what is going on at california pizza kitchen?

what decisions does susan collyns face?

Everyone knows that 95% of restaurants fail in the first two years, and a lot of people think it's "location, location, location. "It could be, but my experience is you have to have the financial staying power. You could have the greatest idea, but many restaurants do not start out making money-they build over time. So it's really about having the capital and the staying power. -Rick Rosenfield, Co-CEO, California Pizza Kitchen 1 In early July 2007, the financial team at California Piza Kitchen (CPK), led by Chief Financial Officer Susan Collyns, was compiling the preliminary results for the second quarter of 2007. Despite industry challenges of rising commodity, labor, and energy costs, CPK was about to announce near-record quarterly profits of over $6 million. CPK's profit expansion was explained by strong revenue growth with comparable restaurant sales up over 5%. The announced numbers were fully in line with the company's forecasted guidance to investors. The company's results were particularly impressive when contrasted with many other casual dining firms, which had experienced sharp declines in customer traffic. Despite the strong performance, industry difficulties were such that CPK's share price had declined 10% during the month of June to a current value of $22.10. Given the price drop, the management team had discussed repurchasing company shares. With little money in excess cash, however, a large share repurchase program would require debt financing. Since going public in 2000 , CPK's managetnent had avoided putting any debt on the balance sheet. Financial policy was conservative to preserve what co-CEO Rick Rosenfeld referred to as staying power. The view was that a strong balance sheet would maintain the borrowing ability needed to support CPK's expected growth trajectory. Yet with interest rates on the rise from historical lows, Collyns was aware of the benefits of moderately levering up CPK's equity. Page 392 California Pizza Kitchen Inspired by the gourmet piza offerings at Wolfgang Puck's celebrity-filled restaurant, Spago, and eager to flee their carcers as white-collar criminal defense attomeys, Larry Flax and Rick Rosenfield created the first California Pizza Kitchen in 1985 in Beverly Hills, California. Known for its hearth-baked barbecue-chicken pizm, the "designer pizma at off-the-rack prices" concept flourishod. Expansion across the state, country, and globe followed in the subsequent two decades. At the end of the second quarter of 2007 , the company had 213 locations in 28 states and 6 forcign countries. While still very California-centric (approximately 41% of the U.S. stores were in California), the casual dining model tad done well throughout all U.S. regions with its familyfriendly surroundings, excellent ingredients, and inventive offerings. California Pirsa Kitchen derived its revenues from three sources: sales at company-owned restaurants, royaltics from franchised restaurants, and royalties from a partmership with Kraft Foods to sell CPK-branded fromon nizms in erncery stores. While the compary had expanded beyond its orignal concept with two other California Pizza Kitchen Inspired by the gourmet pima offerings at Wolfgang Puck's celebrity-filled restaurant, Spago, and eager to flee their careers as white-collar criminal defense attomeys, Larry Flax and Rick Rosenfield created the first California Piza Kitchen in 1985 in Beverly Hills, California. Known for its hearth-baked barbecue-chicken piza, the "designer piza at off-the-rack prices" concept flourished. Expansion across the state, country, and globe followed in the subsequent two decades. At the end of the second quarter of 2007 , the company had 213 locations in 28 states and 6 foreign countries. While still very Califomia-centric (approximately 41% of the U.S. stores were in California), the casual dining model had done well throughout all U.S. regions with its familyfriendly surroundings, excellent ingredients, and inventive offerings. California Piza Kitchen derived its revenues from three sources: sales at company-owned restaurants, royalties from franchised restaurants, and royalties from a partnership with Kraft Foods to sell CPK-branded frozen pizas in grocery stores. While the company had expanded beyond its original concept with two other restaurant brands, its main focus remained on operating company-owned full-service CPK restaurarts, of which there were 170 units. Show offered a more upscale experience and expansive menu than CPK. CPK inereased its minority interest to full ownership of the LAFood Show in 2005 and planned to open a second location in early 2008. EXHIBIT 32.1 | Selected Mena Offerings Appetizers Avocado Club Egg Rolls: A fusion of East and West with fresh avocado, chicken, tomato, Monterey Jack cheesc, and applewood smoked bacon, wrapped in a crispy