**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,DC 20549**

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**FORM 10-Q**
| x      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE  26, 2007** |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
|   | ** **                                                                                                                                 |
| o      | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                              |

 

**CommissionFile Number 000-29643**

**GRANITE CITY FOOD & BREWERYLTD.**

(Exact Name ofRegistrant as Specified in Its Charter)

| **Minnesota**                      |   | **41-1883639**       |
|------------------------------------|--------|----------------------|
| (State or Other  Jurisdiction      |   | (I.R.S. Employer     |
| of Incorporation  or Organization) |   | 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) has filedall reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes x   Noo

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the ExchangeAct.  (Check one):
|  | Large accelerated filer o | Accelerated filer o | Non-accelerated filer x |
|--|---------------------------|---------------------|-------------------------|

 

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

Yes o   No x

As of August 1, 2007, theissuer had outstanding 16,014,320 shares of common stock.

 

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**TABLE OFCONTENTS**
| **PART I**             | **FINANCIAL INFORMATION**                                                                                                     |   |
|------------------------|-------------------------------------------------------------------------------------------------------------------------------|--------|
| ** **             | ** **                                                                                                                    |   |
| ITEM 1                 | Financial Statements                                                                                                          |   |
|                   |                                                                                                                          |   |
|                   | Condensed  Consolidated Balance Sheets as of June 26, 2007 and December 26, 2006                                              |   |
|                   |                                                                                                                          |   |
|                   | Condensed  Consolidated Statements of Operations for the Thirteen and Twenty-six weeks  ended June 26, 2007 and June 27, 2006 |   |
|                   |                                                                                                                          |   |
|                   | Condensed  Consolidated Statements of Cash Flows for the Twenty-six Weeks ended June 26,  2007 and June 27, 2006              |   |
|                   |                                                                                                                          |   |
|                   | Notes to  Condensed Consolidated Financial Statements                                                                         |   |
|                   |                                                                                                                          |   |
| ITEM 2                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.                                  |   |
|                   |                                                                                                                          |   |
| ITEM 3                 | Quantitative  and Qualitative Disclosures about Market Risk                                                                   |   |
|                   |                                                                                                                          |   |
| ITEM 4                 | Controls and  Procedures                                                                                                      |   |
|                   |                                                                                                                          |   |
| **PART II**            | **OTHER INFORMATION**                                                                                                         |   |
| ** **             | ** **                                                                                                                    |   |
| ITEM 1                 | Legal  Proceedings                                                                                                            |   |
|                   |                                                                                                                          |   |
| ITEM 1A                | Risk  Factors                                                                                                                 |   |
|                   |                                                                                                                          |   |
| 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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**PARTI FINANCIAL INFORMATION**

**ITEM1  Financial Statements**

**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**
| ** **                                                                                                                                                                 | ** ** | **June 26,** | ** ** | **December 26,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| **ASSETS:**                                                                                                                                                                |       |              |       |                  |       |
| Current assets:                                                                                                                                                            |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                 |       | $                 | 11,247,205 |                  | $          | 7,671,750 |   |
| Inventory                                                                                                                                                                  |       | 485,254           |       | 511,146               |       |
| Prepaids and  other                                                                                                                                                        |       | 431,009           |       | 393,803               |       |
| Total current  assets                                                                                                                                                      |       | 12,163,468        |       | 8,576,699             |       |
|                                                                                                                                                                       |       |              |       |                  |       |
| Prepaid rent,  net of current portion                                                                                                                                      |       | 474,337           |       | 503,267               |       |
| Property and  equipment, net                                                                                                                                               |       | 55,335,695        |       | 54,018,124            |       |
| Intangible  assets and other                                                                                                                                               |       | 718,218           |       | 760,420               |       |
| Total assets                                                                                                                                                               |       | $                 | 68,691,718 |                  | $          | 63,858,510 |   |
|                                                                                                                                                                       |       |              |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY:**                                                                                                                            |       |              |       |                  |       |
| Current  liabilities:                                                                                                                                                      |       |              |       |                  |       |
| Accounts payable                                                                                                                                                           |       | $                 | 3,786,603  |                  | $          | 2,289,433 |   |
| Accrued expenses                                                                                                                                                           |       | 4,392,504         |       | 5,104,730             |       |
| Deferred rent,  current portion                                                                                                                                            |       | 164,699           |       | 143,928               |       |
| Long-term debt,  current portion                                                                                                                                           |       | 278,923           |       | 259,940               |       |
| Capital lease  obligations, current portion                                                                                                                                |       | 983,930           |       | 1,885,388             |       |
| Total current  liabilities                                                                                                                                                 |       | 9,606,659         |       | 9,683,419             |       |
|                                                                                                                                                                       |       |              |       |                  |       |
| Deferred rent, net of  current portion                                                                                                                                     |       | 1,865,697         |       | 1,603,557             |       |
| Long-term debt, net of  current portion                                                                                                                                    |       | 1,865,474         |       | 2,004,986             |       |
| Capital lease  obligations, net of current portion                                                                                                                         |       | 31,880,585        |       | 37,501,605            |       |
| Total  liabilities                                                                                                                                                         |       | 45,218,415        |       | 50,793,567            |       |
|                                                                                                                                                                       |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                             |       |              |       |                  |       |
| Shareholders’ equity:                                                                                                                                                 |       |              |       |                  |       |
| Common stock,  $0.01 par value, 90,000,000 shares authorized; 16,014,320 and 13,370,331shares  issued and outstanding at June 26, 2007 and December 26, 2006, respectively |       | 160,143           |       | 133,703               |       |
| Additional  paid-in capital                                                                                                                                                |       | 42,347,573        |       | 29,122,306            |       |
| Accumulated  deficit                                                                                                                                                       |       | (19,034,413       | )          | (16,191,066           | )          |
| Total  shareholders’ equity                                                                                                                                           |       | 23,473,303        |       | 13,064,943            |       |
|                                                                                                                                                                       |       |              |       |                  |       |
| Total liabilities and  shareholders’ equity                                                                                                                           |       | $                 | 68,691,718 |                  | $          | 63,858,510 |   |

 

See notes to condensed consolidated financialstatements.

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**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**
| ** **                                              | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|---------------------------------------------------------|------------|------------------------------------|------------|--------------------------------------|------------|
| ** **                                              | ** ** | **June 26,**                  | ** ** | **June 27,**                    | ** ** | **June 26,** | ** ** | **June 27,** | ** ** |
| ** **                                              | ** ** | **2007**                           | ** ** | **2006**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Restaurant  revenues                                    |       | $                                  | 18,453,954 |                                 | $          | 14,417,118 |   | $ | 36,636,146 |   | $ | 26,309,437 |   |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Cost of sales:                                          |       |                               |       |                                 |       |   |   |   |   |
| Food, beverage and retail                               |       | 5,524,901                          |       | 4,258,148                            |       | 10,919,623 |   | 7,773,083 |   |
| Labor                                                   |       | 6,544,272                          |       | 4,990,804                            |       | 13,151,175 |   | 9,257,632 |   |
| Direct restaurant operating                             |       | 2,491,215                          |       | 1,652,845                            |       | 4,934,154 |   | 3,247,489 |   |
| Occupancy                                               |       | 1,103,348                          |       | 795,873                              |       | 2,274,892 |   | 1,477,528 |   |
| Total cost of sales                                     |       | 15,663,736                         |       | 11,697,670                           |       | 31,279,844 |   | 21,755,732 |   |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Pre-opening                                             |       | 416,341                            |       | 262,572                              |       | 512,182 |   | 1,074,374 |   |
| General and  administrative                             |       | 1,904,946                          |       | 1,621,374                            |       | 3,638,998 |   | 3,070,934 |   |
| Depreciation and  amortization                          |       | 1,122,405                          |       | 814,489                              |       | 2,242,728 |   | 1,566,945 |   |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Operating income  (loss)                                |       | (653,474                           | )          | 21,013                               |       | (1,037,606 | ) | (1,158,548 | ) |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Interest:                                               |       |                               |       |                                 |       |   |   |   |   |
| Income                                                  |       | 70,009                             |       | 24,114                               |       | 102,485 |   | 56,164 |   |
| Expense                                                 |       | (857,713                           | )          | (563,648                             | )          | (1,903,278 | ) | (1,061,677 | ) |
| Net interest expense                                    |       | (787,704                           | )          | (539,534                             | )          | (1,800,793 | ) | (1,005,513 | ) |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Loss before  income tax                                 |       | (1,441,178                         | )          | (518,521                             | )          | (2,838,399 | ) | (2,164,061 | ) |
| Income tax  provision                                   |       | (2,695                             | )          | —                               |       | (4,948 | ) | (500 | ) |
| Net loss                                                |       | $                                  | (1,443,873 | )                                    | $          | (518,521 | ) | $ | (2,843,347 | ) | $ | (2,164,561 | ) |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Loss per common  share, basic and diluted               |       | $                                  | (0.09      | )                                    | $          | (0.04 | ) | $ | (0.19 | ) | $ | (0.16 | ) |
|                                                    |       |                               |       |                                 |       |   |   |   |   |
| Weighted average shares  outstanding, basic and diluted |       | 16,004,680                         |       | 13,226,526                           |       | 14,975,124 |   | 13,226,526 |   |

 

See notes to condensedconsolidated financial statements.

