Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

 

**FORM10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended September 27, 2010**

 

**OR**

 

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

 

**For thetransition period from          to          **

 

**Commission File No. 000-50052**

 

**COSÌ, INC.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **06-1393745**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.) |

 

**1751 Lake Cook Road**

**Deerfield, Illinois 60015**

(Addressof principal executive offices) (Zip Code)

 

**(847) 597-8800**

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the registrant:  (1) has filedall reports required to be filed by Section 13 or 15 (d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x  No o

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” inRule 12b-2 of the Exchange Act. (Check one):

 

| Large  accelerated filer o |   | Accelerated  filer o         |
|----------------------------|--------|------------------------------|
|                       |   |                         |
| Non-Accelerated  filer o   |   | Smaller  reporting company x |

 

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

 

Number of shares of CommonStock, $.01 par value, outstanding as of November 10, 2010: 51,682,891.

 

 

 

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Table of Contents

 

**COSI, INC.**

 

Indexto Form 10-Q

Forthe nine-month period ended September 27, 2010

 
| ** **                                          | ** **                                                                                                                  | **Page Number** |
|-----------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------|----------------------|
|                                                |                                                                                                                        |                 |
| **PART  I.   FINANCIAL INFORMATION** |
|                                                |                                                                                                                        |                 |
| Item 1.                                             | Financial Statements (Unaudited)                                                                                            |                 |
|                                                |                                                                                                                        |                 |
|                                                | Consolidated  Balance Sheets — as of September 27, 2010 and December 28, 2009                                          | 3                    |
|                                                |                                                                                                                        |                 |
|                                                | Consolidated Statements of  Operations — Three and nine-month periods ended September 27, 2010 and  September 28, 2009 | 4                    |
|                                                |                                                                                                                        |                 |
|                                                | Consolidated Statement of  Stockholders’ Equity — Nine-month period ended September 27, 2010                      | 5                    |
|                                                |                                                                                                                        |                 |
|                                                | Consolidated Statements of  Cash Flows — Nine-month periods ended September 27, 2010 and September 28,  2009           | 6                    |
|                                                |                                                                                                                        |                 |
|                                                | Notes to Condensed  Consolidated Financial Statements                                                                       | 7-11                 |
|                                                |                                                                                                                        |                 |
| Item 2.                                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                 | 12-26                |
|                                                |                                                                                                                        |                 |
| Item 3.                                             | Quantitative  and Qualitative Disclosures about Market Risk                                                                 | 27                   |
|                                                |                                                                                                                        |                 |
| Item 4.                                             | Controls and  Procedures                                                                                                    | 27                   |
|                                                |                                                                                                                        |                 |
| **PART II. OTHER INFORMATION**                      |
|                                                |                                                                                                                        |                 |
| Item 1.                                             | Legal Proceedings                                                                                                           | 28                   |
|                                                |                                                                                                                        |                 |
| Item 1A.                                            | Risk Factors                                                                                                                | 28                   |
|                                                |                                                                                                                        |                 |
| Item 5.                                             | Exhibits                                                                                                                    | 28                   |
|                                                |                                                                                                                        |                 |
| SIGNATURES                                          | 29                                                                                                                          |
|                                                |                                                                                                                        |                 |
| EXHIBIT  INDEX                                      | 30                                                                                                                          |
|                                                |                                                                                                                        |                 |
| CERTIFICATIONS                                      | 31-33                                                                                                                       |

 

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**PARTI.  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

**Cosi, Inc.**

**Consolidated Balance Sheets**

**As of Sepember 27, 2010 and December 28, 2009**

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

 
| ** **                                                                                                            | ** ** | **September 27, 2010** | ** ** | **December 28, 2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                            | ** ** | **(Unaudited)**                  | ** ** | **(Note 1)**               | ** ** |
| **Assets**                                                                                                            |       |                             |       |                            |       |
| Current  assets:                                                                                                      |       |                             |       |                            |       |
| Cash  and cash equivalents                                                                                            |       | $                                | 11,500     |                            | $          | 4,079 |   |
| Accounts  receivable, net                                                                                             |       | 1,025                            |       | 560                             |       |
| Inventories                                                                                                           |       | 782                              |       | 967                             |       |
| Prepaid  expenses and other current assets                                                                            |       | 744                              |       | 2,136                           |       |
| Total  current assets                                                                                                 |       | 14,051                           |       | 7,742                           |       |
|                                                                                                                  |       |                             |       |                            |       |
| Furniture  and fixtures, equipment and leasehold improvements, net                                                    |       | 15,976                           |       | 22,100                          |       |
| Intangibles,  security deposits and other assets, net                                                                 |       | 2,689                            |       | 1,728                           |       |
| Total  assets                                                                                                         |       | $                                | 32,716     |                            | $          | 31,570 |   |
|                                                                                                                  |       |                             |       |                            |       |
| **Liabilities and Stockholders’ Equity**                                                                         |       |                             |       |                            |       |
| Current  liabilities:                                                                                                 |       |                             |       |                            |       |
| Accounts  payable                                                                                                     |       | $                                | 2,514      |                            | $          | 3,079 |   |
| Accrued  expenses                                                                                                     |       | 7,755                            |       | 9,628                           |       |
| Deferred  franchise revenue                                                                                           |       | 61                               |       | 44                              |       |
| Current  portion of other long-term liabilities                                                                       |       | 921                              |       | 588                             |       |
| Total  current liabilities                                                                                            |       | 11,251                           |       | 13,339                          |       |
|                                                                                                                  |       |                             |       |                            |       |
| Deferred  franchise revenue                                                                                           |       | 2,238                            |       | 2,563                           |       |
| Other  long-term liabilities, net of current portion                                                                  |       | 4,876                            |       | 6,343                           |       |
| Total  liabilities                                                                                                    |       | 18,365                           |       | 22,245                          |       |
|                                                                                                                  |       |                             |       |                            |       |
| Commitments  and contingencies                                                                                        |       |                             |       |                            |       |
|                                                                                                                  |       |                             |       |                            |       |
| Stockholders’  equity:                                                                                           |       |                             |       |                            |       |
| Common  stock - $.01 par value; 100,000,000 shares authorized, 51,682,891 and  40,862,474 shares issued, respectively |       | 517                              |       | 409                             |       |
| Additional  paid-in capital                                                                                           |       | 283,269                          |       | 277,994                         |       |
| Treasury  stock, 239,543 shares at cost                                                                               |       | (1,198                           | )          | (1,198                          | )          |
| Accumulated  deficit                                                                                                  |       | (268,237                         | )          | (267,880                        | )          |
| Total  stockholders’ equity                                                                                      |       | 14,351                           |       | 9,325                           |       |
| Total  liabilities and stockholders’ equity                                                                      |       | $                                | 32,716     |                            | $          | 31,570 |   |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**Cosi, Inc.**

**Consolidated Statements of Operations**

**For the Three and Nine Month Periods Ended September 27, 2010and September 28, 2009**

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

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **September 27,**           | ** ** | **September 28,**          | ** ** | **September 27,** | ** ** | **September 28,** | ** ** |
| ** **                                               | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                               | ** ** | **(Unaudited)**                  | ** ** | **(Unaudited)**                 | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| Revenues:                                                |       |                             |       |                            |       |   |   |   |   |
| Restaurant  net sales                                    |       | $                                | 26,341     |                            | $          | 29,528 |   | $ | 82,004 |   | $ | 88,667 |   |
| Franchise  fees and royalties                            |       | 782                              |       | 505                             |       | 2,340 |   | 1,668 |   |
| Total  revenues                                          |       | 27,123                           |       | 30,033                          |       | 84,344 |   | 90,335 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Costs  and expenses:                                     |       |                             |       |                            |       |   |   |   |   |
| Cost  of food and beverage                               |       | 5,835                            |       | 6,858                           |       | 18,730 |   | 20,011 |   |
| Restaurant  labor and related benefits                   |       | 9,684                            |       | 11,043                          |       | 30,979 |   | 32,592 |   |
| Occupancy  and other restaurant operating expenses       |       | 8,257                            |       | 9,412                           |       | 26,005 |   | 27,607 |   |
|                                                     |       | 23,776                           |       | 27,313                          |       | 75,714 |   | 80,210 |   |
| General  and administrative expenses                     |       | 3,156                            |       | 3,441                           |       | 10,108 |   | 10,916 |   |
| Depreciation  and amortization                           |       | 1,096                            |       | 1,701                           |       | 3,672 |   | 5,444 |   |
| Provision  for losses on asset impairments and disposals |       | 88                               |       | —                          |       | 300 |   | 238 |   |
| Lease  termination expense and closed store costs        |       | 172                              |       | —                          |       | 184 |   | 252 |   |
| Gain  on sale of assets                                  |       | (59                              | )          | —                          |       | (5,266 | ) | — |   |
| Total  costs and expenses                                |       | 28,229                           |       | 32,455                          |       | 84,712 |   | 97,060 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Operating  loss                                          |       | (1,106                           | )          | (2,422                          | )          | (368 | ) | (6,725 | ) |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Interest  income                                         |       | 1                                |       | —                          |       | 1 |   | 2 |   |
| Interest  expense                                        |       | (1                               | )          | (1                              | )          | (3 | ) | (4 | ) |
| Other  income                                            |       | 10                               |       | 61                              |       | 13 |   | 70 |   |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Net  loss                                                |       | $                                | (1,096     | )                               | $          | (2,362 | ) | $ | (357 | ) | $ | (6,657 | ) |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Per  Share Data:                                         |       |                             |       |                            |       |   |   |   |   |
| Loss  per share, basic and diluted                       |       | $                                | (0.02      | )                               | $          | (0.06 | ) | $ | (0.01 | ) | $ | (0.16 | ) |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Weighted  average shares outstanding:                    |       | 51,228,298                       |       | 40,521,231                      |       | 50,439,627 |   | 40,387,960 |   |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**Cosi, Inc.**

**Consolidated Statement of Stockholders’ Equity**

**For theNine Months Ended September 27, 2010**

**(unaudited)**

**(dollars in thousands, except share data)**

 
| ** **                       | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | ** **       | ** ** | ** **         | ** ** |
|----------------------------------|------------|-----------------------|------------|-------------------------|------------|------------------|------------|--------------------|------------|
| ** **                       | ** ** | ** **            | ** ** | ** **              | ** ** | **Additional**   | ** ** | ** **         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Number of**    | ** ** | ** **              | ** ** | **Paid In** | ** ** | **Number of** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**      | ** ** | **Shares**         | ** ** | **Amount** | ** ** | **Deficit** | ** ** | **Total** | ** ** |
|                             |       |                  |       |                    |       |             |       |               |       |   |   |   |   |   |   |
| Balance,  December 28, 2009      |       | 40,862,474            |       | $                       | 409        |             | $          | 277,994            |       | 239,543 |   | $ | (1,198 | ) | $ | (267,880 | ) | $ | 9,325 |   |
|                             |       |                  |       |                    |       |             |       |               |       |   |   |   |   |   |   |
| Issuance  of common stock (1)    |       | 10,451,677            |       | 105                     |       | 4,790            |       |               |       |   |   |   |   | 4,895 |   |
| Forfeitures  of restricted stock |       | (21,950               | )          | 3                       |       | (3               | )          |               |       |   |   |   |   | — |   |
| Stock-based  compensation        |       | 390,690               |       | —                  |       | 488              |       |               |       |   |   |   |   | 488 |   |
| Net  loss                        |       |                  |       |                    |       |             |       |               |       |   |   | (357 | ) | (357 | ) |
|                             |       |                  |       |                    |       |             |       |               |       |   |   |   |   |   |   |
| Balance,  September 27, 2010     |       | 51,682,891            |       | $                       | 517        |             | $          | 283,269            |       | 239,543 |   | $ | (1,198 | ) | $ | (268,237 | ) | $ | 14,351 |   |

 

----

(1)          The additional paid-incapital represents the proceeds net of issuance costs of approximately $273,000from the shareholder rights offering and related private placement to directorsand officers of the Company, completed in January 2010

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**Cosi, Inc.**

**Consolidated Statements of Cash Flows**

**For the Nine Month Periods Ended September 27, 2010 andSeptember 28, 2009**

**(dollars in thousands)**

 
| ** **                                                                                                                                                           | ** ** | **September 27,  2010** | ** ** | **September 28,  2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **(Unaudited)**              | ** ** | **(Unaudited)**              | ** ** |
| Cash  flows from operating activities:                                                                                                                               |       |                         |       |                         |       |
| Net  loss                                                                                                                                                            |       | $                            | (357       | )                            | $          | (6,657 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities                                                                                          |       |                         |       |                         |       |
| Depreciation  and amortization                                                                                                                                       |       | 3,672                        |       | 5,444                        |       |
| Gain  on sale of restaurants                                                                                                                                         |       | (5,120                       | )          | —                       |       |
| Gain  on sale of assets                                                                                                                                              |       | (146                         | )          | —                       |       |
| Non-cash  portion of asset impairments and disposals                                                                                                                 |       | 300                          |       | 238                          |       |
| Provision  for bad debts                                                                                                                                             |       | 13                           |       | 78                           |       |
| Stock-based  compensation expense                                                                                                                                    |       | 488                          |       | 838                          |       |
| Changes  in operating assets and liabilities:                                                                                                                        |       |                         |       |                         |       |
| Accounts  receivable                                                                                                                                                 |       | (207                         | )          | 130                          |       |
| Inventories                                                                                                                                                          |       | 185                          |       | 43                           |       |
| Prepaid  expenses and other current assets                                                                                                                           |       | 1,392                        |       | 2,793                        |       |
| Other  assets                                                                                                                                                        |       | 32                           |       | 162                          |       |
| Accounts  payable and accrued expenses                                                                                                                               |       | (2,489                       | )          | (2,651                       | )          |
| Deferred  franchise revenue                                                                                                                                          |       | (308                         | )          | (70                          | )          |
| Lease  termination accrual                                                                                                                                           |       | 127                          |       | (183                         | )          |
| Other  liabilities                                                                                                                                                   |       | (882                         | )          | (612                         | )          |
| Net  cash used in operating activities                                                                                                                               |       | (3,300                       | )          | (447                         | )          |
| ** **                                                                                                                                                           | ** ** | ** **                   | ** ** | ** **                   | ** ** |
| Cash  flows from investing activities:                                                                                                                               |       |                         |       |                         |       |
| Proceeds  from sale of restaurants                                                                                                                                   |       | 6,400                        |       | —                       |       |
| Capital  expenditures                                                                                                                                                |       | (806                         | )          | (553                         | )          |
| Proceeds  from sale of assets                                                                                                                                        |       | 184                          |       | —                       |       |
| Return  of security deposits                                                                                                                                         |       | 48                           |       | —                       |       |
| Net  cash provided by (used in) investing activities                                                                                                                 |       | 5,826                        |       | (553                         | )          |
| ** **                                                                                                                                                           | ** ** | ** **                   | ** ** | ** **                   | ** ** |
| Cash  flows from financing activities:                                                                                                                               |       |                         |       |                         |       |
| Net  proceeds from issuance of common stock                                                                                                                          |       | 5,168                        |       | —                       |       |
| Common  stock issuance costs                                                                                                                                         |       | (273                         | )          | —                       |       |
| Net  cash provided by financing activities                                                                                                                           |       | 4,895                        |       | —                       |       |
| ** **                                                                                                                                                           | ** ** | ** **                   | ** ** | ** **                   | ** ** |
| Net  increase (decrease) in cash and cash equivalents                                                                                                                |       | 7,421                        |       | (1,000                       | )          |
| Cash  and cash equivalents, beginning of period                                                                                                                      |       | 4,079                        |       | 5,589                        |       |
| Cash  and cash equivalents, end of period                                                                                                                            |       | $                            | 11,500     |                         | $          | 4,589 |   |
|                                                                                                                                                                 |       |                         |       |                         |       |
| Supplemental  disclosure of cash flow information:                                                                                                                   |       |                         |       |                         |       |
| Cash  paid for:                                                                                                                                                      |       |                         |       |                         |       |
| Corporate  franchise and income taxes                                                                                                                                |       | $                            | 201        |                         | $          | 168 |   |
|                                                                                                                                                                 |       |                         |       |                         |       |
| Supplemental  disclosure of non-cash investing activities:                                                                                                           |       |                         |       |                         |       |
| In  connection with the sale of the thirteen Company-owned restaurants in D.C. to  a franchisee (see Note 9), a $1.35 million three-year promissory note was  issued |       |                         |       |                         |       |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**COSI, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**Note 1 —Basis of Presentation**

 

We have prepared theaccompanying unaudited condensed consolidated financial statements in accordancewith the requirements of Form 10-Q and, therefore, they do not include allinformation and footnotes necessary for a fair presentation of financialposition, results of operations, and cash flows in conformity with accountingprinciples generally accepted in the United States of America (“U.S. GAAP”).  In our opinion, the financial statementsreflect all adjustments that are necessary for a fair presentation of theresults of operations for the periods shown. All such adjustments are of anormal recurring nature. In preparing financial statements in conformity withU.S. GAAP, we must make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues, expenses, and related disclosures atthe date of the financial statements and during the reporting period. Actualresults could differ from those estimates.

 

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

 

The balance sheet atDecember 28, 2009 has been derived from audited financial statements at thatdate but does not include all of the information and footnotes required by U.S.GAAP for complete financial statements.

 

The results for the threeand nine month periods ended September 27, 2010 and September 28, 2009 are notindicative of the results for the full fiscal year.

 

Certain amounts in theSeptember 28, 2009 consolidated statement of operations have been reclassifiedto conform to the September 27, 2010 presentation.

 

This report should be readin conjunction with our Annual Report on Form 10-K for the fiscal year endedDecember 28, 2009, as filed with the Securities and Exchange Commission (“SEC”).

 

There have been no materialchanges to our significant accounting policies and estimates from theinformation provided in Note 1 of our consolidated financial statementsincluded in our Form 10-K for the fiscal year ended December 28, 2009.

 

**Note 2 —Stock-Based Compensation Expense**

 

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

 
| ** **                                                            | ** ** | **For the Three Months Ended** | ** ** | **For the Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                            | ** ** | **(in thousands)**                            | ** ** | **(in thousands)**                           | ** ** |
| ** **                                                            | ** ** | **September 27,  2010**                       | ** ** | **September 28,  2009**                      | ** ** | **September 27,  2010** | ** ** | **September 28,  2009** | ** ** |
|                                                                  |       |                                               |       |                                              |       |   |   |   |   |
| Stock option compensation  expense                                    |       | $                                                  | —     |                                              | $          | 10 |   | $ | 1 |   | $ | 38 |   |
| Restricted stock  compensation expense, net of forfeitures            |       | 125                                                |       | 244                                               |       | 487 |   | 800 |   |
| Total  non-cash, stock-based compensation expense, net of forfeitures |       | $                                                  | 125        |                                              | $          | 254 |   | $ | 488 |   | $ | 838 |   |

 

As of September 27, 2010,all compensation expense related to stock options granted under the Company’svarious incentive plans have been recognized in full. In addition, as ofSeptember 27, 2010, there was approximately $0.5 million of total unrecognizedcompensation expense related to restricted stock shares and units granted underthe Cosi, Inc. 2005 Omnibus Long-Term Incentive Plan (the “2005 Plan”). Theexpense related to these grants is being recognized on a straight-line basisfrom the date of each grant through fiscal 2014.

 

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**COSI, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued**

 

In the nine-month periodended September 27, 2010, pursuant to the 2005 Plan and in accordance with theterms and conditions prescribed by the Compensation Committee of our Board ofDirectors, we granted and issued 238,250 restricted stock shares and 200,000restricted stock units to key employees. The vesting of these shares and stockunits will occur as follows: (i) 20% of the stock shares and stock units vestedon the grant date, and (ii) an additional 20% of the stock shares and stockunits will vest on each anniversary of the grant date provided that at eachsuch date the employee continues to be employed by the Company. The value ofthe shares and the stock units for the grants made in the nine-month periodended September 27, 2010, based on the closing price of our common stock on thedate of the grants, was approximately $0.4 million. In the nine-month periodended September 28, 2009, we granted and issued 10,000 restricted stock sharesof our authorized but unissued common stock to key employees. The value of theshares for the grants made during that period, based on the closing price ofour common stock on the date of the grants, was approximately $0.01 million.

