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Cosi 10-K 2009
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Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
 
 
 
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 29, 2008
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
 
 
     
Delaware
  06-1393745
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
 
Telephone Number (847) 597-8800
 
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 þ
 
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 þ
 
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 þ     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 þ
 
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer o
  Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
The aggregate market value of voting stock held by non-affiliates of the registrant was approximately $43,942,783 as of June 30, 2008 based upon the closing price of the registrant’s common stock on the Nasdaq Global Market reported for June 30, 2008. 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.
 
40,661,189 shares of the registrant’s common stock were outstanding on March 10, 2009.
 
 
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 18, 2009. 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 29, 2008.
 


 

 
 
                 
Item
 
Description
  Page
 
PART I
      Business     3  
      Risk Factors     8  
      Unresolved Staff Comments     17  
      Properties     18  
      Legal Proceedings     20  
      Submission of Matters to a Vote of Security Holders     20  
 
      Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities     21  
      Selected Financial Data     24  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     25  
      Quantitative and Qualitative Disclosures about Market Risk     41  
      Financial Statements and Supplementary Data     42  
      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     42  
      Controls and Procedures     42  
      Other Information     43  
 
      Directors, Executive Officers and Corporate Governance     44  
      Executive Compensation     44  
      Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     44  
      Certain Relationships and Related Transactions and Director Independence     44  
      Principal Accounting Fees and Services     44  
 
      Exhibits and Financial Statement Schedules     45  
 EX-23.1
 EX-31.1
 EX-31.2
 EX-32.1


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PART I
 
Item 1.   BUSINESS
 
 
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, Cosi bagels, flatbread pizzas, S’mores and other desserts, and a variety of coffees along with other soft drink beverages, teas and alcoholic beverages. 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 29, 2008, there were 151 Cosi® 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.
 
 
As previously announced, our Board, consistent with its fiduciary duties, has formed a special committee of independent directors to review and evaluate strategic alternatives to enhance shareholder value. The Special Committee has engaged an investment banking firm to act as its financial advisor in connection with this review. The Special Committee is assessing a wide variety of options to improve our business and competitive position, including, but not limited to, opportunities for organizational and operational improvement, a possible merger or sale, acquisition opportunities, third party investment and other strategic alternatives. The Board has not set any specific timeline for the completion of this strategic review, and there is no assurance that, as a result of this review, the Board will decide upon any particular course of action or engage in any specific transaction.
 
 
Our goal is to become a leading national premium convenience restaurant company, and we are focused on knowing our customers and their needs. We believe that our customers are primarily adults aged 18 to 40, upscale suburbanites and metro elites of all ages, and that there are approximately 40 million heads of households in this demographic mix.
 
We plan to become a leading national premium convenience restaurant by:
 
Offering an innovative menu appealing to our target customer.  Our restaurants offer innovative savory, freshly made-to-order products featuring our authentic hearth-baked crackly crust signature Cosi bread and high quality 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.
 
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 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 everyday.


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Expanding marketing initiatives to build brand awareness.  We focus our marketing efforts on building brand awareness and increasing frequency of visits. We do this through the development of a marketing calendar that focuses on five time periods (Winter, Spring, Summer, Fall, and Holiday), improved merchandising to better influence the purchasing behavior of our customers and reduce ordering complexity, developing marketing at the local store level and at grand openings, our CosiCard loyalty program, print advertising, and targeted direct-mail and electronic marketing campaigns.
 
Increasing comparable restaurant sales and average unit volumes.  We seek to increase comparable restaurant sales and average unit volumes by introducing new menu items, expanding our catering sales, increasing sales across all dayparts and running seasonal product promotions. Comparable restaurant sales for our Company-owned restaurants during fiscal 2008 decreased 0.9% compared to fiscal 2007 and increased 0.2% and 0.3% during fiscals 2007 and 2006, respectively, as compared to each prior year period.
 
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 continually seek to refine and improve upon those disciplines.
 
 
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 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; 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. We launched our franchising program in fiscal 2004 and continue to grow our franchise system through the development of new restaurants by new franchisees. We require that our franchisees have experience in multi-unit restaurant operations and development. We believe that our concept, growth 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 as evidenced by our partnership with Aramark for the operation of the Cosi restaurant located at St. Joseph’s University in Philadelphia, PA and the grab-and-go operations inside select Goldman Sachs buildings in New York.
 
 
We offer proprietary food and beverage products for three major dayparts — breakfast, lunch and dinner. Our food menu includes Cosi bagels, sandwiches, salads, soups, appetizers, melts, flatbread pizzas, S’mores and other desserts. We feature our authentic hearth-baked crackly crust 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 and specialty drinks, soft drinks, bottled beverages, which include premium still and sparkling waters, and teas. 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. And for our young guests, we offer a smaller-portion Kids Menu which includes an activity page and crayons. We also offer beer and wine at most of our locations and an additional limited selection of alcoholic beverages in some locations.
 
All 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 call centers in the New York City and Chicago metropolitan areas and our catering orders for these two major metropolitan areas are produced at central catering hubs. We offer set up and delivery by Cosi personnel to all our catering customers.


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We periodically introduce new menu segments and products in order to keep our product offerings relevant to consumers in each daypart. Our expanded breakfast menu now includes hearth-baked quiches, oatmeal, fresh fruit parfaits and a variety of craveable signature breakfast sandwiches. We recently 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 food and beverage team. These recipes are thoroughly evaluated, both internally and through consumer testing input.
 
 
On December 29, 2008, we had 101 Company-owned restaurants and approximately 2,514 employees, of whom approximately 86 served in administrative or executive capacities, 247 served as restaurant management employees and 2,181 were hourly restaurant employees. None of our employees is 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.
 
 
Management Structure.  The restaurant operations team is built around regional centers, led by Regional Vice Presidents, who report to the Chief Executive Officer. Regional Vice Presidents are responsible for all operations, training, recruiting and human resources within their region. Regional Vice Presidents are also responsible for the financial plan for their region and for the people development plan to support the growth in their region. The Vice President of Operations Services and Platforms is responsible for developing infrastructure standards and procedures across the system for the benefit of the entire brand.
 
We recently introduced an Operations Excellence Framework that provides new business assessment tools that our field management teams can 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.
 
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.  Regional Vice Presidents 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 operational alignment with financial planning efforts.


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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.
 
 
We use a select group of service providers to supplement our information technology infrastructure. This provides us access to up-to-date technology and the flexibility to adjust service levels as needed. Our strategy includes utilizing web-based technology to provide timely information to operate the business.
 
The systems are structured for the integration of data from the point-of-sale and back-office modules in the restaurants to our financial and inventory management systems. Key information relating to restaurant operations is uploaded onto a secure website multiple times throughout the day and pre-selected reports are electronically distributed to our operations team.
 
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 resilient facilities for our servers and storage area networks.
 
 
We have relationships with some of the country’s best food, paper, and beverage providers to provide our restaurants with high quality proprietary 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 of 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 transmit the invoice 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. that provides us access to a national network of independent distributors. Under this agreement, which expires in November 2010, the independent distributors supply us with approximately 78% of our food and paper products, primarily under pricing agreements that we negotiate directly with the suppliers.
 
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. Although we are eligible to receive additional amounts under the agreement if certain purchase levels are achieved, no additional amounts have been received or recorded as of December 29, 2008.
 
We purchase all contracted coffee products through a single supplier, Coffee Bean International, Inc. (“Coffee Bean International”), under an agreement that expires in June 2010. In the event of a business interruption, Coffee Bean International is required to utilize the services of a third-party roaster to fulfill its obligations. If the services of a third-party roaster are used, Coffee Bean International will guarantee that the product fulfillment standards stated in our contract will remain in effect throughout such business interruption period. Either party may terminate the agreement by written notice in accordance and subject to the terms of the agreement.
 
Our primary suppliers and independent distributors have parallel facilities and systems to minimize the risk of any disruption of our supply chain.
 
 
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 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 product 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


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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.
 
 
We have the following U.S. Trademark registrations: “Cosi”, “Cosi (& Hearth Design)”, “Così (& Hearth Design (horizontal)”, “Cosi Break Bar”, “CosiCard”, “Cosi Corners”, “Cosi-Dillas”, “Cosi Downtown”, “Cosi Pronto”, “Hearth-Baked Dinners”, “Relax. Catering by Cosi (& Design)” “Simply Good Taste”, “Squagels” and “Xando”.
 
We have U.S. Trademark applications pending for the following trademarks: Sun & Moon Design, and Recycling Design. “Arctic”, “Slim Latte”, and “Cosi Lighter Side” are unregistered trademarks.
 
We have registered the trademark “Cosi” in 18 foreign jurisdictions with respect to goods and services. We also have trademark applications pending for registration for the trademark “Cosi” in the European Community and four other foreign jurisdictions, and we have applications pending for registration for the trademark “Cosi (& Hearth Design)” in five foreign jurisdictions and “Simply Good Taste” in two foreign jurisdictions.
 
 
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.
 
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, citizenship 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 and advertising practices. Casual dining chains have been


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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 nutrition 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.
 
 
Risks Related to Our Growth Strategy
 
 
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 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;
 
  •  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;
 
  •  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 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 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


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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.
 
 
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.
 
 
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 entered into an international license agreement with a licensee for the development of Cosi restaurants in six countries in the Persian Gulf. They currently operate seven 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 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 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.


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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.
 
 
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.
 
 
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.
 
 
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
 
 
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;


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  •  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;
 
  •  consumer trends;
 
  •  the cost of our principal food products and supply and delivery shortages or interruptions;
 
  •  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.
 
 
In fiscal 2008, we incurred net losses of $16.2 million, and, since we were formed, we have incurred net losses of approximately $256.8 million through the end of fiscal 2008 primarily due to funding operating losses which have included significant impairment charges, the cost of our merger in 1999 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.
 
 
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 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.
 
 
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


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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 unable to raise additional capital, our business, results of operations and financial condition could be materially adversely affected.
 
 
Our Board, consistent with its fiduciary duties, has formed a special committee of independent directors to review and evaluate strategic alternatives to enhance shareholder value. The Special Committee has engaged an investment banking firm to act as its financial advisor in connection with this review. The Special Committee is assessing a wide variety of options to improve our business and competitive position, including, but not limited to, opportunities for organizational and operational improvement, a possible merger or sale, acquisition opportunities, third party investment and other strategic alternatives. The Board has not set any specific timeline for the completion of this strategic review, and there is no assurance that as a result of this review, the Board will decide upon any particular course of action or engage in any specific transaction.
 
 
As the recent economic crisis has broadened and intensified, many sectors of the economy have been adversely impacted. As a retailer that depends upon consumer discretionary spending, we could face a challenging fiscal 2009, because our customers may make fewer discretionary purchases as a result of job losses, foreclosures, bankruptcies, reduced access to credit and sharply falling home prices. Many of the effects and consequences of the financial crisis and a broader global economic downturn are currently unknown and any one or all of them 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. Cosi®, as an “affordable luxury,” may be disproportionally affected by a slowdown in the United States economy or an uncertain economic outlook.
 
 
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.
 
 
A franchisee or government agency may bring legal action against us based on the franchisee/franchisor relationships. Various state, federal and, where applicable, foreign 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.
 
 
We receive royalties from our franchisees. Our financial results are therefore somewhat 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.


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We currently operate 69 Company-owned restaurants in Northeastern and Mid-Atlantic states, of which 30 are located in the New York City and Washington, D.C. 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.
 
 
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;
 
  •  introduction of new menu items;
 
  •  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
 
  •  consumer trends.
 
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.
 
If we cannot meet the continued listing requirements of The NASDAQ Stock Market (“NASDAQ”), NASDAQ may delist our common stock, which could have an adverse impact on the liquidity and market price of our common stock.
 
Our common stock is currently listed on NASDAQ. Under NASDAQ rules, a stock can be delisted and not allowed to trade on NASDAQ if the closing bid price of the stock over a 30 consecutive trading-day period is less than $1.00. Since the beginning of the financial markets crisis, we have experienced and continue to experience significant volatility, including substantial decreases, in the price of our common stock. On March 11, 2009, the closing price of our common stock was $0.20 per share. NASDAQ implemented a temporary suspension of the rules requiring a minimum $1.00 closing bid price on October 16, 2008, and later extended the suspension until April 20, 2009. If the suspension is not extended further, there is a risk, in light of the continued depressed state of the economy and credit and capital markets, that our common stock could be delisted from NASDAQ. A delisting of our common stock could negatively impact us by reducing the liquidity and market price of our common stock and the number of investors willing to hold or acquire our common stock, which could negatively impact our ability to raise equity financing.
 
