**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

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**FORM 10-Q**

 
| **x**  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 25, 2008** |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                       |
| **o**  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**                                                   |

 

**CommissionFile Number 000-29643**

 

**GRANITECITY FOOD & BREWERY LTD.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

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

 

**5402Parkdale Drive, Suite 101**

**Minneapolis,Minnesota  55416**

**(952)215-0660**

(Address ofPrincipal Executive Offices and Issuer’s

Telephone Number,including Area Code)

 

Indicate by check markwhether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

 
| Yes x     No  o |
|------------------------------------------|

 

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

 
| Large accelerated filer  o |   | Accelerated filer x |   | Non-accelerated  filer o | Smaller reporting  company o |
|----------------------------|--------|---------------------|--------|--------------------------|------------------------------|

(Do not check if smaller reporting company)

 

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

 
| Yes o     No  x |
|------------------------------------------|

 

Asof May 1, 2007, the issuer had outstanding 16,197,849****shares of common stock.

 

 

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**TABLE OFCONTENTS**

 
| ** **             | ** **                                                                                                                 | ** ** | **Page** |
|------------------------|----------------------------------------------------------------------------------------------------------------------------|------------|----------|
|                   |                                                                                                                       |       |     |
| **PART I**        | **FINANCIAL INFORMATION**                                                                                                  |       | 1        |
|                   |                                                                                                                       |       |     |
| ITEM 1                 | Financial Statements                                                                                                       |       | 1        |
|                   |                                                                                                                       |       |     |
|                   | Condensed Consolidated Balance Sheets as of  March 25, 2008 and December 25, 2007                                |       | 1        |
|                   |                                                                                                                       |       |     |
|                   | Condensed  Consolidated Statements of Operations for the Thirteen weeks ended  March 25, 2008 and March 27, 2007 |       | 2        |
|                   |                                                                                                                       |       |     |
|                   | Condensed  Consolidated Statements of Cash Flows for the Thirteen weeks ended  March 25, 2008 and March 27, 2007 |       | 3        |
|                   |                                                                                                                       |       |     |
|                   | Notes to Condensed Consolidated Financial Statements                                                                       |       | 4        |
|                   |                                                                                                                       |       |     |
| ITEM 2                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                |       | 13       |
|                   |                                                                                                                       |       |     |
| ITEM 3                 | Quantitative  and Qualitative Disclosures about Market Risk                                                                |       | 25       |
|                   |                                                                                                                       |       |     |
| ITEM 4                 | Controls and  Procedures                                                                                                   |       | 25       |
|                   |                                                                                                                       |       |     |
| **PART II**       | **OTHER INFORMATION**                                                                                                      |       | 26       |
|                   |                                                                                                                       |       |     |
| ITEM 1                 | Legal Proceedings                                                                                                          |       | 26       |
|                   |                                                                                                                       |       |     |
| ITEM 1A                | Risk Factors                                                                                                               |       | 26       |
|                   |                                                                                                                       |       |     |
| ITEM 2                 | Unregistered  Sales of Equity Securities and Use of Proceeds                                                               |       | 26       |
|                   |                                                                                                                       |       |     |
| ITEM 3                 | Defaults upon  Senior Securities                                                                                           |       | 26       |
|                   |                                                                                                                       |       |     |
| ITEM 4                 | Submission of  Matters to a Vote of Security Holders                                                                       |       | 27       |
|                   |                                                                                                                       |       |     |
| ITEM 5                 | Other Information                                                                                                          |       | 27       |
|                   |                                                                                                                       |       |     |
| ITEM 6                 | Exhibits                                                                                                                   |       | 27       |
|                   |                                                                                                                       |       |     |
| **SIGNATURES**         |                                                                                                                       |       | 28       |
|                   |                                                                                                                       |       |     |
| **INDEX TO  EXHIBITS** |                                                                                                                       |       | 29       |

 

i

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**PART I              FINANCIALINFORMATION**

 

**ITEM 1  Financial Statements**

 

**GRANITE CITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                              | ** ** | **March 25,** | ** ** | **December 25,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| **ASSETS:**                                                                                                                                                                             |       |               |       |                  |       |
| Current assets:                                                                                                                                                                         |       |               |       |                  |       |
| Cash and cash equivalents                                                                                                                                                               |       | $                  | 2,463,707  |                  | $          | 7,076,835 |   |
| Inventory                                                                                                                                                                               |       | 971,965            |       | 827,370               |       |
| Prepaids and  other                                                                                                                                                                     |       | 465,403            |       | 519,505               |       |
| Total current  assets                                                                                                                                                                   |       | 3,901,075          |       | 8,423,710             |       |
|                                                                                                                                                                                    |       |               |       |                  |       |
| Prepaid rent,  net of current portion                                                                                                                                                   |       | 500,038            |       | 514,503               |       |
| Property and  equipment, net                                                                                                                                                            |       | 76,846,010         |       | 72,410,886            |       |
| Intangible and  other assets                                                                                                                                                            |       | 1,071,354          |       | 1,061,691             |       |
| Total assets                                                                                                                                                                            |       | $                  | 82,318,477 |                  | $          | 82,410,790 |   |
|                                                                                                                                                                                    |       |               |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY:**                                                                                                                                         |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                                   |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                        |       | $                  | 2,744,883  |                  | $          | 3,628,444 |   |
| Accrued expenses                                                                                                                                                                        |       | 6,074,447          |       | 6,473,894             |       |
| Deferred rent,  current portion                                                                                                                                                         |       | 176,909            |       | 195,707               |       |
| Long-term debt,  current portion                                                                                                                                                        |       | 292,274            |       | 284,620               |       |
| Capital lease  obligations, current portion                                                                                                                                             |       | 1,615,540          |       | 1,509,342             |       |
| Total current  liabilities                                                                                                                                                              |       | 10,904,053         |       | 12,092,007            |       |
|                                                                                                                                                                                    |       |               |       |                  |       |
| Deferred rent,  net of current portion                                                                                                                                                  |       | 2,278,509          |       | 2,189,278             |       |
| Long-term debt,  net of current portion                                                                                                                                                 |       | 1,657,880          |       | 1,732,416             |       |
| Capital lease  obligations, net of current portion                                                                                                                                      |       | 53,952,049         |       | 48,719,728            |       |
| Total  liabilities                                                                                                                                                                      |       | 68,792,491         |       | 64,733,429            |       |
|                                                                                                                                                                                    |       |               |       |                  |       |
| Commitments and  contingencies                                                                                                                                                          |       |               |       |                  |       |
| Shareholders’  equity:                                                                                                                                                             |       |               |       |                  |       |
| Common stock,  $0.01 par value, 90,000,000 shares authorized; 16,197,849 and 16,158,945  shares issued and outstanding at March 25, 2008 and December 25, 2007,  respectively |       | 161,978            |       | 161,589               |       |
| Additional  paid-in capital                                                                                                                                                             |       | 43,419,431         |       | 43,264,493            |       |
| Accumulated  deficit                                                                                                                                                                    |       | (30,055,423        | )          | (25,748,721           | )          |
| Total  shareholders’ equity                                                                                                                                                        |       | 13,525,986         |       | 17,677,361            |       |
|                                                                                                                                                                                    |       |               |       |                  |       |
| Total  liabilities and shareholders’ equity                                                                                                                                        |       | $                  | 82,318,477 |                  | $          | 82,410,790 |   |

 

See notes to condensed consolidated financialstatements.

 

1

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**GRANITE CITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                  | ** ** | **Thirteen Weeks Ended** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| ** **                                  | ** ** | **March 25,**                 | ** ** | **March 27,** | ** ** |
| ** **                                  | ** ** | **2008**                           | ** ** | **2007** | ** ** |
|                                        |       |                               |       |   |   |
| Restaurant  revenues                        |       | $                                  | 24,019,485 |   | $ | 18,182,192 |   |
|                                        |       |                               |       |   |   |
| Cost of sales:                              |       |                               |       |   |   |
| Food, beverage  and retail                  |       | 7,524,068                          |       | 5,394,722 |   |
| Labor                                       |       | 9,352,023                          |       | 6,606,903 |   |
| Direct  restaurant operating                |       | 3,580,036                          |       | 2,442,939 |   |
| Occupancy                                   |       | 1,546,898                          |       | 1,171,544 |   |
| Total cost of  sales                        |       | 22,003,025                         |       | 15,616,108 |   |
|                                        |       |                               |       |   |   |
| Pre-opening                                 |       | 583,373                            |       | 95,841 |   |
| General and  administrative                 |       | 2,704,525                          |       | 1,736,305 |   |
| Depreciation and  amortization              |       | 1,561,646                          |       | 1,120,323 |   |
|                                        |       |                               |       |   |   |
| Operating loss                              |       | (2,833,084                         | )          | (386,385 | ) |
|                                        |       |                               |       |   |   |
| Interest:                                   |       |                               |       |   |   |
| Income                                      |       | 15,208                             |       | 32,476 |   |
| Expense                                     |       | (1,488,826                         | )          | (1,045,565 | ) |
| Net interest  expense                       |       | (1,473,618                         | )          | (1,013,089 | ) |
|                                        |       |                               |       |   |   |
| Net loss                                    |       | $                                  | (4,306,702 | ) | $ | (1,399,474 | ) |
|                                        |       |                               |       |   |   |
| Loss per common  share, basic               |       | $                                  | (0.27      | ) | $ | (0.10 | ) |
|                                        |       |                               |       |   |   |
| Weighted average  shares outstanding, basic |       | 16,182,284                         |       | 13,945,569 |   |

 

See notes to condensedconsolidated financial statements.

