UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 27, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _____to _____
Commission File No. 000-50052
COSI, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1393745
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1751 Lake Cook Road
Deerfield, Illinois 60015
(Address of principal executive offices) (Zip Code)
(847) 597-8800
(Registrant's telephone number, including area code)
242 West 36th Street, New York, New York 10018
- --------------------------------------------------------------------------------
(Former Name or Former Address, if Changed Since Last Report)
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 Exchange Act Rule 12b-2. Yes No X
--- ---
Number of shares of Common Stock, $.01 par value, outstanding at November 2,
2004: 30,744,490
COSI, INC.
Index to Form 10-Q
For the three and nine month periods ended September 27, 2004
Page Number
-----------
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets - as of September 27, 2004
and December 29, 2003 ......................................... 3
Consolidated Statements of Operations - Three and nine month
periods ended September 27, 2004 and September 29, 2003........ 4
Consolidated Statement of Stockholders' Equity - Nine month
period ended September 27, 2004 ............................... 5
Consolidated Statements of Cash Flows - Nine month periods ended
September 27, 2004 and September 29, 2003...................... 6
Notes to Condensed Consolidated Financial Statements........... 7-13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 14-22
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 23
Item 4. Controls and Procedures........................................ 23
PART II. OTHER INFORMATION
--------------------------
Item 1. Legal Proceedings............................................. 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds... 25
Item 6. Exhibits and Reports on Form 8-K.............................. 25
SIGNATURES .............................................................. 26
CERTIFICATIONS........................................................... 27-29
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Cosi, Inc.
Consolidated Balance Sheets
As of September 27, 2004 and December 29, 2003
(dollars in thousands, except share data)
September 27, 2004 December 29, 2003
------------------ -----------------
(Unaudited) (Note A)
Assets
Current assets:
Cash and cash equivalents $ 8,609.4 $ 7,957.0
Investments 9,938.2 --
Accounts receivable, net of allowances of $133.2 and $393.1, respectively 890.8 608.4
Inventories 947.7 982.9
Prepaid expenses and other current assets 620.7 1,436.0
------------------ -----------------
Total current assets 21,006.8 10,984.4
================== =================
Property, equipment and leasehold improvements, net 30,883.9 33,574.0
Intangibles, security deposits and other assets, net 2,222.7 1,943.9
------------------ -----------------
Total assets $ 54,113.4 $ 46,502.4
================== =================
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 4,004.5 $ 6,933.6
Accrued liabilities 7,108.8 7,158.4
Current portion of other liabilities 505.4 484.5
Current portion of long-term debt 153.9 163.6
------------------ -----------------
Total current liabilities 11,772.6 14,740.0
Other long-term liabilities, net of current portion 4,980.0 6,525.5
Long-term debt, net of current portion 191.9 227.6
------------------ -----------------
Total liabilities 16,944.5 21,493.1
Commitments and contingencies
Stockholders' equity:
Common stock - $.01 par value; 100,000,000 shares authorized,
30,724,958 and 26,259,109 shares issued and outstanding, respectively 307.2 262.6
Additional paid-in capital 225,049.4 203,075.4
Deferred stock compensation (1,077.4) (1,835.8)
Notes receivable from stockholders (1,252.8) (2,724.8)
Accumulated deficit (185,857.5) (173,768.2)
------------------ -----------------
Total stockholders' equity 37,168.9 25,009.2
------------------ -----------------
Total liabilities and stockholders' equity $ 54,113.4 $ 46,502.4
================== =================
The accompanying notes are an integral part of these consolidated financial
statements
3
Cosi, Inc.
Consolidated Statements of Operations
For the Three and Nine Month Periods Ended September 27, 2004 and
September 29, 2003
(dollars in thousands, except share data)
Three Months Ended Nine Months Ended
September 27, September 29, September 27, September 29,
2004 2003 2004 2003
------------- ------------- ------------- -------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net sales $ 28,170.0 $ 27,539.3 $ 82,095.8 $ 82,130.2
Cost of sales:
Cost of goods sold 7,016.6 7,515.4 20,695.0 23,004.5
Restaurant operating expenses 16,529.6 17,442.3 49,679.2 52,062.3
------------- ------------- ------------- -------------
Total cost of sales 23,546.2 24,957.7 70,374.2 75,066.8
General and administrative expenses 4,910.0 3,396.5 13,221.3 15,369.6
Corporate office relocation 935.6 -- 935.6 --
Stock compensation expense (benefit)(1) (799.8) 105.6 2,768.0 493.1
Depreciation and amortization 1,653.5 1,862.8 5,050.5 5,815.8
Restaurant pre-opening expenses 125.5 32.2 185.1 381.4
Provision for losses on asset impairments
and disposals -- 339.9 474.4 5,698.6
Lease termination costs (benefit) 357.3 (602.8) (374.5) (345.7)
------------- ------------- ------------- -------------
Operating loss (2,558.3) (2,552.6) (10,538.8) (20,349.4)
Interest income 58.4 4.2 85.2 39.7
Interest expense (2.8) (87.1) (38.0) (239.8)
Reserve for notes receivable from
stockholders (1,472.0) -- (1,472.0) --
Other income (expense) 11.9 99.0 (125.7) 99.0
------------- ------------- ------------- -------------
Net loss $ (3,962.8) $ (2,536.5) $ (12,089.3) $ (20,450.5)
============= ============= ============= =============
Per Share Data:
Net loss per share, basic and diluted $ (0.13) $ (0.14) $ (0.42) $ (1.20)
============= ============= ============= =============
Weighted average shares outstanding: 30,609,402 17,710,000 28,954,759 17,036,000
============= ============= ============= =============
(1) Allocation of stock compensation expense:
Restaurant operating expenses $ (110.5) $ -- $ 262.6 $ --
General and administrative expenses (689.3) 105.6 2,505.4 493.1
------------- ------------- ------------- -------------
Stock compensation expense $ (799.8) $ 105.6 $ 2,768.0 $ 493.1
============= ============= ============= =============
The accompanying notes are an integral part of these consolidated financial
statements
4
Cosi, Inc.
