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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

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**FORM 10-Q**

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

 

**FOR THEQUARTERLY PERIOD ENDED March 31, 2009**

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

 

**CommissionFile Number 000-29643**

 

**GRANITE CITY FOOD & BREWERY LTD.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Minnesota**                                                    |   | **41-1883639**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction  of Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |

 

**5402Parkdale Drive, Suite 101****Minneapolis, Minnesota  55416****(952) 215-0660**(Address of Principal Executive Offices and Issuer’sTelephone Number, including Area Code)

 

Indicate by check markwhether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§ 229.405 of thischapter) during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files).  Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 

| Large  accelerated filer o              |   | Accelerated  filer o         |
|----------------------------------------------|--------|-----------------------------------|
|                                         |   |                              |
| Non-accelerated  filer o                |   | Smaller  reporting company x |
| (Do not check if  smaller reporting company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

 

Asof May 5, 2009, the issuer had outstanding 16,197,849****shares ofcommon stock.

 

 

 

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**TABLE OF CONTENTS**

 
| ** **             | ** ** | ** **                                                                                                                 | ** ** | **Page** |
|------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                   |       |                                                                                                                       |       |     |
| **PART I**        | ** ** | **FINANCIAL  INFORMATION**                                                                                                 |       | 1        |
|                   |       |                                                                                                                       |       |     |
| ITEM 1                 |       | Financial Statements                                                                                                       |       | 1        |
|                   |       |                                                                                                                       |       |     |
|                   |       | Condensed Consolidated Balance Sheets as of  March 31, 2009 and December 30, 2008                                |       | 1        |
|                   |       |                                                                                                                       |       |     |
|                   |       | Condensed  Consolidated Statements of Operations for the Thirteen Weeks ended  March 31, 2009 and March 25, 2008 |       | 2        |
|                   |       |                                                                                                                       |       |     |
|                   |       | Condensed Consolidated Statements of Cash Flows for  the Thirteen Weeks ended March 31, 2009 and March 25, 2008  |       | 3        |
|                   |       |                                                                                                                       |       |     |
|                   |       | Notes to Condensed Consolidated Financial Statements                                                                       |       | 4        |
|                   |       |                                                                                                                       |       |     |
| ITEM 2                 |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                |       | 16       |
|                   |       |                                                                                                                       |       |     |
| ITEM 3                 |       | Quantitative  and Qualitative Disclosures about Market Risk                                                                |       | 28       |
|                   |       |                                                                                                                       |       |     |
| ITEM 4                 |       | Controls and  Procedures                                                                                                   |       | 29       |
|                   |       |                                                                                                                       |       |     |
| **PART II**       | ** ** | **OTHER INFORMATION**                                                                                                      |       | 30       |
|                   |       |                                                                                                                       |       |     |
| ITEM 1                 |       | Legal Proceedings                                                                                                          |       | 30       |
|                   |       |                                                                                                                       |       |     |
| ITEM 1A                |       | Risk Factors                                                                                                               |       | 30       |
|                   |       |                                                                                                                       |       |     |
| ITEM 2                 |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                               |       | 30       |
|                   |       |                                                                                                                       |       |     |
| ITEM 3                 |       | Defaults  upon Senior Securities                                                                                           |       | 30       |
|                   |       |                                                                                                                       |       |     |
| ITEM 4                 |       | Submission  of Matters to a Vote of Security Holders                                                                       |       | 30       |
|                   |       |                                                                                                                       |       |     |
| ITEM 5                 |       | Other Information                                                                                                          |       | 30       |
|                   |       |                                                                                                                       |       |     |
| ITEM 6                 |       | Exhibits                                                                                                                   |       | 30       |
|                   |       |                                                                                                                       |       |     |
| **SIGNATURES**         |       | 31                                                                                                                         |
|                   |       |                                                                                                                       |
| **INDEX  TO EXHIBITS** |       | 32                                                                                                                         |

 

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**PART I****                              ****FINANCIAL INFORMATION**

 

**ITEM 1  Financial Statements**

 

**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                | ** ** | **March 31,** | ** ** | **December 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ASSETS:                                                                                                                                                   |       |               |       |                  |       |
| Current assets:                                                                                                                                           |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                |       | $                  | 1,407,926  |                  | $          | 2,652,411 |   |
| Inventory                                                                                                                                                 |       | 874,179            |       | 773,468               |       |
| Prepaids and  other                                                                                                                                       |       | 608,571            |       | 473,343               |       |
| Total current  assets                                                                                                                                     |       | 2,890,676          |       | 3,899,222             |       |
|                                                                                                                                                      |       |               |       |                  |       |
| Prepaid rent,  net of current portion                                                                                                                     |       | 442,206            |       | 456,644               |       |
| Property and  equipment, net                                                                                                                              |       | 77,517,488         |       | 76,251,463            |       |
| Intangible and  other assets                                                                                                                              |       | 1,620,332          |       | 1,503,336             |       |
| Total assets                                                                                                                                              |       | $                  | 82,470,702 |                  | $          | 82,110,665 |   |
|                                                                                                                                                      |       |               |       |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ (DEFICIT) EQUITY:                                                                                                     |       |               |       |                  |       |
| Current liabilities:                                                                                                                                      |       |               |       |                  |       |
| Accounts payable                                                                                                                                          |       | $                  | 1,802,960  |                  | $          | 2,000,812 |   |
| Accrued expenses                                                                                                                                          |       | 5,096,207          |       | 5,962,487             |       |
| Accrued exit or  disposal activities, current portion                                                                                                     |       | 20,225             |       | 19,999                |       |
| Deferred rent,  current portion                                                                                                                           |       | 198,439            |       | 203,062               |       |
| Long-term debt,  current portion                                                                                                                          |       | 324,750            |       | 320,697               |       |
| Capital lease  obligations, current portion                                                                                                               |       | 3,180,369          |       | 3,201,829             |       |
| Total current  liabilities                                                                                                                                |       | 10,622,950         |       | 11,708,886            |       |
|                                                                                                                                                      |       |               |       |                  |       |
| Accrued exit or  disposal activities, net of current portion                                                                                              |       | 1,117,353          |       | 822,494               |       |
| Deferred rent,  net of current portion                                                                                                                    |       | 2,769,296          |       | 2,817,593             |       |
| Long-term debt,  net of current portion                                                                                                                   |       | 2,339,392          |       | 1,668,134             |       |
| Capital lease  obligations, net of current portion                                                                                                        |       | 65,756,848         |       | 62,616,992            |       |
| Total  liabilities                                                                                                                                        |       | 82,605,839         |       | 79,634,099            |       |
|                                                                                                                                                      |       |               |       |                  |       |
| Shareholders’  (deficit) equity:                                                                                                                     |       |               |       |                  |       |
| Common stock,  $0.01 par value, 90,000,000 shares authorized; 16,197,849 shares issued and  outstanding at March 31, 2009 and December 30, 2008 |       | 161,978            |       | 161,978               |       |
| Additional  paid-in capital                                                                                                                               |       | 43,962,281         |       | 43,844,373            |       |
| Accumulated  deficit                                                                                                                                      |       | (44,259,396        | )          | (41,529,785           | )          |
| Total  shareholders’ (deficit) equity                                                                                                                |       | (135,137           | )          | 2,476,566             |       |
|                                                                                                                                                      |       |               |       |                  |       |
| Total  liabilities and shareholders’ (deficit) equity                                                                                                |       | $                  | 82,470,702 |                  | $          | 82,110,665 |   |

 

See notes tocondensed consolidated financial statements.

 

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**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                  | ** ** | **Thirteen Weeks Ended** | ** ** |
|---------------------------------------------|------------|--------------------------|------------|
| ** **                                  | ** ** | **March 31,**       | ** ** | **March 25,** | ** ** |
| ** **                                  | ** ** | **2009**                 | ** ** | **2008** | ** ** |
|                                        |       |                     |       |   |   |
| Restaurant  revenues                        |       | $                        | 21,424,701 |   | $ | 24,019,485 |   |
|                                        |       |                     |       |   |   |
| Cost of sales:                              |       |                     |       |   |   |
| Food, beverage  and retail                  |       | 5,826,253                |       | 7,524,068 |   |
| Labor                                       |       | 7,531,642                |       | 9,352,023 |   |
| Direct  restaurant operating                |       | 3,193,754                |       | 3,557,835 |   |
| Occupancy                                   |       | 1,572,200                |       | 1,546,898 |   |
| Total cost of  sales                        |       | 18,123,849               |       | 21,980,824 |   |
|                                        |       |                     |       |   |   |
| Pre-opening                                 |       | 192,929                  |       | 583,373 |   |
| General and  administrative                 |       | 2,064,316                |       | 2,690,966 |   |
| Depreciation and  amortization              |       | 1,706,577                |       | 1,561,646 |   |
| Exit or disposal  activities                |       | 428,080                  |       | — |   |
| Other                                       |       | 9,101                    |       | 35,764 |   |
|                                        |       |                     |       |   |   |
| Operating loss                              |       | (1,100,151               | )          | (2,833,088 | ) |
|                                        |       |                     |       |   |   |
| Interest:                                   |       |                     |       |   |   |
| Income                                      |       | 1,498                    |       | 15,208 |   |
| Expense                                     |       | (1,630,958               | )          | (1,488,826 | ) |
| Net interest  expense                       |       | (1,629,460               | )          | (1,473,618 | ) |
|                                        |       |                     |       |   |   |
| Net loss                                    |       | $                        | (2,729,611 | ) | $ | (4,306,706 | ) |
|                                        |       |                     |       |   |   |
| Loss per common  share, basic               |       | $                        | (0.17      | ) | $ | (0.27 | ) |
|                                        |       |                     |       |   |   |
| Weighted average  shares outstanding, basic |       | 16,197,849               |       | 16,182,284 |   |

 

See notes tocondensed consolidated financial statements.

 

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**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
| ** **                                                                         | ** ** | **Thirteen Weeks Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**       | ** ** | **March 25,** | ** ** |
| ** **                                                                         | ** ** | **2009**                 | ** ** | **2008** | ** ** |
|                                                                               |       |                     |       |   |   |
| Cash flows from  operating activities:                                             |       |                     |       |   |   |
| Net loss                                                                           |       | $                        | (2,729,611 | ) | $ | (4,306,702 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:       |       |                     |       |   |   |
| Depreciation and  amortization                                                     |       | 1,693,742                |       | 1,549,977 |   |
| Other  amortization                                                                |       | 12,835                   |       | 11,669 |   |
| Stock warrant/option  expense                                                      |       | 117,908                  |       | 121,281 |   |
| Loss on disposal  of property and equipment                                        |       | 9,101                    |       | 35,764 |   |
| Loss on exit or  disposal activities                                               |       | 295,085                  |       | — |   |
| Deferred rent                                                                      |       | (52,920                  | )          | 70,433 |   |
| Changes in  operating assets and liabilities:                                      |       |                     |       |   |   |
| Inventory                                                                          |       | (100,711                 | )          | (144,595 | ) |
| Prepaids and  other                                                                |       | (120,790                 | )          | 68,567 |   |
| Accounts payable                                                                   |       | (254,112                 | )          | 270,266 |   |
| Accrued expenses                                                                   |       | (866,280                 | )          | (399,447 | ) |
| Net cash used in  operating activities                                             |       | (1,995,753               | )          | (2,722,787 | ) |
|                                                                               |       |                     |       |   |   |
| Cash flows from  investing activities:                                             |       |                     |       |   |   |
| Purchase of:                                                                       |       |                     |       |   |   |
| Property and  equipment                                                            |       | (196,662                 | )          | (1,221,694 | ) |
| Intangible and  other assets                                                       |       | (129,831                 | )          | (214,782 | ) |
| Net cash used in  investing activities                                             |       | (326,493                 | )          | (1,436,476 | ) |
|                                                                               |       |                     |       |   |   |
| Cash flows from  financing activities:                                             |       |                     |       |   |   |
| Payments on  capital lease obligations                                             |       | (597,550                 | )          | (421,029 | ) |
| Proceeds from  capital leases                                                      |       | 1,000,000                |       | — |   |
| Payments on  long-term debt                                                        |       | (124,689                 | )          | (66,882 | ) |
| Proceeds from  long-term debt                                                      |       | 800,000                  |       | — |   |
| Net proceeds  from issuance of stock                                               |       | —                   |       | 34,046 |   |
| Net cash  provided by (used in) financing activities                               |       | 1,077,761                |       | (453,865 | ) |
|                                                                               |       |                     |       |   |   |
| Net decrease in  cash                                                              |       | (1,244,485               | )          | (4,613,128 | ) |
| Cash and cash  equivalents, beginning                                              |       | 2,652,411                |       | 7,076,835 |   |
| Cash and cash  equivalents, ending                                                 |       | $                        | 1,407,926  |   | $ | 2,463,707 |   |
|                                                                               |       |                     |       |   |   |
| Supplemental  disclosure of non-cash investing and financing activities:           |       |                     |       |   |   |
| Land, buildings  and equipment acquired under capital lease agreements             |       | $                        | 2,855,116  |   | $ | 5,759,548 |   |
| Property and  equipment and intangibles purchased and included in accounts payable |       | $                        | 56,260     |   | $ | 1,153,827 |   |

 

See notes tocondensed consolidated financial statements.

