Cosi (COSIQ) 10-Q 2014 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

ACT OF 1934

For the quarterly period ended June 30, 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.)

294 Washington Street, Suite 510

Boston, Massachusetts, 02108

(Address of principal executive offices) (Zip Code)

(857) 415-5000

(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 T 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 T 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 T

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

Number of shares of Common Stock, $.01 par value, outstanding as of August 8, 2014: 19,457,794

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COSI, INC.

Index to Form 10-Q

For the six-month period ended June 30, 2014

	PART I. FINANCIAL INFORMATION	Page Number
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets – as of June 30, 2014 and December 30, 2013	3
	Consolidated Statements of Operations – Three and six-month periods ended June 30, 2014 and July 1, 2013	4
	Consolidated Statement of Stockholders’ Equity – Six-month period ended June 30, 2014	5
	Consolidated Statements of Cash Flows – Six-month periods ended June 30, 2014 and July 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	12-27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.	Controls and Procedures	28
	PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 5.	Exhibits	29
SIGNATURES		30
EXHIBIT INDEX		31
CERTIFICATIONS

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Cosi, Inc.

Consolidated Balance Sheets

As of June 30, 2014 and December 30, 2013

(dollars in thousands)

	June 30, 2014			December 30, 2013
Assets
Current assets:
Cash and cash equivalents	$	6,084		$	6,021
Accounts receivable, net		641			594
Notes receivable, current portion		551			551
Inventories		793			779
Prepaid expenses and other current assets		744			1,348
Total current assets		8,813			9,293
Furniture and fixtures, equipment and leasehold improvements, net		7,143			8,195
Other assets		1,470			1,115
Total assets	$	17,426		$	18,603
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	1,691		$	2,462
Accrued expenses		8,474			9,088
Deferred franchise revenue		18			18
Current portion of other long-term liabilities		998			196
Total current liabilities		11,181			11,764
Long-term debt		6,023			-
Deferred franchise revenue		1,931			1,931
Other long-term liabilities, net of current portion		1,642			2,189
Total liabilities		20,777			15,884
Stockholders' deficit:
Common stock - $.01 par value; 100,000,000 shares authorized, 19,312,794 and 18,106,979 shares issued, respectively		193			181
Additional paid-in capital		299,039			297,181
Treasury stock, 59,886 shares at cost		(1,198	)		(1,198	)
Accumulated deficit		(301,385	)		(293,445	)
Total stockholders' deficit		(3,351	)		2,719
Total liabilities and stockholders' deficit	$	17,426		$	18,603

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

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Cosi, Inc.

Consolidated Statements of Operations and Comprehensive Loss

For the Three and Six Month Periods Ended June 30, 2014 and July 1, 2013

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

	Three Months Ended						Six Months Ended
	June 30,			July 1,			June 30,			July 1,
	2014			2013			2014			2013
	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Revenues:
Restaurant net sales	$	20,007		$	22,656		$	37,735		$	43,510
Franchise fees and royalties		663			752			1,310			1,459
Total revenues		20,670			23,408			39,045			44,969
Costs and expenses:
Cost of food and beverage		5,122			5,521			9,537			10,723
Restaurant labor and related benefits		7,432			8,198			14,526			16,308
Occupancy and other restaurant operating expenses		7,078			7,523			14,079			14,669
		19,632			21,242			38,142			41,700
General and administrative expenses		3,685			3,141			6,054			5,898
Depreciation and amortization		601			672			1,240			1,420
Restaurant pre-opening expenses		-			11			-			11
Provision for losses on asset impairments and disposals		120			355			120			694
Lease termination expense and closed store costs		1,269			126			1,255			147
Gain on sale of assets		(50	)		-			(50	)		-
Total costs and expenses		25,257			25,547			46,761			49,870
Operating loss		(4,587	)		(2,139	)		(7,716	)		(4,901	)
Interest expense		(239	)		-			(239	)		-
Other income		12			4			15			25
Net loss and comprehensive loss	$	(4,814	)	$	(2,135	)	$	(7,940	)	$	(4,876	)
Per Share Data:
Loss per share, basic and diluted	$	(0.27	)	$	(0.12	)	$	(0.44	)	$	(0.27	)
Weighted average shares outstanding		18,148,966			17,988,624			18,101,773			17,969,198

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

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Cosi, Inc.

Consolidated Statement of Stockholders' Equity

For the Six Months Ended June 30, 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, net		1,204,064		12		(12	)										-
Stock-based compensation		1,751				299											299
Issuance of stock warrants (1)						1,571											1,571
Net loss														(7,940	)		(7,940	)
Balance, June 30, 2014		19,312,794	$	193	$	299,039			59,886	$	(1,198	)	$	(301,385	)	$	(3,351	)

(1) Represents proceeds from issuance of Senior Secured Promissory Notes and related stock warrants

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Cosi, Inc.

