On May 15, COSI Restaurants ($COSI) announced earnings for the first quarter, which ended on March 31. In the earnings call, new CEO RJ Dourney enthusiastically described his strategy to improve discipline at the corporate level and return the company to profitability. He plans to maximize the brand’s capacity, and he has the experience in the industry to do it. He has worked to grow what he calls “best-in-class” companies Chilli’s from 16 to 890 restaurants domestically, and Applebees from 250 to 1300 restaurants domestically. RJ was nice enough to give me 30 minutes of his time last Friday, and after speaking with him I am confident he is the right guy to turn around COSI’s fortunes.
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 opened 5 stores in Boston and grew to 15 locations by 2014, all operating successfully and profitably. In March of this year, Mr. Dourney became the new CEO of the company.
RJ has already started to deploy his successful franchise strategy at the corporate level. He hired a new VP of HR, an operations expert, and an IT manager. He has imported the operating system from the Boston locations. He has re-started the review of 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.
He plans to increase the percentage of franchises compared to company stores in the long-run by partnering with exceptional franchisees that can successfully own and operate multiple locations. He cited the Applebees model, which consists of primarily franchises (about 80%).
One of the biggest issues facing turnaround candidate companies is cash flow. First quarter cash burn was $3.2mm, and cash on the balance sheet was $2.8mm at 3/31. On May 20, the company placed a $2.5mm note with AB Opportunity Fund and AB Value Partners. At the current cash burn rate, they have about 1-2 quarters before they will need to raise capital again. RJ said on the earnings call that he plans to slow the bleed significantly in the second quarter, and he doesn’t believe there will be additional need for financing.
In order to achieve a successful turnaround we believe the company should seek funding to allow it to execute its plan accordingly. A $5 million raise would give the company the much needed capital for achieving success. Our view on this subject differs from management’s perspective but successful turnarounds usually require more capital than expected. If the company decides to raise more capital, it is something we would be interested in looking at.
We have a very small position in the company but will build a meaningful position if we can convince ourselves that the success the company is achieving in the Boston area can be exported across the chain. We believe that the company will invest a material amount of effort and money in redesigning corporate policies to improve structure and discipline company-wide. Management believes it can bring the overall performance of the company on par with Boston franchisee Hearthstone. If they are right, COSI could join the ranks of best-in-class fast-casual companies like Chipotle ($CMG) or Panera ($PNRA). COSI’s brand resonates with customers, and we think that if they can get it together at the corporate level with quality customer service and clean restaurants, the customers will return. There is always execution risk, but we think RJ has the right mix of experience and attitude to get this done if the company is capitalized properly for success.
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Disclaimer: Bigger Capital owns a small trading position in COSI. COSI is a highly distressed situation and it is not suitable for the majority of investors. The likely outcome of an investment is a loss of principal. In other words, the probability of losing all your investment in this situation is very high.