax income of $359,000 in the prior year. The increase in net lossis partially the result of a $2.8 million expense to accrue future payments to be made pursuant toan agreement to settle litigation with the Company’s former president and chief executive officer,impairment of long-lived assets and write-off of capitalized software costs totaling $1,443,000,and a 10% reduction in food and supply sales and a 7% reduction in franchise revenue. In addition,pre-tax earnings were negatively impacted by stock compensation expense of $341,000 and an increaseinbad debt provision of $271,000. Those negative impacts to pre-tax earnings were partiallyoffset by a gain of $147,000 on the sale of land in Prosper, TX, a reduction in compensationexpense of $24,000 due to a change in the estimate for the bonus accrual, and a reduction of statetax expense of $71,000 due to a change in estimated state taxes.     Results of operations for fiscal 2006 and 2005 both include fifty-two weeks.     Management believes that key performance indicators in evaluating financial results includechain-wide retail sales and the number and type of operating restaurants. The following tablesummarizes these key performance indicators.           Fiscal Year Ended  June 25, June 26,  2006 2005Chainwide retail sales Buffet Units (in thousands) $119,369  $126,723 Chainwide retail sales Delco Units (in thousands) $13,765  $13,842 Chainwide retail sales Express Units (in thousands) $8,579  $9,333 Average number of Buffet Units  186   203 Average number of Delco Units  51   53 Average number of Express Units  69   71 ***Revenues***     Revenues are primarily derived from sales of food, paper products and equipment and suppliesby Norco to franchisees, franchise royalties and franchise fees. Financial results are dependentin large part upon the pricing and cost of these products and supplies to franchisees, and thelevel of chain-wide retail sales, which is driven by changes in same store sales and restaurantcount.**Food and Supply Sales**     Food and supply sales by Norco include food and paper products, equipment, marketing materialsand other distribution revenues. Food and supply sales decreased 10%, or $4,959,000, to$44,202,000 from $49,161,000 compared to the comparable period last year. The decrease ispartially due to lower cheese prices, which negatively impacted revenues by approximately$1,450,000. Cheese product sales were approximately $896,000 lower than the comparable period inthe prior year due to the lower retail sales. Additionally, a decline of 5.5% in overall chainwideretail sales negatively impacted non-cheese sales by approximately $1,873,000. The sale ofrestaurant-level marketing materials to franchisees decreased $304,000 primarily as a result of theCompany’s decision to reduce the prices at which it sells such materials to franchisees.
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**Franchise Revenue**     Franchise revenue, which includes income from royalties and franchise fees, decreased 7% or$363,000 compared to the comparable period last year primarily due to lower royalties for thecomparable period in the previous year as a result of lower retail sales. The following chartsummarizes the major components of franchise revenue (in thousands):           Fiscal Year Ended   June 25,  June 26,   2006  2005 Domestic royalties $4,229  $4,624 International royalties  370   365 Domestic franchise fees  147   173 International development fees  53   —        Franchise Revenue $4,799  $5,162        **Restaurant Sales**     Restaurant sales, which consist of revenue generated by Company-owned restaurants,increased 54%, or $512,000, compared to the comparable period of the prior year. The increaseis the result of opening three new Buffet Units, which replaced one Buffet Unit that was soldto a franchisee and one Delco Unit that was closed. The following chart details the revenuesat Company-owned restaurants (in thousands):           June 25,  June 26,   2006  2005 Buffet Units $855  $574 Buffet unit — sold February 2006  354   — Delco unit — closed April 2006  249   372        Restaurant sales $1,458  $946        **Cost of Sales**     Cost of sales decreased 6% or $2,855,000 compared to the comparable period in the prioryear. This decrease is the primarily the result of lower food and supply sales. Cost ofsales, as a percentage of food and supply sales and restaurant sales, increased to 96% from 93%for the comparable period last year. This percentage increase is primarily due to higher fueland energy prices and $161,000 of pre-opening costs associated with the three new company-ownedBuffet Units.**Franchise Expenses**     Franchise expenses include selling, general and administrative expenses (primarily wagesand travel expenses) directly related to the sale and continuing service of franchises andterritories. These expenses increased 12% or $335,000 compared to the comparable period lastyear. This increase is primarily the result of higher payroll and travel due to increased headcount. These expenses were partially offset by lower product research, and outside marketingexpenses.