Consolidated Statements of Cash Flows

For the Six-Month Periods Ended June 30, 2014 and July 1, 2013

(dollars in thousands)

	June 30, 2014			July 1, 2013
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net loss	$	(7,940	)	$	(4,876	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization		1,240			1,420
Non-cash portion of asset impairments and disposals		120			694
Provision for bad debts		(2	)		29
Stock-based compensation expense		299			(5	)
Changes in operating assets and liabilities:
Accounts receivable		(45	)		613
Notes receivable		-			24
Inventories		(14	)		21
Prepaid expenses and other current assets		604			755
Other assets		(2	)		3
Accounts payable and accrued expenses		(1,398	)		(1,134	)
Deferred franchise revenue		-			40
Lease termination accrual		814			128
Other liabilities		(453	)		(270	)
Net cash used in operating activities		(6,777	)		(2,558	)
Cash flows from investing activities:
Capital expenditures		(307	)		(896	)
Proceeds from sale of assets		50			-
Net cash used in investing activities		(257	)		(896	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt		7,500			-
Issuance of long-term debt and stock warrants		(403	)		-
Net cash provided by financing activities		7,097			-
Net increase (decrease) in cash and cash equivalents		63			(3,454	)
Cash and cash equivalents, beginning of period		6,021			15,417
Cash and cash equivalents, end of period	$	6,084		$	11,963
Supplemental disclosure of cash flow information:
Cash paid for:
Corporate franchise and income taxes	$	88		$	63
Non-cash financing activities:
Issuance of stock warrants	$	1,570		$	-

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

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COSI, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 – Basis of Presentation

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

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

The balance sheet at December 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 and six-month periods ended June 30, 2014 and July 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					For the Six Months Ended
	(in thousands)					(in thousands)
	June 30, 2014		July 1, 2013			June 30, 2014		July 1, 2013
Stock option compensation expense	$	-	$	1		$	-	$	6
Restricted stock compensation expense (credit), net of forfeitures		131		(110	)		299		(11	)
Total non-cash, stock-based compensation expense (credit), net of forfeitures	$	131	$	(109	)	$	299	$	(5	)

As of June 30, 2014, the unrecognized compensation expense related to stock options and restricted shares of common stock granted under the Cosi, Inc. 2005 Omnibus Long-Term Incentive Plan, as amended, (the “2005 Plan”), is approximately $1.0 million and is being recognized on a straight-line basis over the remaining vesting period through fiscal 2018.

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 175,000 shares of restricted common stock to key employees during the second quarter of fiscal 2014, of which 87,500 shares are time-vested (“Time Vested Shares”) and 87,500 are performance-based (“Performance Shares”). During the six months ended June 30, 2014, we granted 1,204,164 shares of restricted common stock to key employees. 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. The rest of the shares granted during the six months of fiscal 2014 are subject to the following vesting schedules:

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(a)           The Time-Vested Shares 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 the employee remains in the continuous employ of the Company through each such vesting date.

(b)           The Performance Shares vest in four equal installments, provided that the employee 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).

The value of the shares for the grants made during the second quarters of fiscal 2014, based on the closing price of our common stock on the date of the grants, was approximately $0.2 million.

We did not grant any shares of common stock to employees in the three months ended July 1, 2013.

In the three months ended June 30, 2014 and July 1, 2013, we issued 1,751 and 44,640 shares, respectively, of our restricted common stock to members of the Board of Directors under the 2005 Plan and pursuant to the Non-Employee Directors Stock Incentive Plan. These shares had immaterial aggregate value in 2014 and approximately $0.1 million in 2013, and vested upon issuance.

During the three months ended June 30, 2014 and July 1, 2013, 100 and 250,000 shares, respectively, 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 in the second quarter of fiscal 2014 and approximately $0.7 million during the second quarter of fiscal 2013.

Note 3 –Fair Value Measurements

The Company’s 1,650,000 stock warrants at June 30, 2014 were carried at their fair value of approximately $2.0 million based on the Black-Scholes model. Inputs into the warrant valuation include expected life of warrants, risk-free interest rates, and stock volatility. As all significant inputs are market-based and observable, warrants are categorized in Level 2 of the fair value hierarchy.

