No one who watches the pizza industry would call Pizza Inn a newsmaker.

Until now.

For the past decade, the 417-unit chain hasn't posted significant gains in revenue, units or market share. In the years following its 1989 bankruptcy, the company's stock did grow an impressive six-fold, but slipped below a dollar by 2002. Negligible earnings per share (EPS) and small trading volume now keep it below the radar of every Wall Street analyst.

And yet, seemingly without explanation, in 2003 the stock has tripled in value, rising from $1.33 in February, peaking at $3.95 in September and hovering near $3 during December.

Why?

To outsiders, the answer is difficult to pinpoint since no one from Pizza Inn's board of directors or Newcastle Partners (the chain's largest shareholder, which owns more than 35 percent of its stock) is talking. The only available clues to this surprising stock turnaround are obscured by the dense details of multiple Securities Exchange Commission (SEC) filings. Those documents—hundreds of pages long in total—reveal an increasingly heated war of words between the two camps.

Newcastle believes the lack of initiative and strategic planning displayed by Pizza Inn's current board threatens the company's future in the highly competitive pizza segment. As the company's major shareholder, it wants to increase the chain's board positions from seven to nine and acquire four of them.

For its part, Pizza Inn claims Newcastle's efforts to gain more board spots and change certain company bylaws could constitute a "change of employment" based on the contracts of its executive officers. Such changes, it claims, will trigger parachute payouts in the millions, which the highly leveraged chain cannot afford.

A November-through-December flurry of SEC filings illustrating the two camps' differences marks a path leading toward a bitter proxy battle at Pizza Inn's annual shareholders meeting on Jan. 21, 2004. The looming showdown at the company's headquarters in The Colony, Texas, foreshadows significant change in the near future of Pizza Inn.

History begets itself

In 1989, Pizza Inn filed for bankruptcy. Bludgeoned by increasingly tough competition from the pizza delivery segment, the mostly buffet-store chain was on a slippery slope of negative sales trends and unit closures.

When Jeff Rogers was

What's Important

Despite poor sales performance, Pizza Inn's stock price has almost tripled in 2003.

Pizza Inn's board of directors is set for a showdown with the company's largest shareholder, Newcastle Partners, when the groups meet for the chain's annual meeting in January.

Pizza Inn claims that certain board appointments could be construed as changes of employment as detailed in the contracts of some of its executives. Such changes would trigger millions in payouts to those executives, which the heavily leveraged company cannot afford to make.

appointed CEO over the struggling firm in 1990, his orders were simple: turn the company around or liquidate it.

Rogers chose the former and applied his high-energy leadership to pumping life back into the aging chain. To boost morale at Pizza Inn's headquarters (then located in a less-than-desirable section of downtown Dallas), Rogers made simple fixes such as painting the corporate offices, replacing burned-out lights and hiring security guards to patrol the employee parking lot.

He successfully persuaded franchisees to remain in the system by assuring them they were the key to returning Pizza Inn to its once-proud heritage.

Over time, Rogers formed a management team that targeted and repaired operational breakdowns and deficiencies, and by 1995, Pizza Inn was well on the mend. By 1998, same-store sales trends were positive, the chain's stock was trading at an all-time high of $6.25 and Rogers was regarded as a turnaround genius.

Four years later, however, it all changed. At the completion of fiscal '02 (Pizza Inn's accounting year ends in June), the chain's unit growth and same-store sales were flat again. Though revenue hit a five-year high of $66.64 million, profits plunged, EPS was a mere 11 cents and the stock was trading near $1.30. It also marked the second straight year Pizza Inn shareholders did not receive stock dividends (a trend which continues unabated).

Two months later, when the company released its annual report, it blamed the bulk of the period's losses on a massive pre-tax charge taken for the balance of a stock option loan made to CEO Rogers. In 1999, Pizza Inn advanced him $1.95 million for the loan, but three years later, Rogers, who had paid interest on the note, still owed $1.9 million. The balance was due in mid-2004, but the board believed Rogers could not meet that obligation. The CEO resigned and was replaced by his handpicked president, Ronald Parker.

