Cosi (COSIQ) 10-Q 2014 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE

ACT OF 1934

For the quarterly period ended March 31, 2014

OR

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

ACT OF 1934

For the transition period from _____to _____

Commission File No. 000-50052

COSÌ, INC.

(Exact name 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

(Address of principal executive offices) (Zip Code)

(847) 597-8800

(Registrant's telephone number, including area code)

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

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

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

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

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

Number of shares of Common Stock, $.01 par value, outstanding at May 8, 2014: 19,261,143

COSI, INC.

Index to Form 10-Q

For the three-month period ended March 31, 2014

PART  I.   FINANCIAL INFORMATION		Page Number
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets – as of March 31, 2014 and December 30, 2013	3
	Consolidated Statements of Operations and Comprehensive Loss – Three-month periods ended March 31, 2014 and April 1, 2013	4
	Consolidated Statement of Stockholders’ Equity – Three-month period ended March 31, 2014	5
	Consolidated Statements of Cash Flows – Three-month periods ended March 31, 2014 and April 1, 2013	6
	Notes to Condensed Consolidated Financial Statements	7-11
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	12-24
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24
Item 4.	Controls and Procedures	25
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	26
Item 1A.	Risk Factors	26
Item 4.	Mine Safety Disclosures	26
Item 6.	Exhibits	26

SIGNATURES	27
EXHIBIT INDEX	28
CERTIFICATIONS	29-31

2

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Cosi, Inc.

Consolidated Balance Sheets

As of March 31, 2014 and December 30, 2013

(dollars in thousands)

	March 31, 2014			December 30, 2013
Assets
Current assets:
Cash and cash equivalents	$	2,813		$	6,021
Accounts receivable, net		599			594
Notes receivable, current portion		551			551
Inventories		789			779
Prepaid expenses and other current assets		1,136			1,348
Total current assets		5,888			9,293
Furniture and fixtures, equipment and leasehold improvements, net		7,742			8,195
Other assets		1,100			1,115
Total assets	$	14,730		$	18,603
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	3,249		$	2,462
Accrued expenses		7,481			9,088
Deferred franchise revenue		18			18
Current portion of other long-term liabilities		186			196
Total current liabilities		10,934			11,764
Deferred franchise revenue		1,931			1,931
Other long-term liabilities, net of current portion		2,104			2,189
Total liabilities		14,969			15,884
Stockholders' equity (deficit):
Common stock - $.01 par value; 100,000,000 shares authorized, 19,136,143 and 18,106,979 shares issued, respectively		191			181
Additional paid-in capital		297,339			297,181
Treasury stock, 59,886 shares at cost		(1,198	)		(1,198	)
Accumulated deficit		(296,571	)		(293,445	)
Total stockholders' equity (deficit)		(239	)		2,719
Total liabilities and stockholders' equity (deficit)	$	14,730		$	18,603

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

3

Cosi, Inc.

Consolidated Statements of Operations and Comprehensive Loss

For the Three Month Periods Ended March 31, 2014 and April 1, 2013

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

	Three Months Ended
	March 31,			April 1,
	2014			2013
	(Unaudited)			(Unaudited)
Revenues:
Restaurant net sales	$	17,728		$	20,854
Franchise fees and royalties		647			707
Total revenues		18,375			21,561
Costs and expenses:
Cost of food and beverage		4,415			5,202
Restaurant labor and related benefits		7,094			8,110
Occupancy and other restaurant operating expenses		7,001			7,146
		18,510			20,458
General and administrative expenses		2,369			2,757
Provision for losses on asset impairments and disposals		-			339
Depreciation and amortization		639			748
Closed store costs		2			17
Lease termination expense (income)		(16	)		4
Total costs and expenses		21,504			24,323
Operating loss		(3,129	)		(2,762	)
Other income		3			21
Net loss and comprehensive loss	$	(3,126	)	$	(2,741	)
Per Share Data:
Loss per share, basic and diluted	$	(0.17	)	$	(0.15	)
Weighted average shares outstanding:		18,054,580			17,949,772

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

4

Cosi, Inc.

Consolidated Statement of Stockholders' Equity

For the Three Months Ended March 31, 2014

(unaudited)

(dollars in thousands, except share data)

	Common Stock							Treasury Stock
	Number of Shares		Amount		Additional Paid In Capital			Number of Shares		Amount			Accumulated Deficit			Total
Balance, December 30, 2013		18,106,979		181		297,181			59,886		(1,198	)		(293,445	)		2,719
Issuance of restricted stock		1,029,164		10		(10	)										-
Stock-based compensation		-				168											168
Net loss														(3,126	)		(3,126	)
Balance, March 31, 2014		19,136,143	$	191	$	297,339			59,886	$	(1,198	)	$	(296,571	)	$	(239	)

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

5

Cosi, Inc.

