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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
(Mark one)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 28, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 000-50052
Cosi, Inc.
(Exact name of registrant as specified in its charter)
Delaware 06-1393745
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
242 West 36th St,
New York, NY 10018
(Address of principal (Zip code)
executive offices)
(212) 653-1600
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act) Yes [ ] No [X]
As of August 4, 2004, 30,576,047 shares of the registrant's Common Stock, $.01
par value, were outstanding.
COSI, INC.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (unaudited)
Consolidated Balance Sheets as of June 28, 2004 and December 29, 2003
(unaudited)
Consolidated Statements of Operations for the three months and six months ended
June 28, 2004, and June 30, 2003 (unaudited)
Consolidated Statements of Cash Flows for the six months ended June 28, 2004,
and June 30, 2003 (unaudited)
Consolidated Statement of Stockholders' Equity for the six months ended June 28,
2004 (unaudited)
Notes to Consolidated Financial Statements (unaudited)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
2
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
COSI, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share information)
JUNE 28, DECEMBER 29,
2004 2003
------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ...................................................... $ 13,236.8 $ 7,957.0
Investments .................................................................... 7,914.1 --
Accounts receivable, net of allowances of $254.7 and $393.1, respectively ...... 390.7 608.4
Inventory ...................................................................... 985.2 982.9
Prepaid expenses and other current assets ...................................... 997.6 1,436.0
------------ ------------
Total current assets .................................................... 23,524.4 10,984.4
PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS, net .............................. 30,568.9 33,574.0
INTANGIBLES, SECURITY DEPOSITS AND OTHER ASSETS, net ............................ 1,879.2 1,943.9
------------ ------------
Total assets ............................................................ $ 55,972.5 $ 46,502.4
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................... $ 3,439.0 $ 6,933.6
Accrued liabilities ............................................................ 6,565.8 7,158.4
Current portion of other liabilities ........................................... 460.8 484.5
Current portion of capital lease obligations ................................... 1.6 2.9
Current portion of long-term debt .............................................. 151.3 160.7
------------ ------------
Total current liabilities ............................................... 10,618.5 14,740.0
OTHER LIABILITIES, net of current portion ........................................ 5,090.7 6,525.5
LONG-TERM DEBT, net of current portion ........................................... 204.0 227.6
------------ ------------
Total liabilities ....................................................... $ 15,913.2 $ 21,493.1
============ ============
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock -- $.01 par value: 100,000,000 shares authorized,
30,515,095 and 26,259,109 shares issued and outstanding, respectively ........ 305.2 262.6
Additional paid-in capital ..................................................... 225,630.6 203,075.4
Deferred stock compensation .................................................... (1,256.9) (1,835.8)
Notes receivable from stockholders ............................................. (2,724.8) (2,724.8)
Accumulated deficit ............................................................ (181,894.8) (173,768.2)
------------ ------------
Total stockholders' equity .............................................. 40,059.3 25,009.2
------------ ------------
Total liabilities, and stockholders' equity ............................. $ 55,972.5 $ 46,502.4
============ ============
The accompanying notes are an integral part of these consolidated statements.
3
COSI, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 28, JUNE 30, JUNE 28, JUNE 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
NET SALES ....................................... $ 29,008.5 $ 28,936.4 $ 53,925.7 $ 54,590.9
COST OF SALES:
Cost of goods sold ............................ 7,182.8 8,172.5 13,678.4 15,489.0
Restaurant operating expenses ................. 17,036.8 17,818.9 33,149.6 34,620.1
---------- ---------- ---------- ----------
TOTAL COST OF SALES ..................... 24,219.6 25,991.4 46,828.0 50,109.1
GENERAL AND ADMINISTRATIVE EXPENSE .............. 4,047.8 4,048.0 8,311.3 11,973.2
STOCK COMPENSATION EXPENSES (1) ................. 586.7 387.4 3,567.8 387.4
DEPRECIATION AND AMORTIZATION ................... 1,695.8 1,994.4 3,397.1 3,953.0
RESTAURANT PRE-OPENING EXPENSES ................. 0.1 -- 59.5 349.1
PROVISION FOR LOSSES ON ASSET IMPAIRMENTS
AND DISPOSALS -- 2,790.8 474.4 5,358.8
LEASE TERMINATION COSTS ......................... (29.5) -- (731.8) 257.1
---------- ---------- ---------- ----------
Operating loss .......................... (1,512.0) (6,275.6) (7,980.6) (17,796.8)
INTEREST INCOME ................................. 12.1 10.4 26.8 35.5
INTEREST EXPENSE ................................ (32.0) (50.9) (35.1) (97.9)
OTHER INCOME (EXPENSE) (141.3) (29.8) (137.7) (54.8)
---------- ---------- ---------- ----------
NET LOSS ................................ $ (1,673.2) $ (6,345.9) $ (8,126.6) $(17,914.0)
========== ========== ========== ==========
PER SHARE DATA:
Net Loss Per Share:
Basic and diluted ........................... $ (0.06) $ (0.38) $ (0.29) $ (1.07)
Weighted Average Common Shares Outstanding: (in
thousands) .................................. 29,305.6 16,823.7 28,127.4 16,698.6
(1) Allocation of stock compensation expenses:
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
JUNE 28, JUNE 30, JUNE 28, JUNE 30,
2004 2003 2004 2003
---------- ---------- ---------- ----------
RESTAURANT OPERATING EXPENSES ................... 39.1 -- 373.2 --
GENERAL AND ADMINISTRATIVE EXPENSES ............. 547.6 387.4 3,194.6 387.4
---------- ---------- ---------- ----------
STOCK COMPENSATION EXPENSE ...................... $ 586.7 $ 387.4 $ 3,567.8 $ 387.4
The accompanying notes are an integral part of these consolidated statements.
4
COSI, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
SIX MONTHS ENDED
JUNE 28, JUNE 30,
2004 2003
------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................... $ (8,126.6) $(17,914.0)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ............................................ 3,397.1 3,953.0
Amortization of deferred financing costs ................................. -- 54.8
Amortization of discount on investments .................................. 1.9 --
Non-cash portion of asset impairments and disposals ...................... 360.5 4,923.3
(Recovery) Provision for bad debts ....................................... (58.7) 18.0
Stock compensation expense ............................................... 3,567.8 387.4
Non-cash employee severance cost ......................................... -- 43.1
Changes in operating assets and liabilities:
Accounts receivable .................................................... 276.4 397.5
Inventory .............................................................. (2.4) 189.2
Other assets ........................................................... 31.8 (266.5)
Accounts payable ....................................................... (3,494.7) (4,334.6)
Accrued liabilities .................................................... (1,297.1) 3,229.6
Accrued contractual lease increases .................................... 10.8 287.6
Prepaid expenses and other current assets .............................. 438.5 499.0
Lease termination accrual .............................................. (768.4) (43.4)
---------- ----------
Net cash used in operating activities ................................ (5,663.1) (8,576.2)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, equipment and leasehold improvements ................ (752.5) (3,379.1)
Purchases of investments ................................................... (7,912.2)
Return of security deposits ................................................ 32.9 187.6
---------- ----------
Net cash used in investing activities ................................ (8,631.8) (3,191.5)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock ..................................... 19,608.9 43.1
Principal payments on capital lease obligations ............................ (1.3) (101.1)
Proceeds from long-term debt plus related warrants and accrued interest .... -- 3000.0
Principal payments on long-term debt ....................................... (32.9) (463.6)
---------- ----------
Net cash provided by (used in) financing activities .................. 19,574.7 2,478.5
---------- ----------
Net increase (decrease) in cash .............................................. 5,279.8 (9,289.2)
CASH AND CASH EQUIVALENTS, beginning of year ................................. 7,957.0 13,032.3
---------- ----------
CASH AND CASH EQUIVALENTS, end of period ..................................... $ 13,236.8 $ 3,743.1
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest ................................................................. $ 35.1 $ 97.9
Corporate franchise and income taxes ..................................... 220.9 80.3
The accompanying notes are an integral part of these consolidated statements.
