Power Hungry

D Magazine, Mar 01, 2005 by McGill, Adam

MARK SCHWARZ, THE LEAN AND YOUTHFUL-looking chairman of Pizza Inn, walks a visitor through the company's gleaming, state-of-the-art corporate headquarters in The Colony. It's a bank holiday, but many of the 150 employees are still working. Schwarz shows off the vast, chilly warehouse where pickers load pallet upon pallet with boiled eggs, tomato tidbits in heavy puree, and other supplies to he shipped out to the more than 400 Pizza Inn units in 20 states. Franchisees run nearly all of them.

The $12 million, 11-acre campus also houses an R&D kitchen, where such creations as the Taco Pizza and cinnamon stromboli came to life. In the office building, Schwarz points out the employees' exercise room and the sections of leatherbacked booths, prototypes destined for new Pizza Inn restaurants.

But walking among mostly empty cubicles and offices, Schwarz shakes his head with either disgust or disbelief. It's hard to tell. "This building, this facility, it represents the best of everything," he says. "This is the best that money can buy. There's a lot of potential here, but nobody was even thinking about how you capture that potential."

"Potential" is an optimist's word for "languor." Pizza Inn, in its 43-year history, has never been a huge company. Its stock has not ventured much higher than $3 per share in the past few years. Trading volume is consistently low. The company's 2003 net earnings were only $3.1 million on revenue of $60 million; Pizza Hut, by comparison, generated $2.2 billion in sales. With only a handful of investors holding the majority of Pizza Inn's stock, Wall Street analysts don't even bother.

Schwarz, though, is an optimist. Back in 2002, he and his investment group Newcastle Partners had 3.3 million shares of the company, making him the largest shareholder. The way he saw it, all he had to do was win control of the board of directors and fire Ronnie Parker, the CEO he deemed overpaid and underperforming. He'd be rolling in the dough in no time. Except it hasn't been that easy. After a yearlong proxy battle, Schwarz did finally get control of Pizza Inn's board. And last December, that board fired Parker. But that move could cost the company as much as $7.4 million in compensation packages. Parker himself claims he's owed more than $5 million. It led to arbitration. Bad publicity. And a mess worse than a Taco Pizza in a blender.

It all started in the summer of 2002 when the CEO at the time, Jeff Rogers, was forced to resign [see "The Rise and Fall of Jeff Rogers," March 20031. Basically Rogers took out a loan from the company to exercise his stock options. When the market tanked post-9/11, Pizza Inn's stock tanked as well. Rogers wasn't liquid enough to pay his debt, and the company wrote off the $1.9 million as a loss.

Still, Rogers vowed to pay back the loan, and he did. He sold his multimillion-dollar vacation home in Lake Tahoe for about half of what it was worth. He also sold his 29 percent interest in Pizza Inn to a Dallas investment firm called Newcastle Partners.

Schwarz, 44, founded Newcastle 12 years ago with an investment philosophy based on the intrinsic value of assets. Basically, Schwarz and his Newcastle partners find a small, publicly traded company that isn't performing well. That's step one. Step two: buy a controlling interest. Step three: insinuate yourself onto the board of directors, clean house, and get the company to perform to its potential. Step four: profit. Philosophy is good; results matter. Newcastle boasts a 12-year annualized return of about 27 percent.

Schwarz has elbowed his way into the boardrooms of companies like Tandycrafts and Hallmark Financial Services. Other company's boards, like those of Gehl, a maker of construction equipment, and Haggar, maker of pants, have fended off his advances.

Ronnie Parker tried to fend them off, too. When Rogers stepped down in August 2002, the board of directors approached Parker, who was COO at the time, to take over as president and CEO. Parker was nearing the end of his second five-year contract with the company. In his new contract, Parker wanted what anybody with a new boss knocking on the door would want - job security, not only for himself but also for his team of executives. Parker's new employment agreement would include a golden parachute so mighty that one would think twice before firing him.

On December 18, 2002, less than two weeks after Schwarz bought controlling interest in the company but before he had representation on the board of directors, the board unanimously approved Parker's new employee agreement. Parker's new severance package would equal four times the sum of his highest salary plus his largest bonus - about $5.4 million. When added to similar compensation packages for the three executives on Parker's team, Pizza Inn would be faced with a payment of about $7.4 million. The poison pill would go into effect if ever there were a change of control of the board of directors.

On February 11, 2004, there was a change of control of the board of directors. Sort of. After a proxy battle that started early in 2003, Newcastle Partners finally assumed two seats on Pizza Inn's board, and Mark Schwarz was named chairman. An independent law firm, however, ruled that the "incumbent board" was still intact, and so the poison pill provision didn't kick in.