California Pizza Kitchen 10-Q 2005
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FOR THE QUARTERLY PERIOD ENDED July 3, 2005
For the transition period from to
Commission file number 000-31149
California Pizza Kitchen, Inc.
(Exact name of registrant as specified in its charter)
6053 West Century Boulevard, 11th Floor
Los Angeles, California 90045-6438
(Address of principal executive offices, including zip code)
(Registrants telephone number, including area code)
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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES x NO ¨
As of August 9, 2005, 19,437,443 shares of the registrants Common Stock, $0.01 par value, were outstanding.
California Pizza Kitchen, Inc. and Subsidiaries
TABLE OF CONTENTS
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PART I FINANCIAL INFORMATION
Consolidated Balance Sheets
(in thousands, except for share data)
See accompanying notes
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Consolidated Statements of Income (unaudited)
(in thousands, except per share data)
See accompanying notes
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Consolidated Statements of Cash Flows (unaudited)
See accompanying notes
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Notes to Consolidated Financial Statements
July 3, 2005
1. Basis of Presentation
California Pizza Kitchen, Inc. (referred to herein as the Company) owns, operates, licenses or franchises 184 restaurants as of August 9, 2005 under the names California Pizza Kitchen, California Pizza Kitchen ASAP and LA Food Show.
The accompanying consolidated financial statements have been prepared by the Company in accordance with U.S. generally accepted accounting principles (GAAP) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying unaudited interim financial statements include all adjustments (consisting of normal recurring adjustments), which are necessary for a fair statement of the Companys consolidated financial condition, results of operations and cash flows for the periods presented. However, these results are not necessarily indicative of results for any other interim periods or for the full fiscal year. The consolidated balance sheet data presented herein for January 2, 2005 was derived from the Companys audited consolidated financial statements for the fiscal year then ended, but does not include all disclosures required by GAAP. The preparation of financial statements in accordance with GAAP requires the Company to make certain estimates and assumptions for the reporting periods covered by the financial statements. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses. Actual amounts could differ from these estimates.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted pursuant to the requirements of the Securities and Exchange Commission (SEC). The Company believes the disclosures included in the accompanying interim consolidated financial statements and footnotes are adequate to make the information not misleading, but should be read in conjunction with the consolidated financial statements and notes thereto included in the Companys filings with the SEC.
2. Restatement of Financial Statements
On February 7, 2005, the Office of the Chief Accountant of the SEC issued a letter to the American Institute of Certified Public Accountants (AICPA) expressing its views regarding certain lease related accounting issues and their application under GAAP. On March 18, 2005, management and the Audit Committee of the Board of Directors concluded that certain of the Companys historical methods of accounting for operating leases were not in accordance with GAAP, and the Company restated certain of its previously issued consolidated financial statements.
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The Company had historically recognized rent expense for operating leases using a lease term that commenced when actual rent payments began, and generally coincided with a point in time near the date the restaurants opened. As a result of the Companys review of the SECs guidance provided in the February 7, 2005 letter and Financial Accounting Standards Board (FASB) Technical Bulletin No. 85-3, Accounting for Operating Leases with Scheduled Rent Increases, the Company now recognizes rent over a lease term that includes the build-out period. In addition, the Company now capitalizes rent during the build-out period as a cost of constructing the related leasehold improvements. Rent from the date the premises are ready for their intended use through the restaurant opening date are included as rent expense in pre-opening expenses.
Further, in prior periods, consolidated balance sheets reflected the unamortized portion of tenant improvement allowances funded by landlords as a reduction of the related leasehold improvements. In keeping with the SECs February 7, 2005 letter and FASB Technical Bulletin No. 88-1, Issues Relating to Accounting for Leases, tenant improvement allowances are recognized as deferred rent credits and amortized over the lease term as a reduction of rent expense on the consolidated statements of income and as a component of operating activities on the consolidated statements of cash flows.
The Company restated the consolidated balance sheet at December 28, 2003, and the consolidated statements of income, stockholders equity and cash flows for the years ended December 28, 2003 and December 29, 2002 in its Annual Report on Form 10-K for the fiscal year ended January 2, 2005. In addition, the Company filed a Current Report on Form 8-K on April 28, 2005 disclosing the effects of the restatement on the consolidated statements of income for the 2003 and 2004 quarterly periods.
The following tables contain information regarding the impact of the restatement adjustments on the Companys consolidated statements of income and cash flows for the six months ended June 27, 2004. All amounts, except per share amounts, are in thousands.
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3. Common Stock
On January 15, 2005, employees purchased 25,451 shares of common stock from the Company under the Companys employee stock purchase plan. The net proceeds to the Company were $411,000. Additionally, employees exercised options to purchase 157,706 shares of common stock during the first six months ended July 3, 2005, which resulted in net proceeds to the Company of $2,893,000.
On January 15, 2004, employees purchased 27,364 shares of common stock from the Company under the Companys employee stock purchase plan. The net proceeds to the Company were $440,000. Additionally, employees exercised options to purchase 98,587 shares of common stock during the first six months ended June 27, 2004, which resulted in net proceeds to the Company of $1,435,000
On August 16, 2004, the Board of Directors authorized a stock repurchase program to acquire the Companys common stock from time to time in the open market and through privately negotiated transactions. Under the program, up to $20.0 million of the Companys common stock could be reacquired from time to time over a 24-month period. 68,938 shares were repurchased during the second quarter of 2005 for an aggregate purchase price of $1.6 million and an average purchase price per share of $22.88. No shares were repurchased during the first quarter of 2005. Since the program was authorized, a total of 139,046 shares have been repurchased for a total of $2.9 million and average purchase price of $21.02.