 

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**GRANITE CITY FOOD & BREWERY LTD.**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

**Thirteen weeks ended March 31, 2009 and March 25,2008**

 

**1.****             ****Summary of significant accountingpolicies**

 

Background

GraniteCity Food & Brewery Ltd. (the “Company”) develops and operates ModernAmerican casual dining restaurants known as Granite City Food &Brewery®.   The restaurant theme isupscale casual dining with a wide variety of menu items that are prepared freshdaily, combined with freshly brewed hand-crafted beers finished on-site.  The Company opened its first Granite Cityrestaurant in St. Cloud, Minnesota in July 1999 and has since expanded toother Midwest markets.  As of March 31,2009, the Company operated 26 restaurants. The Company also operates a beer production facility which is used toprovide raw material support to its restaurants to create consistent qualityand operational efficiencies in the production of its proprietary beer.  In 2007, the Company was granted a patent bythe United States Patent Office for its brewing process.

 

Principlesof consolidation and basis of presentation

Asa result of the Company’s history of recurring losses, negative cash flow fromoperations and its accumulated deficit, the Company has carefully assessed itsanticipated cash needs for the next 12 months.  Although the Company has no further plans forexpansion in 2009, the Company believes that long-term expansion plans willallow the Company to gain greater leverage of its current infrastructure.  During the first three months of operationsin 2009, the Company did not meet its internal budget primarily due todeclining revenue.  If the economicslowdown continues to adversely affect the U.S. economy and the restaurantindustry in particular, the Company will require further funding for operationsduring 2009.  The Company would berequired to raise such funds through the incurrence of indebtedness or publicor private sales of equity securities, which may be dilutive to shareholders.The amount of any such required funding would depend upon sales trends and theCompany’s ability to generate positive cash flow.  The Company anticipates that it will need toraise additional funds for future expansion depending upon the level ofexpansion determined to be appropriate in later years as compared to the cashflow of the Company.  If cash flow fromoperations and other sources of liquidity are insufficient to fund expectedcapital needs, or the Company’s needs are greater than anticipated, itsbusiness and results of operations will be materially and adversely affected.

 

TheCompany’s ability to fund its operations in future periods will depend upon itsfuture operating performance, and more broadly, achieving budgeted revenue andon the availability of equity and debt financing, all of which will be affectedby prevailing economic conditions in the industry and its financial, businessand other factors, which may be beyond the Company’s control.  The Company cannot assure you that it willobtain financing on favorable terms or at all. If the Company elects to raise additional capital through the issuanceand sale of equity securities, the sales may be at prices below the marketprice of its stock, and its shareholders may suffer significant dilution.  Debt financing, if available, may involvesignificant cash payment obligations, covenants and financial ratios thatrestrict the Company’s ability to operate and grow its business, and wouldcause it to incur additional interest expense and financing costs.

 

TheCompany’s condensed consolidated financial statements include the accounts andoperations of the Company and its subsidiary corporation under which its Kansaslocations are operated.  Fifty percent ofthe stock of the subsidiary corporation is owned by a resident of Kansas.  Granite City Restaurant Operations, Inc.,a wholly-owned subsidiary of the Company, owns the remaining 50% of the stockof the subsidiary corporation.  Theresident-owner of the stock of that entity has entered into a buy-sellagreement with the subsidiary corporation providing, among other things, thattransfer of the shares is restricted and that the shareholder must sell hisshares to the subsidiary corporation upon certain events, or any event thatdisqualifies the resident-owner from owning the shares under applicable lawsand regulations of the state.  TheCompany has entered into a master agreement with the subsidiary corporationthat permits the operation of the restaurants and leases to the subsidiarycorporation the Company’s property and facilities.  The subsidiary corporation pays all of itsoperating expenses and obligations, and the Company retains, as considerationfor the operating arrangements and the lease of property and facilities, allthe net profits, as defined, if any, from such operations.  The Company has determined that the foregoingownership structure

 

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willcause the subsidiary corporation to be treated as a variable interest entity inwhich the Company has a controlling financial interest for the purpose ofFinancial Accounting Standards Board (“FASB”) Interpretation 46 (R), *Consolidation of Variable Interest Entities. *As such, the subsidiarycorporation is consolidated with the Company’s financial statements and theCompany’s financial statements do not reflect a minority ownership in thesubsidiary corporation.  Also included inthe Company’s condensed consolidated financial statements are otherwholly-owned subsidiaries.  Allreferences to the Company in these notes to condensed consolidated financialstatements relate to the consolidated entity, and all intercompany balanceshave been eliminated.

 

Inthe opinion of management, all adjustments, consisting of normal recurring adjustments,which are necessary for a fair statement of its financial position as of March 31,2009  and the results of operations forthe interim periods ended March 31, 2009 and March 25, 2008 have beenincluded.

 

Thebalance sheet at December 30, 2008 has been derived from the auditedfinancial statements at that date, but does not include all of the informationand notes required by generally accepted accounting principles for completefinancial statements.  Certain information and note disclosuresnormally included in the Company’s annual financial statements have beencondensed or omitted.  These condensedfinancial statements should be read in conjunction with the financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the fiscal year ended December 30, 2008, filed with the Securities andExchange Commission on March 19, 2009.

 

The results of operationsfor the thirteen weeks ended March 31, 2009 are not necessarily indicativeof the results to be expected for the entire year.

 

Useof estimates

Thepreparation of financial statements in conformity with generally acceptedaccounting principles in the United States of America and regulations of theSecurities and Exchange Commission requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expense during the reportingperiod.  Significant estimates includeestimates related to asset lives, lease accounting and revenuerecognition.  Actual results could differfrom these estimates.

 

Reclassifications

Certainminor reclassifications have been made to the condensed consolidated financialstatements for fiscal year 2008 for them to conform to the presentation of thecondensed consolidated financial statements for fiscal year 2009.  These reclassifications have no effect on theaccumulated deficit or net loss previously reported.

 

Revenuerecognition

Revenueis derived from the sale of prepared food and beverage and select retailitems.  Revenue is recognized at the timeof sale and is reported on the Company’s condensed consolidated statements ofoperations net of sales taxes collected. Revenue derived from gift card sales is recognized at the time the giftcard is redeemed.  Until the redemptionof gift cards occurs, the outstanding balances on such cards are included inaccrued expenses in the accompanying consolidated balance sheets.  The Company periodically recognizes gift cardbreakage which represents the portion of its gift card obligation for whichmanagement believes the likelihood of redemption by the customer is remote,based upon historical redemption patterns. Such amounts are included as a reduction to general and administrativeexpense.

 

Cashequivalents

TheCompany considers all highly liquid instruments with original maturities ofthree months or less to be cash equivalents.

 

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Stock-basedcompensation

The Company accounts for stock-based compensation in accordance withthe provisions of SFAS No. 123 (revised 2004) (“SFAS 123(R)”), *Share-Based Payment*, and SEC StaffAccounting Bulletin No. 107 (“SAB 107”), *Share-BasedPayment,* requiring the measurement and recognition of allshare-based compensation under the fair value method.

 

The fair value of optionsat date of grant was estimated using the Black-Scholes option-pricing modelwith the following assumptions for the first quarters of 2009 and 2008:

 
| ** **                                | ** ** | **Thirteen Weeks Ended** | ** ** |
|-------------------------------------------|------------|--------------------------|------------|
| ** **                                | ** ** | **March 31,**       | ** ** | **March 25,** | ** ** |
| ** **                                | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| Weighted average  risk-free interest rate |       | 2.25% - 2.91%            |       | 4.04% |   |
| Expected life of  options                 |       | 10 years                 |       | 10 years |   |
| Expected stock  volatility                |       | 66.30% - 74.01%          |       | 40.53% |   |
| Expected  dividend yield                  |       | None                     |       | None |   |

 

Netloss per share

Basicnet loss per share is computed based on the weighted average number of sharesof common stock outstanding during the fiscal year.  Diluted net loss per share is not presentedsince the effect would be anti-dilutive due to the losses.  Calculations of the Company’s net loss percommon share for the quarters ended March 31, 2009 and March 25,2008 are set forth in the following table:

 
| ** **                                  | ** ** | **Thirteen Weeks Ended** | ** ** |
|---------------------------------------------|------------|--------------------------|------------|
| ** **                                  | ** ** | **March 31,**       | ** ** | **March 25,** | ** ** |
| ** **                                  | ** ** | **2009**                 | ** ** | **2008** | ** ** |
| Net loss                                    |       | $                        | (2,729,611 | ) | $ | (4,306,706 | ) |
| Loss per common  share, basic               |       | $                        | (0.17      | ) | $ | (0.27 | ) |
| Weighted average  shares outstanding, basic |       | 16,197,849               |       | 16,182,284 |   |

 

Recent accounting pronouncements

In December 2007, theFinancial Accounting Standards Board (FASB) issued FASB Statement (“SFAS”) No. 141(Revised 2007),*Business Combinations*(“SFAS141R”)*.*  SFAS 141R will significantly change theaccounting for business combinations and certain other transactions.  SFAS 141R will apply prospectively tobusiness combinations and certain other transactions for which the acquisitiondate is on or after the start of the first annual reporting period beginning onor after December 15, 2008*.*  The Company currently does not contemplateany business combinations or other transactions that will be subject to SFAS141R.

 

In December 2007, theFASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated Financial Statements - An Amendment ofARB No. 51*(“SFAS 160”)*.* SFAS 160 establishes new accounting andreporting standards for the noncontrolling interest in a subsidiary and for thedeconsolidation of a subsidiary.  Inaddition, this statement requires that a parent recognize a gain or loss in netincome when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of thenoncontrolling equity investment on the deconsolidation date.  SFAS 160 is effective for fiscal years, andinterim periods within those fiscal years, beginning on or after December 15,2008.  Since the Company does notcurrently have and does not contemplate acquiring any interests in subsidiariesor variable interest entities with noncontrolling interests, management expectsthat SFAS 160 will not have an impact on the Company’s future financialposition, results of operations and operating cash flows.

 

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InApril 2008, the FASB issued FASB Staff Position No. FAS 142-3, *Determination of the Useful Life of Intangible Assets* (“FSP142-3”).  FSP 142-3 amends the factorsthat should be considered in developing renewal or extension assumptions usedto determine the useful life of a recognized intangible asset under FASBStatement No. 42, *Goodwill and OtherIntangible Assets. *FSP 142-3must be applied prospectively to all intangible assets acquired subsequent tofiscal years beginning after December 15, 2008.  The implementation of this staff position inthe first quarter of fiscal 2009 has not had a material impact on the Company’sfinancial position,results of operations and operating cash flows.

 

InJune 2008, the FASB issued Emerging Issues Task Force No. 08-03, *Accounting for Leases for Maintenance Deposits*(“EITF No,08-03”).  EITF No. 08-03 addresses how a lessee should account for anonrefundable maintenance deposit under an arrangement accounted for as alease.  The guidance in EITF No. 08-03 is effective for fiscal yearsbeginning after December 15, 2008, including interim periods within thosefiscal years.  Implementation ofthis staff position in the first quarter of fiscal 2009 has not had a materialimpact on the Company’s financialposition, results of operations and operating cash flows.

 

**2.****             ****Fairvalue of financial instruments**

 

At March 31, 2009 and December 30, 2008, the fair value ofcash and accounts payable approximate their carrying value due to theshort-term nature of the instruments. The fair value of the capital leaseobligations and long-term debt is estimated at its carrying value based uponcurrent rates available to the Company.

 

**3.****             ****Exit ordisposal activities**

 

Rogers,Arkansas

InAugust 2008, the Company ceased operations at its Rogers, Arkansasrestaurant.  Since opening in October 2007,the restaurant failed to generate positive cash flow and had approximately $1.4million of net loss.  Management believesthe closure of this restaurant will allow the Company to focus its capital andpersonnel resources on its other restaurants in order to increase futureoperating efficiencies and cash flow. The Company is working to find a replacement tenant for the location,for which it is bound by a 20-year net lease. Costs incurred in connection with this closure include one-time benefitsto employees who were involuntarily terminated of $57,681, costs incurred for earlycontract termination of $4,578 and costs to close and maintain the facility of$364,494.  Until the Company is able tofind a replacement tenant, it will incur ongoing costs such as utilities,landscape and maintenance and general liability insurance. In accordance withthe requirements of SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities,* the Company recorded anon-cash lease termination liability of $852,146 based on management’s estimateof the fair value of these obligations. This required management to estimate the present value of the futureminimum lease obligations offset by the estimated sublease rentals that couldbe reasonably obtained for the property. During the third quarter of 2008, the Company recorded a non-cashimpairment charge of $135,057 related to the write-off of the carrying value ofthe restaurant equipment at the Rogers location.  The amount of this write-off is equal to thedifference between the net book value of the equipment and the expected futurecash flows generated by leasing the equipment to a replacement tenant.

 

Troy, Michigan

In May 2008, the Company entered into a 20-year net leaseagreement relating to the restaurant it had planned to open in Troy,Michigan.  However, in February 2009,the Company decided not to build on that site, and as part of an agreement withDunham Capital Management, L.L.C. (“Dunham”), DHW Leasing, L.L.C. (“DHW”) andDunham Equity Management, L.L.C. (collectively, the “Dunham Entities”), theCompany will reimburse Dunham for any out-of-pocket expenses incurred,including the carrying cost of the related land,  less net proceeds from the sale of the realestate or lease income associated with the site (Note 9).  Such expenses will be amortized and payableto Dunham over a 60-month period commencing January 2011, at a 6% annualinterest rate.  The Company’s managementhas concluded that as of March 31, 2009, it is probable that the Companywill need to reimburse Dunham approximately $300,000 of such costs.   Pursuant to SFAS No. 5,*Accounting for Contingencies,* the Company has included $300,000 in“exit or disposal activities” on 

 

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its condensed consolidated statements of operations and “accrued exitor disposal activities” on its balance sheet.