Consolidated Statements of Cash Flows

For the Three Month Periods Ended March 31, 2014 and April 1, 2013

(dollars in thousands)

	March 31,			April 1,
	2014			2013
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net loss	$	(3,126	)	$	(2,741	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization		639			748
Non-cash portion of asset impairments and disposals		-			339
Provision for bad debts		(11	)		14
Stock-based compensation expense		168			104
Changes in operating assets and liabilities:
Accounts receivable		5			219
Notes receivable		-			8
Inventories		(10	)		32
Prepaid expenses and other current assets		212			373
Other assets		16			6
Accounts payable and accrued expenses		(814	)		(2,018	)
Lease termination reserve		(16	)		4
Other long-term liabilities		(85	)		(104	)
Net cash used in operating activities		(3,022	)		(3,016	)
Cash flows from investing activities:
Capital expenditures		(186	)		(265	)
Net cash used in investing activities		(186	)		(265	)
Net decrease in cash and cash equivalents		(3,208	)		(3,281	)
Cash and cash equivalents, beginning of period		6,021			15,417
Cash and cash equivalents, end of period	$	2,813		$	12,136
Supplemental disclosure of cash flow information:
Cash paid for:
Corporate franchise and income taxes	$	23		$	32

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

6

COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 - Basis of Presentation

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

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

The balance sheet at December 30, 2013 has been derived from audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

The results for the three-month periods ended March 31, 2014 and April 1, 2013 are not indicative of the results for the full fiscal year.

This Report should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 30, 2013, as filed with the Securities and Exchange Commission (“SEC”).

There have been no material changes to our significant accounting policies and estimates from the information provided in Note 1 of our consolidated financial statements included in our Form 10-K for the fiscal year ended December 30, 2013.

Note 2 – Stock-Based Compensation Expense

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

	For the Three Months Ended
	(in thousands)
	March 31, 2014		April 1, 2013
Restricted stock compensation expense, net of forfeitures		168		98
Stock option compensation expense		-		6
Total non-cash, stock-based compensation expense, net of forfeitures	$	168	$	104

As of March 31, 2014, the unrecognized compensation expense related to stock options and restricted shares of stock granted under the Cosi, Inc. 2005 Omnibus Long-Term Incentive Plan (the “2005 Plan”) was approximately $0.9 million and will be recognized on a straight-line basis over the remaining vesting period through fiscal 2018.

7

Pursuant to the 2005 Plan and in accordance with the terms and conditions prescribed by the Compensation Committee of our Board of Directors, we granted 1,029,164 shares of restricted common stock to key employees during the first quarter of fiscal 2014. The vesting of 200,000 of these shares occurs as follows: (i) 50% of the grant vested on the grant date and (ii) the remaining 50% vest in four equal quarterly installments through March 2015 provided that at each such date the employee continues to be employed by the Company.

Pursuant to the terms of the employment agreement entered into by the Company and Robert J. Dourney, dated March 17, 2014, in which Mr. Dourney agreed to serve as the Company’s Chief Executive Officer and President, Mr. Dourney was granted 829,164 unregistered shares of restricted stock, of which 414,582 shares are time-vested (“Time Vested Shares”) and 414,582 are performance-based (“Performance Shares”), which shares were issued pursuant to a restricted stock agreement entered into on March 17, 2014, and which shares are subject to the following vesting schedules:

(a)           The Time-Vested Shares will vest in four equal installments, with 25% vesting on each of the first, second, third and fourth anniversaries of the Date of Grant, provided that Mr. Dourney remains in the continuous employ of the Company through each such vesting date.

(b)           The Performance Shares will vest in four equal installments, provided that Mr. Dourney remains in the continuous employment of the Company from and after the Date of Award and through the respective vesting dates set forth below and the specified price targets set forth below for the Company’s common stock are achieved:

(i) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $2.00 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events);

(ii) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $2.50 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events);

(iii) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $3.00 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events); and

(iv) 25% on the first day on which the closing price of the Company’s common stock shall have exceeded $4.00 for 30 consecutive trading days (as adjusted for stock splits, recapitalizations, reorganizations or similar events).

During the first quarter of fiscal 2013, we granted and issued 30,000 shares of restricted stock and 25,000 options to purchase common stock to key employees. The value of the shares for the grants made during the first quarters of fiscal years 2014 and 2013, based on the closing price of our common stock on the date of the grants, was approximately $1.0 million and $0.1 million, respectively.

No shares of previously issued restricted common stock were forfeited during the first quarter of fiscal 2014. During the first quarter of fiscal 2013, 4,725 shares of previously issued restricted common stock were forfeited. The value of the forfeited shares, based on the closing price of our common stock on the date of the grants, was immaterial.

Note 3 – Earnings Per Share

Basic and diluted loss per common share is calculated by dividing the net loss by the weighted average common shares outstanding during the period. As of March 31, 2014 and April 1, 2013, there were, 932,639 and 282,075 unvested restricted shares of common stock and 53,445 and 38,196 out-of-the-money stock options outstanding. Additionally, as of April 1, 2013, there were 25,000 in-the-money stock options outstanding. The unvested restricted shares and the outstanding stock options meet the requirements for participating securities but were not included in the computation of basic and diluted earnings per share because we incurred a net loss in all periods presented and, hence, the impact would be anti-dilutive.

8

Note 4 – Asset Impairments

In accordance with FASB Accounting Standards Codification Topic 360 (ASC Topic 360), Property, Plant & Equipment, we evaluate possible impairments at the individual restaurant level periodically and record an impairment loss whenever we determine impairment factors are present. We consider a history of poor financial operating performance to be the primary indicator of potential impairment for individual restaurant locations. We determine whether a restaurant location is impaired based on expected undiscounted cash flows, generally for the remainder of the lease term, and then determine the impairment charge based on discounted cash flows for the same period.

Restaurants are not considered for impairment during the period before they enter the comparable restaurant base, unless specific circumstances warrant otherwise.

We did not record an asset impairment charge during the first quarter of fiscal 2014. The charge recorded during the first quarter of fiscal 2013 was approximately $0.3 million and related to three underperforming restaurants.