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**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**
| ** **                                                                                 | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                 | ** ** | **June 26,**                    | ** ** | **June 27,** | ** ** |
| ** **                                                                                 | ** ** | **2007**                             | ** ** | **2006** | ** ** |
|                                                                                       |       |                                 |       |   |   |
| Cash flows from  operating activities:                                                     |       |                                 |       |   |   |
| Net loss                                                                                   |       | $                                    | (2,843,347 | ) | $ | (2,164,561 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities:               |       |                                 |       |   |   |
| Depreciation and amortization                                                              |       | 2,242,728                            |       | 1,566,945 |   |
| Stock option compensation expense                                                          |       | 466,459                              |       | 407,484 |   |
| Loss on disposal of asset                                                                  |       | 79,126                               |       | 2,414 |   |
| Deferred rent                                                                              |       | 264,022                              |       | 181,195 |   |
| Changes in operating assets and liabilities:                                               |       |                                 |       |   |   |
| Inventory                                                                                  |       | 25,892                               |       | (76,151 | ) |
| Prepaids and other                                                                         |       | (8,276                               | )          | (593,770 | ) |
| Accounts payable                                                                           |       | 209,092                              |       | 253,990 |   |
| Accrued expenses                                                                           |       | (712,226                             | )          | 344,783 |   |
| Net cash used in operating activities                                                      |       | (276,530                             | )          | (77,671 | ) |
|                                                                                       |       |                                 |       |   |   |
| Cash flows from  investing activities:                                                     |       |                                 |       |   |   |
| Purchase of:                                                                               |       |                                 |       |   |   |
| Property and equipment                                                                     |       | (2,289,499                           | )          | (2,580,432 | ) |
| Intangible assets and other                                                                |       | (3,617                               | )          | (11,112 | ) |
| Net cash used in investing activities                                                      |       | (2,293,116                           | )          | (2,591,544 | ) |
|                                                                                       |       |                                 |       |   |   |
| Cash flows from  financing activities:                                                     |       |                                 |       |   |   |
| Payments on capital lease obligations                                                      |       | (6,522,478                           | )          | (442,214 | ) |
| Payments on long term-debt                                                                 |       | (120,529                             | )          | (119,132 | ) |
| Proceeds (cost incurred) from issuance of stock                                            |       | 12,788,108                           |       | (2,141 | ) |
| Net cash provided by (used in) financing activities                                        |       | 6,145,101                            |       | (563,487 | ) |
|                                                                                       |       |                                 |       |   |   |
| Net increase  (decrease) in cash                                                           |       | 3,575,455                            |       | (3,232,702 | ) |
| Cash and cash  equivalents, beginning                                                      |       | 7,671,750                            |       | 9,836,231 |   |
| Cash and cash  equivalents, ending                                                         |       | $                                    | 11,247,205 |   | $ | 6,603,529 |   |
|                                                                                       |       |                                 |       |   |   |
| Supplemental  disclosure of non-cash investing and financing activities:                   |       |                                 |       |   |   |
| Land, buildings and equipment acquired under capital  lease agreements                     |       | $                                    | —     |   | $ | 5,364,351 |   |
| Property and equipment, intangibles and stock  issuance costs included in accounts payable |       | $                                    | 1,288,078  |   | $ | 1,322,239 |   |
|                                                                                       |       |                                 |       |   |   |
| Income taxes  paid                                                                         |       | $                                    | 4,948      |   | $ | 500 |   |

 

See notes to condensed consolidated financialstatements.

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**GRANITE CITY FOOD & BREWERY LTD.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

Thirteen and Twenty-six weeks ended June 26, 2007 andJune 27, 2006

**1.****                           Summaryof significant accounting policies**

Background

Granite City Food &Brewery Ltd. (the “Company”) develops and operates casual dining restaurantsknown as Granite City Food & Brewery®.  The restaurant theme is upscale casual dining with a wide variety ofmenu items that are prepared fresh daily, combined with freshly brewedhand-crafted beers finished on-site.  Thefirst Granite City restaurant opened in St. Cloud, Minnesota in July 1999 andthe Company subsequently expanded to other Midwest markets, opening its 19th restaurant on July 3, 2007.  The Company also operates a beer productionfacility which is used to provide raw material support to its restaurants tocreate consistent quality and operational efficiencies.

The Company’s expansion strategy focuses ondevelopment of restaurants in markets where management believes the Company’sconcept will have broad appeal and attractive 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 eachcorporation.  Each resident-owner of thestock of these entities has entered into a buy-sell agreement with eachcorporation providing, among other things, that transfer of the shares isrestricted and that the shareholder must sell his shares to the corporationupon certain events, including termination of employment (if employed by theCompany) or any event which disqualifies the resident-owner from owning theshares under applicable laws and regulations of the state.  The Company has entered into a masteragreement with each separate corporation that permits the operation of therestaurants 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, the net profit from its operations. The Company has determined that the foregoing ownership structure willcause these separate corporations to be treated as variable interest entitiesin which the Company has a controlling financial interest for the purpose ofFASB Interpretation 46 (R), *Consolidation of VariableInterest Entities. *As such,the corporations are consolidated with the Company’s financial statements andthe Company’s financial statements do not reflect a minority ownership in thoseseparate corporations.  All references tothe Company in these financial statements relate to the consolidated entity.

In the opinion of management, alladjustments, consisting of normal recurring adjustments, which are necessaryfor a fair statement of its financial position as of June 26, 2007 and theresults of operations for the interim periods ended June 26, 2007 and June 27,2006 have been included.

The balance sheet at December 26, 2006, 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 annualfinancial statements have been condensed or omitted.  These condensed financial statements shouldbe read in conjunction with the financial statements and notes thereto includedin the Company’s Annual Report 

4

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on Form 10-K forthe fiscal year ended December 26, 2006, filed with the Securities and ExchangeCommission on February 21, 2007.

The results ofoperations for the twenty-six weeks ended June 26, 2007 are not necessarilyindicative of the results to be expected for the entire year.

Reclassification

Certain reclassifications have been made to the financial statementsfor the second quarter and first half of 2006 in order for them to conform tothe presentation of the financial statements for the second quarter and firsthalf of 2007.  These reclassificationshave no effect on the accumulated deficit or net loss previously reported.

Revenue recognition

Revenue is derived from thesale of prepared food and beverage and select retail items.  Revenue is recognized at the time of sale andis reported on the Company’s statement of operations net of sales taxescollected.  Revenue derived from giftcard sales is recognized at the time the gift card is redeemed.  Until the redemption of gift cards occurs,the outstanding balances on such cards are included in accrued expenses in theaccompanying consolidated balance sheets. The Company recognizes gift card breakage amounts based upon historical redemptionpatterns, which represent the balance of gift cards for which the Companybelieves the likelihood of redemption by the customer is remote.

Cash and cash equivalents

The Company maintains it cash at financial institutions in Minnesota,South Dakota, Kansas and Ohio.  At timesthe bank balances exceed the limits insured by federal agencies.  The Company considers all highly liquidinstruments with maturities of three months or less at the time of issuance tobe 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 123(R)”),*Share-Based Payment*, and SEC StaffAccounting Bulletin No. 107 (“SAB 107”), *Share-Based Payment,*requiring the measurement and recognition of all share-based compensation underthe fair value method.  The Companyimplemented SFAS 123(R) using the modified prospective method, effective December28, 2005, the first day of its 2006 fiscal year.

Accounting for leases

The Company leases most of its restaurant properties.  Leases are accounted for under the provisionsof SFAS No. 13 and SFAS No. 98, *Accounting for Leases,*aswell as other subsequent amendments and authoritative literature including FASBStaff Position No. FAS 13-1, *Accountingfor Rental Costs Incurred During a Construction Period. *For leases that contain rent escalations, the Company records the totalrent payable during the lease term on a straight-line basis over the initiallease term, including the “build-out” or “rent-holiday” period where no rentpayments are typically due under the terms of the lease.  Any difference between minimum rent andstraight-line rent is recorded as deferred rent.  Contingent rent expense, which is based on apercentage of revenue, is also recorded to the extent it exceeds minimum baserent per the lease agreement.  Deferredrent also includes a tenant improvement allowance the Company received which isbeing amortized as a reduction of rent expense on a straight-line basis overthe initial term of the lease.

Earnings (loss) per share

Basic loss per common share is calculated by dividing net loss bythe weighted average number of common shares outstanding in eachrespective fiscal period.

Recent accounting pronouncements

In July 2006, the Financial AccountingStandards Board (“FASB”) issued FASB Interpretation No. 48, *“Accounting for Uncertainty in Income Taxes,”* (“FIN 48,”)which clarifies the accounting and disclosures for uncertainty in income taxesrecognized in the financial statements in accordance with SFAS No. 109, 

5

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*“Accounting for Income Taxes.”*  FIN48 also provides guidance on the de-recognition of uncertain tax positions,financial statement classification, accounting for interest and penalties,accounting for interim periods and adds new disclosure requirements.  The adoption of FIN 48 did not have amaterial impact on the Company’s financial statements or disclosures.  As of December 26, 2006 and June 26, 2007 theCompany did not recognize any assets or liabilities for unrecognized taxbenefits relative to uncertain tax positions. Upon review of the Company’s net operating loss carryforwards,management believes it is more likely than not that the Company’s tax positionstaken will be sustained.  Any interest orpenalties resulting from examinations will be recognized as a component of theincome tax provision.  However, since thereare no unrecognized tax benefits as a result of tax positions taken, there areno accrued interest and penalties.

In September 2006, the FASBissued SFAS No. 157, *Fair ValueMeasurements*(“SFAS 157”). SFAS 157 provides guidance for using fair value to measure assetsand liabilities.  The standard expands requireddisclosures about the extent to which companies measure assets and liabilitiesat fair value, the information used to measure fair value, and the effect offair value measurements on earnings. SFAS 157 is effective for fiscalyears beginning after November 15, 2007. The Company is currently evaluating the impact of adopting SFAS 157on its consolidated financial statements.

In February 2007, the FASBissued SFAS 159, *The Fair Value Option forFinancial Assets and Financial Liabilities (as amended*(“SFAS 159”)*,* which permits entities to choose tomeasure many financial instruments and certain other items at fair value.  The standard provides companies with theopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting provisions.  Theprovisions of SFAS 159 are effective for fiscal years beginning after November15, 2007.  The Company is currentlyevaluating the impact of adopting SFAS 159 on its financial statements.

