Attached files

file filename
EX-31.1 - EXHIBIT 31.1 - COSI INCex31_1.htm
EX-31.2 - EXHIBIT 31.2 - COSI INCex31_2.htm
EX-32.1 - EXHIBIT 32.1 - COSI INCex32_1.htm
EXCEL - IDEA: XBRL DOCUMENT - COSI INCFinancial_Report.xls

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

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the quarterly period ended September 29, 2014

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the transition period from _____to _____

Commission File No. 000-50052

COSÌ, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
06-1393745
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

294 Washington Street, Suite 510
Boston, Massachusetts, 02108
(Address of principal executive offices) (Zip Code)

(857) 415-5000
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 shorter period that the registrant was required to submit and post such files). Yes x No o

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o
Non-Accelerated filer o
Smaller reporting company x

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

Number of shares of Common Stock, $.01 par value, outstanding as of November 7, 2014: 25,016,887
 


COSI, INC.

Index to Form 10-Q
For the nine-month period ended September 29, 2014

 
PART I.   FINANCIAL INFORMATION
Page Number
     
Item 1.
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7-13
     
Item 2.
14-31
     
Item 3.
32
     
Item 4.
32
     
PART II. OTHER INFORMATION
 
     
Item 1.
33
     
Item 1A.
33
     
Item 5.
33
     
34
     
35
     
CERTIFICATIONS
36-38

2

PART I.   FINANCIAL INFORMATION

Item 1.
Financial Statements

Cosi, Inc.
Consolidated Balance Sheets
As of September 29, 2014 and December 30, 2013
(dollars in thousands)

   
September 29,
2014
   
December 30,
2013
 
Assets
       
Current assets:
       
Cash and cash equivalents
 
$
6,113
   
$
6,021
 
Accounts receivable, net
   
799
     
594
 
Notes receivable, current portion
   
551
     
551
 
Inventories
   
768
     
779
 
Prepaid expenses and other current assets
   
454
     
1,348
 
Total current assets
   
8,685
     
9,293
 
                 
Furniture and fixtures, equipment and leasehold improvements, net
   
6,768
     
8,195
 
Other assets
   
1,411
     
1,115
 
Total assets
 
$
16,864
   
$
18,603
 
                 
Liabilities and Stockholders' Equity
               
Current liabilities:
               
Accounts payable
 
$
3,023
   
$
2,462
 
Accrued expenses
   
6,591
     
9,088
 
Deferred franchise revenue
   
18
     
18
 
Current portion of other long-term liabilities
   
497
     
196
 
Total current liabilities
   
10,129
     
11,764
 
                 
Long-term debt
   
6,154
     
-
 
Deferred franchise revenue
   
1,966
     
1,931
 
Other long-term liabilities, net of current portion
   
1,530
     
2,189
 
Total liabilities
   
19,779
     
15,884
 
                 
Stockholders' deficit:
               
Common stock - $.01 par value; 100,000,000 shares authorized, 24,547,257 and 18,106,979 shares issued, respectively
   
245
     
181
 
Additional paid-in capital
   
303,571
     
297,181
 
Treasury stock, 59,886 shares at cost
   
(1,198
)
   
(1,198
)
Accumulated deficit
   
(305,533
)
   
(293,445
)
Total stockholders' (deficit) equity
   
(2,915
)
   
2,719
 
Total liabilities and stockholders' (deficit) equity
 
$
16,864
   
$
18,603
 

The accompanying notes are an integral part of these consolidated financial statements.
 

3

Cosi, Inc.
Consolidated Statements of Operations and Comprehensive Loss
For the Three and Nine Month Periods Ended September 29, 2014 and September 30, 2013
(dollars in thousands, except share and per share data)

   
Three Months Ended
   
Nine Months Ended
 
   
September 29,
2014
   
September 30,
2013
   
September 29,
2014
   
September 30,
2013
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Revenues:
               
Restaurant net sales
 
$
18,574
   
$
20,602
   
$
56,309
   
$
64,112
 
Franchise fees and royalties
   
635
     
810
     
1,945
     
2,269
 
Total revenues
   
19,209
     
21,412
     
58,254
     
66,381
 
                                 
Costs and expenses:
                               
Cost of food and beverage
   
5,087
     
5,177
     
14,624
     
15,900
 
Restaurant labor and related benefits
   
7,114
     
8,172
     
21,640
     
24,480
 
Occupancy and other restaurant operating expenses
   
6,816
     
7,231
     
20,896
     
21,900
 
     
19,017
     
20,580
     
57,160
     
62,280
 
General and administrative expenses
   
3,110
     
2,565
     
9,164
     
8,463
 
Depreciation and amortization
   
573
     
674
     
1,812
     
2,094
 
Restaurant pre-opening expenses
   
-
     
18
     
-
     
29
 
Provision for losses on asset impairments and disposals
   
317
     
5
     
437
     
699
 
Lease termination expense and closed store costs
   
62
     
34
     
1,317
     
181
 
Gain on sale of assets
   
-
     
-
     
(50
)
   
-
 
Total costs and expenses
   
23,079
     
23,876
     
69,840
     
73,746
 
                                 
Operating loss
   
(3,870
)
   
(2,464
)
   
(11,586
)
   
(7,365
)
                                 
Interest expense
   
(335
)
   
-
     
(574
)
   
-
 
Other income
   
57
     
9
     
72
     
34
 
                                 
Net loss and comprehensive loss
 
$
(4,148
)
 
$
(2,455
)
 
$
(12,088
)
 
$
(7,331
)
                                 
Per Share Data:
                               
Loss per share, basic and diluted
 
$
(0.20
)
 
$
(0.14
)
 
$
(0.64
)
 
$
(0.41
)
                                 
Weighted average shares outstanding
   
20,334,567
     
18,012,465
     
18,846,038
     
17,983,620
 

The accompanying notes are an integral part of these consolidated financial statements.
 
4

Cosi, Inc.
Consolidated Statement of Stockholders' Equity
For the Nine Months Ended Septmeber 29, 2014
(unaudited)
(dollars in thousands, except share data)

   
   
Common Stock
   
Treasury Stock
         
   
Number of
Shares
   
Amount
   
 
Additional
Paid In
Capital
   
Number of
Shares
   
Amount
   
Accumulated
Deficit
   
Total
 
                             
Balance, December 30, 2013
   
18,106,979
   
$
181
   
$
297,181
     
59,886
   
$
(1,198
)
 
$
(293,445
)
 
$
2,719
 
                                                         
Issuance of common stock (1)
   
3,889,613
     
39
     
4,434
     
-
     
-
     
-
     
4,473
 
Issuance of restricted stock, net
   
1,374,064
     
14
     
(14
)
   
-
     
-
     
-
     
-
 
Stock-based compensation
   
76,601
     
-
     
399
     
-
     
-
     
-
     
399
 
Issuance of stock warrants (2)
   
-
     
-
     
1,571
     
-
     
-
     
-
     
1,571
 
Exercise of warrants to purchase common stock (3)
   
1,100,000
     
11
     
-
     
-
     
-
     
-
     
11
 
Net loss
   
-
     
-
     
-
     
-
     
-
     
(12,088
)
   
(12,088
)
                                                         
Balance, September 29, 2014
   
24,547,257
   
$
245
   
$
303,571
     
59,886
   
$
(1,198
)
 
$
(305,533
)
 
$
(2,915
)

(1)
Represents proceeds from Stock Purchase Agreement for the purchase of approximately 3.9 million of unregistered shares completed on August 22, 2014
 
(2)
Represents the relative value of proceeds from issuance of Senior Secured Promissory Notes and related stock warrants for MILFAM II L.P. and AB Opportunity Fund LLC & AB Value Partners L.P., of $1,027 and $544, respectively, as of the issuance date
 
(3)
Represents proceeds exercise of warrants in order to purchase 1.1 million of unregistered shares completed on September 16, 2014
 
5

Cosi, Inc.
Consolidated Statements of Cash Flows
For the Nine-Month Periods Ended September 29, 2014 and September 30, 2013
(dollars in thousands)
 
   
September
29, 2014
   
September
30, 2013
 
   
(Unaudited)
   
(Unaudited)
 
Cash flows from operating activities:
       
Net loss
 
$
(12,088
)
 
$
(7,331
)
Adjustments to reconcile net loss to net cash used in operating activities
               
Depreciation and amortization
   
1,812
     
2,094
 
Non-cash portion of asset impairments and disposals
   
336
     
699
 
Provision for bad debts
   
(7
)
   
32
 
Stock-based compensation expense
   
399
     
61
 
Interest expense
   
574
     
-
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(195
)
   
568
 
Notes receivable
   
-
     
40
 
Inventories
   
11
     
29
 
Prepaid expenses and other current assets
   
898
     
1,135
 
Other assets
   
-
     
(74
)
Accounts payable and accrued expenses
   
(1,934
)
   