 

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**GRANITE CITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Thirteen Weeks Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                                         | ** ** | **March 25,**                 | ** ** | **March 27,** | ** ** |
| ** **                                                                         | ** ** | **2008**                           | ** ** | **2007** | ** ** |
|                                                                               |       |                               |       |   |   |
| Cash flows from  operating activities:                                             |       |                               |       |   |   |
| Net loss                                                                           |       | $                                  | (4,306,702 | ) | $ | (1,399,474 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:       |       |                               |       |   |   |
| Depreciation and  amortization                                                     |       | 1,549,977                          |       | 1,120,323 |   |
| Other  amortization                                                                |       | 11,669                             |       | — |   |
| Stock option  compensation expense                                                 |       | 121,281                            |       | 181,248 |   |
| Loss on disposal  of asset                                                         |       | 35,764                             |       | 54,289 |   |
| Deferred rent                                                                      |       | 70,433                             |       | 68,614 |   |
| Changes in  operating assets and liabilities:                                      |       |                               |       |   |   |
| Inventory                                                                          |       | (144,595                           | )          | 43,928 |   |
| Prepaids and  other                                                                |       | 68,567                             |       | (47,895 | ) |
| Accounts payable                                                                   |       | 270,266                            |       | (237,352 | ) |
| Accrued expenses                                                                   |       | (399,447                           | )          | (1,198,743 | ) |
| Net cash used in  operating activities                                             |       | (2,722,787                         | )          | (1,415,062 | ) |
|                                                                               |       |                               |       |   |   |
| Cash flows from  investing activities:                                             |       |                               |       |   |   |
| Purchase of:                                                                       |       |                               |       |   |   |
| Property and  equipment                                                            |       | (1,221,694                         | )          | (367,617 | ) |
| Intangible and  other assets                                                       |       | (214,782                           | )          | (6,617 | ) |
| Net cash used in  investing activities                                             |       | (1,436,476                         | )          | (374,234 | ) |
|                                                                               |       |                               |       |   |   |
| Cash flows from  financing activities:                                             |       |                               |       |   |   |
| Payments on  capital lease obligations                                             |       | (421,029                           | )          | (6,289,293 | ) |
| Payments on long  term-debt                                                        |       | (66,882                            | )          | (60,035 | ) |
| Net proceeds  from issuance of stock                                               |       | 34,046                             |       | 12,852,678 |   |
| Net cash (used  in) provided by financing activities                               |       | (453,865                           | )          | 6,503,350 |   |
|                                                                               |       |                               |       |   |   |
| Net (decrease)  increase in cash                                                   |       | (4,613,128                         | )          | 4,714,054 |   |
| Cash and cash  equivalents, beginning                                              |       | 7,076,835                          |       | 7,671,750 |   |
| Cash and cash  equivalents, ending                                                 |       | $                                  | 2,463,707  |   | $ | 12,385,804 |   |
|                                                                               |       |                               |       |   |   |
| Supplemental  disclosure of non-cash investing and financing activities:           |       |                               |       |   |   |
| Land, buildings  and equipment acquired under capital lease agreements             |       | $                                  | 5,759,548  |   | $ | — |   |
| Property and  equipment and intangibles purchased and included in accounts payable |       | $                                  | 1,153,827  |   | $ | 203,783 |   |

 

See notes to condensed consolidated financialstatements.

 

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**GRANITE CITY FOOD & BREWERY LTD.**

 

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

Thirteen weeks ended March 25, 2008 and March 27,2007

 

**1.     Summary of significant accounting policies**

 

Background

 

Granite City Food & Brewery Ltd. (the “Company”) develops andoperates Modern American casual dining restaurants known as Granite City Food &Brewery®.   The restaurant theme isupscale casual dining with a wide variety of menu items that are prepared freshdaily, combined with freshly brewed hand-crafted beers finished on-site.  The first Granite City restaurant opened inSt. Cloud, Minnesota in July 1999 and the Company subsequently expanded toother Midwest markets, opening its 25th restaurant on February 12,2008.  The Company also operates a beerproduction facility which is used to provide raw material support to its restaurantsto create consistent quality and operational efficiencies in the production ofits proprietary beer.  In 2007, theCompany was granted a patent by the United States Patent Office for its brewingprocess.

 

TheCompany’s expansion strategy focuses on development of restaurants in marketswhere management believes the Company’s concept will have broad appeal andattractive restaurant-level economics.

 

Principlesof consolidation and presentation

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America and regulations of the Securities and ExchangeCommission.  Accordingly, they do notinclude all the information and footnotes required by U.S. generally acceptedaccounting principles for complete financial statements.  These statements include the accounts andoperations of the Company and its subsidiary corporations under which itsKansas locations are operated.  Fifty-onepercent of the stock of each of the subsidiary corporations is owned by aresident of Kansas and the Company owns the remainder of the stock of eachsubsidiary corporation.  Eachresident-owner of the stock of these entities has entered into a buy-sellagreement with each corporation providing, among other things, that transfer ofthe shares is restricted and that the shareholder must sell his shares to thecorporation upon certain events, including termination of employment (ifemployed by the Company) or any event that disqualifies the resident-owner fromowning the shares under applicable laws and regulations of the state.  The Company has entered into a masteragreement with each separate subsidiary corporation that permits the operationof the restaurants and leases to each corporation the Company’s property andfacilities.  Each corporation pays all ofits operating expenses and obligations, and the Company retains, asconsideration for the operating arrangements and the lease of property andfacilities, all the net profits, as defined, if any, from its operations.  The Company has determined that the foregoingownership structure will cause these separate corporations to be treated asvariable interest entities in which the Company has a controlling financial interestfor the purpose of Financial Accounting Standards Board (FASB) Interpretation46 (R), *Consolidation of Variable Interest Entities. *As such, the corporations areconsolidated with the Company’s financial statements and the Company’sfinancial statements do not reflect a minority ownership in those separatecorporations.  All references to theCompany in these notes to the condensed consolidated financial statementsrelate to the consolidated entity.

 

Inthe opinion of management, all adjustments, consisting of normal recurringadjustments, which are necessary for a fair statement of its financial positionas of March 25, 2008 and the results of operations for the interim periodsended March 25, 2008 and March 27, 2007 have been included.

 

The balance sheet at December 25, 2007, has been derived from theaudited financial statements at that date, but does not include all of theinformation and notes required by generally accepted accounting principles forcomplete financial statements.  Certaininformation and note disclosures normally included in the Company’s

 

4

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annual financialstatements have been condensed or omitted. These condensed financial statements should be read in conjunction withthe financial statements and notes thereto included in the Company’s AnnualReport on Form 10-K for the fiscal year ended December 25, 2007,filed with the Securities and Exchange Commission on March 10, 2008.

 

The results ofoperations for the thirteen weeks ended March 25, 2008 are not necessarily indicative of theresults to be expected for the entire year.

 

Use of estimates

 

The preparation of financial statements in conformity with generallyaccepted accounting principles in the United States of America and regulationsof the Securities and Exchange Commission requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenue and expense during the reportingperiod.  Significant estimates includeestimates related to asset lives, lease accounting and revenuerecognition.  Actual results could differfrom these estimates.

 

Reclassifications

 

Certain minor reclassifications have been made to the financialstatements for the first quarter of 2007 in order for them to conform to thepresentation of the financial statements for the first quarter of 2008.  These reclassifications have no effect on theaccumulated deficit or net loss previously reported.

 

Revenue recognition

 

Revenue is derived from the sale of prepared food and beverage andselect retail items.  Revenue isrecognized at the time of sale and is reported on the Company’s statement of operationsnet of sales taxes collected.  Revenuederived from gift card sales is recognized at the time the gift card isredeemed. Until the redemption of gift cards occurs, the outstanding balanceson such cards are included in accrued expenses in the accompanying consolidatedbalance sheets.  The Company periodicallyrecognizes gift card breakage which represents the portion of its gift cardobligation for which management believes the likelihood of redemption by thecustomer is remote, based upon historical redemption patterns.

 

Cash and cash equivalents

 

The Company considers all highly liquid instruments with originalmaturities of three months or less to be cash equivalents.

 

Stock-based compensation

 

The Company records stock-based compensation in accordance with theprovisions of Financial Accounting Standards Board (FASB) Statement ofFinancial Accounting Standard (SFAS) No. 123 (revised 2004) (“SFAS 123R”),*Share-Based Payment*, and SECStaff Accounting Bulletin No. 107, *Share-BasedPayment*, requiring the measurement and recognition of allshare-based compensation under the fair value method.

 

The fair value of options at date of grant was estimated using theBlack-Scholes option-pricing model with the following assumptions for the firstquarter of 2008 and 2007:

 
| ** **                                | ** ** | **Thirteen Weeks Ended** | ** ** |
|-------------------------------------------|------------|------------------------------------|------------|
| ** **                                | ** ** | **March 25,**                 | ** ** | **March 27,** | ** ** |
| ** **                                | ** ** | **2008**                           | ** ** | **2007** | ** ** |
| Weighted average  risk-free interest rate |       | 4.04%                              |       | 4.46% - 4.78% |   |
| Expected life of  options                 |       | 10 years                           |       | 5 - 10 years |   |
| Expected stock  volatility                |       | 40.53%                             |       | 38.20% - 38.65% |   |
| Expected  dividend yield                  |       | None                               |       | None |   |

 

5

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Earnings (loss) per share

 

Basicnet income (loss) per share is computed based on the weighted average number ofshares of common stock outstanding during the interim period.  Diluted net loss per share is not presentedsince the effect would be anti-dilutive due to the losses.  Calculations of the Company’s net loss percommon share for the quarters ended March 25, 2008 and March 27, 2007are set forth in the following table:

 
| ** **                                  | ** ** | **Thirteen Weeks Ended** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| ** **                                  | ** ** | **March 25, 2008**       | ** ** | **March 27, 2007** | ** ** |
|                                        |       |                               |       |   |   |
| Net loss                                    |       | $                                  | (4,306,702 | ) | $ | (1,399,474 | ) |
| Loss per common  share, basic               |       | $                                  | (0.27      | ) | $ | (0.10 | ) |
| Weighted average  shares outstanding, basic |       | 16,182,284                         |       | 13,945,569 |   |

 

Recentaccounting pronouncements

 

In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”),which defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements.  SFAS No. 157 became effective forfinancial statements issued for the Company’s fiscal year 2008, subject to aone-year delay for nonfinancial assets. In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets andFinancial Liabilities—Including an amendment of FASB Statement No. 115*(“SFAS 159”),which will permit the option of choosing to measure certain eligible items atfair value at specified election dates and report unrealized gains and lossesin earnings, providing SFAS 157 is also adopted.  The adoption of SFAS 157 andSFAS 159 have not had, nor do we expect them to have, a material impact onthe Company’s consolidated financial statements.

 

**2.****             ****Fair value of financialinstruments**

 

At March 25, 2008 and December 25, 2007, the fair value ofcash and accounts payable approximate their carrying value due to theshort-term nature of the instruments. The fair value of the capital lease obligations and long-term debt isestimated at its carrying value based upon current rates available to the Company.

