PANCHOS MEXICAN BUFFET INC /DE, 10-K, 1997-12-22

PANCHOS MEXICAN BUFFET INC /DE
10-K, 1997-12-22
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================================================================================

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
--- THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
--- THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NO. 0-4678

PANCHO'S MEXICAN BUFFET, INC.

(Exact name of registrant as specified in its Charter)

<TABLE>
<S> <C>
DELAWARE 75-1292166
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3500 NOBLE AVENUE, FORT WORTH, TEXAS 76111
(Address of principal executive offices) (Zip Code)
831-0081 817
(Registrant's telephone number) (Area Code)
</TABLE>

Securities registered pursuant to Section 12(b) of the Act:
NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $0.10 PER SHARE
(Title of Class)

INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---

INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF THE REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY
AMENDMENT TO THIS FORM 10-K [ ].

THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE
REGISTRANT ON NOVEMBER 28, 1997, BASED ON THE ACTUAL STOCK PRICE ON SUCH DATE
WAS $7,717,077.

NUMBER OF SHARES OF COMMON STOCK OUTSTANDING AS OF NOVEMBER 28,
1997:..................................................................4,389,159

DOCUMENTS INCORPORATED BY REFERENCE

THE COMPANY'S DEFINITIVE PROXY STATEMENT FOR THE ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD JANUARY 28, 1998, IS INCORPORATED BY REFERENCE IN PART III HEREOF.
================================================================================
<PAGE> 2

PART I

ITEM 1. BUSINESS

GENERAL

The Company, Pancho's Mexican Buffet, Inc. and subsidiaries, is principally
engaged in the operation and development of the Pancho's Mexican Buffet
restaurant chain serving Mexican food cafeteria style. However, Pancho's is more
than a cafeteria, because it features "all-you-can-eat" at a fixed price. Along
the cafeteria line, servers fill a piping hot platter with a diner's choices
from more than 20 items of freshly prepared Mexican food. Pancho's becomes a
full-service restaurant when a diner is at the table. A waitress or waiter
brings refills, or other food a diner may request from the buffet, at no extra
charge. For more service, a diner simply raises the small flag on the table. The
Company currently operates 57 restaurants located in the states of Texas (43),
Louisiana (6), Arizona (3), Oklahoma (3) and New Mexico (2).

The Company opened a restaurant in Guadalajara, Mexico in October 1995.
This operation was the result of a joint venture between the Company and one of
its non-employee directors to test the Mexican market for possible expansion. No
other new restaurants were opened in fiscal 1996. No new restaurants were opened
in fiscal 1997, and none are currently planned, as management intends to focus
on improving sales and profitability and reducing debt.

In March 1997, the Company established a restructuring plan in an effort to
improve cash flow and return to profitability. The plan included closing seven
underperforming restaurants, disposing of the Mexico joint venture, impairing
four other restaurants and increasing the reserves for carrying costs of two
previously closed locations. Under the plan, the Company closed seven U.S.
locations on April 15, 1997 and disposed of its interest in the Mexico venture
effective May 31, 1997.

In June 1995, following declining sales and net operating losses in the
first two quarters of 1995, the Company adopted a restructuring plan. The plan
included closing nine underperforming restaurants and writing down assets at
seven restaurants operating at lower sales volumes and at the Company's
constructed but then-unopened restaurant in Guadalajara, Mexico. Consistent with
ongoing efforts to improve operating margins, three other restaurants were
closed during the year, and two locations formerly operated as Emiliano's Buffet
Mexicano restaurants were re-opened as Pancho's Mexican Buffets.

Jesse Arrambide, a Company founder, developed and opened the first Pancho's
Mexican Buffet in El Paso, Texas in 1958. The Company was organized under the
laws of the State of Delaware in December 1968 to succeed to the business
operated by predecessor corporations which were merged into the Company on
January 23, 1969. The Company's principal offices are located at 3500 Noble
Avenue, Fort Worth, Texas 76111 (telephone number [817] 831-0081).

BUSINESS DEVELOPMENT

The Company's long-term strategy is to expand Pancho's Mexican Buffet
within the Company's existing five-state market and other contiguous states. The
Company intends to concentrate on the development of existing markets to reduce
its supervision expense as a percentage of sales and to improve the Company's
competitive position, marketing potential and profitability. There can be no
assurance that the Company will be able to achieve these objectives. The Company
has no plans for franchising in the U.S.; however, one Pancho's is currently
being operated under a license agreement. Due to its losses on the Guadalajara
restaurant, the Company does not plan further development in Mexico.

The most important factors in selecting new locations are the demographics
of the immediate market area within a radius of three to four miles and the
occupancy cost of the proposed restaurant. The Company's experience indicates
that it is relatively immaterial whether the location is free-standing or in a
mall or shopping center. Senior management inspects each restaurant site prior
to its acquisition. The Company has developed prototypes of both a free-standing
building design and a shopping center space design to enhance site flexibility.
In its restaurants, the Company maintains distinctive styling and colorful decor
using authentic artifacts in a Mexican motif.
<PAGE> 3

The Pancho's concept is designed to combine the serving speed and economy
of cafeteria-style service within an environment typical of table service
restaurants. The customer selects and is served food and beverage items from the
serving line. When the patron is seated a uniformed employee serves chips, hot
sauce, sopaipillas (Mexican bread), beverage refills and more food on request
for the "all-you-can-eat" patrons. This is a unique variation of the traditional
cafeteria concept, providing full table service after a customer has completed
selection from the service line. During fiscal 1993, the Company added
self-service soup/salad bars and dessert bars to provide greater food variety
and value.

RESTAURANT OPERATIONS

The Company's restaurants serve continuously from 11:00 a.m. to 9:00 p.m.
seven days a week. The restaurants are family-oriented and are designed to match
serving-line service speed (three to three and one half patrons per minute) to
seating capacity for optimum utilization of space and return on investment.
Older Pancho's average approximately 7,300 square feet and seat 180 to 200. New
restaurants, and higher volume restaurants in which seating capacity has been
expanded, average approximately 9,000 square feet and seat 240 to 300. A typical
new restaurant in a strip shopping center costs about $900,000 to $1,000,000 to
develop, including equipment and leasehold improvements. Free-standing units
cost from $1.5 million to $1.9 million for land, building and equipment.

In addition to the "all-you-can-eat" buffet, the menu includes
competitively-priced limited-selection plates (the Super Combo value meal),
fajitas, a taco salad, soup/salad bar, and a child's plate. Children five years
of age and under are served any three items free. Senior citizens who belong to
Pancho's Seniors Club are given a 20% discount on their personal purchases.
Beverages are priced separately. All menu items include the soup/salad bar and
dessert bar.

More than 20 items of Mexican food are served, including tamales, refried
beans, Mexican rice, flautas, five kinds of enchiladas, red chili stew, green
chili stew, chili rellenos, chili con queso, three kinds of sauces, tacos,
chalupas, pico de gallo, assorted relishes, chips, hot sauce and sopaipillas.
Beverages are also available. Alcoholic beverages are served in 35 restaurants
and accounted for 0.9% of the Company's sales for the year ended September 30,
1997. Pancho's restaurants offer food to go, which accounted for 10.3% of sales
for the year ended September 30, 1997.

The Company has standard procedures for customer service, sanitation, food
preparation and other operational matters. Each restaurant is under the
direction of a general manager, associate manager and production manager (chef).
Additionally, higher volume units have a first assistant manager who typically
has completed the Company's formal Manager Training Program. The basic
three-manager team participates in an incentive compensation program based upon
sales and profitability of their specific restaurant. Company Area Supervisors
and Production Supervisors inspect the restaurants regularly and assist the unit
management to assure compliance with quality standards set by the Company. They
also participate in incentive compensation based on the restaurant group for
which they are responsible. Depending on the size of the restaurant and the time
of the year, each Pancho's will have from 30 to 90 employees.

Special attention is directed to personnel planning for new restaurants.
"Blue Ribbon Teams" which assist in the opening of new restaurants are selected
from existing restaurants on the basis of superior employee performance in all
categories of restaurant operations. This program provides recognition for
superior employee performance and ensures immediate compliance with Company
standards of service in newly-opened restaurants.

MARKETING AND ADVERTISING

From fiscal 1993 through fiscal 1996, the Company employed a mix of
television, radio and newspaper advertising combined with local store marketing
programs. Same-store sales increases in the fourth quarter of fiscal 1993 and
the first three quarters of fiscal 1994 were subsequently offset by declining
same-store sales. Management has concluded that television advertising is not
efficient for the Company's size and market, and so plans to focus on local
store marketing.

2
<PAGE> 4

Local store marketing efforts reach out to each restaurant's specific
neighborhood customers. Restaurant managers are encouraged to participate in
community affairs and, with the assistance of the general office, to cater
school, church and other community events. Pancho's supports local schools with
free meals for honor roll and perfect attendance students, and sponsors sports
leagues for local children. There is a birthday club for children under twelve
which serves the child free on his or her birthday and also provides a free
pinata for the birthday celebration. A senior citizens program includes
registered membership that entitles the member to a 20% discount.

The Company has engaged the marketing consulting firm of Feltenstein
Partners to assist in conducting market research, developing marketing strategy
and tactics, and implementing marketing programs. The Company's previous market
research was updated in fiscal 1997, and is being updated again in fiscal 1998.
Local store marketing programs tailored to each restaurant were implemented
during 1997, and will be updated in 1998.

PURCHASING AND DISTRIBUTION

The Company owns a warehouse and cold storage facility located at its
headquarters in Fort Worth, Texas. Until September 1994, grocery products and
supplies were distributed to the Company's restaurants from that facility.

In July 1994, the Company entered into an agreement with The SYGMA Network,
Inc. to purchase, warehouse and distribute substantially all the food products
and supplies for the Company's restaurants. This agreement provided immediate
benefits through increased delivery frequency at lower cost and decreased
investment in inventory. SYGMA's nationwide distribution network will also allow
the Company to develop new markets without capital investments to expand an
internal distribution system. The SYGMA Network is a subsidiary of SYSCO
Corporation, one of the nation's largest food service and distribution
organizations. The SYGMA Network specializes in distribution for restaurant
chains.

The Company believes that its system of central purchasing and distribution
is critical to control of product cost and quality and permits restaurant
managers to concentrate on quality of food preparation and customer service.
Minimal items are purchased locally.

HUMAN RESOURCES

On September 30, 1997, the Company had about 2,598 employees, of whom 63
were corporate personnel, 2,521 were employed in restaurants and 14 were
employed in maintenance and construction.

The Company considers its employee relations to be good. Most employees,
other than restaurant management and corporate personnel, are paid on an hourly
basis. The Company believes that it provides working conditions and wages that
compare favorably with those of its competition. The Company's employees are not
covered by a collective bargaining agreement.

COMPETITION

All aspects of the restaurant business are highly competitive. Price,
restaurant location, food quality, service and attractiveness of facilities are
important aspects of competition, and the competitive environment is often
affected by factors beyond a particular restaurant's control, including changes
in population, traffic patterns and economic conditions. The Company's
restaurants compete with a wide variety of value-priced and "all-you-can-eat"
restaurants, ranging from national and regional restaurant chains to
locally-owned restaurants. The Company believes that its principal competitive
strengths lie in the value, variety and quality of food products served, in the
distinctive atmosphere and food presentation, and in the strength of the
Pancho's Mexican Buffet name.

ITEM 2. PROPERTIES

The Company owns a combination general office/warehouse building located at
3500 Noble Avenue, Fort Worth, Texas. The headquarters facility consists of
general offices and freezer space of about 194,000

3
<PAGE> 5

cubic feet and warehouse dry storage of approximately 31,400 square feet. The
Company also owns land (85,500 sq. ft.) and a warehouse building (25,000 sq.
ft.) adjoining its present general office/warehouse property and land (42,600
sq. ft.) located at 3565 McCart Street, Fort Worth, Texas. The Company plans to
sell or lease the McCart Street property.

The sites of eleven operating restaurants are owned by the Company. The
Company is seeking to sell a closed restaurant building and land which it owns
in Phoenix, Arizona. Forty-six operating restaurants are occupied pursuant to
lease agreements which have varying expiration dates into the year 2007. At
September 30, 1997, the Company had remaining lease obligations on four closed
restaurant locations. As of November 30, 1997, three of these locations were
subleased, and the Company is seeking to sublease the other site, for which the
lease term expires in February 1999. Leases typically provide for a minimum
rental based on the cost of improvements provided by the lessor and a maximum
rental based upon the gross sales of the facility. The Company does not deem any
individual restaurant lease to be significant in relation to its overall
operations.

The Company has leased its Fort Worth cold storage facility to a food
manufacturing concern whose chairman and chief executive officer is a
non-employee director of the Company. The remainder of the space formerly
occupied by the Company's internal distribution operation is currently used for
equipment and document storage, and is being held for future office expansion.

In connection with its revolving credit and term loan agreement with a
bank, the bank has a security interest in substantially all of the real property
owned by the Company. Substantially all of the equipment and furniture used in
the operation of the restaurants and the headquarters facility are owned by the
Company.

Information as to restaurant locations is set forth below:

ARIZONA:
Mesa
Phoenix-2

LOUISIANA:
Baton Rouge
Bossier City
Chalmette
Lafayette
Metairie
Shreveport

NEW MEXICO:
Albuquerque-2

OKLAHOMA:
Oklahoma City-2
Tulsa

TEXAS:
Abilene
Amarillo
Arlington-3
Baytown
Beaumont
Burleson
Carrollton
Conroe
Corpus Christi*
Dallas-3
Denton
El Paso-2**
Euless
Fort Worth-3
Galveston
Garland
Houston-6
Humble
Irving
Killeen
League City
Lewisville
Longview
Mesquite
North Richland Hills
Plano
Richardson
San Antonio
Sherman
South Houston
Texarkana
Tyler
Waco
Windcrest

- ---------------

* Operated by licensee

** Operated by A&A Foods

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

4
<PAGE> 6

EXECUTIVE OFFICERS OF THE REGISTRANT

<TABLE>
<CAPTION>
POSITION AND OFFICE PERIOD OF
NAME WITH REGISTRANT PRESENT OFFICE AGE
---- ------------------- -------------- ---
<S> <C> <C> <C>
Jesse Arrambide, III.......... Chairman of the Board and Since December 9, 1994 45
Chief Operations
Officer -- also Director and
officer of subsidiary
companies
Hollis Taylor................. Director and President and Since August 10, 1979 61
Chief Executive
Officer -- also Director and
officer of subsidiary
companies
Samuel L. Carlson............. Director and Senior Vice Since December 21, 1988 61
President, Administration
and Secretary -- also
Director and officer of
subsidiary companies
Brad Fagan.................... Vice President, Treasurer, Since September 29, 1995 38
Controller and Assistant
Secretary -- also Director
and officer of subsidiary
companies
</TABLE>

Jesse Arrambide, III has been a Director since 1977. He has been Chairman
of the Board of Directors since August 1993, and Chief Operations Officer since
December 1994. He was Vice President, Operations from November 1984 to August
1993.

Hollis Taylor has been a Director since March 1974. He has been President
and Chief Executive Officer since August 1979.

Samuel L. Carlson has been a Director since November 1993. He has been
Senior Vice President, Administration and Secretary since December 1988.

Brad Fagan has been Vice President, Treasurer and Assistant Secretary since
September 1995 and Controller since December 1991. Mr. Fagan, a certified public
accountant, was Controller of Staffing Services, Inc. from July 1989 through
April 1991. He was a corporate audit supervisor for PepsiCo, Inc. from May 1985
through July 1989, and worked for the accounting firm of Arthur Andersen & Co.
from July 1983 to May 1985.

5
<PAGE> 7

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

COMMON STOCK DATA

The Company's common stock is traded over-the-counter in the National
Association of Securities Dealers, Inc. (NASDAQ) National Market System, under
the symbol "PAMX." On November 28, 1997, the number of record holders was about
685 and the Company estimates that on that date there were an additional 1300
beneficial owners. The following table sets forth the quarterly high and low
closing prices of the common stock, as reported by NASDAQ, for the calendar
quarters indicated.

<TABLE>
<CAPTION>
FISCAL QUARTER ENDED HIGH LOW
-------------------- ------ ------
<S> <C> <C>
December 31, 1995........................................... $3.750 $2.625
March 31, 1996.............................................. 3.500 2.250
June 30, 1996............................................... 3.000 1.875
September 30, 1996.......................................... 2.563 1.875
December 31, 1996........................................... 2.750 1.875
March 31, 1997.............................................. 2.688 1.625
June 30, 1997............................................... 2.063 1.500
September 30, 1997.......................................... 2.500 1.563
</TABLE>

COMMON STOCK DIVIDENDS

The Company has paid cash dividends for the past 17 years. In 1997, cash
dividends were $.03 per share. Future cash dividends will depend on loan
restrictions, earnings, financial position, capital requirements and other
relevant factors.

6
<PAGE> 8

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data of the Company for each of the five
fiscal years ended September 30, 1993 through 1997 has been derived from the
more detailed consolidated financial statements and notes thereto of the Company
contained elsewhere in this report or in previous reports.

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
YEARS ENDED SEPTEMBER 30,

<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
------- ------------- ------------- ------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Sales.................................... $66,957 $71,487 $80,893 $86,062 $75,968
------- ------- ------- ------- -------
Costs and Expenses:
Food costs............................. 18,792 19,681 22,910 23,347 20,956
Restaurant labor and related
expenses............................ 25,235 26,561 30,400 30,806 27,256
Restaurant operating expenses.......... 15,799 16,508 18,376 19,134 16,014
Depreciation and amortization.......... 3,426 3,949 4,512 4,420 3,635
General and administrative expenses.... 5,160 5,067 5,547 5,475 5,203
Restructuring charges.................. 5,066 7,572 (264)
------- ------- ------- ------- -------
Total.......................... 73,478 71,766 89,317 82,918 73,064
------- ------- ------- ------- -------
Operating income (loss).................. (6,521) (279) (8,424) 3,144 2,904
Interest expense......................... (348) (540) (590) (34)
Other, including interest income......... 303 269 309 66 147
------- ------- ------- ------- -------
Earnings (loss) before income taxes and
cumulative effect of change in
accounting principle................... (6,566) (550) (8,705) 3,176 3,051
Provision (benefit) for income taxes..... (1,850) (135) (3,343) 1,101 937
------- ------- ------- ------- -------
Net earnings (loss) before cumulative
effect of change in accounting
principle.............................. (4,716) (415) (5,362) 2,075 2,114
Cumulative effect of change in accounting
for income taxes....................... 722
------- ------- ------- ------- -------
Net earnings (loss)...................... $(4,716) $ (415) $(5,362) $ 2,075 $ 2,836
======= ======= ======= ======= =======
Cash dividends........................... $ 132 $ 132 $ 462 $ 1,056 $ 1,051
======= ======= ======= ======= =======
Per Share Data:
Net earnings (loss) before cumulative
effect of change in accounting
principle........................... $ (1.07) $ (.09) $ (1.22) $ .47 $ .48
Net earnings (loss).................... (1.07) (.09) (1.22) .47 .64
Cash dividends......................... .03 .03 .105 .24 .24
At Year End:
Total assets........................... $32,858 $37,968 $44,387 $49,159 $43,092
Long-term debt......................... 2,287 3,489 8,705 5,840
Stockholders' equity................... 22,269 26,521 26,988 33,155 31,783
Number of restaurants.................. 57 65 64 72 66
</TABLE>

7
<PAGE> 9

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated: (i) items in the
consolidated statements of operations as a percentage of sales; (ii) average
restaurant sales; and (iii) the number of restaurants open at the end of each
year.