(2,480
)
Deferred franchise revenue
   
-
     
(18
)
Lease termination accrual
   
340
     
(8
)
Other liabilities
   
(964
)
   
(242
)
Net cash used in operating activities
   
(10,818
)
   
(5,495
)
                 
Cash flows from investing activities:
               
Capital expenditures
   
(721
)
   
(1,670
)
Proceeds from sale of assets
   
50
     
-
 
Net cash used in investing activities
   
(671
)
   
(1,670
)
                 
Cash flows from financing activities:
               
Proceeds from issuance of long-term debt
   
7,500
     
-
 
Proceeds from issuance of common stock
   
4,473
     
-
 
Proceeds from exercise of warrants to purchase common stock
   
11
     
-
 
Long-term debt issuance costs
   
(403
)
   
-
 
Net cash provided by financing activities
   
11,581
     
-
 
                 
Net increase (decrease) in cash and cash equivalents
   
92
     
(7,165
)
Cash and cash equivalents, beginning of period
   
6,021
     
15,417
 
Cash and cash equivalents, end of period
 
$
6,113
   
$
8,252
 
                 
Supplemental disclosure of cash flow information:
               
Cash paid for:
               
Interest
 
$
-
   
$
-
 
Corporate franchise and income taxes
 
$
211
   
$
86
 
                 
Non-cash financing activities:
               
Issuance of stock warrants
 
$
1,571
   
$
-
 

The accompanying notes are an integral part of these consolidated financial statements.
 
6

COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 – Basis of Presentation

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the requirements of Form 10-Q and, therefore, they do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  In our opinion, the financial statements reflect all adjustments that are necessary for a fair presentation of the results of operations for the periods shown. All such adjustments are of a normal recurring nature. In preparing financial statements in conformity with U.S. GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates.

As used in this quarterly report on Form 10-Q, unless the context requires otherwise, the terms “we,” “our,” “Company” or “Cosi” refer to Cosi, Inc. and its consolidated subsidiaries.

The balance sheet at December 30, 2013 has been derived from audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

The results for the three and nine-month periods ended September 29, 2014 and September 30, 2013 are not indicative of the results for the full fiscal year.

This report should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 30, 2013, as filed with the Securities and Exchange Commission (“SEC”).

There have been no material changes to our significant accounting policies and estimates from the information provided in Note 1 of our consolidated financial statements included in our Form 10-K for the fiscal year ended December 30, 2013.

Note 2 – Stock-Based Compensation Expense

A summary of non-cash, stock-based compensation expense is as follows:

   
For the Three Months Ended
   
For the Nine Months Ended
 
   
(in thousands)
   
(in thousands)
 
   
September 29,
2014
   
September 30,
2013
   
September 29,
2014
   
September 30,
2013
 
                 
Stock option compensation expense
 
$
-
   
$
-
   
$
-
   
$
6
 
Restricted stock compensation expense (credit), net of forfeitures
   
100
     
66
     
399
     
55
 
Total non-cash, stock-based compensation expense (credit), net of forfeitures
 
$
100
   
$
66
   
$
399
   
$
61
 

As of September 29, 2014, the unrecognized compensation expense related to stock options and restricted shares of common stock granted under the Cosi, Inc. 2005 Omnibus Long-Term Incentive Plan, as amended, which was amended and restated as of August 26, 2014 (the “2005 Plan”), was approximately $1.0 million and is being recognized on a straight-line basis over the remaining vesting period through fiscal 2018.
 
Pursuant to the 2005 Plan and in accordance with the terms and conditions prescribed by the Compensation Committee of our Board of Directors, we granted 170,000 shares of restricted common stock to key employees during the third quarter of 2014, of which 50% of the shares vest over time (“Time-Vested Shares”) and 50% of the shares vest based on performance (“Performance-Vested Shares”), which based on the schedules set forth on the following page.
 
7

During the nine months ended September 29, 2014, we granted 1,374,064 shares of restricted common stock to key employees.  The vesting of 200,000 of these shares occurs as follows: (i) 50% of the grant vested on the grant date and (ii) the remaining 50% vest in four equal quarterly installments through March 2015 provided that at each such date the employee continues to be employed by the Company.  The rest of the shares granted during the nine months of fiscal 2014 are subject to the following vesting schedules:

(a)           Time-Vested Shares vest in four equal installments, with 25% vesting on each of the first, second, third and fourth anniversaries of the date of grant, provided that the employee remains in the continuous employ of the Company through each such vesting date.

(b)          Performance-Vested Shares vest in four equal installments, provided that the employee remains in the continuous employment of the Company from and after the date of award and through the respective vesting dates set forth below and the specified price targets set forth below for the Company’s common stock are achieved:
 
(i) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $2.00 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events);

(ii) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $2.50 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events);

(iii) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $3.00 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events); and

(iv) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $4.00 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events).

The value of the shares for the grants made during the third quarter of fiscal 2014, based on the closing price of our common stock on the date of the grants, was approximately $0.2 million.

In the three months ended September 29, 2014, we issued 74,850 of our restricted common stock to members of the Board of Directors under the 2005 Plan and pursuant to the Non-Employee Directors Stock Incentive Plan. These shares had an aggregate value of approximately $0.1 million in 2014 and vested upon issuance.  We did not grant any shares of common stock to employees or members of the Board of Directors in the three months ended September 30, 2013.
 
In the nine months ended September 29, 2014 and September 30, 2013, we issued 76,601 and 44,640 shares, respectively, of our restricted common stock to members of the Board of Directors under the 2005 Plan and pursuant to the Non-Employee Directors Stock Incentive Plan. These shares had an aggregate value of approximately $0.1 million in both the nine months ended September 29, 2014 and September 30, 2013 and vested upon issuance.
 
During the three months ended September 29, 2014 and September 30, 2013, 77,475 and 2,000 shares, respectively, of previously issued restricted common stock were forfeited. The value of the forfeited shares, based on the closing price of our common stock on the date of the grants, was approximately $0.1 million in the third quarter of 2014 and was immaterial in the third quarter of 2013.
 
During the nine months ended September 29, 2014 and September 30, 2013, 77,575 and 256,725 shares, respectively, of previously issued restricted common stock were forfeited. The value of the forfeited shares, based on the closing price of our common stock on the date of the grants, was immaterial in the nine months ended September 29, 2014 and approximately $0.7 million in the nine months ended September 30, 2013.

Note 3 –Fair Value Measurements
 
The Company’s 550,000 stock warrants at September 29, 2014 have been valued as of the issuance date at $0.7 million based on the Black-Scholes model. Inputs into the warrant valuation include expected life of warrants, risk-free interest rates, and stock volatility. As all significant inputs are market-based and observable, warrants are categorized in Level 2 of the fair value hierarchy.
 
8

Note 4 – Earnings Per Share

   
For the Three Months Ended
   
For the Nine Months Ended
 
   
(net loss in thousands)
   
(net loss in thousands)
 
   
September 29, 2014
   
September 30, 2013
   
September 29, 2014
   
September 30, 2013
 
Net loss and comprehensive loss
 
$
(4,148
)
 
$
(2,455
)
 
$
(12,088
)
 
$
(7,331
)
Shares:
                               
Weighted average number of shares outstanding
   
20,334,567
     
18,012,465
     
18,846,038
     
17,983,620
 
                                 
Basic and diluted loss per share
 
$
(0.20
)
 
$
(0.14
)
 
$
(0.64
)
 
$
(0.41
)
 
Basic and diluted loss per common share is calculated by dividing the net loss by the weighted average common shares outstanding during the period. As of September 29, 2014 and September 30, 2013, there were 1,175,064 and 17,575 unvested restricted shares of common stock outstanding, respectively, and 3,750 and 53,652 out-of-the-money stock options to purchase shares of common stock, respectively. In addition, as of September 29, 2014, there were 550,000 of outstanding warrants to purchase shares of common stock. The unvested restricted shares and the outstanding stock options and warrants meet the requirements for participating securities but were not included in the computation of basic and diluted earnings per share because we incurred a net loss in all periods presented and, hence, the impact would be anti-dilutive.
 
Note 5 – Asset Impairments

In accordance with FASB Accounting Standards Codification Topic 360 (ASC Topic 360), Property, Plant & Equipment, we evaluate possible impairments 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 period before they enter the comparable restaurant base, unless specific circumstances warrant otherwise.

We did not record any impairment charges during the three and nine months ended September 29, 2014. Additionally, during the three months ended September 30, 2013, we did not record any impairment charges.  During the nine months ended September 30, 2013, we recorded asset impairment charges of approximately $0.7 million.

Note 6 – Lease Termination Costs

Future restaurant closings, if any, resulting from our decision to close underperforming locations prior to their scheduled lease expiration dates may result in additional lease termination charges. 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. We recognize costs associated with exit or disposal activities at the time a commitment to an exit or disposal plan is communicated to the landlord.
 