4. Long-term Debt and Credit Facilities
The Company has a $20.0 million revolving line of credit with Bank of America, N.A. The line of credit bears interest at either the bank base rate minus 0.75% or LIBOR plus 0.80% and expires on June 30, 2007. No amounts were outstanding as of July 3, 2005. Availability under the line of credit is reduced by outstanding letters of credit, which totaled $4.3 million as of July 3, 2005. The credit facility also includes financial and non-financial covenants, with which the Company was in compliance as of July 3, 2005.
5. Stock Option Plans
The Company grants stock options for a fixed number of shares to certain employees and directors with an exercise price equal to or greater than the fair value of the shares at the date of grant. The Company accounts for stock option grants using the intrinsic value method, and, accordingly, recognizes no compensation expense for the stock option grants.
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The following table represents the effect on net income and net income per common share if the Company had applied the fair-value based method and recognition provisions to stock-based employee compensation (in thousands, except net income per common share):
Stock-based compensation of $3.1 million of the proforma $4.8 million in expense for the first six months of 2005, relates to an aggregate of 600,000 options vesting pursuant to employment agreements entered into with the Companys co-founders, co-Chief Executive Officers (co-CEOs), co-Presidents, and co-Chairmen of the Board of Directors, Richard L. Rosenfield and Larry S. Flax.
The fair value of these options was estimated at the date of grant using a Black-Scholes option-pricing model with the following assumptions for the three and six months ended July 3, 2005 and June 27, 2004, respectively.
6. Net Income Per Common Share
Reconciliation of the components included in the computation of basic and diluted net income per common share in accordance with Statement of Financial Accounting Standard (SFAS)
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No. 128, Earnings Per Share, for the three months and six months ended July 3, 2005 and June 27, 2004 is as follows (in thousands):
7. Recent Acquisition
The Company previously owned a 25% interest in LA Food Show, Inc., a joint venture accounted for under the equity method. On April 25, 2005, the Company purchased the remaining 75% interest in LA Food Show, Inc., which was predominately owned by Larry S. Flax and Richard L. Rosenfield, the Companys co-founders, co-CEOs, co-Presidents and co-Chairmen of the Board. Of the $6 million purchase price, Messrs. Flax and Rosenfield received an aggregate of $5,938,840. The purchase price of LA Food Show, Inc. represents its fair market value as determined by a merger and acquisition and valuation advisory firm. This firm also provided a fairness opinion to the Companys Board of Directors and concluded that the purchase price was fair to the Companys stockholders from a financial point of view. The excess of the purchase price over the net assets acquired was recorded as goodwill and is included in Other Assets in the Consolidated Balance Sheet. As of the date of acquisition, 100% of the operating results were included in the Consolidated Statement of Income of the Company.
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8. Impact of Recent Accounting Pronouncements
In April 2005, the United States Securities and Exchange Commission (SEC) approved a new rule that delays the effective date of Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment. Except for this deferral of the effective date, the guidance in SFAS No. 123R is unchanged. Under the SECs rule, SFAS No. 123R is now effective for the Company for annual, rather than interim, periods that begin after June 15, 2005. The Company will apply this Statement to all awards granted on or after January 2, 2006 and to awards modified, repurchased, or cancelled after that date. The impact of the adoption of SFAS No. 123R cannot be predicted at this time, because it will depend on the levels of share-based payments granted in the future as well as outstanding options not vested as of January 2, 2006.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error CorrectionsA Replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.
In June 2005, the Financial Accounting Standards Boards (FASB) Emerging Issues Task Force reached a consensus on Issue No. 05-6, Determining the Amortization Period for Leasehold Improvements (EITF 05-6). The guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. The guidance is effective for periods beginning after June 29, 2005. As this is consistent with our current policy, the adoption of EITF 05-6 will not have an impact on our consolidated financial statements.
California Pizza Kitchen, Inc. (referred to hereafter as we and our) is a leading casual dining restaurant chain in the premium pizza segment. As of August 9, 2005, we own and operate 152 restaurants under the name California Pizza Kitchen, California Pizza Kitchen ASAP, or LA Food Show in 26 states and the District of Columbia. We also franchise our concepts and there are 32 restaurants which operate under franchise agreements and use the California Pizza Kitchen and California Pizza Kitchen ASAP brand names and trademarks. We opened our first restaurant in 1985 in Beverly Hills, California and during our 20 years of operating history, we have developed a recognized consumer brand and demonstrated the appeal of our concept in a wide variety of geographic areas. Our restaurants, which feature an exhibition-style kitchen centered around an open-flame oven, provide a distinctive casual dining experience, which is family friendly and has a broad consumer appeal.
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We manage our operations by restaurant and have aggregated our operations into one reportable segment. For analytical purposes we have broken this segment into six classes (as of July 3, 2005): 1) the Pre-2002 Class which consists of 94 full service restaurants; 2) the Class of 2002 which consists of 18 full service restaurants; 3) the Class of 2003 which consists of 20 full service restaurants; 4) the Class of 2004 which consists of four full service restaurants; 5) the Class of 2005 which consists of eight full service restaurants and 6) our company-owned ASAP locations and LA Food Show which consists of six restaurants.
