UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

Commission File No. 000-50052

Cosi, Inc.

(Exact name of registrant as specified in its charter)

 

 

1751 Lake Cook Road, Suite 600, Deerfield, Illinois 60015
(Address and Zip Code of Principal Executive Offices)

 

(847) 597-8800
(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by a check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of Exchange Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such a shorter period that the registrant was required to submit and post such files.)  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  Yes o     No þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $24,151,684 as of June 30, 2009 based upon the closing price of the registrant’s common stock on the Nasdaq Global Market reported for June 30, 2009. Shares of voting stock held by each executive officer and director and by each person who, as of such date, may be deemed to have beneficially owned more than 5% of the outstanding voting stock have been excluded. This determination of affiliate status is not necessarily a conclusive determination of affiliate status for any other purpose.

 

51,316,105 shares of the registrant’s common stock were outstanding on March 23, 2010.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III of this Form 10-K incorporates certain information from the Registrant’s definitive proxy statement for its Annual Meeting of Stockholders expected to be held on May 18, 2010. The definitive proxy statement will be filed by the Registrant with the Securities and Exchange Commission no later than 120 days from the end of the Registrant’s fiscal year ended December 28, 2009.

 

 

TABLE OF CONTENTS

 

 

 

General

 

Cosi, Inc., a Delaware corporation incorporated on May 15, 1998, owns, operates and franchises premium convenience restaurants which sell high-quality hot and cold sandwiches, freshly-tossed salads, Cosi bagels, flatbread pizzas, S’mores and other desserts, and a variety of coffees along with other soft drink beverages, teas and alcoholic beverages, mostly beer and wine. Our restaurants are located in a wide range of markets and trade areas, including business districts and residential communities in both urban and suburban locations. We believe that we have created significant brand equity in our markets and that we have demonstrated the appeal of our concept to a wide variety of customers.

 

As of December 28, 2009, there were 145 Cosi^® owned and franchised restaurants operating in 18 states, the District of Columbia, and the United Arab Emirates (UAE).

 

Our internet website is www.getcosi.com. We make available free-of-charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission (“SEC”). In addition, our internet website includes, among other things, our corporate governance principles, charters of various committees of the Board of Directors, and our code of business conduct and ethics applicable to all employees, officers and directors. Copies of these documents may be obtained free of charge from our internet website. Any stockholder also may obtain copies of these documents, free of charge, by sending a request in writing to: Cosi, Inc., c/o Investor Relations, 1751 Lake Cook Road, Suite 600, Deerfield, Illinois 60015.

 

Business Strategy

 

Our goal is to become the preferred fast-casual dining concept nationally. We strive to serve delicious food that is always surprising, with unparalleled customer service, in a unique, welcoming and sophisticated ambiance. The Cosi restaurant concept, whose name was inspired by Mozart’s famous opera, Così Fan Tutte, originated in Paris as a Parisian café. We strive to create a romance between our famous, made-fresh bread, our barista-crafted coffees and specialty drinks, and our loyal guests.

 

We believe that our customers are primarily adults aged 18 to 40, upscale suburbanites and metro elites of all ages. Our market studies show that there are approximately 40 million heads of households in this demographic mix. Our strategy is to make Cosi the restaurant of choice for those who insist that...LIFE SHOULD BE DELICIOUS.

 

We plan to become the preferred national fast casual restaurant by:

 

Offering an innovative menu appealing to the sophisticated tastes of our target customer.  Our restaurants offer innovative savory, freshly made-to-order products featuring our authentic hearth-baked signature Cosi bread and distinctive high quality, fresh ingredients. We maintain a pipeline of new menu offerings that are introduced seasonally through limited time offerings to keep our products relevant to our target customers.

 

Providing customers with an exceptional service and dining experience.  Our restaurants are designed to provide a memorable dining experience in a warm, welcoming environment offering free internet access through a managed Wi-Fi network.

 

We believe our partners are proud to be part of an organization that stands for quality, innovation and distinctive flair. We are passionate about serving excellent food in an atmosphere that is comfortable and inviting. We seek to train our partners to provide the highest level of friendly customer service. We believe that we provide an “affordable luxury” that our customers can enjoy everyday.

 

Expanding marketing initiatives to build brand awareness.  Our marketing strategy is to focus our marketing efforts on building brand awareness and increasing the frequency of visits. We do this through the

development of a marketing calendar that focuses on five time periods (Winter, Spring, Summer, Fall, and Holiday), improved merchandising to better influence the purchasing behavior of our guests and reduced ordering complexity. Our marketing strategies include our CosiCard loyalty program, food focused out-of-restaurant advertising, print advertising, targeted direct-mail, and our recently deployed web-based social media marketing campaigns. We want our message to energize our guests by all that there is to taste, see, and do. We aim to attract guests who seek to enjoy life’s full flavor.

 

Increasing comparable restaurant sales and average unit volumes.  We seek to increase comparable restaurant sales and average unit volumes by increasing top-of-mind awareness of the Cosi brand through the introduction of new menu items, expansion of our catering sales opportunities, increasing sales across all dayparts and the promotion of seasonal product offerings.

 

Operating our restaurants efficiently.  We have developed operating disciplines that are designed to optimize the cost structure of our restaurants and to be applied consistently across all our restaurants, Company-owned and franchise, and we continually seek to refine and improve upon those disciplines both domestically and internationally.

 

Growth Strategy

 

We plan to grow in both existing and new markets through the following:

 

Build a system of franchised restaurants and develop Company-owned restaurants.  We expect that Company-owned restaurants (restaurants that we own as opposed to franchised restaurants) will always be an important part of our new restaurant growth; however, our franchising and area developer model will be the primary driver of our growth strategy. We will continue to pursue Company-owned development to achieve critical mass in our core markets while focusing on expanding our franchise system nationally. We launched our franchising program in fiscal 2004 and seek to expand our franchise system through an influx of new domestic and international franchisees. As part of our strategy to expand our franchise base and attract quality franchisees, we will consider the potential sale of a restaurant or a group of restaurants to fuel the overall growth of the system. We prefer that our franchisees have experience in multi-unit restaurant operations and development. We believe that our concept positioning, national and international growth opportunity and potential for strong unit-level economics will enable us to attract experienced and well-capitalized area developers. We are currently eligible to offer franchises in 47 states and the District of Columbia.

 

Pursue foodservice strategic alliances.  We will explore strategic alliances with our Cosi Pronto (our grab-and-go concept) and full service concepts in educational institutions, airports, train stations and other venues that meet our operating and financial criteria. We believe that this is an attractive opportunity to further Cosi’s growth through alternative venues. We currently operate Cosi restaurants at St. Joseph’s University in Philadelphia, PA and Georgetown University in Washington, DC under a franchisee agreement with Aramark. We also operate our grab-and-go concept at New York’s LaGuardia and Boston’s Logan airports through franchisee agreements.

 

Cosi Product Offerings

 

We offer proprietary food and beverage products for four major dayparts — breakfast, lunch, snacking and dinner. Our food menu includes Cosi Squagels, sandwiches, salads, soups, appetizers, melts, flatbread pizzas, S’mores and other desserts. We feature our authentic hearth-baked signature Cosi bread in two varieties, our original Rustica and our Etruscan Whole Grain. Our beverage menu features a variety of house coffees and other espresso-based beverages, seasonal fruit smoothies and specialty drinks, soft drinks, flavored teas and bottled beverages, which include premium still and sparkling waters. For our health-conscious guests, we have a “lighter side” menu featuring lower-calorie versions of popular menu items and other unique salads and sandwiches that are lower in calorie content than other items in the same menu categories. We offer beer and wine at most of our locations and an additional limited selection of alcoholic beverages in some locations. For our young guests, we offer our Parent Magazine award winning Kids Menu which includes an activity page and crayons.

Most of our restaurants offer catering service for the breakfast and lunch dayparts. Our catering offerings include breakfast baskets, lunch buffets, dessert platters, and include most of our menu offerings. We operate a catering call center in New York City which coordinates the ordering and fulfillment process for 16 catering hub locations in four major metropolitan areas. We offer set up and delivery by Cosi personnel to all our catering customers.

 

We periodically introduce new menu platforms and products in order to keep our product offerings relevant to consumers in each daypart. Our expanded breakfast menu now includes hearth-baked quiches, oatmeal, fresh fruit parfaits and a variety of craveable signature breakfast wraps and sandwiches. We enhanced our guest’s dining options by introducing “Cosi Duo” to the menu which allows them to create their own meal by combining two items of proportion from our offerings of unique sandwiches, fresh salads and soups. New recipes are developed by our Executive Chef with the support of the food and beverage team. These recipes are thoroughly evaluated, both internally and through beta testing in consumer markets.

 

People

 

On December 28, 2009, we had 99 Company-owned restaurants and 2,409 employees, of whom 76 served in administrative or executive capacities, 264 served as restaurant management employees and 2,069 were hourly restaurant employees. None of our employees are covered by a collective bargaining agreement and we have never experienced an organized work stoppage or strike. We believe that our compensation packages are competitive and our relations with our employees are good.

 

Restaurant Operations

 

Management Structure.  The restaurant operations team is built around regional districts led by District Managers, who report to a Vice President of Operations. The Vice President of Operations and District Managers are responsible for all operations, training, recruiting and human resources within their regions. The Vice President of Operations is also responsible for the financial plan for all Company-owned locations and for the people development plan to support the execution of our plans. The Vice President of Operations reports directly to the Chief Executive Officer. Supporting the field operations teams is a Vice President of Operations Services and Platforms who is responsible for developing and implementing operating standards and best practices across the system for the benefit of the entire brand. The Vice President of Operations Services and Platforms reports to the Chief Executive Officer.

 

During fiscal 2008 we introduced an Operations Excellence Framework that provides two new business assessment tools, Operations Excellence Basics (“OEB”) and Operations Excellence Review (“OER”) that our field management teams use for evaluating our guest services, facility maintenance, unit-level financial performance, partner assessments and product quality and assurance. These assessment tools provide the framework and process for identification of areas of opportunity as well as the development of actionable plans to improve operations. During fiscal 2009, we added an action plan component to the OER that allows the field operations teams to assess performance and, additionally, to address the opportunities with a specific action plan to drive desired results. During fiscal 2010 we expect to measure the improvements in key restaurant metrics in relation to the completion of these action plans. The OEB continues to be an important tool that allows our District Managers to perform an evaluation of our 10 most critical operations and administrative standards during every visit.