 
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


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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.
 
 
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, citizenship 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 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 nutrition 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 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.
 
 
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.


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As of the end of fiscal 2008, we had $29.8 million in net fixed assets that we have defined as illiquid assets, which includes 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.
 
 
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 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.
 
 
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.
 
 
Computer viruses or terrorism may disrupt our operations and harm 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 way, we would be unable to fulfill critical business functions, which could have a material adverse effect on our business, operating results, and financial condition.


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Risks Relating to the Food Service Industry
 
 
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.
 
 
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 declines in sales during periods of uncertainty like that which followed the September 11, 2001 terrorist attacks on the United States. In addition, economic uncertainty due to military action overseas, such as in Iraq and post-war 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 stores, which could have a material adverse impact on our business, financial condition, and results of operation.
 
 
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.
 
 
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 78% of our food and paper products under an agreement which expires in November 2010. 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 2008. Certain commodities such as wheat and dairy and dairy-related products experienced significant increases in prices during 2008 and these increases could have an adverse effect on us during fiscal 2009 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.


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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.
 
 
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 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.
 
 
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 2008 fiscal year and that remain unresolved.


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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 either the landlord’s real estate taxes or yearly increases in the landlord’s real estate taxes.
 
The following table lists existing Company-owned restaurants, by region, as of December 29, 2008:
 
             
Street Address
 
City
 
Date Opened
 
Format
 
MIDATLANTIC
234 South 15th Street
  Philadelphia, PA   September-96   Cosi
325 Chestnut Street
  Philadelphia, PA   April-97   Cosi
1350 Connecticut Avenue
  Washington, DC   September-97   Cosi
1128 Walnut Street
  Philadelphia, PA   December-97   Cosi
1647 20th Street NW
  Washington, DC   August-98   Cosi
140 South 36th Street
  Philadelphia, PA   August-98   Cosi
761 Lancaster Avenue
  Bryn Mawr, PA   September-98   Cosi
301 Pennsylvania Avenue SE
  Washington, DC   March-99   Cosi
2050 Wilson Boulevard
  Arlington, VA   April-99   Cosi
215 Lombard Street
  Philadelphia, PA   May-99   Cosi
1700 Pennsylvania Avenue
  Washington, DC   August-99   Cosi Downtown
1700 Market Street
  Philadelphia, PA   September-99   Cosi Downtown
700 King Street
  Alexandria, VA   May-00   Cosi
700 11th Street
  Washington, DC   May-00   Cosi
4250 Fairfax Drive
  Arlington, VA   June-00   Cosi
1919 M Street
  Washington, DC   September-00   Cosi
201 South 18th Street
  Philadelphia, PA   October-00   Cosi
1001 Pennsylvania Avenue NW
  Washington, DC   October-00   Cosi Downtown
7251 Woodmont Avenue
  Bethesda, MD   December-00   Cosi
11909 Democracy Drive
  Reston, VA   May-01   Cosi
4074 The Strand West
  Columbus, OH   October-01   Cosi
1501 K Street NW
  Washington, DC   December-01   Cosi Downtown
1875 K Street
  Washington, DC   July-02   Cosi Downtown
6390 Sawmill Road
  Columbus, OH   September-02   Cosi
601 Pennsylvania Ave. NW
  Washington, DC   September-02   Cosi
1275 K Street
  Washington, DC   September-02   Cosi
2212 East Main Street
  Bexley, OH   September-02   Cosi
1478 Bethel Road
  Columbus, OH   November-02   Cosi
295 Main Street
  Exton, PA   November-02   Cosi
7166 N. High Street
  Worthington, OH   December-02   Cosi
5252 Wisconsin Ave, NW
  Washington, DC   December-02   Cosi
177 Kentlands Blvd
  Gaithersburg, MD   January-03   Cosi
1333 H Street, NW
  Washington DC   January-03   Cosi Downtown
1310 Polaris Parkway
  Columbus, OH   February-03   Cosi
1801 N. Lynn Street
  Arlington, VA   November-05   Cosi
4025 Welsh Road
  Willow Grove, PA   December-05   Cosi
50 Yorktown Plaza
  Elkins Park, PA   April-06   Cosi


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Street Address
 
City
 
Date Opened
 
Format
 
833 Chestnut
  Philadelphia, PA   June-06   Cosi
9177 Reisterstown Road
  Owing Mills, MD   June-06   Cosi
424 West Swedesford Road
  Berwyn, PA   June-06   Cosi
100 South Charles
  Baltimore, MD   July-06   Cosi
513 West Broad Street
  Falls Church, VA   October-06   Cosi
3503 Fairfax Drive, Suite 200
  Arlington, VA   November-06   Cosi
201 N. Washington #290
  Rockville, MD   March-07   Cosi
2955 Market St. 
  Philadelphia, PA   July-07   Cosi
2011 Crystal Drive Suite 100-B
  Arlington, VA   May-08   Cosi
 
MIDWEST
116 S. Michigan Avenue
  Chicago, IL   September-00   Cosi
55 E. Grand Street
  Chicago, IL   October-00   Cosi
230 W. Washington Street
  Chicago, IL   November-00   Cosi Downtown
203 North LaSalle Street
  Chicago, IL   May-01   Cosi Downtown
301 South State Street
  Ann Arbor, MI   May-01   Cosi
1101 Lake Street
  Oak Park, IL   June-01   Cosi
101 North Old Woodward Avenue
  Birmingham, MI   August-01   Cosi
25 E. Hinsdale
  Hinsdale, IL   December-01   Cosi
8775 N. Port Washington Road
  Fox Point, WI   December-01   Cosi
230 West Monroe Street
  Chicago, IL   May-02   Cosi Downtown
301 East Grand River Avenue
  East Lansing, MI   May-02   Cosi
84 W. Adams Road
  Rochester Hills, MI   September-02   Cosi
28674 Telegraph Road
  Southfield, MI   November-02   Cosi
37652 Twelve Mile Road
  Farmington Hills, MI   December-02   Cosi
15131 LaGrange Road
  Orland Park, IL   December-02   Cosi
233 North Michigan Avenue
  Chicago, IL   December-02   Cosi Downtown
33 N Dearborn
  Chicago, IL   June-05   Cosi Downtown
1740 Sherman Avenue
  Evanston, IL   September-05   Cosi
1825 2nd Street
  Highland Park, IL   December-05   Cosi
18 West 066 22nd Street
  Oak Brook Terrace, IL   August-06   Cosi
2200 North Clark
  Chicago, IL   August-06   Cosi
8310 Greenway Boulevard, #106
  Middleton, WI   September-06   Cosi
250 State Street
  Madison, WI   September-06   Cosi
910 North Milwaukee Avenue, Suite A
  Lincolnshire, IL   November-06   Cosi
220 South Washington Street
  Naperville, IL   December-06   Cosi
21720 W. Long Grove Rd.
  Deer Park, IL   March-07   Cosi
 
NORTHEAST
257 Park Avenue South
  New York, NY   February-97   Cosi
38 East 45th Street
  New York, NY   February-97   Cosi Downtown
11 West 42nd Street
  New York, NY   June-97   Cosi Downtown
60 East 56th Street
  New York, NY   September-97   Cosi Downtown
3 World Financial Center
  New York, NY   January-98   Cosi Downtown
55 Broad Street
  New York, NY   March-98   Cosi Downtown
1633 Broadway
  New York, NY   July-98   Cosi Downtown
61 West 48th Street
  New York, NY   August-98   Cosi Downtown
685 Third Avenue
  New York, NY   June-99   Cosi Downtown
970 Farmington Avenue
  W. Hartford, CT   August-99   Cosi

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Street Address
 
City
 
Date Opened
 
Format
 
461 Park Avenue South
  New York, NY   January-00   Cosi
50 Purchase Street
  Rye, NY   March-00   Cosi
841 Broadway
  New York, NY   September-00   Cosi
15 S. Moger Avenue
  Mt. Kisco, NY   December-00   Cosi
77 Quaker Ridge Road
  New Rochelle, NY   November-01   Cosi
1298 Boston Post Road
  Larchmont, NY   December-01   Cosi
471 Mount Pleasant Road
  Livingston, NJ   September-02   Cosi
29 Washington Street
  Morristown, NJ   December-02   Cosi
385 West Main Street
  Avon, CT   December-02   Cosi
498 7th Avenue
  New York, NY   December-02   Cosi
700 6th Avenue
  New York, NY   February-03   Cosi
980 Boston Post Road
  Darien, CT   October-05   Cosi
129 West Putnam Avenue
  Greenwich, CT   February-06   Cosi
441 South Oyster Bay Road
  Plainview, NY   June-06   Cosi
1209 High Ridge Road
  Stamford, CT   July-06   Cosi
44 Great Neck Road
  Great Neck, NY   July-06   Cosi
53 E. 8th St. 
  New York, NY   April-07   Cosi
2186 Broadway
  New York, NY   June-07   Cosi
230 Tresser Blvd. Ste 005
  Stamford, CT   November-07   Cosi
 
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.
 
On January 4, 2005, one of our former officers filed a complaint in the Superior Court in the Judicial District of Stamford/Norwalk in Stamford in the State of Connecticut, alleging claims against us relating to the vesting and valuation of, and entitlement to, employee stock options. On February 25, 2009, we entered into a court-approved agreement to settle the case. Under the settlement, we agreed to pay the plaintiff a total of $1.3 million in installments. We made an initial cash payment of $0.3 million during the first quarter of fiscal 2009, and the balance will be paid in 36 non-interest bearing monthly installments, secured by certain of our physical assets located in the State of Connecticut and 239,543 shares of our treasury stock. The amount of the settlement will be reduced by up to $0.2 million if we exercise certain prepayment rights under the settlement. In connection with the settlement, we dismissed our appeal of the judgment that we had previously filed. Although we believe we had valid defenses and had vigorously defended this case, we determined that settling the litigation was in the best interests of us and our stockholders.
 
Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this annual report.

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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 $0.20 on March 11, 2009.
 
 
Set forth below are the high and low closing sale prices for shares of our common stock for each quarter during fiscal 2008 and 2007 as reported by Nasdaq.
 
                                 
    Fiscal 2008     Fiscal 2007  
Fiscal Quarter:
  High     Low     High     Low  
 
First Quarter
  $ 3.14     $ 1.81     $ 6.67     $ 5.10  
Second Quarter
  $ 3.15     $ 2.23     $ 5.74     $ 4.47  
Third Quarter
  $ 2.85     $ 1.57     $ 5.02     $ 3.24  
Fourth Quarter
  $ 1.97     $ 0.18     $ 3.89     $ 2.10  
 
 
The number of our common stockholders of record as of February 25, 2009 was 90. This number excludes stockholders whose stock is held in nominee or street name by brokers.
 
 
We have never paid cash dividends on our common stock, and we do not currently intend to pay any dividends.


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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 Così’s initial public offering on November 22, 2002, through the end of Così’s 2008 fiscal year on December 29, 2008. The Company’s common stock trades on NASDAQ 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.
 
Cummulative Total Return
 
(PERFORMANCE GRAPH)
 
                                                                                 
      22-Nov-02     31-Dec-02     31-Dec-03     31-Dec-04     30-Dec-05     29-Dec-06     31-Dec-07     29-Dec-08
COSI
      100         73         37         80         109         67         29         3  
NASDAQ
      100         91         136         148         150         164         181         103  
S&P
      100         100         100         111         118         135         133         85  
                                                                                 
 
Recent Sales of Unregistered Securities
 
We sold the following unregistered securities in reliance upon the exemption from registration provided pursuant to section 4(2) of the Securities Act of 1933, as amended.
 
(a)   Exercises of Warrants
 
On September 26, 2008, we sold 130 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method, a net of 129 shares were issued and one share was surrendered.
 
On October 2, 2008, we sold 1,299 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants.
 