Rogers was out, but in terms of his stake in Pizza Inn, he wasn't down. According to SEC filings, he still owned 35 percent of the company's shares then outstanding. On Dec. 6, 2002, he sold nearly all of it to Newcastle Partners, a Dallas-based investment group, for $7.4 million.

Three days later, Rogers paid off his $1.9 million debt (19 months ahead of the actual due date) and Newcastle Partners was the majority shareholder of Pizza Inn.

Able to move Rogers' $1.9 million payment to its bottom line, Pizza Inn's stock jumped nearly a dollar almost immediately. But while the boost enlivened the company's stock price throughout 2003, it could not counter the company's sagging store sales. At the end of fiscal 2003 in June, Pizza Inn's comparable revenues were $58 million—down $8 million from 2002.

Speaking, but only on paper

Finding stock analysts to comment on Pizza Inn's situation is a needle-in-a-haystack effort since so few shares of its stock trade daily. For example, about 7,700 Pizza Inn shares are traded on a given day: a diminutive amount compared to the 152,000 shares of Papa John's moving daily.

"I used to watch (Pizza Inn) about 20 years ago," said Mike Smith, a restaurant stock analyst who covers Papa John's for Kansas City, Mo.-based Fahnestock. "But there hasn't been anything there to watch in a long time."

Even Joseph Agnese, the named author of a Dec. 15, 2003, Standard & Poor's "Wall Street Consensus" report on Pizza Inn, said he was unfamiliar with the chain. The contents of the five-page report, he said, are a generic patchwork of basic Pizza Inn information combined with other foodservice industry companies. (Agnese said he thought another S&P analyst may have put the report together, but that analyst did not return calls for comment.)

Still, what's clear is someone's not only watching Pizza Inn's stock, but buying enough of it to drive the price from $1.23 to $3.95 in just seven months.

Since market players who own less than 5 percent of a company do not have to disclose small trades to the SEC, current Pizza Inn filings reveal nothing about who is buying its shares. It's noteworthy that the 54 percent share of the company held by insiders (defined as a company's executives and board members) has neither increased nor declined this year.

So the question comes 'round again: Why would small market players buy Pizza Inn? Perhaps they like its cumulative EPS for 2003: 33 cents per share, a 172 percent increase over 2002.

A cursory glance at the company's balance sheet makes this unlikely, since Rogers' debt payment is solely responsible for the hike. And anyone taking a long-term look at Pizza Inn's sales history also would see a discouraging downward trend, which explains Standard & Poor's "hold" recommendation for the stock.

The remaining logical assumption for the stock run-up, therefore, lies in outsider interest in the brewing battle for board positions. In fact, as word of Newcastle's desire to gain greater control of Pizza Inn's board became public, the chain's stock price began climbing. One Pizza Inn observer, who declined to speculate on the record, wondered whether Newcastle might take the company private or even put Rogers back in the CEO's seat.

None of Newcastle's SEC filings, however, render such speculation likely.

Passive resistance

SEC filings in late 2003 show Newcastle urging Pizza Inn to change its bylaws in order to broaden its board to accommodate two additional Newcastle-nominated members. On Oct. 10, Newcastle submitted a list of 18 potential nominees to Pizza Inn's board, and at the board's Oct. 14 meeting, Newcastle's Schwarz asked board member F. Jay Taylor and Chairman Steve Ungerman to step down to make room for two of those nominees.

According to a Pizza Inn filing, Schwarz did not have specific nominees for consideration, which led Pizza Inn's board to vote 5-2 to re-nominate all three existing directors up for re-election. Those included Ungerman, Taylor and Steven Pully, president of Newcastle.

Schwarz and Pully voted against the proposal.

