<PAGE>   1



                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-KSB
       (Mark one):

       /X/    Annual report under Section 13 or 15(d) of the
              Securities Exchange Act of 1934
              For the fiscal year ended December 28, 1997

       / /    Transition report under Section 13 or 15(d) of the Securities
              Exchange Act of 1934
              For the transition period from ___________ to _____________

         Commission File No. 0-25926

                             WOODROAST SYSTEMS, INC.
                 (Name of Small Business Issuer in its Charter)

            Minnesota                                      41-1563961
------------------------------------------             ------------------------
 (State or Other Jurisdiction                             (I.R.S. Employer
 of Incorporation or Organization)                       Identification No.)

   10250 Valley View Road, Suite 145
        Eden Prairie, Minnesota                                 55344
------------------------------------------             ------------------------
(Address of Principal Executive Offices)                      (Zip Code)

                               (612) 944-5113
               -----------------------------------------------
              (Issuer's telephone number, Including Area Code)


Securities registered pursuant to Section 12(b) of the Exchange Act:  NONE

Securities to be registered pursuant to Section 12(g) of the Exchange Act:
COMMON STOCK, $.005 PAR VALUE

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 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 / /

Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. /X/

The issuer had total revenues of $6,226,631 for its fiscal year ended
December 28, 1997.

As of March 20, 1998, assuming as market value the price of $1.125 per share
(the last sales price of the Company's Common Stock on the Nasdaq SmallCap
Market), the aggregate market value of shares held by non-affiliates was
$3,476,135. For purposes of this computation, affiliates of the Registrant are
deemed only to be the Registrant's executive officers and directors.

As of March 20, 1998, the Company had outstanding 4,242,397 shares of Common
Stock, $.005 par value.

Documents Incorporated by Reference: Portions of the Company's Proxy Statement
for its Annual Meeting of Shareholders to be held June 4, 1998 (the "1998 Proxy
Statement") are incorporated by reference into Part III of this Form 10-KSB, to
the extent described in Part III. The 1998 Proxy Statement will be filed within
120 days after the end of the fiscal year ended December 28, 1997.




<PAGE>   2
                              TABLE OF CONTENTS



<TABLE>
<CAPTION>
PART I                                                                                                  PAGE NO.
                                                                                                        --------
<S>             <C>           <C>                                                                         <C>
                ITEM 1.       DESCRIPTION OF BUSINESS..................................................     1
                ITEM 2.       DESCRIPTION OF PROPERTIES................................................     7
                ITEM 3.       LEGAL PROCEEDINGS........................................................     8
                ITEM 4.       SUBMISSION OF MATTERS TO A VOTE OF
                                SECURITY HOLDERS.......................................................     8

PART II

                ITEM 5.       MARKET FOR COMMON EQUITY
                                AND RELATED STOCKHOLDER MATTERS........................................    10
                ITEM 6.       MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                                CONDITION AND RESULTS OF OPERATIONS....................................    11
                ITEM 7.       CONSOLIDATED FINANCIAL STATEMENTS........................................    17
                ITEM 8.       CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
                                ON ACCOUNTING AND FINANCIAL DISCLOSURE.................................    17

PART III

                ITEM 9.       DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS
                                AND CONTROL PERSONS; COMPLIANCE WITH
                                SECTION 16(A) OF THE EXCHANGE ACT......................................    18
                ITEM 10.      EXECUTIVE COMPENSATION...................................................    18
                ITEM 11.      SECURITY OWNERSHIP OF CERTAIN
                                BENEFICIAL OWNERS AND MANAGEMENT.......................................    18
                ITEM 12.      CERTAIN RELATIONSHIPS AND RELATED
                                TRANSACTIONS...........................................................    18
                ITEM 13.      EXHIBITS AND REPORTS ON
                                FORM 8-K...............................................................    18

SIGNATURES.............................................................................................    19

CONSOLIDATED FINANCIAL STATEMENTS......................................................................   F-1

</TABLE>


<PAGE>   3

                                    PART I


ITEM 1.  DESCRIPTION OF BUSINESS

         The following discussion contains trend information and other
forward-looking statements that involve a number of risks and uncertainties.
The actual results of the Company could differ materially from the Company's
historical results of operations and those discussed in the forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to, lack of profitability, inability to open
additional units, competition in the hospitality industry, unexpected increases
in labor and food costs, and changes in government regulation of the sectors in
which the Company operates.

GENERAL
         Woodroast Systems, Inc. (the "Company") is a hospitality development
company which was incorporated in 1987 as a Minnesota corporation. The Company
owns and operates two free-standing full service restaurants (one with an
attached tavern) and, as of January 22, 1998, two taverns built on the theme of
the turn-of-the-century London divans.

         The Shelly's Woodroast restaurants are located in St. Louis Park,
Minnesota, a suburb of Minneapolis (the "St. Louis Park Restaurant"), and
Rockville, Maryland, a suburb of Washington, D.C. (the "Rockville Restaurant")
(together with the St. Louis Park Restaurant, the "Restaurants"). The Company
has been operating the St. Louis Park Restaurant since 1989 and the Rockville
Restaurant since November 1995.

         The original Shelly's Back Room(R) prototype tavern is attached to the
Rockville Restaurant, and as such, is considered part of the restaurant unit. In
June of 1997, the first single concept of Shelly's Back Room (the "Back
Room")(together with the Restaurants, the "Units"), The American Tavern, opened
in Washington, D.C. (the "DC Back Room"). Recently, on January 22, 1998, the
second stand-alone Back Room was opened in the Gold Coast Area of Chicago,
Illinois (the "Chicago Back Room"), adjacent to the Magnificent Mile and Oak
Street shopping areas. This concept brings a touch of the traditional divan to
America. Divans were turn-of-the-century gathering places in London, synonymous
with comfort and service, an exclusive place where the elite could meet, enjoy
good food and sip a little cognac. The Company hopes to redefine the American
tavern as a place much like the historic divan, yet accessible to all. Shelly's
Back Room offers comfortable club seating, private cigar humidor lockers,
hand-crafted micro-brewery beers, single malt scotches, small-batch bourbons and
other select premium spirits. The food menu includes premium-quality, freshly
made specialty sandwiches, homemade soups, salads, appetizers and dinner
entrees, including hand-cut steaks and salmon.

         The Company is in the process of attempting to sell the Restaurants in
the context of changing its business strategy to focus exclusively on Back Room
taverns rather than on full service restaurants.

                                      1

<PAGE>   4

         The Company's executive offices are located at 10250 Valley View Road,
Suite 145, Eden Prairie, Minnesota 55344. The corporate office telephone number
is 612.944.5113. The corporate facsimile number is 612.944.5199. The Company's
web site address is www.woodroast.com.

THE SHELLY'S WOODROAST CONCEPT

     ORIGINAL WOODROAST COOKING

         Original Woodroast Cooking is a proprietary style of cooking with
origins in America's north woods country -- where Canada meets the United
States. As the name suggests, it is a cooking method in which meats, fish and
fowl are slowly roasted in wood burning ovens. Invented by the Company's
founder, the patented ovens release the flavorful, aromatic components of a
carefully selected combination of hardwoods and fruitwoods, surrounding each
dish with mellow even heat.

         Original Woodroast Cooking involves more than simply slow roasting.
Each offering is also marinated in a proprietary blend of herbs and spices for
48 hours or longer before the cooking begins. During the cooking process, the
food is continually basted with the marinade and spice combinations by computer
controlled mechanisms in the patented Woodroast ovens, keeping it moist while
imparting subtle, distinctive flavor throughout.


     FACILITIES

         The design of the Restaurants is reminiscent of the great
turn-of-the-century hunting lodges of the north woods. The St. Louis Park
Restaurant's main dining room features a 20-foot high ceiling with handcrafted
log-scissor trusses resting atop a one-ton log beam. A birch log bar completes
the northern lodge atmosphere. Other natural elements at the restaurant include
exposed beam ceilings in the bar, leather covered booths, barstools covered with
Holstein hide with the hair remaining and a massive fieldstone fireplace. The
Rockville Restaurant's main dining room -- The Great Hall -- features a 20-foot
ceiling and Norman trusses of Minnesota red pine. In The Green Room, a second
dining room adjoining The Great Hall, yellow pine parallel-cord log trusses form
an extraordinary pattern of beams bound together with hand-wrought iron, copper
and brass. The fireplace in The Great Hall includes an impressive double-log
mantle and fieldstone set in a classic random pattern. The Green Room fireplace
is laid in a traditional rough coursed pattern. Like its Minnesota counterpart,
the bar in the Rockville Restaurant features furniture made of natural elements
(tables supported by rough-hewn birch logs) and display cases replete with
antique fishing lures, decoys and other items which bring to mind a sense of the
north woods.

         One important variation from the traditional appearance of a north
woods lodge is the lack of hunting trophies mounted on the walls. Rather, the
attitude toward north woods wildlife exhibited in the concept is one of respect
and appreciation for its abundance and vigor. Consequently, it is that sense of
vitality which is portrayed through the use of photographs throughout the
restaurant.

         The execution of the north woods concept is far more extensive than is
typically present even in a "theme" restaurant. The cost to develop the
St. Louis Park Restaurant in 1989, which has 138

                                      2
<PAGE>   5


seats, was approximately $1,750,000. The cost to develop the Rockville
Restaurant, which was opened in November 1995 and has approximately 258 indoor
dining seats, was approximately $3,500,000.

     MENU

         The meat, fish and fowl, which are the centerpiece of the menu, are
simple and moderately priced. It is the preparation which makes them unique.
Featured dinner items include roast duck and game hen, turkey drumsticks,
salmon, trout and walleye, beef brisket, spare ribs and roast pork. Pricing is
generally moderate, between $9 and $18, and portions are large. Several side
dishes are included with the entrees, such as herb roasted potatoes, marinated
vegetable salad and homemade popovers.


THE SHELLY'S BACK ROOM CONCEPT

         Nestled in a private corner adjoining the Rockville Restaurant is the
original Shelly's Back Room. This pioneering prototype represents a significant
evolution in the development of "cigar bars" and "cigar rooms," reflecting the
expertise of its creator. This special room was designed as a retreat for cigar
smokers who may want to follow a lunch or dinner in the restaurant with cigars
from their personal humidors. This room boasts exquisitely hand-crafted,
floor-to-ceiling humidors, one which is designed for communal use and another
which houses 72 private lockers for use by special patrons. Coupling a
state-of-the-art air purification system with relaxed club seating and the rich
woods used throughout, it is a popular haven for the restaurant's cigar-smoking
guests. Unlike many existing facilities, Shelly's Back Room is open to the
public -- no exclusive memberships and high fees. The only requirements for
admittance are a love of good cigars, good food, good drink and good company.
All of the unique qualities from this small prototype unit have been utilized in
the continuation of the development of Shelly's Back Room.