**2.****                          ****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 June 26, 2007 and December26, 2006:
|                                | ** ** | **June 26, 2007** | ** ** | **December 26, 2006** | ** ** |
|--------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
|                           |       |                        |       |                            |       |
| Land                           |       | $                           | 18,000     |                            | $          | 18,000 |   |
| Buildings                      |       | 33,841,945                  |       | 33,851,945                      |       |
| Leasehold  improvements        |       | 8,262,104                   |       | 8,220,963                       |       |
| Equipment and  furniture       |       | 21,187,216                  |       | 20,728,013                      |       |
| Construction in  progress*     |       | 3,634,098                   |       | 624,422                         |       |
|                           |       | 66,943,363                  |       | 63,443,343                      |       |
| Less accumulated  depreciation |       | 11,607,668                  |       | 9,425,219                       |       |
|                           |       | $                           | 55,335,695 |                            | $          | 54,018,124 |   |

 

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*Construction inprogress includes the following approximate amounts for items yet to be placedin service:
|                                                     | ** ** | **June 26, 2007** | ** ** | **December 26, 2006** | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Architecture  fees for future locations             |       | $                           | 400,000    |                            | $          | 100,000 |   |
| Equipment at  future locations                      |       | $                           | 3,180,000  |                            | $          | 400,000 |   |
| Equipment at the  beer production facility          |       | —                      |       | $                               | 125,000    |   |
| Cost to secure property  leases at future locations |       | $                           | 45,000     |                            | —     |   |

 

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Included in property and equipment are the following assets held undercapital leases:
|                                       | ** ** | **June 26, 2007** | ** ** | **December 26, 2006** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Land                                  |       | $                           | 18,000     |                            | $          | 18,000 |   |
| Building                              |       | 33,841,945                  |       | 33,851,945                      |       |
| Equipment and  leasehold improvements |       | 1,624,533                   |       | 7,807,724                       |       |
|                                  |       | 35,484,478                  |       | 41,677,669                      |       |
| Less accumulated  depreciation        |       | 4,351,987                   |       | 3,718,654                       |       |
|                                  |       | $                           | 31,132,491 |                            | $          | 37,959,015 |   |

 

Intangible assets and other

Intangible assets and otherassets consisted of the following:
|                               | ** ** | **June 26, 2007** | ** ** | **December 26, 2006** | ** ** |
|-------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Intangible  assets:           |       |                        |       |                            |       |
| Liquor licenses               |       | $                           | 264,415    |                            | $          | 264,415 |   |
| Trademarks                    |       | 123,251                     |       | 109,741                         |       |
| Other:                        |       |                        |       |                            |       |
| Capitalized loan costs        |       | 175,379                     |       | 205,054                         |       |
| Security deposits             |       | 269,279                     |       | 279,427                         |       |
|                          |       | 832,324                     |       | 858,637                         |       |
| Less accumulated amortization |       | 114,106                     |       | 98,217                          |       |
|                          |       | $                           | 718,218    |                            | $          | 760,420 |   |

 

**3.****                          ****Accrued expenses**

Accrued expenses consisted of the following:
|                                   | ** ** | **June 26, 2007** | ** ** | **December 26, 2006** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Payroll related                   |       | $                           | 1,914,607  |                            | $          | 2,205,712 |   |
| Deferred revenue  from gift cards |       | 869,914                     |       | 1,355,773                       |       |
| Sales taxes                       |       | 465,048                     |       | 493,772                         |       |
| Interest                          |       | 279,083                     |       | 278,131                         |       |
| Real estate  taxes                |       | 335,536                     |       | 245,299                         |       |
| Insurance                         |       | —                      |       | 89,646                          |       |
| Other                             |       | 528,316                     |       | 436,397                         |       |
|                              |       | $                           | 4,392,504  |                            | $          | 5,104,730 |   |

 

**4.****                          ****Capital leases**

In March 2007, the Company completed a private placement of commonstock to accredited investors described in Note 7 below.  Utilizing approximately $6.0 million of theseproceeds, the Company retired the entire balance of capital lease debt due DHWLeasing, L.L.C. (“DHW”) pursuant to the master lease agreement entered into inSeptember 2006.

7

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Minimum future leasepayments under all capital leases as of June 26, 2007 are:
|                                             | ** ** | **Capital** | ** ** |
|---------------------------------------------|------------|-------------|------------|
| **Year ended:**                        | ** ** | **Leases**  | ** ** |
| 2007                                        |       | $           | 2,075,557  |   |
| 2008                                        |       | 4,076,234   |       |
| 2009                                        |       | 4,023,444   |       |
| 2010                                        |       | 3,847,242   |       |
| 2011                                        |       | 3,737,719   |       |
| Thereafter                                  |       | 52,462,327  |       |
| Total minimum lease payments                |       | 70,222,523  |       |
|                                        |       |        |       |
| Less amount representing interest           |       | 37,358,008  |       |
| Present value of net minimum lease payments |       | 32,864,515  |       |
| Less current portion                        |       | 983,930     |       |
| Long-term  portion of obligations           |       | $           | 31,880,585 |   |

 

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

**5.        Commitments andcontingencies**

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.

Rockford, Illinois:

In July 2007, the Company commenced leasing its Rockford, Illinoisrestaurant under a 15-year net lease agreement based on the terms specified inthe development agreement with Dunham Capital Management L.L.C. (“Dunham”) forthe development of restaurants.  Therestaurant was constructed for the Company on a build-to-suit basis.  Currently, the annual rent is $441,000 ofwhich $231,742 is classified as a capital lease and $179,258 plus percentagerent is classified as an operating lease. Every five years, base rent exclusive of the land portion of the leasewill increase 10%.  The Company will beresponsible for any real-estate taxes and all operating costs and the lease maybe extended at the Company’s option for up to three additional five-yearperiods on the same terms and conditions. Rental costs associated with the operating lease incurred during theconstruction period were recognized as pre-opening costs and escalated rentwill be recognized as expense on a straight-line basis over the term of thelease.

East Peoria and Orland Park, Illinois, Creve Coeur, Missouri andRogers, Arkansas:

In 2007, the Company entered into 20-year net lease agreements relatingto restaurants it anticipates opening during 2007 in East Peoria and OrlandPark, Illinois, Creve Coeur, Missouri and Rogers, Arkansas under the termsspecified in the development agreement with Dunham.  Each restaurant will be constructed for theCompany on a build-to-suit basis.  Theannual rent of each will be equal to 10.5% of the construction cost includingland cost and will escalate 10% at the end of each five-year period.  The Company will be responsible for anyreal-estate taxes and all operating costs. The term of each lease will commence when operations begin and may beextended at the Company’s option for up to five additional five-year periods onthe same terms and conditions.  Rentalcosts associated with the operating leases incurred during the 

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construction period are recognized as pre-opening costs and escalatedrent will be recognized as expense on a straight-line basis over the term ofthe leases.

Woodbury, Minnesota:

In April 2007, the Company entered into a development agreement and a20-year net lease with an independent third party relating to the restaurant itplans to open in Woodbury, Minnesota. The restaurant will be constructed on a build-to-suit basis and theannual rent will be equal to 10.5% of the total construction cost.  The Company will be responsible for anyreal-estate taxes and all operating costs. The lease may be extended at the Company’s option for up to fouradditional five-year periods on the same terms and conditions, except the rentmay increase based on a formula using the Consumer Price Index during any suchextension.  Rental costs associated withthe operating lease incurred during the construction period are recognized aspre-opening costs and escalated rent will be recognized as expense on astraight-line basis over the term of the lease.

**6.        Long-term debt**

As of the end of the first quarter of fiscal year 2007, the Company hadtwo outstanding long-term loans with an independent financial institution forthe purchase of equipment for its restaurants located in Des Moines andDavenport.  These loans are secured onlyby the personal property and fixture property at the respective locations.  In addition to these two loan agreements, theCompany has a long-term loan outstanding with the same independent financialinstitution secured by the tangible personal property and fixtures at the Fargorestaurant.  Such loan is guaranteed bySteven J. Wagenheim, the Company’s president, chief executive officer and oneof its directors.  As of June 26, 2007,the balances, interest rates and maturity dates of these loans were:
|                       | ** ** | **Des Moines** | ** ** | **Davenport**   | ** ** | **Fargo**       | ** ** |
|-----------------------|------------|---------------------|------------|-----------------|------------|-----------------|------------|
| Loan balance          |       | $                   | 399,792    |            | $          | 434,447         |       | $ | 1,310,158 |   |
| Annual interest  rate |       | 10.25               | %          | 10.25           | %          | 8.75            | %          |
| Maturity date         |       | August 27, 2010     |       | January 6, 2011 |       | August 15, 2011 |       |
|                       |            |                     |            |                 |            |                 |            |  |  |  |

 

**7.****             ****Common stock**

On March 8, 2007, the Company entered into a stock purchase agreementwith accredited investors under which it sold 2,617,334 shares of common stockat a price of $5.35 per share.  TheCompany obtained gross proceeds of $14,002,737, paid its placement agents cashcommissions aggregating $1,050,205 and paid expenses aggregating $173,500.  Pursuant to the conditions of the stockpurchase agreement, the Company used approximately $6.0 million of the$12,779,032 net proceeds to retire the entire balance of equipment lease debtobtained from DHW pursuant to the master lease agreement entered into inSeptember 2006.  The members of DHW areDonald A. Dunham, Charles J. Hey and Steven J. Wagenheim.  Mr. Wagenheim is the Company’s president,chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interestin DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders. Theremaining net proceeds from this placement are being used to fund expansion ofthe Company’s restaurant operations.

**8.****             ****Stock plans**

In July 1997, theCompany adopted the 1997 Stock Option Plan for employees and non-employees,including consultants to the Company, to purchase the Company’s common stock atan exercise price that equals or exceeds the fair market value on the date ofgrant.   The number of shares authorizedfor issuance under the plan was 400,000, of which 364,500 were issued as ofJune 26, 2007.  No additional optionswill be issued pursuant to the terms of this plan which expired July 28,2007.  All options outstanding under thisplan are fully vested and are exercisable for ten years from the date of grant.

