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.

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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(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.

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:

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.