     FACILITIES

         Key elements of the Shelly's Back Room concept were perfected by Mr.
Jacobs (Chairman of The Board and Chief Executive Officer), from his
knowledge not only of cigars and cigar smoking, but also of high quality food
and beverages. The Back Room offers casual comfortable seating, a full-service
bar, food service and a state-of-the-art air purification system. The
specialized air purification system is a critical component of the Back Room
concept. Designed in recognition that no filtration and recycling system can
adequately handle the unique and intensive needs of a dedicated cigar smoking
emporium, this system will utilize 100% fresh air. The innovative air
purification system, the kleen-aire(TM) system, replaces the room's entire
volume of air with fresh, filtered outdoor air as frequently as every 90
seconds. The result is air quality that is perceptively and objectively cleaner
and fresher than virtually any other smoking area in America.

         Shelly's Back Room features comfortable club seating, including
couches, club chairs and high-back wooden chairs, the use of warm interior
colors, large wall murals and warm aged woods to contribute to the casual
atmosphere. One wall accommodates built in, handcrafted, private wood

                                      3
<PAGE>   6


humidor lockers for guests to rent. These humidor lockers are rented on
an annual basis, allowing those guests to maintain their own private stock of
cigars. Each locker has a plate attached, engraved with the guest's names and
titles, used in part for security reasons.

     MENU

         The menu is fresh, simple and hearty. An array of appetizers ranges
from Campfire Chicken Wings to smoked Pacific Coast oysters. Featured dinner
items include hand-cut New York strip steaks, grilled Atlantic salmon, roasted
chicken, sandwiches and salads. Pricing is generally moderate, between $4 and
$20.

     RETAIL ITEMS

         An important signature item of Shelly's Back Room is in development,
that of an exclusive premium cigar created with the oversight of Shelly himself.
However, availability of such cigars is subject to change in the future, as is
the case of any product imported from a foreign country.

         A smaller but important element of the Back Room concept is the retail
humidor and counter offering a canny selection of some of the world's finest
cigars for purchase. Cigar aficionados know that obtaining favorite premium
brands can occasionally present problems during this extended period of
explosive demand growth. Mr. Jacobs will use his personal knowledge and
connections to ensure that the Back Room humidors offer the most complete and
current selections available, featuring, of course, the private Back Room label
which Mr. Jacobs is developing. In addition to cigars, the Back Rooms will offer
a selection of premium logo merchandise including ashtrays, lighters, selected
clothing items, pocket knives, cutters and glassware.

EXPANSION PLANS

         The Company is in the process of developing new Back Room locations and
is visiting and evaluating potential sites in Boston, Philadelphia and
Minneapolis. However, there are presently no binding agreements to develop new
restaurants or Back Rooms. The Company completed construction and opened its
second Shelly's Back Room on January 22, 1998, located in the Gold Coast Area of
Chicago, Illinois, adjacent to the Magnificent Mile and Oak Street shopping
areas.

         Shelly's Back Room has been designed with the intention of being
efficiently reproduced on a national basis. Target sites will be high
walking-traffic storefront units with convenient parking in major cities and
upscale suburban strip malls and shopping centers, comparable, for example, to
sites targeted by retailers like Starbucks Coffee.

         The market position of the Back Room concept can best be described as
accessibly upscale. The very nature of the product offering dictates a refined
sophisticated ambiance with commensurate service and pricing. However, the broad
appeal of cigars and the relative affordability of premium

                                      4
<PAGE>   7



brands compared to other forms of luxury consumption encourages a national
market position capable of appealing to a variety of clientele. Such a
position is also far more conducive to more rapid and widespread duplication as
the concept grows in popularity and exposure. Indeed, the Back Room concept is
not dissimilar to a coffeehouse concept such as Starbucks, offering a convenient
location for the enjoyment of premium versions of popular consumables in a
relaxed setting. Of course, the difference in the average ticket for even a
premium coffee beverage and dessert versus a premium cigar and cognac can be
substantial.

         A full, independent Back Room facility is designed to require
approximately 2,500 to 4,000 square feet of space. In special applications such
as casinos, hotels or resorts, which would have their own food service
operations, space requirements could be as little as 800 square feet. The
estimates to construct a Shelly's Back Room range from $679,500 to $1,344,500
depending on square footage, construction costs and the level of landlord
contributions.

         The Company entered into a license agreement with Grand Casinos, Inc.
(The "Grand Casinos") to open a Shelly's Back Room in Grand Casinos Tunica,
Mississippi Casino. The essence of the license agreement is this: the Company
collects a one-time fee and provides architectural services for the Tunica site.
Additionally, the Company would sell its normal Back Room retail items (with a
mark-up from cost) to Grand Casinos for resale purposes. The Company's future
financial benefits from Grand Casinos will not be material, if at all. In
addition, the Company's negotiations to acquire a license agreement with Host
Marriott (the "Host"), to locate Back Rooms in their airport facilities, has
stalled. The Company has provided all the resources necessary for Host to move
ahead. Any future activity will be required from Host. The Company believes that
there may be no future dealings with Host for the foreseeable future. The
Company will explore all future licensing options presented for consideration.
However, no assurance can be given that any license agreement will be
successfully concluded or that developing new Back Rooms will materialize.

ADVERTISING

         The Company's target market are people between the ages of 30 and 60,
typically living in high density suburban locations, who have expendable
household income. The Company advertises its restaurant and Back Room locations
through radio advertisements and direct mailings. Approximately 3% of the
Company's sales were spent on such advertising. Special efforts to increase
sales at the Restaurants were addressed during 1997, accounting for
approximately 2% of the total advertising dollars spent. As the Company opens
Back Rooms in new markets, the amount spent on advertising as a percentage of
sales may be increased as the Company seeks to establish itself in these new
markets.

COMPETITION

         The hospitality business is highly competitive and is affected by
changes in taste and eating habits of the public, local and national economic
conditions affecting spending habits, and population and traffic patterns. The
principal competitive factors in the hospitality industry are believed to be the
quality and price of the food. The location of Units, name recognition,
efficiency of service, advertising, and attractiveness of facilities are also
important. Units compete on a general basis with a large variety of national and
regional hospitality operations, as well as locally owned


                                      5
<PAGE>   8


restaurants, diners, and other establishments that offer moderately priced
food and beverages to the public.

PATENTS AND TRADEMARKS

         The Company holds the rights to U.S. Patent Number 4,924,071, which
covers the Woodroast oven invented by Mr. Jacobs. In addition, the Company owns
U.S. registrations of the marks "Woodroast", "Original Woodroast Cooking", "The
Original Shelly's Woodroast" and "Birch Bay Brewing Company." The mark "Original
Woodroast Cooking" has also been registered in the United Kingdom and France,
and the mark "Birch Bay Brewing Company" has been registered in Canada. The
Company has aggressively defended its trademarks against infringement by
competitors on a national basis. Birch Bay Brewing Company is a mark used by the
Company for certain of its own beverages and is not a separate legal entity.

REGULATION

         Restaurants and taverns are subject to licensing and regulation by
state and local health, sanitation, safety, fire, and other authorities and are
also subject to state and local licensing and regulation of the sale of
alcoholic beverages, food, cigarettes, games, and the like. Difficulties or
failure in obtaining required licenses and approvals will result in delays in,
or cancellation of, the opening of Back Rooms. The food and liquor licenses are
also subject to suspension or non-renewal if the granting authority determines
that the conduct of the holder does not meet the standards for initial grant or
renewal.

RESTAURANT AND BACK ROOM OPERATIONS

     STAFFING

         At March 16, 1998, the Company had 210 employees, including 55 at the
St. Louis Park Restaurant, 81 at the Rockville Restaurant, 34 at the DC Back
Room, 35 at the Chicago Back Room and five at the Company's executive offices.
The staff of the St. Louis Park Restaurant consists of a general manager,
service manager, bar manager, kitchen manager and assistant kitchen manager, and
approximately 50 hourly employees, 40 of whom are employed part-time. The staff
of the Rockville Restaurant consists of a general manager, service manager, bar
manager, kitchen manager and assistant kitchen manager, and approximately 76
hourly employees, 55 of whom are employed part-time. The staff of the DC Back
Room consists of a general and an assistant manager, and approximately 32 hourly
employees, 25 of whom are employed part-time. The staff of the Chicago Back Room
consists of a general and an assistant manager, and approximately 33 hourly
employees, 30 of whom are part-time. The Company believes that its relationship
with its employees is good.

     EMPLOYEE TRAINING AND SUPERVISION

         The Company believes strongly in the concept of teamwork and the
importance of a well trained and motivated staff. The Units are closely
supervised by a general manager, who is directly responsible for that Unit's
success. Each staff member is given a Staff Member Guideline Manual, which
provides background information on the Company and outlines basic policies and
procedures applicable to all personnel. Each staff member is also given either a
Service Manual or Kitchen


                                      6

<PAGE>   9


Manual as appropriate. These manuals provide job descriptions for each
position in the restaurant or Back Room and detailed guidelines and background
information for the execution of the duties associated with employment in either
the preparation or service of food and beverages. Employees are tested on an
occasional basis to measure their knowledge of the products served and the
policies of the Company.

         New employees receive a training manual and training packet, which
outlines the training agenda for their employment and provides basic background
information on the names and prices of food and beverage items, as well as other
terminology which they need to know. New employees are trained by designated
staff members with considerable experience and proven performance.

     REPORTING

         The Company prepares a monthly income statement and gross profit
report, which provides overall performance information for each of the Units.
The Company also utilizes a point-of-sale system which allows daily and weekly
reports to be generated regarding cash control, sales and theoretical food
costs. On a monthly basis, the Units count the food, beverage, supply and retail
inventories.

         Sales and guest counts are forecasted in advance for each week of the
month. Actual sales and guest counts are then compared to forecasted levels.
Sales and guest counts are also compared to the annual budget and the prior
year's performance. Labor hours are tracked weekly by day and position. Actual
hours are compared to budgeted levels to identify variance.



ITEM 2.  DESCRIPTION OF PROPERTIES

         The St. Louis Park Restaurant is located on Interstate 394, a major
thoroughfare connecting downtown Minneapolis with its western suburbs. The St.
Louis Park Restaurant is a 6,500 square foot facility which seats approximately
138 people, plus a bar that seats 26 people. The Company constructed the
building and improvements on the land which is subject to a 15-year ground lease
expiring in 2004. The Company has the option to extend such lease for two
additional five year periods. Annual base rent pursuant to the lease is $66,000
for fiscal years ended December 1995 through 1998 and approximately $75,000 per
annum for the last five years of the lease. The Company also pays real estate
taxes and operating expenses. At the end of the lease term, the building and
improvements will remain with the land. Mr. Jacobs has personally guaranteed the
landlord's indebtedness related to the land subject to this ground lease.