The Companyreserved 590,000 shares of common stock for issuance under the 1997 DirectorStock Option Plan (“DSOP”), of which 516,500 were issued at June 26, 2007.  No additional options will be issued pursuantto the 

9

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terms of this planwhich expired July 29, 2007.  Under thisplan, the Company automatically granted an option to each outside director onthe date such person became a director for the purchase of 15,000 shares ofcommon stock and thereafter on each successive anniversary of the grant of the first optionfor the purchase of 15,000 shares.  Eachoption vests one year after the option was granted and is exercisable for fiveyears from the date of grant. Options were granted at fair market value.  The Company’s board of directors seeks tobridge the gap in equity compensation for non-employee directors until theadoption of any future equity plan for non-employee directors.  As aresult, on May 2, 2007, upon the recommendation of the compensation committee,the board resolved that award 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 five years. The compensation committee is presently evaluating alternative means ofproviding equity awards to non-employee directors.

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 June 26, 2007 was 1,826,244, of which417,244 shares remained available for future issuance.  Although vesting schedules may vary, optiongrants under this plan generally vest evenly over a three or four-year periodand options are exercisable for no more than ten years from the date of grant.

A summary of the status of the Company’s stock options as of June 26,2007 is presented below:
|                                                             | ** ** | ** ** | ** ** | ** **             | ** ** | **Weighted**    | ** ** | ** **               | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------------------|------------|-----------------|------------|--------------------------|------------|
| ** **                                                  | ** ** | ** ** | ** ** | ** **             | ** ** | **Average**     | ** ** | ** **               | ** ** |
| ** **                                                  | ** ** | ** ** | ** ** | ** **             | ** ** | **Remaining**   | ** ** | ** **               | ** ** |
| ** **                                                  | ** ** | ** ** | ** ** | **Weighted**           | ** ** | **Contractual** | ** ** | **Aggregate**            | ** ** |
| **Fixed Options**                                      | ** ** | **Shares** | ** ** | **Average Price** | ** ** | **Life**        | ** ** | **Intrinsic Value** | ** ** |
| Outstanding at  December 26, 2006                           |       | 1,595,000  |       | $                      | 3.70       |            | 6.1 years  |                     |       |   |
| Granted                                                     |       | 470,000    |       | 5.52                   |       | 6.2 years       |       |                     |       |
|                                                        |       |       |       |                   |       |            |       |                     |       |
| Exercised                                                   |       | (3,200     | )          | 2.23                   |       | —          |       |                     |       |
|                                                        |       |       |       |                   |       |            |       |                     |       |
| Forfeited                                                   |       | (18,000    | )          | 5.17                   |       | —          |       |                     |       |
| Outstanding at  June 26, 2007                               |       | 2,043,800  |       | $                      | 4.11       |            | 5.7 years  |                     | $          | 2,668,104 |   |
|                                                        |       |       |       |                   |       |            |       |                     |       |
| Options  exercisable at December 26, 2006                   |       | 1,076,502  |       | $                      | 3.46       |            | 5.2 years  |                     |       |   |
| Options  exercisable at June 26, 2007                       |       | 1,310,304  |       | $                      | 3.61       |            | 5.2 years  |                     | $          | 2,282,314 |   |
|                                                        |       |       |       |                   |       |            |       |                     |       |
| Weighted-average fair  value of options granted during 2007 |       | $          | 3.43       |                   |       |            |       |                     |       |   |
|                                                             |            |            |            |                        |            |                 |            |                          |            |  |  |  |

 

The fair value of options at date of grant was estimated using theBlack-Scholes option pricing model with the following assumptions:  (a) no dividend yield, (b) 58.13% to 61.60%expected volatility, (c) expected life of options of five to ten years and (d)a risk-free interest rate of 4.46% to 4.80%.

The aggregate intrinsic value in the table above represents the totalpretax intrinsic value (the difference between the closing price of the Company’sstock on June 26, 2007 and the exercise price, multiplied by the number ofin-the-money options) that would have been received by the option holders hadall option holders exercised their options on June 26, 2007.  As of June 26, 2007, there was approximately$1,514,389 of total unrecognized compensation cost related to unvestedshare-based compensation arrangements, of which $570,421 is expected to berecognized during the remainder of fiscal year 2007, $569,043 in fiscal year 2008,$338,511 in fiscal year 2009 and $36,414 in fiscal year 2010.

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If all options outstanding at June 26, 2007 were exercised for cash,proceeds to the Company would be approximately $8.4 million.

The following table summarizes information about stock optionsoutstanding at June 26, 2007:
| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **Number of**           | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Options**                  | ** ** | **Average**                  | ** ** | **Weighted** | ** ** | **Options** | ** ** | **Weighted** | ** ** |
| **Range of**        | ** ** | **Outstanding**              | ** ** | **Remaining**                | ** ** | **Average** | ** ** | **Exercisable** | ** ** | **Average** | ** ** |
| **Exercise Prices** | ** ** | **6/26/2007**                | ** ** | **Contractual Life**    | ** ** | **Exercise Price** | ** ** | **6/26/2007** | ** ** | **Exercise Price** | ** ** |
|                     |       |                         |       |                         |       |   |   |   |   |   |   |
| $1.00 - $2.00            |       | 155,500                      |       | 3.7 years                    |       | $ | 1.61 |   | 155,500 |   | $ | 1.61 |   |
| $2.01 - $3.00            |       | 180,000                      |       | 4.8 years                    |       | $ | 2.41 |   | 180,000 |   | $ | 2.41 |   |
| $3.01 - $4.00            |       | 698,000                      |       | 5.5 years                    |       | $ | 3.89 |   | 518,502 |   | $ | 3.88 |   |
| $4.01 - $5.00            |       | 492,300                      |       | 6.8 years                    |       | $ | 4.40 |   | 411,302 |   | $ | 4.39 |   |
| $5.01 - $6.00            |       | 368,000                      |       | 4.5 years                    |       | $ | 5.19 |   | 45,000 |   | $ | 5.01 |   |
| $6.01 - $7.00            |       | 150,000                      |       | 9.8 years                    |       | $ | 6.20 |   | — |   | $ | — |   |
|                     |       |                         |       |                         |       |   |   |   |   |   |   |
| Total                    |       | 2,043,800                    |       | 5.7 years                    |       | $ | 4.11 |   | 1,310,304 |   | $ | 3.61 |   |

 

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 second quarter of fiscal year 2007, the Companyissued an aggregate of 23,455 shares of common stock upon the cashless exerciseof such warrants for the purchase of an aggregate of 31,380 shares of commonstock.  As of June 26, 2007, 210,222 ofthe agent warrants remained exercisable.

In May 2003, the Company entered into a two-year financial advisoryservices agreement. As part of the agreement between the Company and thefinancial consultant, the consultant received five-year warrants to purchase anaggregate of 35,000 shares of common stock at exercise prices ranging from$2.85 to $5.40 per share.  As of June 26,2007, none of such warrants had been exercised.

In September 2004, the Company entered into a securities purchaseagreement with certain accredited investors, whereby the Company issued1,045,844 five-year warrants exercisable at $5.00 per share.  The Company may call for the mandatory exerciseof such warrants if certain conditions are met. As part of this private placement, the Company sold to its placementagents, for $100, five-year warrants to purchase an aggregate of 130,730 sharesof common stock at an exercise price of $5.00 per share.  As of June 26, 2007, none of such warrantshad 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 price of $6.50 to the Company’s placementagent. As of June 26, 2007, none of such warrants had been exercised.

During the first half of fiscal year 2007, no warrants were issued andno warrants expired.  As of June 26,2007, 1,698,994 were outstanding and exercisable.  The weighted average exercise price of suchwarrants was $4.80 per share.

If all warrants outstanding at June 26, 2007 were exercised for cash,proceeds to the Company would be approximately $8.1 million.

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**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 21E ofthe 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 for the fiscal year ended December 26, 2006,filed with the Securities and Exchange Commission on February 21, 2007, foradditional factors known to us that may cause actual results to vary.*

**Overview**

We are a Modern American upscale casual restaurant chain.  As of August 1, 2007, we operated 19restaurants in eight Midwestern states featuring on-premises breweries underthe name of Granite City Food & Brewery®. We believe our menu features affordable yet high quality family favoritemenu items prepared from made-from-scratch recipes and served in generousportions. We believe that the sophisticated yet unpretentious restaurants,proprietary food and beverage products, attractive price points and highservice standards combine for a great dining experience.  The location of each restaurant and the monthand year of its opening appear in the following chart:
| Unit | ** ** | **Location**               | ** ** | **Opened** |
|------|------------|----------------------------|------------|------------|
| 1    |       | St. Cloud,  Minnesota      |       | Jun-99     |
| 2    |       | Sioux Falls,  South Dakota |       | Dec-00     |
| 3    |       | Fargo, North  Dakota       |       | Nov-01     |
| 4    |       | Des Moines, Iowa           |       | Sep-03     |
| 5    |       | Cedar Rapids,  Iowa        |       | Nov-03     |
| 6    |       | Davenport, Iowa            |       | Jan-04     |
| 7    |       | Lincoln,  Nebraska         |       | May-04     |
| 8    |       | Maple Grove,  Minnesota    |       | Jun-04     |
| 9    |       | East Wichita,  Kansas      |       | Jul-05     |
| 10   |       | Eagan, Minnesota           |       | Sep-05     |
| 11   |       | Kansas City,  Missouri     |       | Nov-05     |
| 12   |       | Kansas City,  Kansas       |       | Jan-06     |
| 13   |       | Olathe, Kansas             |       | Mar-06     |
| 14   |       | West Wichita,  Kansas      |       | Jul-06     |
| 15   |       | St. Louis Park,  Minnesota |       | Sep-06     |
| 16   |       | Omaha, Nebraska            |       | Oct-06     |
| 17   |       | Roseville,  Minnesota      |       | Nov-06     |
| 18   |       | Madison,  Wisconsin        |       | Dec-06     |
| 19   |       | Rockford,  Illinois        |       | Jul-07     |

 

We developed the foregoingrestaurants using proceeds from the sale of our securities, building andequipment financing and cash flow from operations.  We built units 4-9, 11-14 and 16-19 basedupon the prototype we developed in early 2003. In 2004 and 2005, we retrofitted units 1-3 to conform to this prototypemodel.  In 2005 and 2006, we developedunits 10 and 15, respectively, which were conversions of existingrestaurants.  With the exception of units1-3 and 15, we developed all of our units under our multi-site developmentagreement with a commercial developer that provides us with assistance in siteselection, 

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constructionmanagement and financing for new restaurants. Under this agreement, we lease the land and building of each newrestaurant from our developer.