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**General and Administrative Expenses**     General and administrative expenses increased 13% or $649,000 compared to the comparableperiod last year. The following chart summarizes the primary variances in general andadministrative expenses (in thousands):           Fiscal Year Ended   June 25,  June 26,   2006  2005 Professional Fees $1,850  $1,657 Payroll  834   758 Stock Compensation  341   — Occupancy Costs  833   944 Administrative expenses and other  380   383 Depreciation and Amortization  330   346 Information Technology  269   126 Utilities  216   138 Board of Directors Fees  191   297 Marketing  118   73 Travel  91   63 Repairs and Maintenance  78   97        Total general and administrative expenses $5,531  $4,882             The increase in professional fees is primarily due to increased legal fees and outsidefranchise audits. The increase in payroll costs is the result of stock compensation expenseand Chief Executive Officer bonus accrual. Stock compensation expense increased with theimplementation of SFAS 123R on June 27, 2005. SFAS 123R requires the Company to recordcompensation charges for share-based transactions in the Consolidated Statement of Operations.See the “New Pronouncements” section below. Occupancy costs decreased due to lower taxes andinsurance. The increase in IT costs related to the write off of the on line ordering system.**Gain on Sale of Assets**     In fiscal 2006, the Company sold property in Prosper, Texas for a gain of approximately$149,000.**Impairment of Long-lived Assets and Goodwill**     In the fourth quarter of fiscal 2006, the Company incurred an impairment of approximately$152,000 to the goodwill related to the Company-owned stores and an impairment of approximately$1,166,000 to the equipment and improvements related to the two Company-owned Buffet Units inthe Houston, Texas market and one Company-owned Delco Unit in Little Elm, Texas. Theimpairments were recognized due to the underperformance of the Company-owned stores and theCompany’s determination that it was more likely than not that the Company-owned restaurants inHouston, Texas and Little Elm, Texas would be sold prior to the end of their useful lives.     In fourth quarter of fiscal 2006, the Company incurred a $125,000 expense related to thewrite-off of capitalized software development costs associated with a proprietary on-lineordering system that was under development for the Company by a third party and that had beenintended to serve as an ordering and communication platform for franchisees placing orders withNorco. The system was never fully developed or implemented and the Company’s decision toterminate the development contract and suspend system implementation was primarily a factor ofthe Company’s decision to outsource certain distribution services to third party providers. Inthe fourth quarter, the Company also accrued an expense of $20,000 to terminate a serviceagreement related to the online-ordering system.
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**Litigation Settlement Accrual**     The fiscal year 2006 expense includes a $2,800,000 expense to accrue future payments to bemade pursuant to an agreement to settle litigation with the Company’s former president andchief executive officer. Both fiscal 2006 and fiscal 2005 include legal expenses related toongoing and settled litigation and related matters.**Interest Expense**     Interest expense increased 33% or $197,000 for the period ended June 25, 2006, compared tothe comparable period of the prior year due to higher interest rates and a higher balance underthe Revolving Credit Agreement (defined below).**Provision for Bad Debt**     Bad debt provision related to accounts receivable from franchisees increased by $271,000to $301,000. The Company believes that most of the restaurant closings in fiscal 2006 did nothave a material impact on collectibility of any outstanding receivables and royalties due to usbecause the vast majority of these closed restaurants were lower volume restaurants whosefinancial impact on its business as a whole was immaterial. The majority of the Company’s baddebt provision in fiscal 2006 was related to accounts receivable due from one franchisee thatclosed 2 restaurants during the year and has closed his 3 remaining restaurants in fiscal 2007.For those restaurants that are anticipated to close or exhibiting signs of financial distress,credit terms are typically restricted, weekly food orders are required to be paid for ondelivery and/or with certified funds and royalty and advertising fees are collected as add-onsto the delivered price of weekly food orders.