<TABLE>
<CAPTION>
PERCENTAGE OF SALES
YEARS ENDED SEPTEMBER 30,
--------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Sales....................................................... 100.0% 100.0% 100.0%
------ ------ ------
Costs and Expenses:
Food costs................................................ 28.1 27.5 28.3
Restaurant labor and related expenses..................... 37.7 37.2 37.6
Restaurant operating expenses............................. 23.6 23.1 22.7
Depreciation and amortization............................. 5.1 5.5 5.6
General and administrative expenses....................... 7.7 7.1 6.8
Restructuring charges..................................... 7.6 9.4
------ ------ ------
Total............................................. 109.8 100.4 110.4
------ ------ ------
Operating income (loss)..................................... (9.8) (0.4) (10.4)
Interest expense............................................ (0.5) (0.8) (0.7)
Other, including interest income............................ 0.5 0.4 0.3
------ ------ ------
Earnings (loss) before income taxes......................... (9.8) (0.8) (10.8)
Income tax benefit.......................................... (2.8) (0.2) (4.2)
------ ------ ------
Net earnings (loss)......................................... (7.0)% (0.6)% (6.6)%
====== ====== ======
Average sales (in thousands) for restaurants open throughout
the year.................................................. $1,123 $1,106 $1,190
Number of restaurants open at end of year................... 57 65 64
</TABLE>

Fiscal 1997 Compared to Fiscal 1996

The Company's same store sales trend turned positive in the fourth quarter
of fiscal 1997, up 2.0% over the fourth quarter of 1996. This reversed quarterly
same store sales decreases ranging from 1.2% to 12.7% over the past three fiscal
years. Same store customer counts were down 1.4% for the fourth quarter of
fiscal 1997, but price increases July 1 and mid-September 1997 helped raise
average sales per customer significantly. The chart below shows quarterly and
annual same store sales comparisons over the past four fiscal years.

COMPARABLE-STORE SALES BY QUARTER

<TABLE>
<CAPTION>
1997 1996 1995 1994
---- ----- ----- -----
<S> <C> <C> <C> <C>
1st Quarter............................. -5.0% -12.7% - 9.6% +14.3%
2nd Quarter............................. -7.4 - 5.3 -11.3 +15.1
3rd Quarter............................. -1.2 - 8.2 -11.8 + 9.2
4th Quarter............................. +2.0 - 6.5 -11.7 - 6.2
Fiscal Year........................ -2.8 - 7.8 -11.5 + 7.6
</TABLE>

To address unsatisfactory results of operations, the Company adopted a
restructuring plan in the quarter ended March 31, 1997. Under the plan, the
Company closed seven low sales restaurants on April 15, 1997, and disposed of
its interest in the Mexico operations effective May 31,1997. Those eight
locations contributed $2,854,000 in sales in fiscal 1997, versus $5,512,000 in
fiscal 1996, a difference of $2,658,000. Each closed unit had been producing far
below company average sales per unit. No other closings are currently planned,
but management will continue to evaluate operating results and consider closing
other locations based on profitability and cash flow.

8
<PAGE> 10

Sales decreased $4,530,000 in fiscal 1997 due to the store closings and
same store sales declines in the first three fiscal quarters. Same-store sales
were down 2.8% in fiscal 1997 compared with a decrease of 7.8% in fiscal 1996.
The price increases and restructuring steps helped raise average sales for
restaurants open throughout 1997 to $1,123,000, up 1.5% over 1996.

Total fourth quarter sales were down $1,054,000 in 1997 due to the
restructuring. The eight eliminated locations accounted for $1,391,000 in fourth
quarter 1996 sales. The restructuring and price increases brought a 7.4%
increase in average sales for restaurants open throughout the fourth quarter of
1997 versus average sales for the fourth quarter of 1996. This trend continued
into fiscal 1998, as October 1997 average unit sales were up 8.2% compared with
October 1996.

In fiscal 1997, the Company embraced a focused neighborhood marketing
strategy using company-wide and store-specific neighborhood marketing tactics
based on detailed market research and analysis, supported by intensive planning
and training. Neighborhood marketing will strengthen Pancho's ties to each
restaurant's community with a portfolio of specific tactics developed for each
location. A series of company-wide tactics complement existing Company programs
such as the Birthday Club and School Rewards programs. The results of all
marketing tactics will be carefully measured to evaluate their impact on sales.
The marketing consulting firm of Feltenstein Partners was engaged to assist in
developing and implementing marketing strategy and tactics. The Company's first
major external marketing tactic in fiscal 1997 was initiated in July 1997 after
the first major price increase since December 1993.

To respond to declining margins caused primarily by wage inflation, the
Company raised its menu pricing mix effective July 1, 1997 an estimated average
of 5.1%. Another price increase, of about 1.5% was instituted in mid-September
1997 to partially offset the effect of the September federal minimum wage
increase.

No new restaurants were opened in fiscal 1997, and none are planned for
fiscal 1998. Management plans to continue to improve same store sales and
operating margins at its existing units before adding new locations.

Thanks to the fourth quarter 1997 price increases, food cost was down 0.7%
of sales for the fourth quarter of fiscal 1997 versus the same period in 1996,
despite being up 0.6% of sales for the year. Meat cost was up 0.4% and 0.8% for
the fourth quarter and year of 1997 compared with the same periods in 1996.

Labor and related expenses were up 1.5% and 0.5% of sales for the fourth
quarter and year 1997, respectively, compared with the same periods in 1996. The
benefits from 1997 adjustments to employment-related insurance reserves were
more than offset by the effects of lower sales and wage rate inflation.

The Company benefited from reductions to the workers' compensation and
Voluntary Employee Injury Benefit (VEIB) Plan insurance reserves of $500,000 in
the third quarter and $558,000 in the second quarter of fiscal 1997. The
reduction of VEIB Plan reserves recognized the benefits from effective risk and
case management, based on closing out claim years 1990 through 1992. After
removing the benefit from the VEIB Plan and workers' compensation credits, labor
costs were 37.9% of sales for the fourth quarter and 39.3% for 1997.

Labor costs in fiscal 1996 benefited from a $128,000 refund of prior year
health insurance payments and a $125,000 reduction in VEIB Plan reserves in the
second and third quarters, plus fourth quarter reserve reductions of $82,000 for
the VEIB Plan and $80,000 for workers' compensation. Without these benefit cost
adjustments, labor costs were 37.3% and 37.8% of sales for the fourth quarter
and year of 1996.

After removing the benefit of the above adjustments from all quarters and
years, labor costs were up 0.6% and 1.5% of sales for the fourth quarter and
year 1997 versus the same periods for 1996. Although the Company has had success
with its loss control and risk management programs, the gains from adjustment of
prior year reserves should be considered one-time gains which may not be
repeated in the future.

Labor and related expenses were up for 1997 due to higher restaurant
salaries and wages caused by wage rate inflation and lower sales. Health
insurance costs were up 0.2% over 1996 due to inflation and the refund benefit
in 1996. Lower profitability in 1997 reduced store bonuses 0.2% of sales
compared with 1996. The Company continued to augment its primary restaurant
management bonus programs with additional bonus

9
<PAGE> 11

programs for restaurant service and management personnel to provide increased
incentives for excellent service.

Fourth quarter restaurant salaries and wages were the same percentage of
sales in 1997 and 1996, reflecting the benefit of the fourth quarter 1997 price
increases. The fourth quarter operating results improvement increased store
bonuses 0.2% of sales.

The federal minimum wage increased $0.50 per hour effective October 1,
1996, the first day of the Company's fiscal 1997, and $0.40 more September 1,
1997. Pancho's experienced increases of 7.8% and 5.9% in average hourly wage
rates for the 1997 fourth quarter and year, respectively, versus the same
periods in 1996. This wage rate inflation represented hourly labor cost
increases of 1.6% and 2.2% of sales for the fourth quarter and year of 1997,
respectively, compared with the same 1996 periods.

An increasingly tight labor market will continue to contribute to general
wage inflation. Higher wages will make it difficult for the Company to achieve
reductions in labor and related costs unless the sales trend improvement
continues.

Pancho's prepares a large quantity and variety of fresh food in small
batches throughout the day, and provides buffet-line and table service in each
restaurant. Maintaining a high level of quality service, sanitation and food
preparation makes it difficult to reduce labor costs in proportion to recent
sales declines, as staffing cannot be reduced below certain levels to maintain
Pancho's standards for quality service and sanitation.

Restaurant operating expenses rose 0.5% of sales in 1997 compared with
1996. The percentage increase for the year resulted from lower total sales
despite spending $711,000 less in 1997 than in 1996. As many restaurant
operating costs are fixed or semi-fixed, such as occupancy costs, future changes
in this cost factor will bear an inverse relationship to sales trends

Restaurant operating expenses include occupancy costs, which rose 0.6% of
sales in 1997 due equally to higher maintenance costs, property taxes and rent
on lower sales. Restaurant supplies and other operating expenses each rose 0.2%
of sales. These increases were partially offset by reductions of 0.3% of sales
for marketing, and 0.2% of sales for restaurant general and administrative
costs, which benefited from discontinuing employment practices insurance.

The Company spent $1,591,000, 2.4% of sales, and $1,908,000, 2.7% of sales,
on marketing in fiscal 1997 and 1996, respectively. Due to its strategic shift
from broadcast media to more local store marketing, the Company spent $953,000
less for advertising media, but $276,000 more for marketing research and
consulting, plus $187,000 more for promotions.

The price increase and restructuring helped reduce fourth quarter
restaurant operating expenses 1.4% of sales in 1997. Utilities were down 0.3% of
sales, marketing was down 0.6% of sales, supplies were down 0.4% and other
operating costs were down 0.4% of sales. These were partially offset by the 0.4%
increase in fourth quarter occupancy costs.

The Company spent 2.1% versus 2.7% of sales on marketing in the fourth
quarter of fiscal 1997 and 1996, respectively. The Company spent $130,000 less
in the 1997 fourth quarter due to the strategic shift from broadcast advertising
to local store marketing. In the fourth quarter of 1996, the Company spent
$243,000 for broadcast media for TV ads, compared with zero dollars for
broadcast media in the fourth quarter of 1997. The savings were partially offset
by $57,000 more spent on marketing consulting and research, and $15,000 more on
promotions.

Depreciation and amortization decreased $199,000, 0.8% of sales, and
$521,000, 0.4% of sales, in the fourth quarter and year 1997, respectively, due
to the asset write-downs taken in the March 1997 restructuring.

In fiscal 1997, the Company recorded a restructuring charge of $5,066,000
to execute the restructuring plan established in the quarter ended March 31,
1997. This charge included $3,033,000 for the impairment of land, buildings,
leasehold improvements and equipment. Impairment charges were determined in
accordance with Statement of Financial Accounting Standards (SFAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." The charge also included $1,538,000 to

10
<PAGE> 12

reserve for exit and carrying costs of closed locations. The rest of the charges
consisted of a $455,000 loss from recognition of the Cumulative Foreign Currency
Translation Adjustment for disposal of the Mexico venture, plus $40,000 to
record a valuation allowance for deferred tax assets unlikely to be realized due
to the closing of two Arizona locations under the restructuring.

The Company realized net gains on sale of assets of $256,000 and $141,000
in fiscal 1997 and 1996, respectively. Long-lived assets held for sale are
carried at the lower of depreciated cost or fair value less cost to sell.

In fiscal 1997, interest expense was $192,000 lower than in 1996.
Outstanding debt decreased from $3,641,000 on September 30, 1996 to $2,479,000
on September 30, 1997. As outstanding debt decreased, interest expense declined,
from $84,000 in the fourth quarter of fiscal 1996 to $58,000 in the fourth
quarter of fiscal 1997. Interest expense is expected to continue falling in
fiscal 1998 as debt is reduced.

The Company achieved net earnings of $125,000 in the fourth quarter of
1997, compared with a net loss of $143,000 for the 1996 fourth quarter. The
price increases and restructuring helped improve operating margins in the final
quarter of 1997. The Company's future profitability depends on its ability to
stabilize or improve customer counts and to offset cost inflation with price
increases.

Due to the factors discussed above, the Company reported net losses of
$4,716,000 and $415,000 for fiscal years 1997 and 1996, respectively. The 1997
restructuring charge and net loss resulted from declining sales trends that
could not be fully offset with cost controls. The Company's future earnings
depend largely on improving sales and maintaining tight cost controls in the
highly-competitive restaurant industry.

SFAS No. 123, "Accounting for Stock-Based Compensation", is effective for
the Company for the 1997 fiscal year. SFAS No. 123 requires expanded disclosures
of stock-based compensation arrangements with employees and encourages (but does
not require) compensation cost to be measured based on the fair value of the
equity instrument awarded. Companies are permitted, however, to continue to
apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees," which recognizes compensation cost based on the intrinsic
value of the equity instrument awarded. The Company will continue to apply APB
Opinion No. 25 to its stock-based compensation awards to employees and will
disclose the required pro forma effect on net income and earning per share (see
Note 6 to the consolidated financial statements).

Provision for Income Taxes

The effective tax rate in fiscal 1997 was a benefit of 28.2% of the total
loss before income taxes, compared to a benefit of 24.6% for fiscal 1996 and a
benefit of 38.4% for fiscal 1995. These effective rates include the results of
Mexico operations, which commenced in fiscal 1996, and for which no tax benefit
was recognized. As detailed in Note 5 to the consolidated financial statements,
the effective tax rates differed from the base federal rate of 34% each year due
primarily to the effects of state income taxes, federal employer tax credits and
the results of foreign operations.

Significant current and deferred income tax benefits were recognized for
1997, resulting primarily from the restructuring charges and operating losses.
Income taxes receivable and deferred tax assets were recorded for these benefits
based on tax loss carry back opportunities and the Company's long history of and
expected future taxable income. The income tax receivable of $538,000 is
expected to be received in March 1998.

Net deferred tax assets increased $1,288,000 in fiscal 1997. The increase
was due mainly to the federal net operating loss (NOL) carryforward, accrued
restructuring reserves and tax-book differences for fixed assets. These
increases were partially offset by the reduction of insurance reserves, and the
$783,000 increase in the valuation allowance to offset federal and state NOL
carryforwards more likely than not to expire before realization. Note 5 to the
consolidated financial statements identifies the components of the deferred tax
assets and liabilities.

The deferred federal tax assets totaled $4,511,000 at September 30, 1997.
Of that amount, $1,983,000 was a federal NOL carryforward which expires
September 30, 2012, and $416,000 were employer tax credits which expire in
fiscal years 2009 through 2012. The valuation allowance was increased $671,000
in fiscal 1997

11
<PAGE> 13

to provide for the federal portion of the NOL carryforward which might not be
realized. No other assets relating to federal income taxes have expiration
dates.

State deferred tax assets were a net $464,000 after subtracting the related
valuation allowance at September 30, 1997. The valuation allowance was increased
$111,000 in fiscal 1997 to provide for state NOL carryforwards likely to expire
before being realized. State NOL carryforwards which expire on the fiscal
yearend 1998 through 2002 represent $149,000 of those deferred tax assets, net
of the related valuation allowances. Another $167,000 in deferred tax assets,
net of related valuation allowances, are based on state NOL carryforwards which
expire in fiscal years 2003 through 2012. The remaining $148,000 of state
deferred tax assets do not have expiration dates.

The Company believes it will realize substantial benefits from the use of
the federal NOL carryforward and employer tax credits and the state NOL
carryforwards to reduce future federal and state income tax liabilities. Full
realization of these and other deferred tax assets depends on the Company
achieving certain levels of taxable income in the future. If the Company's
results from operations fail to timely achieve the levels necessary to use the
employer tax credits or the state NOL carryforwards, they could expire before
use, resulting in charges against income. The Company has established a
valuation allowance to offset the amount of deferred tax assets it believes are
likely to not be realized. If the Company does not achieve an operating profit
for the year ending September 30, 1998, the Company may be required to write off
all or a portion of the deferred tax assets on that date.

Net deferred tax assets decreased $186,000, to $3,017,000 from September
30, 1995 to September 30, 1996. The decrease was due mainly to the reversal of
tax-book differences for fixed assets and the realization of tax benefits as
restructuring reserves were actually paid. These decreases were partially offset
by the tax loss, which increased the federal alternative minimum tax
carryforwards and the state NOL carryforwards. The valuation allowance was
increased to $43,000 from $25,000 based on the expectation that not all the
state NOL carryforwards will be realized before they expire.

Current and deferred income tax benefits were recognized in 1996, resulting
primarily from operating losses. The federal income tax refund receivable
September 30, 1996 of about $180,000 was received in February 1997.

Liquidity and Capital Resources

The Company's current ratio was 0.43 to 1 at September 30, 1997 compared
with 0.39 to 1 at September 30, 1996. The increase was due to a $321,000
reduction in current accrued insurance costs plus the $284,000 increase in cash
equivalents and $352,000 increase in income taxes receivable.

The current ratio had decreased 0.5 during fiscal 1996 mainly because about
$1.2 million received for income taxes receivable plus about $1 million in cash
at September 30, 1995 was applied primarily to reduce long-term debt. Cash
equivalents decreased $1,054,000 in 1996 to a balance of $145,000 at September
30 as all available cash was applied to reduce long-term debt. Cash equivalents
decreased $462,000 in fiscal 1995, as capital spending exceeded cash provided by
operating and financing activities.

Operating activities provided net cash of $882,00 in fiscal 1997 compared
with $4,657,000 in 1996. The 1997 net loss of $4,716,000 included non-cash
charges of $3,426,000 for depreciation and amortization, $3,033,000 for asset
impairments, $1,538,000 for restructuring reserves, $455,000 to recognize the
cumulative foreign currency translation adjustment, and a non-cash deferred tax
benefit of $1,288,000. Cash was used to reduce accounts payable and accrued
liabilities by $272,000, restructuring reserves by $961,000, and income taxes
receivable increased $352,000.

The 1996 net loss of $415,000 included non-cash charges of $3,949,000 for
depreciation and amortization and a $186,000 provision for deferred income
taxes. The receipt of the 1995 income tax receivable caused a net reduction in
income taxes receivable of $1,041,000.

12
<PAGE> 14

Operating activities provided net cash of $3,464,000 in fiscal 1995. The
1995 loss included pre-tax non-cash restructuring charges of $7,572,000 for
restaurant closings and impairments, and non-cash income tax benefits of
$3,343,000 included in income taxes receivable and deferred tax assets.

Investing activities provided $622,000 cash during fiscal 1997. The Company
realized $1,081,000 in proceeds from asset sales, including the Tucson land and
building. The Company spent $459,000 cash to remodel three existing restaurants,
install computer point-of-sale systems in two restaurants, and provide routine
capital replacements. No new restaurants were opened or under construction in
fiscal 1997, and none are planned for fiscal 1998. Management plans to continue
to emphasize improving sales and operating margins in existing units. Capital
expenditures to remodel existing restaurants, install restaurant computer
systems and provide routine capital replacements will continue within the
constraints of available operating cash flow and Loan Agreement restrictions
(see Note 3 to the consolidated financial statements). The Company may also
enter into lease agreements to acquire computer point-of-sale systems or other
equipment.

