1. Organization and Summary of Significant Accounting Policies

Organization

Cosi, Inc., a Delaware corporation, owns, operates, and franchises fast-casual dining restaurants which sell high-quality, made-to-order sandwiches, salads, bowls, and coffees along with a variety of other soft drink beverages, teas, baked goods and alcoholic beverages. As of December 31, 2012, there were 75 Company-owned and 50 franchise restaurants operating in 16 states, the District of Columbia, the United Arab Emirates (UAE), and Costa Rica.

Fiscal Year

Our fiscal year ends on the Monday closest to December 31. Fiscal years ended December 31, 2012, January 2, 2012, and December 27, 2010 are referred to as fiscal 2012, 2011, and 2010, respectively. Each of fiscal years 2012 and 2010 included 52 weeks while fiscal year 2011 included 53 weeks.

Basis of Presentation

The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated.

Cash and Cash Equivalents

We consider all short-term investments with a maturity of three months or less from the date of purchase to be cash equivalents.

Concentration of Credit Risks

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash deposits. We place our cash deposits in Federal Deposit Insurance Corporation ("FDIC") insured financial institutions, US government and government sponsored agency securities, commercial paper and money market funds. Balances of cash deposits may, at times, exceed FDIC insured limits. We have never experienced losses related to these balances. All of our non-interest bearing cash balances were fully insured on December 31, 2012 due to a temporary federal program in effect from December 31, 2010 through December 31, 2012. Under the program, there was no limit to the amount of insurance for eligible accounts. Beginning with 2013, insurance coverage reverted to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances currently exceed federally insured limits.

Our accounts receivable consist principally of trade or "house" accounts representing corporate customers and amounts due from franchisees. We have established credit procedures and analyses to control the granting of credit to customers.

Accounts Receivable

Trade accounts receivable are stated at net realizable value. The Company maintains a reserve for potential uncollectible accounts based on historical trends and known current factors impacting the Company's customers.

Inventories

Inventories are stated at the lower of cost, determined using a weighted average valuation method that approximates the first-in, first-out method, or market, and consist principally of food, beverage, liquor, packaging and related food supplies.

Furniture and Fixtures, Equipment and Leasehold Improvements

Furniture and fixtures, equipment and leasehold improvements are stated at cost. Depreciation of furniture and fixtures and equipment is computed using the straight-line method over estimated useful lives that range from two to ten years. Leasehold improvements are amortized using the straight-line method over the shorter of their estimated useful lives or the term of the related leases.

Upon retirement or sale, the cost of assets disposed of and their related accumulated depreciation are removed from the accounts. Any resulting gain or loss is credited or charged to operations. Maintenance and repairs are charged to expense when incurred, while betterments are capitalized.

Long-Lived Assets

Impairment losses are recorded on long-lived assets on a restaurant-by-restaurant basis whenever impairment factors are determined to be present. We consider a consistent history of poor financial operating performance to be the primary indicator of potential impairment for individual restaurant locations. We determine whether a restaurant location is impaired based on expected undiscounted cash flows, generally for the remainder of the original lease term, and then determine the impairment charge based on discounted cash flows for the same period.

In accordance with the provisions of the impairment or disposal subsections of ASC 360-10, Property, Plant & Equipment, long-lived assets held and used with a carrying amount of $0.7 million were written down to their fair value of $0.3 million, resulting in asset impairment and disposal charges of $0.4 million which were included in earnings for fiscal 2012. We considered all relevant valuation techniques that could be obtained without undue cost and effort, and concluded that the discounted cash flow approach continued to provide the most relevant and reliable means by which to determine fair value of the long-lived assets held and used.

Long-lived assets held and used	Total value at end of period		Prices in Active Markets for Identical Assets (Level 1)		Significant Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Gains (Losses)

	(in thousands)
December 31, 2012	$	348	$	—	$	—	$	348	$	(424	)

	$	348	$	—	$	—	$	348	$	(424	)

January 2, 2012	$	647	$	—	$	—	$	647	$	(431	)

	$	647	$	—	$	—	$	647	$	(431	)

December 27, 2010	$	552	$	—	$	—	$	552	$	(732	)

	$	552	$	—	$	—	$	552	$	(732	)

The asset impairment charges relate to four and six underperforming restaurants in fiscal years 2012 and 2011, respectively, three of which in fiscal 2011 were impaired as a result of the short remaining lives of their operating leases. Three of the impaired locations in 2012 and two in 2011 were also impaired in previous years. The asset impairment charge during fiscal 2010 relates to four underperforming restaurants, three of which were previously impaired, and to maintenance capital expenditures on previously impaired restaurants.

Accounting for Lease Obligations

We recognize rent expense on a straight-line basis over the lease term commencing on the date we take possession. We record landlord allowances as deferred rent in other long-term liabilities on the consolidated balance sheets and amortize them on a straight-line basis over the term of the related lease.

Lease Termination Charges

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

The lease termination charges that we recorded in fiscal years 2012 and 2011 were immaterial. We incurred lease termination charges of approximately $0.2 million during fiscal 2010 related to one restaurant in the Midwest where we reached an early termination agreement with the landlord and one restaurant in the Seattle market where we assigned the lease in fiscal 2008 and reached an agreement with the landlord and subtenant to terminate it in fiscal 2010.

