Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

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**FORM 10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 28, 2010**

 

**o****         TRANSITION REPORT PURSUANT TO SECTION 13OR 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  of Incorporation or Organization) |   | (I.R.S. Employer  Identification No.) |

 

**5402 Parkdale Drive, Suite 101**

**Minneapolis, Minnesota  55416**

**(952) 215-0660**

(Address of Principal Executive Offices and Issuer’s

Telephone Number, including Area Code)

 

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

 

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

 

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 November 8, 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 September 28, 2010 and  December 29, 2009                                                   | 1        |
|                   |                                                                                                                                               |     |
|                   | Condensed  Consolidated Statements of Operations for the Thirteen and Thirty-nine Weeks  ended September 28, 2010 and September 29, 2009 | 2        |
|                   |                                                                                                                                               |     |
|                   | Condensed  Consolidated Statements of Cash Flows for the Thirty-nine Weeks ended  September 28, 2010 and September 29, 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                                                                                        | 29       |
|                   |                                                                                                                                               |     |
| ITEM 4                 | Controls and  Procedures                                                                                                                           | 29       |
|                   |                                                                                                                                               |     |
| **PART II**       | **OTHER INFORMATION**                                                                                                                              | 30       |
|                   |                                                                                                                                               |     |
| ITEM 1                 | Legal Proceedings                                                                                                                                  | 30       |
|                   |                                                                                                                                               |     |
| ITEM 1A                | Risk Factors                                                                                                                                       | 30       |
|                   |                                                                                                                                               |     |
| ITEM 2                 | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                                       | 31       |
|                   |                                                                                                                                               |     |
| ITEM 3                 | Defaults  upon Senior Securities                                                                                                                   | 31       |
|                   |                                                                                                                                               |     |
| ITEM 4                 | (Removed and  Reserved)                                                                                                                            | 31       |
|                   |                                                                                                                                               |     |
| ITEM 5                 | Other Information                                                                                                                                  | 31       |
|                   |                                                                                                                                               |     |
| ITEM  6                | Exhibits                                                                                                                                           | 31       |
|                   |                                                                                                                                               |     |
| **SIGNATURES**         |                                                                                                                                               | 32       |
|                   |                                                                                                                                               |     |
| **INDEX  TO EXHIBITS** | 33                                                                                                                                                 |

 

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**PART I  FINANCIAL INFORMATION**

 

**ITEM 1 Financial Statements**

 