Under the restructuring plan formulated in the quarter ended March 31,
1997, the Company closed seven restaurants on April 15, 1997 and disposed of its
interest in the Mexico venture. Units closed included leased locations in
Houston, Dallas, San Antonio, Lubbock and College Station, Texas. The Company
provided estimated restructuring reserves to buy out of the leases for those
locations. The Company sold the land and building for the closed Tucson
restaurant in September 1997, and is seeking to sell the land and building for
the closed Phoenix location. Proceeds from real estate sales must be used to pay
down debt in accordance with the Company's bank loan requirements.

Investing activities used a net of $411,000 in fiscal 1996. Capital
additions to remodel two existing restaurants, install computer point-of-sale
systems in three restaurants and provide ordinary replacements were partially
recouped by $278,000 in proceeds from the sale of fixed assets. The Company
opened its Guadalajara restaurant in October 1995. No other new restaurants were
opened in fiscal 1996.

Investing activities used $6.4 million in fiscal 1995. The Company invested
$7 million cash to build new restaurants, remodel existing restaurants, install
restaurant computer systems and pay accrued construction costs from the prior
year. Three new Pancho's Mexican Buffet restaurants, in Pasadena, Baytown and
Galveston, Texas were opened in 1995 and two former Emiliano's Buffet Mexicano
restaurants were reopened as Pancho's Mexican Buffets. Also in 1995, the Company
sold a restaurant site in Colorado for $290,000, and sold a closed restaurant
building to the landowner for $175,000 and termination of the ground lease.

Financing activities consumed $1,217,000 in fiscal 1997, primarily to
reduce total debt by $1,162,000 and pay $132,000 in dividends.

Financing activities used $5,291,000 in fiscal 1996, mainly for net debt
reduction of $5,226,000 and dividends paid of $132,000. In 1995, financing
activities provided net cash of $2,478,000, based primarily on net long-term
borrowings of $2,865,000 less the payment of cash dividends of $725,000.

The Company's revolving credit and term loan agreement (Loan Agreement)
with a bank has reduced the revolving credit line limit from $6,483,000 at
September 30, 1996 to $2,962,000 at September 30, 1997. The Company had $920,000
of credit available under the line at September 30, 1997.

The Company plans to finance its fiscal 1997 operations and capital
additions mainly with cash flow from operations and the line of credit. The
Company may also use operating leases to acquire new point-of-sale systems for
some or all of the 17 restaurants which have not yet been updated to the newer
system.

In December 1997, the Company and the bank agreed to amend the Loan
Agreement limit-reduction schedule and covenants, effective December 1, 1997.
Under this amendment, the credit line limit is reduced

13
<PAGE> 15

the last day of each quarter until the agreement terminates June 30, 2000. The
credit limits effective through each quarter end under the amended agreement are
shown below.

<TABLE>
<CAPTION>
CREDIT
FROM THROUGH LIMIT
---- ------- ------
<S> <C> <C>
December 19, 1997 December 30, 1997 $3,461,748
December 31, 1997 March 30, 1998 3,300,000
March 31, 1998 June 29, 1998 3,200,000
June 30, 1998 September 29, 1998 2,600,000
September 30, 1998 December 30, 1998 2,000,000
December 31, 1998 March 30, 1999 1,900,000
March 31, 1999 June 29, 1999 1,700,000
June 30, 1999 September 29, 1999 1,100,000
September 30, 1999 December 30, 1999 500,000
December 31, 1999 March 30, 2000 400,000
March 31, 2000 June 29, 2000 200,000
June 30, 2000 -0-
</TABLE>

One financial covenant requires the Company to achieve trailing
three-months earnings before interest, taxes, depreciation and amortization
(EBITDA) to equal or exceed the sum of 125% of the next scheduled commitment
reduction plus capital expenditures during each three-month period, beginning
March 31, 1998. Cash capital expenditures are limited by the amended agreement
to $650,000 each fiscal year. Cash dividends are limited by the amendment to
$150,000 per fiscal year, and are prohibited until the Company achieves trailing
12-months EBITDA of $3 million. The loan is secured with all of the Company's
real property.

The Loan Agreement includes various financial covenants. Due to the
operating loss (as defined by the Loan Agreement) incurred by the Company in the
quarter ended December 31, 1996, the Company violated a loan covenant. The bank
has subsequently granted a permanent waiver for this covenant violation. The
Company was in compliance with this and all other loan covenants at September
30, 1997.

Due to the net losses incurred by the Company in September 1996 and the
quarter ended December 31, 1995, and in each of the first three quarters of
fiscal 1995, the Company violated certain loan covenants. The bank has
subsequently granted permanent waivers for each of those past covenant
violations. However, to obtain the waivers, the Company agreed to collateralize
the loan with substantially all of its real property.

Management is taking steps to ensure that the Company will be able to
comply with all of its covenants under the Loan Agreement in the future.
However, if the bank declined to waive a future covenant violation, the bank
would be required under the Loan Agreement to give the Company 15 days written
notice of the violation, after which time the Company would be in default. At
the bank's option, it could then declare the loan principal and all accrued
interest current and payable and/or refuse to make additional advances on the
credit line. The Company could then be forced to seek alternative sources of
financing.

On October 17, 1997, the Company's board of directors declared a $.015 per
share dividend to be paid December 9, 1997 to holders of record on November 25,
1997. The Company paid a dividend of $.015 per share on December 10, 1996 and
again on June 10, 1997 to holders of record on November 26, 1996 and May 27,
1997, respectively. Future cash dividends will depend on loan restrictions,
earnings, financial position, capital requirements and other relevant factors.
The Loan Agreement prohibits cash dividends until an earnings target is met, and
limits them to $150,000 per fiscal year.

Fiscal 1996 Compared to Fiscal 1995

Sales decreased $9,406,000 in fiscal 1996 due to lower same-store sales and
twelve restaurant closings in fiscal 1995.

14
<PAGE> 16

Same-store sales were down 7.8% in fiscal 1996 compared with a decrease of
11.5% in 1995. Comparable-store sales decreases continued to be significant, but
the rate of decrease was less severe in 1996.

Stores open all of fiscal 1996 averaged sales of $1,106,000, a decrease of
7.1% from 1995. Fourth quarter average store sales were down 5.6% in fiscal 1996
versus 1995. This trend continued into fiscal 1997, as October 1996 average unit
sales were down 6.6% compared with October 1995.

The Company closed nine restaurants under a June 1995 restructuring plan
and closed three others in the ordinary course of business in fiscal 1995. The
closed locations contributed $5,430,000 in sales in fiscal 1995. Each closed
unit had been producing far below company average sales per unit.

The Guadalajara, Mexico restaurant was opened in October 1995, and three
new restaurants were opened in fiscal 1995. These four new restaurants
contributed $1,615,000 more sales in fiscal 1996 than in 1995.

Food costs decreased 0.8% of sales for fiscal 1996 compared to the prior
year. Increased costs for some items were more than offset by ingredient
changes, more efficient usage and effective purchasing. Fourth quarter food
costs increased 0.2% of sales in fiscal 1996 versus fiscal 1995.

Labor and related expenses were down 0.4% of sales in 1996 due to lower
benefits costs. Proactive risk management helped the Company reduce its costs
for the Voluntary Employee Injury Benefit (VEIB) Plan (see Note 7 to the
consolidated financial statements) by 0.3% of sales from fiscal 1995 to fiscal
1996. Based on lower than expected claims costs for prior years, the Company
received a $128,000 refund from its previous health insurance provider, which
contributed to a 0.2% of sales decline in employee health insurance expenses for
fiscal 1996.

Despite disappointing restaurant margins, incentive compensation was up
0.1% of sales for fiscal 1996. The Company increased bonus expense by
introducing additional bonus programs for restaurant service and management
personnel to provide increased incentives for excellent service. In fiscal 1996,
the Company absorbed a 2.1% increase in average hourly wages by reducing
overtime worked and achieving a better sales per hour worked ratio. This
management focus on labor cost controls maintained other labor-related costs
about stable despite the effect of lower sales and general wage inflation.

The fiscal 1996 fourth quarter labor and related expenses were 0.3% of
sales lower than in the fourth quarter of fiscal 1995, reflecting continued
emphasis on labor cost control.

Restaurant operating expenses were up 0.4% in fiscal 1996. The increase was
due mainly to the effect of lower sales on expenses that are fixed or
semi-fixed, such as rent and utilities.

The fourth quarter of fiscal 1996 reflected an increase in restaurant
operating costs of 2.2% of sales compared with the fourth quarter of 1995.
Fourth quarter advertising costs increased 1.2% of sales due to increased
spending on broadcast, newspaper and billboard media. Occupancy costs were up
0.8% of sales versus the prior year quarter due primarily to lower sales
compared with generally fixed costs.

Depreciation and amortization decreased $563,000 in fiscal year 1996, down
0.1% of sales, due to the asset write-downs taken in the June 1995
restructuring. Fourth quarter depreciation expense was up 0.1% of sales in
fiscal 1996 due to lower sales despite being $49,000 lower.

General and administrative expenses rose 0.3% of sales for the year and
fourth quarter in fiscal 1996 versus 1995. The percentage increase resulted from
the effect of lower sales despite cost savings from staff reductions and other
cost cutting measures of $480,000 and $40,000 for the year and quarter,
respectively.

The Company recorded a charge of $7.6 million during the third quarter of
1995 for asset impairments and store closings. The asset impairments primarily
resulted from the closing of 9 restaurants in June 1995, the write-down of asset
values in 7 restaurants that were kept in operation despite low sales, and the
write-down of the Company's restaurant in Guadalajara, Mexico. One of the
impaired locations, in Tulsa, Oklahoma, was subsequently closed, with no
additional impairment charges incurred. The 1995 charge also included asset
impairments on new and used equipment inventory and property held for
disposition, as well as exit and carrying costs for the closed locations.

15
<PAGE> 17

In fiscal 1996, interest expense was $50,000 lower than in 1995 due to a
decreasing debt balance, partially offset by slightly higher interest rates and
no capitalization of interest in fiscal 1996. Outstanding debt has decreased
from a quarterly high of $10,310,000 on June 30, 1995 to $3,640,000 on September
30, 1996. As outstanding debt decreased, interest expense steadily declined,
from $191,000 in the fourth quarter of fiscal 1995 to $84,000 in the fourth
quarter of fiscal 1996.

Due to the factors discussed above, the Company reported net losses of
$415,000 and $5,362,000 for fiscal years 1996 and 1995, respectively. The 1996
loss resulted from lower sales that could not be fully-offset with the benefits
of cost control measures.

Seasonality

The Company's business is seasonal. Traditionally, sales are higher in
summer months, when students are not attending school.

Impact of Inflation

In the restaurant business, food, labor, and labor related expenses are the
major cost factors that effect profits. Many of the Company's employees are paid
wages related to the statutory minimum wage and any increase in the minimum wage
would increase the Company's cost. Also, most of the Company's leases require
the payment of percentage rentals based on revenues, which along with taxes,
repairs and maintenance, utilities and insurance are subject to inflation. The
Company expects to be able to offset the effects of inflation through occasional
price increases and savings due to volume purchasing.

The federal minimum wage increased $.50 per hour effective October 1, 1996,
and further increased $.40 per hour effective September 1, 1997. The Company
implemented price increases July 1, 1997 and mid-September 1997 to offset the
labor cost increases due to higher minimum wage levels.

Other Uncertainties and Trends

In recent years, there has been accelerated development of value-priced
menus and "all-you-can-eat" restaurant offerings. Pancho's Mexican Buffet has
operated as a value-priced, "all-you-can-eat" concept for over 30 years and
expects to compete effectively.

Some computer hardware and software use only two digits to identify the
year in date information. If not corrected, such systems could fail when
processing dates for the year 2000 or later. The Company is in the process of
evaluating its risk and the related costs of updating its computer hardware and
software to properly process year 2000 and later dates.

Special Note Regarding Forward-Looking Information

The foregoing section contains various forward-looking statements which
represent the Company's expectations or beliefs concerning future events,
including, but not limited to the following: statements regarding unit growth,
future capital expenditures, future borrowings, future cash flow and future
results of operations. The Company warns that many factors could, individually
or in aggregate, cause actual results to differ materially from those included
in the forward-looking statements, including, without limitation, the following:
consumer spending trends and habits; increased competition in the restaurant
industry; weather conditions; and laws and regulations affecting labor and
employee benefit costs.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements and related notes thereto required by
this item are listed and set forth herein beginning on page 22.

ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

16
<PAGE> 18

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

(a) Directors of Registrant

Information as to the names, ages, positions and offices with the Company,
terms of office, periods of service, business experience during the past five
years and other directorships held by each director or person nominated to
become a director of the Company is set forth under the caption THE BOARD OF
DIRECTORS appearing on page 2 of the Company's Proxy Statement dated December
22, 1997, and is incorporated herein by reference.

(b) Executive Officers of the Registrant

At the meeting of the Board of Directors of the Registrant, which
immediately follows the annual meeting of stockholders, the Board of Directors
elects officers for the Registrant. Such officers hold office until death,
resignation, removal from office or until their successors are chosen and
qualified. The names and ages of all executive officers of the Registrant, as
well as all persons chosen to become executive officers, together with the
nature of any family relationships between them, all positions and offices with
the Registrant held by each person named and the period during which each person
named has served as such officer is included in Part I under Executive Officers
of the Registrant.

ITEM 11. EXECUTIVE COMPENSATION

Information concerning remuneration received by the Company's directors and
executive officers, stock options and transactions with management is set forth
under the captions EXECUTIVE COMPENSATION, COMPENSATION OF DIRECTORS, AGGREGATED
OPTION EXERCISES IN 1997 AND 1997 YEAR-END OPTION VALUES, REPORT OF THE
COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS and TRANSACTIONS WITH
MANAGEMENT AND OTHERS appearing on pages 5 through 10 of the Company's Proxy
Statement dated December 22, 1997, and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information as to the security ownership of certain beneficial owners of
the Company and by each of its directors and nominees for directors and officers
as of December 11, 1997, and the amount of such shares with respect to which
certain of the directors or nominees and officers have the right to acquire
beneficial ownership, is set forth under the caption SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AS OF DECEMBER 11, 1997, appearing on
page 3 of the Company's Proxy Statement dated December 22, 1997, and is
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning transactions with management and others and certain
business relationships is set forth under the caption TRANSACTIONS WITH
MANAGEMENT AND OTHERS appearing on page 10 of the Company's Proxy Statement
dated December 22, 1997, and is incorporated herein by reference.

17
<PAGE> 19

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) 1. and 2. Financial Statements and Financial Statement
Schedules -- see Index to Consolidated Financial Statements and
Schedules on page 21.

(a) 3. Exhibits Required by Item 601 of Regulation S-K

18
<PAGE> 20
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C>
10(n) -- Amendment No. 3 to 1982 Stock Option Plan for Non-Employee Directors of Pancho's
Mexican Buffet, Inc.(11)
10(o) -- 1992 Stock Option Plan of Pancho's Mexican Buffet, Inc.(12)
10(p) -- Revolving Credit and Term Loan Agreement dated February 16, 1994, between PMB
Enterprises West, Inc. and First Interstate Bank of Texas, N.A.(13)
10(q) -- First Amendment to Revolving Credit and Term Loan Agreement dated February 9, 1995,
between PMB Enterprises West, Inc. and First Interstate Bank of Texas, N.A.(14)
10(r) -- Second Amendment to Revolving Credit and Term Loan Agreement dated May 9, 1995, between
PMB Enterprises West, Inc. and First Interstate Bank of Texas, N.A.(14)
10(s) -- Third Amendment to Revolving Credit and Term Loan Agreement dated September 29,
1995(15)
10(t) -- Employment Contract between the Registrant and one executive officer, dated September
29, 1995(15)
10(u) -- Fourth Amendment to Revolving Credit and Term Loan Agreement dated February 16,
1996(16)
10(v) -- Fifth Amendment to Revolving Credit and Term Loan Agreement dated June 28, 1996(17)
10(w) -- Sixth Amendment to Revolving Credit and Term Loan Agreement dated December 16, 1996(18)
10(x) -- Amendment to Revolving Credit and Term Loan Agreement, dated February 11, 1997(19)
10(y) -- Amendment to Revolving Credit and Term Loan Agreement, dated March 31, 1997(20)
10(z) -- Seventh Amendment to Revolving Credit and Term Loan Agreement, dated December 1,
1997 -- filed herewith
11 -- Not required -- Explanation of earnings per share computation is contained in Notes to
Consolidated Financial Statements.
12 -- Not applicable
13 -- Not applicable
16 -- Not applicable
18 -- Not applicable
21 -- Subsidiaries of the registrant -- filed herewith
22 -- Not applicable
23 -- Consent of Independent Public Accountants -- filed herewith
24 -- Not applicable
27 -- Financial Data Schedule -- filed herewith
28 -- Not applicable
</TABLE>

- ---------------

19
<PAGE> 21
(3) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1982 -- such Exhibit is incorporated herein by reference.
(4) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1983 -- such Exhibits are incorporated herein by reference.
(5) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1984 -- such Exhibits are incorporated herein by reference.
(6) Filed with the Commission as an Exhibit to Form 8-A
Registration Statement on February 21, 1996 -- such Exhibit
is incorporated herein by reference.
(7) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1986 -- such Exhibits are incorporated herein by reference.
(8) Filed with the Commission as an Exhibit to Form S-2
Registration Statement No. 33-14484 on May 22, 1987 -- such
Exhibit is incorporated herein by reference.
(9) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1988 -- such Exhibits are incorporated herein by reference.
(10) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1990 -- such Exhibits are incorporated herein by reference.
(11) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1991 -- such Exhibits are incorporated herein by reference.
(12) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1993 -- such Exhibits are incorporated herein by reference.
(13) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended March 31, 1995 -- such Exhibits are
incorporated herein by reference.
(14) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended June 30, 1995 -- such Exhibits are
incorporated herein by reference.
(15) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1995 -- such Exhibits are incorporated herein by reference.
(16) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended March 31, 1996 -- such Exhibits are
incorporated herein by reference.
(17) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended June 30, 1996 -- such Exhibits are
incorporated herein by reference.
(18) Filed with the Commission as an Exhibit to form 10-K for the
year ended September 30, 1996 -- such Exhibits are
incorporated herein by reference.
(19) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended December 31, 1996 -- such Exhibits are
incorporated herein by reference.
(20) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended March 31, 1997 -- such Exhibits are
incorporated herein by reference.
(21) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended June 30, 1997 -- such Exhibits are
incorporated herein by reference.

(b) Reports on Form 8-K.

No reports on Form 8-K were filed during the quarter ended September 30,
1997.

20
<PAGE> 22

For the purposes of complying with the amendments to the rules governing
Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the
undersigned registrant hereby undertakes as follows, which undertaking shall be
incorporated by reference into registrant's Registration Statement on Form S-8
No. 2-86238 (filed August 31, 1983):

Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the registrant pursuant to the foregoing provisions,
or otherwise, the registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act of 1933 and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, the registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to
a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.