 

To ensure consistent performance execution and application of our policies and procedures, we have a Standard Operations Manual which is reviewed and updated periodically.

 

Sales Forecasting.  The Vice President of Operations and District Managers have real-time access to sales forecasts and actual sales information through our web-based reporting system. This allows the entire management team to plan staffing requirements on a weekly, daily and even hourly basis to effectively serve our customers.

 

Product Quality.  Our food and beverage quality is managed at four critical stages: sourcing, distribution, line readiness and product preparation. Products are delivered to the restaurants several times each week so that all restaurants maintain fresh quality products. Because our restaurants serve a different variety of products during different dayparts, a specific line readiness checklist is completed to ensure that the products have been rotated,

prepared and staged correctly. Finally, our partner training program includes certification in both product knowledge and product preparation standards.

 

Food and Labor Cost Controls.  Our information system allows us to track actual versus theoretical cost of goods sold. Detailed reports are available at the restaurant level showing variances on an item-by-item basis. The system is interfaced into our accounts payable and general ledger systems so that restaurant managers have control of their operations and can be held accountable for their results.

 

Our labor management standards help our managers control labor and ensure that staffing levels are appropriate to meet our service standards. Our reporting system provides our multi-unit managers with performance reports that help them make staffing adjustments during the course of the week. All labor scheduling is approved by a District Manager and unit level performance is reviewed weekly.

 

For manager and support controllable costs, we use either a fixed dollar budget standard or a percentage of net sales approach to plan expenditures effectively. Actual performance for each of these expense items is compared to budget on a weekly basis to help ensure accountability and operational alignment with financial planning efforts. We believe that the combination of these structured restaurant operating systems and technologies allows our restaurant managers to focus their time more effectively on the day-to-day drivers of our business.

 

Management Information Systems

 

Our systems are structured for the integration of data from the point-of-sale and back-office modules in the restaurants to our financial, reporting and inventory management systems. Key information relating to restaurant operations is uploaded onto a secure website multiple times throughout the day. This operational restaurant information is available to key internal customers, along with pre-selected reports that are automatically distributed to our operations team.

 

We use a select group of service providers to supplement our information technology infrastructure and system offerings. This provides us access to up-to-date technology and allows us the flexibility to adjust service levels and cost as needed. Our application strategy includes utilizing web-based technology to provide timely information to operate and manage the business.

 

We have a disaster recovery plan in place for all critical hardware, software, data and related processes. The plan encompasses scheduled back-ups, off-site storage, security, and failover configurations with redundancy built into key processes.

 

Purchasing

 

We have agreements with some of the nation’s largest food, paper, and beverage manufacturers in the industry. This enables us to provide our restaurants with high quality proprietary food products and non-food items at competitive prices. We source and negotiate prices directly with these suppliers and distribute these products to our restaurants primarily through a national network that consists of some of the nation’s largest independent distributors. We do not utilize a commissary system. Our inventory control system allows each restaurant to place orders electronically with our master distributor and then transmits the invoices electronically to our accounts payable system. Our scalable system eliminates duplicate work, and we believe it gives our management tight control of costs while ensuring quality and consistency across all restaurants.

 

We have an agreement with Distribution Market Advantage, Inc. (“Distribution Marketing Advantage”) that provides us access to a national network of independent distributors. Under this agreement the independent distributors supply us with approximately 78% of our food and paper products, primarily under pricing agreements that we negotiate directly with the suppliers. This agreement expires in November 2010 and we have issued a request for proposal to Distribution Marketing Advantage and other distribution organizations. We expect to complete the review and evaluation of proposals during the second quarter of fiscal 2010.

 

We have a long-term beverage marketing agreement with the Coca-Cola Company. We received a marketing allowance under this agreement, which is being recognized as a reduction to expense ratably based on actual

products purchased. Although we are eligible to receive additional amounts under the agreement if certain purchase levels are achieved, no additional amounts have been received or recorded as of December 28, 2009.

 

We purchase all contracted coffee products through a single supplier, Coffee Bean International, Inc. (“Coffee Bean International”). In the event of a business interruption, Coffee Bean International is required to utilize the services of a third-party roaster to fulfill its obligations. If the services of a third-party roaster are used, Coffee Bean International will guarantee that the product fulfillment standards stated in our contract will remain in effect throughout such business interruption period. This agreement expires in June 2010 and we have issued a request for a proposal to Coffee Bean International and other coffee suppliers. We will conclude the review and evaluation of proposals prior to the expiration of the current contract.

 

Our primary suppliers and independent distributors have parallel facilities and systems to minimize the risk of any disruption of our supply chain.

 

Competition

 

The restaurant industry is intensely competitive and we compete with many well-established food service companies, including other sandwich retailers, specialty coffee retailers, bagel shops, fast food restaurants, delicatessens, cafes, bars, take-out food service companies, supermarkets and convenience stores. The principal factors on which we compete are taste, quality and price of products offered, customer service, atmosphere, location and overall guest experience. Our competitors change with each daypart, ranging from coffee bars and bakery cafes in the morning daypart, to fast food restaurants and cafes during the lunch daypart, to casual dining chains during the dinner daypart. Many of our competitors or potential competitors have substantially greater financial and other resources than we do which may allow them to react more quickly to changes in pricing, marketing and the quick-service restaurant industry. We also compete with other employers in our markets for hourly workers and may be subject to higher labor costs. We believe that our concept, attractive price-value relationship and quality of products and service allow us to compete favorably with our competitors.

 

Intellectual Property

 

We have the following U.S. Trademark registrations: “COSÌ”, “(SUN & MOON DESIGN)”, “COSÌ (& HEARTH DESIGN)”, “(HEARTH DESIGN)”, “COSÌ BREAK BAR”, “COSÌ CARD”, “COSÌ CORNERS”, “COSÌ-DILLAS”, “COSÌ DOWNTOWN”, “COSÌ PRONTO”, “HEARTH-BAKED DINNERS”, “RELAX. CATERING BY COSÌ (& DESIGN)”, “SIMPLY GOOD TASTE”, “SQUAGELS”, “GET COSI”, AND “XANDO”.

 

We have U.S. Trademark applications pending for the following trademarks: “GET COSÌ”, “COSÌ (& Sun & Moon Design)”, “LIFE SHOULD BE DELICIOUS”, “(SUN & MOON SMILEY FACE DESIGN)”.

 

“COSÌ SANDWICH BAR”, “ARCTIC”, “SLIM LATTE”, “COSÌ LIGHTER SIDE”, “COSÌ DUO TASTE TWO”, and ‘‘(RECYCLING DESIGN)” are unregistered trademarks.

 

We have registered the trademark “COSÌ” in 18 foreign jurisdictions with respect to restaurant services. We also have the following registered trademarks in one foreign jurisdiction with respect to restaurant services: “COSI (& HEARTH DESIGN)”, “(HEARTH DESIGN)”, and “SIMPLY GOOD TASTE”. We have the following registered trademarks in three foreign jurisdictions with respect to restaurant services: “(HEARTH DESIGN)”.

 

We have trademark applications pending for registration of the following trademarks with respect to restaurant services: “COSÌ” in the European Community and three other foreign jurisdictions; “COSÌ (& HEARTH DESIGN)” in two foreign jurisdictions; “(SUN & MOON DESIGN)” in one foreign jurisdiction; “SIMPLY GOOD TASTE” in one foreign jurisdiction; “LIFE SHOULD BE DELICIOUS” in one foreign jurisdiction; and “(HEARTH DESIGN)” in five foreign jurisdictions.

 

Governmental Regulation

 

Our restaurants are subject to regulation by federal agencies and to licensing and regulation by state, local and, where applicable, foreign health, sanitation, building, zoning, safety, fire and other departments relating to the

development and operation of restaurants. These regulations include matters relating to environmental, building, construction and zoning requirements, franchising and the preparation and sale of food and alcoholic beverages. In addition, our facilities are licensed and subject to regulation under state and local fire, health and safety codes.

 

Our restaurants that sell alcoholic beverages are required to obtain a license from a state authority and, in certain locations, county and/or municipal authorities. Typically, licenses must be renewed annually and may be revoked or suspended for cause at any time. Alcoholic beverage control regulations relate to numerous aspects of the daily operations of each of our restaurants, including minimum age of patrons and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, and storage and dispensing of alcoholic beverages. We have not encountered any material problems relating to alcoholic beverage licenses to date. The failure to receive or retain a liquor license in a particular location could adversely affect that restaurant and may impact our ability to obtain such a license elsewhere.

 

We are subject to “dram shop” statutes in the states in which our restaurants sell alcoholic beverages. 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 individual. We carry liquor liability coverage as part of our existing comprehensive general liability insurance, which we believe is consistent with coverage carried by other similarly-situated entities in the restaurant industry. Although we are covered by insurance, a judgment against us under a dram-shop statute in excess of our liability coverage could have a material adverse effect on us.

 

Our operations are also subject to federal and state laws governing such matters as wages, working conditions, citizenship requirements, overtime, insurance matters, workers’ compensation, child labor laws, and anti-discrimination laws. Some states have set minimum wage requirements higher than the federal level. Some of our hourly personnel at our restaurants are paid at rates based on the applicable minimum wage, and increases in the minimum wage will directly affect our labor costs. We are also subject to the Americans with Disabilities Act of 1990, which, among other things, prohibits discrimination on the basis of disability in public accommodations and employment. We are required to comply with the Americans with Disabilities Act and regulations relating to accommodating the needs of the disabled in connection with the construction of new facilities and with significant renovations of existing facilities.

