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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

For the quarterly period ended September 26, 2011

OR

For the transition period from           to           

Commission File No. 000-50052

COSÌ, INC.

(Exact name of registrant as specified in its charter)

1751 Lake Cook Road

Deerfield, Illinois 60015

(Address of principal executive offices) (Zip Code)

(847) 597-8800

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 shorter period that the registrant was required to submit and post such files).  Yes x  No o

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

Number of shares of Common Stock, $.01 par value, outstanding as of November 8, 2011: 51,849,511

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COSI, INC.

Index to Form 10-Q

For the nine-month period ended September 26, 2011

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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Cosi, Inc.

Consolidated Balance Sheets

As of September 26, 2011 and December 27, 2010

(dollars in thousands)

The accompanying notes are an intergral part of these consolidated financial statements.

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Cosi, Inc.

Consolidated Statements of Operations

For the Three and Nine Month Periods Ended September 26, 2011 and September 27, 2010

(dollars in thousands, except share and per share data)

The accompanying notes are an integral part of these consolidated financial statements.

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Cosi, Inc.

Consolidated Statement of Stockholders’ Equity

For the Nine Months Ended September 26, 2011

(unaudited)

(dollars in thousands, except share data)

The accompanying notes are an integral part of these consolidated financial statements.

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Cosi, Inc.

Consolidated Statements of Cash Flows

For the Nine-Month Periods Ended September 26, 2011 and September 27, 2010

(dollars in thousands)

The accompanying notes are an integral part of these consolidated financial statements.

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COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 — Basis of Presentation

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the requirements of Form 10-Q and, therefore, they do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  In our opinion, the financial statements reflect all adjustments that are necessary for a fair presentation of the results of operations for the periods shown. All such adjustments are of a normal recurring nature. In preparing financial statements in conformity with U.S. GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates.

As used in this quarterly report on Form 10-Q, unless the context requires otherwise, the terms “we,” “our,” “Company” or “Cosi” refer to Cosi, Inc. and its consolidated subsidiaries.

The balance sheet at December 27, 2010 has been derived from audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

The results for the three and nine-month periods ended September 26, 2011 and September 27, 2010 are not indicative of the results for the full fiscal year.

Certain amounts in the September 27, 2010 consolidated statement of cash flows have been reclassified to conform to the September 26, 2011 presentation.

This report should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 27, 2010, as filed with the Securities and Exchange Commission (“SEC”).

There have been no material changes to our significant accounting policies and estimates from the information provided in Note 1 of our consolidated financial statements included in our Form 10-K for the fiscal year ended December 27, 2010.

Note 2 — Stock-Based Compensation Expense

A summary of non-cash, stock-based compensation expense is as follows:

As of September 26, 2011, all compensation expense related to stock options granted under the Company’s various incentive plans have been recognized in full. In addition, as of September 26, 2011, there was approximately $0.2 million of total unrecognized compensation expense related to restricted stock shares granted under the Cosi, Inc. 2005 Omnibus Long-Term Incentive Plan (the “2005 Plan”). The expense related to these grants is being recognized on a straight-line basis from the date of each grant through fiscal 2015.

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COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued

In the nine-month period ended September 26, 2011, pursuant to the 2005 Plan and in accordance with the terms and conditions prescribed by the Compensation Committee of our Board of Directors, we granted and issued 98,000 restricted stock shares and 100,000 restricted stock units to key employees. The vesting of these shares and stock units will occur as follows: (i) 20% of the stock shares and stock units vested on the grant date, and (ii) an additional 20% of the stock shares and stock units will vest on each anniversary of the grant date provided that at each such date the employee continues to be employed by the Company. The value of the shares and the stock units for the grants made in the nine-month period ended September 26, 2011, based on the closing price of our common stock on the date of the grants, was approximately $0.3 million. In the nine-month period ended September 27, 2010, we granted and issued 238,250 restricted stock shares and 200,000 restricted stock units of our authorized but unissued common stock to key employees. The value of the shares and the stock units for the grants made during that period, based on the closing price of our common stock on the date of the grants, was approximately $0.4 million. No restricted shares or stock units were issued during the three months ended September 26, 2011 and September 27, 2010.