Consolidated Statement of Stockholders' Equity
For the Nine Months Ended September 27, 2004
(unaudited)
(dollars in thousands, except share data)
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 2,009.6 758.4 2,768.0
Exercise of warrants 3,424 -- --
Exercise of options 178,022 1.8 398.1 399.9
Issuance of common
stock 4,284,403 42.8 19,566.3 19,609.1
Reserve for notes
receivable from
stockholders 1,472.0 1,472.0
Net loss (12,089.3) (12,089.3)
Balance, September ---------- -------- ----------- ------------ ------------- -------------- ----------
27, 2004 30,724,958 $ 307.2 $ 225,049.4 $ (1,077.4) $ (1,252.8) $ (185,857.5) $ 37,168.9
========== ======== =========== ============= ============== =============== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
5
Cosi, Inc.
Consolidated Statements of Cash Flows
For the Nine Month Periods Ended September 27, 2004 and September 29, 2003
(dollars in thousands)
September 27, 2004 September 29, 2003
------------------ ------------------
(Unaudited) (Unaudited)
Cash flows from operating activities:
Net loss $ (12,089.3) $ (20,450.5)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization 5,050.5 5,815.8
Amortization of deferred financing costs -- 62.1
Non-cash portion of asset impairments and disposals 380.5 5,293.9
(Recovery) provision for bad debts (58.7) 27.0
Stock compensation expense 2,768.0 493.1
Non-cash employee severance -- 43.1
Reserve on notes receivable from stockholders 1,472.0 --
Changes in operating assets and liabilities:
Accounts receivable (223.7) 269.7
Inventories 35.2 316.3
Other assets 62.1 (751.5)
Prepaid expenses and other current assets 815.4 721.3
Accounts payable (2,929.1) (4,728.2)
Accrued liabilities (444.4) 3,445.5
Accrued contractual lease increases (85.1) 436.7
Lease termination accrual (1,044.6) (1,025.8)
------------------ ------------------
Net cash used in operating activities (6,291.2) (10,031.5)
Cash flows used in investing activities:
Capital expenditures (2,740.9) (3,571.6)
Purchases of investments (9,938.2) --
(Payment) return of security deposits (340.9) 290.5
------------------ ------------------
Net cash used in investing activities (13,020.0) (3,281.1)
Cash flows provided by financing activities:
Proceeds from issuance of common stock 20,009.0 --
Principal payments on capital lease obligations (1.4) (118.0)
Proceeds from long-term debt plus related warrants and accrued interest -- 4,500.0
Principal payments on long-term debt (44.0) (862.7)
------------------ ------------------
Net cash provided by financing activities 19,963.6 3,519.3
------------------ ------------------
Net increase (decrease) in cash and cash equivalents 652.4 (9,793.3)
Cash and cash equivalents, beginning of period 7,957.0 13,032.3
------------------ ------------------
Cash and cash equivalents, end of period $ 8,609.4 $ 3,239.0
================== ==================
Supplemental disclosures of cash flow information: Cash paid for:
Interest $ 48.0 $ 229.2
================== ==================
Corporate franchise and income taxes $ 145.1 $ 134.6
================== ==================
The accompanying notes are an integral part of the consolidated financial
statements.
6
COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note A - Basis of Presentation
We have prepared the accompanying unaudited condensed consolidated financial
statements in accordance with the requirements of Form 10-Q and, therefore, they
do not include all information and footnotes necessary for a fair presentation
of financial position, results of operations, and cash flows in conformity with
accounting principles generally accepted in the United States of America. In our
opinion, the financial statements reflect all adjustments that are necessary for
a fair presentation of the results of operations for the periods shown. All such
adjustments are of a normal recurring nature. In preparing financial statements
in conformity with accounting principles generally accepted in the United States
of America, we must make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenues, expenses, and related disclosures at
the date of the financial statements and during the reporting period. Actual
results could differ from those estimates.
The balance sheet at December 29, 2003 has been derived from 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 of America for complete financial statements.
The results for the three and nine month periods ended September 27, 2004 may
not be indicative of the results for the fiscal year.
This Report should be read in conjunction with our Annual Report on Form 10-K
for the year ended December 29, 2003, as filed with the Securities and Exchange
Commission ("SEC").
Note B - Investments
During the nine month period ended September 27, 2004, we purchased certain debt
securities as investments. These investments consist of United States government
agency notes with original maturities of greater than 30 days at the date of
purchase.
In accordance with Statement of Financial Accounting Standards ("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 September 27, 2004 was
$9.9 million and the weighted average interest rate was 1.76%. The amortized
principal amount approximates fair value at September 27, 2004. We determined
the fair value of our investments in debt securities based upon public market
rates. All investments held at September 27, 2004 mature within one year.