wonton roll. Served with ranchico susce and herb ranch drossing Singapone Shirimp Rolls: Shrimp, baby broccoli, soy-glazed shirake mushrooms, romainc, caurots, noodles, bean sprouts, green onion, and cilantro wrapped in rice paper. Served chilled with a secame physer dipping sauce and Szechane sliww. Plonas The Original BBQ Chicken CPK's most-popular purza, introduced in their fint rotaurant in Bevaly Hilb a 1965 . Barbecue sauce, smoked gouda and mozxarella checses, BBQ chicken, wiced red orions, and cilantro. Pizzas The Original BBQ Chicken: CPK's most-popular pizza, introduced in their first restaurant in Beverly Hills in I985. Barbecue sauce, smoked gouda and mozzarella cheeses, BBQ chicken, sliced red onions, and cilantro. Carne Asada: Grilled steak, fire-roasted mild chilies, onions, cilantro pesto, Montercy Jack, and mozzarella cheeses. Topped with fresh tomato salsa and cilantro. Served with a side of tomatillo salsa. Thai Chicken: This is the original! Pieces of chicken breast marinated in a spicy peanut ginger and sesame sauce, mozarella cheese, green onions, bean sprouts, julienne carrots, cilantro, and roasted peanuts. Milan: A combination of grilled spicy Italian sausage and sweet Italian sausage with sautced wild mushrooms, caramelized onions, fontina, mozzarella, and parmesan cheeses. Topped with fresh herbs. Pasta Shanghai Garlic Noodles: Chinese noodles wok-stirred in a garlie ginger sauce with snow peas, shitake mushrooms, mild onions, red and yellow peppers, baby broccoli, and green onions. Also available with chicken and/or shrimp. Chicken Tequila Fettuccine: The originall Spinach fettuccine with chicken, red, green, and yellow peppers, red onions, and fresh cilantro in a tequila, lime, and jalapeo cream sauce. Source Californis Purna Kitchen Wob side, hatgdiswawakkecemimens (aceessed on August 12. 2008). In addition to crediting its inventive menu, analysts also pointed out that its average check of $13.30 was below that of many of its upscale dining casual peers, such as P.F. Chang's and the Cheesecake Factory. Analysts from RBC Capital Markets labeled the chain a "Price-Valuc-Experience" leader in its sector." CPK spent 1% of its sales on advertising, far less than the 3% to 4% of sales that casual dining competitors, such as Chili's, Red Lobster, Olive Garden, and Outback Steakhouse, spent annually. Management felt careful execution of its company model resulted in devoted patrons who created free, but far more-valuable word-ofmouth marketing for the company. Of the actual dollars spent on marketing, roughly 50% was spent on menudevelopment costs, with the other half consumed by more typical marketing strategies, such as public Page 394 relations efforts, direct mail offerings, outdoor media, and on-line marketing. CPK's clientele was not only attractive for its endorsements of the chain, but also because of its were made to address higher costs. Restaurant companies with large franchising operations also did not have the huge amount of capital invested in locations or potentially heavy lease obligations associated with companyowned units. Some analysts included operating lease requirements when considering a restaurant company's leverage. 2 Analysts also believed limited-service restaurants would benefit from any consumers trading down from the casual dining sub-sector of the full-service sector. 10 The growth of the fast-casual subsector and the food-quality improvements in fast food made trading down an increasing likelihood in an economic slowdown. The longer-term outlook for overall restaurant demand looked much stronger. A study by the National Restaurant Association projected that consumers would increase the percentage of their food dollars spent on dining out from the 45% in recent years to 53% by 2010 . II That long-term positive trend may have helped explain the extensive interest in the restaurant industry by activist shareholders, often the executives of private equity firms and hedge funds. Activist investor William Ackman with Pershing Square Capital Management initiated the current round of activist investors forcing change at major restaurant chains. Roughly one week after Ackman vociferously criticized the McDonald's corporate organization at a New York investment conference in late 2005 , the company declared it would divest 1,500 restaurants, repurchase $1 billion of its stock, and disclose more restaurant-level performance details. Ackman advocated all those changes and was able to leverage the power of his 4.5% stake in McDonald's by using the media. His success did not go unnoticed, and other vocal minority investors aggressively pressed for changes at mumerous chains including Applebee's, Wendy's, and Friendly's. These changes included the outright sale of the company, sales of noncore Page396 divisions, and closure of poor-performing locations. In response, other chains embarked on shareholder-friendly plans