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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

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

 

for the fiscal year ended December 27, 2010

 

OR

 

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

 

for the transition period from             to             

 

Commission File No. 000-50052

 

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.)

 

1751 Lake Cook Road, Suite 600, Deerfield, Illinois 60015

(Address and Zip Code of Principal Executive Offices)

 

(847) 597-8800

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

Title of class

 

 

 

 

Common Stock

 

 

 

 

($.01 par value)

 

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No x

 

Indicate by a check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of Exchange Act.  Yes o  No x

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such a shorter period that the registrant was required to submit and post such files.)  Yes o  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  Yes o  No x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller Reporting Company x

 

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

 

The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $37,728,912 as of June 30, 2010 based upon the closing price of the registrant’s common stock on The Nasdaq Global Market reported for June 30, 2010. Shares of voting stock held by each executive officer and director and by each person who, as of such date, may be deemed to have beneficially owned more than 5% of the outstanding voting stock have been excluded. This determination of affiliate status is not necessarily a conclusive determination of affiliate status for any other purpose.

 

51,780,891 shares of the registrant’s common stock were outstanding on March 23, 2011.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III of this Form 10-K incorporates certain information from the Registrant’s definitive proxy statement for its Annual Meeting of Stockholders expected to be held on May 17, 2011.  The definitive proxy statement will be filed by the Registrant with the Securities and Exchange Commission no later than 120 days from the end of the Registrant’s fiscal year ended December 27, 2010.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

Item

 

Description

 

Page

 

 

 

 

 

 

 

PART I

 

 

 

 

 

 

 

1.

 

Business

 

3

1A.

 

Risk Factors

 

9

1B.

 

Unresolved Staff Comments

 

21

2.

 

Properties

 

21

3.

 

Legal Proceedings

 

23

4.

 

Reserved

 

23

 

 

 

 

 

 

 

PART II

 

 

 

 

 

 

 

5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

 

24

6.

 

Selected Financial Data

 

26

7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

28

7A.

 

Quantitative and Qualitative Disclosures about Market Risk

 

45

8.

 

Financial Statements and Supplementary Data

 

46

9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

73

9A.

 

Controls and Procedures

 

73

9B.

 

Other Information

 

74

 

 

 

 

 

 

 

PART III

 

 

 

 

 

 

 

10.

 

Directors, Executive Officers and Corporate Governance

 

75

11.

 

Executive Compensation

 

75

12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

75

13.

 

Certain Relationships and Related Transactions and Director Independence

 

75

14.

 

Principal Accounting Fees and Services

 

75

 

 

 

 

 

 

 

PART IV

 

 

 

 

 

 

 

15.

 

Exhibits and Financial Statement Schedules

 

76

 

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PART I

 

Item 1.           BUSINESS

 

General

 

Cosi, Inc., a Delaware corporation incorporated on May 15, 1998, owns, operates and franchises premium convenience restaurants which sell high-quality hot and cold sandwiches, freshly-tossed salads, breakfast wraps, Cosi® Squagels®, hot melts, flatbread pizzas, S’mores and other desserts, and a variety of coffees and specialty coffees along with other soft drink beverages, bottled beverages including premium still and sparkling water, teas and beer and wine in some locations. Our restaurants are located in a wide range of markets and trade areas, including business districts and residential communities in both urban and suburban locations. We believe that we have created significant brand equity in our markets and that we have demonstrated the appeal of our concept to a wide variety of customers.

 

As of December 27, 2010, there were 142 Company-owned and franchised restaurants operating in 18 states, the District of Columbia, and the United Arab Emirates (UAE).

 

Our internet website is www.getcosi.com. We make available free-of-charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file or furnish such materials to the Securities and Exchange Commission (“SEC”). In addition, our internet website includes, among other things, our corporate governance principles, charters of various committees of the Board of Directors, and our code of business conduct and ethics applicable to all employees, officers and directors. Copies of these documents may be obtained free of charge from our internet website. Any stockholder also may obtain copies of these documents, free of charge, by sending a request in writing to: Cosi, Inc., c/o Investor Relations, 1751 Lake Cook Road, Suite 600, Deerfield, Illinois 60015.

 

Business Strategy

 

Our goal is to become the preferred fast-casual dining concept nationally. We strive to serve delicious food that is always surprising, with unparalleled customer service, in a unique, welcoming and sophisticated ambiance.  The Cosi® restaurant concept, whose name was inspired by Mozart’s famous opera, Così Fan Tutte, originated in Paris as a Parisian café. We strive to create a romance between our famous, freshly-made bread, our barista-crafted coffees and specialty drinks, and our loyal guests.

 

We believe that our customers are primarily adults aged 18 to 40, upscale suburbanites and metro elites of all ages. Our market studies show that there are approximately 40 million heads of households in this demographic mix. Our strategy is to make Cosi® the restaurant of choice for those who insist that…LIFE SHOULD BE DELICIOUS®.

 

We plan to become the preferred national fast casual restaurant by:

 

Offering an innovative menu appealing to the sophisticated tastes of our target customers. Our restaurants offer innovative savory, freshly made-to-order products featuring our authentic hearth-baked signature Cosi® bread and distinctive high quality, fresh ingredients. We maintain a pipeline of new menu offerings that are introduced seasonally through limited time offerings to keep our products relevant to our target customers.

 

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Providing customers with an exceptional service and dining experience. Our restaurants are designed to provide a memorable dining experience in a warm, welcoming environment offering free internet access through a managed Wi-Fi network. We believe our partners are proud to be part of an organization that stands for quality, innovation and distinctive flair. We are passionate about serving quality food in an atmosphere that is comfortable and inviting. We seek to train our partners to provide the highest level of friendly customer service. We believe that we provide an “affordable luxury” that our customers can enjoy every day.

 

Expanding marketing initiatives to build brand awareness.  Our strategy is to focus our marketing efforts on building brand awareness and increasing the frequency of restaurant visits. During 2010, we expanded our marketing initiatives into certain electronic media channels including television, streaming video content into trains and taxis and on-line programming.  We believe this broader exposure allows us to engage our customers the way they interact with us, on the go. Other marketing strategies include the development of a marketing calendar that focuses on five time periods (Winter, Spring, Summer, Fall, and Holiday), and improved merchandising to better influence the purchasing behavior of our guests and reduce ordering complexity. In January 2011, we launched our new “Così® Flavors of the World” menu marketing campaign that will allow our customers to experience products and tastes from around the world. We also look to build brand awareness and frequency through our CosiCard® loyalty program, through food-focused out-of-restaurant advertising placements, print advertising, targeted email, and our web-based social media marketing campaigns. We want our message to energize our guests by all that there is to taste, see, and do. We aim to attract and retain guests who seek to explore and enjoy life’s full flavor, and who know that LIFE SHOULD BE DELICIOUS®.

 

Increasing comparable restaurant sales and average unit volumes. We seek to increase comparable restaurant sales and average unit volumes by increasing top-of-mind awareness of the Cosi® brand through the introduction of new menu items, expansion of our catering sales opportunities, introduction of on-line ordering capabilities, communicating through social media channels, increasing sales across all dayparts and the promotion of seasonal product offerings.

 

Operating our restaurants efficiently.  We have developed operating disciplines that are designed to optimize the cost structure of our restaurants and to be applied consistently across all our restaurants, Company-owned and franchise, and we continuously seek to refine and improve upon those disciplines both domestically and internationally.

 

Growth Strategy

 

We plan to grow in both existing and new markets through the following:

 

Build a system of franchised restaurants and develop Company-owned restaurants. We believe that Company-owned restaurants (restaurants that we own as opposed to franchised restaurants) are an important part of our new restaurant growth; however, our franchising and area developer model will be the primary driver of our growth strategy. We will continue to pursue Company-owned development to achieve critical mass in our core markets while focusing on expanding our franchise system nationally. We launched our franchising program in fiscal 2004 and seek to expand our franchise system through an influx of new domestic and international franchisees. As part of our strategy to expand our franchise base and attract quality franchisees, we may consider the potential sale of a restaurant or a group of restaurants to fuel the overall growth of the system. We prefer that our franchisees have experience in multi-unit restaurant operations and development. We believe that our concept positioning, national and international growth

 

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opportunity, and potential for strong unit-level economics will enable us to attract experienced and well-capitalized area developers. We are currently eligible to offer franchises in 47 states and the District of Columbia.

 

Pursue foodservice strategic alliances. We will explore strategic alliances with our Cosi Pronto® (our grab-and-go concept) and full service concepts in educational institutions, airports, train stations and other venues that meet our operating and financial criteria.  We believe that this is an attractive opportunity to further Cosi’s growth through alternative venues. We currently operate Cosi® restaurants at St. Joseph’s University in Philadelphia, PA and Georgetown University in Washington, DC under a franchisee agreement with Aramark. We also operate our grab-and-go concept at New York’s LaGuardia and Boston’s Logan airports through franchisee agreements.

 

Cosi® Product Offerings

 

We offer proprietary food and beverage products for four major dayparts — breakfast, lunch, snacking and dinner. Our food menu includes Cosi® Squagels®, sandwiches, salads, soups, appetizers, melts, flatbread pizzas, breakfast wraps, S’mores and other desserts. We feature our authentic hearth-baked signature Cosi® bread in two varieties, our original Rustica and our Etruscan Whole Grain. Our beverage menu features a variety of house coffees and other espresso-based beverages, seasonal fruit smoothies and specialty drinks, soft drinks, flavored teas and bottled beverages, which include premium still and sparkling waters. For our health-conscious guests, we have a “lighter side” menu featuring lower-calorie versions of popular menu items and other unique salads and sandwiches that are lower in calorie content than other items in the same menu categories. We offer beer and wine at many of our locations and an additional limited selection of alcoholic beverages in some locations. For our young guests, we offer our Parent Magazine award-winning Kids Menu which includes an activity page and crayons.

 

Most of our restaurants offer catering service for the breakfast and lunch dayparts. Our catering offerings include breakfast baskets, lunch buffets, dessert platters, and include most of our menu offerings. We operate a catering call center in New York City which coordinates the ordering and fulfillment process for 17 catering hub locations in four major metropolitan areas. We offer set up and delivery by Cosi® personnel to all of our catering customers.

 

We periodically introduce new menu platforms and products in order to keep our product offerings relevant to consumers in each daypart. Our expanded breakfast menu now includes Cosi® Squagels®, hearth-baked quiches, oatmeal, fresh fruit parfaits and a variety of craveable signature breakfast wraps and sandwiches. We enhanced our guests’ dining options by introducing “Cosi® Duo” to the menu which allows them to create their own meal by combining two items of proportion from our offerings of unique sandwiches, fresh salads and soups. New recipes are developed by our Executive Chef with the support of the food and beverage team.

 

People

 

On December 27, 2010, we had 83 Company-owned restaurants and 2,038 employees, of whom 66 served in administrative or executive capacities, 214 served as restaurant management employees and 1,758 were hourly restaurant employees. None of our employees are covered by a collective bargaining agreement, and we have never experienced an organized work stoppage or strike. We believe that our compensation packages are competitive and our relations with our employees are good.

 

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Restaurant Operations

 

Management Structure. The restaurant operations team is built around regional districts led by District Managers, who report to a Vice President of Operations. The Vice President of Operations and District Managers are responsible for all operations, training, recruiting and human resources within their regions. The Vice President of Operations is also responsible for the financial plan for all Company-owned locations and for the people development plan to support the execution of the financial plan. The Vice President of Operations reports directly to the Chief Executive Officer. Supporting the field operations teams is a Vice President of Operations Services and Platforms who is responsible for developing and implementing operating standards and best practices across the system for the benefit of the entire brand. The Vice President of Operations Services and Platforms reports to the Chief Executive Officer.

 

We currently have in place an Operations Excellence Framework that provides two business assessment tools, Operations Excellence Basics (“OEB”) and Operations Excellence Review (“OER”) that our field management teams use for evaluating our guest services, facility maintenance, unit-level financial performance, partner assessments and product quality and assurance. These assessment tools provide the framework and process for identification of areas of opportunity as well as the development of actionable plans to improve operations. During fiscal 2010, we began the process of linking together and further enhancing the OER and OEB tools and our District Managers currently have the ability to track each action plan to completion, measure the improvement in key restaurant metrics, and hold our operators accountable for adhering to our most critical operations and administrative standards.

 

To ensure consistent performance, execution and application of our policies and procedures, we have a Standard Operations Manual which is reviewed and updated periodically.

 

Sales Forecasting. The Vice President of Operations and District Managers have real-time access to sales forecasts and actual sales information through our web-based reporting system. This allows the entire management team to plan staffing requirements on a weekly, daily and even hourly basis to effectively serve our customers.

 

Product Quality. Our food and beverage quality is managed at four critical stages: sourcing, distribution, line readiness and product preparation. Products are delivered to the restaurants several times each week so that all restaurants maintain fresh, quality products. Because our restaurants serve a different variety of products during different dayparts, a specific line-readiness checklist is completed to ensure that the products have been rotated, prepared and staged correctly. Finally, our partner training program includes certification in both product knowledge and product preparation standards.

 

Food and Labor Cost Controls. Our information system allows us to track actual versus theoretical cost of goods sold. Detailed reports are available at the restaurant level showing variances on an item-by-item basis. The system is interfaced into our accounts payable and general ledger systems so that restaurant managers have control of their operations and can be held accountable for their results.

