Rave Restaurant Group - 10-Q quarterly report FY

The accompanying condensed consolidated financial statements of Pizza Inn, Inc. (the "Company") have been prepared without audit pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in the financial statements have been omitted pursuant to such rules and regulations.  The condensed consolidated financial statements should be read in conjunction with the notes to the Company's audited consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended June 24, 2007.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to fairly present the Company's financial position and results of operations for the interim periods.  All adjustments contained herein are of a normal recurring nature.  Results of operations for the fiscal periods presented herein are not necessarily indicative of fiscal year-end results.  Certain prior period amounts have been reclassified to conform with current period presentation.

The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned.  All appropriate inter-company balances and transactions have been eliminated.

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

Fiscal second quarter ended December 23, 2007 and December 24, 2006, both contained 13 weeks and the fiscal six months ended December 23, 2007 and December 24, 2006, both contained 26 weeks.

The Company recognizes revenue when products are delivered and the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable.  The Company's Norco division sells food and supplies to franchisees on trade accounts under terms common in the industry.  Food and supply revenue are recognized upon delivery of the product.  Equipment that is sold requires acceptance prior to installation.  Recognition of revenue for equipment sales occurs upon acceptance of such equipment.  Other than for large remodel projects, delivery date and acceptance date are the same.  Norco sales are reflected under the caption "food and supply sales."  Shipping and handling costs billed to customers are recognized as revenue.

Franchise revenue consists of income from license fees, royalties, and area development and foreign master license (collectively, "Territory") fees. License fees are recognized as income when there has been substantial performance of the agreement by both the franchisee and the Company.  Foreign master license fees are generally recognized upon execution of the agreement as all material services relating to the sale have been substantially performed by the Company and the fee has been collected.  Royalties are recognized as income when earned.  Domestic franchise fees are generally recognized at the time the restaurant is opened.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company’s management to make estimates and assumptions that affect its reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent liabilities.  The Company bases its estimates on historical experience and other various assumptions that it believes are reasonable under the circumstances.  Estimates and assumptions are reviewed periodically and actual results could differ materially from estimates.

In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation Number 48, Accounting for Uncertainty in Income Taxes (FIN 48).  FIN 48 clarifies the accounting for income taxes by prescribing the minimum requirements a tax position must meet before being recognized in the financial statements.  In addition, FIN 48 prohibits the use of Statement of Financial Accounting Standards (SFAS) Number 5, Accounting for Contingencies, in evaluating the recognition and measurement of uncertain tax positions.  We adopted FIN 48 at the beginning of our fiscal year on June 25, 2007 and recognized no adjustment in the liability for unrecognized tax benefits upon adoption.  At December 23, 2007, the Company’s unrecognized tax benefits, including interest and penalties, were $0 and the amount of unrecognized tax benefits that would impact the effective rate, if recognized, is $0.  Although the Company believes it has adequately provided for all tax positions, taxing authorities could assess amounts greater or less than the Company’s accrued position.  The Company does not anticipate a significant change to the total amount of unrecognized tax benefits.

In September 2006, the FASB issued SFAS Number 157, Fair Value Measurements. SFAS Number 157 establishes a framework for measuring fair value within generally accepted accounting principles clarifies the definition of fair value within that framework and expands disclosures about the use of fair value measurements.  SFAS Number 157 does not require any new fair value measurements in generally accepted accounting principles.  However, the definition of fair value in SFAS Number 157 may affect assumptions used by companies in determining fair value.  The Company will be required to adopt SFAS Number 157 on June 30, 2008.  The Company has not completed its evaluation of the impact of adoption of SFAS Number 157 on the Company’s financial statements, but currently believes the impact of the adoption of SFAS Number 157 will not require material modification of the Company’s fair value measurements and will be substantially limited to expanded disclosures in the notes to the Company’s consolidated financial statements.

In February 2007, the FASB issued SFAS Number 159, Fair Value Option for Financial Assets and Financial Liabilities.  SFAS Number 159 permits entities to choose to measure many financial instruments, including employee stock option plans and operating leases accounted for in accordance with SFAS Number 13, Accounting for Leases, at their Fair Value.  This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007.  The Company has not completed its evaluation of the impact of adoption of SFAS Number 159 on the Company’s financial statements but currently believes the impact of the adoption of SFAS Number 159 will not require material modification of the Company’s consolidated financial statements.

In December 2007, the FASB issued SFAS Number 141 (Revised), Business Combinations.  SFAS Number 141(R) improves the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date.  This statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The adoption of this Statement is not expected to have a material impact on the Company’s financial position or results of operations.