 

**3.****             ****Non-current assets**

 

Property and equipment

 

Property and equipment are recorded at cost and depreciated over theestimated useful lives of the related assets. The cost of leasehold improvements is depreciated over the initial termof the related lease.  Depreciation iscomputed on the straight-line method for financial reporting purposes andaccelerated methods for income tax purposes. Amortization of assets acquired under capital lease is included indepreciation expense.  The following is asummary of the Company’s property and equipment at March 25, 2008 and December 25,2007:

 
| ** **                     | ** ** | **March 25, 2008** | ** ** | **December 25, 2007** | ** ** |
|--------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Land                           |       | $                            | 18,000     |                            | $          | 18,000 |   |
| Buildings                      |       | 53,187,796                   |       | 46,238,741                      |       |
| Leasehold  improvements        |       | 8,759,493                    |       | 8,516,291                       |       |
| Equipment and  furniture       |       | 30,247,985                   |       | 26,133,376                      |       |
| Construction in  progress*     |       | 204,776                      |       | 5,540,980                       |       |
|                           |       | 92,418,050                   |       | 86,447,388                      |       |
| Less accumulated  depreciation |       | (15,572,040                  | )          | (14,036,502                     | )          |
|                           |       | $                            | 76,846,010 |                            | $          | 72,410,886 |   |

 

6

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*Construction inprogress includes the following approximate amounts for items yet to be placedin service:

 
| ** **                                  | ** ** | **March 25, 2008** | ** ** | **December 25, 2007** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Architecture  fees for future locations     |       | $                            | 155,000    |                            | $          | 240,000 |   |
| Building and  equipment at future locations |       | 50,000                       |       | 5,300,000                       |       |
|                                             |            |                              |            |                                 |            |  |  |

 

Intangible and other assets

Intangible and other assets consisted of the following:

 
| ** **                     | ** ** | **March 25, 2008** | ** ** | **December 25, 2007** | ** ** |
|--------------------------------|------------|------------------------------|------------|---------------------------------|------------|
|                           |       |                         |       |                            |       |
| Liquor licenses                |       | $                            | 331,415    |                            | $          | 331,415 |   |
| Trademarks                     |       | 138,021                      |       | 137,601                         |       |
|                           |       |                         |       |                            |       |
| Capitalized loan  costs        |       | 218,355                      |       | 199,912                         |       |
| Security  deposits             |       | 527,372                      |       | 524,903                         |       |
|                           |       | 1,215,163                    |       | 1,193,831                       |       |
| Less accumulated  amortization |       | (143,809                     | )          | (132,140                        | )          |
|                           |       | $                            | 1,071,354  |                            | $          | 1,061,691 |   |

 

**4.        Accrued expenses**

 

Accrued expenses consisted of the following:

 
| ** **                        | ** ** | **March 25, 2008** | ** ** | **December 25, 2007** | ** ** |
|-----------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Payroll related                   |       | $                            | 2,206,387  |                            | $          | 2,472,513 |   |
| Deferred revenue  from gift cards |       | 1,479,512                    |       | 2,103,294                       |       |
| Sales taxes                       |       | 827,438                      |       | 692,758                         |       |
| Interest                          |       | 449,539                      |       | 399,387                         |       |
| Real estate  taxes                |       | 343,421                      |       | 212,950                         |       |
| Insurance                         |       | 123,761                      |       | —                          |       |
| Other                             |       | 644,389                      |       | 592,992                         |       |
|                              |       | $                            | 6,074,447  |                            | $          | 6,473,894 |   |

 

**5.        Deferred rent payable**

 

The Company leases most of its restaurant properties.  Leases are accounted for under the provisionsof SFAS No. 13 and SFAS No. 98, *Accountingfor Leases,* as well as other subsequent amendments and authoritativeliterature including FASB Staff Position No. FAS 13-1, *Accounting for Rental Costs Incurred During aConstruction Period.*  Forleases that contain rent escalation clauses, the Company records the total rentpayable during the lease term and recognizes expense on a straight-line basisover the initial lease term, including the “build-out” or “rent-holiday” periodwhere no rent payments are typically due under the terms of the lease.  Any difference between minimum rent andstraight-line rent is recorded as deferred rent payable.  Additionally, pursuant to Emerging IssuesTask Force No. 98-09, *Accounting forContingent Rent*, contingent rent expense based on a percentage ofrevenue is accrued and recorded to the extent it is expected to exceed minimumbase rent per the lease agreement, based on estimates of probable levels ofrevenue during the contingency period. Deferred rent payable also includes a tenant improvement allowance theCompany received, which is being amortized as a reduction of rent expense on astraight-line basis over the initial term of the lease.

 

7

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Deferred rent payable consists of the following:

 
| ** **                                              | ** ** | **March 25, 2008** | ** ** | **December 25, 2007** | ** ** |
|---------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Difference  between minimum rent and straight-line rent |       | $                            | 2,058,452  |                            | $          | 1,961,283 |   |
| Contingent rent  expected to exceed minimum rent        |       | 45,577                       |       | 64,813                          |       |
| Tenant  improvement allowance                           |       | 351,389                      |       | 358,889                         |       |
|                                                    |       | $                            | 2,455,418  |                            | $          | 2,384,985 |   |

 

**6.        Long-term debt**

 

As of the end of the first quarter of fiscal year 2008, the Company hadtwo outstanding long-term loans with an independent financial institution theproceeds of which it used to purchase equipment for its restaurants in DesMoines and Davenport, IA.  These loansare secured only by the personal property and fixtures at the respectivelocations.  In addition to these two loanagreements, the Company has a long-term loan outstanding with the sameindependent financial institution secured by the tangible personal property andfixtures at the Fargo, ND restaurant. Such loan is guaranteed by Steven J. Wagenheim, the Company’s president,chief executive officer and one of its directors.  As of March 25, 2008 and December 25,2007, the balances, interest rates and maturity dates of these loans were:

 
| ** **            | ** ** | **March 25, 2008** | ** ** | **December 25, 2007** | ** ** |
|-----------------------|------------|------------------------------|------------|---------------------------------|------------|
| Des Moines            |       |                         |       |                            |       |
| Loan balance          |       | $                            | 316,805    |                            | $          | 345,295 |   |
| Annual interest  rate |       | 10.25                        | %          | 10.25                           | %          |
| Maturity date         |       | August 27, 2010         |       | August 27, 2010            |       |
| Davenport             |       |                         |       |                            |       |
| Loan balance          |       | $                            | 356,581    |                            | $          | 383,330 |   |
| Annual interest  rate |       | 10.25                        | %          | 10.25                           | %          |
| Maturity date         |       | January 6, 2011         |       | January 6, 2011            |       |
| Fargo                 |       |                         |       |                            |       |
| Loan balance          |       | $                            | 1,276,768  |                            | $          | 1,288,411 |   |
| Annual interest  rate |       | 8.75                         | %          | 8.75                            | %          |
| Maturity date         |       | August 15, 2011         |       | August 15, 2011            |       |

 

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

 
| ** **            | ** ** | **Long-term** | ** ** |
|-----------------------|------------|---------------|------------|
| **Year ending:** | ** ** | **Debt**      | ** ** |
| 2008                  |       | $             | 217,660    |   |
| 2009                  |       | 309,913       |       |
| 2010                  |       | 290,551       |       |
| 2011                  |       | 1,132,030     |       |
|                  |       | $             | 1,950,154  |   |

 

**7.        Capital leases**

 

Asof March 25, 2008, the Company had 23 capital lease agreements related toits restaurant properties, 21 of which originated with its developer.  The land portion of these leases isclassified as an operating lease while the building portion of these leases isclassified as a capital lease because its present value was greater than 90% ofthe estimated fair value at the beginning of the lease and/or the lease termrepresents 75% or more of the expected life of the property.  The Company also has a land and buildinglease agreement for its beer production facility.

 

8

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Thisten-year lease allows the Company to purchase the facility at any time for$1.00 plus the unamortized construction costs. Because the construction costs will be fully amortized through paymentof rent during the base term, if the option is exercised at or after the end ofthe initial ten-year period, the option price will be $1.00.  As such, the lease is classified as a capitallease.  For information regarding leasesentered into subsequent to March 25, 2008, see Note 12.

 

Asof March 25, 2008, the Company had capital lease agreements that it usedto finance the equipment at nine of its restaurants.  These leases are classified as capital leasesas a bargain purchase option exists on each lease.

 

Includedin property and equipment are the following assets held under capital leases:

 
| ** **                            | ** ** | **March 25, 2008** | ** ** | **December 25, 2007** | ** ** |
|---------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Land                                  |       | $                            | 18,000     |                            | $          | 18,000 |   |
| Building                              |       | 50,988,741                   |       | 33,851,945                      |       |
| Equipment and  leasehold improvements |       | 8,253,622                    |       | 7,807,724                       |       |
|                                  |       | 59,260,363                   |       | 41,677,669                      |       |
|                                  |       |                         |       |                            |       |
| Less accumulated  depreciation        |       | (6,296,576                   | )          | (3,718,654                      | )          |
|                                  |       | $                            | 52,963,787 |                            | $          | 37,959,015 |   |

 

Minimum futurelease payments under all capital leases as of March 25, 2008 are:

 
| ** **                                   | ** ** | **Capital** | ** ** |
|----------------------------------------------|------------|-------------|------------|
| **Year ending:**                        | ** ** | **Leases**  | ** ** |
| 2008                                         |       | $           | 11,348,584 |   |
| 2009                                         |       | 8,522,983   |       |
| 2010                                         |       | 8,780,453   |       |
| 2011                                         |       | 7,564,134   |       |
| 2012                                         |       | 9,884,709   |       |
| Thereafter                                   |       | 89,882,088  |       |
| Total minimum  lease payments                |       | 135,982,951 |       |
|                                         |       |        |       |
| Less amount  representing interest           |       | (70,942,420 | )          |
| Present value of  net minimum lease payments |       | 65,040,531  |       |
| Less current  portion                        |       | (1,615,540  | )          |
| Long-term  portion of obligations            |       | $           | 63,424,991 |   |

 

The foregoingtable considers additional lease commitments commencing after March 25,2008.  Amortization expense related tothe assets held under capital leases is included with depreciation expense onthe Company’s statements of operations.

 

**8.        Commitments andcontingencies**

 

TheCompany will need to expend additional capital in connection with its long-termexpansion plans.  Based on the Company’s April 21, 2008 cash position of $5.3 million,and the December 2007 $16.0 million DHW Equipment LeaseCommitment (see below), of which approximately $8.0 million leasefinancing remained available as of April 21, 2008, as well as cashgenerated from operations, management believes that the Company will havesufficient funds to complete planned restaurant openings into 2010 and maintainsufficient working capital for operations. However, the Company may require further funding to open additionalrestaurants

 

9

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dependingupon the number of planned openings, cost of capital, availability of developerfinancing or landlord tenant improvement funding, adverse sales trends, and theCompany’s ability to generate positive cash flow.  If sources of liquidity are insufficient tofund expected capital needs, or the Company’s needs are greater thananticipated, the Company will be required to raise additional funds in thefuture through the incurrence of indebtedness or public or private sales ofequity securities.  As of March 25,2008, management continued to pursue debt financing alternatives in order tosolidify the Company’s expansion plans.

 

Equipmentleases

 

Between March 27, 2008 and April 21, 2008, DHW Leasing,L.L.C. (“DHW”) purchased and leased to the Company equipment at four of itsrestaurants under the terms and conditions of the Equipment Lease Commitmentthe Company entered into with DHW in December 2007.  The value of the equipment financed at eachrestaurant is approximately $1.0 million. The annual interest rate on one five-year lease is 10.65%.  The Company will pay 10.3% annual interest onthe other three leases for 12 months, at which time the interest rate will belocked in at the then 5-year Treasury bill rate plus 8.3%.  The Company has the option to purchase theleased equipment for $1.00 upon payment in full of all rent payments due undereach lease.  While Mr. Wagenheimowns a 20% membership interest in DHW and has agreed to personally guarantee20% of DHW’s indebtedness to its lenders, he will not receive a guarantee feeor other payment in connection with this DHW financing.