Note 5 - Lease Termination Costs

Future store closings, if any, resulting from our decision to close underperforming locations prior to their scheduled lease expiration dates may result in additional lease termination charges. For all exit activities, we estimate our likely liability under contractual leases for restaurants that have been closed. Such estimates have affected the amount and timing of charges to operating results and are impacted by management’s judgments about the time it may take to find a suitable subtenant or assignee, or the terms under which a termination of the lease agreement may be negotiated with the landlord. We recognize costs associated with exit or disposal activities at the time a commitment to an exit or disposal plan is communicated to the landlord.

The lease termination reserve adjustment that we recorded during the first quarters of fiscal years 2014 and 2013 were immaterial.

Note 6 - Contingencies

From time to time, we are a defendant in litigation arising in the ordinary course of our business. As of the date of this report, there are no legal proceedings that would require accrual or disclosure under ASC 450. We cannot predict with certainty the outcome of any litigation or the potential for future litigation. Regardless of the outcome of any particular litigation and the merits of any particular claim, litigation can have a material adverse impact on our company due to, among other reasons, any injunctive relief granted, which could inhibit our ability to operate our business, amounts paid as damages or in settlement of any such matter, diversion of management resources and defense costs.

Note 7 – Income Taxes

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

As of December 30, 2013, we had net operating loss (“NOL”) carryforwards of approximately $226.0 million for U.S. federal income tax purposes. Under the Internal Revenue Code, an “ownership change” with respect to a corporation can significantly limit the amount of pre-ownership change NOLs and certain other tax assets that the corporation may utilize after the ownership change to offset future taxable income, possibly reducing the amount of cash available to the corporation to satisfy its obligations. An ownership change generally would occur if the aggregate stock ownership of holders of at least 5% of our stock increases by more than 50 percentage points over the preceding three year period. We do not believe that the rights offering and the related private placement of common stock that we completed in fiscal years 2012 and 2010 have triggered an ownership change. In addition, a limitation would not have an impact on our consolidated financial statements as we have recorded a valuation allowance for the entire amount of our deferred tax assets.

9

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

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

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

Note 8 – Other Events

Appointment of a New President and CEO

On March 17, 2014, the Company appointed R.J. Dourney as President and CEO as well as a member of the Board of Directors. Prior to his appointment, R.J. was founder and CEO of Hearthstone, a Boston based company which operates 13 restaurants in the Boston market as Cosi’s largest franchisee.

Election to Cause Merger Agreement

On March 18, 2014, Cosi, Inc. (the “Company” or “Cosi”) entered into an Election to Cause Merger Agreement (collectively with all exhibits thereto, the “Agreement”) with Hearthstone Associates, LLC (“Hearthstone”), Robert J. Dourney and Nancy Dourney (collectively with Robert J. Dourney, the “Holders”). Hearthstone, which is wholly-owned by the Holders, operates certain Company franchise restaurants through its wholly-owned subsidiary, Hearthstone Partners, LLC (the “Subsidiary”).

Under the terms of the Agreement, the Company granted to Hearthstone the sole and exclusive right (the “Right”), exercisable at the discretion of Hearthstone at any time after January 1, 2015 and before March 18, 2015, to elect to require Cosi to acquire Hearthstone by effecting a reverse triangular merger of Hearthstone with and into a subsidiary of Cosi (the “Merger”). If the Merger is consummated, the Company shall issue 1,790,993 shares of common stock of the Company to the Holders in the Merger.

The obligation of the Company to effect the Merger is subject to the satisfaction of a number of conditions at the time of the Merger, including (a) the transfer to Hearthstone of all indebtedness under a certain existing promissory note made by Robert J. Dourney to a third party, (b) the completion of construction of certain additional Company franchise restaurants, (c) the receipt of certain lender consents, (d) the approval of the Merger by the shareholders of the Company if then required pursuant to the NASDAQ Stock Market Rules and (e) other customary conditions.

The Company has provided customary representations and warranties to Hearthstone and is obligated to indemnify Hearthstone and the Subsidiary from any breach by the Company of such representations and warranties or the Agreement. The Company’s indemnification obligations shall terminate if the Right is not exercised prior to its expiration. In the event of a material breach of the Agreement by either the Company or Hearthstone, the other party, in addition to other remedies available at law, may be entitled to rescind the Merger, if applicable.

10

Until the Merger is consummated or the Right expires, Hearthstone and the Subsidiary are bound by certain restrictive covenants, including prohibitions or limitations on issuing or transferring equity securities, incurring additional debt, engaging in acquisitions, dispositions or mergers, amending governance documents, or suffering events of default under their loan or franchise agreements. In addition, Hearthstone and Subsidiary are obligated to provide the Company access to their financial information, books and records and personnel until the Merger is consummated or the Right expires.

The Election to Cause Merger Agreement between the Company, Hearthstone, Robert J. Dourney and Nancy Dourney was filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K dated March 21, 2014.