21
<PAGE> 23

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
FOR THE THREE YEARS ENDED SEPTEMBER 30, 1997

<TABLE>
<CAPTION>
PAGE
<S> <C>
Consolidated Financial Statements:

Consolidated Balance Sheets............................... F-1

Consolidated Statements of Operations..................... F-2

Consolidated Statements of Stockholders' Equity........... F-3

Consolidated Statements of Cash Flows..................... F-4

Notes to Consolidated Financial Statements................ F-5

Independent Auditors' Report................................ F-17
</TABLE>

All schedules are omitted because of the absence of conditions under which
they are required or because the required information is given in the
consolidated financial statements or notes thereto.

22
<PAGE> 24

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------
1997 1996
----------- -----------
<S> <C> <C>
Current Assets:
Cash and cash equivalents................................. $ 429,000 $ 145,000
Accounts and notes receivable, current portion............ 222,000 254,000
Income taxes receivable................................... 538,000 186,000
Inventories............................................... 539,000 640,000
Prepaid expenses.......................................... 117,000 180,000
Deferred income taxes..................................... 670,000 742,000
----------- -----------
Total current assets.............................. 2,515,000 2,147,000
----------- -----------
Property, Plant and Equipment:
Land...................................................... 2,995,000 3,446,000
Buildings................................................. 9,477,000 10,561,000
Leasehold improvements.................................... 21,072,000 22,532,000
Equipment and furniture................................... 26,115,000 28,579,000
Construction in progress.................................. 15,000 7,000
----------- -----------
Total............................................. 59,674,000 65,125,000
Less accumulated depreciation and amortization............ (33,487,000) (32,359,000)
----------- -----------
Property, plant and equipment -- net.............. 26,187,000 32,766,000
----------- -----------
Other Assets:
Deferred income taxes..................................... 3,635,000 2,275,000
Other, including noncurrent portion of receivables........ 521,000 780,000
----------- -----------
Total other assets................................ 4,156,000 3,055,000
----------- -----------
Total............................................. $32,858,000 $37,968,000
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
Accounts payable.......................................... $ 1,761,000 $ 1,273,000
Accrued wages and bonuses................................. 1,478,000 1,485,000
Accrued insurance costs, current.......................... 1,022,000 1,343,000
Other current liabilities................................. 1,528,000 1,398,000
----------- -----------
Total current liabilities......................... 5,789,000 5,499,000
----------- -----------
Other Liabilities:
Long-term debt............................................ 2,287,000 3,489,000
Accrued insurance costs, non-current...................... 2,107,000 2,459,000
Restructuring reserves, non-current....................... 406,000
----------- -----------
Total other liabilities........................... 4,800,000 5,948,000
----------- -----------
Commitments and Contingencies
Stockholders' Equity:
Preferred stock, $10 par value (Authorized 500,000 shares,
none issued.)
Common stock, $.10 par value (Authorized 20,000,000
shares. Issued 4,397,559 shares, and 4,389,159 shares
outstanding.).......................................... 440,000 440,000
Additional paid-in capital................................ 18,633,000 18,633,000
Retained earnings......................................... 3,499,000 8,347,000
Cumulative foreign currency translation adjustment........ -- (436,000)
Stock notes receivable.................................... (290,000) (463,000)
Treasury stock at cost (8,400 shares)..................... (13,000) --
----------- -----------
Stockholders' equity.............................. 22,269,000 26,521,000
----------- -----------
Total............................................. $32,858,000 $37,968,000
=========== ===========
</TABLE>

See notes to consolidated financial statements.

F-1
<PAGE> 25

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Sales................................................... $66,957,000 $71,487,000 $80,893,000
----------- ----------- -----------
Costs and Expenses:
Food costs............................................ 18,792,000 19,681,000 22,910,000
Restaurant labor and related expenses................. 25,235,000 26,561,000 30,400,000
Restaurant operating expenses......................... 15,799,000 16,508,000 18,376,000
Depreciation and amortization......................... 3,426,000 3,949,000 4,512,000
General and administrative expenses................... 5,160,000 5,067,000 5,547,000
Restructuring charges................................. 5,066,000 7,572,000
----------- ----------- -----------
Total......................................... 73,478,000 71,766,000 89,317,000
----------- ----------- -----------
Operating income (loss)................................. (6,521,000) (279,000) (8,424,000)
Interest expense........................................ (348,000) (540,000) (590,000)
Other, including interest income........................ 303,000 269,000 309,000
----------- ----------- -----------
Earnings (loss) before income taxes..................... (6,566,000) (550,000) (8,705,000)
Income tax benefit...................................... (1,850,000) (135,000) (3,343,000)
----------- ----------- -----------
Net earnings (loss)..................................... $(4,716,000) $ (415,000) $(5,362,000)
=========== =========== ===========
Net earnings (loss) per share........................... $ (1.07) $ (.09) $ (1.22)
=========== =========== ===========
</TABLE>

See notes to consolidated financial statements.

F-2
<PAGE> 26

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CUMULATIVE
FOREIGN
COMMON STOCK ADDITIONAL CURRENCY TREASURY STOCK
---------------------- PAID-IN RETAINED TRANSLATION ------------------------
SHARES AMOUNT CAPITAL EARNINGS ADJUSTMENT SHARES AMOUNT
---------- --------- ----------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, October 1, 1994............. 5,545,191 $ 555,000 $26,217,000 $14,718,000 $ (30,000) 1,147,632 $(7,699,000)
Treasury stock retired............. (1,147,632) (115,000) (7,584,000) (1,147,632) 7,699,000
Net loss........................... (5,362,000)
Dividends, $.105 per share......... (462,000)
Foreign currency translation
adjustment....................... (419,000)
Payments received on stock notes...
---------- --------- ----------- ----------- --------- ---------- -----------
Balance, September 30, 1995.......... 4,397,559 440,000 18,633,000 8,894,000 (449,000)
Net loss........................... (415,000)
Dividends, $.03 per share.......... (132,000)
Payments received on stock notes...
Foreign currency translation
adjustment....................... 13,000
---------- --------- ----------- ----------- --------- ---------- -----------
Balance, September 30, 1996.......... 4,397,559 440,000 18,633,000 8,347,000 (436,000)
Net loss........................... (4,716,000)
Dividends, $.03 per share.......... (132,000)
Realization of foreign currency
translation adjustment........... 436,000
Treasury stock acquired............ 8,400 (13,000)
Payments and writeoffs on stock
notes............................
---------- --------- ----------- ----------- --------- ---------- -----------
Balance, September 30, 1997.......... 4,397,559 $ 440,000 $18,633,000 $ 3,499,000 $ -- 8,400 $ (13,000)
========== ========= =========== =========== ========= ========== ===========

<CAPTION>
STOCK
NOTES
RECEIVABLE
FROM STOCKHOLDERS'
OFFICERS EQUITY
---------- -------------
<S> <C> <C>
Balance, October 1, 1994............. $(606,000) $33,155,000
Treasury stock retired............. 0
Net loss........................... (5,362,000)
Dividends, $.105 per share......... (462,000)
Foreign currency translation
adjustment....................... (419,000)
Payments received on stock notes... 76,000 76,000
--------- -----------
Balance, September 30, 1995.......... (530,000) 26,988,000
Net loss........................... (415,000)
Dividends, $.03 per share.......... (132,000)
Payments received on stock notes... 67,000 67,000
Foreign currency translation
adjustment....................... 13,000
--------- -----------
Balance, September 30, 1996.......... (463,000) 26,521,000
Net loss........................... (4,716,000)
Dividends, $.03 per share.......... (132,000)
Realization of foreign currency
translation adjustment........... 436,000
Treasury stock acquired............ (13,000)
Payments and writeoffs on stock
notes............................ 173,000 173,000
--------- -----------
Balance, September 30, 1997.......... $(290,000) $22,269,000
========= ===========
</TABLE>

See notes to consolidated financial statements.

F-3
<PAGE> 27

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net earnings (loss).............................. $ (4,716,000) $ (415,000) $ (5,362,000)
------------ ------------ ------------
Adjustments to reconcile net earnings (loss) to
net cash provided by operating activities:
Depreciation and amortization................. 3,426,000 3,949,000 4,512,000
Provision (benefit) for deferred income
taxes....................................... (1,288,000) 186,000 (2,057,000)
Impairment of long-lived assets............... 3,033,000 6,624,000
Provision for exit and carrying costs of
closed locations............................ 1,538,000 948,000
Realization of foreign currency translation
adjustment.................................. 455,000
Loss on writeoff of stock notes receivable.... 83,000
Amortization of restaurant start-up costs..... 36,000 127,000
Payment of restaurant start-up costs.......... (70,000)
(Gain) loss on sale of assets................. (256,000) (141,000) 53,000
Minority interest in net loss................. (138,000)
Changes in operating assets and liabilities:
Accounts and notes receivable............... 9,000 216,000 166,000
Income taxes receivable..................... (352,000) 1,041,000 (1,139,000)
Inventories, prepaid expenses and other
assets................................... 181,000 389,000 978,000
Accounts payable and accrued expenses....... (272,000) (353,000) (544,000)
Restructuring reserves...................... (959,000) (349,000) (634,000)
Other....................................... 98,000
------------ ------------ ------------
Total adjustments........................ 5,598,000 5,072,000 8,826,000
------------ ------------ ------------
Net cash provided by operating
activities............................. 882,000 4,657,000 3,464,000
Cash Flows From Investing Activities:
Property additions............................... (459,000) (689,000) (7,050,000)
Proceeds from sale of assets..................... 1,081,000 278,000 638,000
------------ ------------ ------------
Net cash provided by (used in) investing
activities............................. 622,000 (411,000) (6,412,000)
Cash Flows From Financing Activities:
Short-term borrowings, net....................... 40,000 (10,000) 162,000
Long-term borrowings............................. 28,583,000 28,676,000 43,950,000
Repayments of long-term borrowings............... (29,785,000) (33,892,000) (41,085,000)
Proceeds from increase in minority interest...... 100,000
Treasury stock purchases......................... (13,000)
Dividends paid................................... (132,000) (132,000) (725,000)
Payments on officer stock notes receivable....... 90,000 67,000 76,000
------------ ------------ ------------
Net cash provided by (used in) financing
activities............................. (1,217,000) (5,291,000) 2,478,000
------------ ------------ ------------
Effect of Foreign Exchange Rate Change on Cash..... (3,000) (9,000) 8,000
------------ ------------ ------------
Net Increase (Decrease) in Cash and Cash
Equivalents...................................... 284,000 (1,054,000) (462,000)
Cash and Cash Equivalents at Beginning of Year..... 145,000 1,199,000 1,661,000
------------ ------------ ------------
Cash and Cash Equivalents at End of Year........... $ 429,000 $ 145,000 $ 1,199,000
============ ============ ============
Supplemental Information:
Income taxes paid and (refunds received), net.... $ (170,000) $ (1,348,000) $ 36,000
Assets sold for notes receivable................. 140,000
Interest paid, net of capitalized amounts........ 306,000 533,000 555,000
</TABLE>

See notes to consolidated financial statements.

F-4
<PAGE> 28

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of
Pancho's Mexican Buffet, Inc. and its subsidiaries (the Company). Effective May
31, 1997, the Company abandoned its interest in a Mexican partnership. That
partnership owned 73% of a Mexican subsidiary formed to develop one or more
restaurants in Mexico. The minority interest in that subsidiary is reflected in
the consolidated balance sheets as of September 30, 1996. The minority interest
balance was reduced to zero by the minority partner's interest in the operating
losses of the joint venture. All material intercompany balances and transactions
have been eliminated.

ACCOUNTING ESTIMATES

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those amounts.

ACCOUNT CLASSIFICATION

Certain prior year amounts have been reclassified to conform to the current
year presentation.

CASH AND CASH EQUIVALENTS

For balance sheet classification and reporting cash flows, the Company
considers all highly liquid investments with maturities of three months or less
when purchased to be cash equivalents.

INVENTORIES

Inventories consist primarily of food and supplies, and are stated at the
lower of cost (first-in, first-out basis) or market.

DEFERRED INCOME TAXES

The Company accounts for and reports income taxes in accordance with
Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for
Income Taxes." Applying SFAS No. 109, deferred tax assets and liabilities are
recognized for temporary differences caused when the tax basis of an asset or
liability differs from that reported in the consolidated financial statements,
and for carryforwards for tax credits and operating losses. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. Deferred tax expense or benefit is recognized for the
change in the asset or liability during the year.

PROPERTY, PLANT AND EQUIPMENT

Depreciation is provided for buildings and equipment on a straight-line
basis over the following estimated service lives:

<TABLE>
<S> <C>
Buildings................................................... 25 to 30 years
Equipment and furniture..................................... 3 to 10 years
</TABLE>

F-5
<PAGE> 29

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Leasehold improvements are amortized over the life of the original lease
term, including renewal periods if applicable, or the life of the improvement,
whichever is shorter.

The Company capitalizes interest incurred on debt for major construction
projects and includes the capitalized interest in the asset basis. The Company
capitalized $91,000 out of total interest incurred of $681,000 in 1995. No
interest was capitalized in 1997 or 1996.

LONG-LIVED ASSETS

In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," the Company
reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset or a group of assets
may not be recoverable. The Company considers a history of operating losses or
negative cash flows to be its main indicators of potential impairment. Assets
are generally evaluated for impairment at the operating unit level. Long-lived
assets to be disposed of are reported at the lower of carrying amount or fair
value less cost to sell. An asset or group of assets is deemed to be impaired if
a forecast of undiscounted future cash flows directly related to the asset(s),
including disposal value if any, is less than the carrying amount(s). If an
asset is determined to be impaired, the loss is measured as the amount by which
the carrying amount of the asset exceeds its fair value. Considerable management
judgment is necessary to estimate cash flows and expected fair values.
Accordingly, it is reasonably possible that actual results could vary
significantly from such estimates.

PREOPENING COSTS

Certain direct and incremental costs related to the commencement of each
restaurant's operations, primarily training-related costs, are capitalized as
preopening costs. Amounts capitalized are amortized using the straight-line
method over 12 months. No preopening costs are capitalized at September 30, 1997
or 1996.

EARNINGS (LOSS) PER SHARE

Earnings (loss) per share are based on the weighted average number of
shares and equivalent shares (including stock options, when dilutive)
outstanding during each period. The weighted average of such shares for the
years ended September 30, 1997, 1996 and 1995 were 4,396,000, 4,398,000, and
4,398,000, respectively.

FOREIGN OPERATIONS AND CURRENCY TRANSLATION

The functional currency of the Company's Mexican operations was the new
peso. Financial statements of the Company's Mexican subsidiaries were translated
into U.S. dollars in accordance with SFAS No. 52, "Foreign Currency
Translation." Results of operations were translated using an average exchange
rate during the period, and assets and liabilities were translated using the
year end exchange rate. The resulting cumulative foreign currency translation
adjustment was shown as a separate line in stockholders' equity at September 30,
1996. When the plan to dispose of its Mexican operations was adopted in the
quarter ended March 31, 1997, the balance of the cumulative foreign currency
translation adjustment was expensed as part of the restructuring charge for that
quarter.

STATEMENT OF CASH FLOWS

Cash flows from the Company's Mexican operations were calculated based on
the new peso, in accordance with SFAS No. 95, "Statement of Cash Flows." As a
result, amounts related to assets and liabilities reported on the consolidated
statement of cash flows will not necessarily agree to changes in the
corresponding balances on the consolidated balance sheets. The effect of
exchange rate changes on cash

F-6
<PAGE> 30

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

balances held in foreign currencies is reported on a separate line in the
consolidated statement of cash flows, below cash flows from financing
activities.

STOCK-BASED COMPENSATION

The Company adopted SFAS No. 123, "Accounting for Stock-Based
Compensation," in fiscal 1997. Under the provisions of SFAS No. 123, companies
can elect to account for stock-based compensation plans using a fair-value based
method or continue measuring compensation expense for those plans using the
intrinsic value method prescribed in Accounting Principles Board (APB) Opinion
No. 25, "Accounting for Stock Issued to Employees" and related Interpretations.
The Company has elected to continue using the intrinsic value method to account
for our stock-based compensation plans. SFAS No. 123 requires companies electing
to continue using the intrinsic value method to make certain pro forma
disclosures (see Note 6).

NEW ACCOUNTING STANDARDS

SFAS No. 128 -- "Earnings Per Share" specifies new computation,
presentation and disclosure requirements. The statement will be effective for
both interim and annual periods ending after December 15, 1997. Management
believes that the adoption of this statement will not have a material impact on
the earnings per share presented.

SFAS No. 130 -- In June 1997, the Financial Accounting Standards Board
issued SFAS No. 130, "Reporting on Comprehensive Income," which is effective for
periods beginning after December 15, 1997. SFAS No. 130 establishes standards
for reporting and presenting comprehensive income in the financial statements.
Management believes that the adoption of this statement will not have a material
impact on the Company's financial statements.

SFAS No. 131 -- In June 1997, the Financial Accounting Standards Board
issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 131 redefines how operating segments are determined and
requires disclosure of certain financial and descriptive information about a
Company's operating segments. Management believes that the adoption of SFAS No.
131 will not have a material effect on the Company's future disclosures.

2. OTHER CURRENT LIABILITIES

Other current liabilities consist of:

<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1997 1996
---------- ----------
<S> <C> <C>
Accrued taxes other than income taxes....................... $1,049,000 $1,094,000
Restructuring reserves...................................... 346,000 173,000
Other....................................................... 133,000 131,000
---------- ----------
Total............................................. $1,528,000 $1,398,000
========== ==========
</TABLE>

3. LONG-TERM DEBT

The Company has a revolving credit and term loan agreement (Loan Agreement)
with a bank. In December 1997, the Company and the bank agreed to amend the Loan
Agreement limit-reduction schedule and covenants, effective December 1, 1997.
Under this amendment, the credit line limit is reduced the last day

F-7
<PAGE> 31

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

of each quarter until the agreement terminates June 30, 2000. The credit limits
effective through each quarter end under the amended agreement are shown below:

One financial covenant requires the Company to achieve trailing
three-months earnings before interest, taxes, depreciation and amortization
(EBITDA) to equal or exceed the sum of 125% of the next scheduled commitment
reduction plus capital expenditures during each three-month period, beginning
March 31, 1998. Cash capital expenditures are limited by the amended agreement
to $650,000 each fiscal year. Cash dividends are limited by the amendment to
$150,000 per fiscal year, and are prohibited until the Company achieves trailing
12-months EBITDA of at least $3 million. The loan is secured by all of the
Company's real property. Any proceeds from real estate sales must be applied to
loan repayment.

Management is taking steps to ensure that the Company will be able to
comply with all of the covenants under the Loan Agreement in the future.
However, if the bank declined to waive a future covenant violation, the bank
would be required under the Loan Agreement to give the Company 15 days written
notice of the violation, after which time the Company would be in default. At
the bank's option, it could then declare the loan principal and all accrued
interest current and payable and/or refuse to make additional advances on the
credit line. The Company could then be forced to seek alternative sources of
financing.

Interest is payable monthly at a variable rate equal to the bank's prime
rate plus a margin of 0 to 1% or, after the Company meets certain earnings
goals, rates based upon the London Interbank Offering Rate. The blended interest
rate effective at September 30, 1997 was 8.1%. The Company pays a commitment fee
of 3/8 of 1 percent annually on the unused portion of the credit line.