 

In recent years, there has been an increased legislative, regulatory and consumer focus at the federal, state and municipal levels on the food industry, including nutrition, labelling and advertising practices. Casual dining chains have been a particular focus. For example, New York City has adopted regulations requiring that chain restaurants include caloric or other nutritional information on their menu boards and on printed menus, which must be plainly visible to consumers at the point of ordering. We may in the future become subject to other initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of our food, which could increase our expenses, particularly given differences among applicable legal requirements and practices within the restaurant industry with respect to testing and disclosure, or otherwise adversely affect us.

 

 

Risks Related to Our Growth Strategy

 

We may not be able to achieve our planned expansion. If we or our franchisees are unable to successfully open new restaurants, our revenue growth rate and profits may be reduced.

 

To successfully expand our business, we and our franchisees must open new restaurants on schedule and in a profitable manner. In the past, we have experienced delays in restaurant openings and may experience similar delays in the future. Delays or failures in opening new restaurants could hurt our ability to meet our growth objectives, which may affect the expectations of securities analysts and others and thus our stock price. We cannot guarantee that we or our franchisees will be able to achieve our expansion goals or that new restaurants will be operated profitably. Further, any restaurants that we or our franchisees open may not obtain operating results similar to those of our existing restaurants. Our ability to expand successfully will depend on a number of factors, many of which are beyond our control. These factors include, but are not limited to:

 

 

 

We must identify and obtain a sufficient number of suitable new restaurant sites for us to achieve a sustainable revenue growth rate.

 

We require that all proposed restaurant sites, whether Company-owned or franchised, meet site-selection criteria established by us. We and our franchisees may not be able to find sufficient new restaurant sites to support our planned expansion in future periods. We face significant competition from other restaurant companies and retailers for sites that meet our criteria and the supply of sites may be limited in some markets. As a result of these factors, our costs to obtain and lease sites may increase, or we may not be able to obtain certain sites due to unacceptable costs. Our inability to obtain suitable restaurant sites at reasonable costs may reduce our growth rate, which may affect the expectations of securities analysts and others and thus our stock price.

 

Our expansion in existing markets can cause sales in some of our existing restaurants to decline, which could result in restaurant closures.

 

As part of our expansion strategy, we and our franchisees intend to open new restaurants 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, which could result in restaurant closures. In addition, new restaurants added in existing markets may not achieve the same operating performance as our existing restaurants.

 

Our expansion into new markets, both foreign and domestic, may present increased risks due to our unfamiliarity with the area. The restaurants we open in new geographic regions may not achieve market acceptance.

 

Some of our new franchised restaurants and Company-owned restaurants are located in areas where we have little or no meaningful experience. Those markets may have different demographic characteristics, competitive conditions, consumer tastes and discretionary spending patterns than our existing markets that may cause our new restaurants to be less successful than restaurants in our existing markets. An additional risk in expansion into new markets is the lack of market awareness of the Cosi^® brand. Restaurants opened in new markets may open at lower

average weekly sales volumes than restaurants opened in existing markets and may have higher restaurant-level operating expense ratios than in existing markets. Sales at restaurants opened in new markets may take longer to reach mature average annual Company-owned restaurant sales, if at all, thereby affecting the profitability of these restaurants.

 

We have entered into an international license agreement with a licensee for the development of Cosi restaurants in six countries in the Persian Gulf. This licensee currently operates three franchise locations in the United Arab Emirates. As these franchise locations and future foreign locations open, the Company’s international operations will be subjected to various factors of uncertainty. The Company’s business outside of the United States is subject to a number of additional factors, including international economic and political conditions, local economic conditions, differing cultures and consumer preferences, currency regulations and fluctuations, diverse government regulations and tax systems, uncertain or differing interpretations of rights and obligations in connection with international license agreements and the collection of royalties from international licensees, the availability and cost of land and construction costs, and the availability of experienced management, appropriate licensees, and joint venture partners. Although we believe that we have developed the support structure required for international growth, there is no assurance that such growth will occur or that international operations will be profitable.

 

We may not be able to successfully incorporate a franchising and area developer model into our strategy.

 

We have and will continue to incorporate a franchising and area developer model into our business strategy in certain selected markets. We did not use a franchising or area developer model prior to fiscal 2004, and we may not be as successful as predicted in attracting franchisees and developers to the Cosi concept or identifying franchisees and developers that have the business abilities or access to financial resources necessary to open our restaurants or to successfully develop or operate our restaurants in a manner consistent with our standards. Incorporating a franchising and area developer model into our strategy also requires us to devote significant management and financial resources to support the franchise of our restaurants. Our future performance will depend on our franchisees’ ability to execute our concept and capitalize upon our brand recognition and marketing. We may not be able to recruit franchisees who have the business abilities or financial resources necessary to open restaurants on schedule, or who will conduct operations in a manner consistent with our concept and standards. Our franchisees may not be able to operate restaurants in a profitable manner. If we are not successful in incorporating a franchising or area developer model into our strategy, we may experience delays in our growth or may not be able to expand and grow our business.

 

If our franchisees cannot develop or finance new restaurants, build them on suitable sites or open them on schedule, our growth and success may be impeded.

 

Our growth depends in large part upon our ability to establish a successful and effective franchise program and to attract qualified franchisees. If our franchisees are unable to locate suitable sites for new restaurants, negotiate acceptable lease or purchase terms, obtain the necessary financial or management resources, meet construction schedules or obtain the necessary permits and government approvals, our growth plans may be negatively affected. We cannot assure you that any of the restaurants our franchisees open will be profitable.

 

Additional foodservice strategic alliances may not be successful and may materially adversely affect our business and results of operations.

 

We may decide to enter into additional alliances with third parties to develop foodservice strategic alliances in select markets or through select channels. Identifying strategic partners, negotiating agreements and building such alliances may divert management’s attention away from our existing businesses and growth plans. If we are not successful in forming additional foodservice strategic alliances, we may experience delays in our growth and may not be able to expand and grow our business. If we do form additional strategic alliances, we cannot assure you that the restaurants opened pursuant to these strategic alliances will be profitable.

Any inability to manage our growth effectively could materially adversely affect our operating results.

 

Failure to manage our growth effectively could harm our business. We have grown significantly since our inception and intend to grow substantially in the future both through a franchising strategy and opening new Company-owned restaurants. Our existing restaurant management systems, financial and management controls and information systems may not be adequate to support our planned expansion. Our ability to manage our growth effectively will require us to continue to enhance these systems, procedures and controls. We must attract and retain talented operating personnel to maintain the quality and service levels at our existing and future restaurants. We may not be able to effectively manage these or other aspects of our expansion. We cannot assure you that 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 on our existing infrastructure. If we are unable to manage our growth effectively, our business, results of operations and financial condition could be materially adversely impacted.

 

If we are unable to successfully integrate future acquisitions, our business could be negatively impacted. Any acquisitions may also be costly.

 

We may consider future strategic acquisitions. Acquisitions involve numerous risks, including difficulties assimilating new operations and products. In addition, acquisitions may require significant management time and capital resources. We cannot assure you that we will have access to the capital required to finance potential acquisitions on satisfactory terms, that any acquisition would result in long-term benefits to us, or that management would be able to manage effectively the resulting business. Future acquisitions are likely to result in the incurrence of additional indebtedness, which could contain restrictive covenants, or the issuance of additional equity securities, which could dilute our existing stockholders. We may also pay too much for a concept that we acquire relative to the actual economic return obtained. If our integration efforts are unsuccessful, our business and results of operations could suffer.

 

Risks Related to Our Business

 

If we are unable to execute our business strategy, we could be materially adversely affected.

 

Our ability to successfully execute our business strategy will depend on a number of factors, some of which are beyond our control, including, but not limited to:

 

 

 

Each of these factors could delay or prevent us from successfully executing our business strategy, which could adversely affect our growth, revenues and our results of operations.

 

During our operating history, we have been unable to achieve profitability.

 

In fiscal 2009, we incurred net losses of $11.1 million, and, since we were formed, we have incurred net losses of approximately $267.8 million through the end of fiscal 2009 primarily due to funding operating losses which have included significant impairment charges, the cost of our merger in 1999 and new restaurant opening expenses. We intend to continue to expend significant financial and management resources on the development of additional restaurants, both franchised and Company-owned. We cannot predict whether we will be able to achieve or sustain revenue growth, profitability or positive cash flow in the future. See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” and the financial statements included in this Annual Report on Form 10-K for information on the history of our losses.

 

If internally generated cash flow from our restaurants does not meet our expectations, our business, results of operations and financial condition could be materially adversely affected.

 

Our cash resources, and therefore our liquidity, are highly dependent upon the level of internally generated cash from operations and upon future financing transactions. Although we believe that we have sufficient liquidity to fund our working capital requirements for the next twelve months, if cash flows from our existing restaurants or cash flows from new restaurants that we open or franchise fees and royalties do not meet our expectations or are otherwise insufficient to satisfy our cash needs, we may have to seek additional financing from external sources to continue funding our operations or reduce or cease our plans to open or franchise new restaurants. We cannot predict whether such financing will be available on terms acceptable to us, or at all.

 

We may need additional capital in the future and it may not be available on acceptable terms.

 

Our business has in the past required, and may continue to require, significant additional capital to, among other things, fund our operations, increase the number of Company-owned or franchised restaurants, expand the range of services we offer and finance future acquisitions and investments. There is no assurance that financing will be available on terms acceptable to us, or at all. Our ability to obtain additional financing will be subject to a number of factors, including market conditions, our operating performance and investor sentiment. These factors may make the timing, amount, terms and conditions of additional financings unattractive to us. If we are unable to raise additional capital, our business, results of operations and financial condition could be materially adversely affected.

 

The current economic recession could adversely affect our business and financial results and have a material adverse effect on our liquidity and capital resources.

 

If the economic recession continues, many sectors of the economy may continue to be adversely impacted. As a retailer that depends upon consumer discretionary spending, we could face a challenging fiscal 2010, because our customers may make fewer discretionary purchases as a result of job losses, foreclosures, bankruptcies, reduced access to credit and sharply falling home prices. Many of the effects and consequences of the financial crisis and a broader global economic downturn are currently unknown and any one or all of them could potentially have a material adverse effect on our liquidity and capital resources, including our ability to raise additional capital if needed or to maintain satisfactory credit terms with our suppliers. Cosi, as an “affordable luxury,” may be

disproportionally affected by a continued slowdown in the United States economy or an uncertain economic outlook.

