Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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 THE QUARTERLY PERIOD  ENDED SEPTEMBER 29, 2009** |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                      |
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                   |

 

**Commission File Number 000-29643**

 

**GRANITE CITY FOOD &BREWERY LTD.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Minnesota**

(State or Other Jurisdiction

of Incorporation or Organization) | ** ** | **41-1883639**

(I.R.S. Employer

Identification No.) |
|--------------------------------------------------------------------------------|------------|-------------------------------------------------------|

 

**5402 Parkdale Drive, Suite 101**

**Minneapolis, Minnesota  55416**

**(952) 215-0660**

(Address of Principal Executive Offices and Issuer’s

Telephone Number, including Area Code)

 

Indicateby check mark whether 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

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T(§ 229.405 of this chapter) during the preceding 12 months (or for suchshorter period that the registrant was required to submit and post suchfiles).  Yes  o No  o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-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.  (Check one):

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

 

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

 

Yes o     No x

 

As of November 9, 2009, the issuer hadoutstanding 44,197,849****shares of common stock.

 

 

 

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Table of Contents

 

**TABLE OF CONTENTS**

 
| ** **             | ** **                                                                                                                                                                            | **Page** |
|------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                   |                                                                                                                                                                                  |     |
| **PART I**        | **FINANCIAL INFORMATION**                                                                                                                                                             | 1        |
|                   |                                                                                                                                                                                  |     |
| ITEM 1                 | Financial Statements                                                                                                                                                                  | 1        |
|                   |                                                                                                                                                                                  |     |
|                   | Condensed Consolidated Balance Sheets as of  September 29, 2009 and December 30, 2008                                                                                       | 1        |
|                   |                                                                                                                                                                                  |     |
|                   | Condensed Consolidated Statements of Operations for  the Thirteen and Thirty-nine weeks ended September 29, 2009 and the  Fourteen and Forty weeks ended September 30, 2008 | 2        |
|                   |                                                                                                                                                                                  |     |
|                   | Condensed Consolidated Statements of Cash Flows for  the Thirty-nine weeks ended September 29, 2009 and the Forty weeks Ended  September 30, 2008                           | 3        |
|                   |                                                                                                                                                                                  |     |
|                   | Notes to Condensed Consolidated Financial Statements                                                                                                                                  | 4        |
|                   |                                                                                                                                                                                  |     |
| ITEM 2                 | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                                                           | 21       |
|                   |                                                                                                                                                                                  |     |
| ITEM 3                 | Quantitative and Qualitative Disclosures  about Market Risk                                                                                                                           | 36       |
|                   |                                                                                                                                                                                  |     |
| ITEM 4                 | Controls and Procedures                                                                                                                                                               | 37       |
|                   |                                                                                                                                                                                  |     |
| **PART II**       | **OTHER INFORMATION**                                                                                                                                                                 | 37       |
|                   |                                                                                                                                                                                  |     |
| ITEM 1                 | Legal Proceedings                                                                                                                                                                     | 37       |
|                   |                                                                                                                                                                                  |     |
| ITEM 1A                | Risk Factors                                                                                                                                                                          | 37       |
|                   |                                                                                                                                                                                  |     |
| ITEM 2                 | Unregistered Sales of Equity Securities  and Use of Proceeds                                                                                                                          | 37       |
|                   |                                                                                                                                                                                  |     |
| ITEM 3                 | Defaults upon Senior Securities                                                                                                                                                       | 38       |
|                   |                                                                                                                                                                                  |     |
| ITEM 4                 | Submission of Matters to a Vote of  Security Holders                                                                                                                                  | 38       |
|                   |                                                                                                                                                                                  |     |
| ITEM 5                 | Other Information                                                                                                                                                                     | 38       |
|                   |                                                                                                                                                                                  |     |
| ITEM 6                 | Exhibits                                                                                                                                                                              | 38       |
|                   |                                                                                                                                                                                  |     |
| **SIGNATURES**         |                                                                                                                                                                                  | 39       |
|                   |                                                                                                                                                                                  |     |
| **INDEX TO  EXHIBITS** |                                                                                                                                                                                  | 40       |

 

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| **PART I ** | **FINANCIAL  INFORMATION** | ** ** |
|-----------------------|----------------------------|------------|

 

**ITEM 1  Financial Statements**

 

**GRANITE CITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                    | ** ** | **September 29,** | ** ** | **December 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                    | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ASSETS:                                                                                                                                                       |       |                   |       |                  |       |
| Current assets:                                                                                                                                               |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                     |       | $                      | 547,160    |                  | $          | 2,652,411 |   |
| Inventory                                                                                                                                                     |       | 914,956                |       | 773,468               |       |
| Prepaids and other                                                                                                                                            |       | 625,391                |       | 473,343               |       |
| Total current assets                                                                                                                                          |       | 2,087,507              |       | 3,899,222             |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Deferred transaction cost                                                                                                                                     |       | 938,164                |       | —                |       |
| Prepaid rent, net of current portion                                                                                                                          |       | 318,256                |       | 456,644               |       |
| Property and equipment, net                                                                                                                                   |       | 72,741,268             |       | 76,251,463            |       |
| Intangible and other assets                                                                                                                                   |       | 1,306,247              |       | 1,503,336             |       |
| Total assets                                                                                                                                                  |       | $                      | 77,391,442 |                  | $          | 82,110,665 |   |
|                                                                                                                                                          |       |                   |       |                  |       |
| LIABILITIES AND SHAREHOLDERS’ (DEFICIT) EQUITY:                                                                                                          |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                          |       |                   |       |                  |       |
| Accounts payable                                                                                                                                              |       | $                      | 2,538,762  |                  | $          | 2,000,812 |   |
| Accrued expenses                                                                                                                                              |       | 5,264,768              |       | 5,962,487             |       |
| Accrued exit or disposal activities, current portion                                                                                                          |       | 20,684                 |       | 19,999                |       |
| Deferred rent, current portion                                                                                                                                |       | 900,366                |       | 203,062               |       |
| Long-term debt, current portion                                                                                                                               |       | 981,434                |       | 320,697               |       |
| Capital lease obligations, current portion                                                                                                                    |       | 4,836,705              |       | 3,201,829             |       |
| Total current liabilities                                                                                                                                     |       | 14,542,719             |       | 11,708,886            |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Accrued exit or disposal activities, net of current  portion                                                                                                  |       | 1,196,895              |       | 822,494               |       |
| Deferred rent, net of current portion                                                                                                                         |       | 3,106,421              |       | 2,817,593             |       |
| Long-term debt, net of current portion                                                                                                                        |       | 1,547,615              |       | 1,668,134             |       |
| Capital lease obligations, net of current portion                                                                                                             |       | 61,134,302             |       | 62,616,992            |       |
| Total liabilities                                                                                                                                             |       | 81,527,952             |       | 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 September 29,  2009 and December 30, 2008 |       | 161,978                |       | 161,978               |       |
| Additional paid-in capital                                                                                                                                    |       | 44,210,898             |       | 43,844,373            |       |
| Accumulated (deficit) equity                                                                                                                                  |       | (48,509,386            | )          | (41,529,785           | )          |
| Total shareholders’ (deficit) equity                                                                                                                     |       | (4,136,510             | )          | 2,476,566             |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Total liabilities and shareholders’ (deficit) equity                                                                                                     |       | $                      | 77,391,442 |                  | $          | 82,110,665 |   |

 

See notes to condensed consolidated financial statements.

 

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**GRANITE CITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
| ** **                                 | ** ** | **Thirteen**           | ** ** | **Fourteen**           | ** ** | **Thirty-nine**        | ** ** | **Forty**              | ** ** |
|--------------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** |
| ** **                                 | ** ** | **September 29,** | ** ** | **September 30,** | ** ** | **September 29,** | ** ** | **September 30,** | ** ** |
| ** **                                 | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008**               | ** ** |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Restaurant revenues                        |       | $                      | 21,478,123 |                   | $          | 25,483,423             |       | $                      | 65,004,189 |   | $ | 74,601,745 |   |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Cost of sales:                             |       |                   |       |                   |       |                   |       |                   |       |
| Food, beverage and retail                  |       | 5,982,592              |       | 7,580,660              |       | 17,864,596             |       | 22,705,868             |       |
| Labor                                      |       | 7,578,646              |       | 9,117,270              |       | 22,805,179             |       | 27,767,400             |       |
| Direct restaurant operating                |       | 3,261,449              |       | 3,817,757              |       | 9,619,339              |       | 10,913,287             |       |
| Occupancy                                  |       | 1,670,941              |       | 1,472,968              |       | 4,814,456              |       | 4,637,939              |       |
| Total cost of sales                        |       | 18,493,628             |       | 21,988,655             |       | 55,103,570             |       | 66,024,494             |       |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Pre-opening                                |       | —                 |       | 498,744                |       | 211,262                |       | 1,328,812              |       |
| General and administrative                 |       | 1,397,184              |       | 2,735,500              |       | 5,892,251              |       | 8,206,848              |       |
| Depreciation and amortization              |       | 1,760,339              |       | 1,640,343              |       | 5,195,056              |       | 4,815,399              |       |
| Exit or disposal activities                |       | 174,787                |       | 1,119,545              |       | 776,327                |       | 1,119,545              |       |
| Other                                      |       | 8,278                  |       | 53,768                 |       | 58,686                 |       | 105,138                |       |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Operating loss                             |       | (356,093               | )          | (2,553,132             | )          | (2,232,963             | )          | (6,998,491             | )          |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Interest:                                  |       |                   |       |                   |       |                   |       |                   |       |
| Income                                     |       | 79                     |       | 3,231                  |       | 1,687                  |       | 28,477                 |       |
| Expense                                    |       | (1,365,885             | )          | (1,701,871             | )          | (4,748,325             | )          | (4,841,825             | )          |
| Net interest expense                       |       | (1,365,806             | )          | (1,698,640             | )          | (4,746,638             | )          | (4,813,348             | )          |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Net loss                                   |       | $                      | (1,721,899 | )                      | $          | (4,251,772             | )          | $                      | (6,979,601 | ) | $ | (11,811,839 | ) |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Loss per common share, basic               |       | $                      | (0.11      | )                      | $          | (0.26                  | )          | $                      | (0.43      | ) | $ | (0.73 | ) |
|                                       |       |                   |       |                   |       |                   |       |                   |       |
| Weighted average shares outstanding, basic |       | 16,197,849             |       | 16,197,849             |       | 16,197,849             |       | 16,192,844             |       |

 

See notes to condensed consolidated financial statements.

 

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**GRANITE CITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Thirty-nine**        | ** ** | **Forty**              | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** |
| ** **                                                                         | ** ** | **September 29,** | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2009**               | ** ** | **2008**               | ** ** |
|                                                                               |       |                   |       |                   |       |
| Cash flows from operating activities:                                              |       |                   |       |                   |       |
| Net loss                                                                           |       | $                      | (6,979,601 | )                      | $          | (11,811,839 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities:       |       |                   |       |                   |       |
| Depreciation and amortization                                                      |       | 5,107,214              |       | 4,779,634              |       |
| Other amortization                                                                 |       | 87,842                 |       | 35,765                 |       |
| Stock warrant/option expense                                                       |       | 185,870                |       | 413,646                |       |
| Loss on disposal of property and equipment                                         |       | 58,686                 |       | 105,138                |       |
| Loss on exit or disposal activities                                                |       | 375,085                |       | 986,613                |       |
| Deferred rent                                                                      |       | 1,166,787              |       | 453,443                |       |
| Changes in operating assets and liabilities:                                       |       |                   |       |                   |       |
| Inventory                                                                          |       | (141,488               | )          | 6,942                  |       |
| Prepaids and other                                                                 |       | (108,679               | )          | (791,240               | )          |
| Accounts payable                                                                   |       | 489,424                |       | (414,946               | )          |
| Accrued expenses                                                                   |       | (697,719               | )          | (2,033,332             | )          |
| Net cash used in operating activities                                              |       | (456,579               | )          | (8,270,176             | )          |
|                                                                               |       |                   |       |                   |       |
| Cash flows from investing activities:                                              |       |                   |       |                   |       |
| Purchase of:                                                                       |       |                   |       |                   |       |
| Property and equipment                                                             |       | (427,730               | )          | (2,862,173             | )          |
| Intangible and other assets                                                        |       | (291,685               | )          | (436,096               | )          |
| Net cash used in investing activities                                              |       | (719,415               | )          | (3,298,269             | )          |
|                                                                               |       |                   |       |                   |       |
| Cash flows from financing activities:                                              |       |                   |       |                   |       |
| Payments on capital lease obligations                                              |       | (1,531,310             | )          | (1,276,329             | )          |
| Proceeds from capital leases                                                       |       | 1,000,000              |       | 8,000,000              |       |
| Payments on long-term debt                                                         |       | (259,782               | )          | (205,579               | )          |
| Proceeds from long-term debt                                                       |       | 800,000                |       | —                 |       |
| Deferred transaction costs                                                         |       | (938,164               | )          | —                 |       |
| Net proceeds from issuance of stock                                                |       | —                 |       | 29,066                 |       |
| Net cash provided by (used in) financing activities                                |       | (929,256               | )          | 6,547,158              |       |
|                                                                               |       |                   |       |                   |       |
| Net decrease in cash                                                               |       | (2,105,251             | )          | (5,021,287             | )          |
| Cash and cash equivalents, beginning                                               |       | 2,652,411              |       | 7,076,835              |       |
| Cash and cash equivalents, ending                                                  |       | $                      | 547,160    |                   | $          | 2,055,548 |   |
|                                                                               |       |                   |       |                   |       |
| Supplemental disclosure of non-cash investing and  financing activities:           |       |                   |       |                   |       |
| Land, buildings and equipment acquired under capital  lease agreements             |       | $                      | 2,938,266  |                   | $          | 8,526,868 |   |
| Property and equipment and intangibles purchased and  included in accounts payable |       | $                      | 48,526     |                   | $          | 1,271,883 |   |

 

See notes to condensed consolidated financial statements.

 

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**GRANITE CITY FOOD & BREWERY LTD.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**Thirteen and Thirty-nine weeks ended September 29,2009 and September 30, 2008**

 

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

 

Background

 

Granite City Food & Brewery Ltd. (the “Company”)develops and operates Modern American casual dining restaurants known asGranite City Food & Brewery®.  The restaurant theme is upscale casual dining with a wide variety ofmenu items that are prepared fresh daily, combined with freshly brewedhand-crafted beers finished on-site.  TheCompany opened its first Granite City restaurant in St. Cloud, Minnesota in July 1999and has since expanded to other Midwest markets.  As of September 29, 2009, the Companyoperated 26 restaurants in 11 states. The Company also operates a centralized beer production facility whichis used to provide raw material support to its restaurants to create consistentquality and operational efficiencies in the production of its proprietarybeer.  The Company believes that thisbrewing process improves the economics of microbrewing as it eliminates theinitial stages of brewing and storage at multiple locations.  In 2007, the Company was granted a patent bythe United States Patent Office for its brewing process.

 

Principlesof consolidation and basis of presentation

 

During the first nine months of operations in 2009,the Company did not meet its internal budget primarily due to decliningrevenue.  In June 2009, the Companyannounced the hiring of MorrisAnderson in an effort to restructure its debt andleases.  To conserve cash for operations,the Company has been reducing, delaying or withholding payments to itslandlords during periods of negotiations with the landlords in order to satisfyoperating obligations as necessary to avoid disruption of restaurantoperations.  In October 2009, theCompany completed a debt conversion transaction (the “Transaction”) with DHWLeasing, L.L.C. (“DHW”), its primary source of financing for furniture,fixtures and equipment, as contemplated under the Debt Conversion Agreementbetween the Company and DHW dated September 21, 2009.  In the Transaction, approximately $15 millionof the Company’s indebtedness to DHW was converted into 28,000,000 shares ofthe Company’s common stock at a conversion price of approximately $0.54 pershare.  As a result, DHW and affiliatedparties beneficially own an aggregate of 64.8% of the Company’s common stock,which constituted a change in control of the Company.  In connection with the Transaction, theparties entered into a number of ancillary agreements which include, but arenot limited to, lease amendments, deferred lease payments and an agreement toseek to obtain further rent reductions (Note 13).