 

Our labor management standards help our managers control labor and ensure that staffing levels are appropriate to meet our service standards. Our reporting system provides our multi-unit managers with performance reports that help them make staffing adjustments during the course of the week. All labor scheduling is approved by a District Manager and unit level performance is reviewed weekly.

 

For manager and support controllable costs, we use either a fixed dollar budget standard or a percentage of net sales approach to plan expenditures effectively. Actual performance for each of these expense items is compared to budget on a weekly basis to help ensure accountability and

 

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operational alignment with financial planning efforts. We believe that the combination of these structured restaurant operating systems and technologies allows our restaurant managers to focus their time more effectively on the day-to-day drivers of our business.

 

Management Information Systems

 

Our systems are structured for the integration of data from the point-of-sale and back-office modules in the restaurants to our financial, reporting and inventory management systems. Key information relating to restaurant operations is uploaded onto a secure website multiple times throughout the day. This operational restaurant information is available to key internal customers, along with pre-selected reports that are automatically distributed to our operations team.

 

We use a select group of service providers to supplement our information technology infrastructure and system offerings.  This provides us access to up-to-date technology and allows us the flexibility to adjust service levels and costs as needed. Our application strategy includes utilizing web-based technology to provide timely information to operate and manage the business.

 

We have a disaster recovery plan in place for all critical hardware, software, data and related processes. The plan encompasses scheduled back-ups, off-site storage, security, and failover configurations with redundancy built into key processes.

 

Purchasing

 

We have agreements with some of the nation’s largest food, paper, and beverage manufacturers in the industry. This enables us to provide our restaurants with high quality proprietary food products and non-food items at competitive prices. We source and negotiate prices directly with these suppliers and distribute these products to our restaurants primarily through a national network that consists of some of the nation’s largest independent distributors. We do not utilize a commissary system. Our inventory control system allows each restaurant to place orders electronically with our master distributor and then transmits the invoices electronically to our accounts payable system. Our scalable system eliminates duplicate work, and we believe it gives our management tight control of costs while ensuring quality and consistency across all restaurants.

 

We have an agreement with Distribution Market Advantage, Inc. (“Distribution Marketing Advantage”) that provides us access to a national network of independent distributors. Under this agreement the independent distributors supply us with approximately 79% of our food and paper products, primarily under pricing agreements that we negotiate directly with the suppliers. This agreement was renegotiated and has been extended through December 2013.

 

We have a long-term beverage marketing agreement with the Coca-Cola Company. We received a marketing allowance under this agreement, which is being recognized as a reduction to expense ratably based on actual products purchased. Effective January 1, 2010, the beverage marketing agreement with the Coca-Cola Company was amended to provide for additional products as well as higher marketing allowances based on purchases.

 

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

 

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

 

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Competition

 

The restaurant industry is intensely competitive and we compete with many well-established food service companies, including other sandwich retailers, specialty coffee retailers, bagel shops, fast food and casual dining restaurants, delicatessens, cafes, bars, take-out food service companies, supermarkets and convenience stores. The principal factors on which we compete are taste, quality and price of products offered, customer service, atmosphere, location and overall guest experience. Our competitors change with each daypart, ranging from coffee bars and bakery cafes in the morning daypart, to fast food restaurants and cafes during the lunch daypart, to casual dining chains during the dinner daypart. Many of our competitors or potential competitors have substantially greater financial and other resources than we do which may allow them to react more quickly to changes in pricing, marketing and the quick-service restaurant industry. We also compete with other employers in our markets for hourly workers and may be subject to higher labor costs. We believe that our concept, attractive price-value relationship and quality of products and service allow us to compete favorably with our competitors.

 

Intellectual Property

 

We have the following U.S. Trademark registrations: “COSÌ”, “(SUN & MOON DESIGN)”, “GET COSÌ”, “COSÌ (& SUN & MOON DESIGN)”, “LIFE SHOULD BE DELICIOUS”, AND “(SUN & MOON SMILEY FACE DESIGN)”, “COSÌ (& HEARTH DESIGN)”, “(HEARTH DESIGN)”, “COSÌ BREAK BAR”, “COSÌ CARD”, “COSÌ CORNERS”, “COSÌ-DILLAS”, “COSÌ DOWNTOWN”, “COSÌ PRONTO”, “HEARTH-BAKED DINNERS”, “RELAX. CATERING BY COSÌ (& DESIGN)”, “SIMPLY GOOD TASTE”, “SQUAGELS”, and “XANDO”.

 

We have U.S. Trademark applications pending for the following trademarks (CLASS 25): “LIFE SHOULD BE DELICIOUS”, “(SUN & MOON SMILEY FACE DESIGN)”.

 

“COSÌ SANDWICH BAR”, “ARCTIC”, “SLIM LATTE”, “COSÌ LIGHTER SIDE”, “COSÌ DUO TASTE TWO”, and “(RECYCLING DESIGN)” are unregistered trademarks.

 

We have registered the trademark “COSÌ” in 20 foreign jurisdictions with respect to restaurant services.  Also, we have registered the following trademarks with respect to restaurant services:  “COSI (& HEARTH DESIGN)” in two foreign jurisdictions; “(HEARTH DESIGN)” in four foreign jurisdictions; and “SIMPLY GOOD TASTE” in one foreign jurisdiction.

 

We have trademark applications pending for registration of the following trademarks with respect to restaurant services:  “COSÌ” in the European Community and one other foreign jurisdiction; “COSÌ (& HEARTH DESIGN)” in one foreign jurisdiction; “(SUN & MOON DESIGN)” in one foreign jurisdiction; “SIMPLY GOOD TASTE” in one foreign jurisdiction; “LIFE SHOULD BE DELICIOUS” in one foreign jurisdiction; and “(HEARTH DESIGN)” in two foreign jurisdictions.

 

Governmental Regulation

 

Our restaurants are subject to regulation by federal agencies and to licensing and regulation by state, local and, where applicable, foreign health, sanitation, building, zoning, safety, fire and other departments relating to the development and operation of restaurants. These regulations include matters relating to environmental, building, construction and zoning requirements, franchising and the preparation and sale of food and alcoholic beverages. In addition, our facilities are licensed and subject to regulation under state and local fire, health and safety codes.

 

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Our restaurants that sell alcoholic beverages are required to obtain a license from a state authority and, in certain locations, county and/or municipal authorities. Typically, licenses must be renewed annually and may be revoked or suspended for cause at any time. Alcoholic beverage control regulations relate to numerous aspects of the daily operations of each of our restaurants, including minimum age of patrons and employees, hours of operation, advertising, wholesale purchasing, inventory control and handling, and storage and dispensing of alcoholic beverages. We have not encountered any material problems relating to alcoholic beverage licenses to date. The failure to receive or retain a liquor license in a particular location could adversely affect that restaurant and may impact our ability to obtain such a license elsewhere.

 

We are subject to “dram shop” statutes in the states in which our restaurants sell alcoholic beverages. These statutes generally provide a person injured by an intoxicated person the right to recover damages from an establishment that wrongfully served alcoholic beverages to the intoxicated individual. We carry liquor liability coverage as part of our existing comprehensive general liability insurance, which we believe is consistent with coverage carried by other similarly-situated entities in the restaurant industry. Although we are covered by insurance, a judgment against us under a dram-shop statute in excess of our liability coverage could have a material adverse effect on us.

 

Our operations are also subject to federal and state laws governing such matters as wages, working conditions, work eligibility requirements, overtime, insurance matters, workers’ compensation, child labor laws, and anti-discrimination laws. Some states have set minimum wage requirements higher than the federal level. Some of our hourly personnel at our restaurants are paid at rates based on the applicable minimum wage, and increases in the minimum wage will directly affect our labor costs.  We are also subject to the Americans with Disabilities Act of 1990, which, among other things, prohibits discrimination on the basis of disability in public accommodations and employment. We are required to comply with the Americans with Disabilities Act and regulations relating to accommodating the needs of the disabled in connection with the construction of new facilities and with significant renovations of existing facilities.

 

In recent years, there has been an increased legislative, regulatory and consumer focus at the federal, state and municipal levels on the food industry, including nutrition, labeling and advertising practices. Casual dining chains have been a particular focus. For example, New York City has adopted regulations requiring that chain restaurants include caloric or other nutritional information on their menu boards and on printed menus, which must be plainly visible to consumers at the point of ordering. We may in the future become subject to other initiatives in the area of nutritional disclosure or advertising, such as requirements to provide information about the nutritional content of our food, which could increase our expenses, particularly given differences among applicable legal requirements and practices within the restaurant industry with respect to testing and disclosure, or otherwise adversely affect us.

 

Item 1A. RISK FACTORS

 

Risks Related to Our Growth Strategy

 

We may not be able to achieve our planned expansion.  If we or our franchisees are unable to successfully open new restaurants, our revenue growth rate and profits may be reduced.

 

To successfully expand our business, we and our franchisees must open new restaurants on schedule and in a profitable manner. In the past, we have experienced delays in restaurant openings and may experience similar delays in the future. Delays or failures in opening new restaurants could hurt our ability to meet our growth objectives, which may affect the

 

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expectations of securities analysts and others and thus our stock price. We cannot guarantee that we or our franchisees will be able to achieve our expansion goals or that new restaurants will be operated profitably. Further, any restaurants that we, or our franchisees, open may not obtain operating results similar to those of our existing restaurants. Our ability to expand successfully will depend on a number of factors, many of which are beyond our control. These factors include, but are not limited to:

 

·                  locating suitable restaurant sites in new and existing markets;

 

·                  negotiating acceptable lease terms;

 

·                  ability to obtain financing for new restaurant development;

 

·                  generating positive cash flow from existing and new restaurants;

 

·                  successful operation and execution in new and existing markets;

 

·                  recruiting, training and retaining qualified corporate and restaurant personnel and management;

 

·                  attracting and retaining qualified franchisees with sufficient experience and financial resources to develop and operate our restaurants successfully;

 

·                  cost effective and timely planning, design and build-out of restaurants;

 

·                  the reliability of our customer and market studies;

 

·                  the reliability of our site identification studies;

 

·                  consumer trends;

 

·                  obtaining and maintaining required local, state, federal and where applicable, foreign governmental approvals and permits related to the construction of the sites and the sale of food and alcoholic beverages;

 

·                  creating customer awareness of our restaurants in new markets;

 

·                  competition in our markets, both in our business and in locating suitable restaurant sites;

 

·                  the cost of our principal food products and supply and delivery shortages or interruptions;

 

·                  weather conditions; and

 

·                  general economic conditions.

 

We must identify and obtain a sufficient number of suitable new restaurant sites for us to achieve a sustainable revenue growth rate.

 

We require that all proposed restaurant sites, whether Company-owned or franchised, meet site-selection criteria established by us. We and our franchisees may not be able to find sufficient new restaurant sites to support our planned expansion in future periods. We face significant

 

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competition from other restaurant companies and retailers for sites that meet our criteria and the supply of sites may be limited in some markets. As a result of these factors, our costs to obtain and lease sites may increase, or we may not be able to obtain certain sites due to unacceptable costs. Our inability to obtain suitable restaurant sites at reasonable costs may reduce our growth rate, which may affect the expectations of securities analysts and others and thus our stock price.

 

Our expansion in existing markets can cause sales in some of our existing restaurants to decline, which could result in restaurant closures.

 

As part of our expansion strategy, we and our franchisees intend to open new restaurants in our existing markets. Since we typically draw customers from a relatively small radius around each of our restaurants, the sales performance and customer counts for restaurants near the area in which a new restaurant opens may decline due to cannibalization, which could result in restaurant closures. In addition, new restaurants added in existing markets may not achieve the same operating performance as our existing restaurants.

 

Our expansion into new markets, both foreign and domestic, may present increased risks due to our unfamiliarity with the area. The restaurants we open in new geographic regions may not achieve market acceptance.

 

Some of our new franchised restaurants and Company-owned restaurants are located in areas where we have little or no meaningful experience. Those markets may have different demographic characteristics, competitive conditions, consumer tastes and discretionary spending patterns than our existing markets that may cause our new restaurants to be less successful than restaurants in our existing markets. An additional risk in expansion into new markets is the lack of market awareness of the Cosi® brand. Restaurants opened in new markets may open at lower average weekly sales volumes than restaurants opened in existing markets and may have higher restaurant-level operating expense ratios than in existing markets. Sales at restaurants opened in new markets may take longer to reach mature average annual Company-owned restaurant sales, if at all, thereby affecting the profitability of these restaurants.

 

We have an international license agreement with a licensee for the development of Cosi® restaurants in six countries in the Persian Gulf. This licensee currently operates four franchise locations in the United Arab Emirates. As these franchise locations and future foreign locations open, the Company’s international operations will be subjected to various factors of uncertainty. The Company’s business outside of the United States is subject to a number of additional factors, including international economic and political conditions, local economic conditions, differing cultures and consumer preferences, currency regulations and fluctuations, diverse government regulations and tax systems, uncertain or differing interpretations of rights and obligations in connection with international license agreements and the collection of royalties from international licensees, the availability and cost of land and construction costs, and the availability of experienced management, appropriate licensees, and joint venture partners. Although we believe that we have developed the support structure required for international growth, there is no assurance that such growth will occur or that international operations will be profitable.

 

We may not be able to successfully incorporate a franchising and area developer model into our strategy.