 

Seasonality, inclement weather and other variable factors may adversely affect our sales and results of operations and could cause our quarterly results to fluctuate and fall below expectations of securities analysts and investors, resulting in a decline in our stock price.

 

Our business is subject to significant seasonal fluctuations and weather influences on consumer spending and dining out patterns. Inclement weather may result in reduced frequency of dining at our restaurants. Customer counts (and consequently revenues) are generally highest in spring and summer months and lowest during the winter months because of the high proportion of our restaurants located in the Northern part of the country where inclement winter weather affects customer visits. As a result, our quarterly and yearly results have varied in the past, and we believe that our quarterly operating results will vary in the future. Other factors such as unanticipated increases in labor, commodities, energy, insurance or other operating costs may also cause our quarterly results to fluctuate. For this reason, you should not rely upon our quarterly operating results as indications of future performance.

 

Our franchisees could take actions that could harm our business.

 

Franchisees are independent operators and are not our employees. Although we have developed criteria to evaluate and screen prospective franchisees, we are limited in the amount of control we can exercise over our franchisees, and the quality of franchised restaurant operations may be diminished by any number of factors beyond our control. Franchisees may not have the business acumen or financial resources necessary to successfully operate restaurants in a manner consistent with our standards and requirements and may not hire and train qualified managers and other restaurant personnel. Poor restaurant operations may affect each restaurant’s sales. Our image and reputation, and the image and reputation of other franchisees, may suffer materially and system-wide sales could significantly decline if our franchisees do not operate successfully.

 

We could face liability from our franchisees.

 

A franchisee or government agency may bring legal action against us based on the franchisee/franchisor relationships. Various state, federal and, where applicable, foreign laws govern our relationship with our franchisees and potential sales of our franchised restaurants. If we fail to comply with these laws, we could be liable for damages to franchisees and fines or other penalties. Expensive litigation with our franchisees or government agencies may adversely affect both our profits and our important relations with our franchisees.

 

Our financial results are affected by the financial results of our franchisees.

 

We receive royalties from our franchisees. Our financial results are therefore to an extent contingent upon the operational and financial success of our franchisees, including implementation of our strategic plans, as well as their ability to secure adequate financing. If sales trends or economic conditions worsen for our franchisees, their financial health may worsen and our collection rates may decline. Additionally, refusal on the part of franchisees to renew their franchise agreements may result in decreased royalties. Entering into restructured franchise agreements may result in reduced franchise royalty rates in the future.

 

Our restaurants are currently concentrated in the Northeastern and Mid-Atlantic regions of the United States, particularly in the New York City and Washington, D.C. areas. Accordingly, we are highly vulnerable to negative occurrences in these regions.

 

We currently operate 68 Company-owned restaurants in Northeastern and Mid-Atlantic states, of which 30 are located in the New York City and Washington, D.C. central business districts. As a result, we are particularly susceptible to adverse trends and economic conditions in these areas. In addition, given our geographical concentration, negative publicity regarding any of our restaurants could have a material adverse effect on our business and operations, as could other regional occurrences impacting the local economies in these markets.

You should not rely on past increases in our average unit volumes as an indication of our future results of operations because they may fluctuate significantly.

 

A number of factors have historically affected, and will continue to affect, our average unit sales, including, among other factors:

 

 

It is not reasonable to expect our average unit volumes to increase at rates achieved over the past several years. Changes in our average unit volumes could cause the price of our common stock to fluctuate substantially.

 

Our common stock may be delisted from the Nasdaq Global Market, which could have an adverse impact on the liquidity and market price of our common stock.

 

Our common stock is currently listed on The Nasdaq Global Market. On September 15, 2009, we received notice from the Listing Qualifications Department of The Nasdaq Stock Market (“Nasdaq”) indicating that, for the previous 30 consecutive business days, the bid price for our common stock had closed below the minimum $1.00 per share requirement for continued inclusion on the Nasdaq Global Market under Nasdaq Listing Rule 5450(a)(1) and that we would be afforded 180 calendar days, or until March 15, 2010, to regain compliance with the minimum bid price requirement. On March 16, 2010, we received a letter from the Nasdaq staff stating that we had failed to comply with the $1.00 minimum bid price required for continued listing of our common stock on The Nasdaq Global Market and as a result our common stock is subject to delisting. We have appealed the staff determination and the delisting of our common stock has been stayed pending the Nasdaq Listing Qualifications Panel’s determination of our appeal. Although there can be no assurance that the Panel will grant our request for continued listing, the appeal will stay the delisting of our stock from The Nasdaq Global Market pending the Panel’s decision. We intend to present a plan to the panel that includes a discussion of the events that we believe will enable us to regain compliance with Nasdaq Listing Rule 5450(a)(1), which plan will include a commitment to effect a reverse stock split, if necessary. Alternatively, we may be eligible for an additional grace period if we satisfy all of the requirements, other than the minimum bid price requirement, for initial listing on the Nasdaq Capital Market set forth in Nasdaq Listing Rule 5505. To avail ourselves of this alternative, we would need to submit an application to transfer our securities to the Nasdaq Capital Market.

 

The delisting of our common stock would adversely affect the market liquidity for our common stock, the per share price of our common stock and impair our ability to raise capital that may be needed for future operations. Delisting from the Nasdaq Global Market could also have other negative results, including, without limitation, the potential loss of confidence by customers and employees, the loss of institutional investor interest and fewer business development opportunities. If our common stock is not eligible for quotation on another market or exchange, trading of our common stock could be conducted in the over-the-counter market or on an electronic bulletin board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more difficult to dispose of, or obtain accurate quotations for the price of our common stock, and there would likely also be a reduction in our coverage by security analysts and the news media, which could cause the price of our common stock to decline further.

If we fail to comply with governmental regulations or if these regulations change, our business could suffer.

 

We are subject to extensive federal, state, local, and, where applicable, foreign government regulations, including regulations relating to alcoholic beverage control, the preparation and sale of food, public health and safety, sanitation, building, zoning and fire codes. Our operations are also subject to federal and state laws governing such matters as wages, working conditions, citizenship requirements, overtime, insurance matters, workers’ compensation, disability laws such as the Americans with Disabilities Act, child labor laws and anti-discrimination laws. Although we believe that compliance with these laws has not had a material effect on our operations to date, we may experience material difficulties or failures with respect to compliance in the future. Our failure to comply with these laws could result in required renovations to our facilities, litigation, fines, penalties, judgments or other sanctions, any of which could adversely affect our business, operations or our reputation.

 

In recent years, there has been an increased legislative, regulatory and consumer focus at the federal, state and municipal levels on the food industry, including nutrition, labeling and advertising practices. Casual dining chains have been a particular focus. For example, New York City has adopted regulations requiring that chain restaurants include caloric or other nutritional information on their menu boards and on printed menus, which must be plainly visible to consumers at the point of ordering. We may in the future become subject to other initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of our food, which could increase our expenses, particularly given differences among applicable legal requirements and practices within the restaurant industry with respect to testing and disclosure, or otherwise adversely affect us. See “Business — Government Regulation” in this Annual Report on Form 10-K for a discussion of the regulations with which we must comply.

 

Our operations depend upon governmental licenses and we may face liability under “dram shop” statutes.

 

Our business depends upon obtaining and maintaining required food service and/or liquor licenses for each of our restaurants. If we fail to obtain or maintain all necessary licenses, we may be forced to delay or cancel new restaurant openings and close or reduce operations at existing locations. In addition, our sale of alcoholic beverages subjects us to “dram shop” statutes in some states. These statutes allow an injured person to recover damages from an establishment that served alcoholic beverages to an intoxicated person. Although we take significant precautions to ensure that all employees are trained in the responsible service of alcohol and maintain insurance policies in accordance with all state regulations regarding the sale of alcoholic beverages, the misuse of alcoholic beverages by customers may create considerable risks for us. If we are the subject of a judgment substantially in excess of our insurance coverage, or if we fail to maintain our insurance coverage, our business, financial condition, operating results or cash flows could be materially and adversely affected.

 

Our failure or inability to enforce our trademarks or other proprietary rights could adversely affect our competitive position or the value of our brand.

 

We own certain common law trademark rights and a number of federal and international trademark and service mark registrations, and proprietary rights to certain of our core menu offerings. We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We, therefore, devote appropriate resources to the protection of our trademarks and proprietary rights. The protective actions that we take, however, may not be enough to prevent unauthorized usage or imitation by others, which might cause us to incur significant litigation costs and could harm our image or our brand or competitive position.

 

We also cannot assure you that third parties will not claim that our trademarks or offerings infringe the proprietary rights of third parties. Any such claim, whether or not it has merit, could be time-consuming, result in costly litigation, cause product delays or require us to enter into royalty or licensing agreements. As a result, any such claim could have a material adverse effect on our business, results of operations and financial condition.

 

We hold significant amounts of illiquid assets and may have to dispose of them on unfavorable terms.

 

As of the end of fiscal 2009, we had $22.1 million in net fixed assets that we have defined as illiquid assets, which includes leasehold improvements, equipment and furniture and fixtures. These assets cannot be converted

into cash quickly and easily. We may be compelled, based on a significant underperformance of a specific location or market, to dispose of some illiquid assets on unfavorable terms, which could have a material adverse effect on our business.

 

We may face litigation that could have a material adverse effect on our business, financial condition and results of operations.

 

From time to time, we are a defendant in litigation arising in the ordinary course of our business. Our customers may file complaints or lawsuits against us alleging that we are responsible for an illness or injury they suffered at or after a visit to a Cosi^® restaurant, or alleging that there was a problem with food quality or operations at a Cosi^® restaurant. We may also be subject to a variety of other claims arising in the ordinary course of our business, including personal injury claims, contract claims, claims from franchisees and claims alleging violations of federal, state and, where applicable, foreign law regarding workplace and employment matters, discrimination and similar matters. We could also become subject to class action lawsuits related to these matters in the future.

