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COSI > SEC Filings for COSI > Form 10-Q on 15-Nov-2012All Recent SEC Filings

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Form 10-Q for COSI INC


15-Nov-2012

Quarterly Report


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 October 1, 2012 and September 26, 2011 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 2011 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
                                October 1, 2012                 September 26, 2011
                         Company-                         Company-
                          Owned     Franchise    Total     Owned     Franchise    Total

Restaurants at
beginning of period            79          54       133         81          59       140
New restaurants opened          -           -         -          -           -         -
Restaurants
permanently closed              2           2         4          1           1         2
Restaurants at end of
period                         77          52       129         80          58       138




                                            For the Nine Months Ended
                                October 1, 2012                 September 26, 2011
                         Company-                         Company-
                          Owned     Franchise    Total     Owned     Franchise    Total

Restaurants at
beginning of period            80          56       136         83          59       142
New restaurants opened          -           1         1                                -
Restaurants
permanently closed              3           5         8          3           1         4
Restaurants at end of
period                         77          52       129         80          58       138

As of October 1, 2012, there were 77 Company-owned and 52 franchised restaurants operating in 16 states, the District of Columbia, and the United Arab Emirates ("UAE"). During the three months ended October 1, 2012, we closed two Company-owned restaurants at the expiration of their leases. In addition, two franchised restaurants closed during the quarter and another one closed subsequent to it.

Our restaurants offer innovative, savory, made-to-order products featuring our authentic hearth-baked crackly crust signature Cosi® bread and fresh distinctive ingredients. We maintain a pipeline of new menu offerings that are introduced seasonally through limited time offerings to keep our products relevant to our target customers. Our menu features high-quality sandwiches, freshly-tossed salads, breakfast wraps, Cosi® Squagels®, hot melts, flatbread pizzas, S'mores and other desserts, and a variety of coffees along with other soft drink beverages, bottled beverages including premium still and sparkling water, teas, alcoholic beverages, and other specialty coffees and beverages. Our restaurants offer lunch and afternoon coffee in a counter-service format, with most offering breakfast and/or dinner and dessert menus as well.

We are currently eligible to offer franchises in 46 states and the District of Columbia. We offer franchises to area developers and individual franchise operators. The initial franchise fee, payable to us, for both an area developer and an individual franchise operator, is $40,000 for the first restaurant and $35,000 for each additional restaurant.


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

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

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 and other public venues that meet our operating and financial criteria.

Recent Developments

Regaining Compliance with The Nasdaq's Market Value of Listed Securities Standard

On August 8, 2012, we received notice from the Listing Qualifications Department of The Nasdaq Stock Market that we have regained compliance with The Nasdaq Listing Standards by curing the market value of listed securities deficiency. The notification letter states that for the 10 consecutive business days, from July 25, 2012 to August 7, 2012, the Company's market value of listed securities has been $50,000,000 or greater.

Rights Offering and Private Placement of Common Stock

On July 9, 2012, we completed a shareholders' rights offering to our shareholders of record as of May 24, 2012. We issued a total of 19,661,844 shares of our $0.01 par value common stock at a subscription price of $0.65 per share. As part of the rights offering, our executive officers and outside directors purchased an aggregate of 2,534,323 shares of our $0.01 par value common stock, at a subscription price of $0.65 per share, through a private placement, based on the number of shares that would have been available to them had they executed their basic and oversubscription privilege in the rights offering. We received net proceeds of approximately $12.6 million from the rights offering and the private placement of common stock which we intend to use for growth and general corporate purposes, which may include, but are not limited to, working capital and capital expenditures.

Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard

As previously disclosed, on May 25, 2012, the Company received a notice from the Listing Qualifications Department (the "Staff") of The Nasdaq Stock Market ("NASDAQ") indicating that Cosi's common stock (the "Common Stock") did not meet the continued listing requirement for the NASDAQ Capital Market as set forth in NASDAQ Listing Rule 5450(a)(1) (the "Rule") because the closing bid price of the Common Stock for the preceding 30 business days had been below $1.00 per share. The Company was granted 180 calendar days, until November 21, 2012, to regain compliance with the Rule.