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Note 4 – Earnings Per Share

	For the Three Months Ended						For the Six Months Ended
	(net loss in thousands)						(net loss in thousands)
	June 30, 2014			July 1, 2013			June 30, 2014			July 1, 2013
Net loss and comprehensive loss	$	(4,814	)	$	(2,135	)	$	(7,940	)	$	(4,876	)
Shares:
Weighted average number of shares outstanding		18,148,966			17,988,624			18,101,773			17,969,198
Basic and diluted loss per share	$	(0.27	)	$	(0.12	)	$	(0.44	)	$	(0.27	)

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 June 30, 2014 and July 1, 2013, there were, respectively, 1,082,539 and 25,825 unvested restricted shares of common stock outstanding and 7,500 in-the-money and 53,652 out-of-the-money stock options to purchase shares of common stock. In addition, as of June 30, 2014, there were 1,650,000 outstanding warrants to purchase shares of common stock. The unvested restricted shares and the outstanding stock options and warrants 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.

Note 5 – 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 any impairment charges during the three and six months ended June 30, 2014. During the three and six months ended July 1, 2013, we recorded asset impairment charges of approximately $0.4 million and $0.7 million, respectively.

Note 6 – Lease Termination Costs

Future restaurant 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 costs of approximately $1.2 million and $0.1 million that we recorded during the three months ended June 30, 2014 and July 1, 2013, respectively, relate to the closings of eight and three Company-owned restaurants, respectively.

Note 7 – 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.

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Note 8 – 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.

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 9 – Debt

On April 14, 2014, the Company entered into a $5.0 million Senior Secured Promissory Note Agreement with MILFAM II L. P. ( the “MILFAM II Note” and the “MILFAM II Note Agreement”, respectively). The MILFAM II Note bears interest at nine percent (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 percent (11%) in kind in the form of additional promissory notes. The principal obligations under the MILFAM II Note are due three (3) years from the effective date of the MILFAM II Note. The MILFAM II Note Agreement provided for the payment of a finance fee of 3.5% of the principal amount of the MILFAM II 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 of the obligations under the MILFAM II 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 MILFAM II Note and 2) $4.0 million. The MILFAM II 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, which is the general partner of MILFAM II L. P. Mr. Miller is also a significant shareholder of the Company.

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On May 20, 2014, the Company entered into a $2.5 million Senior Secured Note Purchase Agreement with AB Opportunity Fund LLC and AB Value Partners, L.P. (the “AB Notes”, the “AB Note Purchase Agreement”, and the “Lenders”, respectively). The AB Notes are payable in full on the third anniversary from the effective date of the AB Notes. Interest will accrue at the rate of nine percent (9%), and will be paid in arrears semi-annually, provided that the Company may elect to pay the first two interest payments in kind at a rate of eleven percent (11%). As consideration for the AB Notes, the Company provided a fee of 3.5% of the principal amount of the AB Notes and warrants exercisable to purchase up to an aggregate, initially, of 550,000 shares of the common stock of the Company at an exercise price per share of $.01, provided that the Lenders shall not be permitted to exercise the warrants to the extent such exercise would result in any Lender or any of its affiliates owning in excess of 19.9% of the common stock of the Company. The warrants are exercisable by the Lenders at any time prior to the third anniversary from the effective date of the AB Notes, in whole or in part, by surrendering the warrants and a form of exercise to the Company.

We are currently in compliance with all covenant requirements under the MILFAM Senior Secured Note Purchase Agreement and the AB Note Purchase Agreement.

The Company’s 1,650,000 stock warrants at June 30, 2014 were carried at their fair value of approximately $2.0 million based on the Black-Scholes model using the following assumptions:

Expected life (in years)	3
Volatility	63.86	%
Risk Free interest rate	81.80	%
Divident yield (on comon stock)	-

The relative value of the warrants was $1,570,146, which was the amount recorded as debt discount, with an offset to additional paid-in capital. The debt discount will be amortized over the life of the Notes, three years, and charged to interest expense using the effective interest rate calculation method.

Note 10 – Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard

On May 16, 2014, the Company received notice from the Listing Qualifications Department of the Nasdaq Stock Market indicating that as of the date of the filing of our Form 10-Q for the period ended March 31, 2014, we had fallen below the $2,500,000 minimum level of stockholders equity required for continued listing on the Nasdaq Capital Market under Nasdaq Listing Rule 5550(b)(1). The notification letter stated that the Company would be afforded 45 calendar days, or until June 14, 2014, to submit a plan to regain compliance and that if the plan was accepted, the Company may be granted an extension of up to 180 calendar days from the date of notification, or until November 12, 2014 to evidence compliance.

On July 25, 2014, the Listing Qualifications Department of the Nasdaq Stock Market notified the Company of its determination to grant the Company an extension of time to regain compliance with the Nasdaq Listing Rule 5550(b)(1) for a minimum level of stockholders equity based on review of a plan submitted by the Company. The plan consisted of raising capital through an equity transaction, such as a rights offering, private placement, public offering or other equity or debt transactions. The Company has until November 12, 2014 to evidence compliance with the Nasdaq continued listing requirements.

