Table ofContents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

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**FORM 10-Q**

 

| **x**                                             | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|---------------------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                              |                                                                                                    |
| **FOR  THE QUARTERLY PERIOD ENDED JUNE 29, 2010** |
|                                              |                                                                                                    |
| **o**                                             | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission File Number 000-29643**

 

**GRANITE CITY FOOD & BREWERY LTD.**

(Exact Name of Registrant as Specified in Its Charter)

 

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

 

**5402 Parkdale Drive, Suite 101**

**Minneapolis, Minnesota  55416**

**(952) 215-0660**

(Address of Principal Executive Offices and Issuer’s

Telephone Number, including Area Code)

 

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

 

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes o   No x

 

Asof August 9, 2010, the issuer had outstanding 7,367,895****shares of common stock.

 

 

 

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**TABLE OF CONTENTS**

 

 
| ** **            | ** **                                                                                                                              | **Page** |
|-----------------------|-----------------------------------------------------------------------------------------------------------------------------------------|----------|
| ** **            | ** **                                                                                                                              |     |
| **PART I**       | **FINANCIAL INFORMATION**                                                                                                               | 1        |
| ** **            | ** **                                                                                                                              |     |
| ITEM 1                | Financial Statements                                                                                                                    | 1        |
|                  |                                                                                                                                    |     |
|                  | Condensed Consolidated  Balance Sheets as of June 29, 2010 and December 29, 2009                                              | 1        |
|                  |                                                                                                                                    |     |
|                  | Condensed Consolidated  Statements of Operations for the Thirteen and Twenty-six Weeks ended  June 29, 2010 and June 30, 2009 | 2        |
|                  |                                                                                                                                    |     |
|                  | Condensed Consolidated  Statements of Cash Flows for the Twenty-six Weeks ended June 29, 2010  and June 30, 2009              | 3        |
|                  |                                                                                                                                    |     |
|                  | Notes to  Condensed Consolidated Financial Statements                                                                                   | 4        |
|                  |                                                                                                                                    |     |
| ITEM 2                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                             | 16       |
|                  |                                                                                                                                    |     |
| ITEM 3                | Quantitative  and Qualitative Disclosures about Market Risk                                                                             | 28       |
|                  |                                                                                                                                    |     |
| ITEM 4                | Controls and  Procedures                                                                                                                | 28       |
|                  |                                                                                                                                    |     |
| **PART II**      | **OTHER INFORMATION**                                                                                                                   | 29       |
| ** **            | ** **                                                                                                                              |     |
| ITEM 1                | Legal Proceedings                                                                                                                       | 29       |
|                  |                                                                                                                                    |     |
| ITEM 1A               | Risk Factors                                                                                                                            | 29       |
|                  |                                                                                                                                    |     |
| ITEM 2                | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                            | 29       |
|                  |                                                                                                                                    |     |
| ITEM 3                | Defaults  upon Senior Securities                                                                                                        | 29       |
|                  |                                                                                                                                    |     |
| ITEM 4                | (Removed and Reserved)                                                                                                                  | 29       |
|                  |                                                                                                                                    |     |
| ITEM 5                | Other Information                                                                                                                       | 29       |
|                  |                                                                                                                                    |     |
| ITEM  6               | Exhibits                                                                                                                                | 29       |
|                  |                                                                                                                                    |     |
| **SIGNATURES**        |                                                                                                                                    | 30       |
| ** **            |                                                                                                                                    |     |
| **INDEX TO EXHIBITS** | 31                                                                                                                                      |

 

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**PART I               FINANCIAL INFORMATION**

 

**ITEM1  Financial Statements**

 

**GRANITE CITY FOOD &BREWERY LTD.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

** **
| ** **                                                                                                                                                 | ** ** | **June 29,** | ** ** | **December 29,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                 | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ASSETS:                                                                                                                                                    |       |              |       |                  |       |
| Current assets:                                                                                                                                            |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                  |       | $                 | 2,485,207  |                  | $          | 1,743,599 |   |
| Inventory                                                                                                                                                  |       | 866,324           |       | 832,135               |       |
| Prepaids and other                                                                                                                                         |       | 499,879           |       | 563,284               |       |
| Total current assets                                                                                                                                       |       | 3,851,410         |       | 3,139,018             |       |
| Prepaid rent, net of current portion                                                                                                                       |       | 274,834           |       | 303,763               |       |
| Property and equipment, net                                                                                                                                |       | 48,682,876        |       | 51,336,414            |       |
| Intangible and other assets                                                                                                                                |       | 1,179,342         |       | 1,242,761             |       |
| Total assets                                                                                                                                               |       | $                 | 53,988,462 |                  | $          | 56,021,956 |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY:                                                                                                                 |       |              |       |                  |       |
| Current liabilities:                                                                                                                                       |       |              |       |                  |       |
| Accounts payable                                                                                                                                           |       | $                 | 2,220,202  |                  | $          | 2,497,858 |   |
| Accrued expenses                                                                                                                                           |       | 5,553,791         |       | 6,300,053             |       |
| Accrued exit or disposal activities, current  portion                                                                                                      |       | 136,220           |       | 133,195               |       |
| Deferred rent, current portion                                                                                                                             |       | 1,746,127         |       | 1,356,391             |       |
| Deferred gain, current portion                                                                                                                             |       | 273,607           |       | 273,607               |       |
| Long-term debt, current portion                                                                                                                            |       | 552,655           |       | 389,391               |       |
| Capital lease obligations, current portion                                                                                                                 |       | 958,975           |       | 718,470               |       |
| Total current liabilities                                                                                                                                  |       | 11,441,577        |       | 11,668,965            |       |
| Accrued exit or disposal activities, net of  current portion                                                                                               |       | 2,032,593         |       | 2,005,468             |       |
| Deferred rent, net of current portion                                                                                                                      |       | 3,923,915         |       | 3,398,193             |       |
| Deferred gain, net of current portion                                                                                                                      |       | 1,855,370         |       | 1,991,859             |       |
| Long-term debt, net of current portion                                                                                                                     |       | 1,688,138         |       | 2,122,120             |       |
| Capital lease obligations, net of current portion                                                                                                          |       | 26,902,399        |       | 27,507,051            |       |
| Total liabilities                                                                                                                                          |       | 47,843,992        |       | 48,693,656            |       |
| Shareholders’ equity:                                                                                                                                 |       |              |       |                  |       |
| Common stock, $0.01 par value, 15,000,000 shares  authorized; 7,367,895 and 7,366,217 shares issued and outstanding at 6/29/10  and 12/29/09, respectively |       | 73,679            |       | 73,662                |       |
| Preferred stock, $0.01 par value, 10,000,000  shares authorized                                                                                            |       |              |       |                  |       |
| Additional paid-in capital                                                                                                                                 |       | 58,697,098        |       | 58,409,379            |       |
| Accumulated deficit                                                                                                                                        |       | (52,626,307       | )          | (51,154,741           | )          |
| Total shareholders’ equity                                                                                                                            |       | 6,144,470         |       | 7,328,300             |       |
| Total liabilities and shareholders’ equity                                                                                                            |       | $                 | 53,988,462 |                  | $          | 56,021,956 |   |

 

See notes to condensedconsolidated financial statements.

 

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**GRANITE CITY FOOD &BREWERY LTD.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

 
| ** **                                 | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                 | ** ** | **June 29,**        | ** ** | **June 30,**          | ** ** | **June 29,** | ** ** | **June 30,** | ** ** |
| ** **                                 | ** ** | **2010**                 | ** ** | **2009**                   | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Restaurant revenue                         |       | $                        | 23,219,069 |                       | $          | 22,101,365 |   | $ | 45,458,432 |   | $ | 43,526,066 |   |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Cost of sales:                             |       |                     |       |                       |       |   |   |   |   |
| Food, beverage and retail                  |       | 6,444,974                |       | 6,055,751                  |       | 12,531,220 |   | 11,882,004 |   |
| Labor                                      |       | 7,871,400                |       | 7,694,891                  |       | 15,563,923 |   | 15,226,533 |   |
| Direct restaurant operating                |       | 3,199,471                |       | 3,164,136                  |       | 6,427,042 |   | 6,357,890 |   |
| Occupancy                                  |       | 2,232,251                |       | 1,571,315                  |       | 4,401,963 |   | 3,143,515 |   |
| Total cost of sales                        |       | 19,748,096               |       | 18,486,093                 |       | 38,924,148 |   | 36,609,942 |   |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Pre-opening                                |       | —                   |       | 18,333                     |       | — |   | 211,262 |   |
| General and administrative                 |       | 1,659,041                |       | 2,430,751                  |       | 3,215,044 |   | 4,495,067 |   |
| Depreciation and amortization              |       | 1,480,103                |       | 1,728,140                  |       | 2,957,079 |   | 3,434,717 |   |
| Exit or disposal activities                |       | 128,791                  |       | 173,460                    |       | 260,392 |   | 601,540 |   |
| (Gain) loss on disposal of assets          |       | (27,632                  | )          | 41,307                     |       | (76,155 | ) | 50,408 |   |
| Operating income (loss)                    |       | 230,670                  |       | (776,719                   | )          | 177,924 |   | (1,876,870 | ) |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Interest:                                  |       |                     |       |                       |       |   |   |   |   |
| Income                                     |       | 3,884                    |       | 110                        |       | 4,183 |   | 1,608 |   |
| Expense                                    |       | (814,288                 | )          | (1,751,482                 | )          | (1,653,673 | ) | (3,382,440 | ) |
| Net interest expense                       |       | (810,404                 | )          | (1,751,372                 | )          | (1,649,490 | ) | (3,380,832 | ) |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Net loss                                   |       | $                        | (579,734   | )                          | $          | (2,528,091 | ) | $ | (1,471,566 | ) | $ | (5,257,702 | ) |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Loss per common share, basic               |       | $                        | (0.08      | )                          | $          | (0.94 | ) | $ | (0.20 | ) | $ | (1.95 | ) |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Weighted average shares outstanding, basic |       | 7,366,309                |       | 2,699,642                  |       | 7,366,263 |   | 2,699,642 |   |

 

Seenotes to condensed consolidated financial statements.

 

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**GRANITE CITY FOOD &BREWERY LTD.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                 | ** ** | **June 29,**          | ** ** | **June 30,** | ** ** |
| ** **                                                                                 | ** ** | **2010**                   | ** ** | **2009** | ** ** |
|                                                                                       |       |                       |       |   |   |
| Cash flows from operating activities:                                                      |       |                       |       |   |   |
| Net loss                                                                                   |       | $                          | (1,471,566 | ) | $ | (5,257,702 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                       |       |   |   |
| Depreciation and amortization                                                              |       | 2,873,551                  |       | 3,396,279 |   |
| Amortization of deferred gain                                                              |       | (126,134                   | )          | — |   |
| Other amortization                                                                         |       | 83,528                     |       | 38,438 |   |
| Stock warrant/option expense                                                               |       | 285,252                    |       | 157,281 |   |
| Non-cash interest expense                                                                  |       | 13,195                     |       | — |   |
| (Gain) loss on disposal of assets                                                          |       | 49,979                     |       | 50,408 |   |
| Loss on exit or disposal activities                                                        |       | 19,795                     |       | 332,113 |   |
| Deferred rent                                                                              |       | 907,682                    |       | 483,723 |   |
| Changes in operating assets and liabilities:                                               |       |                       |       |   |   |
| Inventory                                                                                  |       | (34,189                    | )          | (147,155 | ) |
| Prepaids and other                                                                         |       | 92,334                     |       | (253,109 | ) |
| Accounts payable                                                                           |       | (74,354                    | )          | 615,198 |   |
| Accrued expenses                                                                           |       | (746,262                   | )          | (62,757 | ) |
| Net cash provided by (used in) operating  activities                                       |       | 1,872,811                  |       | (647,283 | ) |
|                                                                                       |       |                       |       |   |   |
| Cash flows from investing activities:                                                      |       |                       |       |   |   |
| Purchase of:                                                                               |       |                       |       |   |   |
| Property and equipment                                                                     |       | (334,936                   | )          | (420,702 | ) |
| Intangible and other assets                                                                |       | (44,243                    | )          | (187,571 | ) |
| Net cash used in investing activities                                                      |       | (379,179                   | )          | (608,273 | ) |
|                                                                                       |       |                       |       |   |   |
| Cash flows from financing activities:                                                      |       |                       |       |   |   |
| Payments on capital lease obligations                                                      |       | (364,147                   | )          | (1,073,213 | ) |
| Proceeds from capital leases                                                               |       | —                     |       | 1,000,000 |   |
| Payments on long-term debt                                                                 |       | (276,137                   | )          | (188,643 | ) |
| Proceeds from long-term debt                                                               |       | —                     |       | 800,000 |   |
| Net costs related to issuance of stock                                                     |       | (111,740                   | )          | — |   |
| Net cash (used in) provided by financing  activities                                       |       | (752,024                   | )          | 538,144 |   |
|                                                                                       |       |                       |       |   |   |
| Net increase (decrease) in cash                                                            |       | 741,608                    |       | (717,412 | ) |
| Cash and cash equivalents, beginning                                                       |       | 1,743,599                  |       | 2,652,411 |   |
| Cash and cash equivalents, ending                                                          |       | $                          | 2,485,207  |   | $ | 1,934,999 |   |
| Supplemental disclosure of non-cash investing and  financing activities:                   |       |                       |       |   |   |
| Land, buildings and equipment acquired under  long-term debt agreement                     |       | $                          | —     |   | $ | 2,938,266 |   |
| Property and equipment and intangibles purchased  and included in accounts payable         |       | $                          | 203,302    |   | $ | 64,543 |   |

 

See notes to condensedconsolidated financial statements.