On October 2, 2008, we sold 1,299 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method, a net of 1,291 shares were issued and eight shares were surrendered.


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On October 7, 2008, we sold 118 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method, a net of 117 shares were issued and one share was surrendered.
 
On October 7, 2008, we sold 327 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method, a net of 324 shares were issued and three shares were surrendered.
 
On October 9, 2008, we sold 649 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the next exercise method, a net of 644 shares were issued and five shares were surrendered.
 
On October 13, 2008, we sold 649 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method, a net of 645 shares were issued and four shares were surrendered.
 
On October 14, 2008, we sold 3,246 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method, a net of 3,227 shares were issued and 19 shares were surrendered.
 
On October 14, 2008, we sold 649 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method , a net of 645 shares were issued and four shares were surrendered.
 
On October 14, 2008, we sold 649 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants. Using the net exercise method, a net of 645 shares were issued and four shares were surrendered.
 
On December 29, 2008, we sold 2,597 shares of our common stock to a shareholder for nominal consideration pursuant to the exercise of warrants.


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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 2008, 2007 and 2006 and selected balance sheet data for fiscal 2008 and 2007 are derived from our audited consolidated financial statements that are 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  
    2008     2007     2006     2005     2004  
    (In thousands, except per share data)  
 
Consolidated Statement of Operations Data:
                                       
Revenues:
                                       
Restaurant net sales
  $ 132,501     $ 132,414     $ 122,849     $ 114,036     $ 110,040  
Franchise fees and royalties
    3,078       2,142       849       101        
                                         
Total revenues
    135,579       134,556       123,698       114,137       110,040  
Costs and expenses:
                                       
Cost of food and beverage
    30,235       30,972       28,170       27,104       27,820  
Restaurant labor and related benefits
    45,375       45,995       40,782       37,264       38,428  
Occupancy and other restaurant operating expenses
    39,821       38,369       32,045       27,726       27,720  
                                         
      115,431       115,336       100,997       92,094       93,968  
General and administrative expenses
    19,966       22,973       26,887       24,265       24,573 (1)
Depreciation and amortization
    8,409       8,823       7,196       6,516       6,874  
Restaurant pre-opening expenses
    100       710       1,451       824       64  
Provision for losses on asset impairments and disposals
    7,099       3,845       249       675       1,406  
Closed store costs
    69       262                    
Lease termination expenses (benefit), net
    551       347       (232 )     (179 )     (589 )
Gain on sale of assets
          (23 )     (482 )     (1,432 )      
                                         
Total costs and expenses
    151,625       152,273       136,066       122,763       126,296  
                                         
Operating loss
    (16,046 )     (17,717 )     (12,368 )     (8,626 )     (16,256 )
                                         
Other income (expense):
                                       
Interest income
    102       524       1,411       802       159  
Interest expense
    (7 )     (42 )     (9 )     (34 )     (62 )
Allowance for notes receivable from stockholders
                      (261 )     (1,266 )
Other income (expense)
    41       705       77       104       (103 )
                                         
Total other income (expense)
    136       1,187       1,479       611       (1,272 )
                                         
Loss from continuing operations
    (15,910 )     (16,530 )     (10,889 )     (8,015 )     (17,528 )
                                         
Discontinued operations:
                                       
Operating loss from discontinued operations
    (224 )     (903 )     (1,183 )     (1,906 )     (504 )
Asset impairments of discontinued operations
    (88 )     (3,350 )     (256 )     (3,205 )     (341 )
                                         
Loss from discontinued operations
    (312 )     (4,253 )     (1,439 )     (5,111 )     (845 )
                                         
Net loss
  $ (16,222 )   $ (20,783 )   $ (12,328 )   $ (13,126 )   $ (18,373 )
                                         
Per share data:
                                       
Loss per share — basic and diluted
                                       
Continuing operations
  $ (0.40 )   $ (0.42 )   $ (0.28 )   $ (0.23 )   $ (0.59 )
Discontinued operatons
  $     $ (0.11 )   $ (0.04 )   $ (0.15 )   $ (0.03 )
                                         
Net loss
  $ (0.40 )   $ (0.53 )   $ (0.32 )   $ (0.38 )   $ (0.62 )
                                         
Weighted average shares used in computing net loss per share — basic and diluted
    40,079       39,332       38,207       34,929       29,432  
                                         
 
 
(1) Includes $1.0 million in expense related to the relocation of our corporate office from New York to Deerfield, IL.
 


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    Fiscal Year  
    2008     2007     2006     2005     2004  
    (In thousands)  
 
Selected Consolidated Balance Sheet Data:
                                       
Cash and cash equivalents
  $ 5,589     $ 6,309     $ 938     $ 1,952     $ 1,090  
Investments
  $     $     $ 18,962     $ 32,918     $ 9,962  
Total assets
  $ 42,781     $ 56,412     $ 75,757     $ 76,544     $ 51,138  
Total stockholders’ equity
  $ 19,026     $ 33,846     $ 50,631     $ 56,208     $ 29,152  
Selected Consolidated Statement of Cash Flow Data:
                                       
Cash flow provided by (used in) operating activities
  $ 2,044     $ (2,369 )   $ 3,949     $ 4,249     $ (9,631 )
Cash flow (used in) provided by investing activities
  $ (2,817 )   $ 5,727     $ (6,674 )   $ (31,536 )   $ (17,268 )
Cash flow provided by financing activities
  $ 53     $ 2,013     $ 1,711     $ 36,648     $ 20,032  
Selected Operating Data:
                                       
Company-owned restaurants open at the end of the fiscal year
    101       107       110       96       92  
 
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 29, 2008, December 31, 2007 and January 1, 2007 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  
    2008     2007     2006  
    Company-
                Company-
                Company-
             
    Owned     Franchise     Total     Owned     Franchise     Total     Owned     Franchise     Total  
 
Restaurants at beginning of period
    107 c     34       141       110 b     13       123       96 a     5       101  
New restaurants opened
    1       19       20       6       22       28       21       8       29  
Restaurants permanently closed
    7       3       10       9       1       10       7             7  
                                                                         
Restaurants at end of period
    101       50       151       107 c     34       141       110 b     13       123  
                                                                         
 
 
a - Includes six locations that are classified as discontinued operations.
 
b - Includes nine locations that are classified as discontinued operations.
 
c - Includes three locations that are classified as discontinued operations.
 
There are currently 98 Company-owned and 48 franchise premium convenience restaurants operating in 18 states, the District of Columbia, and the United Arab Emirates (UAE), of which one franchised restaurant opened subsequent to fiscal 2008 in the UAE. In addition, we closed three Company-owned and three franchise restaurants

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subsequent to fiscal 2008, of which two were in the Chicago area, two were in Pennsylvania, and two were in New Jersey. One additional Company-owned restaurant in the Chicago area is scheduled to close during the first quarter of fiscal 2009.
 
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, Cosi® bagels, 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. 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 operate our Company-owned restaurants in two formats: Cosi® and Cosi Downtown®. Cosi Downtown® restaurants, which are located in nonresidential central business districts, close for the day in the early evening, while Cosi® restaurants offer dinner and dessert in a casual dining atmosphere.
 
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.
 
During fiscal 2008, we opened one and permanently closed seven Company-owned restaurants, of which three were underperforming locations, one location where the lease expired and we were unable to negotiate acceptable renewal terms, and three locations in Seattle, Washington where we exited the market and sold the assets at those locations to a local restaurant development company that is operating them under a different brand.
 
 
As previously announced, our Board, consistent with its fiduciary duties, has formed a special committee of independent directors to review and evaluate strategic alternatives to enhance shareholder value. The Special Committee has engaged an investment banking firm to act as its financial advisor in connection with this review. The Special Committee is assessing a wide variety of options to improve our business and competitive position, including, but not limited to, opportunities for organizational and operational improvement, a possible merger or sale, acquisition opportunities, third party investment and other strategic alternatives. The Board has not set any specific timeline for the completion of this strategic review, and there is no assurance that as a result of this review, the Board will decide upon any particular course of action or engage in any specific transaction.
 
 
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires the appropriate application of certain accounting policies, many of which require us to make estimates 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 require


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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.
 
Long Lived Assets:  Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long Lived Assets, requires management judgments regarding the future operating and disposition plans for marginally performing assets, and estimates of expected realizable values for assets to be sold. Actual results may differ from those estimates. The application of SFAS 144 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 whenever we determine impairment factors are present and at least annually. We consider a consistent 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.
 
Lease Termination Charges:  SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, requires companies to recognize costs associated with exit or disposal activities when they are incurred, rather than at the date of a commitment to an exit or disposal plan. 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.
 
Stock-Based Compensation Expense:  We recognize stock-based compensation expense according to the fair value recognition provision of SFAS 123R, Share-Based Payment, 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. Stock-based compensation expense that we recognized for all fiscal years reported reflect the adoption of SFAS 123R.
 
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, calculated in accordance with SFAS 123R were determined using the Black-Scholes option-pricing model with the following weighted average assumptions:
 
         
Expected dividend yield
    0 %
Expected stock price volatility
    68 %
Average risk-free interest rate
    3.79 %
Average expected life of options
    5 years  
Weighted average grant date fair value
  $ 3.89  
 
We estimate forfeitures in calculating the expense relating to stock-based compensation. Pre-vesting forfeiture rates are estimated based on historical data. The expected volatility is based on an average of the historical volatility of the Company’s stock, the implied volatility of market options, peer company volatility, and other factors. The average expected life represents the period of time that stock option grants are expected to be outstanding and is derived from historical terms and other factors. The risk-free interest rate is based on the rate of U.S. Treasury zero-coupon issues with remaining term equal to the expected life of stock option grants.
 
Accounting for Lease Obligations:  In accordance with Financial Accounting Standards Board (“FASB”) Technical Bulletin No. 85-3, Accounting for Operating Leases with Scheduled Rent Increases, 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 construction periods and other rent holidays in our straight-line rent expense calculation.
 
Landlord Allowances:  In accordance with FASB Technical Bulletin No. 88-1, Issues Relating to Accounting for 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.


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Income Taxes:  We have recorded a full valuation allowance to reduce our deferred tax assets related 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-forward 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 FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”) as of January 2, 2007. FIN 48 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. FIN 48 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 be reported as a cumulative effect of a change in accounting principle.
 
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.
 
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.
 
 
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.
 
 
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 any restaurant that is temporarily shut down for remodeling for a complete period in the period that it is shut down. At fiscal years ended December 29, 2008, December 31, 2007, and January 1, 2007 there were 99, 95, and 81 restaurants in our comparable restaurant base, respectively.
 
 
Cost of Food and Beverage.  Cost of food and beverage is composed of food and beverage costs. Food and beverage costs are variable and increase with sales volume.
 
Restaurant Labor and Related Benefits.  The costs of restaurant labor and related benefits include direct hourly and management wages, bonuses, payroll taxes, health insurance and all other fringe benefits.


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Occupancy and Other Restaurant Operating Expenses.  Occupancy and other restaurant operating expenses include direct restaurant level operating expenses, including the cost of paper and packaging, supplies, restaurant 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, which are expensed as incurred, include the costs of recruiting, hiring and training the initial restaurant work force, travel, the cost of food and labor used during the period before opening, the cost of initial quantities of supplies and other direct costs related to the opening 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 percent of total revenues, except where otherwise noted, for the periods indicated:
 
                         
    Fiscal Year  
    2008     2007     2006  
 
Revenues:
                       
Restaurant net sales
    97.7 %     98.4 %     99.3 %
Franchise fees and royalties
    2.3       1.6       0.7  
                         
Total revenues
    100.0       100.0       100.0  
                         
Cost and expenses:
                       
Cost of food and beverage(1)
    22.8       23.4       22.9  
Restaurant labor and related benefits(1)
    34.2       34.7       33.2  
Occupancy and other restaurant operating expenses(1)
    30.1       29.0       26.1  
                         
      87.1       87.1       82.2  
General and administrative expenses:
    14.7       17.1       21.7  
Depreciation and amortization
    6.2       6.6       5.8  
Restaurant pre-opening expenses
    0.1       0.5       1.2  
Provision for losses on asset impairments and disposals
    5.2       2.9       0.2  
Closed store costs
    0.1       0.2        
Lease termination expense (benefit), net
    0.4       0.3       (0.2 )
Gain on sale of assets
                (0.4 )
                         
Total costs and expenses
    111.8       113.2       110.0  
                         
Operating loss
    (11.8 )     (13.2 )     (10.0 )
Other income (expense):
                       
Interest income
          0.4       1.1  
Other income
          0.5       0.1  
                         
Loss from continuing operations
    (11.8 )     (12.3 )     (8.8 )
Discontinued operations:
                       
Operating loss from discontinued operations
    (0.2 )     (0.7 )     (1.0 )
Asset imparments of discontinued operations
          (2.4 )     (0.20 )
                         
Loss from discontinued operations
    (0.2 )     (3.1 )     (1.2 )
                         
Net loss
    (12.0 )     (15.4 )     (10.0 )
                         
 
 
(1) These are expressed as a pecentage of restaurant net sales versus all other items expressed as a percentage of total revenues.
 