Note 9 – Subsequent Event

Entry into a Senior Secured Promissory Note Agreement

On April 14, 2014, the Company entered into a $5.0 million Senior Secured Promissory Note Agreement with MILFAM II L.P.. The Note bears interest at nine (9%) per annum, compounded semi-annually, and payable in arrears on a semi-annual basis. At the Company’s option, the first two semi-annual interest payments may be paid at eleven (11%) in kind in the form of additional Notes. The principal obligations under the Note are due three (3) years from the effective date of the Note. The Note agreement provides for the payment of a finance fee of 3.5% of the principal amount of the Note at closing as well as providing a warrant exercisable to purchase up to 1.1 million shares of the Company’s common stock at an exercise price per share of $0.01.  The warrant would not be exercisable to the extent that doing so resulted in the Milfam II L.P. and any related parties, in the aggregate, owning more than 19.9% of the Company’s common stock.  Further, until all the obligations under the Note are paid in full, MILFAM II L.P. will have the right to participate in any future financing transactions consummated by the Company in an amount up to the greater of 1) the then-outstanding balance of obligations under the Note and 2) $4.0 million. The Note is guaranteed by the Company’s subsidiaries and secured by a lien on all assets of the Company and its subsidiaries.  Mr. Lloyd I. Miller, III, is the manager of MILFAM LLC, the general partner of MILFAM II L.P.  Mr. Miller is also a significant shareholder of the Company.

11

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

The following discussion and analysis of our financial condition and results of operations for the fiscal quarters ended March 31, 2014 and April 1, 2013 should be read in conjunction with “Selected Consolidated Financial Data” and our audited consolidated financial statements and the notes to those statements that are in our 2013 Annual Report on Form 10-K. Our discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under “Cautionary Note Regarding Forward-Looking Statements” below and elsewhere in this Quarterly Report.

OVERVIEW

System wide restaurants:

	For the Three Months Ended
	March 31, 2014						April 1, 2013
	Company-Owned		Franchise		Total		Company-Owned		Franchise		Total
Restaurants at beginning of period		70		52		122		75		50		125
Franchise-owned converted to Company-owned		2		2		-		-		-		-
Restaurants permanently closed		-		1		1		1		-		1
Restaurants at end of period		72		49		121		74		50		124

As of March 31, 2014, there were 72 Company-owned and 49 franchised restaurants operating in 16 states, the District of Columbia, the United Arab Emirates (UAE), and Costa Rica. During the first quarter of fiscal 2014, we converted two franchised restaurants in Pennsylvania to Company-owned. In addition, one franchised restaurant in the District of Columbia closed during the same period. Subsequent to the end of the first quarter of fiscal 2014, we closed two Company-owned restaurants, one of each in Virginia and Illinois.

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

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

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

12

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

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

Recent Developments

Appointment of a New President and CEO

On March 17, 2014, the Company appointed R.J. Dourney as President and CEO as well as a member of the Board of Directors. Prior to his appointment, R.J. was founder and CEO of Hearthstone, a Boston-based company which operates 13 restaurants in the Boston market as Cosi’s largest franchisee.

Election to Cause Merger Agreement

On March 18, 2014, Cosi, Inc. (the “Company” or “Cosi”) entered into an Election to Cause Merger Agreement (collectively with all exhibits thereto, the “Agreement”) with Hearthstone Associates, LLC (“Hearthstone”), Robert J. Dourney and Nancy Dourney (collectively with Robert J. Dourney, the “Holders”). Hearthstone, which is wholly-owned by the Holders, operates certain Company franchise restaurants through its wholly-owned subsidiary, Hearthstone Partners, LLC (the “Subsidiary”).

Under the terms of the Agreement, the Company granted to Hearthstone the sole and exclusive right (the “Right”), exercisable at the discretion of Hearthstone at any time after January 1, 2015 and before March 18, 2015, to elect to require Cosi to acquire Hearthstone by effecting a reverse triangular merger of Hearthstone with and into a subsidiary of Cosi (the “Merger”). If the Merger is consummated, the Company shall issue 1,790,993 shares of common stock of the Company to the Holders in the Merger.

The obligation of the Company to effect the Merger is subject to the satisfaction of a number of conditions at the time of the Merger, including (a) the transfer to Hearthstone of all indebtedness under a certain existing promissory note made by Robert J. Dourney to a third party, (b) the completion of construction of certain additional Company franchise restaurants, (c) the receipt of certain lender consents, (d) the approval of the Merger by the shareholders of the Company if then required pursuant to the NASDAQ Stock Market Rules and (e) other customary conditions.

The Company has provided customary representations and warranties to Hearthstone and is obligated to indemnify Hearthstone and the Subsidiary from any breach by the Company of such representations and warranties or the Agreement. The Company’s indemnification obligations shall terminate if the Right is not exercised prior to its expiration. In the event of a material breach of the Agreement by either the Company or Hearthstone, the other party, in addition to other remedies available at law, may be entitled to rescind the Merger, if applicable.

Until the Merger is consummated or the Right expires, Hearthstone and the Subsidiary are bound by certain restrictive covenants, including prohibitions or limitations on issuing or transferring equity securities, incurring additional debt, engaging in acquisitions, dispositions or mergers, amending governance documents, or suffering events of default under their loan or franchise agreements. In addition, Hearthstone and Subsidiary are obligated to provide the Company access to their financial information, books and records and personnel until the Merger is consummated or the Right expires.

The Election to Cause Merger Agreement between the Company, Hearthstone, Robert J. Dourney and Nancy Dourney was filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K dated March 21, 2014.

13

Critical Accounting Policies

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

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable and generally accepted for companies in the restaurant industry. We believe that the following addresses the more critical accounting policies used in the preparation of our consolidated financial statements and requires management’s most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. There have been no material changes in the application of our most critical accounting policies and estimates, judgments and assumptions during the first quarter of fiscal 2014.

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

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

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

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

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

14

We measure the estimated fair value of our granted stock options using a Black-Scholes pricing model and of our restricted stock based on the fair market value of a share of registered stock on the date of grant. The weighted average fair values of the stock options granted through the first quarter of fiscal 2014, were determined using the Black-Scholes option-pricing model.