We intend to open no fewer than 15 new full service restaurants by the end of 2005, eight of which were opened in the first six months of 2005. We will continue our development in existing markets and plan to enter one new market in 2005. We have signed lease agreements for all of our new full service restaurants planned for fiscal 2005. We intend to continue to develop new full service restaurants that range in size from 5,700 to 6,000 square feet. The majority of these new restaurants require, on average, a total cash investment by the Company of approximately $2.5 million. Approximately $500,000 of this average total investment is from tenant improvement allowances contributed by the landlord. In addition, pre-opening expenses are expected to range from approximately $230,000 to $240,000 per new full service restaurant.
Newly opened restaurants experience higher cost of sales, labor and direct operating and occupancy costs for approximately their first 90 to 120 days of operations in both percentage and dollar terms when compared with our mature restaurants. Accordingly, the volume and timing of newly opened restaurants has had, and is expected to continue to have, an impact on pre-opening expenses, cost of sales, labor and direct operating and occupancy costs until our restaurant operating base is large enough to mitigate these opening costs and inefficiencies.
Our revenues are comprised of restaurant sales and franchise royalties. Our restaurant sales are comprised almost entirely of food and beverage sales.
Cost of sales is comprised of food, beverage and paper supplies, labor, and direct operating and occupancy costs. Food, beverage and paper supply costs are variable and increase with sales volume. Labor costs include direct hourly and management wages, bonuses, taxes and benefits for restaurant employees. Direct operating and occupancy costs include restaurant supplies, marketing costs, fixed rent, percentage rent, common area maintenance charges, utilities, real estate taxes, repairs and maintenance and other related costs.
General and administrative costs include all corporate and administrative functions that support existing operations and provide infrastructure to facilitate our future growth. Components of this category include management, supervisory and staff salaries and related employee benefits, travel, information systems, training, corporate rent and professional and consulting fees. Depreciation and amortization principally includes depreciation on capital expenditures for restaurants. Pre-opening costs, which are expensed as incurred, consist of rent from the date the premises are ready for their intended use through the restaurant opening date, the costs of hiring and training the initial work force, travel costs, the cost of food used in training, marketing costs, the cost of the initial stocking of operating supplies and other direct costs related to the opening of a new restaurant.
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Our fiscal year consists of 52 or 53 weeks and ends on the Sunday closest to December 31 in each year. The three and six month periods ended July 3, 2005 and June 27, 2004 consist of 13 and 26 weeks, respectively. In calculating company-owned comparable restaurant sales, we include a restaurant in the comparable base once it has been open for 18 months.
Critical Accounting Policies
Managements Discussion and Analysis of Financial Condition and Results of Operations discusses our unaudited Consolidated Financial Statements, which have been prepared in accordance with GAAP. When we prepare these financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to investments, self-insurance, leasing activities, deferred tax assets, intangible assets and long-lived assets. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
For further information regarding the accounting policies that we believe to be critical accounting policies and that affect our more significant judgments and estimates used in preparing our consolidated financial statements, see our Form 10-K filed for fiscal year ended January 2, 2005.
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Results of Operations
Our operating results for the three and six months ended July 3, 2005 and June 27, 2004 (restated) are expressed as a percentage of revenues below, except for cost of sales which is expressed as a percentage of restaurant sales:
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As a result of recently experienced variations in performance among our restaurants opened in 2002 and 2003 when compared to our more mature restaurants, we now present supplemental operating data for our restaurants which have been grouped by class in an effort to better clarify unit level economics. Accordingly, supplemental information for full service restaurants opened (A) prior to 2002, (B) in 2002, (C) in 2003, (D) in 2004, (E) in 2005, and (F) ASAP and LA Food Show restaurants are presented in the table below:
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Three months ended July 3, 2005 compared to the three months ended June 27, 2004 (restated)
Total Revenues. Total revenues increased by $16.9 million, or 16.5%, to $119.4 million in the second quarter of 2005 from $102.5 million for the second quarter of 2004 due to a $16.6 million increase in restaurant sales and a $254,000 increase in franchise and other revenues. The increase in restaurant sales was due to a 8.6% increase in weekly sales averages for the Pre-2002 Class, $12.5 million and $11.6 million in sales derived from the Classes of 2002 and 2003, respectively, $2.8 million in sales derived from the four restaurants in the Class of 2004, $5.8 million in sales derived from the eight restaurants in the Class of 2005 and $2.5 million in sales derived from our total of six ASAP and LA Food Show restaurants. The 18-month comparable base restaurant sales increase was 8.6%. The 8.6% increase in 18-month comparable restaurant sales consisted of a 3.4% increase in customer counts, a 2.7% increase in pricing, and menu mix
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changes of 2.5%. The increase in franchise and other revenues was primarily due to increased ASAP franchise royalties and royalties from Kraft Frozen Pizza sales.
Food, beverage and paper supplies. Food, beverage and paper supplies increased by $4.7 million, or 18.8%, to $29.7 million for the second quarter of 2005 from $25.0 million for the second quarter of 2004. Food, beverage and paper supplies as a percentage of restaurant sales increased to 25.1% for the second quarter of 2005 from 24.6% in the comparable quarter for the prior year. This increase was primarily due to the opening of four new restaurants compared to no new restaurants in the second quarter of the prior year, the impact of the new point of sale (POS) implementation, the new menu rollout and increased paper usage due to increased takeout business.
Labor. Labor increased by $6.1 million, or 16.2%, to $43.7 million for the second quarter of 2005 from $37.6 million for the second quarter of 2004. Labor as a percentage of restaurant sales was 36.9% for the second quarters of 2005 and 2004. Increases in labor costs were primarily due to the expected inefficiencies of new store openings, higher wages and the POS implementation.
Direct operating and occupancy. Direct operating and occupancy increased by $2.7 million, or 13.4%, to $22.9 million for the second quarter of 2005 from $20.2 million for the second quarter of 2004. Direct operating and occupancy as a percentage of restaurant sales decreased to 19.3% for the second quarter of 2005 from 19.9% for the second quarter of 2004. The decrease was primarily due to the decrease of fixed expenses, such as base rent, as a percentage of restaurant sales.
General and administrative. General and administrative increased by $1.5 million, or 23.8%, to $7.8 million for the second quarter of 2005 from $6.3 million for the second quarter of 2004. General and administrative as a percentage of total revenues was 6.5% for the second quarter of 2005 and 6.2% for the second quarter of 2004. The increase in general and administrative expenses was primarily due to the increase in the number of management trainees and office expenses.
Depreciation and amortization. Depreciation and amortization increased by $900,000 or 16.1%, to $6.5 million for the second quarter of 2005 from $5.6 million for the second quarter of 2004. The increase was primarily due to the addition of 11 new full service restaurants, one ASAP and the acquisition of LA Food Show since the second quarter of 2004, in addition to six remodels and the new POS system.
Pre-opening. Pre-opening costs amounted to $946,000 for the second quarter of 2005 compared to no pre-opening costs for the second quarter of 2004 as no restaurants were opened during that prior period compared to three full service restaurants and one ASAP opened in the second quarter of 2005.
Interest income. Interest income increased by $79,000 to $200,000 for the second quarter of 2005 from $121,000 for the second quarter of 2004. The increase was a result of higher interest rates offset by lower cash and cash equivalents and marketable securities balances.
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Other income. Other income amounted to $1.1 million for the second quarter of 2005 as compared to no other income in the second quarter of 2004. This other income resulted from unredeemed gift certificates, that were previously recorded as liability, and whose likelihood of being redeemed was determined to be remote, being taken into income.
Income tax provision. The income tax provision for the second quarter of 2005 and 2004 was based on estimated annual effective tax rates. A rate of 32.0% was applied to the second quarter of 2005 and 31.7% to the second quarter of 2004. These rates comprise the federal and state statutory rates, less the effect of any tax credits.
Six months ended July 3, 2005 compared to the six months ended June 27, 2004 (restated)
Total Revenues. Total revenues increased by $28.6 million, or 14.2%, to $229.8 million in the first six months of 2005 from $201.2 million for the first six months of 2004 due to a $28.3 million increase in restaurant sales and a $277,000 increase in franchise and other revenues. The increase in restaurant sales was due to a 8.8% increase in weekly sales averages for the Pre-2002 Class, $24.6 million and $22.2 million in sales derived from the Classes of 2002 and 2003, respectively, $5.5 million in sales derived from the four restaurants in the Class of 2004, $8.6 million in sales derived from the eight restaurants in the Class of 2005 and $3.9 million in sales derived from our total of six ASAP and LA Food Show restaurants. The 18-month comparable base restaurant sales increase was 8.9%. The 8.9% increase in 18-month comparable restaurant sales consisted of a 3.2% increase in customer counts, a 4.0% increase in pricing, and menu mix changes of 1.7%. The increase in franchise and other revenues was primarily due to increased ASAP franchise sales.
Food, beverage and paper supplies. Food, beverage and paper supplies increased by $7.7 million, or 15.7%, to $56.7 million for the first six months of 2005 from $49.0 million for the first six months of 2004. Food, beverage and paper supplies as a percentage of restaurant sales increased to 24.9% for the first six months of 2005 from 24.6% in the comparable six months for the prior year. This increase was primarily due to the opening of nine new restaurants compared to acquiring two formerly franchised restaurants in the first six months of the prior year and the expected inefficiencies of new store openings, the new POS implementation, the new menu rollout and increased paper usage due to increased takeout business.
Labor. Labor increased by $10.8 million, or 14.6%, to $84.8 million for the first six months of 2005 from $74.0 million for the first six months of 2004. Labor as a percentage of restaurant sales increased to 37.2% for the first six months of 2005 from 37.1% for the first six months of 2004. The increase in labor as a percentage of restaurant sales was primarily due to the expected inefficiencies of new store openings, higher wages and the POS implementation.
Direct operating and occupancy. Direct operating and occupancy increased by $4.9 million, or 12.3%, to $44.9 million for the first six months of 2005 from $40.0 million for the first six months of 2004. Direct operating and occupancy as a percentage of restaurant sales decreased to 19.7% for the first six months of 2005 from 20.0% for the first six months of 2004. The decrease
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was primarily due to the decrease of fixed expenses, such as base rent, as a percentage of higher restaurant sales.
General and administrative. General and administrative increased by $2.2 million, or 16.8%, to $15.3 million for the first six months of 2005 from $13.1 million for the first six months of 2004. General and administrative as a percentage of total revenues was 6.6% for the first six months of 2005 and 6.5% for the first six months of 2004. The increase in general and administrative expenses was primarily due to increases in the number of management trainees and corporate office expenses.