 

The Company believes this restructuring has improvedits balance sheet by reducing aggregate indebtedness and better positions theCompany to operate its business.  TheCompany continues to review its capital needs and its ability to raiseadditional capital.  If the restructuringefforts do not enable the Company to have sufficient working capital due to achange in its business operations, further declining revenues or any otherreason, the Company will be required to raise funds during 2009 through theincurrence of indebtedness or public or private sales of equity securities,which may be dilutive to shareholders and may or may not be available to theCompany. The amount of any such required funding would depend upon sales trendsand the Company’s ability to generate working capital.  If cash flow from operations are insufficientto fund expected capital needs, or if the Company’s needs are greater thananticipated and the Company is unable to obtain additional capital, itsbusiness and results of operations will be materially and adversely affected.

 

The Company’s ability to fund its operations infuture periods will depend upon its future operating performance, and morebroadly, achieving budgeted revenue, and on the availability of equity and debtfinancing, all of which will be affected by prevailing economic conditions inthe retail and casual dining industries and other factors, which may be beyondthe Company’s control.  There can be noassurance that the Company will obtain financing on favorable terms or atall.  If the Company raises additionalcapital through 

 

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the issuance and sale of equity securities, thesecurities may be issued at prices below the market price of its stock, and itsshareholders may suffer significant dilution. Debt financing, if available, may involve significant cash paymentobligations, covenants and financial ratios that restrict the Company’s abilityto operate and grow its business, and would cause it to incur additionalinterest expense and financing costs.

 

The Company’s condensed consolidated financialstatements include the accounts and operations of the Company and itssubsidiary corporation under which its Kansas locations are operated.  Fifty percent of the stock of the subsidiarycorporation is owned by a resident of Kansas. Granite City Restaurant Operations, Inc., a wholly-owned subsidiaryof the Company, owns the remaining 50% of the stock of the subsidiarycorporation.  The resident-owner of thestock of that entity has entered into a buy-sell agreement with the subsidiarycorporation providing, among other things, that transfer of the shares isrestricted and that the shareholder must sell his shares to the subsidiarycorporation upon certain events, or any event that disqualifies theresident-owner from owning the shares under applicable laws and regulations ofthe state.  The Company has entered intoa master agreement with the subsidiary corporation that permits the operationof the restaurants and leases to the subsidiary corporation the Company’sproperty and facilities.  The subsidiarycorporation pays all of its operating expenses and obligations, and the Companyretains, as consideration for the operating arrangements and the lease ofproperty and facilities, all the net profits, as defined, if any, from suchoperations.  The Company has determinedthat the foregoing ownership structure will cause the subsidiary corporation tobe treated as a variable interest entity in which the Company has a controllingfinancial interest for the purpose, pursuant the Financial Accounting StandardsBoard’s (“FASB”) accounting guidance on accounting for variable interestentities.* *Assuch, the subsidiary corporation is consolidated with the Company’s financialstatements and the Company’s financial statements do not reflect a minorityownership in the subsidiary corporation. Also included in the Company’s condensed consolidated financialstatements are other wholly-owned subsidiaries. All references to the Company in these notes to condensed consolidatedfinancial statements relate to the consolidated entity, and all intercompanybalances have been eliminated.

 

In the opinion of management, all adjustments,consisting of normal recurring adjustments, which are necessary for a fairstatement of its financial position as of September 29, 2009, and theresults of operations for the interim periods ended September 29, 2009 andSeptember 30, 2008, have been included.

 

The balance sheet at December 30, 2008 has beenderived from the audited financial statements at that date, but does notinclude all of the information and notes required by generally acceptedaccounting principles for complete financial statements.  Certain information and note disclosures normallyincluded in the Company’s annual financial statements have been condensed oromitted.  These condensed financial statementsshould be read in conjunction with the financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the fiscal yearended December 30, 2008, filed with the Securities and Exchange Commissionon March 19, 2009.

 

Theresults of operations for the thirteen weeks and thirty-nine weeks ended September 29,2009 are not necessarily indicative of the results to be expected for theentire year.

 

Useof estimates

 

The preparation of financial statements inconformity with generally accepted accounting principles in the United Statesof America and regulations of the Securities and Exchange Commission requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosures of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenue andexpense during the reporting period. Significant estimates include estimates related to asset lives, leaseaccounting and revenue recognition. Actual results could differ from these estimates.

 

Revenuerecognition

 

Revenue is derived from the sale of prepared foodand beverage and select retail items. Revenue is recognized at the time of sale and is reported on the Company’scondensed consolidated statements of operations net of sales taxescollected.  Revenue derived from giftcard sales is recognized at the time the gift 

 

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card is redeemed. Until the redemption of gift cards occurs, the outstanding balances onsuch cards are included in accrued expenses in the accompanying condensedconsolidated balance sheets.  The Companyperiodically recognizes gift card breakage which represents the portion of itsgift card obligation for which management believes the likelihood of redemptionby the customer is remote, based upon historical redemption patterns.  Such amounts are included as a reduction togeneral and administrative expense.

 

Cashequivalents

 

The Company considers all highly liquid instrumentswith original maturities of three months or less to be cash equivalents.

 

Stock-based compensation

 

The Company measures and recognizes all stock-based compensationunder the fair value method using the Black-Scholes option-pricing model.  Share-based compensation expense recognizedis based on awards ultimately expected to vest, and as such, it must be reducedfor estimated or actual forfeitures. Forfeitures are estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates.  The Company used the following assumptionswithin the Black-Scholes option-pricing model for the first three quarters of2009 and 2008:

 
| ** **                                | ** ** | **Thirty-nine  Weeks Ended** | ** ** | **Forty  Weeks Ended**       | ** ** |
|-------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                | ** ** | **September 29,  2009** | ** ** | **September 30,  2008** | ** ** |
| Weighted average  risk-free interest rate |       | 2.25% - 3.80%                |       | 3.62% - 4.25%                |       |
| Expected life of  options                 |       | 10 years                     |       | 10 years                     |       |
| Expected stock  volatility                |       | 66.30% - 95.95%              |       | 40.53% - 47.38%              |       |
| Expected  dividend yield                  |       | None                         |       | None                         |       |

 

Net loss per share

 

Basic net loss per share is computed based on theweighted average number of shares of common stock outstanding during the fiscalyear.  Diluted net loss per share is notpresented since the effect would be anti-dilutive due to the losses.  Calculations of the Company’s net loss percommon share for the third quarter and first three quarters ended September 29,2009 and September 30, 2008 are set forth in the following table:

 
| ** **                                 | ** ** | **Thirteen  Weeks**

**Ended**   | ** ** | **Fourteen  Weeks**

**Ended**   | ** ** | **Thirty-nine  Weeks**

**Ended** | ** ** | **Forty  Weeks**

**Ended**      | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **September 29,**

**2009** | ** ** | **September 28,**

**2008** | ** ** | **September 29,**

**2009**  | ** ** | **September 28,**

**2008** | ** ** |
| Net loss                                   |       | $                                | (1,721,899 | )                                | $          | (4,251,772                        | )          | $                                | (6,979,601 | ) | $ | (11,811,839 | ) |
| Loss per common share, basic               |       | $                                | (0.11      | )                                | $          | (0.26                             | )          | $                                | (0.43      | ) | $ | (0.73 | ) |
| Weighted average shares outstanding, basic |       | 16,197,849                       |       | 16,197,849                       |       | 16,197,849                        |       | 16,192,844                       |       |

 

Recent accounting literature

 

InJune 2009, the FASB approved the FASB Accounting Standards Codification (“theCodification”) as the single source of authoritative nongovernmental GAAP.  All existing accounting standard documents,such as FASB, American Institute of Certified Public Accountants, EmergingIssues Task Force and other related literature, excluding guidance from theSecurities and Exchange Commission (“SEC”), have been superseded by theCodification.  All othernon-grandfathered, non-SEC accounting literature not included in theCodification has become nonauthoritative. The Codification did not change GAAP, but instead introduced a newstructure that combines all authoritative standards into a comprehensive,topically organized online database.  TheCodification is effective for interim or annual periods ending after September 15,2009, and impacts the Company’s financial statement disclosures as all futurereferences to authoritative accounting 

 

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literaturewill be referenced in accordance with the Codification.  There have been no changes to the content ofthe Company’s financial statements or disclosures as a result of implementingthe Codification during the quarter ended September 29, 2009.

 

In June 2009, the FASB issued new accountingguidance to improve financial reporting by companies involved with variableinterest entities and to provide more relevant and reliable information tousers of financial statements.  Thisguidance is effective for fiscal years beginning after November 15,2009.  We are currently evaluating theimpact that the adoption of this guidance will have on our consolidatedfinancial statements.

 

In May 2009, theFASB issued new accounting guidance which establishes generalstandards of accounting for and disclosure of events that occur after thebalance sheet date, but before the financial statements are issued or availableto be issued (“subsequent events”). Thisguidance requires disclosure of the date through which the entity has evaluatedsubsequent events and the basis for that date. Forpublic entities, this is the date the financial statements are issued.  This guidancedoes not apply to subsequent events or transactions that are within the scope ofother GAAP and will not result in significant changes in the subsequent eventsreported by the Company. This guidance is effective forinterim or annual periods ending after June 15, 2009.  The Company adopted this guidance during thequarter ended June 30, 2009.

 

In April 2009, the FASB issuednew accounting guidance related to interim disclosures about the fair values offinancial instruments.  This guidancerequires disclosures about the fair value of financial instruments for interimreporting periods, as well as annual reporting periods and is effective for allinterim and annual reporting periods ending after June 15, 2009.  The adoption of this guidance did not impactthe Company’s consolidated financial statements.

 

InJune 2008, the FASB issued new accounting guidance related to determiningwhether an instrument (or embedded feature) is indexed to an entity’s own stockand the needed accounting and disclosure requirements.  This statement provides guidance in assessingwhether an equity-linked financial instrument (or embedded feature) is indexedto an entity’s own stock for purposes of determining whether the appropriateaccounting treatment falls under the scope of earlier FASB guidance related toaccounting for derivative instruments and hedging activities and accounting forderivative financial instruments indexed to, and potentially settled in acompany’s own stock  This guidance iseffective for fiscal years beginning after December 15, 2008 and did notimpact the Company’s financial statements.

 

InApril 2008, the FASB issued new accounting guidance related to the determination of the useful life ofintangible assets.  This guidanceamends the factors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder earlier FASB guidance related to goodwilland other intangible assets.  Thischange is intended to improve the consistency between the useful life of arecognized intangible asset and the period of expected cash flows used tomeasure the fair value of the asset.  The requirementfor determining useful lives must be applied prospectively to intangible assetsacquired after the effective date and the disclosure requirements must beapplied prospectively to all intangible assets recognized as of, and subsequentto, the effective date.  This guidance is effectivefor financial statements issued for fiscal years beginning after December 15,2008, and interim periods within those fiscal years.  The adoption ofthis guidance did not impact the Company’s consolidated financial statements.

 

InDecember 2007, the FASB issued new accounting guidance related to businesscombinations.  This guidance willsignificantly change the accounting for business combinations and certain othertransactions.  This guidance is to beapplied prospectively to business combinations and certain other transactionsfor which the acquisition date is on or after the start of the first annualreporting period beginning on or after December 15, 2008*.* The Company currently does not contemplate any business combinations orother transactions that will be subject to this guidance.

 

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InDecember 2007, the FASB issued new accounting guidance related tononcontrolling interests in consolidated financial statements.  This guidance 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 the noncontrollingequity investment on the deconsolidation date. This guidance is effective for fiscal years, and interim periods withinthose fiscal years, beginning on or after December 15, 2008.  Since the Company does not currently have anyinterests in subsidiaries or variable interest entities with noncontrollinginterests, this guidance did not impact the Company’s consolidated financialstatements.

 

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

 

AtSeptember 29, 2009 and December 30, 2008, the fair value of cash andaccounts payable approximate their carrying value due to the short-term natureof the instruments. The fair value of the capital lease obligations andlong-term debt is estimated at its carrying value based upon current ratesavailable to the Company.

 

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

 

Rogers,Arkansas

 

In August 2008, the Company ceased operationsat its Rogers, Arkansas restaurant. Since opening in October 2007, the restaurant failed to generatepositive cash flow and had approximately $1.4 million of net loss.  Management believes the closure of thisrestaurant will allow the Company to focus its capital and personnel resourceson its other restaurants in order to increase future operating efficiencies andcash flow.  The Company is working to finda replacement tenant for the location, for which it is bound by a lease.  Such lease expires December 31, 2018pursuant to an amendment entered into in October 2009 (Note 13).  Costs incurred in connection with thisclosure include one-time benefits to employees who were involuntarilyterminated of $57,681, costs incurred for early contract termination of $4,578and costs to close and maintain the facility of $632,739.  Until the Company is able to find areplacement tenant, it will incur ongoing costs such as utilities, landscapeand maintenance and general liability insurance. In accordance with the FASBguidance on accounting for costs associated with exit or disposal activities,the Company recorded a non-cash lease termination liability of $852,146 basedon management’s estimate of the fair value of these obligations.  This required management to estimate thepresent value of the future minimum lease obligations offset by the estimatedsublease rentals that could be reasonably obtained for the property.  During the third quarter of 2008, the Companyrecorded a non-cash impairment charge of $135,057 related to the write-off ofthe carrying value of the 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.  As of September 29, 2009, the annuallease payments for the Roger’s site were $405,000 and the ongoing costs tomaintain the property were approximately $10,500 per month.  As of October 5, 2009, the date of thelease amendment, the Company’s future undiscounted cash payments under theterms of this lease were approximately $4.1 million.

 

Troy,Michigan

 

In May 2008, the Company entered into a 20-yearnet lease agreement 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. (“DCM”), DHW and Dunham Equity Management,L.L.C. (“DEM”) (collectively, the “Dunham Entities”), the Company willreimburse DCM for any out-of-pocket expenses incurred, including the carryingcost of the related land, less net proceeds from the sale of the real estate orlease income associated with the site (Note 9). As of September 29, 2009, the carrying cost of the landapproximated $16,000 per month.  Suchexpenses will be amortized and payable to DCM over a 60-month period commencingJanuary 2011, at a 6% annual interest rate.  The Company’s management has concluded thatas of September 29, 2009, it is probable that the Company will need toreimburse DCM approximately $390,000 of such costs.   Pursuant to the FASB guidance on accountingfor 

 

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contingencies, the Company has included $390,000 in “exit or disposalactivities” on its condensed consolidated statements of operations and “accruedexit or disposal activities” on its balance sheet.