Notes payable were issued in fiscal 1997 and 1996 to buy out the remaining
lease terms of certain closed locations. The long-term portion of those notes
was $287,000 and $39,000 at September 30, 1997 and 1996, respectively. The
current portion of $150,000 and $151,000 is included in accounts payable at
September 30,

F-8
<PAGE> 32

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1997 and 1996, respectively. The effective interest rates range from 5.9% to
6.9%, with payments due monthly through November 2001.

4. OPERATING LEASES

The Company leases restaurant facilities under operating leases with terms
expiring at various dates into 2007, some of which contain renewal options.
Certain of the leases have provisions for contingent rentals based on a
percentage of the excess of restaurant sales over stipulated minimum sales.

The minimum aggregate annual rentals required under operating leases in
effect at September 30, 1997, exclusive of maintenance, taxes, etc., were as
follows:

<TABLE>
<CAPTION>
YEARS ENDING
SEPTEMBER 30,
- -------------
<S> <C> <C>
1998................................................................... $ 2,526,000
1999................................................................... 2,132,000
2000................................................................... 1,770,000
2001................................................................... 1,231,000
2002................................................................... 954,000
Later years............................................................ 1,187,000
-----------
Total........................................................ $ 9,800,000
===========
</TABLE>

The composition of total yearly rental expense for operating leases is:

<TABLE>
<CAPTION>
SEPTEMBER 30,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Minimum rentals................................ $2,528,000 $2,533,000 $2,946,000
Contingent rentals............................. 188,000 216,000 240,000
Less: Sublease rentals......................... (33,000) (31,000) (126,000)
---------- ---------- ----------
Total................................ $2,683,000 $2,718,000 $3,060,000
========== ========== ==========
</TABLE>

5. INCOME TAXES

Income tax benefits consist of:

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
-------------------------------------
1997 1996 1995
----------- --------- -----------
<S> <C> <C> <C>
Current:
U.S. federal................................. $ (572,000) $(321,000) $(1,286,000)
State........................................ 10,000
----------- --------- -----------
Combined current.......................... (562,000) (321,000) (1,286,000)
Deferred:
U.S. federal................................. (1,326,000) 81,000 (1,658,000)
State........................................ 38,000 105,000 (399,000)
----------- --------- -----------
Combined deferred......................... (1,288,000) 186,000 (2,057,000)
----------- --------- -----------
Income tax benefit...................... $(1,850,000) $(135,000) $(3,343,000)
=========== ========= ===========
</TABLE>

F-9
<PAGE> 33

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The income tax benefit differs from the amounts computed by applying the
U.S. federal statutory rate of 34 percent to the net loss before income taxes as
follows:

<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Expected tax at federal statutory rate of
34%......................................... $(2,232,000) $ (187,000) $(2,957,000)
Increase (decrease) in taxes due to:
Change in valuation allowance............... 782,000 18,000 5,000
Tax effect of abandonment of foreign
operations............................... (305,000)
State income tax provision (benefit), net of
federal income tax effect................ (63,000) 69,000 (399,000)
Tax effect of employer tax credits.......... (45,000) (44,000) (162,000)
Eliminate tax benefit from losses of foreign
operations............................... 76,000 230,000
Adjustment for prior year tax refunds
received................................. 6,000 (135,000)
Other....................................... 7,000 68,000 (60,000)
----------- ----------- -----------
Total............................... $(1,850,000) $ (135,000) $(3,343,000)
=========== =========== ===========
</TABLE>

Significant components of the Company's deferred tax assets and liabilities
are as follows:

<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------------
1997 1996
---------- ----------
<S> <C> <C>
Deferred tax assets:
Current:
Restructuring costs.................................... $ 112,000 $ 65,000
Accrued vacation pay................................... 140,000 142,000
Accrued insurance cost, current........................ 418,000 536,000
Current valuation allowance............................ (1,000)
---------- ----------
Current deferred tax asset, net of valuation
allowance........................................... 670,000 742,000
---------- ----------
Noncurrent:
Accrued insurance costs................................ 860,000 981,000
Federal net operating loss carryforwards (expires
2012)................................................. 1,983,000 2,000
Noncurrent restructuring costs......................... 149,000
Alternative minimum tax carryforward................... 383,000 904,000
State net operating loss carryforwards (expire
1998 -- 2012)......................................... 464,000 392,000
Property, plant and equipment.......................... 453,000
Federal employer tax credits (expire 2009 -- 2012)..... 416,000 321,000
Noncurrent valuation allowance......................... (825,000) (42,000)
---------- ----------
Noncurrent deferred tax asset, net of valuation
allowance........................................... 3,883,000 2,558,000
---------- ----------
Deferred tax liabilities:
Noncurrent:
Property, plant and equipment.......................... 35,000
Basis difference in note receivable.................... 248,000 248,000
---------- ----------
Total deferred tax liabilities.................... 248,000 283,000
---------- ----------
Net deferred non-current tax asset................ $3,635,000 $2,275,000
========== ==========
</TABLE>

The 1997 federal NOL carryforward, of $5,832,000, includes the loss on
abandonment of the Mexico partnership. Due to the Company's abandonment of its
Mexico partnership, previous losses which were treated

F-10
<PAGE> 34

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

as permanent differences were reclassified as temporary differences in 1997 and
included in the 1997 federal NOL carryforward.

The valuation allowance is required to reduce deferred tax assets to the
amount that will more likely than not be realized. This reduction is necessary
due to uncertainty of the Company's ability to use all of the federal and state
net operating loss (NOL) carryforwards before they expire. In 1997, the
valuation allowance was increased $671,000 for the increased federal NOL
carryforward and $111,000 for state NOL carryforwards. The valuation allowance
was increased $18,000 in 1996 for state NOL carryforwards.

6. STOCKHOLDERS' EQUITY

STOCK NOTES RECEIVABLE

In April 1992, the Company sold 104,500 shares of common stock to certain
officers in exchange for notes receivable in the amount of $758,000, the current
balance of which is shown in the balance sheet as a deduction from stockholders'
equity. The notes bear interest at 7.83%, are payable in ten equal annual
installments plus interest and are secured by the common stock. The shares were
sold at the quoted market price on the day of sale.

In fiscal 1997, the Company recognized expense of $83,000 to write off the
excess of stock notes receivable over the market value of stock collateral held
for two former employees for which the receivable balances were considered
uncollectable. One of those employees returned the stock collateral in fiscal
1997, which provided the treasury stock reflected on the balance sheet at
September 30, 1997.

STOCKHOLDERS' RIGHTS PLAN AND PREFERRED STOCK PURCHASE RIGHTS

In January 1996, the Company's Board of Directors adopted a Stockholders'
Rights Plan to replace a similar plan which expired on March 31, 1996. Under the
new plan, the Company declared a dividend distribution of one preferred share
purchase right (Right) for each share of common stock outstanding at the close
of business on March 29, 1996. Each Right entitles the holder to buy one
one-thousandth of a share of the Company's newly-designated Series A Junior
Participating Preferred Stock, for the exercise price of $10 per one
one-thousandth of a Preferred Share, subject to adjustment.

If any person or group (other than certain current stockholders and their
affiliates, associates and successors, which may acquire up to 28%) acquires 15%
of the Common Stock, all stockholders except the acquiring person (Acquiror)
will be entitled to purchase Common Stock having twice the market value of the
Rights exercise price. If the Company is involved in a merger or other business
combination, or sells 50% or more of its assets or earning power, all of the
Stockholders, other than the Acquiror, will be entitled to purchase Common
Shares of the other person having twice the market value of the exercise price.
Under the Plan's exchange provision, any time after such an acquisition but
before any person acquires a majority of the Common Stock, the Board of
Directors may exchange all or part of the outstanding Rights (other than the
Rights of the Acquiror) for Common Stock at a ratio of one Right per share.

The Rights trade with the common stock, and are not exercisable or
transferable apart from the common stock until 10 days after a person or group
acquires, or announces a tender offer for, 15% or more of the Company's
outstanding common stock. Before acquisition by someone of beneficial ownership
of 15% or more of the Company's common stock, the Rights are redeemable by the
Board for $.01 per Right. The Rights expire on March 27, 2006.

Under the Plan, the Company's Board of Directors has designated 10,000
shares of preferred stock as Series A Junior Participating Preferred Stock. This
designation is part of the 500,000 shares of preferred stock, par value $10,
previously authorized. None is issued.

F-11
<PAGE> 35

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

STOCK OPTIONS

The Company's stock option plans authorize the grant of options to purchase
common stock to directors, officers, employees and consultants of the Company at
prices not less than the fair market value of the stock at dates of grant.
Outstanding options become exercisable cumulatively in four or five equal annual
installments commencing one year from date of grant and expire ten years from
the date of grant. Options may be granted through November 5, 2002.

Summary information on stock option activity is shown below.

<TABLE>
<CAPTION>
1997 1996 1995
-------------------------- -------------------------- --------------------------
WEIGHTED- RANGE OF RANGE OF
NUMBER AVERAGE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES EXERCISE PRICE OF SHARES PRICES OF SHARES PRICES
--------- -------------- --------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding on October
1...................... 407,350 $10.13 586,650 $3.19 - $15.25 575,600 $5.88 - $15.25
Granted.................. 10,000 2.06 10,000 2.63 17,000 3.19 - 6.00
Exercised................
Forfeited/Expired........ (12,750) 13.69 (189,300) 5.88 - 11.38 (5,950) 7.25 - 11.38
------- ------ -------- -------------- ------- --------------
Outstanding
September 30........... 404,600 $ 9.82 407,350 $2.63 - $15.25 586,650 $3.19 - $15.25
------- ------ -------- -------------- ------- --------------
Exercisable
September 30........... 306,600 $10.05 236,638 $2.63 - $15.25 284,810 $5.88 - $15.25
------- ------ -------- -------------- ------- --------------
Available for Grant
September 30........... 62,750 67,750 9,000
------- -------- -------
</TABLE>

For shares outstanding at September 30, 1997:

<TABLE>
<CAPTION>
WEIGHTED- WEIGHTED-AVERAGE
NUMBER AVERAGE REMAINING
RANGE OF EXERCISE PRICES OF SHARES EXERCISE PRICE LIFE IN YEARS
------------------------ --------- -------------- ----------------
<S> <C> <C> <C>
$ 2.06 to $ 3.19.......... 25,000 $ 2.51 8.5
$ 5.88 to $ 7.00.......... 15,000 6.20 6.7
$ 7.25 to $ 8.38.......... 85,600 7.69 3.0
$10.50 to $11.38.......... 279,000 11.33 6.1
------- ------ ---
$ 2.06 to $11.38 404,600 $ 9.82 5.6
------- ------ ---
</TABLE>

The weighted-average fair value of options granted in 1997 was $1.00 per
share.

The pro forma effects of reporting stock options using the fair value
approach under SFAS No. 123 are shown below.

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30 1997 1996
----------------------- ----------- ---------
<S> <C> <C>
Net loss
As reported............ $(4,716,000) $(415,000)
Pro forma.............. (4,722,000 (418,000)
Net loss per share
As reported............ (1.07) (0.09)
Pro forma.............. (1.07) (0.09)
</TABLE>

F-12
<PAGE> 36

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1997 and 1996.

<TABLE>
<CAPTION>
1997 1996
----- -----
<S> <C> <C>
Dividend yield.............................................. 1.00% 1.00%
Expected volatility......................................... 55.00% 55.00%
Risk free interest rates.................................... 6.30% 5.30%
Expected life in years...................................... 5 5
</TABLE>

PREFERRED STOCK

Shares of preferred stock, when issued, will have such rights, preferences
and privileges as shall be adopted by the Board of Directors.

SUBSEQUENT DIVIDEND

On October 17, 1997, the Company's Board of Directors declared a $.015 per
common share quarterly cash dividend, to be paid December 9, 1997 to holders of
record on November 25, 1997.

7. EMPLOYEE BENEFIT PLANS

VOLUNTARY EMPLOYEE INJURY BENEFIT PLAN

Concurrent with its decision to become a non-subscriber to the Workers'
Compensation Act of Texas in December 1990, the Company adopted a Voluntary
Employee Injury Benefit (VEIB) Plan to provide benefits for employees located in
Texas who incur job related injuries in connection with their employment. The
VEIB Plan, which is subject to Employee Retirement Income Security Act (ERISA)
rules and regulations, provides for medical, short-term wage replacement,
dismemberment and death benefits.

Coverage under the VEIB Plan is provided by the Company and through excess
liability insurance, which provides coverage for claims in excess of certain
stipulated amounts. The consolidated statements of operations for the years
ended September 30, 1997, 1996, and 1995 include provisions for estimated
benefits and expenses of the VEIB Plan of $557,000, $854,000, and $1,308,000,
respectively.

BONUS PLANS

The Company has a bonus plan for restaurant managers and supervisors which
provides bonuses based on restaurant performance. Such bonuses amounted to
$233,000, $417,000, and $365,000 for the years ended September 30, 1997, 1996
and 1995, respectively.

The Company has a bonus plan for corporate officers as a group based on
stipulated operating results. Under this plan, no corporate officer bonuses were
paid for the years ended September 30, 1997, 1996 and 1995.

An additional bonus plan compensates participants employed by the Company
for the annual principal and interest payments on the stock notes receivable
from officers (see Note 6). Under this plan, the Company recognized compensation
expense of $130,000, $148,000 and $135,000 in fiscal years 1997, 1996 and 1995,
respectively.

STOCK PURCHASE PLAN

The Company maintains a voluntary employee stock purchase plan for all
eligible employees. The Company contributes 25% of the amount invested by the
employee plus all commissions and brokerage fees. Company contributions vest
immediately. Contributions are invested in common stock of the Company by a

F-13
<PAGE> 37

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

brokerage firm. The Company recognized expenses for contributions to the plan of
$23,000, $36,000, and $36,000 for the years ended September 30, 1997, 1996 and
1995, respectively.

8. RELATED PARTY TRANSACTIONS

The Company sold food and supplies on a cost-plus basis to the family-owned
restaurant operations of the Chairman of the Company, until the Company's food
distribution center was closed in September 1994. Occasional sales of supplies
and equipment are still made to those affiliates. Sales amounts were $7,000,
$7,000, and $4,000 for the years ended September 30, 1997, 1996, and 1995,
respectively.

The Chairman of the Company and the family-owned restaurant operations,
collectively, were indebted to the Company in the amount of $88,000 and $86,000
on September 30, 1997 and 1996, respectively. This indebtedness includes the
loan to purchase Company stock (see Note 6 regarding officer stock notes
receivable, secured by Company stock), trade receivables for sales to the
family-owned restaurant operations, and other advances.

The Company purchases food products manufactured by a Company whose
chairman and chief executive officer is a non-employee director of the Company.
Purchases were $2,728,000, $2,714,000, and $2,992,000 for the years ended
September 30, 1997, 1996 and 1995, respectively. The same vendor purchased items
from the Company in the amount of $75,000, $81,000, and $122,000 in 1997, 1996
and 1995, respectively. This vendor also leases the company's cold-storage
facilities. The lease term including options runs through October 31, 2000, and
represented $60,000 of annual rental revenue for the company in fiscal 1997,
1996 and 1995.

The Company and one of its non-employee directors were involved in a joint
venture to open at least one restaurant in Mexico. The Company incurred expenses
in setting up the joint venture of about $60,000 for the year ended September
30, 1995. The Company invested $2,323,000 in its Mexican subsidiaries and
operations related to the venture. The joint venture subsidiaries are included
in the Company's consolidated financial statements. A company owned by this
non-employee director received fees from the joint venture for management
services of $36,000, $48,000 and $48,000 in fiscal 1997, 1996 and 1995,
respectively.

Due to continuing operating losses and negative cash flows for the Mexico
operations, the Company transferred its interest in the Mexico operations to its
joint venture partner effective May 31, 1997. The Company believes this was the
most appropriate method of exiting the Mexico market under the available
circumstances.

9. COMMITMENTS AND CONTINGENCIES

The Company has employment contracts with four executives which call for
payment of salaries and benefits at or above current levels throughout the
contract periods. Three of those agreements expire in December 2001, and one
expires in December 1998.

The Company has been named in various lawsuits involving claims in the
ordinary course of business, many of which are covered by insurance. Although
the amounts of losses from such claims cannot be estimated, in the opinion of
management, the ultimate disposition of these lawsuits and claims will not
result in a material adverse effect on the Company's financial position, results
of operations or cash flows.

10. RESTRUCTURING COSTS

In the quarter ended March 31, 1997, the Company established a
restructuring plan in an effort to return to profitability. The plan included
closing seven underperforming restaurants, disposing of the Mexico joint
venture, impairing four other restaurants and increasing the reserves for lease
buyout for two previously closed locations.

F-14
<PAGE> 38

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company recorded restructuring charges of $5,066,000 in fiscal 1997 to
execute the plan. Under the plan, the Company recognized $4,988,000 in
restructuring charges in the quarter ended March 31, 1997, and $78,000 more in
the quarter ended June 30, 1997. The charges included $3,033,000 for the
impairment of land, buildings, leasehold improvements and equipment. Impairment
charges were determined in accordance with Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of." The charge also included
$1,538,000 to reserve for exit and carrying costs of closed locations. The rest
of the charge consisted of a $455,000 loss from the recognition of the
Cumulative Translation Adjustment for disposal of the Mexico venture, plus
$40,000 to record a valuation allowance for deferred tax assets unlikely to be
realized due to the closing of two Arizona locations under the restructuring.

Under the plan, the Company closed seven U.S. locations on April 15, 1997.
The Company has written off its entire investment in the Mexico venture and has
reserved for exit and carrying costs to dispose of its interest. The Company has
transferred its interest in the Mexico venture effective May 31, 1997 to its
joint venture partner, a non-employee director of the Company.

Sales for the seven closed locations plus the Mexico operation were
$2,854,000, $5,512,000 and $5,624,000 for fiscal years 1997, 1996 and 1995,
respectively.

Under a previous restructuring plan, adopted in June 1995, a restructuring
charge of $7,572,000 before income taxes was recorded for the closing of nine
restaurants and the impairment of eight others, including the restaurant in
Guadalajara, Mexico. The charge included $6,624,000 to write down leasehold
improvements and equipment and $948,000 for remaining lease costs and other exit
costs associated with the restaurant closings. The charge for impairments was
determined in accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."

The assets of the locations closed under the 1995 restructuring were
written down to fair value less disposal costs, providing an impairment charge
of $2,367,000. The net book value after the write down of property, plant and
equipment related to the company's closed restaurant locations was $663,000. The
remaining restaurant equipment will either be sold or used elsewhere in the
Company's operations. Sales for the nine closed locations totaled $4,652,000 for
fiscal 1995.

An impairment charge of $3,445,000 was recognized under the 1995
restructuring for seven low sales volume restaurants that the Company planned to
continue to operate. Due to the low or negative projected cash flows of these
restaurants, the assets were written down to fair value. One of those impaired
restaurants was subsequently closed, without incurring any additional impairment
charges.

The Company's investment in a restaurant in Guadalajara, Mexico was also
evaluated for impairment and a charge of $812,000 was recorded in the 1995
restructuring. Fair value of the assets was estimated based on the discounted
expected future cash flows from operation of the restaurant.