5
COSI, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For Six Months Ended June 28, 2004
(unaudited)
(in thousands, except share information)
Common Stock
-------------------------------------
Notes
Additional Receivable
Number of Paid In Deferred from Accumulated
Shares Amount Capital Compensation Stockholders Deficit Total
---------- ---------- ---------- ------------ ------------ ----------- ----------
BALANCE, December 29, 2003 26,259,109 $ 262.6 $203,075.4 $ (1,835.8) $ (2,724.8) $(173,768.2) $ 25,009.2
Stock Compensation ....... -- -- 2,988.9 578.9 -- -- 3,567.8
Exercise of Warrants ..... 1,224 -- -- -- -- -- --
Issuance of Common Stock . 4,254,762 42.6 19,566.3 -- -- -- 19,608.9
Net Loss ................. -- -- -- -- -- (8,126.6) (8,126.6)
---------- ---------- ---------- ---------- ---------- ---------- ----------
BALANCE, June 28, 2004 ... 30,515,095 $ 305.2 $225,630.6 $ (1,256.9) $ (2,724.8) $(181,894.8) $ 40,059.3
========== ========== ========== ========== ========== ========== ==========
6
Notes to Consolidated Financial Statements (unaudited)
June 28, 2004
NOTE A -- BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Cosi,
Inc. and its subsidiaries (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information, and
with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly
they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the twenty-six-week period ended June 28, 2004
are not necessarily indicative of the results that may be expected for the
fiscal year ending January 3, 2005.
The balance sheet at December 29, 2003 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by accounting principles generally accepted in the United
States for complete financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K for the year ended December 29, 2003.
NOTE B -- INVESTMENTS
During the second quarter of 2004, the Company purchased certain debt securities
with a portion of the proceeds of the private placement (see Note K).
Investments consist of United States government agency notes with original
maturities of greater than 91 days at the date of purchase.
In accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and
Equity Securities," and based on our intentions regarding these instruments, we
classify all marketable debt securities as held-to-maturity and account for
these investments at amortized cost. The amortized principal amount of
investments at June 28, 2004 was $7.9 million and the weighted average interest
rate was 1.36%. The amortized principal amount approximates fair value at June
28, 2004. We determined the fair value of our investments in debt securities
based upon public market rates. All investments held at June 28, 2004 mature
within one year.
NOTE C -- STOCK-BASED COMPENSATION
The Company complies with the disclosure only provisions of SFAS No. 123,
"Accounting for Stock Based Compensation". This statement establishes financial
accounting and reporting standards for stock-based employee compensation plans.
The provisions of SFAS 123 encourage entities to adopt a fair value based method
of accounting for stock compensation plans; however, these provisions also
permit the Company to continue to measure compensation costs under pre-existing
accounting pronouncements. Pursuant to SFAS 123, the Company has elected to
continue the accounting set forth in Accounting Principles Board ("APB") Opinion
No. 25, "Accounting for Stock Issued to Employees" and to provide the necessary
pro forma disclosures.
The following table illustrates the effect on net loss attributable to common
stock and net loss per common share as if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation.
THREE MONTHS ENDED SIX MONTHS ENDED
------------------ ----------------
(IN 000'S, EXCEPT PER SHARE DATA) JUNE 28, JUNE 30, JUNE 28, JUNE 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net loss attributable to common stock - as reported $ (1,673.2) $ (6,345.9) $ (8,126.6) $ (17,914.0)
Stock based compensation included in the
determination of net loss, as reported .......... 407.1 -- 2,988.9 43.1
Stock based compensation determined under SFAS 123 (725.9) (350.6) (1,253.2) (801.3)
------------- ------------- ------------- -------------
Net loss attributable to common stock - Pro forma .. $ (1,992.0) $ (6,696.5) $ (6,390.9) $ (18,672.2)
Net loss per common share -- Basic and Diluted:
As reported ........................................ $ (0.06) $ (0.38) $ (0.29) $ (1.07)
============= ============= ============= =============
Pro forma .......................................... $ (0.07) $ (0.40) $ (0.23) $ (1.12)
============= ============= ============= =============
Pursuant to a stock option repricing approved by shareholders, on December 29,
2003, 1,246,164 options with exercise prices ranging from $2.37 to $12.25 were
repriced at $2.26 per share. In accordance with APB 25, the Company has recorded
an expense for the
7
three months ended June 28, 2004 and six months ended June 28, 2004 of
approximately $0.4 million and $3.0 million respectively resulting from repriced
options as of June 28, 2004. This expense is the result of an increase in the
Company's stock price from $2.26, as of the date of the repricing, to a stock
price of $6.05, as of the close of business on June 28, 2004. The Company may be
required to record additional charges in the future, which may be material,
depending upon the movement of the Company's stock price. Potential forfeitures
of repriced options may occur for those employees who are not relocating with
the Company to its new corporate headquarters. For those forfeitures, the
Company will reverse the stock compensation expense recorded in previous
quarters related to the unvested portion of those options in the period that the
forfeitures become effective.
NOTE D -- PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Property, equipment and leasehold improvements consist of the following:
JUNE 28, DECEMBER 29,
(IN 000'S) 2004 2003
------------ ------------
Leasehold improvements ........... $ 33,142.1 $ 32,978.8
Furniture and fixtures ........... 9,253.4 9,139.6
Restaurant equipment ............. 13,151.5 13,172.9
Computer and telephone equipment . 8,091.8 7,862.5
Construction in progress ......... 31.8 126.1
------------ ------------
63,670.6 63,279.9
Less: accumulated depreciation and
amortization ..................... (33,101.7) (29,705.8)
------------ ------------
$ 30,568.9 $ 33,574.0
============ ============
RESTAURANT IMPAIRMENT CHARGES
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long Lived Assets." SFAS 144 supercedes SFAS No. 121, "Accounting
for the Impairment of Long Lived Assets and for Long Lived Assets to be disposed
of", and APB Opinion No. 30, "Reporting Results of Operations Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." SFAS 144 retains the
fundamental provisions of SFAS 121 for recognition and measurement of
impairment, but amends the accounting and reporting standards for segments of a
business to be disposed of. In accordance with SFAS 144 and previously under
SFAS 121, impairment losses are recorded on long-lived assets on a restaurant by
restaurant basis whenever impairment factors are determined to be present. The
Company considers a history of restaurant operating losses to be the primary
indicator of potential impairment for individual restaurant locations. The
Company determines whether a restaurant location is impaired based on expected
undiscounted cash flows, generally for the remainder of the lease term, and then
determines the impairment charge based on discounted cash flows for the same
period. During the first half of 2004, the Company identified one unit that has
been impaired and recorded a charge of approximately $0.4 million and also
recorded a charge of $0.1 million related to the write-down on the disposal of
fixed assets. During the first half of 2003, the Company recorded an asset
impairment charge of $3.5 million (related to 8 restaurants). In addition,
during the first half of fiscal 2003, the Company recorded a charge of $0.6
million to reflect the writedown of fixed assets associated with the closure of
three underperforming restaurants and also recorded a writedown of approximately
$1.3 million to reflect the writeoff of construction in progress on 25
restaurants which were in the company's development pipeline, but have been
cancelled.