Fiscal Year 2008 (52 weeks) compared to Fiscal Year 2007 (52 weeks)
 
 
                 
    Restaurant Net Sales  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 132,501       97.7 %
Fiscal 2007
  $ 132,414       98.4 %


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Restaurant net sales increased 0.1%, or $0.1 million, in fiscal 2008 as compared to fiscal 2007. This increase was due primarily to $3.0 million in net sales at new restaurants not yet in the comparable restaurant base as of December 29, 2008, and $0.9 million in net sales related to restaurants temporarily closed for remodeling during fiscal 2007, almost fully offset by the decline of $2.7 million in net sales related to restaurants closed during and subsequent to fiscal 2007, and the decrease of 0.9% or approximately $1.1 million in net sales in our comparable restaurant base. For comparable restaurants in fiscal 2008, our average check increased 1.7% and our transaction count decreased by 2.6%, as compared to fiscal 2007.
 
 
                 
    Franchise Fees and Royalties  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 3,078       2.3 %
Fiscal 2007
  $ 2,142       1.6 %
 
Franchise fees and royalties during fiscal 2008 consist of $2.1 million in royalties from the franchise restaurants operated during fiscal 2008 and $1.0 million in fees related to the 19 franchise restaurants that opened during fiscal 2008, including $0.03 million in fees earned under the international licensing agreement for the locations in the UAE and also $0.5 million in franchise fees related to the termination of two area developer agreements. Franchise fees and royalties during fiscal 2007 consist of $1.3 million in royalties from franchise restaurants operated during fiscal 2007 and $0.8 million in fees related to the 22 franchise restaurants that opened during fiscal 2007, including $0.09 million related to the licensing fees earned under the international licensing agreement for the locations in the UAE.
 
 
                 
    Cost of Food and Beverage  
          As a % of
 
    (In Thousands)     Restaurant Net Sales  
 
Fiscal 2008
  $ 30,235       22.8 %
Fiscal 2007
  $ 30,972       23.4 %
 
Cost of Food and Beverage.  The decrease in food and beverage costs as a percentage of net sales during fiscal 2008, as compared to fiscal 2007, is due primarily to menu price increases taken during fiscal 2008 which averaged 2.1% for the year and lower costs associated with promotional menu offerings, partially offset by year-over-year price increases on commodities such as wheat and dairy and dairy related products, as well as higher fuel costs.
 
                 
    Restaurant Labor and Related Benefits  
          as a % of
 
    (In thousands)     restaurant net sales  
 
Fiscal 2008
  $ 45,375       34.2 %
Fiscal 2007
  $ 45,995       34.7 %
 
Restaurant Labor and Related Benefits.  The decrease in restaurant labor and related benefits as a percentage of restaurant net sales during fiscal 2008, as compared to fiscal 2007, is due primarily to our continued efforts to drive more effective labor management during both peak and non-peak hours of operation and lower costs for workers’ compensation insurance.
 
                 
    Occupancy and Other Restaurant Operating Expenses  
          As a % of
 
    (In Thousands)     Restaurant Net Sales  
 
Fiscal 2008
  $ 39,821       30.1 %
Fiscal 2007
  $ 38,369       29.0 %


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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 2008, as compared to fiscal 2007, is due primarily to higher utility costs, the deleveraging of occupancy costs against relatively flat sales in our comparable restaurant base, and slightly higher costs for repairs and maintenance.
 
                 
    General and Administrative Costs  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 19,966       14.7 %
Fiscal 2007
  $ 22,973       17.1 %
 
General and administrative costs.  The reduction in general and administrative costs of $3.0 million during fiscal 2008, as compared to fiscal 2007, is due to labor savings from administrative workforce reductions, lower stock-based compensation costs, lower recruiting costs resulting from our search to select and appoint a permanent Chief Executive Officer during 2007 and lower corporate travel costs, offset by severance costs related to the workforce reductions. In addition, during fiscal 2008, we booked approximately $2.0 million in charges related to legal settlements.
 
                 
    Depreciation and Amortization  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 8,409       6.2 %
Fiscal 2007
  $ 8,823       6.6 %
 
Depreciation and Amortization.  The lower depreciation and amortization costs in fiscal 2008, as compared to fiscal 2007, are due primarily to the impact of impairments recorded during and subsequent to the fourth quarter of fiscal 2007, as well as the continued depreciation and amortization of our comparable restaurant base, partially offset by higher depreciation and amortization costs related to one new restaurant opened during fiscal 2008.
 
                 
    Restaurant Pre-Opening Expenses  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 100       0.1 %
Fiscal 2007
  $ 710       0.5 %
 
Restaurant Pre-Opening Expenses.  Restaurant pre-opening expenses were $0.1 million during fiscal 2008, due 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. Restaurant pre-opening expenses were $0.7 million in fiscal 2007, due primarily to occupancy, pre-opening payroll, supplies and training costs for six new restaurants opened during fiscal 2007. During fiscal 2007, 54.8% of restaurant pre-opening expenses were for occupancy costs incurred prior to the opening of the restaurants.
 
                 
    Provision for Losses on Asset Impairments and Disposals  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 7,099       5.2 %
Fiscal 2007
  $ 3,845       2.9 %
 
Provision for Losses on Asset Impairments and Disposals.  During 2008 we recorded 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, determined to be impaired, of which nine are in the Midwest region, five are in the Mid-Atlantic region and two are in the Northeast region, including four locations that have been closed or are scheduled to close during the first quarter of fiscal 2009. During fiscal 2008, we recorded asset impairment charges of approximately $0.1 million related to the Seattle locations, which are reported in discontinued operations. The asset impairment charges of $3.8 million recorded in fiscal 2007 are attributable to seven underperforming locations determined to be impaired including one location that was closed during the third quarter of fiscal 2008. In addition, during fiscal 2007, we


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recorded impairment charges of $3.4 million related to six Macy’s and three Seattle locations, which are reported in discontinued operations.
 
                 
    Closed Store Costs  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 69       0.1 %
Fiscal 2007
  $ 262       0.2 %
 
Closed Store Costs.  Closed store costs during fiscal 2008 are related to two underperforming locations that closed during the first quarter of fiscal 2008 at the expiration of their operating leases and two additional underperforming locations that closed, one each during the second and third quarters of fiscal 2008. Closed store costs during fiscal 2007 are related to one restaurant in New York City that closed at the lease expiration and was relocated within the immediate area during the second quarter of fiscal 2007, one underperforming location where the lease expired and we exited the location, and one underperforming location where the lease was scheduled to expire in fiscal 2008 and we negotiated an early exit agreement with the landlord.
 
                 
    Lease Termination Expense  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 551       0.4 %
Fiscal 2007
  $ 347       0.3 %
 
Lease Termination Expense.  Lease termination expense during fiscal 2008 is 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. The lease termination expense during fiscal 2007 relates to a location where, due to the enforcement of restrictions in a zoning overlay district, Cosi was denied the necessary permits to build a restaurant and we exercised the exit provision under the lease, and to an underperforming restaurant in Chicago where we exercised an early exit provision of the lease and exited the location in the first quarter of fiscal 2008.
 
                 
    Gain on Sale of Assets  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
           
Fiscal 2007
  $ 23        
 
Gain on Sale of Assets.  The gain recognized during fiscal 2007 is related to the sale of a liquor license.
 
                                 
    Interest Income     Interest Expense  
          As a % of
          As a % of
 
    (In Thousands)     Total Revenues     (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 102           $ 7        
Fiscal 2007
  $ 524       0.4 %   $ 42        
 
Interest Income and Expense.  The decrease in interest income in fiscal 2008, as compared to fiscal 2007, is due primarily to lower average rates of interest earned on deposit accounts as well as a decline in short-term investments during fiscal 2008. During both fiscal 2008 and fiscal 2007, interest expense was insignificant.
 
                 
    Other Income  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ 41        
Fiscal 2007
  $ 705       0.5 %


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Other income.  During fiscal 2008, we recorded other income related to a tax refund. Other income during fiscal 2007 is due primarily to a cash settlement on an insurance claim related to a location that we operated in The World Trade Center on September 11, 2001.
 
                 
    Loss from Continuing Operations  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2008
  $ (15,910 )     (11.8 )%
Fiscal 2007
  $ (16,530 )     (12.3 %)
 
Loss from Continuing Operations.  The decrease in our loss from continuing operations in fiscal 2008, as compared to fiscal 2007, is due primarily to a decrease in general and administrative expenses and higher income from franchise fees and royalties, offset by higher non-cash charges for asset impairments and higher lease termination costs.
 
Discontinued Operations.  During the third quarter of fiscal 2007, the Company reached an agreement with Macy’s Inc. (“Macy’s”) relating to six Cosi® restaurants operated within Macy’s stores. Under the terms of the agreement, we ceased operations and closed those locations on August 19, 2007.
 
In addition, we sold the assets of three underperforming Company-owned locations that operated in the state of Washington 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 is operating those locations under a different brand. We ceased operating these restaurants as of the end of the first quarter of fiscal 2008.
 
In accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Macy’s and Seattle locations qualify as discontinued operations, and accordingly we have reported the results of operations of this group in discontinued operations in the accompanying consolidated financial statements for all periods presented. During fiscals 2008 and 2007, the operating loss from discontinued operations was $0.2 million and $0.9 million, respectively.
 
In addition, we recorded charges of $0.1 million and $3.4 million during fiscals 2008 and 2007, respectively, related to the impairment of the assets at the Seattle and Macy’s locations, which are also reported in discontinued operations in the accompanying consolidated financial statements.
 
Fiscal Year 2007 (52 weeks) compared to Fiscal Year 2006 (52 weeks)
 
 
                 
    Restaurant Net Sales  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 132,414       98.4 %
Fiscal 2006
  $ 122,849       99.3 %
 
Restaurant net sales increased 7.8% in fiscal 2007 as compared to fiscal 2006. This increase was due primarily to $12.7 million in net sales at new restaurants not yet in the comparable restaurant base, as of December 31, 2007, and a 0.2%, or $0.3 million, increase in comparable restaurant net sales, partially offset by a decrease of approximately $1.8 million in net sales associated with two Company-owned restaurants sold to franchisees during the fourth quarter of fiscal 2006, the decline of $1.2 million in net sales related to restaurants closed subsequent to fiscal 2006, and a decline of $0.4 million in net sales related to restaurants temporarily closed for remodeling during fiscals 2006 and 2007. For comparable restaurants in fiscal 2007, our average check increased 3.4% and our transaction count decreased by 3.1%, compared to fiscal 2006.


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Table of Contents

 
                 
    Franchise Fees and Royalties  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 2,142       1.6 %
Fiscal 2006
  $ 849       0.7 %
 
Franchise fees and royalties during fiscal 2007 consist of $1.3 million in royalties from franchise restaurants operated during fiscal 2007 and $0.8 million in fees related to the 22 franchise restaurants that opened during fiscal 2007, including $0.09 million related to the licensing fees earned under the international licensing agreement for the locations in the UAE. Franchise fees and royalties during fiscal 2006 consisted of $0.4 million in royalties from franchise restaurants operated during fiscal 2006 and $0.4 million in fees related to the eight franchise restaurants that opened during fiscal 2006, including fees related to the conversion of two Company-owned restaurants to franchise restaurants during fiscal 2006, one each in Connecticut and New Jersey, and three Boston restaurants converted to franchise restaurants at the end of fiscal 2005.
 