In the three-month period ended September 26, 2011, 200,000 shares of previously issued restricted stock units were forfeited. The value of the forfeited stock units, based on the closing price of our common stock on the date of the grants, was approximately $0.2 million. During the third quarter of fiscal 2010, the value of the forfeited restricted shares of common stock was immaterial. During the nine-month periods ended September 26, 2011 and September 27, 2010, 42,000 and 21,950 shares, respectively, of previously issued restricted stock shares were forfeited. The value of the forfeited shares, based on the closing price of our common stock on the date of the grants, was approximately $0.02 million and $0.03 million in the nine-month periods ended September 26, 2011 and September 27, 2010, respectively. The accompanying consolidated statements of operations for the nine-month periods ended September 26, 2011 and September 27, 2010 reflects the reversal of approximately $0.06 million and $0.01 million, in each nine-month period, of previously amortized costs related to forfeited shares and units of common stock.

On September 23, 2011, James Hyatt resigned as the Company’s Chief Executive Officer, President, and Director. As a result of his resignation, Mr. Hyatt forfeited 200,000 shares of previously issued restricted stock units, as noted in the preceding paragraph. The value of these stock units, based on the closing price of our common stock on the date of each of the grants, was approximately $0.2 million. Of the previously amortized stock compensation costs reversed during the third quarter of fiscal 2011, the entire amount of approximately $0.03 million was related to Mr. Hyatt’s forfeitures

In the nine-month periods ended September 26, 2011 and September 27, 2010, we issued 110,620 and 152,440 shares, respectively, of our restricted stock shares to members of the Board of Directors pursuant to the 2005 Plan. These shares had an aggregate value of approximately $0.1 million at the time of issuance in both years and vested upon issuance.

Stock-based compensation expense relating to restricted stock grants of approximately $0.1 million is included in the accompanying consolidated statement of operations for each of the quarters ended September 26, 2011 and September 27, 2010. For the nine-month periods ended September 26, 2011 and September 27, 2010, stock-based compensation expense relating to restricted stock grants is $0.3 million and $0.4 million, respectively.

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COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued

Note 3 — Earnings Per Share

Basic and diluted loss per common share is calculated by dividing the net loss by the weighted-average common shares outstanding during each period. As of September 26, 2011 and September 27, 2010, there were, respectively, 188,800 and 215,050 unvested restricted shares of common stock outstanding and 447,228 and 548,312 out-of-the-money stock options to purchase shares of common stock. There were no in-the-money stock options as of September 26, 2011 and September 27, 2010. The unvested restricted shares of common stock meet the requirements for participating securities but were not included in the computation of basic and diluted earnings per share because we incurred a net loss in all periods presented and, hence, the impact would be anti-dilutive. The outstanding out-of-the-money stock options to purchase shares of common stock at September 26, 2011 and September 27, 2010 do not meet the requirements for participating securities and were not included in the computation of basic and diluted earnings per share.

In the nine months ended September 27, 2010, the effect on basic and diluted earnings per share attributable to the approximately $5.1 million gain from the sale of the thirteen restaurants to a franchisee in the District of Columbia was net income of $0.10 per basic and diluted common share. Excluding this gain from our net loss, we would have realized a net loss per basic common weighted average share outstanding of ($0.11) in the nine months ended September 27, 2010.

Note 4 — Asset Impairments

In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 360 (ASC Topic 360), Property, Plant & Equipment, we evaluate possible impairments 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 period before they enter the comparable restaurant base, unless specific circumstances warrant otherwise.

We did not record any asset impairments in the three months ended September 26, 2011. The impairment charge in the nine months ended September 26, 2011 relates to one underperforming restaurant. In the three months ended September 27, 2010, we recorded an asset impairment charge of approximately $0.1 million related to maintenance capital expenditures for previously impaired restaurants. In the nine months ended September 27, 2010, we recorded an asset impairment charge of approximately $0.3 million related to two underperforming restaurants.

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COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued

Note 5 — Lease Termination Costs

In the nine-month periods ended September 26, 2011 and September 27, 2010, we incurred lease termination costs of approximately $0.02 million, in each of the periods, related to the closing of two restaurants.

Future store closings, if any, may result in additional lease termination charges. The incurrence of additional lease termination costs will be dependent on our ability to improve operations in those restaurants.  If unsuccessful, lease termination costs will be determined through negotiating acceptable terms with our landlords to terminate the leases for those restaurants or on our ability to locate sub-tenants or assignees for the leases at those locations.

Note 6 — Contingencies

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.