Depreciation and amortization. Depreciation and amortization increased by $1.1 million, or 10.0%, to $12.1 million for the first six months of 2005 from $11.0 million for the first six months of 2004. The increase was primarily due to the addition of 11 new full services restaurants, one ASAP and the acquisition of LA Food Show since the second quarter of 2004, in addition to six remodels and the new POS system implementation.
Pre-opening. Pre-opening costs increased by approximately $1.9 million to $2.0 million for the first six months of 2005 from $64,000 for the first six months of 2004. The increase was a result of opening eight new full service restaurants and one ASAP in the first six months of 2005 compared to no new restaurant openings in the first six months of 2004.
Interest income. Interest income increased by $178,000 to $395,000 for the first six months of 2005 from $217,000 for the first six months of 2004. The increase was a result of higher interest rates offset by lower cash and marketable securities balances.
Income tax provision. The income tax provision for the first six months of 2005 and 2004 was based on estimated annual effective income tax rates. A rate of 31.9% was applied to the first six months of 2005 and 32.0% for the first six months of 2004. These rates comprise the federal and state statutory rates, less the effect of any tax credits.
Liquidity and capital resources
We have funded our capital requirements through cash flow from operations and proceeds from the initial public offering of our stock on August 2, 2000. For the first six months of 2005, net cash flows provided by operating activities was $19.1 million compared to $21.4 million for the first six months of 2004. Net cash flows provided by operating activities for the first six months of 2005 was lower than the first six months of 2004 primarily due to increases in prepaid expenses and other assets, accompanied by decreases in accrued liabilities and other liabilities.
Net cash used in investing activities for the first six months of 2005 was $31.8 million compared to $18.9 million for the first six months of 2004. Investing activities primarily consisted of capital expenditures relating to new restaurants, remodels, capitalized maintenance and other costs in addition to the acquisition of the remaining 75% of LA Food Show.
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We opened eight new prototype, full service restaurants in the first six months of 2005. The new restaurant prototype is larger than our former prototype. These new restaurants will require on average a higher net investment than our historical restaurants due to their increased size. However, we expect corresponding sales to be higher and to ultimately generate a higher restaurant cash flow. Pre-opening expenses for each of these new restaurants is expected to range from approximately $230,000 to $240,000; however, any unexpected delays in construction, labor shortages or other factors could result in higher than anticipated pre-opening costs.
Net proceeds from issuance of common stock was $3.3 million for the first six months of 2005 compared to $1.9 million for the first six months of 2004 and consisted of purchases under our employee stock purchase plan of $411,000 and $440,000, respectively, and common stock option exercises of $2.9 million and $1.4 million respectively. Additionally, in August 2004, the Board of Directors authorized a stock repurchase program to acquire the Companys common stock from time to time in open market purchases and through privately negotiated transactions. We repurchased no shares during the first quarter of 2005 and 68,938 shares during the second quarter of 2005 for an aggregate purchase price of $1.6 million and an average purchase price of $22.88. Since the program was authorized, a total of 139,046 shares have been repurchased for a total of $2.9 million and average purchase price of $21.02.
We have a $20.0 million revolving line of credit with Bank of America, N.A. The line of credit bears interest at either the bank base rate minus 0.75% or LIBOR plus 0.80% and expires on June 30, 2007. No amounts were outstanding as of July 3, 2005. Availability under the line of credit is reduced by outstanding letters of credit, which totaled $4.3 million as of July 3, 2005 and as of the end of second the quarter of 2004. The credit facility also includes financial and non-financial covenants, with which we were in compliance as of July 3, 2005.
Our capital requirements, including costs related to opening additional restaurants, have been and will continue to be significant. Our future cash requirements and the adequacy of available funds will depend on many factors, including the pace of expansion, real estate markets, site locations and the nature of the arrangements negotiated with landlords. We believe that our current cash balances, together with anticipated cash flows from operations and funds anticipated to be available from our credit facility, will be sufficient to satisfy our working capital and capital expenditure requirements on a short-term and long-term basis. Changes in our operating plans, acceleration of our expansion plans, lower than anticipated sales, increased expenses, non-compliance with our credit facility, financial and non-financial covenant requirements or other events may cause us to seek additional financing sooner than anticipated. Additional financing may not be available on acceptable terms, or at all. Failure to obtain additional financing as needed could have a material adverse effect on our business and results of operations.
As of July 3, 2005 we had no financing transactions, arrangements or other relationships with any unconsolidated entities or related parties, except as described below in Related Party Transactions. Additionally, we had no financing arrangements involving synthetic leases or trading activities involving commodity contracts.
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The following table summarizes our contractual commitments as of July 3, 2005 (in millions):
Related Party Transactions
On March 6, 2003 we paid $2.0 million for a 25.0% stake in LA Food Show, an upscale family casual dining restaurant created by our co-founders, co-Chairmen of the Board of Directors and co-CEOs, Larry S. Flax and Richard L. Rosenfield. We have accounted for this investment in accordance with the equity method of accounting as interpreted by APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. APB Opinion No. 18 requires an investor to record the initial investment at cost and adjust the carrying value of its investment to recognize the investors share of the earnings or loss after the date of acquisition. On April 25, 2005 we purchased the remaining 75% of LA Food Show for $6 million. LA Food Shows financial results are included in the Companys consolidated financial results. The interest we acquired in LA Food Show was predominantly owned by Messrs. Flax and Rosenfield. Of the $6 million purchase price, Messrs. Flax and Rosenfield received an aggregate of $5,938,840.