**Provision for Income Tax**     Provision for income taxes was a benefit of $1,029,000, a decrease of $1,184,000 comparedto the comparable period in the prior year due to lower income in the current year. Thebenefit from the income tax provision was reduced by a valuation allowance of $1,448,000 for areserve against its deferred tax asset, which was recognized in the fourth quarter of 2006.The effective tax rate was 15% compared to 43% in the previous year. The change in theeffective tax rate is primarily due to the effect of permanent differences on lower net incomein the current year as compared to the prior year and the valuation allowance in 2006. The2006 loss was carried back against prior taxes paid, and the Company received a refund ofapproximately $680,000 in February 2007 for a portion of prior taxes paid.**Restaurant Openings and Closings**     During fiscal 2006 a total of 23 new franchise restaurants and one Company ownedrestaurant opened, including 13 domestic and 11 international restaurants. Domestically, 35restaurants were closed by franchisees or terminated by the Company, typically because ofunsatisfactory standards of operation or performance. In addition, one Company-owned DelcoUnit closed and 11 international restaurants were closed. The following chart summarizesrestaurant openings and closings for the periods ended June 25, 2006 compared to the comparableperiod in the prior year:
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Fiscal year ended June 25, 2006                       Beginning         Concept End ofDomestic of Period Opened Closed Change PeriodBuffet Units  199   4   21   —   182 Delco Units  52   4   7   —   49 Express Units  73   5   8   —   70 International Units  74   11   11   —   74                      Total  398   24   47   —   375                      Fiscal year ended June 26, 2005                       Beginning         Concept End ofDomestic of Period Opened Closed Change PeriodBuffet Units  212   8   18   (3)  199 Delco Units  53   6   8   1   52 Express Units  73   8   10   2   73 International Units  67   7   —   —   74                      Total  405   29   36   —   398                      **Liquidity and Capital Resources**     Cash flows from operating activities are generally the result of net income (loss) adjustedfor depreciation and amortization and changes in working capital. In fiscal 2007, the Company usedcash of ($1,371,000) in operating activities as compared to generating cash flows from operatingactivities of $1,235,000 in fiscal 2006 and $1,088,000 in fiscal 2005. The net use of cash flowsfrom operations in fiscal 2007 was primarily due to the payment of $2,800,000 to the Company’sformer Chief Executive Officer. This payment was fully accrued in fiscal 2006 and paid in fiscal2007.     The Company generated net cash flows from investing activities of approximately $11,076,000 infiscal 2007. Cash flows from investing activities primarily reflect (i) proceeds from theCompany’s sale of its corporate office building and distribution facility to Vintage Interests,L.P. for approximately $11.5 million in December 2007 (as discussed below) and (ii) a reduction incapital expenditures of approximately $1,978,000 in fiscal 2007 compared to fiscal 2006. In fiscal2007, the Company used cash of approximately $249,000 for capital expenditures compared toapproximately $2,227,000 in fiscal 2006 as no new Company-owned restaurants were opened orpurchased in fiscal 2007. In fiscal 2006, the Company used cash of approximately $1,638,000 forinvesting activities as compared to approximately $753,000 in fiscal 2005. Cash flow used forinvesting activities during fiscal 2006 consisted primarily of the capital expenditures relating tothe opening of one new Company-owned Buffet Unit, the Company’s purchase, lease and remodeling oftwo existing Buffet Units, and purchases of warehouse equipment. Offsetting these expenditures wasapproximately $474,000 of proceeds from the sale of land in Prosper, Texas and approximately$115,000 from the sale of a Company-owned Buffet Unit in Dallas, Texas. In fiscal 2005, the Companyused cash flow for investing activities of approximately $753,000, primarily to purchase land inProsper, TX and for the enlargement of the warehouse parking lot.     Cash flows from financing activities generally reflect changes in the Company’s net repaymentsof borrowings during the period, together with treasury stock purchases and exercise of stockoptions. During fiscal 2007, the Company used net cash for financing activities of approximately($8,010,000). This use of cash included approximately $8,232,000 to pay off the Revolving CreditAgreement and Term Loan Agreement with Wells Fargo in December 2006. Net cash provided byfinancing activities was $414,000 in fiscal 2006 as compared to cash used for financing activitiesof $779,000 in fiscal 2005. In fiscal 2006, the Company increased its net bank borrowings by$747,000 primarily due to increased capital expenditures incurred in the current year. In fiscal2005, the