Current and deferred income tax benefits of $2,366,000 were recognized in
the United States in connection with the 1995 restructuring. No tax benefits
were recognized for the write down of assets in Mexico.

11. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with the provisions of SFAS No. 107, "Disclosures About Fair
Value of Financial Instruments," the Company has estimated the fair value of
financial instruments as of September 30, 1997. The estimated fair value amounts
are determined by using available market information and appropriate valuation
methodologies.

The Company's consolidated financial instruments under SFAS No. 107
include: accounts receivable, notes receivable, notes payable, accounts payable
and long-term debt. The Company has estimated that the

F-15
<PAGE> 39

PANCHO'S MEXICAN BUFFET, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

carrying amount of accounts receivable, notes payable and accounts payable
approximates fair value due to the short-term maturities of these instruments.
Notes receivable bear interest at a rate that approximates the current market
rate, therefore, the carrying value approximates the fair value. In addition,
because the Company's long-term debt bears interest at rates which float with
market rates, the Company has estimated that the carrying amounts of its
long-term debt also approximates its fair value.

12. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)

<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30, 1997 YEAR ENDED SEPTEMBER 30, 1996
----------------------------------------------- -----------------------------------------------
QUARTER ENDED QUARTER ENDED
------------------------------------- -------------------------------------
(AMOUNTS IN THOUSANDS EXCEPT 12/31 3/31 6/30 9/30 TOTAL 12/31 3/31 6/30 9/30 TOTAL
PER SHARE DATA) ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Sales......................... $16,574 $16,585 $16,745 $17,053 $66,957 $17,460 $17,915 $18,005 $18,107 $71,487
Operating income (loss)....... (939) (5,638) (124) 180 (6,521) (510) 65 259 (93) (279)
Net earnings (loss)........... (674) (4,087) (80) 125 (4,716) (356) (37) 121 (143) (415)
Net earnings (loss) per
share....................... (0.15) (0.93) (0.02) 0.03 (1.07) (.08) (.01) .03 (.03) (.09)
</TABLE>

- ---------------

(1) Third quarter 1997 results include a pre-tax benefit of $500,000 to reduce
insurance reserves for workers' compensation and the Voluntary Employee
Injury Benefit (VEIB) Plan.

(2) Second quarter 1997 results include a pre-tax benefit of $558,000 to reduce
insurance reserves for workers' compensation and the VEIB Plan.

(3) Fourth quarter 1996 results include a pre-tax benefit of $162,000 to reduce
insurance reserves for workers' compensation and the VEIB Plan.

(4) Third quarter 1996 results include a pre-tax benefit of $179,000 to reduce
insurance reserves for the VEIB Plan and to reduce expenses for the employee
health insurance plan.

(5) Second quarter 1996 results include a pre-tax benefit of $74,000 to reduce
expenses for the employee health insurance plan.

F-16
<PAGE> 40

INDEPENDENT AUDITORS' REPORT

To the Board of Directors of
Pancho's Mexican Buffet, Inc.:

We have audited the consolidated balance sheets of Pancho's Mexican Buffet,
Inc. and subsidiaries as of September 30, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended September 30, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Pancho's Mexican Buffet, Inc.
and subsidiaries at September 30, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 1997, in conformity with generally accepted accounting principles.

/s/ DELOITTE & TOUCHE LLP

Fort Worth, Texas
November 14, 1997
(December 19, 1997 as to the first and second paragraph of Note 3)

F-17
<PAGE> 41

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

PANCHO'S MEXICAN BUFFET, INC.

By /s/ HOLLIS TAYLOR
-----------------------------------
Hollis Taylor, President and Chief
Executive Officer
(Principal Executive Officer)

December 19, 1997

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
SIGNATURE AND TITLE DATE
------------------- ----
<C> <C>
/s/ JESSE ARRAMBIDE, III December 19, 1997
- ------------------------------------------------------------
Jesse Arrambide, III, Chairman of the Board of Directors

/s/ HOLLIS TAYLOR December 19, 1997
- ------------------------------------------------------------
Hollis Taylor, President and Chief Executive Officer and
Director
(Principal Executive Officer)

/s/ W. BRAD FAGAN December 19, 1997
- ------------------------------------------------------------
Brad Fagan, Vice President, Treasurer, Controller and
Assistant Secretary (Principal Financial and Accounting
Officer)

/s/ SAMUEL L. CARLSON December 19, 1997
- ------------------------------------------------------------
Samuel L. Carlson, Director

/s/ MAURICIO SANCHEZ GARCIA December 19, 1997
- ------------------------------------------------------------
Mauricio Sanchez Garcia, Director

/s/ ROBERT L. LIST December 19, 1997
- ------------------------------------------------------------
Robert L. List, Director

/s/ TOMAS ORENDAIN December 19, 1997
- ------------------------------------------------------------
Tomas Orendain, Director

/s/ GEORGE N. RIORDAN December 19, 1997
- ------------------------------------------------------------
George N. Riordan, Director

/s/ RUDOLPH RODRIGUEZ, JR. December 19, 1997
- ------------------------------------------------------------
Rudolph Rodriguez, Jr., Director
</TABLE>
<PAGE> 42

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C>
2 -- Not applicable
3(a) -- Certificate of Incorporation of Pancho's Mexican Buffet, Inc.(2)
3(b) -- Certificates of Amendment of Certificate of Incorporation(3)
3(c) -- Certificate of Amendment of Certificate of Incorporation(5)
3(d) -- Certificate of Amendment of Certificate of Incorporation(8)
3(e) -- Bylaws of Pancho's Mexican Buffet, Inc. as amended through October 5, 1990(10)
3(f) -- Agreement and Plan of Merger dated December 31, 1968(1)
3(g) -- Certificate of Amendment of Certificate of Incorporation, dated January 25, 1995(15)
3(h) -- Restated Certificate of Incorporation, as revised January 25, 1995(15)
4(a) -- Certificate of Incorporation and Bylaws of Registrant, as amended. See Exhibit 3 items
above.
4(b) -- Rights Agreement dated as of January 30, 1996, between Pancho's Mexican Buffet, Inc.
and KeyCorp Shareholder Services, Inc. with Exhibit A (form of Certificate of
Designation, Preferences and Rights of Series A Preferred Stock), Exhibit B (form of
Right Certificate), and Exhibit C (Summary of Rights to Purchase Series A Preferred
Stock) attached(6)
4(c) -- Amendment to Rights Agreement, dated July 25, 1997(21)
9 -- Not applicable
10(a) -- 1982 Stock Option Plan for Non-Employee Directors of Pancho's Mexican Buffet, Inc.(4)
10(b) -- Amendment No. 1 and 2 to 1982 Stock Option Plan for Non-Employee Directors of Pancho's
Mexican Buffet, Inc.(9)
10(c) -- 1982 Incentive Stock Option Plan of Pancho's Mexican Buffet, Inc.(4)
10(d) -- Amendment No. 1, 2 and 3 to Pancho's Mexican Buffet, Inc. 1982 Incentive Stock Option
Plan(9)
10(e) -- Pancho's Mexican Buffet, Inc. Employee Stock Purchase Plan(4)
10(i) -- Memo re: Officers Bonus Plan approved by Board of Directors of Pancho's Mexican Buffet,
Inc. on February 28, 1986(7)
10(j) -- Note, security agreement and investment letter -- re: sale of authorized but unissued
Common Stock of the Registrant to four executive officers in 1992(15)
10(k) -- Employment Contracts between the Registrant and four executive officers dated May 23,
1986 and March 25, 1994(15)
10(l) -- Pancho's Mexican Buffet, Inc. Cafeteria Plan(9)
10(m) -- Amendment No. 4 to 1982 Incentive Stock Option Plan of Pancho's Mexican Buffet,
Inc.(11)
10(n) -- Amendment No. 3 to 1982 Stock Option Plan for Non-Employee Directors of Pancho's
Mexican Buffet, Inc.(11)
10(o) -- 1992 Stock Option Plan of Pancho's Mexican Buffet, Inc.(12)
10(p) -- Revolving Credit and Term Loan Agreement dated February 16, 1994, between PMB
Enterprises West, Inc. and First Interstate Bank of Texas, N.A.(13)
</TABLE>
<PAGE> 43
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C> <C>
10(q) -- First Amendment to Revolving Credit and Term Loan Agreement dated February 9, 1995,
between PMB Enterprises West, Inc. and First Interstate Bank of Texas, N.A.(14)
10(r) -- Second Amendment to Revolving Credit and Term Loan Agreement dated May 9, 1995, between
PMB Enterprises West, Inc. and First Interstate Bank of Texas, N.A.(14)
10(s) -- Third Amendment to Revolving Credit and Term Loan Agreement dated September 29,
1995(15)
10(t) -- Employment Contract between the Registrant and one executive officer, dated September
29, 1995(15)
10(u) -- Fourth Amendment to Revolving Credit and Term Loan Agreement dated February 16,
1996(16)
10(v) -- Fifth Amendment to Revolving Credit and Term Loan Agreement dated June 28, 1996(17)
10(w) -- Sixth Amendment to Revolving Credit and Term Loan Agreement dated December 16, 1996(18)
10(x) -- Amendment to Revolving Credit and Term Loan Agreement, dated February 11, 1997(19)
10(y) -- Amendment to Revolving Credit and Term Loan Agreement, dated March 31, 1997(20)
10(z) -- Seventh Amendment to Revolving Credit and Term Loan Agreement, dated December 1,
1997 -- filed herewith
11 -- Not required -- Explanation of earnings per share computation is contained in Notes to
Consolidated Financial Statements.
12 -- Not applicable
13 -- Not applicable
16 -- Not applicable
18 -- Not applicable
21 -- Subsidiaries of the registrant -- filed herewith
22 -- Not applicable
23 -- Consent of Independent Public Accountants -- filed herewith
24 -- Not applicable
27 -- Financial Data Schedule -- filed herewith
28 -- Not applicable
</TABLE>

- ---------------

<TABLE>
<C> <S>
(1) Filed with the Commission as an Exhibit to Form S-1
Registration Statement No.
2-32378 -- such Exhibits are incorporated herein by
reference.
(2) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K as amended on Form 8 for the year
ended September 30, 1981 -- such Exhibits are incorporated
herein by reference.
(3) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1982 -- such Exhibit is incorporated herein by reference.
(4) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1983 -- such Exhibits are incorporated herein by reference.
(5) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1984 -- such Exhibits are incorporated herein by reference.
</TABLE>
<PAGE> 44
(6) Filed with the Commission as an Exhibit to Form 8-A
Registration Statement on February 21, 1996 -- such Exhibit
is incorporated herein by reference.
(7) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1986 -- such Exhibits are incorporated herein by reference.
(8) Filed with the Commission as an Exhibit to Form S-2
Registration Statement No. 33-14484 on May 22, 1987 -- such
Exhibit is incorporated herein by reference.
(9) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1988 -- such Exhibits are incorporated herein by reference.
(10) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1990 -- such Exhibits are incorporated herein by reference.
(11) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1991 -- such Exhibits are incorporated herein by reference.
(12) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1993 -- such Exhibits are incorporated herein by reference.
(13) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended March 31, 1995 -- such Exhibits are
incorporated herein by reference.
(14) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended June 30, 1995 -- such Exhibits are
incorporated herein by reference.
(15) Filed with the Commission as an Exhibit to the Company's
Annual Report on Form 10-K for the year ended September 30,
1995 -- such Exhibits are incorporated herein by reference.
(16) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended March 31, 1996 -- such Exhibits are
incorporated herein by reference.
(17) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended June 30, 1996 -- such Exhibits are
incorporated herein by reference.
(18) Filed with the Commission as an Exhibit to form 10-K for the
year ended September 30, 1996 -- such Exhibits are
incorporated herein by reference.
(19) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended December 31, 1996 -- such Exhibits are
incorporated herein by reference.
(20) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended March 31, 1997 -- such Exhibits are
incorporated herein by reference.
(21) Filed with the Commission as an Exhibit to Form 10-Q for the
quarter ended June 30, 1997 -- such Exhibits are
incorporated herein by reference.

<PAGE> 1
EXHIBIT 10(z)

SEVENTH AMENDMENT TO REVOLVING
CREDIT AND TERM LOAN AGREEMENT

This Seventh Amendment To Revolving Credit and Term Loan Agreement
(this "Seventh Amendment") is made by and between PMB Enterprises West, Inc., a
New Mexico corporation ("Company"), and Wells Fargo Bank (Texas), National
Association (formerly First Interstate Bank of Texas, N.A.) ("Bank").

WHEREAS, the parties entered into that one certain Revolving Credit
and Term Loan Agreement dated February 16, 1994 (the Revolving Credit and Term
Loan Agreement dated February 16, 1994 and all amendments thereto and
restatements thereof are hereinafter collectively referred to as the "Loan
Agreement"); and

WHEREAS, the parties entered into that one certain First Amendment To
Revolving Credit and Term Loan Agreement dated February 9, 1995 ("First
Amendment"); and

WHEREAS, the parties entered into that one certain Second Amendment To
Revolving Credit and Term Loan Agreement dated May 9, 1995 ("Second
Amendment"); and

WHEREAS, the parties entered into that one certain Third Amendment To
Revolving Credit and Term Loan Agreement dated September 29, 1995 ("Third
Amendment"); and

WHEREAS, the parties entered into that one certain Fourth Amendment To
Revolving Credit and Term Loan Agreement dated February 16, 1996 ("Fourth
Amendment"); and

WHEREAS, the parties entered into that one certain Fifth Amendment To
Revolving Credit and Term Loan Agreement dated July 9, 1996 ("Fifth
Amendment"); and
<PAGE> 2
WHEREAS, the parties entered into a letter agreement dated December
16, 1996; and

WHEREAS, the parties entered into a letter agreement dated February
11, 1997; and

WHEREAS, the parties entered into that one certain Sixth amendment To
Revolving Credit and Term Loan Agreement dated March 31, 1997 ("Sixth
Amendment"); and

WHEREAS, the parties desire to amend the Loan Agreement in certain
respects; and

WHEREAS, capitalized terms used herein shall have the meaning assigned
to them in the Loan Agreement.

NOW THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, it is agreed by and among the
parties as follows:

The definition of Termination Date in Article I of the Loan Agreement
is amended to read in its entirety as follows:

"Termination Date" shall mean June 30, 2000.

The following new definitions are added to Article I of the Loan
Agreement:

"Applicable Margin" shall mean the rate per annum set forth
below for the type of advance indicated in effect from time to time in
the case of a Floating Prime Advance and at the time of Advance in the
case of a Eurodollar Advance:

2
<PAGE> 3
<TABLE>
<CAPTION>
12-Month Trailing Floating Prime Eurodollar
EBITDA Advance Advance
----------------- -------------- ----------
<S> <C> <C>
<$3,200,000 1.0% N/A

$3,200,000 - $4,000,000 .5% N/A

$4,000,000 - $4,500,000 -0- N/A

>$4,500,000 -0- 2.75%
</TABLE>

"Commitment Reduction" shall mean the amount shown opposite each
calendar quarter in section 2.01(a).

"EBITDA" shall mean earnings before interest, taxes, depreciation and
amortization.

Section 2.01(a) of the Loan Agreement is amended to read as follows:

(a) Revolving Loan Commitments. Subject to the terms and
conditions of this Loan Agreement, Bank agrees to extend to Company from the
date hereof through the Termination Date (the "Revolving Credit Period"), a
revolving line of credit which shall not exceed three million four hundred
sixty-one thousand seven hundred forty-seven and 80/100 dollars ($3,461,747.80)
at any one time outstanding prior to December 31, 1997. On the last day of each
and every calendar quarter beginning with the calendar quarter ended December
31, 1997 the maximum principal amount which may at any one time be outstanding
under the revolving line of credit shall be further and additionally reduced by
Company by the amount set forth opposite the particular quarter below:

<TABLE>
<CAPTION>
Quarter Commitment Reduction
------- --------------------
<S> <C>
December 31, 1997 $161,747.80
March 31, l998 100,000.00
June 30, 1998 600,000.00
September 30, 1998 600,000.00
December 31, 1998 100,000.00
March 31, 1999 200,000.00
June 30, 1999 600,000.00
September 30, 1999 600,000.00
December 31, 1999 100,000.00
March 31, 2000 200,000.00
June 30, 2000 200,000.00
</TABLE>

(each maximum amount outstanding under the line of credit from time to time in
effect is hereinafter referred to as the "Commitment"). The amount of the
Commitment shall also be reduced by the amount of net proceeds from the sale of
real property of Borrower or any Subsidiary applied to the payment of the Note.
Any payments received from the proceeds of sale of real property of Borrower or
any Subsidiary will not reduce or affect the next scheduled Commitment
Reduction, but shall be applied in inverse order to the scheduled

3
<PAGE> 4
Commitment Reductions. For example, the application of $300,000 in net proceeds
from the sale of real estate will first cause the Commitment Reduction on March
31, 2000 to be reduced to zero and cause the Commitment Reduction on December
31, 1999 to be reduced to $300,000, and the subsequent application of $400,000
of net proceeds from a second sale of real estate will reduce the Commitment
Reduction on December 31, 1999 to zero and cause the Commitment Reduction on
September 30, 1999 to be reduced to $400,000. Bank shall not be obligated to
make any Advance hereunder if, immediately after giving effect thereto, the
aggregate amount of the Obligations of Company to Bank hereunder exceeds Bank's
Commitment in effect at such time.

Within the limits of this Section 2.01, during the Revolving Credit
Period, Company may borrow, prepay pursuant to Section 4.04 hereof and reborrow
under this Section 2.01. Each advance made by Bank under Section 2.01 and
Section 2.02 is herein called an "Advance" and all Advances made by Bank
hereunder are herein collectively called a "Revolving Credit Loan".

Section 2.02(a) of the Loan Agreement is amended to read as follows:

(a) Request for Advance. Each request by Company to Bank
for an Advance under Section 2.01 hereof (a "Request for Advance")
shall be in writing and specify the aggregate amount of such requested
Advance, the requested date of such Advance, and when the Request for
Advance specifies a Eurodollar Advance, the Interest Period which
shall be applicable thereto; provided, however, Borrower shall not be
entitled to request a Eurodollar Advance unless 12-months trailing
EBITDA exceeds four million five hundred thousand dollars
($4,500,000). The aggregate number of unpaid Eurodollar Advances shall
not exceed four (4) at any time. Company shall furnish to Bank the
Request for Advance by at least 11:00 a.m. (Fort Worth time) three (3)
Eurodollar Business Days prior to the requested Eurodollar Advance
date (which must be a Eurodollar Business Day) and by at least 2:00
p.m. (Fort Worth time) on the requested borrowing date (which must be
a Business Day) for a Floating Prime Advance. Any written Request for
Advance shall: (i) in the case of a Floating Prime Advance, be in the
form attached hereto as Exhibit "C," and (ii) in the case of a
Eurodollar Advance, be in the form attached hereto as Exhibit "D."
Each Floating Prime Advance shall be in an aggregate principal amount
of ten thousand dollars ($10,000.00) or any integral multiple of ten
thousand dollars ($10,000.00). Each Eurodollar Advance shall be in an
amount of at least one million dollars ($1,000,000.00) or any higher
integral multiple of $1,000,000.00.