 

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**GRANITE CITY FOOD &BREWERY LTD.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Thirteen and Twenty-six weeksended June 29, 2010 and June 30, 2009**

 

**1.     Summary of significantaccounting policies**

 

Background

 

Granite City Food & Brewery Ltd. (the “Company”) develops andoperates Modern American casual dining restaurants known as Granite City Food &Brewery®.   The restaurant theme isupscale casual dining with a wide variety of menu items that are prepared freshdaily, combined with freshly brewed hand-crafted beers finished on-site.  The Company opened its first Granite Cityrestaurant in St. Cloud, Minnesota in July 1999 and has since expanded toother Midwest markets.  As of June 29,2010, the Company operated 26 restaurants in 11 states.  The Company also operates a centralized beerproduction facility which is used to provide raw material support to itsrestaurants to create consistent quality and operational efficiencies in theproduction of its proprietary beer.  TheCompany believes that this brewing process improves the economics ofmicrobrewing as it eliminates the initial stages of brewing and storage atmultiple locations.  In 2007, the Companywas granted a patent by the United States Patent Office for its brewingprocess.

 

Principlesof consolidation and basis of presentation

 

For the twenty-six weeks ended June 29, 2010, the Company operatedat a level that allowed it to fund its existing operations.  The Company believes this same level of salesand margins will allow it to fund its obligations for the foreseeablefuture.  However, the Company’s abilityto continue funding its operations and meet its debt service obligationscontinues to depend upon its operating performance, and more broadly, achievingbudgeted revenue and operating margins, both of which will be affected byprevailing economic conditions in the retail and casual dining industries andother factors, which may be beyond the Company’s control.  If revenue or margins, or a combination ofboth, decrease to levels unsustainable for continuing operations, the Companywill require equity or debt financing to meet ongoing obligations.  The amount of any such required funding woulddepend upon the Company’s ability to generate working capital.  There can be no assurance that the Companywill obtain financing on favorable terms or at all.  If the Company raises additional capital throughthe issuance and sale of equity securities, the securities may be issued atprices below the market price of its stock, and its shareholders may suffersignificant dilution.  Debt financing, ifavailable, may involve significant cash payment obligations, covenants andfinancial ratios that restrict the Company’s ability to operate and grow itsbusiness, and would cause it to incur additional interest expense and financingcosts.  If cash flow from operations isinsufficient to fund expected capital needs, or if the Company’s needs aregreater than anticipated and the Company is unable to obtain additionalcapital, the Company will be required to further restructure its debtobligations.  The failure to reachagreements with creditors to further restructure indebtedness, including leaseobligations, would have a material adverse effect upon the Company’s businessand results of operations.

 

The Company’s condensed consolidated financial statements include theaccounts and operations of the Company and its subsidiary corporation underwhich its four Kansas locations are operated. By Kansas state law, 50% of the stock of the subsidiary corporation mustbe owned by a resident of Kansas. Granite City Restaurant Operations, Inc., a wholly-owned subsidiaryof the Company, owns the remaining 50% of the stock of the subsidiarycorporation.  The resident-owner of thestock of that entity has entered into a buy-sell agreement with the subsidiarycorporation providing, among other things, that transfer of the shares is restrictedand that the shareholder must sell his shares to the subsidiary corporationupon certain events, or any event that disqualifies the resident-owner fromowning the shares under applicable laws and regulations of the state.  The Company has entered into a masteragreement with the subsidiary corporation that permits the operation of therestaurants and leases to the subsidiary corporation the Company’s property andfacilities.  The subsidiary corporationpays all of its operating expenses and obligations, and the Company retains, as

 

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consideration for the operating arrangements and the lease of propertyand facilities, all the net profits, as defined, if any, from suchoperations.  The foregoing ownershipstructure was set up to comply with the licensing and ownership regulationsrelated to microbreweries within the state of Kansas.  The Company has determined that suchownership structure will cause the subsidiary corporation to be treated as avariable interest entity in which the Company has a controlling financialinterest for the purpose of Financial Accounting Standards Board’s (“FASB”)accounting guidance on accounting for variable interest entities.* *As such, thesubsidiary corporation is consolidated with the Company’s financial statementsand the Company’s financial statements do not reflect a minority ownership inthe subsidiary corporation.  Alsoincluded in the Company’s condensed consolidated financial statements are otherwholly-owned subsidiaries.  Allreferences to the Company in these notes to the condensed consolidatedfinancial statements relate to the consolidated entity, and all intercompanybalances have been eliminated.

 

Inthe opinion of management, all adjustments, consisting of normal recurringadjustments, which are necessary for a fair statement of the Company’sfinancial position as of June 29, 2010, and its results of operations forthe interim periods ended June 29, 2010 and June 30, 2009, have beenincluded.

 

The balance sheet at December 29, 2009 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 on Form 10-K for the fiscal year ended December 29,2009, filed with the Securities and Exchange Commission (“SEC”) on March 22,2010.

 

The results of operations for the thirteen and twenty-six weeks ended June 29,2010 are not necessarily indicative of the results to be expected for theentire year.

 

Related parties

 

DHW Leasing, L.L.C. (“DHW”), the beneficial owner of approximately63.3% of the Company’s common stock, gained control of the Company in October 2009.  The members of DHW are Donald A. Dunham, Jr.and Charles J. Hey.  Mr. Dunham, whois also the sole member of Dunham Capital Management, LLC (“DCM”) and 70% ownerof Dunham Equity Management, LLC (“DEM”), became one of the Company’s directorsin October 2009.  DHW, DCM and DEMare collectively, with Mr. Dunham, referred to herein as the “DunhamEntities.”  As of June 29, 2010, Mr. Dunhambeneficially owned approximately 64.3% of the Company’s common stock, includingthe shares held by DHW.  DCM and DEM areentities that either are the landlord or the general partner in various limitedpartnerships that own real estate leased to the Company.  Mr. Dunham, as an individual, also ownsa limited partnership interest in one of the limited partnerships that own realestate leased to the Company.

 

Use of estimates

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles in the United States of America and regulations of theSEC requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosures of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenue and expense during the reporting period.  Significant estimates include estimatesrelated to asset lives and gift card liability. Actual results could differ from these estimates.

 

Revenuerecognition

 

Revenueis derived from the sale of prepared food and beverage and select retail items.  Revenue is recognized at the time of sale andis reported on the Company’s consolidated statements of operations net of salestaxes collected.  Revenue derived fromgift card 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 periodically recognizes gift card breakage which representsthe portion of its gift card obligation for which management believes thelikelihood 

 

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ofredemption by the customer is remote, based upon historical redemptionpatterns.  Such amounts are included as areduction to general and administrative expense.

 

Cash and cash equivalents

 

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

 

Stock-based compensation

 

The Company measures and recognizes all stock-based compensation underthe fair value method using the Black-Scholes option-pricing model.  Share-based compensation expense recognizedis based on awards ultimately expected to vest, and as such, it is reduced forestimated or actual forfeitures. Forfeitures are estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from thoseestimates.  The Company used thefollowing assumptions within the Black-Scholes option-pricing model for thefirst half of 2010 and 2009:

 
| ** **                                | ** ** | **Twenty-six Weeks Ended** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|
| ** **                                | ** ** | **June 29, 2010**     | ** ** | **June 30, 2009** | ** ** |
| Weighted  average risk-free interest rate |       | 3.21% - 3.89%              |       | 2.25% - 3.71% |   |
| Expected  life of options                 |       | 10 years                   |       | 10 years |   |
| Expected  stock volatility                |       | 95.53% - 95.86%            |       | 66.30% - 94.69% |   |
| Expected  dividend yield                  |       | None                       |       | None |   |

 

Net loss per share

 

Basic net loss per share is computed based on the weighted averagenumber of shares of common stock outstanding during the fiscal year.  Diluted net loss per share is not presentedsince the effect would be anti-dilutive due to the losses.  Calculations of the Company’s net loss percommon share reflect the Company’s January 2010 one-for-six sharecombination and are set forth in the following table:

 
| ** **                                 | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                 | ** ** | **June 29, 2010**   | ** ** | **June 30, 2009**     | ** ** | **June 29, 2010** | ** ** | **June 30, 2009** | ** ** |
|                                       |       |                     |       |                       |       |   |   |   |   |
| Net loss                                   |       | $                        | (579,734   | )                          | $          | (2,528,091 | ) | $ | (1,471,566 | ) | $ | (5,257,702 | ) |
| Loss per common share, basic               |       | $                        | (0.08      | )                          | $          | (0.94 | ) | $ | (0.20 | ) | $ | (1.95 | ) |
| Weighted average shares outstanding, basic |       | 7,366,309                |       | 2,699,642                  |       | 7,366,263 |   | 2,699,642 |   |

 

**2.     Fair value of financialinstruments**

 

At June 29, 2010 and December 29, 2009, the fair value ofcash and accounts payable approximates their carrying value due to theshort-term nature of the instruments. The fair value of the capital leaseobligations and long-term debt is estimated at its carrying value based uponcurrent rates available to the Company.

 

**3.****             ****Reversestock split**

 

OnDecember 29, 2009, the Company’s board of directors approved a one-for-sixshare combination of its common stock which became effective onJanuary 13, 2010.  As a result ofthis reverse stock split, every six shares of the Company’s common stock thatwere issued and outstanding as of January 13, 2010 were automaticallycombined into one issued and outstanding share without any change in the parvalue of such shares, and the number of authorized but unissued shares of theCompany’s common stock was proportionally reduced.  A proportionate adjustment was also made tothe Company’s outstanding stock options and warrants.  No fractional shares were issued inconnection with this reverse stock split, but rather shareholders who wereentitled 

 

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tofractional shares received cash in lieu of receiving fractional shares.  All references within this document to lossper share reflect this reverse stock split. Additionally, the number of common shares, stock options and warrants,and the price per common share, stock option and warrant, reflect this reversestock split.

 

**4.****             ****Restaurantclosing and asset impairment charges**

 

Rogers,Arkansas

 

InAugust 2008, the Company ceased operations at its Rogers, Arkansasrestaurant.  Since opening in October 2007,the restaurant failed to generate positive cash flow and had approximately $1.4million of net loss.  Management believesthe closure of this restaurant has allowed the Company to focus its capital andpersonnel resources on its other restaurants in order to increase futureoperating efficiencies and cash flow. The Company has attempted to find a replacement tenant or negotiate fora lease termination for this location which expires December 31,2018.  Costs incurred in connection withthis closure include one-time benefits to employees who were involuntarilyterminated of $57,681, costs incurred for early contract termination of $4,578and costs to close and maintain the facility of $956,997.  During the third quarter of 2008, the Companyrecorded a non-cash impairment charge of $135,057 related to the write-off ofthe carrying value of the restaurant equipment at the Rogers location.  The amount of this write-off is equal to thedifference between the net book value of the equipment and the expected futurecash flows generated by leasing the equipment to a replacement tenant.  Until the Company is able to find areplacement tenant, it will incur ongoing costs such as utilities, landscapeand maintenance and general liability insurance. In accordance with the FASBguidance on accounting for costs associated with exit or disposal activities,the Company recorded a non-cash lease termination liability of $1,762,689 basedon management’s estimate of the fair value of these obligations.  This required management to estimate thepresent value of the future minimum lease obligations offset by the estimatedsublease rentals that could be reasonably obtained for the property.  Pursuant to the terms of the lease, theannual lease payments for the Roger’s site were $405,000 as of June 29,2010, and the ongoing costs to maintain the property were approximately $4,600per month.  As of June 29, 2010, theCompany’s future undiscounted cash payments under the terms of this lease wereapproximately $3.8 million.