 
                 
    Cost of Food and Beverage  
          As a % of
 
    (In Thousands)     Restaurant Net Sales  
 
Fiscal 2007
  $ 30,972       23.4 %
Fiscal 2006
  $ 28,170       22.9 %
 
Cost of Food and Beverage.  The increase in food and beverage costs as a percentage of restaurant net sales is due primarily to year over year increased pricing pressure on certain commodities, like wheat, dairy and dairy related products, as well as the impact of an unfavorable shift in beverage sales mix, and higher promotional discounts compared to fiscal 2006.
 
                 
    Restaurant Labor and Related Benefits  
          As a % of
 
    (In Thousands)     Restaurant Net Sales  
 
Fiscal 2007
  $ 45,995       34.7 %
Fiscal 2006
  $ 40,782       33.2 %
 
Restaurant Labor and Related Benefits.  The increase in restaurant labor and related benefits as a percentage of restaurant net sales during fiscal 2007 is due primarily to higher labor costs as a percentage of restaurant net sales in new restaurants opened since the second quarter of fiscal 2006 that have not yet reached maximum sales or operating efficiency and a slight deleveraging of labor costs against a relatively flat sales performance at comparable locations during fiscal 2007 as compared to fiscal 2006.
 
                 
    Occupancy and Other Restaurant Operating Expenses  
          As a % of
 
    (In Thousands)     Restaurant Net Sales  
 
Fiscal 2007
  $ 38,369       29.0 %
Fiscal 2006
  $ 32,045       26.1 %


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Table of Contents

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 2007 is due primarily to the impact of fixed occupancy costs against sales at new restaurants that have not yet reached expected sales levels, higher costs for repairs and maintenance, the impact of relatively flat sales performance at comparable locations on occupancy costs, and slightly higher costs for paper and packaging.
 
                 
    General and Administrative Costs  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 22,973       17.1 %
Fiscal 2006
  $ 26,887       21.7 %
 
General and Administrative Costs.  The reduction in general and administrative costs during fiscal 2007 as compared to fiscal 2006 is due to lower costs associated with litigation, lower stock-based compensation costs, labor savings, including the impact of an administrative workforce reduction during the third quarter of fiscal 2007, and lower professional and consulting fees partially offset by higher recruiting costs primarily related to the search to select and appoint a new Chief Executive Officer.
 
                 
    Depreciation and Amortization  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 8,823       6.6 %
Fiscal 2006
  $ 7,196       5.8 %
 
Depreciation and Amortization.  The higher depreciation and amortization costs in 2007 as compared to 2006 are due primarily to the opening of new Company-owned restaurants during and subsequent to fiscal 2006. The increase in depreciation and amortization expense was partially offset by the impact of impairments recorded during fiscal 2006 and the second quarter of fiscal 2007 as well as the continued depreciation and amortization of our comparable restaurant base.
 
                 
    Restaurant Pre-Opening Expenses  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 710       0.5 %
Fiscal 2006
  $ 1,451       1.2 %
 
Restaurant Pre-opening Expenses.  Restaurant pre-opening expenses were $0.7 million during fiscal 2007, due primarily to occupancy, pre-opening payroll, supplies and training costs for six new restaurants opened during fiscal 2007. During fiscal 2007, 54.8% of restaurant pre-opening expenses were for occupancy costs incurred prior to the opening of the restaurants. Restaurant pre-opening expenses were $1.5 million in fiscal 2006, due primarily to pre-opening payroll, supplies and training costs for 21 new restaurants opened during fiscal 2006 and one new restaurant that opened in the first quarter of fiscal 2007. During fiscal 2006, 42% of restaurant pre-opening expenses were for occupancy costs incurred prior to the opening of the restaurants.
 
                 
    Provision for Losses on Asset Impairments and Disposals  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 3,845       2.9 %
Fiscal 2006
  $ 249       0.2 %


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Provision for Losses on Asset Impairments and Disposals.  The asset impairment charges of $3.8 million recorded in fiscal 2007 are related to seven underperforming locations that we have determined to be impaired, of which one is in the Mid-Atlantic region and three each are in the Northeast and Midwest regions. In addition, during fiscal 2007, we recorded impairment charges of $3.4 million related to Macy’s and Seattle locations, which are reported in discontinued operations. During fiscal 2006, we recorded asset disposal charges of approximately $0.2 million.
 
                 
    Closed Store Costs  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 262       0.2 %
Fiscal 2006
           
 
Closed Store Costs.  Closed store costs during fiscal 2007 are related to one restaurant in New York City that closed at the lease expiration and was relocated within the immediate area during the second quarter of fiscal 2007, one underperforming location where the lease expired and we exited the location, as well as one underperforming location where the lease was scheduled to expire in fiscal 2008 and where we negotiated an early exit agreement with the landlord. We did not have any closed store costs during fiscal 2006.
 
                 
    Lease Termination Expense (Benefit)  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 347       0.3 %
Fiscal 2006
  $ (232 )     (0.2 )%
 
Lease Termination Expense (Benefits), net.  The lease termination expense during fiscal 2007 relates to a location where, due to the enforcement of restrictions in a zoning overlay district, we were denied the necessary permits to build a restaurant and we exercised the exit provision under the lease, and to an underperforming restaurant in Chicago where we exercised an early exit provision of the lease and exited the location in the first quarter of fiscal 2008. During fiscal 2006, we recognized lease termination income due primarily to the reversal of accruals deemed no longer necessary.
 
                 
    Gain on Sale of Assets  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 23        
Fiscal 2006
  $ 482       (0.4 )%
 
Gain on Sale of Assets.  The gain recognized during fiscal 2007 is related to the sale of a liquor license. The gain recognized during fiscal 2006 was related to the sale of a Company-owned restaurant in New Jersey sold to a franchise area developer during the fourth quarter of fiscal 2006.
 
                                 
    Interest Income     Interest Expense  
          As a % of
          As a % of
 
    (In Thousands)     Total Revenues     (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 524       0.4 %   $ 42        
Fiscal 2006
  $ 1,411       1.1 %   $ 9        
 
Interest Income and Expense.  The decrease in interest income during fiscal 2007 as compared to fiscal 2006 is due primarily to lower average levels of short-term investments during fiscal 2007. During both fiscal 2007 and fiscal 2006, interest expense was insignificant.
 
                 
    Other Income  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ 705       0.5 %
Fiscal 2006
  $ 77       0.1 %


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Other Income.  Other income during fiscal 2007 is due primarily to the cash settlement on an insurance claim related to a location that we operated in The World Trade Center on September 11, 2001. In fiscal 2006, other income was due primarily to the receipt of payment on an insurance claim related to the two stores impacted by Hurricane Wilma.
 
                 
    Loss from Continuing Operations  
          As a % of
 
    (In Thousands)     Total Revenues  
 
Fiscal 2007
  $ (16,530 )     (12.3 )%
Fiscal 2006
  $ (10,889 )     (8.8 )%
 
Loss from Continuing Operations.  The increase in our loss from continuing operations during fiscal 2007, as compared to fiscal 2006, is due primarily to a decrease in restaurant operating margins driven mainly by operating inefficiencies at restaurants opened since the second quarter of fiscal 2006, higher food and labor costs, non-cash charges for asset impairments, higher depreciation and amortization costs, higher lease termination charges, and higher closed store costs.
 
Discontinued Operations.  During the third quarter of fiscal 2007, the Company reached an agreement with Macy’s Inc. (“Macy’s”) relating to six Cosi® restaurants operated within Macy’s stores. Under the terms of the agreement, we ceased operations and closed those locations on August 19, 2007.
 
In addition, we sold the assets of three underperforming Company-owned locations that operated in the state of Washington to a local restaurant development company. Under the terms of the agreement, Cosi 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 is operating those locations under a different brand. We ceased operating these restaurants as of the end of the first quarter of fiscal 2008.
 
In accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Macy’s and Seattle locations qualify as discontinued operations, and accordingly we have reported the results of operations of this group in discontinued operations in the accompanying consolidated financial statements for all periods presented. During fiscals 2007 and 2006, the operating loss from discontinued operations was $0.9 million and $1.2 million, respectively.
 
We recorded a charge of $3.4 million during fiscal 2007 related to the impairment of the assets at the Seattle and Macy’s locations, which is also reported in discontinued operations in the accompanying consolidated financial statements.
 
 
Cash and cash equivalents were approximately $5.6 million on December 29, 2008, compared with $6.3 million on December 31, 2007. We had negative working capital of ($2.8) million on December 29, 2008, compared with negative working capital of ($0.7) million as of December 31, 2007. The decrease in working capital was primarily a function of deploying capital to build a new Company-owned restaurant, maintaining existing Company-owned restaurants, and funding the operating loss for the period. Our principal requirements for cash in 2009 will be for working capital needs and routine maintenance of our existing restaurants.
 
Net cash provided by operating activities during the twelve-month period ended December 29, 2008, was approximately $2.0 million compared to $2.4 million of net cash used in operating activities in the twelve-month period ended December 31, 2007. The increase in cash provided by operating activities during fiscal 2008 was the result of a lower year-over-year operating loss, the reduction of receivables from landlords and a shift in the timing of payments of certain accrued expenses.
 
Total cash used in investing activities was $2.8 million during fiscal 2008, compared to cash provided by investing activities of $5.7 million fiscal 2007. The year-over-year decrease was due primarily to the decline in net redemptions of short-term investments, partially offset by lower capital expenditures in fiscal 2008 as compared to fiscal 2007. During fiscal 2007, we had net redemptions of short term investments of $19.0 million compared to none during fiscal 2008 as we held no short-term investments.


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Total capital expenditures during fiscal 2008 were approximately $2.9 million, compared to expenditures of $14.3 million during fiscal 2007. Capital expenditures during fiscal 2008 were primarily for the construction of a new restaurant and maintenance of existing restaurants. Capital expenditures during fiscal 2007 were primarily associated with the construction of nine new Company-owned restaurants that opened during and subsequent to the fourth quarter of fiscal 2006, including one restaurant that opened during the fourth quarter of fiscal 2007 and remodel and maintenance costs associated with existing Company-owned locations.
 
Cash provided by financing activities of approximately $0.05 million and $2.0 million during fiscals 2008 and 2007, respectively, was primarily from proceeds associated with the exercise of stock options.
 
We opened one new Company-owned restaurant during fiscal 2008 and currently do not expect to open any additional Company-owned restaurants in fiscal 2009. We estimate the cost to open a Company-owned restaurant is approximately $800,000, net of landlord contributions and including pre-opening expenses. We do not expect to incur any significant remodeling capital costs during fiscal 2009. However, we do expect to incur capital maintenance costs on existing Company-owned restaurants. As we currently have no credit facility or available line of credit, we expect to fund any required capital maintenance costs on existing Company-owned locations 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 expected cash flows from Company-owned restaurant operations and franchise fees and royalties will be sufficient to fund our cash requirements for working capital needs and maintenance in existing restaurant locations for the next twelve months. Our conclusion is based on expected performance for 2009 and included a sensitivity analysis that projected varying levels of decline in consumer demand in 2009. 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 2008, 42.0% of our capital cash outlay was spent on construction of new Company-owned restaurants and another 46.1% of our cash outlay was spent on maintenance costs associated with existing Company-owned locations. Due to having spent significant capital over the last three years to remodel and refresh existing locations as well as a number of the locations having only been opened within the last three years, we currently do not anticipate significant levels of cash outlays for capital expenditures during fiscal 2009. However, if our existing and new Company-owned restaurants do not generate the cash flow levels that we expect, if new franchised restaurants do not open according to our expectations, or if we do not generate the franchise fees and royalties that we currently expect, then we may have to initiate further labor reductions in general and administrative support functions, seek to sell certain Company-owned locations to franchisees or other third parties or seek other sources of debt or equity financing.
 
In such circumstances, there could be no assurance that we would be able to obtain such debt or equity financing or sell Company-owned locations to franchisees. If the prevailing instability in the credit and financial markets continues, it may be more difficult for the Company to obtain additional financing and for franchisees to obtain 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.
 