**GRANITE CITY FOOD &BREWERY LTD.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

** **
| ** **                                                                                                                                                                                                       | ** ** | **September 28,** | ** ** | **December 29,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                       | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ASSETS:                                                                                                                                                                                                          |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                                                  |       |                   |       |                  |       |
| Cash and cash equivalents                                                                                                                                                                                        |       | $                      | 1,949,564  |                  | $          | 1,743,599 |   |
| Inventory                                                                                                                                                                                                        |       | 945,029                |       | 832,135               |       |
| Prepaids and other                                                                                                                                                                                               |       | 473,133                |       | 563,284               |       |
| Total current assets                                                                                                                                                                                             |       | 3,367,726              |       | 3,139,018             |       |
| Prepaid rent, net of current portion                                                                                                                                                                             |       | 260,369                |       | 303,763               |       |
| Property and equipment, net                                                                                                                                                                                      |       | 49,784,543             |       | 51,336,414            |       |
| Intangible and other assets                                                                                                                                                                                      |       | 1,153,245              |       | 1,242,761             |       |
| Total assets                                                                                                                                                                                                     |       | $                      | 54,565,883 |                  | $          | 56,021,956 |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY:                                                                                                                                                                       |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                                             |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                                                 |       | $                      | 2,449,047  |                  | $          | 2,497,858 |   |
| Accrued expenses                                                                                                                                                                                                 |       | 4,943,188              |       | 6,300,053             |       |
| Accrued exit or disposal activities, current  portion                                                                                                                                                            |       | 137,758                |       | 133,195               |       |
| Deferred rent, current portion                                                                                                                                                                                   |       | 1,506,992              |       | 1,356,391             |       |
| Deferred gain, current portion                                                                                                                                                                                   |       | 122,754                |       | 273,607               |       |
| Long-term debt, current portion                                                                                                                                                                                  |       | 1,743,443              |       | 389,391               |       |
| Capital lease obligations, current portion                                                                                                                                                                       |       | 1,101,012              |       | 718,470               |       |
| Total current liabilities                                                                                                                                                                                        |       | 12,004,194             |       | 11,668,965            |       |
| Accrued exit or disposal activities, net of  current portion                                                                                                                                                     |       | 2,197,321              |       | 2,005,468             |       |
| Deferred rent, net of current portion                                                                                                                                                                            |       | 4,029,039              |       | 3,398,193             |       |
| Deferred gain, net of current portion                                                                                                                                                                            |       | 820,613                |       | 1,991,859             |       |
| Long-term debt, net of current portion                                                                                                                                                                           |       | 422,908                |       | 2,122,120             |       |
| Capital lease obligations, net of current portion                                                                                                                                                                |       | 30,216,494             |       | 27,507,051            |       |
| Total liabilities                                                                                                                                                                                                |       | 49,690,569             |       | 48,693,656            |       |
| Shareholders’ equity:                                                                                                                                                                                       |       |                   |       |                  |       |
| Common stock, $0.01 par value, 90,000,000 and  15,000,000 shares authorized at 9/28/10 and 12/29/09, respectively; 7,367,895  and 7,366,217 shares issued and outstanding at 9/28/10 and 12/29/09,  respectively |       | 73,679                 |       | 73,662                |       |
| Preferred stock, $0.01 par value, 10,000,000  shares authorized                                                                                                                                                  |       |                   |       |                  |       |
| Additional paid-in capital                                                                                                                                                                                       |       | 58,885,631             |       | 58,409,379            |       |
| Accumulated deficit                                                                                                                                                                                              |       | (54,083,996            | )          | (51,154,741           | )          |
| Total shareholders’ equity                                                                                                                                                                                  |       | 4,875,314              |       | 7,328,300             |       |
| Total liabilities and shareholders’ equity                                                                                                                                                                  |       | $                      | 54,565,883 |                  | $          | 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** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|--------------------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|
| ** **                                 | ** ** | **September 28,**             | ** ** | **September 29,**                | ** ** | **September 28,** | ** ** | **September 29,** | ** ** |
| ** **                                 | ** ** | **2010**                           | ** ** | **2009**                              | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Restaurant revenue                         |       | $                                  | 22,271,547 |                                  | $          | 21,478,123 |   | $ | 67,729,980 |   | $ | 65,004,189 |   |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Cost of sales:                             |       |                               |       |                                  |       |   |   |   |   |
| Food, beverage and retail                  |       | 6,163,390                          |       | 5,982,592                             |       | 18,694,615 |   | 17,864,596 |   |
| Labor                                      |       | 7,639,081                          |       | 7,578,646                             |       | 23,203,003 |   | 22,805,179 |   |
| Direct restaurant operating                |       | 3,504,658                          |       | 3,261,449                             |       | 9,931,699 |   | 9,619,339 |   |
| Occupancy                                  |       | 1,997,789                          |       | 1,670,941                             |       | 6,399,753 |   | 4,814,456 |   |
| Total cost of sales                        |       | 19,304,918                         |       | 18,493,628                            |       | 58,229,070 |   | 55,103,570 |   |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Pre-opening                                |       | —                             |       | —                                |       | — |   | 211,262 |   |
| General and administrative                 |       | 1,588,399                          |       | 1,397,184                             |       | 4,803,441 |   | 5,892,251 |   |
| Depreciation and amortization              |       | 1,512,449                          |       | 1,760,339                             |       | 4,469,527 |   | 5,195,056 |   |
| Exit or disposal activities                |       | 374,485                            |       | 174,787                               |       | 634,876 |   | 776,327 |   |
| Loss (gain) on disposal of assets          |       | 17,969                             |       | 8,278                                 |       | (58,186 | ) | 58,686 |   |
| Operating loss                             |       | (526,673                           | )          | (356,093                              | )          | (348,748 | ) | (2,232,963 | ) |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Interest:                                  |       |                               |       |                                  |       |   |   |   |   |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Income                                     |       | 5,968                              |       | 79                                    |       | 10,151 |   | 1,687 |   |
| Expense                                    |       | (936,985                           | )          | (1,365,885                            | )          | (2,590,658 | ) | (4,748,325 | ) |
| Net interest expense                       |       | (931,017                           | )          | (1,365,806                            | )          | (2,580,507 | ) | (4,746,638 | ) |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Net loss                                   |       | $                                  | (1,457,690 | )                                     | $          | (1,721,899 | ) | $ | (2,929,255 | ) | $ | (6,979,601 | ) |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Loss per common share, basic               |       | $                                  | (0.20      | )                                     | $          | (0.64 | ) | $ | (0.40 | ) | $ | (2.59 | ) |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Weighted average shares outstanding, basic |       | 7,367,895                          |       | 2,699,642                             |       | 7,366,807 |   | 2,699,642 |   |