In March 2007, we enteredinto a stock purchase agreement with accredited investors under which we sold2,617,334 shares of common stock at a price of $5.35 per share.  We obtained gross proceeds of $14,002,737,paid our placement agents cash commissions aggregating $1,050,205 and paidexpenses aggregating $173,500.  Pursuantto the conditions of the stock purchase agreement, we used approximately $6.0million of the $12,779,032 net proceeds to retire the entire balance ofequipment lease debt we had obtained from DHW pursuant to the master leaseagreement we entered into in September 2006. The members of DHW are Donald A. Dunham, Charles J. Hey and Steven J.Wagenheim.  Mr. Wagenheim is our company’spresident, chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interestin DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders.  The remaining net proceeds from thisplacement are being used to fund the expansion of our restaurant operations.

We operate a beer production facility whichfacilitates the initial stage of our brewing process using our patented brewingprocess.  We believe that this brewingprocess and the use of a centrally located beer production facility improve theeconomics of microbrewing as it eliminates the initial stages of brewing andstorage at multiple locations, thereby reducing equipment and development costsat new restaurant locations. Additionally, having a common starting point the beer production createsconsistency of taste for our product from unit to unit.  The initial product produced at our beerproduction facility is transported by truck to the fermentation vessels at eachof our restaurants where the brewing process is completed.  We believe that our current beer productionfacility, which was opened in June 2005, has the capacity to service 30 to 35restaurant locations.

We operate Granite City University where thetraining of each of our managers takes place under the instruction offull-time, dedicated trainers.  Oureight-week training program consists of both “hands on” as well as classroomtraining for all aspects of management. All salaries of our managers in training and our trainers as well as allrelated costs incurred at Granite City University are recorded as a componentof corporate general and administrative costs.

We utilize a new store opening team whichconsists of experienced restaurant managers who are dedicated to the opening ofour new restaurants.  Generally, thisteam arrives 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.  We believe that adedicated team delivers a more disciplined opening process and ensuresadherence to our company’s exacting standards and culture.

We believe that our operating results will fluctuate significantlybecause of several factors, including the timing of new restaurant openings andrelated expenses, profitability of new restaurants, changes in food and laborcosts, increases or decreases in comparable restaurant sales, general economicconditions, consumer confidence in the economy, changes in consumerpreferences, competitive factors, the skill and experience of ourrestaurant-level management teams and weather conditions.

We expect the timing of new restaurant openings to have a significantimpact on restaurant revenues and costs. We believe we will incur the most significant portion of pre-openingcosts associated with a new restaurant within the two months immediatelypreceding, and the month of, the opening of such restaurant.

Thethirteen and twenty-six weeks ended June 26, 2007 included 234 and 468restaurant weeks, respectively, which is the sum of the actual number of weekseach restaurant operated. The thirteen and twenty-six weeks ended June 27, 2006included 169 and 320 restaurant weeks, respectively.  The source of the additional restaurant weeksin fiscal year 2007 is shown in the following chart:

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|                                    | ** ** | **Thirteen **          | ** ** | **Twenty-six **        | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **Weeks Ended**        | ** ** | **Weeks Ended**        | ** ** |
| **Location**                       | ** ** | **June 26, 2007** | ** ** | **June 26, 2007** | ** ** |
| Kansas City, Kansas                |       | —                      |       | 5                           |       |
| Olathe, Kansas                     |       | —                      |       | 13                          |       |
| West Wichita                       |       | 13                          |       | 26                          |       |
| St. Louis Park, Minnesota          |       | 13                          |       | 26                          |       |
| Omaha, Nebraska                    |       | 13                          |       | 26                          |       |
| Roseville, Minnesota               |       | 13                          |       | 26                          |       |
| Madison, Wisconsin                 |       | 13                          |       | 26                          |       |
| Total Additional  Restaurant Weeks |       | 65                          |       | 148                         |       |

 

Because we continue toexpand our operations and open new restaurants at various times throughout theyear, we provide this statistical measure to enhance the comparison of revenuesfrom period to period as changes occur in the number of units we are operating.

Ourrestaurant revenues are comprised almost entirely of the sales of food andbeverages.  The sale of retail items,such as cigarettes and promotional items, typically represent less than onepercent of total revenue.  Product costsinclude the costs of food, beverages and retail items.  Labor costs include direct hourly andmanagement wages, taxes and benefits for restaurant employees.  Direct and occupancy costs include restaurantsupplies, marketing costs, rent, utilities, real estate taxes, repairs and maintenanceand other related costs.  Pre-openingcosts consist of direct costs related to hiring and training the initialrestaurant workforce, the salaries and related costs of our dedicated new storeopening team, rent expense incurred during the construction period and otherdirect costs associated with opening new restaurants.  General and administrative expenses arecomprised of expenses associated with all corporate and administrativefunctions that support existing operations which include management and staffsalaries, employee benefits, travel, information systems, training, marketresearch, professional fees, supplies and corporate rent.  Depreciation and amortization includesdepreciation on capital expenditures at the restaurant and corporate levels andamortization of intangibles that do not have indefinite lives.  Interest expense represents the cost ofinterest expense on debt and capital leases net of interest income on investedassets.

**Resultsof operations as a percentage of sales**

The following table compares operating resultsexpressed as a percentage of total revenue for the thirteen weeks ended June26, 2007 and June 27, 2006.
|                             | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|-----------------------------|------------|------------------------------------|------------|--------------------------------------|------------|
| ** **                  | ** ** | **June 26,**                  | ** ** | **June 27,**                    | ** ** | **June 26,** | ** ** | **June 27,** | ** ** |
| ** **                  | ** ** | **2007**                           | ** ** | **2006**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
|                        |       |                               |       |                                 |       |   |   |   |   |
| Restaurant  revenues        |       | 100.0                              | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
|                        |       |                               |       |                                 |       |   |   |   |   |
| Cost of sales:              |       |                               |       |                                 |       |   |   |   |   |
| Food, beverage and retail   |       | 29.9                               |       | 29.5                                 |       | 29.8 |   | 29.5 |   |
| Labor                       |       | 35.5                               |       | 34.6                                 |       | 35.9 |   | 35.2 |   |
| Direct restaurant operating |       | 13.5                               |       | 11.5                                 |       | 13.5 |   | 12.3 |   |
| Occupancy                   |       | 6.0                                |       | 5.5                                  |       | 6.2 |   | 5.6 |   |
| Total cost of sales         |       | 84.9                               |       | 81.1                                 |       | 85.4 |   | 85.9 |   |
|                        |       |                               |       |                                 |       |   |   |   |   |
| Pre-opening                 |       | 2.3                                |       | 1.8                                  |       | 1.4 |   | 4.1 |   |
| General and  administrative |       | 10.3                               |       | 11.2                                 |       | 9.9 |   | 11.7 |   |

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| Depreciation and  amortization |   | 6.1    |   | 5.6    |   | 6.1    |   | 6.0    |   |
|--------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                           |   |   |   |   |   |   |   |   |   |
| Operating income  (loss)       |   | (3.5   | )      | 0.1    |   | (2.8   | )      | (4.4   | )      |
|                           |   |   |   |   |   |   |   |   |   |
| Interest:                      |   |   |   |   |   |   |   |   |   |
| Income                         |   | 0.4    |   | 0.2    |   | 0.3    |   | 0.2    |   |
| Expense                        |   | (4.6   | )      | (3.9   | )      | (5.2   | )      | (4.0   | )      |
| Net interest expense           |   | (4.3   | )      | (3.7   | )      | (4.9   | )      | (3.8   | )      |
|                           |   |   |   |   |   |   |   |   |   |
| Net loss                       |   | (7.8   | )%     | (3.6   | )%     | (7.7   | )%     | (8.2   | )%     |

 

Certain percentageamounts do not sum due to rounding.

**Resultsof operations for the thirteen and twenty-six weeks ended June 26, 2007 andJune 27, 2006**

**Revenue**

We generated$18,453,954 and $14,417,118 of revenues during the second quarter of 2007 and2006, respectively.  During the firsthalf of 2007 and 2006, we generated revenues of $36,636,146 and $26,309,437,respectively.  The increase infirst half revenues of 39.3% was primarily the result of the additionalrestaurant operating weeks related to the five restaurants that openedsubsequent to the second quarter of 2006. The first half of 2007 included 468 restaurant operating weeks, which isthe sum of the actual number of weeks each restaurant operated, while the firsthalf of 2006 included 320 operating weeks. Comparable restaurant revenues, which include restaurants in operationover 18 months, increased 1.2% and 1.8% for the second quarter and first halfof 2007 over the same periods of 2006, respectively.  The increase in comparable restaurantrevenues was due primarily to a 2.1% price increase that took effect at the endof November 2006.

Average weeklyrevenues decreased $6,445 from $85,308 per week in the second quarter of 2006to $78,863 per week in the second quarter of 2007.  Average weekly revenues decreased $3,935 from$82,217 per week in the first half of 2006 to $78,282 per week in the firsthalf of 2007 for all the restaurants in operation.  Average weekly revenues for comparablerestaurants increased $1,404 from $77,067 in the first half of 2006 to $78,471in the first half of 2007.