 

We have and will continue to incorporate a franchising and area developer model into our business strategy in certain selected markets. We did not use a franchising or area developer model prior to fiscal 2004, and we may not be as successful as predicted in attracting franchisees and developers to the Cosi® concept or identifying franchisees and developers that have the

 

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business abilities or access to financial resources necessary to open our restaurants or to successfully develop or operate our restaurants in a manner consistent with our standards.  Incorporating a franchising and area developer model into our strategy also requires us to devote significant management and financial resources to support the franchise of our restaurants. Our future performance will depend on our franchisees’ ability to execute our concept and capitalize upon our brand recognition and marketing. We may not be able to recruit franchisees who have the business abilities or financial resources necessary to open restaurants on schedule, or who will conduct operations in a manner consistent with our concept and standards. Our franchisees may not be able to operate restaurants in a profitable manner. If we are not successful in incorporating a franchising or area developer model into our strategy, we may experience delays in our growth or may not be able to expand and grow our business.

 

If our franchisees cannot develop or finance new restaurants, build them on suitable sites or open them on schedule, our growth and success may be impeded.

 

Our growth depends in large part upon our ability to establish a successful and effective franchise program and to attract qualified franchisees. If our franchisees are unable to locate suitable sites for new restaurants, negotiate acceptable lease or purchase terms, obtain the necessary financial or management resources, meet construction schedules or obtain the necessary permits and government approvals, our growth plans may be negatively affected. We cannot assure you that any of the restaurants our franchisees open will be profitable.

 

Additional foodservice strategic alliances may not be successful and may materially adversely affect our business and results of operations.

 

We may decide to enter into additional alliances with third parties to develop foodservice strategic alliances in select markets or through select channels. Identifying strategic partners, negotiating agreements and building such alliances may divert management’s attention away from our existing businesses and growth plans. If we are not successful in forming additional foodservice strategic alliances, we may experience delays in our growth and may not be able to expand and grow our business. If we do form additional strategic alliances, we cannot assure you that the restaurants opened pursuant to these strategic alliances will be profitable.

 

Any inability to manage our growth effectively could materially adversely affect our operating results.

 

Failure to manage our growth effectively could harm our business. We have grown significantly since our inception and intend to grow substantially in the future both through a franchising strategy and opening new Company-owned restaurants. Our existing restaurant management systems, financial and management controls and information systems may not be adequate to support our planned expansion. Our ability to manage our growth effectively will require us to continue to enhance these systems, procedures and controls. We must attract and retain talented operating personnel to maintain the quality and service levels at our existing and future restaurants. We may not be able to effectively manage these or other aspects of our expansion.  We cannot assure you that we will be able to respond on a timely basis to all of the changing demands that our planned expansion will impose on management and on our existing infrastructure. If we are unable to manage our growth effectively, our business, results of operations and financial condition could be materially adversely impacted.

 

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If we are unable to successfully integrate future acquisitions, our business could be negatively impacted.  Any acquisitions may also be costly.

 

We may consider future strategic acquisitions. Acquisitions involve numerous risks, including difficulties assimilating new operations and products. In addition, acquisitions may require significant management time and capital resources. We cannot assure you that we will have access to the capital required to finance potential acquisitions on satisfactory terms, that any acquisition would result in long-term benefits to us, or that management would be able to manage effectively the resulting business. Future acquisitions are likely to result in the incurrence of additional indebtedness, which could contain restrictive covenants, or the issuance of additional equity securities, which could dilute our existing stockholders. We may also pay too much for a concept that we acquire relative to the actual economic return obtained. If our integration efforts are unsuccessful, our business and results of operations could suffer.

 

Risks Related to Our Business

 

If we are unable to execute our business strategy, we could be materially adversely affected.

 

Our ability to successfully execute our business strategy will depend on a number of factors, some of which are beyond our control, including, but not limited to:

 

·                  our ability to generate positive cash flow from operations;

 

·                  identification and availability of suitable restaurant sites;

 

·                  competition for restaurant sites and customers;

 

·                  negotiation of favorable leases;

 

·                  management of construction and development costs of new and renovated restaurants;

 

·                  securing required governmental approvals and permits;

 

·                  recruitment and retention of qualified operating personnel;

 

·                  successful operation and execution in new and existing markets;

 

·                  recruiting, training and retaining qualified corporate and restaurant personnel and management;

 

·                  identification of under-performing restaurants and our ability to improve or efficiently close under-performing restaurants, including securing favorable lease termination terms;

 

·                  the rate of our internal growth, and our ability to generate increased revenue from existing restaurants;

 

·                  our ability to incorporate a franchising and area developer model into our strategy;

 

·                  competition in new and existing markets;

 

·                  the reliability of our customer and market studies;

 

·                  the impact of the general economic conditions and high unemployment rates on consumer spending, particularly in geographic regions that contain a high concentration of our restaurants;

 

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·                  the cost of our principal food products and supply and delivery shortages or interruptions;

 

·                  changes in commodity costs, labor, supply, fuel, utilities, distribution and other operating costs;

 

·                  availability of additional capital and financing;

 

·                  weather conditions; and

 

·                  general regional, national and, where applicable, foreign economic conditions.

 

Each of these factors could delay or prevent us from successfully executing our business strategy, which could adversely affect our growth, revenues and our results of operations.

 

During our operating history, we have been unable to achieve profitability.

 

In fiscal 2010, we incurred net losses of $3.1 million, and, since we were formed, we have incurred net losses of approximately $271.0 million through the end of fiscal 2010 primarily due to funding operating losses which have included significant impairment charges, costs associated with closing restaurants, early lease termination fees, and new restaurant opening expenses. We intend to continue to expend significant financial and management resources on the development of additional restaurants, both franchised and Company-owned. We cannot predict whether we will be able to achieve or sustain revenue growth, profitability or positive cash flow in the future. See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” and the financial statements included in this Annual Report on Form 10-K for information on the history of our losses.

 

If internally generated cash flow from our restaurants does not meet our expectations, our business, results of operations and financial condition could be materially adversely affected.

 

Our cash resources, and therefore our liquidity, are highly dependent upon the level of internally generated cash from operations and upon future financing transactions. Although we believe that we have sufficient liquidity to fund our working capital requirements for the next twelve months, if cash flows from our existing restaurants or cash flows from new restaurants that we open or from franchise fees and royalties do not meet our expectations or are otherwise insufficient to satisfy our cash needs, we may have to seek additional financing from external sources to continue funding our operations 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 may need additional capital in the future and it may not be available on acceptable terms.

 

Our business has in the past required, and may continue to require, significant additional capital to, among other things, fund our operations, increase the number of Company-owned or franchised restaurants, expand the range of services we offer and finance future acquisitions and investments. There is no assurance that financing will be available on terms acceptable to us, or at all. Our ability to obtain additional financing will be subject to a number of factors, including market conditions, our operating performance and investor sentiment. These factors may make the timing, amount, terms and conditions of additional financings unattractive to us. If we are

 

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unable to raise additional capital, our business, results of operations and financial condition could be materially adversely affected.

 

Economic conditions in the United States and globally could adversely affect our business and financial results and have a material adverse effect on our liquidity and capital resources.

 

If the economic conditions fail to substantially improve, many sectors of the economy may continue to be adversely impacted. As a retailer that depends upon consumer discretionary spending, we could face a challenging fiscal 2011 because our customers may make fewer discretionary purchases as a result of job losses, foreclosures, bankruptcies, reduced access to credit and falling home prices. Cosi®, as an “affordable luxury,” may be disproportionally affected by a significant decrease in customer traffic or lower average check prices as a result of customers switching to lower-priced products on our menu. The current economic environment could potentially have a material adverse effect on our liquidity and capital resources, including our ability to raise additional capital if needed or to maintain satisfactory credit terms with our suppliers.

 

Seasonality, inclement weather and other variable factors may adversely affect our sales and results of operations and could cause our quarterly results to fluctuate and fall below expectations of securities analysts and investors, resulting in a decline in our stock price.

 

Our business is subject to significant seasonal fluctuations and weather influences on consumer spending and dining out patterns. Inclement weather may result in reduced frequency of dining at our restaurants. Customer counts (and consequently revenues) are generally highest in spring and summer months and lowest during the winter months because of the high proportion of our restaurants located in the Northern part of the country where inclement winter weather affects customer visits. As a result, our quarterly and yearly results have varied in the past, and we believe that our quarterly operating results will vary in the future. Other factors such as unanticipated increases in labor, commodities, energy, insurance or other operating costs may also cause our quarterly results to fluctuate. For this reason, you should not rely upon our quarterly operating results as indications of future performance.

 

Our franchisees could take actions that could harm our business.

 

Franchisees are independent operators and are not our employees. Although we have developed criteria to evaluate and screen prospective franchisees, we are limited in the amount of control we can exercise over our franchisees, and the quality of franchised restaurant operations may be diminished by any number of factors beyond our control. Franchisees may not have the business acumen or financial resources necessary to successfully operate restaurants in a manner consistent with our standards and requirements and may not hire and train qualified managers and other restaurant personnel. Poor restaurant operations may affect each restaurant’s sales. Our image and reputation, and the image and reputation of other franchisees, may suffer materially and system-wide sales could significantly decline if our franchisees do not operate successfully.

 

We could face liability from our franchisees.

 

A franchisee or government agency may bring legal action against us based on the franchisee/franchisor relationships. Various state, federal and, where applicable, foreign and international laws govern our relationship with our franchisees and potential sales of our franchised restaurants. If we fail to comply with these laws, we could be liable for damages to franchisees and fines or other penalties. Expensive litigation with our franchisees or government agencies may adversely affect both our profits and our important relations with our franchisees.

 

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Our financial results are affected by the financial results of our franchisees.

 

We receive royalties from our franchisees. Our financial results are therefore to an extent contingent upon the operational and financial success of our franchisees, including implementation of our strategic plans, as well as their ability to secure adequate financing. If sales trends or economic conditions worsen for our franchisees, their financial health may worsen and our collection rates may decline. Additionally, refusal on the part of franchisees to renew their franchise agreements may result in decreased royalties. Entering into restructured franchise agreements may result in reduced franchise royalty rates in the future.

 

Our restaurants are currently concentrated in the Northeastern, Midwestern, and Mid-Atlantic regions of the United States, particularly in the New York City, Chicago and Philadelphia areas. Accordingly, we are highly vulnerable to negative occurrences in these regions.

 

We currently operate 82 Company-owned restaurants in Northeastern, Midwest, and Mid-Atlantic states, of which 30 are located in the New York City, Chicago and Philadelphia central business districts. As a result, we are particularly susceptible to adverse trends and economic conditions in these areas. In addition, given our geographical concentration, negative publicity regarding any of our restaurants could have a material adverse effect on our business and operations, as could other regional occurrences impacting the local economies in these markets.

 

You should not rely on past increases in our average unit volumes as an indication of our future results of operations because they may fluctuate significantly.

 

A number of factors have historically affected, and will continue to affect, our average unit sales, including, among other factors:

 

·                  our ability to execute our business and growth strategy effectively;

 

·                  success of promotional and marketing initiatives including advertising and new product and concept development;

 

·                  sales performance by our new and existing restaurants;

 

·                  management turnover in the restaurants;

 

·                  competition;

 

·                  general regional, national, and where applicable, foreign economic conditions;

 

·                  weather conditions; and

 

·                  the impact of the general economic conditions and high unemployment rates on consumer spending, particularly in geographic regions that contain a high concentration of our restaurants.

 

It is not reasonable to expect our average unit volumes to increase at rates achieved over the past several years. Changes in our average unit volumes could cause the price of our common stock to fluctuate substantially.

 

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Our common stock may be delisted from The Nasdaq Global Market, which could have an adverse impact on the liquidity and market price of our common stock.

 

Our common stock is currently listed on The Nasdaq Global Market and we currently meet all continued listing standards for The Nasdaq Global Market. During 2010, we received two separate notices from the Listing Qualifications Department of The Nasdaq Stock Market notifying us that we were not in compliance with the minimum bid price and stockholders equity requirements for continued listing. We have since regained compliance with the Nasdaq Listing Standards. However, it is possible that we may again fail to meet the continued listing standards for The Nasdaq Global Maket and our common stock could be delisted.

 

If we fail to comply with governmental regulations or if these regulations change, our business could suffer.

 

We are subject to extensive federal, state, local, and, where applicable, foreign government regulations, including regulations relating to alcoholic beverage control, the preparation and sale of food, public health and safety, sanitation, building, zoning and fire codes. Our operations are also subject to federal and state laws governing such matters as wages, working conditions, work eligibility requirements, overtime, insurance matters, workers’ compensation, disability laws such as the Americans with Disabilities Act, child labor laws and anti-discrimination laws.  Although we believe that compliance with these laws has not had a material effect on our operations to date, we may experience material difficulties or failures with respect to compliance in the future. Our failure to comply with these laws could result in required renovations to our facilities, litigation, fines, penalties, judgments or other sanctions, any of which could adversely affect our business, operations or our reputation.

 

In recent years, there has been an increased legislative, regulatory and consumer focus at the federal, state and municipal levels on the food industry, including nutrition, labeling and advertising practices. Casual dining chains have been a particular focus. For example, New York City has adopted regulations requiring that chain restaurants include caloric or other nutritional information on their menu boards and on printed menus, which must be plainly visible to consumers at the point of ordering. We may in the future become subject to other initiatives in the area of nutritional disclosure or advertising, such as requirements to provide information about the nutritional content of our food, which could increase our expenses, particularly given differences among applicable legal requirements and practices within the restaurant industry with respect to testing and disclosure, or otherwise adversely affect us.  See “Business — Government Regulation” in this Annual Report on Form 10-K for a discussion of the regulations with which we must comply.