including initiating share repurchase programs; increasing dividends; decreasing corporate expenditures; and divesting secondary assets. Doug Brooks, chief executive of Brinker International Ine., which owned Chili's, noted at a recent conference: There is no shortage of interest in our industry these days, and much of the recent news has centered on the participation of activist sharcholders ... but it is my job as CEO to act as our internal activist 12 In April 2007, Brinker announced it had secured a new $400 million unsecured, committed credit-facility to fund an acceldrated share repurchase transaction in which approximately $300 million of its common stock would be repurchased. That followed a tender offer recapitalization in 2006 in which the company repurchased $50 million worth of common shares. Recent Developments CPK's positive second-quarter results would affirm many analysts' conclusions that the company was a safe haven in the casual dining sector. Exhibits 32.2 and 32.3 contain CPK's financial statements through July 1 , 2007. Exhibit 32.4 presents comparable store sales trends for CPK and peers. Exhibit 32.5 contains selected analysts' forecasts for CPK, all of which anticipated revenue and earnings growth. A Morgan Keegan analyst commented in May: Despite increased market pressures on consumer spending, California Piza Kitchen's concept continues to post impressive customer traffic gains. Traditionally appealing to a more discriminating, higher-income clientele, CPK's creative farc, low check average, and high service standards have umiquely positioned the concept for success in a tough consumer macroeconomic environment, 13 officer under the terma of their separation agreesenta. di Bata for coopany owned restaurants. Sources of data: Cuspany unitial and quarterly roports and quarterly coapany earnifiki conference.calls. Nate: (11) Brinker' a conparable atore malen vere a bleaded rate for its various branda. Solirce of data: KoyBane Capital Market equity research. EXH1BIT 32. 5 I Selected Forecasts for California Pizze Kitehen While other restaurant companies experienced weakening sales and earnings growth, CPK's revenues increased more than 16% to $159 million for the second quarter of 2007 . Notably, royalties from the Kraft partnership and international franchises were up 37% and 21%, respectively, for the second quarter. Development plans for opening a total of 16 to 18 new locations remained on schedule for 2007 . Funding CPK's 2007 growth plan was anticipated to require $85 million in capital expenditures. The company was successfully managing its two largest expense items in an environment of rising labor and food costs. Labor costs had actually declined from 36.6% to 36.3% of total revenues from the second quarter of 2006 to the second quarter of 2007. Food, beverage, and paper-supply costs remained constant at roughly 24.5% of total revenue in both the second quarter of 2006 and 2007 . The company was implementing a number of taskforce initiatives to deal with the commodity price pressures, especially as cheese prices increased from \$1.37 per pound in April to almost $2.00 a pound by the first week of July. Management felt that much of the cost improvements had been achieved through enhancements in restaurant operations. Capital Structure Decision CPK's book equity was expected to be around $226 million at the end of the second quarter. With a share price in the low 20 s, CPK's market capitalization stood at $644 million. The company had recently issued a 50% stock dividend, which had effectively split CPK shares on a 3-for-2 shares basis. CPK investors received one additional share for every two shares of common stock held. Adjusted for the stock dividend, Exhibit 32,6 Sotes: (1) For the years ended Deceebine 31, 2006, January 1, 2006 and Jantary 2,2005 , Decenber 28,2003. officer under the teres of theif separation agrendents. indata for cospany-ovied restaurints. The recent 10% share price decline seemed to raise the question of whether this was an ideal time to .t. Sar. leuprage the company's balance sheet with ample borrowings available on its The recent 10% share price decline seemed to raise the question of whether this was an ideal time to repurchase shares and potentially leverage the company's balance sheet with ample borrowings available on its existing line of credit. One gain from the leverage would be to reduce the corporate income-tax liability, which had been almost $10 million in 2006. Exhibit. 