Note 11 – Subsequent Event

Appointment of a new CFO

On July 7, 2014, the Company appointed Scott Carlock as Chief Financial Officer, effective as of July 28, 2014.

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

The following discussion and analysis of our financial condition and results of operations for the fiscal quarters ended June 30, 2014 and July 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
	June 30, 2014						July 1, 2013
	Company-Owned		Franchise		Total		Company-Owned		Franchise		Total
Restaurants at beginning of period		72		49		121		74		50		124
Restaurants permanently closed		6		2		8		-		-		-
Restaurants at end of period		66		47		113		74		50		124

	For the Six Months Ended
	June 30, 2014						July 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		6		3		9		1		-		1
Restaurants at end of period		66		47		113		74		50		124

As of June 30, 2014, there were 66 Company-owned restaurants and 47 franchised restaurants operating in 16 states, the District of Columbia, the United Arab Emirates (“UAE”), and Costa Rica. During the three months ended June 30, 2014, as a result of a continued assessment of our restaurant portfolio, we closed six Company-owned restaurants. During the same period, two franchised restaurants closed, one of which was an international location. Subsequent to the end of the fiscal quarter, we closed four Company-owned restaurants and converted one franchised restaurant to a Company-owned. We did not open or close any restaurants during the three months ended July 1, 2013.

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, Squagels®, hot melts, flatbread pizzas, S’mores and other desserts, and a variety of coffees and hand-crafted 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.

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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, by both an area developer and an individual franchise operator, is $40,000 for the first restaurant and $35,000 for each additional restaurant.

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

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

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

Critical Accounting Policies

Our discussion and analysis of our consolidated financial condition and results of operations are 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 second 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 at the time a lease termination commitment is made and communicated to the landlord. 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.

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

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

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. As of June 30, 2014 and July 1, 2013, there were 66 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.

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

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

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RESULTS OF OPERATIONS

Our operating results for the three and six-month periods ended June 30, 2014 and July 1, 2013, expressed as a percentage of total revenues (except where otherwise noted), were as follows:

	Three Months Ended						Six Months Ended
	June 30, 2014			July 1, 2013			June 30, 2014			July 1, 2013
Revenues:
Restaurant net sales		96.8	%		96.8	%		96.6	%		96.8	%
Franchise fees and royalties		3.2			3.2			3.4			3.2
Total revenue		100.0			100.0			100.0			100.0
Cost and expenses:
Cost of food and beverage (1)		25.6			24.4			25.3			24.6
Restaurant labor and related benefits (1)		37.1			36.2			38.5			37.5
Occupancy and other restaurant operating expenses (1)		35.4			33.2			37.3			33.7
		98.1			93.8			101.1			95.8
General and administrative expenses		17.8			13.4			15.5			13.1
Depreciation and amortization		2.9			2.9			3.2			3.2
Provision for losses on asset impairments and disposals		0.6			1.5			0.3			1.5
Lease termination expense and closed store costs		6.2			0.5			3.2			0.3
Gain on sales of assets		(0.2	)		-			(0.1	)		-
Total costs and expenses		122.2			109.1			119.8			110.9
Operating loss		(22.2	)		(9.1	)		(19.8	)		(10.9	)
Interest expense		(1.2	)		-			(0.6	)		-
Other income		0.1			-			0.1			0.1
Net loss and comprehensive loss		(23.3	)%		(9.1	)%		(20.3	)%		(10.8	)%

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

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Restaurant Net Sales

	Restaurant net sales
	(in thousands)		as a % of total revenues
Three months ended June 30, 2014	$	20,007		96.8	%
Three months ended July 1, 2013	$	22,656		96.8	%
	(in thousands)		as a % of total revenues
Six months ended June 30, 2014	$	37,735		96.6	%
Six months ended July 1, 2013	$	43,510		96.8	%

Restaurant net sales: Restaurant net sales decreased 11.7%, or approximately $2.6 million, in the three months ended June 30, 2014, as compared to the same period in fiscal 2013, due to an approximately $1.6 million, or 7.5%, decrease in net sales in our comparable restaurant base, a decrease of approximately $1.5 million in net restaurant sales related to eleven Company-owned restaurants closed during and after the second quarter of fiscal 2013, partially offset by approximately $0.5 million in sales from the two franchised restaurants converted to Company-owned restaurants during the first quarter of fiscal 2014. The decrease in comparable restaurant net sales was comprised of a 9.2% decrease in traffic, partially offset by a 1.7% increase in average check price.