 
We have entered into agreements that create contractual obligations. These obligations will have an impact on future liquidity and capital resources. The table below presents a summary of these obligations as of December 29, 2008.
 
                                         
    Payments Due by Period  
                Due
    Due
    Due
 
    Total
    Due
    Fiscal 2010
    Fiscal 2012
    After
 
Description
  Obligations     Fiscal 2009     to Fiscal 2011     to Fiscal 2013     Fiscal 2013  
    (In thousands)  
 
Long-term debt(1)(2)
  $ 1,400     $ 600     $ 717     $ 83     $  
Operating leases(3)
    76,591       15,337       27,092       18,046       16,116  
                                         
Total contractual cash obligations
  $ 77,991     $ 15,937     $ 27,809     $ 18,129     $ 16,116  
                                         


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(1) Amounts shown include a $0.1 million obligation including aggregate scheduled interest payments of $0.2 million related to a settlement for a trademark dispute. The principal amount of the debt, net of interest obligations, is included in the other long-term liabilities in the attached consolidated balance sheets.
 
(2) Amounts shown include $1.3 million for a legal settlement related to a claim from a former employee. The installment payments for this settlement are non-interest bearing. The amount of this settlement is included in other long-term liabilities in the attached consolidated balance sheets.
 
(3) Amounts shown are net of an aggregate $0.2 million of sublease rental income due under non-cancelable subleases and include accrued contractual lease increases of an aggregate $4.6 million, which are included in other long-term liabilities in the attached consolidated balance sheets.
 
 
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.
 
 
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 2008 and 2007 include results for 13 weeks. The unaudited selected quarterly results for fiscal 2008 and 2007 are shown below:
 
                                 
    First
    Second
    Third
    Fourth
 
    Quarter     Quarter     Quarter     Quarter  
    (Dollars in thousands, except share data)  
 
Fiscal 2008
                               
Total revenues
  $ 33,191     $ 36,723     $ 34,930     $ 30,735  
Total costs and expenses
  $ 35,979     $ 38,447     $ 38,078     $ 39,121  
                                 
Net loss
  $ (3,028 )   $ (1,729 )   $ (3,095 )   $ (8,370 )
                                 
Basic and diluted loss per share:
  $ (0.08 )   $ (0.04 )   $ (0.08 )   $ (0.21 )
                                 
Fiscal 2007
                               
Total revenues
  $ 31,121     $ 35,448     $ 34,837     $ 33,150  
Total costs and expenses
  $ 35,198     $ 39,624     $ 38,511     $ 38,940  
                                 
Net loss
  $ (4,205 )   $ (7,401 )   $ (3,002 )   $ (6,175 )
                                 
Basic and diluted loss per share:
  $ (0.11 )   $ (0.19 )   $ (0.08 )   $ (0.16 )
                                 
 
 
See Note 1 to the Consolidated Financial Statements included in Part II, Item 8 of this report for further details of new accounting pronouncements not yet adopted.
 
 
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 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


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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 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;
 
  •  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;
 
  •  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
 
 
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


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results of operations. During fiscal 2008 we held no short-term investments and, as a result, a hypothetical one percentage point interest change from those in effect during fiscal 2008 would not have resulted in a fluctuation of interest income. In fiscals 2008 and 2007, interest income was $0.1 million and $0.5 million, respectively.
 
 
As of fiscal 2008, all of our transactions are conducted, and our accounts denominated, in U.S. dollars. Accordingly, we are not exposed to foreign currency risk.
 
 
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.
 
Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The consolidated financial statements required to be filed hereunder are set forth on pages 51 through 74 of this Report.
 
Item 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None.
 
Item 9A.   CONTROLS AND PROCEDURES
 
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the fiscal year covered by this report. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective (i) to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) to ensure that information required to be disclosed by us in the reports that we submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.
 
 
We are responsible for the preparation and integrity of the consolidated financial statements appearing in this our Annual Report on Form 10-K. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States and include amounts based on management’s estimates and judgments. All other financial information in this report has been presented on a basis consistent with the information included in the financial statements.
 
We are also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). We maintain a system of internal controls that is designed to provide reasonable assurance as to the fair and reliable preparation and presentation of the consolidated financial statements, as well as to safeguard assets from unauthorized use or disposition.


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Our control environment is the foundation for our system of internal control over financial reporting and is embodied in our Corporate Governance Policy. It sets the tone of our organization and includes factors such as integrity and ethical values. Our internal control over financial reporting is supported by formal policies and procedures which are reviewed, modified and improved as changes occur in business conditions and operations.
 
The Audit Committee of the Board of Directors, on behalf of the shareholders, oversees management’s financial reporting responsibilities. The Audit Committee, which is composed solely of independent outside directors, meets periodically with the independent auditors, management and our Director of Internal Audit to review matters relating to financial reporting, internal accounting controls and auditing. The independent registered public accountants, the Director of Internal Audit and our Chief Compliance Officer advise the committee of any significant matters resulting from their audits or reviews and have free access to the committee without management being present. The Chief Compliance Officer, the independent registered public accountants and the Director of Internal Audit have free and full access to senior management and the Audit Committee at any time.
 
We assessed the effectiveness of the Company’s system of internal control over financial reporting as of December 29, 2008. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. We have concluded that, as of December 29, 2008, the Company’s system of internal control over financial reporting was effective.
 
Our system of internal control over financial reporting as of December 29, 2008, has been audited by BDO Seidman, LLP, the independent registered public accounting firm who also audited our consolidated financial statements. BDO Seidman, LLP’s attestation report on our system of internal control over financial reporting is included herein.
 
 
There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended December 29, 2008, to which this report relates, that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.
 
Item 9B.   OTHER INFORMATION
 
None.


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Item 10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
The information required by this Item will be set forth in our definitive proxy statement for our Annual Meeting of Stockholders expected to be held on May 18, 2009 (the “Proxy Statement”) and is incorporated herein by reference.
 
Item 11.   EXECUTIVE COMPENSATION
 
The information required by this Item will be set forth in the Proxy Statement and is incorporated herein by reference.
 
Item 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
The information required by this Item will be set forth in the Proxy Statement and is incorporated herein by reference.
 
Item 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
The information required by this Item will be set forth in the Proxy Statement and is incorporated herein by reference.
 
Item 14.   PRINCIPAL ACCOUNTING FEES AND SERVICES
 
The information required by this Item will be set forth in the Proxy Statement and is incorporated herein by reference.


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Item 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
(a) The following documents are filed as part of this Report:
 
1. The Financial Statements required to be filed hereunder are listed in the Index to Financial Statements on page 48 of this Report
 
(b) Exhibits
 
         
Exhibit
   
Number
 
Description of Exhibit
 
  2 .1   Merger Agreement by and among Xando, Incorporated, Xando Merger Corp. and Cosi Sandwich Bar, Inc. dated as of October 4, 1999 (Filed as Exhibit 2.1 to the Company’s Registration Statement on Form S-1, file #333-86390).
  3 .1   Amended and Restated Certificate of Incorporation of Cosi, Inc. (Filed as Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the period ended December 30, 2002).
  3 .2   Amended and Restated By-Laws of Cosi, Inc. (Filed as Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 1, 2007).
  4 .1   Form of Certificate of Common Stock (Filed as Exhibit 4.1 to the Company’s Registration Statement on Form S-1, file #333-86390).
  4 .2   Rights Agreement between Cosi, Inc. and American Stock Transfer and Trust Company as Rights Agent dated November 21, 2002 (Filed as Exhibit 4.2 to the Company’s Annual Report on Form 10-K for the period ended December 30, 2002).
  4 .3   Amended and Restated Registration Agreement, dated as of March 30, 1999 (Filed as Exhibit 4.3 to the Company’s Registration Statement on Form S-1, file #333-86390).
  4 .4   Supplemental Registration Rights Agreement, dated as of August 5, 2003 by and among the Company and the parties thereto (Filed as Exhibit 4.4.2 to the Company’s Registration Statement on Form S-1, file #333-107689).
  4 .5   Amendment No. 1 to Rights Agreement dated as of November 21, 2002, between Cosi, Inc. and American Stock Transfer and Trust Company, as rights agent (Filed as Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2003).
  4 .6   Investment Agreement, dated as of August 5, 2003, among the Company, Eric J. Gleacher, Charles G. Phillips, LJCB Nominees Pty Ltd, and ZAM Holdings, L.P. (Filed as Exhibit 4.9 to the Company’s Registration Statement on Form S-1/A, file #333-107689).
  4 .7   Letter Agreement, dated as of August 5, 2003, among the Company, Eric J. Gleacher, Charles G. Phillips, LJCB Nominees Pty Ltd, and ZAM Holdings, L.P. (Filed as Exhibit 4.10 to the Company’s Registration Statement on Form S-1/A, file #333-107689).
  10 .1   Cosi, Inc. 2005 Omnibus Long-Term Incentive Plan (Filed as Exhibit C to the Company’s Proxy Statement on Schedule 14A filed on March 31, 2005, file #000-50052).
  10 .2   Cosi Employee Stock Purchase Plan (Filed as Exhibit 10.2 to the Company’s Registration Statement on Form S-1, file #333-86390).
  10 .3   Cosi Non-Employee Director Stock Incentive Plan (Filed as Exhibit 10.3 to the Company’s Registration Statement on Form S-1, file #333-86390).
  10 .4   Cosi Sandwich Bar, Inc. Incentive Stock Option Plan (Filed as Exhibit 10.4 to the Company’s Registration Statement on Form S-1, file #333-86390).
  10 .5.3   Employment agreement between Cosi, Inc. and Kevin Armstrong, dated May 9, 2005 (Filed as Exhibit 10.5.11 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 4, 2005).
  10 .5.4   Separation and Release Agreement between Cosi, Inc. and Cynthia Jamison, dated August 17, 2005 (Filed as Exhibit 10.1 to the Company’s Current report on Form 8-K, dated August 23, 2005).
  10 .5.5   Employment Agreement between Cosi, Inc. and William D. Forrest, dated December 12, 2005 (Filed as Exhibit 10.1 to the Company’s Current report on Form 8-K, dated December 16, 2005).


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Exhibit
   
Number
 
Description of Exhibit
 
  10 .5.6   Terms of Employment between Cosi, Inc. and William E. Koziel, effective as of August 17, 2005 as described in the Company’s Current Report on Form 8-K (Filed on August 23, 2005).
  10 .5.7   Terms of Employment between Cosi, Inc. and Christopher Carroll, effective as of May 22, 2006 as described in the Company’s Current Report of Form 8-K (Filed on May 25, 2006).
  10 .5.8   Terms of Employment between Cosi, Inc. and Christopher Ames, effective as of November 13, 2006 as described in the Company’s Current Report on Form 8-K (Filed on November 17, 2006).
  10 .5.9   Terms of Employment between Cosi, Inc. and Robert Merritt, effective as of March 12, 2007 as described in the Company’s Current Report on Form 8-K (Filed on March 12, 2007).
  10 .5.10   General separation and release agreement by and between the Company and Patrick Donnellan, dated August 8, 2007 (Filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 1, 2007).
  10 .5.11   Employment agreement, dated as of September 15, 2007 by and between the Company and James F. Hyatt (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated September 18, 2007).
  10 .5.12   General separation and release agreement by and between the Company and Gilbert Melott, dated October 17, 2007 (Filed as Exhibit 10.2 to the company’s Quarterly Report on Form 10-Q for the fiscal quarter ended October 1, 2007).
  10 .5.13   General Separation and Release Agreement by and between the Company and Christopher Ames, dated August 26, 2008 (Filed as Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 29, 2008).
  10 .5.14   General Separation and Release Agreement by and between the Company and Christopher Carroll, dated August 26, 2008 (Filed as Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 29, 2008).
  10 .5.15   Form of Indemnification Agreement, dated as of December 19, 2008 by and between the Directors and Officers of the Company (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated December 18, 2008).
  10 .5.16   Change in Control Severance Agreement, dated as of December 18, 2008 by and between William Koziel and the Company (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated December 18, 2008).
  10 .5.17   Change in Control Severance Agreement, dated as of December 18, 2008 by and between Vicki Baue and the Company (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated December 18, 2008).
  10 .5.18   Change in Control Severance Agreement, dated as of December 18, 2008 by and between Paul Bower and the Company (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated December 18, 2008).
  10 .5.19   Change in Control Severance Agreement, dated as of December 18, 2008 by and between Becky Iliff and the Company (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K, dated December 18, 2008).
  10 .5.20   First Amendment to Employment Agreement, dated as of December 18, 2008 by and between the Company and James Hyatt (filed as Exhibit 10.5 to the Company’s Current Report on Form 8-K, dated December 18, 2008).
  10 .6.1   Foodservice Distribution Agreement between Cosi, Inc. and Distribution Market Advantage, Inc. dated as of November 1, 2005.(1)
  10 .7.1   Cosi, Inc. Form of Franchise Agreement (Filed as Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended July 4, 2005).
  10 .7.2   Cosi, Inc. Form of Area Developer Franchise Agreement (Filed as Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended July 4, 2005).
  10 .8   Form of Senior Secured Note and Warrant Purchase Agreement (Filed as Exhibit 10.7 to the Company’s Registration on Form S-1, file #333-86390).
  10 .9   Securities Purchase Agreement dated as of April 27, 2004 (Filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K, dated April 28, 2004).