We anticipate thatrestaurant revenues will vary from quarter to quarter.  We anticipate seasonal fluctuations inrestaurant revenues due in part to increased outdoor seating and generally favorableweather conditions at our locations during the summer months.   Due to the honeymoon effect thatperiodically occurs with the opening of a restaurant, we expect the timing ofnew restaurant openings to cause fluctuations in restaurant revenues.  Additionally, consumer confidence in theeconomy and changes in consumer preferences may affect our future revenues.

**Restaurantcosts**

***Foodand beverage***

Our food andbeverage costs increased 0.4% as a percentage of revenue from 29.5% in thesecond quarter of 2006 to 29.9% in the second quarter of 2007.  These costs increased 0.3% as a percentage ofrevenue from 29.5% in the first half of 2006 to 29.8% in the first half of2007.  Food and beverage costsincreased as a percentage of revenues due in part to the increase in the costof meat and dairy.

We expect that our food and beverage costs will vary going forward dueto numerous variables, including seasonal changes in food and beverage costs,and guest preferences.  We periodicallycreate new menu offerings and introduce new craft brewed beers based upon guestpreferences.  Although such menumodifications may temporarily result in increased food and beverage cost, webelieve we are able to offset such increases with our weekly specials whichprovide variety and value to our guests. Our varieties of craft brewed beer, which we 

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believe we can produce at lower cost than beers wepurchase for resale, also enable us to keep our food and beverage costs lowwhile fulfilling guest requests and building customer loyalty.  As we open additional units, we believe wewill experience increased purchasing power, partially offsetting food andbeverage cost increases, and maintain or reduce our food and beverage costs asa percentage of revenue.  Additionally,as we add new units, we believe our brewing process, Fermentus Interruptus,will allow us to keep our high quality beer products intact while leveragingour fixed production costs, thereby enhancing overall profitability.

***Labor***

Labor expenses consist 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 stafflabor costs associated with a newly opened restaurant, for approximately itsfirst four to six months of operation, are greater than what can be expectedafter that time, both in aggregate dollars and as a percentage of revenues.

Our labor costs, as a percentage of revenues, increased 0.9% from 34.6%in the second quarter of 2006 to 35.5% in the second quarter of 2007.  These costs increased 0.7% as a percentage ofrevenues from 35.2% in the first half of 2006 to 35.9% in the first half of2007.  Such increases were due in part tominimum wage increases which took effect at some of our markets in the secondquarter as well as to non-cash stock-based compensation resulting from stockoptions issued in the first half of 2007.

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 andreduces hiring and training costs.

***Direct restaurant operating***

Operatingsupplies, repairs and maintenance, utilities, promotions and restaurant-leveladministrative expense represent the majority of our direct restaurant operatingexpenses, a substantial portion of which is fixed or indirectly variable.  Our direct restaurant operating expenses as apercentage of revenue increased 2.0% from 11.5% in the second quarter of 2006to 13.5% in the second quarter of 2007. These expenses increased 1.2% as a percentage of revenues from 12.3% inthe first half of 2006 to 13.5% in the first half of 2007.  While we realized a decrease in repairs andmaintenance expense, we experienced an increase in expenses related to hiringand training, advertising and promotions and loss on disposal of assets as wemade some upgrades primarily at our mature properties.

***Occupancy***

Our occupancy costs whichinclude both fixed and variable portions of rent, common area maintenancecharges, property insurance and property taxes, increased 0.5% as a percentageof revenues from 5.5% in the second quarter of 2006 to 6.0% in the secondquarter of 2007.  These costs increased0.6% as a percentage of revenues from 5.6% in the first half of 2006 to 6.2% inthe first half of 2007.  These increaseswere due to higher rent expense and property tax, offset slightly by a decreasein property and casualty insurance.

**Pre-o**pening

Pre-opening costs, which areexpensed as incurred, consist of expenses related to hiring and training theinitial restaurant workforce, wages and expenses of our dedicated new storeopening teams, rental costs incurred during the construction period and certainother direct costs associated with opening new restaurants.  Pre-opening costs in the first half of 2007are made up primarily of costs incurred during construction periods of therestaurant we opened in Rockford in July 2007 and the two additionalrestaurants we plan to open in Illinois later this year.  Pre-opening costs in the first half of 2006related primarily to our restaurants opened in the first and 

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thirdquarters of that year.  Pre-openingcosts, excluding construction-period rent, are primarily incurred in the monthof, and two months prior to, the restaurant opening.

**Generaland administrative**

General and administrative expenses include 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 Granite City University, excess capacity costs relatedto our beer production facility, and salaries and expenses of our new storeopening team when it is not dedicated to a particular restaurant opening.  Other general and administrative expensesalso include advertising, professional fees, investor relations, officeadministration, centralized accounting system costs, and travel by our corporatemanagement.

General and administrative expenses increased$283,572 from $1,621,374 in the second quarter of 2006 to $1,904,946 in thesecond quarter of 2007.  These expensesincreased $568,064 from $3,070,934 in the first half of 2006 to $3,638,998 in thefirst half of 2007.  The primary sourcesof such increase were expenses related to legal, investor relations, expansionand recruiting, insurance, payroll and stock-based compensation.  These increases were partially offset bydecreases in accounting fees and marketing costs.

Despite the foregoing increases in general andadministrative expenses, the increase in restaurant revenues associated withadditional locations and the increase in comparable sales caused our generaland administrative expenses to decrease 0.9% as a percentage of revenue from 11.2% in the second quarter of 2006 to10.3% in the second quarter of 2007. These expenses decreased 1.8% as a percentage of revenue from 11.7% inthe first half of 2006 to 9.9% in the first half of 2007.

As we continue to expand our restaurant chain, weexpect general and administrative expenses will decrease as a percentage ofrevenues in the long term.

**Depreciation and amortization**

Depreciation andamortization expense increased $307,916 during the second quarter of 2007compared to the same period in 2006. These expenses increased $675,783 during the first half of 2007 comparedto the first half of 2006, due principally to the additional depreciationrelated to restaurants opened in the second half of 2006.  As a percentage of revenues, depreciationexpense increased as a percentage of revenue 0.5% and 0.1% for the secondquarter and first half of 2007 over the same periods of 2006, respectively.

**Interest**

Net interestexpense consists of interest expense on capital leases and long-term debt, netof interest earned from cash on hand. Interest expense increased $294,065 from $563,648 in the second quarterof 2006 to $857,713 in the second quarter of 2007, and increased $841,601 from$1,061,677 in the first half of 2006 to $1,903,278 in the first half of2007.  The increase was due to increasesin capital leases as a result of additional restaurants.  Interest income increased $45,895 and $46,321for the second quarter and first half of 2007 over the same periods of 2006,respectively, due to theproceeds from the sale of our common stock in March 2007.

**Liquidity and capitalresources**

As of June 26, 2007, we had $11,247,205 of cash andworking capital of $2,556,809 compared to $7,671,750 of cash and a workingcapital deficit of $1,106,720 at December 26, 2006.

During the twenty-six weeks ended June 26, 2007, weused $276,530 of net cash in operating activities, $2,293,116 of net cash topurchase equipment and other assets, and made payments aggregating $6,643,007on our debt and capital lease obligations. Additionally, during the first quarter of 2007, we received net cash of$12,788,108 from the issuance of our common stock.

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During the twenty-six weeks ended June 27, 2006, weused $77,671 of net cash in operating activities, $2,591,544 of net cash topurchase equipment and other assets primarily for our new restaurants andrestaurants under construction, and made payments aggregating $561,346 on ourdebt and capital lease obligations. Additionally, during the first half of 2006, we used $2,141 of net cashto pay expenses associated with the issuance of our common stock in the fourthquarter of 2005.

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 $173,500.  Pursuant to the conditions of the stockpurchase agreement, we used approximately $6.0 million of the $12,779,032 netproceeds to retire the entire balance of equipment lease debt we had obtainedfrom DHW pursuant to the master lease agreement we entered into in September2006.  The members of DHW are Donald A.Dunham, Charles J. Hey and Steven J. Wagenheim. Mr. Wagenheim is our company’s president, chief executive officer andone of its directors.  Mr. Wagenheim ownsa 20% membership interest in DHW and personally guaranteed 20% of DHW’sindebtedness to its lenders.  Theremaining net proceeds from this placement are being used to fund the expansionof our restaurant operations.

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 model as weopen future restaurants; however, where appropriate, we will convert existingrestaurants to our Granite City concept. Additionally, we intend to explore alternative restaurant designs toreduce the cost of our initial capital investment and we may alter our model tomeet various state and local regulatory requirements, including, but notlimited to, pollution control requirements, liquor license ordinances andsmoking regulations.  We opened one newrestaurant in Rockford, Illinois in July 2007 and intend to open six additionalrestaurants in 2007.  We have enteredinto agreements or are in negotiation for locations in Illinois, Arkansas,Missouri, Ohio and Minnesota.

Based upon our existing prototype, we anticipate that pre-opening costsand the initial purchase of furniture, fixtures and equipment will require aninvestment by us of approximately $1.0 million to $1.3 million for each newrestaurant.  We anticipate that our newrestaurants will require an investment by our developer of approximately $1.8million to $2.3 million for the building and approximately $1.2 million for thepurchase of the land.  In some instanceswe may elect to use our own cash for a portion of the building costs.  We expect these costs will vary from onemarket to another based on real estate values, zoning regulations, labormarkets and other variables.