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

Revenue

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

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

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

Comparable Restaurant Sales

In calculating comparable restaurant sales, we include a restaurant in the comparable restaurant base after it has been in operation for 15 full months. We remove from the comparable restaurant base for the period any restaurant that is temporarily shut down for remodeling during that period. On March 31, 2014 and April 1, 2013, there were 70 and 74 restaurants in our comparable restaurant base, respectively.

Costs and Expenses

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

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

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

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

15

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

RESULTS OF OPERATIONS

Our operating results for the three-month periods ended March 31, 2014 and April 1, 2013, expressed as a percentage of total revenues (except where otherwise noted), were as follows:

	Three Months Ended
	March 31			April 1,
	2014			2013
Revenues:
Restaurant net sales		96.5	%		96.7	%
Franchise fees and royalties		3.5			3.3
Total revenues		100.0			100.0
Cost and expenses:
Cost of food and beverage (1)		24.9			24.9
Restaurant labor and related benefits (1)		40.0			38.9
Occupancy and other restaurant operating expenses (1)		39.5			34.3
		104.4			98.1
General and administrative expenses		12.9			12.8
Provision for lossess on asset impairments and disposals		-			1.6
Depreciation and amortization		3.5			3.5
Closed store costs		-			0.1
Lease termination income		(0.1	)		-
Total costs and expenses		117.0			112.8
Operating loss		(17.0	)		(12.8	)
Other income		-			0.1
Net loss and comprehensive loss		(17.0	)%		(12.7	)%

(1) Expressed as a percentage of restaurant net sales versus all otheritems expressed as a percentage of total revenues.

16

Restaurant Net Sales

	Restaurant net sales
	(in thousands)		as a % of total revenues
Quarter ended March 31, 2014	$	17,728		96.5	%
Quarter ended April 1, 2013	$	20,854		96.7	%

Restaurant net sales. Restaurant net sales decreased 15.0%, or approximately $3.1 million, during the first quarter of fiscal 2014 due primarily to a decrease in net sales in our comparable restaurant base of 12.4%, or approximately $2.5 million, as well as a decrease in net sales of approximately $0.6 million related to restaurants closed during and subsequent to the first quarter of fiscal 2013. The decrease in comparable restaurant net sales was comprised of 12.9% decrease in traffic, partially offset by 0.5% increase in average check.

Franchise Fees and Royalties

	Franchise fees and royalties
	(in thousands)		as a % of total revenues
Quarter ended March 31, 2014	$	647		3.5	%
Quarter ended April 1, 2013	$	707		3.3	%

Franchise fees and royalties. Franchise fees and royalties decreased 8.5%, or approximately $0.06 million, due primarily to the decrease in comparable franchised restaurant net sales in the quarter, as well as the decrease in sales from the closing of franchised stores during and after the first quarter of fiscal 2013.

Costs and Expenses

	Cost of food and beverage
	(in thousands)		as a % of restaurant net sales
Quarter ended March 31, 2014	$	4,415		24.9	%
Quarter ended April 1, 2013	$	5,202		24.9	%

Cost of food and beverage. The cost of food and beverage as a percentage of restaurant net sales for the 2014 first quarter was comparable to the prior year’s quarter at 24.9%. During the 2013 first quarter, the cost of food and beverage was adversely impacted in certain produce items due to crop freeze caused by the unseasonably cold weather in the Southwestern United States. That impact was offset in the first quarter of 2014 by a shift in sales mix as well as higher year over year cost on dairy products, primarily cheese.

	Restaurant labor and related benefits
	(in thousands)		as a % of restaurant net sales
Quarter ended March 31, 2014	$	7,094		40.0	%
Quarter ended April 1, 2013	$	8,110		38.9	%

17

Restaurant labor and related benefits. The increase in restaurant labor and related benefits, as a percentage of restaurant net sales, is due primarily to the unfavorable impact on the fixed portion of labor from the decrease in comparable net restaurant sales, partially offset by savings realized from adjustments to restaurant management staffing levels at certain locations during the quarter.

	Occupancy and other restaurant operating expenses
	(in thousands)		as a % of restaurant net sales
Quarter ended March 31, 2014	$	7,001		39.5	%
Quarter ended April 1, 2013	$	7,144		34.3	%

Occupancy and other restaurant operating expenses. The increase in occupancy and other restaurant operating expenses, as a percentage of restaurant net sales, is due primarily to the unfavorable effect on fixed occupancy-related costs of the decrease in comparable net restaurant sales, as well as higher year over year costs for utilities and repairs and maintenance of existing Company-owned restaurants.

	General and administrative expenses
	(in thousands)		as a % of total revenues
Quarter ended March 31, 2014	$	2,369		12.9	%
Quarter ended April 1, 2013	$	2,757		12.8	%

General and administrative expenses. The 14.1% decrease in general and administrative expenses in the quarter, as compared to the prior year quarter, is due primarily to labor and related benefit savings resulting from administrative workforce reductions effected during 2013, prototype design costs incurred during 2013, as well as lower year over year costs for corporate insurance, partially offset by higher legal fees in the quarter.

	Provision for losses on asset impairments and disposals
	(in thousands)		as a % of total revenues
Quarter ended March 31, 2014	$	-		-
Quarter ended April 1, 2013	$	339		1.6	%

Provision for losses on asset impairments and disposals: The provision for losses on asset impairments and disposals during the first quarter of fiscal 2013 is related to three underperforming restaurants.

	Depreciation and amortization
	(in thousands)		as a % of total revenues
Quarter ended March 31, 2014	$	639		3.5	%
Quarter ended April 1, 2013	$	748		3.5	%

Depreciation and amortization. The lower depreciation and amortization expense during the first quarter of fiscal 2014 is due primarily to the impact of impairments recorded during and subsequent to the first quarter of fiscal 2013 as well as the impact on depreciation of assets in our restaurant base that have become fully depreciated in the last year.

18

	Closed store costs
	(in thousands)		as a % of total revenues
Quarter ended March 31, 2014	$	2		-
Quarter ended April 1, 2013	$	17		0.1	%

Closed store costs. The closed store costs incurred during fiscal 2014 resulted from an adjustment for a previously closed restaurant. The closed store costs incurred during the first quarter of fiscal 2013 are related to the closing of one Company-owned restaurant at the expiration of its lease.

	Lease termination expense (income)
	(in thousands)			as a % of total revenues
Quarter ended March 31, 2014	$	(16	)		-0.1	%
Quarter ended April 1, 2013	$	4			-

Lease termination expense (income). The lease termination income in the first quarter of fiscal 2014 is related to a reserve adjustment on a sublease ending during fiscal 2014. The lease termination expense adjustment in the first quarter of fiscal 2013 was immaterial.

	Other income
	(in thousands)		as a % of total revenues
Quarter ended March 31, 2014TT	$	3		-
Quarter ended April 1, 2013	$	21		0.1	%

Other income: Other income was immaterial in fiscal 2014 and included adjustments related to the discounting of the long-term portion of a note receivable in the first quarter of fiscal 2013.

	Net loss
	(in thousands)			as a % of total revenues
Quarter ended March 31, 2014	$	(3,126	)		(17.0	%)
Quarter ended April 1, 2013	$	(2,741	)		(12.7	%)

Net loss: The increase in net loss in the quarter is due primarily to the unfavorable effect of the decrease in comparable restaurant net sales on restaurant labor and occupancy-related costs, partially offset by labor savings resulting from the administrative and restaurant management workforce reductions as well as lower depreciation expense.

LIQUIDITY AND CAPITAL RESOURCES

On April 14, 2014, the Company entered into a $5.0 million Senior Secured Promissory Note Agreement with MILFAM II L.P.. The Note bears interest at nine (9%) per annum, compounded semi-annually, and payable in arrears on a semi-annual basis. At the Company’s option, the first two semi-annual interest payments may be paid at eleven (11%) in kind in the form of additional Notes. The principal obligations under the Note are due three (3) years from the effective date of the Note. The Note agreement provides for the payment of a finance fee of 3.5% of the principal amount of the Note at closing as well as providing a warrant exercisable to purchase up to 1.1 million shares of the Company’s common stock at an exercise price per share of $0.01.  The warrant would not be exercisable to the extent that doing so resulted in the Milfam II L.P. and any related parties, in the aggregate, owning more than 19.9% of the Company’s common stock.  Further, until all the obligations under the Note are paid in full, MILFAM II L.P. will have the right to participate in any future financing transactions consummated by the Company in an amount up to the greater of 1) the then-outstanding balance of obligations under the Note and 2) $4.0 million. The Note is guaranteed by the Company’s subsidiaries and secured by a lien on all assets of the Company and its subsidiaries.  Mr. Lloyd I. Miller, III, is the manager of MILFAM LLC, the general partner of MILFAM II L.P.  Mr. Miller is also a significant shareholder of the Company.

19

Cash and cash equivalents were approximately $2.8 million on March 31, 2014, compared with $6.0 million on December 30, 2013. We had negative working capital of approximately $5.0 million on March 31, 2014, compared with negative working capital of approximately $2.5 million on December 30, 2013. The decrease in working capital was a result of funding our first quarter operating loss, net of depreciation and other non-cash expenses as well as payments made for capital expenditures. Our principal requirements for cash in 2014 will be for working capital needs and routine maintenance of our existing restaurants.

Net cash used in operating activities during the first quarters of fiscal 2014 and 2013 was approximately $3.0 million. During fiscal 2014, net cash used in operating activities, as compared to the same period in fiscal 2013, was a result of a higher operating loss, net of depreciation and other non-cash expenses, partially offset by lower payments for insurance and certain other vendor obligations during the quarter.

Cash used in investing activities was approximately $0.2 and $0.3 million in the first quarters of fiscal 2014 and 2013, respectively, and was the result of capital expenditures for existing company-owned restaurants.

No cash was used in or provided by financing activities during the first quarters of fiscal 2014 and 2013.

As of March 31, 2014, seven quarterly payments of $62,500 each were not paid as scheduled in accordance with the terms of the Subordinated Secured Promissory Note associated with the sale of restaurants to a franchisee in 2010. As of March 31, 2014, the Company has a reserve of $0.45 million recorded against the Subordinated Secured Promissory Note.

We expect to incur capital costs associated with the maintenance of existing Company-owned restaurants during fiscal 2014. We expect to fund any required restaurant capital maintenance costs on existing Company-owned restaurants from proceeds of the $5.0 million Senior Secured Promissory Note, cash and cash equivalents on hand, expected cash flows generated by existing Company-owned restaurants, and expected franchise fees and royalties.