During the nine months ended September 29, 2014, the Company incurred and recorded $1.3 million of lease termination charges that relate to the closing of 10 Company-owned restaurants.  The lease termination costs that we recorded during the three months ended September 29, 2014 were not material as a majority of the costs had been accrued during the second quarter of 2014.
 
9

Note 7 – Contingencies

From time to time, we are a defendant in litigation arising in the ordinary course of our business. As of the date of this report, there are no legal proceedings that would require accrual or disclosure under ASC 450. We cannot predict with certainty the outcome of any litigation or the potential for future litigation. Regardless of the outcome of any particular litigation and the merits of any particular claim, litigation can have a material adverse impact on our Company due to, among other reasons, any injunctive relief granted, which could inhibit our ability to operate our business, amounts paid as damages or in settlement of any such matter, diversion of management resources and defense costs.

Note 8 – 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.
 
As of December 30, 2013, we had net operating loss (“NOL”) carryforwards of approximately $226.0 million for U.S. federal income tax purposes. Under the Internal Revenue Code, an “ownership change” with respect to a corporation can significantly limit the amount of pre-ownership change NOLs and certain other tax assets that the corporation may utilize after the ownership change to offset future taxable income, possibly reducing the amount of cash available to the corporation to satisfy its obligations. An ownership change generally would occur if the aggregate stock ownership of holders of at least 5% of our stock increases by more than 50 percentage points over the preceding three-year period. We do not believe the sale of common stock that we completed as of August 22, 2014 (see Note 9), the exercise of MILFAM’s right to purchase 1.1 million shares of the Company’s common stock completed on September 16, 2014 (see Note 10), or the rights offering and related sale of common stock that we completed in fiscal year 2012 has triggered an ownership change. In addition, a limitation would not have an impact on our consolidated financial statements as we have recorded a valuation allowance for the entire amount of our deferred tax assets.  The purchase of shares of our common stock pursuant to the registration statement on Form S-1 that we filed on September 26, 2014 for a rights offering to our existing shareholders may trigger an ownership change with respect to our stock (see Note 11).

We adopted ASC 740-10, Income Taxes, which prescribes a comprehensive financial statement model of how a company should recognize, measure, present and disclose uncertain tax positions that the company has taken or expects to take in its income tax returns. The standard requires that only income tax benefits that meet the “more likely than not” recognition threshold be recognized or continue to be recognized on the effective date. Initial recognition amounts would have been reported as a cumulative effect of a change in accounting principle.

Should the Company need to accrue interest or penalties on uncertain tax positions, it would recognize the interest as interest expense and the penalties as a general and administrative expense.

Due to our unexpired NOLs, Cosi could be subject to IRS income tax examination for the tax year 1996 and all subsequent years. We could also be subject to state income tax examinations in certain states where we have unexpired NOLs.
 
10

Note 9 – Stock Purchase Agreement
 
On August 22, 2014, the Company sold 3,367,874 unregistered shares of the Company’s common stock, par value of $0.01 per share, at a purchase price of $1.15 per share to Plaisance Fund, LP, a fund managed by Janus Capital Management LLC, for gross proceeds of $3,873,055 and concurrently therewith sold 521,739 unregistered shares of the Company’s common stock, par value of $0.01 per share, at a purchase price of $1.15 per share to Lloyd I. Miller Trust C for gross proceeds of $600,000.
 
Note 10 – Debt
 
On April 14, 2014, the Company entered into a $5.0 million Senior Secured Promissory Note Agreement with MILFAM II L. P. (the “MILFAM Note” and the “MILFAM Note Agreement”, respectively). The MILFAM Note bears interest at nine percent (9%) per annum, compounded semi-annually, and payable in arrears on a semi-annual basis. At the Company’s option, the first two semi-annual interest payments may be paid at eleven percent (11%) in kind in the form of additional promissory notes. The principal obligations under the MILFAM Note are due three (3) years from the effective date of the MILFAM Note. The MILFAM Note Agreement provided for the payment of a finance fee of 3.5% of the principal amount of the MILFAM Note at closing as well as providing a warrant exercisable to purchase up to 1.1 million shares of the Company’s common stock at an exercise price per share of $0.01. The warrant would not be exercisable to the extent that doing so resulted in the MILFAM and any related parties, in the aggregate, owning more than 19.9% of the Company’s common stock. Further, until all of the obligations under the MILFAM Note are paid in full, MILFAM will have the right to participate in any future financing transactions consummated by the Company in an amount up to the greater of 1) the then-outstanding balance of obligations under the MILFAM Note and 2) $4.0 million. The MILFAM Note is guaranteed by the Company’s subsidiaries and secured by a lien on all assets of the Company and its subsidiaries. Mr. Lloyd I. Miller, III, is the manager of MILFAM LLC, which is the general partner of MILFAM.  Mr. Miller is also a significant shareholder of the Company.
 
On September 16, 2014, 1.1 million of the warrants provided under the MILFAM Note Agreement were exercised in order to purchase 1.1 million unregistered shares of the Company’s common stock at an exercise price of $0.01 per share, resulting in an aggregate purchase price of $11,000.  At June 30, 2014, the Company’s 1,650,000 stock warrants included the 1.1 million provided under the MILFAM Note Agreement and were carried at a fair value as of the issuance date of approximately $1.3 million based on the Black-Scholes model using the following assumptions:
 
Expected life (in years)
   
3
 
         
Volatility
   
63.86
%
         
Risk Free interest rate
   
81.83
%
         
Dividend yield (on comon stock)
   
0
 

As of the issuance date, the relative value of the warrants was $1.0 million, which was the amount recorded as debt discount, with an offset to additional paid-in capital. The debt discount will be amortized over the life of the Notes, three years, and charged to interest expense using the effective interest rate calculation method.
 
On May 20, 2014, the Company entered into a $2.5 million Senior Secured Note Purchase Agreement with AB Opportunity Fund LLC and AB Value Partners, L.P. (the “AB Notes”, the “AB Note Agreement”, and the “AB Entities”, respectively). The AB Notes are payable in full on the third anniversary from the effective date of the AB Notes. Interest will accrue at the rate of nine percent (9%), compounded semi-annually, and will be paid in arrears semi-annually, provided that the Company, at its option, may elect to pay the first two semi-annual interest payments at a rate of eleven percent (11%) in kind in the form of additional promissory notes. As consideration for the AB Notes, the Company provided a fee of 3.5% of the principal amount of the AB Notes and warrants exercisable to purchase up to an aggregate, initially, of 550,000 shares of the common stock of the Company at an exercise price per share of $.01, provided that the AB Entities would not be permitted to exercise the warrants to the extent such exercise would result in any of the AB Entities or any of their affiliates owning in excess of 19.9% of the common stock of the Company. The warrants were exercisable by the AB Entities at any time prior to the third anniversary from the effective date of the AB Notes, in whole or in part, by surrendering the warrants and a form of exercise to the Company.  On October 14, 2014, subsequent to the end of the third quarter of 2014, 550,000 of the warrants provided under the AB Note Purchase Agreement were exercised by the cashless exercise method (see Note 13).
 
11

We are currently in compliance with all covenant requirements under the MILFAM and AB Note Agreements.

The Company’s 550,000 stock warrants at September 29, 2014 were carried at their fair value as of the issuance date of approximately $0.7 million based on the Black-Scholes model using the following assumptions:
 
Expected life (in years)
3
   
Volatility
63.86%
   
Risk Free interest rate
81.83%
   
Dividend yield (on comon stock)
0

As of the issuance date, the relative value of the warrants was $0.5 million, which was the amount recorded as debt discount, with an offset to additional paid-in capital. The debt discount will be amortized over the life of the Notes, three years, and charged to interest expense using the effective interest rate calculation method.

Note 11 – Planned Rights Offering
 
On September 26, 2014, the Company filed a registration statement on Form S-1 with the SEC for a rights offering to our existing shareholders.  The Company plans to make the rights offering through the distribution of non-transferable subscription rights to purchase shares of our common stock, par value $0.01 per share, at a subscription price of $1.50 per share and subject to an aggregate ownership limitation equal to 19.9% of our issued and outstanding common stock.  Assuming all shares of common stock offered are sold, the gross proceeds from the rights offering will be approximately $20 million.  We are conducting the rights offering to raise capital that we intend to use for general corporate purposes, which may include funding our growth plan, working capital and capital expenditures, including initiatives to propel sales growth in our restaurants, such as investing in technology, including remote ordering, POS system upgrade, and initiatives to increase through-put efficiencies; upgrading equipment and furnishings, and refreshing our restaurants; construction of a new restaurant in Chicago scheduled to open in December of 2014; and funding our operations until we become cash flow positive from operations (excluding capital expenditures).  We may also use the proceeds from the rights offering to pay the MILFAM Note ($5,000,000) and AB Notes ($2,500,000) as well as the debt that we may incur in connection with the potential acquisition of Hearthstone Associates, Inc. ($10,421,057).
 