In December 2007, the FASB issued SFAS Number 160, Noncontrolling Interests in Consolidated Financial Statements.  SFAS Number 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary and clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements.  This statement is effective for fiscal years beginning on or after December 15, 2008.  The adoption of this Statement is not expected to have a material impact on the Company’s financial position or results of operations.

On January 23, 2007, the Company and The CIT Group / Commercial Services, Inc. (“CIT”) entered into an agreement for a revolving credit facility of up to $3.5 million (the “CIT credit facility”).  The actual availability on the CIT credit facility is determined by advance rates on eligible inventory and accounts receivable.  Interest on borrowings outstanding on the CIT credit facility is provided for at a rate equal to a range of the prime rate plus an interest rate margin of 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 certain financial ratio tests.  An annual commitment fee is payable on any unused portion of the CIT credit facility at a rate of 0.375%.  All of the Company’s (and its subsidiaries’) personal property assets (including, but not limited to, accounts receivable, inventory, equipment, and intellectual property) have been pledged to secure payment and performance of the CIT credit facility, which is subject to customary covenants for asset-based loans.

On June 27, 2007, the Company and CIT entered into an agreement to amend the CIT credit facility 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’s shareholders in the ordinary course of business and (iii) increase the aggregate capital expenditure limit from $750,000 per fiscal year to $3,000,000.  As of December 23, 2007, there were no borrowings outstanding on the CIT credit facility. The Company has used the facility to obtain one letter of credit for approximately $190,000 in connection with deposit requirements under the sale leaseback agreement and another letter of credit for approximately $230,000 to reinsurers to secure loss reserves.  The $190,000 letter of credit obtained in connection with deposit requirements under the sale lease back agreement was terminated during the quarter ended December 23, 2007.

PIBCO, Ltd., a wholly-owned insurance subsidiary of the Company, in the normal course of operations, arranged for the issuance of a letter of credit for $230,000 to reinsurers to secure loss reserves.  At June 25, 2006, this letter of credit was secured under the Revolving Credit Agreement.  In December 2006, the letter of credit was terminated and replaced by a deposit of $230,000.  At June 24, 2007 this deposit was included in cash and cash equivalents in the consolidated balance sheet.  In July 2007, CIT issued a letter of credit for approximately $230,000 to secure these loss reserves and the $230,000 deposit was returned to the Company.  Loss reserves for approximately the same amount have been recorded by PIBCO, Ltd. and are reflected as current liabilities in the Company's consolidated financial statements as of December 23, 2007.

On May 23, 2007, the Company announced that its Board of Directors had authorized a stock repurchase plan whereby the Company may repurchase up to 1,016,000 shares of its currently outstanding common stock.  As of December 23, 2007, 313,107 shares have been repurchased under the plan at an average price of $2.80 per share.

On August 31, 2006, the Company was served with notice of a lawsuit filed against it by a former franchisee and its guarantors who operated one restaurant in the Harlingen, Texas market in 2003.  The former franchisee and guarantor allege generally that the Company intentionally and negligently misrepresented costs associated with development and operation of the Company’s franchise, and that as a result they sustained business losses that ultimately led to the closing of the restaurant.  They seek damages of approximately $768,000, representing amounts the former franchisees claim to have lost in connection with their development and operation of the restaurant.  In addition, they seek unspecified punitive damages, and recovery of attorneys’ fees and court costs.  The Eastern District of Texas magistrate recently ruled in the Company’s favor to transfer this action to the Northern District of Texas pursuant to the forum selection clause in the franchise agreement.  On December 18, 2007, the parties entered into an Agreed Stipulation of Dismissal and Order where the plaintiff agreed to dismiss the claim, in federal court, with prejudice and plaintiff agreed that he has sixty days to re-file the case in the state district courts of Dallas County, Texas.  The Company is currently waiting to see if plaintiff files in state court.  Due to the preliminary nature of this matter and the general uncertainty surrounding the outcome of any form of legal proceeding, it is not practicable for the Company to provide any certain or meaningful analysis, projection or expectation at this time regarding the outcome of this matter.  Although the outcome of the legal proceeding cannot be projected with certainty, the Company believes that the plaintiff’s allegations are without merit.  The Company intends to vigorously defend against such allegations and to pursue all relief to which it may be entitled, including pursuing a counterclaim for recovery of past due amounts, future lost royalties and attorneys’ fees and costs.  An adverse outcome to the proceeding could materially affect the Company’s financial position and results of operation.  The Company has not made any accrual for any such amounts as of December 23, 2007.