 

Troy, Michigan

 

In May 2008, the Company entered into a 20-year net leaseagreement relating to the restaurant it had planned to open in Troy,Michigan.  However, in February 2009,the Company decided not to build on that site, and as part of an agreement withthe Dunham Entities, the Company will reimburse DCM for any out-of-pocketexpenses incurred, including the carrying cost of the related land, less netproceeds from the sale of the real estate or lease income associated with thesite.  As of June 29, 2010, thecarrying cost of the land approximated $16,000 per month.  Such expenses will be amortized and payableto DCM over a 60-month period commencing January 2011, at a 6% annualinterest rate.  The Company’s managementhas concluded that as of June 29, 2010, it is probable that the Companywill need to reimburse DCM approximately $534,000 and has included such amountas “accrued exit or disposal activities” on its balance sheet, pursuant to theFASB guidance on accounting for contingencies.

 

The costs related to the closing of the Rogers restaurant and thedecision not to build the Troy restaurant aggregated $260,392 in the first halfof 2010 and are reflected on the Company’s condensed consolidated statements ofoperations as “exit or disposal activities.”**  **The following is a reconciliationof the beginning and ending balances of exit or disposal activities:

 
| Accrued exit or disposal costs at  December 29, 2009 |   | $        | 2,138,663 |   |
|-----------------------------------------------------------|--------|----------|-----------|--------|
|                                                      |   |     |      |
| Costs incurred and charged to expense                     |   | 326,242  |      |
| Payments                                                  |   | (230,242 | )         |
| Amortization of sublease liability                        |   | (65,850  | )         |
| Accrued exit or disposal costs at June 29,  2010     |   | $        | 2,168,813 |   |

 

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**5.****             ****Non-currentassets**

 

Property and equipment

 

Property and equipment is recorded at cost and depreciated over theestimated useful lives of the assets. Leasehold improvements are depreciated over the term of the relatedlease or the estimated useful life, whichever is shorter.  Depreciation and amortization of assets heldunder capital leases and leasehold improvements are computed on the straight-linemethod for financial reporting purposes. The following is a summary of the Company’s property and equipment at June 29,2010 and December 29, 2009:

 
| ** **                    | ** ** | **June 29, 2010** | ** ** | **December 29, 2009** | ** ** |
|-------------------------------|------------|------------------------|------------|----------------------------|------------|
|                          |       |                   |       |                       |       |
| Land                          |       | $                      | 18,000     |                       | $          | 18,000 |   |
| Buildings                     |       | 31,298,404             |       | 31,311,399                 |       |
| Leasehold improvements        |       | 9,537,749              |       | 9,444,418                  |       |
| Equipment and furniture       |       | 33,650,781             |       | 33,536,306                 |       |
| Construction in progress *    |       | 96,242                 |       | 108,868                    |       |
|                          |       | 74,601,176             |       | 74,418,991                 |       |
| Less accumulated depreciation |       | (25,918,300            | )          | (23,082,577                | )          |
|                          |       | $                      | 48,682,876 |                       | $          | 51,336,414 |   |

 

----

*Construction in progress includes the following approximate amountsfor items yet to be placed in service:

 
| ** **                                                  | ** ** | **June 29, 2010** | ** ** | **December 29, 2009** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Prototype/Leasehold improvements for future  locations      |       | $                      | 76,700     |                       | $          | 96,400 |   |
| Equipment and leasehold improvements for current  locations |       | $                      | 19,500     |                       | $          | 12,400 |   |

 

Intangible and other assets

 

Intangible and other assets consisted of the following:

 
| ** **                    | ** ** | **June 29, 2010** | ** ** | **December 29, 2009** | ** ** |
|-------------------------------|------------|------------------------|------------|----------------------------|------------|
| Intangible assets:            |       |                   |       |                       |       |
| Liquor licenses               |       | $                      | 760,865    |                       | $          | 760,865 |   |
| Trademarks                    |       | 180,757                |       | 160,193                    |       |
|                          |       |                   |       |                       |       |
| Other:                        |       |                   |       |                       |       |
| Deferred loan costs           |       | 394,428                |       | 386,083                    |       |
| Security deposits             |       | 224,346                |       | 233,146                    |       |
|                          |       | 1,560,396              |       | 1,540,287                  |       |
| Less accumulated amortization |       | (381,054               | )          | (297,526                   | )          |
|                          |       | $                      | 1,179,342  |                       | $          | 1,242,761 |   |

 

**6.        Accrued expenses**

 

Accrued expenses consisted of the following:

 
| ** **                            | ** ** | **June 29, 2010** | ** ** | **December 29, 2009** | ** ** |
|---------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Payroll and related                   |       | $                      | 1,951,452  |                       | $          | 1,863,688 |   |
| Deferred revenue from gift card sales |       | 1,556,211              |       | 2,304,312                  |       |
| Sales taxes payable                   |       | 520,514                |       | 606,051                    |       |
| Interest                              |       | 282,396                |       | 269,076                    |       |
| Real estate taxes                     |       | 560,545                |       | 580,879                    |       |
| Deferred registration costs           |       | 157,360                |       | 172,179                    |       |
| Other                                 |       | 525,313                |       | 503,868                    |       |
|                                  |       | $                      | 5,553,791  |                       | $          | 6,300,053 |   |

 

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**7.        Deferred rent**

 

Under the terms of the lease agreement the Company entered intoregarding its Lincoln, Nebraska property, the Company received a leaseincentive of $450,000, net.  This leaseincentive was recorded as deferred rent and is being amortized to reduce rentexpense over the initial term of the lease using the straight-line method.

 

Also included in deferred rent is thedifference between minimum rent payments and straight-line rent over theinitial lease term including the “build out” or “rent-holiday” period.  Additionally, certain of the Company’slandlords have agreed to defer a portion of the payments due them for specifiedperiods of time.  The Company alsocontinues to negotiate with its landlords to reduce rents and has withheld rentto certain of its landlords during rent negotiations.  The deferrals are offset in part by the fairvalue of the warrants issued to certain landlords in consideration of rentreductions.  Contingent rent expense,which is based on a percentage of revenue, is also recorded to the extent itexceeds minimum base rent per the lease agreement.  Deferred rent consisted of:

 
| ** **                                              | ** ** | **June 29, 2010** | ** ** | **December 29, 2009** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Difference between minimum rent and straight-line  rent |       | $                      | 3,805,253  |                       | $          | 3,251,235 |   |
| Deferred rent, net of $142,392 warrant value*           |       | 1,524,956              |       | 1,140,843                  |       |
| Contingent rent expected to exceed minimum rent         |       | 55,944                 |       | 63,617                     |       |
| Tenant improvement allowance                            |       | 283,889                |       | 298,889                    |       |
|                                                    |       | $                      | 5,670,042  |                       | $          | 4,754,584 |   |

 

----

*Of this amount, approximately $215,000 was paid to DCM, our primarylandlord, in August 2010, $528,000 will be due to DCM in October 2010,and approximately $889,000 is due to General Growth Properties with which weare negotiating reduced lease costs for three of our locations.

 

**8.  Long-term debt**

 

As of June 29, 2010, the Company had three long-term loansoutstanding with First National Bank (“FNB”), an independent financialinstitution in Pierre, South Dakota, the proceeds of which the Company used topurchase assets at its Fargo, North Dakota; Des Moines and Davenport, Iowarestaurants.  These loans are secured bythe tangible personal property and fixtures at the respective locations and areguaranteed by Steven J. Wagenheim, the Company’s president, chief executiveofficer and one of its directors.

 

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

 

In March 2009, the Company entered into a bridge loan agreementwith Harmony Equity Income Fund, L.L.C. and Harmony Equity Income Fund II,L.L.C. (collectively, “Harmony”), a group of accredited investors.  A former director of the Company, Eugene E.McGowan, is a member of, and has a beneficial interest in Harmony.  The bridge loan was funded to the extent of$800,000 on March 30, 2009 and is evidenced by notes bearing interest at9.0% per annum.  In addition, the Companyissued to Harmony warrants for the purchase of an aggregate of 53,332 shares ofcommon stock at a price of $1.52 per share. The notes are secured by a mortgage 

 

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against the lease, and security agreements against personal propertyand intangibles relating to the Company’s Sioux Falls, South Dakota restaurant,including a grant of the rights to use patents, trademarks and otherintangibles associated with that restaurant. Up to 20% of each bridge note may be converted into common stock at aconversion price equal to $3.00 per share.

 

As of June 29, 2010 and December 29, 2009, the balances,interest rates and maturity dates of our long-term debt were as follows:

 
| ** **                  | ** ** | **June 29, 2010** | ** ** | **December 29, 2009** | ** ** |
|-----------------------------|------------|------------------------|------------|----------------------------|------------|
| Des Moines (FNB)            |       |                   |       |                       |       |
| Balance                     |       | $                      | 24,043     |                       | $          | 94,865 |   |
| Annual interest rate        |       | 5.50                   | %          | 5.50                       | %          |
| Maturity date               |       | 8/27/2010              |       | 8/27/2010                  |       |
|                        |       |                   |       |                       |       |
| Davenport (FNB)             |       |                   |       |                       |       |
| Balance                     |       | $                      | 81,520     |                       | $          | 148,828 |   |
| Annual interest rate        |       | 5.50                   | %          | 10.25                      | %          |
| Maturity date               |       | 1/6/2011               |       | 1/6/2011                   |       |
|                        |       |                   |       |                       |       |
| Fargo (FNB)                 |       |                   |       |                       |       |
| Balance                     |       | $                      | 1,159,111  |                       | $          | 1,187,349 |   |
| Annual interest rate        |       | 8.75                   | %          | 8.75                       | %          |
| Maturity date               |       | 8/15/2011              |       | 8/15/2011                  |       |
|                        |       |                   |       |                       |       |
| South Bend (Liquor license) |       |                   |       |                       |       |
| Balance                     |       | $                      | 243,870    |                       | $          | 245,640 |   |
| Annual interest rate        |       | 8.00                   | %          | 8.00                       | %          |
| Maturity date               |       | 9/30/2023              |       | 9/30/2023                  |       |
|                        |       |                   |       |                       |       |
| Harmony (Bridge loan)       |       |                   |       |                       |       |
| Balance                     |       | $                      | 748,479    |                       | $          | 856,479 |   |
| Annual interest rate        |       | 9.00                   | %          | 9.00                       | %          |
| Maturity date               |       | 12/1/2011              |       | 12/1/2011                  |       |

 

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

 
| Year  ending: |   |      |      |
|---------------|--------|-----------|-----------|
| 2010          |   | $         | 130,924   |   |
| 2011          |   | 1,888,019 |      |
| 2012          |   | 4,263     |      |
| 2013          |   | 4,617     |      |
| 2014          |   | 5,000     |      |
| Thereafter    |   | 224,200   |      |
|          |   | $         | 2,257,023 |   |

 

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** **

**9.        Capital leases**

 

Asof June 29, 2010, the Company operated 15 restaurants under capital leaseagreements, of which one expires in 2019, one in 2020, one in 2021, two in2022, two in 2023, three in 2024, two in 2026 and three in 2027, all withrenewable options for additional periods. Thirteen of these lease agreementsoriginated with Donald A. Dunham, Jr. and entities affiliated with him(collectively, the “Dunham Landlords”). Under certain of the leases, theCompany may be required to pay additional contingent rent based upon restaurantsales. At the inception and the amendment date of each of these leases, theCompany evaluated the fair value of the land and building separately pursuantto the FASB guidance on accounting for leases. The land portion of these leasesis classified as an operating lease while the building portion of these leasesis classified as a capital lease because its present value was greater than 90%of the estimated fair value at the beginning or amendment date of the leaseand/or the lease term represents 75% or more of the expected life of theproperty.