 

In the three-month periodended September 27, 2010, 550 shares of previously issued restricted commonstock were forfeited. The value of the forfeited shares, based on the closingprice of our common stock on the date of the grants, was immaterial. There wereno forfeitures of restricted stock during the third quarter of 2009. During thenine-month periods ended September 27, 2010 and September 28, 2009, 21,950 and2,000 shares, respectively, of previously issued restricted common stock wereforfeited. The value of the forfeited shares, based on the closing price of ourcommon stock on the date of the grants, was approximately $0.03 million and$0.02 million in the nine-month periods ended September 27, 2010 and September28, 2009, respectively. The accompanying consolidated statement of operationsfor the nine-month periods ended September 27, 2010 and September 28, 2009reflects the reversal of approximately $0.01 million, in each nine-monthperiod, of previously amortized costs related to these forfeited shares.

 

In the nine-month periodsended September 27, 2010 and September 28, 2009, we issued 152,440 and 195,310shares, respectively, of our restricted common stock to members of the Board ofDirectors pursuant to the 2005 Plan. These shares had an aggregate value ofapproximately $0.1 million at the time of issuance in both years and vestedupon issuance.

 

**Note 3 —Earnings Per Share**

 
| ** **                                     | ** ** | **For the Three Months Ended** | ** ** | **For the Nine Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **(net loss in thousands)**         | ** ** | **(net loss in thousands)**        | ** ** |
| ** **                                     | ** ** | **September 27,  2010**                       | ** ** | **September 28,  2009**                      | ** ** | **September 27,  2010** | ** ** | **September 28,  2009** | ** ** |
| Net  loss                                      |       | $                                                  | (1,096     | )                                                 | $          | (2,362 | ) | $ | (357 | ) | $ | (6,657 | ) |
| Shares:                                        |       |                                               |       |                                              |       |   |   |   |   |
| Weighted  average number of shares outstanding |       | 51,228,298                                         |       | 40,521,231                                        |       | 50,439,627 |   | 40,387,960 |   |
|                                           |       |                                               |       |                                              |       |   |   |   |   |
| Basic  and diluted loss per share              |       | $                                                  | (0.02      | )                                                 | $          | (0.06 | ) | $ | (0.01 | ) | $ | (0.16 | ) |

 

Basic and diluted loss percommon share is calculated by dividing the net loss by the weighted-averagecommon shares outstanding during each period. As of September 27, 2010 andSeptember 28, 2009, there were, respectively, 215,050 and 105,700 unvestedrestricted shares of common stock outstanding and 548,312 and 690,149out-of-the-money stock options to purchase shares of common stock. There wereno in-the-money stock options as of September 27, 2010 and September 28, 2009.The unvested restricted shares meet the requirements for participatingsecurities but were not included in the computation of basic and dilutedearnings per share because we incurred a net loss in all periods presented and,hence, the impact would be anti-dilutive. The outstanding out-of-the-moneystock options to purchase shares of common stock at September 27, 2010 andSeptember 28, 2009 do not meet the requirements for participating securitiesand were not included in the computation of basic and diluted earnings pershare. As of September 27, 2010 and September 28, 2009, there were,respectively, 215,000 and 110,000 unvested restricted stock units. 

 

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**COSI, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued**

 

The unvested stock units donot meet the requirements for participating securities and were not included inthe computation of basic and diluted earnings per share.

 

**Note 4 — Asset Impairments**

 

In accordance with FASBAccounting Standards Codification Topic 360 (ASC Topic 360), (formerly SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets”), weevaluate possible impairment at the individual restaurant level periodicallyand record an impairment loss whenever we determine impairment factors arepresent. We consider a history of poor financial operating performance to bethe primary indicator of potential impairment for individual restaurantlocations. We determine whether a restaurant location is impaired based onexpected undiscounted cash flows, generally for the remainder of the leaseterm, and then determine the impairment charge based on discounted cash flowsfor the same period.

 

Restaurants are notconsidered for impairment during the period before they enter the comparablerestaurant base, unless specific circumstances warrant otherwise.

 

In the three-month periodended September 27, 2010, we recorded an asset impairment charge ofapproximately $0.1 million related to maintenance capital expenditures forpreviously impaired restaurants. In the nine-month period ended September 27,2010, we recorded an asset impairment charge of approximately $0.3 millionrelated to two underperforming restaurants We recorded an asset impairmentcharge of approximately $0.2 million related to one underperforming location inthe Chicago area in the three and nine-month periods ended September 28, 2009.

 

**Note 5 — Lease Termination Costs**

 

In the three and nine-monthperiods ended September 27, 2010, we incurred lease termination costs ofapproximately $0.2 million related to the closing of two underperforminglocations. In the nine-month period ended September 28, 2009, we recorded leasetermination charges of approximately $0.2 million related to an underperforminglocation where we reached a lease termination agreement with the landlord.

 

Future store closings, ifany, may result in additional lease termination charges. The incurrence ofadditional lease termination costs will be dependent on our ability to improveoperations in those restaurants.  Ifunsuccessful, lease termination costs will be determined through negotiatingacceptable terms with our landlords to terminate the leases for those restaurantsor on our ability to locate sub-tenants or assignees for the leases at thoselocations.

 

**Note 6 — Contingencies**

 

From time to time, we are adefendant 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 accommodationsor other federal and state laws applicable to our business operations,employment-related claims, property damages, claims from guests allegingillness, injury or other food quality, health or operational concerns, andenforcement of intellectual property rights.

 

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

 

**Note 7 — Income Taxes**

 

We have recorded a fullvaluation allowance to reduce our deferred tax assets related primarily to netoperating loss (“NOL”) carryforwards. Our determination of the valuationallowance is based on an evaluation of whether it is more likely than not thatwe will be able to utilize the NOL carryforwards, based on the Company’soperating results. A positive adjustment to income will be recorded in futureyears if we determine that we could realize these deferred tax assets.

 

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**COSI, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued**

 

As of December 28, 2009,we had NOL carryforwards of approximately $187.5 million for U.S. federalincome tax purposes. Under the Internal Revenue Code, an “ownership change”with respect to a corporation can significantly limit the amount ofpre-ownership change NOLs and certain other tax assets that the corporation mayutilize after the ownership change to offset future taxable income, possiblyreducing the amount of cash available to the corporation to satisfy itsobligations. An ownership change generally would occur if the aggregate stockownership of holders of at least 5% of our stock increases by more than50 percentage points over the preceding three-year period. We do notbelieve that the rights offering that we completed during the first quarter offiscal 2010 has triggered an ownership change. In addition, a limitation wouldnot have an impact on our consolidated financial statements as we have recordeda valuation allowance for the entire amount of our deferred tax assets.

 

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

 

No adjustment was made tothe beginning retained earnings balance, as the ultimate deductibility of alltax positions is highly certain but there is uncertainty about the timing ofsuch deductibility. No interest or penalties have been accrued relative to taxpositions due to the Company having either a tax loss or NOL carryforwards tooffset any taxable income in all subject years. As a result, no liability foruncertain tax positions has been recorded.

 

Should the Company need toaccrue interest or penalties on uncertain tax positions, it would recognize theinterest as interest expense and the penalties as a general and administrativeexpense.

 

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

 

**Note 8 — New AccountingPronouncements**

 

In January 2010, theFinancial Accounting Standards Board (“FASB”) issued Update No. 2010-06 (“ASU2010-06”), which provides updated guidance on disclosure requirements underAccounting Standards Codification (“ASC”) 820 Fair Value Measurements andDisclosures (formerly SFAS 157, “Fair Value Measures”). We have adopted ASU2010-06 as of January 25, 2010. The adoption did not have a significant impacton the Company’s consolidated financial statements.

 

**Note 9 — Sale of Restaurants**

 

On April 27, 2010, wecompleted the sale of thirteen restaurants and related assets in theWashington, D.C. market to Capitol C Restaurants LLC (“Capitol C”) for $8.35million. The sale was made pursuant to an Asset Purchase and SaleAgreement dated April 27, 2010, by and among the Company, Cosi Sandwich Bar,Inc., a wholly-owned subsidiary of the Company, Capitol C and Capitol CHoldings LLC (“Holdings”), the parent company of Capitol C. Therestaurants will be operated under franchise agreements between the Company andCapitol C, and Holdings has entered into a development agreement to open sixadditional Cosi restaurants in the District of Columbia area. Under the termsof the Asset Purchase and Sale Agreement, $6.4 million of the purchase pricewas paid in cash at closing and $1.35 million is payable to Cosi under asubordinated secured promissory note and will be paid in 120 weeklyinstallments, commencing January 2011, based on a percentage of net sales, witha final balloon payment for the balance of the note due on May 2013. Thebalance of $0.6 million is being held in escrow and will be paid to Cosi whenCapitol C achieves a certain sales target at any time during the three-yearperiod following the closing date of the transaction. 

 

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**COSI, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) — continued**

 

Disbursement from theescrow, either in full or in part, is based on a formula that comparesthen-current trailing twelve-month sales to a sales baseline and applies theresulting percentage to the escrow amount. The disbursement calculation can beapplied up to three times at Cosi’s sole discretion over the three year period.

 

As a result of this sale, wedisposed of approximately $3.0 million in net furniture, fixtures, equipmentand leasehold improvements, and recognized a gain on the sale of assets ofapproximately $5.1 million during the second quarter of fiscal 2010, includingapproximately $0.3 million in unamortized landlord allowances and reversal ofstraight line rent expense. We will recognize an additional gain from the saleof these assets at the time that the disbursement, either in full or in part,is made to us from the $0.6 million held in escrow. In addition, as a result ofthis sale, our cash position increased by $6.4 million, other non-currentassets and current receivables increased by approximately $1.2 million and$0.15 million, respectively, due to the $1.35 million promissory note.