Effective September 29, 2003, we entered into an employee leasing arrangement with LA Food Show under which we provided LA Food Show with all of its restaurant level employees and managers, as well as administrative and support services such as payroll, marketing, human resources, facilities management, accounting, information technology and training. Prior to our acquisition of LA Food Show, it reimbursed us for all of the leased employees wages, benefits and other employee-related costs, as well as all business-related expenses incurred by the leased employees. This agreement was subsequently terminated upon our complete acquisition of LA Food Show on April 25, 2005.
One of our former directors, Mr. Caruso, also serves as President and is sole owner of CAH Restaurants of California, LLC (Mr. Caruso did not stand for re-election at the Companys May 26, 2005 stockholders meeting). We had entered into franchise and development agreements with CAH Restaurants of California, LLC pursuant to which it operated two California Pizza Kitchen restaurants. CAH Restaurants of California, LLC paid franchise and royalty fees to us under these agreements. On December 29, 2003 we acquired the territory rights and assets used to operate two restaurants from CAH Restaurants of California, LLC for $2.5 million. These California restaurants, one ASAP and one full service, are located in Thousand Oaks and
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Ventura, respectively. The transaction was executed with $1.2 million cash with the balance of the purchase price paid in common stock. CAH Restaurants of California, LLC assigned its right to receive these shares to Mr. Caruso. As part of the acquisition, we assumed the leases for the two restaurants, one of which is entered into with Westlake Promenade, LLC, an affiliate of Mr. Caruso.
For the first six months of 2005, we made aggregated lease payments of $106,000 and $288,000 to entities owned by Mr. Caruso, for two California restaurant locations, Thousand Oaks and Marina Del Rey, respectively. The payments for the Thousand Oaks location consisted of rent and common area maintenance charges of $105,000 and property tax of $1,000. The payments for the Marina Del Rey location consisted of rent and common area maintenance charges of $89,000 and percentage rent of $199,000. Westlake Promenade, LLC was the owner of record prior to our purchase of the Thousand Oaks restaurant on December 29, 2003 and another of Mr. Carusos affiliates purchased Marina Waterside shopping center, where our Marina Del Rey restaurant is located, on January 20, 2004.
Recent Accounting Pronouncements
Please refer to footnote eight in the Notes to Consolidated Financial Statements for a discussion of the impact of recent accounting pronouncements.
The primary inflationary factors affecting our operations are food and labor costs. A large number of our restaurant personnel are paid at rates based on the applicable minimum wage, and increases in the minimum wage directly affect our labor costs. Many of our leases require us to pay for taxes, maintenance, repairs, insurance and utilities, all of which are generally subject to inflationary increases. We believe inflation has not had a material impact on our results of operations in recent years.
Our growth strategy requires us to open new restaurants at a measured pace. We may not be able to achieve our planned expansion.
We are pursuing a disciplined growth strategy, which to be successful depends on our ability, and the ability of our franchisees to open new restaurants and to operate these new restaurants on a profitable basis. The success of our planned expansion will be dependent upon numerous factors, many of which are beyond our control including: the hiring, training and retention of qualified operating personnel, especially managers; identification and availability of suitable restaurant sites; competition for restaurant sites; negotiation of favorable lease terms; timely development of new restaurants, including the availability of construction materials and labor; management of construction and development costs of new restaurants; securing required
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governmental approvals and permits; competition in our markets; and general economic conditions.
Our success depends on our ability to locate a sufficient number of suitable new restaurant sites.
One of our biggest challenges in meeting our growth objectives will be to secure an adequate supply of suitable new restaurant sites. We have experienced delays in opening some of our restaurants and may experience delays in the future. There can be no assurance that we will be able to find sufficient suitable locations for our planned expansion in any future period. Delays or failures in opening new restaurants could materially adversely affect our business, financial condition, operating results or cash flows.
We could face labor shortages, which could slow our growth.
Our success depends, in part, upon our ability to attract, motivate and retain a sufficient number of qualified employees, including restaurant managers, kitchen staff and servers, necessary to keep pace with our expansion schedule. Qualified individuals of the requisite caliber and number needed to fill these positions are in short supply in some areas. Although we have not experienced any significant problems in recruiting or retaining employees, any future inability to recruit and retain sufficient individuals may delay the planned openings of new restaurants. Any such delays or any material increases in employee turnover rates in existing restaurants could have a material adverse effect on our business, financial condition, operating results or cash flows. Additionally, competition for qualified employees could require us to pay higher wages to attract a sufficient number of employees, which could result in higher labor costs.
Our expansion into new markets may present increased risks due to our unfamiliarity with the area.
As a part of our expansion strategy, we will be opening restaurants in markets in which we have no prior operating experience. These new markets may have different competitive conditions, consumer tastes and discretionary spending patterns than our restaurants in our existing markets.
In addition, our new restaurants will typically take several months to reach budgeted operating levels due to problems associated with new restaurants, including lack of market awareness, inability to hire sufficient staff and other factors. Although we have attempted to mitigate these factors by paying careful attention to training and staffing needs, there can be no assurance that we will be successful in operating new restaurants on a profitable basis.
Our expansion may strain our infrastructure, which could slow our restaurant development.