 

Our operations depend upon governmental licenses and we may face liability under “dram shop” statutes.

 

Our business depends upon obtaining and maintaining required food service and/or liquor licenses for each of our restaurants. If we fail to obtain or maintain all necessary licenses, we may be forced to delay or cancel new restaurant openings and close or reduce operations at existing locations. In addition, our sale of alcoholic beverages subjects us to “dram shop” statutes in some states. These statutes allow an injured person to recover damages from an establishment that served alcoholic beverages to an intoxicated person. Although we take significant precautions to ensure that all employees are trained in the responsible service of alcohol and maintain insurance policies in accordance with all state regulations regarding the sale of alcoholic beverages, the misuse of alcoholic beverages by customers may create considerable risks for us. If we are the subject of a judgment substantially in excess of our insurance coverage, or if we fail to maintain our insurance coverage, our business, financial condition, operating results or cash flows could be materially and adversely affected.

 

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Our failure or inability to enforce our trademarks or other proprietary rights could adversely affect our competitive position or the value of our brand.

 

We own certain common law trademark rights and a number of federal and international trademark and service mark registrations, and proprietary rights to certain of our core menu offerings. We believe that our trademarks and other proprietary rights are important to our success and our competitive position. We, therefore, devote appropriate resources to the protection of our trademarks and proprietary rights. The protective actions that we take, however, may not be enough to prevent unauthorized usage or imitation by others, which might cause us to incur significant litigation costs and could harm our image or our brand or competitive position.

 

We also cannot assure you that third parties will not claim that our trademarks or offerings infringe the proprietary rights of third parties. Any such claim, whether or not it has merit, could be time-consuming, result in costly litigation, cause product delays or require us to enter into royalty or licensing agreements. As a result, any such claim could have a material adverse effect on our business, results of operations and financial condition.

 

We hold significant amounts of illiquid assets and may have to dispose of them on unfavorable terms.

 

As of the end of fiscal 2010, we had $15.0 million in net fixed assets that we have defined as illiquid assets, which include leasehold improvements, equipment and furniture and fixtures.   These assets cannot be converted into cash quickly and easily. We may be compelled, based on a significant underperformance of a specific location or market, to dispose of some illiquid assets on unfavorable terms, which could have a material adverse effect on our business.

 

We may face litigation that could have a material adverse effect on our business, financial condition and results of operations.

 

From time to time, we are a defendant in litigation arising in the ordinary course of our business. Our customers may file complaints or lawsuits against us alleging that we are responsible for an illness or injury they suffered at or after a visit to a Cosi® restaurant, or alleging that there was a problem with food quality or operations at a Cosi® restaurant. We may also be subject to a variety of other claims arising in the ordinary course of our business, including personal injury claims, contract claims, claims from franchisees and claims alleging violations of federal, state and, where applicable, foreign law regarding workplace and employment matters, discrimination and similar matters. We could also become subject to class action lawsuits related to these matters in the future.

 

Regardless of whether any future claims against us are valid or whether we are found to be liable, claims may be expensive to defend and may divert our management’s attention away from our operations and hurt our performance. The outcome of litigation, particularly class action lawsuits and regulatory actions, is difficult to assess or quantify. Plaintiffs in these types of lawsuits may seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time. A judgment significantly in excess of our insurance coverage for any claims could materially adversely affect our financial condition or results of operations. There may also be adverse publicity associated with litigation that could decrease customer acceptance of our services or those of our franchisees, regardless of whether the allegations are valid or whether we are ultimately found liable. As a result, litigation may have a material adverse affect on our business, financial condition and results of operations. Moreover, complaints, litigation or adverse publicity experienced by one or more of our franchisees could also hurt our business as a whole.

 

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If we are unable to protect our customers’ credit card data, we could be exposed to data loss, litigation and liability, and our reputation could be significantly harmed.

 

In connection with credit card sales, we transmit confidential credit card information securely over public networks. Third parties may have the technology or know-how to breach the security of this customer information, and our security measures may not effectively prohibit others from obtaining improper access to this information. If a person is able to circumvent our security measures, he or she could destroy or steal valuable information or disrupt our operations. Any security breach could expose us to risks of data loss, litigation and liability and could seriously disrupt our operations and any resulting negative publicity could significantly harm our reputation.

 

We rely on computer systems and information technology to run our business. Any material failure, interruption or security breach of our computer systems or information technology may adversely affect the operation of the business and our results of operations.

 

Computer viruses or terrorism may disrupt our operations and adversely affect our operating results. Despite our implementation of security measures, all of our technology systems are vulnerable to disability or failures due to hacking, viruses, acts of war or terrorism, and other causes. If our technology systems were to fail and we were unable to recover in a timely manner, we would be unable to fulfill critical business functions, which could have a material adverse effect on our business, operating results, and financial condition.

 

Risks Relating to the Food Service Industry

 

Our business is affected by changes in consumer preferences.

 

Our success depends, in part, upon the popularity of our food and beverage products, our ability to develop new menu items that appeal to consumers and what we believe is an emerging trend in consumer preferences toward premium convenience restaurants. We depend on consumers who prefer made-to-order food in a sophisticated environment and are willing to pay a premium price for our products. We also depend on trends toward consumers eating away from home more often. Shifts in consumer preferences away from our restaurants or cuisine, our inability to develop new menu items that appeal to consumers or changes in our menu that eliminate items popular with some consumers could harm our business and future profitability.

 

Natural disasters, war, acts of terrorism or other armed conflict, or the threat of such actions, on the United States or international economies may cause a decline in discretionary consumer spending, which would negatively affect our business.

 

Our success depends to a significant extent on discretionary consumer spending, which is influenced by general economic and political conditions and the availability of discretionary income. Discretionary consumer spending may decline in the event of a natural disaster, war, acts of terrorism or other armed conflict. Accordingly, we may experience a decline in sales during periods of uncertainty like the one that followed the September 11, 2001 terrorist attacks on the United States. In addition, economic uncertainty due to military action overseas, such as the wars in Iraq and Afghanistan, and other military, diplomatic or financial responses, may lead to further declines in sales. Any decline in consumer spending or economic conditions could reduce customer traffic or impose practical limits on pricing, either of which could have a material adverse effect on our sales, results of operations, business and financial condition. In the event of a natural disaster or acts of terrorism in the United States, or the threat of either, we may be required to suspend operations in some or all of our restaurants, which could have a material adverse impact on our business, financial condition, and results of operation.

 

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Our success depends on our ability to compete with many food service businesses.

 

The restaurant industry is intensely competitive and we compete with many well-established food service companies on the basis of taste, quality and price of product offered, customer service, atmosphere, location and overall customer experience. We compete with other sandwich retailers, specialty coffee retailers, bagel shops, fast-food restaurants, delicatessens, cafes, bars, take-out food service companies, supermarkets and convenience stores. Our competitors change with each daypart (breakfast, lunch and dinner), ranging from coffee bars and bakery cafes during the breakfast and lunch dayparts to casual dining chains during the dinner daypart. Aggressive pricing by our competitors or the entrance of new competitors into our markets could reduce our sales and profit margins.

 

Many of our competitors or potential competitors have substantially greater financial and other resources than we do, which may allow them to react to changes in pricing, marketing and the quick-service restaurant industry better than we can. As competitors expand their operations, we expect competition to intensify. We also compete with other employers in our markets for hourly workers and may be subject to higher labor costs.

 

Changes in food and supply costs and availability could adversely affect our results of operations.

 

Our restaurants receive frequent deliveries of products. Most of these deliveries are made by distributors who are part of a national network of independent distributors with whom we have a distribution agreement. These independent distributors supply us with approximately 79% of our food and paper products under an agreement which expires in December 2013. Our profitability depends in part on our ability to anticipate and react to changes in food and supply costs, such as the volatility in certain commodity markets we experienced in recent years. Certain commodities such as wheat, coffee and dairy and dairy-related products have experienced significant fluctuations in the recent past. These types of increases could have an adverse effect on us during fiscal 2011 and in future fiscal years. Although many of our products are made to our specifications, we believe that alternative distribution sources are available for the majority of our ingredients and products.

 

We believe that we have adequate sources of supply for our ingredients and products to support our restaurant operations and, if necessary, we can make menu modifications to address any material supply issues. However, there are many factors which can cause shortages or interruptions in the supply of our ingredients and products including weather, unanticipated demand, labor, production or distribution problems, quality issues and cost, some of which are beyond our control, and any of which could have an adverse effect on our business and results of operations.

 

Health concerns relating to the consumption of beef, poultry, produce or other food products could adversely affect the price and availability of beef, poultry, produce, and other food products, consumer preferences and our results of operations and stock price.

 

Since 2004, Asian and European countries have experienced outbreaks of avian flu, or “bird flu.” Additional instances of avian flu or other food-borne illnesses, such as “mad cow disease,” E.coli, salmonella, or hepatitis A could adversely affect the price and availability of beef, poultry or other food products. As a result, we could experience a significant increase in cost of food.

 

In addition, like other restaurant chains, consumer preferences could be affected by health concerns about the consumption of poultry, beef, or produce, the key ingredients in many of our menu items, or by negative publicity concerning food quality, illness and injury generally, such

 

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as negative publicity concerning, E.coli, salmonella, “mad cow disease” or “bird flu”, publication of government or industry findings about food products we serve or other health concerns or operating issues stemming from the food served in our restaurants. Our operational controls and training may not be fully effective in preventing all food-borne illnesses. Some food-borne illness incidents could be caused by food suppliers and transporters and would be outside of our control. If our food suppliers and transporters do not comply with governmental health regulations, they may not be able to deliver food products or we may be subject to food product recalls. Any negative publicity, health concerns or specific outbreaks of food-borne illnesses attributed to one or more of our restaurants, or the perception of an outbreak, could result in a decrease in customer traffic to our restaurants and could have a material adverse effect on our sales, results of operations, business, financial condition and stock price.

 

The food service industry is affected by litigation and publicity concerning food quality, health and other issues, which can cause customers to avoid our products and result in liabilities.

 

Food service businesses can be adversely affected by litigation and complaints from customers or government authorities resulting from food quality, illness, injury or other health concerns or operating issues stemming from one restaurant or a limited number of restaurants. Adverse publicity about these allegations may negatively affect us, regardless of whether the allegations are true, by discouraging customers from buying our products. We could also incur significant liabilities if a lawsuit or claim results in a decision against us or if we incur litigation costs, regardless of the result.

 

Our business could be adversely affected by increased labor costs or labor shortages.

 

Labor is a primary component in the cost of operating our business. We devote significant resources to recruiting and training our managers and employees. Increased labor costs, due to competition, increased minimum wage or employee benefits costs or otherwise, would adversely impact our operating expenses. In addition, our success depends on our ability to attract, motivate and retain qualified employees, including restaurant managers and staff, to keep pace with our needs. If we are unable to do so, our results of operations may be adversely affected.

 

Item 1B. UNRESOLVED STAFF COMMENTS

 

We have received no written comments regarding our periodic or current reports from the staff of the Securities and Exchange Commission that were issued 180 days or more preceding the end of our 2010 fiscal year and that remain unresolved.

 

Item 2. PROPERTIES

 

Our principal executive offices are located at 1751 Lake Cook Road, Suite 600, Deerfield, Illinois 60015.  The lease for our executive offices expires in September 2012. We believe the offices are adequate to accommodate our needs.

 

All of our restaurants are located on leased properties. Each lease typically has a 10-year base rent period, with various renewal options. In addition to the base rent, some leases provide for contingent rental payments, insurance, common area, and other operating costs. At most locations, we reimburse the landlord for a proportionate share of the landlord’s annual real estate taxes.

