The CPK Bankruptcy and Restaurant Reality

The devastation of the restaurant industry ($165 billion in lost sales between March and July, according to The National Restaurant Association) at the hands of COVID-19 hardly warrants a mention these days. More than six months after the onset of the pandemic, to even the most casual industry watcher, the life and death struggle facing all but the best-capitalized restaurant companies has, like COVID-19 itself, simply become an unfortunate reality with which we must now simply live. And the prognosis isn’t getting a whole lot better.

As we’ve noted previously, the hardest-hit segment of the market is the independent eatery. It’s estimated that as many as 85% of such establishments may be forced to permanently shutter, with just over a third of independent operators confident in survival beyond the end of October.

Not far behind are businesses in the casual dining space. In recent months, we’ve seen several household names, in the absence of a cash infusion or a buyer, seek bankruptcy protection. Those forced into this difficult decision include NPC International (a large Pizza Hut/Wendy’s franchisee), Chuck E. Cheese, FoodFirst Global, Le Pain Quotidien (US), CraftWorks Holdings, SD Holdings (a large Sonic franchisee), Houlihan’s, Bar Louie and Matchbox Food Group. We thought it might be instructive to examine the road traveled by another such company.

On July 30, California Pizza Kitchen (CPK), its business hamstrung by forced closures, capacity and indoor dining restrictions, and ongoing consumer skittishness, under the weight of massive debt and a dwindling stockpile of cash, declared Chapter 11 (reorganization) bankruptcy. Acquired in July 2011 by private equity firm Golden Gate Capital and the company’s management team, CPK operates more than 200 ”California cuisine”-inspired Italian restaurants in 32 U.S. states and ten international markets.

Like many restaurant companies, CPK was on a knife’s edge before COVID conjured a perfect storm. According to CEO Jim Hyatt, the company was suffering from a number of broad industry and societal trends: the increased popularity of “fast-casual” eateries, increased customer demand for takeout/takeaway (as opposed to dine-in, which accounts for 80% of sales) and the “Amazon/Netflix effect.” According to the filing, the company has faced a “liquidity crunch” for about two years. As a result, by pre-pandemic 2019, CPK had secured a $30 million cash infusion, which, according to Hyatt, was meant to serve as a “bridge to negotiate a comprehensive restructuring”, and was seeking a buyer. It would thus be disingenuous to lay all of the blame for CPK’s hardship at COVID’s door. The company’s flirtation with disaster had long since begun.

On the other hand, while COVID, essentially, only expedited the inevitable, it did so more blindingly and devastatingly than anyone could have imagined. Despite something of a rebound from the utter desolation of April, May, and early-June, year-over-year sales were still down some 40% in the last week of June. By the end of July, CPK faced default notices and lawsuits from landlords, stemming from four months of unpaid rent for “the majority of its locations.” The company’s debt burden had ballooned to more than $400 million and, despite paying neither rent nor interest on loans, CPK suffered a cash outflow of $18.9 million between March and June, and ended July with just $13.5 million in cash on hand.

At the time of the filing, CPK said that it had closed an unspecified number of unprofitable locations and was seeking to reject 59 of 180+ U.S. leases (with evaluations of others ongoing), but with no intention of closing additional locations. As part of the reorganization, the company secured a commitment from some lenders for $47 million of new financing in order to continue operating through the bankruptcy process. Additionally – and most vitally – the agreement saw the company “equitize the vast majority of long-term debt”, meaning that a significant portion of the company’s debt  (in this case $230 million) was converted into equity, held by its creditors. According to CEO Hyatt, the “proactive filing will allow [CPK] to reduce long-term debt” and “emerge as a much stronger company” on an “expedited timeline.” It is anticipated that the company will spend less than three months in Chapter 11.

Some commercial landlords – recognizing an environment in which tenants are not easily replaced – have tried to work on rent abatements, deferrals, or deals in which base rent is cut, and a percentage of sales is paid instead. However, in the absence of direct government aid – or a massive, unforeseen rebound in restaurant traffic – there’s only so much to be done. These landlords have their own bills and creditors with which to contend. In response, tenants that are committed to keeping their doors open will increasingly look to ease their financial burden. Many will find bankruptcy, and the ability to: reject leases in bulk (as CPK has) and; convert liabilities into equity, as their best recourse.

Restaurant sales have rebounded somewhat in the post-lockdown summer months. However, this rebound – driven overwhelmingly by outdoor/patio dining – is on borrowed time, as much of the country prepares for colder and more inclement weather, while typically balmier portions of the wildfire-stricken western U.S. deal with drastically reduced air quality. Combined with the gradual depletion of funds dedicated to government assistance, and the inability of lawmakers to agree upon a new stimulus package, industry experts anticipate that another wave of restaurant bankruptcies may soon be upon us.

Just over six weeks on from its bankruptcy filing, CPK is providing us a clearer picture of not only the form in which it will emerge from Chapter 11 but the route that their industry counterparts may also seek to take.

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