We also face the risk that our existing systems and procedures, restaurant management systems, financial controls, and information systems will be inadequate to support our planned expansion. We cannot predict whether we will be able to respond on a timely basis to all of the changing demands that our planned expansion will impose on management and these systems and controls. If we fail to continue to improve our information systems and financial controls or to manage
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other factors necessary for us to achieve our expansion objectives, our business, financial condition, operating results or cash flows could be materially adversely affected.
Our restaurant expansion strategy focuses primarily on further penetrating existing markets. This strategy can cause sales in some of our existing restaurants to decline.
In accordance with our expansion strategy, we intend to open new restaurants primarily in our existing markets. Since we typically draw customers from a relatively small radius around each of our restaurants, the sales performance and customer counts for restaurants near the area in which a new restaurant opens may decline due to cannibalization of the existing restaurants customer base.
Our operations are susceptible to changes in food and supply costs, which could adversely affect our margins.
Our profitability depends, in part, on our ability to anticipate and react to changes in food and supply costs. Our centralized purchasing staff negotiates prices for all of our ingredients and supplies through either contracts (terms of one month up to one year) or commodity pricing formulas. Our national master distributor delivers goods twice a week at a set, flat fee per case to all of our restaurants. Our contract with our national master distributor, Meadowbrook Meat Company, Inc. (MBM), is up for renewal in July 2007. Furthermore, various factors beyond our control, including adverse weather conditions and governmental regulations, could also cause our food and supply costs to increase. We cannot predict whether we will be able to anticipate and react to changing food and supply costs by adjusting our purchasing practices. A failure to do so could adversely affect our operating results or cash flows.
Changes in consumer preferences or discretionary consumer spending or negative publicity could adversely impact our results.
Our restaurants feature pizzas, pastas, salads and appetizers in an upscale, family-friendly, casual environment. Our continued success depends, in part, upon the popularity of these foods and this style of informal dining. Shifts in consumer preferences away from this cuisine or dining style could materially adversely affect our future profitability. Also, our success depends to a significant extent on numerous factors affecting discretionary consumer spending, including economic conditions, disposable consumer income and consumer confidence. Adverse changes in these factors could reduce customer traffic or impose practical limits on pricing, either of which could materially adversely affect our business, financial condition, operating results or cash flows. Like other restaurant chains, we can also be materially adversely affected by negative publicity concerning food quality, illness, injury, publication of government or industry findings concerning food products served by us, or other health concerns or operating issues stemming from one restaurant or a limited number of restaurants.
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Thirty-nine percent of our U.S. based restaurants are located in California. As a result, we are highly sensitive to negative occurrences in that state.
Together with our franchisees, we currently operate a total of 67 restaurants in California (62 are company-owned and five are owned by franchisees). As a result, we are particularly susceptible to adverse trends and economic conditions in California. In addition, given our geographic concentration, negative publicity regarding any of our restaurants in California could have a material adverse effect on our business and operations, as could other regional occurrences such as local strikes, earthquakes or other natural disasters.
Increases in the minimum wage may have a material adverse effect on our business and financial results.
A number of our employees are subject to various minimum wage requirements. The federal minimum wage has remained at $5.15 per hour since September 1, 1997. However, 39.0% of our U.S. based restaurants are located in California where employees receive compensation equal to the California minimum wage, which rose from $6.25 per hour effective January 1, 2001 to $6.75 per hour effective January 1, 2002. In addition, minimum wage has or is expected to increase in 2005 in three states in which we have a 15.0% market penetration: New York, Illinois and Florida. There may be similar increases implemented in other jurisdictions in which we operate or seek to operate. The possibility exists that the federal minimum wage will be increased in the near future. These minimum wage increases may have a material adverse effect on our business, financial condition, results of operations or cash flows.
Rising insurance costs could negatively impact profitability.
The rising cost of insurance (workers compensation insurance, general liability insurance, health insurance and directors and officers liability insurance) could have a negative impact on our profitability if we are not able to negate the effect of such increases by continuing to improve our operating efficiencies.
Compliance with changing regulation of corporate governance and public disclosure may result in additional expense.
Keeping abreast of, and in compliance with, changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules, has required an increased amount of management attention and external resources. We remain committed to maintaining high standards of corporate governance and public disclosure. As a result, we intend to invest all reasonably necessary resources to comply with evolving standards, and this investment may result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.
The restaurant industry is affected by litigation and publicity concerning food quality, health and other issues, which can cause customers to avoid our restaurants and result in liabilities.
We are sometimes the subject of complaints or litigation from customers or employees alleging illness, injury or other food quality, health or operational concerns. Adverse publicity resulting from these allegations may materially adversely affect our restaurants, regardless of whether the
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allegations are valid or whether California Pizza Kitchen is liable. In fact, we are subject to the same risks of adverse publicity resulting from these sorts of allegations even if the claim involves one of our franchisees. Further, employee claims against us based on, among other things, wage discrimination, harassment or wrongful termination may divert financial and management resources that would otherwise be used to benefit the future performance of our operations. We have been subject to these employee claims before, and a significant increase in the number of these claims or any increase in the number of successful claims could materially adversely affect our business, financial condition, operating results or cash flows. We also are subject to some states dram shop statutes. These statutes generally provide a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated person.
Future changes in financial accounting standards may cause adverse unexpected operating results and affect our reported results of operations.
A change in accounting standards can have a significant effect on our reported results and may affect our reporting of transactions before the change is effective. As an example, any changes requiring that we record compensation expense in our consolidated statements of income for employee stock options using the fair value method could have a significant negative effect on our reported results. New pronouncements and varying interpretations of pronouncements have occurred and may occur in the future. Changes to existing accounting rules or the questioning of current accounting practices may adversely affect our reported financial results.