NOTE E -- ACCRUED LIABILITIES
Accrued liabilities consist of the following:
JUNE 28, DECEMBER 29,
(IN 000'S) 2004 2003
------------ ------------
Payroll and related benefits and taxes $ 1,889.3 $ 1,756.2
Professional and legal costs ......... 232.4 407.3
Taxes payable ........................ 830.6 816.2
Severance payable - current
portion .............................. 792.1 1,485.4
Other ................................ 2,821.4 2,693.3
------------ ------------
$ 6,565.8 $ 7,158.4
============ ============
NOTE F - LONG-TERM DEBT
NOTES PAYABLE
8
The Company maintains a credit facility in the original amount of $3 million
under a Master Loan and Security Agreement dated October 28, 1999 (the
"Equipment Loan Credit Facility"). The proceeds are required to be used for the
purchases of equipment. Borrowings are secured by the equipment purchased. Each
borrowing under the Equipment Loan Credit Facility is payable over 36 months and
the interest rate is determined at the time of the borrowing. Warrants to
purchase shares of common stock were issued in connection with the Equipment
Loan Credit Facility. The warrants entitle the holder to acquire 8,068 shares of
the Company's common stock for $14.875 per share. One note with the remaining
principal amount of $113,738 was satisfied in full on September 1, 2003
according to the terms of the note. As of June 28, 2004, $91,849 still remains
outstanding under the facility.
The Company has an outstanding note payable of approximately $98,000. The note
is due March 2007 and requires monthly payments of $3,097, which commenced in
May 1998, and accrues interest at a rate of 10% per year.
In 2001, the Company entered into a settlement agreement involving a trademark
dispute. Under that agreement, the Company is obligated to make annual payments
of $25,000 per year through 2011. The present value of those future payments is
included in Long Term Debt in the accompanying balance sheets.
NOTE G - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share for the periods indicated (in thousands, except for per share data):
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------ ------------------------
JUNE 28, JUNE 30, JUNE 28, JUNE 30,
(IN 000'S, EXCEPT PER SHARE DATA) 2004 2003 2004 2003
---------- ---------- ---------- ----------
Basic and Diluted:
Net loss attributable to common stock ...... $ (1,673.2) $ (6,345.9) $ (8,126.6) $(17,914.0)
Weighted average common shares outstanding . 29,305.6 16,823.7 28,127.4 16,698.6
Net loss per share ......................... $ (0.06) $ (0.38) $ (0.29) $ (1.07)
========== ============= ============= =============
Basic and diluted loss per common share is calculated by dividing net loss by
the weighted average common shares outstanding during the period. In-the-money
stock options and warrants to purchase an aggregate of 6,015,679 and 273,701
shares of common stock were outstanding at June 28, 2004 and June 30, 2003,
respectively. These stock options and warrants outstanding were not included in
the computation of diluted earnings per share because the Company incurred a net
loss in all periods presented and hence, the impact would be anti-dilutive.
NOTE H- LEASE TERMINATION CHARGES
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities," which addresses accounting for restructuring,
discontinued operation, plant closing or other exit or disposal activity. SFAS
146 requires companies to recognize costs associated with exit or disposal
activities when they are incurred, rather than at the date of a commitment to an
exit or disposal plan. SFAS 146 has been applied prospectively to exit or
disposal activities initiated after December 31, 2002. In the first half of
2004, the Company recognized $0.9 million of lease termination income related to
the reversal of certain lease termination accruals deemed no longer required,
which was partially offset by charges of $0.2 million resulting in a net
reversal of approximately $0.7 million. In addition, payments of $0.4 million
were made during the first half of 2004, $0.3 million of which was covered by
amounts recorded previously as accrued contractual lease increases.
The Company announced previously that the Board of Directors had concluded that
the Company's financial performance would be strengthened by closing in an
orderly fashion as many as thirteen of the Company's restaurants, three of which
were closed in the first quarter of fiscal 2003, three of which were closed in
the third quarter of fiscal 2003, two of which were closed in the fourth quarter
of fiscal 2003, one of which closed in the first quarter of fiscal 2004 and one
of which closed in the second quarter of fiscal 2004. Subsequent to the second
quarter, one additional restaurant was closed, leaving two stores on the
disposition list. Future closings are dependent on the Company's ability to
improve operations in those stores and if unsuccessful to negotiate acceptable
terms with its landlords to terminate the leases for those units, and on its
ability to locate acceptable sub-tenants or assignees for the leases at those
locations. Moreover, future closings may result in additional lease termination
costs. There can be no assurances that the Company
9
will be successful in negotiating terms that will enable it to close additional
underperforming units.
NOTE I - CONTINGENCIES
From time to time, Cosi is a defendant in litigation arising in the ordinary
course of our business, including claims resulting from "slip and fall"
accidents, claims under federal and state laws governing access to public
accommodations, employment related claims and claims from guests alleging
illness, injury or other food quality, health or operational concerns. To date,
none of such litigation, some of which is covered by insurance, has had a
material adverse effect on Cosi's consolidated financial position, results of
operations or cash flows.
On February 5, 2003, a purported shareholder class action complaint was filed in
the United States District Court for the Southern District of New York (the
"Court"), alleging that Cosi and various of our officers and directors and the
underwriter of our IPO violated Sections 11, 12(a)(2) and 15 of the Securities
Act of 1933, as amended, by misstating, and by failing to disclose, certain
financial and other business information (Sheel Mohnot v. Cosi, Inc., et al.,
No. 03 CV 812). At least eight additional class action complaints with
substantially similar allegations were later filed. These actions have been
consolidated in In re Cosi, Inc. Securities Litigation (collectively, the
"Securities Act Litigation"). On July 7, 2003, lead plaintiffs filed a
Consolidated Amended Complaint, alleging on behalf of a purported class of
purchasers of Cosi's stock allegedly traceable to the Company's November 22,
2002 IPO, that at the time of the IPO, the Company's offering materials failed
to disclose that the funds raised through the IPO would be insufficient to
implement Cosi's expansion plan; that it was improbable that the Company would
be able to open 53 to 59 new restaurants in 2003; that at the time of the IPO,
Cosi had negative working capital and therefore did not have available working
capital to repay certain debts; and that the principal purpose for going forward
with the IPO was to repay certain existing shareholders and members of the Board
of Directors for certain debts and to operate the Company's existing
restaurants.
The plaintiffs in the Securities Act Litigation generally seek to recover
recessionary damages, expert fees, attorneys' fees, costs of Court and pre and
post judgment interest. Based on the allegations set forth in the complaint, the
Company believes that the amount of recessionary damages that could be awarded
to the plaintiffs, if a judgment is rendered against the Company, would not
exceed approximately $24 million. In addition, the underwriter is seeking
indemnification from the Company for any damages assessed against it in the
Securities Act Litigation. On August 22, 2003, lead plaintiffs filed a Second
Consolidated Amended Complaint, which was substantially similar to the
Consolidated Amended Complaint. The Securities Act Litigation is at a
preliminary stage, and the Company believes that it has meritorious defenses to
these claims, and intend to vigorously defend against them.
On September 22, 2003, defendants filed motions to dismiss the Second
Consolidated Amended Complaint in the Securities Act Litigation. Plaintiffs
filed their opposition to defendants' motions to dismiss on October 23, 2003.
Defendants filed reply briefs on November 12, 2003.
On July 30, 2004, the Court granted plaintiffs permission to replead their
complaint against the defendants. If plaintiffs choose to file an amended
complaint, they must do so on or before August 27, 2004.
Cosi cannot predict what the outcome of these lawsuits will be. It is possible
that the Company may be required to pay substantial damages or settlement costs
in excess of the Company's insurance coverage, which could have a material
adverse effect on Cosi's financial condition or results of operations. Cosi
could also incur substantial legal costs, and management's attention and
resources could be diverted from the business.
NOTE J - RESTRICTED STOCK
On June 26, 2003, the Company entered into an employment agreement with William
D. Forrest. Pursuant to the agreement, Mr. Forrest will serve as Executive
Chairman for three years ending on March 31, 2006. In consideration for Mr.