In the six months ended June 30, 2014, restaurant net sales decreased 13.3%, or approximately $5.8 million, as compared to the six months ended July 1, 2013, due to an approximately $4.1 million, or 9.9%, decrease in net sales in our comparable restaurant base, a decrease of approximately $2.2 million in net sales related to twelve Company-owned restaurants closed during and after the first quarter of fiscal 2013, partially offset by approximately $0.5 million in sales from the two franchised restaurants converted to Company-owned restaurants during the first quarter of fiscal 2014. The decrease in comparable restaurant net sales was comprised of 11.0% decrease in traffic, partially offset by a 1.1% increase in average check price.

Franchise Fees and Royalties

	Franchise fees and royalties
	(in thousands)		as a % of total revenues
Three months ended June 30, 2014	$	663		3.2	%
Three months ended July 1, 2013	$	752		3.2	%
	(in thousands)		as a % of total revenues
Six months ended June 30, 2014	$	1,310		3.4	%
Six months ended July 1, 2013	$	1,459		3.2	%

Franchise fees and royalties: In the three and six months ended June 30, 2014 and July 1, 2013, franchise fees and royalties decreased by approximately $0.1 million in each of the periods, as compared to the three and six months ended July 1, 2013. The decrease is due primarily to lower franchise royalties resulting from the closing of six and seven franchised restaurants during and subsequent to the second and first quarters of fiscal 2013, respectively, as well as the decrease in franchise comparable net restaurant sales during the six months of fiscal 2014.

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Costs and Expenses

	Cost of food and beverage
	(in thousands)		as a % of restaurant net sales
Three months ended June 30, 2014	$	5,122		25.6	%
Three months ended July 1, 2013	$	5,521		24.4	%
	(in thousands)		as a % of restaurant net sales
Six months ended June 30, 2014	$	9,537		25.3	%
Six months ended July 1, 2013	$	10,723		24.6	%

Cost of food and beverage: The increase in cost of food and beverage, as a percentage of restaurant net sales, for the three and six months ended June 30, 2014, is largely due to a shift in menu sales mix towards products with higher food costs, as well as higher year-over-year costs of certain commodities, including poultry and dairy products.

	Restaurant labor and related benefits
	(in thousands)		as a % of restaurant net sales
Three months ended June 30, 2014	$	7,432		37.1	%
Three months ended July 1, 2013	$	8,198		36.2	%
	(in thousands)		as a % of restaurant net sales
Six months ended June 30, 2014	$	14,526		38.5	%
Six months ended July 1, 2013	$	16,308		37.5	%

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 year, as well as lower costs related to healthcare benefits.

	Occupancy and other restaurant operating expenses
	(in thousands)		as a % of restaurant net sales
Three months ended June 30, 2014	$	7,078		35.4	%
Three months ended July 1, 2013	$	7,523		33.2	%
	(in thousands)		as a % of restaurant net sales
Six months ended June 30, 2014	$	14,079		37.3	%
Six months ended July 1, 2013	$	14,669		33.7	%

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Occupancy and other restaurant operating expenses: The increase in occupancy and other restaurant operating expenses, as a percentage of restaurant net sales, 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
Three months ended June 30, 2014	$	3,685		17.8	%
Three months ended July 1, 2013	$	3,141		13.4	%
	(in thousands)		as a % of total revenues
Six months ended June 30, 2014	$	6,054		15.5	%
Six months ended July 1, 2013	$	5,898		13.1	%

General and administrative expenses: The increase in general and administrative expenses in the three and six months ended June 30, 2014 is due primarily to charges of approximately $0.8 million resulting from the relocation of the corporate headquarters from Chicago, IL to Boston, MA, including termination of the corporate office lease and severance pay, as well as higher legal fees incurred in the quarter, partially offset by labor and related benefits 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 and the reversal of previously amortized restricted stock compensation expenses during fiscal 2013.

	Depreciation and amortization
	(in thousands)		as a % of total revenues
Three months ended June 30, 2014	$	601		2.9	%
Three months ended July 1, 2013	$	672		2.9	%
	(in thousands)		as a % of total revenues
Six months ended June 30, 2014	$	1,240		3.2	%
Six months ended July 1, 2013	$	1,420		3.2	%

Depreciation and amortization: The depreciation and amortization expense, as a percentage of total revenues, remained the same in the three and six months ended June 30, 2014 compared to the same periods in fiscal 2013 and decreased by approximately $0.1 million and $0.2 million in the three and six months ended June 30, 2014, respectively. The dollar decrease was due primarily to the impact of impairments of approximately $1.0 million recorded during and subsequent to the first quarter of fiscal 2013 as well as the continued depreciation of our comparable restaurant base.