The rights offering also includes an over-subscription privilege, which will entitle each rights holder that exercises all of its basic subscription privilege in full the right to purchase additional shares of common stock that remain unsubscribed at the expiration of the rights offering, subject to the availability and pro rata allocation of shares among persons exercising this over-subscription right.

The registration statement relating to the securities became effective on November 7, 2014.  The rights will be issued to all shareholders as of the record date of October 31, 2014 at a price of $1.50 per share.

Note 12 – Notice of Compliance with Nasdaq Listing Standards
 
On September 15, 2014, the Company announced that it had received notice from the Listing Qualifications Department of the Nasdaq Capital Market that the Company had regained compliance with the Nasdaq Listing Standards by curing the Company’s deficiency in minimum $2.5 million shareholders’ equity, $35 million market value in listed securities or $500,000 of net income from continuing operations requirements for the Nasdaq Capital Market as set forth in Listing Rules 5550(b).  As of September 11, 2014, for the prior 10 consecutive business days, the Company’s market value of listed securities had been $35 million or greater.  The Company now meets the continued listing standards for the Nasdaq Capital Market and no further action is required.
 
12

 
As previously disclosed, on May 16, 2014, the Company received notice from the Listing Qualifications Department of the Nasdaq Stock Market indicating that as of the date of the filing of our Form 10-Q for the period ended March 31, 2014, we had fallen below the $2.5 million minimum level of stockholders equity required for continued listing on the Nasdaq Capital Market under Nasdaq Listing Rule 5550(b)(1).  The notification letter stated that the Company would be afforded 45 calendar days, or until June 14, 2014, to submit a plan to regain compliance and that if the plan was accepted, the Company may be granted an extension of up to 180 calendar days from the date of notification, or until November 12, 2014 to evidence compliance.
 
Also, as previously disclosed, on July 25, 2014, the Listing Qualifications Department of the Nasdaq Stock Market notified the Company of its determination to grant the Company an extension of time to regain compliance with the Nasdaq Listing Rule 5550(b)(1) for a minimum level of stockholders equity based on review of a plan submitted by the Company. The plan consisted of raising capital through an equity transaction, such as a rights offering, private placement, public offering or other equity or debt transactions. The Company had until November 12, 2014 to evidence compliance with the Nasdaq continued listing requirements.

Note 13 – Subsequent Event
 
On October 14, 2014, subsequent to the end of the third quarter 2014, 550,000 of the warrants provided under the AB Note Agreement were exercised using the cashless exercise method, in order to purchase 547,105 unregistered shares of the Company’s common stock at an exercise price of $0.01 per share, resulting in the surrender of 2,895 shares for an aggregate purchase price of $5,500.
13

Item 2:
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations for the fiscal quarters ended September 29, 2014 and September 30, 2013 should be read in conjunction with “Selected Consolidated Financial Data” and our audited consolidated financial statements and the notes to those statements that are in our 2013 Annual Report on Form 10-K. 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 Quarterly Report.

OVERVIEW

System-wide restaurants:

   
For the Three Months Ended
 
   
September 29, 2014
   
September 30, 2013
 
   
Company-
Owned
   
Franchise
   
Total
   
Company-
Owned
   
Franchise
   
Total
 
                         
Restaurants at beginning of period
   
66
     
48
     
114
     
74
     
50
     
124
 
New restaurants opened
   
-
     
-
     
-
     
-
     
3
     
3
 
Franchise-owned converted to Company-owned
   
1
     
1
     
-
     
-
     
-
     
-
 
Restaurants permanently closed
   
4
     
-
     
4
     
2
     
2
     
4
 
Restaurants at end of period
   
63
     
47
     
110
     
72
     
51
     
123
 
                                                 
   
For the Nine Months Ended
 
   
September 29, 2014
   
September 30, 2013
 
   
Company-
Owned
   
Franchise
   
Total
   
Company-
Owned
   
Franchise
   
Total
 
                                                 
Restaurants at beginning of period
   
70
     
52
     
122
     
75
     
50
     
125
 
New restaurants opened
   
-
     
-
     
-
      -      
3
     
3
 
Franchise-owned converted to Company-owned
   
3
     
3
     
-
     
-
     
-
     
-
 
Restaurants permanently closed
   
10
     
2
     
12
     
3
     
2
     
5
 
Restaurants at end of period
   
63
     
47
     
110
     
72
     
51
     
123
 

As of September 29, 2014, there were 63 Company-owned restaurants and 47 franchise-owned restaurants operating in 16 states, the District of Columbia, the United Arab Emirates (“UAE”), and Costa Rica. During the three months ended September 29, 2014, we closed four Company-owned restaurants. During the same period, one franchise-owned restaurant was converted to Company-owned.  During the three months ended September 30, 2013, three new franchise-owned restaurants opened.  During that same period, two Company-owned and two franchise-owned restaurants closed.
 
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, made-to-order hot and cold sandwiches, hand-tossed salads, bowls, breakfast wraps, Squagels®, flatbread pizzas, S’mores and other desserts, and a variety of coffees and hand-crafted beverages, bottled beverages including premium still and sparkling water, teas, alcoholic beverages, and other specialty coffees and beverages. Our restaurants offer lunch and afternoon coffee in a counter-service format, with most offering breakfast and/or dinner, snack and dessert menus as well.
 
14

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. The initial franchise fee, payable to us, by both an area developer and an individual franchise operator, is $40,000 for the first restaurant and $35,000 for each additional restaurant.
 
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 franchise-owned restaurants) will always be an important part of our new restaurant growth.
 
We also continue to explore strategic opportunities with our Cosi Pronto® (our grab-and-go concept) and full-service concepts in educational establishments, airports, train stations, hospitals and other public venues that meet our operating and financial criteria.

Recent Developments
 
Stock Purchase Agreement
On August 22, 2014, the Company sold 3,367,874 unregistered shares of the Company’s common stock, par value of $0.01 per share, at a purchase price of $1.15 per share to Plaisance Fund, LP, a fund managed by Janus Capital Management LLC, for gross proceeds of $3,873,055 and concurrently therewith sold 521,739 unregistered shares of the Company’s common stock, par value of $0.01 per share, at a purchase price of $1.15 per share to Lloyd I. Miller Trust C for gross proceeds of $600,000.

Notice of Compliance with Nasdaq Listing Standards
On September 15, 2014, the Company announced that it had received notice from the Listing Qualifications Department of the Nasdaq Capital Market that the Company had regained compliance with the Nasdaq Listing Standards by curing the Company’s deficiency in minimum $2.5 million shareholders’ equity, $35 million market value in listed securities or $500,000 of net income from continuing operations requirements for the Nasdaq Capital Market as set forth in Listing Rules 5550(b).  As of September 11, 2014, for the prior 10 consecutive business days, the Company’s market value of listed securities had been $35 million or greater.  The Company now meets the continued listing standards for the Nasdaq Capital Market and further action is not required.

MILFAM II L. P. Exercise of Warrants to Purchase Common Stock
On September 16, 2014, 1.1 million of the warrants provided under the MILFAM Note Agreement were exercised in order to purchase 1.1 million unregistered shares of the Company’s common stock at an exercise price of $0.01 per share, resulting in an aggregate purchase price of $11,000.

Planned Rights Offering
On September 26, 2014, the Company filed a registration statement on Form S-1 with the SEC for a rights offering to our existing shareholders.  The Company plans to make the rights offering through the distribution of non-transferable subscription rights to purchase shares of our common stock, par value $0.01 per share, at a subscription price of $1.50 per share and subject to an aggregate ownership limitation equal to 19.9% of our issued and outstanding common stock.  Assuming all shares of common stock offered are sold, the gross proceeds from the rights offering will be approximately $20 million.  We are conducting the rights offering to raise capital that we intend to use for general corporate purposes, which may include funding our growth plan, working capital and capital expenditures, including initiatives to propel sales growth in our restaurants, such as investing in technology, including remote ordering, POS system upgrade, and initiatives to increase through-put efficiencies; upgrading equipment and furnishings, and refreshing our restaurants; construction of a new restaurant in Chicago scheduled to open in December of 2014; and funding our operations until we become cash flow positive from operations (excluding capital expenditures).  We may also use the proceeds from the rights offering to pay the MILFAM Note ($5,000,000) and AB Notes ($2,500,000) as well as the debt that we may incur in connection with the potential acquisition of Hearthstone Associates, Inc. ($10,421,057).
 
15

 
The proposed rights offering will also include an over-subscription privilege, which will entitle each rights holder that exercises all of its basic subscription privilege in full the right to purchase additional shares of common stock that remain unsubscribed at the expiration of the rights offering, subject to the availability and pro rata allocation of shares among persons exercising this over-subscription right.