We will need to expend significant capital in connection with ourexpansion plans. With our existing capital resources, cash generated fromoperations, and the proceeds received from our sale of common stock, we believethat we will have sufficient funds to complete our planned restaurant openingsin 2007, maintain sufficient working capital for our operations and continueour future expansion.  We are continuallyevaluating our development plans and we are exploring options relative to thepace of our growth.  If our availablesources of liquidity are insufficient to fund our expected capital needs beyond2007, or our needs are greater than anticipated, we will be required to raiseadditional funds in the future through public or private sales of equitysecurities or the incurrence of indebtedness. If we do not generate sufficient cash flow from current operations or iffinancing is not available to us, we will have to curtail projected growth,which could materially adversely affect our business, financial condition,operating results and cash flows.

**Commitments and contingent liabilities**

*Capital Leases:*

As of June 26, 2007, we had 16 capital lease agreements related to ourrestaurants.  Of these leases, oneexpires in 2020, two in 2023, four in 2024, three in 2025, four in 2026 and theremaining two in 2027, all with renewable options for additional periods.Fourteen of these lease agreements are with our developer. Under six of theleases, we are required to pay additional percentage rent based upon restaurantsales. The land portion of these

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leases is classified as an operating lease while thebuilding portion of these leases is classified as capital lease because itspresent value was greater that 90% of the estimated fair value at the beginningof the lease.

In December 2004, we entered into a land and building lease agreementfor our beer production facility.  Thisten-year lease commenced February 1, 2005, and contains a bargain purchaseoption.

We entered into a sale-leaseback agreement for the equipment andleasehold improvements at St. Cloud and Sioux Falls in June 2001 and a leasefor equipment under agreements expiring in 2008.  A director and former director of our companyhave personally guaranteed these leases.

In August 2006, we entered into a master lease agreement with CarltonFinancial Corporation (“Carlton”) pursuant to which we may “finance lease” upto $3,000,000 of equipment purchases for three future restaurant locations. OnSeptember 28, 2006, we entered into a lease schedule and amendment to thismaster lease, pursuant to which we are leasing equipment for our restaurant inSt. Louis Park for an initial lease term of 39 months. Our president and chiefexecutive officer was required to personally guarantee payments to be made toCarlton under the lease financing and our board of directors agreed to pay himfor such guarantee.  Details regardingsuch guarantee fees appear below under the caption “Personal Guaranties.”

*Operating Leases:*

The land portions of the 16 property leases referenced above, 14 ofwhich are lease agreements with our developer, are classified as operatingleases because the fair value of the land was 25% or more of the leasedproperty at the inception of each lease. All scheduled rent increases for theland during the initial term of each lease are recognized on a straight-linebasis. In addition to such property leases, we have obligations under thefollowing operating leases:

In January 2001, we entered into a 20-year operating lease for the landupon which we built our Fargo restaurant. Under these terms, we are obligated to pay annual rent of $72,000 pluspercentage rent based upon restaurant sales.

In August 2005, we entered into a 38-month lease agreement for theoffice space for our corporate offices. The lease commenced October 1, 2005. Annual rent is $41,520 with scheduled annual increases throughout theterm of the lease.  Such scheduled rentincreases are recognized on a straight-line basis over the term of the lease.

In November 2005, we entered into an agreement for a facility inMinneapolis, Minnesota which we use as a test kitchen.  Obligations under this three-year leaseagreement began November 1, 2005.  Theagreement calls for annual rent of $42,000 and has an option for a three-yearrenewal.

In March 2006, we entered into a lease agreement for the land and thebuilding for our St. Louis Park restaurant. This operating lease expires in 2016 with renewal options for additionalperiods.

During the first half of fiscal year 2007, we entered into leaseagreements relating to restaurants in Rockford, East Peoria and Orland Park,Illinois, Rogers, Arkansas and Creve Coeur, Missouri under the terms specifiedin the development agreement with Dunham. Additionally, we entered into a lease agreement with an independentthird party for a restaurant in Woodbury, Minnesota.  Each restaurant will be constructed for us ona build-to-suit basis.  The annual rentof each will be equal to 10.5% of the construction cost including land cost andwill escalate 10% at the end of each five-year period.  The term of each lease will commence whenoperations begin and may be extended at our option for additional five-yearperiods on the same terms and conditions, except the rent for our Woodburylocation may increase based on a formula using the Consumer Price Index duringany such extension.  Rental costsassociated with the operating leases that are incurred during the constructionperiod are recognized as pre-opening costs, and escalated rent will berecognized as expense on a straight-line basis over the term of the leases.

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*Personal Guaranties:*

Two of our directors and one former director have personally guaranteedcertain of our leases and loan agreements. At a meeting held in March 2004, our board of directors agreed to payour president and chief executive officer for his personal guaranties ofequipment loans entered into in August 2003 and January 2004.  The amount of the annual guarantee fee is 3%of the balance of such loans.  This amountis calculated and accrued based on the weighted average daily balances of suchloans at the end of each monthly accounting period.  During the first half of 2007 and 2006, weaccrued $13,036 and $16,111 of such fees, respectively, and paid $0 and $15,000of such fees, respectively.

In August 2006, we entered into a lease agreement with Carlton pursuantto which we may finance lease up to $3.0 million of equipment.  Mr. Wagenheim was required to personallyguarantee payment to be made to Carlton under this lease financing agreementand our board of directors agreed to pay him for such guarantee.  The amount of the annual guarantee fee is 3%of the balance of such lease and is calculated and accrued based on theweighted average daily balance of the lease at the end of each monthlyaccounting period.  Although we did notpay any of such fees during the first half of 2007, $10,604 of such expense wasrecorded in general and administrative expense.

*Employment Agreements:*

In June 2005, we entered into a three-year employment agreementwith Steven J. Wagenheim, our president and chief executive officer, who isalso a director of our company.  The agreement provided for a minimum basesalary of $225,000, commencing January 1, 2005, cash incentivecompensation ranging from $0 to $125,550 based on performance, and a stockoption for the purchase of 150,000 shares of common stock.  InFebruary 2006, we amended the compensatory arrangements under theagreement to provide for an annual base salary of $275,000, commencingJanuary 1, 2006, cash incentive compensation ranging from $0 to $167,400 basedon performance, and a stock option for the purchase of 100,000 shares of commonstock.  In April 2007, we amended the compensatory arrangements under theagreement to provide for an annual base salary of $300,000, commencing April 1,2007, cash incentive compensation for 2007 ranging from $0 to $197,400 based onperformance, and a stock option for the purchase of 100,000 shares of commonstock.  In addition to annualcompensation terms and other provisions, the agreement includes change incontrol provisions that would entitle him to receive severance pay equal to 18months of salary if there is a change in control of our company and hisemployment terminates.

In August 2006, we entered into an at-will employment agreement withPeter P. Hausback that provides for Mr. Hausback to serve as our chieffinancial officer and principal accounting officer. The agreement provides fora minimum annual base salary of $215,000 and the eligibility to participate inany performance-based cash bonus or equity award plans for senior executivesbased upon goals established by the board or compensation committee.  Mr. Hausback’s possible cash incentivecompensation for fiscal years 2006 and 2007 is up to $75,000 based uponperformance.  The employment agreementprovides that a severance payment equal to 12 months of base salary will bemade if Mr. Hausback’s employment is terminated in connection with a change ofcontrol, by our company without cause, or by the officer for good reason.

*Development Agreement:*

We have entered into a development agreement with Dunham for thedevelopment of our restaurants.  Dunhamis controlled by Donald A. Dunham, Jr., who is a member of DHW Leasing, L.L.C.and an affiliate of Granite Partners LLC, a beneficial owner of less than 2% ofour securities.  The agreement givesDunham the right to develop, construct and lease up to 22 restaurants for usprior to December 31, 2012.  We are notbound to authorize the construction of restaurants during the term of thedevelopment agreement, but generally cannot use another developer to develop orown a restaurant as long as the development agreement is in effect.  We can use another developer if Dunhamdeclines to build a particular restaurant, if the agreement is terminatedbecause of a default by Dunham, or if our company is sold or merged intoanother company.  In the case of a mergeror sale of

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our company, the development agreement may beterminated.  As of August 1, 2007, 15restaurants had been constructed for us under this development agreement.

The development agreement provides for a cooperative process betweenDunham and our company for the selection of restaurant sites and thedevelopment of restaurants on those sites, scheduling for the development andconstruction of each restaurant once a location is approved, and controls onthe costs of development and construction using bidding and guaranteed maximumcost concepts.  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 interestrate.  The term of each lease isgenerally 20 years with five five-year options to renew.

In September 2006, we entered into an amendment of this developmentagreement.  Under the terms of theamendment, in lieu of future adjustments to restaurant leases, lease rateswould be increased by 10% commencing on the fifth anniversary of each lease andon each five-year anniversary thereafter. The lease rate increases apply to our Omaha, Roseville and Madisonleases as well as all future leases under the development agreement.

Dunham also has the right to sell the underlying land and building tothird parties or assign our leases. As of August 1, 2007, Dunham had sold threeof our restaurants sites to third parties. The assignment or sale of a lease byDunham has no material impact on our agreement.

*Off- balance sheet arrangements:*

It is not our business practice to enterinto off-balance sheet arrangements.

*Summary of contractual obligations:*

The following table summarizes our obligations under contractualagreements as of June 26, 2007 and the time frame within which payments on suchobligations are due.  This table does notinclude amounts related to percentage rent as such future amounts are notdeterminable.  In addition, whether wewould incur any additional expense on our employment agreements depends uponthe existence of a change in control of the company.  Therefore, no percentage rent nor severanceexpense has been included in the following table.
| ** **                                       | ** ** | **Payments due by period** | ** **  |
|--------------------------------------------------|------------|-------------------------------------------|-------------|
| **Contractual  Obligations**                     | ** ** | **Total**                                 | ** **  | **Fiscal Year  2007** | ** ** | **Fiscal Years  2008-2009** | ** ** | **Fiscal Years  2010-2011** | ** ** | **Fiscal Years  Thereafter** | ** ** |
| Long-term debt,  principal                       |       | $                                         | 2,144,397   |   | $ | 135,880 |   | $ | 574,272 |   | $ | 1,434,244 |   | $ | — |   |
| Interest on  long-term debt                      |       | 598,368                                   |        | 97,352 |   | 319,606 |   | 181,410 |   | — |   |
| Capital lease  obligations, including interest   |       | 70,222,523                                |        | 2,075,557 |   | 8,099,678 |   | 7,584,961 |   | 52,462,327 |   |
| Operating lease  obligations, including interest |       | 38,996,719                                |        | 1,176,464 |   | 4,586,249 |   | 4,554,911 |   | 28,679,095 |   |
| Loan guaranties                                  |       | 144,505                                   |        | 80,812 |   | 48,903 |   | 3,330 |   | — |   |
| Total obligations                                |       | $                                         | 112,106,512 |   | $ | 3,566,063 |   | $ | 13,628,709 |   | $ | 13,758,857 |   | $ | 81,141,422 |   |

 

Certain amounts donot sum due to rounding.

