California Pizza Kitchen Downgraded To 'CCC+' On Weak Expected Performance And Tight Covenant Cushion, Outlook Negative

  • We expect U.S.-based restaurant operator California Pizza Kitchen Inc. (CPK) to generate modestly negative free operating cash flow (FOCF) and project that the cushion under its financial covenant will be tight.
  • We are downgrading CPK to 'CCC+' from 'B-' to reflect our view that the company's capital structure may be unsustainable over the long term.
  • At the same time, we are lowering our issue-level rating on the company's $320 million senior secured credit facility (including the revolver due August 2021 and term loan due August 2022) to 'CCC+' from 'B-' and our issue-level rating on its $75 million second-lien debt due August 2023 to 'CCC-' from 'CCC'. Our recovery ratings on the debt facilities remain unchanged.
  • The negative outlook reflects our view that CPK's capital structure may be unsustainable over the long term given its elevated risk of a covenant breach absent an equity cure or amendment as well as its negative FOCF, challenging business backdrop, and significant debt obligations maturing in 2022.
NEW YORK (S&P Global Ratings) July 17, 2019--S&P Global Ratings today took the rating actions listed above. The downgrade reflects our expectation that CPK's heavy debt burden, along with our expectation for limited improvement in its operating performance, may render the company's capital structure unsustainable over the long term. It also reflects CPK's limited covenant headroom as its total rent adjusted net leverage was about 5.5x in the first quarter ended March 2019 according to its bank's definition, which provides it with a cushion of less than 10% relative to the 6.0x covenant limit for the period. For the next 12 months, we project that the covenant headroom will shrink further because of a the contractual step down later this year and because we expect CPK to face a competitive environment, leading to a relatively flat performance while it continues to generate negative FOCF.
The negative outlook on CPK reflects our expectation for a weak operating performance and negative FOCF generation given its challenged customer traffic trends amid intense competition in the casual dining industry. We also believe the company's execution risks will remain elevated over the next 12 months and see increased risk for a covenant breach.
We could lower our rating on CPK if we envision a specific default scenario over the next 12 months, including a shortfall in its near-term liquidity or the violation of a financial covenant. We could also lower our rating if we thought the company planned to undertake a distressed exchange.
We could revise our outlook on CPK to stable or raise our rating if we believe CPK's performance is stabilizing and expect it to maintain an adequate cushion of 15% or more under its financial maintenance covenants. Under such a scenario, we would expect the company's comparable sales growth and EBITDA margin improvement to increase its EBITDA by 15% relative to our projections and also likely lead it to generate modestly positive FOCF.
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