A summary of lease termination reserve activity is as follows:



Balance as of December 28, 2009	785
Charged to costs and expenses	203
Payments and adjustments	(455	)

Balance as of December 27, 2010	533
Charged to costs and expenses	22
Payments and adjustments	(310	)

Balance as of January 2, 2012	245
Charged to costs and expenses	2
Payments and adjustments	(33	)

Balance as of December 31, 2012	214

Other Liabilities

Other liabilities consist of deferred rent, landlord allowances and accrued lease termination costs (see Note 12 to our consolidated financial statements).

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 31, 2012, we had net operating loss ("NOL") carryforwards of approximately $212.9 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 2010 have triggered an ownership change. The purchase of shares of our common stock pursuant to the rights offering and private placement of common stock that we completed during the third quarter of fiscal 2012 may trigger an ownership change with respect to our common stock. 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.

Revenue Recognition

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.

Gain on Sale of Assets

We recognized income from the sale of liquor licenses of approximately $0.1 million in each of fiscal years 2011 and 2010. No gain was recognized in fiscal 2012.

Gain on Sale of Restaurants

We did not recognize any gain or loss on sale of restaurants in fiscal years 2012 and 2011. As a result of the sale of the thirteen Company-owned restaurants in Washington, D.C. to a franchisee during fiscal 2010, we recognized a gain on sale of restaurants of approximately $5.1 million, including approximately $0.3 million in unamortized landlord allowances and reversal of straight line rent expense. If the disbursement, either in full or in part, is made to us from the $0.6 million held in escrow, we will recognize an additional gain from the sales of these assets at that time. The balance in escrow will be paid to Cosi if the franchisee achieves a certain sales target at any time during the repayment period of the promissory note through 2016. Disbursement from the escrow, either in full or in part, is based on a formula that compares then-current trailing twelve-month sales to a sales baseline and applies the resulting percentage to the escrow amount. The disbursement calculation can be applied up to three times at Cosi's sole discretion over the three year period.

Restaurant Pre-opening Expenses

Restaurant pre-opening expenses are expensed as incurred and include the costs of recruiting, hiring and training the initial restaurant work force, travel, the cost of food and labor used during the period before opening, the cost of initial quantities of supplies and other direct costs related to the opening or remodeling of a restaurant. Pre-opening expenses also include rent expense recognized on a straight-line basis from the date we take possession through the period of construction or renovation prior to opening the restaurant.

Advertising Costs

Domestic franchise-operated Cosi® restaurants contribute 1% of their sales to a national marketing fund and are also required to spend 1% of their sales on advertising in their local markets. Our international franchise-operated restaurants contribute 0.5% of their sales to an international marketing fund. The Company also contributes 1% of sales from Company-owned restaurants to the national marketing fund. The Company's contributions, as well as its own local market media costs, are recorded as part of occupancy and other restaurant operating expenses on the Company's consolidated statements of operations. Advertising costs are expensed as incurred and approximated $1.2 million, $2.1 million, and $2.4 million in fiscal years 2012, 2011, and 2010, respectively.

Net Loss Per Share

Basic and diluted loss per common share is calculated by dividing the net loss by the weighted-average common shares outstanding during each period. As of December 31, 2012, January 2, 2012, and December 27, 2010, there were, respectively, 1,085,600, 1,288,400, and 205,050 unvested restricted shares of common stock outstanding and 154,209, 164,282, and 542,977 out-of-the-money stock options to purchase shares of common stock. There were no in-the-money stock options as of the end of fiscal years 2012, 2011, and 2010. The unvested restricted shares and the out-of-the-money stock options meet the requirements for participating securities but were not included in the computation of basic and diluted earnings per share because we incurred a net loss in all periods presented and, hence, the impact would be anti-dilutive. There were no unvested restricted stock units as of December 31, 2012 and January 2, 2012, and there were 215,000 unvested stock units as of December 27, 2010. The unvested stock units do not meet the requirements for participating securities and were not included in the computation of basic and diluted earnings per share.

Stock-Based Compensation

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 is measured using a fair value method and that all the resulting compensation expense is recognized in the financial statements. In accordance with the standard, our stock-based compensation expense is recognized on a straight-line basis over the requisite service period of the award, which is the vesting term. As a result, we recognized stock compensation expense of approximately $0.4 million, $0.4 million, and $0.6 million during fiscal years 2012, 2011, and 2010, respectively. We measure the estimated fair value of our granted stock options using a Black-Scholes pricing model and of our restricted stock based on the fair market value of a share of registered stock on the date of the grant.

Segment Information

Operating segments are defined as components of an enterprise about which separate financial information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources in assessing performance. Our chief operating decision maker reviews one aggregated set of financial statements to make decisions about resource allocations and to assess performance. Consequently, we have one reportable segment for all sales generated.

Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates.

Recent Accounting Pronouncements

Effective January 1, 2012, the Company adopted Accounting Standards Update ("ASU") No. 2011-05, "Presentation of Comprehensive Income." The adoption of ASU 2011-05 concerns presentation and disclosure only and did not have an impact on the Company's consolidated financial position or results of operations. In February 2013, the Financial Accounting Standards Board ("FASB") issued ASU 2013-02, which adds new disclosure requirements for items reclassified out of accumulated other comprehensive income. Our adoption of this ASU on January 1, 2013 is not expected to have an impact on our consolidated financial position or results of operations.