 

Regardless of whether any future claims against us are valid or whether we are found to be liable, claims may be expensive to defend and may divert our management’s attention away from our operations and hurt our performance. The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. A judgment significantly in excess of our insurance coverage for any claims could materially adversely affect our financial condition or results of operations. There may also be adverse publicity associated with litigation that could decrease customer acceptance of our services or those of our franchisees, regardless of whether the allegations are valid or whether we are ultimately found liable. As a result, litigation may have a material adverse affect on our business, financial condition and results of operations. Moreover, complaints, litigation or adverse publicity experienced by one or more of our franchisees could also hurt our business as a whole.

 

If we are unable to protect our customers’ credit card data, we could be exposed to data loss, litigation and liability, and our reputation could be significantly harmed.

 

In connection with credit card sales, we transmit confidential credit card information securely over public networks. Third parties may have the technology or know-how to breach the security of this customer information, and our security measures may not effectively prohibit others from obtaining improper access to this information. If a person is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt our operations. Any security breach could expose us to risks of data loss, litigation and liability and could seriously disrupt our operations and any resulting negative publicity could significantly harm our reputation.

 

We rely on computer systems and information technology to run our business. Any material failure, interruption or security breach of our computer systems or information technology may adversely affect the operation of the business and our results of operations.

 

Computer viruses or terrorism may disrupt our operations and harm our operating results. Despite our implementation of security measures, all of our technology systems are vulnerable to disability or failures due to hacking, viruses, acts of war or terrorism, and other causes. If our technology systems were to fail and we were unable to recover in a timely way, we would be unable to fulfill critical business functions, which could have a material adverse effect on our business, operating results, and financial condition.

 

Risks Relating to the Food Service Industry

 

Our business is affected by changes in consumer preferences.

 

Our success depends, in part, upon the popularity of our food and beverage products, our ability to develop new menu items that appeal to consumers and what we believe is an emerging trend in consumer preferences toward premium convenience restaurants. We depend on consumers who prefer made-to-order food in a sophisticated environment and are willing to pay a premium price for our products. We also depend on trends toward consumers eating away from home more often. Shifts in consumer preferences away from our restaurants or cuisine, our

inability to develop new menu items that appeal to consumers or changes in our menu that eliminate items popular with some consumers could harm our business and future profitability.

 

Natural disasters, war, acts of terrorism or other armed conflict, or the threat of such actions, on the United States or international economies may cause a decline in discretionary consumer spending, which would negatively affect our business.

 

Our success depends to a significant extent on discretionary consumer spending, which is influenced by general economic and political conditions and the availability of discretionary income. Discretionary consumer spending may decline in the event of a natural disaster, war, acts of terrorism or other armed conflict. Accordingly, we may experience declines in sales during periods of uncertainty like that which followed the September 11, 2001 terrorist attacks on the United States. In addition, economic uncertainty due to military action overseas, such as in Iraq and post-war military, diplomatic or financial responses, may lead to further declines in sales. Any decline in consumer spending or economic conditions could reduce customer traffic or impose practical limits on pricing, either of which could have a material adverse effect on our sales, results of operations, business and financial condition. In the event of a natural disaster or acts of terrorism in the United States, or the threat of either, we may be required to suspend operations in some or all of our restaurants, which could have a material adverse impact on our business, financial condition, and results of operation.

 

Our success depends on our ability to compete with many food service businesses.

 

The restaurant industry is intensely competitive and we compete with many well-established food service companies on the basis of taste, quality and price of product offered, customer service, atmosphere, location and overall customer experience. We compete with other sandwich retailers, specialty coffee retailers, bagel shops, fast-food restaurants, delicatessens, cafes, bars, take-out food service companies, supermarkets and convenience stores. Our competitors change with each daypart (breakfast, lunch and dinner), ranging from coffee bars and bakery cafes during the breakfast and lunch dayparts to casual dining chains during the dinner daypart. Aggressive pricing by our competitors or the entrance of new competitors into our markets could reduce our sales and profit margins.

 

Many of our competitors or potential competitors have substantially greater financial and other resources than we do, which may allow them to react to changes in pricing, marketing and the quick-service restaurant industry better than we can. As competitors expand their operations, we expect competition to intensify. We also compete with other employers in our markets for hourly workers and may be subject to higher labor costs.

 

Changes in food and supply costs and availability could adversely affect our results of operations.

 

Our restaurants receive frequent deliveries of products. Most of these deliveries are made by distributors who are part of a national network of independent distributors with whom we have a distribution agreement. These independent distributors supply us with approximately 78% of our food and paper products under an agreement which expires in November 2010. Although we have issued a request for proposal to several distribution organizations, there can be no assurance that any agreement will be reached prior to expiration of our current agreement. Our profitability depends in part on our ability to anticipate and react to changes in food and supply costs, such as the volatility in certain commodity markets we experienced in recent years. Certain commodities such as wheat and dairy and dairy-related products have experienced significant fluctuations in the recent past. These types of increases could have an adverse effect on us during fiscal 2010 and in future fiscal years. Although many of our products are made to our specifications, we believe that alternative distribution sources are available for the majority of our ingredients and products.

 

We believe that we have adequate sources of supply for our ingredients and products to support our restaurant operations and if necessary we can make menu modifications to address any material supply issues. However, there are many factors which can cause shortages or interruptions in the supply of our ingredients and products including weather, unanticipated demand, labor, production or distribution problems, quality issues and cost, some of which are beyond our control, and any of which could have an adverse effect on our business and results of operations.

Health concerns relating to the consumption of beef, poultry, produce or other food products could adversely affect the price and availability of beef, poultry, produce, and other food products, consumer preferences and our results of operations and stock price.

 

Since 2004, Asian and European countries have experienced outbreaks of avian flu, or “bird flu.” Additional instances of avian flu or other food-borne illnesses, such as “mad cow disease,” E.coli, salmonella, or hepatitis A could adversely affect the price and availability of beef, poultry or other food products. As a result, we could experience a significant increase in cost of food.

 

In addition, like other restaurant chains, consumer preferences could be affected by health concerns about the consumption of poultry, beef, or produce, the key ingredients in many of our menu items, or by negative publicity concerning food quality, illness and injury generally, such as negative publicity concerning, E.coli, salmonella, “mad cow disease” or “bird flu”, publication of government or industry findings about food products we serve or other health concerns or operating issues stemming from the food served in our restaurants. Our operational controls and training may not be fully effective in preventing all food-borne illnesses. Some food-borne illness incidents could be caused by food suppliers and transporters and would be outside of our control. If our food suppliers and transporters do not comply with governmental health regulations, they may not be able to deliver food products or we may be subject to food product recalls. Any negative publicity, health concerns or specific outbreaks of food-borne illnesses attributed to one or more of our restaurants, or the perception of an outbreak, could result in a decrease in customer traffic to our restaurants and could have a material adverse effect on our sales, results of operations, business, financial condition and stock price.

 

The food service industry is affected by litigation and publicity concerning food quality, health and other issues, which can cause customers to avoid our products and result in liabilities.

 

Food service businesses can be adversely affected by litigation and complaints from customers or government authorities resulting from food quality, illness, injury or other health concerns or operating issues stemming from one restaurant or a limited number of restaurants. Adverse publicity about these allegations may negatively affect us, regardless of whether the allegations are true, by discouraging customers from buying our products. We could also incur significant liabilities if a lawsuit or claim results in a decision against us or if we incur litigation costs, regardless of the result.

 

Our business could be adversely affected by increased labor costs or labor shortages.

 

Labor is a primary component in the cost of operating our business. We devote significant resources to recruiting and training our managers and employees. Increased labor costs, due to competition, increased minimum wage or employee benefits costs or otherwise, would adversely impact our operating expenses. In addition, our success depends on our ability to attract, motivate and retain qualified employees, including restaurant managers and staff, to keep pace with our needs. If we are unable to do so, our results of operations may be adversely affected.

 

 

We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our 2009 fiscal year and that remain unresolved.

 

 

Our principal executive offices are located at 1751 Lake Cook Road, Suite 600, Deerfield, Illinois 60015. The lease for our executive offices expires in September 2012. We believe the offices are adequate to accommodate our needs.

 

All of our restaurants are located on leased properties. Each lease typically has a 10-year base rent period, with various renewal options. In addition to the base rent, some leases provide for contingent rental payments, insurance, common area, and other operating costs. At most locations, we reimburse the landlord for a proportionate share of the landlord’s annual real estate taxes.

The following table lists existing Company-owned restaurants, by region, as of December 28, 2009:

 

 

 

From time to time, we are a defendant in litigation arising in the ordinary course of our business, including but not limited to, claims resulting from “slip and fall” accidents, claims under federal and state laws governing access to public accommodations or other federal and state laws applicable to our business operations, employment-related claims, property damages, claims from guests alleging illness, injury or other food quality, health or operational concerns, and enforcement of intellectual property rights.

 

On February 23, 2009, the Company commenced an action in the United States District Court for the Southern District of New York to recover, under Section 16(b) of the Securities Exchange Act of 1934, as amended, short-swing profits realized by a stockholder of the Company in connection with certain purchases and sales of the Company’s common stock by the stockholder. On July 7, 2009, the parties entered into an agreement to settle the claims, which agreement was subject to court approval. The parties reached a settlement and the Company received a settlement of $0.4 million.

 

 

 

On November 22, 2002, our common stock began trading on the Nasdaq Global Market System (“Nasdaq”) under the symbol “COSI.” The closing price of our common stock on Nasdaq was $0.89 on March 25, 2009. On March 16, 2010, we were notified by The Nasdaq Stock Market that our common stock is subject to delisting from the Nasdaq Global Market. We have appealed this determination and the delisting has been stayed pending the outcome of the appeal.

 

Stock Price Information

 

Set forth below are the high and low closing sale prices for shares of our common stock for each quarter during fiscal 2009 and 2008 as reported by Nasdaq.

 

 

Stockholders

 

The number of our registered common stockholders of record as of February 26, 2010 was 90. This number excludes stockholders whose stock is held in nominee or street name by brokers.