32.9 provides pro forma financial summaries of CPK's tax shield under alternative capital structures. Still, CPK needed to preserve its ability to fund the strong expansion outlined for the company. Any use of financing to return capital to shareholders needed to be balanced with management's goal of growing the business. EXIHB IT 32.9 Pro Forma Tax Shiold Bffect of Recapitalization Scenarios (dollara in thousands, except share data: figures based on end of June 2007) Everyone knows that 95% of restaurants fail in the first two years, and a lot of people think it's "location, location, location. "It could be, but my experience is you have to have the financial staying power. You could have the greatest idea, but many restaurants do not start out making money-they build over time. So it's really about having the capital and the staying power. -Rick Rosenfield, Co-CEO, California Pizza Kitchen 1 In early July 2007, the financial team at California Piza Kitchen (CPK), led by Chief Financial Officer Susan Collyns, was compiling the preliminary results for the second quarter of 2007. Despite industry challenges of rising commodity, labor, and energy costs, CPK was about to announce near-record quarterly profits of over $6 million. CPK's profit expansion was explained by strong revenue growth with comparable restaurant sales up over 5%. The announced numbers were fully in line with the company's forecasted guidance to investors. The company's results were particularly impressive when contrasted with many other casual dining firms, which had experienced sharp declines in customer traffic. Despite the strong performance, industry difficulties were such that CPK's share price had declined 10% during the month of June to a current value of $22.10. Given the price drop, the management team had discussed repurchasing company shares. With little money in excess cash, however, a large share repurchase program would require debt financing. Since going public in 2000 , CPK's managetnent had avoided putting any debt on the balance sheet. Financial policy was conservative to preserve what co-CEO Rick Rosenfeld referred to as staying power. The view was that a strong balance sheet would maintain the borrowing ability needed to support CPK's expected growth trajectory. Yet with interest rates on the rise from historical lows, Collyns was aware of the benefits of moderately levering up CPK's equity. Page 392 California Pizza Kitchen Inspired by the gourmet piza offerings at Wolfgang Puck's celebrity-filled restaurant, Spago, and eager to flee their carcers as white-collar criminal defense attomeys, Larry Flax and Rick Rosenfield created the first California Pizza Kitchen in 1985 in Beverly Hills, California. Known for its hearth-baked barbecue-chicken pizm, the "designer pizma at off-the-rack prices" concept flourishod. Expansion across the state, country, and globe followed in the subsequent two decades. At the end of the second quarter of 2007 , the company had 213 locations in 28 states and 6 forcign countries. While still very California-centric (approximately 41% of the U.S. stores were in California), the casual dining model tad done well throughout all U.S. regions with its familyfriendly surroundings, excellent ingredients, and inventive offerings. California Pirsa Kitchen derived its revenues from three sources: sales at company-owned restaurants, royaltics from franchised restaurants, and royalties from a partmership with Kraft Foods to sell CPK-branded fromon nizms in erncery stores. While the compary had expanded beyond its orignal concept with two other California Pizza Kitchen Inspired by the gourmet pima offerings at Wolfgang Puck's celebrity-filled restaurant, Spago, and eager to flee their careers as white-collar criminal defense attomeys, Larry Flax and Rick Rosenfield created the first California Piza Kitchen in 1985 in Beverly Hills, California. Known for its hearth-baked barbecue-chicken piza, the "designer piza at off-the-rack prices" concept flourished. Expansion across the state, country, and globe followed in the subsequent two decades. At the end of the second quarter of 2007 , the company had 213 locations in 28 states and 6 foreign countries. While still very Califomia-centric (approximately 41% of the U.S. stores were in California), the casual dining model had done well throughout all U.S. regions with its familyfriendly surroundings, excellent ingredients, and inventive offerings. California Piza Kitchen derived its revenues from three sources: sales at company-owned restaurants, royalties from franchised restaurants, and royalties from a partnership with Kraft Foods to sell CPK-branded frozen pizas in grocery stores. While the company had expanded beyond its original concept with two other restaurant brands, its main focus remained on operating company-owned full-service CPK restaurarts, of which there were 170 units. Show offered a more upscale experience and expansive menu than CPK. CPK inereased its minority interest to full ownership of the LAFood Show in 2005 and planned to open a second location in early 2008. EXHIBIT 32.1 | Selected Mena Offerings Appetizers Avocado Club Egg Rolls: A fusion of East and West with fresh avocado, chicken, tomato, Monterey Jack cheesc, and applewood smoked bacon, wrapped in a crispy wonton roll. Served with ranchico susce and herb