 

Seenotes to condensed consolidated financial statements.

 

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** **

**GRANITE CITY FOOD &BREWERY LTD.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
| ** **                                                                                 | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                 | ** ** | **September 28,**                | ** ** | **September 29,** | ** ** |
| ** **                                                                                 | ** ** | **2010**                              | ** ** | **2009** | ** ** |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from operating activities:                                                      |       |                                  |       |   |   |
| Net loss                                                                                   |       | $                                     | (2,929,255 | ) | $ | (6,979,601 | ) |
| Adjustments to reconcile net loss to net cash provided  by (used in) operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                              |       | 4,349,460                             |       | 5,107,214 |   |
| Amortization of deferred gain                                                              |       | (135,959                              | )          | — |   |
| Other amortization                                                                         |       | 120,067                               |       | 87,842 |   |
| Stock warrant/option expense                                                               |       | 473,786                               |       | 185,870 |   |
| Non-cash interest expense                                                                  |       | 19,786                                |       | — |   |
| Loss on disposal of assets                                                                 |       | 77,773                                |       | 58,686 |   |
| Loss on exit or disposal activities                                                        |       | 180,807                               |       | 375,085 |   |
| Deferred rent                                                                              |       | 769,783                               |       | 1,166,787 |   |
| Changes in operating assets and liabilities:                                               |       |                                  |       |   |   |
| Inventory                                                                                  |       | (112,894                              | )          | (141,488 | ) |
| Prepaids and other                                                                         |       | 133,545                               |       | (108,679 | ) |
| Accounts payable                                                                           |       | 92,877                                |       | 489,424 |   |
| Accrued expenses                                                                           |       | (1,356,866                            | )          | (697,719 | ) |
| Net cash provided by (used in) operating  activities                                       |       | 1,682,910                             |       | (456,579 | ) |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from investing activities:                                                      |       |                                  |       |   |   |
| Purchase of:                                                                               |       |                                  |       |   |   |
| Property and equipment                                                                     |       | (445,424                              | )          | (427,730 | ) |
| Intangible and other assets                                                                |       | (52,364                               | )          | (291,685 | ) |
| Net cash used in investing activities                                                      |       | (497,788                              | )          | (719,415 | ) |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from financing activities:                                                      |       |                                  |       |   |   |
| Payments on capital lease obligations                                                      |       | (514,135                              | )          | (1,531,310 | ) |
| Proceeds from capital leases                                                               |       | —                                |       | 1,000,000 |   |
| Payments on long-term debt                                                                 |       | (353,282                              | )          | (259,782 | ) |
| Proceeds from long-term debt                                                               |       | —                                |       | 800,000 |   |
| Deferred transaction costs                                                                 |       | —                                |       | (938,164 | ) |
| Net costs related to issuance of stock                                                     |       | (111,740                              | )          | — |   |
| Net cash used in financing activities                                                      |       | (979,157                              | )          | (929,256 | ) |
|                                                                                       |       |                                  |       |   |   |
| Net increase (decrease) in cash                                                            |       | 205,965                               |       | (2,105,250 | ) |
| Cash and cash equivalents, beginning                                                       |       | 1,743,599                             |       | 2,652,410 |   |
| Cash and cash equivalents, ending                                                          |       | $                                     | 1,949,564  |   | $ | 547,160 |   |
|                                                                                       |       |                                  |       |   |   |
| Supplemental disclosure of non-cash investing and  financing activities:                   |       |                                  |       |   |   |
|                                                                                       |       |                                  |       |   |   |
| Land, buildings and equipment acquired under  capital lease agreements/amendments          |       | $                                     | 2,451,199  |   | $ | 2,938,266 |   |
| Property and equipment and intangibles purchased  and included in accounts payable         |       | $                                     | 141,688    |   | $ | 48,526 |   |

 

See notes to condensedconsolidated financial statements.