 

OnJune 30, 2010, the Company’s board of directors approved amendments tofive of the Company’s leases with the Dunham Landlords, changing the rentalamount and extending the term of each lease (Note 14). The amended terms willcause the classification of four such leases to change from operating tocapital. The fifth amended lease was, and will remain, a capital lease.

 

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

 

InMay 2008, the Company entered into a 20-year net lease agreement relatingto the restaurant it had planned to open in Troy, Michigan. However, in February 2009,the Company decided not to build on that site, and as part of an agreement withthe Dunham Entities, the Company will reimburse DCM for any out-of-pocketexpenses incurred less net proceeds from the sale of the real estate or leaseincome associated with the site (Note 4).

 

Asof June 29, 2010, the Company leased equipment at three of its restaurantspursuant to a lease agreement with Carlton Financial Corporation (“Carlton”).The value of the equipment financed at each of the three locations ranges fromapproximately $0.8 million to $1.1 million, the annual interest rateon each ranges from 12.9% to 19.6% and the leases will expire in October 2012.The Company may purchase Carlton’s interest in all, but not less than all, ofthe equipment for a purchase price equal to 15% of the original cost of theequipment. Steven J. Wagenheim, the Company’s president, chief executiveofficer and one of its directors, was required to personally guarantee paymentsto be made to Carlton under the lease financing and the Company’s board ofdirectors agreed to compensate him for such guarantee.

 

InJune 2007, the Company entered into a lease for an energy optimizationsystem at its Maple Grove, Minnesota restaurant for approximately $30,000. Thisfive-year lease carries an annual interest rate of approximately 11.9% andcontains a bargain purchase option.

 

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

 
| ** **                           | ** ** | **June 29, 2010** | ** ** | **December 29, 2009** | ** ** |
|--------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Land                                 |       | $                      | 18,000     |                       | $          | 18,000 |   |
| Building                             |       | 31,298,404             |       | 31,311,399                 |       |
| Equipment and leasehold improvements |       | 3,365,588              |       | 3,365,587                  |       |
|                                 |       | 34,681,992             |       | 34,694,986                 |       |
| Less accumulated depreciation        |       | (8,445,754             | )          | (7,374,244                 | )          |
|                                 |       | $                      | 26,236,238 |                       | $          | 27,320,742 |   |

 

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Minimum future lease payments under all capital leases are as follows:

 
| **Year ending:**                            | ** ** | **Capital Leases** | ** ** |
|---------------------------------------------|------------|--------------------|------------|
| 2010                                        |       | $                  | 2,397,461  |   |
| 2011                                        |       | 4,689,674          |       |
| 2012                                        |       | 4,312,862          |       |
| 2013                                        |       | 4,244,084          |       |
| 2014                                        |       | 4,303,148          |       |
| Thereafter                                  |       | 44,683,972         |       |
| Total minimum lease payments                |       | 64,631,201         |       |
| Less amount representing interest           |       | (33,163,707        | )          |
| Present value of net minimum lease payments |       | 31,467,494         |       |
| Less current portion                        |       | (995,567           | )          |
| Long-term portion of obligations            |       | $                  | 30,471,927 |   |

 

The foregoing table includes changes to lease commitments commencingafter June 29, 2010 (Note 14). Amortization expense related to the assetsheld under capital leases is included with depreciation expense on the Company’sstatements of operations.

 

**10.      Commitments andcontingencies**

 

Litigation

 

From time to time, lawsuits are threatened or filed against the Companyin the ordinary course of business. Such lawsuits typically involve claims fromcustomers, former or current employees, and others related to issues common tothe restaurant industry. A number of such claims may exist at any given time. Althoughthere can be no assurance as to the ultimate disposition of these matters, itis management’s opinion, based upon the information available as of August 9,2010,****that the expected outcome of these matters,individually or in the aggregate, will not have a material adverse effect onthe results of operation, liquidity or financial condition of the Company. Inaddition, some property owners have brought actions against the Company or itslandlords arising out of the Company’s withholding of rent during the period inwhich it is attempting to negotiate the lease terms. Management believes theseactions have been stayed and will continue in abeyance while activenegotiations are taking place with property owners.

 

Rent reductions

 

Along with DCM, the Company continues to seek to lower the cost of itsland leases at several locations. In some instances, the Company and DCM havenot paid rent during this negotiating period. The Company accrues for any non-paidrent during this period under “deferred rents” on the balance sheet (see Note 7regarding amounts due landlords). To the extent the parties are unable to reachagreements to reduce lease costs, legal action could be brought by lessors thatmay result in material adverse consequences to the Company, DCM or both. Suchmaterial adverse consequences could include legal actions by land owners orother landlords to terminate leases and recover delinquent and future rents. Additionally,if any of the Company’s landlords or parties from whom the Company’s landlordslease property fail financially, the ramifications upon the Company and theCompany’s continued occupancy of the leased restaurants would be uncertain. TheCompany could lose the future revenue from any such affected locations and losethe value of its investment in improvements thereon, if it is unable tonegotiate arrangements with new owners of the leased locations, or creditors orbankruptcy trustees of such landlords.

 

Employment agreements

 

TheCompany has entered into employment agreements with Steven J. Wagenheim, itspresident and chief executive officer; James G. Gilbertson, its chief financialofficer; and Darius H. Gilanfar, its chief operating officer, providing fortheir employment on an at-will basis. Each agreement, as amended in June 2010,

 

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providesthat the executive will have employment through October 6, 2012. Eachexecutive will be entitled to severance benefits that include one year of basecompensation if his employment is terminated without cause or for good reason,as defined therein, in addition to the balance of the applicable term, if terminatedprior to the end of such term. Each employment agreement is automaticallyextended for a one-year term unless either the Company or the executive givesat least 60 days’ notice to the other of an intent not to extend. If theCompany elects not to extend the executive’s employment beyond October 6,2012, or beyond the end of any applicable extension, and terminate executive’semployment, such termination will be deemed to be a termination without causefor purposes of severance benefits and the continuation of base compensationthrough the end of the applicable term. The agreements also provide for a baseannual salary which may be increased by the Company’s board of directors,incentive compensation as determined by the Company’s compensation committeefrom time to time, and participation in the Company’s other employee benefitplans. In addition, each agreement includes change in control provisions thatentitle the executive to receive severance pay equal to 12 months of salary ifthere is a change in control of the Company and his employment is involuntarilyterminated for any reason other than for cause, as defined in the agreement, ordeath or disability. Each executive has also agreed to certain nondisclosureprovisions during the term of his employment and any time thereafter, andcertain non-competition, non-recruitment and/or non-interference provisionsduring the term of his employment and for a certain period thereafter. As of August 9,2010, the current annual base salaries in effect for such executives under theforegoing employment agreements were as follows: Mr. Wagenheim ($300,000),Mr. Gilbertson ($225,000), and Mr. Gilanfar ($202,860).

 

Developmentagreement

 

In April 2008, the Company entered intoa development agreement with United Properties Investment LLC (“UnitedProperties”) for the development of up to 22 restaurants to be built between2009 and 2012. United Properties will be responsible for all costs related tothe land and building of each restaurant. The development agreementprovides for a cooperative process between United Properties and the Company’smanagement for the selection of restaurant sites and the development ofrestaurants on those sites and scheduling for the development and constructionof each restaurant once a location is approved. The annual lease rate for fee-simple land and building developments willbe 9.5% and the Company will have the right of first offer to purchase theserestaurants. Additionally, in the event United Properties sells one of thebuildings that it develops for the Company at an amount in excess of thethreshold agreed to by the parties in the agreement, then the Company willshare in the profits of that sale. The Company assumes no liability in theevent United Properties sells a building at a loss. The Company is notbound to authorize the construction of restaurants during that time period, butgenerally cannot use another developer to develop or own a restaurant as longas the development agreement is in effect. The Company can, however, useanother developer if United Properties declines to build a particularrestaurant. The Company currently has no sites under development.

 

PurchaseCommitments

 

TheCompany has entered into contracts through 2016 with certain suppliers of rawmaterials (primarily hops) for minimum purchases both in terms of quantity andin pricing.  As of June 29, 2010, theCompany’s future obligations under such contracts aggregated approximately $1.2million.

 

**11.****      ****Stockplans**

 

In July 1997, the Company adopted the 1997 Stock Option Plan foremployees and non-employees, including consultants to the Company, to purchasethe Company’s common stock at an exercise price that equals or exceeds the fairmarket value on the date of grant. As of June 29,2010, no options to purchase common stock were outstanding under the plan,which expired July 28, 2007.

 

As of June 29, 2010, options to purchase 20,000 shares of commonstock were outstanding under the 1997 Director Stock Option Plan, which expiredJuly 29, 2007. All such options are fully vested and exercisable for fiveyears from the date of grant. On May 2, 2007, the Company’s board ofdirectors agreed that until the adoption of any future equity plan fornon-employee directors, awards of stock options for the purchase of 2,500shares of common stock per year, exercisable for a period of ten years, shouldbe made to each non-employee

 

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director on the anniversary of his election to the board under the 2002Equity Incentive Plan. In May 2010, the Company’s board of directorsagreed to increase such annual issuance to non-employee directors from 2,500 to5,000 shares of common stock.

 

In August 2002, the Company adopted the 2002 Equity IncentivePlan, now known as the Amended and Restated Equity Incentive Plan, foremployees, prospective employees, officers and members of the Company’s boardof directors, as well as consultants and advisors to the Company, to purchaseshares of the Company’s common stock at an exercise price that equals orexceeds the fair market value on the date of grant. The number of sharesauthorized for issuance as of June 29, 2010 was 468,290. As ofJune 29, 2010, there were options outstanding under the plan for thepurchase of 906,316 shares including 575,500 shares underlying stock optionsgranted in May 2010 at an exercise price of $2.25 per share, which aresubject to shareholder approval of a proposed plan amendment which wouldincrease the number of shares available under the plan to 1,125,000. Althoughvesting schedules vary, option grants under this plan generally vest over athree or four-year period and options are exercisable for no more than tenyears from the date of grant.

 

A summary of the status of the Company’s stock options as of June 29,2010 is presented below:

 
| **Fixed Options**                                      | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at  December 30, 2008                      |       | 364,689    |       | $                                          | 21.60      |                                                | 6.2 years  |                            |       |   |
|                                                        |       |       |       |                                       |       |                                                |       |                            |       |
| Granted                                                     |       | 126,888    |       | 1.35                                       |       | 9.2 years                                           |       |                            |       |
| Exercised                                                   |       | —     |       | —                                     |       |                                                |       |                            |       |
| Forfeited                                                   |       | (98,391    | )          | 17.49                                      |       |                                                |       |                            |       |
| Outstanding at  December 29, 2009                      |       | 393,186    |       | $                                          | 16.10      |                                                | 6.6 years  |                            | $          | 78,467 |   |
|                                                        |       |       |       |                                       |       |                                                |       |                            |       |
| Granted                                                     |       | 585,497    |       | 2.24                                       |       | 9.9 years                                           |       |                            |       |
| Exercised                                                   |       | —     |       | —                                     |       |                                                |       |                            |       |
| Forfeited                                                   |       | (44,868    | )          | 11.85                                      |       |                                                |       |                            |       |
| Outstanding at  June 29, 2010                          |       | 933,815    |       | $                                          | 7.61       |                                                | 8.5 years  |                            | $          | 53,661 |   |
|                                                        |       |       |       |                                       |       |                                                |       |                            |       |
| Options exercisable at  December 29, 2009              |       | 198,659    |       | $                                          | 23.01      |                                                | 5.2 years  |                            |       |   |
| Options exercisable at  June 29, 2010                  |       | 384,995    |       | $                                          | 14.05      |                                                | 7.0 years  |                            | $          | 17,698 |   |
|                                                        |       |       |       |                                       |       |                                                |       |                            |       |
| Weighted-average fair value of options granted  during 2010 |       | $          | 1.99       |                                       |       |                                                |       |                            |       |   |
|                                                             |            |            |            |                                            |            |                                                     |            |                                 |            |  |  |  |

 

The aggregate intrinsic value in the table above represents the totalpretax intrinsic value (the difference between the closing price of the Company’sstock on the last day of the reporting period and the exercise price,multiplied by the number of in-the-money options) that would have been receivedby the option holders had all option holders exercised their options on thelast day of the reporting period. As of June 29, 2010, there wasapproximately $1,132,169 of total unrecognized compensation cost related tounvested share-based compensation arrangements, of which $479,347 is expectedto be recognized during the remainder of fiscal year 2010, $432,480 in fiscalyear 2011, $177,701 in fiscal year 2012, $42,478 in fiscal year 2013 and $163in fiscal year 2014.