 

Dividend Policy

 

We have never paid cash dividends on our common stock, and we do not currently intend to pay any dividends.

Securities Authorized for Issuance Under Equity Compensation Plans

 

The information relating to securities authorized for issuance under our equity compensation plans is disclosed in Item 11 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.

 

Set forth below is a graph comparing the cumulative total stockholder return on Così’s common stock with the NASDAQ Composite Index and the Standard & Poor’s Small Cap 600 Index for the period covering our initial public offering on November 22, 2002, through the end of our 2009 fiscal year on December 28, 2009. The Company’s common stock trades on the NASDAQ Global Market under the symbol “COSI.” The graph assumes an investment of $100.00 made at the opening of trading on November 22, 2002, in (i) Così’s common stock, (ii) the stocks comprising the NASDAQ Composite Index, and (iii) stocks comprising the Standard & Poor’s Small Cap 600 Index.

 

Cummulative Total Return

 

 

The following table sets forth our summary of selected consolidated financial data, which should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes included elsewhere in this Report. The selected statement of operations data for fiscal 2009, 2008, and 2007 and selected balance sheet data for fiscal 2009 and 2008 are derived from our audited consolidated financial statements that are included in this Report. The following historical results of consolidated operations are not necessarily indicative of results to be expected for any subsequent period.

 

 

 

The following discussion and analysis of our financial condition and results of operations for the fiscal years ended December 28, 2009, December 29, 2008, and December 31, 2007 should be read in conjunction with “Selected Consolidated Financial Data” and our audited consolidated financial statements and the notes to those statements that are included elsewhere in this Annual Report. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Cautionary Note Regarding Forward-Looking Statements” below and elsewhere in this Annual Report.

 

Business Overview

 

System-wide Restaurants:

 

 

 

 

There are currently 99 Company-owned and 44 franchise premium convenience restaurants operating in 18 states, the District of Columbia, and the United Arab Emirates (UAE). One franchised restaurant in Minnesota and one location in the UAE closed subsequent to fiscal 2009.

Our restaurants offer innovative savory made-to-order products featuring our authentic hearth-baked crackly crust signature Cosi bread and fresh distinctive ingredients. We maintain a pipeline of new menu offerings that are introduced seasonally through limited time offerings to keep our products relevant to our target customers. Our menu features high-quality sandwiches, freshly-tossed salads, Cosi bagels, hot melts, flatbread pizzas, S’mores and other desserts, and a variety of coffees along with other soft drink beverages, bottled beverages including premium still and sparkling water, teas, alcoholic beverages, and other specialty coffees. Our restaurants offer lunch and afternoon coffee in a counter-service format, with most offering breakfast and/or dinner and dessert menus as well. We operate our Company-owned restaurants in two formats: Cosi and Cosi Downtown. Cosi Downtown restaurants, which are located in nonresidential central business districts, close for the day in the early evening, while Cosi restaurants offer dinner and dessert in a casual dining atmosphere.

 

We are currently eligible to offer franchises in 47 states and the District of Columbia. We offer franchises to area developers and individual franchise operators. Domestically, the initial franchise fee, payable to us, for both an area developer and an individual franchise operator, is $40,000 for the first restaurant and $35,000 for each additional restaurant. The fees for international agreements vary based on a variety of factors.

 

We believe that offering Cosi^® franchised restaurants to area developers and individual franchisees offers the prospects of strong financial returns. By franchising, we believe we will be able to increase the presence of our restaurants in various markets throughout the country and generate additional revenue without the large upfront capital commitments and risk associated with opening Company-owned restaurants.

 

We believe that incorporating a franchising and area developer model into our strategy will position us to maximize the market potential for the Cosi^® brand and concept consistent with our available capital and we expect that Company-owned restaurants (restaurants that we own as opposed to franchised restaurants) will always be an important part of our new restaurant growth.

 

During fiscal 2009, we opened one new Company-owned restaurant in Kohl Children’s Museum in Illinois and we purchased one franchised restaurant in Minnesota and are now operating it as a Company-owned location. During 2009, we permanently closed four underperforming Company-owned restaurants where we were able to negotiate acceptable lease termination agreements with the landlords. In addition, during fiscal 2009, we opened six new and permanently closed ten franchised restaurants.

 

Critical Accounting Policies

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires the appropriate application of certain accounting policies, many of which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.

 

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable and generally accepted for companies in the restaurant industry. We believe that the following addresses the more critical accounting policies used in the preparation of our consolidated financial statements and require management’s most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

 

Long Lived Assets:  ASC 360-10-35 Property, Plant, & Equipment requires management judgments regarding the future operating and disposition plans for marginally-performing assets, and estimates of expected realizable values for assets to be sold. The application of this standard has affected the amount and timing of charges to operating results that have been significant in recent years. We evaluate possible impairment at the individual restaurant level periodically and record an impairment loss whenever we determine impairment factors are present. We consider a history of poor financial operating performance to be the primary indicator of potential impairment for individual restaurant locations. We determine whether a restaurant location is impaired based on expected undiscounted cash flows, generally for the remainder of the lease term, and then determine the impairment charge based on discounted cash flows for the same period. Restaurants are not considered for impairment during

the “ramp-up” period before they enter the comparable restaurant base, unless specific circumstances warrant otherwise.

 

Lease Termination Charges:  ASC 820-30 Exit or Disposal Cost Obligations requires companies to recognize costs associated with exit or disposal activities when they are incurred, rather than at the end of a commitment to an exit or disposal plan. For all exit activities, we estimate our likely liability under contractual leases for restaurants that have been closed. Such estimates have affected the amount and timing of charges to operating results and are impacted by management’s judgments about the time it may take to find a suitable subtenant or assignee, or the terms under which a termination of the lease agreement may be negotiated with the landlord.

 

Accounting for Lease Obligations:  In accordance with ASC 840-25 Leases, we recognize rent expense on a straight-line basis over the lease term commencing on the date we take possession. We include any rent escalations, rent abatements during the construction period and any other rent holidays in our straight-line rent expense calculation.

 

Landlord Allowances:  In accordance with ASC 840-25 Leases, we record landlord allowances as deferred rent in other long-term liabilities on the consolidated balance sheets and amortize them on a straight-line basis over the term of the related leases.

 

Stock-Based Compensation Expense:  In accordance with ASC 718-10-25 Compensation — Stock Compensation we recognize stock-based compensation expense according to the fair value recognition provision, which generally requires, among other things, that all employee share-based compensation be measured using a fair value method and that all the resulting compensation expense be recognized in the financial statements.

 

We measure the estimated fair value of our granted stock options using a Black-Scholes pricing model and of our restricted stock based on the fair market value of a share of registered stock on the date of grant. The weighted average fair values of the stock options granted through 2005, the last time we issued stock options, were determined using the Black-Scholes option-pricing model.

 

We estimate forfeitures in calculating the expense relating to stock-based compensation. Pre-vesting forfeiture rates are estimated based on historical data. The expected volatility is based on an average of the historical volatility of the Company’s stock, the implied volatility of market options, peer company volatility, and other factors. The average expected life represents the period of time that stock option grants are expected to be outstanding and is derived from historical terms and other factors. The risk-free interest rate is based on the rate of U.S. Treasury zero-coupon issues with remaining term equal to the expected life of stock option grants.

 

Income Taxes:  We have recorded a full valuation allowance to reduce our deferred tax assets that relate primarily to net operating loss carryforwards. Our determination of the valuation allowance is based on an evaluation of whether it is more likely than not that we will be able to utilize the net operating loss carryforwards based on the Company’s operating results. A positive adjustment to income will be recorded in future years if we determine that we could realize these deferred tax assets.

 

We have adopted the provisions of ASC 740-10 Income Taxes beginning in fiscal 2007. No adjustment was made to the beginning retained earnings balance, as the ultimate deductibility of all tax positions is highly certain but there is uncertainty about the timing of such deductibility. No interest or penalties have been accrued relative to tax positions due to the Company having either a tax loss or net operating loss carry-forwards to offset any taxable income in all subject years. As a result, no liability for uncertain tax positions has been recorded.

 

Revenue

 

Restaurant Net Sales.  Our Company-owned restaurant sales are composed almost entirely of food and beverage sales. We record revenue at the time of the purchase of our products by our customers.

 

Franchise Fees and Royalties.  Franchise fees and royalties includes fees earned from franchise agreements entered into with area developers and franchise operators, as well as royalties received based on sales generated at franchised restaurants. We recognize the franchise fee in the period in which a franchise location opens or when fees are forfeited as a result of a termination of an area developer agreement. We recognize franchise royalties in the period in which sales are made by our franchise operators.

Gift Card Sales.  We offer our customers the opportunity to purchase gift cards at our restaurants and through our website. Customers can purchase these cards at varying dollar amounts. At the time of purchase by the customer, we record a gift card liability for the face value of the card purchased. We recognize the revenue and reduce the gift card liability when the gift card is redeemed. We do not reduce our recorded liability for potential non-use of purchased gift cards.

 

Comparable Restaurant Sales

 

In calculating comparable restaurant sales, we include a restaurant in the comparable restaurant base after it has been in operation for 15 full months. We remove from the comparable restaurant base any restaurant that is temporarily shut down for remodeling for a complete period in the period that it is shut down. At fiscal years ended December 28, 2009, December 29, 2008, and December 31, 2007, there were 97, 99, and 95 restaurants in our comparable restaurant base, respectively.

 

Costs and Expenses

 

Cost of Food and Beverage.  Cost of food and beverage is composed of food and beverage costs. Food and beverage costs are variable and fluctuate with sales volume.

 

Restaurant Labor and Related Benefits.  The costs of restaurant labor and related benefits include direct hourly and management wages, bonuses, payroll taxes, health insurance and all other fringe benefits.

 

Occupancy and Other Restaurant Operating Expenses.  Occupancy and other restaurant operating expenses include direct restaurant-level operating expenses, including the cost of paper and packaging, supplies, repairs and maintenance, utilities, rent and related occupancy costs.

