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Executives

Bill Koziel - Chief Financial Officer

Steven Edwards - President and CEO

Analysts

James Fronda - Sidoti & Company

William Meyers - Miller Asset Management

Cosi Inc. (COSI) Q3 2013 Earnings Conference Call November 14, 2013 10:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the Third Quarter 2013 Cosi Incorporated Earnings Conference Call. My name is Denise and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I’d now like to turn the conference over to your host for today, Mr. Bill Koziel, Chief Financial Officer. Please proceed.

Bill Koziel

Thank you, operator. Good morning, everyone. I’d like to welcome you to Cosi’s 2013 third quarter results conference call. Joining me on the call again this morning is Steven Edwards, Cosi’s President and Chief Executive Officer.

Cosi’s earnings release was issued earlier today and is available in the Investor Information section of our website at www.getcosi.com. Our form 10-Q was filed this morning with the Securities and Exchange Commission. During the call, we’ll be referencing supplemental materials, which are also available in the Investor Information section of our website. If you have not already done so, please access the supplemental materials at this time.

As we always do, we’ll address our regulatory housekeeping matters before we begin. During our introductory comments and in our responses to your questions, certain items may be discussed which are not based on historical fact. Any such items, including expected results, and any details related to expected performance should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All such forward-looking statements involve risks and uncertainties that could cause our future performance and financial results to differ materially, and therefore, you should not place undue reliance on these forward-looking statements.

We refer all of you to our filings with the Securities and Exchange Commission for a more detailed discussion of the risks and uncertainties that may have a direct bearing on our operating results, our performance, and our financial conditions.

For the call today, Steven will begin with comments about our business, I’ll then take us through a brief review of the results for the quarter and then we’ll open the call for your questions.

I’ll now turn it over to Steven.

Steven Edwards

Thank you Bill and good morning everyone. Once again my prepared comments today will be brief. I want to reiterate our objectives and highlight some of the actions we have already taken. As I have previously stated we must reverse the decline in revenues. We are working to meet its objective by offering better products and service to our customers.

Next, we must explore options to optimize our collection of company stores, and finally we must establish a long term strategy to develop our brand and grow our business. We have made progress in our second two objectives, but we have not been successful in the first. In the majority of our stores sales continue to decline, despite our efforts to improve the cleanliness appearance and hospitality of our stores. We established store cleanliness and hospitality as a priority early in the quarter and many of our employees have responded to the call. Most of our stores look cleaner and brighter and our employees are more engage with our customers. We see the results primarily to a decline in number of customer complaints, but there is still more work to do.

Turning to asset management, we are working on several transactions, for a number of our company-owned stores. As I said, these transactions will take various forms including early termination, subleasing and re-franchising. We have completed four such transactions so far and have others currently in process. We will provide you with additional disclosure, if and when these transactions are completed. And finally, we are working on building a better Cosi. Our effort involves a complete rethinking of our products, our operating systems, our brand and our business.

Many individuals in our company have stepped forward with a renewed drive to make Cosi great again. And the band [of our legions] grows broader every day. Some of the changes we are pursuing are simple and some are more significant, they are all driven towards developing a highly profitable business model that offers compelling value to consumers in a simple, fun and cost effective way. There is still much to work to do, but we are committed to the goal.

And now let me turn it back over to Bill, who will provide additional information on our quarterly financial results.

Bill Koziel

Thanks Steven. I'll make some brief comments about the financial and operating performance for the quarter and then we will take your questions.

Please refer to pages four and five of the supplemental information as I make my comments. We reported a net loss today of $2.5 million or $0.14 per share. This compared with the 2012 third quarter net loss of $1.4 million or $0.08 per share. The net loss per share calculations for both quarters reflect the impact of the reverse stock split affected on May 9th this year.

Let’s look now at revenue performance which was the main driver of our financial performance for the quarter. The $3 million decline in company-owned restaurant sales was largely due to the $2 million loss in sales from seven locations that closed during and subsequent to the third quarter of 2012. The balance of the decline in company-owned restaurant sales was due to the 4.8% decrease in third quarter comparable company-owned restaurant sales that was comprised of a 6.1% decrease in traffic partially offset by a 1.3% increase in average check. The traffic decline for the quarter occurred across all day parts. The increase in average check was largely the result of an increase in catering sales as a percentage of revenues when compared to the prior year, the impact of price increases taken since the third quarter of last year and the launch this year of the new bowl category which has higher average selling prices than our other entrée categories. The strongest market performance for the third quarter was again New York City where we did achieve positive comparable sales growth.

The quarter-over-quarter improvement in franchise fees and royalties of $71,000 was the result of $115,000 in fees related to three restaurants that opened during the 2013 third quarter and partially offset by the impact on royalties of the 1.9% comparable sales decline as well as the impact of store closings since the third quarter of last year. As to the other components of operating performance for the quarter, cost of food and beverage for the 2013 third quarter was 25.1% of restaurant net sales, compared to the prior year at 23.5%.