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

On August 23, 2011, Cosi, Inc. (the “Company”) received notice from the Listing Qualifications Department of the Nasdaq Stock Market indicating that, for the last 30 consecutive business days, the bid price for the Company’s 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 states that the Company will be afforded 180 calendar days, or until February 21, 2012, to regain compliance with the minimum bid price requirement. In order to regain compliance, shares of the Company’s common stock must maintain a minimum bid closing price of at least $1.00 per share for a minimum of ten consecutive business days. The Company intends to actively monitor the bid price for its common stock between now and February 21, 2012, and will consider all available options to resolve the deficiency and regain compliance with the Nasdaq minimum bid price requirement.

Additionally, on August 24, 2011, the Company received notice from the Listing Qualifications Department of the Nasdaq Stock Market indicating that, for the last 30 consecutive business days, the market value of the Company’s listed securities (“MVLS”) had closed below the minimum $50,000,000 required for continued listing on The Nasdaq Global Market under Nasdaq Listing Rule 5450(b)(2)(A). The notification letter states that the Company will be afforded 180 calendar days, or until February 21, 2012, to regain compliance with the minimum MVLS requirement. In order to regain compliance, the Company must maintain a minimum MVLS of at least $50,000,000 for a minimum of ten consecutive business days. The Company intends to actively monitor its MVLS between now and February 21, 2012, and will consider all available options to resolve the deficiency and regain compliance with the Nasdaq minimum MVLS requirement.

Other Events

On September 23, 2011, James Hyatt resigned as the Company’s Chief Executive Officer, President and Director. The Board of Directors appointed Mark Demilio, the Company’s current Chairman of the Board, as Interim Chief Executive Officer of the Company until a successor for Mr. Hyatt is identified. The Board of Directors has created a search committee to select and appoint a permanent Chief Executive Officer and President.

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COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued

Note 7 — Income Taxes

We have recorded a full valuation allowance to reduce our deferred tax assets related primarily to net operating loss carryforwards. 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 carryforwards, 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.

As of December 27, 2010, we had net operating loss (“NOL”) carryforwards of approximately $193.9 million for U.S. federal income tax purposes. Under the Internal Revenue Code, an “ownership change” with respect to a corporation can significantly limit the amount of pre-ownership change NOLs and certain other tax assets that the corporation may utilize after the ownership change to offset future taxable income, possibly reducing the amount of cash available to the corporation to satisfy its obligations. An ownership change generally would occur if the aggregate stock ownership of holders of at least 5% of our stock increases by more than 50 percentage points over the preceding three year period. We do not believe that the rights offering that we filed during our first quarter of fiscal 2010 has triggered an ownership change. In addition, a limitation would not have an impact on our consolidated financial statements as we have recorded a valuation allowance for the entire amount of our deferred tax assets.

We adopted ASC 740-10, Income Taxes, which prescribes a comprehensive financial statement model of how a company should recognize, measure, present and disclose uncertain tax positions that the company has taken or expects to take in its income tax returns. The standard requires that only income tax benefits that meet the “more likely than not” recognition threshold be recognized or continue to be recognized on the effective date. Initial recognition amounts would have been reported as a cumulative effect of a change in accounting principle.

No adjustment was made to the beginning retained earnings balance in fiscal 2007, 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 carryforwards to offset any taxable income in all subject years. As a result, no liability for uncertain tax positions has been recorded.

Should the Company need to accrue interest or penalties on uncertain tax positions, it would recognize the interest as interest expense and the penalties as a general and administrative expense.

Due to our unexpired NOLs, Cosi could be subject to IRS income tax examination for the tax year 1996 and all subsequent years. We could also be subject to state income tax examinations in certain states where we have unexpired NOLs.

Note 8 — New Accounting Pronouncements

In May 2011, FASB issued Accounting Standards Update (“ASU”) No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”).” This pronouncement was issued to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for level 3 fair value measurements. This pronouncement is effective for reporting periods beginning on or after December 15, 2011. The adoption of ASU 2011-04 is not expected to have a significant impact to the Company’s consolidated financial position or results of operations.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate

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COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued

but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The adoption of ASU 2011-05 is not expected to have a significant impact to the Company’s consolidated financial position or results of operations.

In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment.” ASU 2011-08 simplifies how entities test goodwill for impairment and permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The adoption of ASU 2011-08 did not have a significant impact to the Company’s consolidated financial position or results of operations.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a significant impact on our consolidated financial statements upon adoption.

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Item 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations for the fiscal quarters ended September 26, 2011 and September 27, 2010 should be read in conjunction with “Selected Consolidated Financial Data” and our audited consolidated financial statements and the notes to those statements that are in our 2010 Annual Report on Form 10-K. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions.  Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Cautionary Note Regarding Forward-Looking Statements” below and elsewhere in this Quarterly Report.

OVERVIEW

System-wide restaurants:

As of September 26, 2011, there were 80 Company-owned and 58 franchised premium convenience restaurants operating in 17 states, the District of Columbia, and the United Arab Emirates (“UAE”). During the three months ended September 26, 2011, we closed one Company-owned restaurant in Meadowbrook, Michigan at the end of its operating lease and one franchised restaurant in Florida closed. During the nine months ended September 26, 2011, we closed three Company-owned restaurants, one in Illinois, New York and Michigan. Subsequent to the end of the third quarter of 2011, one franchised restaurant in Normal, IL closed.

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

We are currently eligible to offer franchises in 47 states and the District of Columbia. We offer franchises to area

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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

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

On August 23, 2011, Cosi, Inc. (the “Company”) received notice from the Listing Qualifications Department of the Nasdaq Stock Market indicating that, for the last 30 consecutive business days, the bid price for the Company’s 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 states that the Company will be afforded 180 calendar days, or until February 21, 2012, to regain compliance with the minimum bid price requirement. In order to regain compliance, shares of the Company’s common stock must maintain a minimum bid closing price of at least $1.00 per share for a minimum of ten consecutive business days. The Company intends to actively monitor the bid price for its common stock between now and February 21, 2012, and will consider all available options to resolve the deficiency and regain compliance with the Nasdaq minimum bid price requirement.

Additionally, on August 24, 2011, the Company received notice from the Listing Qualifications Department of the Nasdaq Stock Market indicating that, for the last 30 consecutive business days, the market value of the Company’s listed securities (“MVLS”) had closed below the minimum $50,000,000 required for continued listing on The Nasdaq Global Market under Nasdaq Listing Rule 5450(b)(2)(A). The notification letter states that the Company will be afforded 180 calendar days, or until February 21, 2012, to regain compliance with the minimum MVLS requirement. In order to regain compliance, the Company must maintain a minimum MVLS of at least $50,000,000 for a minimum of ten consecutive business days. The Company intends to actively monitor its MVLS between now and February 21, 2012, and will consider all available options to resolve the deficiency and regain compliance with the Nasdaq minimum MVLS requirement.

Other Events

On September 23, 2011, James Hyatt resigned as the Company’s Chief Executive Officer, President and Director. The Board of Directors appointed Mark Demilio, the Company’s current Chairman of the Board, as Interim Chief Executive Officer of the Company until a successor for Mr. Hyatt is identified. The Board of Directors has created a search committee to select and appoint a permanent Chief Executive Officer and President.

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

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accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of the consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable and generally accepted for companies in the restaurant industry. We believe that the following addresses the more critical accounting policies used in the preparation of our consolidated financial statements and requires management’s most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. There have been no material changes in the application of our most critical accounting policies and estimates, judgments and assumptions during the third quarter of fiscal 2011.

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

Lease Termination Charges: ASC 420-10-30 Exit or Disposal Cost Obligations requires companies to recognize a liability for the costs associated with an exit or disposal activity when the liability is incurred, rather than at the time of a commitment to an exit or disposal plan. For all exit activities, we estimate our likely liability under contractual leases for restaurants that have been closed. Such estimates have affected the amount and timing of charges to operating results and are impacted by management’s judgments about the time it may take to find a suitable subtenant or assignee, or the terms under which a termination of the lease agreement may be negotiated with the landlord.

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

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

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.

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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.

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

COMPARABLE RESTAURANT SALES

In calculating comparable restaurant sales, we include a restaurant in the comparable restaurant base after it has been in operation for 15 full months. We remove from the comparable restaurant base for the period any restaurant that is temporarily shut down for remodeling during that period. As of September 26, 2011 and September 27, 2010, there were 80 and 84 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.