 

Our2009 net restaurant sales from the thirteen restaurants sold were approximately$18.7 million with related restaurant level operating costs and expenses ofapproximately $16.1 million. Additionally, there was $1.4 million ofdepreciation and amortization associated with these restaurants and $0.9million of general and administrative costs. Had the sale of these restaurantsoccurred on the first day of our fiscal 2009, and assuming these restaurantsgenerated the same level of sales when operated by Capitol C, the franchiseroyalty income recognized from these thirteen restaurants would have beenapproximately $0.9 million for fiscal 2009. This would have resulted in areduction in our fiscal 2009 net loss of approximately $0.6 million.

 

**Note 10 — Rights Offering andPrivate Placement of Common Stock**

 

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

 

**Note 11 — Subsequent Event**

 

*Regaining Compliance with NASDAQListing Standards*

 

On November 4, 2010 wereceived notice from the Listing Qualifications Department of The NASDAQ StockMarket that we have regained compliance with the NASDAQ Listing Standards bycuring the minimum bid price deficiency. As of November 3, 2010, the bidprice of our common stock had closed at or above the $1.00 minimum requirementfor the last 10 consecutive business days. We now meet all continued listingstandards for the NASDAQ Global Market.

 

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

 

*Thefollowing discussion and analysis of our financial condition and results ofoperations for the fiscal quarters ended September 27, 2010 and September 28, 2009 should be read inconjunction with “Selected Consolidated Financial Data” and our auditedconsolidated financial statements and the notes to those statements that are inour 2009 Annual Report on Form 10-K. Our discussion containsforward-looking statements based upon current expectations that involve risksand uncertainties, such as our plans, objectives, expectations andintentions.  Actual results and thetiming of events could differ materially from those anticipated in theseforward-looking statements as a result of a number of factors, including thoseset forth under “Cautionary Note Regarding Forward-Looking Statements” belowand elsewhere in this Quarterly Report.*

 

**OVERVIEW**

 

System-wide restaurants:

 
| ** **                          | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **September 27, 2010**                   | ** ** | **September 28, 2009** | ** ** |
| ** **                          | ** ** | **Company-  Owned**                                | ** ** | **Franchise** | ** ** | **Total** | ** ** | **Company-  Owned** | ** ** | **Franchise** | ** ** | **Total** | ** ** |
|                                |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Restaurants  at beginning of period |       | 86                                                 |       | 58 |   | 144 |   | 98 |   | 44 |   | 142 |   |
| New  restaurants opened             |       | —                                             |       | 1 |   | 1 |   | 1 |   | 1 |   | 2 |   |
| Restaurants  permanently closed     |       | 1                                                  |       | — |   | 1 |   | — |   | — |   | — |   |
| **Restaurants at end of period**    | ** ** | **85**                                             | ** ** | **59** | ** ** | **144** | ** ** | **99** | ** ** | **45** | ** ** | **144** | ** ** |

 
| ** **                          | ** ** | **For the Nine Months Ended** | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **September 27, 2010**                  | ** ** | **September 28, 2009** | ** ** |
| ** **                          | ** ** | **Company-  Owned**                               | ** ** | **Franchise** | ** ** | **Total** | ** ** | **Company-  Owned** | ** ** | **Franchise** | ** ** | **Total** | ** ** |
|                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Restaurants  at beginning of period |       | 99                                                |       | 46 |   | 145 |   | 101 |   | 50 |   | 151 |   |
| Company-owned  sold to franchisee   |       | 13                                                |       | 13 |   | — |   | — |   | — |   | — |   |
| New  restaurants opened             |       | —                                            |       | 2 |   | 2 |   | 2 |   | 4 |   | 6 |   |
| Restaurants  permanently closed     |       | 1                                                 |       | 2 |   | 3 |   | 4 |   | 9 |   | 13 |   |
| **Restaurants at end of period**    | ** ** | **85**                                            | ** ** | **59** | ** ** | **144** | ** ** | **99** | ** ** | **45** | ** ** | **144** | ** ** |

 

As of September 27,2010, there were 85 Company-owned and 59 franchised premium conveniencerestaurants operating in 18 states, the District of Columbia, and the UnitedArab Emirates (“UAE”). During the three months ended September 27, 2010,one new franchised restaurant opened at Logan Airport in Boston and we closedone underperforming Company-owned restaurant in Great Neck, New York. Duringthe nine months ended September 27, 2010, we sold thirteen Company-ownedrestaurants in the District of Columbia to a franchisee (see Note 9), openedtwo new franchised restaurants which included one location in the UAE and onelocation at Logan Airport. We closed one Company-owned restaurant in GreatNeck, New York and one franchised restaurant in the UAE and one in Minnesota.Subsequent to the end of the third quarter of 2010, we closed oneunderperforming Company-owned restaurant in Darien, Connecticut.

 

Our restaurants offerinnovative, savory, made-to-order products featuring our authentic hearth-bakedcrackly crust signature Cosi bread and fresh distinctive ingredients. Wemaintain a pipeline of new menu offerings that are introduced seasonallythrough limited time offerings to keep our products relevant to our targetcustomers. Our menu features high-quality sandwiches, freshly-tossed salads,Cosi Squagels®, hot melts, flatbread pizzas, S’mores and other desserts, and avariety of coffees along with other soft drink beverages, bottled beveragesincluding premium still and sparkling water, teas, alcoholic beverages, andother specialty coffees and beverages. Our restaurants offer lunch andafternoon coffee in a counter-service format, with most offering breakfast and/ordinner and dessert menus as well. We operate our Company-owned restaurants intwo formats: Cosi and Cosi Downtown. Cosi Downtown 

 

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restaurants, which arelocated in nonresidential central business districts, close for the day in theearly evening, while Cosi restaurants offer dinner and dessert in a casualdining atmosphere.

 

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

 

Webelieve that offering Cosi® franchised restaurants to area developers andindividual franchisees offers the prospects of strong financial returns. Byfranchising, we believe we will be able to increase the presence of ourrestaurants in various markets throughout the country and generate additionalrevenue without the large upfront capital commitments and risk associated withopening Company-owned restaurants.

 

We believe thatincorporating a franchising and area developer model into our strategy willposition us to maximize the market potential for the Cosi® brand and conceptconsistent with our available capital, and we expect that Company-ownedrestaurants (restaurants that we own as opposed to franchised restaurants) willalways be an important part of our new restaurant growth.

 

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

 

Recent Developments

 

*Rights Offering and PrivatePlacement of Common Stock*

 

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

 

*Sale of Restaurants*

 

On April 27, 2010, wecompleted the sale of thirteen restaurants and related assets in theWashington, D.C. market to Capitol C Restaurants LLC (“Capitol C”) for $8.35million. The sale was made pursuant to an Asset Purchase and SaleAgreement dated April 27, 2010, by and among the Company, Cosi SandwichBar, Inc., a wholly-owned subsidiary of the Company, Capitol C and CapitolC Holdings LLC (“Holdings”), the parent company of Capitol C. Therestaurants will be operated under franchise agreements between the Company andCapitol C, and Holdings has entered into a development agreement to open sixadditional Cosi restaurants in the District of Columbia area. Under the termsof the Asset Purchase and Sale Agreement, $6.4 million of the purchase pricewas paid in cash at closing and $1.35 million is payable to Cosi under asubordinated secured promissory note and will be paid in 120 weeklyinstallments, commencing January 2011, based on a percentage of net sales,with a final balloon payment for the balance of the note due on May 2013.The balance of $0.6 million is being held in escrow and will be paid to Cosiwhen Capitol C achieves a certain sales target at any time during thethree-year period following the closing date of the transaction. Disbursementfrom the escrow, either in full or in part, is based on a formula that comparesthen-current trailing twelve-month sales to a sales baseline and applies theresulting percentage to the escrow amount. The disbursement calculation can beapplied up to three times at Cosi’s sole discretion over the three year period.

 

As a result of this sale, wedisposed of approximately $3.0 million in net furniture, fixtures, equipmentand leasehold improvements, and recognized a gain on the sale of assets ofapproximately $5.1 million during the second quarter of fiscal 2010, includingapproximately $0.3 million in unamortized landlord allowances and reversal ofstraight line rent expense. We will recognize an additional gain from the saleof these assets at the time that the disbursement, either in full or in part,is made to us from the $0.6 million held in escrow. In addition, as a result ofthis sale, our cash position increased by $6.4 million, other non-currentassets and current receivables increased by approximately $1.2 million and$0.15 million, respectively, due to the $1.35 million promissory note.

 

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Our2009 net restaurant sales from the thirteen restaurants sold in D.C. wereapproximately $18.7 million with related restaurant-level operating costs andexpenses of approximately $16.1 million. Additionally, there was $1.4 millionof depreciation and amortization associated with these restaurants and $0.9million of general and administrative costs. Had the sale of these restaurantsoccurred on the first day of our fiscal 2009, and assuming these restaurantsgenerated the same level of sales when operated by Capitol C, the franchiseroyalty income recognized from these thirteen restaurants would have beenapproximately $0.9 million for fiscal 2009. This would have resulted in a reductionin our fiscal 2009 net loss of approximately $0.6 million.

 

*Regaining Compliance with NASDAQListing Standards*

 

On November 4, 2010 wereceived notice from the Listing Qualifications Department of The NASDAQ StockMarket that we have regained compliance with the NASDAQ Listing Standards bycuring the minimum bid price deficiency. As of November 3, 2010, the bidprice of our common stock had closed at or above the $1.00 minimum requirementfor the last 10 consecutive business days. We now meet all continued listingstandards for the NASDAQ Global Market.

 

**CRITICAL ACCOUNTING POLICIES**

 

Thepreparation of the consolidated financial statements in conformity withaccounting principles generally accepted in the United States of America (“USGAAP”) requires the appropriate application of certain accounting policies,many of which require us to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenue and expenses during the reporting period. Actualresults may differ from those estimates.

 

Webelieve the application of our accounting policies, and the estimates inherently required therein, are reasonable and generallyaccepted for companies in the restaurant industry. We believe that thefollowing addresses the more critical accounting policies used in thepreparation of our consolidated financial statements and require management’smost difficult and subjective judgments, often as a result of the need to makeestimates about the effect of matters that are inherently uncertain.