The increase in cost over the prior year was attributable to several factors. First, our sales mix in the quarter shifted towards products that have a higher cost as a percentage of net sales and other products, most notably our new category of bowls which were launched earlier this year. We were also impacted by the continued erosion of beverage sales, specifically fountain beverages and coffee that historically have a lower average cost compared to the other beverage and non-beverage products.

The increase in labor and related benefits as a percentage of restaurant net sales was due in large part to the deployment of additional hourly labor in an effort improve speed of service and guest satisfaction, combined with the deleveraging impact of the comparable stores sales decline on the fixed portion of our labor costs. We were also adversely impacted in the quarter by higher employee health insurance costs. The increase in occupancy and other operating costs as a percentage of restaurant net sales resulted from the deleveraging impact of the comparable stores sales decline and increase in costs for the repair and maintenance of existing company restaurants, higher paper and packaging costs, primarily related to the growth in catering sales and a year-over-year increase in the purchase of small wears.

General and administrative expense decreased by $421,000 in the 2013 third quarter as compared to the prior year, due primarily to labor savings resulting from the administrative headcount reduction implemented in the second quarter of 2013.

Cash, cash equivalents and short-term investments were approximately $8.3 million as of September 30th and Cosi has virtually no debt. Capital expenditures for the quarter were $770,000 and were most related to the new location opened in the Easton Town Center Mall in Ohio during the quarter. Slide 5 of the supplemental material provides a reconciliation of the non-GAAP measures on slide 4 to our reported quarterly results.

This concludes our brief presentation portion this morning. Stephen and I look forward to answer your questions. Operator, please open the line for questions.

Question-and-Answer session

Operator

(Operator Instructions) Our first question comes from James Fronda with Sidoti & Company. Please proceed.

James Fronda - Sidoti & Company

Hi guys, how are you?

Steven Edwards

Good thanks. How are you?

James Fronda - Sidoti & Company

Good, thanks. I guess any guidance on when you might develop some revenue growth in the foreseeable future. And any more specifics on how you may improve store traffic going forward?

Steven Edwards

Yeah James, I wish I had that crystal ball and I wish I could tell you. I would say that we are working on a number of fronts to figure out the right magic to bring people back in the store. I think we still have a lot of work do and I am not sure that I do want to give you that kind of a forward projection right now.

James Fronda - Sidoti & Company

Okay. And Bill, just in terms of food costs, are they rising currently? Any specific on how you might offset those going forward?

Bill Koziel

Yeah James, I think when you look at the third quarter year-over-year the commodity costs were the driver of the higher cost year-over-year. And there was a shift in the mix. When we talk about that comp sales erosion, our breakfast category held up better than lunch and dinner. And breakfast tends to be a higher cost as a percentage of sales just because of the [S'mores]. So when you look at that mix of items, that's really what drove that year-over-year increase, not necessarily the commodity cost.

James Fronda - Sidoti & Company

Okay, alright. That's fine. Thanks guys.

Steven Edwards

Thank you.

Operator

Our next question comes from Alex [Zaslow] with Midtown Partners. Please proceed.

Unidentified Analyst

Good morning, gentlemen.

Steven Edwards

Hi Alex.

Unidentified Analyst

I was just wondering, you talked a lot about customer service last time and its importance. And I'm just wondering if you got any better response so far, you could just give us some color on that?

Steven Edwards

Yeah. It's a hard thing to quantify. As I mentioned in my remarks, we've seen a meaningful decline in the number of complaints that we're receiving from people and we're receiving a number of very positive feedback from people who are experiencing hospitality and service that kind of goes beyond what they had expected, which is really what you have to be before people find it could be notable.

I will tell you that there is a lot of people in the system who just responded to them and they are having to relearn what is involved with great customer service. Some of them, when given the opportunity and explain to them what's involved with it will step to look forward and deliver what we're asking. Some people are still uncomfortable. And what’s interesting about our business is that there is really no way to hide people in the back of the house. Everybody on the team has to be outgoing and has to be willing to engage positively with our customers.

So dealing with I think 1,400 people in the whole organization. But we've asked everyone to sign a commitment that they understand that hospitality is an important part of what we do. And I think they’re all taking it very seriously, some people are better at it than other though.

Unidentified Analyst

Yeah definitely. The other question, we're curious about your strategy for attracting franchisees, has that shifted at all. And I know in the past you mentioned about Red Rooster and initiatives working with them towards like a different concept. And I was just wondering if you could talk a little bit about that or any ships that happened?

Steven Edwards

No, so franchisees we still have an ongoing, we've maintained an ongoing effort to try and identify new franchisees and continued growth with our existing franchisees. We have a number of stores that are currently in process. We have a number of new franchisees who are in the process of signing agreements. And I think that process that activity is continuing to perform reasonably well.

They are all very excited with the new design of the store that we're showing them, the graphics that we're working with and the products that we have under development. And so I think that there is more to come there, but I don’t want to provide any additional statements about what’s actually been done or the numbers involved.

With regard to Big Red Rooster that was really a one-time project that we work with them where we work with them to help us pull together some of the key elements that we wanted to have in the Eastern location. I will tell you that we are continuing to develop that, but we’ve really moved to an in-house effort. And we have a team that is working daily to make sure that our branding and our messaging, that our colors, that our customer experience is all cohesive so that when we develop new units or when our franchisees develop new units or when we go back and retrofit existing units that they have a very consist look which today is not the case.

Unidentified Analyst

Okay. And also if you could talk a little bit more about the new chef you added and if there is a strategic shift in menu innovation and what not? Maybe even which products are you really just seeing aren’t a good fit anymore?

Steven Edwards

Yeah. So Michael Foley joined us over a year ago now. He has carried the title Vice President of Strategic Innovation, but Michael is really involved in all aspects of the brand. And he has been the key driver not only of the appearance of our stores, but messaging in our stores and the food.

Michael is a very talented individual with a great track record as a successful chef and is well recognized. And we are limited we have been limited to some extent in terms of what we could do given the breadth of what we currently do in the stores. What we’ve been attempting to do recently with our test is to sort of mitigate to some extent what we are trying to offer and it gives us greater flexibility to elevate what remains.

And so we have been experimenting with a number of what I would call premium sandwiches with a focus more heavily on sandwiches, but trying to really drive something that’s significantly better than you can find other places. So it’s really early in the process, but I would say there are experimentations brought. It involves ingredients, it involves bread, working through bread and how we can make the bread better overtime. So Michael, it’s been very helpful to the process.

Unidentified Analyst

Okay, thank you. That’s all I have at this time.

Operator

Our next question comes from William Meyers with Miller Asset Management. Please proceed.

William Meyers - Miller Asset Management

Thanks for taking the questions. I guess what I would like to hear a little bit more about is the franchise revenue, it looks to me like it’s coming out about 15,000 per store per quarter. And I am wondering if that just would drop straight to the bottom line or if there are costs outside of that that would -- how would you see the franchise stores comparing to the slight losses you are having at the company stores, some color on that? Thanks.

Steven Edwards

So we have very lean franchise organization right now, but obviously we need someone who oversees operations and development. We have franchise sales person and we have a construction person. And I guess you could say that their costs would be borne by the franchise revenue if you’re going to properly allocate their costs. But beyond that, there is no significant costs other than accounting allocations you might make against that for overall corporate activities, but yeah, it’s fairly profitable revenue.

William Meyers - Miller Asset Management

Okay. So then one of your turnaround initiatives would presumably be to get more franchises as they are more obviously profitable than say opening a new company. So would that be a correct statement?

Steven Edwards

I think we've stated in the past that our goal would be to migrate some of our company stores. We haven't to be in franchised operations for a number of reasons. Number one of which is it provides probably better localized management and oversight. And number two would be it eliminates some of the capital investment. It might be necessary to upgrade the stores. And the final one would be that it eliminates the need for the same amount of corporate overhead that you would have with a company owned store operation.

William Meyers - Miller Asset Management

Okay. Thank you. That's all for me.

Operator

Our next question comes from [Sam Moble], a Private Investor. Please proceed.

Unidentified Analyst

This question is directly to Mr. Edwards. I want to know why it is a company that is losing money and it's having such a hard time, just to have [meet] has CEO that takes so many trips?

Steven Edwards

Take so many trips.

Unidentified Analyst

Yeah. Two trips per month, fully expense, paid and so forth. I mean why don't we just use Skype?

Steven Edwards

Well, we do use Skype from time to time when it's necessary and we conduct a lot of business over the phone, but we're a people business and sometimes business has to be done face to face and we're broadly distributed business. We have operations throughout the Northeast, all the way out to Midwest, and so you do what you can without actually having to travel, but there is not a lot you can do. Sometimes you just have to meet with people, you have to see what’s happening in operations, you have to have discussions with general managers, you need to sit with the finance staff, you need to develop plans, it’s not something that you can necessarily avoid.

Unidentified Analyst

The next question what is this stockholder rights plan and what benefit are the current investors getting from it when again the company is losing money and there is, what are you guys trying to protect if there is nothing really to protect?

Steven Edwards

I am not sure why you would say nothing to protect, but the rights offering was implemented. Così has historically has a rights offering in the past and it was allowed to lapse over time. The rights offering is there, was reinstated if there for the protection of all shareholders to ensure that one shareholder doesn’t necessarily develop a meaningful imbalance in terms of power and control without having paid premium or have the -- received the approval of the Board or the balance of the shareholders to do so. So it’s there for your protection, as shareholders there for the protection of all shareholders.

Unidentified Analyst

That concludes my questions. Thank you.

Operator

We have no further questions. I would now like to turn the call back over to Bill Koziel. Please proceed.

Bill Koziel

Thank you, Operator. Again we want to thank all of you for joining us on today’s call and we look forward to updating you again in the future. Thank you so much. Good bye.

Operator

This concludes today’s conference. You may now disconnect. Have a great day.

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