 

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The following table summarizes information about stock optionsoutstanding at June 29, 2010:

 
| ** **                     | ** ** | **Options Outstanding**             | ** ** | **Options Exercisable**                             | ** ** |
|--------------------------------|------------|-------------------------------------|------------|-----------------------------------------------------|------------|
| **Range  of  Exercise Prices** | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted  Average  Remaining  Contractual  Life** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number of  Options   Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                           |       |                                |       |                                                |       |   |   |   |   |   |   |
| $1.00 - $6.00                  |       | 687,583                             |       | 9.7 years                                           |       | $ | 2.15 |   | 176,998 |   | $ | 2.09 |   |
| $6.01 - $12.00                 |       | 22,497                              |       | 6.9 years                                           |       | $ | 10.17 |   | 11,288 |   | $ | 9.81 |   |
| $12.01 - $18.00                |       | 44,947                              |       | 5.7 years                                           |       | $ | 14.09 |   | 26,974 |   | $ | 14.59 |   |
| $18.01 - $24.00                |       | 55,330                              |       | 5.3 years                                           |       | $ | 21.94 |   | 55,330 |   | $ | 21.94 |   |
| $24.01 - $30.00                |       | 77,964                              |       | 5.0 years                                           |       | $ | 26.15 |   | 69,630 |   | $ | 26.25 |   |
| $30.01 - $36.00                |       | 28,828                              |       | 1.9 years                                           |       | $ | 31.14 |   | 28,109 |   | $ | 31.12 |   |
| $36.01 - $42.00                |       | 16,666                              |       | 6.8 years                                           |       | $ | 37.20 |   | 16,666 |   | $ | 37.20 |   |
|                           |       |                                |       |                                                |       |   |   |   |   |   |   |
| Total                          |       | 933,815                             |       | 8.5 years                                           |       | $ | 7.61 |   | 384,995 |   | $ | 14.05 |   |

 

**12.  Common stock warrants**

 

InOctober 2005, the Company entered into a securities purchase agreementwith certain accredited investors for the sale of approximately $5.34 millionof common stock and warrants. Under this agreement, the Company issuedfive-year warrants for the purchase of 36,960 shares of common stock at anexercise price of $39.00 per share to such investors and five-year warrants forthe purchase of 9,239 shares of common stock at an exercise price of $39.00 pershare to the Company’s placement agent. Such warrant agreements with theinvestors and placement agent for this transaction contain certainanti-dilution provisions. Pursuant to these provisions, the number of sharespurchasable upon exercise of these warrants and the related purchase price bothrequired adjustment upon the issuance of warrants in the first quarter of 2009,at an exercise price less than the thresholds set forth in the securitypurchase agreement. The exercise price of each existing warrant was multipliedby a fraction, the numerator of which was the sum of the number of shares ofcommon stock outstanding immediately prior to such issuance, plus the number ofshares of common stock which the offering price for such shares of common stockwould purchase at the closing price of our common stock on the closing date ofthis securities purchase agreement; and the denominator of which was the sum ofthe number of shares of common stock outstanding immediately prior to suchissuance plus the number of such new securities so issued. As a result of theissuance of common stock in October 2009 at a price per share less thanthe thresholds set forth in the security purchase agreement, furtheranti-dilution adjustments were required. As a result of these adjustments, thenumber of shares purchasable under these warrants at June 29, 2010 was110,956 and the exercise price was $16.24 per share. As of June 29, 2010,none of such warrants had been exercised.

 

Duringthe first nine months of 2009, in consideration of rent reduction agreementsentered into with certain of its landlords, the Company issued five-yearwarrants to purchase the Company’s common stock to such landlords. Theaggregate number of shares underlying such warrants was 201,028 shares and theweighted average exercise price was $1.60 per share. Pursuant to the provisionsof such agreements, the number of shares purchasable upon exercise of thesewarrants and the related purchase price both required adjustment upon theissuance of warrants in the first quarter of 2009, at an exercise price lessthan the thresholds set forth in the agreement. The exercise price of eachwarrant issued prior to such issuance was multiplied by a fraction, thenumerator of which was the sum of the number of shares of common stockoutstanding immediately prior to such issuance of warrants, plus the number ofshares of common stock which the offering price for such shares of common stockwould purchase at the warrant exercise price in effect immediately prior tosuch issuance; and the denominator of which was the sum of the number of sharesof common stock outstanding immediately prior to such issuance plus the number ofsuch new securities so issued. As a result of these adjustments, the number ofshares purchasable under these warrants came to be 201,125 and the weightedaverage exercise price was $1.60 per share. In June 2010, a 

 

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warrantfor the purchase of 1,678 shares was exercised at an exercise price of $1.58per share. As of June 29, 2010, warrants for the purchase of 199,447shares remained unexercised.

 

Pursuantto the Harmony bridge loan agreement entered into in March 2009, theCompany issued to the investors warrants for the purchase of an aggregate of53,332 shares of common stock at a price of $1.52 per share. Such warrantsbecame exercisable September 30, 2009, and remained unexercised at June 29,2010.

 

As of June 29, 2010, warrants for the purchase of an aggregate of363,735 shares of common stock were outstanding and exercisable. The weightedaverage exercise price of such warrants was $6.05 per share.

 

**13.       Retirement plan**

 

The Company sponsors a defined contribution plan under the provisionsof section 401(k) of the Internal Revenue Code. The plan is voluntary andis provided to all employees who meet the eligibility requirements. Aparticipant can elect to contribute up to 100% of his/her compensation subjectto IRS limits. Prior to fiscal year 2009, the Company made no contribution tothe plan. Beginning in fiscal year 2009, the Company elected to match 10% of suchcontributions up to 6% of the participant’s compensation. In fiscal year 2009,the Company contributed $12,761 under the plan, and in the first half of 2010,the Company contributed an additional $7,303 under the plan. The Companyexpects to contribute approximately $7,500 under the plan during the remainderof fiscal year 2010.

 

**14.       Subsequent events**

 

On June 30, 2010, the Company’s board of directors approvedamendments to five of the Company’s leases with the Dunham Landlords, changingthe rental amount and extending the term of each lease. The amended terms willcause the classification of four such leases to change from operating tocapital. The fifth amended lease was, and will remain, a capital lease (Note9). As a result of these amendments, the Company will record additional assetsand capital lease liabilities of approximately $3.6 million each. Such assetsand liabilities will each be reduced by a write off of approximately $1.2million of deferred gain related to these properties.

 

**ITEM 2 Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

*This discussion and analysis contains various non-historicalforward-looking statements within the meaning of Section 21E of theExchange Act. Although we believe that, in making any such statement, ourexpectations are based on reasonable assumptions, any such statement may beinfluenced by factors that could cause actual outcomes and results to bematerially different from those projected. When used in the following discussion,the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates”and similar expressions, as they relate to us or our management, are intendedto identify such forward-looking statements. You are cautioned not to attributeundue certainty to such forward-looking statements, which are qualified intheir entirety by the cautions and risks described herein. Please refer to the “RiskFactors” section of our Annual Report on Form 10-K, filed with theSecurities and Exchange Commission on March 22, 2010, and the “RiskFactors” section of our Quarterly Report on Form 10-Q, filed with theSecurities and Exchange Commission on May 10, 2010, for additional factorsknown to us that may cause actual results to vary.*

 

**Overview**

 

Weare a Modern American upscale casual restaurant chain.     As of June 29, 2010, we operated 26 restaurants in 11Midwestern states featuring on-premises breweries, substantially all of whichoperate under the name of Granite City Food & Brewery®. We believe ourmenu features high quality yet affordable family favorite menu items preparedfrom made-from-scratch recipes and served in generous portions. We believe thatthe sophisticated yet unpretentious restaurants, proprietary food and beverageproducts, attractive price points and high service standards combine for agreat dining experience. The location of each restaurant in operation and themonth and year of its opening appear in the following chart:

 

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

 

InAugust 2008, we ceased operations at our restaurant in Rogers, Arkansas(see Note 4 to our condensed consolidated financial statements). However, weare currently bound by the terms of this lease agreement through December 2018.

 

Weoperate a centrally-located beer production facility in Ellsworth, Iowawhich facilitates the initial stage of our patented brewing process. We believethat this brewing process improves the economics of microbrewing as iteliminates the initial stages of brewing and storage at multiple locations,thereby reducing equipment and development costs at new restaurant locations. Additionally,having a common starting point, the beer production creates consistency oftaste for our product from restaurant to restaurant. The initial productproduced at our beer production facility is transported by truck to thefermentation vessels at each of our restaurants where the brewing process iscompleted. In 2007, we were granted a patent by the United States Patent Officefor this brewing process. We believe that our current beer production facility,which opened in June 2005, has the capacity to service up to 35 restaurantlocations.

 

DHWLeasing, L.L.C. (“DHW”), the beneficial owner of approximately 63.3% of ourcommon stock, gained control of our company in October 2009. The membersof DHW are Donald A. Dunham, Jr. and Charles J. Hey. Mr. Dunham, whois also the sole member of Dunham Capital Management, LLC (“DCM”) and 70% ownerof Dunham Equity Management, LLC (“DEM”), became one of our directors in October 2009.DHW, DCM and DEM are collectively, with Mr. Dunham, referred to herein asthe “Dunham Entities.” As of June 29, 2010, Mr. Dunham beneficiallyowned approximately 64.3% of our common stock, including the shares held byDHW. DCM and DEM are entities that either are the landlord or the generalpartner in various limited partnerships that own real estate leased to ourcompany. Mr. Dunham, as an individual, also owns a limited partnershipinterest in one of the limited partnerships that own real estate leased to ourcompany.

 

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Ourindustry can be significantly affected by changes in economic conditions,discretionary spending patterns, consumer tastes, and cost fluctuations.  Over the past two years, consumers have beenunder increased economic pressures and as a result, many have changed theirdiscretionary spending patterns.  Manyconsumers are dining out less frequently than in the past and/or have decreasedthe amount they spend on meals while dining out.  To offset the negative impact of decreasedsales, we undertook a series of initiatives to renegotiate the pricing ofvarious aspects of our business, effectively reducing our cost of food, insurance,payroll processing, shipping, supplies and most recently, our property andequipment rent.  We have implementedmarketing initiatives designed to increase brand awareness and help drive guesttraffic.  We believe these initiativescontributed to the increase in sales and guest traffic in the first half of2010.

 

Webelieve that our operating results will fluctuate significantly because ofseveral factors, including the operating results of our restaurants, changes infood and labor costs, increases or decreases in comparable restaurant sales,general economic conditions, consumer confidence in the economy, changes inconsumer preferences, nutritional concerns and discretionary spending patterns,competitive factors, the skill and the experience of our restaurant-levelmanagement teams, the maturity of each restaurant, adverse weather conditionsin our markets, our ability to recommence our expansion plans, and the timingof any future restaurant openings and related expenses.

 

Weutilize a 52/53-week fiscal year ending the last Tuesday in December forfinancial reporting purposes.  The firstquarter of 2010 and 2009 each included 338 operating weeks, which is the sum ofthe actual number of weeks each restaurant operated.  The first half of 2010 and 2009 included 676and 670 operating weeks, respectively. The six additional operating weeks in the first half of 2010 wererelated to our Indianapolis, Indiana restaurant which opened in February 2009.  Because we have opened new restaurants atvarious times throughout the years, we provide this statistical measure toenhance the comparison of revenues from period to period as changes occur inthe number of units we are operating.