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Company used cash flow from operations to decrease its net bank borrowings and capitallease obligations by $649,000.     Management believes that future operations will generate sufficient taxable income, along withthe reversal of temporary differences, to fully realize the net deferred tax asset of $458,000primarily related to the Company’s recent history of pre-tax losses and the potential expiration ofcertain foreign tax credit carryforwards. Additionally, management believes that taxable incomebased on the Company’s existing franchise base should be more than sufficient to enable the Companyto realize its net deferred tax asset without reliance on material non-routine income. The 2006loss was carried back against prior taxes paid, and the Company received a refund of approximately$680,000 for a portion of taxes paid in the prior two years in February 2007.     On October 20, 2006, the Company and Vintage Interests, L.P. (“Vintage”) entered into apurchase and sale agreement (the “Sale-Leaseback Agreement”) pursuant to which Vintage agreed topurchase from the Company for $11.5 million the real estate, corporate office building anddistribution facility located at 3551 Plano Parkway, The Colony, Texas. Under the terms of theSale-Leaseback Agreement, the Company agreed to (i) assign to Vintage the three-year leaseagreement for the distribution facility entered into between the Company and The SYGMA Network onAugust 25, 2006, and (ii) enter into a ten-year lease agreement with Vintage for the corporateoffice building (the “Office Lease”). On November 21, 2006, Pizza Inn and Vintage entered into anamendment to the Sale-Leaseback Agreement, the material terms of which were (i) Vintage couldextend the closing date from December 19, 2006 to December 29, 2006 if Vintage provided notice ofsuch extension by December 15, 2006 and deposited an additional $100,000 of earnest money byDecember 19, 2006, and (ii) upon closing, Pizza Inn would deposit with Vintage an amount equal tosix months of rent for the office building in cash or by letter of credit until Pizza Inn’sshareholders’ equity exceeded $4 million. The sale-leaseback transaction was completed on December19, 2006 when the Company sold the property, pursuant to the Sale-Leaseback Agreement forapproximately $11.5 million.     The Company used a portion of the proceeds from the sale-leaseback transaction to pay off allobligations owed to Wells Fargo of $8,232,000 on December 19, 2006 and then terminated theRevolving Credit Agreement, the Term Loan Agreement, and all related agreements with Wells Fargo.At that time, the agreements with Newcastle regarding the Newcastle L/C were also terminated.Subsequently, the remaining proceeds from the sale-leaseback transaction were used to pay offamounts owed under two litigation settlement agreements. The Company paid to PepsiCo the $410,000settlement amount due under the PepsiCo Settlement Agreement on December 29, 2006. The Companypaid to Mr. Parker the remaining $2,350,000 due under the Parker Settlement Agreement on December22, 2006. As of June 24, 2007 the Company had no debt outstanding and no amounts due under theabove mentioned settlement agreements.     On January 23, 2007, the Company and The CIT Group / Commercial Services, Inc. (“CIT”) enteredinto an agreement for a revolving credit facility of up to $3.5 million (the “CIT CreditFacility”). The actual availability on the CIT Credit Facility is determined by advance rates oneligible inventory and accounts receivable. Interest on borrowings outstanding on the CIT CreditFacility is provided for at a rate equal to a range of the prime rate plus an interest rate marginof 0.0% to 0.5% or, at the Company’s option, at the LIBOR rate plus an interest rate margin of 2.0%to 3.0%. The specific interest rate margin is based on the Company’s performance under certainfinancial ratio tests. An annual commitment fee is payable on any unused portion of the CIT CreditFacility at a rate of 0.375%. All of the Company’s (and its subsidiaries’) personal propertyassets (including, but not limited to, accounts receivable, inventory, equipment, and intellectualproperty) have been pledged to secure payment and performance of the CIT Credit Facility, which issubject to customary covenants for asset-based loans.     On June 27, 2007, the Company and CIT entered into an agreement to amend the CIT CreditFacility to (i) allow the Company to repurchase Company stock in an amount up to $3,000,000, (ii)allow the Company to make permitted cash distributions or cash dividend payments to the Company’sshareholders in the ordinary course of business and (iii) increase the aggregate capitalexpenditure limit from $750,000 per fiscal year to $3,000,000. As of June 24, 2007, there were noborrowings outstanding on the CIT Credit Facility, and the Company has used the facility to obtainone letter of credit for approximately $190,000 in connection with deposit requirements under thesale leaseback agreement and another letter of credit for approximately $230,000 to reinsurers tosecure loss reserves.