ranch drossing Singapone Shirimp Rolls: Shrimp, baby broccoli, soy-glazed shirake mushrooms, romainc, caurots, noodles, bean sprouts, green onion, and cilantro wrapped in rice paper. Served chilled with a secame physer dipping sauce and Szechane sliww. Plonas The Original BBQ Chicken CPK's most-popular purza, introduced in their fint rotaurant in Bevaly Hilb a 1965 . Barbecue sauce, smoked gouda and mozxarella checses, BBQ chicken, wiced red orions, and cilantro. Pizzas The Original BBQ Chicken: CPK's most-popular pizza, introduced in their first restaurant in Beverly Hills in I985. Barbecue sauce, smoked gouda and mozzarella cheeses, BBQ chicken, sliced red onions, and cilantro. Carne Asada: Grilled steak, fire-roasted mild chilies, onions, cilantro pesto, Montercy Jack, and mozzarella cheeses. Topped with fresh tomato salsa and cilantro. Served with a side of tomatillo salsa. Thai Chicken: This is the original! Pieces of chicken breast marinated in a spicy peanut ginger and sesame sauce, mozarella cheese, green onions, bean sprouts, julienne carrots, cilantro, and roasted peanuts. Milan: A combination of grilled spicy Italian sausage and sweet Italian sausage with sautced wild mushrooms, caramelized onions, fontina, mozzarella, and parmesan cheeses. Topped with fresh herbs. Pasta Shanghai Garlic Noodles: Chinese noodles wok-stirred in a garlie ginger sauce with snow peas, shitake mushrooms, mild onions, red and yellow peppers, baby broccoli, and green onions. Also available with chicken and/or shrimp. Chicken Tequila Fettuccine: The originall Spinach fettuccine with chicken, red, green, and yellow peppers, red onions, and fresh cilantro in a tequila, lime, and jalapeo cream sauce. Source Californis Purna Kitchen Wob side, hatgdiswawakkecemimens (aceessed on August 12. 2008). In addition to crediting its inventive menu, analysts also pointed out that its average check of $13.30 was below that of many of its upscale dining casual peers, such as P.F. Chang's and the Cheesecake Factory. Analysts from RBC Capital Markets labeled the chain a "Price-Valuc-Experience" leader in its sector." CPK spent 1% of its sales on advertising, far less than the 3% to 4% of sales that casual dining competitors, such as Chili's, Red Lobster, Olive Garden, and Outback Steakhouse, spent annually. Management felt careful execution of its company model resulted in devoted patrons who created free, but far more-valuable word-ofmouth marketing for the company. Of the actual dollars spent on marketing, roughly 50% was spent on menudevelopment costs, with the other half consumed by more typical marketing strategies, such as public Page 394 relations efforts, direct mail offerings, outdoor media, and on-line marketing. CPK's clientele was not only attractive for its endorsements of the chain, but also because of its were made to address higher costs. Restaurant companies with large franchising operations also did not have the huge amount of capital invested in locations or potentially heavy lease obligations associated with companyowned units. Some analysts included operating lease requirements when considering a restaurant company's leverage. 2 Analysts also believed limited-service restaurants would benefit from any consumers trading down from the casual dining sub-sector of the full-service sector. 10 The growth of the fast-casual subsector and the food-quality improvements in fast food made trading down an increasing likelihood in an economic slowdown. The longer-term outlook for overall restaurant demand looked much stronger. A study by the National Restaurant Association projected that consumers would increase the percentage of their food dollars spent on dining out from the 45% in recent years to 53% by 2010 . II That long-term positive trend may have helped explain the extensive interest in the restaurant industry by activist shareholders, often the executives of private equity firms and hedge funds. Activist investor William Ackman with Pershing Square Capital Management initiated the current round of activist investors forcing change at major restaurant chains. Roughly one week after Ackman vociferously criticized the McDonald's corporate organization at a New York investment conference in late 2005 , the company declared it would divest 1,500 restaurants, repurchase $1 billion of its stock, and disclose more restaurant-level performance details. Ackman advocated all those changes and was able to leverage the power of his 4.5% stake in McDonald's by using the media. His success did not go unnoticed, and other vocal minority investors aggressively pressed for changes at mumerous chains including Applebee's, Wendy's, and Friendly's. These changes included the outright sale of the company, sales of noncore Page396 divisions, and closure of poor-performing locations. In response, other chains embarked on shareholder-friendly plans including initiating share repurchase