The Company will not regain compliance within the 180-day period and accordingly, the Company anticipates receiving written notification from the Staff (the "Staff Determination") stating that the Common Stock would be subject to delisting from The NASDAQ Capital Market unless the Company appeals the Staff Determination by requesting a hearing before the NASDAQ Listing Qualifications Panel (the "Panel") to review the Staff's Determination.

The Company intends to appeal the Staff Determination by requesting a hearing. The Company anticipates the hearing request will suspend any action with respect to the Staff Determination and allow the continued listing of the Company's Common Stock on The NASDAQ Capital Market until the Panel renders a decision subsequent to the


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hearing. In our appeal, the Company intends to present a plan to regain compliance with the Rule and request that the Panel allow the Company additional time within which to regain compliance. There can be no assurance that the Panel will accept the Company's plan and grant the Company's request for continued listing. If the Panel's decision denies the Company's request for continued listing, the Company may also appeal that decision, which would not stay a delisting decision.

Other Events

Pursuant to the employment agreement with Carin Stutz, Chief Executive Officer and President, and in connection with the September 21, 2012 sale of Ms. Stutz' primary residence in Dallas, TX, the Company has been released from its contractual obligation to purchase the Executive's residence prior to December 31, 2012.

Critical Accounting Policies

Our discussion and analysis of our consolidated financial condition and results of operations is 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 fiscal 2012.

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 when the liability is incurred, rather than at the time of a commitment to an exit or disposal plan. For all exit activities, we estimate our likely liability under contractual leases for restaurants that have been closed. Such estimates have affected the amount and timing of charges to operating results and are impacted by management's judgments about the time it may take to find a suitable subtenant or assignee, or the terms under which a termination of the lease agreement may be negotiated with the landlord.

Accounting for Lease Obligations: In accordance with ASC 840-10-25 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.


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

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

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 October 1, 2012 and September 26, 2011, there were 77 and 80 restaurants in our comparable restaurant base, respectively.

Costs and Expenses

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

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

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

General and Administrative Expenses. General and administrative expenses include all corporate and administrative functions that support our restaurants and provide an infrastructure to operate our business. Components of these expenses include executive management costs; supervisory and staff salaries; non-field stock-based compensation


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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.


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RESULTS OF OPERATIONS



Our operating results for the three and nine months ended October 1, 2012 and
September 26, 2011, expressed as a percentage of total revenues (except where
otherwise noted), were as follows:



                                       Three Months Ended              Nine Months Ended
                                   October 1,    September 26,    October 1,    September 26,
                                      2012           2011            2012           2011

Revenues:
Restaurant net sales                     97.0 %           96.6 %        96.7 %           96.9 %
Franchise fees and royalties              3.0              3.4           3.3              3.1
Total revenue                           100.0            100.0         100.0            100.0
Cost and expenses:
Cost of food and beverage (1)            23.5             23.5          23.2             23.1
Restaurant labor and related
benefits (1)                             36.2             36.6          35.6             36.3
Occupancy and other restaurant
operating expenses (1)                   32.5             31.8          32.0             31.9
                                         92.2             91.9          90.8             91.3
General and administrative
expenses                                 12.3             13.1          11.5             12.9
Depreciation and amortization             3.7              4.3           3.7              4.2
Provision for losses on asset
impairments and disposals                   -              0.2             -              0.3
Lease termination expense and
closed store costs                        0.2                -           0.1                -
Gain on sale of assets                      -             (0.4 )           -             (0.2 )
Total costs and expenses                105.6            105.9         103.2            105.7
Operating loss                           (5.6 )           (5.9 )        (3.2 )           (5.7 )
Other income                                -                -             -              0.1
Net loss and comprehensive loss          (5.6 )%          (5.9 )%       (3.2 )%          (5.6 )%



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


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Restaurant Net Sales



                                              Restaurant net sales
                                                          as a % of total
                                        (in thousands)       revenues
Three months ended October 1, 2012      $        23,620              97.0 %
Three months ended September 26, 2011   $        24,468              96.6 %




                                                         as a % of total
                                       (in thousands)       revenues
Nine months ended October 1, 2012      $        72,863              96.7 %
Nine months ended September 26, 2011   $        73,586              96.9 %

Restaurant net sales: Restaurant net sales decreased 3.5%, or approximately $0.8 million, in the three months ended October 1, 2012, as compared to the same period of fiscal 2011, due to an approximately $0.6 million, or 2.5%, decrease in net sales in our comparable restaurant base, as well as an approximately $0.2 million decrease in net sales related to Company-owned restaurants closed during and after the third quarter of fiscal 2011. The decrease in comparable restaurant net sales was comprised of 3.2% decrease in transactions, partially offset by a 0.7% increase in average check price.