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     We expect to fund planned capital expenditures, new restaurant openings and any additionalshare repurchases of our common stock for the next fiscal year from operating cash flow and the$3,500,000 CIT Credit Facility under our revolving line of credit, reduced for certain outstandingletters of credit. At June 24, 2007, there was no debt outstanding.**Contractual Obligations and Commitments**     The following chart summarizes all of the Company’s material obligations and commitments tomake future payments under contracts such as operating lease and employment agreements as of June24, 2007 (in thousands):                           Fiscal Year  Fiscal Years  Fiscal Years  After Fiscal   Total  2008  2009 - 2010  2011 - 2012  Year 2012 Operating lease obligations $5,297  $689  $1,190  $1,040  $2,378 Employment Agreements  300   300   —   —   —                 Total contractual cash obligations $5,597  $989  $1,190  $1,040  $2,378                 **Transactions with Related Parties**     Two directors of the Company were franchisees during fiscal 2006 and one director was afranchisee during part of fiscal 2007.     This director, Ramon Phillips, did operate one restaurant in Oklahoma. He sold thisrestaurant in April 2007 and is no longer a Pizza Inn franchisee. Purchases by this franchiseecomprised 0.4%, 0.4%, and 0.4% of the Company’s total food and supply sales in the years ended June24, 2007, June 25, 2006 and June 26, 2005,respectively. Royalties from this franchisee comprised 0.4%, 0.4%, and 0.5% of the Company’stotal franchise revenues in the years ended June 24, 2007, June 25, 2006 and June 26, 2005,respectively. As of June 24, 2007 and June 25, 2006, his accounts payable to the Company were $0and approximately $10,000, respectively. This restaurant paid royalties to the Company andpurchased a majority of its food and supplies from Norco.     One of the director franchisees, Bobby Clairday, currently operates a total of 10 restaurantslocated in Arkansas. Purchases by this franchisee comprised 6.9%, 6.5%, and 6.3% of the Company’stotal food and supply sales in the years ended June 24, 2007, June 25, 2006 and June 26, 2005,respectively. Royalties and license fees and area development sales from this franchisee comprised3.4%, 3.5%, and 3.4% of the Company’s total franchise revenues in the years ended June 25, 2006,June 26, 2005 and June 27, 2004, respectively. As of June 25, 2006 and June 26, 2005, his accountsand note payable to the Company were $442,000 and $898,000, respectively. These restaurants payroyalties to the Company and purchase a majority of their food and supplies from Norco. Thisfranchisee director did not stand for re-election on the board in December 2006.     The Company believes that the above transactions were at the same prices and on the samepayment terms available to non-related parties, with one exception. This exception relates to theenforcement of the personal guarantee by Mr. Clairday of the debt of a franchisee of which he isthe President and sole shareholder. In addition to normal trade receivables, the Company claimedthat the franchisee, Advance Food Services, Inc., owed the Company approximately $339,000,representing debt incurred by Advance Foods, Inc. for royalty and advertising fee payments andNorco product deliveries during a period in 1996 and 1997 following Mr. Clairday’s sale of thatcompany to unrelated third parties and prior to his reacquisition of the company in 1997 (“AdvanceFoods Debt”). Mr. Clairday had guaranteed payment of approximately $236,000 of the Advance FoodsDebt (“Guaranteed Amount”). During fiscal 2005 the Company applied against the Guaranteed Amountof the Advance Foods Debt approximately $7,250 in board fees due Mr. Clairday, and on June 20, 2006the Company and Mr. Clairday entered into a settlement agreement whereby Mr. Clairday paid theCompany the remaining balance of the Guaranteed Amount. In the fourth quarter of 2006 the Companyrecognized a bad debt provision to related party accounts receivable of approximately $76,000,representing the amount of the Advance Foods Debt either in dispute or not guaranteed by Mr.Clairday. The full amount of the provision was written off as uncollectible at that time.