	Provision for losses on asset impairments and disposals
	(in thousands)		as a % of total revenues
Three months ended June 30, 2014	$	120		0.6	%
Three months ended July 1, 2013	$	355		1.5	%
	(in thousands)		as a % of total revenues
Six months ended June 30, 2014	$	120		0.3	%
Six months ended July 1, 2013	$	694		1.5	%

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Provision for losses on asset impairments and disposals: In the three and six-months ended June 30, 2014, we recorded a provision for losses on asset impairments and disposals of approximately $0.1 million, related to the disposals of assets at six Company-owned restaurants at the termination of their leases. In the three and six-months ended July 1, 2013, we recorded a provision for losses on asset impairments and disposals of approximately $0.4 million and $0.7 million, respectively, related to three and six underperforming restaurants, respectively, as well as to maintenance capital expenditures on previously impaired restaurants.

	Lease termination expense and closed store costs
	(in thousands)		as a % of total revenues
Three months ended June 30, 2014	$	1,269		6.2	%
Three months ended July 1, 2013	$	126		0.5	%
	(in thousands)		as a % of total revenues
Six months ended June 30, 2014	$	1,255		3.2	%
Six months ended July 1, 2013	$	147		0.3	%

Lease termination and closed store costs: In the three and six months ended June 30, 2014, we incurred lease termination expenses and closed store cost of approximately $1.3 million related to the closing of six Company-owned restaurants resulting from the continued assessment of our restaurant portfolio. The lease termination and closed store costs of approximately $0.1 million in the three and six months ended July 1, 2013 are related to two Company-owned locations which closed subsequent to the end of the second quarter of fiscal 2013, one of each in New York and New Jersey.

	Gain on sale of assets
	(in thousands)			as a % of total revenues
Three months ended June 30, 2014	$	(50	)		(0.2	%)
Three months ended July 1, 2013	$	-			-
	(in thousands)			as a % of total revenues
Six months ended June 30, 2014	$	(50	)		(0.1	%)
Six months ended July 1, 2013	$	-			-

20

Gain on sale of assets: The gain on sale of assets in the three and six months of fiscal 2014 is related to the sale of one liquor license.

	Interest expense
	(in thousands)			as a % of total revenues
Three months ended June 30, 2014	$	(239	)		(1.2	%)
Three months ended July 1, 2013	$	-			-
	(in thousands)			as a % of total revenues
Six months ended June 30, 2014	$	(239	)		(0.6	%)
Six months ended July 1, 2013	$	-			-

Interest expense: In the three and six months of fiscal 2014, we incurred interest expense related to obligations on senior secured promissory notes, as well as accretion expense on the discounting of our long-term debt.

	Other income
	(in thousands)		as a % of total revenues
Three months ended June 30, 2014	$	12		0.1	%
Three months ended July 1, 2013	$	4		0.0	%
	(in thousands)		as a % of total revenues
Six months ended June 30, 2014	$	15		0.1	%
Six months ended July 1, 2013	$	25		0.1	%

	Net loss
	(in thousands)			as a % of total revenues
Three months ended June 30, 2014	$	(4,814	)		(23.3	%)
Three months ended July 1, 2013	$	(2,135	)		(9.1	%)
	(in thousands)			as a % of total revenues
Six months ended June 30, 2014	$	(7,940	)		(20.3	%)
Six months ended July 1, 2013	$	(4,876	)		(10.8	%)

Net loss: The increase in net loss is due primarily to the $1.2 million in lease termination expenses, the one-time charge of $0.8 million for the relocation of the corporate headquarters to Boston, MA, the decrease in restaurant net sales and its unfavorable effect on the fixed-portion of manager labor and occupancy-related costs, the increase in food and beverage costs, as well as the interest expense recorded in the quarter, partially offset by labor savings resulting from the administrative and restaurant management workforce reductions, and 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 “MILFAM II Note” and the “MILFAM II Note Agreement”, respectively). The MILFAM II Note bears interest at nine percent (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 percent (11%) in kind in the form of additional promissory notes. The principal obligations under the MILFAM II Note are due three (3) years from the effective date of the MILFAM II Note. The MILFAM II Note Agreement provided for the payment of a finance fee of 3.5% of the principal amount of the MILFAM II 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 of the obligations under the MILFAM II 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 MILFAM II Note and 2) $4.0 million. The MILFAM II 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, which is the general partner of MILFAM II L. P. Mr. Miller is also a significant shareholder of the Company.