 

*Long Lived Assets*: ASC 360-10-35Property, Plant, & Equipment requires management judgments regardingthe future operating and disposition plans for marginally-performing assets,and estimates of expected realizable values for assets to be sold. Theapplication of this standard has affected the amount and timing of charges tooperating results that have been significant in recent years. We evaluatepossible impairment at the individual restaurant level periodically and recordan impairment loss whenever we determine impairment factors are present. Weconsider a history of poor financial operating performance to be the primaryindicator of potential impairment for individual restaurant locations. Wedetermine whether a restaurant location is impaired based on expectedundiscounted cash flows, generally for the remainder of the lease term, andthen determine the impairment charge based on discounted cash flows for thesame period. Restaurants are not considered for impairment during the “ramp-up”period before they enter the comparable restaurant base, unless specificcircumstances warrant otherwise.

 

*Lease Termination Charges*: ASC 820-30Exit or Disposal Cost Obligations requires companies to recognize costsassociated with exit or disposal activities when they are incurred, rather thanat the end of a commitment to an exit or disposal plan. For all exitactivities, we estimate our likely liability under contractual leases forrestaurants that have been closed. Such estimates have affected the amount andtiming of charges to operating results and are impacted by management’sjudgments 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 negotiatedwith the landlord.

 

*Accounting for Lease Obligations*: In accordancewith ASC 840-25 Leases, we recognize rent expense on a straight-line basis overthe lease term commencing on the date we take possession. We include any rentescalations, rent abatements during the construction period and any other rentholidays in our straight-line rent expense calculation.

 

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*Landlord Allowances*: In accordancewith ASC 840-25 Leases, we record landlord allowances as deferred rent in otherlong-term liabilities on the consolidated balance sheets and amortize them on astraight-line basis over the term of the related leases.

 

*Stock-Based Compensation Expense*:  In accordance with ASC 718-10-25 Compensation— Stock Compensation, we recognize stock-based compensation expense accordingto the fair value recognition provision, which generally requires, among otherthings, that all employee share-based compensation is measured using a fairvalue method and that all the resulting compensation expense is recognized inthe financial statements.

 

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

 

We estimate stock optionforfeitures in calculating the expense relating to stock-based compensation.The expected volatility is based on an average of the historical volatility ofthe Company’s stock, the implied volatility of market options, peer companyvolatility, and other factors. The average expected life represents the periodof time that stock option grants are expected to be outstanding and is derivedfrom historical terms and other factors. The risk-free interest rate is based on the rate of U.S. Treasuryzero-coupon issues with remaining term equal to the expected life of stockoption grants.

 

*Income Taxes*: We have recordeda full valuation allowance to reduce our deferred tax assets that relateprimarily to net operating loss carryforwards. Our determination of thevaluation allowance is based on an evaluation of whether it is more likely thannot that we will be able to utilize the net operating loss carryforwards basedon the Company’s operating results. A positive adjustment to income will berecorded in future years if we determine that we could realize these deferredtax assets.

 

We have adopted theprovisions of ASC 740-10 Income Taxes beginning in fiscal 2007. No adjustmentwas made to the beginning retained earnings balance, as the ultimatedeductibility of all tax positions is highly certain but there is uncertaintyabout the timing of such deductibility. No interest or penalties have beenaccrued relative to tax positions due to the Company having either a tax lossor net operating loss carryforwards to offset any taxable income in all subjectyears. As a result, no liability for uncertain tax positions has been recorded.

 

REVENUE

 

*Restaurant Net Sales.*OurCompany-owned and operated restaurant sales are composed almost entirely offood and beverage sales. We record revenue at the time of purchase of ourproducts by our customers.

 

*Franchise Fees and Royalties.*Franchise feesand royalties includes fees earned from franchise agreements entered into witharea developers and franchise operators as well as royalties received based onsales generated at franchised restaurants. We recognize the franchise fee inthe period in which a franchise restaurant opens or when fees are forfeited asa result of termination of an area development agreement. We recognizefranchise royalties in the period in which sales are made by our franchiseoperators.

 

*Gift Card Sales*. We offer ourcustomers the opportunity to purchase gift cards at our restaurants and throughour website. Customers can purchase these cards at varying dollar amounts. Atthe time of purchase of the card, we record a gift card liability for the facevalue of the card purchased. We recognize the revenue and reduce the gift cardliability when the gift card is redeemed. We do not reduce our recordedliability for potential non-use of purchased gift cards.

 

COMPARABLE RESTAURANT SALES

 

In calculating comparablerestaurant sales, we include a restaurant in the comparable restaurant baseafter it has been in operation for 15 full months. We remove from thecomparable restaurant base any restaurant that is temporarily shut down forremodeling for a complete period in the period that it is shut down. 

 

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As of September 27,2010 and September 28, 2009, there were 84 and 97 restaurants in ourcomparable restaurant base, respectively.

 

COSTS AND EXPENSES

 

*Cost ofFood and Beverage.*Cost of food and beverage is comprised of food andbeverage costs. Food and beverage costs are variable and increase with salesvolume.

 

*Restaurant Labor and RelatedBenefits.* The costs of labor and related benefits includedirect hourly and management wages, bonuses, payroll taxes, health insuranceand all other fringe benefits.

 

*Occupancyand Other Restaurant Operating Expenses.*  Occupancy and other operating expensesinclude direct restaurant level operating expenses, including the cost of paperand packaging, supplies, restaurant repairs and maintenance, utilities, rentsand related occupancy costs.

 

*Generaland Administrative Expenses.* General and administrativeexpenses include all corporate and administrative functions that support ourrestaurants and provide an infrastructure to operate our business. Componentsof these expenses include executive management costs; supervisory and staffsalaries; non-field stock-based compensation expense; non-field bonuses andrelated taxes and employee benefits; travel; information systems; training;support center rent and related occupancy costs; and professional andconsulting fees. The salaries, bonuses and employee benefits costs included asgeneral and administrative expenses are generally more fixed in nature and donot vary directly with the number of restaurants we operate. Stock-basedcompensation expense includes the charges related to recognizing the fair valueof stock options and restricted stock as compensation for awards to certain keyemployees and non-employee directors, except the costs related to stock-basedcompensation for restaurant employees which are included in restaurant laborand related benefits.

 

*Depreciationand Amortization.* Depreciation and amortization consists principallyof depreciation and amortization of restaurant assets.

 

*RestaurantPre-opening Expenses.* Restaurant pre-opening expenses, which areexpensed as incurred, include the costs of recruiting, hiring and training theinitial restaurant work force, travel, the cost of food and labor used duringthe period before opening, the cost of initial quantities of supplies and otherdirect costs related to the opening or remodeling of a restaurant. Pre-openingexpenses also include rent expense recognized on a straight-line basis from thedate we take possession through the period of construction, renovation andfixturing prior to opening the restaurant.

 

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**RESULTS OF OPERATIONS**

 

Our operating results forthe three and nine-month periods ended September 27, 2010 and September 28,2009, expressed as a percentage of total revenues (except where otherwisenoted), were as follows:

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **September 27,  2010**     | ** ** | **September 28,  2009**    | ** ** | **September 27,  2010** | ** ** | **September 28,  2009** | ** ** |
|                                                     |       |                             |       |                            |       |   |   |   |   |
| Revenues:                                                |       |                             |       |                            |       |   |   |   |   |
| Restaurant  net sales                                    | ** ** | **97.1**                         | **%**      | 98.3                            | %          | **97.2** | **%** | 98.2 | % |
| Franchise  fees and royalties                            | ** ** | **2.9**                          |       | 1.7                             | ** ** | **2.8** |   | 1.8 |   |
| Total  revenues                                          | ** ** | **100.0**                        |       | 100.0                           | ** ** | **100.0** |   | 100.0 |   |
| Cost  and expenses:                                      |       |                             |       |                            |       |   |   |   |   |
| Cost  of food and beverage (1)                           | ** ** | **22.2**                         |       | 23.2                            | ** ** | **22.8** |   | 22.6 |   |
| Restaurant  labor and related benefits (1)               | ** ** | **36.8**                         |       | 37.4                            | ** ** | **37.8** |   | 36.8 |   |
| Occupancy  and other restaurant operating expenses (1)   | ** ** | **31.3**                         |       | 31.9                            | ** ** | **31.7** |   | 31.1 |   |
|                                                     | ** ** | **90.3**                         |       | 92.5                            | ** ** | **92.3** |   | 90.5 |   |
| General  and administrative expenses                     | ** ** | **11.6**                         |       | 11.4                            | ** ** | **12.0** |   | 12.1 |   |
| Depreciation  and amortization                           | ** ** | **4.0**                          |       | 5.7                             | ** ** | **4.4** |   | 6.0 |   |
| Provision  for losses on asset impairments and disposals | ** ** | **0.3**                          |       | —                          | ** ** | **0.4** |   | 0.3 |   |
| Lease  termination expense and closed store costs        | ** ** | **0.6**                          |       | —                          | ** ** | **0.2** |   | 0.2 |   |
| Gain  on sale of assets                                  | ** ** | **(0.2**                         | **)**      | —                          | ** ** | **(6.2** | **)** | — |   |
| Total  costs and expenses                                | ** ** | **104.0**                        |       | 108.1                           | ** ** | **100.4** |   | 107.4 |   |
| Operating  loss                                          | ** ** | **(4.0**                         | **)**      | (8.1                            | )          | **(0.4** | **)** | (7.4 | ) |
| Interest  income                                         | ** ** | **—**                       |       | —                          | ** ** | **—** |   | — |   |
| Interest  expense                                        | ** ** | **—**                       |       | —                          | ** ** | **—** |   | — |   |
| Other  income                                            | ** ** | **—**                       |       | 0.2                             | ** ** | **—** |   | 0.1 |   |
| Net  loss                                                | ** ** | **(4.0**                         | **)%**     | (7.9                            | )%         | **(0.4** | **)%** | (7.3 | )% |

 

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

 

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**Restaurant Net Sales**

 
| ** **                                  | ** ** | **Restaurant net sales** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**            | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                                  | 26,341     |   | 97.1 | % |
| Three  months ended September 28, 2009 |       | $                                  | 29,528     |   | 98.3 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                  | 82,004     |                          | 97.2       | % |
| Nine  months ended September 28, 2009 |       | $                  | 88,667     |                          | 98.2       | % |

 

*Restaurant net sales.*  Restaurant net sales decreased 10.8%, orapproximately $3.2 million, in the three months ended September 27, 2010,as compared to the same period of fiscal 2009, due to an approximately $4.9million decrease in net restaurant sales from the thirteen Company-ownedrestaurants that were sold to a franchisee during the second quarter of fiscal2010, partially offset by an approximately $1.6 million, or 6.6%, increase innet sales in our comparable restaurant base and approximately $0.1 million innet sales at one new restaurant not yet in its sixteenth month in operation asof September 27, 2010. The 6.6% increase in comparable restaurant netsales in the three months ended September 27, 2010 was comprised of 3.7%increase in traffic and 2.9% increase in average check.