We believe that our current cash and cash equivalents, the $5.0 million in proceeds received on April 14, 2014 under the Senior Secured Promissory Note entered into with MILFAM II L.P., the expected cash flows from Company-owned restaurant operations and the expected franchise fees and royalties will be sufficient to fund our cash requirements for working capital needs and capital improvements and maintenance of existing restaurants for the next twelve months. Our conclusion is based on our financial performance during fiscal 2013 and the first quarter of fiscal 2014 and our projected financial performance for the remainder of fiscal 2014 and includes a sensitivity analysis that projects varying levels of decline in consumer demand. The range of levels selected was based on our reasonable expectation of demand given the seasonality of our historical performance. The Company also expects to realize continued savings in general and administrative expenses in fiscal 2014 as compared to the fiscal 2013 expense, excluding any costs associated with relocating the administrative offices from Chicago to Boston. In analyzing our capital cash outlays during the first quarters of fiscal 2014 and 2013, 93.3% and 92.4%, respectively, of our capital expenditures were spent on improvements and repairs and maintenance associated with existing Company-owned locations. The balance of the capital cash outlays was spent on information technology related projects. Capital cash outlays for the 2014 first quarter were 30% lower than the year ago quarter. The Company’s capital expenditures for repairs and maintenance of existing restaurants is expected to be consistent with the fiscal 2013 spend at approximately $1.0 million.

20

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

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

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

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

If we default on our Senior Secured Promissory Note, our business, results of operations and financial condition could be materially adversely affected.

Our cash resources, and therefore our liquidity, are primarily dependent upon the proceeds of the Senior Secured Promissory Note. We believe that with the proceeds from the Senior Secured Promissory Note, we have sufficient liquidity to fund our working capital requirements for the next twelve months. If we default on the Senior Secured Promissory Note, we may be forced to pay higher interest costs or repay the debt earlier than anticipated. If that were to occur we may have to seek additional financing from external sources to cure the default and continue funding our operations. We cannot predict whether such financing will be available on terms acceptable to us, or at all.

We may need additional capital in the future and it may not be available on acceptable terms.

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

21

We have entered into agreements that create contractual obligations. These obligations will have an impact on future liquidity and capital resources. The table below presents a summary of these obligations as of March 31, 2014:

	Payments Due by Period
	(in thousands)
Description	Total Obligations		Due Fiscal 2014		Due Fiscal 2015 to Fiscal 2016		Due Fiscal 2017 to Fiscal 2018		Due After Fiscal 2018
Operating leases (1)		47,709		9,420		19,317		8,329		10,643
Other long-term liabilities (2)		135		37		98		-		-
Total contractual cash obligations	$	47,844	$	9,457	$	19,415	$	8,329	$	10,643

(1) Amounts shown are net of an aggregate $0.2 million of sub-lease rental income due under non-cancelable subleases and include accrued contractual lease increases of approximately $1.7 million, which are included in other long-term liabilities in the attached consolidated balance sheets.

(2) Amounts shown are related to contractual obligations for lease termination agreements. These obligations are non-interest bearing and are included in other long-term liabilities in the attached consolidated balance sheets.

We are obligated under non-cancelable operating leases for our restaurants and our administrative offices. Lease terms are generally ten years with renewal options and generally require us to pay a proportionate share of real estate taxes, insurance and common area and other operating costs. Some restaurant leases provide for contingent rental payments which are not included in the above table.

We have entered into an agreement to terminate the lease at our corporate headquarters in Deerfield, Illinois effective May 31, 2014. As part of the agreement, we will pay a lease termination fee of $0.5 million on May 31, 2014.

Certain of our lease agreements provide for scheduled rent increases during the lease term or for rental 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 the respective lease from the date we take possession. Our obligation with respect to these scheduled rent increases has been presented as a long‑term liability in other liabilities in the accompanying consolidated balance sheets and totaled approximately $1.7 million and $2.1 million as of the end of the first quarter of fiscal 2014 and 2013, respectively.

Certain of our leases also provide for landlord contributions to offset a portion of the cost of our leasehold improvements. These allowances are recorded as deferred liabilities and amortized on a straight-line basis as a reduction to rent expense over the term of the related leases. Included in other liabilities in the accompanying consolidated balance sheets for the first quarters of fiscal years 2014 and 2013 are landlord allowances of approximately $0.1 million and $0.5 million, respectively.

As of March 31, 2014, the Company had outstanding approximately $0.2 million in standby letters of credit, which were provided as security deposits for certain of the lease obligations. The letters of credit are fully secured by cash deposits or marketable securities held in accounts at the issuing banks and are not available for withdrawal by the Company. These amounts are included as a component of “Other Assets” in the accompanying consolidated balance sheets.

Purchase Commitments

We have agreements with some of the nation’s largest food, paper, and beverage manufacturers in the industry. This enables us to provide our restaurants with high quality proprietary food products and non-food items at competitive prices. We source and negotiate prices directly with these suppliers and distribute these products to our restaurants primarily through a national network that consists of some of the nation’s largest independent distributors. These primary suppliers and independent distributors have parallel facilities and systems to minimize the risk of any disruption of our supply chain. We do not utilize a commissary system. Our inventory control system allows each restaurant to place orders electronically with our master distributor and then transmits the invoices electronically to our accounts payable system.

22

We have an agreement with Distribution Market Advantage, Inc. (“Distribution Marketing Advantage”) that provides us access to a national network of independent distributors. Under this agreement the independent distributors supply us with approximately 76% of our food and paper products, primarily under pricing agreements that we negotiate directly with the suppliers. This agreement was renegotiated and has been extended through December 2015.