 

Litigation

 

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

 

**9.****             ****Common stock**

 

Exercise of warrants and options

 

On December 31, 2007, a director of the Company exercised a stockoption for the purchase of 15,000 shares of common stock at an exercise priceof $2.27 per share.  These options wereissued pursuant to the 1997 Director Stock Option Plan and had an expirationdate of January 1, 2008.

 

On January 31, 2008, the Company issued 10,153 shares of commonstock upon the cashless exercise of a warrant for the purchase of 23,996 sharesof common stock originally issued March 20, 2003 to one of the agents forits private placement of Series A Convertible Preferred Stock andwarrants.  The foregoing warrant had anexercise price of $1.58 per share and an expiration date of March 20,2008.

 

On March 5, 2008, the Company issued 7,070 shares of common stockupon the cashless exercise of a warrant for the purchase of 23,996 shares ofcommon stock originally issued March 20, 2003 to one of the agents for itsprivate placement of Series A Convertible Preferred Stock andwarrants.  The foregoing warrant had anexercise price of $1.58 per share and an expiration date of March 20,2008.

 

On March 7, 2008, the Company issued 6,681 shares of common stockupon the cashless exercise of a warrant for the purchase of 25,842 shares ofcommon stock originally issued March 20, 2003 to one of the agents for itsprivate placement of Series A Convertible Preferred Stock andwarrants.  The foregoing warrant had anexercise price of $1.58 per share and an expiration date of March 20,2008.

 

10

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

 

In July 1997,the Company adopted the 1997 Stock Option Plan for employees and non-employees,including consultants to the Company, to purchase the Company’s common stock atan exercise price that equals or exceeds the fair market value on the date ofgrant.   As of March 25, 2008,options to purchase 316,500 shares of common stock were outstanding under theplan, which expired July 28, 2007. All options outstanding under this plan are fully vested and areexercisable for ten years from the date of grant.

 

As of March 25,2008, options to purchase 300,000 shares of common stock were outstanding underthe 1997 Director Stock Option Plan (“DSOP”), which expired July 29,2007.  Under this plan, the Companyautomatically granted an option to each outside director on the date suchperson became a director for the purchase of 15,000 shares of common stock andthereafter on each successive anniversary of the grant of the first option for the purchase of 15,000shares.  On May 2, 2007, the Company’sboard of directors agreed that until the adoption of any future equity plan fornon-employee directors, awards of stock options for the purchase of 15,000shares of common stock per year should continue to be made to each non-employeedirector on the anniversary of his election to the Board under the 2002 EquityIncentive Plan.  The board further resolved that such awards are to havethe same terms and conditions as those made under the DSOP; provided, however,that they are to be exercisable for a period of ten years rather than fiveyears.

 

In August 2002,the Company adopted the 2002 Equity Incentive Plan for employees, prospectiveemployees, officers and members of the Company’s board of directors, as well asconsultants and advisors to the Company, to purchase shares of the Company’scommon stock at an exercise price that equals or exceeds the fair market valueon the date of grant.  The number ofshares authorized for issuance as of March 25, 2008 was 2,649,743, ofwhich 1,113,743 shares remained available for future issuance and options topurchase 1,460,300 shares were outstanding. Although vesting schedules may vary, option grants under this plangenerally vest evenly over a three or four-year period and options areexercisable for no more than ten years from the date of grant.

 

A summary of the status of the Company’s stock options as of March 25, 2008 is presentedbelow:

 
| ** **                                                  | ** ** | ** ** | ** ** | ** **              | ** ** | **Weighted**              | ** ** | ** **    | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-------------------------|------------|---------------------------|------------|---------------|------------|
| ** **                                                  | ** ** | ** ** | ** ** | **Weighted**            | ** ** | **Average**               | ** ** | **Aggregate** | ** ** |
| ** **                                                  | ** ** | ** ** | ** ** | **Average**             | ** ** | **Remaining**             | ** ** | **Intrinsic** | ** ** |
| **Fixed Options**                                      | ** ** | **Shares** | ** ** | **Exercise Price** | ** ** | **Contractual Life** | ** ** | **Value**     | ** ** |
| Outstanding at  December 26, 2006                      |       | 1,595,000  |       | $                       | 3.70       |                      | 6.1 years  |          |       |   |
| Granted                                                     |       | 824,000    |       | $                       | 4.82       |                      | 7.3 years  |          |       |   |
| Exercised                                                   |       | (36,200    | )          | $                       | 1.52       |                      |       |          |       |   |
| Forfeited                                                   |       | (110,000   | )          | $                       | 4.63       |                      |       |          |       |   |
| Outstanding at  December 25, 2007                      |       | 2,272,800  |       | $                       | 4.10       |                      | 6.7 years  |          |       |   |
|                                                        |       |       |       |                    |       |                      |       |          |       |
| Granted                                                     |       | 15,000     |       | $                       | 2.66       |                      | 9.8 years  |          |       |   |
| Exercised                                                   |       | (15,000    | )          | $                       | 2.27       |                      |       |          |       |   |
| Forfeited                                                   |       | (150,000   | )          | $                       | 4.19       |                      |       |          |       |   |
| Outstanding at  March 25, 2008                         |       | 2,122,800  |       | $                       | 4.09       |                      | 5.6 years  |          | $          | 47,775 |   |
|                                                        |       |       |       |                    |       |                      |       |          |       |
| Options  exercisable at December 25, 2007              |       | 1,507,304  |       | $                       | 3.71       |                      | 5.7 years  |          |       |   |
| Options  exercisable at March 25, 2008                 |       | 1,450,802  |       | $                       | 3.74       |                      | 4.8 years  |          | $          | 47,775 |   |
|                                                        |       |       |       |                    |       |                      |       |          |       |
| Weighted-average  fair value of options granted during 2008 |       | $          | 1.55       |                    |       |                      |       |          |       |   |
|                                                             |            |            |            |                         |            |                           |            |               |            |  |  |  |

 

11

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The aggregate intrinsic value in the table above represents the totalpretax intrinsic value (the difference between the closing price of the Company’sstock on March 25, 2008 and the exercise price, multiplied by the numberof in-the-money options) that would have been received by the option holdershad all option holders exercised their options on March 25, 2008.  As of March 25, 2008, there wasapproximately $716,487 of total unrecognized compensation cost related tounvested share-based compensation arrangements, of which $363,844 is expectedto be recognized during the remainder of fiscal year 2008, $292,859 in fiscalyear 2009, $51,617 in fiscal year 2010 and $8,167 in fiscal year 2011.

 

The following table summarizes information about stock optionsoutstanding at March 25, 2008:

 
| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **Number of**           | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Options**                  | ** ** | **Average**                  | ** ** | **Weighted** | ** ** | **Options** | ** ** | **Weighted** | ** ** |
| **Range of**        | ** ** | **Outstanding**              | ** ** | **Remaining**                | ** ** | **Average** | ** ** | **Exercisable** | ** ** | **Average** | ** ** |
| **Exercise Prices** | ** ** | **3/25/2008**                | ** ** | **Contractual Life**    | ** ** | **Exercise Price** | ** ** | **3/25/2008** | ** ** | **Exercise Price** | ** ** |
|                     |       |                         |       |                         |       |   |   |   |   |   |   |
| $1.00 - $2.00            |       | 122,500                      |       | 3.8 years                    |       | $ | 1.65 |   | 122,500 |   | $ | 1.65 |   |
| $2.01 - $3.00            |       | 201,000                      |       | 4.9 years                    |       | $ | 2.48 |   | 165,000 |   | $ | 2.42 |   |
| $3.01 - $4.00            |       | 713,000                      |       | 5.2 years                    |       | $ | 3.77 |   | 596,002 |   | $ | 3.82 |   |
| $4.01 - $5.00            |       | 607,300                      |       | 6.7 years                    |       | $ | 4.37 |   | 492,300 |   | $ | 4.40 |   |
| $5.01 - $6.00            |       | 329,000                      |       | 4.0 years                    |       | $ | 5.21 |   | 75,000 |   | $ | 5.13 |   |
| $6.01 - $7.00            |       | 150,000                      |       | 9.1 years                    |       | $ | 6.20 |   | — |   | $ | — |   |
|                     |       |                         |       |                         |       |   |   |   |   |   |   |
| Total                    |       | 2,122,800                    |       | 5.6 years                    |       | $ | 4.09 |   | 1,450,802 |   | $ | 3.74 |   |

 

**11.  Common stock warrants**

 

In November 2002, the Company completed a private placement of Series AConvertible Preferred Stock and warrants to purchase common stock.  As part of the agreement between the Companyand its private placement agents, the agents received five-year warrants topurchase an aggregate of 288,604 shares of common stock at an exercise price of$1.58 per share. During the first quarter of fiscal year 2008, the Companyissued an aggregate of 23,904 shares of common stock upon the cashless exerciseof such warrants for the purchase of an aggregate of 73,834 shares of commonstock.  No such agent warrants relatingto this private placement remain outstanding.

 

In May 2003, the Company entered into a two-year financialadvisory services agreement. As part of the agreement between the Company andthe financial consultant, the consultant received five-year warrants topurchase an aggregate of 35,000 shares of common stock at exercise pricesranging from $2.85 to $5.40 per share. As of March 25, 2008, none of such warrants had been exercised.

 

In September 2004, the Company entered into a securities purchaseagreement with certain accredited investors for the sale of approximately $8.5million of common stock and warrants. Under this agreement, the Company issued five-year warrants for thepurchase of 1,045,844 shares of common stock at an exercise price of $5.00 per share.  The Company may call for the mandatoryexercise of such warrants if certain conditions are 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 $5.00per share.  As of March 25, 2008,none of such warrants had been exercised.

 

In October 2005, the Company entered into a securities purchaseagreement with certain accredited investors for the sale of approximately $5.34million of common stock and warrants. Under this agreement, the Company issued five-year warrants for thepurchase of 221,762 shares of common stock at an exercise price of $6.50 pershare to such investors and five-year warrants for the purchase of 55,436shares of common stock at an exercise 

 

12

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price of $6.50 to the Company’s placement agent. As of March 25,2008, none of such warrants had been exercised.

 

During the first quarter of fiscal year 2008, no warrants were issuedand no warrants expired unexercised.  Asof March 25, 2008, warrants for the purchase of 1,485,165 shares wereoutstanding and exercisable.  Theweighted average exercise price of such warrants was $5.25 per share.

 

**12.  Subsequent Events**

 

SouthBend and Indianapolis, Indiana lease agreements

 

In March and April 2008, the Company entered into 20-year netlease agreements relating to restaurants its anticipates opening in South Bend,Indiana in the third quarter of 2008 and Indianapolis, Indiana in the fourthquarter of 2008, respectively, under the terms specified in the developmentagreement with Dunham Capital Management L.L.C. (“Dunham”) for the developmentof restaurants.  The restaurants will beconstructed for the Company on a build-to-suit basis.  Basic terms of the leases include annual rentequal to 10.5% of the construction cost plus the land lease and contingent rentbased on a percentage of revenue.  Thebase rent will escalate 10% at the end of each five-year period.  The term of each lease will commence whenoperations begin and the Company will be responsible for any real-estate taxesand all operating costs.  Rental costsassociated with the operating lease incurred during the construction period arerecognized as pre-opening costs and escalated rent will be recognized asexpense on a straight-line basis over the term of each lease.

 

Development agreement with United Properties Investment LLC (“UnitedProperties”)

 

In April 2008, the Company entered into a development agreement withUnited Properties for the development of up to 22 restaurants to be builtbetween 2009 and 2012.  As the Company’sdeveloper, United Properties will be responsible for all costs related to theland and building of each restaurant. The annual lease rate for fee-simple land and building developments willbe 9.5% and the Company will have the right of first offer to purchase theserestaurants.  Additionally, in the eventUnited Properties sells one of the buildings that it develops for the Companyat a cap rate agreed to by the parties in the agreement, then the Company willshare in the profits of that sale.  TheCompany assumes no liability in the event United Properties sell a building ata loss.

 

**ITEM 2 Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*This discussion and analysis contains variousnon-historical forward-looking statements within the meaning of Section 21Eof the Exchange Act.  Although we believethat, in making any such statement, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  You are cautioned not to attribute unduecertainty to such forward-looking statements, which are qualified in theirentirety by the cautions and risks described herein.  Please refer to the “Risk Factors” section ofour Annual Report on Form 10-K, filed with the Securities and ExchangeCommission on March 10, 2008, for additional factors known to us that maycause actual results to vary.*

 

**Overview**

 

We are a Modern Americanupscale casual restaurant chain. As of March 25, 2008, we operated 25restaurants in 12 Midwestern states, substantially all of which featureon-premises breweries, operating under the name of Granite City Food &Brewery®.  We believe our menu featureshigh quality yet affordable family favorite menu items prepared frommade-from-scratch recipes and served in generous portions.  We believe that the sophisticated yetunpretentious restaurants, proprietary food and beverage products, attractiveprice points and high service standards combine for a great diningexperience.  The location of eachrestaurant and the month and year of its opening appear in the following chart:

 

13

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| **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       |       | Rogers, Arkansas           |       | Oct-07     |
| 21       |       | East Peoria,  Illinois     |       | Oct-07     |
| 22       |       | Orland Park,  Illinois     |       | Dec-07     |
| 23       |       | St. Louis,  Missouri       |       | Jan-08     |
| 24       |       | Ft. Wayne,  Indiana        |       | Jan-08     |
| 25       |       | Toledo, Ohio               |       | Feb-08     |

 

We operate acentrally-located beer production facility in Ellsworth, Iowa which facilitatesthe initial stage of our brewing process using our patented brewingprocess.  We believe that this brewingprocess improves the economics of microbrewing as it eliminates the initialstages of brewing and storage at multiple locations, thereby reducing equipmentand development costs at new restaurant locations.  Additionally, having a common starting point,the beer production creates consistency of taste for our product from unit tounit.  The initial product produced atour beer production facility is transported by truck to the fermentation vesselsat each of our restaurants where the brewing process is completed. In 2007, wewere granted a patent by the United States Patent Office for this brewingprocess.  We believe that our currentbeer production facility, which opened in June 2005, has the capacity toservice up to 35 restaurant locations.

 

We operate Granite City University, where ourmanagers are trained under the instruction of full-time, dedicatedtrainers.  Our seven to fourteen-weektraining program consists of both “hands on” as well as classroom training forall aspects of management.  All salariesof our managers in training and our trainers as well as all related costsincurred at Granite City University are recorded as a component of our generaland administrative costs.

 

We utilize a new store opening team whichconsists of experienced restaurant managers who are dedicated to the opening ofour new restaurants.  This team generallyarrives at a new restaurant site two to three months in advance of therestaurant opening date and coordinates all staffing and training matters forthat new restaurant.  However, due toopening six restaurants in a period of approximately 120 days, the team was notable

 

14

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totrain at each location for our typical two to three-month time period inconnection with our most recent openings. We believe that a dedicated team delivers a more disciplined openingprocess and ensures adherence to our company’s exacting standards and culture.

 

We have developed our restaurants usingproceeds from the sale of our securities, building and equipment financing andcash flow from operations.  We builtunits 4-9, 11-14 and 16-25 based upon the prototype we developed in early 2003.  In 2004 and 2005, we retrofitted units 1-3 toconform to this prototype model. In 2005 and 2006, we developed units 10 and15, respectively, which were conversions of existing restaurants.  With the exception of units 1-3 and 15, wedeveloped all of our units under our multi-site development agreement with acommercial developer that provides us with assistance in site selection,construction management and financing for new restaurants.  Under the development agreement, we lease theland and building of each new restaurant from the developer.

 

In April 2008, we enteredinto a development agreement with United Properties Investment LLC (“UnitedProperties”) for the development of up to 22 restaurants to be built between2009 and 2012.  As our developer, UnitedProperties will be responsible for all costs related to the land and buildingof each restaurant.  The developmentagreement provides for a cooperative process between United Properties and ourmanagement for the selection of restaurant sites and the development ofrestaurants on those sites, scheduling for the development and construction ofeach restaurant once a location is approved. We will lease each restaurant developed under this agreement from UnitedProperties.

 

We believe that ouroperating results will fluctuate significantly because of several factors,including the timing of new restaurant openings and related expenses,profitability of new restaurants, changes in food and labor costs, increases ordecreases in comparable restaurant sales, general economic conditions, consumerconfidence in the economy, changes in consumer preferences, competitivefactors, the skill and experience of our restaurant-level management teams andweather conditions.

 

We expect the timing of newrestaurant openings to have a significant impact on restaurant revenues andcosts.  We believe we will incur the mostsignificant portion of pre-opening costs associated with a new restaurantwithin the two months immediately preceding, and the month of, the opening ofsuch restaurant.

 

The thirteen weeks ended March 25, 2008and March 27, 2007 included 310 and 234 restaurant weeks, respectively,which is the sum of the actual number of weeks each restaurant operated. Thesource of the additional restaurant weeks in the first quarter of fiscal year2008 is shown in the following chart:

 
| ** **                        | ** ** | **Thirteen Weeks  Ended** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|
| **Location**                      | ** ** | **March 25, 2008**   | ** ** |
| Rockford, Illinois                |       | 13                             |       |
| Rogers, Arkansas                  |       | 13                             |       |
| East Peoria, Illinois             |       | 13                             |       |
| Orland Park, Illinois             |       | 13                             |       |
| St. Louis, Missouri               |       | 10                             |       |
| Ft. Wayne, Indiana                |       | 8                              |       |
| Toledo, Ohio                      |       | 6                              |       |
| Total Additional Restaurant Weeks |       | 76                             |       |

 

Because we continue to expand our operationsand open new restaurants at various times throughout the year, we provide thisstatistical measure to enhance the comparison of revenues from period to periodas changes occur in the number of units we are operating.

 

15

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Our restaurant revenue is comprised almostentirely of the sales of food and beverages. The sale of retail items typically represents less than one percent oftotal revenue.  Product costs include thecosts of food, beverages and retail items. Labor costs include direct hourly and management wages, taxes andbenefits for restaurant employees. Direct and occupancy costs include restaurant supplies, marketing costs,rent, utilities, real estate taxes, repairs and maintenance and other relatedcosts.  Pre-opening costs consist ofdirect costs related to hiring and training the initial restaurant workforce,the salaries and related costs of our dedicated new store opening team, rentexpense incurred during the construction period and other direct costsassociated with opening new restaurants. General and administrative expenses are comprised of expenses associatedwith all corporate and administrative functions that support existingoperations, which include management and staff salaries, employee benefits,travel, information systems, training, market research, professional fees,supplies and corporate rent.  Depreciationand amortization includes depreciation on capital expenditures at therestaurant and corporate levels and amortization of intangibles that do nothave indefinite lives.  Interest expenserepresents the cost of interest expense on debt and capital leases net ofinterest income on invested assets.

 

**Results of operations as a percentage of sales**

 

Thefollowing table sets forth results of our operations expressed as a percentageof sales for the thirteen weeks ended March 25, 2008 and March 27,2007.

 
| ** **                     | ** ** | **Thirteen Weeks Ended** | ** ** |
|--------------------------------|------------|------------------------------------|------------|
| ** **                     | ** ** | **March 25,**                 | ** ** | **March 27,** | ** ** |
| ** **                     | ** ** | **2008**                           | ** ** | **2007** | ** ** |
|                           |       |                               |       |   |   |
| Restaurant  revenues           |       | 100.0                              | %          | 100.0 | % |
|                           |       |                               |       |   |   |
| Cost of sales:                 |       |                               |       |   |   |
| Food, beverage  and retail     |       | 31.3                               |       | 29.7 |   |
| Labor                          |       | 38.9                               |       | 36.3 |   |
| Direct  restaurant operating   |       | 14.9                               |       | 13.4 |   |
| Occupancy                      |       | 6.4                                |       | 6.4 |   |
| Total cost of  sales           |       | 91.6                               |       | 85.9 |   |
|                           |       |                               |       |   |   |
| Pre-opening                    |       | 2.4                                |       | 0.5 |   |
| General and  administrative    |       | 11.3                               |       | 9.5 |   |
| Depreciation and  amortization |       | 6.5                                |       | 6.2 |   |
|                           |       |                               |       |   |   |
| Operating loss                 |       | (11.8                              | )          | (2.1 | ) |
|                           |       |                               |       |   |   |
| Interest:                      |       |                               |       |   |   |
| Income                         |       | 0.1                                |       | 0.2 |   |
| Expense                        |       | (6.2                               | )          | (5.8 | ) |
| Net interest  expense          |       | (6.1                               | )          | (5.6 | ) |
|                           |       |                               |       |   |   |
| Net loss                       |       | (17.9                              | )%         | (7.7 | )% |

 

Certain percentage amounts do not sum due to rounding.

 

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**Critical Accounting Policies**

 

Ourcritical accounting policies are those that require significant judgment.  There have been no material changes to thecritical accounting policies previously reported in our 2007 Annual Report on Form 10-Kfiled with the Securities and Exchange Commission on March 10, 2008.

 

**Results of operations for the thirteen weeks ended March 25,2008 and March 27, 2007**

 

**Revenue**

 

We generated $24,019,485 and $18,182,192 ofrevenue during the first quarters of fiscal years 2008 and 2007,respectively.  The increase in the firstquarter revenue of 32.1% was primarily the result of the additional restaurantoperating weeks related to the seven restaurants that opened in late 2007 andearly 2008.  The first quarter of 2008included 310 restaurant operating weeks while the first quarter of 2007included 234 operating weeks.  Averageweekly revenue decreased from $77,702 per week in 2007 to $77,482 per week in2008 for all the restaurants in operation during the quarter.  Comparable restaurant revenue, which includesrestaurants in operation over 18 months, increased 1.8% from the firstquarter of 2007 to the first quarter of 2008 primarily due to a 4.0% priceincrease that took effect in October 2007 and another 4.0% price increasethat took effect in March 2008, offset by a decrease in guesttraffic.  Average weekly revenue percomparable restaurant increased $1,402 from $78,213 in the first quarter of2007 to $79,615 in the first quarter of 2008.

 

We expect that restaurantrevenue will vary from quarter to quarter. We anticipate continued seasonal fluctuations in restaurant revenue duein part to increased outdoor seating and generally favorable weather conditionsat many of our locations during the summer months.  Due to the honeymoon effect that periodicallyoccurs with the opening of a restaurant, we expect the timing of new restaurantopenings to cause fluctuations in restaurant revenue.  Additionally, consumer confidence in theeconomy and changes in consumer preferences may affect our future revenue.  We believe that decreased consumer confidencenegatively impacted the restaurant industry as a whole during the first quarterof 2008.

 

**Restaurant costs**

 

***Foodand beverage***

** **

Our food and beveragecosts, as a percentage of revenue, increased 1.6% to 31.3% in the first quarterof 2008 from 29.7% in the first quarter of 2007.  The increase was primarily due to newstore-openings and the increase in the cost of dairy, chicken, fish, bread,general groceries and beer.  In order tooffset these increases in commodity costs, we have taken steps to increase ouroversight of inventory and kitchen management. Additionally, we believe the price increase of approximately 4.0% whichbecame effective in March 2008 will help to address such commodity priceincreases.  We will continue to monitorour prices in an effort to address future commodity price increases.

 

Weexpect that our food and beverage costs will vary going forward due to numerousvariables, including seasonal changes in food and beverage costs, and guestpreferences.  We periodically create newmenu 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.  However, as we open additional restaurants,we believe we will experience increased purchasing power company-wide,partially offsetting food and beverage cost increases, thereby enabling us tomaintain or reduce our food and beverage costs as a percentage of revenue.  Additionally, as we add new restaurants, 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***

 

Labor expense consists of restaurant management salaries, hourly staffpayroll costs, other payroll-related items including partner and managementbonuses, and non-cash stock-based compensation expense.  Our experience to date has been that staff laborcosts associated with a newly opened restaurant, for approximately its firstfour to six months of operation, are greater than what can be expected afterthat time, both in aggregate dollars and as a percentage of revenue.

 

Our labor costs, as a percentage of revenue, increased 2.6% to 38.9% inthe first quarter of 2008 from 36.3% in the first quarter of 2007 due primarilyto new store-openings and minimum wage increases, turnover and the addition ofa new position at each restaurant to oversee inventory and kitchen managementin an effort to address the increases in commodity costs.  Although the immediate effect of thesepersonnel additions was to increase labor costs, we believe we will realize anoverall decrease in costs of goods in the long term that will more than offsetthis labor increase.

 

We expect that labor costs will vary as we add new restaurants.  Minimum wage laws, local labor laws andpractices, as well as unemployment rates vary from state to state and willaffect our labor costs, as will hiring and training expenses at our newunits.  We believe that retaining goodemployees and more experienced staff ensures high quality guest service and mayreduce 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 1.5% to 14.9% in thefirst quarter of 2008 from 13.4% in the first quarter of 2007 primarily due tonew store-openings as well as increased cost of utilities and expenses relatedto repair and maintenance at our mature properties.  Additionally, expenses related to acceptanceof credit and debit cards increased due to increased usage.

 

***Occupancy***

 

Ouroccupancy costs, which include both fixed and variable portions of rent, commonarea maintenance charges, property insurance and property taxes, remained at6.4% as a percentage of revenue in the first quarter of 2008 and 2007.  While rent expense increased slightly, it wasoffset by a decrease in property and casualty insurance.

 

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

 

Pre-opening costs, which are expensed as incurred, consist of expensesrelated to hiring and training the initial restaurant workforce, wages andexpenses of our dedicated new store opening teams, rental costs incurred duringthe construction period and certain other direct costs associated with openingnew restaurants.  Pre-opening costs,excluding construction-period rent, are primarily incurred in the month of, andtwo months prior to, the restaurant opening.

 

Pre-opening costs increased $487,532 to $583,373 in the first quarterof 2008 from $95,841 in the first quarter of 2007.  Included in such expense was $40,154 and$88,992 of non-cash rental costs incurred during construction periods in thefirst quarters of 2008 and 2007, respectively. Pre-opening costs in 2008 consisted primarily of costs related to thethree restaurants we opened in the first quarter, while pre-opening expenses inthe first quarter of 2007 represented primarily the non-cash constructionperiod rent related to the restaurant we opened in the later part of that year.

 

**General and administrative**

 

General and administrative expense includes all salaries and benefits,including non-cash stock-based compensation, associated with our corporatestaff that is responsible for overall restaurant quality, future expansion intonew locations, financial controls and reporting, restaurant managementrecruiting, training at

 

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Granite City University,excess capacity costs related to our beer production facility, and salaries andexpenses of our new store opening team when it is not dedicated to a particularrestaurant opening.  Other general andadministrative expense includes advertising, professional fees, investorrelations, office administration, centralized accounting system costs andtravel by our corporate management.

 

General and administrative expense increased $968,220 to $2,704,525 inthe first quarter of 2008 from $1,736,305 in the first quarter of 2007.  As a percentage of revenue, general andadministrative expenses increased 1.8% from 9.5% in the first quarter of 2007to 11.3% in the first quarter of 2008. The primary sources of such increase were expenses related to increasedstaff levels related to growth, recruiting, relocation and consulting costs, aswell as accounting services, marketing and occupancy expense.  We undertook an ambitious recruiting plan toupgrade our overall restaurant management teams, particularly in ourKansas/Missouri markets.  These increaseswere partially offset by decreases in insurance, non-cash stock-basedcompensation and repair and maintenance expense. Non-cash stock basedcompensation included in general and administrative expense was $103,585 and$136,236 in the first quarters of 2008 and 2007, respectively.

 

As we continue to expand our restaurant chain, we will closely monitorour general and administrative expense while seeking to preserve aninfrastructure that remains suitable for our anticipated growth.  We plan to add personnel as needed,specifically district operators, to provide better oversight of operations andwe plan to continue to improve our recruiting, training and retentioninitiatives.  While our general andadministrative expense may increase in the near term as we reinforce ourcurrent infrastructure, we expect such expense will decrease as a percentage ofrevenue in the long term due to economies of scale.

 

**Depreciation and amortization**

 

Depreciation and amortization expense increased $441,323 to $1,561,646in the first quarter of 2008 from $1,120,323 in the first quarter of 2007, dueprincipally to the additional depreciation related to new restaurants.  As a percentage of revenue, depreciationexpense increased 0.3% to 6.5% in the first quarter of 2008 from 6.2% in the firstquarter of 2007.

 

**Interest**

 

Net interest expense consists of interest expense on capital leases andlong-term debt, net of interest earned from cash on hand.  Interest expense increased $443,261 to$1,488,826 in the first quarter of 2008 from $1,045,565 in the first quarter of2007.  The increase was due to additionalcapital leases as a result of new restaurants. Interest income decreased $17,268 in the first quarter of 2008 comparedto the first quarter of 2007 due to the reduction of cash on hand.

 

**Liquidity and capital resources**

 

As of March 25, 2008, we had $2,463,707 of cash and a workingcapital deficit of $7,002,978 compared to $7,076,835 of cash and a workingcapital deficit of $3,668,297 at December 25, 2007.

 

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

 

During the thirteen weeks ended March 27, 2007, we used $1,415,062of net cash in operating activities, $374,234 in net cash to purchase equipmentand other assets, and made payments aggregating $6,349,328 on our debt andcapital lease obligations.  Additionally,during the first quarter of 2007, we received net cash of $12,852,678 from theissuance of our common stock.

 

In March 2007, we entered into a stock purchase agreement withaccredited investors under which we sold 2,617,334 shares of common stock at aprice of $5.35 per share.  We obtainedgross proceeds of $14,002,737, paid our placement agents cash commissionsaggregating $1,050,205 and paid expenses aggregating $181,675.  Pursuant to the conditions of the stockpurchase agreement, we used approximately $6.0 million of the

 

19

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$12,770,857 net proceeds to retire the entire balance of equipmentlease debt we had obtained from DHW pursuant to the master lease agreement weentered into in September 2006.  Themembers of DHW are Donald A. Dunham, Charles J. Hey and Steven J.Wagenheim.  Mr. Wagenheim is ourcompany’s president, chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membershipinterest in DHW and personally guaranteed 20% of DHW’s indebtedness to itslenders.  The remaining net proceeds fromthis placement were used to fund the expansion of our restaurant operations.

 

In April 2008, weentered into a development agreement with United Properties for the developmentof up to 22 restaurants to be built between 2009 and 2012.  As our developer, United Properties will beresponsible for all costs related to the land and building of eachrestaurant.  The development agreement provides for acooperative process between United Properties and our management for theselection of restaurant sites and the development of restaurants on thosesites, scheduling for the development and construction of each restaurant oncea location is approved.  We will leaseeach restaurant developed under this agreement from United Properties.

 

We intend to continue expansion in markets where we believe our conceptwill have broad appeal and attractive restaurant-level economics.  We plan to continue using our restaurantprototype as we open future restaurants; however, where appropriate, we willconvert existing restaurants to our Granite City concept.  Additionally, we intend to explore alternativerestaurant designs to reduce the cost of our initial capital investment and wemay alter our prototype to meet various state and local regulatoryrequirements, including, but not limited to, pollution control requirements,liquor license ordinances and smoking regulations.  We intend to open two additional restaurantsin 2008 and have signed lease agreements for these locations in South Bend andIndianapolis, Indiana.

 

Basedupon our existing prototype, we anticipate that pre-opening costs and theinitial purchase of furniture, fixtures and equipment will require aninvestment by us of approximately $1.0 million to $1.3 million foreach new restaurant.  We anticipate thatour new restaurants will require an investment by our developer of approximately$1.8 million to $2.3 million for the building and approximately$1.2 million to $1.5 million for the purchase of the land.  We expect these costs will vary from onemarket to another based on real estate values, zoning regulations, labormarkets and other variables.

 

Pursuantto the terms of some of our lease agreements, our developer receives aconstruction allowance from the landlord which, in turn, is passed on to us asa reduction in the construction cost of a new restaurant.  Landlord contributions received related torestaurants developed in 2007 and 2008 ranged from $1.0 million to$1.5 million per location.  Our netcapital investment is lower for a restaurant that receives a landlordcontribution.  In some instances weelected to use our own cash for a portion of the building costs, resulting inlower minimum lease payments.

 

Tofinance restaurant openings in 2008, we entered into a master equipment leasewith DHW in December 2007.  Detailsregarding such arrangement appear below under the caption “Commitments—CapitalLeases.”

 

Wewill need to expend significant capital in connection with our expansionplans.  Utilizing the December 2007$16.0 million DHW Equipment Lease Commitment, of which approximately$8.0 million lease financing remained available to us as of April 21,2008, as well as cash generated from operations, we believe that we will havesufficient funds to complete our planned restaurant openings into 2010 andmaintain sufficient working capital for our operations.  If we deviate from our planned openings,experience a change in our cost of capital, are unable to obtain developerfinancing or landlord contributions, experience adverse sales trends or areunable to generate positive cash flow, we may require further funding soonerthan anticipated.  We are exploringopportunities to reduce our cash usage per restaurant by utilizing sites thatoffer lower costs of capital and real estate funding.  If our available sources of liquidity areinsufficient to fund our expected capital needs, or our needs are greater thananticipated, we will be required to raise additional funds in the futurethrough the incurrence of indebtedness or public or private sales of equitysecurities.  As of March 25, 2008,we continued to pursue debt financing alternatives in order to solidify ourexpansion plans.  If we do not generatesufficient cash flow from current operations or if financing is not availableto us, we will have to curtail projected

 

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growth, which could materially adverselyaffect our business, financial condition, operating results and cash flows.

 

Ourability to fund our operations in future periods will depend upon our futureoperating performance, and more broadly, on the availability of equity and debtfinancing, which will be affected by prevailing economic conditions in ourindustry and financial, business and other factors, some of which are beyondour control.  We cannot assure you thatwe will obtain financing on favorable terms or at all.  If we elect to raise additional capital throughthe issuance and sale of equity securities, the sales may be at prices belowthe market price of our stock, and our shareholders may suffer significantdilution.  Debt financing, if available,may involve significant cash payment obligations, covenants and financialratios that restrict our ability to operate and grow our business, and wouldcause us to incur additional interest expense and financing costs.

 

**Commitments**

 

*Capital Leases:*

* *

*As of March 25,2008, we had 23 capital lease agreements related to our restaurantproperties.  Of these leases, one expiresin 2020, two in 2023, four in 2024, three in 2025, six in 2026, four in 2027and the remaining three in 2028, all with renewable options for additional periods.  Twenty-one of these lease agreementsoriginated with our developer.  Under 13of the leases, we may be required to pay additional contingent rent based uponrestaurant sales.  The land portion ofthese leases is classified as an operating lease while the building portion ofthese leases is classified as a capital lease because its present value wasgreater than 90% of the estimated fair value at the beginning of the leaseand/or the lease term represents 75% or more of the expected life of theproperty.*

* *

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

* *

*We enteredinto a sale-leaseback agreement for the equipment and leasehold improvements atthe St. Cloud, MN and Sioux Falls, SD restaurants in June 2001 and alease for equipment under agreements expiring in May 2008.  The annual interest rate on such lease isapproximately 6.8%. Steven J. Wagenheim, our president, chief executiveofficer and one of our directors, and a former director of ours have personallyguaranteed these leases.*

* *

*In August 2006,we entered into a master lease agreement with Carlton Financial Corporation (“Carlton”)pursuant to which we could “finance lease” up to $3,000,000 of equipmentpurchases for three restaurant locations. As of March 25, 2008, we had entered into three lease schedules andamendments to this master lease, pursuant to which we are leasing equipment forthree locations for an initial lease term ranging from 36 to39 months.  The value of theequipment financed at each of the three locations ranges from approximately$0.8 million to $1.1 million and the annual interest rate on eachranges from 12.9% to 19.6% annually.  Wehave provided Carlton with refundable security deposits aggregating $251,165 aswell as a security interest in certain other equipment.  At the end of each initial lease term, we may(a) purchase Carlton’s interest in all, but not less than all, of theequipment for a purchase price equal to the greater of (1) the fair marketvalue of the equipment, or (2) 15% of the original cost of the equipment,or (b) renew such lease for 12 months at a monthly lease payment ofapproximately one-half of the original monthly payment and take ownership ofthe equipment thereafter for $1.00. Steven J. Wagenheim, our president, chief executive officer and oneof our directors, was required to personally guarantee payments to be made to Carltonunder the lease financing and our board of directors agreed to compensate himfor such guarantee.  The amount of annualcompensation is 3% of the balance of such lease and is calculated and accruedbased on the weighted average daily balance of the lease at the end of eachmonthly accounting period.*

 

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*In December 2007,we entered into an Equipment Lease Commitment with DHW, relating to the leaseof furniture, fixtures and equipment for current and future restaurants.  Under the terms of the Equipment LeaseCommitment, DHW agreed to purchase and lease to us equipment costing up to$16.0 million.  Each five-year leaseis intended to be for equipment costing a minimum of $0.8 million and amaximum of $1.25 million per restaurant. Payments due DHW have an interest rate equal to the DHW bank base rateplus 4.8%.  Principal payments on theamounts borrowed depend upon the repayment schedule specified by the banks thathave provided the financing commitments to DHW. The lease financing is subject to the availability of financingcommitments to DHW from its lenders.  Wehave the option to purchase the leased equipment for $1.00 upon payment in fullof all rent payments due under each lease. We are not obligated to enter into any equipment leases with DHW,although we intend to enter into equipment leases with DHW for the foreseeablefuture.  DHW is not obligated to provideequipment leases for restaurants that are not developed and constructed byDunham Capital Management, L.L.C. (“Dunham”). While Mr. Wagenheim owns a 20% membership interest in DHW and hasagreed to personally guarantee 20% of DHW’s indebtedness to its lenders, hedoes not receive a guarantee fee or other payment in connection with this DHW financing.  As of April 21, 2008, DHW had purchasedand leased to us equipment at eight of our restaurants under this EquipmentLease Commitment.  The value of theequipment financed at each restaurant is approximately $1.0 million andthe current annual interest rate on each lease ranges from 10.3% to 12.3%.*

* *

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

* *

*Operating Leases:*

 

The land portions of the 23 property leases referencedabove, 21 of whichoriginated with our developer, are classified as operating leases because thefair value of the land was 25% or more of the leased property at the inceptionof each lease.  All scheduled rent increasesfor the land during the initial term of each lease are recognized on astraight-line basis.  In addition to such propertyleases, we have obligations under the following operating leases:

 

In January 2001, weentered into a 20-year operating lease for the land upon which we built ourFargo restaurant.  Under the lease terms, weare obligated to annual rent of $72,000 plus contingent rent based upon restaurantsales.

 

In August 2005, weentered into a 38-month lease agreement for office space for our corporateoffices.  The lease commenced October 1,2005. In November 2007, we entered into anamendment to such lease to include additional space commencing December 1,2007.  Pursuant to the amendedlease,which expiresin November 2011, annual rent is $96,613 with scheduled annual increasesthroughout the term of the lease.  Such scheduledrent increases are recognized on a straight-line basis over the term of thelease.

 

In November 2005, weentered into an agreement for a facility in Minneapolis, Minnesota which we useas a test kitchen.  Obligations under thisthree-year lease agreement began November 1, 2005.  The agreementcalls for annual rent of $42,000 and has an option for a three-year renewal.

 

In March 2006, weentered into a lease agreement for the land and building for our St. LouisPark, Minnesota restaurant.  Rental payments for thislease are $148,625 annually.  This operating lease expiresin 2016 with renewal options for additional periods.

 

In March and April 2008, weentered into lease agreements for the restaurants we plan to open in South Bend, Indiana in the thirdquarter of 2008 and Indianapolis, Indiana in the fourth quarter of 2008,respectively.  Each leaseagreement was entered into under the terms specified in the developmentagreement with Dunham.  The restaurantswill be constructed for us on a build-to-suit basis.  Basic terms ofthe leases include annual rent equal to 10.5% of the construction cost plus theland lease and contingent rent.  The baserent will escalate 10% at the end of each five-year period.  The term ofeach lease will commence when operations begin and we are

 

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responsible for anyreal-estate taxes and all operating costs.  Rental costsassociated with each operating lease incurred during the construction period are recognized as pre-openingcosts and escalating rent will be recognized as expense on a straight-linebasis over the term of each lease.

 

*Personal Guaranties*

* *

*Two of ourdirectors and one former director have personally guaranteed certain of ourleases and loan agreements.  Inconnection with the $1.5 million loan we obtained in July 2001 tofinance our Fargo restaurant, we entered into an agreement concerning guarantywhich provides, among other things, that such guarantors will be indemnifiedfrom any liabilities they may incur by reason of their guaranties of ourindebtedness.  Our board of directors hasagreed to compensate Steven J. Wagenheim, our president, chief executiveofficer and one of our directors, for his personal guaranties of equipmentloans entered into in August 2003 and January 2004.  In August 2006, we entered into a leaseagreement with Carlton pursuant to which we may finance lease up to$3.0 million of equipment.  Mr. Wagenheimwas required to personally guarantee payments to be made to Carlton under thislease financing agreement for which our board of directors agreed to compensatehim.  The amount of annual compensationfor each of these guarantees is 3% of the balance of the obligation and iscalculated and accrued based on the weighted average daily balance of theobligation at the end of each monthly accounting period.  During the first quarters of 2008 and 2007,we recorded $25,803 and $12,179, of such compensation in general andadministrative expense, respectively.  Wepaid no such compensation in the first quarter of 2008 or the first quarter of2007.*

* *

*In December 2007,we entered into an Equipment Lease Commitment and Master Equipment Lease withDHW, relating to the lease of furniture, fixtures and equipment for current andfuture restaurants.  Under the terms ofthe Equipment Lease Commitment, DHW has agreed to purchase and lease to usequipment costing up to $16.0 million. Mr. Wagenheim owns a 20% membership interest in DHW and has agreedto personally guarantee 20% of DHW’s indebtedness to its lenders.  Neither DHW nor our company compensates Mr. Wagenheimfor this personal guarantee of DHW’s indebtedness.*

* *

*Employment Agreements:*

* *

*In June 2005,we entered into a three-year employment agreement with Steven J. Wagenheim, ourpresident and chief executive officer, who also is one of our directors.  In April 2007, we amended thecompensatory arrangements under the agreement to provide for an annual basesalary of $300,000, commencing April 1, 2007, cash incentive compensationfor 2007 ranging from $0 to $197,400 based on performance, and a stock optionfor the purchase of 100,000 shares of common stock.  In addition to annual compensation terms andother provisions, the agreement includes change in control provisions thatwould entitle Mr. Wagenheim to receive severance pay equal to18 months of salary if there is a change in control of our company and hisemployment terminates.*

* *

*In November 2007,we entered into an employment agreement with James G. Gilbertson providing forhis employment as our chief financial officer on an at-will basis at an annualbase salary of $225,000.  He is entitledto participate in performance-based cash bonus or equity award plans for seniorexecutives based upon goals established by our board or compensation committeeafter reasonable consultation with Mr. Gilbertson.  He may be eligible to receive a bonus of upto 50% of his base salary.  We alsogranted to Mr. Gilbertson a stock option for the purchase of 175,000shares of common stock, vesting over a two-year period, upon the commencementof his employment.  The employmentagreement provides for provisions for termination with and without cause by usand for good reason by Mr. Gilbertson and for the payment of a severancepayment equal to 12 months of base salary upon termination of employmentresulting from a change of control of our company, or if Mr. Gilbertson isterminated without cause.  The employmentagreement contains other customary terms and conditions.*

 

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*Development Agreements:*

 

In April 2008, we entered into a development agreement with UnitedProperties for the development of up to 22 restaurants to be built between 2009and 2012.  As our developer, UnitedProperties will be responsible for all costs related to the land and buildingof each restaurant.  The development agreement provides for acooperative process between United Properties and our management for theselection of restaurant sites and the development of restaurants on thosesites, scheduling for the development and construction of each restaurant oncea location 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 a cap rate agreed to by the parties in theagreement, then we will share in the profits of that sale.  We assume no liability in the event UnitedProperties sell a building at a loss.

 

InOctober 2002, we entered into a development agreement with Dunham for thedevelopment of restaurants.  Dunham iscontrolled by Donald A. Dunham, Jr., who is a member of DHW and anaffiliate of Granite Partners, LLC, a beneficial owner approximately onepercent of our securities.  The agreementgives Dunham the right to develop, construct and lease up to 22 restaurants forus prior to December 31, 2012.  Asof March 25, 2008, 21 restaurants had been constructed for us under thisdevelopment agreement and we had signed two additional lease agreements forrestaurants to open later this year. Dunham also has the right to sell the underlying land and building tothird parties or assign these leases.  Asof March 25, 2008, Dunham had sold four of our restaurant sites to thirdparties.  The assignment or sale of alease by Dunham has had no material impact on our company.

 

*Off- balance sheet arrangements:*

 

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

 

*Summary of contractual obligations:*

 

Thefollowing table summarizes our obligations under contractual agreements as of March 25,2008 and the time frame within which payments on such obligations are due.  This table does not include amounts relatedto contingent rent as such future amounts are not determinable.  In addition, whether we would incur anyadditional expense on our employment agreements depends upon the existence of achange in control of the company or other unforeseeable events.  Therefore, neither contingent rent norseverance expense has been included in the following table.

 
| ** **                                       | ** ** | **Payments due by period** | ** **  |
|--------------------------------------------------|------------|-------------------------------------------|-------------|
| **Contractual Obligations**                 | ** ** | **Total**                                 | ** **  | **Fiscal Year  2008** | ** ** | **Fiscal Years  2009-2010** | ** ** | **Fiscal Years  2011-2012** | ** ** | **Fiscal Years  Thereafter** | ** ** |
| Long-term debt,  principal                       |       | $                                         | 1,950,076   |   | $ | 217,660 |   | $ | 600,464 |   | $ | 1,131,952 |   | $ | — |   |
| Interest on  long-term debt                      |       | 454,850                                   |        | 128,236 |   | 258,494 |   | 68,120 |   | — |   |
| Capital lease  obligations, including interest   |       | 135,982,952                               |        | 11,348,584 |   | 17,303,436 |   | 17,448,843 |   | 89,882,088 |   |
| Operating lease  obligations, including interest |       | 60,036,504                                |        | 2,512,821 |   | 6,605,040 |   | 6,576,671 |   | 44,341,972 |   |
| Loan guarantee                                   |       | 219,087                                   |        | 139,570 |   | 58,363 |   | 21,144 |   | — |   |
| Total  obligations                               |       | $                                         | 198,643,469 |   | $ | 14,346,872 |   | $ | 24,825,797 |   | $ | 25,246,730 |   | $ | 134,224,060 |   |

 

Certain amounts donot sum due to rounding.

 

Based on our cash position at March 25, 2008, the December 2007$16.0 million DHW Equipment Lease Commitment, of which approximately$8.0 million lease financing remained available to us as of April 21,2008,

 

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as well as cash generatedfrom operations, we believe that we will have sufficient capital to meet our current obligations.

 

**Seasonality**

 

We expect that our sales and earnings willfluctuate based on seasonal patterns.  Weanticipate that our highest sales and earnings will occur in the second andthird quarters due to the milder climate and availability of outdoor seatingduring those quarters in our existing and proposed markets.

 

**Inflation**

** **

Theprimary inflationary factors affecting our operations are food, supplies andlabor costs.  A large number of ourrestaurant personnel is paid at rates based on the applicable minimum wage, andincreases in the minimum wage directly affect our labor costs.  In the past, we have been able to minimizethe effect of these increases through menu price increases and otherstrategies.  To date, inflation has nothad a material impact on our operating results.

 

**ITEM 3****                                                       ****Quantitative andQualitative Disclosures about Market Risk**

 

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

 

*Changesin interest rate:*

 

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

 

*Changes in commodity prices:*

 

Manyof the food products we purchase are affected by commodity pricing and are,therefore, subject to unpredictable price volatility.  These commodities are generally purchasedbased upon market prices established with vendors.  Extreme fluctuations in commodity pricesand/or long-term changes could have an adverse affect on us.  Although a large national distributor is ourprimary supplier of food, substantially all of the food and supplies wepurchase is available from several sources, which helps to control commodityprice risks.  Additionally, we have theability to increase menu prices, or vary the menu items offered, in response tofood product price increases.  If,however, competitive circumstances limit our menu price flexibility, marginscould be negatively impacted.

 

Our company does notenter into derivative contracts either to hedge existing risks or forspeculative purposes.

 

**ITEM 4****                                                       ****Controls and Procedures**

 

*Evaluationof disclosure controls and procedures*

 

We maintain a system of disclosure controlsand procedures that is designed to ensure that information required to bedisclosed in our Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms,and that such information is accumulated and communicated to our management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding disclosures.

 

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Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of our disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)). Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that, as of March 25, 2008, our disclosurecontrols and procedures were effective.

 

*Changes in internal control over financial reporting*

 

There were no changes in our internal controlover financial reporting that occurred during the quarter ended March 25,2008, that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II   OTHER INFORMATION**

 

**ITEM 1****                  LegalProceedings**

 

Not applicable.

 

**ITEM 1A****               RiskFactors**

 

Please refer to the “Risk Factors” section ofour Annual Report on Form 10-K for the fiscal year ended December 25,2007, filed with the Securities and Exchange Commission on March 10, 2008.

 

**ITEM 2****                  UnregisteredSales of Equity Securities and Use of Proceeds**

 

(a)**          **On January 31, 2008, we issued 10,153shares of common stock upon the cashless exercise of a warrant for the purchaseof 23,996 shares of common stock originally issued March 20, 2003 to oneof the agents for our private placement of Series A Convertible PreferredStock and warrants.  The foregoingwarrant had an exercise price of $1.58 per share and an expiration date of March 20,2008.

 

On March 5, 2008, we issued 7,070 shares of common stock upon thecashless exercise of a warrant for the purchase of 23,996 shares of commonstock originally issued March 20, 2003 to one of the agents for ourprivate placement of Series A Convertible Preferred Stock andwarrants.  The foregoing warrant had anexercise price of $1.58 per share and an expiration date of March 20,2008.

 

On March 7, 2008, we issued 6,681 shares of common stock upon thecashless exercise of a warrant for the purchase of 25,842 shares of commonstock originally issued March 20, 2003 to one of the agents for ourprivate placement of Series A Convertible Preferred Stock andwarrants.  The foregoing warrant had anexercise price of $1.58 per share and an expiration date of March 20,2008.

 

The foregoing issuances were made in reliance upon the exemptionprovided in Section 4(2) of the Securities Act.  The certificates representing such securitiescontain a restrictive legend preventing sale, transfer or other disposition,absent registration or an applicable exemption from registrationrequirements.  The recipients of such securitiesreceived, or had access to, material information concerning our company,including, but not limited to, our reports on Form 10-K, Form 10-Q,and Form 8-K, as filed with the Securities and Exchange Commission.  No discount or commission was paid inconnection with the issuance of common stock upon exercise of such warrants.

 

**ITEM 3****                 ****Defaults upon Senior Securities**

 

Not applicable.

 

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**ITEM 4****                 ****Submission of Matters to a Voteof Security Holders**

 

Not applicable.

 

**ITEM 5****                 ****Other Information**

 

(a)**          **Item 1.01. Entry into a Material Definitive Agreement

 

On April 30, 2008, we entered into adevelopment agreement with United Properties Investment LLC (“United Properties”)pursuant to which United Properties agrees to develop, build and lease up to 22restaurants for our company in the period commencing January 1, 2009through December 31, 2012.  UnitedProperties, based in Minneapolis, Minnesota, is a diversified commercial realestate company with more than 500 employees and 30 million square feet of office,corporate, industrial, retail and multi-family properties undermanagement.  Under the agreement, UnitedProperties will provide all services relating to the development ofrestaurants, oversee construction and perform various services and responsibilitiesset forth in detail in the agreement.

 

We will enter into a lease for eachrestaurant developed.  Each lease willprovide for a base rent determined by multiplying the total project cost by9.5%.  The agreement provides forincreases in base rent on the 5th, 10th and 15thanniversaries of the lease.  It iscontemplated that United Properties will sell all or a portion of theleases.  The parties have agreed thatbeginning in January 2010, they will annually review the market conditionfor the terminal cap rate used to calculate an expected sales price ofleases.  The terminal cap rate will bereviewed to determine whether to adjust the percent used to calculate theannual base rent for a restaurant where a lease has not been executed.  The parties have agreed that the marketterminal cap rate as of the date of the agreement is 8.25%.  If market conditions change, the partiesagree to use good faith efforts to agree upon a changed percent used tocalculate the annual base rent that will be 125 basis points over the changedmarket terminal cap rate.  The agreementprovides for a sharing of half of any excess profit on the sale of arestaurant, as defined in the agreement.

 

We have a right of first offer to purchaserestaurants owned by United Properties prior to any sale by United Propertiesto a third party.  The agreement providesthat if either our company or United Properties fails to comply with adevelopment schedule, such failure will constitute a material breach of theagreement, giving the non-defaulting party the right to terminate theagreement.  Termination of thedevelopment agreement will not affect individual restaurants under constructionwhich are in compliance with the development schedule or for which a lease hasbeen executed, but will terminate the development agreement with respect toobligations to construct or lease additional restaurants.  If an event of default occurs as a result ofacts or omissions of United Properties, subject to a cure right, we may suspendour performance under the development agreement and cancel, rescind orterminate the development agreement.  Ifan event of default occurs as a result of an act or omission of our company,United Properties has the right to terminate the development agreement, subjectto a cure period.

 

The development agreement, which appears as Exhibit 10.1to this report, is incorporated by reference herein.

 

**ITEM 6****                 ****Exhibits**

 

See “Index to Exhibits.”

 

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**SIGNATURES**

 

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

 

 
|   |              |   | GRANITE CITY FOOD &  BREWERY LTD. |
|--------|-------------------|--------|--------------------------------------------|
|   |              |   |                                       |
|   |              |   |                                       |
| Date:  | May 5,  2008 | By:    | /s/ James G. Gilbertson                    |
|   |              |   | James G. Gilbertson                        |
|   |              |   | Chief Financial Officer                    |

 

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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                |       | Development  Agreement between United Properties Investment LLC and the Company, dated  April 30, 2008.                                                                                                           |
|                |       |                                                                                                                                                                                                                   |
| 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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