 

Thecosts related to the closing of the Rogers restaurant and the decision not tobuild the Troy restaurant aggregated approximately $776,327 in the first threequarters of 2009 and are reflected on the Company’s consolidated statements ofoperations 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                      |   | 791,241  |      |
| Payments                                                   |   | (401,240 | )         |
| Amortization of sublease liability                         |   | (14,915  | )         |
| Accrued exit or disposal costs at September 29,  2009 |   | $        | 1,217,579 |   |

 

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

 

Propertyand equipment

 

Property and equipment is recorded at cost anddepreciated over the estimated useful lives of the assets.  Leasehold improvements are depreciated overthe term of the related lease or the estimated useful life, whichever isshorter.  Depreciation and amortizationof assets held under capital leases and leasehold improvements are computed onthe straight-line method for financial reporting purposes.  The following is a summary of the Company’sproperty and equipment at September 29, 2009 and December 30, 2008:

 
| ** **                    | ** ** | **September 29,  2009** | ** ** | **December 30,  2008** | ** ** |
|-------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Land                          |       | $                            | 18,000     |                        | $          | 18,000 |   |
| Buildings                     |       | 55,209,120                   |       | 54,991,656                  |       |
| Leasehold improvements        |       | 9,364,949                    |       | 9,117,667                   |       |
| Equipment and furniture       |       | 33,567,034                   |       | 31,877,053                  |       |
| Construction in progress*     |       | —                       |       | 642,579                     |       |
|                          |       | 98,159,103                   |       | 96,646,955                  |       |
| Less accumulated depreciation |       | (25,417,835                  | )          | (20,395,492                 | )          |
|                          |       | $                            | 72,741,268 |                        | $          | 76,251,463 |   |

----

*                 Construction in progress includes the followingapproximate amounts for items yet to be placed in service:

 
| ** **                                  | ** ** | **September 29,  2009** | ** ** | **December 30,  2008** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Leasehold improvements for future locations |       | $                            | —     |                        | $          | 187,400 |   |
| Building and equipment at future locations  |       | $                            | —     |                        | $          | 255,200 |   |
| Equipment at current locations              |       | $                            | —     |                        | $          | 199,900 |   |

 

Intangibleand other assets

 

Intangible and other assets consisted of thefollowing:

 
| ** **                    | ** ** | **September 29,  2009** | ** ** | **December 30,  2008** | ** ** |
|-------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Intangible assets:            |       |                         |       |                        |       |
| Liquor licenses               |       | $                            | 760,865    |                        | $          | 760,865 |   |
| Trademarks                    |       | 144,812                      |       | 140,141                     |       |
| Other:                        |       |                         |       |                        |       |
| Deferred loan costs           |       | 422,809                      |       | 243,421                     |       |
| Security deposits             |       | 245,881                      |       | 539,187                     |       |
|                          |       | 1,574,367                    |       | 1,683,614                   |       |
| Less accumulated amortization |       | (268,120                     | )          | (180,278                    | )          |
|                          |       | $                            | 1,306,247  |                        | $          | 1,503,336 |   |

 

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

 

Accruedexpenses consisted of the following:

 
| ** **                            | ** ** | **September 29,  2009** | ** ** | **December 30,  2008** | ** ** |
|---------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Payroll and related                   |       | $                            | 1,135,341  |                        | $          | 1,770,802 |   |
| Deferred revenue from gift card sales |       | 1,255,952                    |       | 1,971,477                   |       |
| Sales taxes payable                   |       | 599,886                      |       | 619,377                     |       |
| Interest                              |       | 846,826                      |       | 568,777                     |       |
| Real estate taxes                     |       | 1,006,909                    |       | 536,290                     |       |
| Other                                 |       | 419,854                      |       | 495,764                     |       |
|                                  |       | $                            | 5,264,768  |                        | $          | 5,962,487 |   |

 

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

 

Under the terms of thelease agreement the Company entered into regarding its Lincoln property, theCompany 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 is thedifference between minimum rent payments and straight-line rent over theinitial lease term including the “build out” or “rent-holiday” period.  Additionally, certain of the Company’slandlords have agreed to defer a portion of the payments due them until futureyears.  Contingent rent expense, which isbased on a percentage of revenue, is also recorded to the extent it exceedsminimum base rent per the lease agreement.  Deferred rent payable consisted of:

 
| ** **                                              | ** ** | **September 29,  2009** | ** ** | **December 30,  2008** | ** ** |
|---------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Difference between minimum rent and straight-line  rent |       | $                            | 2,945,952  |                        | $          | 2,633,912 |   |
| Deferred rent payments                                  |       | 692,572                      |       | —                      |       |
| Contingent rent expected to exceed minimum rent         |       | 61,874                       |       | 57,854                      |       |
| Tenant improvement allowance                            |       | 306,389                      |       | 328,889                     |       |
|                                                    |       | $                            | 4,006,787  |                        | $          | 3,020,655 |   |

 

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

 

Asof September 29, 2009, the Company had three long-term loans outstandingwith First National Bank (“FNB”), an independent financial institution inPierre, South Dakota, the proceeds of which it used to purchase assets at itsFargo, North Dakota; Des Moines and Davenport, Iowa restaurants.  These loans are secured by the tangiblepersonal property and fixtures at the respective locations and are guaranteedby Steven J. Wagenheim, the Company’s president, chief executive officer andone 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 lead investors inthe transaction were Harmony Equity Income Fund, L.L.C. and Harmony EquityIncome 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 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 loanoriginally to be funded by April 30, 2009. The Company and Harmony have entered into several amendments to extendthe date for the balance of the funding, which is now December 16, 2009(see Note 13).  The notes are secured bya mortgage 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 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.  The notes maybe prepaid upon 30 days prior notice without premium or penalty.  The notes must also be paid if the Companyreceives $4.0 million or more of proceeds from the sale of equity securities orsecurities convertible into equity securities. The notes must also be repaid in the event the Company defaults underthe terms and conditions of the bridge loan, including the financial covenantsset forth therein.  Such covenantsinclude maintaining minimum operating income before interest, taxes,depreciation and amortization from the Sioux Falls, South Dakota restaurantoperations, and minimum consolidated revenue of the Company, as provided in thebridge loan agreement.  Up to 20% of eachbridge note may be converted into common stock at a conversion price equal to$0.50 per share**. **Harmonyhas agreed to defer the quarterly interest payments that were due July 1,2009 and October 1, 2009 until the maturity date of the loans.

 

Inaddition, the Company agreed to issue to Harmony warrants for the purchase ofan aggregate of 400,000 shares of common stock exercisable six months afterdate of issuance at a price of $0.25267 per share, or 110% of the closing priceof the Company’s stock on March 30, 2009. As of September 29, 2009, warrants to purchase an aggregate of320,000 shares of common stock had been issued to such investors.  The notes and the warrants provide customaryanti-dilution rights to the holders, including weighted average anti-dilutionprovisions for sales at less than the exercise or conversion pricesthereof.  The Company has also agreedthat if it proposes to issue new securities in excess of 1.0% of itsoutstanding shares prior to May 1, 2010, subject to the exceptions notedbelow, it will give the investors the right to purchase up to that portion ofthe new securities which equals the proportion of the number of securitiespurchasable upon conversion of notes and exercise of the warrants relative tothe 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 hasalso granted the investors certain rights to require the Company to registercommon stock acquired by them upon conversion of the notes or exercise of thewarrants under the Securities Act of 1933, as amended (the “Act”) on Form S-3,or include such shares in certain company registrations under the Act, at theexpense 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 to theFASB guidance on accounting for convertible debt and debt issued with stockpurchase warrants, the Company allocated the fair value of the warrants topaid-in capital and the remainder of the proceeds to long-term debt.  The value of these warrants is being expensedas additional interest over the term of the related loan.

 

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Asof September 29, 2009 and December 30, 2008, the balances, interestrates and maturity dates of our long-term debt were as follows:

 
| ** **                  | ** ** | **September 29,  2009** | ** ** | **December 30,  2008** | ** ** |
|-----------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Des Moines (FNB)            |       |                         |       |                        |       |
| Balance                     |       | $                            | 129,545    |                        | $          | 226,802 |   |
| Annual interest rate        |       | 5.5                          | %          | 10.25                       | %          |
| Maturity date               |       | 27-Aug-10                    |       | 27-Aug-10                   |       |
|                        |       |                         |       |                        |       |
| Davenport (FNB)             |       |                         |       |                        |       |
| Balance                     |       | $                            | 180,858    |                        | $          | 272,081 |   |
| Annual interest rate        |       | 10.25                        | %          | 10.25                       | %          |
| Maturity date               |       | 6-Jan-11                     |       | 6-Jan-11                    |       |
|                        |       |                         |       |                        |       |
| Fargo (FNB)                 |       |                         |       |                        |       |
| Balance                     |       | $                            | 1,201,008  |                        | $          | 1,239,948 |   |
| Annual interest rate        |       | 8.75                         | %          | 8.75                        | %          |
| Maturity date               |       | 15-Aug-11                    |       | 15-Aug-11                   |       |
|                        |       |                         |       |                        |       |
| South Bend (Liquor license) |       |                         |       |                        |       |
| Balance                     |       | $                            | 246,504    |                        | $          | 250,000 |   |
| Annual interest rate        |       | 8.00                         | %          | 8.00                        | %          |
| Maturity date               |       | 30-Sep-23                    |       | 30-Sep-23                   |       |
|                        |       |                         |       |                        |       |
| Harmony (Bridge loan)       |       |                         |       |                        |       |
| Balance                     |       | $                            | 771,134    |                        | $          | 0 |   |
| Annual interest rate        |       | 9.00                         | %          | N/A                         |       |
| Maturity date               |       | 1-Oct-10                     |       | N/A                         |       |

 

Futurematurities of long-term debt, exclusive of interest, are as follows:

 
| Year ending: |   |      |      |
|--------------|--------|-----------|-----------|
| 2009         |   | $         | 81,767    |   |
| 2010         |   | 1,066,112 |      |
| 2011         |   | 1,143,101 |      |
| 2012         |   | 4,263     |      |
| 2013         |   | 4,617     |      |
| Thereafter   |   | 229,189   |      |
|         |   | $         | 2,529,049 |   |

 

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

 

Asof September 29, 2009, the Company operated 24 restaurants under capitallease agreements, of which one expires in 2020, two in 2023, four in 2024,three in 2025, four in 2026, seven in 2027, two in 2028 and one in 2029, allwith renewable options for additional periods. Twenty-two of these lease agreements originated with Donald A. Dunham, Jr.or one of the affiliated Dunham entities (collectively “the Dunham Landlords”).  Under certain of the leases, the Company maybe required to pay additional contingent rent based upon restaurant sales.  At the inception of each of these leases, theCompany evaluated the fair value of the land and building separately pursuantto the FASB guidance on accounting for leases. The land portion of these leases is classified as an operating leasewhile the building portion of these leases is classified as a capital leasebecause its present value was greater than 90% of the estimated fair value atthe beginning of the lease and/or the lease term represents 75% 

 

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ormore of the expected life of the property.  As part of the Transaction entered into in October 2009, 17 ofthese leases were amended (see Note 13). The amended terms were effective January 1, 2009, and in most casesthe expiration date of the lease is December 31, 2018.  Applying the FASB guidance on accounting forleases, the Company has determined that a minimum of seven of the amendedleases will qualify as operating leases, and a minimum of seven will remaincapital leases.  The Company is awaitingadditional information to evaluate the classification of the remaining threeamended leases.

 

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, including land, isclassified as a capital lease.

 

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 DCM 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).

 

In August 2008, the Company ceased operations at its restaurant inRogers, Arkansas (see Note 3).  However,the Company is currently bound by the terms of this lease agreement entered intounder the terms specified in the development agreement with DCM as amended in October 2009.  Pursuant to an agreement with the DunhamEntities described in Note 9, the Company will reimburse DCM for anyout-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.

 

As of September 29, 2009, the Company had 20 capital leaseagreements that it used 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.  Of such financing, $1.0 million was theresult of a sale-leaseback transaction with DHW for which the Company receivedcash proceeds.  This sale-leasebacktransaction met one or more criteria for treatment as a capital lease pursuantto the FASB guidance on accounting for leases. Because the Company retained substantially all the benefits and risksincident to the ownership of the property sold, the Company considered thissale-leaseback transaction merely a financing pursuant to the FASB guidance onaccounting for sales with leasebacks.  Assuch, the Company did not recognize any gain or loss on the transaction andincluded it as a financing activity on its condensed consolidated statement ofcash flows.  As part of the Transactionentered into in October 2009**,**the aggregatebalance remaining on 16 of these leases of approximately $15 million wasextinguished through the issuance of 28,000,000 shares of our common stock(Note 13).

 

In February 2009 and again in August 2009, the Companyentered into amendments to the three lease schedules of its master leaseagreement with Carlton Financial Corporation (“Carlton”) reducing the monthlypayments and extending the terms of the lease schedules by approximately twoyears.  Pursuant to the amendments, theCompany may purchase Carlton’s interest in all, but not less than all, of theequipment for a purchase price equal to 15% of the original cost of theequipment.  Steven J. Wagenheim, the Company’spresident, chief executive officer and one of its directors, was required topersonally guarantee payments to be made to Carlton under the lease financingand the Company’s board of directors agreed to compensate him for suchguarantee.

 

Includedin property and equipment as of September 29, 2009 are the followingassets held under capital leases:

 
| ** **                           | ** ** | **September 29,  2009** | ** ** | **December 30,  2008** | ** ** |
|--------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Land                                 |       | $                            | 18,000     |                        | $          | 18,000 |   |
| Building                             |       | 55,289,864                   |       | 54,991,656                  |       |
| Equipment and leasehold improvements |       | 19,820,483                   |       | 17,588,649                  |       |
|                                 |       | 75,128,347                   |       | 72,598,305                  |       |
| Less accumulated depreciation        |       | (16,035,503                  | )          | (9,600,913                  | )          |
|                                 |       | $                            | 59,092,844 |                        | $          | 62,997,392 |   |

 

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Minimum future leasepayments under all capital and operating leases are as follows:

 
| ** **                                  | ** ** | **Capital** | ** ** | **Operating** | ** ** |
|---------------------------------------------|------------|-------------|------------|---------------|------------|
| **Year ending:**                            | ** ** | **Leases**  | ** ** | **Leases**    | ** ** |
| 2009                                        |       | $           | 1,384,800  |          | $          | 1,414,155 |   |
| 2010                                        |       | 4,636,861   |       | 4,302,401     |       |
| 2011                                        |       | 5,090,024   |       | 5,316,130     |       |
| 2012                                        |       | 4,727,254   |       | 5,286,371     |       |
| 2013                                        |       | 4,701,598   |       | 5,428,790     |       |
| Thereafter                                  |       | 46,454,646  |       | 38,935,063    |       |
| Total minimum lease payments                |       | 66,995,183  |       | $             | 60,682,909 |   |
| Less amount representing interest           |       | (31,877,450 | )          |          |       |
| Present value of net minimum lease payments |       | 35,117,733  |       |          |       |
| Less current portion                        |       | (1,507,196  | )          |          |       |
| Long-term portion of obligations            |       | $           | 33,610,537 |          |       |   |

 

The foregoing tableincludes changes to lease commitments commencing after September 29, 2009(Note 13).  Amortization expense relatedto the assets held under capital leases is included with depreciation expenseon the Company’s statements of operations.