 

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

 

**Resultsof operations as a percentage of sales**

 

The following table sets forth results of our operations expressed as apercentage of sales for the thirteen and twenty-six weeks ended June 29,2010 and June 30, 2009:

 

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| ** **                        | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|-----------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                        | ** ** | **June 29,**        | ** ** | **June 30,**          | ** ** | **June 29,** | ** ** | **June 30,** | ** ** |
| ** **                        | ** ** | **2010**                 | ** ** | **2009**                   | ** ** | **2010** | ** ** | **2009** | ** ** |
|                              |       |                     |       |                       |       |   |   |   |   |
| Restaurant revenue                |       | 100.0                    | %          | 100.0                      | %          | 100.0 | % | 100.0 | % |
|                              |       |                     |       |                       |       |   |   |   |   |
| Cost of sales:                    |       |                     |       |                       |       |   |   |   |   |
| Food, beverage and retail         |       | 27.8                     |       | 27.4                       |       | 27.6 |   | 27.3 |   |
| Labor                             |       | 33.9                     |       | 34.8                       |       | 34.2 |   | 35.0 |   |
| Direct restaurant operating       |       | 13.8                     |       | 14.3                       |       | 14.1 |   | 14.6 |   |
| Occupancy                         |       | 9.6                      |       | 7.1                        |       | 9.7 |   | 7.2 |   |
| Total cost of sales               |       | 85.1                     |       | 83.6                       |       | 85.6 |   | 84.1 |   |
|                              |       |                     |       |                       |       |   |   |   |   |
| Pre-opening                       |       | —                   |       | 0.1                        |       | — |   | 0.5 |   |
| General and administrative        |       | 7.1                      |       | 11.0                       |       | 7.1 |   | 10.3 |   |
| Depreciation and amortization     |       | 6.4                      |       | 7.8                        |       | 6.5 |   | 7.9 |   |
| Exit or disposal activities       |       | 0.6                      |       | 0.8                        |       | 0.6 |   | 1.4 |   |
| (Gain) loss on disposal of assets |       | (0.1                     | )          | 0.2                        |       | (0.2 | ) | 0.1 |   |
| Operating income (loss)           |       | 1.0                      |       | (3.5                       | )          | 0.4 |   | (4.3 | ) |
|                              |       |                     |       |                       |       |   |   |   |   |
| Interest:                         |       |                     |       |                       |       |   |   |   |   |
| Income                            |       | —                   |       | —                     |       | — |   | — |   |
| Expense                           |       | (3.5                     | )          | (7.9                       | )          | (3.6 | ) | (7.8 | ) |
| Net interest expense              |       | (3.5                     | )          | (7.9                       | )          | (3.6 | ) | (7.8 | ) |
|                              |       |                     |       |                       |       |   |   |   |   |
| Net loss                          |       | (2.5                     | )%         | (11.4                      | )%         | (3.2 | )% | (12.1 | )% |

 

Certainpercentage amounts do not sum due to rounding.

 

**Critical Accounting Policies**

 

Our critical accounting policies are those that require significantjudgment.  There have been no materialchanges to the critical accounting policies previously reported in our 2009Annual Report on Form 10-K filed with the Securities and ExchangeCommission on March 22, 2010.

 

**Resultsof operations for the thirteen and twenty-six weeks ended June 29, 2010 andJune 30, 2009**

 

**Revenue**

 

Wegenerated $23,219,069 and $22,101,365 of revenue during the second quarter of2010 and 2009, respectively.  The 5.1%increase in revenue was due primarily to the 4.5% increase in guest traffic inthe second quarter of 2010 compared to the second quarter of 2009.  Comparable restaurant revenue, which includesrestaurants in operation over 18 months, increased 5.3% from the second quarterof 2009 to the second quarter of 2010 due to an increase in guest traffic of4.6%.  The average weekly revenue perrestaurant at our comparable restaurants increased $3,469 from $64,900 in thesecond quarter of 2009 to $68,369 in the second quarter of 2010.

 

Duringthe first half of 2010 and 2009, we generated revenue of $45,458,432 and$43,526,066, respectively.  The 4.4%increase in first half revenue was primarily the result of an increase in guesttraffic of approximately 6.5%.  The firsthalf of 2010 included six additional restaurant operating weeks compared to thesame period in 2009.  Comparablerestaurant revenue increased 3.8% from the first half of 2009 to the first halfof 2010 primarily due to an increase in guest traffic of approximately5.6%.  Average weekly revenue percomparable restaurant increased $2,450 from $64,846 in the first half of 2009to $67,296 in the first half of 2010.

 

Throughout2009 and particularly in the last half of the year, we began heavy discountingand a marketing program to drive guest traffic back into the restaurants.  Although the discounting reduced our averagecheck on a year-to-date basis, our guest traffic improved in late 2009 and thefirst half of 2010, and our average check increased slightly in the secondquarter of 2010 compared to the second quarter of 2009.

 

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Weexpect that restaurant revenue will vary from quarter to quarter.  We anticipate continued seasonal fluctuationsin restaurant revenue due in part to increased outdoor seating and generallyfavorable weather conditions at many of our locations during the summermonths.  Due to the honeymoon effect thatperiodically occurs with the opening of a restaurant, we expect the timing ofany future restaurant openings to cause fluctuations in restaurantrevenue.  Additionally, other factorsoutside of our control, such as inclement weather, timing of holidays, consumerconfidence in the economy and changes in consumer preferences may affect ourfuture revenue.

 

**Restaurantcosts**

 

***Food and beverage***

 

Ourfood and beverage costs, as a percentage of revenue, increased 0.4% to 27.8% inthe second quarter of 2010 from 27.4% in the second quarter of 2009.  Such costs increased 0.3% as a percentage ofrevenue to 27.6% in the first half of 2010 from 27.3% in the first half of2009.  While we did experience slightcost increases primarily in fish, chicken and produce, such costs were offsetin part by decreases in wine and liquor costs. While pricing negotiations with our suppliers have reduced our exposureto commodity price increases, we do expect that our food and beverage costswill continue to vary going forward due to numerous variables, includingseasonal changes in food and beverage costs for which we do not have contractedpricing, fluctuations within commodity-priced goods and guest preferences.  We periodically create new menu offerings andintroduce new craft brewed beers based upon guest preferences.  Although such menu modifications maytemporarily result in increased food and beverage cost, we believe we are ableto offset such increases with our weekly specials which provide variety andvalue to our guests.  Our varieties ofcraft brewed beer, which we 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.

 

***Labor***

 

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

 

Ourlabor costs, as a percentage of revenue, decreased 0.9% to 33.9% in the secondquarter of 2010 from 34.8% in the second quarter of 2009.  Such costs decreased 0.8% as a percentage ofrevenue to 34.2% in the first half of 2010 from 35.0% in the first half of2009.  We have not opened additionalrestaurants since the first quarter of 2009, and therefore did not incur additionallabor costs typically associated with newly opened restaurants in the firsthalf of 2010.  Additionally, we havetrained our managers on a number of operational metrics and initiatives focusedon manager accountability and internal development of restaurant-level staff toreduce labor costs as a percentage of revenue.

 

Weexpect that labor costs will vary as minimum wage laws, local labor laws andpractices, and unemployment rates vary from state to state, as will hiring andtraining expenses.  We believe thatretaining good employees and more experienced staff ensures high quality guestservice and may reduce hiring and training costs.

 

***Direct restaurant operating***

 

Operatingsupplies, repairs and maintenance, utilities, promotions and restaurant-leveladministrative expense represent the majority of our direct restaurantoperating expense, a substantial portion of which is fixed or indirectlyvariable.  Our direct restaurantoperating expense as a percentage of revenue decreased 0.5% to 13.8% in the secondquarter of 2010 from 14.3% in the second quarter of 2009.  Such costs decreased 0.5% as a percentage ofrevenue to 14.1% in the first half of 2010 from 14.6% in the first half of2009.  Decreases in costs 

 

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ofutilities, paper and plastic and uniforms were offset in part by the increasein advertising costs as we continued the marketing initiatives we began in2009.

 

Wecontinue to seek ways to reduce our direct operating costs going forwardincluding additional pricing negotiations and the elimination of waste.

 

***Occupancy***

 

Our occupancy costs, which include both fixed and variable portions ofrent, common area maintenance charges, property insurance and property taxes,increased 2.5% as a percentage of revenue to 9.6% in the second quarter of 2010from 7.1% in the second quarter of 2009. Such costs increased 2.5% as a percentage of revenue to 9.7% in the firsthalf of 2010 from 7.2% in the first half of 2009.  Our occupancy cost increased significantly inthe fourth quarter of 2009 as leases at nine of the restaurants we operate wereconverted from capital leases to operating leases as a result of lease amendmentsentered into in October 2009.  As capitalleases, a portion of the lease expense was recorded as interest expense andreduction of liability.  As operatingleases, all lease expense is recorded as an occupancy cost included in rentexpense.  Also included in our rentexpense is the difference between our current rent payments and straight-linerent expense over the initial lease term. This non-cash rent expense of $550,093 and $294,241 is included inoccupancy costs in the first half of 2010 and 2009, respectively.  The $255,852 increase in non-cash rentexpense was due primarily to the one and two-year rent reductions provided bycertain of our landlords.  On June 30,2010, our board of directors approved amendments to five of our leases with theDunham Landlords, changing the rental amount and extending the term of eachlease.  The amended terms will cause theclassification of four such leases to change from operating to capital.  As such, a portion of the lease expense whichwas classified as occupancy costs in the first half of 2010 will be classifiedas interest expense and a reduction of liability in future periods.

 

**Pre-opening**

 

Pre-openingcosts, which are expensed as incurred, consist of expenses related to hiringand training the initial restaurant workforce, wages and expenses of a newrestaurant opening team during periods of expansion, rental costs incurredduring the construction period and certain other direct costs associated withopening new restaurants.  Pre-openingcosts, excluding construction-period rent, are primarily incurred in the monthof, and two months prior to, restaurant opening.

 

Inthe first half of 2009, our pre-opening costs of $211,262 were related to therestaurant we opened in Indianapolis, Indiana in February 2009.  We have not opened additional restaurantssince that time, and therefore incurred no pre-opening costs in the first halfof 2010.

 

**Generaland administrative**

 

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

 

Generaland administrative expense decreased $771,710 to $1,659,041 in the secondquarter of 2010 from $2,430,751 in the second quarter of 2009.  Such expenses decreased $1,280,023 to $3,215,044in the first half of 2010 from $4,495,067 in the first half of 2009.  As a percentage of revenue, general andadministrative expenses decreased 3.9% in the second quarter of 2010 and 3.2%in the first half of 2010 over the respective periods in 2009.  The primary sources of such decreases wereexpenses related to recruiting, consulting, compensation and travelexpense.  Non-cash stock-basedcompensation included in general and administrative expense was $208,725 and$81,343 in the first half of 2010 and 2009, respectively.

 

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Wecontinue to seek ways to reduce our general and administrative expenses throughadditional pricing negotiations with our vendors.  While we have started seeing the effects ofpreviously renegotiated general and administrative costs, we will closelymonitor and attempt to further reduce these expenses while seeking to preservean infrastructure that remains suitable for our current operations.  Although we may need to recruit additionalpersonnel to provide continued oversight of operations, we expect our turnoverratios to return to levels more consistent with the industry, allowing us to containour costs.  To the extent our turnoverincreases above our expectations, additional costs above our budgeted figurescould be incurred in our recruiting and training expenses.  We believe our general and administrativeexpense and our general and administrative expense as a percentage of revenuewill decrease in 2010 compared to 2009.

 

**Depreciationand amortization**

 

Depreciationand amortization expense decreased $248,037 to $1,480,103 in the second quarterof 2010 from $1,728,140 in the second quarter of 2009.  Such expense decreased $477,638 to $2,957,079in the first half of 2010 from $3,434,717 in the first half of 2009, dueprincipally to the reclassification of the leases at nine of the restaurants weoperate from capital leases to operating leases in October 2009.  As a percentage of revenue, depreciationexpense decreased 1.4% in the second quarter and first half of 2010 compared tothe respective periods in 2009.

