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COSI > SEC Filings for COSI > Form 10-K on 14-Mar-2013All Recent SEC Filings

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Form 10-K for COSI INC


14-Mar-2013

Annual Report


Item 7. 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 years ended December 31, 2012, January 2, 2012, and December 27, 2010 should be read in conjunction with "Selected Consolidated Financial Data" and our audited consolidated financial statements and the notes to those statements that are included elsewhere in this Annual Report. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under "Cautionary Note Regarding Forward-Looking Statements" below and elsewhere in this Annual Report.

Business Overview

System-wide Restaurants:

                                                             Fiscal Year
                              2012                               2011                               2010
                 Company-                           Company-                           Company-
                  Owned      Franchise    Total      Owned      Franchise    Total      Owned      Franchise    Total
Restaurants
at beginning
of period               80           56      136           83           59      142           99           46      145
Company-owned
sold to
franchisee               -            -        -            -            -        -           13           13        -
New
restaurants
opened                   -            2        2            -            -        0            -            2        2
Restaurants
permanently
closed                   5            8       13            3            3        6            3            2        5

Restaurants
at end of
period                  75           50      125           80           56      136           83           59      142

As of December 31, 2012, there were 75 Company-owned and 50 franchised fast-casual restaurants operating in 16 states, the District of Columbia, the United Arab Emirates (UAE), and Costa Rica. During fiscal 2012, we closed five Company-owned restaurants, three in Illinois and two in New York, all of which at the expiration of their leases. During the same period, eight franchised restaurants closed and two new franchised restaurants opened. Subsequent to the end of fiscal 2012, we closed one additional Company-owned restaurant in Ohio, at the expiration of its lease.

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, 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.

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


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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.

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 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.


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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.

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 restaurant 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. At fiscal years ended December 31, 2012, January 2, 2012, and December 27, 2010, there were 75, 80, and 83 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.


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

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

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

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


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Results of Operations

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

                                                                   Fiscal Year
                                                            2012      2011      2010
 Revenues:
 Restaurant net sales                                         96.7 %    96.9 %    97.2 %
 Franchise fees and royalties                                  3.3       3.1       2.8

 Total revenue                                               100.0     100.0     100.0

 Cost and expenses:
 Cost of food and beverage(1)                                 23.4      23.2      22.8
 Restaurant labor and related benefits(1)                     36.1      36.5      37.7
 Occupancy and other restaurant operating expenses(1)         32.0      31.7      31.9

                                                              91.5      91.4      92.4
 General and administrative expenses                          11.9      13.5      12.5
 Depreciation and amortization                                 3.7       4.1       4.4
 Provision for losses on asset impairments and disposals       0.4       0.4       0.7
 Closed store costs                                            0.1       0.1       0.1
 Lease termination expense                                       -         -       0.2
 Gain on sale of assets                                          -      (0.1 )    (4.7 )

 Total costs and expenses                                    104.6     106.4     102.9

 Operating loss                                               (4.6 )    (6.4 )    (2.9 )

 Other income                                                  0.1         -         -

 Net loss                                                     (4.5 )    (6.4 )    (2.9 )


º (1)
º Expressed as a pecentage of restaurant net sales versus all other items expressed as a percentage of total revenue

Fiscal Year 2012 (52 weeks) compared to Fiscal Year 2011 (53 weeks)

Restaurant Net Sales

                                       Restaurant Net Sales
                                                   as a % of total
                                (in thousands)         revenues
                 Fiscal 2012     $       94,757                96.7 %
                 Fiscal 2011     $       98,920                96.9 %

Restaurant net sales decreased by approximately $4.2 million, or 4.2%, in fiscal 2012, as compared to fiscal 2011, due to an approximately $2.0 million decrease in net sales related to Company-owned restaurants closed during and subsequent to the first quarter of fiscal 2011, $1.3 million associated with the additional fifty-third week in fiscal 2011 and an approximately $0.9 million, or 0.9%, decrease in net sales in our comparable restaurant base during the fifty-two weeks of fiscal years 2012 and 2011. The decrease in comparable net sales includes approximately $0.6 million related to the impact of Hurricane Sandy during the fourth quarter of fiscal 2012. Excluding the impact of the hurricane, the decrease in our comparable net restaurant sales was approximately $0.3 million, or 0.3%, and was comprised of a 1.1% decrease in traffic, partially offset by 0.8% increase in average check.


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Franchise Fees and Royalties

                                   Franchise Fees and Royalties
                                                     as a % of total
                               (in thousands)           revenues
                Fiscal 2012     $         3,195                   3.3 %
                Fiscal 2011     $         3,215                   3.1 %

Franchise Fees and Royalties: Total franchise fees and royalties during fiscal years 2012 and 2011 were comparable. The additional royalties from the fifty-third week in fiscal 2011 were offset by the franchise fees recognized from the opening of one franchised location in Costa Rica during fiscal 2012.