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On May 20, 2014, the Company entered into a $2.5 million Senior Secured Note Purchase Agreement with AB Opportunity Fund LLC and AB Value Partners, L.P. (the “AB Notes”, the “AB Note Purchase Agreement”, and the “Lenders”, respectively). The AB Notes are payable in full on the third anniversary from the effective date of the AB Notes. Interest will accrue at the rate of nine percent (9%), and will be paid in arrears semi-annually, provided that the Company may elect to pay the first two interest payments in kind at a rate of eleven percent (11%). As consideration for the AB Notes, the Company provided a fee of 3.5% of the principal amount of the AB Notes and warrants exercisable to purchase up to an aggregate, initially, of 550,000 shares of the common stock of the Company at an exercise price per share of $.01, provided that the Lenders shall not be permitted to exercise the warrants to the extent such exercise would result in any Lender or any of its affiliates owning in excess of 19.9% of the common stock of the Company. The warrants are exercisable by the Lenders at any time prior to the third anniversary from the effective date of the AB Notes, in whole or in part, by surrendering the warrants and a form of exercise to the Company.

We are currently in compliance with all covenant requirements under the MILFAM Senior Secured Note Purchase Agreement and the AB Note Purchase Agreement.

Cash and cash equivalents were approximately $6.1 million on June 30, 2014, compared with $6.0 million on December 30, 2013. We had negative working capital of approximately $2.4 million on June 30, 2014, compared with negative working capital of approximately $2.5 million on December 30, 2013. The slight increase in working capital was a result of the net proceeds of approximately $7.1 million from the Senior Secured Promissory Note agreements entered into during the quarter, partially offset by funding our operating loss, net of depreciation and other non-cash expenses, payments made during the quarter to exit the leases at our corporate headquarters in Chicago, IL and two restaurant locations closed during the quarter, as well as payments made for capital expenditures. Our principal requirements for cash in the remainder of fiscal 2014 will be for working capital needs, payments on early termination of restaurant operating leases, and routine maintenance of our existing restaurants.

Net cash used in operating activities in the six months ended June 30, 2014 was approximately $6.8 million compared to $2.6 million in the six months ended July 1, 2013. The increase was primarily the result of the higher operating loss, net of depreciation and other non-cash expenses, payments made during the quarter to exit the leases at our corporate headquarters in Chicago, IL and two restaurant locations closed during the quarter, as well as timing of certain vendor payments made during the 2014 second quarter.

Net cash used in investing activities in the six months ended June 30, 2014 was approximately $0.3 million compared to $0.9 million in the six months ended July 1, 2013. The decrease was primarily due to payments for construction of a new Company-owned restaurant in the six months of fiscal 2013, as well as lower maintenance capital expenditures in fiscal 2014.

Net cash provided by financing activities of approximately $7.1 million was from proceeds associated with issuance of Senior Secured Promissory Notes and stock warrants.

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As of June 30, 2014, eight quarterly payments of $62,500 each were not paid as scheduled in accordance with the terms of the Subordinated Secured Promissory Note receivable associated with the sale of restaurants to a franchisee in 2010. As of June 30, 2014, the Company has a reserve of $0.45 million recorded against the Subordinated Secured Promissory Note.

During the first and second quarters of fiscal 2014, we closed 10 Company-owned restaurants and the Support Center in Deerfield, Illinois, and during the second quarter of fiscal 2014, we relocated the Company’s Support Center to Boston, Massachusetts. As a result, we incurred approximately $0.9 million of one-time costs related to these events in the second quarter of fiscal 2014. While we believe these events will strengthen our business in the long-term, the charges associated with these events reduced our current cash and cash equivalents.

We expect to incur capital costs associated with the maintenance of existing Company-owned restaurants during the remainder of fiscal 2014. During the first two quarters of fiscal 2014 and 2013, 94.5% and 93.3%, 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. The Company’s capital expenditures for repairs and maintenance of existing restaurants during fiscal 2014 are expected to be less than fiscal 2013, and at this time the Company does not expect to incur any significant capital costs for repairs and maintenance or otherwise during the balance of fiscal 2014.

As a result of the administrative work force reductions we undertook in fiscal 2013, the Company expects to realize continued savings in general and administrative expenses in fiscal 2014 as compared to the fiscal 2013, excluding any costs associated with relocating the corporate headquarters from the Chicago, Illinois, area to Boston, Massachusetts

Despite the capital raised in the second quarter 2014, the reductions in our workforce and the improved store operating results, we believe that our liquidity will remain very tight for the foreseeable future. Absent significant continued improvement in store operating results, we will need to seek additional capital to meet our cash requirements including our working capital needs and capital improvements and maintenance. Our conclusion is based on our financial performance during fiscal 2013, first two quarters of fiscal 2014 and our projected financial performance through the second quarter of fiscal 2015, and includes a sensitivity analysis that projects varying levels of decline in the consumer demand from those assumed in our projections. The range of levels selected was based on our reasonable expectation of demand given our historical performance.