         The Rockville Restaurant, which opened in November 1995, is located in
the Congressional Plaza along Rockville Pike (Highway 355), a main artery
linking the Washington area's northwestern suburbs and the District of Columbia.
The Rockville Restaurant has approximately 9,400 square feet and approximately
258 indoor dining seats, as well as bar seating, and 50 outdoor seats. In
November 1994, the Company signed a 10-year lease for the property on which the
Rockville Restaurant is located. The Company has the option to extend such lease
for two additional five year


                                      7

<PAGE>   10


periods. The lease provides for annual base rent of $300,000 for the first
five years of the lease, and $315,000 for the remaining five years of the
lease. The Company also pays real estate taxes, operating expenses and a
percentage rent equal to 5% of annual gross sales in excess of $6,500,000. No
percentage rents were paid for fiscal years 1996 or 1997. At the end of the
lease term, the building and improvements will remain with the land.

         The DC Back Room, which opened in June 1997, is located in the District
of Columbia, near the historic Willard Hotel and across from the National Press
Club. The Company signed a 10-year building lease for this Back Room located at
1331 F Street, N.W., Washington, D.C. The lease became effective on August 1,
1996. The DC Back Room has approximately 3,100 square feet and seating for
approximately 72 people. The lease provides for annual base rent of $62,000 for
the first year of the lease, with the base rent to increase by two percent per
year for the second, third, fourth and fifth years of the lease. Effective
during the sixth year of the lease, the base rent will be increased by $7,750,
and will increase by two percent annually over the remaining years of the term.
The Company also pays a pro rata share of real estate taxes and operating
expenses. At the end of the lease term, the improvements will remain with the
building.

         The Chicago Back Room, which opened January 22, 1998, is located in the
Gold Coast Area of Chicago, Illinois, adjacent to the Magnificent Mile and Oak
Street shopping areas. This site is part of the multimillion dollar condominium
and retail development which includes restoration of the historic Mayfair-Regent
Hotel on Lakeshore Drive overlooking Lake Michigan. The Company signed a 10 year
lease, effective May 27,1997, for 4,000 square feet at 192 East Walton Street.
There is a total of 106 seats and accommodations for approximately 150 people.
The lease provides for annual base rent of $140,000 for the first year of the
lease, with the base rent to increase by two and a half percent per year for
the remainder of the lease. At the end of the lease term, the improvements will
remain with the building.



ITEM 3.  LEGAL PROCEEDINGS
         The Company is not a party to any material pending legal proceedings.



ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
         Not applicable.



                                      8

<PAGE>   11

                      EXECUTIVE OFFICERS OF THE COMPANY

<TABLE>
<CAPTION>
         Name                               Age                                                  Office
         ----                               ---                                                  ------
<S>                                        <C>                                <C>
Sheldon F. Jacobs                            53                                 Chairman of the Board and Chief
                                                                                Executive Officer

Ralph J. Guarino                             51                                 President, Chief Operating Officer
                                                                                And Chief Financial Officer

</TABLE>

     SHELDON F. JACOBS has been Chairman of the Board and Chief Executive
Officer of the Company since its inception in 1987 and was also its President
and Chief Financial Officer until 1996. From 1980 to 1987, Mr. Jacobs worked
toward the development of the Shelly's Woodroast concept, from engineering and
patenting the design of the Woodroast ovens, to introducing the Original
Woodroast Cooking to existing restaurants and testing consumer response. In
1974, Mr. Jacobs was a co-founder of J.Y.J. Corporation, a liquidation company
that was eventually merged into C.O.M.B. Company. He served as its president
from 1974 to 1980. In 1980 Mr. Jacobs sold his interest in J.Y.J. Corporation.

         RALPH J. GUARINO joined the Company in November 1996 as its President,
Chief Operating Officer and Chief Financial Officer. Mr. Guarino brings over 25
years of restaurant operations experience to the Company. From July 1992 until
that time Mr. Guarino served as Senior Vice President, Chief Operating Officer
and member of the Board of Directors for The Italian Oven, Inc., a 100-unit
chain of full-service, moderately-priced Italian family restaurants based in
Latrobe, Pennsylvania. He became President in February 1993. During his
four-year tenure at that company, he oversaw The Italian Oven, Inc.'s initial
public offering of common stock, the opening of 18 additional company-owned
units and 71 franchised units, as well as the sale of over 250 franchises. The
Italian Oven, Inc. filed a voluntary petition for reorganization under Chapter
11 of the United States Bankruptcy Code on October 21, 1996. He served as Senior
Vice President, Chief Financial Officer and member of the Board of Directors for
Boston Chicken, Inc., a restaurant and prepared food chain based in Boston,
Massachusetts, from 1990 until 1992.




                                      9



<PAGE>   12

                                   PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         Since June 1994, the Common Stock of the Company has been traded in the
over-the-counter market and quoted on the Nasdaq SmallCap Market under the
symbol "WRSI". The following table sets forth the high and low bid prices of the
Company's Common Stock for the periods indicated. The Nasdaq bid quotations
represent inter-dealer prices, without retail mark-ups, mark-downs or
commissions, and may not necessarily represent actual transactions:


<TABLE>
<CAPTION>
         1996                                                                      HIGH               LOW
         ----                                                                     ------             ----
<S>                                                                              <C>             <C>
         First Quarter.....................................................        $6.50             $3.02
         Second Quarter....................................................         9.50              3.88
         Third Quarter.....................................................         8.50              4.00
         Fourth Quarter....................................................         6.38              2.88

         1997
         ----
         First Quarter.....................................................        $3.38             $1.88
         Second Quarter....................................................         3.00              1.82
         Third Quarter.....................................................         2.13              1.13
         Fourth Quarter....................................................         1.94               .66

</TABLE>

---------------
         All prices set forth above have been adjusted to reflect a
         three-for-one split of the Company's common stock effected
         as a stock dividend on January 18, 1996.

         As of March 16, 1998, there were approximately 51 shareholders of
record of the Company's common stock, and approximately 1,350 other beneficial
owners whose shares are held in street name at brokerage houses.

         The Company has never paid or declared any cash dividends on its Common
Stock and does not intend to pay cash dividends on its Common Stock in the
foreseeable future. The Company presently expects to retain its earnings to
finance the development and expansion of its business. The payment by the
Company of dividends, if any, on its Common Stock in the future is subject to
the discretion of the Board of Directors and will depend on the Company's
earnings, financial condition, capital requirements and other relevant factors.



                                      10

<PAGE>   13


ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS


OVERVIEW

         The Company was organized in 1987 to develop Shelly's Original
Woodroast Restaurants. The Company has operated a restaurant in St. Louis Park,
Minnesota since 1989, and a restaurant in Rockville, Maryland since November
1995. As a result of the Company's recruitment of senior management staff, its
focus on building the larger superstore restaurants has changed. The Company is
in the process of attempting to sell the Restaurants in the context of changing
its business strategy to focus exclusively on Back Room taverns rather than on
full service restaurants. Therefore, the Company plans to pursue development of
the Shelly's Back Room, The American Tavern concept, which is designed to
capitalize on the popular cigar smoking trend in an upscale atmosphere featuring
exceptional food and drink. This concept is not a departure from the main core
of the Company's business, which is to provide customers with a quality food and
beverage experience in a relaxed atmosphere. This shift of focus allows the
Company to pursue other avenues to generate revenue, primarily because of the
simpler structure to operate a Back Room and lower capital investment, which
would allow franchising of this concept. The successful operation and future
expansion of Shelly's Back Room by the Company will depend on various factors,
including market acceptance of the Shelly's Back Room concept and general
economic conditions. The Company also faces all of the risks, expenses and
difficulties frequently encountered in connection with the operation,
development and franchising of a new and expanding business. Furthermore, to the
extent that the Company's expansion strategy is successful, the Company must
manage the transition to multiple site operations (both Company-owned and
franchisee operations), higher volume operations, the control of overhead
expenses and the addition of necessary personnel. The Company had losses of
$3,182,294 and $1,702,566 for the fiscal years ended December 28, 1997 and
December 29, 1996, respectively, and expects losses to continue for the near
future.

     The Company uses a 52/53 week fiscal year ending on the last Sunday of
December. Fiscal years 1997 and 1996 were a 52-week year.


RESULTS OF OPERATIONS

         The following table sets forth, for fiscal years 1997 and 1996, the
percentage relationship to net sales of selected items in the Company's
consolidated statements of operations, and the percentage of increase or
decrease in such items from the previous year. Please note: the following table
sets forth the information relating to Units operation, a combination of the
Restaurants and the DC Back Room.

         It is management's intention to provide such information on a per store
basis as future stores are developed and reach a level of maturity where
comparability is meaningful.


                                      11

<PAGE>   14


<TABLE>
<CAPTION>
                                                             %                               %            %Change
                                          Fiscal Year     Relation-      Fiscal Year      Relation-         from
                                            Dollars         ship           Dollars          ship           Prior
                                              1997          1997             1996           1996            Year
                                          -------------   ---------      -------------    ---------      -----------
<S>                                       <C>             <C>            <C>              <C>            <C>
Net Sales                                 $  6,226,631       100.0       $  6,272,724        100.0             -0.7
                                          -------------   ---------      -------------    ---------      -----------
Costs and expenses:
 Food, beverage, supply & retail costs       2,063,806        33.1          2,103,563         33.5             -1.9
 Units operating expenses                    3,829,482        61.5          3,801,839         60.6              0.7
 Depreciation (units basis)                    408,118         6.6            382,417          6.1              6.7
 Pre-opening expenses                          165,593         2.7                  0          0.0             ----
 Impairment of restaurant assets               477,253         7.7                  0          0.0             ----
 G & A and development                       2,183,208        35.1          1,515,268         24.2             44.1
                                          -------------   ---------      -------------    ---------      -----------
   Total costs and expenses                  9,127,460       146.6          7,803,087        124.4             17.0
                                          -------------   ---------      -------------    ---------      -----------
   Loss from operations                     -2,900,829       -46.6         -1,530,363        -24.4             89.6
Other income (expense):
 Loss on disposal                             -181,560        -2.9            -41,094         -0.7            341.8
 Other income (expense)                        -99,905        -1.6           -131,109         -2.1            -23.8
                                          -------------   ---------      -------------    ---------      -----------
  Total other income (expense)                -281,465        -4.5           -172,203         -2.7             63.4
   Net loss                               $ -3,182,294       -51.1       $ -1,702,566        -27.2             86.9
                                          =============   =========      =============    =========      ===========
</TABLE>


FISCAL YEAR 1997 COMPARED TO FISCAL YEAR 1996

     NET SALES

         Net sales decreased by $46,093 or 0.7% to $6,226,631 for fiscal year
1997 from $6,272,724 for fiscal year 1996. Sales at the St. Louis Park
Restaurant decreased by approximately 1.1%, to $2,466,312. The St. Louis Park
Restaurant continues to have guest counts at or near seating capacity on a daily
basis. Over the years, the St. Louis Park Restaurant has become a favorite
dining experience for many Twin City patrons. The product mix sold is very
repetitive, with all menu items being good sellers. Due to seating limitations,
sales at the St. Louis Park Restaurant are not anticipated to increase much, if
at all, over its current level. Sales at the Rockville Restaurant decreased by
approximately 14.2%, to $3,290,013. The Company believes that the menu items
that are so well cherished in the Midwest may be too heavy for the tastes of the
seacoast patrons. The Rockville Pike's offerings are vast in the available
restaurants for the dining public to choose from



                                      12


<PAGE>   15

and together with the menu selection, sales were less than projected.  The
Company is in the process of attempting to sell the Restaurants in order to
focus exclusively on the expansion of the Back Room concept, and as such, will
focus its attention on cost control to enhance salability of the Restaurants.
The first stand-alone Shelly's Back Room opened on June 10, 1997 in Washington
D.C. and sales for the first 7 months of operation were $470,306.