Costs and Expenses

                                     Cost of Food and Beverage
                                                   as a % of total
                                (in thousands)         revenues
                  Fiscal 2012    $       22,171                23.4 %
                  Fiscal 2011    $       22,902                23.2 %

Cost of Food and Beverage: The increase in cost of food and beverage, as a percentage of restaurant net sales, is due primarily to higher costs of certain commodities, including poultry, and the impact on total menu mix of an increase in sales of breakfast items which carry a higher cost of goods as a percentage of net sales, coupled with a decline in beverages that have a lower cost of goods as a percentage of sales, partially offset by the favorable impact of menu price increases.

                                       Restaurant Labor and
                                         Related Benefits
                                                   as a % of total
                                (in thousands)         revenues
                 Fiscal 2012     $       34,165                36.1 %
                 Fiscal 2011     $       36,068                36.5 %

Restaurant Labor and Related Benefits: The decrease in restaurant labor and related benefits, as a percentage of restaurant net sales, 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, primarily the impact on the fixed-portion of manager labor from the decrease in sales resulting from Hurricane Sandy, as well as higher costs related to healthcare benefits.

                                       Occupancy and Other
                                            Restaurant
                                        Operating Expenses
                                                   as a % of total
                                (in thousands)         revenues
                 Fiscal 2012     $       30,337                32.0 %
                 Fiscal 2011     $       31,330                31.7 %

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 the increase in paper and packaging costs resulting from both a year-over-year increase in catering sales as a percentage of total sales and the higher costs for resin-based packaging, as well as higher credit card fees resulting from


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greater usage and an increase in rates, partially offset by the lower costs for repairs and maintenance of existing Company-owned restaurants and lower marketing expenditures.

                                            General and
                                      Administrative Expenses
                                                   as a % of total
                                (in thousands)         revenues
                  Fiscal 2012     $      11,641                11.9 %
                  Fiscal 2011     $      13,824                13.5 %

General and Administrative Expenses: The decrease in general and administrative expenses of approximately $2.2 million is due primarily to higher costs in fiscal 2011, including legal fees and certain settlement-related costs, professional and board fees related to the chief executive officer search and certain other shareholder activities, and the impact of the additional fifty-third week of payroll in fiscal 2011. Also driving the decrease in fiscal 2012 were lower costs for marketing materials, advertising media expenses and third-party information-technology fees, partially offset by the cost of certain relocation expenses in connection with the CEO appointment earlier in the year.

                                         Depreciation and
                                       Amortization Expenses
                                                    as a % of total
                                (in thousands)         revenues
                 Fiscal 2012     $        3,613                  3.7 %
                 Fiscal 2011     $        4,230                  4.1 %

Depreciation and Amortization: The decrease in depreciation and amortization expenses is due primarily to the continued depreciation of our comparable restaurant base and the impact of asset impairments recorded during and subsequent to fiscal 2011.

                                   Provision for Losses on Asset
                                     Impairments and Disposals
                                                    as a % of total
                               (in thousands)           revenues
                 Fiscal 2012      $        424                   0.4 %
                 Fiscal 2011      $        431                   0.4 %

Provision for Losses on Asset Impairments and Disposals: We recorded an impairment loss of approximately $0.3 million during fiscal 2012, as well as a loss of approximately $0.1 million from the disposal of assets related to the closing of Company-owned restaurants.

                                        Closed Store Costs
                            (in thousands)     as a % of total revenues
             Fiscal 2012      $         117                          0.1 %
             Fiscal 2011      $          61                          0.1 %


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Closed Store Costs: The closed store costs resulted from the closing of Company-owned restaurants at the expiration of their leases.

                                        Lease Termination
                                      (Income) Expense, net
                                                    as a % of total
                               (in thousands)          revenues
                Fiscal 2012      $         (13 )                   -
                Fiscal 2011      $          22                     -

Lease Termination (Income)/Expense, net: The lease termination income during fiscal 2012 is related to an adjustment to the lease termination reserve at one subleased location.

                                           Other Income
                                                   as a % of total
                                (in thousands)         revenues
                 Fiscal 2012        $        62                 0.1 %
                 Fiscal 2011        $        46                   -

Other Income: Other income is primarily due to the discounting of the long-term portion of a note receivable.

                                          Net Loss and
                                       Comprehensive Loss
                                                   as a % of total
                               (in thousands)         revenues
                Fiscal 2012     $       (4,441 )              -(4.5 )%
                Fiscal 2011     $       (6,539 )              -(6.4 )%

Net Loss and Comprehensive Loss: The reduction in net loss by approximately $2.1 million, or 32%, is primarily due to the decrease in general and administrative expenses, the decrease in labor costs and the lower depreciation expense, partially offset by the unfavorable effect on fixed occupancy-related costs of the decrease in comparable net restaurant sales, including the effect from the additional fifty-third week in fiscal 2011, as well as the increase in food and beverage and paper and packaging costs.

Fiscal Year 2011 (53 weeks) compared to Fiscal Year 2010 (52 weeks)

Restaurant Net Sales

                                       Restaurant Net Sales
                                                   as a % of total
                                (in thousands)         revenues
. . .
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