Based on our cash and working capitalposition at June 26, 2007, we believe we have sufficient capital to meet ourcurrent obligations.

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**Critical accounting policies**

This discussion and analysis is based upon our consolidated financialstatements, which were prepared in conformity with generally acceptedaccounting principles.  These principlesrequire management to make estimates and assumptions that affect the amountsreported in the consolidated financial statements and accompanying notes.  We believe our estimates and assumptions arereasonable; however, actual results and the timing of the recognition of suchamounts could differ from those estimates. We have identified the following critical accounting policies and estimatesutilized by management in the preparation of our financial statements:

*Property and equipment*

The cost of property and equipment is depreciated over the estimateduseful lives of the related assets ranging from three to 20 years.  The cost of leasehold improvements isdepreciated over the initial term of the related lease, which is generally 20years.  Depreciation is computed on thestraight-line method for financial reporting purposes and accelerated methodsfor income tax purposes.  Amortization ofassets acquired under capital lease is included in depreciation expense.  We review property and equipment, includingleasehold improvements, for impairment when events or circumstances indicatethese assets might be impaired pursuant to Statement of Financial AccountingStandard (SFAS) No. 144.  We base thisassessment upon the carrying value versus the fair market value of the assetand whether or not that difference is recoverable.  Such assessment is performed on arestaurant-by-restaurant basis and includes other relevant facts andcircumstances including the physical condition of the asset.

Our accounting policies regarding property and equipment includecertain management judgments regarding the estimated useful lives of suchassets and the determination as to what constitutes enhancing the value of orincreasing the life of existing assets. These judgments and estimates may produce materially different amountsof depreciation and amortization expense than would be reported if differentassumptions were used.

We continually reassess our assumptions and judgments and makeadjustments when significant facts and circumstances dictate.  Historically, actual results have not beenmaterially different than the estimates we have made.

*Leasing activities*

We have entered into various leases for our buildings, equipment andfor ground leases.  At the inception of alease, we evaluate it to determine whether the lease will be accounted for asan operating or capital lease pursuant to SFAS No. 13.

Our lease term used for straight-line rent expense is calculated fromthe date we take possession of the leased premises through the terminationdate.  There is potential for variabilityin our “rent holiday” period which begins on the date the lease agreement issigned and ends on the store open date, during which no cash rent payments aretypically due.  Factors that may affectthe length of the rent holiday period generally relate to construction relateddelays.  Extension of the rent holidayperiod due to delays in store opening will result in greater pre-opening rentexpense recognized during the rent holiday period.

Certain leases contain provisions that require additional rent paymentsbased upon restaurants sales volume (“contingent rentals”).  Contingent rentals are accrued each period asthe liabilities are incurred.

Management makes judgments regarding the probable term for eachrestaurant property lease which can impact the classification and account for alease as capital or operating.  Thesejudgments may produce materially different amounts of depreciation, rentexpense and interest expense than would be reported if different assumptionswere made.

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*Stock-based compensation*

We have granted stock options to certain employees and non-employeedirectors.  We account for stock-basedcompensation in accordance with the fair value recognition provisions of SFASNo. 123(R).  Under such provisions,stock-based compensation is measured at the grant date based on the value of theaward and is recognized as an expense over the vesting period.  Under the Black-Scholes option-pricing model,we determine the fair value of stock-based compensation at the grant date.  This requires judgment, including but notlimited to the expected volatility of our stock.  If actual results differ significantly fromthese estimates, stock-based compensation expense and our results of operationscould be materially impacted.

*Revenue recognition*

Revenue is derived from the sale of prepared food and beverage andselect retail items and is recognized at the time of sale.  Revenue derived from gift card sales isrecognized at the time the gift card is redeemed.  Until the redemption of gift cards occurs,the outstanding balances on such cards are included in accrued expenses in theaccompanying consolidated balance sheets. We recognize gift card breakage amounts based upon historical redemptionpatterns, which represent the balance of gift cards for which we believe thelikelihood of redemption by the customer is remote.  We arrive at this amount using certainmanagement judgments and estimates.  Suchjudgments and estimates may produce different amounts of breakage than would bereported if different assumptions were used.

**Seasonality**

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

**Inflation**

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

**ITEM3****           ****Quantitative andQualitative Disclosures about Market Risk**

Our company isexposed to market risk from changes in interest rates on debt and changes incommodity prices.

*Changesin interest rate:*

Pursuant to the terms of the loan we entered into in January 2004 forequipment at our Davenport location, the interest rate increased from 6.125% to10.25% effective January 1, 2007.  As ofJanuary 1, 2007, the unpaid balance on this loan was $481,190.  The 412.5 basis point change in this rate,assuming consistent levels of floating rate debt, will have an impact ofapproximately $16,190 on annual interest expense in fiscal year 2007.

*Changesin commodity prices:*

Many of the food products we purchase are affected by commodity pricingand 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 SYSCO Corporation is our primarysupplier of food, substantially all of the food and supplies

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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 toa food product price increase.  If,however, competitive circumstances limit our menu price flexibility, marginscould be negatively impacted.

Our company doesnot enter 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 report is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms, andthat 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.

Under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, we conducted an evaluation of our disclosure controlsand procedures (as defined in Exchange Act Rules 13a-15(e)).  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of June 26, 2007, ourdisclosure controls and procedures were effective.

*Changes in internal control over financial reporting*

There were no changes in our internal controlover financial reporting that occurred during the quarter ended June 26, 2007,that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

**PART II            OTHERINFORMATION**

**ITEM 1****                  ****Legal Proceedings**

Not applicable.

**ITEM 1A****               ****Risk Factors**

OnMay 4, 2007, we filed with the SEC a Cautionary Statement pursuant to thePrivate Securities Litigation Reform Act of 1995 for use as a readily availablewritten document to which reference may be made in connection withforward-looking statements, as defined in such act.  Our CautionaryStatement amended and restated the risk factors we previouslypresented in Item 1A of our Annual Report on Form 10-K for the fiscalyear ended December 26, 2006.  Our Cautionary Statement, whichappears as Exhibit 99 to this report, is incorporated by reference in responseto this Item 1A.

**ITEM 2****                  ****Unregistered Sales of EquitySecurities and Use of Proceeds**

(a)           On April 3, 2007, we issued 4,102 shares of common stock upon thecashless exercise of a warrant for the purchase of 5,538 shares of common stockoriginally issued November 27, 2002 to one of the agents for our privateplacement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise priceof $1.58 per share and an expiration date of November 27, 2007.

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On May 2, 2007, we issued19,353 shares of common stock upon the cashless exercise of a warrant for thepurchase of 25,842 shares of common stock originally issued December 20, 2002to one of the agents for our private placement of Series A ConvertiblePreferred Stock and warrants.  Theforegoing warrant had an exercise price of $1.58 per share and an expirationdate of December 20, 2007.

The foregoing issuances weremade in reliance upon the exemption provided in Section 4(2) of the SecuritiesAct.  The certificates representing suchsecurities contain a restrictive legend preventing sale, transfer or otherdisposition, absent registration or an applicable exemption from registrationrequirements.  The recipients of suchsecurities received, or had access to, material information concerning ourcompany, including, but not limited to, our reports on Form 10-KSB, Form10-QSB, and Form 8-K, as filed with the SEC. No discount or commission was paid in connection with the issuance ofcommon stock upon exercise of the warrants.

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

Not applicable.

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

Not applicable.

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

Not applicable.

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

See “Index toExhibits.”

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|   | GRANITE CITY FOOD & BREWERY LTD. |
|--------|--------------------------------------|
|   |                                 |
|   |                                 |
| Date:  | August 8, 2007                       | By: | /s/ Peter P. Hausback |   |
|   | Peter P.  Hausback                   |   |
|   | Chief Financial  Officer             |   |
|        |                                      |  |  |  |

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**INDEX TO EXHIBITS**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                                                                      |
|-----------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                 |
| 3.1             |       | Articles of Incorporation of the Registrant, 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 Registrant, dated  May 2, 2007 (incorporated by reference to our Current Report on Form 8-K,  filed on May 4, 2007 (File No. 000-29643)).                                         |
|            |       |                                                                                                                                                                                                                 |
| 10.1            |       | Granite City Food & Brewery Ltd. 2002 Equity  Incentive Plan, as amended effective April 13, 2007 (incorporated by  reference to our Quarterly Report on Form 10-Q, filed on May 4, 2007 (File  No. 000-29643)). |
|            |       |                                                                                                                                                                                                                 |
| 31.1            |       | Certification by Steven J. Wagenheim, President and  Chief Executive Officer of the Company, pursuant to Exchange Act Rule  13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.        |
|            |       |                                                                                                                                                                                                                 |
| 31.2            |       | Certification by Peter P. Hausback, 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 Peter P. Hausback, 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.                              |
|            |       |                                                                                                                                                                                                                 |
| 99              |       | Cautionary Statement (incorporated by reference to  our Current Report on Form 8-K, filed on May 4, 2007 (File No. 000-29643)).                                                                                      |

 

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