Forrest's service as the Company's Executive Chairman, on June 26, 2003, the
Company issued to Mr. Forrest 1,156,407 shares of its authorized but unissued
common stock, representing 5% of its outstanding common stock on a fully diluted
basis (assuming all outstanding options and warrants are exercised). Pursuant to
the December 29, 2003 completion of the rights offering, the Company issued an
additional 522,064 shares to Mr. Forrest such that Mr. Forrest's ownership of
Cosi, on a fully diluted basis, remained at 5%. Mr. Forrest's rights in the
shares vest as follows: (i) 25% of the shares vested upon issuance; (ii) 25% of
the shares vested on April 1, 2004; and (iii) on the last day of each month,
commencing with April 2004, and ending on March 2006, 2.08% of the shares will
vest, and an additional .08% of the shares will vest on March 31, 2006, provided
that at the end of each month the agreement is still in effect. All shares not
vested will fully vest upon the termination of this agreement by Cosi without
cause (as defined in the agreement), or upon a change of
10
control (as defined in the agreement). If Mr. Forrest is terminated by the
Company for cause (as defined in the agreement), all unvested shares will be
forfeited. Mr. Forrest agreed that, during the term of the agreement and for a
period of 12 months thereafter, he will not compete with the Company or solicit
its employees. The value of Mr. Forrest's shares, based on the closing price of
the Company's common stock on the dates of the grants, was $2,729,439, which was
recorded as deferred stock compensation within stockholder's equity.
Amortization of deferred stock compensation expense of approximately $578,900
for the six months ending June 28, 2004 is included in stock compensation
expense in the accompanying consolidated statements of operations. The remaining
balance is being amortized as stock compensation expense evenly over the
remaining life of Mr. Forrest's employment. On February 9, 2004, the Company and
Mr. Forrest executed an addendum to the agreement when Mr. Forrest agreed to
serve as the Company's Executive Chairman on a full-time basis. The addendum
provides for an annual salary of $350,000 and grants of stock options to Mr.
Forrest.
NOTE K - PRIVATE PLACEMENT
On April 30, 2004, the Company issued 3,550,000 shares of common stock to a
limited number of institutional investors at a price of $5.65 per share pursuant
to a private placement under Section 4(2) of the Securities Act of 1933, as
amended. This issuance provided the Company with gross proceeds of approximately
$20.0 million.
Pursuant to the Securities Purchase Agreement relating to the private placement,
the Company filed a registration statement with the SEC covering the resale of
the shares purchased in the private placement. Because the registration
statement was not declared effective by the staff of the SEC by July 29, 2004,
pursuant to the Securities Purchase Agreement, the Company was required to make
a payment to the purchasers of approximately $190,000. The payment is recorded
in the other expense caption of the consolidated statement of operations. The
registration statement was declared effective by the SEC on August 11, 2004.
NOTE L - SUBSEQUENT EVENTS
In July 2004, Ms. Cynthia Jamison joined Cosi as its full-time Chief Financial
Officer. In connection with her employment, Ms. Jamison was granted options to
purchase 200,000 shares of the Company's common stock at a price of $5.73, the
closing market price on the grant date. Ms. Jamison's options vest at a rate of
50,000 shares at the date of the agreement, and an additional 50,000 shares
vests on each anniversary for three years.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
OVERVIEW
We currently own and operate 86 fast casual restaurants in eleven states
and the District of Columbia. Cosi restaurants are all day cafes that feature
signature bread and coffee products in an environment we adjust appropriately
throughout the day. The majority of our restaurants offer breakfast, lunch,
afternoon coffee, dinner and dessert menus.
We currently operate our restaurants in two formats: Cosi and Cosi Sandwich
Bar. The majority of our restaurants offer breakfast, lunch and afternoon coffee
in a counter service format. Cosi Sandwich Bar restaurants, which are located in
non residential central business districts, close for the day in the early
evening, while Cosi restaurants offer dinner and dessert in a casual dining
atmosphere. The atmosphere of Cosi is appropriately managed for each daypart by
changing the music and lighting throughout the day. All of our restaurants are
designed to be welcoming and comfortable, featuring oversized sofas, chairs and
tables, and faux painted walls. The design scheme of our counters and bars, menu
boards as well as condiment counters and server stations incorporate warm colors
and geometric patterns, intended to create a visual vocabulary that can be
easily identified by our customers.
Our objective is to build a nationwide system of distinctive restaurants that
generate attractive unit economics by appealing to a broad range of customers.
In 2003, we announced our intention to incorporate a franchising and area
developer model into our business strategy. In 2003, we conducted a study of our
target customers and their geographic distribution to determine our market
potential in different real estate sites. We determined that our target customer
base skewed towards females, metro elites and upscale suburbanites of all ages.
Additionally, we found the age and situation of our target demographic included
adults 18-24 years of age without children. We utilized these results to
determine our overall market potential. As a result, we believe we can more
accurately assess the viability of different real estate sites. Our study
suggested the potential for up to 1,400 units in the top 25 markets and up to
1,900 units in the top 75 markets. We also developed a store design prototype
that improves our customers' experience. This prototype was unveiled in Avon, CT
in March 2004.
11
During the first half of 2004, we launched our franchising program. We have
completed our franchise offering circular and are currently eligible to offer
franchises in 43 states. We will seek to offer Cosi franchises to area
developers and individual franchise operators. The initial franchise fee,
payable to Cosi, for an area developer is $40,000 for the first restaurant and
$17,500 for each additional restaurant. The initial franchise fee, payable to
Cosi, for an individual franchise operator is $40,000 for the first restaurant
and $35,000 for each additional restaurant.
The Company believes that offering Cosi franchised restaurants to area
developers and individual franchisees offers attractive economics. By
franchising, we believe we will be able to increase the presence of Cosi
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. As of June 28, 2004, the Company has not
licensed any franshisees.
We expect that company owned restaurants (restaurants that the Company owns
as opposed to franchised restaurants) will always be an important part of our
new restaurant growth, and 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 thus maximize stockholder value.
Additionally, earlier this year we announced a foodservice partnership with
Federated Department Stores. In the initial phase of the agreement, Cosi plans
to open 10 restaurants this summer and fall at some of the largest Macy's
stores, including locations in Seattle, Atlanta, Miami and Memphis.
We opened no new restaurants in the six months ended June 28, 2004. Six new
restaurants were opened in the six months ended June 30, 2003. We closed one
underperforming restaurant in the first quarter of fiscal 2004 and one
underperforming restaurant in the second quarter of fiscal 2004. We closed three
underperforming restaurants in the first six months of fiscal 2003. As of June
28, 2004 we operated 87 restaurants. Subsequent to the second quarter, one
additional restaurant was closed.
JUNE 28, JUNE 30,
SIX MONTHS ENDED 2004 2003
---------- ---------
Restaurants open at beginning of period 89 91
Restaurants opened 0 6
Restaurants closed 2 3
Restaurants open at end of period 87 94
CRITICAL ACCOUNTING POLICIES
Our consolidated financial statements and the notes to our consolidated
financial statements contain information that is pertinent to management's
discussion and analysis of financial conditions and results of operations. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities. We believe the following
critical accounting policies involve additional management judgment due to the
sensitivity of the methods, assumptions and estimates necessary in determining
the related asset and liability amounts.
Statement of Financial Accounting Standards ("SFAS") 144, "Accounting for the
Impairment or Disposal of Long Lived Assets," supercedes SFAS 121, "Accounting
for the Impairment of Long Lived Assets and for Long Lived Assets to be Disposed
of," and APB Opinion No. 30, "Reporting Results of Operations Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." SFAS 144 retains the
fundamental provisions of SFAS 121 for recognition and measurement of
impairment, but amends the accounting and reporting standards for segments of a
business to be disposed of. SFAS 144 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. Actual results
may differ from those estimates. The application of SFAS 144, and previously
SFAS 121, 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 and record an impairment loss whenever we
determine impairment factors are present. We have developed and implemented an
operational improvement plan, and we undertake impairment reviews periodically.