On December 19, 2006, the Company notified Nasdaq that the Company is aware that it fails to satisfy the audit committee composition requirements under Nasdaq Marketplace Rule 4350(d)(2)(A) due to one vacancy on the audit committee of the Company’s Board of Directors.  Nasdaq Marketplace Rule 4350(d)(2)(A) requires an audit committee of at least three members, each of whom must, among other requirements, be independent as defined under NASDAQ Marketplace Rule 4200(a)(15) and meet the criteria for independence set forth in Rule 10A-3(b)(1) under the Securities Exchange Act of 1934, as amended (subject to the exemptions provided in Exchange Act Rule 10A-3(c)).  On January 8, 2007, the Company received a staff deficiency letter from NASDAQ indicating that the Company fails to comply with Nasdaq Marketplace Rule 4350(d)(2)(A).  In the January 8, 2007 letter, NASDAQ notified the Company that NASDAQ will provide the Company until April 16, 2007 to regain compliance.  However in a letter dated March 19, 2007, Nasdaq notified the Company that the Company will have until the earlier of its next annual shareholders’ meeting or December 13, 2007 to add an additional member to its audit committee in order to regain compliance with the audit committee composition requirements under Nasdaq Marketplace Rule 4350 (d)(2)(A).  The March 19, 2007 letter supersedes the staff deficiency letter dated January 8, 2007 in which NASDAQ notified the Company that the Company would only have until April 16, 2007 to regain compliance.

In a letter dated December 17, 2007, NASDAQ notified Pizza Inn, Inc. that, by virtue of the election of W.C. Hammett, Jr. to the Company’s board of directors at the Company’s annual shareholders’ meeting on December 13, 2007 and Mr. Hammett’s subsequent appointment to the board’s audit committee, the Company has regained compliance with NASDAQ Marketplace Rule 4350(d)(2) and Marketplace Rule 4200(a)(15) and accordingly NASDAQ’s listing standards.

The Company is also subject to other various claims and contingencies related to employment agreements, lawsuits, taxes, food product purchase contracts and other matters arising out of the normal course of business.  With the possible exception of the matters set forth above, management believes that any such claims and actions currently pending against us are either covered by insurance or would not have a material adverse effect on the Company's results of operations, cash flows, or financial condition if decided in a manner that is unfavorable to us.

At December 23, 2007, options to purchase 170,000 shares of common stock at exercise prices ranging from $2.15 to $2.31 per share were outstanding and included in the computation of diluted EPS, using the Treasury Stock Method, because the options’ exercise price was less than the average market price of the common shares during the quarter.  Options to purchase 115,000 shares of common stock at exercise prices ranging from $2.74 to $3.17 were not included in the computation of diluted EPS for both the quarter ended and the six month period ended December 23, 2007, because the options’ exercise prices were greater than the average market price of the common shares for the respective periods.

At December 24, 2006, no options to purchase shares of common stock were included in the computation of diluted EPS.

SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires that discontinued operations, that meet certain criteria, be reflected in the statement of operations after results of continuing operations as a net amount. SFAS No. 144 also requires that the operations of the closed restaurants, including any impairment charges, be reclassified to discontinued operations for all periods presented.

SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred.  This Statement also establishes that fair value is the objective for initial measurement of the liability.

The Company closed two restaurants in Houston, Texas during the quarter ended September 23, 2007.  No provision for impairment was required to be taken during the quarter ended September 23, 2007. The impairment taken in the fiscal year ended June 24, 2007, reduced the carrying value of the properties to their estimated net realizable value.  That net realizable value remains unchanged.  The two properties are on the market for sub-lease and have received a number of site visits.  Because we believe that the property will sub-lease at or above the current rate, we have not reserved any additional costs related to our obligations under these non-cancelable leases.

The Company’s federal net operating losses of $1,350,000 will begin to expire in 2027.  The Company also has state net operating losses of $1,466,000 which will begin to expire in 2011.  Management re-evaluates the net deferred tax asset each quarter and believes that it is more likely than not, that the net deferred tax asset of $458,000 will be realized based on the Company’s recent history of profit and the expectation of future taxable income as well as the future reversal of temporary differences.  A valuation allowance has been provided for amounts in excess of the asset expected to be realized.  For the three and six month periods ended December 23, 2007, the effective income tax rate of 0% differs from the statutory U.S. federal income tax rate of 34%, as the Company has provided a valuation allowance for the deferred tax assets for which it is considered more likely than not such assets will not be recognized.

The Company had $331,000 and $336,000 of assets classified as held for sale as of December 23, 2007 and June 24, 2007 respectively.  As of December 23, 2007, approximately $288,000 represents the carrying value of the Company’s real estate and equipment located in Little Elm, Texas and the remaining $43,000 of assets held for sale represents miscellaneous transportation equipment.  All assets held for sale are currently listed with brokers for sale to third parties.