 

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The following table lists existing Company-owned restaurants, by region, as of December 27, 2010:

 

Street Address

 

City

 

Date Opened

MIDATLANTIC

234 South 15th Street

 

Philadelphia, PA

 

September-96

325 Chestnut Street

 

Philadelphia, PA

 

April-97

1128 Walnut Street

 

Philadelphia, PA

 

December-97

140 South 36th Street

 

Philadelphia, PA

 

August-98

761 Lancaster Avenue

 

Bryn Mawr, PA

 

September-98

2050 Wilson Boulevard

 

Arlington, VA

 

April-99

1700 Market Street

 

Philadelphia, PA

 

September-99

700 King Street

 

Alexandria, VA

 

May-00

4250 Fairfax Drive

 

Arlington, VA

 

June-00

201 South 18th Street

 

Philadelphia, PA

 

October-00

7251 Woodmont Avenue

 

Bethesda, MD

 

December-00

11909 Democracy Drive

 

Reston, VA

 

May-01

4074 The Strand West

 

Columbus, OH

 

October-01

6390 Sawmill Road

 

Columbus, OH

 

September-02

2212 East Main Street

 

Bexley, OH

 

September-02

1478 Bethel Road

 

Columbus, OH

 

November-02

295 Main Street

 

Exton, PA

 

November-02

7166 N. High Street

 

Worthington, OH

 

December-02

177 Kentlands Blvd

 

Gaithersburg, MD

 

January-03

1310 Polaris Parkway

 

Columbus, OH

 

February-03

1801 N. Lynn Street

 

Arlington, VA

 

November-05

4025 Welsh Road

 

Willow Grove, PA

 

December-05

50 Yorktown Plaza

 

Elkins Park, PA

 

April-06

833 Chestnut

 

Philadelphia, PA

 

June-06

9177 Reisterstown Road

 

Owing Mills, MD

 

June-06

424 West Swedesford Road

 

Berwyn, PA

 

June-06

100 South Charles

 

Baltimore, MD

 

July-06

513 West Broad Street

 

Falls Church, VA

 

October-06

3503 Fairfax Drive, Suite 200

 

Arlington, VA

 

November-06

201 N. Washington #290

 

Rockville, MD

 

March-07

2955 Market St.

 

Philadelphia, PA

 

July-07

2011 Crystal Drive, ste 100

 

Arlington, VA

 

May-08

MIDWEST

116 S. Michigan Avenue

 

Chicago, IL

 

September-00

55 E. Grand Street

 

Chicago, IL

 

October-00

230 W. Washington Street

 

Chicago, IL

 

November-00

203 North LaSalle Street

 

Chicago, IL

 

May-01

1101 Lake Street

 

Oak Park, IL

 

June-01

101 North Old Woodward Avenue

 

Birmingham, MI

 

August-01

25 E. Hinsdale

 

Hinsdale, IL

 

December-01

8775 N. Port Washington Road

 

Fox Point, WI

 

December-01

230 West Monroe Street

 

Chicago, IL

 

May-02

301 East Grand River Avenue

 

East Lansing, MI

 

May-02

84 W. Adams Road

 

Rochester Hills, MI

 

September-02

28674 Telegraph Road

 

Southfield, MI

 

November-02

37652 Twelve Mile Road

 

Farmington Hills, MI

 

December-02

 

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131 LaGrange Road

 

Orland Park, IL

 

December-02

233 North Michigan Avenue

 

Chicago, IL

 

December-02

33 N Dearborn

 

Chicago, IL

 

June-05

1740 Sherman Avenue

 

Evanston, IL

 

September-05

18 West 066 22nd Street

 

Oak Brook Terrace, IL

 

August-06

2200 North Clark

 

Chicago, IL

 

August-06

8310 Greenway Boulevard, #106

 

Middleton, WI

 

September-06

250 State Street

 

Madison, WI

 

September-06

910 North Milwaukee Avenue, Suite A

 

Lincolnshire, IL

 

November-06

Crystal Court Ste 150, 710 Marquette Ave

 

Minneapolis, MN

 

March-09

2100 Patriot Blvd

 

Glenview, IL

 

September-09

NORTHEAST

257 Park Avenue South

 

New York, NY

 

February-97

38 East 45th Street

 

New York, NY

 

February-97

11 West 42nd Street

 

New York, NY

 

June-97

60 East 56th Street

 

New York, NY

 

September-97

3 World Financial Center

 

New York, NY

 

January-98

55 Broad Street

 

New York, NY

 

March-98

1633 Broadway

 

New York, NY

 

July-98

61 West 48th Street

 

New York, NY

 

August-98

685 Third Avenue

 

New York, NY

 

June-99

970 Farmington Avenue

 

W. Hartford, CT

 

August-99

461 Park Avenue South

 

New York, NY

 

January-00

50 Purchase Street

 

Rye, NY

 

March-00

841 Broadway

 

New York, NY

 

September-00

15 S. Moger Avenue

 

Mt. Kisco, NY

 

December-00

77 Quaker Ridge Road

 

New Rochelle, NY

 

November-01

1298 Boston Post Road

 

Larchmont, NY

 

December-01

471 Mount Pleasant Road

 

Livingston, NJ

 

September-02

385 West Main Street

 

Avon, CT

 

December-02

29 Washington Street

 

Morristown, NJ

 

December-02

498 7th Avenue

 

New York, NY

 

December-02

700 6th Avenue

 

New York, NY

 

February-03

129 West Putnam Avenue

 

Greenwich, CT

 

February-06

441 South Oyster Bay Road

 

Plainview, NY

 

June-06

1209 High Ridge Road

 

Stamford, CT

 

July-06

53 E. 8th St.

 

New York, NY

 

April-07

2186 Broadway

 

New York, NY

 

June-07

230 Tresser Blvd. Ste 005

 

Stamford, CT

 

November-07

 

Item 3. LEGAL PROCEEDINGS

 

From time to time, we are a defendant in litigation arising in the ordinary course of our business, including but not limited to, claims resulting from “slip and fall” accidents, claims under federal and state laws governing access to public accommodations or other federal and state laws applicable to our business operations, employment-related claims, property damages, claims from guests alleging illness, injury or other food quality, health or operational concerns, and enforcement of intellectual property rights.

 

As of the date of this report, there are no legal proceedings pending which, at this time, are expected to have a material adverse effect if decided against the Company.

 

Item 4. RESERVED

 

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PART II

 

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, STOCK AND RELATED        STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

 

On November 22, 2002, our common stock began trading on The Nasdaq Global Market System (“Nasdaq”) under the symbol “COSI.” The closing price of our common stock on Nasdaq was $1.30 on March 23, 2011.

 

On April 27, 2010 we received notice from the Listing Qualifications Department of The Nasdaq Stock Market that we have regained compliance with The Nasdaq Listing Standards by curing our bid price and stockholders’ equity deficiencies. As of April 21, 2010, the bid price of our common stock had closed above the $1.00 minimum requirement for a period of 10 consecutive trading days. Additionally, based on total shares outstanding of 51,551,201, our common stock has exceeded the alternative minimum $50 million market value of listed securities requirement as required by Listing Rule 5450(b)(2)(A). Therefore, we met all continued listing standards for The Nasdaq Global Market. As a result, we were removed from the hearings process and the scheduled hearing before The Nasdaq Hearings Panel was cancelled.

 

On July 8, 2010, we received another notice from the Listing Qualifications Department of The Nasdaq Stock Market indicating that, for the previous 30 consecutive business days, the bid price for our common stock had closed below the minimum $1.00 per share required for continued inclusion on The Nasdaq Global Market under Nasdaq Listing Rule 5450(a)(1). The notification letter stated that we would be afforded 180 calendar days, or until January 4, 2011, to regain compliance with the minimum bid price requirement. In order to regain compliance, the shares of our common stock had to maintain a minimum bid closing price of at least $1.00 per share for a minimum of ten consecutive business days.

 

On November 4, 2010 we received notice from the Listing Qualifications Department of The Nasdaq Stock Market that we have regained compliance with The Nasdaq Listing Standards by curing the minimum bid price deficiency. As of November 3, 2010, the bid price of our common stock had closed at or above the $1.00 minimum requirement for the last 10 consecutive business days. We currently meet all continued listing standards for The Nasdaq Global Market.

 

Stock Price Information

 

Set forth below are the high and low closing sale prices for shares of our common stock for each quarter during fiscal 2010 and 2009 as reported by Nasdaq.

 

 

 

Fiscal 2010

 

Fiscal 2009

 

Fiscal Quarter

 

High

 

Low

 

High

 

Low

 

First Quarter

 

$

0.94

 

$

0.57

 

$

0.43

 

$

0.19

 

Second Quarter

 

$

1.34

 

$

0.75

 

$

1.00

 

$

0.34

 

Third Quarter

 

$

0.90

 

$

0.66

 

$

0.73

 

$

0.44

 

Fourth Quarter

 

$

1.33

 

$

0.83

 

$

0.97

 

$

0.51

 

 

Stockholders

 

The number of our registered common stockholders of record as of March 11, 2011 was 82. This number excludes stockholders whose stock is held in nominee or street name by brokers.

 

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Dividend Policy

 

We have never paid cash dividends on our common stock, and we do not currently intend to pay any dividends.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The information relating to securities authorized for issuance under our equity compensation plans is disclosed in Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.

 

Set forth below is a graph comparing the cumulative total stockholder return on Così’s common stock with The Nasdaq Composite Index and the Standard & Poor’s Small Cap 600 Index for the period covering our initial public offering on November 22, 2002, through the end of our 2010 fiscal year on December 27, 2010. The Company’s common stock trades on The Nasdaq Global Market under the symbol “COSI.” The graph assumes an investment of $100.00 made at the opening of trading on November 22, 2002, in (i) Così’s common stock, (ii) the stocks comprising The Nasdaq Composite Index, and (iii) stocks comprising the Standard & Poor’s Small Cap 600 Index.

 

 

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Item 6. SELECTED FINANCIAL DATA

 

The following table sets forth our summary of selected consolidated financial data, which should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and the related notes included elsewhere in this report. The selected statement of operations data for fiscal 2010, 2009, and 2008 and selected balance sheet data for fiscal 2010 and 2009 are derived from our audited consolidated financial statements that are included in this report. The selected statement of operations data for fiscal 2007 and 2006 and selected balance sheet data for fiscal 2008, 2007 and 2006 are derived from our audited consolidated financial statements not included in this report. The following historical results of consolidated operations are not necessarily indicative of results to be expected for any subsequent period.

 

 

 

Fiscal Year

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

 

(in thousands, except per share data)

 

Consolidated Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Restaurant net sales

 

$

106,636

 

$

116,375

 

$

132,501

 

$

132,414

 

$

122,849

 

Franchise fees and royalties

 

3,063

 

2,198

 

3,078

 

2,142

 

849

 

Total revenus

 

109,699

 

118,573

 

135,579

 

134,556

 

123,698

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of food and beverage

 

24,366

 

26,429

 

30,235

 

30,972

 

28,170

 

Restaurant labor and related benefits

 

40,161

 

43,151

 

46,024

 

45,995

 

40,782

 

Occupancy and other restaurant operating expenses

 

33,977

 

36,617

 

39,821

 

38,369

 

32,045

 

 

 

98,504

 

106,197

 

116,080

 

115,336

 

100,997

 

General and administrative expenses

 

13,692

 

14,635

 

19,317

 

22,973

 

26,887

 

Depreciation and amortization

 

4,773

 

7,050

 

8,409

 

8,823

 

7,196

 

Restaurant pre-opening expenses

 

 

13

 

100

 

710

 

1,451

 

Provision for losses on asset impairments and disposals

 

732

 

1,530

 

7,099

 

3,845

 

249

 

Closed store costs

 

152

 

48

 

69

 

262

 

 

Lease termination expense (benefit), net

 

203

 

322

 

551

 

347

 

(232

)

Gain on sale of assets

 

(5,205

)

(102

)

 

(23

)

(482

)

Total costs and expenses

 

112,851

 

129,693

 

151,625

 

152,273

 

136,066

 

Operating loss

 

(3,152

)

(11,120

)

(16,046

)

(17,717

)

(12,368

)

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

1

 

3

 

102

 

524

 

1,411

 

Interest expense

 

(4

)

(4

)

(7

)

(42

)

(9

)

Other income

 

14

 

17

 

41

 

705

 

77

 

Total other income

 

11

 

16

 

136

 

1,187

 

1,479

 

Loss from continuing operations

 

(3,141

)

(11,104

)

(15,910

)

(16,530

)

(10,889

)

Discontinued operations:

 

 

 

 

 

 

 

 

 

 

 

Operating loss from discontinued operations

 

 

 

(224

)

(903

)

(1,183

)

Asset impairments of discontinued operations

 

 

 

(88

)

(3,350

)

(256

)

Loss from discontinued operations

 

 

 

(312

)

(4,253

)

(1,439

)

Net loss

 

$

(3,141

)

$

(11,104

)

$

(16,222

)

$

(20,783

)

$

(12,328

)

 

 

 

 

 

 

 

 

 

 

 

 

Per share data:

 

 

 

 

 

 

 

 

 

 

 

Loss per share, basic and diluted

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.06

)

$

(0.27

)

$

(0.40

)

$

(0.42

)

$

(0.28

)

Discontinued operatons

 

$

 

$

 

$

 

$

(0.11

)

$

(0.04

)

Net loss

 

$

(0.06

)

$

(0.27

)

$

(0.40

)

$

(0.53

)

$

(0.32

)

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares used in computing net loss per share - basic and diluted

 

50,638

 

40,423

 

40,079

 

39,335

 

38,207

 

 

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Fiscal Year

 

 

 

2010

 

2009

 

2008

 

2007

 

2006

 

 

 

(in thousands, except per share data)

 

Selected Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

10,307

 

$

4,079

 

$

5,589

 

$

6,309

 

$

938

 

Investments

 

$

 

$

 

$

 

$

 

$

18,962

 

Total assets

 

$

31,351

 

$

31,570

 

$

42,781

 

$

56,412

 

$

75,757

 

Total stockholders’ equity

 

$

11,686

 

$

9,325

 

$

19,026

 

$

33,846

 

$

50,631

 

 

 

 

 

 

 

 

 

 

 

 

 

Selected Consolidated Statement of Cash Flow Data:

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by operating activities

 

$

(3,963

)

$

(1,190

)

$

2,044

 

$

(2,370

)

$

3,949

 

Net cash (used in) provided by investing activities

 

$

5,317

 

$

(682

)

$

(2,817

)

$

5,727

 

$

(6,674

)

Net cash provided by financing activities

 

$

4,874

 

$

362

 

$

53

 

$

2,013

 

$

1,711

 

 

 

 

 

 

 

 

 

 

 

 

 

Selected Operating Data:

 

 

 

 

 

 

 

 

 

 

 

Company-owned restaurants open at the end of the fiscal year

 

83

 

99

 

101

 

107

 

110

 

 

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations for the fiscal years ended December 27, 2010, December 28, 2009, and December 29, 2008 should be read in conjunction with “Selected Consolidated Financial Data” and our audited consolidated financial statements and the notes to those statements that are included elsewhere in this Annual Report. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Cautionary Note Regarding Forward-Looking Statements” below and elsewhere in this Annual Report.