To fund our cash requirements, as well as to regain compliance with the Nasdaq minimum listing requirements for stockholders equity, we anticipate raising capital through an equity transaction, such as a rights offering, private placement, public offering or other equity or debt transactions. Additionally, we will continue to seek to effect further reductions in general and administrative expenses, sell certain Company-owned locations to franchisees and/or other third parties, obtain other sources of financing, and take other actions to fund our cash requirements.

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. An inability to access additional sources of liquidity to fund our cash needs could materially adversely affect our financial condition and results of operations.

Our cash resources, and therefore our liquidity, are highly dependent upon the level of internally generated cash from operations and upon future financing transactions. We cannot predict whether such financing will be available on terms acceptable to us, or at all.

If we default on the Senior Secured Promissory Notes, 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.

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.

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As a result of the Company relocating its corporate headquarters to Boston, MA, there is a completely new management team in place. Out new Chief Executive Officer and President joined the Company on March 17, 2014 and our Chief Financial Officer and Treasurer joined on July 28, 2014. In addition, our Vice Presidents of Operations, Information Systems, Supply Chain, Marketing, and Human Resources have been in their positions with the Company for a very short period of time. These new members of management do not have previous experience with us, and we cannot assure you that they will fully integrate themselves into our business or that they will effectively manage our business affairs. Our failure to assimilate the new members of management, the failure of the new members of management to perform effectively, or the loss of any of the new members of management could have a material adverse effect on our business, financial condition and results of operations.

We have entered into agreements that create contractual obligations. These obligations will have an impact on future liquidity and capital resources. The table below presents a summary of these obligations as of June 30, 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)		40,877		5,556		16,825		7,860		10,636
Long-term debt (2)		7,502,187		338		1,456		7,500,393		-
Other long-term liabilities (3)		965		867		98		-		-
Total contractual cash obligations	$	7,544,029	$	6,761	$	18,379	$	7,508,253	$	10,636

(1) Amounts shown are net of an aggregate $0.05 million of sub-lease rental income due under non-cancelable subleases and include accrued contractual lease increases of approximately $1.3 million, which are included in other long-term liabilities in the attached consolidated balance sheets.

(2) Represents interest and principal in relation to the Senior Secured Notes issued during the second quarter of fiscal 2014

(3) Amounts shown are related to contractual obligations for lease termination agreements. These obligations are non-interest bearing and are included in other 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.

As of June 30, 2014, we entered into agreements to terminate the operating leases at ten of our Company-owned restaurants. The unpaid lease termination fees at June 30, 2014 are approximately $0.7 million.

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 $1.3 and $1.7 million as of June 30, 2014 and July 1, 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 as of June 30, 2014 and July 1, 2013 are landlord allowances of approximately $0.4 million at each of the periods.

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As of June 30, 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.

Subsequent Events

Appointment of a new CFO

On July 7, 2014, the Company appointed Scott Carlock as Chief Financial Officer, effective as of July 28, 2014.

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.

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 June 30, 2014 was approximately $0.2 million.

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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-Q 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 our Annual Report on Form 10-K for the fiscal year ended December 30, 2013. If any of these risks or uncertainties actually occurs, our business, financial condition or operating results could be materially and adversely affected, and the trading price of our common stock could decline. We do not undertake to publicly update or revise our forward-looking statements even if our future changes make it clear that any projected results expressed or implied therein will not be realized.

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

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

· labor shortages or increased labor costs;

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

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

· our operation and execution in new and existing markets;

· expansion into new markets, including foreign countries;

· our ability to attract and retain qualified franchisees and our franchisees’ 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;

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· our ability to obtain additional capital and financing on acceptable terms;

· 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.

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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. As of June 30, 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 two quarters of fiscal 2014 and 2013, interest income was immaterial.

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 two quarters of fiscal 2014 and 2013, we did not utilize derivative instruments in managing commodity risk.

Foreign Currency Risk

As of June 30, 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 controls 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.

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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 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.

101 The following financial information, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of June 30, 2014 and December 30, 2013, (ii) Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2014 and July 1, 2013, (iii) Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and July 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.

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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: August 14, 2014	By: /s/ RJ DOURNEY
	RJ Dourney
	President, Chief Executive Officer, and
	Director
Date: August 14, 2014	By: /s/ SCOTT CARLOCK
	Scott Carlock
	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.

101 The following financial information, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of June 30, 2014 and December 30, 2013, (ii) Consolidated Statements of Operations and Comprehensive Loss for the three and six months ended June 30, 2014 and July 1, 2013, (iii) Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and July 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.

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