We consider a history of restaurant operating losses to be the primary indicator
of potential impairment for individual restaurant locations. A lack of
improvement at the restaurants we are monitoring, or deteriorating results at
other restaurants, could result in additional impairment charges. Historically,
we have not recorded material additional impairment charges subsequent to the
initial determination of impairment. During the first half of 2004, the Company
identified one
12
unit that has been impaired and recorded a charge of approximately $0.4 million
and also recorded a charge of $0.1 million related to the write-down on the
disposal of fixed assets.
For all exit activities prior to December 31, 2002, we estimated our likely
liability under contractual leases for restaurants that have been, or will be,
closed. Such estimates have affected the amount and timing of charges to
operating results that have been significant in recent years 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.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities," which addresses accounting for restructuring,
discontinued operation, plant closing or other exit or disposal activity. SFAS
146 requires companies to recognize costs associated with exit or disposal
activities when they are incurred, rather than at the date of a commitment to an
exit or disposal plan. SFAS 146 has been applied prospectively to exit or
disposal activities initiated after December 31, 2002. In the first half of
2004, the Company recognized $0.9 million of lease termination income related to
the reversal of certain lease termination accruals deemed no longer required,
which was partially offset by charges of $0.2 million resulting in a net
reversal of approximately $0.7 million. In addition, payments of $0.4 million
were made during the first half of 2004, $0.3 million of which was covered by
amounts recorded previously as accrued contractual lease increases.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock Based
Compensation -- Transition and Disclosure." SFAS 148 amends SFAS 123,
"Accounting for Stock Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock based employee compensation. In addition, SFAS 148 amends the
disclosure requirements of SFAS 123 to require more prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock based employee compensation and the effect of the method used on reported
results. The additional disclosure requirements of SFAS 148 are effective for
fiscal years ending after December 15, 2002, and have been incorporated into the
accompanying financial statements and footnotes. We have elected to continue to
follow the intrinsic value method of accounting as prescribed by APB 25 to
account for employee stock options. Pursuant to a stock option repricing
approved by shareholders, on December 29, 2003, 1,246,164 options with exercise
prices ranging from $2.37 to $12.25 were repriced at $2.26 per share. In
accordance with APB 25, these options are subject to variable accounting, which
resulted in a charge in the amount of approximately $0.4 million for the second
quarter of fiscal 2004 and $3.0 million for the first half of fiscal 2004.
Charges in the future may be material depending upon the movement in the stock
price.
We have recorded a full valuation allowance to reduce our deferred tax
assets related to net operating loss carry forwards. A positive adjustment to
income will be recorded in future years if we determine that we could realize
these deferred tax assets.
NET SALES
Our sales are composed almost entirely of food and beverage sales.
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. At
June 28, 2004 and June 30, 2003 there were 87 and 64 restaurants in our
comparable restaurant base, respectively.
COSTS AND EXPENSES
Cost of goods sold. Cost of goods sold is composed of food and beverage
costs. Food and beverage costs are variable, and increase with sales volume.
Restaurant operating expenses. Restaurant operating expenses include direct
hourly and management wages, bonuses, taxes and benefits for restaurant
employees, and other direct restaurant level operating expenses including the
cost of supplies, restaurant repairs and maintenance, utilities, rents 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; supervisory and staff salaries, bonuses
and related taxes and employee benefits; travel; information systems; training;
13
support center rent and related occupancy costs and professional and consulting
fees. The salaries, bonus 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 compensation expense. Stock compensation expense includes the charge
related to stock option repricing as well as the amortization of deferred
compensation of restricted stock.
Depreciation and amortization. Depreciation and amortization principally
includes depreciation on restaurant assets.
Restaurant pre opening expenses. Restaurant pre opening expenses, which are
expensed as incurred, 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 of, or remodeling of, a restaurant.
Our fiscal year ends on the Monday falling nearest to December 31. Fiscal
years 2000, 2001 and 2002 each included 52 weeks. The six-month periods ended
June 28, 2004 and June 30, 2003 each contained 26 weeks.
RESULTS OF OPERATIONS
Our operating results for the three and six months ended June 28, 2004 and
June 30, 2003, expressed as a percentage of sales, were as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------- ------------------------
JUNE JUNE JUNE JUNE
----------- ------------- ------------ -----------
28, 2004 30, 2003 28, 2004 30, 2003
----------- ------------- ------------ -----------
Net sales .................................. 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Cost of goods sold ....................... 24.8% 28.2% 25.4% 28.4%
Restaurant operating expenses ............ 58.7% 61.6% 61.5% 63.4%
----- ----- ----- -----
Total costs of sales ..................... 83.5% 89.8% 86.9% 91.8%
General and administrative expenses ...... 14.0% 14.0% 15.4% 21.9%
Stock compensation expenses .............. 2.0% 1.3% 6.6% 0.7%
Depreciation and amortization ............ 5.8% 6.9% 6.3% 7.2%
Restaurant pre-opening expenses .......... 0.0% -- 0.1% 0.6%
Provision for losses on asset impairments
and disposals............................ (0.0)% 9.6% 0.9% 9.8%
Lease termination costs .................. 0.1% -- (1.4)% 0.5%
----- ----- ----- -----
Operating loss ............................. (5.2)% (21.7)% (14.8)% (32.6)%
Other income (expense):
Interest income .......................... 0.0% 0.1% 0.0% 0.0%
Interest expense ......................... (0.1)% (0.2)% (0.1)% (0.2)%
Other Income ............................. (0.5)% (0.1)% (0.2)% (0.1)%
----- ----- ----- -----
Net income (loss) .......................... (5.8)% (21.9)% (15.1)% (32.8)%
THREE AND SIX MONTHS ENDED JUNE 28, 2004 VS. THREE AND SIX MONTHS ENDED JUNE 30,
2003
NET SALES
Sales increased $0.1 million, or less than 0.1%, to $29.0 million in the
second quarter of fiscal 2004, from $28.9 million in the second quarter of
fiscal 2003. One restaurant was closed during the second quarter of 2004, having
minimal impact on sales compared to the same period last year. This increase in
sales is due to an increase in comparable store sales which is partially offset
by having fewer restaurants in the current year quarter. Year-to-date sales
decreased $0.7 million, or 1.2%, to $53.9 million in the first half of fiscal
2004, from $54.6 million in the first half of fiscal 2003. This decrease was
primarily due to fewer restaurants open during the first half of fiscal 2004
than were open during the first half of fiscal 2003 due to the closure of seven
restaurants since the end of the second quarter of 2003.
In the second quarter of fiscal 2004 comparable restaurant sales increased
4.8% compared to the second quarter of 2003. In the comparable restaurants, our
transaction count was up 2.6% compared to the same period last year, and our
average check increased 2.2%. For the first half of fiscal 2004, comparable
restaurant sales increased 4.3%. In comparable restaurants, for the first
quarter of fiscal 2004, our transaction count increased 2.7% and our average
check increased 1.5% compared to the same period last year.
14
During the third quarter of 2003, we identified 22 restaurants that had
insufficient profit contribution from the breakfast daypart. As a result, we
closed those restaurants during the breakfast daypart. While these breakfast
closures will have a negative impact on our sales growth going forward, we
believe that the closures will improve our future profitability. However, there
can be no assurances that this action will have a positive impact on our
profitability. The breakfast daypart closure was part of an overall company
initiative to optimize its labor costs and contributed to the decrease, as a
percentage of sales, in restaurant operating expenses in the first half and
second quarter of 2004.