 

**Exit ordisposal activities**

 

InAugust 2008, we closed our Rogers, Arkansas restaurant.  Since opening in October 2007, therestaurant failed to generate positive cash flow and had approximately $1.4million of net loss.  We believe theclosure of this restaurant has allowed management to focus capital andpersonnel resources on our other restaurants in order to increase futureoperating efficiencies and cash flow.  Weare working to find a replacement tenant for the location, for which we arebound by a lease which expires in December 2018.  Costs incurred in the first half of 2010 and2009 in connection with this closure include costs to maintain the facility ofapproximately $230,242 and $269,427, respectively.  We will incur ongoing costs such asutilities, landscape and maintenance and general liability insurance until weare able to find a replacement tenant. We recorded a non-cash lease terminationliability of $1,762,689 based on management’s estimate of the fair value ofthese obligations.  This requiredmanagement to estimate the present value of the future minimum lease obligationsoffset by the estimated sublease rentals that could be reasonably obtained forthe property.  Amortization of thissublease liability was $65,850 and $9,887 in the first half of 2010 and 2009,respectively.  All costs related to theclosing of the Rogers restaurant, including lease payments, are reflected inour statements of operations as “exit or disposal activities.”  Pursuant to the terms of the lease our annuallease payments for the Rogers site were $405,000 as of June 29, 2010, andour ongoing costs to maintain the property were approximately $4,600 permonth.  As of June 29, 2010, ourfuture undiscounted cash payments under the terms of this lease wereapproximately $3.8 million.

 

Aspart of the Master Agreement we entered into with the Dunham Entities in February 2009,we agreed to reimburse DCM for any out-of-pocket expenses incurred, reduced bynet proceeds from the sale of the real estate or lease income associated withthe Rogers, Arkansas site and the site at Troy, Michigan upon which we decidednot to build a restaurant.  As June 29,2010, the carrying cost of the land at the Troy, Michigan site approximated$16,000 per month and has been recorded in “exit and disposal activities” inour statement of operations.  We haveconcluded that as of June 29, 2010, it is probable we will need toreimburse DCM approximately $534,000 of such costs related to the Troy,Michigan site.

 

Reimbursementof costs related to these sites, including the carrying cost of the relatedland, will be amortized and payable to DCM over a 60-month period commencing January 2011,at a 6% annual interest rate.  The actualamount due DCM could fluctuate due to changes in the economy.

 

**Interest**

 

Netinterest expense consists of interest expense on capital leases and long-termdebt, net of interest earned from cash on hand. Interest expense decreased $937,194 to $814,288 in the second quarter of2010 from 

 

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$1,751,482in the second quarter of 2009.  Suchexpense decreased $1,728,767 to $1,653,673 in the first half of 2010 from$3,382,440 in the first half of 2009. These decreases were due to capital lease reductions from our landlordsand equipment financers and the extinguishment of approximately $15.0 millionof equipment lease debt through the issuance of common stock in October 2009.  Additionally, in October 2009, leases atnine of the restaurants we operate were converted from capital leases tooperating leases.  Expense related tosuch leases that was recorded as interest expense in the first half of 2009,was recorded as an occupancy cost included in rent in the first half of 2010.  Interest income increased $3,774 in the secondquarter of 2010 and $2,575 in the first half of 2010 over the respectiveperiods in 2009 due to the increase in cash on hand.

 

**Liquidityand capital resources**

 

Asof June 29, 2010, we had $2,485,207 of cash and a working capital deficitof $7,590,167 compared to $1,743,599 of cash and a working capital deficit of$8,529,947 at December 29, 2009.

 

Duringthe twenty-six weeks ended June 29, 2010, we generated $1,872,811 of netcash from operating activities.  We used$379,179 of cash to purchase equipment and other assets and made paymentsaggregating $640,284 on our debt and capital lease obligations.  We used $114,223 of cash related to theissuance of common stock to DHW, made cash payments aggregating $175 to shareholdersin lieu of receiving fractional shares related to our reverse stock split. Wereceived $2,658 of cash upon the exercise of a landlord warrant.

 

Duringthe twenty-six weeks ended June 30, 2009, we obtained proceeds of$1,800,000 pursuant to a sales-leaseback capital lease agreement and a loanagreement and made payments aggregating $1,261,856 on our debt and capitallease obligations.  We used $647,283 ofnet cash in operating activities and $608,273 of net cash to purchase equipmentand other assets.

 

InDecember 2009, our board of directors approved aone-for-six-share-combination of our common stock which became effective January 13,2010.  As a result of this reverse stocksplit, every six shares of our common stock that were issued and outstanding asof January 13, 2010, were automatically combined into one issued andoutstanding share without any change in the par value of such shares, and thenumber of authorized but unissued shares of our common stock wereproportionally reduced. A proportionate adjustment was also made to our outstandingstock options and warrants.  Nofractional shares were issued in connection with this reverse stock split.  Shareholders who were entitled to fractionalshares received cash in lieu of receiving fractional shares.  All references within this document to lossper share reflect this reverse stock split. Additionally, the number of common shares, stock options and warrants,and the price per common share, stock option and warrant, reflect this reversestock split.

 

Alongwith DCM, we continue to seek to permanently lower the future cost of our landleases at several locations relative to our lease obligations in 2011 andbeyond.  In some instances, our companyand DCM have not paid rent during this negotiating period.  We accrue for any non-paid rent during thisperiod under “deferred rents” on the balance sheet (see Note 7 to our condensedconsolidated financial statements regarding amounts due landlords).  To the extent the parties are unable to reachagreements to reduce lease costs, legal action could be brought by lessors thatmay result in material adverse consequences to us, DCM or both.  Such material adverse consequences couldinclude legal actions by land owners or other landlords to terminate leases andrecover delinquent and future rents.  Additionally,if any of our landlords or parties from whom our landlords lease property failfinancially, the ramifications upon our company and our continued occupancy ofthe leased restaurants would be uncertain. We could lose the future revenue from any such affected locations andlose the value of our investment in improvements thereon if we are unable tonegotiate arrangements with new owners of the leased locations, or creditors orbankruptcy trustees of such landlords.

 

Forthe first half of fiscal year 2010, we operated at a level that allowed us tofund our existing operations.  We believethis same level of sales and margins will allow us to fund our obligations forthe foreseeable future.  However, ourability to continue funding our operations and meet our debt serviceobligations continues to depend upon our operating performance, and morebroadly, achieving budgeted revenue and operating margins, both of which willbe affected by prevailing economic conditions in the retail and casual diningindustries and 

 

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otherfactors, which may be beyond our control. If revenue or margins, or a combination of both, decrease to levelsunsustainable for continuing operations, we will require equity or debtfinancing to meet ongoing obligations. The amount of any such required funding would depend upon our ability togenerate working capital.  There can beno assurance that we will obtain financing on favorable terms or at all.  If we raise additional capital through theissuance and sale of equity securities, the securities may be issued at pricesbelow the market price of our stock, and our shareholders may suffer significantdilution.  Debt financing, if available,may involve significant cash payment obligations, covenants and financialratios that restrict our ability to operate and grow our business, and wouldcause us to incur additional interest expense and financing costs.  If cash flow from operations is insufficientto fund expected capital needs, or if our needs are greater than anticipatedand we are unable to obtain additional capital, we will be required to furtherrestructure debt obligations.  Thefailure to reach agreements with creditors to further restructure ourindebtedness, including lease obligations, would have a material adverse effectupon our business and results of operations.

 

**Commitments**

 

*CapitalLeases:*

 

Propertyleases

 

Asof June 29, 2010, we operated 15 restaurants under capital leaseagreements, of which one expires in 2019, one in 2020, one in 2021, two in2022, two in 2023, three in 2024, two in 2026 and three in 2027, all withrenewable options for additional periods. Thirteen of these lease agreements originated with Donald A. Dunham, Jr.and entities affiliated with him (collectively, the “Dunham Landlords”).  Under certain of the leases, we may berequired to pay additional contingent rent based upon restaurant sales.  At the inception and the amendment date ofeach of these leases, we evaluated the fair value of the land and buildingseparately pursuant to the FASB guidance on accounting for leases.  The land portion of these leases is classifiedas an operating lease while the building portion of these leases is classifiedas a capital lease because its present value was greater than 90% of theestimated fair value at the beginning or amendment date of the lease and/or thelease term represents 75% or more of the expected life of the property.  On June 30, 2010, our board of directorsapproved amendments to five of our leases with the Dunham Landlords, changingthe rental amount and extending the term of each lease (see Note 14 to ourcondensed consolidated financial statements). The amended terms will cause the classification of four such leases tochange from operating to capital.  Thefifth amended lease was, and will remain, a capital lease.

 

InDecember 2004, we entered into a land and building lease agreement for ourbeer production facility.  This ten-yearlease, which commenced February 1, 2005, allows us to purchase thefacility at any time for $1.00 plus the unamortized construction costs.  Because the construction costs will be fullyamortized through payment of rent during the base term, if the option isexercised at or after the end of the initial ten-year period, the option pricewill be $1.00.  As such, the lease isclassified as a capital lease.

 

InMay 2008, we entered into a 20-year net lease agreement relating to the restaurantwe planned to open in Troy, Michigan. However, in February 2009, we decided not to build on that site,and as part of an agreement with the Dunham Entities, we will reimburse DCM forany out-of-pocket expenses incurred less net proceeds from the sale of the realestate or lease income associated with the site.

 

Equipmentleases

 

Asof June 29, 2010, we had leased equipment at three of our restaurantspursuant to a lease agreement with Carlton Financial Corporation (“Carlton”).The value of the equipment financed at each of the three locations ranges fromapproximately $0.8 million to $1.1 million, the annual interest rateon each ranges from 12.9% to 19.6% annually and the lease will expire in October 2012.  We may purchase Carlton’s interest in all,but not less than all, of the equipment for a purchase price equal to 15% ofthe original cost of the equipment. Steven J. Wagenheim our president, chief executive officer and one ofour directors, was required to personally guarantee

 

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paymentsto be made to Carlton under the lease financing and our board of directorsagreed to compensate him for such guarantee.

 

InJune 2007, we entered into a lease for an energy optimization system atour Maple Grove, Minnesota restaurant for approximately $30,000.  This five-year lease carries an annualinterest rate of approximately 11.9% and contains a bargain purchase option.

 

*Operating****Lease*:

 

Theland portions of the 15 property leases referenced above, 13 lease agreementsof which originated with the Dunham Landlords, are classified as operatingleases because the fair value of the land was 25% or more of the leased propertyat the inception of each lease.  Allscheduled rent increases for the land during the initial term of each lease arerecognized on a straight-line basis.  Inaddition to such property leases, as of June 29, 2010, we had obligationsunder the following operating leases:

 

Weoperate nine restaurants under operating lease agreements with the DunhamLandlords.  Of such leases, one expiresin 2016, one in 2017 and seven in 2018. All leases have renewable options for additional periods and allscheduled rent increases during the initial term are recognized on astraight-line basis.

 

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

 

Wemaintain our corporate office space under a lease agreement which expires in November 2011.  Annual rent is $72,115 with scheduled annualincreases throughout the term of the lease. Such scheduled rent increases are recognized on a straight-line basisover the term of the lease.

 

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

 

InAugust 2008, we ceased operations at our restaurant in Rogers,Arkansas.  However, we are currentlybound by the terms of a lease agreement which expires in 2018.  As part of an agreement with the DunhamEntities, we will reimburse DCM for any out-of-pocket expenses incurred lessnet proceeds from the sale of the real estate or lease income associated withthis site.  The lease, as amended, isclassified as an operating lease as it does not meet the requirements for acapital lease.

 

*PersonalGuaranties:*

 

Ourboard of directors has agreed to compensate Steven J. Wagenheim, ourpresident, chief executive officer and one of our directors, for his personal guarantiesof equipment loans entered into in August 2003 and January 2004.  In addition, in August 2006, we enteredinto a lease agreement with Carlton pursuant to which we financed approximately$3.0 million of equipment. Mr. Wagenheim was required to personally guarantee payments to bemade to Carlton under this lease financing agreement, for which our board ofdirectors agreed to compensate him.  Theamount of annual compensation for each of these guarantees is 3% of the balanceof the obligation and is calculated and accrued based on the weighted averagedaily balance of the obligation at the end of each monthly accountingperiod.  During the first half of 2010and 2009, we recorded $18,272 and $33,576 of such compensation in general andadministrative expense, respectively, and paid $105,000 and $0 of suchcompensation, respectively.