The following table sets forth average weekly gross revenue amounts by quarter
and the percentage of increase over the previous quarter at the DC Back Room for
fiscal year 1997.


<TABLE>
<CAPTION>
             Average Weekly                   Second             Third         %               Forth         %
             Gross Revenues                   Quarter           Quarter    increase           Quarter    increase
                                               1997              1997                          1997
                                             ----------        ----------  ----------        ----------  ----------
<S>                                           <C>               <C>          <C>              <C>          <C>
              DC Back Room                    $13,713           $14,422      5.2%             $18,591      28.9%

</TABLE>

     COSTS AND EXPENSES

         Total Units food, beverage, supply and retail costs were $2,063,806
(33.1% of net sales) for the fiscal year 1997 as compared to $2,103,563 (33.5%
of net sales) for fiscal year 1996, which remain within the normal operating
percentage of net sales, considering the DC Back Room was only in operation for
7 months. The Original Woodroast Cooking style requires longer than normal
preparation time and has higher than regular restaurants' waste costs to create
the uniquely flavored menus used in the Restaurants. This reduction in the
percentage of change from the prior year of 1.9% indicates a stabilization in
overall cost of goods sold. Total Units operating expenses were $3,829,482
(61.5% of net sales) for the fiscal year 1997 compared to $3,801,839 (60.6% of
net sales) for fiscal year 1996. This is an increase of 0.7% in the percentage
of change from the prior year. The Company is in the process of attempting to
sell the Restaurants in order to focus exclusively on the expansion of the Back
Room concept and, as such, will focus its attention on cost control to enhance
salability of the Restaurants. However, no assurance can be given that these
efforts will achieve desired results by year end, if at all.

         As a comparison, the total food, beverage, supply and retail costs for
the DC Back Room were only $143,633 or 30.5% of Back Room sales for the 7 months
of operation.

         The increase of 6.7% in depreciation expense is primarily attributable
to the new DC Back Room.

         Pre-opening costs were $165,593 for fiscal year 1997. Of this total,
$111,302 were the pre-opening costs for the DC Back Room. In addition, $54,291
of start-up costs associated with the new Chicago Back Room were expensed. It is
the Company's policy to expense all pre-opening and start-up costs associated
with new unit development that are not otherwise capitalized as property and
equipment when incurred. See "Proposed New Accounting Standards."

         A loss on impairment of Restaurant related assets of $477,253 has been
recognized for fiscal year 1997. This is in accordance with Statement of
Financial Accounting Standards No. 121



                                      13


<PAGE>   16


"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" which the Company adopted in 1995. Since the Company
is planning to sell the Restaurants in 1998, this recognition of impairment
expense was necessary. The Company has made estimates to receive net proceeds of
approximately $1.3 and $2.0 million for the St. Louis Park Restaurant and the
Rockville Restaurant, respectively. The carrying value of the Restaurants was
$3,777,253 at December 28, 1997. The Company believes that these actions are
mandatory and that these are long-term commitments. In the event that only one
of the Restaurants is sold in 1998, the Company will continue working on
divesting the remaining Restaurant. However, no assurance can be given that
either or both of these Restaurants will be sold by year end. The Company
restates its focus: that the simpler structure of the Back Room, both in terms
of operational management and in terms of capital investment, provides for
growth through franchising of this concept.

         The G & A and development expenses relate to the Company's executive
and administrative office located in Eden Prairie, Minnesota. Total G & A
expenses were $2,183,208 (35.1% of net sales) for the fiscal year 1997 as
compared to $1,515,268 (24.2% of net sales) for fiscal year 1996. This is an
increase of approximately 44.1% or $667,928. With the change in focus of the
Company towards the Back Room concept, the Company is back in the position as a
"start-up company" again. As with any "start-up company", the Company has to
address the numerous executive and administrative staffing requirements, the
requirements needed to manage remote sites, shareowner relationships, etc. and
the development costs associated with site location and franchising. The Company
is re-evaluating its G & A and development expense line items to reduce
corporate overhead expenses for the 1998 fiscal year. Certain events must happen
for these reductions to occur. However, no assurance can be given that any or
all the reductions achieved will produce an acceptable expense percentage of net
sales, or at all. Until more Back Rooms are in operation, the G & A and
development expenses will continue to provide the greatest impact on the net
operating profit or loss of the Company for the foreseeable future. The Company
is updating its Five Year Financial Business Plan (the "Plan") to provide
documentation for future expansion possibilities of the Back Room concept.


     OTHER INCOME (EXPENSE)

         The Company's other income and expense consist of interest income,
interest expense, other related income and expense and the loss on disposal of
property and equipment. The excess of expenses over incomes was $281,465 (4.5%
of net sales) for the fiscal year 1997 compared to $172,203 (2.7% of net sales)
for the fiscal year 1996. This is an increase of $109,262 or 63.4%. The increase
is attributable primarily to the loss on disposal of property and equipment. In
1994, the Company entered into a purchase agreement for an additional 25 of the
patented Woodroast Cooking Ovens (the "Ovens"), at a total cost of approximately
$250,000. Due to the time required for construction of the Ovens and discounts
offered by the manufacturer, 25 Ovens were approved for construction. Under the
1994 business plan, the Company would have required approximately 4 Ovens for
each Shelly's Woodroast location. With the Company's decision to pursue the Back
Room concept, which requires no Ovens, it became necessary to account for the
loss in value of these Ovens. The Company paid the balance due of approximately
$187,000 and took delivery of


                                      14

<PAGE>   17


the remaining 20 Ovens in early 1997. The Restaurants' present Ovens are in
good working order and should not require replacement. However, the Company
will continue to have the expenses of insuring, storing and transporting the
remaining Ovens until such time that both Restaurants are sold. The Company
anticipates to receive only scrap value for the remaining Ovens.

         An employment agreement has been signed, with an effective date of
January 1, 1998, for the Chairman of the Board and Chief Executive Officer.
Therefore, the Company has employment agreements with both of its officers. The
new agreement for the Chairman has a three year term. The existing agreement for
the President and Chief Operating Officer has less than four years remaining,
plus each provides for one year's severance pay. The agreements include
benefits, other compensation and executive perquisites in addition to
non-compete provisions. Additionally, the Company, based on its Plan, will in
future months be seeking other senior management personnel as well as support
staff, which will also have an associated impact on future earnings. The Company
will benefit directly due to the expertise of these senior staff additions.


LIQUIDITY AND CAPITAL RESOURCES

         The Company had a working capital deficit of $1,685,767 at December 28,
1997, compared to working capital of $2,996,568 at December 29, 1996. Cash and
cash equivalents were $67,420 at December 28, 1997, representing a decrease of
$3,605,173 from the cash, cash equivalents and securities available-for-sale of
$3,672,413 at December 29, 1996.

          During the past three fiscal years, the Company's capital requirements
have been met principally through the public and private sale of debt and equity
securities. In June 1994, the Company completed an Initial Public Offering of
750,000 units consisting of 750,000 shares of Common Stock, and 750,000
Redeemable Class A Warrants at an offering price of $5.50 per unit and received
net proceeds of approximately $3,360,000 after approximately $765,000 in
offering costs and underwriting discounts. Such net proceeds had been fully
utilized by December 31, 1995 for development and opening of the Rockville
Restaurant and for the reduction of debt and trade payables.

         In November 1995, the Company completed a private placement of Units
consisting of $1,000,000 in principal amount of 15% Secured Promissory Notes
(the "Notes") (including $700,000 to Company stockholders) and warrants (the
"Warrants") to purchase an aggregate of 200,016 shares of Common Stock. The
private placement of Units resulted in net proceeds of approximately $940,000
which were used to fund construction expenses and other costs related to the
opening of the Rockville Restaurant. The Notes are secured by a senior interest
in substantially all assets owned by the Company and its subsidiary. Property
leased by the Company and its subsidiary, including real estate and certain
equipment, is not included in the security interest. The Warrants have an
exercise price of $.0033 per share, of which 170,008 were exercised in 1996. The
remaining Warrants are exercisable through May 31, 2000. On the date of
issuance, the Warrants had a total value of $299,333 based on the then market
price of the Company's common stock. The discount created by the issuance costs
and the Warrants is being amortized over the life of the Notes using the
interest method. Holders of Warrants or Warrant shares have certain piggyback
registration rights



                                      15

<PAGE>   18

through May 31, 2002. The Notes bear interest of 15%, payable monthly.  The
approximate effective annual interest rate, after considering the value of
the Warrants, is approximately 20%. The Notes require repayment of principal
over an eight-year period beginning in August 1998. Current maturities of the
Notes are $27,916 in fiscal year 1998, $74,518 in fiscal year 1999, $86,497 in
fiscal year 2000, $100,401 in fiscal year 2001, $116,541 in fiscal year 2002 and
$594,127 thereafter.

         In March 1996, the Company sold 625,000 shares of its Common Stock in a
private placement at a purchase price of $2.25 per share, and received and used
the net proceeds of approximately $1,315,000. Holders of such shares have
certain piggyback registration rights.

         In September 1997, the Company entered into a promissory note which has
an outstanding balance of $24,005 at December 28, 1997. The note requires
monthly installments of $1,250 including interest at 15.47%. The note is secured
by equipment and is due November 1999. Current maturities are $12,126 for fiscal
year 1998 and $11,879 for fiscal year 1999.

         In December 1997, the Company entered into a promissory note with the
majority stockholder. The note was unsecured and bears interest at prime plus 2%
annually. The note balance was $250,000 at December 28, 1997. The note has been
fully repaid by February 1998.

         During January 1998, the Company entered into a promissory note with
the majority stockholder for $150,000. The note was unsecured and bears
interest at prime plus 2% annually. The note has been fully repaid by
February 1998.

