-- U.S. casual dining restaurant operator California Pizza Kitchen
has performed below our expectations because of revenue declines due
to weak traffic and store closures.
-- While EBITDA has improved slightly in the past year, we believe there
is significant downside risk to operating performance in the second half of
-- We are revising the outlook to negative from stable and affirming our
'B' corporate credit rating on the company.
-- The negative outlook reflects our expectation for modest cash flow
generation and slightly worsening credit protection metrics despite efforts to
enhance operations through cost cutting this year.
On Aug. 28, 2012, Standard & Poor's Ratings Services revised its outlook on
Los Angeles-based California Pizza Kitchen Inc. (CPK) to negative from stable.
At the same time, we affirmed all of our ratings on the company, including our
'B' corporate credit rating.
The outlook revision reflects the latest two quarters of performance, when
de-leveraging was below our expectations, and our view that sales are likely
to decline over the near term due to continued negative comparable-store sales
and expected commodity cost inflation. It also incorporates our view that
credit metrics and covenant cushions will remain weak relative to the rating
category over the coming year.
The speculative-grade rating on CPK reflects its "highly leveraged" financial
risk profile as a result of the Golden Gate Capital LBO. It also incorporates
our "vulnerable" assessment of the company's business risk profile, reflecting
its participation in the highly competitive casual dining segment of the
restaurant industry, limited format diversity, exposure to volatile commodity
costs, and geographic concentration in California, where more than 30% of the
company's units are located.
We calculate CPK's cushion to its leverage covenant under a credit agreement
at 11.1% in the second quarter ended July 1, 2012, and expect it to remain
between 10% and 15% by the end of fiscal 2012. While credit protection metrics
have improved in the first half of 2012 compared to the end of fiscal 2011, we
expect modest erosion by the end of fiscal 2012 as the company continues to
post negative sales. As such, we forecast lease-adjusted total debt to EBITDA
will worsen to 6.5x by the end of fiscal 2012 from 6.3x in the year through
July 1, 2012. We also project EBITDA coverage of interest will decline to 1.5x
by the end of fiscal 2012 from 1.8x in the year through July 1, 2012, due to
added interest expense following the LBO.
Principal economic factors we considered in our forecast include real GDP
growth of 2.1% in 2012 and 1.8% in 2013, consumer spending growth of 2.0% in
2012 and 2.3% in 2013, and the unemployment rate remaining at or above 8%
through 2013. Further specific details underlying our forecast for CPK include:
-- Low-single-digit percent sales decline as weak traffic causes
continued negative comparable-store sales;
-- Gross margin likely to decline in the mid-double-digit basis points
(bps) as low-single-digit commodity cost inflation offsets menu simplification
and savings associated with food waste;
-- Selling, general, and administrative expense anticipated to decrease
in the low-single-digit percent rate due to continued reduction in headcount
-- Modest increase in capital expenditure for maintenance, but not
restaurant growth, with no unit expansion forecast in the medium term; and
-- Adjusted EBITDA projected to increase in the mid-single-digit percent
this year as continued aggressive cost-cutting through renegotiated food and
distribution contracts and lower labor expenses offset declining sales.
We believe CPK's operating results were weaker than expected in 2011, in part
due to the delay in installing a new CEO and CFO, which delayed realizing
procurement and staffing savings. Our 2012 outlook remains negative for the
casual dining industry in which CPK competes and more favorable for
quick-service pizza players like Pizza Hut franchisee NPC International Inc.
and Domino's Pizza Inc. Both are posting positive comparable sales figures
this year due to promotions and increased delivery and we believe such trends
are detracting from full-service dine-in players like CPK.
We view CPK's liquidity as "adequate," covering cash needs over the next
several years, even in the event of moderate, unforeseen EBITDA declines. As
of July 1, 2012, the company had $33 million in cash on hand and no
outstanding borrowing under its revolver. We do not expect CPK to borrow under
its revolver for the remainder of fiscal 2012. Cash on hand, cash flow from
operations, and availability under the revolver are likely to provide adequate
liquidity sources to fund the company's capital spending needs. Additionally,
a credit agreement mandates the company use 50% of excess cash flows for debt
repayment in coming years, resulting in modest de-leveraging.
Other relevant aspects of the company's liquidity are as follows:
-- We expect that liquidity sources over the next 12-24 months will
exceed uses by 1.2x or more.
-- We also expect that net sources would be positive, even with a 15%
decline in EBITDA.
-- The company's debt maturities over the medium term are manageable, in
-- We believe CPK's cushion to its leverage covenant will remain at or
below 15% by the end of fiscal 2012.
For the complete recovery analysis, see the recovery report on CPK, to be
published soon after this report on RatingsDirect.
Our negative rating outlook on CPK reflects our base-case forecast that the
company's operating performance and credit measures will worsen slightly over
the near term. We could lower the rating if poor execution of CPK's strategic
initiatives, greater-than-expected commodity cost pressure, and intensified
competition result in 50 bps of gross margin deterioration or an annual sales
decline in the mid-single-digit percent range for fiscal 2012. This would
result in flat EBITDA, with leverage remaining close to 7x and coverage
remaining below 2x. A lower rating could also result from a tightening of the
leverage covenant cushion to below 10%.
We could revise the outlook to stable if CPK demonstrates a consistent
commitment to de-leveraging, successfully driving sustainable positive sales
in the low-single-digit percent range or improving gross margin about 50 bps.
This would result in EBITDA growing in the mid-double-digit percent, pushing
leverage down to the mid-5x range and coverage to the mid-2x range. It would
also result in the covenant cushion remaining above 15% for the remainder of
Related Criteria And Research
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Ratios And Adjustments, April 14, 2008
-- Key Credit Factors: Business And Financial Risks In The Restaurant
Industry, Dec. 4, 2008
Ratings Affirmed; Outlook Action
California Pizza Kitchen, Inc.
Corporate Credit Rating B/Negative/-- B/Stable/--
Ratings Affirmed; Recovery Ratings Unchanged
California Pizza Kitchen, Inc.
Senior Secured B
Recovery Rating 3