 

In the nine months ended September 27,2010, restaurant net sales decreased 7.5%, or approximately $6.7 million, ascompared to the nine months ended September 28, 2009, due to anapproximately $8.3 million decrease in net restaurant sales from the thirteenCompany-owned restaurants that were sold to a franchisee in the second quarterof fiscal 2010 and an approximately $0.4 million decrease in net sales relatedto Company-owned restaurants closed during and subsequent to the first quarterof 2009, partially offset by an approximately $1.3 million, or 1.7%, increasein net sales in our comparable restaurant base and approximately $0.7 millionin net sales at two new restaurants not yet in their sixteenth month inoperation for the full nine-month period ended September 27, 2010. The1.7% increase in comparable restaurant net sales in the nine months ended September 27,2010 was comprised of 1.5% increase in average check price and 0.2% increase intraffic. Comparable net restaurant sales for the nine months ended September 27,2010 were adversely impacted in the month of February by severe winterweather across the mid-Atlantic and northeast regions where we have a highconcentration of Company-owned restaurants.

 

**Franchise Fees and Royalties**

 
| ** **                                  | ** ** | **Franchise fees and royalties** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                         | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                                               | 782        |   | 2.9 | % |
| Three  months ended September 28, 2009 |       | $                                               | 505        |   | 1.7 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                  | 2,340      |                          | 2.8        | % |
| Nine  months ended September 28, 2009 |       | $                  | 1,668      |                          | 1.8        | % |

 

*Franchise fees and royalties.*  In the three and nine months ended September 27,2010, franchise fees and royalties increased by 54.8% and 40.2%, respectively,or approximately $0.3 million and $0.7 million in each respective period, toapproximately $0.8 million and $2.3 million, respectively, as compared to thethree and nine months ended September 28, 2009, due primarily to the $0.4million increase in royalties from the thirteen Company-owned restaurants inD.C. sold to a franchisee in the second quarter of 2010 as well as due to the$0.2 million increase in franchise fees resulting from a canceled areadevelopment agreement.

 

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**Costs and Expenses**

 
| ** **                                  | ** ** | **Cost of food and beverage** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                                | ** ** | **as a % of restaurant  net sales** | ** ** |
| Three  months ended September 27, 2010 |       | $                                                 | 5,835      |   | 22.2 | % |
| Three  months ended September 28, 2009 |       | $                                                 | 6,858      |   | 23.2 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of restaurant  net sales** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                  | 18,730     |                                | 22.8       | % |
| Nine  months ended September 28, 2009 |       | $                  | 20,011     |                                | 22.6       | % |

 

*Cost of food and beverage*.  The decrease in cost of food and beverage asa percentage of restaurant net sales in the three-month period ended September 27,2010, as compared to the same period of fiscal 2009, is due primarily to thefavorable impact on cost of goods of the price increase taken at the end of thesecond quarter of fiscal 2010, as well as advantageous pricing obtained oncertain commodities, partially offset by the impact on total menu mix of anincrease in sale of breakfast items which carry a higher cost of goods as apercentage of net sales when compared to items sold during our lunch and dinnerday parts.

 

For the nine-month periodended September 27, 2010, cost of food and beverage as a percentage ofrestaurant net sales was slightly higher compared to the same period of fiscal2009 due primarily to certain new products and limited-time offerings that wereintroduced in the latter half of 2009 which had higher than average costs as apercent of sales, partially offset by the favorable impact of the priceincrease taken at the end of the second quarter of fiscal 2010 as well assavings achieved on purchases of certain commodities.

 
| ** **                                  | ** ** | **Restaurant labor and related benefits** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                                       | ** ** | **as a % of restaurant  net sales** | ** ** |
| Three  months ended September 27, 2010 |       | $                                                             | 9,684      |   | 36.8 | % |
| Three  months ended September 28, 2009 |       | $                                                             | 11,043     |   | 37.4 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of restaurant  net sales** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|--------------------------------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                       | 30,979     |                                                         | 37.8       | % |
| Nine  months ended September 28, 2009 |       | $                       | 32,592     |                                                         | 36.8       | % |

 

*Restaurant labor and relatedbenefits*.  Thedecrease in restaurant labor and related benefits as a percentage of restaurantnet sales in the three months ended September 27, 2010, as compared to thesame period of fiscal 2009, is largely due to the leveraging effect on thefixed portion of manager salaries and hourly labor of the increase incomparable net restaurant sales as well as the favorable impact on labor of theprice increase taken at the end of the second quarter of fiscal 2010, partiallyoffset by the ramp-up stage sales, during the extended evening and weekendrestaurant operating hours that we put in place during the second quarter of2010 and the deployment of labor to support the growth of our breakfast daypart and catering.

 

In the nine months ended September 27,2010, the increase in restaurant labor and related benefits as a percentage ofrestaurant net sales, as compared to the same period of fiscal 2009, isprimarily due to the impact on hourly labor of extended evening and weekendoperating hours in certain restaurants as well as the deployment of labor tosupport the growth of our breakfast day part and catering, partially offset bythe leveraging effect of the increase in comparable restaurant sales and thefavorable impact on labor of the price increase taken at the end of the secondquarter.

 

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| ** **                                  | ** ** | **Occupancy and other restaurant  operating expenses** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                                                    | ** ** | **as a % of restaurant  net sales** | ** ** |
| Three  months ended September 27, 2010 |       | $                                                                          | 8,257      |   | 31.3 | % |
| Three  months ended September 28, 2009 |       | $                                                                          | 9,412      |   | 31.9 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of restaurant  net sales** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                  | 26,005     |                                | 31.7       | % |
| Nine  months ended September 28, 2009 |       | $                  | 27,607     |                                | 31.1       | % |

 

*Occupancy and other restaurantoperating expenses*.  Thedecrease in occupancy and other restaurant operating expenses, as a percentageof restaurant net sales, in the three months ended September 27, 2010, ascompared to the same periods of fiscal 2009, is due primarily to the leveragingeffect on fixed occupancy expenses of the increase in comparable restaurant netsales, as well as a reduction in restaurant paper and packaging costs as apercentage of restaurant net sales.

 

The increase in occupancyand other restaurant operating expenses, as a percentage of restaurant netsales, in the nine months ended September 27, 2010, as compared to thesame period of fiscal 2009 is primarily due to higher costs for repairs andmaintenance of existing Company-owned restaurants.

 
| ** **                                  | ** ** | **General and administrative expenses** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                                     | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                                                      | 3,156      |   | 11.6 | % |
| Three  months ended September 28, 2009 |       | $                                                      | 3,441      |   | 11.4 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                  | 10,108     |                          | 12.0       | % |
| Nine  months ended September 28, 2009 |       | $                  | 10,916     |                          | 12.1       | % |

 

*General and administrativeexpenses*.  Thedecrease in general and administrative expenses of approximately $0.3 millionin the three months ended September 27, 2010, as compared to the sameperiod of fiscal 2009, is due primarily to the savings resulting fromadministrative workforce reductions that occurred during fiscal 2009, thereduction in cost of third-party information technology services and lowerlegal fees, partially offset by the higher costs associated with production andadvertising media expenses associated with our new marketing initiatives.

 

The decrease in general andadministrative expenses of approximately $0.8 million in the nine months ended September 27,2010, as compared to the same period of fiscal 2009, was primarily due to laborsavings resulting from administrative workforce reductions that occurred duringfiscal 2009, higher board fees in the same period of fiscal 2009 associatedwith the work of the special committee established to review strategicalternatives, the reduction in cost of third-party information technologyservices and lower legal fees, partially offset by the higher costs associatedwith production and advertising media expenses associated with our newmarketing initiatives.

 

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| ** **                                  | ** ** | **Depreciation and amortization** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                     | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                                           | 1,096      |   | 4.0 | % |
| Three  months ended September 28, 2009 |       | $                                           | 1,701      |   | 5.7 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                       | 3,672      |                                         | 4.4        | % |
| Nine  months ended September 28, 2009 |       | $                       | 5,444      |                                         | 6.0        | % |

 

*Depreciation and amortization*.  The decrease in depreciation and amortizationexpense in the three and nine-month periods ended September 27, 2010, ascompared to the same periods of fiscal 2009, is due primarily to the impact ofimpairments recorded during and subsequent to the third quarter of fiscal 2009,the continued depreciation and amortization of our comparable restaurant baseand the retirement of assets with approximately $3.0 million in book value as aresult of the sale of the thirteen Company-owned restaurants in D.C. to afranchisee during the second quarter of fiscal 2010.

 
| ** **                                  | ** ** | **Provision for losses on asset impairments  and disposals** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                                                                    | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                                                                                          | 88         |   | 0.3 | % |
| Three  months ended September 28, 2009 |       | $                                                                                          | —     |   | — |   |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|---------------------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                       | 300        |                                              | 0.4        | % |
| Nine  months ended September 28, 2009 |       | $                       | 238        |                                              | 0.3        | % |

 

*Provision for losses on assetimpairments and disposals*.  Inthe three-month period ended September 27, 2010, we recorded an assetimpairment charge of approximately $0.1 million related to maintenance capitalexpenditures on previously impaired restaurants. In the nine-month period endedSeptember 27, 2010, we recorded an asset impairment charge ofapproximately $0.3 million related to two underperforming restaurants. Theimpairment charge of $0.2 million in the nine months ended September 28,2009 was related to one underperforming restaurant in the Chicago area.

 
| ** **                                  | ** ** | **Lease termination expense and closed  store costs** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                                                        | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                                                                              | 172        |   | 0.6 | % |
| Three  months ended September 28, 2009 |       | $                                                                              | —     |   | — |   |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|---------------------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                       | 184        |                                              | 0.2        | % |
| Nine  months ended September 28, 2009 |       | $                       | 252        |                                              | 0.2        | % |

 

*Lease termination expense*.  The lease termination charges in the threeand nine-month periods ended September 27, 2010 are related to tworestaurants where we have reached early termination agreements with thelandlords to exit the leases. The lease termination charge in the nine-monthperiod ended September 28, 2009 was related to an underperformingrestaurant in the Midwest region where we reached an early exit agreement withthe landlord.

