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I recently met with CEO Jim Hyatt at a COSI in NYC.

Normally when you schedule to meet a restaurant executive at a store they pick one that has recently been renovated.  For my meeting with Jim, he picked a store on 6th ave in NYC that is actually under renovation (it was going to get a new coat of paint that night).

How fitting that our first meeting should be at that location; the store serves as a perfect metaphor for the stock.   The perception of passersby in the street, and of investors on Wall Street, is that the store and stock, respectively, are undergoing renovation.  What the street does not see yet is how good things are going to look when it is finished.  I have never met Jim before but he seems to be the right person for what is needed at COSI - a restaurant operator. 

By way of background, Jim was a multi-unit Burger King franchisee and was recruited to join Burger King's corporate operations in 2002.  From 2002 until his promotion to Chief Operations Officer in 2005, his responsibilities at Burger King included Senior Vice President, Operations Services and Programs; Senior Vice President, U.S. Franchise Operations; and Executive Vice President, U.S. Franchise Operations.  Mr. Hyatt was Executive Vice President & Global Chief Operations Officer of Burger King Corporation from August 2005 until joining Cosi in September 2007.

Cosi has had a rocky time as a public company.  First, it went public before it was ready and it was owned and operated by executives who only knew how to grow the store base.  With an overly-aggressive store grow came a corporate infrastructure that did not allow the company to make money.  As I see it, the old management team never figured out the operating model but they continued to open stores regardless.  Needless to say, a disaster ensued but that is all history.

Since joining in 2007, Jim’s operating mentality has been to right-size the ship - close unprofitable stores and get the cost structure of the company better aligned.  In addition, he needed to get all the units operating under one common platform.  Unfortunately, between the time he joined and the results he is posting today, the consumer environment got significantly worse. 

While we are still looking at a difficult consumer environment, the company that has spent the last three years focused on operations and profitability and they should reap significant rewards from their efforts.  We are only now just seeing the fruits of all that work and there is still much to do. 

COSI operates in the more upscale “quick casual” segment of the industry which is seeing better trends than other segments in the restaurant industry.  Like others in the “quick casual” space COSI offers a comfortable and contemporary atmosphere.  It’s a restaurant that appeals to young generations who want to relax, eat, and use their mobile devices.  Not to mention that the signature bread creates customer loyalty.

For 2Q10, system same-store sales increased 3.1% with franchise sales up 2.6% and company-owned sales up by 3.3% (traffic increased 3.1% in the quarter).  On the 2Q10 earnings call COSI reported that July was up 8% and represented the fifth consecutive month of positive same store sales.  I believe that August and September will make it seven straight months. 

The improvement COSI is seeing in the top line is coming from all day-parts: catering, breakfast, lunch, snack and dinner.  The biggest winner on a percentage basis is breakfast with growth well above 8%.  More importantly, next week in Chicago COSI will be testing online ordering and online catering.  If all goes well, the online ordering initiative will be rolled out by the end of November.  Early indications are that this could accelerate same-store sales or, at a minimum, give strong visibility for same-store sales growth well in to 2011 and 2012.  

The current growth in same-store sales is also being driven by increases in, and more efficient use of, marketing dollars.  With the help of a new advertising agency, COSI has increased spending on “out-of-store” media to increase awareness of the brand and drive incremental traffic.  COSI also has a newly designed website, menu boards and a new social media team in place to drive the marketing effort. 

Given the current sales trends and the appeal of the COSI concept, it will not be long before the franchise community is on board.  The better the numbers the company puts up the increased likely hood the company can refranchise stores to new franchisees and see growth from the existing franchise base.  I would also not be surprised to see the company sign a couple of foreign franchise agreements.  

If we assume a 45% flow-through on every additional sale coming through the store base and 8%+ same-store sales (and take into account the company’s ability to control costs), there is a very high probability that the COSI will be profitable in 3Q10.

Lastly, Jim offered up his 2020 vision for the company.  With the backdrop of a concept with a strong operating model, unit growth will occur over time.  So where does he see the company in 2020? He believes that COSI will have 500 stores in the U.S. and 150 overseas.



Howard Penney

Managing Director