The registration statement relating to the securities became effective as of November 7, 2014.  The rights will be issued to all shareholders as of the record date of October 31, 2014 at a price of $1.50 per share.
 
Critical Accounting Policies

Our discussion and analysis of our consolidated financial condition and results of operations are based upon the consolidated financial statements and notes to the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of the consolidated financial statements requires us to make estimates, judgments 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 requires 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. There have been no material changes in the application of our most critical accounting policies and estimates, judgments and assumptions during the third quarter of 2014.

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 420-10-30 Exit or Disposal Cost Obligations requires companies to recognize a liability for the costs associated with an exit or disposal activity at the time a lease termination commitment is made and communicated to the landlord. 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 840-10-25 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 840-10-25 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.
 
16

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 and warrants 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.

Income Taxes: We have recorded a full valuation allowance to reduce our deferred tax assets that relate primarily to net operating loss carry-forwards. 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 carry-forwards 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.
 
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 for the period any restaurant that is temporarily shut down for remodeling during that period. As of September 29, 2014 and September 30, 2013, there were 59 and 72 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.
 
17

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.
 
18

RESULTS OF OPERATIONS

Our operating results for the three and nine-month periods ended September 29, 2014 and September 30, 2013, expressed as a percentage of total revenues (except where otherwise noted), were as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
September
29, 2014
   
September
30, 2013
   
September
29, 2014
   
September
30, 2013
 
                 
Revenues:
               
Restaurant net sales
   
96.7
%
   
96.2
%
   
96.7
%
   
96.6
%
Franchise fees and royalties
   
3.3
     
3.8
     
3.3
     
3.4
 
Total revenue
   
100.0
     
100.0
     
100.0
     
100.0
 
Cost and expenses:
                               
Cost of food and beverage (1)
   
27.4
     
25.1
     
26.0
     
24.8
 
Restaurant labor and related benefits (1)
   
38.3
     
39.7
     
38.4
     
38.2
 
Occupancy and other restaurant operating expenses (1)
   
36.7
     
35.1
     
37.1
     
34.1
 
     
102.4
     
99.9
     
101.5
     
97.1
 
General and administrative expenses
   
16.2
     
12.0
     
15.7
     
12.7
 
Depreciation and amortization
   
3.0
     
3.1
     
3.1
     
3.2
 
Restaurant pre-opening expenses
   
-
     
0.1
     
-
     
-
 
Provision for losses on asset impairments and disposals
   
1.7
     
-
     
0.8
     
1.1
 
Lease termination expense and closed store costs
   
0.3
     
0.2
     
2.3
     
0.3
 
Gain on sales of assets
   
-
     
-
     
(0.1
)
   
-
 
Total costs and expenses
   
120.1
     
111.5
     
119.9
     
111.1
 
Operating loss
   
(20.1
)
   
(11.5
)
   
(19.9
)
   
(11.1
)
Interest expense
   
(1.7
)
   
-
     
(1.0
)
   
-
 
Other income
   
0.3
     
-
     
0.1
     
0.1
 
Net loss and comprehensive loss
   
(21.5
)%
   
(11.5
)%
   
(20.8
)%
   
(11.0
)%

(1)
These are expressed as a percentage of restaurant net sales versus all other items expressed as a percentage of total revenues


19

Restaurant Net Sales

   
Restaurant net sales
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
18,574
     
96.7
%
Three months ended September 30, 2013
 
$
20,602
     
96.2
%
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
56,309
     
96.7
%
Nine months ended September 30, 2013
 
$
64,112
     
96.6
%
 
Restaurant net sales: Restaurant net sales decreased 9.8%, or approximately $2.0 million, in the three months ended September 29, 2014, as compared to the same period in 2013.  This decrease was due to an approximately $0.4 million, or 1.9%, decrease in net sales in our comparable restaurant base, a decrease of approximately $2.2 million in net restaurant sales related to 13 Company-owned restaurants closed as well as one Company-owned restaurant converted to franchised-owned during and after the third quarter of 2013.  This decrease was partially offset by approximately $0.5 million in sales from three franchised restaurants converted to Company-owned restaurants during the first and third quarters of fiscal 2014. The decrease in comparable restaurant net sales was comprised of a 2.2% decrease in traffic, partially offset by a 0.3% increase in average check price.

In the nine months ended September 29, 2014, restaurant net sales decreased 12.2%, or approximately $7.8 million, as compared to the nine months ended September 30, 2013  This decrease was due to an approximately $4.5 million, or 7.5%, decrease in net sales in our comparable restaurant base, a decrease of approximately $5.2 million in net sales related to 16 Company-owned restaurants closed as well as one Company-owned restaurant converted to franchised-owned during and after the first quarter of 2013.  This decrease was partially offset by approximately $0.7 million in sales from three franchised restaurants converted to Company-owned restaurants during the first and third quarters of 2014. The decrease in comparable restaurant net sales was comprised of 7.7% decrease in traffic, partially offset by a 0.2% increase in average check price.

Franchise Fees and Royalties

   
Franchise fees and royalties
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
635
     
3.3
%
Three months ended September 30, 2013
 
$
810
     
3.8
%
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
1,945
     
3.3
%
Nine months ended September 30, 2013
 
$
2,269
     
3.4
%

Franchise fees and royalties: In the three months ended September 29, 2014, franchise fees and royalties decreased approximately $0.2 million as compared to the same period in 2013.  The decrease is primarily due to lower franchise royalties resulting from the closure of five franchised restaurants during and subsequent to the third quarter of 2013 as well as a decrease in franchise comparable net restaurant sales.  This decrease was partially offset by the opening of four new franchised restaurants as well as the conversion of one Company-owned restaurant to franchised-owned during and subsequent to the third quarter of 2013.
 
20

 

In the nine months ended September 29, 2014, franchise fees and royalties decreased approximately $0.3 million as compared to the same period in 2013.  The decrease is primarily due to lower franchise royalties resulting from the closure of five franchised restaurants during and subsequent to the first quarter of 2013 as well as a decrease in franchise comparable net restaurant sales.  This decrease was partially offset by the opening of four new franchised restaurants as well as the conversion of one Company-owned restaurant to franchised-owned during and subsequent to the first quarter of 2013.
 
Costs and Expenses

   
Cost of food and beverage
 
 
 
 
(in thousands)
   
as a % of restaurant
net sales
 
Three months ended September 29, 2014
 
$
5,087
     
27.4
%
Three months ended September 30, 2013
 
$
5,177
     
25.1
%
   
 
 
(in thousands)
   
as a % of restaurant
net sales
 
Nine months ended September 29, 2014
 
$
14,624
     
26.0
%
Nine months ended September 30, 2013
 
$
15,900
     
24.8
%

Cost of food and beverage: The increase in cost of food and beverage, as a percentage of restaurant net sales, for the three and nine months ended September 29, 2014, is largely due to a shift in menu sales mix towards products with higher food costs, as well as higher year-over-year costs of certain commodities, including poultry and dairy products.

   
Restaurant labor and related benefits
 
         
   
(in thousands)
   
as a % of restaurant
net sales
 
Three months ended September 29, 2014
 
$
7,114
     
38.3
%
Three months ended September 30, 2013
 
$
8,172
     
39.7
%
                 
   
(in thousands)
   
as a % of restaurant
net sales
 
Nine months ended September 29, 2014
 
$
21,640
     
38.4
%
Nine months ended September 30, 2013
 
$
24,480
     
38.2
%
 
Restaurant labor and related benefits: The decrease for the three months ended September 29, 2014 compared to the prior year quarter in restaurant labor and related benefits, as a percentage of restaurant net sales, is due primarily to the favorable impact from the adjustments to restaurant management staffing levels at certain locations as well as lower costs related to healthcare benefits.

The slight increase in restaurant labor and related benefits, as a percentage of restaurant net sales in the nine months ended September 29, 2014, is due primarily to the unfavorable impact on the fixed portion of labor from the decrease in comparable net restaurant sales from the first two quarters of 2014, partially offset by savings realized from the adjustments related restaurant management staffing levels and lower benefit costs realized during the third quarter 2014.
 
21

   
Occupancy and other restaurant
operating expenses
 
         
   
(in thousands)
   
as a % of restaurant
net sales
 
Three months ended September 29, 2014
 
$
6,816
     
36.7
%
Three months ended September 30, 2013
 
$
7,231
     
35.1
%
                 
   
(in thousands)
   
as a % of restaurant
net sales
 
Nine months ended September 29, 2014
 
$
20,896
     
37.1
%
Nine months ended September 30, 2013
 
$
21,900
     
34.1
%
 
Occupancy and other restaurant operating expenses: The increase in occupancy and other restaurant operating expenses, as a percentage of restaurant net sales, is due primarily to the unfavorable effect on fixed occupancy-related costs of the decrease in comparable net restaurant sales, as well as higher year-over-year costs for utilities and repairs and maintenance of existing Company-owned restaurants.