 

The costs related to the closing of the Rogers restaurant and thedecision not to build the Troy restaurant aggregated approximately $428,080 inthe first quarter of 2009 and are reflected on the Company’s consolidatedstatements of operations as “exit or disposal activities”.**  **The following is a reconciliationof the beginning and ending balances of exit or disposal activities:

 
| Accrued exit or  disposal costs at December 30, 2008 |   | $        | 842,493   |   |
|-----------------------------------------------------------|--------|----------|-----------|--------|
| Costs incurred  and charged to expense                    |   | 432,996  |      |
| Payments                                                  |   | (132,995 | )         |
| Amortization of  sublease liability                       |   | (4,916   | )         |
| Accrued exit or  disposal costs at March 31, 2009    |   | $        | 1,137,578 |   |

 

**4.****             ****Non-currentassets**

 

Property and equipment

Property and equipment is recorded at cost and depreciated over theestimated useful lives of the assets. Leasehold improvements are depreciated over the term of the relatedlease or the estimated useful life, whichever is shorter.  Depreciation and amortization of assets heldunder capital leases and leasehold improvements are computed on thestraight-line method for financial reporting purposes.  The following is a summary of the Company’sproperty and equipment at March 31, 2009 and December 30, 2008:

 
| ** **                     | ** ** | **March 31, 2009** | ** **       | **December 30, 2008** | ** ** |
|--------------------------------|------------|-------------------------|------------------|----------------------------|------------|
| Land                           |       | $                       | 18,000           |                       | $          | 18,000 |   |
| Buildings                      |       | 57,101,974              |             | 54,991,656                 |       |
| Leasehold  improvements        |       | 9,241,824               |             | 9,117,667                  |       |
| Equipment and  furniture       |       | 33,197,520              |             | 31,877,053                 |       |
| Construction in  progress*     |       | 44,505                  |             | 642,579                    |       |
|                           |       | 99,603,823              |             | 96,646,955                 |       |
| Less accumulated  depreciation |       | (22,086,335             | )                | (20,395,492                | )          |
|                           |       | $                       |  77,517,488 |                       | $          | 76,251,463 |   |

 

----

*Construction in progressincludes the following approximate amounts for items yet to be placed inservice:

 
| ** **                                   | ** ** | **March 31, 2009** | ** ** | **December 30, 2008** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Leasehold  improvements for future locations |       | $                       | —     |                       | $          | 187,400 |   |
| Building and  equipment at future locations  |       | $                       | —     |                       | $          | 255,200 |   |
| Equipment at  current locations              |       | $                       | 44,000     |                       | $          | 199,900 |   |

 

Intangibleand other assets

Intangibleand other assets consisted of the following:

 
| ** **                     | ** ** | **March 31, 2009** | ** **      | **December 30, 2008** | ** ** |
|--------------------------------|------------|-------------------------|-----------------|----------------------------|------------|
| Intangible  assets:            |       |                    |            |                       |       |
| Liquor licenses                |       | $                       | 760,865         |                       | $          | 760,865 |   |
| Trademarks                     |       | 140,141                 |            | 140,141                    |       |
| Other:                         |       |                    |            |                       |       |
| Deferred loan  costs           |       | 268,450                 |            | 243,421                    |       |
| Security  deposits             |       | 643,989                 |            | 539,187                    |       |
|                           |       | 1,813,445               |            | 1,683,614                  |       |
|                           |       |                    |            |                       |       |
| Less accumulated  amortization |       | (193,113                | )               | (180,278                   | )          |
|                           |       | $                       |  1,620,332 |                       | $          | 1,503,336 |   |

 

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**5.****             ****Accruedexpenses**

 

Accruedexpenses consisted of the following:

 
| ** **                             | ** ** | **March 31, 2009** | ** **      | **December 30, 2008** | ** ** |
|----------------------------------------|------------|-------------------------|-----------------|----------------------------|------------|
| Payroll and  related                   |       | $                       |  1,083,830 |                       | $          |  1,770,802 |   |
| Deferred revenue  from gift card sales |       | 1,409,639               |            | 1,971,477                  |       |
| Sales taxes  payable                   |       | 572,276                 |            | 619,377                    |       |
| Interest                               |       | 544,735                 |            | 568,777                    |       |
| Real estate  taxes                     |       | 839,447                 |            | 536,290                    |       |
| Other                                  |       | 646,280                 |            | 495,764                    |       |
|                                   |       | $                       |  5,096,207 |                       | $          |  5,962,487 |   |

 

**6.****             ****Deferredrent payable**

 

Under the terms ofthe lease agreement the Company entered into regarding its Lincoln property,the Company received a lease incentive of $450,000, net.  This lease incentive was recorded as adeferred rent payable and is being amortized to reduce rent expense over theinitial term of the lease using the straight-line method.

 

Also included in deferred rent payable isthe difference between minimum rent payments and straight-line rent over theinitial lease term including the “build out” or “rent-holiday” period.  Contingent rent expense, which is based on apercentage of revenue, is also recorded to the extent it exceeds minimum baserent per the lease agreement. Deferred rent payable consisted of the following:

 
| ** **                                              | ** ** | **March 31, 2009** | ** ** | **December 30, 2008** | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Difference  between minimum rent and straight-line rent |       | $                       | 2,593,827  |                       | $          | 2,633,912 |   |
| Contingent rent  expected to exceed minimum rent        |       | 52,519                  |       | 57,854                     |       |
| Tenant  improvement allowance                           |       | 321,389                 |       | 328,889                    |       |
|                                                    |       | $                       | 2,967,735  |                       | $          | 3,020,655 |   |

 

**7.****             ****Long-termdebt**

 

Asof March 31, 2009, the Company had three long-term loans outstanding withan independent financial institution, the proceeds of which it used to purchaseassets at its Fargo, North Dakota; Des Moines and Davenport, Iowarestaurants.  These loans are secured bythe tangible personal property and fixtures at the respective locations and areguaranteed by Steven J. Wagenheim, the Company’s president, chief executiveofficer and one of its directors.

 

InAugust 2008, the Company issued a promissory note to an Indiana generalpartnership in the amount of $250,000. The note was issued to secure the liquor license for the Company’srestaurant located in South Bend, Indiana.

 

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OnMarch 30, 2009, the Company entered into a bridge loan agreement with agroup of accredited investors to provide $1.0 million of partially convertibledebt financing.  The bridge loan isevidenced by notes bearing interest at 9.0% per annum, payable in six equalmonthly installments commencing on May 1, 2010 and due in full on October 1,2010.  The bridge loan was funded to theextent of $800,000 on March 30, 2009, with the balance of the bridge loanto be funded by the end of May 2009 pursuant to an amendment to theagreement dated April 30, 2009.  Thelead investors in the transaction were Harmony Equity Income Fund, L.L.C. andHarmony Equity Income Fund II, L.L.C. (collectively, “Harmony”).  The Company’s Chairman, Eugene E. McGowan, isa member of, and has a beneficial interest in, both of the Harmony funds.  The transaction was approved by the Company’sAudit Committee as a transaction with a related person.  The notes are secured by a mortgage againstthe lease, and security agreements against personal property and intangiblesrelating to the Company’s Sioux Falls, South Dakota restaurant, including agrant of the rights to use patents, trademarks and other intangibles associatedwith that restaurant.  The Company’sBoard of Directors has authorized it to borrow up to an aggregate of $3.0million under the terms of the bridge loan agreement, which provides that theinvestors may, but are not obligated to, make additional loans on substantiallythe same terms and conditions, including a similar pledge of collateral relatedto either its St. Cloud, Minnesota, or Fargo, North Dakota restaurants.  The notes may be prepaid upon 30 days priornotice without premium or penalty.  Thenotes must also be paid if the Company receives $4.0 million or more ofproceeds from the sale of equity securities or securities convertible intoequity securities.  The notes must alsobe repaid in the event the Company defaults under the terms and conditions ofthe bridge loan, including the financial covenants set forth therein.  Such covenants include maintaining minimumoperating income before interest, taxes, depreciation and amortization from theSioux Falls, South Dakota restaurant operations, and minimum consolidatedrevenue of the Company, as provided in the bridge loan agreement.  Up to 20% of each bridge note may beconverted into common stock at a conversion price equal to $0.50 per share.

 

Inaddition, the Company agreed to issue to the investors warrants for thepurchase of an aggregate of 400,000 shares of common stock exercisable sixmonths after date of issuance at a price of $0.25267 per share, or 110% of theclosing price of the Company’s stock on March 30, 2009.  As of March 31, 2009, warrants topurchase an aggregate of 320,000 shares of common stock had been issued to suchinvestors.  The notes and the warrantsprovide customary anti-dilution rights to the holders, including weightedaverage anti-dilution provisions for sales at less than the exercise orconversion prices thereof.  The Companyhas also agreed that if it proposes to issue new securities in excess of 1.0%of its outstanding shares prior to May 1, 2010, subject to the exceptionsnoted below, it will give the investors the right to purchase up to thatportion of the new securities which equals the proportion of the number ofsecurities purchasable upon conversion of notes and exercise of the warrantsrelative to the Company’s outstanding stock as of March 30, 2009.  The participation right is not applicable tocertain categories of issuances, such as shares issuable pursuant to publicofferings, mergers and acquisitions and options, warrants and other rights topurchase securities. The Company has also granted the investorscertain rights to require the Company to register common stock acquired by themupon conversion of the notes or exercise of the warrants under the SecuritiesAct of 1933, as amended (the “Act”) on Form S-3, or include such shares incertain company registrations under the Act, at the expense of the Company.

 

TheCompany determined the fair value of the warrants issued in the first quarterof 2009 to be $43,299 using the Black Scholes pricing model assuming: (i) aweighted average risk-free interest rate of 1.72%, (ii) an expectedwarrant life of five years, (iii) expected stock volatility of 73.86% and (iv) noexpected dividend yield.  Pursuant toAccounting Principles Board Opinion (“APB”) 14, *Accountingfor Convertible Debt and Debt Issued with Stock Purchase Warrants*,the Company allocated the fair value of the warrants to paid-in capital and theremainder of the proceeds to long-term debt. The value of these warrants is being expensed as additional interestover the term of the related loan.

 

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As of March 31, 2009 and December 30, 2008, the balances,interest rates and maturity dates of our long-term debt were as follows:

 
| ** **            | ** ** | **March 31,  2009** | ** ** | **December 30,  2008** | ** ** |
|-----------------------|------------|--------------------------|------------|-----------------------------|------------|
| Des Moines            |       |                     |       |                        |       |
| Balance               |       | $                        | 195,233    |                        | $          | 226,802 |   |
| Annual interest  rate |       | 10.25                    | %          | 10.25                       | %          |
| Maturity date         |       | 27-Aug-10                |       | 27-Aug-10                   |       |
|                  |       |                     |       |                        |       |
| Davenport             |       |                     |       |                        |       |
| Balance               |       | $                        | 242,442    |                        | $          | 272,081 |   |
| Annual interest  rate |       | 10.25                    | %          | 10.25                       | %          |
| Maturity date         |       | 6-Jan-11                 |       | 6-Jan-11                    |       |
|                  |       |                     |       |                        |       |
| Fargo                 |       |                     |       |                        |       |
| Balance               |       | $                        | 1,221,312  |                        | $          | 1,239,948 |   |
| Annual interest  rate |       | 8.75                     | %          | 8.75                        | %          |
| Maturity date         |       | 15-Aug-11                |       | 15-Aug-11                   |       |
|                  |       |                     |       |                        |       |
| South Bend            |       |                     |       |                        |       |
| Balance               |       | $                        | 248,453    |                        | $          | 250,000 |   |
| Annual interest  rate |       | 8.00                     | %          | 8.00                        | %          |
| Maturity date         |       | 30-Sep-23                |       | 30-Sep-23                   |       |
|                  |       |                     |       |                        |       |
| Harmony               |       |                     |       |                        |       |
| Balance               |       | $                        | 756,701    |                        | $          | 0 |   |
| Annual interest  rate |       | 9.00                     | %          | N/A                         |       |
| Maturity date         |       | 1-Oct-10                 |       | N/A                         |       |

 

Future maturities of long-term debt, exclusive of interest, are asfollows:

 
| Year ending: |   |      |          |   |   |
|--------------|--------|-----------|---------------|--------|--------|
| 2009         |   | $         |  226,348 |   |   |   |
| 2010         |   | 1,063,556 |          |   |   |
| 2011         |   | 1,135,898 |          |   |   |
| 2012         |   | 4,263     |          |   |   |
| 2013         |   | 4,617     |          |   |   |
| Thereafter   |   | 229,460   |          |   |   |
|         |   | $         | 2,664,142     |   |   |   |

 

**8.****             ****Capitalleases**

 

Asof March 31, 2009, the Company operated 24 restaurants under capital leaseagreements.  Of these leases, one expiresin 2020, two in 2023, four in 2024, three in 2025, four in 2026, seven in 2027,two in 2028 and one in 2029, all with renewable options for additionalperiods.  Twenty-two of these leaseagreements originated with Dunham.  Under13 of the leases, the Company may be required to pay additional contingent rentbased upon restaurant sales.  The landportion of these leases is classified as an operating lease while the buildingportion of 

 

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theseleases is classified as a capital lease because its present value was greaterthan 90% of the estimated fair value at the beginning of the lease and/or thelease term represents 75% or more of the expected life of the property.

 

TheCompany also has a land and building lease agreement for its beer productionfacility.  This ten-year lease allows theCompany to purchase the facility at any time for $1.00 plus the unamortizedconstruction costs.  Because theconstruction costs will be fully amortized through payment of rent during thebase term, if the option is exercised at or after the end of the initialten-year period, the option price will be $1.00.  As such, the lease is classified as a capitallease.

 

InMay 2008, the Company entered into a 20-year net lease agreement relatingto the restaurant it had planned to open in Troy, Michigan.  However, in February 2009, the Companydecided not to build on that site, and as part of an agreement with the DunhamEntities, the Company will reimburse Dunham for any out-of-pocket expensesincurred less net proceeds from the sale of the real estate or lease incomeassociated with the site (see Notes 3 and 9).

 

InAugust 2008, the Company ceased operations at its restaurant in Rogers,Arkansas (see Note 3).  However, theCompany is currently bound by the terms of this 20-year net lease agreemententered into under the terms specified in the development agreement withDunham.  Pursuant to an agreement withthe Dunham Entities described in Note 9, the Company will reimburse Dunham forany out-of-pocket expenses incurred less net proceeds from the sale of the realestate or lease income associated with this site.  The building portion of this lease isclassified as a capital lease while the land portion is classified as anoperating lease.

 

Asof March 31, 2009, the Company had 20 capital lease agreements that itused to finance the equipment at its restaurants.  During the first quarter of 2009, the Companyfinanced the equipment at two of those restaurants, aggregating approximately$2.0 million, under the terms and conditions of the equipment lease commitmentthe Company entered into with DHW in December 2007.

 

In February 2009, the Company entered into amendments to the threelease schedules of its master lease agreement with Carlton FinancialCorporation (“Carlton”) reducing the monthly payments and extending the termsby one year on two of the lease schedules. Pursuant to the amendments, the Company may purchase Carlton’s interestin all, but not less than all, of the equipment for a purchase price equal to15% of the original cost of the equipment. Steven J. Wagenheim, the Company’s president, chief executive officerand one of its directors, was required to personally guarantee payments to bemade to Carlton under the lease financing and the Company’s board of directorsagreed to compensate him for such guarantee.

 

Included in property and equipment are the following assets held undercapital leases:

 
| ** **                            | ** ** | **March 31, 2009** | ** **       | **December 30, 2008** | ** ** |
|---------------------------------------|------------|-------------------------|------------------|----------------------------|------------|
| Land                                  |       | $                       |  18,000     |                       | $          |  18,000 |   |
| Building                              |       | 57,113,974              |             | 54,991,656                 |       |
| Equipment and  leasehold improvements |       | 19,601,567              |             | 17,588,649                 |       |
|                                  |       | 76,733,541              |             | 72,598,305                 |       |
| Less accumulated  depreciation        |       | (13,602,999             | )                | (9,600,913                 | )          |
|                                  |       | $                       |  63,130,542 |                       | $          |  62,997,392 |   |

 

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Minimum futurelease payments under all capital leases as of March 31, 2009 are:

 
| **Year ending:**                             | ** ** | **Capital Leases** | ** **      |
|----------------------------------------------|------------|--------------------|-----------------|
| 2009                                         |       | $                  |  7,006,860 |   |
| 2010                                         |       | 9,933,379          |            |
| 2011                                         |       | 10,608,849         |            |
| 2012                                         |       | 12,524,283         |            |
| 2013                                         |       | 10,107,884         |            |
| Thereafter                                   |       | 90,900,415         |            |
| Total minimum  lease payments                |       | 141,081,670        |            |
| Less amount  representing interest           |       | 72,144,453         |            |
| Present value of  net minimum lease payments |       | 68,937,217         |            |
| Less current  portion                        |       | 3,180,369          |            |
| Long-term  portion of obligations            |       | $                  | 65,756,848      |   |

 

Amortizationexpense related to the assets held under capital leases is included withdepreciation expense on the Company’s statements of operations.

 

**9.****             ****Commitmentsand contingencies**

 

RentReductions

InFebruary 2009, the Company entered into a master agreement with the DunhamEntities to provide rent or other cash flow reductions to the Company in theamount of $2.5 million for the calendar year 2009 and $1.5 million for calendaryear 2010 (the “Master Agreement”).  TheMaster Agreement provides that the Dunham Entities will amend and restateapplicable leases and subleases with the Company to reflect negotiated rentreductions.  As a part of the MasterAgreement, Dunham has agreed to amend its building leases with the Company thatare currently treated as capital leases for accounting purposes by reducingtheir terms to periods which will thereafter qualify the leases to be treatedas operating leases in accordance with generally accepted accountingprinciples.  Each amended lease will bemodified for a term of not less than 10 years and will provide that the tenantwill have three consecutive options to extend the leases for five years perextension.  Additionally, the Companyagreed to reimburse Dunham for any out-of-pocket costs that Dunham incurs dueto the closing of the Rogers, Arkansas location and the decision not to buildon the Troy, Michigan site less net sales proceeds from the sale of any realestate or lease income associated with such sites.  Reimbursement of costs related to these siteswill be amortized and payable to Dunham over a 60-month period commencing January 2011,at a 6% annual interest rate.  Suchreimbursement includes the carrying cost of the related land until itsdisposal.

 

Inconsideration of the agreements of Dunham provided in the Master Agreement, theCompany agreed to issue to the Dunham Entities a warrant to purchase 1,000,000shares of common stock of the Company at an exercise price of $0.264 per share,representing 110% of the closing price of the Company’s common stock on thetrading date prior to the date of signing the Master Agreement.  The value of these warrants of $136,495 isbeing amortized over the underlying lease terms.

 

TheCompany subsequently entered into agreements with certain of its otherlandlords for rent reductions.  Such rentreductions are deemed to be part of the above-referenced $4.0 million in rentreductions.  In consideration of suchrent reductions, the Company has issued five-year warrants to purchase theCompany’s common stock to such landlords. Each warrant is exercisable at 110% of the closing price of the Company’scommon stock on the trading date prior to the date on which the Companyreceived the executed rent relief agreement, and is issued only to accreditedinvestors.  As of March 31, 2009,the aggregate number of shares underlying such warrants was 196,070 shares andthe weighted average exercise price was $0.27 per share.  The value of these warrants of $27,376 isbeing amortized over the underlying lease terms.

 

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Litigation

From time to time, lawsuits are threatened or filed against the Companyin the ordinary course of business.  Suchlawsuits typically involve claims from customers, former or current employees,and others related to issues common to the restaurant industry.  A number of such claims may exist at anygiven time.  Although there can be noassurance as to the ultimate disposition of these matters, it is management’sopinion, based upon the information available at this time, that the expectedoutcome of these matters, individually or in the aggregate, will not have amaterial adverse effect on the results of operation, liquidity or financialcondition of the Company.

 

**10.****      ****Stockplans**

 

In July 1997,the Company adopted the 1997 Stock Option Plan for employees and non-employees,including consultants to the Company, to purchase the Company’s common stock atan exercise price that equals or exceeds the fair market value on the date ofgrant.   As of March 31, 2009,options to purchase 123,500 shares of common stock were outstanding under theplan, which expired July 28, 2007. All options outstanding under this plan are fully vested and areexercisable for ten years from the date of grant.

 

As of March 31,2009, options to purchase 240,000 shares of common stock were outstanding underthe 1997 Director Stock Option Plan (“DSOP”), which expired July 29,2007.  On May 2, 2007, theCompany’s board of directors agreed that until the adoption of any futureequity plan for non-employee directors, awards of stock options for thepurchase of 15,000 shares of common stock per year, exercisable for a period often years, should be made to each non-employee director on the anniversary ofhis election to the board under the 2002 Equity Incentive Plan.

 

In August 2002,the Company adopted the 2002 Equity Incentive Plan, now known as the Amendedand Restated Equity Incentive Plan, for employees, prospective employees,officers and members of the Company’s board of directors, as well as consultants and advisors tothe Company, to purchase shares of the Company’s common stock at an exerciseprice that equals or exceeds the fair market value on the date of grant.  The number of shares authorized for issuanceas of March 31, 2009 was 2,729,743, of which 910,074 shares remainedavailable for future issuance and options to purchase 1,743,969 shares wereoutstanding.  Although vesting schedulesvary, option grants under this plan generally vest evenly over a three orfour-year period and options are exercisable for no more than ten years fromthe date of grant.

 

A summary of the status of the Company’s stock options as of March 31, 2009 is presentedbelow:

 
| **Fixed Options**                                           | ** ** | **Shares** | ** ** | **Weighted  Average Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|---------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------|------------|
| Outstanding at  December 25, 2007                      |       | 2,272,800  |       | $                                     |  4.10 |                                                | 6.7 years  |                           |       |   |
|                                                        |       |       |       |                                  |       |                                                |       |                           |       |
| Granted                                                     |       | 615,000    |       | $                                     |  1.92 |                                                | 8.4 years  |                           |       |   |
| Exercised                                                   |       | (15,000    | )          | 2.27                                  |       |                                                |       |                           |       |
| Forfeited                                                   |       | (684,666   | )          | 3.76                                  |       |                                                |       |                           |       |
| Outstanding at  December 30, 2008                      |       | 2,188,134  |       | $                                     |  3.60 |                                                | 6.2 years  |                           |       |   |
|                                                        |       |       |       |                                  |       |                                                |       |                           |       |
| Granted                                                     |       | 45,000     |       | 0.30                                  |       | 7.3 years                                           |       |                           |       |
| Exercised                                                   |       | —     |       | —                                |       |                                                |       |                           |       |
| Forfeited                                                   |       | (80,665    | )          | 3.22                                  |       |                                                |       |                           |       |
| Outstanding at  March 31, 2009                         |       | 2,152,469  |       | $                                     |  3.55 |                                                | 6.0 years  |                           | $          |  140 |   |
|                                                        |       |       |       |                                  |       |                                                |       |                           |       |
| Options  exercisable at December 30, 2008              |       | 1,266,141  |       | $                                     |  3.93 |                                                | 4.9 years  |                           |       |   |
| Options  exercisable at March 31, 2009                 |       | 1,286,141  |       | $                                     |  3.90 |                                                | 4.8 years  |                           | $          | — |   |
|                                                        |       |       |       |                                  |       |                                                |       |                           |       |
| Weighted-average  fair value of options granted during 2009 |       | $          |  0.23 |                                  |       |                                                |       |                           |       |   |
|                                                             |            |            |            |                                       |            |                                                     |            |                                |            |  |  |  |

 

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The aggregate intrinsic value in the table above represents the totalpretax intrinsic value (the difference between the closing price of the Company’sstock on March 31,2009 and the exercise price, multiplied by the number of in-the-moneyoptions) that would have been received by the option holders had all optionholders exercised their options on March 31, 2009.    As of March 31, 2009, there was approximately $270,326of total unrecognized compensation cost related to unvested share-basedcompensation arrangements, of which $155,332 is expected to be recognizedduring the remainder of fiscal year 2009, $71,773 in fiscal year 2010, $33,849in fiscal year 2011, $9,328 in fiscal year 2012 and $44 in fiscal year 2013.

 

The following table summarizes information about stock optionsoutstanding at March 31,2009:

 
| ** **                          | ** ** | **Options Outstanding**                        | ** ** | **Options Exercisable**                            | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------|------------|
| **Range of  Exercise  Prices** | ** ** | **Number of  Options  Outstanding  3/31/2009** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average Exercise  Price** | ** ** | **Number of  Options  Exercisable  3/31/2009** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|                                |       |                                                |       |                                                    |       |   |   |   |   |   |   |
| $0.00 - $1.00                       |       | 130,000                                             |       | 9.6 years                                               |       | $ | 0.57 |   | — |   | $ | — |   |
| $1.01 - $2.00                       |       | 188,500                                             |       | 7.3 years                                               |       | $ | 1.69 |   | 58,500 |   | $ | 1.65 |   |
| $2.01 - $3.00                       |       | 424,334                                             |       | 7.3 years                                               |       | $ | 2.34 |   | 178,667 |   | $ | 2.55 |   |
| $3.01 - $4.00                       |       | 488,000                                             |       | 5.2 years                                               |       | $ | 3.71 |   | 437,001 |   | $ | 3.72 |   |
| $4.01 - $5.00                       |       | 557,300                                             |       | 5.6 years                                               |       | $ | 4.38 |   | 482,300 |   | $ | 4.40 |   |
| $5.01 - $6.00                       |       | 264,335                                             |       | 2.9 years                                               |       | $ | 5.21 |   | 96,339 |   | $ | 5.27 |   |
| $6.01 - $7.00                       |       | 100,000                                             |       | 8.0 years                                               |       | $ | 6.20 |   | 33,334 |   | $ | 6.20 |   |
| Total                               |       | 2,152,469                                           |       | 6.0 years                                               |       | $ | 3.55 |   | 1,286,141 |   | $ | 3.90 |   |

 

**11.  Common stock warrants**

 

In September 2004, the Company entered into asecurities purchase agreement with certain accredited investors for the sale ofapproximately $8.5 million of common stock and warrants.  Under this agreement, the Company issuedfive-year warrants for the purchase of 1,045,844 shares of common stock at anexercise price of $5.00 per share.  TheCompany may call for the mandatory exercise of such warrants if certainconditions are met.  As part of thisprivate placement, the Company sold to its placement agents, for $100,five-year warrants to purchase an aggregate of 130,730 shares of common stockat an exercise price of $5.00 per share. Suchagreements with the investors and placement agents for this transaction containcertain anti-dilution provisions. Pursuant to these provisions, the number of shares purchasable uponexercise of these warrants and the related purchase price both requiredadjustment upon the issuance of warrants to certain of the Company’s landlordsand Harmony (see Notes 7 and 9).  As aresult of these adjustments, the number of shares purchasable under thesewarrants at March 31, 2009 was 1,215,469 and the exercise price was $4.84per share.  As of March 31, 2009, none of suchwarrants had been exercised.

 

In October 2005, the Company entered into asecurities purchase agreement with certain accredited investors for the sale ofapproximately $5.34 million of common stock and warrants.  Under this agreement, the Company issuedfive-year warrants for the purchase of 221,762 shares of common stock at anexercise price of $6.50 per share to such investors and five-year warrants forthe purchase of 55,436 shares of common stock at an exercise price of $6.50 tothe Company’s placement agent. Such agreements with the investors and placementagents for this transaction contain certain anti-dilution provisions.  Pursuant to these provisions, the number ofshares purchasable upon exercise of these warrants and the related purchaseprice both required adjustment upon the issuance of warrants to certain of theCompany’s landlords and Harmony (see Notes 7 and 9).  As a result of these adjustments, the numberof shares purchasable under these warrants at March 31, 2009 was 289,211and the exercise price was $6.23 per share. As of March 31,2009, none of such warrants had been exercised.

 

Inconsideration of rent reduction agreements entered into with certain of itslandlords, the Company issued five-year warrants to purchase the Company’scommon stock to such landlords.  Theaggregate number of shares underlying such warrants was 1,196,070 shares andthe weighted average exercise price was $0.2648 per share.  Pursuant to the provisions of suchagreements, the number of shares purchasable upon exercise of these warrantsand the related purchase price both required adjustment upon the issuance ofwarrants to Harmony (see Note 7).  As aresult of these adjustments, the number of shares purchasable under thesewarrants at March 31, 2009 was 1,197,040 and the weighted average exerciseprice was $0.2646 per share.  As of March 31, 2009, none of suchwarrants had been exercised.

 

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Pursuant to the bridge loan agreement entered intoin March 2009 with a group of accredited investors, the Company issued tothe investors warrants for the purchase of an aggregate of 320,000 shares ofcommon stock at a price of $0.25267 per share. Such warrants become exercisable September 30, 2009.

 

As of March 31, 2009, warrants for the purchaseof an aggregate of 3,021,802 shares of common stock were outstanding andwarrants to purchase an aggregate of 2,701,802 shares were exercisable.  The weighted average exercise price of suchwarrants was $2.67 per share.

 

**12.       Retirement plan**

 

The Companysponsors a defined contribution plan under the provisions of section 401(k) ofthe Internal Revenue Code.  The Plan isvoluntary and is provided to all employees who meet the eligibilityrequirements.  A participant can elect tocontribute up to 100% of his/her compensation subject to IRS limits.  Beginning in fiscal year 2009, the Companyelected to match 10% of such contributions up to 6% of the participant’scompensation.  As of March 31, 2009,the Company had contributed $2,808 in aggregate under the plan.  The Company expects to contribute an additional$11,000 under the plan in fiscal year 2009.

 

**ITEM 2    Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

*This discussion and analysis contains variousnon-historical forward-looking statements within the meaning of Section 21Eof the Exchange Act.  Although we believethat, in making any such statement, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  You are cautioned not to attribute unduecertainty to such forward-looking statements, which are qualified in theirentirety by the cautions and risks described herein.  Please refer to the “Risk Factors” section ofour Annual Report on Form 10-K, filed with the Securities and ExchangeCommission on March 19, 2009, for additional factors known to us that maycause actual results to vary.*

 

**Overview**

 

We are a Modern Americanupscale casual restaurant chain. As of March 31, 2009, we operated 26restaurants in 11 Midwestern states featuring on-premises breweries,substantially all of which operate under the name of Granite City Food &Brewery®.  We believe our menu featureshigh quality yet affordable family favorite menu items prepared frommade-from-scratch recipes and served in generous portions.  We believe that the sophisticated yetunpretentious restaurants, proprietary food and beverage products, attractiveprice points and high service standards combine for a great dining experience.  The location of each restaurant in operationand the month and year of its opening appear in the following chart:

 
| **Unit** | ** ** | **Location**              | ** ** | **Opened** |
|----------|------------|---------------------------|------------|------------|
| 1        |       | St. Cloud, Minnesota      |       | Jun-99     |
| 2        |       | Sioux Falls, South Dakota |       | Dec-00     |
| 3        |       | Fargo, North Dakota       |       | Nov-01     |
| 4        |       | Des Moines, Iowa          |       | Sep-03     |
| 5        |       | Cedar Rapids, Iowa        |       | Nov-03     |
| 6        |       | Davenport, Iowa           |       | Jan-04     |
| 7        |       | Lincoln, Nebraska         |       | May-04     |
| 8        |       | Maple Grove, Minnesota    |       | Jun-04     |
| 9        |       | East Wichita, Kansas      |       | Jul-05     |
| 10       |       | Eagan, Minnesota          |       | Sep-05     |
| 11       |       | Kansas City, Missouri     |       | Nov-05     |
| 12       |       | Kansas City, Kansas       |       | Jan-06     |
| 13       |       | Olathe, Kansas            |       | Mar-06     |
| 14       |       | West Wichita, Kansas      |       | Jul-06     |
| 15       |       | St. Louis Park, Minnesota |       | Sep-06     |
| 16       |       | Omaha, Nebraska           |       | Oct-06     |
| 17       |       | Roseville, Minnesota      |       | Nov-06     |
| 18       |       | Madison, Wisconsin        |       | Dec-06     |
| 19       |       | Rockford, Illinois        |       | Jul-07     |
| 20       |       | East Peoria, Illinois     |       | Oct-07     |
| 21       |       | Orland Park, Illinois     |       | Dec-07     |
| 22       |       | St. Louis, Missouri       |       | Jan-08     |
| 23       |       | Ft. Wayne, Indiana        |       | Jan-08     |
| 24       |       | Toledo, Ohio              |       | Feb-08     |
| 25       |       | South Bend, Indiana       |       | Jul-08     |
| 26       |       | Indianapolis, Indiana     |       | Feb-09     |

 

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In August 2008, weceased operations at our restaurant in Rogers, Arkansas.  However, we are currently bound by the termsof the 20-year net lease agreement which commenced in October 2007 underthe terms specified in the development agreement with Dunham CapitalManagement, L.L.C. (“Dunham”).

 

We operate acentrally-located beer production facility in Ellsworth, Iowa which facilitatesthe initial stage of our patented brewing process.  We believe that this brewing process improvesthe economics of microbrewing as it eliminates the initial stages of brewingand storage at multiple locations, thereby reducing equipment and developmentcosts at new restaurant locations. Additionally, having a common starting point, the beer productioncreates consistency of taste for our product from restaurant torestaurant.  The initial product producedat our beer production facility is transported by truck to the fermentationvessels at each of our restaurants where the brewing process is completed. In2007, we were granted a patent by the United States Patent Office for thisbrewing process.  We believe that ourcurrent beer production facility, which opened in June 2005, has thecapacity to service up to 35 restaurant locations.

 

Our industry can besignificantly affected by changes in economic conditions, discretionaryspending patterns, consumer tastes, and cost fluctuations.  Over the past year, consumers have been underincreased economic pressures and as a result, many have changed theirdiscretionary spending patterns.  Manyconsumers are dining out less frequently than in the past and/or have decreasedthe amount they spend on meals while dining out.  As guest traffic decreases, lower salesresult in decreased leverage that leads to declines in operating margins.  To offset the negative impact of decreasedleverage in a declining sales environment while protecting our guests’ diningexperience, we have undertaken a series of initiatives to renegotiate thepricing of all aspects of our business, effectively reducing our cost of food,insurance, payroll processing, shipping, supplies and most recently, ourproperty and equipment rent.  We havealso begun implementing marketing initiatives designed to increase brandawareness and help drive guest traffic.

 

In February 2009, weentered into a master agreement with Dunham, DHW Leasing, L.L.C. (“DHW”) andDunham Equity Management, L.L.C. (collectively, the “Dunham Entities”) toprovide rent or other cash flow reductions to us in the amount of $2.5 millionfor the calendar year 2009 and $1.5 million for calendar year 2010 (the “MasterAgreement”).  The Master Agreementprovides that the Dunham Entities will amend and restate applicable leases andsubleases to reflect negotiated rent reductions.  We commenced paying reduced rent in January 2009in anticipation of finalizing the Master Agreement, which reductions are deemedto be part of the negotiated rent reductions. As a part of the Master Agreement, Dunham has agreed to amend its leaseswith us that are currently treated as capital leases for accounting purposes byreducing their terms to periods which will thereafter qualify the leases to betreated as operating leases in accordance with generally accepted accountingprinciples.  Each lease will be modifiedfor a term of not less than 10 years and will provide that the tenant will havethree consecutive options to extend the leases for five years perextension.  In consideration of theagreements of Dunham provided in the Master Agreement, we issued to the DunhamEntities a warrant to purchase 1,000,000 shares of our common stock at anexercise price of $0.264 per share, representing 110% of the closing price ofour common stock on the trading date prior to the date of signing the MasterAgreement.

 

Subsequently, we enteredinto agreements with certain of our other landlords for rent reductions.  Such rent reductions are deemed to be part ofthe above-referenced $4.0 million in rent reductions.  In consideration of such rent reductions, wehave issued five-year warrants to purchase our common stock to suchlandlords.  Each 

 

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warrantis exercisable at 110% of the closing price of our common stock on the tradingdate prior to the date on which we received the executed rent relief agreement,and are issued only to accredited investors. As of March 31, 2009, the aggregate number of shares underlyingsuch warrants was 196,070 shares and the weighted average exercise price was$0.27 per share.

 

InMarch 2009, we entered into a bridge loan agreement with a group ofaccredited investors to provide $1.0 million of partially convertible debtfinancing.  The bridge loan is evidenced by notes bearing interest at 9.0%per annum, payable in six equal monthly installments commencing on May 1,2010 and due in full on October 1, 2010.  The notes are secured by amortgage against the lease, and security agreements against personal propertyand intangibles relating to the Company’s Sioux Falls, South Dakota restaurant,including a grant of the rights to use patents, trademarks and otherintangibles associated with that restaurant.  The bridge loan was fundedto the extent of $800,000 on March 30, 2009, with the balance of thebridge loan to be funded by the end of May 2009, pursuant to an amendmentto the agreement dated April 30, 2009. Up to 20% of each bridge note may be converted into common stock at aconversion price equal to $0.50 per share.  In addition, the Companyagreed to issue to the investors warrants for the purchase of an aggregate of400,000 shares of common stock exercisable six months after date of issuance ata price of $0.25267 per share, or 110% of the closing price of the Company’sstock on March 30, 2009.  As of March 31,2009, warrants to purchase an aggregate of 320,000 shares of common stock hadbeen issued to such investors.

 

Thelead investors in the transaction were Harmony Equity Income Fund, L.L.C. andHarmony Equity Income Fund II, L.L.C. (collectively, “Harmony”).  TheCompany’s Chairman, Eugene E. McGowan, is a member of, and has a beneficialinterest in, both of the Harmony funds. The Company’s Board of Directors has authorized it to borrow up to anaggregate of $3.0 million under the terms of the bridge loan agreement, whichprovides that the investors may, but are not obligated to, make additionalloans on substantially the same terms and conditions, including a similarpledge of collateral related to either its St. Cloud, Minnesota, or Fargo,North Dakota restaurants.

 

Weutilize a 52/53-week fiscal year ending the last Tuesday in December forfinancial reporting purposes.  Fiscalyear 2008 had 53 weeks while fiscal year 2009 will have 52 weeks.  The additional week was included in the thirdquarter of 2008.

 

Thethirteen weeks ended March 31, 2009 and March 25, 2008 included 332and 310 operating weeks, respectively, which is the sum of the actual number ofweeks each restaurant operated.  Becausewe have opened new restaurants at various times throughout the years, weprovide this statistical measure to enhance the comparison of revenues fromperiod to period as changes occur in the number of units we are operating.

 

Ourrestaurant revenue is comprised almost entirely of the sales of food andbeverages.  The sale of retail itemstypically represents less than one percent of total revenue.  Product costs include the costs of food,beverages and retail items.  Labor costsinclude direct hourly and management wages, taxes and benefits for restaurantemployees.  Direct and occupancy costsinclude restaurant supplies, marketing costs, rent, utilities, real estatetaxes, repairs and maintenance and other related costs.  Pre-opening costs consist of direct costsrelated to hiring and training the initial restaurant workforce, the salariesand related costs of our dedicated new store opening team, rent expenseincurred during the construction period and other direct costs associated withopening new restaurants.  General andadministrative expenses are comprised of expenses associated with all corporateand administrative functions that support existing operations, which include managementand staff salaries, employee benefits, travel, information systems, training,market research, professional fees, supplies and corporate rent.  Depreciation and amortization includesdepreciation on capital expenditures at the restaurant and corporate levels andamortization of intangibles that do not have indefinite lives.  Interest expense represents the cost ofinterest expense on debt and capital leases net of interest income on investedassets.

 

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**Resultsof operations as a percentage of sales**

 

Thefollowing table sets forth results of our operations expressed as a percentageof sales for the thirteen weeks ended March 31, 2009 and March 25,2008.

 
| ** **                     | ** ** | **Thirteen Weeks Ended** | ** ** |
|--------------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | **March 31,**       | ** ** | **March 25,** | ** ** |
| ** **                     | ** ** | **2009**                 | ** ** | **2008** | ** ** |
|                           |       |                     |       |   |   |
| Restaurant  revenues           |       | 100.0                    | %          | 100.0 | % |
|                           |       |                     |       |   |   |
| Cost of sales:                 |       |                     |       |   |   |
| Food, beverage  and retail     |       | 27.2                     |       | 31.3 |   |
| Labor                          |       | 35.2                     |       | 38.9 |   |
| Direct restaurant  operating   |       | 14.9                     |       | 14.8 |   |
| Occupancy                      |       | 7.3                      |       | 6.4 |   |
| Total cost of  sales           |       | 84.6                     |       | 91.5 |   |
|                           |       |                     |       |   |   |
| Pre-opening                    |       | 0.9                      |       | 2.4 |   |
| General and  administrative    |       | 9.6                      |       | 11.2 |   |
| Depreciation and  amortization |       | 8.0                      |       | 6.5 |   |
| Exit or disposal  activities   |       | 2.0                      |       | — |   |
| Other                          |       | 0.0                      |       | 0.1 |   |
|                           |       |                     |       |   |   |
| Operating loss                 |       | (5.1                     | )          | (11.8 | ) |
|                           |       |                     |       |   |   |
| Interest:                      |       |                     |       |   |   |
| Income                         |       | 0.0                      |       | 0.1 |   |
| Expense                        |       | (7.6                     | )          | (6.2 | ) |
| Net interest  expense          |       | (7.6                     | )          | (6.1 | ) |
|                           |       |                     |       |   |   |
| Net loss                       |       | (12.7                    | )%         | (17.9 | )% |

 

Certain percentageamounts do not sum due to rounding.

 

**Critical Accounting Policies**

 

Ourcritical accounting policies are those that require significant judgment.  There have been no material changes to thecritical accounting policies previously reported in our 2008 Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 19, 2009.

 

**Resultsof operations for the thirteen weeks ended March 31, 2009 and March 25,2008**

 

**Revenue**

 

We generated $21,424,701 and$24,019,485 of revenue during the first quarter of 2009 and 2008,respectively.  The decrease in revenue of10.8% for the first quarter of 2009 compared to 2008 was primarily the resultof a decrease in guest traffic of 11.2%. The first quarter of 2009 included 332 restaurant operating weeks whilethe same period in 2008 included 310 operating weeks.  Comparable restaurant revenue, which includedrestaurants in operation over 18 months, decreased 12.2% from the first quarterof 2008 to the first quarter of 2009 partially due to a decrease in guesttraffic, which we believe was caused primarily by the macroeconomic 

 

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factorsaffecting the restaurant industry in general. Average weekly revenue per comparable restaurant decreased $9,483 from$77,620 in the first quarter of 2008 to $68,137 in the first quarter of 2009.

 

We expect that restaurantrevenue will vary from quarter to quarter. We anticipate continued seasonal fluctuations in restaurant revenue duein part to increased outdoor seating and generally favorable weather conditionsat many of our locations during the summer months.  Due to the honeymoon effect that periodicallyoccurs with the opening of a restaurant, we expect the timing of new restaurantopenings to cause fluctuations in restaurant revenue.  Additionally, other factors outside of ourcontrol, such as inclement weather, timing of holidays, consumer confidence inthe economy and changes in consumer preferences may affect our futurerevenue.  We believe that decreasedconsumer confidence negatively impacted the restaurant industry as a wholebeginning in 2007 and continuing through the first quarter of 2009.

 

**Restaurant costs**

** **

***Foodand beverage***

** **

Our food and beverage costs, as a percentage of revenue, decreased 4.1%from 31.3% in the first quarter of 2008 to 27.2% in the first quarter of2009.  Our pricing negotiations with oursuppliers, our menu price increase of approximately 4.0% in March 2008 andour increased oversight of inventory and kitchen management contributed to thisdecrease.

 

Due to the number ofrestaurants we now operate throughout the Midwest, we were able to contract formany of the food commodities we use in our restaurants for periods up to oneyear.  Based on several new contractsentered into in the later part of 2008, we believe we will be able to maintainor reduce our food and beverage costs as a percentage of revenue for 2009 byreducing our exposure to commodity price increases.  We do, however, expect that our food and beveragecosts will continue to vary going forward due to numerous variables, includingseasonal changes in food and beverage costs for which we do not have contractedpricing and guest preferences.  Weperiodically create new menu offerings and introduce new craft brewed beersbased upon guest preferences.  Althoughsuch menu modifications may temporarily result in increased food and beveragecost, we believe we are able to offset such increases with our weekly specialswhich provide variety and value to our guests. Our varieties of craft brewed beer, which we believe we can produce atlower cost than beers we purchase for resale, also enable us to keep our foodand beverage costs low while fulfilling guest requests and building customerloyalty.  We expect food and beveragecosts at our newer restaurants to be higher initially due to inefficienciesthat are part of the start-up process of a new restaurant.  Additionally, with future expansion, webelieve our brewing process will allow us to keep our high quality beerproducts intact while leveraging our fixed production costs, thereby enhancingoverall profitability.

 

***Labor***

 

Labor expense consists ofrestaurant management salaries, hourly staff payroll costs, otherpayroll-related items including management bonuses, and non-cash stock-basedcompensation expense.  Our experience todate has been that staff labor costs associated with a newly opened restaurant,for approximately its first four to six months of operation, are greater thanwhat can be expected after that time, both in aggregate dollars and as apercentage of revenue.

 

Our labor costs, as apercentage of revenue, decreased 3.7% to 35.2% in the first quarter of 2009from 38.9% in the first quarter of 2008. As our new restaurants began to stabilize and we trained new managers ona number of operational metrics and initiatives focused on manageraccountability and internal development of restaurant-level staff, we were ableto reduce labor costs as a percentage of revenue.

 

We expect that labor costswill vary as minimum wage laws, local labor laws and practices, as well asunemployment rates vary from state to state, as will hiring and trainingexpenses.  We believe that retaining goodemployees and more experienced staff ensures high quality guest service and mayreduce hiring and training costs.

 

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***Direct restaurant operating***

 

Operating supplies, repairsand maintenance, utilities, promotions and restaurant-level administrativeexpense represent the majority of our direct restaurant operating expense, asubstantial portion of which is fixed or indirectly variable.  Our direct restaurant operating expense as apercentage of revenue increased 0.1% to 14.9% in the first quarter of 2009 from14.8% in the first quarter of 2008. While such increase as a percentage of revenue was due in part to asmaller revenue base, increases in utilities and other expenses were offset, inpart, by the decrease in marketing expense and the reduced cost of certainsupplies.

 

We anticipate reducing ourdirect operating costs going forward as we have taken initiatives torenegotiate pricing on all aspects of these costs including credit cardprocessing, supplies, utilities, shipping and various services.  While we started seeing the effects of thesenegotiations in late 2008, we believe we will see the full benefit of theresulting cost reductions during 2009.

 

***Occupancy***

 

Our occupancy costs, whichinclude both fixed and variable portions of rent, common area maintenancecharges, property insurance and property taxes, increased 0.9% as a percentageof revenue to 7.3% in the first quarter of 2009 from 6.4% in the first quarterof 2008, due in part to a smaller revenue base. While rent expense and property and casualty insurance decreasedslightly, they were offset by an increase in common area maintenance expenseand property tax.  While our occupancycost is expected to continue to change as a result of the Master Agreemententered into with the Dunham Entities in 2009, the overall effect of thesechanges is still evolving as the parties are assessing restaurant-by-restaurantlease reductions as well as changes in the terms of the leases.

 

**Pre-o****pening**

 

Pre-opening costs, which areexpensed as incurred, consist of expenses related to hiring and training theinitial restaurant workforce, wages and expenses of our dedicated newrestaurant opening teams, rental costs incurred during the construction periodand certain other direct costs associated with opening new restaurants.  Pre-opening costs, excludingconstruction-period rent, are primarily incurred in the month of, and twomonths prior to, restaurant opening.

 

Pre-opening costs decreased$390,444 to $192,929 in the first quarter of 2009 from $583,373 in the firstquarter of 2008.  Included in suchexpense in the first quarter of 2009 were expenses related to the opening ofour restaurant in Indianapolis, Indiana. Pre-opening expenses incurred in the first quarter of 2008 were relatedprimarily to the restaurants we opened in St. Louis, Missouri; Ft. Wayne,Indiana; and Toledo, Ohio.

 

**General and administrative**

 

General and administrativeexpense includes all salaries and benefits, including non-cash stock-basedcompensation, associated with our corporate staff that is responsible foroverall restaurant quality, future expansion into new locations, financialcontrols and reporting, restaurant management recruiting, management training,excess capacity costs related to our beer production facility, and salaries andexpenses of our new restaurant opening team when it is not dedicated to aparticular restaurant opening.  Othergeneral and administrative expense includes advertising, professional fees,investor relations, office administration, centralized accounting system costsand travel by our corporate management.

 

General and administrativeexpense decreased $626,650 to $2,064,316 in the first quarter of 2009 from$2,690,966 in the first quarter of 2008. As a percentage of revenue such expenses decreased 1.6% from 11.2% inthe first quarter of 2008 to 9.6% in the first quarter of 2009.  The primary sources of such decrease wereexpenses related to recruiting, relocation, training and consulting costs, aswell as travel expense.  Non-cash stockbased compensation included in general and administrative expense was $37,972and $103,585, in the first quarters of 2009 and 2008, respectively.

 

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Webelieve our initiatives to renegotiate pricing with our vendors will assist usin reducing future general and administrative expense.  We have negotiated cost reductions related toshipping, insurance and payroll processing and we continue to focus on allaspects of contracted goods and services. We will closely monitor our general and administrative expense whileseeking to preserve an infrastructure that remains suitable for our currentoperations and future expansion. Although we may need to recruit additional personnel to providecontinued oversight of operations, we expect our turnover ratios for 2009 toreturn to levels more consistent with the industry, allowing us to reduce ourcosts.  To the extent our turnoverincreases above our expectations, additional costs above our budgeted figurescould be incurred in our recruiting and training expenses.  We believe our general and administrativeexpense and our general and administrative expense as a percentage of revenuewill decrease throughout 2009.

 

**Depreciation and amortization**

 

Depreciation andamortization expense increased $144,931 to $1,706,577 in the first quarter of2009 from $1,561,646 in the first quarter of 2008, due principally to theadditional depreciation related to new restaurants.  As a percentage of revenue, depreciationexpense increased 1.5% to 8.0% in the first quarter of 2009 from 6.5% in thefirst quarter of 2008, due in part to a smaller revenue base.

 

**Exit or disposal activities**

 

InAugust 2008, we closed our Rogers, Arkansas restaurant.  Since opening in October 2007, therestaurant failed to generate positive cash flow and had approximately $1.4million of net loss.  We believe theclosure of this restaurant will allow management to focus its capital andpersonnel resources on our other restaurants in order to increase futureoperating efficiencies and cash flow.  Weare working to find a replacement tenant for the location, for which we are boundby a 20-year net lease.  Costs incurredin the first quarter of 2009 in connection with this closure include costs tomaintain the facility of approximately $132,996.  We will incur ongoing costs such asutilities, landscape and maintenance and general liability insurance until weare able to find a replacement tenant. In accordance with the requirements ofSFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities,* we recorded a non-cashlease termination liability of $852,146 based on management’s estimate of thefair value of these obligations.  Thisrequired management to estimate the present value of the future minimum leaseobligations offset by the estimated sublease rentals that could be reasonablyobtained for the property.  During thefirst quarter of 2009, amortization of this sublease liability offset exit ordisposal activities expense by $4,916.  All costs related to the closing of the Rogers restaurant are reflectedin our statements of operations as “exit or disposal activities”.

 

Aspart of the Master Agreement we entered into with the Dunham Entities in February 2009,we agreed to reimburse Dunham for any out-of-pocket expenses incurred less netproceeds from the sale of the real estate or lease income associated with theRogers, Arkansas site and the site at Troy, Michigan upon which we decided notbuild a restaurant.  We have concludedthat as of March 31, 2009, it is probable we will need to reimburse Dunhamapproximately $300,000 of such costs related to the Troy, Michigan site andhave included such costs in “exit or disposal activities” on our statement ofoperations for the first quarter of 2009 pursuant to SFAS No. 5,*Accounting for Contingencies*.  Reimbursement of costs related to thesesites, including the carrying cost of the related land, will be amortized andpayable to Dunham over a 60-month period commencing January 2011, at a 6%annual interest rate.  The actual amountdue Dunham could fluctuate due to changes in the economy.

 

**Interest**

 

Net interest expense consists of interest expense on capital leases andlong-term debt, net of interest earned from cash on hand.  Interest expense increased $142,132 to$1,630,958 in the first quarter of 2009 from $1,488,826 in the first quarter of2008.  The increase was due to additionalcapital leases as a result of new restaurants, equipment leases and long-termdebt.  Interest income decreased $13,710in the first quarter of 2009 over the first quarter of 2008 due to the reductionof cash on hand.

 

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**Liquidity and capital resources**

 

As of March 31, 2009, we had $1,407,926 of cash and a workingcapital deficit of $7,732,274 compared to $2,652,211 of cash and a workingcapital deficit of $7,809,664 at December 30, 2008.

 

During the thirteen weeks ended March 31,2009, we obtained proceeds of $1,800,000 pursuant to a capital lease agreementand loan agreement and made payments aggregating $722,239 on our debt andcapital lease obligations.  We used$1,995,753 of net cash in operating activities and $326,493 of net cash topurchase equipment and other assets.

 

During the thirteen weeks ended March 25,2008, we used $2,722,787 of net cash in operating activities and $1,436,476 ofnet cash to purchase equipment and other assets primarily related to therestaurants we opened in the first quarter of 2008. We made paymentsaggregating $487,911 on our debt and capital lease obligations and received$34,046 of net cash through the exercise of stock options.

 

In February 2009, weentered into a Master Agreement with the Dunham Entities to provide rent orother cash flow reductions to us in the amount of $2.5 million for the calendaryear 2009 and $1.5 million for calendar year 2010.  The Master Agreement provides that the DunhamEntities will amend and restate applicable leases and subleases to reflectnegotiated rent reductions.  As a part ofthe Master Agreement, Dunham has agreed to amend its leases with us that arecurrently treated as capital leases for accounting purposes by reducing theirterms to periods which will thereafter qualify the leases to be treated asoperating leases in accordance with generally accepted accounting principles.  Each lease will be modified for a term of notless than 10 years and will provide that the tenant will have three consecutiveoptions to extend the leases for five years per extension.  In consideration of the agreements of Dunhamprovided in the Master Agreement, we agreed to issue to the Dunham Entities awarrant to purchase 1,000,000 shares of our common stock at an exercise priceof $0.264 per share, representing 110% of the closing price of our common stockon the trading date prior to the date of signing the Master Agreement.

 

Subsequently, we enteredinto agreements with certain of our other landlords for rent reductions.  Such rent reductions are deemed to be part ofthe above-referenced $4.0 million in rent reductions.  In consideration of such rent reductions, wehave issued five-year warrants to purchase our common stock to suchlandlords.  Each warrant is exercisableat 110% of the closing price of our common stock on the trading date prior tothe date on which we received the executed rent relief agreement, and areissued only to accredited investors.  Asof March 31, 2009, the aggregate number of shares underlying such warrantswas 196,070 shares and the weighted average exercise price was $0.27 per share.

 

During the first quarter of 2009, we financed the equipment at two ofour restaurants, aggregating approximately $2.0 million, under the terms andconditions of the equipment lease commitment we entered into with DHW in December 2007.

 

InMarch 2009, we entered into a bridge loan agreement with a group ofaccredited investors to provide $1.0 million of partially convertible debtfinancing.  The bridge loan is evidenced by notes bearing interest at 9.0%per annum, payable in six equal monthly installments commencing on May 1,2010 and due in full on October 1, 2010.  The notes are secured by amortgage against the lease, and security agreements against personal propertyand intangibles relating to our Sioux Falls, South Dakota restaurant, includinga grant of the rights to use patents, trademarks and other intangiblesassociated with that restaurant.  The bridge loan was funded to the extentof $800,000 on March 30, 2009, with the balance of the bridge loan to befunded by the end of May 2009, pursuant to an amendment to the agreementdated April 30, 2009.  Up to 20% ofeach bridge note may be converted into common stock at a conversion price equalto $0.50 per share.  In addition, we agreed to issue to the investorswarrants for the purchase of an aggregate of 400,000 shares of common stockexercisable six months after date of issuance at a price of $0.25267 per share,or 110% of the closing price of our stock on March 30, 2009.  As of March 31, 2009, warrants topurchase an aggregate of 320,000 shares of common stock had been issued to suchinvestors.

 

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The lead investors in the transaction were Harmony Equity Income Fund,L.L.C. and Harmony Equity Income Fund II, L.L.C.  Our Chairman, Eugene E.McGowan, is a member of, and has a beneficial interest in, both of the Harmonyfunds.  Our Board of Directors hasauthorized us to borrow up to an aggregate of $3.0 million under the terms ofthe bridge loan agreement, which provides that the investors may, but are notobligated to, make additional loans on substantially the same terms andconditions, including a similar pledge of collateral related to either our St.Cloud, Minnesota, or Fargo, North Dakota restaurants.

 

As a result of our historyof recurring losses, negative cash flow from operations and our accumulateddeficit, we have carefully assessed our cash needs for the next 12 months.  During the first three months of operationsin 2009, we did not meet our internal budget primarily due to decliningrevenue.  If the economic slowdowncontinues to adversely affect the U.S. economy and the restaurant industry inparticular, we may require further funding for operations during 2009. We would be required to raise such fundsthrough the incurrence of indebtedness or public or private sales of equitysecurities, which may be dilutive to shareholders. The amount of any suchrequired funding would depend upon sales trends and our ability to generatepositive cash flow. We anticipate that we will need to raise additional fundsfor future expansion depending upon the level of expansion determined to beappropriate in later years as compared to our the cash flow. If cash flow fromoperations and other sources of liquidity are insufficient to fund expectedcapital needs, or our needs are greater than anticipated, our business andresults of operations will be materially and adversely affected.

 

Ourability to fund our operations in future periods will depend upon our futureoperating performance, and more broadly, achieving budgeted revenue and on theavailability of equity and debt financing, all of which will be affected byprevailing economic conditions in our industry and financial, business andother factors, which may be beyond our control. We cannot assure you that we will obtain financing on favorable terms orat all.  If we elect to raise additionalcapital through the issuance and sale of equity securities, the sales may be atprices below the market price of our stock, and our shareholders may suffersignificant dilution.  Debt financing, ifavailable, may involve significant cash payment obligations, covenants andfinancial ratios that restrict our ability to operate and grow our business,and would cause us to incur additional interest expense and financing costs.

 

**Commitments**

 

*Capital****Lease:*

* *

As of March 31, 2009,we had 24 capital lease agreements related to our restaurant properties.  Of these leases, one expires in 2020, two in2023, four in 2024, three in 2025, four in 2026, seven in 2027, two in 2028 andone in 2029, all with renewable options for additional periods.  Twenty-two of these lease agreementsoriginated with Dunham.  Under 13 of theleases, we may be required to pay additional contingent rent based uponrestaurant sales.  The land portion ofthese leases is classified as an operating lease while the building portion ofthese leases is classified as a capital lease because its present value wasgreater than 90% of the estimated fair value at the beginning of the leaseand/or the lease term represents 75% or more of the expected life of theproperty.

 

In December 2004, weentered into a land and building lease agreement for our beer productionfacility.  This ten-year lease, whichcommenced February 1, 2005, allows us to purchase the facility at any timefor $1.00 plus the unamortized construction costs.  Because the construction costs will be fullyamortized through payment of rent during the base term, if the option isexercised at or after the end of the initial ten-year period, the option pricewill be $1.00.  As such, the lease isclassified as a capital lease.

 

In August 2006, weentered into a master lease agreement with Carlton Financial Corporation (“Carlton”)pursuant to which we could “finance lease” up to $3.0 million of equipmentpurchases for three restaurant locations. As of March 31, 2009, we had entered into three lease schedules andamendments to this master lease, pursuant to which we began leasing equipmentfor an initial lease term ranging from 36 to 39 months.  The value of the equipment financed at eachof the three locations is approximately $1.0 million and the annual interestrate 

 

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oneach ranges from 12.9% to 19.6% annually. We have provided Carlton with refundable security deposits aggregating$251,165 as well as a security interest in certain other equipment.  In February 2009,these lease schedules were amended to extend the terms by one year and reducethe monthly payments related to two of the lease schedules.  At the end of each initial lease term, wemay, under the amended lease schedules, purchase Carlton’s interest in all, butnot less than all, of the equipment for a purchase price equal to 15% of theoriginal cost of the equipment.  StevenJ. Wagenheim, our president, chief executive officer and one of our directors,was required to personally guarantee payments to be made to Carlton under thelease financing and our board of directors agreed to compensate him for suchguarantee.  The amount of annualcompensation is 3% of the balance of such leases and is calculated and accruedbased on the weighted average daily balance of the leases at the end of eachmonthly accounting period.

 

As of March 31, 2009,DHW had purchased and leased to us equipment costing $16.0 million under theEquipment Lease we entered into with DHW, relating to the lease of furniture,fixtures and equipment for our restaurants. Under the terms of the Equipment Lease Commitment, each five-year leasewith DHW is for equipment costing approximately $1.0 million per restaurant andthe annual interest rate on each lease ranges from 10.3% to 12.3%.  Payments due DHW have an annual interest rateequal to the DHW bank base rate plus 4.8%. Principal payments on the amounts borrowed depend upon the repaymentschedule specified by the banks that have provided the financing commitments toDHW.  We have the option to purchase theleased equipment for $1.00 upon payment in full of all rent payments due undereach lease. While Mr. Wagenheim owns a 20% membership interest in DHW andhas agreed to personally guarantee 20% of DHW’s indebtedness to its lenders, hewill not receive a guarantee fee or other payment in connection with this DHWfinancing.

 

In June 2007, weentered into a lease for an energy optimization system at our Maple Grove,Minnesota restaurant for approximately $30,000. This five-year lease commenced June 28, 2007, carries an annualinterest rate of approximately 11.9% and contains a bargain purchase option.

 

*Operating****Lease:*

* *

The land portions of the 24property leases referenced above, 22 lease agreements of which originated withDunham, are classified as operating leases because the fair value of the land was25% or more of the leased property at the inception of each lease.  All scheduled rent increases for the landduring the initial term of each lease are recognized on a straight-line basis.  In addition to such property leases, we haveobligations under the following operating leases:

 

In January 2001, weentered into a 20-year operating lease for the land upon which we built ourFargo, North Dakota restaurant.  Underthe lease terms, we are obligated to annual rent of $72,000 plus contingentrent based upon restaurant sales.

 

In August 2005, weentered into a 38-month lease agreement for office space for our corporateoffices.  The lease commenced October 1,2005.  In November 2007, we enteredinto an amendment to such lease to include additional space commencing December 1,2007.  Pursuant to the amended lease,which expires in November 2011, annual rent is $96,613 with scheduledannual increases throughout the term of the lease.  Such scheduled rent increases are recognizedon a straight-line basis over the term of the lease.

 

In November 2005, weentered into an agreement for a facility in Minneapolis, Minnesota which we useas a test kitchen.  This lease commenced November 1,2005.  In October 2008, we exerciseda three-year option to extend this lease which, as extended, expires in October 2011.  The agreement calls for annual rent of$43,796.

 

In March 2006, weentered into a lease agreement for the land and building for our St. LouisPark, Minnesota restaurant.  Rentalpayments for this lease are $148,625 annually. This operating lease expires in 2016 with renewal options for additionalperiods.

 

In August 2008, weceased operations at our restaurant in Rogers, Arkansas.  However, we are currently bound by the termsof the 20-year net lease agreement entered into in 2007 under the termsspecified in the 

 

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developmentagreement with Dunham.  Pursuant to theMaster Agreement with the Dunham Entities described above, we will reimburseDunham for any out-of-pocket expenses incurred less net proceeds from the saleof the real estate or lease income associated with this site.  The building portion of this lease is classifiedas a capital lease, while the land portion is classified as an operating lease(see Notes 3 and 9 to our condensed consolidated financial statements).

 

*Personal Guaranties and Guarantee Fees:*

* *

One of our directors and oneformer director have personally guaranteed certain of our leases and loanagreements.  Our board of directors hasagreed to compensate Steven J. Wagenheim, our president, chief executiveofficer and one of our directors, for his personal guaranties of equipmentloans entered into in August 2003, January 2004 and August 2006.  The amount of annual compensation for each ofthese guarantees is 3% of the balance of the obligation and is calculated andaccrued based on the weighted average daily balance of the obligation at theend of each monthly accounting period. During the first quarters of 2009 and 2008, we recorded $17,787 and $25,803 of such compensation ingeneral and administrative expense, respectively.

 

*In December 2007,we entered into an Equipment Lease Commitment and Master Equipment Lease withDHW, relating to the lease of furniture, fixtures and equipment for current andfuture restaurants.  While Mr. Wagenheimowns a 20% membership interest in DHW and has agreed to personally guarantee20% of DHW’s indebtedness to its lenders, his participation in the income andprofits of DHW may not exceed 3% of the average principal balance of the amountguarantied for the term of the guarantied debt. Furthermore, Mr. Wagenheim will not receive a guarantee fee orother payment from our company in connection with the equipment lease financingfrom DHW.*

* *

*Employment Agreements:*

* *

*In June 2005,we entered into a three-year employment agreement with Steven J. Wagenheim, ourpresident and chief executive officer, who also is one of our directors.  In April 2007, we amended thecompensatory arrangements under the agreement to provide for an annual basesalary of $300,000, commencing April 1, 2007.  Mr. Wagenheim’s annual non-equityincentive compensation ranges from $0 to $197,400 based on performance.  In addition to annual compensation terms andother provisions, the agreement includes change in control provisions thatwould entitle Mr. Wagenheim to receive severance pay equal to18 months of salary if there is a change in control of our company and hisemployment terminates.  Mr. Wagenheimhas agreed to certain nondisclosure provisions during the term of hisemployment and any time thereafter, and certain noncompetition andnonrecruitment provisions during the term of his employment and for a period ofone year thereafter.  Our company and Mr. Wagenheimhave agreed to continue operating under the terms of this agreement, which wasamended in December 2008 to comply with the requirements of Section 409Aof the Internal Revenue Code, until such time as a new agreement becomeseffective.*

* *

In November 2007, weentered into an employment agreement with James G. Gilbertson providing for hisemployment as our chief financial officer on an at-will basis at an annual basesalary of $225,000.  He is entitled toparticipate in performance-based cash bonus or equity award plans for seniorexecutives based upon goals established by our board or compensation committeeafter reasonable consultation with Mr. Gilbertson.  He may be eligible to receive a bonus of upto 50% of his base salary.  We alsogranted to Mr. Gilbertson a stock option for the purchase of 175,000shares of common stock, vesting over a two-year period, upon the commencementof his employment.  The employmentagreement provides for provisions for termination with and without cause by usand for good reason by Mr. Gilbertson and for the payment of a severancepayment equal to 12 months of base salary upon termination of employmentresulting from a change of control of our company, or if Mr. Gilbertson isterminated without cause.  The employmentagreement contains other customary terms and conditions.  Mr. Gilbertson’s employment agreementalso was amended in December 2008 to comply with the requirements of Section 409Aof the Internal Revenue Code.

 

In December 2008, weentered into an employment and severance agreement with Darius H. Gilanfarproviding for his continued employment as Chief Operating Officer on an at-willbasis at an annual base salary of 

 

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$202,860.  He also is entitled to participate inemployee benefit plans, policies, programs, perquisites and arrangements thatare provided generally to similarly situated executive employees of ourcompany.  The employment agreementprovides for provisions for termination with and without cause by us and forgood reason by Mr. Gilanfar and for the payment of a severance paymentequal to 12 months of base salary upon termination of employment resulting froma change of control of our company, or if Mr. Gilanfar is terminatedwithout cause.  In addition to the severance payment, we would pay Mr. Gilanfara pro-rated bonus due him pursuant to any bonus plan or arrangement in which heparticipates at the time of the termination of his employment.  Such bonuswould be reduced by the amount of cash severance benefits to which Mr. Gilanfarmay be entitled pursuant to any other cash severance plan, agreement, policy orprogram.  In addition, Mr. Gilanfarhas agreed to certain nondisclosure provisions during the term of hisemployment and any time thereafter, and certain non-competition andnon-recruitment provisions during the term of his employment and for a periodof 12 months thereafter.

 

*Development Agreement*:

* *

In April 2008, we enteredinto a development agreement with United Properties for the development of upto 22 restaurants to be built between 2009 and 2012.  United Properties will be responsible for allcosts related to the land and building of each restaurant.  The development agreement provides fora cooperative process between United Properties and our management for theselection of restaurant sites and the development of restaurants on those sitesand scheduling for the development and construction of each restaurant once alocation is approved.  The annual lease rate for fee-simple land andbuilding developments will be 9.5% and we will have the right of first offer topurchase these restaurants.  Additionally,in the event United Properties sells one of the buildings that it develops forus at an amount in excess of the threshold agreed to by the parties in theagreement, then we will share in the profits of that sale.  We assume no liability in the event UnitedProperties sells a building at a loss.  Weare not bound to authorize the construction of restaurants during that timeperiod, but generally cannot use another developer to develop or own arestaurant as long as the development agreement is in effect.  We can, however, use another developer ifUnited Properties declines to build a particular restaurant.  In addition, we have also agreed to refrainfrom developing any new restaurants in the remainder of 2009 without theconsent of the Dunham Entities (which will not be unreasonably delayed orwithheld).

 

*Off- balance sheet arrangements:*

 

It is not our business practice to enter intooff-balance sheet arrangements.

 

*Summary of contractual obligations:*

 

Thefollowing table summarizes our obligations under contractual agreements as of March 31,2009 and the time frame within which payments on such obligations are due.  This table does not include amounts relatedto contingent rent as such future amounts are not determinable.  In addition, whether we would incur anyadditional expense on our employment agreements depends upon the existence of achange in control of the company or other unforeseeable events.  Therefore, neither contingent rent norseverance expense has been included in the following table.

 
| ** **                                       | ** ** | **Payments due by period** | ** **  |
|--------------------------------------------------|------------|----------------------------|-------------|
| **Contractual Obligations**                 | ** ** | **Total**                  | ** **  | **Fiscal Year  2009** | ** ** | **Fiscal Years  2010-2011** | ** ** | **Fiscal Years  2012-2013** | ** ** | **Fiscal Years  Thereafter** | ** ** |
| Long-term debt,  principal                       |       | $                          | 2,664,142   |   | $ | 226,348 |   | $ | 2,199,454 |   | $ | 8,880 |   | $ | 229,460 |   |
| Interest on long-term  debt                      |       | 686,480                    |        | 179,238 |   | 314,895 |   | 37,429 |   | 154,919 |   |
| Capital lease  obligations, including interest   |       | 141,081,670                |        | 7,006,860 |   | 20,542,228 |   | 22,632,167 |   | 90,900,415 |   |
| Operating lease  obligations, including interest |       | 66,645,821                 |        | 2,200,777 |   | 6,934,497 |   | 7,570,681 |   | 49,939,866 |   |
| Loan guarantee                                   |       | 162,713                    |        | 124,726 |   | 31,301 |   | 6,686 |   | — |   |
| Total  obligations                               |       | $                          | 211,240,827 |   | $ | 9,737,950 |   | $ | 30,022,375 |   | $ | 30,255,842 |   | $ | 141,224,660 |   |

 

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Certain amounts donot sum due to rounding.

 

During the first threemonths of operations in 2009, we did not meet our internal budget primarily dueto declining revenue.  If the economicslowdown continues to adversely affect the U.S. economy and the restaurantindustry in particular, we will require further funding for operations during2009. 

 

*Recent accounting pronouncements:*

 

Seethe “Recent accounting pronouncements” section of Note 1 to our condensedconsolidated financial statements for a summary of recent accounting standards.

 

**Seasonality**

 

We expect that our sales and earnings willfluctuate based on seasonal patterns.  Weanticipate that our highest sales and earnings will occur in the second and thirdquarters due to the milder climate and availability of outdoor seating duringthose quarters in our markets.

 

**Inflation**

** **

Theprimary inflationary factors affecting our operations are food, supplies andlabor costs.  A large percentage of ourrestaurant personnel is paid at rates based on the applicable minimum wage, andincreases in the minimum wage directly affect our labor costs.  In the past, we have been able to minimizethe effect of these increases through menu price increases and other strategies.  To date, inflation has not had a materialimpact on our operating results.

 

**ITEM 3           Quantitativeand Qualitative Disclosures about Market Risk**

 

Our company is exposed tomarket risk from changes in interest rates on debt and changes in commodityprices.

 

*Changesin interest rates:*

 

Pursuantto the terms of our capital leases and long-term debt, we will have balloonpayments due over five years beginning in 2010. If it becomes necessary to refinance such balloon balances, we may notbe able to secure financing at the same interest rate.  The effect of a higher interest rate woulddepend upon the negotiated financing terms.

 

*Changes in commodity prices:*

 

Many of the food productsand other commodities we use in our operations are subject to price volatilitydue to market supply and demand factors outside of our control.  Fluctuations in commodity prices and/orlong-term changes could have an adverse effect on us.  These commodities are generally purchasedbased upon market prices established with vendors.  To manage this risk in part, we have enteredinto fixed price purchase commitments, with terms typically up to one year, formany of our commodity requirements.  Wehave entered into contracts through 2013 with certain suppliers of rawmaterials (primarily hops) for minimum purchases both in terms of quantity andin pricing.   As of March 31, 2009,our future obligations under such contracts aggregated approximately $1.3million.

 

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Although a large nationaldistributor is our primary supplier of food, substantially all of our food andsupplies are available from several sources, which helps to control commodityprice risks.  Additionally, we have theability to increase menu prices, or vary the menu items offered, in response tofood product price increases.  If,however, competitive circumstances limit our menu price flexibility, marginscould be negatively impacted.

 

Ourcompany does not enter into derivative contracts either to hedge existing risksor for speculative purposes.

 

**ITEM 4           Controlsand Procedures**

 

*Evaluationof disclosure controls and procedures*

 

We maintain a system ofdisclosure controls and procedures that is designed to ensure that informationrequired to be disclosed in our Exchange Act reports is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosures.

 

Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of our disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)). Based on this evaluation, ourChief Executive Officer and our Chief Financial Officer concluded that, as of March 31,2009, our disclosure controls and procedures were effective.

 

*Changes in internal control over financial reporting*

 

There were no changes in our internal controlover financial reporting that occurred during the quarter ended March 31,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

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**PART II       OTHERINFORMATION**

 
| **ITEM 1**                                                                                                                                                                                                                 | ** ** | **Legal Proceedings**                                                       | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
|                                                                                                                                                                                                                       |       |                                                                        |       |
|                                                                                                                                                                                                                       |       | Not applicable.                                                             |       |
|                                                                                                                                                                                                                       |       |                                                                        |       |
| **ITEM 1A**                                                                                                                                                                                                                | ** ** | **Risk Factors**                                                            | ** ** |
|                                                                                                                                                                                                                       |       |                                                                        |       |
| Please refer to the  “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year  ended December 30, 2008, filed with the Securities and Exchange  Commission on March 19, 2009. |       |
|                                                                                                                                                                                                                       |       |                                                                        |       |
| **ITEM 2**                                                                                                                                                                                                                 | ** ** | **Unregistered Sales of Equity Securities and Use  of Proceeds**            | ** ** |
|                                                                                                                                                                                                                       |       |                                                                        |       |
|                                                                                                                                                                                                                       |       | None, other than  previously reported in a Current Report on Form 8-K. |       |
|                                                                                                                                                                                                                       |       |                                                                        |       |
| **ITEM 3**                                                                                                                                                                                                                 | ** ** | **Defaults upon Senior Securities**                                         | ** ** |
|                                                                                                                                                                                                                       |       |                                                                        |       |
|                                                                                                                                                                                                                       |       | Not applicable.                                                             |       |
|                                                                                                                                                                                                                       |       |                                                                        |       |
| **ITEM 4**                                                                                                                                                                                                                 | ** ** | **Submission of Matters to a Vote of Security  Holders**                    | ** ** |
|                                                                                                                                                                                                                       |       |                                                                        |       |
|                                                                                                                                                                                                                       |       | Not applicable.                                                             |       |
|                                                                                                                                                                                                                       |       |                                                                        |       |
| **ITEM 5**                                                                                                                                                                                                                 | ** ** | **Other Information**                                                       | ** ** |
|                                                                                                                                                                                                                       |       |                                                                        |       |
|                                                                                                                                                                                                                       |       | Not applicable.                                                             |       |
|                                                                                                                                                                                                                       |       |                                                                        |       |
| **ITEM 6**                                                                                                                                                                                                                 | ** ** | **Exhibits**                                                                | ** ** |
|                                                                                                                                                                                                                       |       |                                                                        |       |
|                                                                                                                                                                                                                       |       | See “Index to Exhibits.”                                          |       |

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|                                      |   | GRANITE CITY FOOD &  BREWERY LTD.                                                                 |
|-------------------------------------------|--------|------------------------------------------------------------------------------------------------------------|
|                                      |   |                                                                                                       |
|                                      |   |                                                                                                       |
| Date:   May 15,  2009 |   | By:                                                                                                        | /s/ James G. Gilbertson |
|                                      |   | James G. Gilbertson                                                                                        |
|                                      |   | Chief Financial Officer                                                                                    |
|                                      |   | (As Principal Financial Officer and Duly Authorized  Officer of Granite City Food & Brewery Ltd.) |

 

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**INDEX TO EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                         |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 3.1                 |       | Articles of Incorporation of the Company, as amended (incorporated by  reference to our Quarterly Report on Form 10-QSB, filed on  November 13, 2002 (File No. 000-29643)).                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 3.2                 |       | Amended and Restated Bylaws of the Company, dated May 2, 2007  (incorporated by reference to our Current Report on Form 8-K, filed on  May 4, 2007 (File No. 000-29643)).                                                                                                                                                                           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 4.1                 |       | Reference is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 4.2                 |       | Specimen common stock certificate (incorporated by reference to our  Current Report on Form 8-K, filed on September 20, 2002 (File  No. 000-29643)).                                                                                                                                                                                                     |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.1                |       | Master Agreement between Dunham Capital Management, L.L.C., DHW  Leasing, L.L.C., Dunham Equity Management, L.L.C. and the Company, dated  February 7, 2009 (incorporated by reference to our Current Report on  Form 8-K, filed on February 12, 2009 (File No. 000-29643)).                                                                        |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.2                |       | Bridge Loan Agreement by and between the Company, Granite City  Restaurant Operations, Inc. and Harmony Equity Income Fund, L.L.C.,  dated March 30, 2009 (incorporated by reference to our Current Report on  Form 8-K, filed on April 3, 2009 (File No. 000-29643)).                                                                         |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.3                |       | Security Agreement by and among the Company, Granite City Restaurant  Operations, Inc. and Harmony Equity Income Fund, L.L.C., dated  March 30, 2009 (incorporated by reference to our Current Report on  Form 8-K, filed on April 3, 2009 (File No. 000-29643)).                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.4                |       | Leasehold 180-Day Redemption Mortgage and Security Agreement and  Fixture Filing Statement by Granite City Restaurant Operations, Inc. as  debtor in favor of Harmony Equity Income Fund, L.L.C., dated March 30,  2009 (incorporated by reference to our Current Report on Form 8-K, filed  on April 3, 2009 (File No. 000-29643)).           |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.5                |       | Patent and Trademark Security Agreement by and between the Company  and Harmony Equity Income Fund, L.L.C., dated March 30, 2009  (incorporated by reference to our Current Report on Form 8-K, filed on  April 3, 2009 (File No. 000-29643)).                                                                                                      |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.6                |       | IP Agreement by and between the Company and Harmony Equity Income  Fund, L.L.C., dated March 30, 2009 (incorporated by reference to our  Current Report on Form 8-K, filed on April 3, 2009 (File  No. 000-29643)).                                                                                                                                 |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.7                |       | Amendment No. 1 to Bridge Loan Agreement by and between the  Company, Granite City Restaurant Operations, Inc. and Harmony Equity  Income Fund, L.L.C., including the Amended Forms of Note and Warrant, dated  April 22, 2009 (incorporated by reference to our Current Report on  Form 8-K, filed on May 6, 2009 (File No. 000-29643)). |
|                |       |                                                                                                                                                                                                                                                                                                                                                                    |
| 10.8                |       | Amendment No. 2 to Bridge Loan Agreement by and between the  Company, Granite City Restaurant Operations, Inc. and Harmony Equity  Income Fund, L.L.C., dated April 30, 2009 (incorporated by reference to  our Current Report on Form 8-K, filed on May 6, 2009 (File  No. 000-29643)).                                                  |

 

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Table ofContents

 
| 31.1   |   | Certification by Steven J. Wagenheim, President and Chief Executive  Officer of the Company, pursuant to Exchange Act Rule 13a-14(a), as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                   |
| 31.2   |   | Certification by James G. Gilbertson, Chief Financial Officer of the  Company, pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.               |
|   |   |                                                                                                                                                                                                                   |
| 32.1   |   | Certification by Steven J. Wagenheim, President and Chief Executive  Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.      |
|   |   |                                                                                                                                                                                                                   |
| 32.2   |   | Certification  by James G. Gilbertson, Chief Financial Officer of the Company, pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                   |

 

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