         During February 1998, the Company completed a private placement of
117,500 shares of Class A 8% convertible preferred stock with a stated value of
$10.00 per share. The preferred stock is convertible into shares of the
Company's $.005 par value common stock based on dividing the aggregated stated
value of the preferred stock and accrued dividends by the lesser of $1.125 or
80% of the average closing bid price for the common stock five days prior to the
conversion. The Company received net proceeds of approximately $996,000. In
addition, the Company issued a warrant to the placement agent to purchase
175,000 shares of the Company's common stock at $1.125 per share in connection
with the offering. The warrant is exercisable for four years. Such net proceeds
will be fully utilized by March 1998.

         During March 1998, the Company entered into a promissory note with the
majority stockholder for $300,000. The note is unsecured and bears interest at
eight percent (8%) annually.

         The Company will require additional financing to implement its
expansion plans. The Company believes that a successful sale of one if not both
of the Restaurants will be able to be completed during the year. The Company is
pursuing additional financing through one or more additional offerings of equity
securities or debt financing in order to finance operations and develop and
open additional Back Rooms. There is no assurance that the sale of one or both
Restaurants and additional financing will be available, or if available, will
be on terms acceptable to the Company or its shareholders.


                                      16

<PAGE>   19

PROPOSED NEW ACCOUNTING STANDARDS

         In April 1997, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants (AICPA) issued an exposure
draft entitled "Reporting on the Costs of Start-Up Activities." The proposed
accounting standard contained in this draft would require entities to expense as
incurred all start-up and pre-opening costs that are not otherwise capitalizable
as long-lived assets. If adopted by the AICPA, this new accounting standard
would be effective for fiscal years beginning after December 15, 1997 with
earlier application encouraged. The comment period for the exposure draft ended
in July 1997, and the AICPA is expected to issue a final pronouncement on this
standard during the first quarter of 1998. The Company's current policy is to
expense pre-opening costs as incurred and, therefore, the proposed accounting
standard would not impact the Company.

FORWARD-LOOKING DISCLOSURE

         The Private Securities Litigation Reform Act of 1995 provides a safe
harbor for forward-looking statements. This Form 10-KSB and other materials
filed or to be filed by the Company with the Securities and Exchange Commission,
as well as other written materials or oral statements that the Company may make
or publish from time to time, contain forward-looking statements relating to
such matters as plans for future expansion, other business development
activities, anticipated financial performance, business prospects and similar
matters. Such forward-looking statements by their nature involve substantial
risks and uncertainties, and actual results may differ materially from the
anticipated results or other expectations expressed in the forward-looking
statements. These risks and uncertainties include, but are not limited to, those
relating to the operation and development of a new and expanding business,
dependence on current management and need for additional management personnel,
and the risks and uncertainties described in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in this Form 10-KSB.


ITEM 7.  CONSOLIDATED FINANCIAL STATEMENTS

         The consolidated financial statements of the Company are included
herein following the SIGNATURES page, beginning at page F-1.


ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE

         Not applicable.





                                      17

<PAGE>   20

                                   PART III


ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(A) OF THE EXCHANGE ACT

         Information required under Item 9 is hereby incorporated by reference
to the Company's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year ended December 28, 1997. With respect to information regarding executive
officers of the Company, see page 9 of this report.


ITEM 10. EXECUTIVE COMPENSATION

         Information required under Item 10 is hereby incorporated by reference
to the Company's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year ended December 28, 1997.


ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         Information required under Item 11 is hereby incorporated by reference
to the Company's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year ended December 28, 1997.


ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         Information required under Item 12 is hereby incorporated by reference
to the Company's definitive proxy statement to be filed with the Commission
pursuant to Regulation 14A within 120 days after the end of the Company's fiscal
year ended December 28, 1997.


ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

         (a) Exhibits. See "Exhibit Index" on the page following the
             Consolidated Financial Statements.

         (b) Reports on Form 8-K.  None.



                                      18

<PAGE>   21


                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on this 26th day of March,
1998.

                                                WOODROAST SYSTEMS, INC.


                                                By  /s/ Sheldon F. Jacob
                                                -----------------------------
                                                Sheldon F. Jacobs
                                                Chairman of the Board and
                                                Chief Executive Officer

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed on March 26, 1998 by the following persons on behalf
of the Registrant, in the capacities indicated.

         Each person whose signature appears below constitutes and appoints
Sheldon F. Jacobs and Richard A. Orenstein as his true and lawful
attorneys-in-fact and agents, each acting alone, with the full power of
substitution and re-substitution, for him and in his name, place and stead, in
any and all capacities, to sign any or all amendments to this Annual Report on
Form 10-KSB and to file the same, with all exhibits thereto, and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, each acting alone, full power and
authority to do and perform each and every act and thing requisite and necessary
to be done in and about the premises, as fully to all intents and purposes as he
might or could do in person, hereby ratifying and confirming all said
attorneys-in-fact and agents, each acting alone, or his substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.


Signature                                                 Title
---------                                                 -----

 /s/ Sheldon F. Jacobs                      Chairman of the Board and
---------------------------                 Chief Executive Officer
Sheldon F. Jacobs                           (Principal Executive Officer)



 /s/ Ralph J. Guarino                       President, Chief Operating Officer
---------------------------                 and Chief Financial Officer
Ralph J. Guarino                            (Principal Financial and
                                            Accounting Officer)



                                      19

<PAGE>   22


/s/ Richard A. Orenstein                    Director
---------------------------
Richard A. Orenstein


---------------------------
Merle J. Shapiro                            Director





                                      20
<PAGE>   23
ITEM 7.  CONSOLIDATED FINANCIAL STATEMENTS





                  REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS




To Woodroast Systems, Inc.:

We have audited the accompanying consolidated balance sheets of Woodroast
Systems, Inc. and Subsidiary as of December 28, 1997 and December 29, 1996 and
the related consolidated statements of operations, stockholders' equity and cash
flows for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Woodroast Systems,
Inc. and Subsidiary as of December 28, 1997 and December 29, 1996 and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered significant
recurring losses from operations and has a working capital deficiency that
raises substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.


                                                LUND KOEHLER COX & COMPANY, PLLP

Minneapolis, Minnesota
February 19, 1998

                                     F-1


<PAGE>   24
                     WOODROAST SYSTEMS, INC. AND SUBSIDIARY
                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                             DECEMBER 28,             DECEMBER 29,
                                                                                                 1997                    1996
                                                                                             ------------             ------------
                                     ASSETS
CURRENT ASSETS:
<S>                                                                                            <C>                     <C>
  Cash and cash equivalents                                                                    $     67,240            $  1,673,663
  Securities available-for-sale                                                                           0               1,998,750
  Inventories                                                                                       244,920                 181,971
  Prepaid expenses and other current assets                                                         112,167                  89,183
                                                                                               ------------            ------------
     Total current assets                                                                           424,327               3,943,567
                                                                                               ------------            ------------

PROPERTY AND EQUIPMENT, NET                                                                       6,044,911               4,537,418
                                                                                               ------------            ------------

OTHER ASSETS:
  Deposits                                                                                           80,609                 138,884
  Patent and trademarks, net                                                                         40,677                   9,834
                                                                                               ------------            ------------
     Total other assets                                                                             121,286                 148,718
                                                                                               ------------            ------------

                                                                                               $  6,590,524            $  8,629,703
                                                                                               ============            ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
  Note payable - stockholder                                                                   $    250,000            $          0
  Current portion of senior secured promissory notes                                                 27,916                       0
  Current portion of long-term debt                                                                  12,126                       0
  Current portion of capital lease obligations                                                       64,215                  77,936
  Accounts payable                                                                                  892,922                 640,752
  Accounts payable - construction                                                                   632,013                       0
  Accrued expenses                                                                                  230,902                 228,311
                                                                                               ------------            ------------
     Total current liabilities                                                                    2,110,094                 946,999

SENIOR SECURED PROMISSORY NOTES, NET OF CURRENT PORTION                                             972,084               1,000,000
LESS: UNAMORTIZED DISCOUNT ON SENIOR SECURED PROMISSORY NOTES                                      (252,114)               (299,514)
LONG-TERM DEBT, NET OF CURRENT PORTION                                                               11,879                       0
CAPITAL LEASE OBLIGATIONS, NET OF CURRENT PORTION                                                    35,358                 107,813
                                                                                               ------------            ------------
     Total liabilities                                                                            2,877,301               1,755,298
                                                                                               ------------            ------------

STOCKHOLDERS' EQUITY:
  Common stock, $.005 par value, 33,333,333 shares authorized,
   4,242,397 shares issued and outstanding                                                           21,212                  21,212
  Additional paid-in capital                                                                     10,033,229              10,033,229
  Unrealized loss on securities available-for-sale                                                        0                 (16,250)
  Unearned compensation                                                                              (4,861)                 (9,723)
  Accumulated deficit                                                                            (6,336,357)             (3,154,063)
                                                                                               ------------            ------------
     Total stockholders' equity                                                                   3,713,223               6,874,405
                                                                                               ------------            ------------

                                                                                               $  6,590,524            $  8,629,703
                                                                                               ============            ============
</TABLE>

          See accompanying notes to consolidated financial statements.

                                      F-2





<PAGE>   25
                      WOODROAST SYSTEM, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF OPERATIONS


<TABLE>
<CAPTION>

                                                                                               FISCAL YEARS ENDED
                                                                                    ------------------------------------------
                                                                                        DECEMBER 28,          DECEMBER 29,
                                                                                            1997                  1996
                                                                                    --------------------  --------------------
<S>                                                                                      <C>                <C>
NET SALES                                                                                $ 6,226,631        $ 6,272,724
                                                                                         -----------        -----------
COSTS AND EXPENSES:
  Food, beverage, supply and retail costs                                                  2,063,806          2,103,563
  Units operating expenses                                                                 3,829,482          3,801,839
  Depreciation and amortization                                                              550,545            425,660
  Pre-opening expenses                                                                       165,593                  0
  Loss on impairment of restaurant related assets                                            477,253                  0
  General, administrative and development                                                  2,040,781          1,472,025
                                                                                         -----------        -----------
     Total costs and expenses                                                              9,127,460          7,803,087
                                                                                         -----------        -----------
LOSS FROM OPERATIONS                                                                      (2,900,829)        (1,530,363)
                                                                                         -----------        -----------
OTHER INCOME (EXPENSE):
  Interest income                                                                             75,587             59,745
  Interest expense                                                                          (211,542)          (241,337)
  Loss on disposal of property and equipment                                                (181,560)           (41,094)
  Other income                                                                                36,050             50,483
                                                                                         -----------        -----------
     Total other income (expense)                                                           (281,465)          (172,203)

LOSS BEFORE INCOME TAXES                                                                  (3,182,294)        (1,702,566)
                                                                                         -----------        -----------

PROVISION FOR INCOME TAXES                                                                         0                  0
                                                                                         -----------        -----------

NET LOSS                                                                                 $(3,182,294)       $(1,702,566)
                                                                                         ===========        ===========

BASIC AND DILUTED NET LOSS PER COMMON SHARE                                              $     (0.75)       $     (0.55)
                                                                                         ===========        ===========

SHARES USED IN COMPUTING BASIC AND DILUTED NET LOSS PER COMMON SHARE                       4,242,397          3,105,043
                                                                                         ===========        ===========
</TABLE>


          See accompanying notes to consolidated financial statements.