   
General and administrative expenses
 
         
   
 
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
3,110
     
16.2
%
Three months ended September 30, 2013
 
$
2,565
     
12.0
%
                 
   
 
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
9,164
     
15.7
%
Nine months ended September 30, 2013
 
$
8,463
     
12.7
%

General and administrative expenses: The increase in general and administrative expenses in the three months ended September 29, 2014 is due primarily to charges of approximately $0.5 million resulting from the relocation of the corporate headquarters from Chicago, Illinois, to Boston, Massachusetts, including severance and recruiting costs.

The increase in general and administrative expenses in the nine months ended September 29, 2014 is due primarily to charges of approximately $1.3 million resulting from the relocation of the corporate headquarters from Chicago, Illinois, to Boston, Massachusetts, including termination of the corporate office lease, severance and recruiting costs as well as higher legal fees incurred.  This increase was partially offset by labor and related benefits savings resulting from administrative workforce reductions effected during and subsequent to the 2013 period, prototype design costs incurred during 2013, as well as lower year-over-year costs for corporate insurance and the reversal of previously amortized restricted stock compensation expenses during 2013.

   
Depreciation and amortization
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
573
     
3.0
%
Three months ended September 30, 2013
 
$
674
     
3.1
%
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
1,812
     
3.1
%
Nine months ended September 30, 2013
 
$
2,094
     
3.2
%

22

Depreciation and amortization: The depreciation and amortization expense, as a percentage of total revenues, remained approximately the same in the three and nine months ended September 29, 2014 compared to the same periods in 2013 and decreased by approximately $0.1 million and $0.3 million in the three and nine months ended September 29, 2014, respectively. The dollar decrease was due primarily to the impact of impairments of approximately $1.0 million recorded during and subsequent to the first quarter of 2013 as well as the continued depreciation of our comparable restaurant base.

   
Provision for losses on asset impairments
and disposals
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
317
     
1.7
%
Three months ended September 30, 2013
 
$
5
     
0.0
%
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
437
     
0.8
%
Nine months ended September 30, 2013
 
$
699
     
1.1
%

Provision for losses on asset impairments and disposals: In the nine months ended September 29, 2014, we recorded a provision for losses on asset impairments and disposals of approximately $0.4 million, related to the disposals of assets and closure costs for 10 Company-owned restaurants at the termination of their leases.  In the nine months ended September 30, 2013 we recorded a provision for losses on asset impairments and disposals of approximately $0.7 million related to six underperforming restaurants, as well as to maintenance capital expenditures on previously impaired restaurants.
 
   
Lease termination expense and closed store costs
 
         
   
 
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
62
     
0.3
%
Three months ended September 30, 2013
 
$
34
     
0.2
%
                 
   
 
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
1,317
     
2.3
%
Nine months ended September 30, 2013
 
$
181
     
0.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Lease termination and closed store costs: In nine months ended September 29, 2014, we incurred lease termination expenses and closed store cost of approximately $1.3 million related to the closing of 10 Company-owned restaurants. The lease termination and closed store costs of approximately $0.2 million for the nine months ended September 30, 2013 are related to two Company-owned locations.
 
23

   
Gain on sale of assets
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
-
     
-
 
Three months ended September 30, 2013
 
$
-
     
-
 
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
50
     
(0.1
%)
Nine months ended September 30, 2013
 
$
-
     
-
 
 
 
 
 
 
 
 
 
 
 
 
 

Gain on sale of assets: The gain on sale of assets in the nine months of 2014 is related to the sale of one liquor license.
 
   
Interest expense
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
335
     
(1.7
%)
Three months ended September 30, 2013
 
$
-
     
-
 
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
574
     
(1.0
%)
Nine months ended September 30, 2013
 
$
-
     
-
 
 
Interest expense: In the three and nine months of 2014, we incurred interest expense related to obligations on senior secured promissory notes as well as accretion expense on the discounting of our long-term debt.
 
   
Other income
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
57
     
0.3
%
Three months ended September 30, 2013
 
$
9
     
0.0
%
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
72
     
0.1
%
Nine months ended September 30, 2013
 
$
34
     
0.1
%

Other income: In the three and nine months of 2014 and 2013, we recorded other income primarily resulting from the discounting of the long-term portion of a note receivable.
 
24

   
Net loss
 
         
   
(in thousands)
   
as a % of total
revenues
 
Three months ended September 29, 2014
 
$
(4,148
)
   
(21.5
%)
Three months ended September 30, 2013
 
$
(2,455
)
   
(11.5
%)
                 
   
(in thousands)
   
as a % of total
revenues
 
Nine months ended September 29, 2014
 
$
(12,088
)
   
(20.8
%)
Nine months ended September 30, 2013
 
$
(7,331
)
   
(11.0
%)

Net loss: For the three months ended September 29, 2014, the $1.7 million increase in net loss is due primarily to one-time charges of $0.8 million for the relocation of the corporate headquarters to Boston, Massachusetts as well as costs related to Company-owned restaurant closures,, $0.5 million year-over-year decrease in restaurant net operating results driven by the decrease in restaurant net sales, $0.3 million of interest expense recorded on long-term debt and $0.2 million year-over-year decrease in franchise fees and royalties.

For the nine months ended September 29, 2014, the $4.8 million increase in net loss is due primarily to one-time charges of $2.6 million for the relocation of the corporate headquarters to Boston, Massachusetts as well as lease termination expenses,  $2.6 million year-over-year decrease  in restaurant net operating results driven by the decrease in restaurant net sales, $0.6 million of interest expense recorded on long-term debt and $0.3 million year-over-year decrease in franchise fees and royalties.  This decrease was partially offset by labor savings resulting from the administrative and restaurant management workforce reductions, and lower depreciation expense.

LIQUIDITY AND CAPITAL RESOURCES

On April 14, 2014, the Company entered into a $5.0 million Senior Secured Promissory Note Agreement with MILFAM II L. P. (the “MILFAM Note” and the “MILFAM Note Agreement”, respectively). The MILFAM Note bears interest at nine percent (9%) per annum, compounded semi-annually, and payable in arrears on a semi-annual basis. At the Company’s option, the first two semi-annual interest payments may be paid at eleven percent (11%) in kind in the form of additional promissory notes. The principal obligations under the MILFAM Note is due three (3) years from the effective date of the MILFAM Note. The MILFAM Note Agreement provided for the payment of a finance fee of 3.5% of the principal amount of the MILFAM Note at closing as well as providing a warrant exercisable to purchase up to 1.1 million shares of the Company’s common stock at an exercise price per share of $0.01. The warrant would not be exercisable to the extent that doing so resulted in the MILFAM II and any related parties, in the aggregate, owning more than 19.9% of the Company’s common stock. Further, until all of the obligations under the MILFAM Note are paid in full, MILFAM will have the right to participate in any future financing transactions consummated by the Company in an amount up to the greater of 1) the then-outstanding balance of obligations under the MILFAM Note and 2) $4.0 million. The MILFAM Note is guaranteed by the Company’s subsidiaries and secured by a lien on all assets of the Company and its subsidiaries. Mr. Lloyd I. Miller, III, is the manager of MILFAM LLC, which is the general partner of MILFAM.  Mr. Miller is also a significant shareholder of the Company.

On May 20, 2014, the Company entered into a $2.5 million Senior Secured Note Purchase Agreement with AB Opportunity Fund LLC and AB Value Partners, L.P. (the “AB Notes”, the “AB Note Agreement”, and the “AB Entities”, respectively). The AB Notes are payable in full on the third anniversary from the effective date of the AB Notes. Interest will accrue at the rate of nine percent (9%), compounded semi-annually, and will be paid in arrears semi-annually, provided that the Company, at its option, may elect to pay the first two interest payments at a rate of eleven percent (11%) in kind in the form of additional promissory notes. As consideration for the AB Notes, the Company provided a fee of 3.5% of the principal amount of the AB Notes and warrants exercisable to purchase up to an aggregate, initially, of 550,000 shares of the common stock of the Company at an exercise price per share of $.01, provided that the AB Entities shall not be permitted to exercise the warrants to the extent such exercise would result in the AB Entities or any of its affiliates owning in excess of 19.9% of the common stock of the Company. The warrants are exercisable by the AB Entities at any time prior to the third anniversary from the effective date of the AB Notes, in whole or in part, by surrendering the warrants and a form of exercise to the Company.
 
25

We are currently in compliance with all covenant requirements under the MILFAM and the AB Note Agreements.
 