 

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| ** **                                  | ** ** | **Gain on sale of assets** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                  | ** ** | **(in thousands)**                        | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                                              | 59         |   | 0.2 | % |
| Three  months ended September 28, 2009 |       | $                                              | —     |   | — |   |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                       | 5,266      |                                         | 6.2        | % |
| Nine  months ended September 28, 2009 |       | $                       | —     |                                         | —     |   |

 

*Gain on sale of assets*.  The gain on sale of assets recognized in thethree months ended September 27, 2010 of approximately $0.1 million wasdue to the sale of a liquor license. The gain on sale of assets in the ninemonths ended September 27, 2010 was due to the sale of the thirteenCompany-owned restaurants in D.C. to a franchisee (see Note 9). An additionalgain of $0.1 million was recognized related to the sale of a liquor licenses.No gain on sale of assets was recognized in the three and nine months ended September 28,2009.

 
| ** **                                  | ** ** | **Net loss**       | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
| Three  months ended September 27, 2010 |       | $                       | 1,096      |   | 4.0 | % |
| Three  months ended September 28, 2009 |       | $                       | 2,362      |   | 7.9 | % |

 
| ** **                                 | ** ** | **(in thousands)** | ** ** | **as a % of total  revenues** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|
| Nine  months ended September 27, 2010 |       | $                       | 357        |                                         | 0.4        | % |
| Nine  months ended September 28, 2009 |       | $                       | 6,657      |                                         | 7.3        | % |

 

*Net loss.*  The net loss for the three months ended September 27,2010 decreased to a net loss of approximately $1.1 million compared to a netloss for the three months ended September 28, 2009 of approximately $2.4million due primarily to the improvement in restaurant operating margins, thereduction in general and administrative expenses and the higher franchise feesand royalties.

 

The net loss for the ninemonths ended September 27, 2010 decreased to a net loss of approximately$0.4 million compared to a net loss for the nine months ended September 28,2009 of approximately $6.7 million due primarily to the gain on the sale ofassets from the thirteen Company-owned restaurants in D.C. to a franchisee, thereduction in general and administrative expenses and the higher franchise feesand royalties.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

Cash and cash equivalentswere approximately $11.5 million on September 27, 2010, compared to $4.1million on December 28, 2009. We had positive working capital ofapproximately $2.8 million on September 27, 2010, compared to negativeworking capital of $5.6 million on December 28, 2009. The increase inworking capital as of September 27, 2010 is primarily due to the $6.4million cash proceeds from the sale of the thirteen Company-owned restaurantsin the District of Columbia to a franchisee (see Note 9), as well as the netproceeds of $4.9 million from our rights offering and related private placementof common stock (see Note 10), partially offset by the funding of the operatingloss for the nine-month period ended September 27, 2010. Our principalrequirements for cash in the remainder of 2010 will be for working capitalneeds and routine maintenance of our existing restaurants.

 

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Net cash used in operatingactivities in the nine-month period ended September 27, 2010 wasapproximately $3.3 million, compared to $0.4 million of net cash used inoperating activities in the nine-month period ended September 28, 2009.The increase in cash used in operating activities in the first nine months of fiscal2010 was primarily the result of funding the higher year-over-year operatingloss, net of depreciation expense and gain on sale of restaurants (see Note 9),as well as the payment of certain lease termination and legal settlementobligations and the timing of vendor payments.

 

The cash provided byinvesting activities in the nine-month period ended September 27, 2010 wasapproximately $5.8 million and resulted primarily from the sale of the thirteenCompany-owned restaurants in D.C. to a franchisee (see Note 9), partiallyoffset by payments for capital expenditure.

 

The cash provided byfinancing activities in the nine-month period ended September 27, 2010 ofapproximately $4.9 million was from proceeds associated with the shareholderrights offering and the private placement of shares to our executive officersand outside directors completed in January 2010 (see Note 10).

 

We do not have any currentplans to open additional Company-owned restaurants during the remainder offiscal 2010. However, we will continue to seek out and evaluate opportunitiesto develop new Company-owned locations in existing markets. We do expect toincur capital maintenance costs on existing Company-owned restaurants duringthe remainder of fiscal 2010. As we currently have no credit facility oravailable line of credit, we expect to fund any required capital maintenancecosts on existing Company-owned locations or required capital for newrestaurant development, if any, from cash and cash equivalents on hand,expected cash flows generated by existing Company-owned restaurants, andexpected franchise fees and royalties.

 

We believe that our currentcash and cash equivalents and the expected cash flows from Company-ownedrestaurant operations and expected franchise fees and royalties will besufficient to fund our cash requirements for working capital needs andmaintenance of existing restaurant locations for the next twelve months and fornew Company-owned restaurant development, if any. Our conclusion is based onour expected performance for fiscal 2010 and includes a sensitivity analysisthat projects varying levels of decline in consumer demand. The range of levelsselected was based on our reasonable expectation of demand given theseasonality of our historical performance and the potential impact the currenteconomic environment may have on consumer spending. In analyzing our capitalcash outlays in the nine-month periods ended September 27, 2010 and September 28,2009, 62.7% and 65.0%, respectively, of our capital expenditures were spent onrepairs and maintenance associated with existing Company-owned locations. Wecurrently do not expect significant levels of cash outlays for capitalexpenditures during the remainder of fiscal 2010.

 

If our Company-ownedrestaurants do not generate the cash flow levels that we expect, if newfranchised restaurants do not open according to our expectations, if we do notgenerate the franchise fees and royalties that we currently expect, if we incursignificant unanticipated cash requirements beyond our normal liquidity needs,or if we experience other unforeseen circumstances then, in order to fund ourcash requirements, we may have to cease new Company-owned restaurantdevelopment efforts and may have to effect further labor reductions in generaland administrative support functions, seek to sell certain Company-ownedlocations to franchisees and/or other third parties, seek other sources offinancing or take other actions necessitated by the impact of suchunanticipated circumstances.

 

There can be no assurancethat we will be able to obtain such financing or sell Company-owned locationsto franchisees or other third parties or that we will be able to do so in atimely manner and on acceptable terms to meet our requirements. Given thecontinued instability in the credit and financial markets, it may be difficultfor the Company to obtain additional financing and for franchisees to obtainthe financing necessary to open restaurants or to acquire Company-ownedlocations. An inability to access additional sources of liquidity to fund ourcash needs could materially adversely affect our financial condition andresults of operations.

 

We have entered intoagreements that create contractual obligations. These obligations will have an impact on future liquidity and capitalresources. The table below presents a summary of these obligations as of September 27,2010:

 

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| ** **                             | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------------|------------|-------------------------------------------|------------|
| ** **                             | ** ** | **(in thousands)**                   | ** ** |
| ** **                             | ** ** | ** **                                | ** ** | ** ** | ** ** | **Due** | ** ** | **Due** | ** ** | **Due** | ** ** |
| ** **                             | ** ** | **Total**                                 | ** ** | **Due** | ** ** | **Fiscal 2011** | ** ** | **Fiscal 2013** | ** ** | **After** | ** ** |
| **Description**                        | ** ** | **Obligations**                           | ** ** | **Fiscal 2010** | ** ** | **to Fiscal 2012** | ** ** | **to Fiscal 2014** | ** ** | **Fiscal 2014** | ** ** |
|                                   |       |                                      |       |   |   |   |   |   |   |   |   |
| **Long-term debt (1)**                 | ** ** | **$**                                     | **50**     |   | $ | 25 |   | $ | 25 |   | $ | — |   | $ | — |   |
| **Operating leases (2)**               | ** ** | **59,674**                                |       | 3,520 |   | 26,471 |   | 17,863 |   | 11,820 |   |
| **Other long-term liabilities (3)**    | ** ** | **1,075**                                 |       | 391 |   | 684 |   | — |   | — |   |
|                                   |       |                                      |       |   |   |   |   |   |   |   |   |
| **Total contractual cash obligations** | ** ** | **$**                                     | **60,799** |   | $ | 3,936 |   | $ | 27,180 |   | $ | 17,863 |   | $ | 11,820 |   |

 

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(1)     Amounts showninclude aggregate scheduled interest payments of $0.01 million. The pricipalamount of the debt, net of interest obligations, is included in the otherlong-term liabilities, in the attached consolidated balance sheets. Thisobligation is related to a trademark infringement settlement.

(2)     Amounts shownare net of an aggregate $0.03 million of sub-lease rental income due undernon-cancelable subleases and include aggregate accrued contractual leaseincreases of approximately $3.6 million, which are included in other long-termliabilities in the attached consolidated balance sheets.

(3)     Theseobligations are related to contractual obligations for lease terminationagreements and for an obligation related to a legal settlement. Theseobligations are non-interest bearing and are included in other long-termliabilities in the attached consolidated balance sheets.

 

We are obligated undernon-cancelable operating leases for our restaurants and our administrativeoffices. Lease terms are generally ten years with renewal options and generallyrequire us to pay a proportionate share of real estate taxes, insurance andcommon area and other operating costs. Some restaurant leases provide forcontingent rental payments which are not included in the above table.