Our market risk exposures are related to our cash and cash equivalents and marketable securities. Cash and cash equivalents are invested in highly liquid short-term investments with maturities of less than three months as of the date of purchase. We are exposed to market risk from changes in market prices related to our investments in marketable securities. As of July 3, 2005 we held $17.4 million in marketable securities. Changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flows and results of operations.
We have a $20.0 million revolving line of credit with Bank of America, N.A. The line of credit bears interest at either the bank base rate minus 0.75% or LIBOR plus 0.80% and expires on June 30, 2007. No amounts were outstanding as of July 3, 2005. Availability under the line of credit is reduced by outstanding letters of credit, which totaled $4.3 million as of July 3, 2005. The credit facility also includes financial and non-financial covenants, with which we were in compliance as of July 3, 2005. Should we draw on this line of credit in the future, changes in interest rates would affect the interest expense on these loans and, therefore, impact our prospective cash flows and results of operations.
Many of the food products purchased by us are affected by changes in weather, production, availability, seasonality and other factors outside our control. In an effort to control some of this risk, we have entered into some fixed price purchase commitments with terms of no more than
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one year. In addition, we believe that almost all of our food and supplies are available from several sources, which helps to control food commodity risks.
Disclosure Controls and Procedures We conducted an evaluation, under the supervision and with the participation of our management, including our co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the design and operations of our disclosure controls and procedures, as defined in rules 13a-15 and 15d-15 promulgated under the Exchange Act. Based upon that evaluation, our Companys co-Chief Executive Officers and Chief Financial Officer concluded that our disclosure controls and procedures are effective, as of the end of the period covered by this report, in ensuring that material information relating to California Pizza Kitchen, Inc., including its consolidated subsidiaries, required to be disclosed in reports we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms, and (ii) is accumulated and communicated to our management, including our co-Chief Executive Officers and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Change in Internal Control Over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). We began implementation of a new point-of-sale system in the first quarter of 2005 and completed the implementation in the second quarter of 2005 for all company-owned restaurants. The point-of-sale (POS) system primarily records and reports restaurant sales transactions and provides time and attendance information to manage hourly labor. Other than the implementation of our new POS system, there have been no significant changes in our internal controls or in other factors that could significantly affect these controls during the first and second quarters of 2005.
PART II OTHER INFORMATION
On February 10, 2003, one of our former servers filed a class action complaint against us in Orange County Superior Court in California. The plaintiff alleges that we failed to give our food servers, bussers, runners, bartenders, and other non-exempt California Restaurant employees at CPK the rest and meal breaks required by California law. Under the Wage Orders, which are administrative regulations promulgated by the California Industrial Welfare Commission and have the force and effect of law, and the California Labor Code, an employer must pay each employee one additional hour of pay at the employees regular rate of compensation for each workday that the required meal or rest period is not provided. The plaintiff also alleges that additional penalties are owed as a consequence of our resulting failure to pay all wages due at the time of termination of employment and under theories characterizing these alleged breaches as
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unfair business practices. If the plaintiff were able to achieve class certification and prevail on the merits of the case, we could potentially be liable for significant amounts. We believe that all of our employees were provided with the opportunity to take all required meal and rest breaks. We have participated in formal mediation and have exchanged information on an informal basis and engaged in numerous meetings and telephone conferences with opposing counsel in furtherance of settlement. In order to avoid the uncertainty of litigation, to avoid further disruption in the work-place and to curtail legal expenses, we agreed to a settlement that received preliminary approval from the Court on June 29, 2005. The settlement contains a maximum pay-out of $1.3 million to all non-exempt employees who worked in any of our restaurants located in California between October 1, 2000 and December 1, 2004. $1.3 million in litigation reserve is included in our balance sheet, based on an estimate of the maximum costs which may be incurred in connection with this case. Class Notices were sent out to class members on or about July 15, 2005. After class administration, there will be a final Fairness Hearing before the Court on September 16, 2005. Following an Order of Final Approval from the Court, the agreed upon sums will be paid out, and the case will be considered fully and finally settled.
We are also subject to other private lawsuits, administrative proceedings and claims that arise in the ordinary course of our business. Such claims typically involve claims from guests, employees and others related to operational issues common to the food service industry. A number of such claims may exist at any given time. We could be affected by adverse publicity resulting from such allegations, regardless of whether such allegations are valid or whether we are determined to be liable. From time to time, we are also involved in lawsuits with respect to infringements of, or challenges to, our registered trademarks. We believe that the final disposition of such lawsuits and claims will not have a material adverse effect on our financial position, results of operations or liquidity.
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The following table provides information with respect to Company purchases made of California Pizza Kitchen, Inc. common stock during the second quarter of 2005:
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Under our credit facility with Bank of America, N.A., we may pay cash dividends, make other distributions, and repurchase shares of our common stock so long as, after giving effect to the dividend, distribution or repurchase, we maintain liquid assets (including for this purpose the unused and available amount of the commitment under the credit facility), in a minimum amount of $10.0 million.
On May 26, 2005, we held our Annual Meeting of Stockholders. The matters submitted for vote and related election results were as follows:
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Pursuant to the requirements 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.
Dated: August 12, 2005
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INDEX TO EXHIBITS
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