Note C - Stock-Based Compensation
We comply 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 illustrates the pro forma effect on net loss attributable to
common stock and net loss per common share as if we had applied the fair value
recognition provisions of SFAS No. 123 to stock-based compensation:
7
COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - continued
Note C - Stock-Based Compensation (continued)
Three Month Periods Ended Nine Month Periods Ended
September 27, September 29, September 27, September 29,
2004 2003 2004 2003
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
Net loss as reported $ (3,962.8) $ (2,536.5) $ (12,089.3) $ (20,450.5)
Add: Stock-based compensation expense (benefit)
included in reported net loss (979.3) -- 2,009.6 43.1
Deduct: Total stock-based employee compensation
expense determined under the fair value based
method for all awards (671.7) (43.2) (1,925.0) (844.5)
-------------- -------------- -------------- --------------
Pro forma net loss $ (5,613.8) $ (2,579.7) $ (12,004.7) $ (21,251.9)
============== ============== ============== ==============
Net loss per common share: basic and diluted
As reported $ (0.13) $ (0.14) $ (0.42) $ (1.20)
Pro forma $ (0.18) $ (0.15) $ (0.41) $ (1.25)
The pro forma amounts are not representative of the effects on reported earnings
for future periods.
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 common share. In accordance with APB 25, we have recorded
income for the three months ended September, 2004 of approximately $1.0 million
resulting from a decrease in our stock price from $6.05, as of the close of
business on June 28, 2004, to a stock price of $5.23, as of the close of
business on September 27, 2004, as well as a decrease in the number of repriced
options outstanding due to forfeitures and exercises during the quarter. For the
nine month period ended September 27, 2004, we have recorded an expense of
approximately $2.0 million resulting from an increase in our stock price from
$2.26, as of the date of the repricing, to a stock price of $5.23, as of the
close of business on September 27, 2004. We may be required to record additional
adjustments in the future, that may be material, depending upon the movement of
our stock price. Potential forfeitures of repriced options may occur for those
employees who have not relocated to our new corporate headquarters in Deerfield,
Illinois. For those forfeitures, we will reverse the stock compensation expense
recorded in previous quarters related to the unvested portion of those options
in the period that the forfeitures become effective.
8
COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - continued
NOTE D - Property, Equipment and Leasehold Improvements
Property, equipment and leasehold improvements consist of the following:
September 27, December 29,
($ in 000's) 2004 2003
------------- ------------
Leasehold improvements 33,204.3 32,978.7
Furniture and fixtures 9,260.9 9,139.6
Restaurant equipment 13,263.7 13,172.9
Computer and telephone equipment 8,248.7 7,862.5
Construction in progress 1,661.9 126.1
------------- ------------
65,639.5 63,279.8
Less: accumulated depreciation and
amortization (34,755.6) (29,705.8)
Net property, equipment and leasehold
------------- ------------
improvements 30,883.9 33,574.0
============= ============
Restaurant Impairment Charges:
In August 2001, the Financial Accounting Standards Board ("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. We consider a history of restaurant
operating losses to be the primary indicator of potential impairment for
individual restaurant locations. We generally determine whether a restaurant
location is impaired based on expected undiscounted cash flows, primarily for
the remainder of the lease term, and then determine the impairment charge based
on discounted cash flows for the same period. During the first quarter of fiscal
2004, we identified one unit that has been impaired and recorded a charge of
approximately $0.4 million. In addition, we recorded a charge of $0.1 million
related to the write-down on the disposal of fixed assets. During the nine month
period ended September 29, 2003, we recorded an asset impairment charge of $3.8
million (related to 9 restaurants). In addition, we recorded a charge of $0.6
million to reflect the writedown of fixed assets associated with the closure of
three underperforming restaurants as well as a charge of approximately $1.3
million to reflect the write-off of construction in progress on 25 restaurants
which were in the company's development pipeline, but were cancelled.
9
COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - continued
Note E - Accrued Liabilities
Accrued liabilities consist of the following:
September 27, December 29,
($ in 000's) 2004 2003
------------- ------------
Payroll and related benefits and taxes $ 1,444.7 $ 1,756.2
Professional and legal costs 707.7 407.3
Taxes payable 598.5 816.2
Severance payable - current portion 1,060.3 1,485.4
Rent obligations (1) 695.8 562.2
Unearned revenue 545.9 566.8
Health insurance 380.3 397.7
Security deposits 170.0 45.0
Other 1,505.6 1,121.6
------------- ------------
Accrued liabilities $ 7,108.8 $ 7,158.4
============= ============
(1) Additional rent obligations recorded in other long-term liabilities
Note F - Long-Term Debt
Notes Payable:
We had 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 were required to be used for the purchases of
equipment. Borrowings were secured by the equipment purchased. Each borrowing
under the Equipment Loan Credit Facility was payable over 36 months and the
interest rate was 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 7,261 shares of our common
stock for $14.875 per share. As of September 27, 2004, $91,849 was outstanding
under the facility. A payment of $91,849 was made in the fourth quarter of
fiscal 2004.
We have an outstanding note payable of approximately $84,000. 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, we entered into a settlement agreement involving a trademark dispute.
Under that agreement, we are 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 sheet.
NOTE G - Earnings Per Share
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 3,424,442 and 1,269,295
shares of common stock were outstanding at September 27, 2004 and September 29,
2003, respectively. These stock options and warrants outstanding were not
included in the computation of diluted earnings per share because we incurred a
net loss in all periods presented and hence, the impact would be anti-dilutive.