 

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**GRANITE CITY FOOD &BREWERY LTD.**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Thirteen and Thirty-nine weeksended September 28, 2010 and September 29, 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 is upscalecasual dining with a wide variety of menu items that are prepared fresh daily,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 September 28,2010, 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 thirty-nine weeks ended September 28, 2010, the Companyoperated at 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.  Furthermore, the Company also believes thatit will need to begin increasing the number of units it operates to lessenturnover costs as managers and other key personnel may otherwise seek newopportunities with growing restaurant chains. The Company will need to obtain equity or debt financing to fund thisgrowth.  There can be no assurance thatthe Company will obtain financing on favorable terms or at all.  If the Company raises additional capitalthrough the issuance and sale of equity securities, the securities may beissued at prices below the market price of its stock, and its shareholders maysuffer significant dilution.  Debtfinancing, if available, may involve significant cash payment obligations,covenants and financial ratios that restrict the Company’s ability to operateand grow its business, and would cause it to incur additional interest expenseand financing costs.  If cash flow fromoperations is insufficient to fund expected capital needs, or if the Company’sneeds are greater than anticipated and the Company is unable to obtainadditional capital, the Company will be required to further restructure itsdebt obligations.  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 isrestricted and that the shareholder must sell his shares to the subsidiarycorporation upon certain events, or any event that disqualifies theresident-owner from owning the shares under applicable laws and regulations

 

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of the state.  The Company hasentered into a master agreement with the subsidiary corporation that permitsthe operation of the restaurants and leases to the subsidiary corporation theCompany’s property and facilities.  Thesubsidiary corporation pays all of its operating expenses and obligations, andthe Company retains, as consideration for the operating arrangements and thelease of property and facilities, all the net profits, as defined, if any, fromsuch operations.  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 September 28, 2010, and its results of operationsfor the interim periods ended September 28, 2010 and September 29,2009, have been included.

 

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 thirty-nine weeks ended September 28,2010 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, both of whom are directors of the Company.  Mr. Dunham is also the sole member ofDunham Capital Management, LLC (“DCM”) and 70% owner of Dunham EquityManagement, LLC (“DEM”).  DHW, DCM andDEM are collectively, with Mr. Dunham, referred to herein as the “DunhamEntities.”  As of September 28,2010, Mr. Dunham beneficially owned approximately 64.3% of the Company’scommon stock, including the shares held by DHW. DCM and DEM are entities that either are the landlord or the generalpartner in various limited partnerships that own real estate leased to theCompany.  Mr. Dunham, as anindividual, also owns a limited partnership interest in one of the limitedpartnerships that own real estate 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 retailitems.  Revenue is recognized at the timeof sale and is reported on the Company’s consolidated statements of operationsnet of sales taxes collected.  Revenuederived from gift card sales is recognized at the time the gift card isredeemed.  

 

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Untilthe redemption of gift cards occurs, the outstanding balances on such cards areincluded in accrued expenses in the accompanying consolidated balancesheets.  When the Company determinesthere is no legal obligation to remit the value of unredeemed gift cards to therelevant jurisdictions, the Company periodically recognizes gift card breakagewhich represents the portion of its gift card obligation for which managementbelieves the likelihood of redemption by the customer is remote, based uponhistorical redemption patterns.  Suchamounts are included as a reduction 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 for estimatedor actual forfeitures.  Forfeitures areestimated at the time of grant and revised, if necessary, in subsequent periodsif actual forfeitures differ from those estimates.  The Company used the following assumptionswithin the Black-Scholes option-pricing model for the first three quarters of2010 and 2009:

 
| ** **                               | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|
| ** **                               | ** ** | **September 28, 2010**      | ** ** | **September 29, 2009** | ** ** |
| Weighted average risk-free interest rate |       | 2.58% - 3.89%                         |       | 2.25% - 3.80% |   |
| Expected life of options                 |       | 10 years                              |       | 10 years |   |
| Expected stock volatility                |       | 94.27% - 95.86%                       |       | 66.30% - 95.95% |   |
| 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 during the respectiveperiods.  Calculations of the Company’snet loss per common share reflect the Company’s January 2010one-for-six share combination and are set forth in the following table:

 
| ** **                                 | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|--------------------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|
| ** **                                 | ** ** | **September 28,  2010**       | ** ** | **September 29,  2009**          | ** ** | **September 28,  2010** | ** ** | **September 29,  2009** | ** ** |
|                                       |       |                               |       |                                  |       |   |   |   |   |
| Net loss                                   |       | $                                  | (1,457,690 | )                                     | $          | (1,721,899 | ) | $ | (2,929,255 | ) | $ | (6,979,601 | ) |
| Loss per common share, basic               |       | $                                  | (0.20      | )                                     | $          | (0.64 | ) | $ | (0.40 | ) | $ | (2.59 | ) |
| Weighted average shares outstanding, basic |       | 7,367,895                          |       | 2,699,642                             |       | 7,366,807 |   | 2,699,642 |   |

 

**2.     Fair value of financialinstruments**

 

At September 28, 2010 and December 29, 2009, the fair valueof cash 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.

 

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** **

**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 to fractional shares received cash in lieu of receiving fractionalshares.  All references within thisdocument to loss per share reflect this reverse stock split.  Additionally, the number of common shares,stock options and warrants, and the price per common share, stock option andwarrant, reflect this reverse stock 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 $1,065,215.  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 September 28,2010, and the ongoing costs to maintain the property were approximately $4,600per month.  As of September 28,2010, the Company’s future undiscounted cash payments under the terms of thislease were approximately $3.5 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 September 28, 2010, thecarrying cost of the land approximated $16,000 per month.  Reimbursement of costs relating to this site,including the carrying cost of the related land, generally will be amortizedand payable to DCM over a 60-month period commencing January 2011, at a 6%annual interest rate; however, in August 2010, the Company’s board ofdirectors agreed to reimburse DCM $100,000 of such expenses.  The Company further expects that if theproperty is sold, it will reimburse DCM for the difference between the cost ofthe land and the sale price.  Based onthe results of a recent appraisal, the Company accrued an additional $251,750in the third quarter of 2010.  TheCompany’s management has concluded that as of September 28, 2010, it isprobable that the Company will need to reimburse DCM approximately $733,750 andhas included such amount as “accrued exit or disposal activities” on itsbalance sheet, pursuant to the FASB guidance on accounting forcontingencies.  The actual amount due DCMcould fluctuate due to changes in the economy.

 

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The costs related to the closing of the Rogers restaurant and thedecision not to build the Troy restaurant aggregated $634,876 in the firstthree quarters of 2010 and are reflected on the Company’s condensedconsolidated statements of operations as “exit or disposal activities.”**  **The following is areconciliation of the beginning and ending balances of exit or disposalactivities:

 
| Accrued exit or disposal costs at December 29,  2009  |   | $        | 2,138,663 |   |
|------------------------------------------------------------|--------|----------|-----------|--------|
|                                                       |   |     |      |
| Costs incurred and charged to expense                      |   | 734,209  |      |
| Payments                                                   |   | (438,460 | )         |
| Amortization of sublease liability                         |   | (99,333  | )         |
| Accrued exit or disposal costs at  September 28, 2010 |   | $        | 2,335,079 |   |

 