programs; increasing dividends; decreasing corporate expenditures; and divesting secondary assets. Doug Brooks, chief executive of Brinker International Ine., which owned Chili's, noted at a recent conference: There is no shortage of interest in our industry these days, and much of the recent news has centered on the participation of activist sharcholders ... but it is my job as CEO to act as our internal activist 12 In April 2007, Brinker announced it had secured a new $400 million unsecured, committed credit-facility to fund an acceldrated share repurchase transaction in which approximately $300 million of its common stock would be repurchased. That followed a tender offer recapitalization in 2006 in which the company repurchased $50 million worth of common shares. Recent Developments CPK's positive second-quarter results would affirm many analysts' conclusions that the company was a safe haven in the casual dining sector. Exhibits 32.2 and 32.3 contain CPK's financial statements through July 1 , 2007. Exhibit 32.4 presents comparable store sales trends for CPK and peers. Exhibit 32.5 contains selected analysts' forecasts for CPK, all of which anticipated revenue and earnings growth. A Morgan Keegan analyst commented in May: Despite increased market pressures on consumer spending, California Piza Kitchen's concept continues to post impressive customer traffic gains. Traditionally appealing to a more discriminating, higher-income clientele, CPK's creative farc, low check average, and high service standards have umiquely positioned the concept for success in a tough consumer macroeconomic environment, 13 officer under the terma of their separation agreesenta. di Bata for coopany owned restaurants. Sources of data: Cuspany unitial and quarterly roports and quarterly coapany earnifiki conference.calls. Nate: (11) Brinker' a conparable atore malen vere a bleaded rate for its various branda. Solirce of data: KoyBane Capital Market equity research. EXH1BIT 32. 5 I Selected Forecasts for California Pizze Kitehen While other restaurant companies experienced weakening sales and earnings growth, CPK's revenues increased more than 16% to $159 million for the second quarter of 2007 . Notably, royalties from the Kraft partnership and international franchises were up 37% and 21%, respectively, for the second quarter. Development plans for opening a total of 16 to 18 new locations remained on schedule for 2007 . Funding CPK's 2007 growth plan was anticipated to require $85 million in capital expenditures. The company was successfully managing its two largest expense items in an environment of rising labor and food costs. Labor costs had actually declined from 36.6% to 36.3% of total revenues from the second quarter of 2006 to the second quarter of 2007. Food, beverage, and paper-supply costs remained constant at roughly 24.5% of total revenue in both the second quarter of 2006 and 2007 . The company was implementing a number of taskforce initiatives to deal with the commodity price pressures, especially as cheese prices increased from \$1.37 per pound in April to almost $2.00 a pound by the first week of July. Management felt that much of the cost improvements had been achieved through enhancements in restaurant operations. Capital Structure Decision CPK's book equity was expected to be around $226 million at the end of the second quarter. With a share price in the low 20 s, CPK's market capitalization stood at $644 million. The company had recently issued a 50% stock dividend, which had effectively split CPK shares on a 3-for-2 shares basis. CPK investors received one additional share for every two shares of common stock held. Adjusted for the stock dividend, Exhibit 32,6 Sotes: (1) For the years ended Deceebine 31, 2006, January 1, 2006 and Jantary 2,2005 , Decenber 28,2003. officer under the teres of theif separation agrendents. indata for cospany-ovied restaurints. The recent 10% share price decline seemed to raise the question of whether this was an ideal time to .t. Sar. leuprage the company's balance sheet with ample borrowings available on its The recent 10% share price decline seemed to raise the question of whether this was an ideal time to repurchase shares and potentially leverage the company's balance sheet with ample borrowings available on its existing line of credit. One gain from the leverage would be to reduce the corporate income-tax liability, which had been almost $10 million in 2006. Exhibit. 32.9 provides pro forma financial summaries of CPK's tax shield under alternative capital structures. Still, CPK needed to preserve its ability to fund the strong expansion outlined for the company. Any use of financing to return capital to shareholders needed to be balanced with management's goal of growing the business. EXIHB IT 32.9 Pro Forma Tax Shiold Bffect of Recapitalization Scenarios (dollara in thousands, except share data: figures based on end of June 2007)