10
COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - continued
NOTE H- Lease Termination Costs
In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for any 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. During the third quarter
of fiscal 2004, we recorded a $0.4 million charge for lease termination costs
due primarily to three restaurants closed during and subsequent to the third
quarter of fiscal 2004.During the first nine months of fiscal 2004, we
recognized approximately $1.3 million of lease termination income related to the
reversal of certain lease termination accruals, which was partially offset by
charges of approximately $0.9 million resulting in a net reversal of
approximately $0.4 million.
We announced previously that the Board of Directors had concluded that our
financial performance would be strengthened by closing in an orderly fashion as
many as thirteen of our 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, one of which closed in the
second quarter of fiscal 2004 and two of which were closed in the third quarter
of fiscal 2004. Subsequent to the third quarter, the last remaining store on the
disposition list was closed.
Future store closings, if any, may result in additional lease termination
charges. Charges for lease termination costs will be dependent on our ability to
improve operations in those stores. If unsuccessful, lease termination costs
will be determined through negotiating acceptable terms with its landlords to
terminate the leases for those units, and also on our ability to locate
acceptable sub-tenants or assignees for the leases at those locations.
NOTE I - Contingencies
From time to time, we are 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 our 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 we 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 our stock allegedly traceable to our November 22, 2002 IPO, that
at the time of the IPO, our offering materials failed to disclose that the funds
raised through the IPO would be insufficient to implement our expansion plan;
that it was improbable that we would be able to open 53 to 59 new restaurants in
2003; that at the time of the IPO, we 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 our existing restaurants.
11
COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - continued
NOTE I - Contingencies, continued
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, we
believe that the amount of recessionary damages that could be awarded to the
plaintiffs, if a judgment is rendered against us, would not exceed approximately
$24 million. In addition, the underwriter is seeking indemnification from us 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 we believe that we have meritorious
defenses to these claims, and intend to vigorously defend against them.
On September 22, 2003, we filed motions to dismiss the Second Consolidated
Amended Complaint in the Securities Act Litigation. Plaintiffs filed their
opposition to our motions to dismiss on October 23, 2003. We filed reply briefs
on November 12, 2003.
On July 30, 2004, the Court granted plaintiffs permission to replead their
complaint against us. On September 10, 2004, plaintiffs filed their Third
Consolidated Amended Complaint. Plaintiffs abandoned their claim that we misled
investors about our ability to execute our growth plans. Instead, plaintiffs
claim that our offering materials failed to disclose that, at the time of the
IPO, we were researching the possibility of franchising our restaurants. On
October 12, 2004, we filed a motion to dismiss plaintiffs' Third Consolidated
Amended Complaint. Plaintiffs' opposition to the motion to dismiss is due
November 19, 2004.
We cannot predict what the outcome of these lawsuits will be. It is possible
that we may be required to pay substantial damages or settlement costs in excess
of our insurance coverage, which could have a material adverse effect on our
financial condition or results of operations. We 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, we 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 our Executive Chairman, we issued 1,156,407 shares of our authorized
but unissued common stock, representing 5% of our outstanding common stock on a
fully diluted basis (assuming all outstanding options and warrants are
exercised) to Mr. Forrest on June 26, 2003. Pursuant to the December 29, 2003
completion of the rights offering, we issued an additional 522,064 shares to Mr.
Forrest such that Mr. Forrest's ownership of us, 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 us without cause (as defined in the agreement),
or upon a change of control (as defined in the agreement). If Mr. Forrest is
terminated by us 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 us or solicit its
employees. The value of Mr. Forrest's shares, based on the closing price of our
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 $758,400 for the nine month
period ended September 27, 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, we and Mr. Forrest executed an
addendum to the agreement when Mr. Forrest agreed to serve as our 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.
12
COSI, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - continued
NOTE K - Private Placement
On April 30, 2004, we 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 us with gross proceeds of approximately $20.0 million.
Pursuant to the Securities Purchase Agreement relating to the private placement,
we filed a registration statement with the SEC covering the resale of the shares
purchased in the private placement. The registration statement was declared
effective by the SEC on August 11, 2004.
In January 2004, pursuant to an investment agreement, a shareholder purchased an
additional 693,963 shares for approximately $1.0 million.
13
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We currently own and operate 90 fast casual restaurants in fourteen states and
the District of Columbia, including six stores opened within Federated
Department Stores subsequent to the end of the third quarter. Cosi restaurants
are all day cafes that feature signature bread, salads 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 day part by changing
the music and lighting throughout the day. 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 comfortable environment 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 fiscal 2003, we announced our intention to incorporate a franchising and area
developer model into our business strategy. In fiscal 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,
primarily 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.
During fiscal 2004, we launched our franchising program. We have completed our
franchise offering circular and are currently eligible to offer franchises in 44
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 $35,000 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. Subsequent to the end of the third quarter of
fiscal 2004, we entered into definitive agreements with two franchisees.
We expect that company owned restaurants will always be an important part of our
new restaurant growth. We also believe that incorporating a franchising and area
developer model into our strategy will position us to maximize the market
potential for the Cosi brand consistent with our available capital, thus
maximizing stockholder value.
Additionally, we previously announced a foodservice partnership with Federated
Department Stores. In the initial phase of the agreement, Cosi plans to open ten
restaurants in some of their largest stores, including locations in Seattle,
Atlanta, Miami and Memphis. Subsequent to the end of the third quarter of fiscal
2004, we opened six restaurants with Federated Department Stores, three in
Florida, two in Georgia and one in Tennessee.