 

Business Overview

 

System-wide Restaurants:

 

 

 

Fiscal Year

 

 

 

2010

 

2009

 

2008

 

 

 

Company-Owned

 

Franchise

 

Total

 

Company-Owned

 

Franchise

 

Total

 

Company-Owned

 

Franchise

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restaurants at beginning of period

 

99

 

46

 

145

 

101

 

50

 

151

 

107

(a)

34

 

141

 

Company-owned sold to franchisee

 

13

 

13

 

 

 

 

 

 

 

 

New restaurants opened

 

 

2

 

2

 

2

 

6

 

8

 

1

 

19

 

20

 

Restaurants permanently closed

 

3

 

2

 

5

 

4

 

10

 

14

 

7

 

3

 

10

 

Restaurants at end of period

 

83

 

59

 

142

 

99

 

46

 

145

 

101

 

50

 

151

 

 


(a) - Includes three locations that are classified as discontinued operations.

 

As of December 27, 2010, there were 83 Company-owned and 59 franchised premium convenience restaurants operating in 18 states, the District of Columbia, and the United Arab Emirates (UAE). During fiscal 2010, two new franchised restaurants opened, one at Logan Airport in Boston and another one in the UAE and we closed three Company-owned restaurants, in Great Neck, New York, Darien, Connecticut, and Ann Arbor, Michigan. During fiscal 2010, two franchised restaurants closed, one in Minnesota and another one in the UAE and we sold thirteen Company-owned restaurants in the District of Columbia to a franchisee (see Note 13 to our consolidated financial statements). We closed one Company-owned restaurant in Illinois subsequent to fiscal 2010.

 

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

 

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specialty coffees and beverages. Our restaurants offer lunch and afternoon coffee in a counter-service format, with most offering breakfast and/or dinner and dessert menus as well.

 

We are currently eligible to offer franchises in 47 states and the District of Columbia. We offer franchises to area developers and individual franchise operators. The initial franchise fee, payable to us, for both an area developer and an individual franchise operator, is $40,000 for the first restaurant and $35,000 for each additional restaurant.

 

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

 

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

 

We also continue to explore strategic opportunities with our Cosi Pronto® (our grab-and-go concept) and full-service concepts in educational establishments, airports, train stations and other public venues that meet our operating and financial criteria.

 

Recent Developments

 

Rights Offering and Private Placement of Common Stock

 

On January 6, 2010, we completed a shareholders’ rights offering to our shareholders of record as of November 9, 2009. We issued a total of 10,000,000 shares of our $0.01 par value common stock at a subscription price of $0.50 per share. In conjunction with the rights offering, our executive officers and outside directors purchased an aggregate 451,677 shares of our $0.01 par value common stock, at a subscription price of $0.50 per share, through a private placement. We received, in the aggregate, net proceeds of approximately $4.9 million from the rights offering and the private placement of common stock.

 

Sale of Restaurants

 

On April 27, 2010, we completed the sale of thirteen restaurants and related assets in the Washington, D.C. market to Capitol C Restaurants LLC (“Capitol C”) for $8.35 million. The sale was made pursuant to an Asset Purchase and Sale Agreement dated April 27, 2010, by and among the Company, Cosi Sandwich Bar, Inc., a wholly-owned subsidiary of the Company, Capitol C and Capitol C Holdings LLC (“Holdings”), the parent company of Capitol C. The restaurants will be operated under franchise agreements between the Company and Capitol C, and Holdings has entered into a development agreement to open six additional Cosi® restaurants in the District of Columbia area. Under the terms of the Asset Purchase and Sale Agreement, $6.4 million of the purchase price was paid in cash at closing and $1.35 million is payable to Cosi under a subordinated secured promissory note and will be paid in 120 weekly installments, commencing January 2011, based on a percentage of net sales, with a final balloon payment for the balance of the note due on May, 2013. The balance of $0.6 million is being held in escrow and will be paid to Cosi if Capitol C achieves a certain sales target at any time during the three-year period following the closing date of the transaction. Disbursement from the escrow, either in

 

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full or in part, is based on a formula that compares then-current trailing twelve-month sales to a sales baseline and applies the resulting percentage to the escrow amount. The disbursement calculation can be applied up to three times at Cosi’s sole discretion over the three year period.

 

As a result of this sale, we disposed of approximately $3.0 million in net furniture, fixtures, equipment and leasehold improvements, and recognized a gain on the sale of assets of approximately $5.1 million during the second quarter of fiscal 2010, including approximately $0.3 million in unamortized landlord allowances and reversal of straight line rent expense. If the disbursement, either in full or in part, is made to us from the $0.6 million held in escrow, we will recognize an additional gain from the sale of these assets at that time. In addition, as a result of this sale, our cash position increased by $6.4 million, other non-current assets and current receivables increased by approximately $0.9 million and $0.35 million, respectively, due to the $1.35 million promissory note, which was discounted to its December 27, 2010 present value of approximately $1.25 million.

 

Critical Accounting Policies

 

Our discussion and analysis of our consolidated financial condition and results of operations is based upon the consolidated financial statements and notes to the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of the consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.

 

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable and generally accepted for companies in the restaurant industry. We believe that the following addresses the more critical accounting policies used in the preparation of our consolidated financial statements and requires management’s most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. There have been no material changes in the application of our most critical accounting policies and estimates, judgments and assumptions during fiscal 2010.

 

Long Lived Assets: ASC 360-10-35 Property, Plant, & Equipment requires management judgments regarding the future operating and disposition plans for marginally-performing assets, and estimates of expected realizable values for assets to be sold. The application of this standard has affected the amount and timing of charges to operating results that have been significant in recent years. We evaluate possible impairment at the individual restaurant level periodically and record an impairment loss whenever we determine impairment factors are present. We consider a history of poor financial operating performance to be the primary indicator of potential impairment for individual restaurant locations. We determine whether a restaurant location is impaired based on expected undiscounted cash flows, generally for the remainder of the lease term, and then determine the impairment charge based on discounted cash flows for the same period.  Restaurants are not considered for impairment during the “ramp-up” period before they enter the comparable restaurant base, unless specific circumstances warrant otherwise.

 

Lease Termination Charges: ASC 420-10-30 Exit or Disposal Cost Obligations requires companies to recognize a liability for the costs associated with an exit or disposal activity when the liability is incurred, rather than at the time of a commitment to an exit or disposal plan. For all exit activities, we estimate our likely liability under contractual leases for restaurants that

 

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have been closed. Such estimates have affected the amount and timing of charges to operating results and are impacted by management’s judgments about the time it may take to find a suitable subtenant or assignee, or the terms under which a termination of the lease agreement may be negotiated with the landlord.

 

Accounting for Lease Obligations: In accordance with ASC 840-10-25 Leases, we recognize rent expense on a straight-line basis over the lease term commencing on the date we take possession. We include any rent escalations, rent abatements during the construction period and any other rent holidays in our straight-line rent expense calculation.

 

Landlord Allowances: In accordance with ASC 840-10-25 Leases, we record landlord allowances as deferred rent in other long-term liabilities on the consolidated balance sheets and amortize them on a straight-line basis over the term of the related leases.

 

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

 

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

 

Income Taxes: We have recorded a full valuation allowance to reduce our deferred tax assets that relate primarily to net operating loss carry-forwards. Our determination of the valuation allowance is based on an evaluation of whether it is more likely than not that we will be able to utilize the net operating loss carry-forwards based on the Company’s operating results. A positive adjustment to income will be recorded in future years if we determine that we could realize these deferred tax assets.

 

We have adopted the provisions of ASC 740-10-25 Income Taxes beginning in fiscal 2007. No adjustment was made to the beginning retained earnings balance, as the ultimate deductibility of all tax positions is highly certain but there is uncertainty about the timing of such deductibility. No interest or penalties have been accrued relative to tax positions due to the Company having either a tax loss or net operating loss carry-forwards to offset any taxable income in all subject years. As a result, no liability for uncertain tax positions has been recorded.

 

Revenue

 

Restaurant Net Sales. Our Company-owned restaurant sales are composed almost entirely of food and beverage sales. We record revenue at the time of the purchase of our products by our customers.

 

Franchise Fees and Royalties. Franchise fees and royalties includes fees earned from franchise agreements entered into with area developers and franchise operators, as well as royalties received based on sales generated at franchised restaurants. We recognize the franchise fee in the period in which a franchise location opens or when fees are forfeited as a result of a termination of an area developer agreement. We recognize franchise royalties in the period in which sales are made by our franchise operators.

 

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Gift Card Sales. We offer our customers the opportunity to purchase gift cards at our restaurants and through our website. Customers can purchase these cards at varying dollar amounts. At the time of purchase by the customer, we record a gift card liability for the face value of the card purchased. We recognize the revenue and reduce the gift card liability when the gift card is redeemed. We do not reduce our recorded liability for potential non-use of purchased gift cards.

 

Comparable Restaurant Sales

 

In calculating comparable restaurant sales, we include a restaurant in the comparable restaurant base after it has been in operation for 15 full months. We remove from the comparable restaurant base for the period any restaurant that is temporarily shut down for remodeling during the period. At fiscal years ended December 27, 2010, December 28, 2009, and December 29, 2008, there were 83, 97, and 99, restaurants in our comparable restaurant base, respectively.

 

Costs and Expenses

 

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

 

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

 

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

 

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

 

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

 

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

 

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Results of Operations

 

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

 

 

 

Fiscal Year

 

 

 

2010

 

2009

 

2008

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

Restaurant net sales

 

97.2

%

98.1

%

97.7

%

Franchise fees and royalties

 

2.8

 

1.9

 

2.3

 

Total revenue

 

100.0

 

100.0

 

100.0

 

Cost and expenses:

 

 

 

 

 

 

 

Cost of food and beverage (1)

 

22.8

 

22.7

 

22.8

 

Restaurant labor and related benefits (1)

 

37.7

 

37.1

 

34.7

 

Occupancy and other restaurant operating expenses (1)

 

31.9

 

31.5

 

30.1

 

 

 

92.4

 

91.3

 

87.6

 

General and administrative expenses

 

12.5

 

12.3

 

14.2

 

Depreciation and amortization

 

4.4

 

5.9

 

6.2

 

Restaurant pre-opening expenses

 

 

 

0.1

 

Provision for losses on asset impairments and disposals

 

0.7

 

1.3

 

5.2

 

Closed store costs

 

0.1

 

 

0.1

 

Lease termination expense

 

0.2

 

0.3

 

0.4

 

Gain on sale of assets

 

(4.7

)

(0.1

)

 

Total costs and expenses

 

102.9

 

109.4

 

111.8

 

Operating loss

 

(2.9

)

(9.4

)

(11.8

)

Loss from continuing operations

 

(2.9

)

(9.4

)

(11.8

)

Discontinued operations:

 

 

 

 

 

 

 

Operating loss from discontinued operations

 

 

 

(0.2

)

Asset imparments of discontinued operations

 

 

 

 

Loss from discontinued operations

 

 

 

(0.2

)

Net loss

 

(2.9

)

(9.4

)

(12.0

)

 


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

 

Fiscal Year 2010 (52 weeks) compared to Fiscal Year 2009 (52 weeks)

 

Restaurant Net Sales

 

 

 

Restaurant Net Sales

 

 

 

(in thousands)

 

as a % of total
 revenues

 

Fiscal 2010

 

$

106,636

 

97.2

%

Fiscal 2009

 

$

116,375

 

98.1

%

 

Restaurant net sales decreased 8.4%, or $9.7 million, in fiscal 2010 as compared to fiscal 2009 due to an approximately $12.4 million decrease in net restaurant sales from the thirteen Company-owned restaurants that were sold to a franchisee in the second quarter of fiscal 2010 and approximately $0.7 million decrease in net sales related to Company-owned restaurants closed during and subsequent to the first quarter of fiscal 2009, partially offset by approximately $2.7 million, or 2.6%, increase in net sales in our comparable restaurant base and approximately $0.7 million in net sales at one new restaurant not yet in its sixteenth month in operation for the full twelve-month period ended December 27, 2010. The 2.6% increase in comparable restaurant net sales was comprised of 1.7% increase in average check price and 0.9% increase in traffic.

 

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Table of Contents

 

Franchise Fees and Royalties

 

 

 

Franchise Fees and Royalties

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

3,063

 

2.8

%

Fiscal 2009

 

$

2,198

 

1.9

%

 

Franchise Fees and Royalties. Franchise fees and royalties increased by approximately $0.9 million, or 39.4%, during fiscal 2010, as compared to fiscal 2009, due primarily to the $0.7 million increase in royalties from the thirteen Company-owned restaurants in Washington, D.C. sold to a franchisee in the second quarter of 2010 as well as due to the $0.2 million increase in franchise fees resulting from a canceled area development agreement.

 

Costs and Expenses

 

 

 

Cost of Food and Beverage

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

24,366

 

22.8

%

Fiscal 2009

 

$

26,429

 

22.7

%

 

Cost of Food and Beverage. During fiscal 2010, cost of food and beverage as a percentage of restaurant net sales was slightly higher compared to fiscal 2009 due primarily to certain new products and limited-time offerings that were introduced in the latter half of 2009 which had higher than average costs as a percentage of sales, partially offset by the favorable impact of the price increase taken at the end of the second quarter of fiscal 2010, as well as savings achieved on purchases of certain commodities.