 

General and Administrative Expenses.  General and administrative expenses include all corporate and administrative functions that support our restaurants and provide an infrastructure to operate our business. Components of these expenses include executive management costs; supervisory and staff salaries; non-field stock-based compensation expense; non-field bonuses and related taxes and employee benefits; travel; information systems; training; support center rent and related occupancy costs; and professional and consulting fees. The salaries, bonuses and employee benefits costs included as general and administrative expenses are generally more fixed in nature and do not vary directly with the number of restaurants we operate. Stock-based compensation expense includes the charges related to recognizing the fair value of stock options and restricted stock as compensation for awards to certain key employees and non-employee directors, except the costs related to stock-based compensation for restaurant employees which are included in restaurant labor and related benefits.

 

Depreciation and Amortization.  Depreciation and amortization principally relates to restaurant assets.

 

Restaurant Pre-opening Expenses.  Restaurant pre-opening expenses are expensed as incurred and include the costs of recruiting, hiring and training the initial restaurant work force, travel, the cost of food and labor used during the period before opening, the cost of initial quantities of supplies and other direct costs related to the opening or remodeling of a restaurant. Pre-opening expenses also include rent expense recognized on a straight-line basis from the date we take possession through the period of construction, renovation and fixturing prior to opening the restaurant.

Results of Operations

 

The following table sets forth our operating results as a percentage of total revenues, except where otherwise noted, for the periods indicated:

 

 

 

 

Fiscal Year 2009 (52 weeks) compared to Fiscal Year 2008 (52 weeks)

 

Restaurant Net Sales

 

Restaurant net sales decreased 12.2%, or $16.1 million, in fiscal 2009 as compared to fiscal 2008. This decrease was due primarily to a decrease of 10.8%, or $13.8 million, in net sales in our comparable restaurant base and $3.6 million in net sales related to restaurants closed during and subsequent to fiscal 2008 partially offset by $1.3 million in net sales at new restaurants not yet in our comparable restaurant base as of December 28, 2009. For comparable restaurants in fiscal 2009, our transaction count decreased by 8.9% and our average check decreased by 1.9%, as compared to fiscal 2008.

 

Franchise Fees and Royalties

 

 

Franchise fees and royalties during fiscal 2009 consist of $2.1 million in royalties from the franchise restaurants operated during fiscal 2009 and $0.1 million in fees related to the six franchise restaurants that opened during fiscal 2009. Franchise fees and royalties during fiscal 2008 consist of $2.1 million in royalties from franchise restaurants operated during fiscal 2008, $0.5 million in fees related to the 19 franchise restaurants that opened during fiscal 2008 and $0.5 million in franchise fees related to the termination of two area development agreements.

 

Costs and Expenses

 

 

Cost of Food and Beverage.  During fiscal 2009 food and beverage costs as a percentage of net sales decreased slightly as compared to fiscal 2008. During fiscal 2009 we had lower year-over-year costs for certain commodities, primarily wheat and dairy products which were partially offset by higher costs associated with our limited time lobster promotional offering during the fiscal 2009 third quarter as well as the introduction in the latter half of fiscal 2009 of a new premium steak product.

 

 

Restaurant Labor and Related Benefits.  The increase in restaurant labor and related benefits as a percentage of restaurant net sales during fiscal 2009, as compared to fiscal 2008, is due to the impact of the decrease in sales in our comparable restaurant base on our fixed manager salaries and hourly labor.

 

 

Occupancy and Other Restaurant Operating Expenses.  The increase in restaurant occupancy and other restaurant operating expenses as a percentage of restaurant net sales during fiscal 2009, as compared to fiscal 2008, is due primarily to the deleveraging of occupancy costs against decreased sales in our comparable restaurant base partially offset by slightly lower costs for repairs and maintenance.

 

 

General and Administrative Expenses.  The reduction in general and administrative costs of $5.0 million, or 2.0% of total revenues, during fiscal 2009, as compared to fiscal 2008, is due primarily to savings in labor and related benefits resulting from administrative workforce reductions, lower year over year legal costs largely resulting from a litigation settlement recorded in fiscal 2008, and lower third-party professional fees partially offset by higher marketing costs and costs associated with the process of reviewing strategic alternatives.

 

 

Depreciation and Amortization.  The lower depreciation and amortization costs in fiscal 2009, as compared to fiscal 2008, are due primarily to the impact of impairments recorded during and subsequent to the fourth quarter of fiscal 2008, as well as the continued depreciation and amortization of our comparable restaurant base assets.

 

 

Restaurant Pre-Opening Expenses.  Restaurant pre-opening expenses during fiscal 2009 are related to supplies and training costs for one new Company-owned restaurant that opened during the third quarter of fiscal 2009. During fiscal 2008 restaurant pre-opening expenses were related primarily to occupancy, pre-opening payroll, supplies and training costs for one new restaurant opened during fiscal 2008. During fiscal 2008, 49.5% of restaurant pre-opening expenses were for occupancy costs incurred prior to the opening of the restaurant.

 

 

Provision for Losses on Asset Impairments and Disposals.  During fiscal 2009, asset impairment charges relate to seven underperforming locations, of which three were opened during fiscal 2006 and two are located in the Detroit, Michigan market which has been significantly impacted by the economic downturn and where it appears unlikely that the remaining asset values can be recovered over the remaining life of the leases. During 2008, the asset impairment charges of $7.1 million related to 16 underperforming locations, most of which were built in 2005 and the first half of 2006. Nine are located in the Midwest region, five in the Mid-Atlantic region and two in the Northeast region, including four locations closed during the first quarter of fiscal 2009. In addition, during fiscal 2008, we recorded asset impairment charges of approximately $0.1 million related to Seattle locations that are reported in discontinued operations.

 

Closed Store Costs.  The closed store costs during fiscal 2009 relate to three underperforming locations where we negotiated early exit agreements with the landlords and closed those locations during the first quarter of fiscal 2009, and one underperforming location that closed at the expiration of the operating lease. Closed store costs during fiscal 2008 relate to two underperforming locations that closed at the expiration of their operating leases during the first quarter of fiscal 2008, and to two additional underperforming locations that closed, one each during the second and third quarters of fiscal 2008.

 

 

Lease Termination Expense, net.  Lease termination expense during fiscal 2009 relates primarily to an underperforming location in the Midwest where we reached an early exit agreement with the landlord and to charges associated with our exercise of a provision allowing for the contraction of our support center office. Lease termination expense during fiscal 2008 primarily related to a location where we made the decision to not build a restaurant subsequent to entering into a lease and reached an agreement with the landlord to exit the lease, and to three underperforming locations in the Midwest region where we reached exit agreements with the landlords. One of these underperforming locations was closed during the third quarter of fiscal 2008 and the other two were closed during the first quarter of fiscal 2009.

 

 

Gain on Sale of Assets.  During fiscal 2009 we recorded a gain related to the sale of four liquor licenses.

 

 

Interest Income and Expense.  The decrease in interest income in fiscal 2009, as compared to fiscal 2008, is due to lower average rates of interest earned on deposit accounts. During both fiscal 2009 and fiscal 2008, interest expense was insignificant.

 

 

Other income.  During fiscal 2009, other income was not significant. During fiscal 2008, we recorded other income related to a tax refund.

 

 

Loss from Continuing Operations.  The decrease in our loss from continuing operations in fiscal 2009, as compared to fiscal 2008, is due primarily to lower non-cash charges for asset impairments and a decrease in general

and administrative expenses, offset by a decrease in our restaurant operating margins resulting from lower restaurant net sales and decreased franchise income related to fees.

 

Discontinued Operations.  During the first quarter of fiscal 2008, we sold the assets of three underperforming Company-owned locations that operated in the Seattle market to a local restaurant development company. Under the terms of the agreement, we transferred rights to the assets and leasehold improvements for minimal cash consideration and the new owner assumed the tenant obligations under the real estate operating leases and operates those locations under a different brand. We ceased operating these restaurants as of the end of the first quarter of fiscal 2008.

 

Fiscal Year 2008 (52 weeks) compared to Fiscal Year 2007 (52 weeks)

 

Restaurant Net Sales

 

 

Restaurant net sales increased 0.1%, or $0.1 million, in fiscal 2008 as compared to fiscal 2007. This increase was due primarily to $3.0 million in net sales at new restaurants not yet in the comparable restaurant base as of December 29, 2008, and $0.9 million in net sales related to restaurants temporarily closed for remodeling during fiscal 2007, almost fully offset by a decline of $2.7 million in net sales related to restaurants closed during and subsequent to fiscal 2007, and a decrease of 0.9%, or approximately $1.1 million, in net sales in our comparable restaurant base. For comparable restaurants in fiscal 2008, our average check increased 1.7% and our transaction count decreased by 2.6%, as compared to fiscal 2007.

 

Franchise Fees and Royalties

 

 

Franchise fees and royalties during fiscal 2008 consist of $2.1 million in royalties from franchise restaurants operated during fiscal 2008 and approximately $0.5 million in fees related to 19 franchise restaurants that opened during fiscal 2008, and approximately $0.5 million in franchise fees related to the termination of two area developer agreements. Franchise fees and royalties during fiscal 2007 consist of $1.3 million in royalties from franchise restaurants operated during fiscal 2007 and $0.8 million in fees related to the 22 franchise restaurants that opened during fiscal 2007.

 

Costs and Expenses

 

 

Cost of Food and Beverage.  The decrease in food and beverage costs as a percentage of net sales during fiscal 2008, as compared to fiscal 2007, is due primarily to menu price increases taken during fiscal 2008 which averaged 2.1% for the year and lower costs associated with promotional menu offerings, partially offset by year-over-year price increases on commodities such as wheat and dairy and dairy-related products and higher fuel costs.

 

 

Restaurant Labor and Related Benefits.  The decrease in restaurant labor and related benefits as a percentage of restaurant net sales during fiscal 2008, as compared to fiscal 2007, is due primarily to our continued efforts to drive more effective labor management during both peak and non-peak hours of operation and lower costs for workers’ compensation insurance.

 

 

Occupancy and Other Restaurant Operating Expenses.  The increase in restaurant occupancy and other restaurant operating expenses as a percentage of restaurant net sales during fiscal 2008, as compared to fiscal 2007, is due primarily to higher utility costs, the deleveraging of occupancy costs against relatively flat sales in our comparable restaurant base and slightly higher costs for repairs and maintenance.