 

Certain of our leaseagreements provide for scheduled rent increases during the lease term or forrental payments to commence at a date other than the date of initial occupancy.Rent expense is recognized on a straight-line basis over the term of therespective lease from the date we take possession. Our obligation with respectto these scheduled rent increases has been presented as a long-term liabilityin other liabilities in the accompanying consolidated balance sheets andtotaled $3.6 million and $4.5 million as of September 27, 2010 and September 28,2009, respectively.

 

Certainof our leases also provide for landlord contributions to offset a portion ofthe cost of our leasehold improvements. These allowances are recorded asdeferred liabilities and amortized on a straight-line basis as a reduction torent expense over the term of the related leases. Included in other long-termliabilities in the accompanying consolidated balance sheets as of September 27,2010 and September 28, 2009 were landlord allowances of approximately $0.9million and $1.3 million, respectively.

 

As of September 27,2010, the Company had outstanding approximately $0.2 million in standby lettersof credit, which were provided as security deposits for certain of the leaseobligations. The letters of credit are fully secured by cash deposits ormarketable securities held in accounts at the issuing banks and are notavailable for withdrawal by the Company. These amounts are included as acomponent of “Intangibles, Security Deposits and Other Assets” in theaccompanying consolidated balance sheets.

 

In fiscal 2001, we enteredinto a settlement agreement involving a trademark dispute. The settlementagreement requires us to make annual payments of approximately $0.03 millionthrough 2011. The estimated present value of those future payments is includedin other liabilities in the accompanying consolidated balance sheets.

 

During fiscal 2008, weentered into a settlement agreement involving a claim from a former employee.The settlement agreement requires us to pay $0.3 million in an initial paymentduring the first quarter of fiscal 2009 and another $1.0 million in theaggregate in non-interest bearing monthly installments thereafter through 2012.The amount of this settlement is included in other liabilities in theaccompanying consolidated balance sheets.

 

During fiscal 2009, weentered into a settlement agreement involving a customer claim alleging damagesunder the American with Disabilities Act with regard to access at ourrestaurants. 

 

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The settlement requires usto pay $0.08 million in the aggregate in non-interest bearing quarterlyinstallments commencing in fiscal 2010 through fiscal 2012. The amount of thissettlement is included in other liabilities in the accompanying consolidatedfirst quarter of 2010 balance sheets.

 

**PURCHASE COMMITMENTS**

 

We have an agreement withDistribution Market Advantage, Inc that provides us access to a nationalnetwork of independent distributors. Under this agreement the independentdistributors supply us with approximately 78% of our food and paper products,primarily under pricing agreements that we negotiate directly with thesuppliers. This agreement was renegotiated and has been extended through December 2013.

 

We have a long-term beveragemarketing agreement with the Coca-Cola Company. We received a marketingallowance under this agreement, which is being recognized as a reduction toexpense ratably based on actual products purchased. Although we are eligible toreceive additional amounts under the agreement if certain purchase levels areachieved, no additional amounts have been received or recorded as of September 27,2010. During the fourth quarter of fiscal 2009 we amended the marketingagreement with the Coca-Cola Company to include additional products and higherper unit amounts are now being applied against the marketing allowance.

 

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

 

**SELF-INSURANCE**

 

We have a self-insured grouphealth insurance plan. We are responsible for all covered claims to a maximumliability of $100,000 per participant during a plan year. Benefits paid inexcess of $100,000 per participant are reimbursed to the plan under ourstop-loss policy. In addition, we have an aggregate stop-loss policy wherebyour liability for total claims submitted cannot exceed a pre-determined dollarfactor based upon, among other things, past years’ claims experience, actualclaims paid, the number of plan participants and monthly accumulated aggregatedeductibles. For our 2010 plan year, this pre-determined dollar amount is $2.5million.

 

**CAUTIONARY NOTE REGARDING FORWARDLOOKING STATEMENTS**

 

We caution that anyforward-looking statements (as such term is defined in the Private SecuritiesLitigation Reform Act of 1995) contained or incorporated by reference in this Form 10-Qor made by our management involve risks and uncertainties and are subject tochange based on various important factors, many of which may be beyond ourcontrol. Accordingly, our future performance and financial results may differmaterially from those expressed or implied in any such forward-lookingstatements. For these statements, we claim the protection of the safe harborfor forward-looking statements contained in the Private Securities LitigationReform Act of 1995. Any such forward-looking statements are subject to risksand uncertainties, including, without limitation, those described in Item 1A ofour Annual Report on Form 10-K for the fiscal year ended December, 28,2009. If any of these risks or uncertainties actually occurs, our business,financial condition or operating results could be materially and adverselyaffected, and the trading price of our common stock could decline. We do notundertake to publicly update or revise our forward-looking statements even ifour future changes make it clear that any projected results expressed orimplied therein will not be realized.

 

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

 

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

 

·              labor shortagesor increased labor costs;

 

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·              changes indemographic trends and consumer tastes and preferences, including changesresulting 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, “madcow disease” and avian influenza or “bird flu;”

 

·              competition inour markets, both in our existing business and locating suitable restaurantsites;

 

·              our operationand execution in new and existing markets;

 

·              expansion intonew markets, including foreign countries;

 

·              our ability toattract and retain qualified franchisees and our franchisees’ ability to openrestaurants on a timely basis;

 

·              our ability tolocate suitable restaurant sites in new and existing markets and negotiate acceptablelease terms;

 

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

 

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

 

·              fluctuations inour quarterly results due to seasonality;

 

·              increasedgovernment regulation and our ability to secure required governmental approvalsand permits;

 

·              our ability tocreate customer awareness of our restaurants in new markets;

 

·              the reliabilityof our customer and market studies;

 

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

 

·              our ability torecruit, train and retain qualified corporate and restaurant personnel andmanagement;

 

·              marketsaturation due to new restaurant openings;

 

·              inadequateprotection of our intellectual property;

 

·              our ability toobtain additional capital and financing;

 

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

 

·              adverseeconomic conditions.

 

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

 

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**Item 3. Quantitative andQualitative Disclosures About Market Risk**

 

InterestRate Risk

 

Ourmarket risk exposures are related to our cash and cash equivalents and interestthat we may pay on debt. We have no derivative financial commodity instruments.We invest our excess cash in investment grade, highly liquid, short-terminvestments. These investments are not held for trading or other speculativepurposes. Changes in interest rates affect the investment income we earn on ourinvestments and, therefore, impact our cash flows and results of operations. Inthe three and nine months ended September 27, 2010, we held no short-terminvestments and, as a result, a hypothetical one percentage point interestchange from those in effect in the three and nine months ended September 27,2010 would not have resulted in a fluctuation of interest income. In the threeand nine months ended September 27, 2010 and September 28, 2009,interest income was not material.

 

ForeignCurrency Risk

 

Asof September 27, 2010, all of our transactions are conducted, and ouraccounts denominated, in U.S. dollars. Accordingly, we are not exposed toforeign currency risk.

 

Inflation

 

Theprimary 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 canhave an adverse impact on our results from operations. Some of our hourlypersonnel at our restaurants are paid at rates based on the applicable minimumwage, 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 ofoperation.

 

**Item 4. Controls and Procedures**

 

Ourmanagement, with the participation of our Chief Executive Officer and our ChiefFinancial Officer, evaluated the effectiveness of our “disclosure controls andprocedures” as such term is defined in Rule 13a-15(e) promulgated underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of theend of the fiscal period covered by this report. Based on this evaluation, ourChief Executive Officer and our Chief Financial Officer concluded that, as ofthe end of the period covered by this report, our disclosure controls andprocedures were effective (i) to ensure that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms and (ii) to ensure that informationrequired to be disclosed by us in the reports that we submit under the ExchangeAct is accumulated and communicated to our management, including our principalexecutive and principal financial officers, or persons performing similarfunctions, as appropriate, to allow timely decisions regarding requireddisclosure.

 

There have been no changesin our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the first fiscal quarter to whichthis report relates that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

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**Part II. OTHER INFORMATION**

 

**Item 1:****      ****Legal Proceedings**

 

From time to time, we are adefendant 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 accommodationsor other federal and state laws applicable to our business operations,employment-related claims, property damages, claims from guests allegingillness, injury or other food quality, health or operational concerns, andenforcement of intellectual property rights.

 

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

 

**Item 1A:  Risk Factors**

 

In addition to the otherinformation set forth in this report, the factors discussed in “Part I.  Item 1A. Risk Factors” in our Annual Report on Form 10-K for our 2009 fiscalyear could materially affect the Company’s business, financial condition oroperating results. There have been no material changes in our risk factorssince our Annual Report on Form 10-K for the year ended December 28,2009.

 

**Item 5:  Exhibits**

 

(a)           **Exhibits**:

 
| **Exhibit Number** | ** ** | **Description**                                                                                                |
|-------------------------|------------|----------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                           |
| Exhibit 31.1       |       | Certification of the Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|                    |       |                                                                                                           |
| Exhibit 31.2       |       | Certification of the Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|                    |       |                                                                                                           |
| Exhibit 32.1       |       | Certification pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                 |

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisReport to be signed on its behalf by the undersigned thereunto duly authorized.

 
| ** **                    | ** ** | **COSI, INC.**                                 |
|-------------------------------|------------|-----------------------------------------------------|
| ** **                    | ** ** | ** **                                          |
| ** **                    | ** ** | ** **                                          |
| Date: November 11,  2010 |       | By:                                                 | /s/ JAMES HYATT |
|                          |       | James Hyatt                                         |
|                          |       | President,                                          |
|                          |       | Chief Executive Officer,  and                       |
|                          |       | Director                                            |
|                          |       |                                                |
|                          |       |                                                |
| Date: November 11,  2010 |       | By:                                                 | /s/ WILLIAM KOZIEL |
|                          |       | William Koziel                                      |
|                          |       | Chief Financial Officer  (chief accounting officer) |
|                          |       | Treasurer and Secretary                             |

 

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**EXHIBIT INDEX**

 
| Exhibit 31.1 |   | Certification of the Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|-------------------|--------|----------------------------------------------------------------------------------------------------------------|
|              |   |                                                                                                           |
| Exhibit 31.2 |   | Certification of the Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002. |
|              |   |                                                                                                           |
| Exhibit 32.1 |   | Certification pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                 |

 

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