 

 

 

Restaurant Labor and Related Benefits

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

40,161

 

37.7

%

Fiscal 2009

 

$

43,151

 

37.1

%

 

Restaurant Labor and Related Benefits. The increase in restaurant labor and related benefits as a percentage of restaurant net sales in fiscal 2010, as compared to fiscal 2009, is primarily due to the impact on hourly labor of extended evening and weekend operating hours in certain restaurants as well as the deployment of labor to support the growth of our breakfast day part and catering, partially offset by the leveraging effect of the increase in comparable restaurant sales and the favorable impact on labor of the price increase taken at the end of the second quarter of fiscal 2010.

 

 

 

Occupancy and Other Restaurant
Operating Expenses

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

33,977

 

31.9

%

Fiscal 2009

 

$

36,617

 

31.5

%

 

Occupancy and Other Restaurant Operating Expenses. The increase in occupancy and other restaurant operating expenses, as a percentage of restaurant net sales, during fiscal 2010, as compared to fiscal 2009, is primarily due to higher costs for repairs and maintenance of existing Company-owned restaurants.

 

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Table of Contents

 

 

 

General and Administrative Expenses

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

13,692

 

12.5

%

Fiscal 2009

 

$

14,635

 

12.3

%

 

General and Administrative Expenses. The decrease in general and administrative expenses of approximately $0.9 million during fiscal 2010, as compared to fiscal 2009, was primarily due to labor savings resulting from administrative workforce reductions that occurred during fiscal 2009, higher board fees in the same period of fiscal 2009 associated with the work of the special committee established to review strategic alternatives, as well as lower legal and audit fees, and stock compensation expense, partially offset by higher costs associated with production and advertising media expenses associated with our new marketing initiatives.

 

 

 

Depreciation and Amortization

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

4,773

 

4.4

%

Fiscal 2009

 

$

7,050

 

5.9

%

 

Depreciation and Amortization. The decrease in depreciation and amortization expenses in fiscal 2010, as compared to fiscal 2009, is due primarily to the continued depreciation of our comparable restaurant base, the impact of impairments recorded during and subsequent to fiscal 2009, and the retirement of assets with approximately $3.0 million in book value as a result of the sale of the thirteen Company-owned restaurants in Washington, D.C. to a franchisee during the second quarter of fiscal 2010.

 

 

 

Provision for Losses on Asset
Impairments and Disposals

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

732

 

0.7

%

Fiscal 2009

 

$

1,530

 

1.3

%

 

Provision for Losses on Asset Impairments and Disposals. During fiscal 2010, we recorded an asset impairment charge of approximately $0.6 million related to four underperforming restaurants, three of which were previously impaired, and approximately $0.1 million related to maintenance capital expenditures on previously impaired restaurants. During fiscal 2009, the asset impairment charges related to seven underperforming locations, two of which were located in the Detroit, Michigan market which was significantly impacted by the economic downturn and where it appeared unlikely that the remaining asset values could be recovered over the remaining life of the leases.

 

 

 

Closed Store Costs

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

152

 

0.1

%

Fiscal 2009

 

$

48

 

 

 

Closed Store Costs. The closed store costs during fiscal 2010 relate to two underperforming locations where we negotiated early exit agreements with the landlords and one underperforming

 

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Table of Contents

 

location that closed at the expiration of the operating lease. The closed store costs during fiscal 2009 relate to three underperforming locations where we negotiated early exit agreements and one underperforming location that closed at the expiration of the operating lease.

 

 

 

Lease Termination Expense, net

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

203

 

0.2

%

Fiscal 2009

 

$

322

 

0.3

%

 

Lease Termination Expense, net. The lease termination expenses during fiscal 2010 relate to one restaurant in the Midwest where we reached an early termination agreement with the landlord and one restaurant in the Seattle market where we assigned the lease in fiscal 2008 and reached an agreement with the landlord and the subtenant to terminate it in fiscal 2010. Lease termination expenses during fiscal 2009 relate primarily to an underperforming location in the Midwest where we reached an early exit agreement with the landlord and to charges associated with our exercise of a provision allowing for the contraction of our support center office.

 

 

 

Gain on Sale of Assets

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

5,205

 

4.7

%

Fiscal 2009

 

$

102

 

0.1

%

 

Gain on Sale of Assets. During fiscal 2010, we recognized gain on the sale of assets of approximately $5.2 million due to the sale of the thirteen Company-owned restaurants in Washington, D.C. to a franchisee (see Note 13 to our consolidated financial statements) as well as the sale of two liquor licenses. During fiscal 2009, we recorded a gain related to the sale of four liquor licenses.

 

 

 

Interest Income

 

Interest Expense

 

 

 

(in thousands)

 

as a % of total
revenues

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

1

 

 

$

4

 

 

Fiscal 2009

 

$

3

 

 

$

4

 

 

 

Interest Income and Expense. During fiscals 2010 and 2009, both interest income and interest expense were insignificant.

 

 

 

Other Income

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

14

 

 

Fiscal 2009

 

$

17

 

 

 

Other Income. During fiscals 2010 and 2009, other income was insignificant.

 

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Table of Contents

 

 

 

Net Loss

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2010

 

$

(3,141

)

-2.9

%

Fiscal 2009

 

$

(11,104

)

-9.4

%

 

Net Loss. The decrease in our net loss of approximately $8.0 million in fiscal 2010, as compared to fiscal 2009, is due primarily to the gain on the sale of assets from the thirteen Company-owned restaurants in Washington, D.C. to a franchisee, the lower depreciation and amortization expense, the higher franchise fees and royalties and the reduction in general and administrative expenses.

 

Fiscal Year 2009 (52 weeks) compared to Fiscal Year 2008 (52 weeks)

 

Restaurant Net Sales

 

 

 

Restaurant Net Sales

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

116,375

 

98.1

%

Fiscal 2008

 

$

132,501

 

97.7

%

 

Restaurant net sales decreased 12.2%, or $16.1 million, in fiscal 2009 as compared to fiscal 2008. This decrease was due primarily to a decrease of 10.8%, or $13.8 million, in net sales in our comparable restaurant base and $3.6 million in net sales related to restaurants closed during and subsequent to fiscal 2008 partially offset by $1.3 million in net sales at new restaurants not yet in our comparable restaurant base as of December 28, 2009. For comparable restaurants in fiscal 2009, our transaction count decreased by 8.9% and our average check decreased by 1.9%, as compared to fiscal 2008.

 

Franchise Fees and Royalties

 

 

 

Franchise Fees and Royalties

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

2,198

 

1.9

%

Fiscal 2008

 

$

3,078

 

2.3

%

 

Franchise Fees and Royalties. Franchise fees and royalties during fiscal 2009 consist of $2.1 million in royalties from the franchise restaurants operated during fiscal 2009 and $0.1 million in fees related to the six franchise restaurants that opened during fiscal 2009. Franchise fees and royalties during fiscal 2008 consist of $2.1 million in royalties from franchise restaurants operated during fiscal 2008, $0.5 million in fees related to the 19 franchise restaurants that opened during fiscal 2008 and $0.5 million in franchise fees related to the termination of two area development agreements.

 

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Table of Contents

 

Costs and Expenses

 

 

 

Cost of Food and Beverage

 

 

 

(in thousands)

 

as a % of
restaurant net
sales

 

Fiscal 2009

 

$

26,429

 

22.7

%

Fiscal 2008

 

$

30,235

 

22.8

%

 

Cost of Food and Beverage.  During fiscal 2009, food and beverage costs as a percentage of net sales decreased slightly as compared to fiscal 2008. During fiscal 2009, we had lower year-over-year costs for certain commodities, primarily wheat and dairy products, which were partially offset by higher costs associated with our limited time lobster promotional offering during the fiscal 2009 third quarter as well as the introduction in the latter half of fiscal 2009 of a new premium steak product.

 

 

 

Restaurant Labor and Related
Benefits

 

 

 

(in thousands)

 

as a % of
restaurant net
sales

 

Fiscal 2009

 

$

43,151

 

37.1

%

Fiscal 2008

 

$

46,024

 

34.7

%

 

Restaurant Labor and Related Benefits. The increase in restaurant labor and related benefits as a percentage of restaurant net sales during fiscal 2009, as compared to fiscal 2008, is due to the impact of the decrease in sales in our comparable restaurant base on our fixed manager salaries and hourly labor.

 

 

 

Occupancy and Other Restaurant
Operating Expenses

 

 

 

(in thousands)

 

as a % of
restaurant net
sales

 

Fiscal 2009

 

$

36,617

 

31.5

%

Fiscal 2008

 

$

39,821

 

30.1

%

 

Occupancy and Other Restaurant Operating Expenses. The increase in restaurant occupancy and other restaurant operating expenses as a percentage of restaurant net sales during fiscal 2009, as compared to fiscal 2008, is due primarily to deleveraging the fixed occupancy costs against decreased sales in our comparable restaurant base partially offset by slightly lower costs for repairs and maintenance.

 

 

 

General and Administrative
Expenses

 

 

 

(in thousands)

 

as a % of
total revenues

 

Fiscal 2009

 

$

14,635

 

12.3

%

Fiscal 2008

 

$

19,317

 

14.2

%

 

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Table of Contents

 

General and Administrative Expenses.  The reduction in general and administrative costs of $4.3 million, or 1.6% of total revenues, during fiscal 2009, as compared to fiscal 2008, is due primarily to savings in labor and related benefits resulting from administrative workforce reductions, lower year over year legal costs largely resulting from a litigation settlement recorded in fiscal 2008, and lower third-party professional fees partially offset by higher marketing costs and costs associated with the process of reviewing strategic alternatives.

 

 

 

Depreciation and Amortization

 

 

 

(in thousands)

 

as a % of
total revenues

 

Fiscal 2009

 

$

7,050

 

5.9

%

Fiscal 2008

 

$

8,409

 

6.2

%

 

Depreciation and Amortization. The lower depreciation and amortization costs in fiscal 2009, as compared to fiscal 2008, are due primarily to the impact of impairments recorded during and subsequent to the fourth quarter of fiscal 2008, as well as the continued depreciation and amortization of our comparable restaurant base assets.

 

 

 

Restaurant Pre-opening Expenses

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

13

 

 

Fiscal 2008

 

$

100

 

0.1

%

 

Restaurant Pre-Opening Expenses. Restaurant pre-opening expenses during fiscal 2009 are related to supplies and training costs for one new Company-owned restaurant that opened during the third quarter of fiscal 2009.  During fiscal 2008, restaurant pre-opening expenses were related primarily to occupancy, pre-opening payroll, supplies and training costs for one new restaurant opened during fiscal 2008. During fiscal 2008, 49.5% of restaurant pre-opening expenses were for occupancy costs incurred prior to the opening of the restaurant.

 

 

 

Provision for Losses on Asset
Impairments and Disposals

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

1,530

 

1.3

%

Fiscal 2008

 

$

7,099

 

5.2

%

 

Provision for Losses on Asset Impairments and Disposals.  During fiscal 2009, asset impairment charges relate to seven underperforming locations, of which three were opened during fiscal 2006 and two are located in the Detroit, Michigan market which has been significantly impacted by the economic downturn and where it appears unlikely that the remaining asset values can be recovered over the remaining life of the leases. During 2008, the asset impairment charges of $7.1 million related to 16 underperforming locations, most of which were built in 2005 and the first half of 2006. Nine are located in the Midwest region, five in the Mid-Atlantic region and two in the Northeast region, including four locations closed during the first quarter of fiscal 2009. In addition, during fiscal 2008, we recorded asset impairment charges of approximately $0.1 million related to Seattle locations that are reported in discontinued operations.

 

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Table of Contents

 

 

 

Closed Store Costs

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

48

 

 

Fiscal 2008

 

$

69

 

0.1

%

 

Closed Store Costs. The closed store costs during fiscal 2009 relate to three underperforming locations where we negotiated early exit agreements with the landlords and closed those locations during the first quarter of fiscal 2009, and one underperforming location that closed at the expiration of the operating lease. Closed store costs during fiscal 2008 relate to two underperforming locations that closed at the expiration of their operating leases during the first quarter of fiscal 2008, and to two additional underperforming locations that closed, one each during the second and third quarters of fiscal 2008.

 

 

 

Lease Termination Expense, net

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

322

 

0.3

%

Fiscal 2008

 

$

551

 

0.4

%

 

Lease Termination Expense, net. Lease termination expense during fiscal 2009 relates primarily to an underperforming location in the Midwest where we reached an early exit agreement with the landlord and to charges associated with our exercise of a provision allowing for the contraction of our support center office. Lease termination expense during fiscal 2008 primarily related to a location where we made the decision to not build a restaurant subsequent to entering into a lease and reached an agreement with the landlord to exit the lease, and to three underperforming locations in the Midwest region where we reached exit agreements with the landlords. One of these underperforming locations was closed during the third quarter of fiscal 2008 and the other two were closed during the first quarter of fiscal 2009.

 

 

 

Gain on Sale of Assets

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

102

 

0.1

%

Fiscal 2008

 

 

 

 

Gain on Sale of Assets. During fiscal 2009, we recorded a gain related to the sale of four liquor licenses.