On August 22, 2014, the Company sold 3,367,874 unregistered shares of the Company’s common stock, par value of $0.01 per share, at a purchase price of $1.15 per share to Plaisance Fund, LP, a fund managed by Janus Capital Management LLC, for gross proceeds of $3,873,055 and concurrently therewith sold 521,739 unregistered shares of the Company’s common stock, par value of $0.01 per share, at a purchase price of $1.15 per share to Lloyd I. Miller Trust C for gross proceeds of $600,000.
 
Cash and cash equivalents were approximately $6.1 million on September 29, 2014, compared with $6.0 million on December 30, 2013. We had negative working capital of approximately $1.4 million on September 29, 2014, compared with negative working capital of approximately $2.5 million on December 30, 2013. The $1.1 million decrease in negative working capital in the nine months ended September 29, 2014, was a result of the net proceeds of approximately $7.5 million from the MILFAM and AB Entities  Note  Agreements entered into during the second quarter of 2014 as well as $4.5 million from the Janus and Trust C Purchase Agreements entered into during the third quarter of 2014, partially offset by funding our operating loss, net of depreciation and other non-cash expenses, payments made during the second and third quarters to exit the leases at our corporate headquarters in Chicago, Illinois, and 10 restaurant locations closed during that time, as well as payments made for capital expenditures. Our principal requirements for cash in the remainder of fiscal 2014 will be for working capital needs, any remaining payments on early termination of restaurant operating leases, one new Company restaurant in Chicago, Illinois currently under construction and scheduled to open in December 2014 and routine maintenance of our existing restaurants.
 
Net cash used in operating activities in the nine months ended September 29, 2014, was approximately $10.8 million compared to $5.5 million in the nine months ended September 30, 2013. The increase was primarily the result of the higher operating loss, net of depreciation and other non-cash expenses, payments made during the second and third quarters to exit the leases at our corporate headquarters in Chicago, Illinois, and 10 restaurant locations closed during the third quarter, as well as higher vendor payments (due to timing of certain vendor payments) made during the third quarter of 2014.

Net cash used in investing activities in the nine months ended September 29, 2014, was approximately $0.7 million compared to $1.7 million in the nine months ended September 30, 2013. The decrease was primarily due to payments for construction of a new Company-owned restaurant in Columbus, Ohio, as a relocation of an existing site, in the nine months of fiscal 2013, as well as lower capital expenditures in fiscal 2014.

Net cash provided by financing activities of approximately $11.6 million during the nine months ended September 29, 2014, was from proceeds associated with issuance of the MILFAM and AB Entities Notes completed during the second quarter of 2014 as well as the sale of approximately 3.9 million shares of the Company’s common stock as part of the Janus and Trust C Purchase Agreements entered into during the third quarter of 2014.

As of September 29, 2014, nine quarterly payments of $62,500 each were not paid as scheduled under the terms of the Subordinated Secured Promissory Note receivable associated with the sale of restaurants to a franchisee in 2010. As of September 29, 2014, the Company has a reserve of $0.5 million recorded against the Subordinated Secured Promissory Note receivable of approximately $1.0MM.

During the nine months ended September 29 2014, we closed 10 Company-owned restaurants and the Support Center in Deerfield, Illinois, and during that same time, we relocated the Company’s Support Center to Boston, Massachusetts. As a result, we incurred approximately $2.6 million of one-time costs related to these events in the second and third quarters of 2014. While we believe these events will strengthen our business in the long-term, the charges associated with these events reduced our current cash and cash equivalents.
 
26

We expect to incur approximately $0.9 million of capital costs associated with the construction of one new Company-owned restaurant in Chicago, Illinois, initial installation of new point-of-sales (“POS”) systems in seven Company-owned restaurants and maintenance of existing Company-owned restaurants during the remainder of fiscal 2014. During the first nine months of fiscal 2014 and 2013, 96.4% and 48.4%, respectively, of our capital expenditures were spent on improvements and repairs and maintenance associated with existing Company-owned locations. The balance of the capital cash outlays was spent on information technology-related projects. The Company’s capital expenditures for repairs and maintenance of existing restaurants during fiscal 2014 are expected to be less than fiscal 2013, and at this time the Company does not expect to incur any significant capital costs for repairs and maintenance or otherwise during the balance of fiscal 2014.

As a result of the administrative work force reductions we undertook in fiscal 2013, the Company expects to realize continued savings in general and administrative expenses in fiscal 2014 as compared to fiscal 2013, excluding any costs associated with relocating the corporate headquarters from the Chicago, Illinois, area to Boston, Massachusetts.

Despite the capital raised in the second and third quarters of fiscal 2014, the reductions in our workforce and the improved restaurant operating results, we believe that our liquidity will remain very tight for the foreseeable future. Absent significant continued improvement in restaurant operating results, we will need to seek additional equity to meet our cash requirements, including our working capital needs and capital improvements and maintenance costs. Our conclusion is based on our financial performance during fiscal 2013, our financial performance during the first nine months of fiscal 2014 and our projected financial performance through the third quarter of fiscal 2015, 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.
 
To fund our cash requirements, we are attempting to raise $20 million of capital through a rights offering that we intend to use for general corporate purposes, which may include funding our growth plan, working capital and capital expenditures, including initiatives to propel sales growth in our restaurants, such as investing in technology, including remote ordering, POS system upgrade, and initiatives to increase through-put efficiencies; upgrading equipment and furnishings, and refreshing our restaurants; construction of a new restaurant in Chicago scheduled to open in December of 2014; and funding our operations until we become cash flow positive from operations (excluding capital expenditures).  Additionally, we will continue to seek to effect further reductions in general and administrative expenses, sell certain Company-owned locations to franchisees and/or other third parties, obtain other sources of financing, and take other actions to fund our cash requirements.
 
There can be no assurance that we will be able to raise $20 million through the rights offering, obtain other 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. An inability to access additional sources of liquidity to fund our cash needs could materially adversely affect our financial condition and results of operations.
 
Our cash resources, and therefore our liquidity, are highly dependent upon the level of internally generated cash from operations and upon cash raised in the rights offering or other future financing transactions. We cannot predict whether we will be able to reduce cash used in operations, whether we will be successful in raising capital in the rights offering or whether other financing will be available on terms acceptable to us, or at all.
 
If we default on the MILFAM or the AB Entities Notes, we may be forced to pay higher interest costs or repay the debt earlier than anticipated. If that were to occur we may have to seek additional financing from external sources to cure the default and continue funding our operations. We cannot predict whether additional financing will be available on terms acceptable to us, or at all.
 
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, finance future acquisitions and investments, and service debt obligations. There is no assurance that the rights offering will be successful, or that other 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.
 
27

As a result of the Company relocating its corporate headquarters to Boston, Massachusetts, there is a completely new management team in place. Out new Chief Executive Officer and President joined the Company on March 17, 2014, and our Chief Financial Officer, Secretary and Treasurer joined the Company on July 28, 2014. In addition, our Vice Presidents of Operations, Information Systems, Supply Chain, Marketing, and Human Resources have been in their positions with the Company for seven months or less. These new members of management do not have previous experience with us, and we cannot assure you that they will fully integrate themselves into our business or that they will effectively manage our business affairs. Our failure to assimilate the new members of management, the failure of the new members of management to perform effectively, or the loss of any of the new members of management could have a material adverse effect on our business, financial condition and results of operations.

We have entered into agreements that create contractual obligations. These obligations will have an impact on future liquidity and capital resources. The table below presents a summary of these obligations as of September 29, 2014:

   
Payments Due by Period
 
   
(in thousands)
 
Description
 
Total
Obligations
   
Due
Fiscal 2014
   
Due
Fiscal 2015
to Fiscal 2016
   
Due
Fiscal 2017
to Fiscal 2018
   
Due
After
Fiscal 2018
 
                     
Operating leases (1)
   
38,924
     
2,754
     
9,786
     
7,473
     
18,911
 
Long-term debt (2)
   
9,687
     
338
     
1,456
     
7,893
     
-
 
Other long-term liabilities (3)
   
491
     
393
     
98
     
-
     
-
 
                                         
Total contractual cash obligations
 
$
49,102
   
$
3,485
   
$
11,340
   
$
15,366
   
$
18,911
 
 
(1) Amounts shown are net of an aggregate $0.5 million of sub-lease rental income due under non-cancelable subleases and include accrued contractual lease increases of approximately $1.2 million, which are included in other long-term liabilities in the attached consolidated balance sheets.
(2) Represents interest and principal in relation to the Senior Secured Notes issued during the second quarter of fiscal 2014
(3) Amounts shown are related to contractual obligations for lease termination agreements. These obligations are non-interest bearing and are included in other liabilities in the attached consolidated balance sheets.

We are obligated under non-cancelable operating leases for our restaurants and our administrative offices. Lease terms are generally ten years with renewal options and generally require us to pay a proportionate share of real estate taxes, insurance and common area and other operating costs. Some restaurant leases provide for contingent rental payments which are not included in the above table.