**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 thestraight-line method for financial reporting purposes.  The following is a summary of the Company’sproperty and equipment at September 28, 2010 and December 29, 2009:

 
| ** **                    | ** ** | **September 28, 2010** | ** ** | **December 29, 2009** | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
|                          |       |                             |       |                            |       |
| Land                          |       | $                                | 18,000     |                            | $          | 18,000 |   |
| Buildings                     |       | 33,694,603                       |       | 31,311,399                      |       |
| Leasehold improvements        |       | 9,631,869                        |       | 9,444,418                       |       |
| Equipment and furniture       |       | 33,729,324                       |       | 33,536,306                      |       |
| Construction in progress *    |       | 85,160                           |       | 108,868                         |       |
|                          |       | 77,158,956                       |       | 74,418,991                      |       |
| Less accumulated depreciation |       | (27,374,413                      | )          | (23,082,577                     | )          |
|                          |       | $                                | 49,784,543 |                            | $          | 51,336,414 |   |

 

----

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

 
| ** **                                                  | ** ** | **September 28, 2010** | ** ** | **December 29, 2009** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Prototype/Leasehold improvements for future  locations      |       | $                                | 85,000     |                            | $          | 96,400 |   |
| Equipment and leasehold improvements for current  locations |       | —                           |       | $                               | 12,400     |   |
|                                                             |            |                                  |            |                                 |            |  |  |

 

Intangible and other assets

Intangible and other assets consisted of thefollowing:  

 
| ** **                    | ** ** | **September 28, 2010** | ** ** | **December 29, 2009** | ** ** |
|-------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Intangible assets:            |       |                             |       |                            |       |
| Liquor licenses               |       | $                                | 760,865    |                            | $          | 760,865 |   |
| Trademarks                    |       | 190,617                          |       | 160,193                         |       |
| Other:                        |       |                             |       |                            |       |
| Deferred loan costs           |       | 395,009                          |       | 386,083                         |       |
| Security deposits             |       | 224,346                          |       | 233,146                         |       |
|                          |       | 1,570,837                        |       | 1,540,287                       |       |
| Less accumulated amortization |       | (417,592                         | )          | (297,526                        | )          |
|                          |       | $                                | 1,153,245  |                            | $          | 1,242,761 |   |

 

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**6.        Accrued expenses**

 

Accrued expenses consisted of the following:

 
| ** **                            | ** ** | **September 28, 2010** | ** ** | **December 29, 2009** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Payroll and related                   |       | $                                | 1,208,271  |                            | $          | 1,863,688 |   |
| Deferred revenue from gift card sales |       | 1,488,746                        |       | 2,304,312                       |       |
| Sales taxes payable                   |       | 523,215                          |       | 606,051                         |       |
| Interest                              |       | 325,783                          |       | 269,076                         |       |
| Real estate taxes                     |       | 768,861                          |       | 580,879                         |       |
| Deferred registration costs           |       | 157,360                          |       | 172,179                         |       |
| Other                                 |       | 470,952                          |       | 503,868                         |       |
|                                  |       | $                                | 4,943,188  |                            | $          | 6,300,053 |   |

 

**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 the following:

 
| ** **                                              | ** ** | **September 28, 2010** | ** ** | **December 29, 2009** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Difference between minimum rent and straight-line  rent |       | $                                | 3,897,569  |                            | $          | 3,251,235 |   |
| Deferred rent*, net of $138,503 warrant value           |       | 1,317,301                        |       | 1,140,843                       |       |
| Contingent rent expected to exceed minimum rent         |       | 44,772                           |       | 63,617                          |       |
| Tenant improvement allowance                            |       | 276,389                          |       | 298,889                         |       |
|                                                    |       | $                                | 5,536,031  |                            | $          | 4,754,584 |   |

 

----

*Of this amount, approximately $239,000 was paid to DCM, our primarylandlord, in October 2010, $50,000 will be due to DCM in each of December 2010and January 2011, and approximately $1,095,000 is due to General GrowthProperties, with which we are negotiating reduced lease costs for three of ourlocations.

** **

**8.  Long-term debt**

 

As of September 28, 2010, the Company had two 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 and Davenport, Iowarestaurants.  These loans are secured bythe tangible

 

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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 against the lease, and securityagreements against personal property and intangibles relating to the Company’sSioux Falls, South Dakota restaurant, including a grant of the rights to usepatents, trademarks and other intangibles associated with that restaurant.  Up to 20% of each bridge note may beconverted into common stock at a conversion price equal to $3.00 per share.