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**Critical Accounting Policies and Estimates**     The preparation of financial statements in conformity with accounting principles generallyaccepted in the United States of America requires the Company’s management to make estimates andassumptions that affect our reported amounts of assets, liabilities, revenues, expenses and relateddisclosure of contingent liabilities. The Company bases its estimates on historical experience andvarious other assumptions that it believes are reasonable under the circumstances. Estimates andassumptions are reviewed periodically. Actual results could differ materially from estimates.     The Company believes the following critical accounting policies require estimates about theeffect of matters that are inherently uncertain, are susceptible to change, and therefore requiresubjective judgments. Changes in the estimates and judgments could significantly impact theCompany’s results of operations and financial condition in future periods.     Accounts receivable consist primarily of receivables generated from food and supply sales tofranchisees and franchise royalties. The Company records a provision for doubtful receivables toallow for any amounts which may be unrecoverable and is based upon an analysis of the Company’sprior collection experience, general customer creditworthiness and the franchisee’s ability to pay,based upon the franchisee’s sales, operating results and other general and local economic trendsand conditions that may affect the franchisee’s ability to pay. Actual realization of accountsreceivable could differ materially from the Company’s estimates.     Notes receivable primarily consist of notes from franchisees for trade receivables, franchisefees and equipment purchases. These notes generally have terms ranging from one to five years andinterest rates of 6% to 12%. The Company records a provision for doubtful receivables to allow forany amounts which may be unrecoverable and is based upon an analysis of the Company’s priorcollection experience, general customer creditworthiness and a franchisee’s ability to pay, basedupon the franchisee’s sales, operating results and other general and local economic trends andconditions that may affect the franchisee’s ability to pay. Actual realization of notes receivablecould differ materially from the Company’s estimates.     Inventory, which consists primarily of food, paper products, supplies and equipment primarilywarehoused by the Company’s two third-party distributors, The SYGMA Network and The InstitutionalJobbers Company, are stated at lower of cost or market, with cost determined according to theweighted average cost method. The valuation of inventory requires us to estimate the amount ofobsolete and excess inventory. The determination of obsolete and excess inventory requires us toestimate the future demand for the Company’s products within specific time horizons, generally sixmonths or less. If the Company’s demand forecast for specific products is greater than actualdemand and the Company fails to reduce purchasing accordingly, the Company could be required towrite down additional inventory, which would have a negative impact on the Company’s gross margin.     Re-acquired development franchise rights are initially recorded at cost. When circumstanceswarrant, the Company assesses the fair value of these assets based on estimated, undiscountedfuture cash flows, to determine if impairment in the value has occurred and an adjustment isnecessary. If an adjustment is required, a discounted cash flow analysis would be performed and animpairment loss would be recorded.     The Company has recorded a valuation allowance to reflect the estimated amount of deferred taxassets that may not be realized based upon the Company’s analysis of existing tax credits byjurisdiction and expectations of the Company’s ability to utilize these tax attributes through areview of estimated future taxable income and establishment of tax strategies. These estimatescould be materially impacted by changes in future taxable income and the results of tax strategies.     The Company assesses its exposures to loss contingencies including legal and income taxmatters based upon factors such as the current status of the cases and consultations with externalcounsel and provides for the exposure by accruing an amount if it is judged to be probable and canbe reasonably estimated. If the actual loss from a contingency differs from management’s estimate,operating results could be impacted.