COSTS AND EXPENSES
Cost of goods sold. In the second quarter of fiscal 2004, cost of goods
sold decreased $1.0 million or 12.1%, to $7.2 million, from $8.2 million in the
second quarter of fiscal 2003. As a percentage of sales, cost of goods sold
decreased to 24.8% of sales in the second quarter of fiscal 2004, from 28.2% in
the second quarter of fiscal 2003. The decrease in cost of goods sold as a
percentage of sales was primarily due to a refinement of our food and beverage
purchasing process. The Company reduced cost of goods sold by becoming a primary
source buyer and by reducing distribution charges. Moreover, to stabilize these
savings and eliminate the risk of sudden movements in food prices, the Company
has entered into several longer term arrangements with its suppliers. Management
believes that these agreements adequately insulate the Company from increases in
most commodities prices. Management anticipates that any movement in food prices
will have a minimal effect, in the short term, on the Company's cost of goods
sold as the majority of the Company's purchases are covered by these longer
termagreements. Year-to-date, cost of goods sold decreased $1.8 million, or
11.7%, to $13.7 million, from $15.5 million in the first half of fiscal 2003. As
a percentage of sales, cost of goods sold decreased to 25.4% of sales in the
first half of fiscal 2004 from 28.4% in the first half of fiscal 2003. The
decrease in cost of goods sold as a percentage of sales this year was primarily
due to improvements in our purchasing process, as discussed above.
Restaurant operating expenses. Restaurant operating expenses decreased by
$0.8 million, or 4.4%, to $17.0 million in the second quarter of fiscal 2004,
from $17.8 million in the second quarter of fiscal 2003. This decrease is
primarily due to the decrease in the number of restaurants in operation this
year compared to last year. As a percentage of sales, restaurant operating
expenses decreased to 58.7% of sales in the second quarter of fiscal 2004, from
61.6% in the second quarter of fiscal 2003. This decrease, as a percentage of
sales, was primarily the result of improved labor scheduling and optimizing the
deployment of employees during peak and non-peak hours as well as the closure of
the breakfast daypart at 22 of our restaurants, as described above.
Year-to-date, restaurant operating expenses decreased by $1.5 million, or 4.2%,
to $33.1 million in the first half of fiscal 2004, from $34.6 million in the
first half of fiscal 2003. This decrease is primarily due to the decrease in the
number of restaurants in operation this year compared to last year. As a
percentage of sales, restaurant operating expenses decreased to 61.5% of sales
in the first half of fiscal 2004, from 63.4% in the first half of fiscal 2003.
This decrease, as a percentage of sales was primarily due to decreases in our
labor costs, as discussed above.
General and administrative costs. General and administrative costs of $4.0
million in the second quarter of fiscal 2004, remained consistent with the
second quarter of fiscal 2003. As a percentage of sales, general and
administrative costs of 14.0% of sales in the second quarter of fiscal 2004,
also remained consistent with the second quarter of fiscal 2003. Year-to-date
general and administrative costs decreased by $3.7 million, or 30.6%, to $8.3
million in the first half of fiscal 2004, from $12.0 million in the first half
of fiscal 2003. This decrease is primarily due to a one time employee severance
charge of $3.7 million that was partially offset by $0.4 million in cost
reductions associated with reductions in our executive, general and
administrative staff during the first quarter of 2003.
Depreciation and amortization. Depreciation and amortization decreased $0.3
million, or 15.0%, to $1.7 million in the second quarter of fiscal 2004, from
$2.0 million in the second quarter of fiscal 2003. This decrease was primarily
due to the closure of seven restaurants since the end of the second quarter of
2003 and impairment charges taken in 2003 and 2004. As a percentage of sales,
depreciation and amortization decreased to 5.8% of sales in the second quarter
of fiscal 2004, compared to 6.9% of sales in the second quarter of fiscal 2003.
This decrease, as a percentage of sales, is primarily due to an increase in
comparable store sales and increased sales resulting from stores opened in 2003.
Year-to-date, depreciation and amortization decreased $0.6 million, or 14.1%, to
$3.4 million in the first half of fiscal 2003, from $4.0 million in the first
half of fiscal 2003. This decrease was primarily due to the closure of seven
restaurants since the end of the second quarter of 2003 and impairment charges
taken in 2003 and 2004 As a percentage of restaurant sales, depreciation and
amortization decreased to 6.3% of sales in the first half of fiscal 2004,
compared to 7.2% of sales in the first half of fiscal 2003. This decrease, as a
percentage of sales, is primarily due to an increase in comparable store sales.
Restaurant pre-opening expenses. Restaurant pre-opening expenses were
negligible in the second quarter of fiscal 2004, compared with no restaurant
pre-opening expenses recorded in the second quarter of fiscal 2003 as no new
restaurants were opened. This negligible increase is due to the re-opening of
our Avon prototype. Year-to-date, restaurant pre-opening expenses decreased $0.3
million to less than $0.1 million in the first half of fiscal 2004, from $0.3
million in the first half of fiscal 2003. As a percentage of
15
restaurant sales, restaurant pre-opening expenses decreased to 0.1% of sales in
the first half of fiscal 2004, from 0.6% of sales in the first half of fiscal
2003. This decrease is primarily due to six new restaurants opened in the first
half of 2003 compared to one reopening and no new openings in of the first half
of fiscal 2004.
Loss on impairment of property and equipment and restaurant disposals.
There were no restaurant impairment charges taken in the second quarter of
fiscal 2004. During the second quarter of fiscal 2003, we recognized $2.8
million of asset impairment and store disposal costs. This entire charge
represented impairment charges taken on six underperforming restaurants.
Year-to-date, we have recognized $0.5 million of asset impairment and store
disposal costs. This was primarily attributed to an impairment charge of $0.4
million related to one underperforming restaurant and disposal costs of $0.1
million related to the closure of one underperforming restaurant. In the first
half of fiscal 2003, $5.4 million of asset impairment and store disposal costs
were recorded. Of this, approximately $0.6 million represents charges related to
the closure of three under-performing restaurants during the first quarter,
approximately $1.3 million were charges taken on twenty-five locations which
were in our development pipeline but have been cancelled, and approximately $3.5
million represents impairment charges taken on eight underperforming
restaurants.
Lease termination costs. In the second quarter of 2004, we recognized less
than $0.1 million of lease termination income compared to none recognized in the
second quarter of 2003. In the first half of fiscal 2004, we recognized $0.7
million of income related to the reversal of certain least termination accruals
deemed no longer required. In the first half of 2004, the Company recognized
$0.9 million of lease termination income related to the reversal of certain
lease termination accruals deemed no longer required, which was partially offset
by charges of $0.2 million resulting in a net reversal of approximately $0.7
million. In addition, payments of $0.4 million were made during the first half
of 2004, $0.3 million of which was covered by amounts recorded previously as
accrued contractual lease increases. Lease termination costs of $0.3 million
were recorded in the first half of fiscal 2003.
We announced previously that our Board of Directors had concluded that the
Company's financial performance would be strengthened by closing in an orderly
fashion as many as thirteen of the Company's restaurants, three of which were
closed in the first quarter of fiscal 2003, three of which were closed in the
third quarter of fiscal 2003, two of which were closed in the fourth quarter of
fiscal 2003, one of which closed in the first quarter of fiscal 2004, and one of
which closed in the second quarter of fiscal 2004. Subsequent to the second
quarter, one additional restaurant was closed, leaving two stores on the
disposition list.
Interest income and expense. During the second quarter of fiscal 2004 and
the second quarter of fiscal 2003, interest income was less than $0.1 million.
