**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

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**FORM 10-QSB**

 

**ý****                                ****QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

**FOR THEQUARTERLY PERIOD ENDED JUNE 28, 2005**

 

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

 

**Commission File Number 000-29643**

 

**GRANITE CITY FOOD &BREWERY LTD.**

(Exact Name of Small Business Issuer as Specified in Its Charter)

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

 

**5831 Cedar Lake Road**

**St. Louis Park, MN 55416**

**(952) 525-2070**

(Address of Principal Executive Offices and Issuer’s

Telephone Number, including Area Code)

 

Checkwhether the issuer:  (1) filed allreports required to be filed by Section 13 or 15(d) of the ExchangeAct during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes ý    No o.

 

As of August 8,2005, the issuer had outstanding 11,623,285****shares ofcommon stock and 1,000,000 Class A Warrants.  The number of outstanding shares of commonstock includes the shares issuable upon separation of the units, eachconsisting of one share of common stock and one redeemable Class AWarrant, sold in the issuer’s initial public offering.

 

TransitionalSmall Business Disclosure Format:

Yes o    No ý.

 

 

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**TABLE OF CONTENTS**

 
| **PART I**       | **FINANCIAL INFORMATION**                                                                                                  |   |
|-----------------------|----------------------------------------------------------------------------------------------------------------------------|--------|
|                  |                                                                                                                       |   |
| ITEM 1                | Financial Statements                                                                                                       |   |
|                  |                                                                                                                       |   |
|                  | Condensed Balance Sheets as of December 28,  2004 and June 28, 2005                                              |   |
|                  |                                                                                                                       |   |
|                  | Condensed Statements of  Operations for the thirteen and twenty-six weeks ended June 27, 2004 and  June 28, 2005 |   |
|                  |                                                                                                                       |   |
|                  | Condensed Statements of Cash  Flows for the twenty-six weeks ended June 27, 2004 and June 28,  2005              |   |
|                  |                                                                                                                       |   |
|                  | Notes to Condensed Financial  Statements                                                                                   |   |
|                  |                                                                                                                       |   |
| ITEM  2               | Management’s Discussion and  Analysis or Plan of Operation                                                            |   |
|                  |                                                                                                                       |   |
| ITEM 3                | Controls and Procedures                                                                                                    |   |
|                  |                                                                                                                       |   |
| **PART II**      | **OTHER INFORMATION**                                                                                                      |   |
|                  |                                                                                                                       |   |
| ITEM 1                | Legal Proceedings                                                                                                          |   |
|                  |                                                                                                                       |   |
| ITEM 2                | Unregistered Sales of Equity Securities and Use of  Proceeds                                                               |   |
|                  |                                                                                                                       |   |
| ITEM 3                | Defaults upon Senior Securities                                                                                            |   |
|                  |                                                                                                                       |   |
| ITEM 4                | Submission of Matters to a Vote of Security Holders                                                                        |   |
|                  |                                                                                                                       |   |
| ITEM 5                | Other Information                                                                                                          |   |
|                  |                                                                                                                       |   |
| ITEM 6                | Exhibits                                                                                                                   |   |
|                  |                                                                                                                       |   |
| **SIGNATURES**        |                                                                                                                       |
|                  |                                                                                                                       |   |
| **INDEX TO EXHIBITS** |                                                                                                                       |

 

i

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**PART I          FINANCIALINFORMATION**

** **

**ITEM 1  Financial Statements**

 

**GRANITE CITY FOOD & BREWERY LTD.**

 

**CONDENSEDBALANCE SHEETS**

 
| ** **                                                                                                                                                                            | ** ** | **December 28,** | ** ** | **June 28,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                                                                                                                                                                            | ** ** | **(audited)**         | ** ** | **(unaudited)**   | ** ** |
| **ASSETS:**                                                                                                                                                                           |       |                  |       |              |       |
| Current assets:                                                                                                                                                                       |       |                  |       |              |       |
| Cash                                                                                                                                                                                  |       | $                     | 9,297,247  |              | $          | 5,742,713 |   |
| Inventory                                                                                                                                                                             |       | 190,897               |       | 190,897           |       |
| Prepaids and other                                                                                                                                                                    |       | 335,435               |       | 332,031           |       |
| Total current assets                                                                                                                                                                  |       | 9,823,579             |       | 6,265,641         |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Property and equipment, net                                                                                                                                                           |       | 21,950,428            |       | 24,953,058        |       |
| Intangible assets and other                                                                                                                                                           |       | 394,950               |       | 396,387           |       |
| Total assets                                                                                                                                                                          |       | $                     | 32,168,957 |              | $          | 31,615,086 |   |
|                                                                                                                                                                                  |       |                  |       |              |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY:**                                                                                                                                        |       |                  |       |              |       |
| Current liabilities:                                                                                                                                                                  |       |                  |       |              |       |
| Accounts payable                                                                                                                                                                      |       | $                     | 654,334    |              | $          | 450,837 |   |
| Accrued expenses                                                                                                                                                                      |       | 2,179,017             |       | 1,892,987         |       |
| Deferred rent, current portion                                                                                                                                                        |       | 30,000                |       | 66,035            |       |
| Long-term debt, current portion                                                                                                                                                       |       | 226,283               |       | 233,846           |       |
| Capital lease obligations, current portion                                                                                                                                            |       | 517,232               |       | 591,594           |       |
| Total current liabilities                                                                                                                                                             |       | 3,606,866             |       | 3,235,299         |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Deferred rent, net of current portion                                                                                                                                                 |       | 400,000               |       | 952,912           |       |
| Long-term debt, net of current portion                                                                                                                                                |       | 2,504,310             |       | 2,385,195         |       |
| Capital lease obligations, net of current portion                                                                                                                                     |       | 11,775,436            |       | 12,077,182        |       |
| Total liabilities                                                                                                                                                                     |       | 18,286,612            |       | 18,650,588        |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Shareholders’ equity:                                                                                                                                                            |       |                  |       |              |       |
| Common stock, $0.01 par value, 90,000,000 shares  authorized; 11,601,067 and 11,622,286 shares issued and outstanding at December 28,  2004 and June 28, 2005, respectively |       | 116,011               |       | 116,223           |       |
| Additional paid-in capital                                                                                                                                                            |       | 20,717,101            |       | 20,802,730        |       |
| Accumulated deficit                                                                                                                                                                   |       | (6,950,767            | )          | (7,954,455        | )          |
| Total shareholders’ equity                                                                                                                                                       |       | 13,882,345            |       | 12,964,498        |       |
|                                                                                                                                                                                  |       |                  |       |              |       |
| Total liabilities and shareholders’ equity                                                                                                                                       |       | $                     | 32,168,957 |              | $          | 31,615,086 |   |

 

See notes to condensed financial statements.

 

1

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**GRANITE CITY FOOD & BREWERYLTD.**

 

**CONDENSED STATEMENTS OFOPERATIONS**

**(Unaudited)**

 
| ** **                                              | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|---------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                              | ** ** | **June 27,**        | ** ** | **June 28,**          | ** ** | **June 27,** | ** ** | **June 28,** | ** ** |
| ** **                                              | ** ** | **2004**                 | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Restaurant revenues                                     |       | $                        | 7,460,935  |                       | $          | 8,534,251 |   | $ | 13,600,302 |   | $ | 16,404,588 |   |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Cost of sales:                                          |       |                     |       |                       |       |   |   |   |   |
| Food, beverage and retail                               |       | 2,333,702                |       | 2,532,927                  |       | 4,209,817 |   | 4,888,315 |   |
| Labor                                                   |       | 2,526,463                |       | 2,875,076                  |       | 4,569,684 |   | 5,588,830 |   |
| Direct and occupancy                                    |       | 1,217,334                |       | 1,485,285                  |       | 2,328,692 |   | 2,968,103 |   |
| Total cost of sales                                     |       | 6,077,499                |       | 6,893,288                  |       | 11,108,193 |   | 13,445,248 |   |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Pre-opening                                             |       | 483,349                  |       | 220,399                    |       | 748,323 |   | 228,111 |   |
| General and administrative                              |       | 605,478                  |       | 1,179,056                  |       | 1,194,062 |   | 2,131,409 |   |
| Depreciation and amortization                           |       | 384,970                  |       | 491,388                    |       | 715,010 |   | 935,784 |   |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Operating loss                                          |       | (90,361                  | )          | (249,880                   | )          | (165,286 | ) | (335,964 | ) |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Interest:                                               |       |                     |       |                       |       |   |   |   |   |
| Income                                                  |       | 221                      |       | 31,085                     |       | 4,192 |   | 69,346 |   |
| Expense                                                 |       | (279,125                 | )          | (320,895                   | )          | (511,298 | ) | (644,883 | ) |
| Other expense, net                                      |       | —                   |       | (39,632                    | )          | — |   | (50,475 | ) |
| Net other expense                                       |       | (278,904                 | )          | (329,442                   | )          | (507,106 | ) | (626,012 | ) |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Net loss                                                |       | (369,265                 | )          | (579,322                   | )          | (672,392 | ) | (961,976 | ) |
| Less preferred stock dividends declared                 |       | (108,710                 | )          | —                     |       | (455,816 | ) | — |   |
| Net loss available to common shareholders               |       | $                        | (477,975   | )                          | $          | (579,322 | ) | $ | (1,128,208 | ) | $ | (961,976 | ) |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Loss per common share, basic and diluted                |       | $                        | (0.11      | )                          | $          | (0.05 | ) | $ | (0.27 | ) | $ | (0.08 | ) |
|                                                    |       |                     |       |                       |       |   |   |   |   |
| Weighted average shares outstanding, basic and  diluted |       | 4,271,439                |       | 11,621,140                 |       | 4,202,186 |   | 11,617,708 |   |

 

See notes to condensed financial statements.

 

2

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**GRANITE CITY FOOD & BREWERY LTD.**

 

**CONDENSED STATEMENTS OF CASHFLOWS**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                 | ** ** | **June 27,**          | ** ** | **June 28,** | ** ** |
| ** **                                                                                 | ** ** | **2004**                   | ** ** | **2005** | ** ** |
|                                                                                       |       |                       |       |   |   |
| Cash flows from operating activities:                                                      |       |                       |       |   |   |
| Net loss                                                                                   |       | $                          | (672,392   | ) | $ | (961,976 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                       |       |   |   |
| Depreciation and amortization                                                              |       | 715,010                    |       | 935,784 |   |
| Stock option/warrant compensation                                                          |       | 12,780                     |       | 12,780 |   |
| Loss on disposal of asset                                                                  |       | —                     |       | 50,475 |   |
| Deferred rent                                                                              |       | —                     |       | (24,009 | ) |
| Decrease (increase) in:                                                                    |       |                       |       |   |   |
| Inventory                                                                                  |       | (100,121                   | )          | — |   |
| Prepaids and other                                                                         |       | (122,511                   | )          | 3,404 |   |
| Increase (decrease) in:                                                                    |       |                       |       |   |   |
| Accounts payable                                                                           |       | 391,473                    |       | (239,015 | ) |
| Accrued expenses                                                                           |       | 438,764                    |       | (244,962 | ) |
| Net cash provided by (used in) operating activities                                        |       | 663,003                    |       | (467,519 | ) |
|                                                                                       |       |                       |       |   |   |
| Cash flows from investing activities:                                                      |       |                       |       |   |   |
| Purchase of:                                                                               |       |                       |       |   |   |
| Property and equipment                                                                     |       | (1,979,625                 | )          | (2,680,688 | ) |
| Intangible assets and other                                                                |       | (29,561                    | )          | (11,164 | ) |
| Net cash used in investing activities                                                      |       | (2,009,186                 | )          | (2,691,852 | ) |
|                                                                                       |       |                       |       |   |   |
| Cash flows from financing activities:                                                      |       |                       |       |   |   |
| Payments on capital lease obligations                                                      |       | (223,642                   | )          | (273,892 | ) |
| Payments on long term-debt                                                                 |       | (90,985                    | )          | (111,552 | ) |
| Proceeds from (payments on) line of credit, net                                            |       | 95,348                     |       | — |   |
| Payment of dividends                                                                       |       | (36                        | )          | (41,068 | ) |
| Proceeds from issuance of long term-debt                                                   |       | 750,000                    |       | — |   |
| Proceeds from issuance of stock                                                            |       | 79,977                     |       | 31,349 |   |
| Net cash provided by (used in) financing activities                                        |       | 610,662                    |       | (395,163 | ) |
|                                                                                       |       |                       |       |   |   |
| Net decrease in cash                                                                       |       | (735,521                   | )          | (3,554,534 | ) |
| Cash, beginning                                                                            |       | 1,439,960                  |       | 9,297,247 |   |
| Cash, ending                                                                               |       | $                          | 704,439    |   | $ | 5,742,713 |   |
|                                                                                       |       |                       |       |   |   |
| Supplemental disclosure of non-cash investing and  financing activities:                   |       |                       |       |   |   |
| Land and buildings acquired under capital lease  agreements                                |       | $                          | 5,675,128  |   | $ | 1,262,956 |   |
| Equipment purchased and included in accounts payable                                       |       | $                          | 9,884      |   | $ | 35,518 |   |

 

See notes to condensed financial statements.

 

3

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**GRANITE CITY FOOD & BREWERY LTD.**

 

**NOTES TO CONDENSED FINANCIALSTATEMENTS**

**(Unaudited)**

 

Thirteen and twenty-six weeks ended June 27, 2004 and June 28,2005

 

**1.****              Natureof business and basis of presentation:**

 

Nature of business:

 

GraniteCity Food & Brewery Ltd. (the “Company”) develops and operates casualdining restaurants featuring on-premise breweries known as Granite City Food &Brewery®, in selected markets throughout the United States.  The theme is casual dining with a widevariety of menu items that are prepared fresh daily, combined with freshlybrewed hand-crafted beers made on-premise. The Company produces its beer using a process called FermentusInterruptusTM, which is intended to maintain high beer quality while enhancingoverall profitability by reducing unit-level brewing costs.  The first restaurant, located in St. Cloud,Minnesota, opened in July 1999. Subsequently, the Company opened restaurants in Sioux Falls, SouthDakota; Fargo, North Dakota; West Des Moines, Cedar Rapids and Davenport, Iowa;Lincoln, Nebraska; Minneapolis, Minnesota; and Wichita, Kansas.

 

TheCompany’s current expansion strategy focuses on development of restaurants inmarkets where management believes the Company’s concept will have broad appealand attractive restaurant-level economics.

 

Interim financialstatements:

 

TheCompany has prepared the condensed financial statements for the thirteen andtwenty-six weeks ended June 27, 2004 and June 28, 2005 without auditby the Company’s independent auditors. In the opinion of the Company’s management, all adjustments necessary topresent fairly the financial position of the Company at June 28, 2005 andthe results of operations and cash flows for the thirteen and twenty-six week periodsended June 27, 2004 and June 28, 2005 have been made. Thoseadjustments consist only of normal and recurring adjustments.

 

The balance sheet at December 28, 2004 has beenderived from the audited financial statements at that date, but does notinclude all of the information and notes required by generally acceptedaccounting principles for complete financial statements.  Certain information and notedisclosures normally included in the Company’s annual financial statements havebeen condensed or omitted.  Thesecondensed financial statements should be read in conjunction with the financialstatements and notes thereto included in the Company’s Annual Report on Form 10-KSBfor the fiscal year ended December 28, 2004, filed with the Securities andExchange Commission on March 24, 2005.

 

Theresults of operations for the thirteen and twenty-six weeks ended June 28,2005 are not necessarily indicative of the results to be expected for the entireyear.

 

Earnings (loss) pershare:

 

Basic earnings (loss) per common shareis calculated by dividing net income (loss) less the sum of preferred stockdividends declared, by the weighted average number of common sharesoutstanding in each year. Diluted earnings (loss) per common share assumesthat outstanding common shares were increased by shares issuable uponexercise of stock options and warrants for which the market price exceeds the exerciseprice, less shares which could have been purchased by the Company withrelated proceeds.  Calculations of the Company’s net loss percommon share for the thirteen and twenty-six weeks ended June 27,2004 and June 28, 2005 are set forth in the following table:

 

4

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| ** **                                             | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **June 27,**        | ** ** | **June 28,**          | ** ** | **June 27,** | ** ** | **June 28,** | ** ** |
| ** **                                             | ** ** | **2004**                 | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                   |       |                     |       |                       |       |   |   |   |   |
| Net loss                                               |       | $                        | (369,265   | )                          | $          | (579,322 | ) | $ | (672,392 | ) | $ | (961,976 | ) |
| Less dividends declared                                |       | (108,710                 | )          | —                     |       | (455,816 | ) | — |   |
| Net loss available to common shareholders              |       | $                        | (477,975   | )                          | $          | (579,322 | ) | $ | (1,128,208 | ) | $ | (961,976 | ) |
|                                                   |       |                     |       |                       |       |   |   |   |   |
| Loss per common share, basic and diluted               |       | $                        | (0.11      | )                          | $          | (0.05 | ) | $ | (0.27 | ) | $ | (0.08 | ) |
|                                                   |       |                     |       |                       |       |   |   |   |   |
| Weighted average shares outstanding, basic and diluted |       | 4,271,439                |       | 11,621,140                 |       | 4,202,186 |   | 11,617,708 |   |

 

**2.****              Stockcompensation:**

 

The Company accounts forits stock-based compensation awards using the intrinsic value method prescribedby Accounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees. *No compensation cost has beenrecognized for options issued to employees when the exercise price of theoptions granted is at least equal to the fair value of the common stock on thedate of grant.  Had compensation costbeen determined consistent with Statement of Financial Accounting Standard (SFAS)No. 123, *Accounting for Stock-BasedCompensation*, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure,* the Company’s net loss and net loss per common sharewould have been changed to the following pro forma amounts:

 
| ** **                                                                                                                                  | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                                                                                                  | ** ** | **June 27,**        | ** ** | **June 28,**          | ** ** | **June 27,** | ** ** | **June 28,** | ** ** |
| ** **                                                                                                                                  | ** ** | **2004**                 | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net loss:                                                                                                                                   |       |                     |       |                       |       |   |   |   |   |
| As reported                                                                                                                                 |       | $                        | (369,265   | )                          | $          | (579,322 | ) | $ | (672,392 | ) | $ | (961,976 | ) |
| Less: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | $                        | (168,831   | )                          | $          | (192,466 | ) | $ | (322,523 | ) | $ | (769,863 | ) |
| Pro forma                                                                                                                                   |       | $                        | (538,096   | )                          | $          | (771,788 | ) | $ | (994,915 | ) | $ | (1,731,839 | ) |
|                                                                                                                                        |       |                     |       |                       |       |   |   |   |   |
| Net loss per common share                                                                                                                   |       |                     |       |                       |       |   |   |   |   |
| Basic and diluted as reported                                                                                                               |       | $                        | (0.11      | )                          | $          | (0.05 | ) | $ | (0.27 | ) | $ | (0.08 | ) |
| Basic and diluted pro forma                                                                                                                 |       | $                        | (0.15      | )                          | $          | (0.07 | ) | $ | (0.35 | ) | $ | (0.15 | ) |

 

The fair value of each optiongrant for the pro forma disclosure required by SFAS No. 123, as amended bySFAS No. 148, is estimated on the grant date using the Black-Scholesoption-pricing model with the following assumptions for the grants:

 

| ** **              | ** ** | **2004**   | ** ** | **2005**    | ** ** |
|-------------------------|------------|------------|------------|-------------|------------|
| Dividend yield          |       | None       |       | None        |       |
| Expected volatility     |       | 71.4%      |       | 46.1%       |       |
| Expected life of option |       | 5-10 years |       | 5-10 years  |       |
| Risk-free interest rate |       | 4.8%       |       | 3.6% - 4.5% |       |

 

5

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**3.****              Changein capitalization:**

 

Exercise of warrants andoptions:

 

On January 3,2005, an employee of the Company exercised a stock option for the purchase of 1,000shares of common stock at an exercise price of $1.65 per share.  These options were issued pursuant to the1997 Stock Option Plan.

 

On January 27,2005, a former employee of the Company exercised a stock option for thepurchase of 18,000 shares of common stock at an exercise price of $1.65 pershare.  These options were issued outsidethe Company’s plans.

 

On May 16,2005, the Company issued 2,219 shares of common stock upon the cashlessexercise of a warrant for the purchase of 3,955 shares of common stock originallyissued April 30, 2003 to one of its agents for the private placement of Series AConvertible Preferred Stock and warrants. The foregoing warrant had an exercise price of $1.58 per share and anexpiration date of April 30, 2008.

 

Dividends:

 

On November 4,2004, the last day shares of the Company’s Series A Convertible Preferred Stockwere outstanding, the Company, pursuant to the terms of the preferred stock,authorized cash payment of dividends to holders of its preferred stock as ofthat date.  Such dividends aggregated$41,068 and were paid on December 31, 2004.

 

**4.****              Lineof credit:**

 

In September 2004, the Company entered into arevolving line of credit agreement with maximum availability of $750,000 withan independent financial institution.  TheCompany incurred no interest expense and borrowed no money against this line inthe first half of fiscal year 2005.  In April 2005,the Company terminated this line of credit agreement.

 

**5.****             ****Reclassification:**

 

As of June 28, 2005, the Company hasreclassified certain of its restaurant operating costs relating tocomplimentary and employee meals from operating expenses to a contra-revenueaccount. This reclassification has no effect on net loss or accumulateddeficit.  The total amount reclassifiedis reflected as a reduction of operating expenses and a corresponding reductionof revenues in the same amount in each period affected. For the thirteen andtwenty-six weeks ended June 27, 2004, the reclassification totaled $164,997and $318,501, respectively.

 

**6.****             ****Leases**

 

On February 7, 2005, the Office of the ChiefAccountant of the Securities and Exchange Commission issued a letter to theAmerican Institute of Certified Public Accountants expressing its viewsregarding certain operating lease-related accounting issues and theirapplication under generally accepted accounting principles in the United Statesof America.  In light of this letter, theCompany’s management initiated a review of its lease accounting and determinedthat instead of accruing rent costs during the period of constructingrestaurants, the Company had accrued rent beginning as of the commencement ofthe lease term, which was typically the commencement of operations.  Management concluded that in order to conformits method of accounting to that set forth in the letter, it would begin accruinglease costs during the construction period and capitalize the lease costs aspart of the costs of the constructed property. As a result, the Company increased its property and equipment by $603,947,and increased its other long-term liabilities by $603,947 on its consolidatedbalance sheet at June 28, 2005.  TheCompany has determined the effects of conforming to this accounting method werenot material to prior years’ financial statements or the financial statementsfor the first quarter of 2005.

 

6

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**ITEM 2  Management’s Discussion and Analysis or Planof Operation**

 

*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 place undue relianceon such forward-looking statements, which are qualified in their entirety bythe cautions and risks described herein. Please refer to our Annual Report on Form 10-KSB for thefiscal year ended December 28, 2004, filed with the Securities andExchange Commission on March 24, 2005, for additional factors known to usthat may cause actual results to vary.*

 

**Overview**

 

We operate nine casual dining restaurants featuringon-premises breweries under the name Granite City Food &Brewery®.  The location of eachrestaurant and the month and year of its opening appear in the following chart:

 

| **Location**              | ** ** | **Opened** | ** ** |
|---------------------------|------------|------------|------------|
| St. Cloud, Minnesota      |       | Jun-99     |       |
| Sioux Falls, South Dakota |       | Dec-00     |       |
| Fargo, North Dakota       |       | Nov-01     |       |
| West Des Moines, Iowa     |       | Sep-03     |       |
| Cedar Rapids, Iowa        |       | Nov-03     |       |
| Davenport, Iowa           |       | Jan-04     |       |
| Lincoln, Nebraska         |       | May-04     |       |
| Minneapolis, Minnesota    |       | Jun-04     |       |
| Wichita, Kansas           |       | Jul-05     |       |

 

We developed the foregoing restaurants using proceedsfrom the sale of our securities, building and equipment leases, debt financingand cash flow from operations.

 

The last six units were built based upon the prototypewe developed in early 2003.  These unitswere developed under our multi-site development agreement with a commercialdeveloper that provides us with assistance in site selection, constructionmanagement and financing for new restaurants. Under this agreement, we lease each new restaurant from our developer.

 

In September 2004, we entered into a securitiespurchase agreement with accredited investors for the sale of approximately $8.5million of common stock and warrants to purchase common stock.  Using the proceeds from this privateplacement and equipment loans as needed, we intend to add three additionalrestaurants in 2005, six additional restaurants in 2006, and eight additionalrestaurants in 2007.  The remaining restaurantswe plan to open in 2005 include sites in Kansas, Minnesota and Missouri.  We anticipate that all of these restaurantswill be designed based on our 2003 prototype.

 

7

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In 2001, we developed a patent-pending brewing processcalled Fermentus InterruptusTM.  Webelieve that Fermentus Interruptus improves the economics of our microbrewingprocess as it eliminates the initial stages of brewing and storage at multiplelocations, thereby reducing equipment and development costs at new restaurantlocations.  Having a common startingpoint for our initial brewing process creates consistency of taste for ourproduct from unit to unit.  In December 2004,we entered into a lease agreement for a building which will facilitatethe initial stage of our brewing process, the production of wort.  The non-alcoholic wort produced at thisfacility will be transported via truck to the fermentation vessels at each ofour restaurants where the brewing process will be completed. We believe this commissary brewing process will allow us to serviceapproximately 30 restaurant locations from one wort production site.  We are evaluating strategies to capitalize onFermentus Interruptus, including licensing of our brewing technology.

 

We believe that our operating results will fluctuatesignificantly because of several factors, including the timing of newrestaurant openings and related expenses, profitability of new restaurants,changes in food and labor costs, increases or decreases in comparablerestaurant sales, general economic conditions, consumer confidence in theeconomy, changes in consumer preferences, competitive factors and weatherconditions.

 

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.

 

Our restaurant revenues are comprised almost entirelyof the sales of food and beverages.  Thesale of retail items, such as cigarettes and promotional items, typicallyrepresents approximately less than one percent of total revenue.  Product costs include the costs of food,beverages and retail items.  Labor costsinclude direct hourly and management wages, taxes and benefits for restaurantemployees.  Direct and occupancy costsinclude restaurant supplies, marketing costs, rent, utilities, real estatetaxes, repairs and maintenance and other related costs.  Pre-opening costs consist of direct costsrelated to hiring and training the initial restaurant workforce and certainother direct costs associated with opening new restaurants.  General and administrative expenses arecomprised of expenses associated with all corporate and administrativefunctions that support existing operations, management and staff salaries,employee benefits, travel, information systems and training and marketresearch.  Depreciation and amortizationincludes depreciation on capital expenditures. Other income and expense represents the cost of interest on debt andcapital leases, interest income on invested assets and loss on disposal ofassets.

 

8

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**Results of Operations**

 

The following table compares operating resultsexpressed as a percentage of total revenue for the thirteen and twenty-six weeksended June 27, 2004 and June 28, 2005.

 
| ** **                    | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|-------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **June 27,**        | ** ** | **June 28,**          | ** ** | **June 27,** | ** ** | **June 28,** | ** ** |
| ** **                    | ** ** | **2004**                 | ** ** | **2005**                   | ** ** | **2004** | ** ** | **2005** | ** ** |
|                          |       |                     |       |                       |       |   |   |   |   |
| Restaurant revenues           |       | 100.0                    | %          | 100.0                      | %          | 100.0 | % | 100.0 | % |
|                          |       |                     |       |                       |       |   |   |   |   |
| Cost of sales:                |       |                     |       |                       |       |   |   |   |   |
| Food, beverage and retail     |       | 31.3                     |       | 29.7                       |       | 31.0 |   | 29.8 |   |
| Labor                         |       | 33.9                     |       | 33.7                       |       | 33.6 |   | 34.1 |   |
| Direct and occupancy          |       | 16.3                     |       | 17.4                       |       | 17.1 |   | 18.1 |   |
| Total cost of sales           |       | 81.5                     |       | 80.8                       |       | 81.7 |   | 82.0 |   |
|                          |       |                     |       |                       |       |   |   |   |   |
| Pre-opening                   |       | 6.5                      |       | 2.6                        |       | 5.5 |   | 1.4 |   |
| General and administrative    |       | 8.1                      |       | 13.8                       |       | 8.8 |   | 13.0 |   |
| Depreciation and amortization |       | 5.2                      |       | 5.8                        |       | 5.3 |   | 5.7 |   |
|                          |       |                     |       |                       |       |   |   |   |   |
| Operating loss                |       | (1.2                     | )          | (2.9                       | )          | (1.2 | ) | (2.0 | ) |
|                          |       |                     |       |                       |       |   |   |   |   |
| Interest:                     |       |                     |       |                       |       |   |   |   |   |
| Income                        |       | —                   |       | 0.4                        |       | — |   | 0.4 |   |
| Expense                       |       | (3.7                     | )          | (3.8                       | )          | (3.8 | ) | (3.9 | ) |
| Other expense, net            |       | —                   |       | (0.5                       | )          | — |   | (0.3 | ) |
| Net other expense             |       | (3.7                     | )          | (3.9                       | )          | (3.7 | ) | (3.8 | ) |
|                          |       |                     |       |                       |       |   |   |   |   |
| Net loss                      |       | (4.9                     | )%         | (6.8                       | )%         | (4.9 | )% | (5.9 | )% |

 

Certain percentage amounts do not sum due to rounding.

 

**Critical Accounting Policies**

 

This discussion and analysisis based upon our financial statements, which were prepared in conformity withgenerally accepted accounting principles in the United States of America.  These principles require management to makeestimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and accompanying notes. We believe our estimates and assumptions are reasonable; however, actualresults and the timing of the recognition of such amounts could differ fromthose estimates.  We have identified thefollowing critical accounting policies and estimates utilized by management inthe preparation of our financial statements:

 

*Propertyand equipment*

 

The cost of property and equipment is depreciatedover the estimated useful lives of the related assets ranging from three to 20years.  The cost of leaseholdimprovements is depreciated over the initial term of the related lease.  Depreciation is computed on the straight-linemethod for financial reporting purposes and accelerated methods for income taxpurposes.  Amortization of assetsacquired under capital lease is included in depreciation expense.  We review property and equipment,including leasehold improvements, for impairment when events or circumstancesindicate these assets might be impaired pursuant to Statement of FinancialAccounting Standard (SFAS) No. 144. We base this assessment upon the carrying value versus the fair marketvalue of the asset and whether that difference is recoverable.  Such assessment is performed on a

 

9

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restaurant-by-restaurantbasis and includes other relevant facts and circumstances, including thephysical condition of the asset.

 

Our accounting policiesregarding property and equipment include certain management judgments regardingthe estimated useful lives of such assets and the determination as to whatconstitutes enhancing the value of or increasing the life of existingassets.  These judgments and estimatesmay produce materially different amounts of depreciation and amortizationexpense than would be reported if different assumptions were used.

 

We continually reassess ourassumptions and judgments and make adjustments when significant facts andcircumstances dictate.  Historically,actual results have not been materially different than the estimates we havemade.

 

**Results of Operations for the Thirteen andTwenty-six Weeks Ended June 27, 2004 and June 28, 2005**

 

**Revenue**

 

We generated $7,460,935 and $8,534,251 of revenuesduring the second quarter of 2004 and 2005, respectively.  During the first half of 2004 and 2005, wegenerated revenue of $13,600,302 and $16,404,588, respectively.  The twenty-six weeks ended June 28, 2005included 208 restaurant weeks, which is the sum of the actual number of weekseach restaurant operated.  The twenty-sixweeks ended June 27, 2004 included 161 restaurant weeks.  The increase in sales of 20.6% for the firsthalf of the fiscal year 2005 over the first half of fiscal year 2004 wasprimarily the result of 47 additional restaurant weeks in 2005.

 

Due to increased demand fostered by the publicitysurrounding the opening of a new restaurant, that restaurant typicallyexperiences a temporary period of high revenues immediately following itsopening (the “honeymoon effect”).  Duringthe first half of 2004, we had five restaurants experiencing the honeymooneffect while no restaurants were experiencing this honeymoon effect in thefirst half of 2005.  As such, averageweekly sales decreased from $85,758 per week in the second quarter of 2004 to $82,060per week in the second quarter of 2005.  Averageweekly sales decreased from $84,474 per week in the first half of 2004 to$78,868 per week in the first half of 2005. Comparable restaurant sales, which include restaurants in operation over18 months, decreased 0.6% and 2.5% in the second quarter and first half of theyear, respectively.

 

We anticipate that restaurant revenues will vary fromquarter to quarter.  We anticipateseasonal fluctuations in restaurant revenues due in part to increased outdoorseating and generally favorable weather conditions at our locations during thesummer months.  Due to the honeymooneffect, we expect the timing of new restaurant openings to cause fluctuationsin restaurant revenues.  Additionally,consumer confidence in the economy and changes in consumer preferences mayaffect our future revenues.

 

**Restaurant Costs**

** **

***Food andBeverage***

** **

Our food and beverage costs decreased 1.6% as apercentage of revenue from 31.3% in the second quarter of 2004 to 29.7% in the secondquarter of 2005.  These costs decreased 1.2%as a percentage of revenue from 31.0% in the first half of 2004 to 29.8% in thefirst half of 2005.  These decreases weredue primarily to more staff members becoming familiar with our operations,thereby generating less waste, since our most recent restaurant opening in June 2004.

 

We expect that our food and beverage costs will varygoing forward due to numerous variables, including seasonal changes in foodcosts and guest preferences.  Weperiodically create new menu offerings and introduce new craftbrewed beersbased upon guest preferences.  Althoughsuch menu modifications may temporarily result in increased food and beveragecost, we believe we are able to offset such increases with

 

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our weekly specials whichprovide variety and value to our guests. Our varieties of craftbrewed beer, which we can produce at lower costthan beers we purchase for resale, also enable us to keep our food and beveragecosts low while fulfilling guest requests and building customer loyalty.  As we have opened additional units, we haveexperienced increased purchasing power and believe we will continue to do sowith additional expansion, thereby partially offsetting food and beverage costincreases and maintaining or reducing our food and beverage costs as apercentage of revenue.  Additionally, aswe add new units, we believe our brewing process, Fermentus Interruptus, willallow us to keep our high quality product intact while reducing productioncost, thereby enhancing overall profitability.

 

***Labor***

** **

Our labor costs expressed as a percentage of revenuedecreased 0.2% from 33.9% in the second quarter of 2004 to 33.7% in the secondquarter of 2005.  These costs increased0.5% as a percentage of revenue from 33.6% in the first half of 2004 to 34.1%in the first half of 2005.  The overallincrease in labor costs for the first half of 2005 was due primarily to increasesin management wages, health insurance and workers compensation insurance expenses.

 

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 new units.  Our management believes that retaining goodemployees and more experienced staff ensures high quality guest service andreduces hiring and training costs.

 

***Directand Occupancy***

** **

Our direct and occupancy expenses increased 1.1% as apercentage of revenues from 16.3% in the second quarter of 2004 to 17.4% in thesecond quarter of 2005.  These expensesincreased 1.0% from 17.1% in the first half of 2004 to 18.1% in the first halfof 2005.  Operating supplies, rent andoccupancy costs, repairs and maintenance, promotions and restaurant-level administrativeexpense represent the majority of our direct and occupancy expenses, asubstantial portion of which is fixed or indirectly variable.  These increases in direct and occupancyexpense were due primarily to the increase in the cost of utilities.

 

**Pre-Opening Costs**

** **

Pre-opening costs during thefirst half of 2004 represented a portion of the pre-opening costs at ourDavenport and Minneapolis restaurants as well as all such costs related to ourLincoln restaurant.  Pre-opening costs inthe first half of 2005 related to our Wichita restaurant which we opened July 5,2005.  Based upon the costs of labor,travel, lodging and training incurred prior to opening, we expect pre-openingexpenses to average between $275,000 and $300,000 per unit.  Such costs are primarily incurred in themonth of, and two months prior to, the restaurant opening.

 

**General andAdministrative**

** **

Generaland administrative expenses include salaries and benefits associated with ourcorporate staff that is responsible for overall restaurant quality, futureexpansion into new locations and financial controls and reporting.  Other general and administrative expensesinclude advertising, professional fees, office administration, centralizedaccounting system costs, and travel by our corporate management to therestaurant locations.  General andadministrative expenses increased $573,578 from $605,478 in the second quarterof 2004 to $1,179,056 in the second quarter of 2005.  Such expenses increased $937,347 from$1,194,062 in the first half of 2004 to $2,131,409 in the first half of 2005.  In order to retain and recruit core management and further build ourinfrastructure to facilitate growth and allow for restaurant management attrition,we incurred increased expenses primarily related to payroll, employee benefits,recruiting and relocation.  Additionally,our professional fees, including investor relations, legal and accountingincreased in the first half of 2005 over the first half of 2004.

 

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Weexpect that general and administrative costs will continue to fluctuate as apercentage of restaurant revenues in the near term as we build ourinfrastructure to adequately sustain operations through further expansion.  The anticipated additional restaurantrevenues associated with further expansion are expected to result in greatereconomies of scale for our corporate expenses in the long term.

 

**Depreciationand Amortization**

** **

Depreciation and amortization expense increased $106,418during the second quarter of 2005 and $220,774 during the first half of 2005compared to the same periods in 2004, due principally to the additionaldepreciation related to the newly opened restaurants. As a percentage ofrevenues, depreciation expense increased 0.4% from 5.3% in the first half of 2004to 5.7% in the first half of 2005.

 

**Other Income and Expense**

** **

Interestexpense increased $41,770 and $133,585 in the second quarter and first half of 2005compared to the second quarter and first half of 2004, respectively, due to an increasein debt and capital leases as a result of additional restaurants.  Interest income increased $30,864 and $65,154in the second quarter and first half of 2005 compared to the second quarter andfirst half of 2004, respectively, due to interest earned on cash obtained fromthe sale of our securities in September 2004.  Management expects interest expense will increase and interest incomewill decrease as we pursue our three-year expansion schedule.  As we completed the remodeling of our three olderrestaurants to mirror the 2003 prototype, we recorded a $50,475 loss on assetswhich had not been fully depreciated.

 

**Liquidity and CapitalResources**

** **

We have funded our capital requirements sinceinception through sales of securities, building and equipment leases, debtfinancing and cash flow from operations. As of June 28, 2005, we had net working capital of $3,030,342, comparedto net working capital of $6,216,713 at December 28, 2004.

 

During the twenty-six weeks ended June 28, 2005, weused $467,519 of net cash in operating activities, $2,691,852 in net cash topurchase equipment and other assets primarily for our wort production facilityand our Wichita, Eagan and Kansas City locations, and made payments aggregating$385,444 on our debt and capital lease obligations.  Additionally, during the first quarter of2005, we paid cash dividends to shareholders of our preferred stock aggregating$41,068 and received net cash of $31,349 from the issuance of our common stockupon the exercise of options and warrants.

 

Duringthe twenty-six weeks ended June 27, 2004, operating activities provided us$663,003 of cash, issuance of common stock pursuant to the exercise of warrantsprovided us $79,977 in cash and proceeds from long-term debt and our line ofcredit provided us $845,348 net cash.  Weused $2,009,186 of cash to purchase equipment and other assets primarily forour Davenport, Lincoln and Minneapolis locations, and made payments on our debtand capital lease obligations aggregating $314,627.

 

Using the proceeds from our 2004 private placement,we continue to expand into markets where we believe our concept will have broadappeal and attractive restaurant-level economics.  We plan to develop three additionalrestaurants in 2005, six additional restaurants in 2006 and eight additionalrestaurants in 2007.  We are utilizingthe multi-site development agreement we entered into in October 2002 with DunhamCapital Management L.L.C. (“Dunham”) to facilitate this expansion plan.  Dunham is controlled by Donald A. Dunham, Jr.,who is an affiliate of Granite Partners, L.L.C., a beneficial owner of approximately1.6% of our securities.  Under thisagreement, our developer provides us assistance in site selection, constructionmanagement and restaurant financing for new restaurants.

 

As part of our expansion strategy, we will continue usingthe prototype model we developed in 2003 and used for our six most recently constructed restaurants.  We anticipate that each of these prototypicalrestaurants will require an investment by our developer of approximately $3.5million to $4.0 million each for

 

12

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land, building andequipment.    We anticipate these costswill vary from one market to another based on real estate values, zoningregulations, labor markets and other variables. Under our developmentagreement, we will lease each new restaurant from our developer.  We anticipate that pre-opening expenses andthe initial purchase of furniture, fixtures and equipment will require aninvestment by us of approximately $1.0 million to $1.6 million per unit.

 

In February 2005, we commenced leasing abuilding in Ellsworth, Iowa which is being constructed in accordance with ourspecifications by an unrelated third party. This building will be used tofacilitate the initial stage of our Fermentus Interruptus brewing process, theproduction of wort.  We have the optionto purchase the facility at any time during the lease term for one dollar plusthe 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 one dollar.  As such, the lease is classified as a capitallease.

 

In July 2005,we opened our restaurant in Wichita.   Weare leasing this property from our developer under a 20-year leaseagreement.   Our annual lease paymentsare $336,000.  This lease may be extendedat our option for up to five additional five-year periods.

 

Withcash generated from operations, proceeds from our 2004 private placement andequipment financing, management believes that we will have sufficient funds topursue our business strategy over the next three years.  If we do not generate the cash needed fromoperations and/or are not able to obtain suitable equipment financing, we mayhave to reduce or delay our planned expansion.

 

**Commitmentsand Contingent Liabilities**

 

*Operatingand Capital Leases:*

 

As of June 28,2005, we had seven land and building lease agreements.  One of these leases expires in 2019, one in2020, two in 2023, and the remaining three expire in 2024, all with renewableoptions for additional periods.  Thebuilding portions of these leases are classified as capital leases becausetheir present value was greater than 90% of the estimated fair value at thebeginning of the lease.  The landportions of these leases are classified as operating leases because the fairvalue of the land was more than 25% of the leased property at the inception ofeach lease.  Under three of the leases,we are required to pay additional percentage rent based upon restaurantsales.  As of June 28, 2005, futureobligations relating to the land portion of these seven leases aggregated $14,962,101plus percentage rent.  The scheduled rentincreases for the land during the life of each lease are recognized on astraight-line basis.  Future obligationsrelating to the building portion of these seven leases aggregated $22,894,345 asof June 28, 2005.

 

In2001, we entered into a 20-year operating lease for land upon which webuilt our Fargo restaurant.  As of June 28,2005, future obligations under the terms of this lease aggregated $1,179,800plus percentage rent.

 

In December 2004,we entered into a land and building lease agreement for a facility to be used forwort production.  This ten-year leasecommenced February 1, 2005 and is classified as a capital lease as itcontains a bargain purchase option.  Asof June 28, 2005, future obligations under the terms of this leaseaggregated $828,004.

 

As of June 28,2005, we have additional capital lease obligations outstanding aggregating $572,333for equipment leases expiring in 2008, and an operating lease obligationoutstanding of $16,750 for a lease expiring in 2005 for office space.

 

Wehave entered into five separate 20-year net leases relating to futurerestaurants in Kansas, Missouri and Minnesota. The annual rent for each lease will be equal to 10.5% of the sum of theconstruction cost and land cost.  Theterms of these leases will commence when operations begin at each location.

 

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*PersonalGuaranties:*

 

Certainof our directors have personally guaranteed certain of our leases and loanagreements.  In connection with the $1.5million loan we obtained in July 2001 to finance our Fargo restaurant, weentered into an agreement concerning guaranty which provides, among otherthings, that such guarantors will be indemnified from any liabilities they mayincur by reason of their guaranties of our indebtedness. The agreement containsvarious covenants, one of which requires us to use our best efforts to obtain arelease of one individual’s guarantee obligation by January 1, 2006.  If we have not accomplished this, we areobligated to pay him a monthly guarantee fee in the amount of $1,000 until suchrelease is obtained.  Additionally, at ameeting held in March 2004, our board of directors agreed to compensateour President and Chief Executive Officer for his personal guaranties ofequipment loans entered into in August 2003 and January 2004.  The amount of annual compensation is 3% ofthe balance of such loans.  This amount iscalculated and accrued based on the weighted average daily balances of suchloans at the end of each monthly accounting period.  As of June 28, 2005, $33,896 of loanguarantee fees were included as a liability on our balance sheet, $19,002 ofwhich was accrued during the twenty-six weeks ended June 28, 2005.

 

*EmploymentAgreement:*

 

Wehave entered into an employment agreement with our President and ChiefExecutive Officer.  In lieu of a salary,we issued stock options to him in 1999, 2001 and 2003 as compensation for hisservices through March 30, 2003. Effective April 1, 2003, we began paying an annual salary to suchofficer.  Among other provisions, theemployment agreement includes change in control provisions that would entitlehim to receive severance pay equal to 18 months of salary if there is a changein control of our company and his employment terminates.  On March 15, 2005, the CompensationCommittee of our board of directors authorized a new three-year employment andcompensation arrangement with him.  Thearrangement provides for a minimum base salary of $225,000, commencing January 1,2005, cash incentive compensation for 2005 ranging from $0 to $125,550 based onperformance, and a stock option for the purchase of 150,000 shares of commonstock.

 

*DevelopmentAgreement:*

 

Wehave entered into a development agreement with Dunham for the development ofour restaurants.  The agreement givesDunham the right to develop, construct and lease up to 22 restaurants for usprior to December 31, 2012.  We arenot bound to authorize the construction of restaurants during that time period,but generally cannot use another developer to develop or own a restaurant aslong as the development agreement is in effect. We can use another developer if Dunham declines to build a particularrestaurant, if the agreement is terminated because of a default by Dunham, orif our company is sold or merged into another company.  In the case of a merger or sale of ourcompany, the development agreement may be terminated at such time as Dunham hascompleted seven restaurants under the agreement.  As of June 28, 2005, six restaurants hadbeen constructed for us under this development agreement.

 

Thedevelopment agreement provides for a cooperative process between Dunham and ourcompany 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, and controls on the costs ofdevelopment and construction using bidding and guaranteed maximum costconcepts.  The development agreementprovides that restaurants will be leased to us on the basis of a triple netlease.  The rental rate of each leasewill be calculated using a variable formula which is based on approved andspecified costs of development and construction and an indexed interest rate.  The term of each lease is 20 years with fivefive-year options to renew.

 

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*Summaryof Contractual Obligations:*

 

Thefollowing table summarizes our obligations under contractual agreements as of June 28,2005 and the time frame within which payments on such obligations are due.  This table does not include amounts relatedto percentage rent as such amounts have not yet been determined.  In addition, whether we would incur any additionalexpense on our employment agreement with Mr. Wagenheim depends upon theexistence of a change in control of the company.  Therefore, no percentage rent nor severanceexpense has been included in the following table.

 
| ** **                                      | ** ** | **Payments due by period** | ** ** |
|-------------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**                     | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **More than 5  years** | ** ** |
| Long-term debt, principal                       |       | $                          | 2,619,041  |   | $ | 114,731 |   | $ | 1,788,123 |   | $ | 469,763 |   | $ | 246,424 |   |
| Interest on long-term debt                      |       | 423,316                    |       | 98,273 |   | 255,708 |   | 61,245 |   | 8,090 |   |
| Capital lease obligations, including interest   |       | 24,294,682                 |       | 823,662 |   | 3,083,365 |   | 2,796,336 |   | 17,591,319 |   |
| Operating lease obligations, including interest |       | 16,158,651                 |       | 483,132 |   | 1,876,663 |   | 1,891,922 |   | 11,906,934 |   |
| Loan guarantee                                  |       | 138,556                    |       | 51,475 |   | 55,170 |   | 28,581 |   | 3,330 |   |
| Total obligations                               |       | $                          | 43,634,246 |   | $ | 1,571,273 |   | $ | 7,059,029 |   | $ | 5,247,847 |   | $ | 29,756,097 |   |

 

Based on our working capital position at June 28,2005, we believe we have sufficient working capital to meet our currentobligations.

 

**Qualitativeand Quantitative Disclosures about Market Risk**

 

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

 

*Changesin Interest Rate:*

 

In February 2007,we will have a balloon payment due of approximately $1,325,000 on the loan weobtained from an independent financial institution in July 2001.  Currently, this loan bears a fixed interestrate of 8.75%. If it becomes necessary to refinance such balloon balance, wemay not be able to secure financing at the same interest rate.  The effect of a higher interest rate woulddepend upon the negotiated financing terms.

 

*Changesin Commodity Prices:*

 

                                                Many of the food products we purchase areaffected by commodity pricing and are, therefore, subject to unpredictableprice volatility.   These commodities aregenerally purchased based upon market prices established with vendors.  Extreme fluctuations in commodity pricesand/or long-term changes could have an adverse affect on us.  Although SYSCO Corporation is our primarysupplier of food, substantially all of the food and supplies we purchase areavailable from several sources, which helps to control commodity pricerisks.  Additionally, we have the abilityto increase menu prices, or vary the menu items offered, in response to a foodproduct price increases.  If, however,competitive circumstances limit our menu price flexibility, margins could benegatively impacted.

 

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

 

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**Seasonality**

 

We expect that our sales and earnings will fluctuatebased 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 are paid at rates based on the applicable minimum wage,and increases 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****                                                       ****Controls and Procedures**

 

We maintain a system ofdisclosure controls and procedures that is designed to provide reasonableassurance that information, which is required to be disclosed, is accumulatedand communicated to management timely. At the end of the period covered by this report, we carried out anevaluation under the supervision and with the participation of our management,including our Chief Executive Officer and Interim Chief Financial Officer, ofthe effectiveness of the design and operation of our disclosure controls andprocedures pursuant to Exchange Act Rule 13a-15.  Based upon that evaluation, our ChiefExecutive Officer and Interim Chief Financial Officer concluded that ourdisclosure controls and procedures are effective.

 

During our most recent fiscal quarter, there hasbeen no change in our internal control over financial reporting (as defined in Rule 13a-15(f) or15d-15(f) under the Exchange Act) that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II          OTHERINFORMATION**

 

ITEM 1                                                      Legal Proceedings

 

Notapplicable.

 

ITEM 2                                                      Unregistered Sales of Equity Securitiesand Use of Proceeds

 

(a)                                  On May 16, 2005, we issued 2,219 sharesof common stock upon the cashless exercise of a warrant for the purchase of3,955 shares of common stock originally issued April 30, 2003 to one ofour agents for the 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 April 30,2008.

 

The foregoing issuance wasmade in reliance upon the exemption provided in Section 4(2) of theSecurities Act.  The certificaterepresenting such securities contains a restrictive legend preventing sale,transfer or other disposition, absent registration or an applicable exemptionfrom registration requirements.  Therecipient of such securities received, or had access to, material informationconcerning our company, including, but not limited to, our reports on Form 10-KSB,Form 10-QSB, and Form 8-K, as filed with the SEC.  No discount or commission was paid inconnection with the issuance of common stock upon exercise of the warrant.

 

(b)                                 Not applicable.

 

(c)                                  Not applicable.

 

ITEM 3                                                      Defaults upon Senior Securities

 

Not applicable.

 

ITEM 4                                                      Submission of Matters to a Vote ofSecurity Holders

 

Not applicable.

 

ITEM 5                                                      Other Information

 

Not applicable.

 

ITEM 6                                                      Exhibits

 

See “Index to Exhibits.”

 

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**SIGNATURES**

 

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

 

 
|                                                     | GRANITE CITY  FOOD & BREWERY LTD. |
|----------------------------------------------------------|--------------------------------------------|
|                                                     |                                       |
|                                                     |                                       |   |   |
| Date:      August 10, 2005 | By:                                        |  /s/ Monica A. Underwood |
|                                                     | Monica A.  Underwood                       |
|                                                     | Interim Chief  Financial Officer and       |
|                                                     | Corporate  Controller                      |
|                                                          |                                            |  |  |  |

 

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**INDEX TOEXHIBITS**

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                                                                                                           |
|-------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                                                                                                      |
| 10.1                    |       | Executive Employment Agreement by and between the Company and Steven  J. Wagenheim, dated June 15, 2005 (incorporated by reference to our  Current Report on Form 8-K/A filed on June 16, 2005 (File No. 000-29643)). |
|                    |       |                                                                                                                                                                                                                                      |
| 31.1                    |       | Certification by  Steven J. Wagenheim, President and Chief Executive Officer of the Company,  pursuant to Exchange Act Rule 13a-14, as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                      |
|                    |       |                                                                                                                                                                                                                                      |
| 31.2                    |       | Certification by  Monica A. Underwood, Interim Chief Financial Officer and Corporate Controller  of the Company, pursuant to Exchange Act Rule 13a-14, 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 Monica A. Underwood, Interim Chief Financial Officer  and Corporate Controller 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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