In the nine months ended October 1, 2012, restaurant net sales deceased 1.0%, or approximately $0.7 million, as compared to the same period of fiscal 2011, due to a decrease of approximately $1.2 million in net sales related to Company-owned restaurant closed during and after the first quarter of fiscal 2011, partially offset by an increase of approximately $0.5 million, or 0.6%, in net sales in our comparable restaurant base. The increase in comparable restaurant net sales was comprised of 0.5% increase in average check price and 0.1% increase in transactions.

Franchise Fees and Royalties



                                              Franchise fees and royalties
                                                              as a % of total
                                        (in thousands)           revenues
Three months ended October 1, 2012      $           739                      3.0 %
Three months ended September 26, 2011   $           868                      3.4 %




                                                          as a % of total
                                        (in thousands)       revenues
Nine months ended October 1, 2012      $          2,477               3.3 %
Nine months ended September 26, 2011   $          2,356               3.1 %

Franchise fees and royalties: The decrease of approximately $0.1 million in the three months ended October 1, 2012, is primarily due to the franchise fee recognized during the 2011 third quarter resulting from a cancelled area development agreement as well as the one-time royalties adjustment during the same period of 2011. The increase in the nine months ended October 1, 2012 is primarily due to the franchise fees recognized during the second quarter of fiscal 2012 resulting from two cancelled area development agreements.


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Costs and Expenses



                                               Cost of food and beverage
                                                           as a % of restaurant
                                         (in thousands)         net sales
Three months ended October 1, 2012      $          5,559                   23.5 %
Three months ended September 26, 2011   $          5,761                   23.5 %




                                                         as a% of restaurant
                                       (in thousands)         net sales
Nine months ended October 1, 2012      $        16,934                  23.2 %
Nine months ended September 26, 2011   $        17,013                  23.1 %

Cost of food and beverage: Cost of food and beverage, as a percentage of restaurant net sales, was comparable in the three months ended October 1, 2012 and September 26, 2011 and only slightly higher in the nine months of fiscal 2012 due primarily to higher costs of certain commodities, including poultry, and the impact on total menu mix of an increase in sales of breakfast daypart items and salads which carry a higher cost of goods as a percentage of net sales, partially offset by the favorable impact of menu price increases.

                                                   Restaurant labor and related benefits
                                                                       as a % of restaurant
                                              (in thousands)                net sales
Three months ended October 1, 2012          $             8,547                            36.2 %
Three months ended September 26, 2011       $             8,957                            36.6 %




                                                         as a % of restaurant
                                       (in thousands)         net sales
Nine months ended October 1, 2012      $        25,949                   35.6 %
Nine months ended September 26, 2011   $        26,714                   36.3 %

Restaurant labor and related benefits: The decrease in restaurant labor and related benefits, as a percentage of restaurant net sales, in the three months ended October 1, 2012 is due primarily to savings realized from better deployment of labor hours during peak and non-peak hours of operation, partially offset by the unfavorable impact on labor of the decrease in comparable net restaurant sales, as well as higher healthcare-related benefits expense during the quarter.

The decrease in labor and related benefits, as a percentage of restaurant net sales, in the nine months ended October 1, 2012 is due primarily to savings realized from better deployment of labor hours during peak and non-peak hours of operation as well as the favorable impact on labor of the increase in comparable net restaurant sales, partially offset by higher payroll taxes.


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                                             Occupancy and other restaurant
                                                   operating expenses
                                                            as a % of restaurant
                                         (in thousands)          net sales
Three months ended October 1, 2012      $          7,670                    32.5 %
Three months ended September 26, 2011   $          7,777                    31.8 %




                                                         as a% of restaurant
                                       (in thousands)         net sales
Nine months ended October 1, 2012      $        23,311                  32.0 %
Nine months ended September 26, 2011   $        23,453                  31.9 %

. . .

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