 

 

General and administrative Expenses.  The reduction in general and administrative expenses of $3.0 million during fiscal 2008, as compared to fiscal 2007, is due to labor savings from administrative workforce reductions, lower stock-based compensation costs, lower recruiting costs resulting from our search to select and appoint a permanent Chief Executive Officer during 2007 and lower corporate travel costs, offset by severance costs related to the workforce reductions. In addition, during fiscal 2008, we recorded approximately $2.0 million in charges related to legal settlements.

 

 

Depreciation and Amortization.  The lower depreciation and amortization costs in fiscal 2008, as compared to fiscal 2007, are due primarily to the impact of impairments recorded during and subsequent to the fourth quarter of fiscal 2007, as well as the continued depreciation and amortization of our comparable restaurant base, partially offset by higher depreciation and amortization costs related to one new restaurant opened during fiscal 2008.

 

 

Restaurant Pre-Opening Expenses.  Restaurant pre-opening expenses of $0.1 million during fiscal 2008, relate primarily to occupancy, pre-opening payroll, supplies and training costs for one new restaurant opened during fiscal 2008. During fiscal 2008, 49.5% of restaurant pre-opening expenses were for occupancy costs incurred prior to the opening of the restaurant. Restaurant pre-opening expenses of $0.7 million in fiscal 2007, relate primarily to

occupancy, pre-opening payroll, supplies and training costs for six new restaurants opened during fiscal 2007. During fiscal 2007, 54.8% of restaurant pre-opening expenses were for occupancy costs incurred prior to the opening of the restaurants.

 

 

Provision for Losses on Asset Impairments and Disposals.  During fiscal 2008, we recorded asset impairment charges of $7.1 million related to 16 underperforming locations, most of which were built in 2005 and the first half of 2006. Nine are located in the Midwest region, five in the Mid-Atlantic region and two in the Northeast region, including four locations closed during the first quarter of fiscal 2009. During fiscal 2008, we recorded asset impairment charges of approximately $0.1 million related to Seattle locations that are reported in discontinued operations. The asset impairment charges of $3.8 million recorded in fiscal 2007 are attributable to seven underperforming locations determined to be impaired, including one location that was closed during the third quarter of fiscal 2008. In addition, during fiscal 2007, we recorded impairment charges of $3.4 million related to six Macy’s Inc. (“Macy’s”) and three Seattle locations, which are reported in discontinued operations.

 

 

Closed Store Costs.  Closed store costs during fiscal 2008 relate to two underperforming locations that closed at the expiration of their operating leases during the first quarter of fiscal 2008 and to two additional underperforming locations that closed, one each during the second and third quarters of fiscal 2008. Closed store costs during fiscal 2007 relate to one restaurant in New York City that closed upon the lease expiration and was relocated within the immediate area during the second quarter of fiscal 2007, one underperforming location where the lease expired and we exited the location, and one underperforming location where the lease was scheduled to expire in fiscal 2008 and we negotiated an early exit agreement with the landlord.

 

 

Lease Termination Expense, net.  Lease termination expense during fiscal 2008 is primarily related to a location where we made the decision to not build a restaurant subsequent to entering into a lease and reached an agreement with the landlord to exit the lease, and to three underperforming locations in the Midwest region where we reached early exit agreements with the landlords. One of these underperforming locations was closed during the third quarter of fiscal 2008 and the other two were closed during the first quarter of fiscal 2009. The lease termination expense during fiscal 2007 relates to a location where, due to the enforcement of restrictions in a zoning overlay district, Cosi was denied the necessary permits to build a restaurant and we exercised the exit provision under the lease, and to an underperforming restaurant in Chicago where we exercised an early exit provision of the lease and exited the location in the first quarter of fiscal 2008.

 

Gain on Sale of Assets.  The gain recognized during fiscal 2007 is related to the sale of a liquor license.

 

 

Interest Income and Expense.  The decrease in interest income in fiscal 2008, as compared to fiscal 2007, is due primarily to lower average rates of interest earned on deposit accounts as well as a decline in short-term investments during fiscal 2008. During both fiscal 2008 and fiscal 2007, interest expense was insignificant.

 

 

Other income.  During fiscal 2008, we recorded other income related to a tax refund. Other income during fiscal 2007 is due primarily to a cash settlement on an insurance claim related to a location that we operated in The World Trade Center on September 11, 2001.

 

 

Loss from Continuing Operations.  The decrease in our loss from continuing operations in fiscal 2008, as compared to fiscal 2007, is due primarily to a decrease in general and administrative expenses and higher income from franchise fees and royalties, offset by higher non-cash charges for asset impairments and higher lease termination costs.

 

Discontinued Operations.  During the third quarter of fiscal 2007, the Company reached an agreement with Macy’s relating to six Cosi restaurants operated within Macy’s stores. Under the terms of the agreement, we ceased operations and closed those locations on August 19, 2007.

 

In addition, we sold the assets of three underperforming Company-owned locations that operated in the state of Washington to a local restaurant development company. Under the terms of the agreement, we transferred rights to the assets and leasehold improvements for minimal cash consideration and the new owner assumed the tenant obligations under the real estate operating leases and is operating those locations under a different brand. We ceased operating these restaurants as of the end of the first quarter of fiscal 2008.

 

In accordance with ASC 360-10-45, Property, Plant, Equipment, we have reported the results of operations of this group in discontinued operations in the accompanying consolidated financial statements for all periods presented. During fiscals 2008 and 2007, the operating loss from discontinued operations was $0.2 million and $0.9 million, respectively.

 

In addition, we recorded charges of $0.1 million and $3.4 million during fiscals 2008 and 2007, respectively, related to the impairment of the assets at the Seattle and Macy’s locations, which are also reported in discontinued operations in the accompanying consolidated financial statements.

 

Liquidity and Capital Resources

 

Cash and cash equivalents were approximately $4.1 million on December 28, 2009, compared with $5.6 million on December 29, 2008. We had negative working capital of ($5.6) million on December 28, 2009, compared with negative working capital of ($2.9) million as of December 29, 2008. The decrease in working capital was primarily a function of funding the operating loss for the year. Our principal requirements for cash in 2010 will be for working capital needs and routine maintenance of our existing restaurants.

Net cash used in operating activities during the twelve-month period ended December 28, 2009, was approximately $1.2 million compared to $2.0 million of net cash provided by operating activities in the twelve-month period ended December 29, 2008. The increase in cash used in operating activities during fiscal 2009 was primarily the result of funding our operating loss and the payment of approximately $1.0 million for certain lease termination and legal settlement obligations.

 

Total cash used in investing activities was $0.7 million during fiscal 2009, compared to $2.8 million during fiscal 2008. The year-over-year decrease is due primarily to lower capital expenditures in fiscal 2009 as compared to fiscal 2008. The capital expenditures during fiscal 2009 were primarily for the capital maintenance of our existing Company-owned restaurants. During fiscal 2008 capital expenditures included the construction of one new Company-owned restaurant that opened during the second quarter of fiscal 2008.

 

Cash provided by financing activities during fiscal 2009 of $0.4 million is from the settlement of a claim, in which we recovered short-swing profits realized by a stockholder of the Company under Section 16(b) of the Securities Exchange Act of 1934. During fiscal 2008, cash provided by financing activities of approximately $0.05 million was from proceeds associated with the exercise of stock options.

 

We currently do not expect to open any additional Company-owned restaurants or incur any significant remodeling capital costs during fiscal 2010. However, we do expect to incur capital maintenance costs on existing Company-owned restaurants. As we currently have no credit facility or available line of credit, we expect to fund any required capital maintenance costs on existing Company-owned locations from cash and cash equivalents on hand, expected cash flows generated by existing Company-owned restaurants, expected franchise fees and royalties and from the proceeds of a shareholders rights offering which was successfully completed subsequent to the end of fiscal 2009. The rights offering was completed during the first quarter of fiscal 2010 (see Note 9) and yielded net proceeds of $4.9 million.

 

We believe that our current cash and cash equivalents, the proceeds from the completed rights offering and the expected cash flows from Company-owned restaurant operations and expected franchise fees and royalties will be sufficient to fund our cash requirements for working capital needs and maintenance of existing restaurant locations for the next twelve months. Our conclusion is based on our expected performance for fiscal 2010 and includes a sensitivity analysis that projects varying levels of decline in consumer demand. The range of levels selected was based on our reasonable expectation of demand given the seasonality of our historical performance and the potential impact the current economic environment may have on consumer spending. In analyzing our capital cash outlays during fiscal 2009, 59.1% of our cash outlay was spent on maintenance costs associated with existing Company-owned locations. We currently do not expect significant levels of cash outlays for capital expenditures during fiscal 2010.

 

If our Company-owned restaurants do not generate the cash flow levels that we expect, if new franchised restaurants do not open according to our expectations, if we do not generate the franchise fees and royalties that we currently expect, if we incur significant unanticipated cash requirements beyond our normal liquidity needs, or if we experience other unforeseen circumstances then, in order to fund our cash requirements, we may have to effect further labor reductions in general and administrative support functions, seek to sell certain Company-owned locations to franchisees and/or other third parties, seek other sources of financing or take other actions necessitated by the impact of such unanticipated circumstances.

 

There can be no assurance that we will be able to obtain such financing, sell Company-owned locations to franchisees or other third parties or that we will be able to do so in a timely manner and on acceptable terms to meet our requirements. If the prevailing instability in the credit and financial markets continues, it may be more difficult for the Company to obtain additional financing and for franchisees to obtain financing necessary to open restaurants or to acquire Company-owned locations. An inability to access additional sources of liquidity to fund our cash needs could materially adversely affect our financial condition and results of operations.

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements, that have or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

 

Selected Quarterly Financial Data

 

Quarterly results are determined in accordance with the accounting policies used for annual data and include certain items based upon estimates for the entire year. All quarters in fiscal 2009 and 2008 include results for 13 weeks. The unaudited selected quarterly results for fiscal 2009 and 2008 are shown below: