• We project $15.3mm in EBITDA based on improved revenues and gross margins.
• We believe COSI has medium-term upside to $5.10 with our best case-case scenario calling for a stock price of $7.28 using the Hearthstone metrics for the overall system.

We have been closely following Cosi ( $ COSI ) since RJ Dourney took over as CEO in March of 2014. Dourney is a successful COSI franchisee, making profits at 13 locations in and around Boston. This is quite an accomplishment since COSI has accumulated more than $ 300mm in net negative earnings over its lifetime, a testimony to poor management of the parent company over that time period.

I first spoke to RJ back in June and in one conversation, I had confidence that he is the right guy to turn around COSI’s fortunes.  After we met him and his team and toured some of his Boston locations on August 20, it became clear to us that RJ has a formula for success in the fast casual arena.  His locations are clean, efficient, and profitable.

RJ Dourney began his relationship with COSI as a franchisee in 2005.  At that time he chose COSI because he believed there is a unique brand essence, with fresh baked bread and healthy menu options.  He and his corporate entity, Hearthstone, opened 5 stores in Boston and grew to 13 locations by 2014.  All of the Hearthstone locations are operating successfully and profitably.  In March of last year, Dourney became the new CEO of the company.

Dourney is wasting no time integrating his successful strategy into the company-owned locations. He mixes together fresh ingredients, clean and organized locations, and an efficient labor force to bake up profits. Long-term, if RJ and team are successful, COSI’s growth trajectory could match the growth of Chipotle ( $ CMG ) and Panera ( $ PNRA ).  This situation has strong potential.

RJ hit the ground running with his turnaround plan for COSI corporate.  In just a few short months, he hired a new VP of HR, an operations expert, and an  IT manager.  He began to implement the operating system from the Boston locations across the company-owned stores.  He is reviewing the culinary component and is happy with the results so far.  He moved the corporate office from a 27,000 sqft facility outside of Chicago to a 6,000 sqft facility near Boston.  He hired HILCO to help the company get out of some of it’s bad leases.

RJ’s formula for operational success at COSI involves cleaning up the stores, increasing labor efficiency, and making the brand more current in line with the Boston model.

Cosi operates in the fast casual dining market. This is a great space for two reasons.  First, fast casual is a growing area filling the void between low-quality fast food and higher quality restaurants that require a full hour for lunch.  At Cosi (and competitors Panera and Chipolte, to name a few), customers can get a delicious lunch in just a few minutes. Second, Americans are moving toward high-quality, healthy food. Cosi makes all its bread in-store, which means the bread contains simple ingredients and tastes fresh.  Most people could eat at Cosi almost 5 days a week due to the large variety of healthy menu options.  Check out this video to see what we mean: youtu.be/-A0eG0s2x9Q.

Anecdotally, Cosi recently rolled out a more high-quality chicken product along with with a price increase to cover the cost. RJ said that not one single customer complained about the higher price.  They noticed it, but are more than willing to pay for the uptick in quality.  So clearly there is a need for high quality, fast, healthy food.

So, we establish that Cosi has a great brand with a great management team in place and a business model that is proven in Boston.

COSI currently has 66 company-owned locations (58%) and 47 franchises locations, for a total of 113 restaurants.  Here is a breakdown of revenues and costs for the company-owned stores during the first half of 2014: