**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549








**FORM
      10-Q**





(Mark
      One)





**x**
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





For
      the
      quarterly period ended September 24, 2006





OR





**o**
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





For
      the
      transition period from _______ to _______.





Commission
      File No. 0-23226





GRILL
      CONCEPTS, INC.


(Exact
      name of registrant as specified in its charter)




Delaware
            13-3319172(State
                or other jurisdiction
              of
                incorporation or
                organization)
            (IRS
                Employer
              Identification
                No.)




11661
      San Vicente Blvd., Suite 404, Los Angeles, California 90049


(Address
      of principal executive offices)(Zip code)





(310)
      820-5559


(Registrant's
      telephone number, including area code)





_______________________________________________________________


(Former
      name, former address and former fiscal year, if changed since last
      report)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. Yes x No o




Indicate
      by check mark whether the registrant is a large accelerated filer an accelerated
      filer or a non-accelerated filer.  See
      definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of
      the Exchange Act. (Check one):





Large
      accelerated filer o   Accelerated
      filer o  Non-accelerated
      filer x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).





Yes
o   No
x




As
      of
      October 31, 2006, 6,393,716 shares of Common Stock of the issuer were
      outstanding.










**GRILL
      CONCEPTS, INC. AND SUBSIDIARIES**





**INDEX**




Page
                Number**PART
                  I - FINANCIAL INFORMATION**Item
                  1. Financial StatementsCondensed
                  Consolidated Balance Sheets -September
                  24, 2006 (unaudited) and December 25, 2005
              
              
              3Condensed
                  Consolidated Statements of Operations -For
                  the three months and nine months ended September24,
                  2006 and September 25, 2005 (both unaudited)
              
              
              5Condensed
                  Consolidated Statements of Cash Flows -For
                  the nine months ended September 24, 2006 andSeptember
                  25, 2005 (both unaudited)
              
              
              6Notes
                  to Condensed Consolidated Financial Statements
              
              
              8Item
                  2. Management's Discussion and Analysis of Financial
                  Conditionand
                  Results of Operations
              
              
              22Item
                  3. Quantitative and Qualitative Disclosures About Market
                  Risk
              
              
              38Item
                  4. Evaluation of Disclosure Controls and Procedures
              
              
              38**PART
                  II - OTHER INFORMATION**Item
                  1. Legal Proceedings
              
              
              39Item
                  1A. Risk Factors
              
              
              39Item
                  6. Exhibits
              
              
              39**SIGNATURES**
              
              
              40




2




**PART
      I - FINANCIAL INFORMATION**





**ITEM
      1. FINANCIAL STATEMENTS**








**GRILL
      CONCEPTS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**





**ASSETS**


(in
      thousands, except share data)




September
                  24,2006
              
              
              December
                  25,2005(Unaudited)Current
                  assets:Cash
              
              $
              2,180
              
              $
              3,161Inventories
              
              
              819
              
              
              727Receivables,
                  net of reserve ($300 in2006
                  and $238 in 2005)
              
              
              747
              
              
              784Note
                  receivable - current portion
              
              
              12
              
              
              11Reimbursable
                  costs receivable
              
              
              853
              
              
              912Prepaid
                  expenses and other current assets
              
              
              855
              
              
              401Total
                  current assets
              
              
              5,466
              
              
              5,996Furniture,
                  equipment, and improvements, net
              
              
              15,454
              
              
              13,372Restricted
                  cash
              
              
              1,192
              
              
              1,042Note
                  receivable
              
              
              66
              
              
              79Liquor
                  licenses
              
              
              411
              
              
              426Deferred
                  tax asset
              
              
              3,945
              
              
              577Non-compete
                  agreement, net
              
              
              2,945
              
              
              -Other
                  assets
              
              
              589
              
              
              276Goodwill,
                  net
              
              
              205
              
              
              205Total
                  assets
              
              $
              30,273
              
              $
              21,973





The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.





3




**GRILL
      CONCEPTS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


(Continued)


**LIABILITIES,
      MINORITY INTEREST AND STOCKHOLDERS' EQUITY**


(in
      thousands, except share data)




September
                  24,2006
              
              
              December
                  25,2005(unaudited)Current
                  liabilities:Accounts
                  payable
              
              $
              1,582
              
              $
              1,457Accrued
                  expenses
              
              
              5,322
              
              
              4,533Accrued
                  managed outlets operating expenses
              
              
              853
              
              
              912Payable
                  to Hotel Restaurant Properties, Inc.
              
              
              3,020
              
              
              —Current
                  portion of long-term debt
              
              
              84
              
              
              48Current
                  portion of notes payable - related parties
              
              
              155
              
              
              312Current
                  portion of liability for debt extinguishment
              
              
              50
              
              
              —Total
                  current liabilities
              
              
              11,066
              
              
              7,262Long-term
                  debt
              
              
              1,612
              
              
              206Notes
                  payable - related parties
              
              
              —
              
              
              671Liability
                  for debt extinguishment
              
              
              100
              
              
              —Other
                  long-term liabilities
              
              
              8,831
              
              
              7,398Total
                  liabilities
              
              
              21,609
              
              
              15,537Minority
                  interest
              
              
              1,509
              
              
              1,630Stockholders'
                  equity:Preferred
                  Stock, 1,000,000 shares authorized,995,935
                  shares undesignated in 2006 and 2005
              
              
              —
              
              
              —Series
                  II, 10% Convertible Preferred Stock, $.001 parvalue;
                  500 shares authorized, 500 sharesissued
                  and outstanding in 2006 and 2005
              
              
              —
              
              
              —Common
                  stock, $.00004 par value; 12,000,000 sharesauthorized
                  in 2006 and 2005, 6,403,212 sharesissued
                  and outstanding in 2006, 5,728,495 sharesissued
                  and outstanding in 2005
              
              
              —
              
              
              —Additional
                  paid-in capital
              
              
              14,488
              
              
              13,686Accumulated
                  deficit
              
              
              (7,333
              )
              
              (8,880
              )Total
                  stockholders' equity
              
              
              7,155
              
              
              4,806Total
                  liabilities, minority interest andstockholders'
                  equity
              
              $
              30,273
              
              $
              21,973




The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.




4




**GRILL
      CONCEPTS, INC. AND SUBSIDIARIES**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


(Unaudited)


(in
      thousands, except share data)




Three
                  Months Ended
              
              
              Nine
                  Months EndedSeptember
                  24, 2006
              
              
              September
                  25, 2005
              
              
              September
                  24, 2006
              
              
              September
                  25, 2005Revenues:Sales
              
              $
              14,792
              
              $
              13,298
              
              $
              44,366
              
              $
              40,102Cost
                  reimbursements
              
              
              3,921
              
              
              3,675
              
              
              11,535
              
              
              10,264Management
                  and license fees
              
              
              491
              
              
              402
              
              
              1,329
              
              
              1,127Total
                  revenues
              
              
              19,204
              
              
              17,375
              
              
              57,230
              
              
              51,493Operating
                  expenses:Cost
                  of sales
              
              
              4,298
              
              
              3,743
              
              
              12,576
              
              
              11,295Restaurant
                  operating
              
              
              9,039
              
              
              8,256
              
              
              26,544
              
              
              23,987Reimbursed
                  costs
              
              
              3,921
              
              
              3,675
              
              
              11,535
              
              
              10,264General
                  and administrative
              
              
              1,443
              
              
              1,147
              
              
              4,305
              
              
              3,417Depreciation
                  and amortization
              
              
              749
              
              
              660
              
              
              1,810
              
              
              1,603Pre-opening
                  costs
              
              
              242
              
              
              11
              
              
              440
              
              
              272Total
                  operating expenses
              
              
              19,692
              
              
              17,492
              
              
              57,210
              
              
              50,838Income
                  (loss) from operations
              
              
              (488
              )
              
              (117
              )
              
              20
              
              
              655Interest,
                  net
              
              
              (90
              )
              
              (43
              )
              
              (197
              )
              
              (123
              )Debt
                  extinguishment costs
              
              
              —
              
              
              —
              
              
              (279
              )
              
              —Income
                  (loss) before benefit (provision) forincome
                  taxes and minority interest
              
              
              (578
              )
              
              (160
              )
              
              (456
              )
              
              532Benefit
                  (provision) for income taxes
              
              
              163
              
              
              (68
              )
              
              2,138
              
              
              (277
              )Minority
                  interest in net (profit)loss
                  of subsidiaries
              
              
              (30
              )
              
              40
              
              
              (135
              )
              
              364Net
                  income (loss)
              
              
              (445
              )
              
              (188
              )
              
              1,547
              
              
              619Preferred
                  dividends accrued
              
              
              (13
              )
              
              (13
              )
              
              (38
              )
              
              (38
              )Net
                  income (loss) applicable tocommon
                  stock
              
              $
              (458
              )
              $
              (201
              )
              $
              1,509
              
              $
              581Net
                  income (loss) per share applicableto
                  common stock:Basic
                  net income (loss)
              
              $
              (0.07
              )
              $
              (0.04
              )
              $
              0.25
              
              $
              0.10Diluted
                  net income (loss)
              
              $
              (0.07
              )
              $
              (0.04
              )
              $
              0.24
              
              $
              0.09Weighted
                  average shares outstanding:Basic
              
              
              6,350,827
              
              
              5,652,230
              
              
              5,980,299
              
              
              5,679,752Diluted
              
              
              6,350,827
              
              
              5,652,230
              
              
              6,474,678
              
              
              6,217,285





The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.





5




**GRILL
      CONCEPTS, INC. AND SUBSIDIARIES**


**CONDENSED**  **CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(Unaudited)


(in
      thousands)




Nine
                  Months EndedSeptember
                  24, 2006
              
              
              September
                  25, 2005Cash
                  flows from operating activities:Net
                  income
              
              $
              1,547
              
              $
              619Adjustments
                  to reconcile net income to net cashprovided
                  by operating activities:Depreciation
                  and amortization
              
              
              1,810
              
              
              1,603Amortized
                  deferred rent and lease incentives
              
              
              (609
              )
              
              (484
              )Amortized
                  debt issuance costs
              
              
              57
              
              
              —Deferred
                  tax asset
              
              
              (3,368
              )
              
              —Stock
                  based compensation
              
              
              153
              
              
              —Provision
                  for doubtful accounts
              
              
              62
              
              
              60Loss
                  on debt extinguishment
              
              
              219
              
              
              —Gain
                  on sale of assets
              
              
              (19
              )
              
              (5
              )Minority
                  interest in net profit (loss) of subsidiaries
              
              
              135
              
              
              (364
              )Changes
                  in operating assets and liabilities:Inventories
              
              
              (92
              )
              
              (22
              )Receivables
              
              
              (25
              )
              
              5Prepaid
                  expenses and other current assets
              
              
              (244
              )
              
              103Tenant
                  improvement allowances
              
              
              1,832
              
              
              1,962Non-compete
                  agreement and other assets
              
              
              (43
              )
              
              (65
              )Accounts
                  payable
              
              
              125
              
              
              (804
              )Accrued
                  expenses
              
              
              686
              
              
              619Net
                  cash provided by operating activities
              
              
              2,226
              
              
              3,227Cash
                  flows from investing activities:Proceeds
                  from disposal of assets
              
              
              55
              
              
              5Collections
                  on note receivable
              
              
              15
              
              
              15Restricted
                  cash
              
              
              (150
              )
              
              (160
              )Purchase
                  of liquor license
              
              
              (16
              )
              
              (71
              )Purchase
                  of furniture, equipment and improvements
              
              
              (3,480
              )
              
              (3,716
              )Net
                  cash used in investing activities
              
              
              (3,576
              )
              
              (3,927
              )




The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.




6




**GRILL
      CONCEPTS, INC. AND SUBSIDIARIES**


**CONDENSED**  **CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


(Continued)


(Unaudited)


(in
      thousands)




Cash
                  flows from financing activities:Capital
                  contributions from minority interests in LLC’s
              
              $
              125
              
              $
              1,274Debt
                  issuance costs
              
              
              (413
              )
              
              —Return
                  of capital and profits to minority shareholder
              
              
              (282
              )
              
              (186
              )Proceeds
                  from line of credit and equipment financing
              
              
              1,233
              
              
              118Proceeds
                  from exercise of stock options and warrants
              
              
              649
              
              
              33Payments
                  on notes payable - to member of Chicago Grill
              
              
              (902
              )
              
              (104
              )Payments
                  on long-term debt
              
              
              (41
              )
              
              (183
              )Net
                  cash provided by financing activities
              
              
              369
              
              
              952Net
                  increase (decrease) in cash
              
              
              (981
              )
              
              252Cash,
                  beginning of period
              
              
              3,161
              
              
              1,407Cash,
                  end of period
              
              $
              2,180
              
              $
              1,659Supplemental
                  cash flow information:Cash
                  paid during the period for:Interest
              
              $
              232
              
              $
              141Income
                  taxes
              
              
              709
              
              
              263Non-cash
                  investing and financing items:Non-compete
                  agreement
              
              $
              3,020
              
              
              —Capital
                  lease equipment financing
              
              
              250
              
              
              —





The
      accompanying notes are an integral part of these unaudited condensed
      consolidated financial statements.





7





**GRILL
      CONCEPTS, INC. AND SUBSIDIARIES**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**** (Unaudited)





**1.**
            **INTERIM
                FINANCIAL PRESENTATION**





The
      interim condensed consolidated financial statements of Grill Concepts, Inc.
      (the
“Company”) are prepared pursuant to the requirements for reporting on Form 10-Q.
      These financial statements have not been audited by our independent registered
      public accounting firm. The December 25, 2005 balance sheet data was derived
      from audited financial statements but does not include all disclosures required
      by generally accepted accounting principles. The interim financial statements
      and notes thereto should be read in conjunction with the financial statements
      and notes included in the Company’s Form 10-K for the year ended December 25,
      2005. In the opinion of management, these interim financial statements reflect
      all adjustments of a normal recurring nature necessary for a fair presentation
      of the results for the interim periods presented. The current period results
      of
      operations are not necessarily indicative of results, which ultimately will
      be
      reported for the full year ending December 31, 2006.





All
      revenues reported in the condensed consolidated statements of operations are
      net
      of all sales and use taxes that are collected from customers and remitted to
      the
      appropriate taxing authorities.





Certain
      reclassifications have been made to the prior period financials to make them
      comparable to the current period results.








**2.**
            **PREPAID
                EXPENSES AND OTHER CURRENT
                ASSETS**





Most
      lease agreements contain one or more of the following: tenant improvement
      allowances, rent holidays, rent escalation clauses and/or contingent rent
      provisions.




Rent
      is
      recognized on a straight-line basis, including the restaurant build-out period.
      This period is normally prior to the commencement of rent payments and is
      commonly called the rent holiday period. The build-out period generally begins
      when the Company enters the space and begins to make improvements in preparation
      for intended use. The Company expenses rent on a straight-line basis during
      the
      build-out period. Tenant improvement allowances are also recognized on a
      straight-line basis beginning at the same time as the commencement of the
      straight-line rent expense.





Prepaid
      expenses and other current assets at September 24, 2006 and December 25, 2005
      were comprised of:





(in
                thousands)
            
            
            2006
            
            
            2005Lease
                incentives receivable
            
            $
            210
            
            $
            —Prepaid
                expenses, other
            
            
            645
            
            
            401Total
                prepaid expenses and other current assets
            
            $
            855
            
            $
            401




8




**3.**
            **RESTRICTED
                CASH**





In
      January 2006 a $1,010,000 certificate of deposit was established at Union Bank
      to act as collateral for the Stand By Letter of Credit opened to support our
      workers’ compensation insurance policy. Other restricted cash consisted of
      $72,000 held in escrow for the Daily Grill at Continental Park in El Segundo,
      California and $110,000 that was placed in escrow with our insurance claims
      processor in 2004 for workers’ compensation claims.





At
      December 25, 2005 restricted cash consisted of a $860,000 certificate of deposit
      serving as collateral for our Stand By Letter of Credit, $72,000 held in escrow
      for the Daily Grill at Continental Park in El Segundo, California and $110,000
      that was placed in escrow with our insurance claims processor in 2004 for
      workers’ compensation claims.





**4.**
            **INCOME
                TAXES**





During
      the nine months ended September 24, 2006, the Company determined, based on
      an
      analysis of its taxable income over the preceding three years and the projected
      taxable income for the next three years, that it is more likely than not that
      the Company will recover the majority of its existing net deferred tax asset.
      Accordingly, during the period, most of the previously recorded valuation
      allowance with respect to the Company’s deferred tax asset was eliminated. As a
      result of the elimination of the valuation allowance, the Company realized
      a net
      tax benefit of about $2.1 million during the nine months ended September 24,
      2006 and the Company’s condensed consolidated balance sheets reflected a
      deferred tax asset of $3.9 million at September 24, 2006.





As
      of
      September 25, 2005, the amount of the valuation allowance was $1.3 million,
      which represents a decrease of about $2.0 million from December 25, 2005, and
      consists of $0.7 million for general business credits and $0.6 million for
      net
      operating loss carryforwards (“NOL’s”). These differences have been allowed for
      due to the limitations on usage. The NOL’s have not been used to reduce current
      taxable income due to the Company not completing its analysis regarding
      limitations on usage. The Company intends to complete its analysis by year-end
      as to the portion of NOL’s that can be utilized. The Company reviews all of the
      available evidence, both positive and negative, in evaluating adequacy of the
      valuation allowance each quarter.








**5.**
            **LONG-TERM
                DEBT**





In
      March
      2006, the Company signed a new financing agreement with Diamond Creek Investment
      Partners, LLC, (the “Lender”) at which time the Company’s previous line of
      credit was terminated. The Credit Agreement provides for a revolving term loan
      (the “Loan” or “Credit Agreement”) to the Company of the lesser of (a) $8.0
      million, or (b) 2.25 times the Company’s trailing 12 month EBITDA. Funds may be
      borrowed under the Credit Agreement, subject to satisfaction of all conditions
      of funding, in monthly advances in minimum increments of $500,000. Proceeds
      of
      the Loan may be used to pay expenses of the Loan and for general corporate
      purposes. The interest rate on the Loan is, at the option of the Company and
      subject to certain limitations on the use of London Interbank Offered Rate
      (“LIBOR”) based loans, equivalent to either (a) prime rate, but not less than
      7%, plus an applicable margin, or (b) the LIBOR, but not less than 4%, plus
      an
      applicable margin. The margin, in each case, varies based upon the Company’s
      leverage ratio (funded debt to EBITDA, each as defined) and ranges from 2.75%
      to
      3.50% with respect to prime rate loans and 5.50% to 6.25% with respect to LIBOR
      loans. The interest rate at September 24, 2006 was equal to 11.2% and was
      adjusted to 10.8% effective October 13, 2006.




9




The
      Credit Agreement provides that the Company will pay all expenses incurred in
      connection with the Loan, including expenses incurred by the Lender. By separate
      agreement, the Company agreed to pay certain fees associated with the Loan,
      including a loan initiation fee of $120,000, an unused line fee of 0.5% of
      the
      unused portion of the credit facility payable monthly and a loan servicing
      fee
      of $3,000 per month. In March 2006, we borrowed $210,000 under the line of
      credit to pay costs associated with obtaining the financing.




On
      March
      31, 2006, the Company borrowed $1 million under the terms of the Credit
      Agreement with the Lender. The borrowed funds were primarily used to retire
      $874,192 of collateralized subordinated notes and manditorily redeemable capital
      obligations owed to MAG by the Company’s subsidiary, Chicago Grill, $5,940 of
      interest and $50,000 for the first annual penalty payment, all of which were
      guaranteed by the Company, with the balance used for general working capital
      purposes. The retired obligations related to the initial funding provided by
      MAG, as a member/investor in Chicago Grill, with respect to the Company’s The
      Grill on the Alley restaurant in Chicago.




The
      Loan
      matures, and is payable in full, on March 9, 2011 subject to mandatory
      prepayment to the extent, if any, that the outstanding principal balance of
      the
      Loan exceeds 2.25 times trailing 12 month EBITDA or upon the occurrence of
      certain defined extraordinary events. The Company may prepay amounts owing
      under
      the Credit Agreement subject to payment of a prepayment premium of (a) 3% with
      respect to prepayments occurring on or before March 9, 2007, and (b) 1% with
      respect to prepayments occurring after March 9, 2007 and on or before March
      9,
      2008.





The
      Company’s obligations under the Credit Agreement are secured by a first lien on
      all of the Company’s assets, including all of the capital stock and other equity
      interests held by the Company in its subsidiaries, subject to existing liens
      on
      such assets. The Loan requires the Company to comply with certain ordinary
      lending covenants. These include, among others, financial covenants relating
      to
      maximum debt to EBITDA ratio, minimum EBITDA and maximum capital expenditures.
      The Company must also comply with certain information requirements, including
      providing periodic financial statements and projections as well as notices
      of
      defaults, litigation and other matters, maintenance of insurance and compliance
      with laws as well as limitations on liens and encumbrances, indebtedness,
      dispositions, dividends and retirement of capital stock, consolidations and
      mergers, changes in nature of business and other operating, financial and
      structural limitations.





Events
      of
      default in the Credit Agreement include, among others, (a) the failure to pay
      when due the obligations owing under the Credit Agreement, (b) the failure
      to
      perform and not timely remedy certain covenants, (c) certain cross defaults
      or
      cross accelerations, (d) the occurrence of bankruptcy or insolvency events,
      (e)
      the failure to make certain payments, or the occurrence of certain events,
      relating to retirement plans, (f) certain adverse judgments against the Company
      or any of its subsidiaries, (g) certain changes in ownership of the Company’s
      stock or the board of directors, or (h) the occurrence of, and failure to
      remedy, a Material Adverse Effect (as defined in the Credit Agreement). Upon
      the
      occurrence of an event of default, the Lender may terminate the Loan commitment
      and declare the Loan due and payable in full.




10




**6.**
            **LIABILITY
                FOR DEBT EXTINGUISHMENT**





In
      March
      2006, the Company retired the collateralized subordinated notes and mandatorily
      redeemable capital obligations owed to the Michigan Avenue Group (“MAG”) a
      member of Chicago Grill on the Alley, LLC (the “Chicago Grill”). As a result of
      the prepayment, MAG required a $200,000 penalty for earlier extinguishment
      of
      the obligations. The penalty is payable in four annual installments of $50,000,
      the first which was paid upon repayment of the obligations. The Company
      guaranteed the payment of the debt extinguishment penalty. The balance due
      to
      MAG as of September 24, 2006 is $150,000, which is included in current and
      long-term liabilities in the condensed consolidated balance sheets.





The
      penalty on early extinguishment will be deemed to be a cash distribution of
      the
      Chicago Grill to MAG if the lease for the restaurant location of the Chicago
      Grill on the Alley is renewed. After renewal, the Company will receive the
      next
      $200,000 of cash distributions from the Chicago Grill, prior to any
      distributions being made to MAG. The Company will record this cash distribution
      when received.





**7.**
            **OTHER
                LONG-TERM LIABILITIES**





In
      connection with certain of the Company's leases, the landlord has provided
      the
      Company with tenant improvement allowances. These lease incentives have been
      recorded as long-term liabilities and are being amortized over the life of
      the
      lease. Additionally, the Company records deferred rent where lease payments
      are
      lower than rental expense recognized on a straight-line basis.





Other
      Long-Term Liabilities at September 24, 2006 and December 25, 2005 were comprised
      of:





(in
                thousands)
            
            
            2006
            
            
            2005Lease
                Incentives
            
            $
            6,726
            
            $
            5,140Deferred
                Rent
            
            
            2,105
            
            
            2,258Total
                Other Long-Term Liabilities
            
            $
            8,831
            
            $
            7,398








**8.**
            **PER
                SHARE DATA**





Pursuant
      to SFAS No. 128, “Earnings Per Share,” basic net income per share is computed by
      dividing the net income attributable to common shareholders by the
      weighted-average number of common shares outstanding during the period. Diluted
      net income per share is computed by dividing the net income attributable to
      common shareholders by the weighted-average number of common and common
      equivalent shares outstanding during the period. Common share equivalents
      included in the diluted computation represent shares issuable upon assumed
      exercise of stock options, warrants and convertible preferred stocks using
      the
      treasury stock method.




11




A
      reconciliation of earnings available to common stockholders and diluted earnings
      available to common stockholders and the related weighted average shares for
      the
      three and nine-month periods ended September 24, 2006 and September 25, 2005
      follows:








Three
                months
            
            2006
            
            2005(in
                thousands, except share data)
            
            Earnings
            
            Shares
            
            Earnings
            
            SharesNet
                loss
            
            $
            (445
            )
            
            
            
            $
            (188
            )Less:
                preferred stock dividends
            
            
            (13
            )
            
            
            
            
            (13
            )Earnings
                available for common stockholders
            
            
            (458
            )
            
            6,350,827
            
            
            (201
            )
            
            5,652,230Dilutive
                earnings available to common stockholders
            
            $
            (458
            )
            
            6,350,827
            
            $
            (201
            )
            
            5,652,230





For
      the
      three months ended September 24, 2006; 857,925 options and 500 shares of
      convertible preferred stock were excluded from the calculation because they
      were
      anti-dilutive. For the three months ended September 25, 2005, 726,675 options;
      1,359,896 warrants; and 500 shares of convertible preferred stock were excluded
      from the calculation because they were anti-dilutive.





Nine
                months
            
            2006
            
            2005(in
                thousands, except share data)
            
            Earnings
            
            Shares
            
            Earnings
            
            SharesNet
                income
            
            $
            1,547
            
            
            
            
            $
            619Less:
                preferred stock dividends
            
            
            (38
            )
            
            
            
            
            (38
            )Earnings
                available for common stockholders
            
            
            1,509
            
            
            5,980,299
            
            
            581
            
            
            5,679,752Dilutive
                securities:Stock
                options
            
            
            —
            
            
            96,487
            
            
            —
            
            
            126,111Warrants
            
            
            —
            
            
            272,892
            
            
            —
            
            
            411,422Convertible
                Preferred Stocks
            
            
            —
            
            
            125,000
            
            
            —
            
            
            —Dilutive
                earnings available to common stockholders
            
            $
            1,509
            
            
            6,474,678
            
            $
            581
            
            
            6,217,285





For
      the
      nine months ended September 24, 2006, 428,825 options were excluded from the
      calculation because they were anti-dilutive. For the nine months ended September
      25, 2005, 324,625 options; 203,645 warrants; and 500 shares of convertible
      preferred stock were excluded from the calculation because they were
      anti-dilutive.





**9.**
            **ISSUANCES
                OF COMMON STOCK**





During
      the nine months ended September 24, 2006, the Company issued 642,317 shares
      of
      common stock pursuant to the exercise, by 17 holders, of 1,333,334 warrants
      originally issued in a 2001 private placement. The Company received $612,749
      from the exercise of 272,333 warrants at $2.25 per share. The remaining 369,984
      shares were issued pursuant to the cashless exercise of 666,667 warrants at
      $2.00 and 394,334 warrants at $2.25 per share.




12




During
      the nine months ended September 24, 2006, the Company issued 32,400 shares
      of
      common stock pursuant to the exercise of stock options for the aggregate
      consideration of $35,812.








**10.**
            **STOCK-BASED
                COMPENSATION**





We
      maintain performance incentive plans under which incentive stock options and
      non-qualified stock options may be granted to employees, consultants and
      non-employee directors.  To date, we have granted both qualified and
      non-qualified stock options under these plans.  Stock options are granted
      at the market price on the date of grant, generally vest at 20% per year, and
      generally expire ten years from the date of grant.  We issue new shares of
      common stock upon exercise of stock options.





In
      March
      2006, the Company’s board of directors adopted the Grill Concepts, Inc. 2006
      Equity Incentive Plan (the “2006 Plan”). The shareholders approved the 2006 Plan
      in June 2006. Under the 2006 Plan, 500,000 shares are reserved for issuance
      pursuant to the exercise of stock options and awards of restricted stock, stock
      appreciation rights and other similar equity based award grants. At September
      24, 2006, there were 316,250 shares available for grant under the 2006 Plan
      and
      an additional 35,825 shares available for grant under predecessor
      plans.




Effective
      December 26, 2005, the first day of our 2006 fiscal year, we adopted Financial
      Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based Payment”
(“SFAS 123R”), using the modified prospective transition method, and as a
      result, did not retroactively adjust results from prior periods.  Under
      this transition method, stock-based compensation was recognized for expenses
      related to the options vesting in the first nine months of 2006 based on the
      grant date fair value estimated in accordance with the provisions of SFAS
      123R.  The Company applies the Black-Scholes valuation model in determining
      the fair value of share-based payments to employees, consultants and
      non-employee directors.  The resulting compensation expense is recognized
      over the requisite service period, which is generally the option vesting term
      of
      five years.  Options issued to non-employee directors are vested 100% at
      grant date. Prior to fiscal 2006, stock-based compensation was included as
      a pro
      forma disclosure in the Notes to the Condensed Consolidated Financial Statements
      as permitted by SFAS 123.




Compensation
      expense is recognized only for those options expected to vest, with forfeitures
      estimated based on our historical experience and future expectations. 
Prior to the adoption of SFAS 123R, the effect of forfeitures on the pro forma
      expense amounts were recognized as the forfeitures occurred.




As
      a
      result of adopting SFAS 123R, the impact to the Condensed Consolidated Statement
      of Operations for the nine months ended September 24, 2006 on income before
      income taxes and net loss was $153,000 and $92,000, respectively, and $0.02
      and
      $0.01 on basic and diluted earnings per share, respectively.





The
      pro
      forma table below reflects net income (loss) and basic and diluted net income
      (loss) per share for the three and nine month periods ended September 25, 2005,
      had we applied the fair value recognition provisions of SFAS 123R:





13




Three
                Months Ended
            
            Nine
                Months Ended(in
                thousands, except per share amounts)
            
            September
                25, 2005
            
            September
                25, 2005Net
                income (loss), as reported
            
            $
            (201
            )
            $
            581Deduct:
                stock compensation expense under fair value method, net of
                taxes
            
            
            (125
            )
            
            (201
            )Net
                income (loss), pro forma
            
            $
            (326
            )
            $
            380Net
                income (loss) per share, as reported:Basic
            
            $
            (0.04
            )
            $
            0.10Diluted
            
            $
            (0.04
            )
            $
            0.09Net
                income (loss) per share, pro forma:Basic
            
            $
            (0.06
            )
            $
            0.07Diluted
            
            $
            (0.06
            )
            $
            0.06




Pro
      forma
      disclosures for the three and nine months ended September 24, 2006 are not
      presented because the amounts are recognized in the condensed consolidated
      financial statements.




There
      were 30,000 options granted in the third quarter of 2006 and 122,250 granted
      in
      the third quarter of 2005. There were 183,750 options granted in the first
      nine months of 2006 and 122,250 options granted in the first nine months of
      2005. For all of 2005 and 2006 we have utilized the Black-Scholes option pricing
      model for estimating our stock-based compensation cost.  The weighted
      average fair value cost for options granted in 2006 and 2005 was $2.13 and
      $3.09
      per share, respectively.






The
      Company has adopted the simplified method for determining the expected term
      of
      the options.  For fiscal 2006, expected stock price volatility is based on
      the historical volatility of our stock. The risk-free interest rate is based
      on
      the U.S. Treasury yield in effect at the time of grant with an equivalent
      remaining term. The Company  has
      not
      paid dividends in the past and does not currently plan to pay any dividends
      in
      the near future.




The
      fair
      value of each option grant issued is estimated at the date of grant using the
      Black-Scholes option-pricing model with the following weighted average
      assumptions:




For
                the nine months endedSeptember
                24, 2006
            
            
            September
                25, 2005Expected
                volatility
            
            
            68.40
            %
            
            66.71
            %Risk
                free interest rate
            
            
            5.15
            %
            
            4.05
            %Expected
                option life
            
            
            6.3
                years
            
            
            8.67
                yearsDividend
                yield
            
            
            0
            %
            
            0
            %Fair
                value cost of options granted
            
            $
            2.13
            
            $
            3.09




14




Stock
      options activity during the nine months ended September 24, 2006 was as follows:




**Shares**
            
            **Weighted
                Average****Exercise
                Price**
            
            **Weighted
                Average Remaining Contractual****Life
                (in years)**
            
            **Aggregate**
              **Intrinsic**
              **Value**Outstanding
                at December 25, 2005
            
            
            713,275
            
            $
            2.89Granted
            
            
            183,750
            
            
            3.17Exercised
            
            
            (32,400
            )
            
            2.18Cancelled
            
            
            (25,200
            )
            
            3.10Outstanding
                at September 24, 2006
            
            
            839,425
            
            $
            2.98
            
            
            6.2
            
            
            462,663Exercisable
                at September 24, 2006
            
            
            485,075
            
            
            2.86
            
            
            4.6
            
            
            347,037




The
      aggregate intrinsic value in the table above represents the total pretax
      intrinsic value (the difference between our closing stock price on September
      22,
      2006 of $3.30 and the exercise price, multiplied by the number of in-the-money
      options) that would have been received by the option holders had all option
      holders exercised their options on September 24, 2006.  This amount changes
      based on the fair market value of our stock.  Total intrinsic value of
      options exercised for the nine months ended September 24, 2006 was
      $36,258----.  As of September 24, 2006, total unrecognized stock-based
      compensation expense related to non-vested stock options was $543,412, which
      is
      expected to be recognized over a weighted average period of approximately 3
      years.  As of September 24, 2006 there were 352,075 shares of common stock
      available for issuance pursuant to future stock option grants.




Additional
      information regarding options outstanding as of September 24, 2006 is as
      follows:




Options
                Outstanding.
            
            Options
                Exercisable.Range
                of
              Exercise
                Price
            
            Number
              Outstanding
                at
              September
                24,
              2006.
            
            Weighted-
              Average
              Remaining
              Contractual
                Life
            
            Weighted-
              Average
              Exercise
                Price
            
            Number
              Outstanding
                at
              September
                24,
              2006.
            
            Weighted-
              Average
              Exercise
                Price$
                1.25
            
            
            1,750
            
            
            3.7
            
            $
            1.25
            
            
            1,750
            
            $
            1.25$
                1.55
            
            
            41,000
            
            
            4.0
            
            $
            1.55
            
            
            41,000
            
            $
            1.55$
                1.65
            
            
            86,500
            
            
            4.9
            
            $
            1.65
            
            
            70,800
            
            $
            1.65$
                1.70
            
            
            34,750
            
            
            6.7
            
            $
            1.70
            
            
            20,050
            
            $
            1.70$
                2.19
            
            
            49,050
            
            
            4.9
            
            $
            2.19
            
            
            49,050
            
            $
            2.19$
                2.23
            
            
            50,000
            
            
            7.8
            
            $
            2.23
            
            
            20,000
            
            $
            2.23$
                2.46
            
            
            14,000
            
            
            0.9
            
            $
            2.46
            
            
            14,000
            
            $
            2.46$
                2.86
            
            
            64,250
            
            
            6.2
            
            $
            2.86
            
            
            37,850
            
            $
            2.86$
                3.14
            
            
            25,000
            
            
            2.6
            
            $
            3.14
            
            
            10,000
            
            $
            3.14$
                3.16
            
            
            203,750
            
            
            3.6
            
            $
            3.16
            
            
            121,000
            
            $
            3.16$
                3.19
            
            
            50,000
            
            
            9.5
            
            $
            3.19
            
            
            —
            
            $
            3.19$
                3.20
            
            
            30,000
            
            
            9.8
            
            $
            3.20
            
            
            —
            
            $
            3.20$
                3.45
            
            
            25,000
            
            
            9.1
            
            $
            3.45
            
            
            —
            
            $
            3.45$
                4.00 to $ 4.68
            
            
            146,750
            
            
            6.2
            
            $
            4.20
            
            
            81,950
            
            $
            4.17$
                5.36 to $14.00
            
            
            17,625
            
            
            0.3
            
            $
            6.40
            
            
            17,625
            
            $
            6.40Total
            
            
            839,425
            
            
            
            
            
            
            
            
            485,075




15





**11.**
            **RECENT
                ACCOUNTING PRONOUNCEMENTS**





In
      July
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation ("FIN") No. 48, "Accounting for Uncertainty in Income Taxes
      - an
      interpretation of FASB Statement No. 109." This interpretation prescribes a
      recognition threshold and measurement attribute for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return, and provides guidance on recognition, classification, interest
      and
      penalties, accounting in interim periods, disclosure, and transition. This
      Interpretation will be effective for the Company on January 1, 2007, with the
      cumulative effect of the change in accounting principle recorded as an
      adjustment to opening retained earnings. The Company is currently assessing
      the
      impact of the adoption of the Interpretation on its financial
      statements.





In
      June
      2006, the FASB ratified the Emerging Issues Task Force’s Abstract (“EITF”) 06-3
“How Taxes Collected from Customers and Remitted to Governmental Authorities
      Should Be Presented in the Income Statement” (“EITF 06-3”). EITF 06-3 requires
      disclosure of the Company’s method for presenting the taxes in the income
      statement. This disclosure is required for interim and annual reporting periods
      beginning after December 15, 2006. The Company reports revenues net of all
      sales
      and use taxes (excluded from revenues). Adoption of EITF 06-3 will not impact
      the Company’s financial statements.





In
      November 2005, the FASB issued FASB Staff Position (“FSP”) FAS 123R-3,
“Transition Election to Accounting for the Tax Effects of Share-Based Payment
      Awards”.  This FSP requires an entity to follow either the transition
      guidance for the additional-paid-in-capital pool as prescribed in SFAS 123R,
      Share-Based Payment, or the alternative transition method as described in the
      FSP.  An entity that adopts SFAS 123R using the modified prospective
      application may make a one-time election to adopt the transition method
      described in this FSP.  An entity may take up to one year from the later of
      its initial adoption of SFAS 123R or the effective date of this FSP to evaluate
      its available transition alternatives and make its one-time election.  This
      FSP became effective in November 2005. The Company has until December 31, 2006
      to make its election.  We continue to evaluate the impact that the adoption
      of this FSP could have on our financial statements.





In
      October 2005, the FASB posted FASB Staff Position (“FSP”) 13-1, which requires
      that rental costs incurred during and after a construction period for the right
      to control the use of a leased asset during and after construction of a lessee
      asset to be recognized as rental expense. The provisions of FSP 13-1 shall
      be
      applied to the first reporting period beginning after December 15, 2005. The
      Company’s existing accounting policy for rental costs incurred during and after
      the construction period conforms to FSP 13-1. The adoption of FSP 13-1 did
      not
      have a material impact on the Company’s condensed consolidated financial
      statements.





In
      May
      2005, the Financial Accounting Standards Board (“FASB”) issued Statement of
      Financial Accounting Standards No. 154, “Accounting Changes and Error
      Corrections” (“SFAS 154”), which requires retroactive application of a voluntary
      change in accounting principle to prior period financial statements unless
      it is
      impractical. SFAS 154 also requires that a change in method of depreciation,
      amortization or depletion for long-lived, non-financial assets be accounted
      for
      as a change in accounting estimate that is affected by a change in accounting
      principle. SFAS 154 replaces APB Opinion 20, “Accounting Changes,” and SFAS 3,
“Reporting Accounting Changes in Interim Financial Statements.” The Company will
      adopt the provisions of SFAS 154, effective in 2007. Management currently
      believes that adoption of the provisions of SFAS 154 will not have a significant
      impact on the Company’s condensed consolidated financial statements.




16




**12.**
            **RELATED
                PARTY TRANSACTIONS**





Terms
      of the Michigan Avenue Group Extinguishment Obligations





In
      March
      2006, the Company retired the collateralized subordinated notes and mandatorily
      redeemable capital obligations owed to the Michigan Avenue Group (“MAG”) a
      member of Chicago Grill on the Alley, LLC (the “Chicago Grill”). As a result of
      the prepayment, MAG required a $200,000 penalty for earlier extinguishment
      of
      the obligations. The penalty is payable in four annual installments of $50,000,
      the first which was paid upon repayment of the obligations. The Company
      guaranteed the payment of the debt extinguishment penalty. The balance due
      to
      MAG as of September 24, 2006 is $150,000, which is included in current and
      long-term liabilities in the condensed consolidated balance sheets.





The
      penalty on early extinguishment will be deemed to be a cash distribution of
      the
      Chicago Grill to MAG if the lease for the restaurant location of the Chicago
      Grill on the Alley is renewed. After renewal, the Company will receive the
      next
      $200,000 of cash distributions from the Chicago Grill, prior to any
      distributions being made to MAG. The Company will record this cash distribution
      when received.





Amendment
      to Starwood Development Agreement





On
      June
      21, 2006, the Company entered into a First Amendment to the Development
      Agreement (the “First DA Amendment”) with Starwood Hotels and Resorts Worldwide,
      Inc. (“Starwood”). The First DA Amendment amends the Company’s July 27, 2001
      Development Agreement with Starwood to (1) eliminate the Company’s obligation to
      issue warrants to Starwood following the opening of ten, fifteen and twenty
      restaurants under the terms of the Development Agreement and (2) modify the
      exercise price of warrants issued following the opening of five restaurants
      under the terms of the Development Agreement.





Under
      the
      terms of the First DA Amendment, if a fifth restaurant is opened under the
      terms
      of the Development Agreement before April 1, 2008, the Company will issue to
      Starwood warrants to purchase a number of shares of common stock equal to 4%
      of
      the then outstanding shares of the Company’s common stock. If the fifth
      restaurant is opened after April 1, 2008, the Company will issue to Starwood
      warrants to purchase a number of shares of common stock equal to 4% of the
      shares outstanding at December 25, 2005.





The
      warrants will have an exercise price equal to (1) if the fair market value
      of
      the common stock as of the date of issuance of the warrants (the “Threshold Date
      Value”) is greater than the fair market value of the common stock as of the date
      of the original Development Agreement (the “Closing Date Value”), the greater of
      (a) 75% of the Threshold Date Value, or (b) the Closing Date Value, or (2)
      if
      the Threshold Date Value of the common stock is less than the Closing Date
      Value, the Threshold Date Value.




17




Amendment
      to Starwood Stockholders’ Agreement





On
      June
      21, 2006, the Company entered into a First Amendment to Stockholders’ Agreement
      (the “First SA Amendment”) with Starwood. The First SA Amendment amends the July
      27, 2001 Stockholders’ Agreement between the Company, Starwood and certain
      stockholders of the Company to (1) eliminate the Company’s obligation to cause
      at least two nominees of Starwood to be elected to the Company’s board of
      directors if ten or more restaurants are operated under the Development
      Agreement, and (2) modify certain provisions limiting the size of the Company’s
      board of directors.





Under
      the
      terms of the First SA Amendment, so long as Starwood continues to hold at least
      333,334 shares of the Company’s common stock, the Company shall take all actions
      reasonably necessary to assure that at least one nominee of Starwood is elected
      to the board of directors and to limit the size of the board of directors to
      no
      more than nine persons.




Purchase
      of Contract Rights from Hotel Restaurant Properties





On
      September 1, 2006, the Company entered into an Agreement for Purchase and Sale
      of Assets (the “Purchase Agreement”) with Hotel Restaurant Properties, Inc.
      (“HRP”), Hotel Restaurant Properties II, Inc., Hotel Restaurant Properties II
      Management, Inc., Keith Wolff and Adam Keller (collectively, the
“Sellers”).





Pursuant
      to the terms of the Purchase Agreement, the Sellers agreed to sell to the
      Company and the Company agreed to purchase from the Sellers certain rights
      and
      interests of the Sellers relating to the current and future operation of Company
      restaurants in hotel properties pursuant to the terms of an Agreement, dated
      August 27, 1998, as amended (the “HRP Agreement”). Under the terms of the HRP
      Agreement, the Sellers had the exclusive right to obtain hotel-based locations
      for Company restaurants and were entitled to receive a portion of the net
      income, management fees, licensing fees or similar fees of the Company from
      the
      operation of such hotel-based restaurants. The Company, at the date of the
      Purchase Agreement, operated seven restaurants subject to the HRP Agreement
      in
      Skokie, Illinois; San Francisco, California; Houston, Texas; Washington D.C.;
      Burbank, California; Portland, Oregon, and Long Beach, California.





Under
      the
      Purchase Agreement, the Sellers agreed to transfer to the Company all of the
      rights in the management agreements (the “Transferred Agreements”) relating to
      the San Francisco; Houston; Washington, D.C.; and Portland restaurants as well
      as ownership of the Houston liquor license.





Pursuant
      to the Purchase Agreement, the HRP Agreement was amended, effective June 30,
      2006 (the ”Effective Date”), to eliminate exclusivity provisions under which the
      Company would use the Sellers as the exclusive parties to identify potential
      hotel locations and to eliminate certain provisions under which the Sellers
      could cause the Company to purchase HRP and the Company could acquire HRP.
      Under
      the Purchase Agreement, the Sellers also agreed to relinquish any rights to
      fees
      or other compensation relating to Company restaurants opened in hotels pursuant
      to management, license or lease agreements entered into on or after March 29,
      2006, including any fees relating to restaurants proposed to be opened in
      Memphis, Tennessee and Seattle, Washington.





The
      Sellers will retain their rights in the management contracts relating to the
      Burbank, Skokie and Long Beach restaurants subject to the continuing terms
      of
      the HRP Agreement, as amended, and subject to the rights of the Company to
      terminate operations of the Skokie and Long Beach restaurants.




18




The
      purchase price of the acquired assets under the Purchase Agreement is $2,771,133
      (the “Purchase Price”). Closing of the purchase and sale shall occur on the
      effective date of June 30, 2006 (the “Closing Date”), and the Purchase Price is
      payable, on the earlier of June 30, 2007 (the “Outside Closing Date”) or a
      mutually agreeable date not more than 10 days after the date on which the
      aggregate payments (the “Income Stream Payments”) received by the Sellers, after
      the Effective Date and prior to closing, under the Transferred Agreements equal
      $294,151 (the “Maximum Income Stream Payments”). From and after the Effective
      Date the Income Stream Payments shall not exceed the Maximum Income Stream
      Payments after the payments of which no further payments shall be made to the
      Sellers with respect to the Transferred Agreements. In the event that the
      Sellers shall not have received the Maximum Income Stream Payments by the
      Outside Closing Date, the Purchase Price shall be increased by the excess of
      the
      Maximum Income Stream Payments over the actual Income Stream Payments as of
      the
      Closing Date.





On
      the
      Closing Date, the HRP Agreement will be further amended to eliminate the license
      granted thereunder for the Sellers to operate managed outlets under the HRP
      Agreement, eliminate restrictions on the Seller’s ability to provide similar
      hotel restaurant location services to parties other than the Company and to
      eliminate other provisions relating to the Transferred Agreements.





At
      closing, the Sellers shall enter into a Non-Competition Agreement pursuant
      to
      which the Sellers, for a period of 5 years from the Closing Date, will not
      assist any owner, operator, franchisor or franchisee of a branded restaurant
      in
      entering into a lease, license or management agreement to operate a restaurant,
      provide room service or provide food or banquet room events at any hotel (the
      “Restricted Business”), provided, however, that the Sellers shall not be
      prohibited from (a) owning up to 10% of any publicly traded company engaged
      in
      the Restricted Business, (b) engaging in the Restricted Business with respect
      to
      hotel properties owned by the Sellers or affiliates of the Sellers and managed
      by the Sellers or the affiliates of the Sellers or (c) engaging in the
      Restricted Business with up to 3 additional hotels. Branded restaurants, for
      purposes of the Non-Competition Agreement, mean a restaurant operated in ten
      or
      more locations under a single brand name.





Pursuant
      to the Purchase Agreement, the Company has agreed to indemnify the Sellers
      with
      respect to any additional tax that may be incurred, as well as related penalties
      and interest, in the event that the goodwill allocated to the sale is reduced
      for tax purposes on audit or other adjustment.





The
      Company recorded the Non-Compete Agreement as of June 30, 2006 as a noncurrent
      asset. The asset is being amortized on a straight-line basis over the five-year
      term of the agreement. A corresponding Payable to HRP was recorded and is
      presented in the condensed consolidated balance sheets net of amortization
      and
      Income Stream Payments made during the quarter.





The
      Company entered into the Purchase Agreement in order to eliminate current and
      future financial restrictions for fees payable to HRP as the Company grows
      it
      business of hotel-based restaurants.




19




**13.**
            **DISTRIBUTION
                OF CAPITAL AND PREFERRED
                RETURNS**




The
      Company’s San Jose Grill, Chicago Grill on the Alley, The Grill on Hollywood,
      South Bay Daily Grill and Downtown Daily Grill restaurants are each owned by
      limited liability companies (the “LLC’s”) in which the Company serves as manager
      and owns a controlling interest. Each of the LLC’s has minority interest owners
      (“Members”) some of whom have participating rights in the joint venture such as
      the ability to approve operating and capital budgets and the borrowing of money.
      In connection with the financing of each of the LLC’s, the minority members may
      have certain rights to priority distributions of capital until they have
      received a return of their initial investments (“Return of Member Capital”) as
      well as rights to receive defined preferred returns on their invested capital
      (“Preferred Return”).




The
      Universal CityWalk Daily Grill is owned by a partnership (the “CityWalk
      Partnership”) for which we serve as manager. Our partner has certain rights to
      priority distributions of capital from the CityWalk Partnership until they
      have
      received their initial investment.





The
      following tables set forth a summary for each of the LLC’s and the CityWalk
      Partnership of (a) the distributions of capital to the Members and/or the
      Company during the nine months ended September 24, 2006, (b) the unreturned
      balance of the capital contributions of the Members and/or the Company at
      September 24, 2006, and (c) the accrued, but unpaid, preferred returns due
      to
      the Members and/or the Company at September 24, 2006:








(in
                thousands)
            
            **San
                Jose Grill, LLC**
            
            **Chicago
                Grill On The Alley, LLC**
            
            **The
                Grill On Hollywood,****LLC**Members
            
            Company
            
            Members
            
            Company
            
            Members
            
            CompanyDistributions
                of profit and note repayments     during the nine
                months ended
              September 24,2006:
            
            $
            255
            
            $
            255
            
            $
            972
                (a
            )
            
            —
            
            
            —
            
            
            —Unreturned
                Initial Capital Contributions at
              September 24, 2006:
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            $
            1,200
            
            $
            250Preferred
                Return rate:
            
            
            10
            %
            
            10
            %
            
            8
            %
            
            —
            
            
            12
            %
            
            12
            %Accrued
                but unpaid Preferred Returns at
              September 24, 2006:
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (b
            )
            
            (b
            )





20




**South
                Bay Daily Grill**
              **(Continental
                Park, LLC)**
            
            **Universal
                Citywalk Daily Grill**
            
            **Downtown
                Daily Grill**
              **(612
                Flower Daily Grill, LLC)**Members
            
            Company
            
            Members
            
            Company
            
            Members
            
            Company
              (d)Distributions
                of profit during the nine months
              ended September 24, 2006:
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            $
            27
            
            $
            9Unreturned
                Initial and Additional Capital
              Contributions at September 24, 2006:
            
            $
            1,100
            
            $
            450
            
            $
            1,496
            
            $
            296
            
            $
            1,373
            
            $
            304Preferred
                Return rate:
            
            
            10
            %
            
            10%
                (c
            )
            
            —
            
            
            —
            
            
            9
            %
            
            9
            %Accrued
                but unpaid Preferred Returns at
              September 24, 2006:
            
            
            (b
            )
            
            (b
            )
            
            (b
            )
            
            —
            
            $
            39
            
            $
            7





(a)
            Distribution
                of capital and note repayments as of September 24, 2006 includes
                $902,000
                of retirement of collateralized subordinated notes and mandatorily
                redeemable capital obligations and $70,000 of interest and preferred
                return.


(b)
            Due
                to the under performance of the restaurants the preferred return
                is not
                being accrued. The Company is not liable to pay the preferred return
                distributions, such that they represent a non-recourse obligation
                of the
                subsidiary entity. If preferred returns were accrued for The Grill
                on
                Hollywood the member would have an accrued preferred return of $950,000
                and the Company would have an accrued preferred return of $198,000.
                If
                preferred returns were accrued for the South Bay Daily Grill the
                member
                would have an accrued preferred return of $466,000 and the Company
                would
                have an accrued preferred return of $183,000.If
                preferred returns were accrued for the CityWalk Partnership the Member
                would have an accrued preferred return of $627,000.


(c)
            The Company’s preferred return with respect to the South
              Bay Daily Grill is based on unrecovered capital contribution and accrued
              but unpaid management fees.


(d)
            The Company is a non-managing member, and a wholly
              owned
              subsidiary of the Company is the manager of this
              restaurant.




21




**14.**
            **LITIGATION
                CONTINGENCIES AND COMMITMENTS**




Litigation
      Contingencies




In
      June
      2004, one of our former hourly restaurant employees filed a class action lawsuit
      against the Company in the Superior Court of California of Orange County. We
      requested, and were granted, a motion to move the suit from Orange County to
      Los
      Angeles County. The lawsuit was then filed in the Superior Court of California
      of Los Angeles in December 2004. The plaintiff has alleged violations of
      California labor laws with respect to providing meal and rest breaks. The
      lawsuit sought unspecified amounts of penalties and other monetary payments
      on
      behalf of the plaintiffs and other purported class members. We believe that
      all
      of our employees were provided with the opportunity to take all required meal
      and rest breaks. The case has been placed in a stay status pending the outcome
      of a review by the California Supreme Court of appealed cases of the same nature
      that is expected to happen in the first half of 2007. We intend to vigorously
      defend our position in all of these matters although the outcome cannot be
      ascertained at this time.




A
      Class
      Action complaint was filed against us in the Superior Court of the State of
      California for the County of Los Angeles on March 15, 2006.  The plaintiff
      and those similarly situated (Servers) complain that the Company has
      violated the labor code by having Servers "Tip Out" Bartenders and Expeditors
      a
      percentage of their tips to these employees who provide no direct table
      service.  The complaint has labeled this act as "Tip-pooling."  At a
      hearing on August 25, 2006 the case was dismissed without prejudice and the
      plaintiff’s counsel stipulated that an appeal will not be filed.





Commitments





In
      June
      2006, the Company signed a management agreement for a hotel-based Daily Grill
      to
      open at the Sheraton Seattle, in Seattle, Washington. The restaurant owner
      will
      pay substantially all construction and pre-opening costs, other than
      approximately $450,000 of remodeling costs to be contributed by the Company
      if
      the total construction costs exceed $1.5 million. The Company will receive
      management and incentive fees and will be entitled to receive a 9% preferred
      return on any capital contribution. The restaurant is scheduled to open in
      the
      summer of 2007.





**Item
      2.**  **Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations** .





The
      following discussion and analysis should be read in conjunction with the
      Company’s financial statements and notes thereto included elsewhere in this Form
      10-Q. Except for the historical information contained herein, the discussion
      in
      this Form 10-Q contains certain forward looking statements that involve risks
      and uncertainties, such as statements of the Company’s plans, objectives,
      expectations and intentions. The cautionary statements made in this Form 10-Q
      should be read as being applicable to all related forward looking statements
      wherever they appear in this Form 10-Q. The Company’s actual results could
      differ materially from those discussed here. For a discussion of certain factors
      that could cause actual results to be materially different, refer to the
      Company’s Annual Report on Form 10-K for the year ended December 25,
      2005.





**Current
      Year Developments**





***Restaurant
      Openings, Leasing and Management*** *.* The
      Company opened one new restaurant during the nine months ended September 24,
      2006. On July 17, 2006, the Company opened a Grill on the Alley restaurant
      in
      Dallas, Texas. This was the first opening of a Grill on the Alley concept
      restaurant since 2001.




22




In
      April
      2006, the
      Company signed a management agreement for a hotel-based Daily Grill to open
      at
      the Westin Memphis Beale Street in Memphis, Tennessee. The restaurant owner
      will
      pay all construction and pre-opening costs. The Company will receive a
      management fee with an annual guaranteed minimum fee of $130,000. The restaurant
      is scheduled to open in the spring of 2007.





In
      June
      2006, the Company signed a management agreement for a hotel-based Daily Grill
      to
      open at the Sheraton Seattle, in Seattle, Washington. The restaurant owner
      will
      pay substantially all construction and pre-opening costs, other than
      approximately $450,000 of remodeling costs to be contributed by the Company
      if
      the total construction costs exceed $1.5 million. The Company will receive
      management and incentive fees and will be entitled to receive a 9% preferred
      return on any capital contribution. The restaurant is scheduled to open in
      the
      summer of 2007.





***Credit
      Facility*** *.* In March
      2006, the Company entered into a financing agreement with Diamond Creek
      Investment Partners, LLC, at which time the Company’s previous line of credit
      was terminated. The Credit Agreement provides for a revolving term loan (the
      “Loan”) to the Company of the lesser of (a) $8.0 million, or (b) 2.25 times the
      Company’s trailing 12 month EBITDA. Funds may be borrowed under the Credit
      Agreement, subject to satisfaction of all conditions of funding, in monthly
      advances in minimum increments of $500,000. Proceeds of the Loan may be used
      to
      pay expenses of the Loan and for general corporate purposes. The interest rate
      on the Loan is, at the option of the Company and subject to certain limitations
      on the use of LIBOR based loans, equivalent to either (a) the prime rate, but
      not less than 7%, plus an applicable margin, or (b) the London Interbank Offered
      Rate, but not less than 4%, plus an applicable margin. The margin, in each
      case,
      varies based upon the Company’s leverage ratio (funded debt to EBITDA, each as
      defined) and ranges from 2.75% to 3.50% with respect to prime rate loans and
      5.50% to 6.25% with respect to LIBOR loans. The interest rate at September
      24,
      2006 was equal to 11.2% and was adjusted to 10.8% effective October 13,
      2006.





The
      Credit Agreement provides that the Company will pay all expenses incurred in
      connection with the Loan, including expenses incurred by the Lender. By separate
      agreement, the Company agreed to pay certain fees associated with the Loan,
      including a loan initiation fee of $120,000, an unused line fee of 0.5% of
      the
      unused portion of the credit facility payable monthly and a loan servicing
      fee
      of $3,000 per month. In March 2006, we borrowed $210,000 under the line of
      credit to pay costs associated with obtaining the financing.





The
      Loan
      matures, and is payable in full, on March 9, 2011 subject to mandatory
      prepayment to the extent, if any, that the outstanding principal balance of
      the
      Loan exceeds 2.25 times trailing 12 month EBITDA or upon the occurrence of
      certain defined extraordinary events. The Company may prepay amounts owing
      under
      the Credit Agreement subject to payment of a prepayment premium of (a) 3% with
      respect to prepayments occurring on or before March 9, 2007, and (b) 1% with
      respect to prepayments occurring after March 9, 2007 and on or before March
      9,
      2008.





The
      Company’s obligations under the Credit Agreement are secured by a first lien on
      all of the Company’s assets, including all of the capital stock and other equity
      interests held by the Company in its subsidiaries, subject to existing liens
      on
      such assets. The Loan requires the Company to comply with certain ordinary
      lending covenants. These include, among others, financial covenants relating
      to
      maximum debt to EBITDA ratio, minimum EBITDA and maximum capital expenditures.
      The Company must also comply with certain information requirements, including
      providing periodic financial statements and projections as well as notices
      of
      defaults, litigation and other matters, maintenance of insurance and compliance
      with laws as well as limitations on liens and encumbrances, indebtedness,
      dispositions, dividends and retirement of capital stock, consolidations and
      mergers, changes in nature of business and other operating, financial and
      structural limitations.




23




On
      March
      31, 2006, the Company borrowed $1 million under the terms of the Credit
      Agreement with the Lender. The borrowed funds were primarily used to retire
      $874,192 of collateralized subordinated notes and manditorily redeemable capital
      obligations owed to MAG by the Company’s subsidiary Chicago Grill, $5,940 of
      interest and $50,000 for the first annual penalty payment, all of which amounts
      were guaranteed by the Company, with the balance used for general working
      capital. The retired obligations related to the initial funding provided by
      MAG,
      as a member/investor in Chicago Grill LLC, with respect to the Company’s The
      Grill on the Alley restaurant in Chicago.





***Management
      Changes*** *.* In June
      2006, following the Company’s annual stockholders meeting, Robert Spivak retired
      as the Company’s President and Chief Executive Officer and Philip Gay, the
      Company’s Executive Vice President and Chief Financial Officer, assumed the
      positions of President and Chief Executive Officer. Mr. Spivak continues to
      provide services to the Company in a consulting capacity and as a director.
      In
      July 2006, Wayne Lipschitz was hired and appointed as Vice President and Chief
      Financial Officer.





***Income
      Taxes*** *.* During
      the nine-months ended September 24, 2006, the Company determined, based on
      an
      analysis of its taxable income over the preceding three years and the projected
      taxable income for the next three years, that it is more likely than not that
      the Company will recover the majority of its existing net deferred tax asset.
      Accordingly, during the period, most of the previously recorded valuation
      allowance with respect to the Company’s deferred tax asset was eliminated. As a
      result of the elimination of the valuation allowance, the Company realized
      a net
      tax benefit of about $2.0 million during the nine-months ended September 24,
      2006 and the Company’s condensed consolidated balance sheets reflected a
      deferred tax asset of $3.9 million at September 24, 2006.





The
      Company still has a valuation allowance of $1.3 million consisting of $0.7
      million for general business credits and $0.6 million for net operating losses
      (“NOL’s”). There is still some analysis to be done as to whether the Company can
      utilize all of the NOL’s and the general business credits as both of these have
      limitations. The Company will continue to review the valuation allowance each
      quarter to see if any further adjustments are necessary.





***Issuances
      of Common Stock*** . During
      the nine months ended September 24, 2006, the Company issued 642,317 shares
      of
      restricted common stock pursuant to the exercise, by 17 holders, of 1,333,334
      warrants originally issued in a 2001 private placement. The Company received
      $612,749 from the exercise of 272,333 warrants at $2.25 per share. The remaining
      369,984 shares were issued pursuant to the cashless exercise of 666,667 warrants
      at $2.00 and 394,334 warrants at $2.25 per share.





During
      the nine months ended September 24, 2006, the Company issued 32,400 shares
      of
      common stock pursuant to the exercise of stock options for the aggregate
      consideration of $35,812.





***Stock
      Based Compensation.*** .
      Effective December 26, 2005, the first day of the Company’s 2006 fiscal year,
      the Company adopted
      Financial Accounting Standards Board (“FASB”) Statement No. 123(R), “Share-Based
      Payment” (“SFAS 123R”), using the modified prospective transition method, and as
      a result, did not retroactively adjust results from prior periods.  Under
      this transition method, stock-based compensation was recognized for expenses
      related to the options vesting in the first nine months of 2006 based on the
      grant date fair value estimated in accordance with the provisions of SFAS
      123R.  The Company applies the Black-Scholes valuation model in determining
      the fair value of share-based payments to employees, consultants and
      non-employee directors.  The resulting compensation expense is recognized
      over the requisite service period, which is generally the option vesting term
      of
      five years. Options issued to non-member directors are vested 100% at grant
      date. Prior to fiscal 2006, stock-based compensation was included as a pro
      forma
      disclosure in the Notes to the condensed consolidated financial statements
      as
      permitted by SFAS 123.




24




As
      a
      result of the adoption of SFAS 123R, during the nine months ended September
      24,
      2006, the Company recorded compensation expense relating to stock option grants
      of $153,000. The Company recorded no compensation expense during the fiscal
      2005
      period relating to stock option grants. Had the Company reported stock based
      compensation expense under SFAS 123R during 2005, the Company’s pro forma
      compensation expense associated with option grants during the nine months ended
      September 25, 2005 would have been $201,000.





There
      were no modifications made to outstanding share options prior to the adoption
      of
      SFAS 123R. There have been no changes made to the quantity or type of incentive
      awards granted since the adoption of SFAS 123R. Terms for incentive compensation
      awards have remained the same in 2006 as they were in 2005.





As
      of
      September 24, 2006, total unrecognized stock-based compensation expense related
      to non-vested stock options was $543,412, which is expected to be recognized
      over a weighted average period of approximately 3 years.





In
      March
      2006, the Company’s board of directors adopted the Grill Concepts, Inc. 2006
      Equity Incentive Plan (the “2006 Plan”). The shareholders approved the 2006 Plan
      in June 2006. Under the 2006 Plan, 500,000 shares are reserved for issuance
      pursuant to the exercise of stock options and awards of restricted stock, stock
      appreciation rights and other similar equity based award grants. There were
      183,750 and 122,250 options granted in the first three quarters of 2006 and
      2005
      respectively.  At September 24, 2006, there were 316,250 shares available
      for grant under the 2006 Plan and an additional 35,825 shares available for
      grant under predecessor plans.





***Amendment
      of Starwood Agreements*** .
      On June
      21, 2006, the Company entered into a First Amendment to the Development
      Agreement (the “First DA Amendment”) with Starwood Hotels and Resorts Worldwide,
      Inc. (“Starwood”). The First DA Amendment amends the Company’s July 27, 2001
      Development Agreement with Starwood to (1) eliminate the Company’s obligation to
      issue warrants to Starwood following the opening of ten, fifteen and twenty
      restaurants under the terms of the Development Agreement and (2) modify the
      exercise price of warrants issued following the opening of five restaurants
      under the terms of the Development Agreement.





Under
      the
      terms of the First DA Amendment, if a fifth restaurant is opened under the
      terms
      of the Development Agreement before April 1, 2008, the Company will issue to
      Starwood warrants to purchase a number of shares of common stock equal to 4%
      of
      the then outstanding shares of the Company’s common stock. If the fifth
      restaurant is opened after April 1, 2008, the Company will issue to Starwood
      warrants to purchase a number of shares of common stock equal to 4% of the
      shares outstanding at December 25, 2005.





The
      warrants will have an exercise price equal to (1) if the fair market value
      of
      the common stock as of the date of issuance of the warrants (the “Threshold Date
      Value”) is greater than the fair market value of the common stock as of the date
      of the original Development Agreement (the “Closing Date Value”), the greater of
      (a) 75% of the Threshold Date Value, or (b) the Closing Date Value, or (2)
      if
      the Threshold Date Value of the common stock is less than the Closing Date
      Value, the Threshold Date Value.





On
      June
      21, 2006, the Company entered into a First Amendment to Stockholders’ Agreement
      (the “First SA Amendment”) with Starwood. The First SA Amendment amends the July
      27, 2001 Stockholders’ Agreement between the Company, Starwood and certain
      stockholders of the Company to (1) eliminate the Company’s obligation to cause
      at least two nominees of Starwood to be elected to the Company’s board of
      directors if ten or more restaurants are operated under the Development
      Agreement, and (2) modify certain provisions limiting the size of the Company’s
      board of directors.





25




Under
      the
      terms of the First SA Amendment, so long as Starwood continues to hold at least
      333,334 shares of the Company’s common stock, the Company shall take all actions
      reasonably necessary to assure that at least one nominee of Starwood is elected
      to the board of directors and to limit the size of the board of directors to
      no
      more than nine persons.





***Purchase
      of HRP Contract Rights*** *.* On
      September 1, 2006, the Company entered into an Agreement for Purchase and Sale
      of Assets (the “Purchase Agreement”) with Hotel Restaurant Properties, Inc.
      (“HRP”), Hotel Restaurant Properties II, Inc., Hotel Restaurant Properties II
      Management, Inc., Keith Wolff and Adam Keller (collectively, the
“Sellers”).





Pursuant
      to the terms of the Purchase Agreement, the Sellers agreed to sell to the
      Company and the Company agreed to purchase from the Sellers certain rights
      and
      interests of the Sellers relating to the current and future operation of Company
      restaurants in hotel properties pursuant to the terms of an Agreement, dated
      August 27, 1998, as amended (the “HRP Agreement”). Under the terms of the HRP
      Agreement, the Sellers had the exclusive right to obtain hotel-based locations
      for Company restaurants and were entitled to receive a portion of the net
      income, management fees, licensing fees or similar fees of the Company from
      the
      operation of such hotel-based restaurants. The Company, at the date of the
      Purchase Agreement, operated seven restaurants subject to the HRP Agreement
      in
      Skokie, Illinois; San Francisco, California; Houston, Texas; Washington D.C.;
      Burbank, California; Portland, Oregon; and Long Beach, California.





Under
      the
      Purchase Agreement, the Sellers agreed to transfer to the Company all of the
      rights in the management agreements (the “Transferred Agreements”) relating to
      the San Francisco; Houston; Washington, D.C.; and Portland restaurants as well
      as ownership of the Houston liquor license.





Pursuant
      to the Purchase Agreement, the HRP Agreement was amended, effective June 30,
      2006 (the ”Effective Date”), to eliminate exclusivity provisions under which the
      Company would use the Sellers as the exclusive parties to identify potential
      hotel locations and to eliminate certain provisions under which the Sellers
      could cause the Company to purchase HRP and the Company could acquire HRP.
      Under
      the Purchase Agreement, the Sellers also agreed to relinquish any rights to
      fees
      or other compensation relating to Company restaurants opened in hotels pursuant
      to management, license or lease agreements entered into on or after March 29,
      2006, including any fees relating to restaurants proposed to be opened in
      Memphis, Tennessee and Seattle, Washington.





The
      Sellers will retain their rights in the management contracts relating to the
      Burbank, Skokie and Long Beach restaurants subject to the continuing terms
      of
      the HRP Agreement, as amended, and subject to the rights of the Company to
      terminate operations of the Skokie and Long Beach restaurants.





The
      purchase price of the acquired assets under the Purchase Agreement is $2,771,133
      (the “Purchase Price”). Closing of the purchase and sale shall occur on the
      Effective Date of June 30, 2006 (the “Closing Date”), and the Purchase Price is
      payable, on the earlier of June 30, 2007 (the “Outside Closing Date”) or a
      mutually agreeable date not more than 10 days after the date on which the
      aggregate payments (the “Income Stream Payments”) received by the Sellers, after
      the Effective Date, and prior to closing, under the Transferred Agreements
      equal
      $294,151 (the “Maximum Income Stream Payments”). From and after the Effective
      Date the Income Stream Payments shall not exceed the Maximum Income Stream
      Payments after the payments of which no further payments shall be made to the
      Sellers with respect to the Transferred Agreements. In the event that the
      Sellers shall not have received the Maximum Income Stream Payments by the
      Outside Closing Date, the Purchase Price shall be increased by the excess of
      the
      Maximum Income Stream Payments over the actual Income Stream Payments as of
      the
      Closing Date.




26




On
      the
      Closing Date, the HRP Agreement will be further amended to eliminate the license
      granted thereunder for the Sellers to operate managed outlets under the HRP
      Agreement, eliminate restrictions on the Seller’s ability to provide similar
      hotel restaurant location services to parties other than the Company and to
      eliminate other provisions relating to the Transferred Agreements.





At
      closing, the Sellers shall enter into a Non-Competition Agreement pursuant
      to
      which the Sellers, for a period of 5 years from the Closing Date, will not
      assist any owner, operator, franchisor or franchisee of a branded restaurant
      in
      entering into a lease, license or management agreement to operate a restaurant,
      provide room service or provide food or banquet room events at any hotel (the
      “Restricted Business”), provided, however, that the Sellers shall not be
      prohibited from (a) owning up to 10% of any publicly traded company engaged
      in
      the Restricted Business, (b) engaging in the Restricted Business with respect
      to
      hotel properties owned by the Sellers or affiliates of the Sellers and managed
      by the Sellers or the affiliates of the Sellers or (c) engaging in the
      Restricted Business with up to 3 additional hotels. Branded restaurants, for
      purposes of the Non-Competition Agreement, mean a restaurant operated in ten
      or
      more locations under a single brand name.





Pursuant
      to the Purchase Agreement, the Company has agreed to indemnify the Sellers
      with
      respect to any additional tax that may be incurred, as well as related penalties
      and interest, in the event that the goodwill allocated to the sale is reduced
      for tax purposes on audit or other adjustment.




27




**Results
      of Operations**





The
      following table sets forth, for the periods indicated, information derived
      from
      the Company's condensed consolidated statements of operations expressed as
      a
      percentage of total revenues:


Three
                  Months Ended
              
              
              Nine
                  Months EndedSeptember
                24,
                  2006
              
              
              September
                25,
                  2005
              
              
              September
                  24, 2006
              
              
              September
                25,
                  2005Revenues:
              
              
              %
              
              
              %
              
              
              %
              
              
              %Sales
              
              
              77.0
              
              
              76.5
              
              
              77.5
              
              
              77.9Cost
                  reimbursements
              
              
              20.4
              
              
              21.2
              
              
              20.2
              
              
              19.9Management
                  and license fees
              
              
              2.6
              
              
              2.6
              
              
              2.3
              
              
              2.2Total
                  revenues
              
              
              100.0
              
              
              100.0
              
              
              100.0
              
              
              100.0Operating
                  expenses:Cost
                  of sales
              
              
              22.4
              
              
              21.5
              
              
              22.0
              
              
              21.9Restaurant
                  operating
              
              
              47.1
              
              
              47.5
              
              
              46.3
              
              
              46.6Reimbursed
                  costs
              
              
              20.4
              
              
              21.2
              
              
              20.2
              
              
              19.9General
                  and administrative
              
              
              7.5
              
              
              6.6
              
              
              7.5
              
              
              6.6Depreciation
                  and amortization
              
              
              3.9
              
              
              3.8
              
              
              3.2
              
              
              3.1Pre-opening
                  costs
              
              
              1.2
              
              
              0.1
              
              
              0.8
              
              
              0.5Total
                  operating expenses
              
              
              102.5
              
              
              100.7
              
              
              100.0
              
              
              98.7Income
                  (loss) from operations
              
              
              (2.5
              )
              
              (0.7
              )
              
              (0.0
              )
              
              1.3Interest,
                  net
              
              
              (0.5
              )
              
              (0.3
              )
              
              (0.3
              )
              
              (0.2
              )Debt
                  extinguishment costs
              
              
              (0.0
              )
              
              —
              
              
              (0.5
              )
              
              —Income
                  (loss) before benefit (provision)for
                  income taxes and minority interest
              
              
              (3.0
              )
              
              (1.0
              )
              
              (0.8
              )
              
              1.1Benefit
                  (provision) for income taxes
              
              
              0.8
              
              
              (0.4
              )
              
              3.7
              
              
              (0.5
              )Minority
                  interest in net (profit) loss ofsubsidiaries
              
              
              (0.1
              )
              
              0.3
              
              
              (0.2
              )
              
              0.7Net
                  income (loss)
              
              
              (2.3
              )
              
              (1.1
              )
              
              2.7
              
              
              1.3





The
      following table sets forth, for the periods indicated, information derived
      from
      the Company’s condensed consolidated financial statements of operations
      expressed as a percentage of total restaurant sales:




Three
                  Months Ended
              
              
              Nine
                  Months EndedSeptember
                  24, 2006
              
              
              September
                  25, 2005
              
              
              September
                  24, 2006
              
              
              September
                  25, 2005Revenues:
              
              
              %
              
              
              %
              
              
              %
              
              
              %Sales
              
              
              100.0
              
              
              100.0
              
              
              100.0
              
              
              100.0Cost
                  of sales
              
              
              29.1
              
              
              28.1
              
              
              28.3
              
              
              28.2Restaurant
                  operating expenses
              
              
              61.1
              
              
              62.1
              
              
              59.8
              
              
              59.8





28




The
      following tables set forth certain financial information and other restaurant
      data relating to Company owned restaurants and Company managed and/or licensed
      restaurants.




Third
                  Quarter
                Openings
              
              
              Year-to-date
                Openings
              
              
              Total
                  open at
                End
                  of Quarter2006
              
              
              2005
              
              
              2006
              
              
              2005
              
              
              2006
              
              
              2005Daily
                  Grill restaurants:Company
                  owned
              
              
              -
              
              
              (1
              )
              
              -
              
              
              1
              
              
              12
              
              
              12Managed
                  and/or licensed
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              8
              
              
              8Grill
                  on the Alley restaurants:Company
                  owned
              
              
              1
              
              
              -
              
              
              -
              
              
              -
              
              
              5
              
              
              4Total
              
              
              1
              
              
              (1
              )
              
              -
              
              
              1
              
              
              25
              
              
              24
   Three
                  Months Ended
              
              Nine
                  Months EndedSeptember
                  24,
                    2006
              
              September
                  25,
                    2005
              
              September
                  24,
                    2006
              
              September
                  25,
                    2005Weighted
                  average weekly salesper
                  Company owned restaurant:Daily
                  Grill
              
              $
              59,814
              
              $
              55,344
              
              $
              63,248
              
              $
              58,735Grill
                  on the Alley
              
              
              87,167
              
              
              81,969
              
              
              85,867
              
              
              81,207Change
                  in comparable restaurant sales (1):Daily
                  Grill
              
              
              5.4
              %
              
              1.1
              %
              
              5.3
              %
              
              0.0
              %Grill
                  on the Alley
              
              
              12.1
              %
              
              13.0
              %
              
              11.2
              %
              
              10.7
              %Total
                  sales (in thousands):Daily
                  Grill
              
              $
              9,331
              
              $
              9,036
              
              $
              29,599
              
              $
              27,434Grill
                  on the Alley
              
              
              5,461
              
              
              4,262
              
              
              14,767
              
              
              12,668Total
                  consolidated sales
              
              $
              14,792
              
              $
              13,298
              
              $
              44,366
              
              $
              40,102




(1)
            When
                computing comparable restaurant sales, restaurants open for at least
                12
                months are compared from period to
                period.




We
      also
      earn revenues from management and license fees based on a percentage of gross
      sales at restaurants under management and licensing arrangements. Our management
      and license fee revenue typically is earned at a rate of five to eight percent
      of reported sales at these restaurants. The sales of managed and licensed
      restaurants are not included in our condensed consolidated statements of
      operations. However, we consider the disclosure of these sales to be a key
      indicator of brand strength and important to understanding how changes in sales
      at the managed and licensed restaurants impact our revenue.





Sales
      at
      non-Company owned Grill Concepts-branded restaurants, categorized as, managed
      and licensed restaurants were as follows:





29




Three
                  Months Ended
              
              Nine
                  Months Ended(in
                  thousands)
              
              September
                  24,
                    2006
              
              September
                  25,
                    2005
              
              September
                  24,
                    2006
              
              September
                  25,
                    2005Managed
                  Daily Grills
              
              $
              5,444
              
              $
              4,830
              
              $
              15,941
              
              $
              14,039Licensed
                  Daily Grills
              
              
              1,801
              
              
              2,173
              
              
              5,486
              
              
              5,943$
              7,245
              
              $
              7,003
              
              $
              21,427
              
              $
              19,982Management
                  and license fees
              
              $
              491
              
              $
              402
              
              $
              1,329
              
              $
              1,127Percent
                  of gross sales
              
              
              6.8
              %
              
              5.7
              %
              
              6.2
              %
              
              5.6
              %




**Material
      Changes in Results of Operations for the Three and Nine Months Ended September
      24, 2006 as compared to the Three and Nine Months Ended September 25,
      2005**





***Revenues*** .
      Total
      revenues increased 10.5% to $19.2 million for the 2006 third quarter from $17.4
      million in the 2005 third quarter and increased 11.1% to $57.2 million for
      the
      2006 year-to-date period from $51.5 million for the 2005 year-to-date period.
      For the quarter, total revenues consisted of sales revenues of $14.8 million,
      up
      11.2% from $13.3 million in the 2005 quarter, management and license fees of
      $0.5 million, up 22.1% from $0.4 million in the 2005 quarter, and reimbursed
      managed outlet expenses of $3.9 million, up 6.7% from $3.7 million in the 2005
      quarter. For the year-to-date period, total revenues consisted of sales revenues
      of $44.4 million, up 10.6% from $40.1 million in the 2005 year-to-date period,
      management and license fees of $1.3 million, up 17.9% from $1.1 million in
      the
      2005 year-to-date period, and reimbursed managed outlet expenses of $11.5
      million, up 12.4% from $10.3 million in the 2005 year-to-date period.





Sales
      for
      Daily Grill restaurants increased by 3.3% from $9.0 million in the 2005 quarter
      to $9.3 million in the 2006 period. The increase in sales revenues for the
      Daily
      Grill restaurants from 2005 to 2006 was primarily attributable to an increase
      in
      same  store
      sales of 5.4% ($0.4 million) for restaurants open for the entire 39 weeks in
      both 2005 and 2006 and an increase in sales at restaurants opened in 2005 ($0.1
      million) partially offset by a decrease in sales at the La Cienega Daily Grill
      ($0.2 million) due to closure of the restaurant in July 2005 at the lease
      expiration.





Sales
      for
      Daily Grill restaurants increased by 7.9% from $27.4 million for the nine months
      in 2005 to $29.6 million in 2006. The increase in sales revenues for the Daily
      Grill restaurants from 2005 to 2006 was primarily due to the 2005 opening of
      the
      Santa Monica Daily Grill and the Downtown Daily Grill ($2.3 million) combined
      with improved sales at the comparable restaurants of 5.3% ($1.3 million)
      partially offset by a decrease at the La Cienega Daily Grill ($1.4 million)
      due
      to closure of the restaurant in July 2005. Management considers performance
      of
      same store or comparable store sales to be an important measure of growth when
      evaluating performance. Weighted average weekly sales at the Daily Grill
      restaurants increased 7.7% from $58,735 in 2005 to $63,248 in 2006. Comparable
      restaurant sales and weighted average weekly sales at the Daily Grill
      restaurants in 2006 reflected a menu price increase in the spring of 2006.
      The
      increase in same store sales was principally attributable to an increase in
      check averages.





Sales
      for
      Grill restaurants increased by 28.1% from $4.3 million in the 2005 quarter
      to
      $5.5 million in the 2006 quarter. The increase in sales revenues for the Grill
      restaurants from 2005 to 2006 was attributable to both the opening of the Dallas
      Grill in July 2006 ($0.7 million) and improved sales at comparable restaurants
      ($0.5 million). The improvement in same store sales was primarily attributable
      to increased guest counts.




30




Sales
      for
      Grill restaurants increased 16.6% from $12.7 million for the nine months in
      2005
      to $14.8 million for the nine-months in 2006. The increase in sales revenues
      for
      the Grill restaurants from 2005 to 2006 was attributable to the opening of
      the
      Dallas Grill in July 2006 ($0.7 million) and improved sales at comparable
      restaurants ($1.4 million). The improvement in same store sales was primarily
      attributable to increased guest counts. Weighted average weekly sales at the
      Grill restaurants increased 5.7% from $81,207 in 2005 to $85,867 in 2006.





Management
      and license fee revenues were attributable to hotel restaurant management
      services which accounted for $438,000 of management fees during the 2006 quarter
      as compared to $348,000 during the 2005 quarter and licensing fees of $53,000
      during the 2006 quarter compared to $54,000 during the 2005 quarter. The
      increase in management and license fees during 2006 was attributable to improved
      sales at managed restaurants. The fees earned from managing restaurants are
      higher rates than those for licensing restaurants resulting in fees being a
      higher percentage of sales with the increase all coming from management fees.





For
      the
      year-to-date period, management and license fee revenues were attributable
      to
      hotel restaurant management services and licensing arrangements which accounted
      for $1,153,000 of management fees during the 2006 period as compared to $954,000
      during the 2005 period and licensing fees of $176,000 during the 2006 period
      as
      compared to $173,000 during the 2005 period. The increase in management and
      license fees during 2006 was attributable to improved sales at all of the
      managed restaurants **.**





Cost
      reimbursements represent amounts incurred by the Company on behalf of managed
      outlets for which the Company receives reimbursements from the owners of the
      managed restaurants. The increase in revenues attributable to cost
      reimbursements for both the quarter and year-to-date periods were attributable
      to increased sales at managed restaurants.





***Operating
      Expenses and Operating Results*** .
      Total
      operating expenses, including cost of sales, restaurant operating expenses,
      reimbursed costs, general and administrative expenses, depreciation and
      amortization, and pre-opening costs, increased 12.6% to $19.7 million in the
      2006 quarter (representing 102.5% of revenues) from $17.5 million in 2005
      (representing 100.7% of revenues). For the nine months, total operating expenses
      increased 12.5% to $57.2 million (representing 100.0% **** of
      revenues) from $50.8 million in 2005 (representing 98.7% of
      revenues).





***Cost
      of Sales*** *.* While
      sales revenues increased by 11.2% ($1.5 million) in the 2006 quarter and 10.6%
      ($4.3 million) for the nine months as compared to 2005, total cost of sales
      increased by 14.8%, or $0.6 million, for the quarter and 11.1% or $1.3 million,
      for the nine months ended September 24, 2006 as compared to the same periods
      in
      2005. The dollar increase in cost of sales is primarily due to the increase
      in
      sales with a minimal amount due to increased prices. Cost of sales as a
      percentage of restaurant sales was 29.1% for the third quarter and 28.3% for
      the  nine
      months ended September 24, 2006 as compared to 28.1% for the third quarter
      and
      28.2% for the year-to-date period in 2005. The increase in cost of sales as
      a
      percentage of restaurant sales for the quarter is due to the opening of the
      Dallas Grill. Excluding the Dallas Grill the percentage would be
      27.5%.





***Restaurant
      operating expenses*** *.* Restaurant
      operating expenses increased by $0.8 million, or 9.5%, for the quarter and
      $2.6
      million, or 10.7%, for the nine months as compared to the same periods in 2005.
      The dollar increase in restaurant operating expenses for the quarter was
      primarily attributable to the opening of the Dallas Grill ($0.4 million), and
      increase in payroll and related costs at comparable restaurants ($0.4 million)
      and variable costs at comparable restaurants ($0.1 million). The dollar increase
      in operating expenses for the nine months was primarily attributable to a full
      39 weeks of operations at the Downtown Daily Grill compared to 17 weeks in
      2005
      ($0.9 million), a full 39 weeks of operations at the Santa Monica Daily Grill
      compared to 28 weeks in 2005 ($0.5 million), the opening of the Dallas Grill
      in
      July 2006 ($0.5 million), increased wages and related benefits at the comparable
      restaurants ($1.1 million), variable costs at comparable restaurants ($0.5
      million) and occupancy costs at comparable restaurants ($0.2 million) partially
      offset by the closure of the La Cienega Daily Grill in July 2005 ($1.1 million).
      Restaurant operating expenses, as a percentage of restaurant sales, were 61.1%
      in the third quarter of 2006 and 62.1% in the third quarter of 2005. For the
      nine months, the percentages were 59.8% in both 2006 and 2005.




31




***Reimbursed
      Costs*** *.* Reimbursed
      costs increased 6.7% from $3.7 million to $3.9 million for the quarter and
      12.4%
      from $10.3 million in 2005 to $11.5 million in 2006 for the nine months. These
      expenses represent the operating costs for which we are the primary obligor
      of
      the restaurants and the Company does not consolidate. The increase is primarily
      due to increased cost of goods and variable expenses resulting from a 12.7%
      and
      13.6% increase in sales for the quarter and year-to-date, respectively.





***General
      and Administrative*** *.* General
      and administrative expense increased 25.8% for the current quarter and 26.0%
      for
      the nine months as compared to the same periods in 2005. As a percentage of
      total revenues, general and administrative expense totaled 7.5% for the quarter
      and nine months as compared to 6.6------% --for the third quarter and nine
      months in 2005. The increase in total general and administrative expense of
      $0.3
      million, or 25.8%, for the 2006 quarter was primarily attributable to increases
      in stock related compensation expenses ($45,000), outside accounting services
      ($64,000), and salaries and related benefits ($194,000). The increase in total
      general and administrative expense of $0.9 million, or 26.0%, for the 2006
      nine
      month period is attributable to travel primarily related to potential site
      visits ($134,000), salaries and related benefits ($347,000), stock related
      compensation expenses ($153,000), establishment of the training department
      ($93,000), outside accounting fees ($78,000), non-recurring legal fees ($41,000)
      and a system implementation fee ($30,000).





***Depreciation
      and Amortization*** *.* Depreciation
      and amortization expense increased by 13.5% for the current quarter and
      increased 12.9% for the nine months of 2006 compared to 2005, representing
      4.1%
      of restaurant sales for the nine months of 2006 and 4.0% of sales for the same
      period in 2005. The absolute dollar increase in depreciation and amortization
      expense for the nine months was primarily due to the opening of the Santa Monica
      and Downtown Daily Grills in 2005.





***Pre-opening
      Costs*** *.* Pre-opening
      costs totaled $242,000 in the 2006 quarter as compared to $11,000 in the 2005
      quarter and $440,000 in the 2006 nine month period as compared with $272,000
      in
      2005. The 2006 pre-opening costs were attributable to the Dallas Grill opening
      and the 2005 costs were attributable to the opening of the Santa Monica and
      Downtown Daily Grills.





***Interest*** .
      Total
      net interest increased by $47,000, or 109.3%, during the current quarter and
      $74,000, or 60.2%, during the current nine months compared to the same periods
      in 2005. The increase in interest expense was primarily attributable to interest
      on the line of credit and the amortization of deferred loan costs related to
      the
      line of credit.





***Debt
      Extinguishment Costs*** *.* On March
      31, 2006 the Company retired the collateralized subordinated note payable and
      mandatorily redeemable capital obligations payable to the Michigan Avenue Group.
      The Company recorded a debt extinguishment loss on retirement of $279,000.
      A
      condition of the early debt retirement was a $200,000 penalty to be paid out
      in
      four annual installments of $50,000 each. Additionally $69,000 of warrant costs
      and $10,000 of deferred loan costs associated with the debt were written off. **  **




32




***Income
      Tax Provision/Benefit*** .
      During
      the quarter and nine months ended September 24, 2006, the Company reported
      a tax
      benefit of $163,000 and $2.1 million, respectively. During the quarter ended
      September 25, 2005, the Company reported a tax provision of $68,000 and for
      the
      nine months a tax provision of $277,000. The favorable change in taxes reported
      during 2006 was attributable to the elimination of the majority of the valuation
      allowance with respect to the Company’s deferred tax asset. The benefit realized
      by the Company during 2006 was attributable to the determination, based on
      its
      taxable income over the preceding three years and its taxable income projected
      for the next three years, that it is more likely than not that the Company
      will
      recover its existing net deferred tax asset.





***Minority
      Interest*** .
      We
      reported a minority interest in the profit of consolidated affiliates of $30,000
      during the 2006 third quarter as compared to a minority interest in the loss
      of
      our majority owned subsidiaries of $40,000 during the 2005 quarter. For the
      nine
      months, we reported a minority interest in the profit of majority owned
      subsidiaries of $135,000 during 2006 as compared to a minority interest in
      the
      loss of consolidated affiliates of $364,000 during 2005. The change in minority
      interest for the quarter and nine months was primarily attributable to improved
      operations at the San Jose Grill, the Downtown Daily Grill, the CityWalk Daily
      Grill and having fully utilized our allocation of minority interest for the
      Hollywood Grill.





***Net
      Income (Loss)*** *.* We
      reported a net loss of $0.5 million for the third quarter and net income of
      $1.5
      million for the nine months of 2006 as compared to net loss of $0.2 million
      for
      the third quarter and net income of $0.6 million  for
      the
      nine months in 2005.





**Material
      Changes in Financial Condition, Liquidity and Capital
      Resources** .





At
      September 24, 2006 we had negative working capital of $5.6 million and a cash
      balance of $2.2 million compared to negative working capital of $1.3 million
      and
      a cash balance of $3.2 million at December 25, 2005.





The
      change in our cash position reflects the following cash flows:





(in
                thousands)
            
            2006
            
            2005Net
                cash provided by operating activities
            
            $
            2,226
            
            $
            3,227Net
                cash used in investing activities
            
            
            (3,576
            )
            
            (3,927
            )Net
                cash provided by financing activities
            
            
            369
            
            
            952Net
                increase (decrease) in cash
            
            $
            (981
            )
            $
            252





Included
      in cash flows from operating activities were tenant improvement allowances
      of
      $1.8 million and $2.0 million in 2006 and 2005, respectively.





The
      $4.3
      million negative change in working capital position was principally attributable
      the recording of a $3.0 million payable to HRP related to the purchase of
      contract rights, $0.8 million increase in accrued expenses, and a $1.0 million
      decrease in cash, offset by a $0.5 million increase in prepaid and other current
      assets.





Our
      need
      for capital resources historically has resulted from, and for the foreseeable
      future is expected to relate primarily to, the construction and opening of
      new
      restaurants. Funds necessary to operate restaurants under management agreements
      are usually funded by cash generated by the restaurants. Sales from these
      outlets are deposited into an agency account belonging to the owner and we
      pay
      the outlet operating expenses, including our fee, from this agency account.
      Historically, we have funded our day-to-day operations through operating cash
      flows that have ranged from $1.8 to $4.6 million over the past three fiscal
      years. Growth has been funded through a combination of lines of credit, bank
      borrowing, loans from stockholders/officers, the sale of debentures and stock,
      loans and tenant allowances from certain of our landlords, and, beginning in
      1999, through joint venture arrangements .




33




***Financing
      Facility*** .
      On
      March 31, 2006, the Company borrowed $1 million under the terms of the Credit
      Agreement with Diamond Creek Investment Partners LLC. The borrowed funds were
      primarily used to retire $874,192 of collateralized subordinated notes and
      manditorily redeemable capital obligations owed to MAG by the Company’s
      subsidiary the Chicago Grill, $5,940 of interest and $50,000 for the first
      annual penalty payment, all of which amounts were guaranteed by the Company,
      with the balance used for general working capital. The retired obligations
      related to the initial funding provided by MAG, as a member/investor in Chicago
      Grill, with respect to the Company’s The Grill on the Alley restaurant in
      Chicago.




At
      September 24, 2006, the Company had $1.2 million owing under our line of credit,
      $0.4 million owing under equipment lease financing transactions, loans from
      stockholders/officers of $0.2 million, and loans/advances from a landlord,
      the
      SBA and others of $0.1 million. As of September 24, 2006, $1.8 million of the
      tenant improvement allowance for the Dallas Grill has been received. These
      tenant incentive allowances have been recorded in other long-term liabilities
      and are being amortized against rent expense over the lease terms.




**** ***Issuances
      of Common Stock*** .
      During
      the nine months ended September 24, 2006, the Company received aggregate
      proceeds of $648,561 from the sale of 304,733 shares of common stock pursuant
      to
      the exercise of outstanding warrants and options. The Company issued an
      additional 369,984 shares of common stock during the nine months ended September
      24, 2006 as a result of the exercise of 1,061,001 warrants pursuant to cashless
      exercise provisions by which the Company received no cash. The warrants
      exercised during the period were issued pursuant to a 2001 private placement
      and
      were exercisable at $2.00 or $2.25 per share.




***Operating
      Leases and Contractual Obligations*** .
      At
      September 24, 2006, we were obligated under eighteen leases covering the
      premises in which our Daily Grill and Grill Restaurants are located as well
      as a
      lease on our executive office. Such restaurant leases and the executive office
      lease contain minimum rent provisions which provide for the payment of minimum
      aggregate rental payments of approximately $30.1 million over the life of those
      leases, with minimum annual rental payments of $3.6 million in 2006, $7.3
      million between 2007 and 2008, $6.1 million between 2009 and 2010, and $13.1
      million thereafter.





The
      following table details our contractual obligations as of September 24,
      2006:





Payments
                due by period (in thousands)Total
            
            2006
            
            2007
                - 2008
            
            2009
                - 2010
            
            ThereafterLong-term
                debt
            
            $
            1,481
            
            $
            175
            
            $
            18
            
            $
            1,243
            
            $
            45Capital
                lease obligations
            
            
            371
            
            
            29
            
            
            153
            
            
            161
            
            
            28Operating
                lease commitments
            
            
            30,139
            
            
            3,647
            
            
            7,324
            
            
            6,061
            
            
            13,107Other
                contractual obligations
            
            
            3,020
            
            
            138
            
            
            2,882
            
            
            -
            
            
            -Total
            
            $
            35,011
            
            $
            3,989
            
            $
            10,377
            
            $
            7,465
            
            $
            13,180





***Capital
      Expenditures*** .
      During
      the nine months ended September 24, 2006, the Company’s capital expenditures
      totaled $3.7 million. Capital expenditures during the period related principally
      to the opening of a Grill restaurant in Dallas, Texas. With regards to capital
      expenditures during the period in connection with the Dallas Grill $2.0 million
      was funded by landlord tenant improvement allowances.




34




***Commitments
      Relating to Managed Restaurants and LLCs*** *.* Under
      certain of our operating and management agreements we have an obligation to
      potentially make additional cash advances and/or contributions and may not
      realize any substantial returns for some time. The agreements and arrangements
      under which we may be required to make cash advances or contributions, guarantee
      obligations or defer receipt of cash are described in the Company’s Form 10-K
      for the year ended December 25, 2005. There were no material developments with
      respect to those agreements and arrangements during the quarter and nine months
      ended September 24, 2006.





Detailed
      information regarding the initial capital contributions to the LLC’s and the
      CityWalk Partnership, Preferred Returns for each, management fees payable to
      the
      Company and principal distribution provisions are included in the Company’s Form
      10-K for the year ended December 25, 2005. The following tables set forth a
      summary for each of the LLCs and the CityWalk Partnership of (a) the
      distributions of capital to the Members and/or the Company during the six months
      ended September 24, 2006, (b) the unreturned balance of the capital
      contributions of the Members and/or the Company at September 24, 2006, and
      (c)
      the accrued, but unpaid, preferred returns due to the Members and/or the Company
      at September 24, 2006:





(in
                thousands)
            
            **San
                Jose Grill, LLC**
            
            **Chicago
                Grill On The Alley, LLC**
            
            **The
                Grill On Hollywood,********LLC**Members
            
            Company
            
            Members
            
            Company
            
            Members
            
            CompanyDistributions
                of profit and note repayments during the nine
              months ended September 24, 2006:
            
            $
            255
            
            $
            255
            
            $
            972
                (a
            )
            
            -
            
            
            -
            
            -Unreturned
                Initial Capital Contributions at September 24,
              2006:
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            $
            1,200
            
            $250Preferred
                Return rate:
            
            
            10
            %
            
            10
            %
            
            8
            %
            
            -
            
            
            12
            %
            12%Accrued
                but unpaid Preferred Returns at September 24, 2006:
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (b
            )
            (b)





35




**South
                Bay Daily Grill**
              **(Continental
                Park, LLC)**
            
            **Universal
                Citywalk Daily Grill**
            
            **Downtown
                Daily Grill**
              **(612
                Flower Daily Grill, LLC)**Members
            
            Company
            
            Members
            
            Company
            
            Members
            
            Company
              (d)Distributions
                of profit during the nine months
              ended September 24, 2006:
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            $
            27
            
            $
            9Unreturned
                Initial and Additional Capital
              Contributions at September 24, 2006:
            
            $
            1,100
            
            $
            450
            
            $
            1,496
            
            $
            296
            
            $
            1,373
            
            $
            304Preferred
                Return rate:
            
            
            10
            %
            
            10%
                (c
            )
            
            -
            
            
            -
            
            
            9
            %
            
            9
            %Accrued
                but unpaid Preferred Returns at
              September 24, 2006
            
            
            (b
            )
            
            (b
            )
            
            (b
            )
            
            -
            
            $
            39
            
            $
            7




a)
            Distribution
                of capital and note repayments as of September 24, 2006 includes
                $902,000
                of retirement of collateralized subordinated notes and mandatorily
                redeemable capital obligations and $70,000 of interest and preferred
                return.b)
            Due
                to the under performance of the restaurants the preferred return
                is not
                being accrued. The Company is not liable to pay the preferred return
                distributions, such that they represent a non-recourse obligation
                of the
                subsidiary entity. If preferred returns were accrued for The Grill
                on
                Hollywood the Member would have an accrued preferred return of $950,000
                and the Company would have an accrued preferred return of $198,000.
                If
                preferred returns were accrued for the South Bay Daily Grill the
                Member
                would have an accrued preferred return of $466,000 and the Company
                would
                have a preferred return of $183,000. If preferred returns were accrued
                for
                the CityWalk Partnership the Member would have an accrued preferred
                return
                of $627,000.c)
            The Company’s preferred return with respect
              to the South Bay Daily Grill is based on unrecovered capital contribution
              and accrued but unpaid management fees.d)
            The Company is a non-managing member
              and a
              wholly owned subsidiary of the Company is the manager of this
              restaurant.




In
      addition to existing contractual and other commitments with respect to managed
      restaurants, the Company has entered into agreements to manage Daily Grill
      restaurants in Memphis, Tennessee and Seattle, Washington. The Memphis
      restaurant is expected to open in the spring of 2007 and the Seattle restaurant
      in the summer of 2007. The Company is obligated to contribute approximately
      $450,000, if construction exceeds $1,500,000, toward the initial remodeling
      cost
      of the Seattle Daily Grill. The Company has no required contribution to the
      Memphis Daily Grill.





36




**Critical
      Accounting Policies**





The
      Company's discussion and analysis of its financial condition and results of
      operations are based upon the Company's financial statements, which have been
      prepared in accordance with accounting principles generally accepted in the
      United States of America. The Company believes certain critical accounting
      policies affect its more significant judgments and estimates used in the
      preparation of its financial statements. A description of the Company’s critical
      accounting policies is set forth in the Company’s Form 10-K for the year ended
      December 25, 2005.




We
      maintain a large deductible insurance policy related to workers’ compensation
      coverage. Predetermined loss limits have been arranged with insurance companies
      to limit our per occurrence cash outlay. Accrued expenses and other liabilities
      include estimated costs to settle unpaid claims and estimated incurred, but
      not
      reported, claims using actuarial methodologies. During the quarter and nine
      months ended September 24, 2006, we recorded a provision to increase the reserve
      for workers compensation claims of $88,000 and $267,000,
      respectively.





With
      the
      adoption for stock-based compensation in accordance with the provisions of
      SFAS
      123R at the beginning of fiscal 2006, we added a new critical accounting policy
      to the previous disclosure included in Item 7, “Management’s Discussion and
      Analysis of Financial Condition and Results of Operations” of our Annual Report
      on Form 10-K for the fiscal year ended December 25, 2005.





***Stock-Based
      Compensation.*** The
      Company accounts for stock-based compensation in accordance with the provisions
      of SFAS 123R. We use the Black-Scholes option-pricing model, which requires
      the
      input of highly subjective assumptions. These assumptions include estimating
      the
      volatility of the Company’s common stock price over the vesting term and the
      number of options that will ultimately not complete their vesting requirements
      (“forfeitures”). Changes in the subjective assumptions can materially affect the
      estimated fair value of stock-based compensation and consequently, the related
      amount recognized on the Condensed Consolidated Statements of Operations. See
      Note 10 of the Notes to the condensed consolidated financial statements in
      this
      Form 10-Q for further discussion of stock-based compensation.





Except
      as
      noted above, there have been no material changes to the other critical
      accounting policies previously reported in our Annual Report on Form 10-K for
      the fiscal year ended December 25, 2005.








**Certain
      Factors Affecting Future Operating Results**





This
      Form
      10-Q contains forward-looking statements within the meaning of Section 27A
      of
      the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
      1934. Our actual results could differ materially from those set forth in the
      forward-looking statements. Certain factors that might cause such a difference
      include the following: adverse weather conditions and other conditions affecting
      agricultural output which may cause shortages of key food ingredients and
      volatility of food prices and which, in turn, may reduce operating margins;
      food-borne illnesses from items supplied by vendors over which we have limited
      control; changes in consumer tastes, demographics and adverse economic
      conditions which may result in reduced frequency of dining at our restaurants;
      the dependence on key personnel and ability to attract and retain qualified
      management and restaurant personnel to support existing operations and future
      growth; regulatory developments, particularly relating to labor matters (i.e.,
      minimum wage, health insurance and other benefit requirements), health and
      safety conditions, service of alcoholic beverages and taxation, which could
      increase the cost of restaurant operations; establishment of market position
      and
      consumer acceptance in new markets in light of intense competition in the
      restaurant industry and the geographic separation of senior management from
      such
      markets; potential delays in securing sites for new restaurants and delays
      in
      opening restaurants which may entail additional costs and lower revenues than
      would otherwise exist in the absence of such delays; the availability of capital
      to fund future restaurant openings; rising energy costs and the occurrence
      of
      rolling blackouts in California which may result in higher occupancy costs
      and
      periodic restaurant closures; national terrorist attacks; earthquakes in
      California; and, other risks described more fully in "Risk Factors" in Part
      I,
      Item 1A of the Company’s Form 10-K for the year ended December 31, 2005 and in
      Part II, Item 1A of this Form 10-Q.




37




**Item
      3.**  **Quantitative and Qualitative Disclosures About Market Risk**





The
      Company is exposed to market risk from changes in interest rates on funded
      debt.
      This exposure relates to our credit line facility. There were $1.2 million
      borrowings outstanding under the Credit Line Facility at September 24, 2006.
      Borrowings under the Credit Facility bear interest at the Prime or LIBOR rates
      plus a margin ranging from 2.75% to 6.25%. A hypothetical 1% interest rate
      change would not have a material impact on the Company's results of
      operations.





**Item
      4. Evaluation of Disclosure Controls and Procedures**




We
      maintain disclosure controls and procedures (as defined in Exchange Act Rule
      13a-15(e) and 15d-15(e)) that are designed to ensure that information required
      to be disclosed in our Exchange Act reports is recorded, processed, summarized
      and reported within the time periods specified in the Securities and Exchange
      Commission's rules and forms, and that such information is accumulated and
      communicated to our management, including our Chief Executive Officer and Chief
      Financial Officer, as appropriate, to allow timely decisions regarding the
      required disclosure.




In
      designing and evaluating the disclosure controls and procedures, management
      recognizes that any controls and procedures, no matter how well designed and
      operated, can provide only reasonable assurance of achieving the desired control
      objectives, and management necessarily is required to apply its judgment in
      evaluating the cost-benefit relationship of possible controls and
      procedures.




An
      evaluation as of the end of the period covered by this report was carried out
      under the supervision and with the participation of our management, including
      our principal executive officer and principal financial officer, of the
      effectiveness of our disclosure controls and procedures, as such term is defined
      under Rule 13a-15(e) and Rule 15d -15(e) promulgated under the Securities
      Exchange Act of 1934, as amended (the "Exchange Act"). Based
      on
      their evaluation, our certifying officers concluded that these disclosure
      controls and procedures are effective in providing reasonable assurance that
      the
      information required to be disclosed by us in our periodic reports filed with
      the Securities and Exchange Commission (“SEC”) is recorded, processed,
      summarized and reported within the time periods specified by the SEC’s rules and
      SEC reports.




There
      have been no changes in our internal control over financial reporting that
      occurred during the period covered by this report that have materially affected,
      or are reasonably likely to materially affect, our internal control over
      financial reporting.




38




**PART
      II - OTHER INFORMATION**





**Item
      1.**  **Legal Proceedings**





A
      Class
      Action complaint was filed in the Superior Court of the State of California
      for
      the County of Los Angeles on March 15, 2006.  The plaintiff and those
      similarly situated (Servers) complain that the Company has violated
      the labor code by having Servers "Tip Out" Bartenders and Expeditors a
      percentage of their tips to these employees who provide no direct table
      service.  The complaint has labeled this act as "Tip-pooling."  At a
      hearing on August 25, 2006 the case was dismissed without prejudice and the
      plaintiff’s counsel stipulated that an appeal will not be filed.





**Item
      1A. Risk Factors**





There
      have been no material changes in our Risk Factors as disclosed in our 2005
      Annual Report on Form 10-K.





**Item
      6. Exhibits**





(a)
            Exhibits




Exhibit
                No.
            Description31.1
            Section 302 Certification of CEO and
              Principal Executive Officer31.2
            Section 302 Certification of CFO and
              Principal Financial Officer32.1
            Certification of CEO and Principal Executive
              Officer Pursuant to 18.U.S.C. Section 1350, as Adopted Pursuant to
              Section
              906 of the Sarbanes-Oxley Act of 2002.32.2
            Certification of CFO and Principal Financial
              Officer Pursuant to 18.U.S.C. Section 1350, as Adopted Pursuant to
              Section
              906 of the Sarbanes-Oxley Act of 2002.





39





**SIGNATURES**





In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly
      authorized.








**GRILL
      CONCEPTS, INC.**






Signature
            
            Title
            
            Date/s/ Philip Gay
            
            President and Chief
              Executive Officer
            
            November 7, 2006Philip
              Gay/s/ Wayne Lipschitz
            
            Vice President and CFO
            
            November 7, 2006Wayne
              Lipschitz





40