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Exhibit
   
Number
 
Description of Exhibit
 
  10 .10   Form of Restricted Stock Award Agreement (Filed as Exhibit 10.1 to the Company’s Current Report of Form 8-K, dated June 6, 2005).
  16     Letter from Ernst & Young LLP to the Securities and Exchange Commission, dated as of August 13, 2004, acknowledging its agreement with the statements made in Current Report on Form 8-K (Filed as Exhibit 16 to the Company’s Current Report on Form 8-K, dated August 13, 2004).
  21     Subsidiaries of Cosi, Inc. (Filed as Exhibit 21.1 to the Company’s Registration Statement on Form S-1, file #333-86390).
  23 .1   Filed herewith Consent of BDO Seidman, LLP, Registered Public Accounting Firm.
  31 .1   Filed herewith Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31 .2   Filed herewith Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32 .1   Filed herewith Certification of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
(1) Portions of Exhibit 10.6.1 have been omitted and filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.

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Board of Directors and Stockholders
Cosi, Inc.
Deerfield, Illinois
 
We have audited the accompanying consolidated balance sheets of Cosi, Inc. as of December 29, 2008 and December 31, 2007 and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 29, 2008. 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. An audit 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 29, 2008 and December 31, 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 29, 2008, in conformity with accounting principles generally accepted in the United States of America.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Cosi, Inc.’s internal control over financial reporting as of December 29, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 16, 2009 expressed an unqualified opinion thereon.
 
/s/  BDO Seidman, LLP
 
Chicago, Illinois
March 16, 2009


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Board of Directors and Stockholders
Cosi, Inc.
Deerfield, Illinois
 
We have audited Cosi, Inc.’s internal control over financial reporting as of December 29, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Cosi, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Item 9A, Management’s Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
 
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, Cosi, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 29, 2008, based on the COSO criteria.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Cosi, Inc. as of December 29, 2008 and December 31, 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 29, 2008 and our report dated March 16, 2009 expressed an unqualified opinion thereon.
 
/s/  BDO Seidman, LLP
Chicago, Illinois
March 16, 2009


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Cosi, Inc.
 
As of December 29, 2008 and December 31, 2007
 
                 
    December 29, 2008     December 31, 2007  
    (Dollars in thousands)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 5,589     $ 6,309  
Accounts receivable, net
    916       658  
Inventories
    998       1,045  
Prepaid expenses and other current assets
    3,650       3,796  
Assets held for sale
          122  
Assets of discontinued operations
          35  
                 
Total current assets
    11,153       11,965  
Furniture and fixtures, equipment and leasehold improvements, net
    29,779       42,477  
Intangibles, security deposits and other assets
    1,849       1,970  
                 
Total assets
  $ 42,781     $ 56,412  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 3,378     $ 2,106  
Accrued expenses
    9,835       9,014  
Deferred franchise revenue
    149       783  
Current liabilities of discontinued operations
    4       285  
Current portion of other long-term liabilities
    668       465  
                 
Total current liabilities
    14,034       12,653  
Deferred franchise revenue
    2,545       2,730  
Other long-term liabilities, net of current portion
    7,176       7,183  
                 
Total liabilities
    23,755       22,566  
                 
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock — $.01 par value; 100,000,000 shares authorized, 40,663,189 and 41,047,985 shares issued, respectively
    407       411  
Additional paid-in capital
    276,593       275,187  
Treasury stock, 239,543 shares at cost
    (1,198 )     (1,198 )
Accumulated deficit
    (256,776 )     (240,554 )
                 
Total stockholders’ equity
    19,026       33,846  
                 
Total liabilities and stockholders’ equity
  $ 42,781     $ 56,412  
                 
 
The accompanying notes are an intergral part of these consolidated financial statements.


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Cosi, Inc
 
For the Fiscal Years Ended December 29, 2008, December 31, 2007 and January 1, 2007
 
                         
    December 29,
    December 31,
    January 1,
 
    2008     2007     2007  
    (Dollars in thousands, except per share data)  
 
Revenues:
                       
Restaurant net sales
  $ 132,501     $ 132,414     $ 122,849  
Franchise fees and royalties
    3,078       2,142       849  
                         
Total revenues
    135,579       134,556       123,698  
                         
Costs and expenses:
                       
Cost of food and beverage
    30,235       30,972       28,170  
Restaurant labor and related benefits
    45,375       45,995       40,782  
Occupancy and other restaurant operating expenses
    39,821       38,369       32,045  
                         
      115,431       115,336       100,997  
General and administrative expenses
    19,966       22,973       26,887  
Depreciation and amortization
    8,409       8,823       7,196  
Restaurant pre-opening expenses
    100       710       1,451  
Provision for losses on asset impairments and disposals
    7,099       3,845       249  
Closed store costs
    69       262        
Lease termination expense (benefit), net
    551       347       (232 )
Gain on sale of assets
          (23 )     (482 )
                         
Total costs and expenses
    151,625       152,273       136,066  
                         
Operating loss
    (16,046 )     (17,717 )     (12,368 )
                         
Interest income
    102       524       1,411  
Interest expense
    (7 )     (42 )     (9 )
Other income
    41       705       77  
                         
Total other income (expense)
    136       1,187       1,479  
                         
Loss from continuing operations
    (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
  $ (16,222 )   $ (20,783 )   $ (12,328 )
                         
Per Share Data:
                       
Loss per share, basic and diluted
                       
Continuing operations
  $ (0.40 )   $ (0.42 )   $ (0.28 )
Discontinued operations
  $     $ (0.11 )   $ (0.04 )
                         
Net loss
  $ (0.40 )   $ (0.53 )   $ (0.32 )
                         
Weighted average common shares outstanding
    40,078,511       39,332,226       38,207,173  
                         
 
The accompanying notes are an intergral part of these consolidated financial statements.


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Cosi, Inc.
 
For the Fiscal Years Ended December 29, 2008, December 31, 2007 and January 1, 2007
 
                                                                 
    Common Stock           Treasury Stock              
                Additional
    Unearned
    Shares of
    Amount
             
    Number of
          Paid In
    Stock
    Treasury
    Treasury
    Accumulated
       
    Shares     Amount     Capital     Compensation     Stock     Stock     Deficit     Total  
    (Dollars in thousands, except share data)  
 
Balance, January 2, 2006
    38,478,796     $ 385     $ 268,330     $ (3,867 )     239,543     $ (1,198 )   $ (207,443 )   $ 56,208  
Adoption of FAS 123R
                    (3,867 )     3,867                                
Issuance of restricted stock, net of forfeitures
    815,000       8       (8 )                                      
Stock-based compensation
    11,376             5,021                                       5,021  
Exercise of warrants
    263,302       3       441                                       444  
Exercise of stock options
    341,640       3       1,283                                       1,286  
Net loss
                                                    (12,328 )     (12,328 )
                                                                 
Balance, January 1, 2007
    39,910,114       399       271,200             239,543       (1,198 )     (219,771 )     50,631  
Issuance of restricted stock, net of forfeitures
    147,932       1       (1 )                                      
Stock-based compensation
                    1,969                                       1,969  
Exercise of warrants
    699       1       (1 )                                      
Exercise of stock options
    989,240       10       2,020                                       2,030  
Net loss
                                                    (20,783 )     (20,783 )
                                                                 
Balance, December 31, 2007
    41,047,985       411       275,187             239,543       (1,198 )     (240,554 )     33,846  
Net forfeiture of restricted stock
    (420,330 )     (4 )     4                                        
Stock-based compensation
                    1,349                                       1,349  
Exercise of warrants
    11,563                                                    
Exercise of stock options
    23,971             53                                       53  
Net loss
                                                    (16,222 )     (16,222 )
                                                                 
Balance, December 29, 2008
    40,663,189     $ 407     $ 276,593     $       239,543     $ (1,198 )   $ (256,776 )   $ 19,026  
                                                                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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Cosi, Inc.
 
For the Fiscal Years Ended December 29, 2008, December 31, 2007 and January 1, 2007
 
                         
    December 29,
    December 31,
    January 1,
 
    2008     2007     2007  
    (In thousands)  
 
Cash flows from operating activities:
                       
Net loss
  $ (16,222 )   $ (20,783 )   $ (12,328 )
Adjustments to reconcile net loss to net cash provided by (used in) operating activities
                       
Depreciation and amortization
    8,414       9,233       7,767  
Gain on sale of assets
          (23 )     (482 )
Non-cash portion of asset impairments and disposals
    7,187       7,195       505  
Non-cash portion of store closing costs
    24       370        
Provision for bad debts
    23       1       4  
Stock-based compensation expense
    1,349       1,968       5,020  
Changes in operating assets and liabilities:
                       
Accounts receivable
    (281 )     1,292       (1,459 )
Inventories
    76       (87 )     (72 )
Prepaid expenses and other current assets
    144       237       (360 )
Other assets
    95       171       307  
Accounts payable and accrued expenses
    1,967       (1,074 )     1,160  
Deferred franchise revenue
    (819 )     (5 )     3,008  
Lease termination reserve
    608       (171 )     (195 )
Other liabilities
    (521 )     (693 )     1,074  
                         
Net cash provided by (used in) operating activities
    2,044       (2,369 )     3,949  
                         
Cash flows from investing activities:
                       
Capital expenditures
    (2,881 )     (14,363 )     (21,307 )
Proceeds from sale of assets
    30       650       775  
Purchases of investments
          (20,777 )     (171,683 )
Redemptions of investments
          39,738       185,639  
Return (payment) of security deposits, net
    34       479       (98 )
                         
Net cash (used in) provided by investing activities
    (2,817 )     5,727       (6,674 )
                         
Cash flows from financing activities:
                       
Proceeds from issuance of common stock
    53       2,030       1,287  
Exercises of warrants
                443  
Principal payments on long-term debt
          (17 )     (19 )
                         
Net cash provided by financing activities
    53       2,013       1,711  
                         
Net (decrease) increase in cash and cash equivalents
    (720 )     5,371       (1,014 )
Cash and cash equivalents, beginning of year
    6,309       938       1,952  
                         
Cash and cash equivalents, end of year
  $ 5,589     $ 6,309     $ 938  
                         
Supplemental disclosures of cash flow information:
                       
Cash paid for:
                       
Interest
  $ 7     $ 42     $ 9  
                         
Corporate franchise and income taxes
  $ 213     $ 300     $ 268  
                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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COSI, INC.
 
 
For the Fiscal Years Ended December 29, 2008, December 31, 2007, and January 1, 2007
 
1.   Organization and Summary of Significant Accounting Policies
 
 
Cosi, Inc., a Delaware corporation, owns, operates, and franchises premium convenience dining restaurants which sell high-quality sandwiches, salads and coffees along with a variety of other soft drink beverages, teas, baked goods and alcoholic beverages. As of December 29, 2008 there were 101 Company-owned and 50 franchise restaurants operating in 18 states, the District of Columbia, and the United Arab Emirates (UAE).
 
Fiscal Year
 
Our fiscal year ends on the Monday closest to December 31. Fiscal years ended December 29, 2008, December 31, 2007 and January 1, 2007 are referred to as fiscal 2008, 2007 and 2006, respectively. Fiscal years 2008, 2007, and 2006 each included 52 weeks.
 
 
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.
 
 
We consider all short-term investments with a maturity of three months or less from the date of purchase to be cash equivalents.
 
 
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash deposits. We place our cash deposits in Federal Deposit Insurance Corporation (“FDIC”) insured financial institutions, US government and government sponsored agency securities, auction rate securities, commercial paper and money market funds. Cash deposits may exceed FDIC insured levels from time to time.
 
Our accounts receivable consist principally of trade or “house” accounts representing corporate customers, amounts due from franchisees, and amounts due from certain landlords for reimbursement of tenant improvements. We have established credit procedures and analyses to control the granting of credit to customers.
 
 
Trade accounts receivable are stated at net realizable value. The Company maintains a reserve for potential uncollectible accounts based on historical trends and known current factors impacting the Company’s customers.
 
 
Inventories are stated at the lower of cost, determined using a weighted average valuation method that approximates the first-in, first-out method, or market, and consist principally of food, beverage, liquor, packaging and related food supplies.
 
 
Assets held for sale consists of property and equipment at the three Seattle, Washington restaurants where we sold the assets and exited the market in the first quarter of fiscal 2008. Assets held for sale are reported at their salvage value less cost to sell.


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COSI, INC.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Furniture and fixtures, equipment and leasehold improvements are stated at cost. Depreciation of furniture and fixtures and equipment is computed using the straight-line method over estimated useful lives that range from two to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the term of the related leases.
 
Upon retirement or sale, the cost of assets disposed of and their related accumulated depreciation are removed from the accounts. Any resulting gain or loss is credited or charged to operations. Maintenance and repairs are charged to expense when incurred, while betterments are capitalized.
 
 
Impairment losses are recorded on long-lived assets on a restaurant-by-restaurant basis whenever impairment factors are determined to be present. We consider a consistent 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 original lease term, and then determine the impairment charge based on discounted cash flows for the same period.
 
During the third quarter of fiscal 2007, the Company reached an agreement with Macy’s Inc. (“Macy’s”) relating to six Cosi® restaurants operated within Macy’s stores. Under the terms of the agreement, we ceased operations and closed those locations on August 19, 2007.
 
In addition, during 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 is operating those locations under a different brand. We ceased operating these restaurants as of the end of the first quarter of fiscal 2008.
 
During fiscal 2008, we recorded 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, of which nine are in the Midwest region, five are in the Mid-Atlantic region and two are in the Northeast region, including three locations that have been closed or are scheduled to be closed during the first quarter of fiscal 2009. During fiscal 2008, we also recorded asset impairment charges of approximately $0.1 million related to the Seattle locations, which are reported in discontinued operations. In fiscal 2007 we recorded asset impairment charges of $3.8 million related to seven underperforming locations. In addition, during fiscal 2007, we recorded impairment charges of $3.4 million related to six Macy’s and three Seattle locations, which are reported in discontinued operations.
 
 
We recognize rent expense on a straight-line basis over the lease term commencing on the date we take possession. 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 lease.
 
 
Intangibles and other assets consist of costs associated with obtaining liquor licenses, trademarks and logos. Liquor licenses are stated at cost which is not in excess of market value. Security deposits primarily consist of deposits placed on leased locations.
 
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we review indefinite-lived intangible assets for impairment on an annual basis, or more often if events or changes in circumstances indicate that the carrying amounts of those assets may not be recoverable. Other intangibles with indefinite lives are not amortized.


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COSI, INC.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Future store closings, if any, resulting from our decision to close underperforming locations prior to their scheduled lease expiration dates may result in additional lease termination charges. 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. The Company recognizes costs associated with exit or disposal activities when they are incurred, rather than at the date of a commitment to an exit or disposal plan.
 
During fiscal 2008, we recorded lease termination charges of $0.6 million 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. The lease termination expense during fiscal 2007 relates to a location where, due to the enforcement of restrictions in a zoning overlay district, we were denied the necessary permits to build a restaurant and we exercised the exit provision under the lease, and to an underperforming restaurant in Chicago where we exercised an early exit provision of the lease and exited the location in the first quarter of fiscal 2008.
 
A summary of lease termination reserve activity is as follows:
 
         
    (In thousands)  
 
Balance as of January 2, 2006
  $ 742  
Benefit from reversal of prior charges
    (231 )
Deductions and adjustments
    (80 )(a)
         
Balance as of January 1, 2007
    431  
Charged to costs and expenses
    347  
Deductions and adjustments
    (518 )(a)
         
Balance as of December 31, 2007
    260  
Charged to costs and expenses
    551  
Deductions and adjustments
    57 (a)
         
Balance as of December 29, 2008
  $ 868  
         
 
 
(a) Deductions and adjustments include payments to landlords for lease obligations.
 
 
Other liabilities consist of deferred rent, landlord allowances and accrued lease termination costs (see Note 12).
 
 
Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. We have recorded a full valuation allowance to reduce our deferred tax assets related 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-forward


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COSI, INC.
 
Notes to Consolidated Financial Statements — (Continued)
 
based on the Company’s operating results. A positive adjustment to income will be recorded in future years if we determine that it is more likely than not that we will realize these deferred tax assets.
 
We have adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”) as of January 2, 2007. FIN 48 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. FIN 48 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 be reported as cumulative effect of a change in accounting principle.
 
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.
 
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.
 
 
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 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.
 
 
During fiscal 2008, we did not recognize any income from the sale of assets. During fiscal 2007, we recognized income of $0.02 million related to the sale of a liquor license and, during fiscal 2006, we recognized income of $0.5 on the sale of a Company-owned New Jersey restaurant to a franchise area developer during the fourth quarter of fiscal 2006.
 
 
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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COSI, INC.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Domestic franchise-operated Cosi® restaurants contribute 1% of their sales to a national marketing fund and are also required to spend 1% of their sales in their local markets on advertising. Our international franchise-operated restaurants contribute 0.5% of their sales to an international marketing fund. The Company contributes 1% of sales from Company-owned restaurants to the national marketing fund. The Company’s contributions to the national marketing fund as well as its own local market media costs are recorded as part of occupancy and other restaurant operating expenses in the Company’s consolidated statements of operations. Advertising costs are expensed as incurred and approximated $1.7 million, $1.9 million and $1.7 million for fiscal years 2008, 2007 and 2006, respectively.
 
 
Basic and diluted net loss per common share is computed by dividing the net loss by the weighted-average number of common shares and dilutive common share equivalents, if any, outstanding during the period. As of December 29, 2008, there were no outstanding in-the-money stock options or warrants to purchase common stock. In-the-money stock options and warrants to purchase an aggregate of 32,744 and 1,944,142 shares of common stock were outstanding at December 31, 2007 and January 1, 2007 respectively. There were 429,050 unvested restricted stock units and unvested restricted shares outstanding at December 29, 2008 and 919,800 and 1,149,700 shares of unvested restricted shares outstanding at December 31, 2007 and January 1, 2007, respectively. These stock options, outstanding warrants, outstanding unvested shares, and unvested stock units were not included in the computation of diluted earnings per share because we incurred a net loss in all periods presented and, hence, the impact would be anti-dilutive. Out-of-the-money stock options and warrants to purchase an aggregate of 1,304,070, 1,780,863 and 3,463,258 shares of common stock were outstanding at December 29, 2008, December 31, 2007 and January 1, 2007 respectively.
 
 
As of January 3, 2006, we adopted the fair value recognition provision of SFAS 123R, Share-Based Payment, which generally requires, among other things, that all employee share-based compensation be measured using a fair value method and that all of the resulting compensation cost be recognized in the financial statements. We selected the modified prospective method of adoption. Under SFAS 123R, our stock-based compensation expense is recognized on a straight-line basis over the requisite service period of the award, which is the vesting term. As a result, we recognized stock option compensation expense of $0.1 million, $0.4 million and $1.1 million, during fiscal years 2008, 2007 and 2006 respectively. 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 the grant.
 
 
Operating segments are defined as components of an enterprise about which separate financial information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources in assessing performance. Our chief operating decision maker reviews one aggregated set of financial statements to make decisions about resource allocations and to assess performance. Consequently, we have one reportable segment for all sales generated.
 
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and


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COSI, INC.
 
Notes to Consolidated Financial Statements — (Continued)
 
the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates.
 
 
Certain amounts in the fiscal 2007 and 2006 consolidated financial statements have been reclassified to conform to the fiscal 2008 presentation.
 
 
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measures. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Statement of Financial Staff Position (“FSP”) No. SFAS 157-2, “Effective Date of FASB Statement No. 157” which permits a one-year deferral for the implementation of SFAS 157 with regards to non-financial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). In October 2008, the FASB issued FSP No. SFAS 157-3, which provides guidance in determining the fair value of a financial asset when the market for that financial asset is not active. We have adopted the provisions of SFAS No. 157 related to financial assets and liabilities as of January 1, 2008. The application of this standard did not have a material impact on our results of operations or financial condition. We elected to defer adoption of SFAS No. 157 for non-financial assets and liabilities and we do not anticipate that full adoption in fiscal 2009 will have a material impact on our results of operations or financial condition.
 
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115. Under SFAS No. 159, a company may elect to measure eligible financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. If elected, SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We did not elect to begin reporting any financial assets or liabilities at fair value upon adoption of SFAS No. 159 on January 1, 2008 and we did not elect to report at fair value any new financial assets or liabilities entered during the twelve-month period ended December 29, 2008.
 
In December 2007, the FASB issued SFAS No. 141R, Business Combinations. SFAS No. 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. We will adopt this standard for our fiscal year 2009. This standard will be applied to any future business combinations. At this point, we do not anticipate that SFAS No. 141R will have an impact on our consolidated financial statements.
 
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB 51. SFAS No. 160 changes the accounting and reporting for minority interests. Minority interests will be reclassified as noncontrolling interests and reported as a component of equity separate from the parent company’s equity, and purchases or sales of equity interests that do not result in a change in control will be accounted for as equity transactions. In addition, net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement and upon a loss of control, the interest sold, as well as any interest retained, will be recorded at fair value with any gain or loss recognized in earnings. SFAS No. 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. We


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COSI, INC.
 
Notes to Consolidated Financial Statements — (Continued)
 
will adopt this standard for our fiscal year 2009. At this point, we do not anticipate that SAFS No. 160 will have an impact on our consolidated financial statements when effective.
 
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB No. 133. This statement amends SFAS No. 133 to provide additional information about how derivative hedging activities affect an entity’s financial position, financial performance, and cash flows. The statement requires enhanced disclosures about an entity’s derivatives and hedging activities. SFAS No. 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. We will adopt this standard for our fiscal year 2009. At this point, we do not anticipate that SAFS No. 160 will have an impact on our consolidated financial statements when effective.
 
2.   Accounts Receivable
 
Accounts receivable consist of the following:
 
                 
    December 29,
    December 31,
 
    2008     2007  
    (In thousands)  
 
Receivables due from franchisees
  $ 548     $ 158  
Reimbursements due from landlords
          200  
Accounts receivable, trade
    262       187  
Other
    132       116  
                 
Total receivables
    942       661  
Less allowance for doubtful accounts
    (26 )     (3 )
                 
Accounts receivable, net
  $ 916     $ 658  
                 
 
A summary of the reserve for doubtful accounts follows:
 
         
    (In thousands)  
 
Balance as of January 2, 2006
    8.0  
Benefit from accrual reversals
    13.0  
Deductions
    (17.0 )(a)
         
Balance as of January 1, 2007
    4.0  
Charged to costs and expenses
    12.0  
Deductions
    (13.0 )(a)
         
Balance as of December 31, 2007
    3  
         
Charged to costs and expenses
    18.0  
Deductions
    5.0 (a)
         
Balance as of December 29, 2008
  $ 26.0  
         
 
 
(a) Recovery (write-off) of uncollectible accounts.


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COSI, INC.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
3.   Prepaid Expenses and Other Current Assets
 
Prepaid expenses and other current assets consist of the following:
 
                 
    December 29,
    December 31,
 
    2008     2007  
    (In thousands)  
 
Prepaid insurance
  $ 1,640     $ 1,705  
Prepaid rent
    1,631       1,709  
Other
    379