 

As of September 28, 2010 and December 29, 2009, the balances,interest rates and maturity dates of our long-term debt were as follows:

 
| ** **                  | ** ** | **September 28, 2010** | ** ** | **December 29, 2009** | ** ** |
|-----------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Des Moines (FNB)            |       |                             |       |                            |       |
| Balance                     |       | $                                | —     |                            | $          | 94,865 |   |
| Annual interest rate        |       | N/A                              |       | 5.50                            | %          |
| Maturity date               |       | N/A                              |       | 8/27/2010                       |       |
|                        |       |                             |       |                            |       |
| Davenport (FNB)             |       |                             |       |                            |       |
| Balance                     |       | $                                | 46,955     |                            | $          | 148,828 |   |
| Annual interest rate        |       | 5.50                             | %          | 10.25                           | %          |
| Maturity date               |       | 1/6/2011                         |       | 1/6/2011                        |       |
|                        |       |                             |       |                            |       |
| Fargo (FNB)                 |       |                             |       |                            |       |
| Balance                     |       | $                                | 1,144,798  |                            | $          | 1,187,349 |   |
| Annual interest rate        |       | 8.75                             | %          | 8.75                            | %          |
| Maturity date               |       | 8/15/2011                        |       | 8/15/2011                       |       |
|                        |       |                             |       |                            |       |
| South Bend (Liquor license) |       |                             |       |                            |       |
| Balance                     |       | $                                | 242,959    |                            | $          | 245,640 |   |
| Annual interest rate        |       | 8.00                             | %          | 8.00                            | %          |
| Maturity date               |       | 9/30/2023                        |       | 9/30/2023                       |       |
|                        |       |                             |       |                            |       |
| Harmony (Bridge loan)       |       |                             |       |                            |       |
| Balance                     |       | $                                | 748,478    |                            | $          | 856,479 |   |
| Annual interest rate        |       | 9.00                             | %          | 9.00                            | %          |
| Maturity date               |       | 12/1/2011                        |       | 12/1/2011                       |       |

 

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

 
| Year ending: |   |      |      |
|--------------|--------|-----------|-----------|
| 2010         |   | $         | 51,435    |   |
| 2011         |   | 1,893,675 |      |
| 2012         |   | 4,263     |      |
| 2013         |   | 4,617     |      |
| 2014         |   | 5,000     |      |
| Thereafter   |   | 224,200   |      |
|         |   | $         | 2,183,190 |   |

 

**9.        Capital leases**

 

Asof September 28, 2010, the Company operated 19 restaurants under capitallease agreements, of which one expires in 2020, one in 2021, two in 2022, threein 2023, four in 2024, two in 2026, three in 2027 and three in 2030, all withrenewable options for additional periods. Seventeen of these lease agreements originated with Donald A. Dunham, Jr.and entities affiliated with him (collectively, the “Dunham Landlords”).  Under certain of the leases, the Company maybe required to pay additional contingent rent based upon restaurant sales.  At the inception and the amendment date ofeach of these leases, the Company evaluated the fair value of the land andbuilding separately pursuant to the FASB guidance on accounting forleases.  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.

 

During the third quarter of 2010, the Company entered into amendmentsto five of the Company’s leases with the Dunham Landlords, changing the rentalamount and extending the term of each lease. The amended terms caused the classification of four such leases tochange from operating to capital (included above).  The fifth amended lease was, and continues tobe, a capital lease.  As a result ofthese amendments, the Company recorded additional assets and capital leaseliabilities of approximately $3.6 million in the aggregate.  Such assets and liabilities were each reducedby a write off of approximately $1.2 million of deferred gain related to theseproperties.

 

The Company’s board of directors has agreed to amend 12 more of theCompany’s leases with the Dunham Landlords, changing the rental amounts andterms of each lease.  Although theamendments were originally to be effective September 1, 2010, suchamendments were not executed as of September 28, 2010.  The parties have agreed to the new rentalpayments beginning September 1, 2010 while finalizing the remaining termsand conditions of the lease amendments. Based on these preliminary understandings, the Company expects toconvert five additional operating leases to capital leases and purchase theproperty improvements at two locations. As such, the Company expects to record additional assets and liabilitiesof approximately $4.8 million in the aggregate. Based on these preliminary understandings, the Company expects topermanently reduce annual rents by approximately $500,000 per year compared tothe original lease rates.