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RESULTS OF OPERATIONS

Our operating results for the three and nine-month periods ended September 26, 2011 and September 27, 2010, expressed as a percentage of total revenues (except where otherwise noted), were as follows:

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

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Restaurant Net Sales

Restaurant net sales.  Restaurant net sales decreased 7.1%, or approximately $1.9 million, in the three months ended September 26, 2011, as compared to the same period of fiscal 2010, due to an approximately $1.1 million decrease in net restaurant sales related to Company-owned restaurants closed during and after the third quarter of fiscal 2010, as well as an approximately $0.8 million, or 3.0%, decrease in net sales in our comparable restaurant base. The decrease in comparable restaurant net sales in the three months ended September 26, 2011 resulted entirely from a decrease in traffic.

In the nine months ended September 26, 2011, restaurant net sales decreased 10.3%, or approximately $8.4 million, as compared to the nine months ended September 27, 2010, due to a decrease of approximately $4.2 million in net restaurant sales from the thirteen Company-owned restaurants sold to a franchisee in the second quarter of fiscal 2010 and a decrease of approximately $4.2 million in net sales related to Company-owned restaurants closed during and subsequent to the first quarter of 2010.

Franchise Fees and Royalties

Franchise fees and royalties. In the three months ended September 26, 2011, franchise fees and royalties increased by approximately $0.1 million, or 11.1%, to approximately $0.9 million, as compared to the three months ended September 27, 2010. The increase is due primarily to the approximately $0.1 million in franchise fees recognized as a result of cancelled area development agreement during the third quarter of fiscal 2011. Franchise fees and royalties in the nine months of fiscals 2011 and 2010 were comparable. The increase of approximately $0.3 million in franchise royalties in the nine months of fiscal 2011 was entirely offset by the approximately $0.3 million higher franchise fees recognized as a result of cancelled area development agreements during the nine months of fiscal 2010.

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Costs and Expenses

Cost of food and beverage. The increase in cost of food and beverage, as a percentage of restaurant net sales, in the three and nine months ended September 26, 2011, as compared to the same periods of fiscal 2010, is due primarily to higher costs on certain commodities, the impact of higher fuel costs on distribution, the impact on total menu mix of an increase in sales of breakfast daypart items which carry a higher cost of goods as a percentage of net sales, as well as the impact of certain one-time vendor rebates received during the third quarter of fiscal 2010. The increase in cost of food and beverage during the nine months ended September 26, 2011 was partially offset by the favorable impact of the price increase taken at the end of the second quarter of fiscal 2010.

Restaurant labor and related benefits. The decrease in restaurant labor and related benefits, as a percentage of restaurant net sales, in the three months ended September 26, 2011, as compared to the same period of fiscal 2010, is due primarily to savings realized from better deployment of labor hours during peak and non-peak hours of operation, as well as savings on certain healthcare-related benefits, partially offset by the deleveraging effect of the decrease in comparable restaurant sales and higher payroll taxes.

The decrease in restaurant labor and related benefits, as a percentage of restaurant net sales in the nine months ended September 26, 2011, as compared to the same period of fiscal 2010, is due primarily to savings realized from better deployment of labor hours during peak and non-peak hours of operation, the favorable impact on labor of the price increase taken at the end of the second quarter of fiscal 2010, and savings on certain healthcare related benefits.

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Occupancy and other restaurant operating expenses. The increase in occupancy and other restaurant operating expenses, as a percentage of restaurant net sales, in the three months ended September 26, 2011, as compared to the same period of fiscal 2010, is due primarily to the deleveraging effect on the fixed portion of occupancy expenses of the decrease in comparable restaurant net sales, as well as higher costs for paper and packaging.

The increase in occupancy and other restaurant operating expenses, as a percentage of restaurant net sales, in the nine months ended September 26, 2011, as compared to the same period of fiscal 2010, is due primarily to the higher fixed occupancy expenses and higher cost for paper and packaging, partially offset by the lower costs for repairs and maintenance of existing Company-owned restaurants.

General and administrative expenses.  The increase in general and administrative expenses of approximately $0.2 million in the three months ended September 26, 2011, as compared to the same period in fiscal 2010, is due primarily to the higher costs associated with advertising media expenses related to our marketing initiatives, as well as higher third-party fees related to legal matters. The decrease in general and administrative expenses of approximately $0.3 million in the nine months ended September 26, 2011, as compared to the same period in fiscal 2010, is due primarily to the lower occupancy costs at our Corporate Headquarters resulting from a reduction of space in late 2010, lower third-party professional fees, labor savings resulting from administrative workforce reductions that occurred during fiscal 2010, and lower business travel-related expenses, partially offset by the higher costs associated with advertising media expenses related to our marketing initiatives.

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