Interest expense was less than $0.1 million in the second quarter of fiscal 2004
and the second quarter of fiscal 2003. In the first half of fiscal 2004 and the
first half of fiscal 2003, interest income was less than $0.1 million. Interest
expense was less than $0.1 million in the first half of fiscal 2004 and was $0.1
million in the first half of fiscal 2003.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $13.2 million on June 28, 2004, compared
with $8.0 million on December 29, 2003. Our working capital was $12.9 million on
June 28, 2004, compared with working capital deficit of $3.8 million as of
December 29, 2003. Our principal requirements for cash are funding operations,
maintaining or remodeling existing restaurants, funding the incorporation of a
franchising and area developer model into our business strategy, financing
construction of new Cosi stores within select Federated locations this year
under the previously announced foodservice partnership with Federated Department
Stores, Inc., and supporting Cosi's plans for new store construction in 2005.
During the first half of fiscal 2004, we financed our requirements for capital
with the proceeds from our rights offering, which was completed in December of
2003 and our private placement, which was completed in April of 2004.
Net cash used in operating activities for the six months ended June 28,
2004 was $5.7 million, compared to $8.6 million for the six months ended June
30, 2003. Funds used in operating activities in the first six months of 2004
decreased primarily as a result of a decrease in our net loss compared to the
first six months of 2003 of $9.8 million offset by the payment of accrued
liabilities in the current quarter.
Total capital expenditures for the six months ended June 28, 2004 were $0.8
million, compared to expenditures of $3.4 million for the six months ended June
30, 2003. The company expects that it will use up to $6.0 million in working
capital during the third and forth quarter of fiscal 2004 for the opening of up
to 10 restaurants in conjunction with its foodservice partnership with Federated
Department Stores.
16
On December 29, 2003, we consummated a rights offering. We raised an
aggregate of approximately $7.5 million ($6.8 million net cash proceeds) in new
cash from the sale of common stock in connection with the rights offering and
pursuant to an investment agreement among us and certain investors that was
approved by our stockholders at our 2003 Annual Meeting. We issued approximately
3.6 million shares of common stock pursuant to the rights offering. In addition,
we issued approximately 1.4 million shares of common stock pursuant to the
investment agreement and approximately 3 million shares of common stock pursuant
to the conversion of $4.5 million of senior secured notes held by certain of the
parties to the investment agreement in connection with the rights offering. In
January 2004, pursuant to the investment agreement, a shareholder purchased an
additional 693,963 shares for approximately $1.0 million.
On April 30, 2004, the Company issued 3,550,000 shares of common stock to a
limited number of institutional investors at a price of $5.65 per share pursuant
to a private placement under Section 4(2) of the Securities Act of 1933, as
amended. This issuance provided the Company with gross proceeds of approximately
$20.0 million. Approximately $6 million of the cash proceeds from this private
placement will be used to finance construction of new Cosi stores within select
Macy's locations this year under the previously announced foodservice
partnership with Federated Department Stores, Inc., and the balance will be
applied to strengthen our balance sheet, support our plans for new store
construction in 2005, and provide for continued infrastructure improvements.
This was the primary financing activity for the six months ended June 28, 2004.
The Company purchased $7.9 million of investments with a portion of the proceeds
of the private placement. Pursuant to the Securities Purchase Agreement,
relating to the private placement, the Company filed a registration statement
with the SEC covering the resale of the shares purchased in the private
placement. Because the registration statement was not declared effective by the
staff of the SEC by July 29, 2004, pursuant to the Securities Purchase
Agreement, the Company was required to make a payment to the purchasers of
approximately $190,000. The payment is recorded in the other expense caption of
the consolidated statement of operations. The registration statement was
declared effective by the SEC on August 11, 2004.
We plan to fund our operations, the maintenance and growth of our
restaurants and our franchising program primarily through cash provided by the
rights offering completed in December 2003, our private placement completed in
April 2004 and expected internally generated cash flows produced by our existing
restaurants. Our cash resources, and therefore our liquidity, are highly
dependent upon the level of internally generated cash from operations and upon
future financing transactions. If cash flows from our existing restaurants or
cash flow from new restaurants that we may open do not meet our expectations or
are otherwise insufficient to satisfy our cash needs or expansion plans, we may
have to seek additional financing from external sources to continue funding our
operations, close underperforming restaurants or reduce or cease our plans to
open or franchise new restaurants. We cannot predict whether such financing will
be available on terms acceptable to us, or at all. We anticipate that our
current cash balances and expected internally generated cash flows will be
sufficient to fund our cash requirements for the next twelve months.
Contractual Obligations
AS OF JUNE 28, 2004
TOTAL DUE JULY - DUE IN 2005 DUE IN 2007 DUE AFTER
CONTRACTUAL OBLIGATIONS (IN THOUSANDS) DECEMBER 2004 AND 2006 AND 2008 2008
- ----------------------- -------------- --------------- --------------- --------------- ---------------
Notes payable $ 355.3 $ 127.7 $ 115.7 $ 47.5 $ 64.4
Employee severance obligations 825.5 515.1 310.4
Capital lease obligations 1.6 1.6
Operating lease obligations (a)(b) 87,999.5 6,097.6 24,578.9 23,670.4 33,652.6
(a) Amounts shown are net of $2.1 million of sublease rental income due under
non-cancelable subleases.
(b) Includes approximately $3.2 million of obligations on leases for
restaurants that have either been closed or are planned to be closed.
We are obligated under non-cancelable operating leases for our restaurants
and our administrative offices. Lease terms are generally for ten years with
renewal options and generally require us to pay a proportionate share of real
estate taxes, insurance, common area and other operating costs. Some restaurant
leases provide for contingent rental payments.
PURCHASE COMMITMENT
17
During fiscal year 1999, the Company entered into an exclusive coffee
supply agreement with Coffee Bean International, Inc. ("Coffee Bean
International"). The agreement calls for minimum purchases, in terms of both
quantity and price, to be made by the Company of coffee beans and related
products. In 2004, the Company renewed the purchase agreement with Coffee Bean
International and is obligated to purchase approximately 75,000 pounds per
quarter of coffee beans and related products, worth approximately $290,000, for
the next five quarters but the agreement may be terminated by the Company or
Coffee Bean International; provided that 180 days notice is given in advance of
such termination.
During fiscal year 2002, the Company entered into a long term beverage
marketing agreement with the Coca Cola Company. Under the agreement, the Company
is obligated to purchase approximately 2.0 million gallons of fountain syrups at
the then current annually published national chain account prices.
Currently, except for the aforementioned coffee contract which can be
terminated with 180 days notice, the company does not have any long term
contracts with its suppliers. However, the Company does have a contract with
Maines Paper and Food Service ("Maines") as the broadline distributor that
expires in January 2005. Maines supplies the Company with approximately 90% of
its products.
FORWARD-LOOKING STATEMENTS
Matters discussed in this report, which relate to events or developments
which are expected to occur in the future, including any discussion, expressed
or implied, of anticipated growth, operating results or earnings constitute
forward-looking statements. Forward-looking statements are based on management's
beliefs, assumptions and expectations of our future economic performance, taking
into account the information currently available to management. These statements
are not statements of historical fact. Forward-looking statements involve risks
and uncertainties that may cause our actual results, performance or financial
condition to differ materially from the expectations of future results,
performance or financial condition we express or imply in any forward-looking
statements. Factors that could contribute to these differences include, but are
not limited to:
o the cost of our principal food products;
o labor shortages or increased labor costs;
o changes in consumer preferences and demographic trends;
o increasing competition in the fast casual dining segment of the
restaurant industry;
o expansion into new markets;
o our ability to effectively manage our business with a reduced
general and administrative staff;
o our ability to incorporate a franchising and area development model
into our strategy;
o the availability and cost of additional financing, both to fund our
existing operations and to grow and open new restaurants;
o fluctuations in our quarterly results due to seasonality;
o the rate of our internal growth, and our ability to generate
increased revenue from our existing restaurants;
o our ability to generate positive cash flow from operations;
o increased government regulation;
o supply and delivery shortages or interruptions;
o market saturation due to new restaurant openings;
o inadequate protection of our intellectual property;
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o adverse weather conditions which impact customer traffic at our
restaurants; and
o adverse economic conditions.