We have a long-term beverage marketing agreement with the Coca‑Cola Company. We received a marketing allowance under this agreement, which is being recognized as a reduction to expense ratably based on actual products purchased. Effective January 1, 2011, the beverage marketing agreement with the Coca-Cola Company was amended to provide for additional products as well as higher marketing allowances based on purchases.

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

Self‑Insurance

We have a self‑insured group health insurance plan. We are responsible for all covered claims to a maximum limit of $100,000 per participant and an additional aggregating maximum limit of $50,000 for the plan year. Benefits paid in excess of these limits are reimbursed to the plan under our stop-loss policy. In addition, we have an aggregate stop-loss policy whereby our liability for total claims submitted cannot exceed a pre‑determined dollar factor based upon, among other things, past years’ claims experience, actual claims paid, the number of plan participants and monthly accumulated aggregate deductibles. During fiscal years 2013 and 2012, we did not exceed this pre-determined maximum. For our 2014 plan year, this pre-determined dollar amount is $1.2 million. The balance in the self-insurance reserve account as of March 31, 2014 was approximately $0.2 million.

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

We caution that any forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995) contained or incorporated by reference in this Form 10-K and Annual Report or made by our management involve risks and uncertainties and are subject to change based on various important factors, many of which may be beyond our control. Accordingly, our future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements are subject to risks and uncertainties, including, without limitation, those described in Item 1A of this Report. If any of these risks or uncertainties actually occurs, our business, financial condition or operating results could be materially and adversely affected, and the trading price of our common stock could decline. We do not undertake to publicly update or revise our forward-looking statements even if our future changes make it clear that any projected results expressed or implied therein will not be realized.

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

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

· labor shortages or increased labor costs;

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

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

23

· our operation and execution in new and existing markets;

· expansion into new markets, including foreign countries;

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

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

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

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

· fluctuations in our quarterly results due to seasonality;

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

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

· the reliability of our customer and market studies;

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

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

· market saturation due to new restaurant openings;

· inadequate protection of our intellectual property;

· our ability to obtain additional capital and financing;

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

· adverse economic conditions.

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

Our market risk exposures are related to our cash and cash equivalents and interest that we may pay on debt. We have no derivative financial commodity instruments. We invest our excess cash in investment grade, highly liquid, short‑term investments. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and, therefore, impact our cash flows and results of operations. During the first quarter of fiscal 2014, we held no short-term investments and, as a result, a hypothetical one percentage point interest change from those in effect would not have resulted in a fluctuation of interest income. In the first quarters of fiscal 2014 and 2013, interest income was immaterial.

24

Commodity Risk

We are exposed to commodity price risks. Many of the ingredients we use to prepare our food, as well as our packaging materials, are commodities or ingredients that are affected by the price of other commodities, exchange rates, foreign demand, weather, seasonality, production, availability, and other factors outside our control. Some of these commodities are purchased under agreements in effect for periods ranging from one month to one year, usually at fixed prices. As a result, we are subject to commodity risk that current market prices may be below our contractual prices. We also purchase certain ingredients at spot prices, as well as prices that are based on specific formulas related to key components within the commodity category, which could adversely affect our operating result in periods of rising commodity or ingredient prices if we choose, for competitive or other reasons, not to increase menu prices at the same rate at which ingredient costs increase, or if menu price increases result in customer resistance. During the first quarters of fiscal 2014 and 2013, we did not utilize derivative instruments in managing commodity risk.

Foreign Currency Risk

As of first quarter of fiscal 2014, all of our transactions are conducted, and our accounts denominated, in U.S. dollars. Accordingly, we are not exposed to foreign currency risk.

Item 4. Controls and Procedures

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

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

25

Part II.  OTHER INFORMATION

Item 1:LEGAL PROCEEDINGS

From time to time, we are a defendant in litigation arising in the ordinary course of our business. As of the date of this report, there are no legal proceedings that would require accrual or disclosure under ASC 450. We cannot predict with certainty the outcome of any litigation or the potential for future litigation. Regardless of the outcome of any particular litigation and the merits of any particular claim, litigation can have a material adverse impact on our company due to, among other reasons, any injunctive relief granted, which could inhibit our ability to operate our business, amounts paid as damages or in settlement of any such matter, diversion of management resources and defense costs.

Item 1A:  RISK FACTORS

In addition to the other information 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 2013 fiscal year could materially affect the Company’s business, financial condition or operating results. There have been no material changes in our risk factors since our Annual Report on Form 10-K for the year ended December 30, 2013.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

Item 4. MINE SAFETY DISCLOSURES

Not applicable.

Item 6:  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.

101 The following financial information, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheet as of March 31, 2014 and December 30, 2013, (ii) Consolidated Statements of Operations and Comprehensive Loss for the three months ended March 31, 2014 and April 1, 2013, (iii) Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and April 1, 2013, and (iv) Notes to Consolidated Financial Statements. In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings.

26

SIGNATURES

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

COSI, INC.

Date: May 15, 2014	By: /s/ RJ DOURNEY
	RJ Dourney
	President, Chief Executive Officer, and Director
Date: May 15, 2014	By: /s/ WILLIAM KOZIEL
	William Koziel
	Chief Financial Officer (chief accounting officer)
	Treasurer and Secretary

27

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.

101 The following financial information, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheet as of March 31, 2014 and December 30, 2013, (ii) Consolidated Statements of Operations and Comprehensive Loss for the three months ended March 31, 2014 and April 1, 2013, (iii) Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and April 1, 2013, and (iv) Notes to Consolidated Financial Statements. In accordance with Regulation S-T, the XBRL-related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall be deemed to be “furnished” and not “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filings.

28