14
We closed four restaurants and did not open any new restaurants during the nine
month period ended September 27, 2004. Six new restaurants were opened and eight
restaurants were closed during the nine month period ended September 29, 2003.
As of September 27, 2004 we operated 85 restaurants. Subsequent to the third
quarter, one additional restaurant was closed and six restaurants were opened
within Federated Department Stores locations.
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 of America 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.
Long lived assets: 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 nine month
period ended September 27, 2004, we identified one unit that had 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.
Lease termination costs: 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 any 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. During the first nine
months of fiscal 2004, the Company recognized $1.3 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 $0.9 million resulting
in a net reversal of approximately $0.4 million.
Stock options: 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
15
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 recording income in the amount of approximately
$1.0 million during the third quarter of fiscal 2004 and year to date a charge
of approximately $2.0 million for fiscal 2004. Adjustments recorded in the
future may be material depending upon the movement in the stock price.
Property and Equipment: Our property and equipment is stated at cost. We compute
depreciation and amortization of property and equipment on a straight-line basis
over the estimated useful lives of the related assets. We amortize leasehold
improvements over the shorter of the estimated useful life or term of the lease.
Income taxes: 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
September 27, 2004 and September 29, 2003, there were 85 and 66 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, 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, 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 pursuant to an employment agreement with
William D. Forrest, our Executive Chairman.
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
16
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.
RESULTS OF OPERATIONS
Our operating results for the three and nine month periods ended September 27,
2004 and September 29, 2003, expressed as a percentage of sales, were as
follows:
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
September 27, September 29, September 27, September 29,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Costs and expenses:
Cost of goods sold 24.9 27.3 25.2 28.0
Restaurant operating expenses 58.7 63.3 60.5 63.4
------------- ------------- ------------- -------------
Total cost of sales 83.6 90.6 85.7 91.4
General and administative expenses 17.4 12.3 16.1 18.7
Corporate office relocation 3.3 1.1
Stock compensation (benefit) expense (2.8) 0.4 3.4 0.6
Depreciation and amortization 5.9 6.8 6.2 7.1
Pre-opening expenses 0.4 0.1 0.2 0.5
Provision for losses on asset
impairments and disposals -- 1.2 0.6 6.9
Lease termination costs (benefit) 1.3 (2.1) (0.5) (0.4)
------------- ------------- ------------- -------------
Operating loss (9.1) (9.3) (12.8) (24.8)
Other income (expense):
Interest income 0.2 -- 0.1 0.1
Interest expense -- (0.3) -- (0.3)
Reserve for stockholders
notes receivables (5.2) -- (1.8) --
Other income -- 0.4 (0.2) 0.1
------------- ------------- ------------- -------------
Net Loss (14.1) % (9.2) % (14.7) % (24.9) %
============= ============= ============= =============
Net Sales
Net sales increased 2.3%, or $0.6 million, to $28.2 million in the third quarter
of fiscal 2004, from $27.6 million in the comparable quarter last year. This
increase was due primarily to an increase in comparable restaurant net sales
partially offset by a decrease in net sales at locations closed during and
subsequent to the third quarter of fiscal 2003. In the third quarter of fiscal
2004 comparable restaurant net sales increased 6.9% as compared to the third
quarter of fiscal 2003. Also, our transaction count and average check in
comparable restaurants was up 5.5% and 1.4%, respectively, compared to the same
period last year. Net sales for the nine month period ended September 27, 2004
were comparable to the same period last year. For the nine month period ended
September 27, 2004, comparable restaurant sales increased 5.2% as compared to
the same period last year. Our transaction count and average check in comparable
restaurants was up 3.7% and 1.5%, respectively, for the nine month period ended
September 27, 2004 compared to the same period last year. The increase in
comparable restaurant net sales for the nine month period ended September 27,
2004 were offset by decreases in net sales associated with the 12 restaurants
closed since the beginning of fiscal 2003.
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 initiative
to optimize our labor costs and has contributed to the decrease, as a percentage
of sales, in restaurant operating expenses during fiscal 2004.
17
Costs and Expenses
Cost of goods sold. Cost of goods sold decreased by 6.6%, or $0.5 million, in
the third quarter of fiscal 2004 as compared to the same period last year. As a
percentage of net sales, cost of goods sold decreased to 24.9% of sales in the
third quarter of fiscal 2004, from 27.3% in the comparable quarter of fiscal
2003. The decrease in cost of goods sold as a percentage of sales was due
primarily to a refinement of our food and beverage purchasing process. We
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 commodity food prices, we have entered into several
purchasing agreements with our suppliers that include fixed pricing components
based on defined quantity commitments over a period of time. We believe these
purchasing agreements adequately insulate us from increases in most commodities
prices. We also anticipate that any movement in commodity food prices will have
a minimal effect, in the short term, on cost of goods sold as the majority of
our purchases are covered by these purchasing agreements. For the year to date
period ended September 27, 2004, cost of goods sold decreased $2.3 million, or
10.0%, to $20.7 million, from $23.0 million in the same period last year. As a
percentage of net sales, cost of goods sold decreased to 25.2% of net sales in
the nine month period ended September 27, 2004 from 28.0% in the same period
last year. The decrease in cost of goods sold as a percentage of net sales was
due primarily to the improvements in our purchasing process discussed above.