                                     F-3



<PAGE>   26
                     WOODROAST SYSTEMS, INC. AND SUBSIDIARY
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>

                                                                            Unrealized loss
                                     Common Stock                Additional  on securities
                                  ----------------------------   Paid-in     available-    Unearned     Accumulated
                                         Shares      Amount      Capital      for-sale    Compensation     Deficit          Total
                                  -------------  -------------  ----------- ------------- ------------  -------------  -----------
                                     <C>           <C>        <C>             <C>         <C>          <C>             <C>
BALANCE - DECEMBER 31, 1995             2,249,967   $ 11,250   $  3,962,406    $      0    $      0    $ (1,451,497)   $  2,522,159

  Private placement of common
   stock at $2.25 per share, net of
   issuance costs                         625,000      3,125      1,312,253          --          --              --       1,315,378

  Exercise of redeemable Class A
   warrants of $4.00 per share, net
   of issuance costs                    1,155,152      5,776      4,567,151          --          --              --       4,572,927

  Redemption of unexercised
   Class A warrants                            --         --           (214)         --          --              --            (214)

  Issuance of warrants for
   services provided                           --         --         48,405          --          --              --          48,405

  Exercise of warrants                    202,278      1,011        120,568          --          --              --         121,579

  Exercise of options                      10,000         50          8,075          --          --              --           8,125

  Unearned compensation from
   grant of options                            --         --         14,585          --     (14,585)             --               0

  Stock option compensation earned             --         --             --          --       4,862              --           4,862

  Change in unrealized loss on                 --         --             --     (16,250)         --              --         (16,250)
   securities available-for sale

  Net loss                                     --         --             --          --          --      (1,702,566)     (1,702,566)
                                     ------------   --------   ------------    --------    --------    ------------    ------------

BALANCE - DECEMBER 29, 1996             4,242,397     21,212     10,033,229     (16,250)     (9,723)     (3,154,063)      6,874,405

  Change in unrealized loss on
   securities available-for sale               --         --             --      16,250          --              --          16,250

  Stock option compensation earned             --         --             --          --       4,862              --           4,862

  Net loss                                     --         --             --          --          --      (3,182,294)     (3,182,294)
                                     ------------   --------   ------------    --------    --------    ------------    ------------

BALANCE - DECEMBER 28, 1997             4,242,397   $ 21,212   $ 10,033,229    $      0    $ (4,861)   $ (6,336,357)   $  3,713,223
                                     ============   ========   ============    ========    ========    ============    ============
</TABLE>


         See accompanying notes to consolidated financial statements.


                                     F-4

<PAGE>   27
                     WOODROAST SYSTEMS, INC. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                           FISCAL YEARS ENDED
                                                                 -------------------------------------------
                                                                          DECEMBER 28,    DECEMBER 29,
                                                                             1997             1996
                                                                  ---------------------  --------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                        <C>            <C>
  Net loss                                                                 $(3,182,294)   $(1,702,566)
  Adjustments to reconcile net loss to
  cash flows from operating activities:
    Depreciation and amortization                                              550,545        425,660
    Loss on impairment of restaurant related assets                            477,253              0
    Loss on disposal of property and equipment                                 181,560         41,094
    Amortization of long-term debt discount                                     47,400         47,400
    Stock option compensation earned                                             4,862              0
    Changes in operating assets and liabilities:
     Inventories                                                               (62,949)       (56,585)
     Prepaid expenses and other current assets                                 (22,984)        11,489
     Accounts payable                                                          252,170       (236,686)
     Accounts payable - construction                                           632,013              0
     Accrued expenses                                                            2,591         54,101
                                                                           -----------    -----------
      Cash flows from operating activities                                  (1,119,833)    (1,416,093)
                                                                           -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from sales of securities available-for-sale                       2,015,000         12,634
  Proceeds from disposal of property and equipment                               3,500              0
  Purchases of securities available-for-sale                                         0     (2,015,000)
  Purchases of property and equipment                                       (2,713,399)      (486,593)
  Purchases of patents and trademarks                                          (32,496)          (714)
  Deposits used (advanced)                                                      58,275        (87,799)
                                                                           -----------    -----------
      Cash flows from investing activities                                    (669,120)    (2,577,472)
                                                                           -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from (payments on) note payable - stockholder                       250,000       (300,000)
  Proceeds from long-term debt                                                  26,756              0
  Proceeds from private placement of common stock, net of issuance costs             0      1,315,378
  Proceeds from exercise of Class A warrants, net of issuance costs                  0      4,572,713
  Proceeds from exercise of warrants                                                 0        121,579
  Proceeds from exercise of options                                                  0          8,125
  Payments on long-term debt                                                    (2,751)             0
  Payments on capital leases obligations                                       (91,475)       (78,410)
                                                                           -----------    -----------
      Cash flows from financing activities                                     182,530      5,639,385
                                                                           -----------    -----------

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                            (1,606,423)     1,645,820

CASH AND CASH EQUIVALENTS, BEGINNING                                         1,673,663         27,843
                                                                           -----------    -----------

CASH AND CASH EQUIVALENTS, ENDING                                          $    67,240    $ 1,673,663
                                                                           ===========    ===========
</TABLE>


          See accompanying notes to consolidated financial statements.

                                      F-5




<PAGE>   28

                   WOODROAST SYSTEMS, INC. AND SUBSIDIARY
                 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


(1)    NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

NATURE OF BUSINESS - Woodroast Systems, Inc. (the Company) currently owns and
operates two Shelly's Woodroast restaurants and one Shelly's Back Room (the Back
Room). The first restaurant (the St. Louis Park unit) is in St. Louis Park,
Minnesota, a suburb of Minneapolis, and opened in 1989. The second restaurant
(the Rockville unit) is in Rockville, Maryland, a suburb of Washington, D.C.,
and opened in November 1995. The Back Room unit is located in Washington D.C.,
and opened in June 1997. The Company currently has a Back Room unit under
development in Chicago that opened on January 22, 1998. In addition, the Company
franchises their Shelly's Back Room concept, but has not yet sold a franchised
Back Room.

The accompanying consolidated financial statements have been prepared on the
basis that the Company will continue as a going concern, that contemplates the
realization of assets and satisfaction of liabilities in the normal course of a
business. The Company has incurred significant operating losses since completing
its initial public offering. At December 28, 1997, the Company had negative
working capital of approximately $1.7 million. Management's plans to raise
additional capital include a private placement of convertible preferred stock
(which was completed in February 1998, see Note 13), the possible sale of one or
both of their restaurants (see Note 4) and obtaining a line of credit from a
private investor ranging from $1.0 million to $2.0 million. In addition,
subsequent to December 28, 1997, the Company's majority stockholder loaned the
Company $450,000 pursuant to two separate notes (see Note 5). There is no
assurance that the possible sale of one or both of the restaurants or obtaining
a line of credit from a private investor will be completed or that terms will
be acceptable to the Company or its stockholders. The Company plans to use the
proceeds from these potential transactions to reduce their liabilities, fund
operating losses and for the possible development of additional Back Rooms.

FISCAL  YEAR - The  Company  uses a 52/53 week  fiscal  year  ending on the last
Sunday of December. Fiscal years 1997 and 1996 were 52 week years.

PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the
accounts of Woodroast Systems, Inc. and its wholly owned subsidiary Shelly's
Woodroast Two, Inc. All significant intercompany transactions and balances have
been eliminated in consolidation.

CASH AND CASH EQUIVALENTS - The Company includes as cash equivalents
certificates of deposit and all other investments with original maturities of
three months or less when purchased which are readily convertible into known
amounts of cash. The balances maintained at financial institutions at times, may
exceed federally insured limits.

INVENTORIES - Inventories consist principally of food, beverages and retail
goods and are recorded at the lower of cost (first-in, first-out) or market.

PRE-OPENING COSTS - It is the Company's policy to expense when incurred all
start-up and pre-opening costs associated with new unit development that are not
otherwise capitalizable as property and equipment.

                                       F-6

<PAGE>   29


                   WOODROAST SYSTEMS, INC. AND SUBSIDIARY
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


DEPRECIATION - Property, equipment and leasehold improvements are recorded at
cost. Furniture, fixtures and equipment are depreciated using the straight-line
method over three to seven years. Leasehold improvements are amortized using the
straight-line method over the shorter of their estimated useful lives or the
lease term including option periods. Maintenance, repairs and minor renewals are
expensed when incurred.

PATENT AND TRADEMARKS - Patent and trademarks are recorded at cost and are being
amortized using the straight-line method over seven to twenty years. Costs
associated with the maintenance and defense of the patent and trademarks are
expensed when incurred. Accumulated amortization was $10,110 and $8,457 at
December 28, 1997 and December 29, 1996.

NET LOSS PER COMMON SHARE - During 1997, the Company adopted Statement of
Financial Accounting Standards No. 128 "Earnings Per Share" (Statement 128) for
all periods shown. Statement 128 requires disclosures of basic earnings per
share (EPS) and diluted EPS, which replaces the existing primary EPS and fully
diluted EPS, as defined by APB No. 15. Basic EPS is computed by dividing net
loss by the weighted average number of shares of common stock outstanding during
the year. Diluted EPS is computed by dividing net loss by the weighted average
common shares outstanding and dilutive common equivalent shares assumed to be
outstanding during each period. In addition, the Company has implemented recent
guidance from the Securities and Exchange Commission issued in February 1998
regarding the implementation of Statement 128. Dilutive common equivalent shares
have not been included in the computation of diluted EPS because their inclusion
would be antidilutive. Antidilutive common equivalent shares issuable based on
future exercise of stock options or warrants could potentially dilute basic EPS
in subsequent periods.

MANAGEMENT'S USE OF ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.

FINANCIAL INSTRUMENTS - The carrying amounts for all financial instruments
approximates fair value. The carrying amounts for cash and cash equivalents,
accounts payable and accrued liabilities approximate fair value because of the
short maturity of these instruments. The fair value of long-term debt and
capital lease obligations approximates the current rates at which the Company
could borrow funds with similar remaining maturities.

RECLASSIFICATIONS - Certain accounts in the prior year consolidated financial
statements have been reclassified for comparative purposes to conform with the
presentation in the current year consolidated financial statements. These
reclassifications had no effect on net loss or stockholders' equity.





                                       F-7

<PAGE>   30

                   WOODROAST SYSTEMS, INC. AND SUBSIDIARY
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


(2)    SECURITIES AVAILABLE-FOR-SALE

The Company classifies all investments which are not cash equivalents as
securities available-for-sale with all gross unrealized gains or losses included
as a separate component of stockholders' equity. There were unrealized losses of
$0 and $16,250 at December 28, 1997 and December 29, 1996.

Securities available-for-sale at December 29, 1996 consisted of United States
Government debt securities, were reported at fair value and were due within one
year of the financial statement date. The market value of the portfolio was
$1,998,750 at December 29, 1996.

(3)    INVENTORIES

Inventories consisted of the following at:


<TABLE>
<CAPTION>
                                                                   December 28,       December 29,
                                                                       1997               1996
                                                              -------------------- --------------------
<S>                                                           <C>                  <C>
Food                                                          $            45,675  $            37,443
Beverage                                                                   54,611               37,032
Retail goods                                                              144,634              107,496
                                                              ===================  ===================
                                                              $           244,920  $           181,971
                                                              ===================  ===================
</TABLE>

(4)    PROPERTY AND EQUIPMENT

Property and equipment consisted of the following at:

<TABLE>
<CAPTION>
                                                                   December 28,       December 29,
                                                                       1997               1996
                                                              -------------------- --------------------
<S>                                                           <C>                  <C>
Leasehold improvements                                        $         4,640,487  $         3,805,261
Restaurant equipment                                                    1,159,403              907,636
Restaurant furniture and fixtures                                         666,668              550,986
Office equipment and furniture                                            470,665              370,036
Less: accumulated deprecation and amortization                          1,708,881            1,160,706
Less: impairment of restaurant related assets                             477,253                    0
                                                              -------------------  -------------------
                                                                        4,751,089            4,473,213
Construction in progress                                                1,293,822               64,205
                                                              ===================  ===================
                                                              $         6,044,911  $         4,537,418
                                                              ===================  ===================
</TABLE>

The Company is planning to sell its two restaurants in 1998. The Company expects
to receive net proceeds of approximately $3.3 million from the sale of
these restaurants. The carrying value of these restaurants was $3,777,253 at
December 28, 1997. In accordance with Statement of Financial Accounting
Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of", which the Company previously adopted, an
impairment of $477,253 was recorded in 1997.

                                       F-8

<PAGE>   31

                    WOODROAST SYSTEMS, INC. AND SUBSIDIARY
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


(5)    NOTE PAYABLE - STOCKHOLDER

At December 28, 1997, the Company had a $250,000 note payable to the majority
stockholder which was unsecured and accrued interest at prime plus 2%. On
January 27, 1998, the Company's majority stockholder loaned the Company an
additional $150,000 which was unsecured and accural interest at prime plus 2%.
On February 19, 1998, both notes were repaid in full. On March 24, 1998, the
majority stockholder loaned $300,000 to the Company which is unsecured and
accrues interest at 8%

(6)    SENIOR SECURED PROMISSORY NOTES AND LONG-TERM DEBT

SENIOR SECURED PROMISSORY NOTES - In November 1995, the Company completed a
private placement of $1,000,000 in principal amount of Secured Promissory Notes
(the Notes) (including $700,000 to Company stockholders) and received net
proceeds of $943,252. The Notes are secured by substantially all Company assets
and bear interest at 15%, payable monthly. In addition, the holders of the Notes
received warrants to purchase an aggregate of 200,016 shares of the Company's
common stock at $.0033 per share, of which 170,008 were exercised in 1996. The
remaining warrants are exercisable through May 31, 2000. On the date of
issuance, the warrants had a total value of $299,333 based on the then market
price of the Company's common stock. The discount created by the issuance costs
and warrants is being amortized over the life of the Notes using the interest
method. The approximate effective annual interest rate of the Notes is 20%. The
Notes require repayment of principal over an eight-year period beginning August
1998. Current maturities of the Notes are $27,916 in fiscal year 1998, $74,518
in fiscal year 1999, $86,497 in fiscal year 2000, $100,401 in fiscal year 2001,
$116,541 in fiscal year 2002 and $594,127 thereafter.

LONG-TERM DEBT - The Company entered into a promissory note during 1997, which
has an outstanding balance of $24,005 at December 28, 1997. The note requires
monthly installments of $1,250 including interest at 15.47%. The note is secured
by equipment and is due November 1999. Current maturities are $12,126 for fiscal
year 1998 and $11,879 for fiscal year 1999.

(7)    CAPITAL LEASE OBLIGATIONS

The Company leases certain items under agreements that expire through 2000.
Interest is provided for at annual rates ranging from approximately 9% to 24%.
These obligations are secured by the items under lease. Total cost and
accumulated amortization of the leased equipment was $256,766 and $96,649 at
December 28, 1997 and $251,467 and $57,795 at December 29, 1996.





                                       F-9
<PAGE>   32

                    WOODROAST SYSTEMS, INC. AND SUBSIDIARY
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


Future minimum lease payments required under the capital leases together with
the present value of the future minimum lease payments are as follows for the
fiscal years ending:


<TABLE>
<S>                                                                            <C>
        1998                                                                   $              75,340
        1999                                                                                  29,455
        2000                                                                                   9,970
                                                                               ---------------------
        Total                                                                                114,765
        Less: amounts representing interest                                                   15,192
                                                                               ---------------------
        Present value of future minimum lease payments                                        99,573
        Less: current portion                                                                 64,215
                                                                               =====================
        Capital leases obligations, net of current portion                     $              35,358
                                                                               =====================
</TABLE>


(8)    STOCKHOLDERS' EQUITY

STOCK SPLITS - In January 1996, the Company declared a 3-for-1 stock
split. The stock split has been retroactively reflected in the
accompanying consolidated financial statements.


PRIVATE PLACEMENT OF COMMON STOCK - During 1996, the Company sold 625,000 shares
of its common stock in a private placement for $2.25 per share and received net
proceeds of approximately $1,315,000.

EXERCISE OF REDEEMABLE CLASS A WARRANTS - During 1996, the holders of 1,155,152
of redeemable Class A warrants exercised the warrants at an exercise price of
$4.00. A total of 20,048 warrants were not exercised and the Company redeemed
these warrants for $0.01 per warrant. The Company received net proceeds of
approximately $4,570,000.

UNDERWRITER'S WARRANT - In connection with its initial public offering in June
1994, the Company issued a warrant to the underwriter to purchase 60,000 shares
of common stock at $6.60 per share. The warrant is exercisable for five years.

STOCK OPTION PLAN - The Company has a Stock Option Plan (the Plan), pursuant
to which options and other awards to acquire an aggregate of 750,000 shares of
the Company's common stock may be granted. Stock options, stock appreciation
rights, restricted stock, other stock and cash awards may be granted under the
Plan. The Plan is administered by a stock option committee which has the
discretion to determine the number and purchase price of the shares subject to
stock options, which may be below the fair market value of the common stock on
the date thereof, the term of each option, and time or times during its term
when the option becomes exercisable. At December 28, 1997, 365,000 options had
been granted at exercise prices of $0.81 to $5.50 per share, none of which had
been exercised. The weighted average contractual life of these options is 7.3
years.



                                      F-10

<PAGE>   33

                    WOODROAST SYSTEMS, INC. AND SUBSIDIARY
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


DIRECTORS' STOCK OPTIONS - At December 29, 1996, 70,001 options were outstanding
to one of the Company's directors. During 1997 an additional 5,000 options were
granted. All of the options expired in 1997.

The Company applies APB Opinion 25 "Accounting for Stock Issued to Employees"
and related Interpretations in accounting for its stock options. Accordingly, no
compensation cost has been recognized for its stock options. Had compensation
cost for the Company's stock options been determined based on the fair value at
the grant dates consistent with the method of Statement of Financial Accounting
Standards No. 123 "Accounting for Stock Based Compensation" (Statement 123), the
Company's net loss would have been increased to the proforma amounts indicated
below:


<TABLE>
<CAPTION>
                                                                   1997                 1996
                                                              -----------------    ----------------
<S>                                                           <C>                  <C>
Net loss:
  As reported                                                 $   3,182,294        $  1,702,566
  Pro forma                                                   $   3,467,428        $  2,094,371
Loss per share:
  Basic and Diluted EPS as reported                           $        (.75)       $       (.55)
  Basic and Diluted EPS pro forma                             $        (.82)       $       (.67)

</TABLE>

Information regarding the Company's stock options is summarized below:


<TABLE>
<CAPTION>
                                                                   1997                                      1996
                                                 ----------------------------------------- -----------------------------------------
                                                                        Weighted                                    Weighted
                                                      Shares             Average                Shares               Average
                                                                       Exercise Price                            Exercise Price
                                                 ------------------ ---------------------- ------------------ ----------------------
<S>                                              <C>                <C>                    <C>                <C>
Options outstanding, beginning of year                     487,001  $                4.69             54,002  $                 .81
  Granted                                                    8,000                   2.73            473,500                   4.87
  Canceled or expired                                      130,001                   4.36             30,501                   1.57
  Exercised                                                      0                    .00             10,000                    .81
                                                 -----------------                         -----------------
Options outstanding, end of year                           365,000  $                4.79            487,001  $                4.69
                                                 =================  =====================  =================  =====================
Options exercisable, end of year                            75,331  $                4.68             71,333  $                3.71
                                                 =================  =====================  =================  =====================
Weighted average fair value of
  options granted during the year                                   $                2.16                     $                4.21
                                                                    =====================                     =====================
</TABLE>



                                      F-11
<PAGE>   34

                    WOODROAST SYSTEMS, INC. AND SUBSIDIARY
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


In determining the compensation cost of the options granted during 1997 and
1996, as specified by Statement 123, the fair value of each option grant has
been estimated on the date of grant using the Black-Scholes option pricing model
and the weighted average assumptions used in these calculations are summarized
below:


<TABLE>
<CAPTION>
                                                                     1997                 1996
                                                              -------------------- --------------------
<S>                                                            <C>                   <C>
        Risk free interest rate                                           7%                   7%
        Expected life of options granted                            10 years             10 years
        Expected volatility                                            75.2%                85.3%
        Expected dividend yield                                           0%                   0%

</TABLE>

(9)     INCOME TAXES

The Company has adopted Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes", under which deferred income tax assets and
liabilities are recognized for the differences between the financial and income
tax reporting basis of assets and liabilities based on currently enacted rates
and laws. The Company has incurred cumulative net operating losses for both
financial reporting and income tax reporting purposes. At December 28, 1997, the
Company had net operating loss carryforwards of approximately $5,315,000, which,
if not used, will begin to expire in 2010. Future changes in the ownership of
the Company may place limitations on the use of these net operating loss
carryforwards. The Company has recorded a full valuation allowance against the
net deferred tax asset due to the uncertainty of realizing the related benefits.

<TABLE>
<CAPTION>
                                                                December 28,      December 29,
                                                                    1997               1996
                                                               --------------   --------------
<S>                                                            <C>              <C>
        Net operating loss carryforward                        $    2,555,000   $    1,268,000
        Less: valuation allowance                                   2,555,000        1,268,000
                                                               ==============   ==============
          Net deferred tax asset                               $            0   $            0
                                                               ==============   ==============

</TABLE>

(10)  SUPPLEMENTAL CASH FLOWS INFORMATION


<TABLE>
<CAPTION>
                                                                   December 28,    December 29,
                                                                      1997            1996
<S>                                                            <C>              <C>
Cash paid for interest                                         $      165,402   $      195,540
                                                               ==============   ==============
Non cash investing and financing activities:
  Equipment purchased under capital lease                      $                $
    obligations                                                         5,299           90,000
                                                               ==============   ==============
  Issuance of private warrants for construction
    services provided                                          $            0   $       48,405
                                                               ==============   ==============
  Unearned compensation from grant of options                  $            0   $       14,585
                                                               ==============   ==============
  Change in unrealized loss on available-for-sale
    securities                                                 $       16,250   $      (16,250)
                                                               ==============   ==============
</TABLE>

                                      F-12

<PAGE>   35

                    WOODROAST SYSTEMS, INC. AND SUBSIDIARY
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996


(11)     RETIREMENT SAVINGS PLAN

In January 1997, the Company implemented a pre-tax salary reduction/profit
sharing plan under the provisions of Section 401(k) of the Internal Revenue
Code, which covers employees meeting certain eligibility requirements. Profit
sharing contributions by the Company are completely discretionary. The Company
did not make a contribution to the plan in 1997.

(12)     COMMITMENTS AND CONTINGENCIES

OPERATING LEASES - The Company has entered into various operating leases for its
existing and future restaurants and Back Rooms and corporate office space with
lease terms ranging from five to fifteen years including lease options. One of
the leases requires a percentage rent of 5% of annual gross sales for the
restaurant in excess of $6,500,000, in addition to the base rent. All of these
leases contain provisions for payments of real estate taxes, insurance and
common area costs. In addition to the leases described above, the Company leases
various equipment on operating leases that expire through 2000.

Total rent expense for the years ended December 28, 1997 and December 29, 1996,
including common area costs and real estate taxes, was $747,436 and $462,245.
The Company was not required to pay percentage rent for years ended December 31,
1997 and 1996.

Future minimum rental payments (excluding percentage rents) for the operating
leases described above are as follows for the years ending December 28:

<TABLE>
<S>                                   <C>
                  1998                  $  676,677
                  1999                     664,209
                  2000                     655,901
                  2001                     667,229
                  2002                     633,612
                  Thereafter             2,021,027
                                        ==========
                    Total               $5,318,655
                                        ==========
</TABLE>

EMPLOYMENT AGREEMENTS - The Company has employment agreements with two of its
officers. The agreements require minimum annual compensation of $175,000 and
$225,000, have terms of three and five years and require one year's severance
pay. The agreements include benefits, other compensation and executive
perquisites in addition to non-compete provisions.



                                      F-13

<PAGE>   36

                   WOODROAST SYSTEMS, INC. AND SUBSIDIARY
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
                   DECEMBER 28, 1997 AND DECEMBER 29, 1996



(13)     SUBSEQUENT EVENTS

During February 1998, the Company completed a private placement of 117,500
shares of Class A 8% convertible preferred stock with a stated value of $10.00
per share (the preferred stock) and received net proceeds of $996,000. The
preferred stock is convertible into shares of the Company's $.005 par value
common stock based on dividing the aggregate stated value of the preferred stock
and accrued dividends by the lesser of $1.125 or 80% (the conversion rate) of
the average closing bid price for common stock five days prior to the
conversion. In addition, the conversion rate is subject to reduction to 70% upon
the passage of specified time periods and the nonoccurrence of certain events as
defined in the private placement. The preferred stock is convertible from
February 1998 to February 2001.

Based on recent guidance by the Securities and Exchange Commission, the Company
will be required to recognize a non-cash charge for approximately $1.1 million
in the first quarter of 1998. The non-cash charge will result in no net effect
on stockholders' equity since the charge, reflecting the approximate discount to
market calculated at the date of the preferred stock was issued, is offset by a
corresponding increase in additional paid-in capital. The preferred stock not
converted by February 2001 is automatically converted into shares of the
Company's $.005 par value common stock. The Company may redeem the preferred
stock in whole upon 20 days notice at a price of 120% of the total stated value
of the preferred stock plus any accrued dividends. Additionally, the Company
issued a warrant to the agent to purchase 175,000 shares of the Company's common
stock at $1.125 per share in connection with the offering. The warrant is
exercisable for four years.



<PAGE>   37

                                EXHIBIT INDEX

<TABLE>
<CAPTION>
    EXHIBIT
      NO.        DESCRIPTION                                                            PAGE NO.
  -----------    -----------                                                            --------
<S>              <C>                                                                    <C>
      3.1        Amended and Restated Articles of Incorporation of Woodroast
                 Systems, Inc., as amended May 24, 1995, incorporated by
                 reference from Exhibit 3.1 to the Company's Registration
                 Statement on Form S-3 (File No. 333-48257) filed with the
                 Securities and Exchange Commission on March 19, 1998 (the "1998
                 S-3")
      3.2        Amended and Restated Bylaws of Woodroast Systems, Inc.,
                 incorporated by reference from Exhibit 3.2 to the Company's
                 Registration Statement on Form SB-2 (File No. 33-75152C) filed
                 with the Securities and Exchange Commission on February 27,
                 1994 (the "1994 SB-2")
        4        Form of Warrant Agreement by and between the Company and
                 Norwest Bank Minnesota, N.A., incorporated by reference from
                 Exhibit 4 to the 1994 SB-2
     10.1        Employment Agreement between the Company and Ralph J. Guarino
                 dated as of September 5, 1996, incorporated by reference from
                 Exhibit 10.1 to the annual report on Form 10-KSB for the fiscal
                 year ended December 31, 1995 filed with the Securities and
                 Exchange Commission on March 31, 1996 (the "1995 10-KSB")
     10.2        Employment Agreement between the Company and Alex Gionta dated
                 as of November 18, 1996, incorporated by reference from Exhibit
                 10.3 to the Company's annual report on Form 10-KSB for the
                 fiscal year ended December 29, 1996 filed with the Securities
                 and Exchange Commission on March 31, 1997 (the "1996 10-KSB")
     10.3        Lease Agreement by and between Northstar Pizza Properties,  Inc. and
                 Shelly's Two dated January 19, 1989,  incorporated  by reference from
                 Exhibit 10.3 to the 1994 SB-2
     10.4        Agreement of Lease by and between 1331 F Street, Inc. and the
                 Company dated July 22, 1996, incorporated by reference from
                 Exhibit 10.5 to the 1996 10-KSB
     10.5        Company's  1994 Stock Plan,  incorporated  by reference  from
                 Exhibit 10.4  to the 1994 SB-2
     10.6        Amendment dated May 29, 1996 to the Company's 1994 Stock Plan,
                 incorporated by reference from Exhibit 10.7 to the 1996 10-KSB
     10.7        Form of Non-qualified Stock Option Agreement, incorporated by
                 reference from Exhibit 10.6 to the 1994 SB-2

</TABLE>

<PAGE>   38
<TABLE>
<CAPTION>
    EXHIBIT
      NO.        DESCRIPTION                                                            PAGE NO.
  -----------    -----------                                                            --------
<S>              <C>                                                                    <C>
       10.8      Form of Restructured Stock Option Agreement, incorporated by
                 reference from Exhibit 10.7 to the 1994 SB-2
       10.9      Registration Rights Agreement by and among the Company, Sheldon
                 F. Jacobs, John B. Goodman and Daniel T. Lindsay, incorporated
                 by reference from Exhibit 10.12 to the 1994 SB-2
      10.10      Form of Escrow Agreement by and among the Company, National
                 City Bank of Minneapolis and Sheldon F. Jacobs, incorporated by
                 reference from Exhibit 10.13 to the 1994 SB-2
      10.11      Second Amendment to and Restatement of Agreement, by and among
                 the Company, Sheldon F. Jacobs, John B. Goodman and Daniel T.
                 Lindsay dated January 27, 1994, incorporated by reference from
                 Exhibit 10.14 to the 1994 SB-2
      10.12      Shareholders Agreement by and among the Company, Sheldon F.
                 Jacobs, John B. Goodman and Daniel T. Lindsay dated January 27,
                 1994, incorporated by reference from Exhibit 10.15 to the 1994
                 SB-2
      10.13      Shareholder Agreement by and between Shelly's Two and Sheldon
                 F. Jacobs dated January 27, 1994, incorporated by reference
                 from Exhibit 10.16 to the 1994 SB-2
      10.14      Escrow Agreement by and among First Trust National Association,
                 Sheldon F. Jacobs, John B. Goodman, Daniel T. Lindsay, Shelly's Two,
                 Woodroast Acquisition Corp. and the Company  dated as of
                 January 27, 1994, incorporated  by reference from Exhibit 10.17
                 to the 1994 SB-2
      10.15      Agreement and Plan of Merger by and among Shelly's Two, the Company,
                 Woodroast Acquisition Corp. and Sheldon F. Jacobs dated May 4, 1994,
                 incorporated by reference from Exhibit 10.18 to the 1994 SB-2
      10.16      Lease by and between Congressional Plaza Associates, Federal
                 Realty, Investment Trust and Woodroast Systems, Inc.,
                 incorporated by reference from Exhibit 10.17 to the 1995 10-KSB
      10.17      Form of Promissory Note dated November 7, 1995, incorporated by
                 reference from Exhibit 10.18 to the 1995 10-KSB
      10.18      Employment Agreement between Woodroast Systems, Inc. and
                 Sheldon F. Jacobs dated as of January 1, 1998, incorporated by
                 reference from Exhibit 10.19 to the 1998 S-3

</TABLE>



<PAGE>   39
<TABLE>
<CAPTION>
    EXHIBIT
      NO.        DESCRIPTION                                                                    PAGE NO.
  -----------    -----------                                                                    --------
<S>              <C>                                                                            <C>
    10.19        Promissory Note of Woodroast Systems, Inc. to Sheldon F. Jacobs dated
                 December 1997, incorporated by reference from Exhibit 10.20 to the 1998
                 S-3
    10.20        Promissory Note of Woodroast Systems, Inc. to Sheldon F. Jacobs dated
                 January 27, 1997, incorporated by reference from Exhibit 10.21 to the
                 1998 S-3
    10.21        Promissory Note of Woodroast  Systems,  Inc. to Sheldon F. Jacobs dated
                 March 24, 1998...........................................................
     21.1        Subsidiary of Woodroast  Systems, Inc. Incorporated by reference from
                 Exhibit 10.18 to the 1995 10-KSB
     23.1        Consent of Lund Koehler Cox & Company, PLLP..............................
       24        Power of Attorney (set forth on the signature page)
       27        Financial Data Schedule for fiscal year ended December 28, 1997..........

</TABLE>