 

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

 

RentReductions

 

In February 2009, the Company entered into amaster agreement with the Dunham Entities to provide rent or other cash flowreductions to the Company in the amount of $2.5 million for calendar year 2009and $1.5 million for calendar year 2010 (the “Master Agreement”).  The Master Agreement provides that the DCMwill amend and restate applicable leases and subleases with the Company toreflect negotiated rent reductions.  As apart of the Master Agreement, DCM has agreed to amend its building leases withthe Company that are currently treated as capital leases for accounting purposesby reducing their terms to periods which will thereafter qualify the leases tobe treated as operating leases in accordance with generally accepted accountingprinciples.  As part of the Transactionentered into in October 2009, the Dunham Landlords amended their buildingleases (Note 13).  The amended terms wereeffective January 1, 2009, and in most cases the expiration date of thelease is December 31, 2018.  TheCompany has determined that a minimum of seven of the amended leases willqualify as operating leases pursuant to the FASB guidance on accounting forleases, and a minimum of seven will remain capital leases.  The Company is awaiting additionalinformation to evaluate the classification of the remaining three amendedleases.  As a result of these amendments,the Company will remove a minimum of $14 million of assets and $16 million ofliabilities from its balance sheet.  Theresulting gain will be recognized over the life of the amended leases.  Additionally, the Company agreed to reimburseDCM for any out-of-pocket costs that DCM incurs due to the closing of theRogers, Arkansas location and the decision not to build on the Troy, Michigansite, reduced by net sales proceeds from the sale of any real estate or leaseincome associated with such sites. Reimbursement of costs related to these sites will be amortized andpayable to DCM over a 60-month period commencing January 2011, at a 6%annual interest rate.  Such reimbursementincludes the carrying cost of the related land until its disposal.

 

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In consideration of the agreements DCM provided inthe Master Agreement, the Company issued to the Dunham Entities a warrant topurchase 1,000,000 shares of common stock of the Company at an exercise priceof $0.264 per share, representing 110% of the closing price of the Company’scommon stock on the trading date prior to the date of signing the MasterAgreement.  The value of these warrantsof $136,495 is being amortized over a ten-year period, which is the anticipatedterm of the underlying lease agreements once they are revised.

 

The Company subsequently entered into agreementswith certain other of its landlords for rent reductions.  Such rent reductions are deemed to be part ofthe above-referenced $4.0 million of rent reductions.  In consideration of such rent reductions, theCompany has issued five-year warrants to purchase the Company’s common stock tosuch landlords.  As of September 29,2009, the aggregate number of shares underlying such warrants was 196,070 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.

 

The Company measured and recognized the value of thewarrants issued to the Dunham Entities and certain of its other landlordsreferenced above under the fair value method. The fair value of the warrants at date of grant was estimated using theBlack-Scholes option-pricing model with the following assumptions: (i) aweighted average risk-free interest rate of 1.79% - 1.99%, (ii) anexpected warrant life of five years, (iii) expected stock volatility of70.24% - 73.90% and (iv) no expected dividend yield.

 

Litigation

 

From time to time, lawsuits are threatened or filedagainst the Company in the ordinary course of business.  Such lawsuits typically involve claims fromcustomers, former or current employees, and others related to issues common tothe restaurant industry.  A number ofsuch claims may exist at any given time. Although there can be no assurance as to the ultimate disposition ofthese matters, it is management’s opinion, based upon the information availableas of November 13, 2009, that the expected outcome of these matters, individuallyor in the aggregate, will not have a material adverse effect on the results ofoperation, liquidity or financial condition of the Company.

 

**10.****      ****Stock plans**

 

In July 1997, theCompany 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 September 29, 2009,options to purchase 32,500 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 September 29,2009, options to purchase 210,000 shares of common stock were outstanding underthe 1997 Director Stock Option Plan (“DSOP”), which expired July 29,2007.  All such options are fully vestedand exercisable for five years from the date of grant.  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, theCompany adopted the 2002 Equity Incentive Plan, now known as the Amended andRestated Equity Incentive Plan, for employees, prospective employees, officersand members of the Company’s board of directors, as well as consultants and advisors to the Company,to purchase shares of the Company’s common stock at an exercise price thatequals or exceeds the fair market value on the date of grant.  The number of shares authorized for issuanceas of September 29, 2009 was 2,729,743, of which 508,909 shares remainedavailable for future issuance and options to purchase 2,145,134 shares wereoutstanding.  Although vesting schedulesvary, option grants under this plan generally vest over a three or four-yearperiod and options are exercisable for no more than ten years from the date of grant.

 

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A summary of the status ofthe Company’s stock options as of September 29, 2009 is presented below:

 
| **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                                                          |       | 721,500    |       | 0.21                                          |       | 9.3 years                                                      |       |                                    |       |
| Exercised                                                        |       | —     |       | —                                        |       |                                                           |       |                                    |       |
| Forfeited                                                        |       | (477,000   | )          | 2.66                                          |       |                                                           |       |                                    |       |
| Outstanding at September 29, 2009                           |       | 2,432,634  |       | $                                             | 2.74       |                                                           | 6.7 years  |                                    | $          | 189,302 |   |
|                                                             |       |       |       |                                          |       |                                                           |       |                                    |       |
| Options exercisable at December 30, 2008                    |       | 1,266,141  |       | $                                             | 3.93       |                                                           | 4.9 years  |                                    |       |   |
| Options exercisable at September 29, 2009                   |       | 1,170,804  |       | $                                             | 3.93       |                                                           | 5.0 years  |                                    | $          | — |   |
|                                                             |       |       |       |                                          |       |                                                           |       |                                    |       |
| Weighted-average fair value of options granted during  2009 |       | $          | 0.17       |                                          |       |                                                           |       |                                    |       |   |
|                                                                  |            |            |            |                                               |            |                                                                |            |                                         |            |  |  |  |

 

The aggregate intrinsicvalue in the table above represents the total pretax intrinsic value (thedifference between the closing price of the Company’s stock on September 29, 2009 and theexercise price, multiplied by the number of in-the-money options) that wouldhave been received by the option holders had all option holders exercised theiroptions on September 29,2009.    As of September 29, 2009, there wasapproximately $182,230 of total unrecognized compensation cost related tounvested share-based compensation arrangements, of which $52,629 is expected tobe recognized during the remainder of fiscal year 2009, $82,168 in fiscal year2010, $36,777 in fiscal year 2011, $10,193 in fiscal year 2012 and $463 infiscal year 2013.

 

The following tablesummarizes information about stock options outstanding at September 29, 2009:

 
| ** **          | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **          | ** ** | ** **              | ** ** | **Weighted**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Number of**           | ** ** | **Average**             | ** ** | **Weighted** | ** ** | **Number of** | ** ** | **Weighted** | ** ** |
| **Range of**        | ** ** | **Options**             | ** ** | **Remaining**           | ** ** | **Average** | ** ** | **Options** | ** ** | **Average** | ** ** |
| **Exercise Prices** | ** ** | **Outstanding**         | ** ** | **Contractual Life**    | ** ** | **Exercise Price** | ** ** | **Exercisable** | ** ** | **Exercise Price** | ** ** |
| $0.00 - $1.00       |       | 731,500                 |       | 9.3 years               |       | $ | 0.27 |   | 4,000 |   | $ | 0.90 |   |
| $1.01 - $2.00       |       | 153,000                 |       | 7.6 years               |       | $ | 1.71 |   | 79,500 |   | $ | 1.66 |   |
| $2.01 - $3.00       |       | 333,000                 |       | 6.7 years               |       | $ | 2.31 |   | 145,833 |   | $ | 2.44 |   |
| $3.01 - $4.00       |       | 378,000                 |       | 5.4 years               |       | $ | 3.67 |   | 328,000 |   | $ | 3.69 |   |
| $4.01 - $5.00       |       | 497,800                 |       | 5.4 years               |       | $ | 4.37 |   | 447,800 |   | $ | 4.39 |   |
| $5.01 - $6.00       |       | 239,334                 |       | 2.4 years               |       | $ | 5.22 |   | 99,004 |   | $ | 5.27 |   |
| $6.01 - $7.00       |       | 100,000                 |       | 7.5 years               |       | $ | 6.20 |   | 66,667 |   | $ | 6.20 |   |
| Total               |       | 2,432,634               |       | 6.7 years               |       | $ | 2.74 |   | 1,170,804 |   | $ | 3.93 |   |

 

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**11.****      ****Common stock warrants**

 

In September 2004, theCompany entered into a securities purchase agreement with certain accreditedinvestors for the sale of approximately $8.5 million of common stock andwarrants.  Under this agreement, theCompany issued five-year warrants for the purchase of 1,045,844 shares ofcommon stock at an exercise price of $5.00 per share.  The Company had the ability to call for themandatory exercise of such warrants if certain conditions were met.  As part of this private placement, theCompany sold to its placement agents, for $100, five-year warrants to purchasean aggregate of 130,730 shares of common stock at an exercise price of $5.00 pershare.  Such warrant agreements with the investors andplacement agents for this transaction contained certain anti-dilutionprovisions.  Pursuant to theseprovisions, the number of shares purchasable upon exercise of these warrantsand the related purchase price both required adjustment upon the issuance ofwarrants, at an exercise price less than the thresholds set forth in thesecurity purchase agreement, to certain of the Company’s landlords and Harmony(see Notes 7 and 9).  The exercise priceof each existing warrant was multiplied by a fraction, the numerator of whichwas the sum of the number of shares of common stock outstanding immediatelyprior to the issuance of warrants to the landlords and Harmony, plus the numberof shares of common stock which the offering price for such shares of commonstock would purchase at the closing price of our common stock on the initialclosing date of this securities purchase agreement, and the denominator ofwhich was the sum of the number of shares of common stock outstandingimmediately prior to such issuance plus the number of such new securities soissued.  As a result of theseadjustments, the number of shares purchasable under these warrants at September 29,2009 was 1,215,469 and the exercise price was $4.84 per share.  As of September 29, 2009, warrants topurchase an aggregate of 275,374 shares expired unexercised.  As a result of the issuance of common stockin October 2009 as part of the Transaction, further anti-dilutionadjustments were required.  The resulting number of sharespurchasable under these warrants became approximately 2,106,509 and theexercise price became $2.16 per share. All of these warrants expired unexercised on November 4,2009.

 

In October 2005, theCompany entered into a securities purchase agreement with certain accreditedinvestors for the sale of approximately $5.34 million of common stock andwarrants.  Under this agreement, theCompany issued five-year warrants for the purchase of 221,762 shares of commonstock at an exercise price of $6.50 per share to such investors and five-yearwarrants for the purchase of 55,436 shares of common stock at an exercise priceof $6.50 to the Company’s placement agent. Such warrant agreements with the investors andplacement agents for this transaction contain certain anti-dilutionprovisions.  Pursuant to theseprovisions, the number of shares purchasable upon exercise of these warrantsand the related purchase price both required adjustment upon the issuance ofwarrants, at an exercise price less than the thresholds set forth in thesecurity purchase agreement, to certain of the Company’s landlords and Harmony(see Notes 7 and 9).  The exercise priceof each existing warrant was multiplied by a fraction, the numerator of whichwas the sum of the number of shares of common stock outstanding immediatelyprior to the issuance of warrants to the landlords and Harmony, plus the numberof shares of common stock which the offering price for such shares of commonstock would purchase at the closing price of our common stock on the closingdate of this securities purchase agreement, and the denominator of which wasthe sum of the number of shares of common stock outstanding immediately priorto such issuance plus the number of such new securities so issued.  As a result of these adjustments, the number of sharespurchasable under these warrants at September 29, 2009 was 289,211 and the exercise pricewas $6.23 per share.  As of September 29, 2009, none of such warrants hadbeen exercised. As a result of the issuance of common stock in October 2009as part of the Transaction, further anti-dilution adjustments wererequired.  The resulting number of shares purchasable under thesewarrants is approximately 666,037 and the exercise price is $2.71 per share.

 

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 1,206,195 shares andthe weighted average exercise price was $0.2668 per share.  Pursuant to the provisions of such agreements, thenumber of shares purchasable upon exercise of these warrants 

 

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and the related purchaseprice both required adjustment upon the issuance of warrants, at an exerciseprice less than the exercise price of the landlord warrants, to Harmony (see Note 7).  The exercise price of eachwarrant issued prior to the issuance of the Harmony warrants was multiplied bya fraction, the numerator of which was the sum of the number of shares ofcommon stock outstanding immediately prior to the issuance of warrants toHarmony, plus the number of shares of common stock which the offering price forsuch shares of common stock would purchase at the warrant exercise price ineffect immediately prior to such issuance, and the denominator of which was thesum of the number of shares of common stock outstanding immediately prior tosuch issuance plus the number of such new securities so issued.  As a result of these adjustments, the number of sharespurchasable under these warrants at September 29, 2009 was 1,207,165 and the weightedaverage exercise price was $0.2666 per share. As of September 29, 2009, none of such warrants had beenexercised.

 

Pursuant to the bridge loanagreement entered into in March 2009 with a group of accredited investors,the Company issued to the investors warrants for the purchase of an aggregateof 320,000 shares of common stock at a price of $0.25267 per share.  Such warrants became exercisable September 30,2009.

 

As of September 29, 2009, warrants for the purchaseof an aggregate of 2,730,712 shares of common stock were outstanding andexercisable.  The weighted averageexercise price of such warrants was $2.47 per share.

 

**12.****      ****Retirement plan**

 

The Company sponsors adefined contribution plan under the provisions of section 401(k) of theInternal 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 September 29, 2009, the Company had contributed$9,512 in aggregate under the plan.  TheCompany expects to contribute an additional $3,200 under the plan in fiscal year2009.

 

**13.****      ****Subsequent events**

 

Closingof DHW transaction

 

On October 5, 2009, the Company completed theTransaction with DHW, its primary source of financing for furniture, fixturesand equipment, as contemplated under the Debt Conversion Agreement between theCompany and DHW dated September 21, 2009. In the Transaction, approximately $15 million of the Company’sindebtedness to DHW was converted into 28,000,000 shares of the Company’scommon stock at a conversion price of approximately $0.54 per share.  TheCompany obtained a waiver under the financial viability exception from NASDAQto its shareholder approval requirements, so the Transaction was not subject toapproval by the Company’s shareholders.  The Transaction was approved by aspecial committee of the Company’s independent directors, by its Board ofDirectors, and by its audit committee under the Company’s related persontransaction policy.  As a result, DHW andaffiliated parties beneficially own an aggregate of 64.8% of the Company’scommon stock, which constituted a change in control of the Company.  Because of this change in control, theCompany’s use of federal net operating loss carryforwards to offset futuretaxable income will be limited.

 

During the first year following closing, if the averagebid price of the Company’s common stock for any period of 20 consecutivetrading days equals or exceeds $0.714, the Company will have the right,exercisable on a one-time basis, to repurchase for $.001 per share an amount ofthe shares issued to DHW in the Transaction as would enable DHW to retain suchissued shares having a market value of $20.0 million following suchrepurchase.  The right may be triggeredmultiple times during the year, but may only be exercised once.  If the Company were to exercise this right,such exercise would be considered an equity transaction reported as a reductionof shareholders’ equity pursuant to the FASB accounting guidance on equityinstruments.

 

In connection with the closing of the Transaction,the parties entered into a number of ancillary agreements. Amendment No. 1to the Master Agreement between the Dunham Entities and the Company amends the 

 

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Master Agreement entered into in February 2009by such parties.  Under the amendment, the parties agreed to provide theagreed-upon rent reductions in 2009 and agreed to use reasonable commercialefforts to seek rent reductions on real estate leases of up to $1.7 million onleases for properties controlled by the Dunham Landlords and properties notcontrolled by the Dunham Landlords, compared to $1.5 million under the originalMaster Agreement.

 

In connection with the Transaction, a MasterAmendment to Leases was entered into by and among the Company and the DunhamLandlords.  Under the Master Amendment to Leases, the Dunham Landlordsagreed to a limited deferral of 30% of the rent due under lease agreementsbetween the Company and the Dunham Landlords. In addition, for all rentpayments due on or after June 1, 2009 under restaurant leases with theDunham Landlords, rent has been deferred for one month.  The deferredrents must be repaid upon the first to occur of (a) the Company completinga debt or equity financing in the amount of $2,000,000 or (b) upon thefirst anniversary of closing.  The Company anticipates that the monthlyaccrued and deferred rent will be approximately $75,000 per month commencing June 2009. In addition, the Dunham Landlords waived any defaults or events of defaultexisting under the leases as of the closing date.

 

In connection with the Transaction, the Company andthree of its executive officers, Steven J. Wagenheim, James G. Gilbertson andDarius H. Gilanfar, entered into amendments to their existing employmentagreements which provide that each will have employment for a term of one yearfollowing the closing of the Transaction, and will be entitled to severancebenefits that include one year of base compensation if employment is terminatedwithout cause, in addition to the balance of the one-year term, if terminatedprior to the end of such term. The employment agreements are automaticallyextended for one-year terms unless either the Company or the executive gives atleast 60 days’ notice to the other of an intent not to extend.  Inaddition, Mr. Wagenheim’s employment agreement was amended to reduce hisseverance benefit from 18 months to 12 months.

 

In connection with the Transaction the Company alsoentered into an amendment to the bridge loan agreement with Harmony whichdefers the October 1, 2009 interest payment, modifies the minimum netconsolidated revenue covenant for the quarters ending September 29, 2009and December 29, 2009, and waives any participation rights in theTransaction.

 

The parties also entered into a Registration RightsAgreement under which the Company granted DHW certain registration rights withrespect to the shares that DHW received in the Transaction.  Pursuant tothe Registration Rights Agreement, the Company agreed to file a registrationstatement with the SEC covering 4,666,666 of DHW’s shares within 90 days of theclosing date, and agreed, upon request by DHW and if DHW has sold the sharespreviously registered, to file registration statements covering 4,666,666additional shares each six months thereafter.  Under the RegistrationRights Agreement, the Company is not obligated to file (a) more than sixregistration statements; (b) registration statements more frequently thanevery six months; or (c) any registration statement more than three yearsafter the closing date.

 

The following presents the Company’s unauditedbalance sheet as of September 29, 2009 as if the issuance of stock toretire debt and the amendments to the property leases had occurred on thatdate.  The pro forma adjustments arebased on available information and certain assumptions that management believesare reasonable.  The unaudited pro formafinancial information is for informational purposes only and does not purportto present what the Company’s results would actually have been had thesetransactions actually occurred on the date presented or to project the Company’sresults of operations or financial position for any future period.  The information set forth below should beread in conjunction with the following reports filed with the Securities and ExchangeCommission:  the Company’s Annual Reporton Form 10-K for the fiscal year ended December 30, 2008, itsQuarterly Report on Form 10-Q for the quarter ended March 31, 2009and its Quarterly Report on Form 10-Q for the quarter ended June 30,2009:

 

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**GRANITE CITY FOOD & BREWERY LTD.**

**UNAUDITED PRO FORMA BALANCE SHEET**

** **
| ** **                                                   | ** ** | **Actual**             | ** ** | ** **      | ** ** | **Pro forma**          | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|-----------------|------------|------------------------|------------|
| ** **                                                   | ** ** | **September 29,** | ** ** | **Pro forma**   | ** ** | **September 29,** | ** ** |
| ** **                                                   | ** ** | **2009**               | ** ** | **Adjustments** | ** ** | **2009**               | ** ** |
| ASSETS:                                                      |       |                   |       |            |       |                   |       |
| Current assets:                                              |       |                   |       |            |       |                   |       |
| Cash and cash equivalents                                    |       | $                      | 547,160    |            |       |                   | $          | 547,160 |   |
| Inventory                                                    |       | 914,956                |       |            |       | 914,956                |       |
| Prepaids and other                                           |       | 625,391                |       |            |       | 625,391                |       |
| Total current assets                                         |       | 2,087,507              |       |            |       | 2,087,507              |       |
|                                                         |       |                   |       |            |       |                   |       |
| Deferred transaction cost                                    |       | 938,164                |       | (938,164        | )(1)       | —                 |       |
| Prepaid rent, net of current portion                         |       | 318,256                |       |            |       | 318,256                |       |
| Property and equipment, net                                  |       | 72,741,268             |       | (14,303,794     | )(2)       | 58,437,474             |       |
| Intangible and other assets                                  |       | 1,306,247              |       | (40,931         | )(3)       | 1,265,316              |       |
| Total assets                                                 |       | $                      | 77,391,442 |            |       |                   | $          | 62,108,553 |   |
|                                                         |       |                   |       |            |       |                   |       |
| LIABILITIES AND SHAREHOLDERS’ (DEFICIT) EQUITY:         |       |                   |       |            |       |                   |       |
| Current liabilities:                                         |       |                   |       |            |       |                   |       |
| Accounts payable                                             |       | $                      | 2,538,762  |            |       |                   | $          | 2,538,762 |   |
| Accrued expenses                                             |       | 5,264,768              |       |            |       | 5,264,768              |       |
| Accrued exit or disposal activities, current portion         |       | 20,684                 |       |            |       | 20,684                 |       |
| Deferred rent, current portion                               |       | 900,366                |       |            |       | 900,366                |       |
| Deferred gain, current portion                               |       | —                 |       | 180,498         | (4)        | 180,498                |       |
| Long-term debt, current portion                              |       | 981,434                |       |            |       | 981,434                |       |
| Capital lease obligations, current portion                   |       | 4,836,705              |       | (3,972,375      | )(5)       | 864,330                |       |
| Total current liabilities                                    |       | 14,542,719             |       |            |       | 10,750,842             |       |
|                                                         |       |                   |       |            |       |                   |       |
| Accrued exit or disposal activities, net of current  portion |       | 1,196,895              |       |            |       | 1,196,895              |       |
| Deferred rent, net of current portion                        |       | 3,106,421              |       |            |       | 3,106,421              |       |
| Deferred gain, net of current portion                        |       | —                 |       | 1,624,478       | (6)        | 1,624,478              |       |
| Long-term debt, net of current portion                       |       | 1,547,615              |       |            |       | 1,547,615              |       |
| Capital lease obligations, net of current portion            |       | 61,134,302             |       | (27,523,765     | )(7)       | 33,610,537             |       |
| Total liabilities                                            |       | 81,527,952             |       |            |       | 51,836,788             |       |
|                                                         |       |                   |       |            |       |                   |       |
| Shareholders’ (deficit) equity:                         |       |                   |       |            |       |                   |       |
| Common stock                                                 |       | 161,978                |       | 280,000         | (8)        | 441,978                |       |
| Additional paid-in capital                                   |       | 44,210,898             |       | 14,194,391      | (9)        | 58,405,289             |       |
| Accumulated (deficit) equity                                 |       | (48,509,386            | )          | (66,116         | )(10)      | (48,575,502            | )          |
| Total shareholders’ (deficit) equity                    |       | (4,136,510             | )          |            |       | 10,271,765             |       |
|                                                         |       |                   |       |            |       |                   |       |
| Total liabilities and shareholders’ (deficit) equity    |       | $                      | 77,391,442 |            |       |                   | $          | 62,108,553 |   |

----

1)              Adjustmentreflects the expenses of the Transaction.

 

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2)              Adjustmentreflects the removal of assets pursuant to the conversion of seven capitalleases to operating leases.

 

3)              Adjustmentreflects the deferred loan costs related to the DHW capital leases.

 

4)              Adjustmentreflects the current portion of the gain realized pursuant to the conversion ofsix capital leases to operating leases which will be recognized over the newlease terms.

 

5)              Adjustmentsreflect the current portion of the capital lease liability extinguished throughthe issuance of common stock to DHW of $2,990,941 and the current portion ofthe capital lease liability adjusted pursuant to the conversion of sevencapital leases to operating leases of $981,434.

 

6)              Adjustmentreflects the gain, net of current portion, realized pursuant to the conversionof six capital leases to operating leases.

 

7)              Adjustmentsreflect the capital lease liability, net of current portion, extinguishedthrough the issuance of common stock to DHW of $12,462,545 and the capitallease liability, net of current portion, adjusted pursuant to the conversion ofseven capital leases to operating leases of $15,061,220.

 

8)              Adjustmentreflects the $0.01 per share par value of the common stock issued to extinguishcapital lease obligations.

 

9)              Adjustmentsreflect the $0.53 per share in excess of par value of the common stock issuedto extinguish capital lease obligations of $14,840,000, the expense of thetransaction of $938,164 and the write-off of deferred loan costs of $40,931related to the DHW capital leases.

 

10)        Adjustmentreflects the loss recognized pursuant to the conversion of one capital lease toan operating lease.

 

 

If the Transaction had occurred at the beginning ofthe Company’s fiscal year, basic loss per share would have been $0.13 for thethirty-nine weeks ended September 29, 2009 with weighted average sharesoutstanding of 44,197,849.  Had thetransaction occurred at the beginning of the Company’s 2008 fiscal year, basicloss per share would have been $0.24 for fiscal year 2008 with weighted averageshares outstanding of 44,194,031.

 

HarmonyBridge Loan

 

Effective October 31, 2009, the Company enteredinto an amendment to the bridge loan agreement dated March 30, 2009 withHarmony to extend the time period for the closing of the $200,000 balance onthe loan to December 16, 2009.  Thebridge loan provided for $1,000,000 of partially convertible debt financing tothe Company.  The Company has closed on$800,000 of the debt.  The time periodfor the second closing was most recently extended to October 31, 2009, asreported on the Company’s Current Report on Form 8-K filed October 6,2009.

 

TheCompany evaluated for subsequent events through November 13, 2009, theissuance date of the Company’s financial statements.

 

**ITEM 2   Management’sDiscussion and Analysis 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 those projected.  When used in the following discussion, thewords “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates” andsimilar expressions, as they relate to us or our management, are intended toidentify such forward-looking statements. You are cautioned not to attribute undue certainty to suchforward-looking statements, which are qualified in their entirety by thecautions and risks described herein. Please refer to the “Risk Factors” section of our Annual Report on Form 10-K,filed with the Securities and Exchange Commission on March 19, 2009, the “RiskFactors” section of our Quarterly Report on Form 10-Q filed with theSecurities and Exchange Commission on August 14, 2009, and the “RiskFactors” section of this document, for additional factors known to us that maycause actual results to vary.*

 

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**Overview**

 

Weare a Modern American upscale casual restaurant chain. As of September 29,2009, we operated 26 restaurants in 11 Midwestern states featuring on-premisesbreweries, substantially all of which operate under the name of Granite CityFood & Brewery®.  We believe ourmenu features high quality yet affordable family favorite menu items preparedfrom made-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 diningexperience.  The location of eachrestaurant in operation and the month and year of its opening appear in thefollowing 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     |       |

 

InAugust 2008, we ceased operations at our restaurant in Rogers,Arkansas.  However, we are currentlybound by the terms of the lease agreement which expires in 2018 under the termsspecified in the development agreement with Dunham Capital Management, L.L.C. (“DCM”).

 

Weoperate a centrally-located beer production facility in Ellsworth, Iowa whichfacilitates the 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.

 

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Ourindustry can be significantly affected by changes in economic conditions,discretionary spending patterns, consumer tastes, and cost fluctuations.  Beginning in 2007, 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 various aspects of our business, effectively reducing our cost offood, 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 October 2009, we completed a debt conversiontransaction (the “Transaction”) with DHW Leasing, L.L.C. (“DHW”), our primarysource of financing for furniture, fixtures and equipment, as contemplatedunder the Debt Conversion Agreement between our company and DHW dated September 21,2009.  In the Transaction, approximately$15 million of our indebtedness to DHW was converted into 28,000,000 shares ofour company’s common stock at a conversion price of approximately $0.54 pershare.  As a result, DHW and affiliatedparties beneficially own an aggregate of 64.8% of our common stock, whichconstituted a change in control of our company. In connection with the closing of the Transaction, the parties enteredinto a number of ancillary agreements which include, but are not limited to,lease amendments, deferred lease payments and an agreement to seek to obtainfurther rent reductions (see “Subsequent Events”, Note 13 to our condensedconsolidated financial statements).

 

We utilize a 52/53-week fiscal year ending the lastTuesday in December for financial reporting purposes.  Fiscal year 2008 had 53 weeks while fiscalyear 2009 has 52 weeks.  The additionalweek was included in the third quarter of 2008.

 

The thirteen and thirty-nineweeks ended September 29, 2009 included 338 and 1,008 operating weeks,respectively, which is the sum of the actual number of weeks each restaurantoperated.   The fourteen and forty weeksended September 30, 2008 included 353 and 988 operating weeks,respectively.  Because we have opened newrestaurants at various times throughout the years, we provide this statisticalmeasure to enhance the comparison of revenues from period to period as changesoccur in the number of units we are operating.

 

Our restaurant revenue iscomprised almost entirely of the sales of food and beverages.  The sale of retail items typically representsless than one percent of total revenue.  Productcosts include the costs of food, beverages and retail items.  Labor costs include direct hourly andmanagement wages, taxes and benefits for restaurant employees.  Direct and occupancy costs include restaurantsupplies, marketing costs, rent, utilities, real estate taxes, repairs andmaintenance and other related costs. Pre-opening costs consist of direct costs related to hiring and trainingthe initial restaurant workforce, the salaries and related costs of ourdedicated new store opening team, rent expense incurred during the constructionperiod and other direct costs associated with opening new restaurants.  General and administrative expenses arecomprised of expenses associated with all corporate and administrativefunctions that support existing operations, which include management and staffsalaries, employee benefits, travel, information systems, training, marketresearch, 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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**Results of operations as apercentage of sales**

 

The following table sets forth results of ouroperations expressed as a percentage of sales for the third quarter and firstthree quarters ended September 29, 2009 and September 30, 2008:

 
| ** **                    | ** ** | **Thirteen**           | ** ** | **Fourteen**           | ** ** | **Thirty-nine**        | ** ** | **Forty**              | ** ** |
|-------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** |
| ** **                    | ** ** | **September 29,** | ** ** | **September 30,** | ** ** | **September 29,** | ** ** | **September 30,** | ** ** |
| ** **                    | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009**               | ** ** | **2008**               | ** ** |
|                          |       |                   |       |                   |       |                   |       |                   |       |
| Restaurant revenues           |       | 100.0                  | %          | 100.0                  | %          | 100.0                  | %          | 100.0                  | %          |
|                          |       |                   |       |                   |       |                   |       |                   |       |
| Cost of sales:                |       |                   |       |                   |       |                   |       |                   |       |
| Food, beverage and retail     |       | 27.9                   |       | 29.7                   |       | 27.5                   |       | 30.4                   |       |
| Labor                         |       | 35.3                   |       | 35.8                   |       | 35.1                   |       | 37.2                   |       |
| Direct restaurant operating   |       | 15.2                   |       | 15.0                   |       | 14.8                   |       | 14.6                   |       |
| Occupancy                     |       | 7.8                    |       | 5.8                    |       | 7.4                    |       | 6.2                    |       |
| Total cost of sales           |       | 86.1                   |       | 86.3                   |       | 84.8                   |       | 88.5                   |       |
|                          |       |                   |       |                   |       |                   |       |                   |       |
| Pre-opening                   |       | —                 |       | 2.0                    |       | 0.3                    |       | 1.8                    |       |
| General and administrative    |       | 6.5                    |       | 10.7                   |       | 9.1                    |       | 11.0                   |       |
| Depreciation and amortization |       | 8.2                    |       | 6.4                    |       | 8.0                    |       | 6.5                    |       |
| Exit or disposal activities   |       | 0.8                    |       | 4.4                    |       | 1.2                    |       | 1.5                    |       |
| Other                         |       | 0.0                    |       | 0.2                    |       | 0.1                    |       | 0.1                    |       |
|                          |       |                   |       |                   |       |                   |       |                   |       |
| Operating loss                |       | (1.7                   | )          | (10.0                  | )          | (3.4                   | )          | (9.4                   | )          |
|                          |       |                   |       |                   |       |                   |       |                   |       |
| Interest:                     |       |                   |       |                   |       |                   |       |                   |       |
| Income                        |       | 0.0                    |       | 0.0                    |       | 0.0                    |       | 0.0                    |       |
| Expense                       |       | (6.4                   | )          | (6.7                   | )          | (7.3                   | )          | (6.5                   | )          |
| Net interest expense          |       | (6.4                   | )          | (6.7                   | )          | (7.3                   | )          | (6.5                   | )          |
|                          |       |                   |       |                   |       |                   |       |                   |       |
| Net loss                      |       | (8.0                   | )%         | (16.7                  | )%         | (10.7                  | )%         | (15.8                  | )%         |

 

Certain percentage amounts do not sum due to rounding.

 

**Critical Accounting Policies**

 

Our critical accounting policies are those thatrequire significant judgment.  There havebeen no material changes to the critical accounting policies previouslyreported in our 2008 Annual Report on Form 10-K filed with the Securitiesand Exchange Commission on March 19, 2009.

 

**Results of operations****for the thirteen and thirty-nine weeks ended September 29, 2009and the fourteen and forty weeks ended September 30, 2008**

 

**Revenue**

 

Wegenerated $21,478,123 and $25,483,423 of revenue during the third quarter of2009 and 2008, respectively.  Thedecrease in revenue of 15.7% for the third quarter of 2009 compared to 2008 wasthe result of a decrease in guest traffic of approximately 2.9% and 15 feweroperating weeks.  The third quarter of2009 included 338 restaurant operating weeks while the same period in 2008 included353 operating weeks.  Throughout 2009 andparticularly in the third quarter, we began a heavy discounting and marketingprogram to drive guest traffic 

 

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back into the restaurants. Although the discounting further reduced our average check and loweredrevenues, we believe our guest traffic trend is improving.  Comparable restaurant revenue, which includedrestaurants in operation over 18 months, decreased 18.9% from the third quarterof 2008 to the third quarter of 2009 was due in part to fewer operating weeksand to a decrease in guest traffic of approximately 6.4%, which we believe wascaused primarily by the macroeconomic factors affecting the restaurant industryin general.  Average weekly revenue percomparable restaurant decreased $9,532 from $75,254 in the third quarter of2008 to $65,722 in the third quarter of 2009.

 

During the first threequarters of fiscal years 2009 and 2008, we generated revenue of $65,004,189 and $74,601,745, respectively.  The 12.9% decrease inrevenue in the first three quarters of 2009 was primarily the result of adecrease in guest traffic of approximately 7.2%, offset in part by 20additional operating weeks.  The firstthree quarters of 2009 included 1,008 restaurant operating weeks while the sameperiod in 2008 included 988 operating weeks. Comparable restaurant revenue, which included restaurants in operationover 18 months, decreased 15.1% from the first three quarters of 2008 to thefirst three quarters of 2009 primarily due to a decrease in guest traffic ofapproximately 9.2%.

 

Weexpect that restaurant revenue will vary from quarter to quarter.  We anticipate continued seasonal fluctuationsin restaurant revenue due in part to increased outdoor seating and generallyfavorable weather conditions at many of our locations during the summermonths.  Due to the honeymoon effect thatperiodically occurs with the opening of a restaurant, we expect the timing ofnew restaurant openings 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 the decreasedconsumer confidence that has negatively impacted the restaurant industry as awhole beginning in 2007 has continued through at least the third quarter of2009.  Overall industry trends have beenslightly worse in the third quarter of 2009 compared to 2008.

 

**Restaurantcosts**

** **

***Food and beverage***

** **

Our food and beverage costs,as a percentage of revenue, decreased 1.8% to 27.9% in the third quarter of2009 from 29.7% in the third quarter of 2008. Such costs decreased 2.9% as a percentage of revenue to 27.5% in thefirst three quarters of 2009 from 30.4% in the first three quarters of2008.  Pricing negotiations with oursuppliers, a menu price increase of approximately 4.0% in March 2008 andimproved oversight of inventory and kitchen management contributed to thisdecrease.

 

Dueto the number of restaurants we now operate throughout the Midwest, we wereable to contract for many of the food commodities we use in our restaurants forperiods up to one year.  Based on severalnew contracts entered into in the later part of 2008, we believe we will beable to maintain or further reduce our food and beverage costs as a percentageof revenue throughout 2009 by reducing our exposure to commodity priceincreases.  We do, however, expect thatour food and beverage costs will continue to vary going forward due to numerousvariables, including seasonal changes in food and beverage costs for which wedo not have contracted pricing, fluctuation within commodity-priced goods andguest preferences.  We periodicallycreate new menu offerings and introduce new craft brewed beers based upon guestpreferences.  Although such menumodifications may temporarily result in increased food and beverage cost, webelieve we are able to offset such increases with our weekly specials whichprovide 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.

 

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***Labor***

 

Laborexpense consists of restaurant management salaries, hourly staff payroll costs,other payroll-related items including management bonuses, and non-cashstock-based compensation expense.  Ourexperience to date has been that staff labor costs associated with a newlyopened restaurant, for approximately its first four to six months of operation,are greater than what can be expected after that time, both in aggregatedollars and as a percentage of revenue.

 

Ourlabor costs, as a percentage of revenue, decreased 0.5% to 35.3% in the thirdquarter of 2009 from 35.8% in the third quarter of 2008.  Such costs decreased 2.1% as a percentage ofrevenue to 35.1% in the first three quarters of 2009 from 37.2% in the firstthree quarters of 2008.  As our newrestaurants began to stabilize and we trained new managers on a number ofoperational metrics and initiatives focused on manager accountability andinternal development of restaurant-level staff, we were able to reduce laborcosts as a percentage of revenue.

 

We expect that labor costs will vary as minimum wagelaws, local labor laws and practices, and unemployment rates vary from state tostate, as will hiring and training expenses. We believe that retaining good employees and more experienced staffensures high quality guest service and may reduce hiring and training costs.

 

***Direct restaurant operating***

 

Operatingsupplies, repairs and maintenance, utilities, promotions and restaurant-leveladministrative expense represent the majority of our direct restaurantoperating expense, a substantial portion of which is fixed or indirectlyvariable.  Our direct restaurantoperating expense as a percentage of revenue increased 0.2% to 15.2% in thethird quarter of 2009 from 15.0% in the third quarter of 2008.  Such costs increased 0.2% as a percentage ofrevenue to 14.8% in the first three quarters of 2009 from 14.6% in the firstthree quarters of 2008.  We began to useoutside media advertising more aggressively in the first three quarters of2009, which was the primary reason for the increase in direct operatingcosts.  While such increases as apercentage of revenue were due in part to a smaller revenue base, increases inrepair and maintenance, consulting and marketing were offset, in part, by thedecrease in utilities and the reduced cost of certain supplies.

 

Wecontinue to seek ways to reduce our direct operating costs going forward bycontinuing to renegotiate pricing on various aspects of these costs.  While we started seeing the effects ofpreviously renegotiated operating items in late 2008, we believe we will seethe full benefit of the resulting cost reductions throughout 2009.

 

***Occupancy***

 

Ouroccupancy costs, which include both fixed and variable portions of rent, commonarea maintenance charges, property insurance and property taxes, increased 2.0%as a percentage of revenue to 7.8% in the third quarter of 2009 from 5.8% inthe third quarter of 2008.  Such costsincreased 1.2% as a percentage of revenue to 7.4% in the first three quartersof 2009 from 6.2% in the first three quarters of 2008, due primarily to asmaller revenue base.  Included in ourrent expense is the difference between our current rent payments andstraight-line rent expense over the initial lease term.  As such, occupancy costs included non-cashrent expense of $475,074 and $194,841 in the first three quarters of 2009 and2008, respectively.  The $280,233increase in non-cash rent expense was due primarily to the rent reductionsprovided by Donald A. Dunham, Jr. or one of the affiliated Dunham entities(collectively “the Dunham Landlords”) and certain of our other landlords.  Our occupancy cost will change as a result ofthe lease amendments entered into in October 2009 as part of theTransaction. We expect our occupancy cost to increase and interest expense todecrease as a result of converting a number of our leases from capital tooperating leases.

 

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

 

Pre-openingcosts, which are expensed as incurred, consist of expenses related to hiringand training the initial restaurant workforce, wages and expenses of ourdedicated new restaurant opening teams, rental costs incurred during theconstruction period and certain other direct costs associated with opening newrestaurants.  Pre-opening costs, excludingconstruction-period rent, are primarily incurred in the month of, and twomonths prior to, restaurant opening.

 

Pre-openingcosts decreased $1,117,550 to $211,262 in the first three quarters of 2009 from$1,328,812 in the first three quarters of 2008. Included in such expense in the first three quarters of 2009 wereexpenses related to the opening of our restaurant in Indianapolis,Indiana.  Pre-opening expenses incurredin the first three quarters of 2008 were related primarily to the restaurantswe opened in St. Louis, Missouri; Ft. Wayne, Indiana; and Toledo, Ohio.

 

**General and administrative**

 

Generaland administrative expense includes all salaries and benefits, includingnon-cash stock-based compensation, associated with our corporate staff that isresponsible for overall restaurant quality, future expansion into newlocations, financial controls and reporting, restaurant management recruiting,management training, excess capacity costs related to our beer productionfacility, and salaries and expenses of our new restaurant opening team when itis not dedicated to a particular restaurant opening.  Other general and administrative expenseincludes advertising, professional fees, investor relations, officeadministration, centralized accounting system costs and travel by our corporatemanagement.

 

Generaland administrative expense decreased $1,338,316 to $1,397,184 in the thirdquarter of 2009 from $2,735,500 in the third quarter of 2008.  Such expenses decreased $2,314,597 to$5,892,251 in the first three quarters of 2009 from $8,206,848 in the firstthree quarters of 2008.  As a percentageof revenue, general and administrative expenses decreased 4.2% in the thirdquarter of 2009 and 1.9% in the first three quarters of 2009 over therespective periods in 2008.  The primarysources of such decreases were expenses related to recruiting, relocation,training and consulting costs, compensation and travel expense.  Such decreases were offset in part byincreased consulting and professional fees as well as marketing expense.  Non-cash stock based compensation included ingeneral and administrative expense was $114,971 and $337,367 in the first threequarters of 2009 and 2008, respectively. In the third quarter of 2009, we reclassed approximately $501,000 in transactioncosts incurred in the first half of 2009 from general and administrativeexpense to deferred transaction cost, due to the closing of the Transaction in October 2009.

 

We continue to seek ways toreduce our general and administrative expenses by continuing to renegotiatepricing with our vendors.  While westarted seeing the effects of previously renegotiated general andadministrative costs, we will closely monitor and attempt to further reducethese expenses while seeking to preserve an infrastructure that remainssuitable for our current operations and future expansion.  Although we may need to recruit additionalpersonnel to provide continued oversight of operations, we expect our turnoverratios for the remainder of 2009 to return to levels more consistent with theindustry, allowing us to reduce our costs. To the extent our turnover increases above our expectations, additionalcosts above our budgeted figures could be incurred in our recruiting andtraining expenses.  We believe ourgeneral and administrative expense and our general and administrative expenseas a percentage of revenue will decrease throughout 2009.

 

**Depreciation and amortization**

 

Depreciationand amortization expense increased $119,996 to $1,760,339 in the third quarterof 2009 from $1,640,343 in the third quarter of 2008.  Such expense increased $379,657 to $5,195,056in the first three quarters of 2009 from $4,815,399 in the first three quartersof 2008, due principally to the additional depreciation related to newrestaurants.  As a percentage of revenue,depreciation expense increased 1.5% to 8.0% in the first three quarters of 2009from 6.5% in the first three quarters of 2008, due in part to a smaller revenuebase.

 

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**Exit or disposal activities**

 

In August 2008, weclosed our Rogers, Arkansas restaurant. Since opening in October 2007, the restaurant failed to generatepositive cash flow and had approximately $1.4 million of net loss.  We believe the closure of this restaurantwill allow management to focus its capital and personnel resources on our otherrestaurants in order to increase future operating efficiencies and cash flow.  We are working to find a replacement tenantfor the location, for which we are bound by a lease.  Such lease expires December 31, 2018pursuant to an amendment entered into in October 2009 (see “Closing of theDHW Transaction” below).  Costs incurredin the third quarter and first three quarters of 2009 in connection with thisclosure include costs to maintain the facility of approximately $131,814 and$401,241, respectively.  We will incurongoing costs such as utilities, landscape and maintenance and generalliability insurance until we are able to find a replacement tenant. We recordeda non-cash lease termination liability of $852,146 based on management’sestimate of the fair value of these obligations.  This required management to estimate thepresent value of the future minimum lease obligations offset by the estimatedsublease rentals that could be reasonably obtained for the property.  During the first three quarters of 2009,amortization of this sublease liability offset exit or disposal activities expenseby $14,915.   All costs related to theclosing of the Rogers restaurant, including lease payments, are reflected inour statements of operations as “exit or disposal activities”.  As of September 29, 2009, our annuallease payments for the Rogers site were $405,000 and our ongoing costs tomaintain the property were approximately $10,500 per month.  As of October 5, 2009, the date of thelease amendment, our undiscounted cash payments under the terms of the leasewere approximately $4.1 million.

 

As part of the MasterAgreement we entered into with the Dunham Entities in February 2009, weagreed to reimburse DCM for any out-of-pocket expenses incurred, reduced by 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 September 29, 2009, it is probable we will need to reimburseDCM approximately $390,000 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 three quarter of 2009. As of September 29, 2009, the carrying cost of the landapproximated $16,000 per month. Reimbursement of costs related to these sites, including the carrying costof the related land, will be amortized and payable to DCM over a 60-monthperiod commencing January 2011, at a 6% annual interest rate.  The actual amount due DCM could fluctuate dueto changes in the economy.

 

**Interest**

 

Net interest expenseconsists of interest expense on capital leases and long-term debt, net ofinterest earned from cash on hand. Interest expense decreased $335,986 to $1,365,885 in the third quarterof 2009 from $1,701,871 in the third quarter of 2008.  Such expense decreased $93,500 to $4,748,325in the first three quarters of 2009 from $4,841,825 in the first three quartersof 2008 due to capital lease reductions from our landlords and equipmentfinancers.  Interest income decreased$3,152 in the third quarter of 2009 and $26,790 in the first three quarters of2009 over the respective periods in 2008 due to the reduction of cash on hand.

 

**Liquidity and capital resources**

 

As of September 29, 2009, we had $547,160 ofcash and a working capital deficit of $12,455,212 compared to $2,652,411 ofcash and a working capital deficit of $7,809,664 at December 30,2008.  During the first nine months ofoperations in 2009, we did not meet our internal budget primarily due todeclining revenue.  In June 2009, weannounced the hiring of MorrisAnderson in an effort to restructure our debt andleases.  To conserve cash for operations,we have been reducing, delaying or withholding payments to our landlords duringperiods of negotiations with the landlords to allow us to satisfy operatingobligations as necessary to avoid disruption of restaurant operations.  In October 2009, we completed theTransaction with DHW whereby approximately $15 million of our indebtedness toDHW was converted into 28,000,000 shares of our common stock at a conversionprice of approximately $0.54 per share. In connection with the closing of the Transaction, the parties enteredinto a number of ancillary agreements which include, but are not limited to,lease amendments, deferred lease payments and an agreement to seek to obtainfurther rent reductions (see “Closing of DHW Transaction” below).  We believe this restructuring has improvedour balance sheet and better positions our

 

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companyto operate our business.  We continue toreview our capital needs and our ability to raise additional capital.  If the restructuring efforts do not enable usto have sufficient working capital due to a change in our business operations,further declining revenues or any other reason, we will be required to raisefunds during 2009 through the incurrence of indebtedness or public or privatesales of equity securities, which may be dilutive to shareholders and may ormay not be available to us. The amount of any such required funding woulddepend upon sales trends and our ability to generate working capital.  If cash flow from operations are insufficientto fund expected capital needs, or if our needs are greater than anticipatedand we are unable to obtain additional capital, our business and results ofoperations will be materially and adversely affected.

 

During the thirty-nine weeksended September 29, 2009, we obtained proceeds of $1,800,000 pursuant to asales-leaseback capital lease agreement and a loan agreement and made paymentsaggregating $1,791,092 on our debt and capital lease obligations.  We used $456,579 of net cash in operatingactivities, $719,415 of net cash to purchase equipment and other assets, and$938,164 of cash for costs related to the Transaction.

 

Duringthe forty weeks ended September 30, 2008, we used $8,270,176 of net cashin operating activities and $3,298,269 of net cash to purchase equipment andother assets primarily related to the restaurants we opened in the first andthird quarters of 2008 and the restaurants we planned to open in Indianapolis,Indiana and Troy, Michigan.  We madepayments aggregating $1,481,908 on our debt and capital lease obligations,received $8,000,000 in proceeds from capital lease obligations and received$29,066 of net cash through the exercise of stock options.

 

*Closing of DHW Transaction:*

 

In October 2009, we completed the Transactionwith DHW, our primary source of financing for furniture, fixtures andequipment.  In the Transaction, approximately $15 million of ourindebtedness to DHW was converted into 28,000,000 shares of our company’scommon stock at a conversion price of approximately $0.54 per share.  Weobtained a waiver under the financial viability exception from NASDAQ to itsshareholder approval requirements, so the Transaction was not subject toapproval by our shareholders.  The Transaction was approved by a specialcommittee of our company’s independent directors, by our Board of Directors,and by our audit committee under our company’s related person transactionpolicy.  As a result, DHW and affiliatedparties beneficially own an aggregate of 64.8% of our company’s common stock,which constituted a change in control of the Company.  Because of this change in control, our use offederal net operating loss carryforwards to offset future taxable income may belimited.

 

During the first year following closing, if theaverage bid price of our common stock for any period of 20 consecutive tradingdays equals or exceeds $0.714, we will have the right, exercisable on aone-time basis, to repurchase for $.001 per share an amount of the sharesissued to DHW in the Transaction as would enable DHW to retain such issuedshares having a market value of $20.0 million following such repurchase.  The right may be triggered multiple timesduring the year, but may only be exercised once.  If we were to exercise this right, suchexercise would be considered an equity transaction reported as a reduction ofshareholders’ equity.

 

In connection with the closing of the Transaction,the parties entered into a number of ancillary agreements. Amendment No. 1to the Master Agreement, between the Dunham Entities and our company amends theMaster Agreement entered into in February 2009 by such parties. Under the amendment, the parties agreed to provide the agreed-upon rentreductions in 2009 and agreed to use reasonable commercial efforts to seek rentreductions on real estate leases of up to $1.7 million on leases for propertiescontrolled by the Dunham Landlords and properties not controlled by the DunhamLandlords, compared to $1.5 million under the original Master Agreement.

 

In connection with the Transaction, a MasterAmendment to Leases was entered into by and among our company and the DunhamLandlords.  Under the Master Amendment to Leases, the Dunham Landlordsagreed to a limited deferral of 30% of the rent due under lease agreementsbetween our company and the Dunham Landlords. In addition, for all rent paymentsdue on or after June 1, 2009 under restaurant leases with the DunhamLandlords, rent has been deferred for one month.  The deferred rents mustbe repaid upon the first to occur of

 

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(a) ourcompleting a debt or equity financing in the amount of $2,000,000 or (b) uponthe first anniversary of closing.  We anticipate that the monthly accruedand deferred rent will be approximately $75,000 per month commencing June 2009. In addition, the Dunham Landlords waived any defaults or events of defaultexisting under the leases as of the closing date.

 

In connection with the Transaction, our company andthree of our executive officers, Steven J. Wagenheim, James G. Gilbertson andDarius H. Gilanfar, entered into amendments to their existing employmentagreements which provide that each will have employment for a term of one yearfollowing the closing of the Transaction, and will be entitled to severancebenefits that include one year of base compensation if employment is terminatedwithout cause, in addition to the balance of the one-year term, if terminatedprior to the end of such term. The employment agreements are automaticallyextended for one-year terms unless either our company or the executive gives atleast 60 days’ notice to the other of an intent not to extend.  Inaddition, Mr. Wagenheim’s employment agreement was amended to reduce hisseverance benefit from 18 months to 12 months.

 

In connection with the Transaction we also enteredinto an amendment to the bridge loan agreement with Harmony which defers the October 1,2009 interest payment, modifies the minimum net consolidated revenue covenantfor the quarters ending September 30, 2009 and December 30, 2009, andwaives any participation rights in the Transaction.

 

The parties also entered into a Registration RightsAgreement under which we granted DHW certain registration rights with respectto the shares that DHW received in the Transaction.  Pursuant to theRegistration Rights Agreement, we agreed to file a registration statement withthe SEC covering 4,666,666 of DHW’s shares within 90 days of the closing date,and agreed, upon request by DHW and if DHW has sold the shares previouslyregistered, to file registration statements covering 4,666,666 additionalshares each six months thereafter.  Under the Registration RightsAgreement, we are not obligated to file (a) more than six registrationstatements; (b) registration statements more frequently than every sixmonths; or (c) any registration statement more than three years after theclosing date.

 

*Rent Reduction Agreement:*

 

InFebruary 2009, we entered into a Master Agreement with the Dunham Entitiesto provide rent or other cash flow reductions to us in the amount of $2.5million for the calendar year 2009 and $1.5 million for calendar year2010.  The Master Agreement provides thatthe DCM will amend and restate applicable leases and subleases to reflectnegotiated rent reductions.  As a part ofthe Master Agreement, DCM 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 as operatingleases in accordance with generally accepted accounting principles.  As part of the Transaction entered into in October 2009,the Dunham Landlords amended their building leases (see “Closing of DHWTransaction” above).  The amended termswere effective January 1, 2009, and in most cases the expiration date ofthe lease is December 31, 2018.  Wehave determined that a minimum of seven of the amended leases will qualify asoperating leases**and a minimum of seven willremain capital leases.  We are awaitingadditional information to evaluate the classification of the remaining threeamended leases.   As a result of theseamendments, we will remove a minimum of $14 million of assets and $16 millionof liabilities from our balance sheet. The resulting gain will be recognized over the life of the amendedleases.  In consideration of theagreements of DCM 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 entered into agreements with certain of our other landlords for rentreductions.  Such rent reductions aredeemed to be part of the 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 such landlords.  Each warrant is exercisable at 110% of theclosing price of our common stock on the trading date prior to the date onwhich we received the executed rent relief agreement, and are issued only toaccredited investors.  As of 

 

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September 29, 2009, the aggregate number of shares underlying suchwarrants was 196,070 and the weighted average exercise price was $0.27 pershare.

 

*Equipment Lease Agreement:*

 

During the first quarter of 2009, we financed theequipment at two of our restaurants, aggregating approximately $2.0 million,under the terms and conditions of the equipment lease commitment we enteredinto with DHW in December 2007.  Ofsuch financing, $1.0 million was the result of a sale-leaseback transactionwith DHW for which we received cash proceeds.

 

*Harmony Bridge Loan:*

 

In March 2009, we entered into a bridge loanagreement with a group of accredited investors to provide $1.0 million ofpartially convertible debt financing.  The bridge loan is evidenced bynotes bearing interest at 9.0% per annum, payable in six equal monthlyinstallments commencing on May 1, 2010 and due in full on October 1,2010.  The lead investors in the transaction were Harmony Equity IncomeFund, L.L.C. and Harmony Equity Income Fund II, L.L.C. (collectively, “Harmony”). The Company’s Chairman, Eugene E. McGowan, is a member of, and has a beneficialinterest in, both of the Harmony funds. The notes are secured by a mortgage against the lease, and securityagreements against personal property and intangibles relating to the Company’sSioux Falls, South Dakota restaurant, including a grant of the rights to usepatents, trademarks and other intangibles associated with that restaurant. The bridge loan was funded to the extent of $800,000 on March 30,2009.  We have entered into severalamendments with Harmony to extend the date for the balance of the funding,which is now December 16, 2009 (see “Subsequent Events” Note 13).  Up to 20% of each bridge note may beconverted into common stock at a conversion price equal to $0.50 pershare.  Harmony has agreed to defer the July 2009 and the October 2009interest payments until the maturity date of the loans.  In addition, the Company agreed to issue tothe investors warrants for the purchase of an aggregate of 400,000 shares ofcommon stock exercisable six months after date of issuance at a price of$0.25267 per share, or 110% of the closing price of the Company’s stock on March 30,2009.  As of September 29, 2009,warrants to purchase an aggregate of 320,000 shares of common stock had beenissued to such investors.

 

Our Board of Directors has authorized us to borrowup to an aggregate of $3.0 million under the terms of the bridge loan agreement,which provides that the investors may, but are not obligated to, makeadditional loans on substantially the same terms and conditions, including asimilar pledge of collateral related to either our St. Cloud, Minnesota, orFargo, North Dakota restaurants.

 

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 the retail and casual dining industries andother factors, which may be beyond our control. There can be no assurance that we will obtain financing on favorableterms or at all.  If we raise additionalcapital through the issuance and sale of equity securities, the securities maybe issued at prices below the market price of our stock, and our shareholdersmay suffer significant dilution.  Debtfinancing, if available, may involve significant cash payment obligations,covenants and financial ratios that restrict our ability to operate and growour business, and would cause us to incur additional interest expense andfinancing costs.

 

**Commitments**

 

*Capital****Lease:*

* *

Asof September 29, 2009, we had 24 capital lease agreements related to ourrestaurant properties, of which one expires in 2020, two in 2023, four in 2024,three in 2025, four in 2026, seven in 2027, two in 2028 and one in 2029, allwith renewable options for additional periods. Twenty-two of these lease agreements originated with the DunhamLandlords.  Under certain of the leases,we may be required to pay additional contingent rent based upon restaurantsales.  At the inception of each of theseleases, we evaluated the fair value of the land and 

 

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building separately pursuant to the FASB accounting guidance onaccounting for leases.  The land portionof these leases is classified as an operating lease while the building portionof these 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.  As part of the Transactionentered into in October 2009, 17 of these leases were amended.  The amended terms were effective January 1,2009, and in most cases the expiration date of the lease is December 31,2018.  We have determined that seven ofthe amended leases will qualify as operating leases and seven will remaincapital leases.  We are awaitingadditional information to evaluate the classification of the remaining threeamended leases.  The resulting changes to future minimumlease payments are reflected in our summary of contractual obligations below.

 

InDecember 2004, we entered into a land and building lease agreement for ourbeer production facility.  This ten-yearlease, which commenced February 1, 2005, allows us to purchase thefacility at any time for $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.

 

InAugust 2006, we entered into a master lease agreement with CarltonFinancial Corporation (“Carlton”) pursuant to which we could “finance lease” upto $3.0 million of equipment purchases for three restaurant locations.  We have entered into three lease schedulesand amendments to this master lease, pursuant to which we began leasingequipment for 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 on each ranges from 12.9% to 19.6% annually.  In February 2009 and again in August 2009,these lease schedules were amended to extend the terms by approximately twoyears and reduce the monthly payments. At the end of each initial lease term, we may, under the amended leaseschedules, purchase Carlton’s interest in all, but not less than all, of theequipment for a purchase price equal to 15% of the original cost of theequipment.  Steven J. Wagenheim, ourpresident, chief executive officer and one of our directors, was required topersonally guarantee payments to be made to Carlton under the lease financingand our board of directors agreed to compensate him for such guarantee.  The amount of annual compensation is 3% ofthe balance of such leases and is calculated and accrued based on the weightedaverage daily balance of the leases at the end of each monthly accountingperiod.

 

As of September 29, 2009, DHW had purchased andleased to us equipment costing $16.0 million under the Equipment Lease weentered into with DHW, relating to the lease of furniture, fixtures andequipment for our restaurants.  Under theterms of the Equipment Lease Commitment, each five-year lease with DHW was forequipment costing approximately $1.0 million per restaurant and the annualinterest rate on each lease ranged from 10.3% to 12.3%.  Payments due DHW had an annual interest rateequal to the DHW bank base rate plus 4.8%. As part of the Transaction entered into in October 2009**,**the aggregate balance remaining on 16 of these leases ofapproximately $15 million was extinguished through the issuance of 28,000,000shares of our common stock.

 

In June 2007, we entered into a lease for anenergy optimization system at our Maple Grove, Minnesota restaurant forapproximately $30,000.  This five-yearlease commenced June 28, 2007, carries an annual interest rate ofapproximately 11.9% and contains a bargain purchase option.

 

*Oper**ating****Lease*:

 

Theland portions of the 24 property leases referenced above, 22 lease agreementsof which originated with the Dunham Landlords, are classified as operatingleases because the fair value of the land was 25% or more of the leased propertyat the inception of each lease.  Allscheduled rent increases for the land during the initial term of each lease arerecognized on a straight-line basis.  Asnoted above, 17 of these leases were amended as part of the Transaction enteredinto in October 2009.  We havedetermined that seven of the amended leases will qualify as operating leases(both building and land) and seven will remain capital leases.  We are awaiting additional information toevaluate the classification of the remaining three amended leases.  In addition to such property leases, we haveobligations under the following operating leases:

 

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InJanuary 2001, we entered into a 20-year operating lease for the land uponwhich we built our Fargo, North Dakota restaurant.  Under the lease terms, we are obligated toannual rent of $72,000 plus contingent rent based upon restaurant sales.

 

InAugust 2005, we entered into a 38-month lease agreement for office spacefor our corporate offices.  The leasecommenced October 1, 2005.  In November 2007,we entered into an amendment to such lease to include additional spacecommencing December 1, 2007. Pursuant to the amended lease, which expires in November 2011,annual rent is $96,613 with scheduled annual increases throughout the term ofthe lease.  Such scheduled rent increasesare recognized on a straight-line basis over the term of the lease.

 

InMarch 2006, we entered into a lease agreement for the land and buildingfor our St. Louis Park, Minnesota restaurant. Rental payments for this lease are $148,625 annually.  This operating lease expires in 2016 withrenewal options for additional periods.

 

InAugust 2008, we ceased operations at our restaurant in Rogers,Arkansas.  However, we are currentlybound by the terms of lease agreement which expires in 2018 pursuant to anamendment entered into in October 2009. Pursuant to the Master Agreement with the Dunham Entities describedabove, we will reimburse DCM for any out-of-pocket expenses incurred less netproceeds from the sale of the real estate or lease income associated with thissite.  The building portion of this leaseis classified as a capital lease, while the land portion is classified as anoperating lease (see “Exit or Disposal Activities” Note 3).

 

In August 2009, weentered into an agreement to terminate the lease for a facility inMinneapolis, Minnesota which we used as a test kitchen.  This operating lease, which was to expire in October 2011,terminated effective August 20, 2009. Pursuant to the termination agreement, we were required to pay rentthrough August 2009 plus an additional $11,064, which is equivalent tothree months of lease payments.

 

*Personal Guaranties and Guarantee Fees:*

* *

Oneof our directors and one former director have personally guaranteed certain ofour leases and loan agreements.  Ourboard of directors has agreed to compensate Steven J. Wagenheim, ourpresident, chief executive officer and one of our directors, for his personalguaranties of equipment loans entered into in August 2003, January 2004and August 2006.  The amount ofannual compensation for each of these guarantees is 3% of the balance of theobligation and is calculated and accrued based on the weighted average dailybalance of the obligation at the end of each monthly accounting period.  During the first three quarters of 2009 and2008, we recorded $45,837 and $71,716 of such compensation ingeneral and administrative expense, respectively.  We paid $25,000 and $40,000 of suchcompensation in the first three quarters of 2009 and 2008, respectively.

 

*In December 2007, we entered into an Equipment LeaseCommitment and Master Equipment Lease with DHW, relating to the lease offurniture, fixtures and equipment for current and future restaurants.  Mr. Wagenheim had a 10.2% interest inDHW and personally guaranteed 20% of DHW’s indebtedness to its lenders.  However, he was not entitled to receive fromDHW cash distributions from its operations, or the sale, disposition orfinancing of its assets, or any other form of fee, dividend, charges ordistribution from DHW arising out of his ownership interest in DHW or hisguaranty of its debt. The company has been advised that an agreement has beenreached among the members of DHW for the termination and redemption of Mr. Wagenheim’sinterest in DHW.  He is no longerobligated to guaranty any of DHW’s obligations to banks.  Mr. Wagenheim will not be entitled toreceive any of the shares of common stock issuable to DHW or any other benefitfrom the Transaction.  Furthermore, Mr. Wagenheimdid not receive a guarantee fee or other payment from our company in connectionwith the equipment lease financing from DHW.*

* *

*Employment Agreements:*

* *

In June 2005, weentered 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 

 

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April 1, 2007. Mr. Wagenheim’s annual non-equity incentive compensation rangesfrom $0 to $197,400 based on performance. In addition to annual compensation terms and other provisions, theagreement included change in control provisions that would have entitled Mr. Wagenheimto receive severance pay equal to 18 months of salary if there is a changein control of our company and his employment terminates.  Mr. Wagenheim has agreed to certainnondisclosure provisions during the term of his employment and any timethereafter, and certain noncompetition and nonrecruitment provisions during theterm of his employment and for a period of one year thereafter.  Our company and Mr. Wagenheim haveagreed 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 connection with theTransaction, we entered into an amendment to Mr. Wagenheim’s existingemployment agreement which provides that he will have employment for a term ofone year following the closing of the Transaction, and will be entitled toseverance benefits that include one year of base compensation if employment isterminated without cause, in addition to the balance of the one-year term, if terminatedprior to the end of such term.  Theemployment agreement is automatically extended for a one-year term unlesseither our company or Mr. Wagenheim gives at least 60 days’ notice to theother of an intent not to extend.  Inaddition, Mr. Wagenheim’s employment agreement was amended to reduce hisseverance benefit from 18 months to 12 months.

 

*In November 2007, we entered into an employmentagreement with James G. Gilbertson providing for his employment as our chieffinancial officer on an at-will basis at an annual base salary of$225,000.  He is entitled to participatein performance-based cash bonus or equity award plans for senior executivesbased upon goals established by our board or compensation committee afterreasonable 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.*

* *

Inconnection with the Transaction, we entered into an amendment to Mr. Gilbertson’sexisting employment agreement which provides that he will have employment for aterm of one year following the closing of the Transaction, and will be entitledto severance benefits that include one year of base compensation if employmentis terminated without cause, in addition to the balance of the one-year term,if terminated prior to the end of such term. The employment agreement is automatically extended for a one-year termunless either our company or Mr. Gilbertson gives at least 60 days’ noticeto the other of an intent not to extend.

 

InDecember 2008, we entered into an employment and severance agreement withDarius H. Gilanfar providing for his continued employment as ChiefOperating Officer on an at-will basis at an annual base salary of$202,860.  He also is entitled toparticipate in employee benefit plans, policies, programs, perquisites andarrangements that are provided generally to similarly situated executiveemployees of our company.  The employmentagreement provides for provisions for termination with and without cause by usand for good 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.

 

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Inconnection with the Transaction, we entered into an amendment to Mr. Gilanfar’sexisting employment agreement which provides that he will have employment for aterm of one year following the closing of the Transaction, and will be entitledto severance benefits that include one year of base compensation if employmentis terminated without cause, in addition to the balance of the one-year term,if terminated prior to the end of such term. The employment agreement is automatically extended for a one-year termunless either our company or Mr. Gilanfar gives at least 60 days’ noticeto the other of an intent not to extend.

 

*Development Agreement*:

* *

In April 2008,we entered into a development agreement with United Properties for thedevelopment of up to 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 buildingsthat it develops for us at an amount in excess of the threshold agreed to bythe parties in the agreement, then we will share in the profits of thatsale.  We assume no liability in theevent United Properties sells a building at a loss.  We are not bound to authorize theconstruction of restaurants during that time period, but generally cannot useanother developer to develop or own a restaurant as long as the developmentagreement is in effect.  We can, however,use another developer if United Properties declines to build a particularrestaurant.  In addition, we have alsoagreed to refrain from developing any new restaurants in the remainder of 2009without the consent of the Dunham Entities (which will not be unreasonablydelayed or withheld).

 

*Off- balance sheet arrangements:*

 

It is not our businesspractice to enter into off-balance sheet arrangements.

 

*Summary of contractual obligations:*

 

The following table summarizes our obligations undercontractual agreements and the time frame within which payments on suchobligations are due.  This table includeschanges to leasecommitments commencing after September 29, 2009 (see “Closing of DHWTransaction” above).  This table doesnot include amounts related to contingent rent as such future amounts are notdeterminable.  In addition, whether wewould incur any additional expense on our employment agreements depends uponthe existence of a change in control of the company or other unforeseeableevents.  Therefore, neither contingentrent nor severance 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                     |       | $                           | 2,529,049   |   | $ | 81,767 |   | $ | 2,209,214 |   | $ | 8,880 |   | $ | 229,188 |   |
| Interest on long-term debt                    |       | 542,400                     |        | 36,915 |   | 313,137 |   | 37,429 |   | 154,919 |   |
| Capital lease obligations, including interest |       | 66,995,183                  |        | 1,384,800 |   | 9,726,885 |   | 9,428,852 |   | 46,454,646 |   |
| Operating lease obligations                   |       | 60,682,909                  |        | 1,414,155 |   | 9,618,530 |   | 10,715,161 |   | 38,935,063 |   |
| Loan guarantee                                |       | 143,382                     |        | 96,450 |   | 45,122 |   | 1,810 |   | — |   |
| Total obligations                             |       | $                           | 130,892,923 |   | $ | 3,014,087 |   | $ | 21,912,888 |   | $ | 20,192,132 |   | $ | 85,773,816 |   |

 

Certain amounts do not sum due to rounding.

 

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Duringthe first nine months of operations in 2009, we did not meet our internalbudget primarily due to declining revenue. We believe the restructuring resulting from the Transaction completed inOctober 2009 has improved our balance sheet by reducing aggregateindebtedness and better positions our company to operate our business.  We continue to review our capital needs andour ability to raise additional capital. If the restructuring efforts do not enable us to have sufficient workingcapital due to a change in our business operations, further declining revenuesor any other reason, we will require further funding for operations during2009.

 

*Recent accounting pronouncements:*

 

See the “Recent accounting pronouncements” sectionof Note 1 to our condensed consolidated financial statements for a summary ofrecent accounting standards.

 

**Seasonality**

 

We expect that our sales andearnings will fluctuate based on seasonal patterns.  We anticipate that our highest sales andearnings will occur in the second and third quarters due to the milder climateand availability of outdoor seating during those quarters in our markets.

 

**Inflation**

** **

The primary inflationary factors affecting ouroperations are food, supplies and labor costs. A large percentage of our restaurant personnel is paid at rates based onthe applicable minimum wage, and increases in the minimum wage directly affectour labor costs.  In the past, we havebeen able to minimize the effect of these increases through menu priceincreases and other strategies.  To date,inflation has not had a material impact on our operating results.

 
| **ITEM 3** | **Quantitative  and Qualitative Disclosures about Market Risk** |
|------------|-----------------------------------------------------------------|

 

Ourcompany is exposed to market risk from changes in interest rates on debt andchanges in commodity prices.

 

*Changesin interest rates:*

 

Pursuant to the terms of our long-term debtagreement with an independent financial institution, we will have a balloonpayment due of approximately $1.1 million in 2011.  If it becomes necessary to refinance suchballoon balance, we may not be able to secure financing at the same interestrate.  The effect of a higher interestrate would depend upon the negotiated financing terms.

 

*Changes in commodity prices:*

 

Manyof the food products and other commodities we use in our operations are subjectto price volatility due to market supply and demand factors outside of ourcontrol.  Fluctuations in commodityprices and/or long-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 entered intofixed price purchase commitments, with terms typically up to one year, for manyof our commodity requirements.  We haveentered into contracts through 2013 with certain suppliers of raw materials(primarily hops) for minimum purchases both in terms of quantity and pricing.   As of September 29, 2009, our futureobligations under such contracts aggregated approximately $1.2 million.

 

Althougha large national distributor is our primary supplier of food, substantially allof our food and supplies are available from several sources, which helps tocontrol commodity price risks.  Additionally,we have the ability to increase menu prices, or vary the menu items offered, inresponse to food product price increases. If, however, competitive circumstances limit our menu price flexibility,our margins could be negatively impacted.

 

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Our company does not enter into derivative contractseither to hedge existing risks or for speculative purposes.

 
| **ITEM 4** | **Controls and Procedures** |
|------------|-----------------------------|

 

*Evaluation of disclosure controls and procedures*

 

Wemaintain a system of disclosure controls and procedures that is designed toensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosures.

 

Under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, we conducted an evaluation of our disclosurecontrols and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)). Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that, as of September 29, 2009, our disclosurecontrols and procedures were effective.

 

*Changes in internal control overfinancial reporting*

 

There were no changes in ourinternal control over financial reporting that occurred during the quarterended September 29, 2009 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART II****                                                  ****OTHER INFORMATION**

 
| **ITEM 1** | **Legal Proceedings** |
|------------|-----------------------|

 

None.

 
| **ITEM 1A** | **Risk Factors** |
|-------------|------------------|

 

There have been no material changes with respect tothe risk factors disclosed in our Annual Report on Form 10-K for the fiscalyear ended December 30, 2008, filed with the Securities and ExchangeCommission on March 19, 2009 and the “Risk Factors” section of our Quarterly Report on Form 10-Qfiled with the Securities and Exchange Commission on August 14, 2009.

 
| **ITEM 2** | **Unregistered Sales of Equity Securities and Use  of Proceeds** |
|------------|------------------------------------------------------------------|

 

On August 25, 2009, we issued a warrant for thepurchase of 10,125 shares of our common stock, exercisable at $0.50 per share,to one of our landlords in exchange for certain rent reductions. These rentreductions represent part of the $4.0 million in rent and cash flow reductionsannounced in our Current Reports on Form 8-K filed on February 12,2009 and February 26, 2009.

 

The foregoing issuance was made in reliance upon theexemption provided in Section 4(2) of the Securities Act and the safeharbor of Rule 506 under Regulation D. Any certificates representing such securities will contain restrictivelegends preventing sale, transfer or other disposition, unless registered underthe Securities Act.  The recipient ofsuch securities received, or had access to, material information concerning ourcompany, including, but not limited to, our reports on Form 10-K, Form 10-Q,and Form 8-K, as filed with the SEC. No discount or commission was paid in connection with the issuance ofthe foregoing securities.

 

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| **ITEM 3** | **Defaults  upon Senior Securities** |
|------------|--------------------------------------|

 

None.

 
| **ITEM 4** | **Submission of Matters to a Vote  of Security Holders** |
|------------|----------------------------------------------------------|

 

None.

 
| **ITEM 5** | **Other Information** |
|------------|-----------------------|

 

None.

 
| **ITEM 6** | **Exhibits** |
|------------|--------------|

 

See “Index to Exhibits.”

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   | GRANITE CITY  FOOD & BREWERY LTD. |
|--------|--------------------------------------------|

 

 
| Date:       November 13,  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        |       | Amendment No. 5 to Bridge Loan Agreement by and between the  Company, Granite City Restaurant Operations, Inc. and Harmony Equity  Income Fund, L.L.C. dated September 30, 2009 (incorporated by reference  to the Company’s Current Report on Form 8-K filed on October 6,  2009 (File No. 000-29643)).                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.2        |       | Debt Conversion Agreement between the Company and DHW Leasing,  L.L.C., dated September 21, 2009 (incorporated by reference to the  Company’s Current Report on Form 8-K filed on September 22, 2009  (File No. 000-29643)).                                                                                                                                                                                                                                                                                                                       |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.3        |       | Amendment No. 1 to Master Agreement by and between Dunham  Capital Management, L.L.C., DHW Leasing, L.L.C., Dunham Equity Management,  L.L.C. and the Company, dated October 5, 2009 (incorporated by reference  to the Company’s Current Report on Form 8-K filed on October 6,  2009 (File No. 000-29643)).                                                                                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.4        |       | Registration Rights Agreement by and between the Company and DHW  Leasing, L.L.C., dated October 5, 2009 (incorporated by reference to the  Company’s Current Report on Form 8-K filed on October 6, 2009 (File  No. 000-29643)).                                                                                                                                                                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.5        |       | Amendment No. 2 to Executive Employment Agreement by and between  the Company and Steven J. Wagenheim, dated October 5, 2009 (incorporated  by reference to the Company’s Current Report on Form 8-K filed on  October 6, 2009 (File No. 000-29643)).                                                                                                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.6        |       | Amendment No. 2 to Executive Employment Agreement by and between  the Company and James G. Gilbertson, dated October 5, 2009 (incorporated  by reference to the Company’s Current Report on Form 8-K filed on  October 6, 2009 (File No. 000-29643)).                                                                                                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.7        |       | Amendment No. 2 to Employment and Severance Agreement by and  between the Company and Darius H. Gilanfar, dated October 5, 2009  (incorporated by reference to the Company’s Current Report on Form 8-K  filed on October 6, 2009 (File No. 000-29643)).                                                                                                                                                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.8        |       | Waiver of Default regarding Bridge Loan Agreement by and between the  Company, Granite City Restaurant Operations, Inc., Harmony Equity Income  Fund I, L.L.C. and Harmony Equity Income Fund II, L.L.C, dated  October 5, 2009 (incorporated by reference to the Company’s Current  Report on Form 8-K filed on October 6, 2009 (File  No. 000-29643)).                                                                                                                                                                                      |
|        |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| 10.9        |       | Master Amendment to Leases by and among GC Omaha Limited Partnership,  Dunham Capital Management, L.L.C., GC Rosedale, L.L.C., GC Lincoln Limited  Partnership, GC Olathe Limited Partnership, GC Eagan Limited Partnership, GC  Cedar Rapids/Davenport Limited Partnership, GC Des Moines Limited  Partnership, GC Holdings Limited Partnership, GC Wichita Limited Partnership,  and the Company, dated October 5, 2009 (incorporated by reference to the  Company’s Current Report on Form 8-K filed on October 6, 2009 (File  No. 000-29643)). |

 

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| 10.10  |   | Termination of Equipment Lease and Bill of Sale by and between the  Company and DHW Leasing, L.L.C., dated October 5, 2009 (incorporated by  reference to the Company’s Current Report on Form 8-K filed on  October 6, 2009 (File No. 000-29643)). |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                         |
| 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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