Restaurant operating expenses. Restaurant operating expenses decreased by $0.9
million, or 5.2%, to $16.5 million in the third quarter of fiscal 2004, from
$17.4 million in the third 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 third quarter of fiscal 2004, from 63.3% in the third
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 $2.4 million, or 4.6%, to $49.7 million in the
first nine months of fiscal 2004, from $52.1 for the same period last year. 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 60.5% of sales for the nine month period ended
September 27, 2004, from 63.4% in the comparable period last year. 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 expenses increased
by 44.6%, or $1.5 million, to $4.9 million in the third quarter of fiscal 2004
as compared $3.4 million for the same period last year. As a percentage of net
sales, general and administrative costs were 17.4% of net sales in the third
quarter of fiscal 2004, as compared to 12.3% of net sales in the third quarter
of fiscal 2003. Included in the third quarter results for fiscal 2003, was
income of approximately $0.6 million resulting from the net reversal of a prior
severance accrual. The increase in general and administrative expenses for the
quarter was due primarily to approximately $0.5 million of costs related to our
Sarbanes-Oxley 404 compliance work, higher legal costs related to financing
activities, higher costs for insurance and employee placement fees. For the nine
month period ended September 27, 2004, general and administrative costs
decreased by 14.0%, or $2.1 million to $13.2 million from $15.3 million in the
comparable period for fiscal 2003 due primarily to a one-time severance charge
of $3.7 million in the first quarter of fiscal 2003.
Corporate office relocation. During the third quarter of fiscal 2004, we
relocated our corporate office from New York, New York to Deerfield, Illinois
and recorded approximately $0.9 million of expense for employee relocation,
severance and travel associated with the move.
Stock compensation expense. During the third quarter of fiscal 2004, we
recognized income of approximately $1.0 million in accordance with APB 25
Accounting for Stock Issued to Employees, associated with 1,246,164 options
repriced as of December 29, 2003 partially offset by a charge for $0.2 million
related to a restricted stock grant. For the nine month period ended September
27, 2004, we have recorded an expense of approximately $2.0 million in
accordance with APB 25 Accounting for Stock Issued to Employees, associated with
1,246,164 options repriced as of December 29, 2003 as well as a charge for $0.8
million related to a restricted stock grant.
18
Depreciation and amortization. Depreciation and amortization decreased 11.2%, or
$0.2 million, to $1.7 million in the third quarter of fiscal 2004, from $1.9
million in the third quarter of fiscal 2003. The decrease was primarily due to
the closure of six restaurants since the end of the third quarter of 2003 and
impairment charges recorded in the latter half of fiscal 2003 and the first
quarter of fiscal 2004. As a percentage of net sales, depreciation and
amortization decreased to 5.9% of sales in the third quarter of fiscal 2004,
compared to 6.8% of sales in the third quarter of fiscal 2003. This decrease, as
a percentage of sales, is primarily due to an increase in comparable store
sales. For the nine month period ended September 27, 2004, depreciation and
amortization decreased 13.2%, or $0.8 million, to $5.0 million during fiscal
2004, from $5.8 million in the same nine month period of fiscal 2003. The
decrease was primarily due to the closure of twelve restaurants since the
beginning of fiscal 2003 as well as impairment charges recorded in the latter
half of fiscal 2003 and the first quarter of fiscal 2004. As a percentage of net
sales, depreciation and amortization decreased to 6.2% for the first nine months
of fiscal 2004, compared to 7.1% for the same period in fiscal 2003. The
decrease, as a percentage of net sales, is due primarily to an increase in
comparable store sales.
Restaurant pre-opening expenses. Restaurant pre-opening expenses were $0.1
million in the third quarter of fiscal 2004, due primarily to pre-opening
payroll costs for the new stores associated with the foodservice partnership
with Federated Department Stores. Pre-opening costs for the third quarter of
fiscal 2003 were negligible. Year-to-date, restaurant pre-opening expenses were
$0.2 million related to the aforementioned new stores associated with the
foodservice partnership with Federated Department Stores. For the first nine
months of fiscal 2003, pre-opening expenses were $0.4 million due primarily to
new stores opened in the first quarter of fiscal 2003.
Loss on impairment of property and equipment and restaurant disposals. There
were no restaurant impairment charges taken in the third quarter of fiscal 2004.
During the third quarter of fiscal 2003, we recognized $0.3 million of asset
impairment and store closure costs. For the nine month period ended September
27, 2004, we have recognized $0.5 million of asset impairment and store closure
costs. This was due primarily to an impairment charge of $0.4 million related to
one underperforming restaurant and closure costs of $0.1 million related to the
closing of one underperforming restaurant. For the comparable nine month period
of fiscal 2003, $5.7 million of asset impairment and store closure 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 $3.8
million represents impairment charges taken on eight underperforming
restaurants.
Lease termination costs. For the third quarter of fiscal 2004, we recorded a
$0.4 million charge for lease termination costs compared to $0.6 million of
income recognized in the third quarter of 2003. The charge for the third quarter
of fiscal 2004 was largely attributable to the three restaurants closed during
and subsequent to the third quarter of fiscal 2004. For the third quarter of
fiscal 2003, we recognized $0.6 million of income related to the reversal of
certain lease termination accruals where we were able to exit the lease on more
favorable terms than previously anticipated. For the nine month period ended
September 27, 2004, we recognized $1.3 million of income related to the reversal
of certain lease termination accruals, partially offset by $0.9 million of
charges resulting in a net reversal for the nine month period of $0.4 million.
For the nine month period ended September 29, 2003, we recognized $0.6 million
of income related to the reversal of certain lease termination accruals
partially offset by $0.3 million in charges resulting in a net income for the
nine month period of $0.3 million.
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, one of
which closed in the second quarter of fiscal 2004 and two that closed during the
third quarter of fiscal 2004. Subsequent to the third quarter of fiscal 2004,
one additional restaurant was closed.
Reserve for notes receivable from stockholders. During the third quarter of
fiscal 2004, we recorded a charge of approximately $1.5 million to establish a
reserve for certain notes receivable from stockholders based on the market value
of the common stock, as of September 27, 2004, that was pledged as collateral
for the notes.
19
Interest income and expense. During the third quarters of fiscal 2004 and fiscal
2003, interest income was less than $0.1 million although slightly higher in
fiscal 2004 as a result of interest income earned on short term investments.
Interest expense was less than $0.1 million in the third quarters of fiscal 2004
and fiscal 2003. For the nine month period ended September 27, 2004 interest
expense was less than $0.1 million as compared to $0.2 million in interest
expense for the same period of fiscal 2003.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $8.6 million on September 27, 2004, compared with
$8.0 million on December 29, 2003. Our working capital was $9.2 million on
September 27, 2004, compared with a working capital deficit of $3.8 million as
of December 29, 2003. Our principal requirements for cash are for funding
working capital needs, financing construction of new restaurants within select
Federated locations this year under the previously announced foodservice
partnership with Federated Department Stores, Inc., maintaining or remodeling
existing restaurants, funding the incorporation of a franchising and area
developer model into our business strategy and supporting our plans for new
stores in 2005. During fiscal 2004, we financed our capital requirements with
the proceeds from our rights offering, which was completed in December 2003 and
our private placement, which was completed in April 2004.
Net cash used in operating activities for the nine month period ended September
27, 2004 was $6.3 million, compared to $10.0 million for the nine month period
ended September 29, 2003. The decrease in cash used in operating activities was
due primarily to a decrease in our net loss of $8.4 million as compared to the
first nine months of fiscal 2003 partially offset by an increase in accrued
liabilities.
Total capital expenditures for the nine month period ended September 27, 2004
were $2.7 million, compared to expenditures of $3.6 million for the comparable
period in fiscal 2003. Approximately 60% of the expenditures year-to-date for
fiscal 2004 are for the new stores we expect to open with Federated Department
Stores this year. We expect total capital expenditures of approximately $6.0
million for fiscal 2004 related to opening ten new stores in conjunction with
our foodservice partnership with Federated Department Stores.
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 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, we 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 us 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 restaurants 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 stores in 2005, and provide for
continued infrastructure improvements. This was the primary financing activity
for the six months ended September 27, 2004. We purchased $9.9 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. The registration statement was declared
effective by the SEC on August 11, 2004.
We plan to fund our working capital needs, the capital requirements for the
construction of the initial ten new restaurants associated with our agreement
with Federated Department Stores, the maintenance of our existing restaurants
and our franchising program primarily through our investments, cash and cash
equivalents on hand at the beginning of the period and our expected internally
generated cash flows produced by our restaurants. We
20
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.
Our cash resources, and therefore our liquidity, are highly dependent upon the
level of internally generated cash from operations. If cash flows from our
existing restaurants or cash flow from our new restaurants that we expect to
open with Federated Department Stores 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 or close underperforming restaurants and 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.
Contractual Obligations: Payments Due by Period
(in thousands)
--------------------------------------------------------------------------
Due 4th Due Due Due
Total Quarter Fiscal 2005 Fiscal 2007 After
Description Obligations 2004 to Fiscal 2006 to Fiscal 2008 Fiscal 2008
- ----------------------------------------------------------------------------------------------------
Long-term debt 345.8 118.2 115.7 47.5 64.4
Operating leases (1)(2) 79,599.7 2,944.6 23,336.6 22,379.4 30,939.1
Employee severance 1,060.3 724.1 336.2 -- --
Purchase obligations 3,777.8 3,527.8 250.0 -- --
Total contractual cash -------- ------- -------- -------- --------
obligations 84,783.6 7,314.7 24,038.5 22,426.9 31,003.5
======== ======= ======== ======== ========
(1) Amounts shown are net of $1.8 million of sublease rental income due under
non-cancelable subleases.
(2) Includes approximately $3.0 million of obligations on leases for restaurants
that have either been closed or are planned to be closed as of September 27,
2004.
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
Currently, we have an exclusive coffee supply agreement with Coffee Bean
International, Inc. ("Coffee Bean International") that requires us to purchase
all contracted coffee products from Coffee Bean International. The agreement is
effective through June 2005, but may be terminated by us or Coffee Bean
International; provided that 180 days notice is given in advance of such
termination.
We also have a long term beverage marketing agreement with the Coca Cola
Company. Under the agreement, executed during fiscal 2002, we are obligated to
purchase approximately 2.0 million gallons of fountain syrups at the then
current annually published national chain account prices.
In addition, we have a contract with Maines Paper and Food Service ("Maines") as
the broadline distributor that expires in January 2006. Maines supplies us with
approximately 90% of our food and paper products, primarily under pricing
agreements that we negotiate directly with the suppliers.
21
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;
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.