 

 

 

Interest Income

 

Interest Expense

 

 

 

(in thousands)

 

as a % of
total
revenues

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

3

 

 

$

4

 

 

Fiscal 2008

 

$

102

 

 

$

7

 

 

 

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Table of Contents

 

Interest Income and Expense. The decrease in interest income in fiscal 2009, as compared to fiscal 2008, is due to lower average rates of interest earned on deposit accounts. During both fiscal 2009 and fiscal 2008, interest expense was insignificant.

 

 

 

Other Income

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

17

 

 

Fiscal 2008

 

$

41

 

 

 

Other income. During fiscal 2009, other income was not significant. During fiscal 2008, we recorded other income related to a tax refund.

 

 

 

Loss from Continuing Operations

 

 

 

(in thousands)

 

as a % of total
revenues

 

Fiscal 2009

 

$

(11,104

)

(9.4

)%

Fiscal 2008

 

$

(15,910

)

(11.8

)%

 

Loss from Continuing Operations. The decrease in our loss from continuing operations in fiscal 2009, as compared to fiscal 2008, is due primarily to lower non-cash charges for asset impairments and a decrease in general and administrative expenses, offset by a decrease in our restaurant operating margins resulting from lower restaurant net sales and decreased franchise income related to fees.

 

Discontinued Operations. During the first quarter of fiscal 2008, we sold the assets of three underperforming Company-owned locations that operated in the Seattle market to a local restaurant development company. Under the terms of the agreement, we transferred rights to the assets and leasehold improvements for minimal cash consideration and the new owner assumed the tenant obligations under the real estate operating leases and operates those locations under a different brand. We ceased operating these restaurants as of the end of the first quarter of fiscal 2008.

 

Liquidity and Capital Resources

 

Cash and cash equivalents were approximately $10.3 million on December 27, 2010, compared with $4.1 million on December 28, 2009. We had positive working capital of $1.1 million on December 27, 2010, compared with negative working capital of ($5.6) million as of December 28, 2009. The increase in working capital as of December 27, 2010 is primarily due to the $6.4 million cash proceeds from the sale of the thirteen Company-owned restaurants in Washington, D.C. to a franchisee (see Note 13 to our consolidated financial statements), as well as the net proceeds of $4.9 million from our rights offering and related private placement of common stock (see Note 9 to our consolidated financial statements), partially offset by the funding of the operating loss during fiscal 2010. Our principal requirements for cash in 2011 will be for working capital needs and routine maintenance and remodels of our existing restaurants.

 

Net cash used in operating activities during the twelve-month period ended December 27, 2010 was approximately $4.0 million compared with $1.2 million of net cash used in operating activities in the twelve-month period ended December 28, 2009. The increase in cash used in

 

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Table of Contents

 

operating activities during fiscal 2010 was primarily the result of funding a higher year-over-year operating loss, net of gain on sale of restaurants (see Note 13 to our consolidated financial statements) and non-cash components of net loss, as well as the payments of certain lease termination and contractual obligations.

 

Cash provided by investing activities in fiscal 2010 was approximately $5.3 million, compared with cash used in investing activities of approximately $0.7 million during fiscal 2009. The year-over-year increase resulted primarily from the sale of the thirteen Company-owned restaurants in Washington, D.C. to a franchisee (see Note 13 to our consolidated financial statements), partially offset by payments for capital maintenance of our existing Company-owned restaurants.

 

Cash provided by financing activities during fiscal 2010 of approximately $4.9 million was from proceeds associated with the shareholder rights offering and the private placement of shares to our executive officers and outside directors completed in January 2010 (see Note 9 to our consolidated financial statements). Cash provided by financing activities during fiscal 2009 of $0.4 million was from the settlement of a claim, in which we recovered short-swing profits realized by a stockholder of the Company under Section 16(b) of the Securities Exchange Act of 1934.

 

We do not have any current plans to open additional Company-owned restaurants during fiscal 2011. However, we will continue to seek out and evaluate opportunities to develop new Company-owned locations in existing markets. We do expect to incur capital costs associated with remodeling and maintenance of existing Company-owned restaurants during fiscal 2011. As we currently have no credit facility or available line of credit, we expect to fund any required restaurant remodeling and capital maintenance costs on existing Company-owned locations or required capital for new restaurant development, if any, from cash and cash equivalents on hand, expected cash flows generated by existing Company-owned restaurants, and expected franchise fees and royalties.

 

We believe that our current cash and cash equivalents and the expected cash flows from Company-owned restaurant operations and expected franchise fees and royalties will be sufficient to fund our cash requirements for working capital needs and remodeling and maintenance of existing restaurant locations for the next twelve months and for new Company-owned restaurant development, if any. Our conclusion is based on our expected performance for fiscal 2011 and includes a sensitivity analysis that projects varying levels of decline in consumer demand. The range of levels selected was based on our reasonable expectation of demand given the seasonality of our historical performance and the potential impact the current economic environment may have on consumer spending. In analyzing our capital cash outlays during fiscal 2010 and fiscal 2009, 44.7% and 59.1%, respectively, of our capital expenditures were spent on repairs and maintenance associated with existing Company-owned locations.

 

If our Company-owned restaurants do not generate the cash flow levels that we expect, if new franchised restaurants do not open according to our expectations, if we do not generate the franchise fees and royalties that we currently expect, if we incur significant unanticipated cash requirements beyond our normal liquidity needs, or if we experience other unforeseen circumstances then, in order to fund our cash requirements, we may have to cease new Company-owned restaurant development efforts and may have to effect further labor reductions in general and administrative support functions, seek to sell certain Company-owned locations to franchisees and/or other third parties, seek other sources of  financing or take other actions necessitated by the impact of such unanticipated circumstances.

 

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There can be no assurance that we will be able to obtain such financing or sell Company-owned locations to franchisees or other third parties or that we will be able to do so in a timely manner and on acceptable terms to meet our requirements. Given the continued instability in the credit and financial markets, it may be difficult for the Company to obtain additional financing and for franchisees to obtain the financing necessary to open restaurants or to acquire Company-owned locations. An inability to access additional sources of liquidity to fund our cash needs could materially adversely affect our financial condition and results of operations.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

 

Selected Quarterly Financial Data

Quarterly results are determined in accordance with the accounting policies used for annual data and include certain items based upon estimates for the entire year. All quarters in fiscal 2010 and 2009 include results for 13 weeks. The unaudited selected quarterly results for fiscal 2010 and 2009 are shown below:

 

 

 

First
Quarter

 

Second
Quarter

 

Third
Quarter

 

Fourth
Quarter

 

 

 

(dollars in thousands, except share data)

 

Fiscal 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

27,599

 

$

29,622

 

$

27,123

 

$

25,355

 

Total costs and expenses

 

$

30,652

 

$

25,831

 

$

28,229

 

$

28,139

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(3,054

)

$

3,793

 

$

(1,096

)

$

(2,784

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted (loss) income per share:

 

$

(0.06

)

$

0.07

 

$

(0.02

)

$

(0.05

)

 

 

 

 

 

 

 

 

 

 

Fiscal 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenues

 

$

28,666

 

$

31,636

 

$

30,033

 

$

28,238

 

Total costs and expenses

 

$

31,995

 

$

32,610

 

$

32,454

 

$

32,634

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(3,326

)

$

(969

)

$

(2,362

)

$

(4,447

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted loss per share:

 

$

(0.08

)

$

(0.02

)

$

(0.06

)

$

(0.11

)

 

Recent Accounting Pronouncements

 

See Note 1 to our consolidated financial statements included in Part II, Item 7 of this report for further details or new accounting pronouncements not yet adopted.

 

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

 

We caution that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained or incorporated by reference in this Form 10-K and

 

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Annual Report or made by our management involve risks and uncertainties and are subject to change based on various important factors, many of which may be beyond our control. Accordingly, our future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements are subject to risks and uncertainties, including, without limitation, those described in Item 1A of this Report. If any of these risks or uncertainties actually occurs, our business, financial condition or operating results could be materially and adversely affected, and the trading price of our common stock could decline. We do not undertake to publicly update or revise our forward-looking statements even if our future changes make it clear that any projected results expressed or implied therein will not be realized.

 

Listed below are just some of the factors that would impact our forward looking statements:

 

·                  the cost of our principal food products and supply and delivery shortages or interruptions;

 

·                  labor shortages or increased labor costs;

 

·                  changes in demographic trends and consumer tastes and preferences, including changes resulting from concerns over nutritional or safety aspects of beef, poultry, produce or other foods or the effects of food-borne illnesses, such as E.coli, “mad cow disease” and avian influenza or “bird flu;”

 

·                  competition in our markets, both in our existing business and locating suitable restaurant sites;

 

·                  our operation and execution in new and existing markets;

 

·                  expansion into new markets, including foreign countries;

 

·                  our ability to attract and retain qualified franchisees and our frachisees’ ability to open restaurants on a timely basis;

 

·                  our ability to locate suitable restaurant sites in new and existing markets and negotiate acceptable lease terms;

 

·                  the rate of our internal growth, and our ability to generate increased revenue from our new and existing restaurants;

 

·                  our ability to generate positive cash flow from  existing and new restaurants;

 

·                  fluctuations in our quarterly results due to seasonality;

 

·                  increased government regulation and our ability to secure required governmental approvals and permits;

 

·                  our ability to create customer awareness of our restaurants in new markets;

 

·                  the reliability of our customer and market studies;

 

·                  cost effective and timely planning, design and build-out of new restaurants;

 

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·                  our ability to recruit, train and retain qualified corporate and restaurant personnel and management;

 

·                  market saturation due to new restaurant openings;

 

·                  inadequate protection of our intellectual property;

 

·                  our ability to obtain additional capital and financing;

 

·                  adverse weather conditions, which impact customer traffic at our restaurants; and

 

·                  adverse economic conditions.

 

The words “believe,” “may,” “will,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive,” “project” or similar words, or the negatives of these words, identify forward-looking statements. We qualify any forward-looking statements entirely by these cautionary factors.

 

Item 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

Our market risk exposures are related to our cash and cash equivalents and interest that we may pay on debt. We have no derivative financial commodity instruments. We invest our excess cash in investment grade, highly liquid, short-term investments. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flows and results of operations. During fiscal 2010, we held no short-term investments and, as a result, a hypothetical one percentage point interest change from those in effect during fiscal 2010 would not have resulted in a fluctuation of interest income. In fiscals 2010 and 2009, interest income was $0.01 million and $0.03 million, respectively. During fiscals 2010 and 2009, we did not have any significant debt.

 

Foreign Currency Risk

 

As of fiscal 2010, all of our transactions are conducted, and our accounts denominated, in U.S. dollars. Accordingly, we are not exposed to foreign currency risk.

 

Inflation

 

The primary inflationary factors affecting our business are food and labor costs. Some of our food costs are subject to fluctuations in commodity prices. Volatility in the commodity markets such as the wheat and dairy markets can have an adverse impact on our results from operations. Some of our hourly personnel at our restaurants are paid at rates based on the applicable minimum wage, and increases in the minimum wage will directly affect our labor costs. Many of our leases require us to pay taxes, maintenance, repairs, insurance, and utilities, all of which are generally subject to inflationary increases. Historically, inflation has not had a material impact on our results of operation.

 

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Item 8.      FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The following consolidated financial statements are included in this item:

 

 

Page

 

 

Report of BDO USA, LLP, Independent Registered Public Accounting Firm

47

 

 

Consolidated Balance Sheets as of December 27, 2010 and December 28, 2009

48

 

 

Consolidated Statements of Operations for the Fiscal Years Ended December 27, 2010, December 28, 2009 and December 29, 2008

49

 

 

Consolidated Statements of Stockholders’ Equity for the Fiscal Years Ended December 27, 2010, December 28, 2009 and December 29, 2008

50

 

 

Consolidated Statements of Cash Flows for the Fiscal Years Ended December 27, 2010, December 28, 2009 and December 29, 2008

51

 

 

Notes to Consolidated Financial Statements for the Fiscal Years Ended December 27, 2010, December 28, 2009 and December 29, 2008

52

 

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Report of Independent Registered Public Accounting Firm

 

Board of Directors and Stockholders

Cosi, Inc.

Deerfield, Illinois

 

We have audited the accompanying consolidated balance sheets of Cosi, Inc. as of December 27, 2010 and December 28, 2009 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ending December 27, 2010.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cosi, Inc. at December 27, 2010 and December 28, 2009, and the results of its operations and its cash flows for each of the three years in the period ending December 27, 2010, in conformity with accounting principles generally accepted in the United States of America.

 

 

/s/ BDO USA, LLP

 

Chicago, Illinois

 

March 28, 2011

 

 

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Cosi, Inc.

Consolidated Balance Sheets

As of December 27, 2010 and December 28, 2009

(dollars in thousands)

 

 

 

December 27, 2010

 

December 28, 2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

10,307

 

$

4,079

 

Accounts receivable, net

 

697

 

539

 

Notes receivable, current portion

 

506

 

21

 

Inventories

 

744

 

967

 

Prepaid expenses and other current assets

 

1,639

 

2,136

 

Total current assets

 

13,893

 

7,742

 

 

 

 

 

 

 

Furniture and fixtures, equipment and leasehold improvements, net

 

15,009

 

22,100

 

Notes receivable, net of current portion

 

1,195

 

141

 

Other assets

 

1,254

 

1,587

 

Total assets

 

$

31,351

 

$

31,570

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

2,992