Prior to making a Request for Advance, Company may (without
specifying whether the anticipated Advance shall be a Floating Prime
Advance or Eurodollar Advance) request that Bank provide Company with
the most recent Interbank Offered Rate available to Bank. Bank shall
endeavor to provide such quoted rates to Company on the date of such
request.

4
<PAGE> 5
Each Request for Advance shall be irrevocable and binding on
Company and, in respect of the Advance specified in such Request for
Advance, Company shall indemnify Bank against any cost, loss or
expense incurred by Bank as a result of any failure to fulfill, on or
before the date specified for such Advance, the conditions to such
Advance set forth herein, including without limitation, any cost, loss
or expense incurred by reason of the liquidation or reemployment of
deposits or other funds acquired by Bank to fund the Advance to be
made by Bank as part of such Advance when such Advance, as a result of
such failure, is not made on such date.

Section 2.02(c) of the Loan Agreement is amended to read in its
entirety as follows:

(c) Selection of Interest Option. Upon making a Request
for Advance under Section 2.02(a) hereof, Company shall advise Bank as
to whether the Advance shall be (i) a Eurodollar Advance, in which
case Company shall specify the applicable Interest Period therefor, or
(ii) a Floating Prime Advance. At least three (3) Eurodollar Business
Days prior to the termination of each Interest Period with respect to
a Eurodollar Advance (whether such termination occurs before or after
the Termination Date) Company shall give Bank written notice (the
"Rollover Notice") of the interest option which shall be applicable to
such Advance to be rolled over upon the expiration of such Interest
Period. If Company shall specify that such Advance shall be a
Eurodollar Advance, such Rollover Notice shall also specify the length
of the succeeding Interest Period selected by Company with respect to
such Advance. Each Rollover Notice shall be irrevocable and effective
upon notification thereof to Bank. If the required Rollover Notice
shall not have been timely received by Bank prior to the expiration of
the then relevant Interest Period, then Company shall be deemed to have
elected to have such Advance be a Floating Prime Advance. With respect
to any Floating Prime Advance, Company shall have the right, on any
Eurodollar Business Day (a "Conversion Date") to convert such Floating
Prime Advance to a Eurodollar Advance by giving Bank a Rollover Notice
of such selection at least three (3) Eurodollar Business Days prior to
such Conversion Date if at such time twelve (12) months trailing
EBITDA exceeds four million five hundred thousand dollars
($4,500,000).

Notwithstanding anything to the contrary contained herein,
Company shall have no right to request a Eurodollar Advance if (a) the
interest rate applicable thereto under Section 2.03 hereof would
exceed the Maximum Rate in effect on the first day of the Interest
Period applicable to such Eurodollar Advance, (b) at such time twelve
(12) months trailing EBITDA is equal to or less than four million five
hundred thousand dollars ($4,500,000), or (c) if an Event of Default
has occurred and is continuing.

5
<PAGE> 6
6.

Section 2.03 of the Loan Agreement is amended to read in its
entirety as follows:

2.03. Interest Rates. The unpaid principal of each
Floating Prime Advance shall bear interest from the date of
advance until paid at a rate per annum which shall from day to
day be equal to the lesser of: (a) the Floating Prime Rate,
plus the Applicable Margin in effect from day to day or (b)
the Maximum Rate. The unpaid principal of each Eurodollar
Advance shall bear interest from the date of advance until
paid at a rate per annum which shall be equal to the lesser of
(a) the sum of the Adjusted Interbank Rate for the applicable
Interest Period, plus the Applicable Margin or (b) the Maximum
Rate. All past due principal of, and to the extent permitted
by applicable law, interest on the Note shall bear interest at
the Past Due Rate. Notwithstanding the foregoing, the unpaid
principal balance of the Note shall bear interest as provided
in Section 4.05(c) hereof, upon the occurrence of the
circumstances described in such section.

A new section 8.19 is added to the Loan Agreement which shall
read in its entirety as follows:

8.19. Real Estate Sales. Company and its
Subsidiaries shall promptly apply all net proceeds of the sale
of real estate owned by Company or any of its Subsidiaries to
the payment of the Note and the amount of such payment shall
reduce the amount of the Commitment in section 2.01(a) in
inverse order.

Section 9.01, Section 9.04, Section 9.14 and Section 9.15 of
the Loan Agreement are amended to read in their entirety as follows:

9.01. Funded Debt to Net Cash Flow. Permit the
ratio of Funded Debt as of the end of any fiscal quarter to
Net Cash Flow of Pancho's Mexican Buffet, Inc. and its
Subsidiaries for the four quarter period ending as of the end
of the preceding fiscal quarter at any time to be greater than
2.25 to 1.0; or

***

9.04. Transfer of Assets. Transfer any funds or
assets to PMB International, Inc. and its Subsidiaries in an
amount in excess of $100,000 during the fiscal year 1998 or
transfer any funds to PMB International, Inc. or its
Subsidiaries in fiscal 1999 or any year thereafter; or

6
<PAGE> 7
9.14 Capital Expenditure. Permit the cash paid for
Capital Expenditures on a Consolidated basis to exceed six
hundred fifty thousand dollars ($650,000) per fiscal year.

9.15 Dividends. Pay any Dividends until 12-month
rolling EBITDA exceeds three million dollars ($3,000,000) or
pay any Dividends in excess of one hundred fifty thousand
dollars ($150,000) in the aggregate during any fiscal year of
Company.

A new section 9.16 is added to the Loan Agreement which shall
read as follows:

9.16. EBITDA. Permit trailing three (3) months
EBITDA to be less than the sum of (a) 125% of the amount of
the next scheduled Commitment Reduction and (b) Capital
Expenditures during any 3-month period beginning with the
quarter ended March 31, 1998.

10.

New sections 10.01(j) and Section 10.01(k) are added to the
Loan Agreement which shall read in their entirety as follows:

(j) The failure of Company to promptly apply all
net proceeds from sale of real property of Company or any of
its Subsidiaries to the unpaid balance of the Note; or

(k) The failure of Company to reduce the unpaid
principal balance of the Note to an amount equal to or less
than the amount of the Commitment then in effect.

Except as amended by the First Amendment, the Second
Amendment, the Third Amendment, the Fourth Amendment, the Fifth Amendment, the
Sixth Amendment, the Seventh Amendment and the letter agreements dated December
16, 1996 and February 11, 1997, the Loan Agreement is ratified and confirmed
and shall remain in full force and effect.

12.

At the time of execution of this Seventh Amendment, Company
shall pay to Bank a fee in the amount of fifteen thousand dollars ($15,000) and
all attorney's fees incurred by Bank.

7
<PAGE> 8
13.

The Company represents and warrants to the Bank, with full
knowledge that the Bank is relying on the following representations and
warranties in executing this Seventh Amendment, as follows:

(a) The Company has corporate power and authority to
execute, deliver and perform this Seventh Amendment, and all corporate action
on the part of the Company requisite for the due execution, delivery and
performance of this Seventh Amendment has been duly and effectively taken.

(b) The Loan Agreement and the Loan Documents and each
and every other document executed and delivered in connection with this Seventh
Amendment to which the Company or any of its Subsidiaries is a party constitute
the legal, valid and binding obligations of the Company and any of its
Subsidiaries to the extent it is a party thereto, enforceable against such
Person in accordance with their respective terms.

(c) This Seventh Amendment does not and will not violate
any provisions of the articles or certificate of incorporation or bylaws of the
Company, or any contract, agreement, instrument or requirement of any
Governmental Authority to which the Company is subject. The Company's execution
of this Seventh Amendment will not result in the creation or imposition of any
lien upon any properties of the Company, other than those permitted by the Loan
Agreement and this Seventh Amendment.

(d) The Company's execution, delivery and performance of
this Seventh Amendment do not require the consent or approval of any other
Person, including, without limitation, any regulatory authority or governmental
body of the United States of America or any state thereof or any political
subdivision of the United States of America or any state thereof.

(e) All financial information previously presented to the
Bank fairly present the financial condition of the Company and its Subsidiaries
as of the date of such information and the results of the operations of the
Company and its Subsidiaries for the periods ended on such dates, all in
accordance with GAAP applied on a consistent basis.

(f) The Company has performed and complied with all
agreements and conditions contained in the Loan Agreement required to be
performed or complied with by the Company prior to or at the time of delivery
of this Seventh Amendment.

(g) After giving effect to this Seventh Amendment, no
default or Event of Default exists and all of the representations and
warranties contained in the Agreement and all instruments and documents
executed pursuant thereto or contemplated thereby are true and correct in all
material respects on and as of this date.

8
<PAGE> 9
14.

The effectiveness of this Seventh Amendment shall be conditioned on
the receipt by the Bank of each of the following:

(a) Corporate resolutions of Company authorizing the
execution of this Seventh Amendment;

(b) Incumbency certificate of Company;

(d) The payment of all attorney's fees incurred by Bank.

15.

Company hereby expressly ratifies, confirms and extends all deed of
trust and mortgage liens and all security interests in favor of Bank and agrees
that each deed of trust lien, mortgage lien and security interest in favor of
Bank shall remain in full force and effect until all indebtedness of Company to
Bank is paid in full and all commitments of Bank to Company have terminated.

16.

Company agrees to pay any and all costs and expenses incurred by Bank
in connection with this Seventh Amendment (including, but not limited to, any
and all appraisal fees, cost of title searches, costs of environmental reports,
recording fees, conveyance fees and reasonable attorneys fees) within ten (10)
days of the date of any invoice for such costs and expenses. Company, at
Company's expense, agrees to promptly execute and deliver to Bank upon request
any and all other and further documents, agreements and instruments as may be
requested by Bank in connection with or relating to this Seventh Amendment and
the Loan Agreement or as may be necessary to correct any omissions or defects
in the documents, agreements or instruments delivered to Bank in connection
therewith.

17.

The parties agree to be bound by the terms and provisions of the
current Arbitration Program of Wells Fargo Bank (Texas), National Association,
which is incorporated by reference herein and is acknowledged as received by
the parties pursuant to which any and all disputes shall be resolved by
mandatory binding arbitration upon the request of any party.

18.

Each of the Guarantors hereby consents to and accepts the terms and
conditions of this Seventh Amendment, agrees to be bound by the terms and
conditions hereof and ratifies and confirms that its continuing Guaranty
Agreement, executed and delivered

9
<PAGE> 10
to the Bank as of February 16, 1994, guaranteeing payment of the obligations is
and remains in full force and effect.

19.

This Seventh Amendment may be executed in any number of counterparts
and by different parties hereto in separate counterparts, each of which when so
executed and delivered shall be deemed to be an original and all of which taken
together shall constitute but one and the same instrument. Delivery of an
executed counterpart of the signature page of this Seventh Amendment by
facsimile shall be equally as effective as delivery of a manually executed
counterpart of this Seventh Amendment.

20.

This Seventh Amendment shall be binding upon and inure to the benefit
of the parties and their respective successors and assigns.

21.

THIS WRITTEN AGREEMENT REPRESENTS THE FINAL AGREEMENT AMONG THE
PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR
SUBSEQUENT ORAL AGREEMENTS AMONG THE PARTIES. THERE ARE NO UNWRITTEN ORAL
AGREEMENTS AMONG THE PARTIES.

Executed to be effective as of December 1, 1997.

PMB ENTERPRISES WEST, INC.

By:/s/ SAMUEL L. CARLSON
----------------------------------------
Samuel L. Carlson, Senior Vice President

COMPANY

WELLS FARGO BANK (TEXAS),
NATIONAL ASSOCIATION (formerly First
Interstate Bank of Texas, N.A.)

By: /s/ ROGER FRUENDT
----------------------------------------
Roger Fruendt, Vice President

BANK

10
<PAGE> 11
AGREED TO:

PANCHO'S MEXICAN BUFFET, INC.

By:/s/ W. BRAD FAGAN
----------------------------------------
Name: Brad Fagan
Title: VP-TREASURER

PMB INTERNATIONAL, INC.

By:/s/ W. BRAD FAGAN
----------------------------------------
Name: Brad Fagan
Title: VP-TREASURER

PAMEX OF TEXAS, INC.

By:/s/ CAROLYN TETTS
----------------------------------------
Name: Carolyn Tetts
Title: SEC/TREAS.

GUARANTORS

11
<PAGE> 12
PMB ENTERPRISES WEST, INC.

OFFICER'S CERTIFICATE

The undersigned hereby certifies that he is the duty elected,
qualified and acting Secretary of PMB Enterprises West, Inc., a New Mexico
corporation (the "Company"), and as such officer, he is familiar with the
Company's properties, affairs and records. The undersigned hereby certifies as
follows:

1. Attached hereto as Exhibit "A" is a true and correct copy of
the Articles of Incorporation of the Company, as filed with the Secretary of
State of the State of New Mexico. Such Articles of Incorporation have not been
amended, modified or restated except as shown in Exhibit "A", and are in full
force and effect as of the date hereof.

2. Attached hereto as Exhibit "B" is a true and correct copy of
the Bylaws of the Company. Such Bylaws are in full force and effect as of the
date hereof and have not been amended, supplemented, altered or repealed.

3. Attached hereto as Exhibit "C" is a true, complete and correct
copy of certain resolutions adopted effective as of December 1, 1997 (the
"Resolutions"). The Resolutions have not been amended, modified, repealed or
otherwise altered in any manner and are in full force and effect as of the date
hereof.

4. Each officer of the Company has been duly authorized to
execute and deliver the Seventh Amendment To Revolving Credit and Term Loan
Agreement dated December 1, 1997 (the "Seventh Amendment") and loan and other
documents required by the Seventh Amendment for and on behalf of the Company.

5. The persons named below are on the date hereof the duly
elected and qualified officers of the Company holding the office set forth
opposite their respective names and their signatures appearing on the right of
their respective names are the genuine signatures of said officers.

<TABLE>
<CAPTION>
Officer Name Signature of Officer
------- ---- --------------------
<S> <C> <C>
President Hollis Taylor /s/ HOLLIS TAYLOR
-------------------------------

Senior Vice President Samuel L. Carlson /s/ SAMUEL L. CARLSON
and Secretary -------------------------------

Assistant Secretary William Brad Fagan /s/ WILLIAM BRAD FAGAN
-------------------------------
</TABLE>

IN WITNESS WHEREOF, I have hereunto subscribed my signature effective
as of the 1 day of December, 1997.
/s/ SAMUEL L. CARLSON
----------------------------
Samuel L. Carlson, Secretary

12
<PAGE> 13
EXHIBIT A
PAGE 1 OF 3

ARTICLES OF INCORPORATION

PMB ENTERPRISES WEST, INC.

ARTICLE I

The name of the proposed corporation shall be PMB Enterprises West, Inc.

ARTICLE II

The period limited for the duration of the corporation is ninety-nine (99)
years from the date hereof.

ARTICLE III

The nature of the business, or objects, or purposes proposed to be
transacted, promoted, or carried on is:

1. To own, lease, manage, or otherwise operate motels, restaurants,
night clubs, including related facilities thereto;

2. To acquire, purchase, lease, option, own, sell, mortgage, work or
otherwise deal in land and personal property;

3. To engage in any and all activities authorized by the Business
Corporation Act of the State of New Mexico.

ARTICLE IV

1. The amount of total authorized capital stock of this corporation
shall be $25,000 divided into 25,000 shares of common stock of par value of ONE
DOLLAR ($1.00) each.

2. The corporation will not commence business until consideration of the
value of at least $1,000 has been received for the issuance of 1,000 shares of
common stock.

3. Any stock of the corporation may be issued for money, property,
services rendered, labor done, cash advances for the company, or for any other
assets of value in accordance with the action of the Board of Directors, whose
judgment as to value received in return therefor shall be conclusive and said
stock when issued shall be fully paid and non-assessable.
<PAGE> 14
EXHIBIT A
PAGE 2 OF 3

ARTICLE V

The location of the corporation's initial registered office shall be
8200 1/2 Menaul NE, Albuquerque, New Mexico, 87110, and the name of its
registered agent at such address is Joe Armijo.

ARTICLE VI

The names and addresses of the persons who are to serve as directors until
the first annual meeting of shareholders or until their successors are elected
and qualified are:

Joe Armijo Mary Lou Armijo
3843 Riverview Drive, N.W. 3843 Riverview Drive, N.W.
Albuquerque, New Mexico Albuquerque, New Mexico

Vincent Arroyo
1616 Speronelli Road, N.W.
Albuquerque, New Mexico

Jesse Arrambide III
1617 Rim Road
El Paso, Texas

ARTICLE VII

The management of the corporation shall be vested in a Board of not less
than three nor more than fifteen directors. The number of directors, within
the aforesaid limits, may be fixed from time to time by the by-laws and until
so fixed shall remain at three. The directors shall be chosen annually by the
stockholders at the time and place provided by the by-laws, and shall hold
office for one year and until others are chosen and qualify in their stead.
Power is hereby conferred upon the Board of Directors to make and alter the
by-laws of the corporation.

ARTICLE VIII

Pre-emptive rights shall not be allowed to the holders of the capital
stock of this corporation.

ARTICLE IX

Cumulative voting shall not be allowed.

ARTICLE X

The name and address of the incorporators:

Joe Armijo
3843 Riverview Drive, N.W.
Albuquerque, New Mexico.
<PAGE> 15
EXHIBIT A
PAGE 3 OF 3

IN WITNESS WHEREOF, I have hereunto set my hand and seal this 4th day of
May, 1976.

/s/ JOE ARMIJO
-----------------
JOE ARMIJO

STATE OF NEW MEXICO )
) ss.
COUNT OF SANTA FE )

The foregoing instrument was acknowledged before me this 4th day of May,
1976, by JOE ARMIJO.

/s/ ANNETTE BYRNES
----------------------
Notary Public

My Commission Expires:

1-10-79
- ----------------------
<PAGE> 16
EXHIBIT B
PAGE 1 OF 6

BY-LAWS

PMB ENTERPRISES WEST, INC.

ARTICLE 1 - OFFICES

SECTION 1. REGISTERED OFFICE. The registered office shall be
established and maintained at 8200 1/2 Menaul NE, Albuquerque, New Mexico,
87110, in the County of Bernalillo in the State of New Mexico.

SECTION 2. OTHER OFFICES. The corporation may have other offices,
either within or without the State of New Mexico, at such place or places as
the Board of Directors may from time to time appoint or the business of the
corporation may require.

ARTICLE II - MEETING OF STOCKHOLDERS

SECTION 1. ANNUAL MEETINGS. Annual meetings of stockholders for the
election of directors and for such other business as may be stated in the
notice of the meeting, shall be held at such place, either within or without
the State of New Mexico, and at such time and date as the Board of Directors,
by resolution, shall determine and as set forth in the notice of the meeting.
In the event the Board of Directors fails to so determine the time, date and
place of meeting, the annual meeting of stockholders shall be held at the
registered office of the corporation in New Mexico on April 25.

If the date of the annual meeting shall fall upon a legal holiday, the
meeting shall be held on the next succeeding business day. At each annual
meeting, the stockholders entitled to vote shall elect a Board of Directors
and may transact such other corporate business as shall be stated in the notice
of the meeting.