On Oct. 27, Pizza Inn's deadline for nominations to its board (which are then voted on by shareholders via proxy), the company received a letter from Newcastle stating its intent to nominate Pully, Barry M. Barron, Sr., and Robert B. Page to the board and solicit its own proxies from shareholders. (By mid-November, Newcastle would substitute Ramon Phillips for Page and then re-nominate Page in place of Barron.)

In subsequent filings, Pizza Inn objected to all three Newcastle nominees: By judgment of its counsel, none of the three men could be considered members of the "Incumbent Board." Therefore, if any of the three were elected to the board via proxy contest, a " 'Change of Control' as defined in the employment agreements" of several key executives, would take effect. Those Pizza Inn executives include: CEO and President Ronald Parker; Senior Vice President Keith Clark; CFO Shawn Preator; and Senior Vice President of Franchise Operations Ward Olgreen.

Newcastle CEO Mark Schwarz accuses Pizza Inn's executives of using their single-trigger provisions not as a legitimate means of retaining key employees, but "as a tool to entrench the existing Board. ... In our opinion the $7 million plus payments smack of irresponsibility on behalf of a board that owns little equity in the Company."

The change, according to a Dec. 8 Pizza Inn SEC filing, would trigger huge payouts to the executives by awarding Parker $5.4 million, Clark $762,000, Olgreen $630,000 and Preator, $597,000—about $7.4 million total.

Additionally, the filing read, should Parker no longer be Pizza Inn's CEO, "the Company would be in default under approximately $9.5 million of indebtedness owed to Wells Fargo Bank (Texas)," plus another $800,000 tied to a similar agreement.

Counsel for Newcastle informed Pizza Inn it disagreed with its opinion, stating that Schwarz and Pully were incumbent directors whose election to the board would not set off a change of control. In a Dec. 15 Newcastle filing, the investor group accused Pizza Inn of using the change-of-control provisions merely "to deter Newcastle Partners from seeking elections of its nominees" and garner shareholder votes.

Also within that filing was a copy of a letter from Schwarz to Board Chair Ungerman that illustrated the Newcastle CEO's frustration over the incumbency issue. Schwarz called the " 'single trigger' employment contacts" egregious, and said they stripped away the basic right of shareholders to choose their board representatives. Schwarz accused Pizza Inn's executives of using their single-trigger provisions not as a legitimate means of retaining key employees, but "as a tool to entrench the existing Board. ... In our opinion the $7 million plus payments smack of irresponsibility on behalf of a board that owns little equity in the Company."

Schwarz then accused the group of solidifying its employment agreements by changing Pizza Inn's bylaws without shareholders' awareness. The changes were made, he added, less than two weeks after Rogers sold his 35 percent share in Pizza Inn to Newcastle in December 2002.

The bath water, not the baby

The blame for the "slow and persistent decline" of Pizza Inn's unit numbers and overall profitability, Schwarz wrote in the filing, rests at the feet of its leaders, who have failed to develop a long-term strategic plan for the company. And despite the company's ongoing negative performance, he continued, senior management continues to reward itself with "guaranteed bonuses paid quarterly irrespective of the Company's results."

Still, Schwarz believes the company has great potential if Pizza Inn's board will reinvest in the brand, build a core of company stores and focus on long-term initiatives.

"Despite the Board's failures, Pizza Inn remains a great company with the potential for a much brighter future," he wrote. "We remain hopeful that the controlling Board members will set aside personal interests, recognize past failures in corporate governance and leadership and work together with us to help make positive change that will benefit all of the Company's stakeholders."

As Pizza Inn's largest shareholder, Schwarz continued, Newcastle's large stake in the chain motivates its own leadership to build the company and maximize its return on investment. Doing that, he concluded, will take both parties' willingness "to resolve this dispute and get on with the much more important task of dealing with the challenging business issues that will determine the future success of the Company."

Read related Pizza Inn stories ...
* SEC filing details battle for Pizza Inn board
* Pizza Inn reschedules annual meeting as proxy battle looms
* Largest Pizza Inn shareholder wants to expand board with two pizza veterans
* Pizza Inn's Q1 '03 comp-sales drop

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