The words "believe," "may," "will," "should," "anticipate," "estimate,"
"expect," "intend," "objective," "seek," "plan," "strive" or similar words, or
the negatives of these words, identify forward-looking statements. We qualify
any forward-looking statements entirely by these cautionary factors.
ITEM 3. Quantitative And Qualitative Disclosures About Market Risk
The Company's market risk exposures are related to its cash, cash
equivalents, investments and interest that it pays on its debt. The Company has
no derivative financial instruments or derivative commodity instruments in its
cash, cash equivalents and investments. The Company invests its 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 the Company earns on its investments and, therefore,
impacts it cash flows and results of operations.
All of the Company's transactions are conducted, and its accounts are
denominated, in United States dollars. Accordingly, the Company is not exposed
to foreign currency risk.
ITEM 4. Controls and Procedures
The Company's management, with the participation of the Company's chief
executive officer and chief financial officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as
amended (the "Exchange Act") as of the end of the period covered by this report.
Based on such evaluation, the Company's chief executive officer and chief
financial officer have concluded that, as of the end of such period, the Company
disclosure controls and procedures are effective in recording, processing,
summarizing and reporting, on a timely basis, information required to be
disclosed by the Company in the reports that it files or submits under the
Exchange Act.
There have not been any changes in the Company's internal control over
financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the second fiscal quarter to which this report
relates that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, Cosi is a defendant in litigation arising in the
ordinary course of our business, including claims resulting from "slip and fall"
accidents, claims under federal and state laws governing access to public
accommodations, employment related claims and claims from guests alleging
illness, injury or other food quality, health or operational concerns. To date,
none of such litigation, some of which is covered by insurance, has had a
material adverse effect on Cosi's consolidated financial position, results of
operations or cash flows.
On February 5, 2003, a purported shareholder class action complaint was
filed in the United States District Court for the Southern District of New York
(the "Court"), alleging that Cosi and various of our officers and directors and
the underwriter of our IPO violated Sections 11, 12(a)(2) and 15 of the
Securities Act of 1933, as amended, by misstating, and by failing to disclose,
certain financial and other business information (Sheel Mohnot v. Cosi, Inc., et
al., No. 03 CV 812). At least eight additional class action complaints with
substantially similar allegations were later filed. These actions have been
consolidated in In re Cosi, Inc. Securities Litigation (collectively, the
"Securities Act Litigation"). On July 7, 2003, lead plaintiffs filed a
Consolidated Amended Complaint, alleging on behalf of a purported class of
purchasers of Cosi's stock allegedly traceable to the Company's November 22,
2002 IPO, that at the time of the IPO, the Company's offering materials failed
to disclose that the funds raised through the IPO would be insufficient to
implement Cosi's expansion plan; that it was improbable that the Company would
be able to open 53 to 59 new restaurants in 2003; that at the time of the IPO,
Cosi had negative working capital and therefore did not have available working
capital to repay certain debts; and that the principal purpose for going forward
with the IPO was to repay certain existing shareholders and members of the Board
of Directors for certain debts and to operate the Company's existing
restaurants.
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The plaintiffs in the Securities Act Litigation generally seek to recover
recessionary damages, expert fees, attorneys' fees, costs of Court and pre and
post judgment interest. Based on the allegations set forth in the complaint, the
Company believes that the amount of recessionary damages that could be awarded
to the plaintiffs, if a judgment is rendered against the Company, would not
exceed approximately $24 million. In addition, the underwriter is seeking
indemnification from the Company for any damages assessed against it in the
Securities Act Litigation. On August 22, 2003, lead plaintiffs filed a Second
Consolidated Amended Complaint, which was substantially similar to the
Consolidated Amended Complaint. The Securities Act Litigation is at a
preliminary stage, and the Company believes that it has meritorious defenses to
these claims, and intend to vigorously defend against them.
On September 22, 2003, defendants filed motions to dismiss the Second
Consolidated Amended Complaint in the Securities Act Litigation. Plaintiffs
filed their opposition to defendants' motions to dismiss on October 23, 2003.
Defendants filed reply briefs on November 12, 2003.
On July 30, 2004, the Court granted plaintiffs permission to replead their
complaint against the defendants. If plaintiffs choose to file an amended
complaint, they must do so on or before August 27, 2004.
Cosi cannot predict what the outcome of these lawsuits will be. It is
possible that the Company may be required to pay substantial damages or
settlement costs in excess of the Company's insurance coverage, which could have
a material adverse effect on Cosi's financial condition or results of
operations. Cosi could also incur substantial legal costs, and management's
attention and resources could be diverted from the business.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
On April 30, 2004, the Company issued 3,550,000 shares of common stock to a
limited number of institutional investors at a price of $5.65 per share pursuant
to a private placement under Section 4(2) of the Securities Act of 1933, as
amended. This issuance provided the Company with gross proceeds of approximately
$20.0 million. Approximately $6 million of the cash proceeds from this private
placement will be used to finance construction of new Cosi stores within select
Macy's locations this year under the previously announced foodservice
partnership with Federated Department Stores, Inc., and the balance will be
applied to strengthen our balance sheet, support our plans for new store
construction in 2005, and provide for continued infrastructure improvements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
The Company solicited proxies in connection with its 2004 Annual Meeting of
Stockholders, held on May 17, 2004. The outcome of such votes were as follows:
VOTES AGAINST
-------------
PROPOSAL VOTES FOR OR WITHHELD ABSTENTIONS
-------- --------- ----------- -----------
Election of Kevin Armstrong as Director .................... 14,417,618 342,897 --
Election of Creed Ford as Director ......................... 14,000,759 759,756 --
Election of Mark Demilio ................................... 14,387,539 372,976
Ratification of Ernst & Young LLP as auditors for 2004 ..... 14,462,052 297,143 1,320
Approval of the Amended and Restated Cosi, Inc. Non-Employee
Director Stock Incentive Plan .............................. 5,185,753 1,848,168 3,710
ITEM 5. OTHER INFORMATION
None
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ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Securities Purchase Agreement, dated as of April 27, 2004 (filed as
Exhibit 10.1 to the Current Report on Form 8-K filed on April 28, 2004).
10.2 Employment Agreement between Cosi, Inc. and Cynthia Jamison, dated as of
July 7, 2004.
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on April 2, 2004 that
announced the Company's financial results for the quarter and year ending
December 29, 2003.
The Company filed a Current Report on Form 8-K on April 12, 2004 that
announced the resignations of Jeffrey Stork and Greg Woolley from the Board of
Directors. The Company also announced the elections of Mark Demilio, Edna Morris
and Garry Stock to the Board of Directors.
The Company filed a Current Report on Form 8-K on April 28, 2004 that
announced the Company's private placement of 3,550,000 shares of common stock
and the preliminary financial results for the Company's first quarter of 2004.
The Company filed a Current Report on Form 8-K on May 28, 2004 that
announced that the Company will open a new support center in Chicago.
The Company filed a Current Report on Form 8-K on June 18, 2004, as amended
on July 29, 2004 and August 6, 2004, that announced that the Company's
independent auditors, Ernst & Young LLP would resign after its review of this
Form 10-Q.
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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.
Dated: August 11, 2004 By: /s/ William D. Forrest
---------------------------
William D. Forrest
Executive Chairman
Dated: August 11, 2004 By: /s/ Kevin Armstrong
---------------------------
Kevin Armstrong
Chief Executive Officer
Dated: August 11, 2004 By: /s/ Cynthia Jamison
---------------------------
Cynthia Jamison
Chief Financial Officer
(Chief Accounting Officer)
Treasurer and Secretary
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