SECTION 2. OTHER MEETINGS. Meetings of stockholders for any purpose
other than the election of directors may be held at such time and place within
or without the State of New Mexico, as shall be stated in the notice of the
meeting.

SECTION 3. VOTING. Each stockholder entitled to vote in accordance
with the terms and provisions of the Certificate of Incorporation and these
By-Laws shall be entitled to one vote, in person or by proxy, for each share of
stock entitled to vote held by such stockholder, but no proxy shall be voted
after three years from its date unless such proxy provides for a longer
period. Upon the demand of any stockholder, the vote for directors and upon
any question before the meeting shall be by ballot. All elections for
directors shall be decided by plurality vote; all other questions shall be
decided by majority vote except as otherwise provided by the Certificate of
Incorporation or the laws of the State of New Mexico.

SECTION 4. STOCKHOLDER LIST. The officer who has charge of the stock
ledger of the corporation shall at least 10 days before each meeting of
stockholders prepare a complete alphabetically addressed list of the
stockholders entitled to vote at the ensuing election, with the number of
shares held by each. Said list shall be open to the examination of any
stockholder, for any purpose germane to the meeting, during ordinary business
hours, for a period of at least ten days prior to the meeting, either at a
place within the city where the meeting is to be held. Which place shall be
specified in the notice of the meeting, or, if not so specified, at the place
where the meeting is to be held. The list shall be available for inspection at
the meeting.

<PAGE> 17
EXHIBIT B
PAGE 2 OF 6

SECTION 5. QUORUM. Except as otherwise required by law, by the
Certificate of Incorporation or by these By-Laws, the presence, in person or by
proxy, of stockholders holding a majority of the stock of the corporation
entitled to vote shall constitute a meeting, a majority in interest of the
stockholders entitled to vote thereat, present in person or by proxy, shall
have power to adjourn the meeting from time to time, without notice other than
announcement at the meeting, until the requisite amount of stock entitled to
vote shall be present. At any such adjourned meeting at which the requisite
amount of stock entitled to vote shall be represented, any business may be
transacted which might have been transacted at the meeting as originally
noticed; but only those stockholders entitled to vote at the meeting as
originally noticed shall be entitled to vote at any adjournment or adjournments
thereof.

SECTION 6. SPECIAL MEETINGS. Special meetings of the stockholders, for
any purpose, unless otherwise prescribed by statute or by the Certificate of
Incorporation, may be called by the president and shall be called by the
president or secretary at the request in writing of a majority of the directors
or stockholders entitled to vote. Such request shall state the purpose of the
proposed meeting.

SECTION 7. NOTICE OF MEETINGS. Written notice, stating the place, date
and time of the meeting, and the general nature of the business to be
considered, shall be given to each stockholder entitled to vote thereat at his
address as it appears on the records of the corporation, not less than ten nor
more than fifty days before the date of the meeting.

SECTION 8. BUSINESS TRANSACTED. No business other than that stated in
the notice shall be transacted at any meeting without the unanimous consent of
all the stockholders entitled to vote thereat.

SECTION 9. ACTION WITHOUT MEETING. Except as otherwise provided by the
Certificate of Incorporation, whenever the vote of stockholders at a meeting
thereof is required or permitted to be taken in connection with any corporate
action by any provisions of the statutes or the Certificate of Incorporation or
these By-Laws, the meeting and vote of stockholders may be dispensed with, if
all the stockholders who would have been entitled to vote upon the action
if such meeting were held, shall consent in writing to such corporate action
being taken.

ARTICLE III - DIRECTORS

SECTION 1. NUMBER AND TERM. The number of directors shall be not less
than three. The directors shall be elected at the annual meeting of stockholders
and each director shall be elected to serve until his successor shall be elected
and shall qualify. The number of directors may not be less than three except
that where all the shares of the corporation are owned beneficially and of
record by either one or two stockholders, the number of directors may be less
than three but not less than the number of stockholders.

SECTION 2. RESIGNATIONS. Any director, member of a committee or other
officer may resign at any time. Such resignation shall be made in writing, and
shall take effect at the time specified therein, and if no time be specified,
at the time of its receipt by the President or Secretary. The acceptance of a
resignation shall not be necessary to make it effective.

SECTION 3. VACANCIES. If the office of any director, member of a
committee or other officer becomes vacant, the remaining directors in office,
though less than a quorum by a majority vote, may appoint any qualified person
to fill such vacancy, who shall hold office for the unexpired term and until
his successor shall be duly chosen.

SECTION 4. REMOVAL. Any director or directors may be removed either
for or without cause at any time by the affirmative vote of the holders of a
majority of all the shares of stock outstanding and entitled
<PAGE> 18
EXHIBIT B
PAGE 3 OF 6

to vote, at a special meeting of the stockholders called for the purpose and
the vacancies thus created may be filled, at the meeting held for the purpose
of removal, by the affirmative vote of a majority in interest of the
stockholders entitled to vote.

SECTION 5. INCREASE OF NUMBER. The number of directors may be
increased by amendment of these By-Laws by the affirmative vote of a majority
of the directors, though less than a quorum, or, by the affirmative vote of a
majority in interest of the stockholders, at the annual meeting or at a special
meeting called for that purpose, and by like vote the additional directors may
be chosen at such meeting to hold office until the next annual election and
until their successors are elected and qualify.

SECTION 6. COMPENSATION. Directors shall not receive any stated salary
for their services as directors or as members of committees, but by resolution
of the board a fixed fee and expenses of attendance may be allowed for
attendance at each meeting. Nothing herein contained shall be construed to
preclude any director from serving the corporation in any other capacity as an
officer, agent or otherwise, and receiving compensation therefor.

SECTION 7. ACTION WITHOUT MEETING. Any action required or permitted to
be taken at any meeting of the Board of Directors, or of any committee thereof,
may be taken without a meeting, if prior of such action a written consent
thereto is signed by all members of the board, or of such committee as the case
may be, and such written consent is filed with the minutes of proceedings of
the board or committee.

ARTICLE IV - OFFICERS

SECTION 1. OFFICERS. The officers of the corporation shall consist of
a President, a Treasurer, and a Secretary, and shall be elected by the Board of
Directors and shall hold office until their successors are elected and
qualified. In addition, the Board of Directors may elect a Chairman, one or
more Vice-Presidents and such Assistant Secretaries and Assistant Treasurers as
it may deem proper. None of the officers of the corporation need be directors.
The officers shall be elected at the first meeting of the Board of Directors
after each annual meeting. More than two offices may be held by the same person.

SECTION 2. OTHER OFFICERS AND AGENTS. The Board of Directors may
appoint such officers and agents as it may deem advisable, who shall hold their
offices for such terms and shall exercise such power and perform such duties as
shall be determined from time to time by the Board of Directors.

SECTION 3. CHAIRMAN. The Chairman of the Board of Directors if one be
elected, shall preside at all meetings of the Board of Directors and he shall
have and perform such other duties as from time to time may be assigned to him
by the Board of Directors.

SECTION 4. PRESIDENT. The President shall be the chief executive
officer of the corporation and shall have the general powers and duties of
supervision and management usually vested in the office of President of a
corporation. He shall preside at all meetings of the stockholders if present
thereat, and in the absence or non-election of the Chairman of the Board of
Directors, at all meetings of the Board of Directors, and shall have general
supervision, direction and control of the business of the corporation except as
the Board of Directors shall authorize the execution thereof in some other
manner, he shall execute bonds, mortgages, and other contracts in behalf of the
corporation and shall cause the seal to be affixed to any instrument requiring
it and when so affixed the seal shall be attested by the signature of the
Secretary or the Treasurer or an Assistant Secretary or an Assistant Treasurer.

SECTION 5. VICE-PRESIDENT. Each Vice-President shall have such powers
and shall perform such duties as shall be assigned to him by the directors.
<PAGE> 19
EXHIBIT B
PAGE 4 OF 6

SECTION 6. TREASURER. The Treasurer shall have the custody of the
corporate funds and securities and shall keep full and accurate account of
receipts and disbursements in books belonging to the corporation. He shall
deposit all moneys and other valuables in the name and to the credit of the
corporation in such depositories as may be designated by the Board of Directors.

The Treasurer shall disburse the funds of the corporation as may be
ordered by the Board of Directors, or the President, taking proper vouchers for
such disbursements. He shall render to the President and Board of Directors at
the regular meetings of the Board of Directors, or whenever they may request
it, an account of all his transactions as Treasurer and of the financial
condition of the corporation. If required by the Board of Directors, he shall
give the corporation a bond for the faithful discharge of his duties in such
amount and with such surety as the board shall prescribe.

SECTION 7. SECRETARY. The Secretary shall give, or cause to be given,
notice of all meetings of stockholders and directors, and all other notices
required by law or by these By-Laws, and in case of his absence or refusal or
neglect to do so, any such notice may be given by any person thereunto directed
by the President, or by the directors, or stockholders, upon whose requisition
the meeting is called as provided in these By-Laws. He shall record all the
proceedings of the meetings of the corporation and of directors in a book to be
kept for that purpose, and shall affix the same to all instruments requiring
it, when authorized by the directors or the President, and attest the same.

SECTION 8. ASSISTANT TREASURERS & ASSISTANT SECRETARIES. Assistant
Treasurers and Assistant Secretaries, if any, shall be elected and shall have
such powers and shall perform such duties as shall be assigned to them,
respectively, by the directors.

ARTICLE V

SECTION 1. CERTIFICATES OF STOCK. Every holder of stock in the
corporation shall be entitled to have a certificate, signed by, or in the name
of the corporation by, the chairman or vice-chairman of the board of directors,
or the president or vice-president and the treasurer or an assistant treasurer,
or the secretary of the corporation, certifying the number of shares owned by
him in the corporation. If the corporation shall be authorized to issue more
than one class of stock or more than one series of any class, the designations,
preferences and relative, participating, optional or other special rights of
each class of stock or series thereof and the qualifications, limitations, or
restrictions of such preferences and/or rights shall be set forth in full or
summarized on the face or back of the certificate which the corporation shall
issue to represent such class or series of stock, provided that, in lieu of the
foregoing requirements, there may be set forth on the face or back of the
certificate which the corporation shall issue to represent such class or series
of stock, a statement that the corporation will furnish without charge to each
stockholder who so requests the powers, designations, preferences and relative,
participating, optional or other special rights of each class of stock or
series thereof and the qualifications, limitations or restrictions of such
preferences and/or rights. Where a certificate is countersigned (1) by a
transfer agent other than the corporation or its employee, or (2) by a
registrar other than the corporation or its employee, the signatures of such
officers may be facsimiles.

SECTION 2. LOST CERTIFICATE. New certificates of stock may be issued
in the place of any certificate therefore issued by the corporation, alleged to
have been lost or destroyed, and the directors may, in their discretion,
require the owner of the lost or destroyed certificate or his legal
representatives, to give the corporation a bond, in such sum as they may
direct, not exceeding double the value of the stock, to indemnify the
corporation against it on account of the alleged loss of any such new
certificate.
<PAGE> 20
EXHIBIT B
PAGE 5 OF 6

SECTION 3. TRANSFER OF SHARES. The shares of stock of the corporation shall
be transferable only upon its books by the holders thereof in person or by their
duly authorized attorneys or legal representatives, and upon such transfer the
old certificates shall be surrendered to the corporation by the delivery thereof
to the person in charge of the stock and transfer books and ledgers, or to such
other persons as the directors may designate, by who they shall be cancelled,
and new certificates shall thereupon be issued. A record shall be made of each
transfer and whenever a transfer shall be made for collateral security, and not
absolutely, it shall be so expressed in the entry of the transfer.

SECTION 4. STOCKHOLDERS RECORD DATE. In order that the corporation may
determine the stockholders entitled to notice of or to vote at any meeting of
stockholders or any adjournment thereof, or to express consent to corporate
action in writing without a meeting, or entitled to receive payment of any
dividend or other distribution or allotment of any rights, or entitled to
exercise any rights in respect of any change, conversion or exchange of stock or
for the purpose of any other lawful action, the Board of Directors may fix, in
advance, a record date, which shall not be more than sixty nor less than ten
days before the day of such meeting, nor more than sixty days prior to any other
action. A determination of stockholders of record entitled to notice of or to
vote a meeting of stockholders shall apply to any adjournment of the meeting;
provided, however, that the Board of Directors may fix a new record date for the
adjourned meeting.

SECTION 5. DIVIDENDS. Subject to the provisions of the Certificate of
Incorporation the Board of Directors may, out of funds legally available
therefor at any regular or special meeting, declare dividends upon the capital
stock of the corporation as and when they deem expedient. Before declaring any
dividends there may be set apart out of any funds of the corporation available
for dividends, such sum or sums as the directors from time to time in their
discretion deem proper working capital or as a reserve fund to meet
contingencies or for equalizing dividends or for such other purposes as the
directors shall deem conducive to the interests of the corporation.

SECTION 6. SEAL. The corporate seal shall contain the name of the
corporation, and the words "CORPORATE SEAL". Said seal may be used by causing
it or a facsimile thereof to be impressed or affixed or otherwise reproduced.

SECTION 7. FISCAL YEAR. The fiscal year of the corporation shall be
determined by resolution of the Board of Directors.

SECTION 8. CHECKS. All checks, drafts, or other orders for the payment of
money, notes or other evidences of indebtedness issued in the name of the
corporation shall be signed by officer or officers, agent or agents of the
corporation, and in such manner as shall be determined from time to time by
resolution of the Board of Directors.

SECTION 9. NOTICE AND WAIVER OF NOTICE. Whenever any notice is required by
these By-Laws to be given, personal notice is not meant unless expressly
stated, and any notice so required shall be deemed to be sufficient if given by
depositing the same in the United States mail, postage prepaid, addressed to
the person entitled thereto at his address as it appears on the records of the
corporation, and such notice shall be deemed to have been given on the day of
such mailing. Stockholders not entitled to vote shall not be entitled to
receive notice of any meetings except as otherwise provided by statute.

Whenever any notice whatever is required to be given under the provisions
of any law, or under the provisions of the Certificate of Incorporation of the
corporation or these By-Laws, a waiver thereof in writing signed by the person
or persons entitled to said notice, whether before or after the time stated
therein, shall be deemed proper notice.

<PAGE> 21
EXHIBIT B
PAGE 6 OF 6

ARTICLE VI - AMENDMENTS

These By-Laws may be altered and repealed and By-Laws may be made at any
annual meeting of the stockholders or at any special meeting thereof if notice
thereof is contained in the notice of such special meeting by the affirmative
vote of a majority of the stock issued and outstanding or entitled to vote
thereat, or by the regular meeting of the Board of Directors, at any regular
meeting of the Board of Directors, or at any special meeting of the Board of
Directors, if notice thereof is contained in the notice of such special meeting.
<PAGE> 22
CORPORATION RESOLUTION OF
PMB ENTERPRISES WEST, INC.

I, SAMUEL L. CARLSON, do hereby certify that I am the Secretary of PMB
ENTERPRISES WEST, INC., a New Mexico Corporation, and that the following is a
full, true and correct copy of resolution adopted by the Board of Directors,
to-wit:

"RESOLVED that PMB Enterprises West, Inc. (the "Corporation")is
authorized to execute the Seventh Amendment to Revolving Credit and
Term Loan Agreement between the Corporation and Wells Fargo Bank
(Texas) National Association in the form attached to these resolutions.

"RESOLVED FURTHER that Hollis Taylor, the president of the
Corporation, Samuel L. Carlson, the senior vice president of the
Corporation, or William Brad Fagan, the assistant secretary of the
Corporation, are each authorized to execute, on behalf of the
Corporation, the Seventh Amendment to Revolving Credit and Term Loan
Agreement in the form attached to these resolutions.

WITNESS MY HAND AND THE SEAL OF PMB ENTERPRISES WEST, INC., December 1, 1997.

/s/ SAMUEL L. CARLSON
-----------------------
SAMUEL L. CARLSON

SUBSCRIBED and sworn to before me by SAMUEL L. CARLSON, Secretary of
PANCHO'S MEXICAN BUFFET, INC. this 1st day of December, 1997.

[Notary Public Seal] /s/ CAROLYN TETTS
-----------------------
Notary Public, Tarrant
County, Texas
My commission expires:

5-24-01
-----------------------

STATE OF TEXAS ()

COUNTY OF TARRANT ()

BEFORE ME, a Notary Public in and for said County and State on this
1st day of December, 1997, personally appeared SAMUEL L. CARLSON, Secretary of
PANCHO'S MEXICAN BUFFET, INC., a Delaware Corporation, well known to me to be
the officer and person whose name is subscribed to the foregoing instrument and
acknowledged to me that he executed the same for the purposes therein
expressed, and in the capacity therein stated, and as the act and deed of said
corporation.

[Notary Public Seal] /s/ CAROLYN TETTS
-----------------------
Notary Public, Tarrant
County, Texas
My commission expires:

5-24-01
-----------------------

<PAGE> 1

EXHIBIT 21

SUBSIDIARIES OF THE REGISTRANT

<TABLE>
<CAPTION>
NAMES UNDER WHICH
STATE OF SUBSIDIARY DOES
SUBSIDIARY INCORPORATION BUSINESS
---------- ------------- -----------------
<S> <C> <C>
PMB Enterprises West, Inc. New Mexico PMB Enterprises West, Inc.
Pancho's Mexican Buffet
Pancho's Mexican Buffet
Advertising
Pancho's Mexican Buffet
Commissary Supply Co.
Pancho's Mexican Buffet
Construction
</TABLE>

- ---------------

The above schedule includes all significant subsidiaries of the Company as
defined in Rule 1-02(w) of Regulation S-X.

<PAGE> 1

EXHIBIT 23

INDEPENDENT AUDITORS' CONSENT

We consent to the incorporation by reference in Registration Statement No.
2-86238 of Pancho's Mexican Buffet, Inc. on Form S-8 of the report of Deloitte &
Touche dated November 14, 1997 (December 19, 1997 as to the first and second
paragraph of Note 3), appearing in this Annual Report on Form 10-K of Pancho's
Mexican Buffet, Inc. for the year ended September 30, 1997.

/s/ DELOITTE & TOUCHE LLP

DELOITTE & TOUCHE LLP

Fort Worth, Texas
December 19, 1997

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) THE
CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 1997 AND THE CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE YEAR THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH (B) CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-END> SEP-30-1997
<CASH> 429,000
<SECURITIES> 0
<RECEIVABLES> 222,000
<ALLOWANCES> 0
<INVENTORY> 539,000
<CURRENT-ASSETS> 2,515,000
<PP&E> 59,674,000
<DEPRECIATION> (33,487,000)
<TOTAL-ASSETS> 32,858,000
<CURRENT-LIABILITIES> 1,761,000
<BONDS> 0
0
0
<COMMON> 440,000
<OTHER-SE> 21,829,000
<TOTAL-LIABILITY-AND-EQUITY> 32,858,000
<SALES> 66,957,000
<TOTAL-REVENUES> 66,957,000
<CGS> 18,792,000
<TOTAL-COSTS> 63,252,000
<OTHER-EXPENSES> 10,226,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 348,000
<INCOME-PRETAX> (6,566,000)
<INCOME-TAX> (1,850,000)
<INCOME-CONTINUING> (4,716,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,716,000)
<EPS-PRIMARY> (1.07)
<EPS-DILUTED> (1.07)

</TABLE>