22
Item 3. Quantitative And Qualitative Disclosures About Market Risk
Our market risk exposures are related to our cash, cash equivalents, investments
and interest that we pay on our debt. We have no derivative financial
instruments or derivative commodity instruments in our cash, cash equivalents
and investments. We invest our excess cash in investment grade highly liquid
short-term investments. These investments are not held for trading or other
speculative purposes. Changes in interest rates affect the investment income we
earn on our investments and, therefore, impact our cash flow and results of
operations. The impact of a hypothetical 1% change in interest rates would be
immaterial.
All of our transactions are conducted, and our accounts are denominated, in
United States dollars. Accordingly, we are not exposed to foreign currency risk.
Item 4. Controls and Procedures
The Company's management, with the participation of the our chief executive
officer and chief financial officer, has evaluated the effectiveness of our
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, our chief executive officer and chief financial officer have
concluded that, as of the end of such period, our disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on
a timely basis, information required to be disclosed by us in the reports that
we file or submit under the Exchange Act.
There have not been any changes in our 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 third fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
23
Part II. OTHER INFORMATION
Item 1: LEGAL PROCEEDINGS
From time to time, we are a defendant in litigation arising in the ordinary
course of our business, 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 our 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 we 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 our stock allegedly traceable to our November 22, 2002 IPO, that
at the time of the IPO, our offering materials failed to disclose that the funds
raised through the IPO would be insufficient to implement our expansion plan;
that it was improbable that we would be able to open 53 to 59 new restaurants in
2003; that at the time of the IPO, we 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 our 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, we
believe that the amount of recessionary damages that could be awarded to the
plaintiffs, if a judgment is rendered against us, would not exceed approximately
$24 million. In addition, the underwriter is seeking indemnification from us 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 we believe that we have meritorious
defenses to these claims, and intend to vigorously defend against them.
On September 22, 2003, we filed motions to dismiss the Second Consolidated
Amended Complaint in the Securities Act Litigation. Plaintiffs filed their
opposition to our motions to dismiss on October 23, 2003. We filed reply briefs
on November 12, 2003.
On July 30, 2004, the Court granted plaintiffs permission to replead their
complaint against us. On September 10, 2004, plaintiffs filed their Third
Consolidated Amended Complaint. Plaintiffs abandoned their claim that we misled
investors about our ability to execute our growth plans. Instead, plaintiffs
claim that the our offering materials failed to disclose that at the time of the
IPO, we were researching the possibility of franchising our restaurants. On
October 12, 2004, we filed a motion to dismiss plaintiffs' Third Consolidated
Amended Complaint. Plaintiffs' opposition to the motion to dismiss is due
November 19, 2004.
We cannot predict what the outcome of these lawsuits will be. It is possible
that we may be required to pay substantial damages or settlement costs in excess
of our insurance coverage, which could have a material adverse effect on our
financial condition or results of operations. We could also incur substantial
legal costs, and management's attention and resources could be diverted from the
business.
Currently, there are no other material pending legal preceedings against us.
24
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Effective May 17, 2004, we issued 4,448 shares of restricted common stock to
each of our non-employee directors pursuant to the Amended and Restated Cosi,
Inc. Non-Employee Director Stock Incentive Plan, which was approved at our 2004
Annual Meeting of Stockholders. On August 11, 2004, we issued 29,641 shares of
restricted common stock in a private placement pursuant to Section 4(2) of the
Securities Act of 1933, as amended, to a subscribing stockholder pursuant to our
rights offering at $1.50 per share.
Item 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
--------
Exhibit Number Description
- -------------- -----------
Exhibit 31.1 Certification of the Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 Certification of the Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
-------------------
On July 29, 2004, we filed a Form 8-K/A that amended our Current Report on Form
8-K filed on June 18, 2004 that announced that our independent auditors, Ernst &
Young would resign after their review of the Form 10-Q for the period ended June
28, 2004.
On August 3, 2004, we filed a Form 8-K that announced that the registration
statement covering the resale of the 3,550,000 shares of common stock purchased
in the private placement completed in April 2004 had not been declared effective
by the SEC and that therefore; we were required to make a payment to the
purchasers of approximately $190,000.
On August 6, 2004, we filed a Form 8-K/A that amended our Current Report on Form
8-K filed on June 18, 2004, as amended July 29, 2004 that announced that our
independent auditors, Ernst & Young would resign after their review of the Form
10-Q for the period ended June 28, 2004.
On August 11, 2004, we filed a Form 8-K that announced our earnings for the
second quarter of fiscal 2004 as well as announcing that the SEC had declared
our registration statement as effective on August 11, 2004.
On August 12, 2004, we filed a Form 8-K that announced that we had engaged BDO
Seidman, LLP as our independent registered public accountant for the fiscal year
ended January 5, 2005.
On August 13, 2004, we filed a Form 8-K that announced that Ernst & Young had
completed its review of our Form 10-Q for the period ended June 28, 2004 and
that its resignation had become effective.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
COSI, INC.
Date: November 9, 2004 By: /s/ WILLIAM D. FORREST
--------------------------
William D. Forrest
Executive Chairman
Date: November 9, 2004 By: /s/ KEVIN ARMSTRONG
-----------------------
Kevin Armstrong
Chief Executive Officer
Date: November 9, 2004 By: /s/ CYNTHIA JAMISON
-----------------------
Cynthia Jamison
Chief Financial Officer (chief accounting officer)
Treasurer and Secretary
26