As of September 29, 2014, we entered into agreements to terminate the operating leases at 10 of our Company-owned restaurants. The unpaid lease termination fees at September 29, 2014, are approximately $0.2 million.

Certain of our lease agreements provide for scheduled rent increases during the lease term or for rental payments to commence at a date other than the date of initial occupancy. Rent expense is recognized on a straight-line basis over the term of the respective lease from the date we take possession. Our obligation with respect to these scheduled rent increases has been presented as a long-term liability in other liabilities in the accompanying consolidated balance sheets and totaled approximately $1.2 and $1.9 million as of September 29, 2014, and September 30, 2013, respectively.
 
Certain of our leases also provide for landlord contributions to offset a portion of the cost of our leasehold improvements. These allowances are recorded as deferred liabilities and amortized on a straight-line basis as a reduction to rent expense over the term of the related leases. Included in other liabilities in the accompanying consolidated balance sheets as of September 29, 2014, and September 30, 2013, are landlord allowances of approximately $0.4 million and $0.6 million, respectively.
 
28

As of September 29, 2014, the Company had outstanding approximately $0.2 million in standby letters of credit, which were provided as security deposits for certain of the lease obligations. The letters of credit are fully secured by cash deposits or marketable securities held in accounts at the issuing banks and are not available for withdrawal by the Company. These amounts are included as a component of “Other Assets” in the accompanying consolidated balance sheets.

Purchase Commitments

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

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 76% of our food and paper products, primarily underpricing agreements that we negotiate directly with the suppliers. This agreement was renegotiated and has been extended through December 2015.

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. Effective January 1, 2011, the beverage marketing agreement with the Coca-Cola Company was amended to provide for additional products as well as higher marketing allowances based on purchases.

In October 2010, we entered into an agreement to purchase all contracted coffee products through a single supplier, Royal Cup Coffee, Inc. This agreement expires in October 2015.

Self-Insurance

We have a self-insured group health insurance plan. We are responsible for all covered claims to a maximum limit of $100,000 per participant and an additional aggregating maximum limit of $50,000 for the plan year. Benefits paid in excess of these limits are reimbursed to the plan under our stop-loss policy. In addition, we have an aggregate stop-loss policy whereby our liability for total claims submitted cannot exceed a pre-determined dollar factor based upon, among other things, past years’ claims experience, actual claims paid, the number of plan participants and monthly accumulated aggregate deductibles. During fiscal years 2013 and 2012, we did not exceed this pre-determined maximum. For our 2014 plan year, this pre-determined dollar amount is $1.2 million. The balance in the self-insurance reserve account as of September 29, 2014, was approximately $0.1 million.
 
29

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
 
We caution that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained or incorporated by reference in this Form 10-Q or made by our management involve risks and uncertainties and are subject to change based on various important factors, many of which may be beyond our control. Accordingly, our future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements are subject to risks and uncertainties, including, without limitation, those described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 30, 2013. If any of these risks or uncertainties actually occurs, our business, financial condition or operating results could be materially and adversely affected, and the trading price of our common stock could decline. We do not undertake to publicly update or revise our forward-looking statements even if our future changes make it clear that any projected results expressed or implied therein will not be realized.
 
Listed below are just some of the factors that would impact our forward looking statements:
 
· the cost of our principal food products and supply and delivery shortages or interruptions;
 
· labor shortages or increased labor costs;
 
· changes in demographic trends and consumer tastes and preferences, including changes resulting from concerns over nutritional or safety aspects of beef, poultry, produce or other foods or the effects of food-borne illnesses, such as E.coli, “mad cow disease” and avian influenza or “bird flu;”
 
· competition in our markets, both in our existing business and locating suitable restaurant sites;
 
· our operation and execution in new and existing markets;
 
· expansion into new markets, including foreign countries;
 
· our ability to attract and retain qualified franchisees and our franchisees’ ability to open restaurants on a timely basis;
 
· our ability to locate suitable restaurant sites in new and existing markets and negotiate acceptable lease terms;
 
· the rate of our internal growth, and our ability to generate increased revenue from our new and existing restaurants;
 
· our ability to generate positive cash flow from existing and new restaurants;
 
· fluctuations in our quarterly results due to seasonality;
 
· increased government regulation and our ability to secure required governmental approvals and permits;
 
· our ability to create customer awareness of our restaurants in new markets;
 
· the reliability of our customer and market studies;
 
· cost effective and timely planning, design and build-out of new restaurants;
 
· our ability to recruit, train and retain qualified corporate and restaurant personnel and management;
 
· market saturation due to new restaurant openings;
 
· inadequate protection of our intellectual property;
30

· our ability to obtain additional capital and financing on acceptable terms;
 
· adverse weather conditions, which impact customer traffic at our restaurants; and
 
· adverse economic conditions.
 
The words “believe,” “may,” “will,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive,” “project” or similar words, or the negatives of these words, identify forward‑looking statements. We qualify any forward‑looking statements entirely by these cautionary factors.
 
31

Item 3.
Quantitative and Qualitative Disclosures about Market Risk
 
Interest Rate Risk

Our market risk exposures are related to our cash and cash equivalents and interest that we may pay on debt. We have no derivative financial commodity instruments. We invest our excess cash in investment grade, highly liquid, short-term investments. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flows and results of operations. As of September 29, 2014, we held no short-term investments and, as a result, a hypothetical one percentage point interest change from those in effect would not have resulted in a fluctuation of interest income. In the first nine months of fiscal 2014 and 2013, interest income was immaterial.

Commodity Risk

We are exposed to commodity price risks. Many of the ingredients we use to prepare our food, as well as our packaging materials, are commodities or ingredients that are affected by the price of other commodities, exchange rates, foreign demand, weather, seasonality, production, availability, and other factors outside our control. Some of these commodities are purchased under agreements in effect for periods ranging from one month to one year, usually at fixed prices. As a result, we are subject to commodity risk that current market prices may be below our contractual prices. We also purchase certain ingredients at spot prices, as well as prices that are based on specific formulas related to key components within the commodity category, which could adversely affect our operating result in periods of rising commodity or ingredient prices if we choose, for competitive or other reasons, not to increase menu prices at the same rate at which ingredient costs increase, or if menu price increases result in customer resistance. During the first nine months of fiscal 2014 and 2013, we did not utilize derivative instruments in managing commodity risk.

Foreign Currency Risk

As of September 29, 2014, all of our transactions are conducted, and our accounts denominated, in U.S. dollars. Accordingly, we are not exposed to foreign currency risk.

Item 4.
Controls and Procedures

Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the fiscal year covered by this report. Based on this evaluation, our Chief  Executive Officer and our Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective (i) to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) to ensure that information required to be disclosed by us in the reports that we submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

There have  been no changes in our internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the first fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

32

Part II.  OTHER INFORMATION

Item 1:
LEGAL PROCEEDINGS

From time to time, we are a defendant in litigation arising in the ordinary course of our business. As of the date of this report, there are no legal proceedings that would require accrual or disclosure under ASC 450. We cannot predict with certainty the outcome of any litigation or the potential for future litigation. Regardless of the outcome of any particular litigation and the merits of any particular claim, litigation can have a material adverse impact on our company due to, among other reasons, any injunctive relief granted, which could inhibit our ability to operate our business, amounts paid as damages or in settlement of any such matter, diversion of management resources and defense costs.

Item 1A:
RISK FACTORS

In addition to the other information set forth in this report, the factors discussed in “Part I.  Item 1A.  Risk Factors” in our Annual Report on Form 10-K for our 2013 fiscal year could materially affect the Company’s business, financial condition or operating results. There have been no material changes in our risk factors since our Annual Report on Form 10-K for the year ended December 30, 2013.

Item 5:
EXHIBITS
 
(a)
Exhibits:
 
Exhibit Number
Description
 
Exhibit 31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
Exhibit 31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
Exhibit 32.1
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101 The following financial information, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of September 29, 2014 and December 30, 2013, (ii) Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 29, 2014 and September 30, 2013, (iii) Consolidated Statements of Cash Flows for the nine months ended September 29, 2014 and September 30, 2013; and (iv) Notes to Consolidated Financial Statements. In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings.


33

SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
COSI, INC.

Date: November 13, 2014
By: /s/ RJ DOURNEY
 
RJ Dourney
 
President, Chief Executive Officer, and
 
Director
   
Date: November 13, 2014
By: /s/ SCOTT CARLOCK
 
Scott Carlock
 
Chief Financial Officer (chief accounting officer)
 
Treasurer and Secretary
34

EXHIBIT INDEX

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101 The following financial information, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of June 30, 2014 and December 30, 2013, (ii) Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 29, 2014 and September 30, 2013, (iii) Consolidated Statements of Cash Flows for the nine months ended September 29, 2014 and September 30, 2013; and (iv) Notes to Consolidated Financial Statements. In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings.
 
 
35