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**New Pronouncements**     In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid FinancialInstruments” an amendment of SFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets andExtinguishments of Liabilities.” This Statement permits fair value remeasurement for any hybridfinancial instrument that contains an embedded derivative that would otherwise be required to bebifurcated from its host contract. The election to measure a hybrid financial instrument at fairvalue, in its entirety, is irrevocable and all changes in fair value are to be recognized inearnings. This Statement also clarifies and amends certain provisions of SFAS No. 133 and SFAS No.140. This Statement is effective for all financial instruments acquired, issued or subject to aremeasurement event occurring in fiscal years beginning after September 15, 2006. Early adoption ispermitted, provided the Company has not yet issued financial statements, including financialstatements for any interim period, for that fiscal year. The adoption of this Statement is notexpected to have a material impact on the Company’s financial position or results of operations.     In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes.” This Interpretation prescribes a comprehensive model for the financial statementrecognition, measurement, presentation and disclosure of uncertain tax positions taken or expectedto be taken in income tax returns. This Interpretation is effective for fiscal years beginningafter December 15, 2006. The cumulative effects, if any, of applying this Interpretation will berecorded as an adjustment to retained earnings as of the beginning of the period of adoption. TheCompany is in the process of determining the impact of adopting this Interpretation.     In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff AccountingBulletin No. (“SAB 108”) which provides interpretive guidance on how the effects of the carryoveror reversal of prior year misstatements should be considered in quantifying a current yearmisstatement. The guidance is applicable for our fiscal 2007. The adoption of this statement didnot have a material impact on the Company’s financial position or results of operation.     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157establishes a framework for measuring fair value within generally accepted accounting principlesclarifies thedefinition of fair value within that framework and expands disclosures about the use of fairvalue measurements. SFAS No. 157 does not require any new fair value measurements in generallyaccepted account principles. However, the definition of fair value in SFAS No. 157 may affectassumptions used by companies in determining fair value. The Company will be required to adoptSFAS No. 157 on June 30, 2008. The Company has not completed its evaluation of the impact ofadoption of SFAS No. 157 on the Company’s financial statements, but currently believes the impactof the adoption of SFAS No. 157 will not require material modification of the Company’s fair valuemeasurement and will be substantially limited to expanded disclosures in the notes to the Company’sconsolidated financial statement.     In February 2007, the FASB issued SFAS No. 159, “Fair Value Option for Financial Assets andFinancial Liabilities.” SFAS No. 159 permits entities to choose to measure many financialinstruments, including employee stock option plans and operating leases accounted for in accordancewith SFAS No. 13, Accounting for Leases, at their Fair Value. This Statement is effective as ofthe beginning of an entity’s first fiscal year that begins after November 15, 2007. The Companyhas not completed its evaluation of the impact of adoption of SFAS No. 159 on the Company’sfinancial statements but currently believes the impact of the adoption of SFAS No. 159 will notrequire material modification of the Company’s consolidated financial statements.**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**     The Company has market risk exposure arising from changes in interest rates. The Company’searnings are affected by changes in short-term interest rates as a result of borrowings under itscredit facilities, which bear interest based on floating rates. There is no current known impactdue to a lack of debt balances at June 24, 2007.     The Company is exposed to market risks from changes in commodity prices. During the normalcourse of business, the Company purchases cheese and certain other food products that are affectedby changes in commodity prices and, as a result, the Company is subject to volatility in its foodsales and cost of sales. Management actively
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monitors this exposure; however, the Company does notenter into financial instruments to hedge commodity prices. The block price per pound of cheeseaveraged $1.38 in fiscal 2007. The estimated change in sales from a hypothetical $0.20 decrease inthe average cheese block price per pound would have been approximately $1.18 million in fiscal2007.     The Company does not believe inflation has materially affected earnings during the past threeyears. Substantial increases in costs, particularly commodities, labor, benefits, insurance,utilities and fuel, could have a significant impact on the Company.
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**PIZZA INN, INC.****ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**Index to Financial Statements and Schedule:r       **PAGE NO.****FINANCIAL STATEMENTS**         Report of Independent Registered Public Accounting Firm.  33      Consolidated Statements of Operations for the years endedJune 24, 2007, June 25, 2006, and June 26, 2005.  34      Consolidated Statements of Comprehensive Income (Loss) for the years endedJune 24, 2007, June 25, 2006, and June 26, 2005.  34      Consolidated Balance Sheets at June 24, 2007 and June 25, 2006.  35      Consolidated Statements of Shareholders’ Equity for the yearsended June 24, 2007, June 25, 2006, and June 26, 2005.  36      Consolidated Statements of Cash Flows for the years ended June 24, 2007,June 25, 2006, and June 26, 2005.  37      Notes to Consolidated Financial Statements.  39      **FINANCIAL STATEMENT SCHEDULE**         Schedule II  —  Consolidated Valuation and Qualifying Accounts  63      All other schedules are omitted because they are not applicable, notrequired or because the required information isincluded in the consolidatedfinancial statements or notes thereto.    
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Report of Independent Registered Public Accounting FirmBoard of Directors and Stockholders