 

*EmploymentAgreements:*

 

Wehave entered into employment agreements with Steven J. Wagenheim, our presidentand chief executive officer; James G. Gilbertson, our chief financial officer;and Darius H. Gilanfar, our chief operating 

 

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officer,providing for their employment on an at-will basis. Each agreement, as amendedin June 2010, provides that the executive will have employment through October 6,2012.  Each executive will be entitled toseverance benefits that include one year of base compensation if his employmentis terminated without cause or for good reason, as defined therein, in additionto the balance of the applicable term, if terminated prior to the end of suchterm.  Each employment agreement isautomatically extended for a one-year term unless either our company or theexecutive gives at least 60 days’ notice to the other of an intent not toextend. If we elect not to extend the executive’s employment beyond October 6,2012, or beyond the end of any applicable extension, and terminate executive’semployment, such termination will be deemed to be a termination without causefor purposes of severance benefits and the continuation of base compensationthrough the end of the applicable term. The agreements also provide for a base annual salary which may beincreased by our board of directors, incentive compensation as determined byour compensation committee from time to time, and participation in our company’sother employee benefit plans. In addition, each agreement includes change incontrol provisions that entitle the executive to receive severance pay equal to12 months of salary if there is a change in control of our company and hisemployment is involuntarily terminated for any reason other than for cause, asdefined in the agreement, or death or disability.  Each executive has also agreed to certainnondisclosure provisions during the term of his employment and any timethereafter, and certain non-competition, non-recruitment and/ornon-interference provisions during the term of his employment and for a certainperiod thereafter. As of August 9, 2010, the current annual base salariesin effect for such executives under the foregoing employment agreements were asfollows: Mr. Wagenheim ($300,000), Mr. Gilbertson ($225,000), and Mr. Gilanfar($202,860).

 

*DevelopmentAgreement:*

 

In April 2008, we enteredinto a development agreement with United Properties Investment LLC (“UnitedProperties”) for the development of up to 22 restaurants to be built between2009 and 2012.  United Properties will beresponsible for all costs related to the land and building of eachrestaurant.  The developmentagreement provides for a cooperative process between United Properties and ourmanagement for the selection of restaurant sites and the development ofrestaurants on those sites and scheduling for the development and constructionof each restaurant once a location is approved. The annual lease rate forfee-simple land and building developments will be 9.5% and we will have theright of first offer to purchase these restaurants.  Additionally, in the event United Propertiessells one of the buildings that it develops for us at an amount in excess ofthe threshold agreed to by the parties in the agreement, then we will share inthe profits of that sale.  We assume noliability in the event United Properties sells a building at a loss.  We are not bound to authorize theconstruction of restaurants during that time period, but generally cannot useanother developer to develop or own a restaurant as long as the developmentagreement is in effect.  We can, however,use another developer if United Properties declines to build a particularrestaurant.  We currently have no sitesunder development.

 

*Off- balance sheet arrangements:*

 

We have not entered into any off-balance sheetarrangements as it is not our business practice to do so.

 

*Summary of contractual obligations:*

 

Thefollowing table summarizes our obligations under contractual agreements and thetimeframe within which payments on such obligations are due.  This table does not include amounts relatedto contingent rent as such future amounts are not determinable.  In addition, whether we would incur anyadditional expense on our employment agreements depends upon the existence of achange in control of the company coupled with a termination of employment orother unforeseeable events.  Therefore,neither contingent rent nor severance expense has been included in thefollowing table.

 

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| ** **                                      | ** ** | **Payment due by period** | ** **  |
|-------------------------------------------------|------------|---------------------------|-------------|
| **Contractual**                                 | ** ** | ** **                | ** **  | **Fiscal Year** | ** ** | **Fiscal Years** | ** ** | **Fiscal Years** | ** ** | **Fiscal Years** | ** ** |
| **Obligations**                                 | ** ** | **Total**                 | ** **  | **2010** | ** ** | **2011-2012** | ** ** | **2013-2014** | ** ** | **Thereafter** | ** ** |
| Long-term debt, principal                       |       | $                         | 2,257,024   |   | $ | 130,924 |   | $ | 1,892,282 |   | $ | 9,617 |   | $ | 224,200 |   |
| Interest on long-term debt                      |       | 412,043                   |        | 95,431 |   | 143,155 |   | 36,692 |   | 136,765 |   |
| Capital lease obligations, including interest   |       | 64,631,201                |        | 2,397,461 |   | 9,002,536 |   | 8,547,231 |   | 44,683,972 |   |
| Operating lease obligations, including interest |       | 68,728,734                |        | 4,110,678 |   | 10,832,162 |   | 11,223,193 |   | 42,562,701 |   |
| Purchase contracts*                             |       | 1,185,804                 |        | 251,020 |   | 350,326 |   | 238,964 |   | 345,494 |   |
| Loan guarantee                                  |       | 38,414                    |        | 22,960 |   | 15,454 |   | — |   | — |   |
| Total obligations                               |       | $                         | 137,253,219 |   | $ | 7,008,475 |   | $ | 22,235,915 |   | $ | 20,055,698 |   | $ | 87,953,131 |   |

 

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*Whilewe are contractually obligated to make these purchases, we have the contractualright to defer such  purchases into lateryears.  However, if we defer suchpurchases into later years, we may incur additional charges.

 

Certainamounts do not sum due to rounding.

 

Basedon our current operating trends, we believe we have sufficient capital tooperate our business for the foreseeable future.  If, however, the existing levels of revenueand margins, or a combination of both, decrease to levels unsustainable forcontinuing operations, or if we choose to develop additional locations, we willrequire equity or debt financing to meet ongoing obligations.

 

*Recent accounting pronouncements:*

 

Seethe “Recently issued accounting standards” section of Note 1 to our condensedconsolidated financial statements for a summary of new accounting literature.

 

**Seasonality**

 

Weexpect that our sales and earnings will fluctuate based on seasonalpatterns.  We anticipate that our highestsales and earnings will occur in the second and third quarters due to themilder climate and availability of outdoor seating during those quarters in ourmarkets.

 

**Inflation**

 

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

 

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** **

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

 

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

 

*Changes in interest rates:*

 

Pursuantto the terms of our long-term debt agreement with an independent financialinstitution, we will have a balloon payment due of approximately $1.1 millionin 2011.  If it becomes necessary torefinance such balloon balance, we may not be able to secure financing at thesame interest rate.  The effect of ahigher interest rate would depend upon the negotiated financing terms.

 

*Changes in commodity prices:*

 

Manyof the food products and other commodities we use in our operations are subjectto price volatility due to market supply and demand factors outside of ourcontrol.  Fluctuations in commodityprices and/or long-term changes could have an adverse effect on us.  These commodities are generally purchased basedupon market prices established with vendors. To manage this risk in part, we have entered into fixed price purchasecommitments, with terms typically up to one year, for many of our commodityrequirements.  We have entered intocontracts through 2014 with certain suppliers of raw materials (primarily hops)for minimum purchases both in terms of quantity and pricing.   As of June 29, 2010, our futureobligations under such contracts aggregated approximately $1.2 million.

 

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

 

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

 

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

 

*Evaluationof disclosure controls and procedures*

 

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

 

Underthe supervision and with the participation of our management, including ourChief Executive Officer and Chief Financial Officer, we conducted an evaluationof our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and15d-15(e)). Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that, as of June 29, 2010, our disclosurecontrols and procedures were effective.

 

*Changesin internal control over financial reporting*

 

Therewere no changes in our internal control over financial reporting that occurredduring the quarter ended June 29, 2010 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II        OTHERINFORMATION**

 

**ITEM 1****                          ****LegalProceedings**

 

From time to time, lawsuits are threatened or filed against us in theordinary 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 as of August 9, 2010,****that the expected outcome of these matters, individually orin the aggregate, will not have a material adverse effect on the results ofoperation, liquidity or financial condition of our company.  In addition, some property owners havebrought actions against us or our landlords arising out of our withholding ofrent during the period in which we are attempting to negotiate the leaseterms.  We believe these actions havebeen stayed and will continue in abeyance while active negotiations are takingplace with property owners.

 

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

 

There have been no material changes with respect to the risk factorsdisclosed in our Annual Report on Form 10-K for the fiscal year ended December 29,2009 and our Quarterly Report on Form 10-Q for the fiscal quarter ended March 29,2010 filed with the Securities and Exchange Commission.

 

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

 

On June 25, 2010, we issued 1,678 shares of common stock upon theexercise for cash of a warrant for the purchase of common stock originallyissued on February 7, 2009 to one of our landlords.  The foregoing warrant had an exercise priceof $1.58 per share and an expiration date of February 7, 2014.

 

The foregoing issuance was made in reliance upon the exemption providedin Section 4(2) of the Securities Act.  The certificate representing such securitiescontains a restrictive legend preventing sale, transfer or other disposition,absent registration or an applicable exemption from registration requirements.  The recipient of such securities received, orhad access to, material information concerning our company, including, but notlimited to, our reports on Form 10-K, Form 10-Q, and Form 8-K,as filed with the Securities and Exchange Commission.  No discount or commission was paid in connectionwith the issuance of common stock upon exercise of such warrant.

 

**ITEM 3****                          ****Defaultsupon Senior Securities**

 

None.

 

**ITEM 4****                          ****(Removedand Reserved)**

 

**ITEM 5****                          ****OtherInformation**

 

None.

 

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

 

See “Index to Exhibits.”

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                        | GRANITE  CITY FOOD & BREWERY LTD. |
|-----------------------------|--------------------------------------------|
|                        |                                       |
|                        |                                       |   |
| Date:  August 10, 2010 |                                       | By: |  /s/ James G. Gilbertson |
|                        |                                       | James  G. Gilbertson |
|                        |                                       | Chief  Financial Officer |
|                        |                                       | (As  Principal Financial Officer and Duly Authorized Officer of Granite City  Food & Brewery Ltd.) |

 

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**INDEX TO EXHIBITS**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                              |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                    |
| 3.1         |       | Articles  of Incorporation of the Company, as amended (incorporated by reference to our  Registration Statement on Form S-3, filed on December 30, 2009  (File No. 333-164065)).                         |
|        |       |                                                                                                                                                                                                                    |
| 3.2         |       | Amended  and Restated Bylaws of the Company, dated May 2, 2007 (incorporated by  reference to our Current Report on Form 8-K, filed on May 4, 2007  (File No. 000-29643)).                          |
|        |       |                                                                                                                                                                                                                    |
| 4.1         |       | Reference  is made to Exhibits 3.1 and 3.2.                                                                                                                                                                             |
|        |       |                                                                                                                                                                                                                    |
| 4.2         |       | Specimen  common stock certificate (incorporated by reference to our Current Report on  Form 8-K, filed on September 20, 2002 (File No. 000-29643)).                                                     |
|        |       |                                                                                                                                                                                                                    |
| 10.1        |       | Amendment  No. 3 to Executive Employment Agreement by and between the Company and  Steven J. Wagenheim, dated June 17, 2010.                                                                                  |
|        |       |                                                                                                                                                                                                                    |
| 10.2        |       | Amendment  No. 3 to Executive Employment Agreement by and between the Company and  James G. Gilbertson, dated June 17, 2010.                                                                                  |
|        |       |                                                                                                                                                                                                                    |
| 10.3        |       | Amended  and Restated Employment and Severance Agreement by and between the Company  and Darius H. Gilanfar, dated August 9, 2010.                                                                                 |
|        |       |                                                                                                                                                                                                                    |
| 31.1        |       | Certification  by Steven J. Wagenheim, President and Chief Executive Officer of the Company,  pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002. |
|        |       |                                                                                                                                                                                                                    |
| 31.2        |       | Certification  by James G. Gilbertson, Chief Financial Officer of the Company, pursuant to Exchange  Act Rule 13a-14(a), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.               |
|        |       |                                                                                                                                                                                                                    |
| 32.1        |       | Certification  by Steven J. Wagenheim, President and Chief Executive Officer of the Company,  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.      |
|        |       |                                                                                                                                                                                                                    |
| 32.2        |       | Certification  by James G. Gilbertson, Chief Financial Officer of the Company, pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                    |

 

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