 

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

 

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

 

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Asof September 28, 2010, the Company leased equipment at three of itsrestaurants pursuant 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 interestin all, but not less than all, of the equipment for a purchase price equal to15% of the original cost of the equipment. Steven J. Wagenheim, the Company’s president, chief executive officerand one of its directors, was required to personally guarantee payments to bemade to Carlton under the lease financing and the Company’s board of directorsagreed 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.  This five-year lease carries an annualinterest rate of approximately 11.9% and contains a bargain purchase option.

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

 
| ** **                           | ** ** | **September 28, 2010** | ** ** | **December 29, 2009** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Land                                 |       | $                                | 18,000     |                            | $          | 18,000 |   |
| Building                             |       | 33,749,572                       |       | 31,311,399                      |       |
| Equipment and leasehold improvements |       | 3,365,588                        |       | 3,365,587                       |       |
|                                 |       | 37,133,160                       |       | 34,694,986                      |       |
| Less accumulated depreciation        |       | (9,010,904                       | )          | (7,374,244                      | )          |
|                                 |       | $                                | 28,122,256 |                            | $          | 27,320,742 |   |

 

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

 
| **Year ending:**                       | ** ** | **Capital Leases** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| 2010                                        |       | $                       | 1,199,989  |   |
| 2011                                        |       | 4,689,674               |       |
| 2012                                        |       | 4,312,862               |       |
| 2013                                        |       | 4,244,084               |       |
| 2014                                        |       | 4,303,148               |       |
| Thereafter                                  |       | 44,683,972              |       |
| Total minimum lease payments                |       | 63,433,729              |       |
| Less amount representing interest           |       | (32,116,223             | )          |
| Present value of net minimum lease payments |       | 31,317,506              |       |
| Less current portion                        |       | (1,101,012              | )          |
| Long-term portion of obligations            |       | $                       | 30,216,494 |   |

 

The foregoing table does not include the leases amendments which havenot been executed.  Amortization expenserelated to the assets held under capital leases is included with depreciationexpense on the Company’s statements of operations.

 

**10.      Commitments andcontingencies**

 

Litigation

From time to time, lawsuits are threatened or filed against the Companyin the ordinary course of business.  Suchlawsuits typically involve claims from customers, former or current employees,and others related to

 

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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 November 8, 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 the Company.  In addition, some property owners havebrought actions against the Company or its landlords arising out of the Company’swithholding of rent during the period in which it is attempting to negotiatethe lease terms.  Management believesthese actions 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.  Insome instances, the Company and DCM have not paid rent during this negotiatingperiod.  The Company accrues for anynon-paid rent during this period under “deferred rents” on the balance sheet(see Note 7 regarding amounts due landlords). To the extent the parties are unable to reach agreements to reduce leasecosts, legal action could be brought by lessors that may result in materialadverse consequences to the Company, DCM or both.  Such material adverse consequences could includelegal actions by land owners or other landlords to terminate leases and recoverdelinquent and future rents. Additionally, if any of the Company’s landlords or parties from whom theCompany’s landlords lease property fail financially, the ramifications upon theCompany and the Company’s continued occupancy of the leased restaurants wouldbe uncertain.  The Company could lose thefuture revenue from any such affected locations and lose the value of itsinvestment in improvements thereon, if it is unable to negotiate arrangementswith new owners of the leased locations, or creditors or bankruptcy trustees ofsuch 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,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 the Company or theexecutive gives at least 60 days’ notice to the other of an intent not toextend. If the Company 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 compensation throughthe end of the applicable term.  Theagreements also provide for a base annual salary which may be increased by theCompany’s board of directors, incentive compensation as determined by theCompany’s compensation committee from time to time, and participation in theCompany’s other employee benefit plans. In addition, each agreement includeschange in control provisions that entitle the executive to receive severancepay equal to 12 months of salary if there is a change in control of the Companyand his employment is involuntarily terminated for any reason other than forcause, as defined in the agreement, or death or disability.  Each executive has also agreed to certainnondisclosure provisions during the term of his employment and any time thereafter,and certain non-competition, non-recruitment and/or non-interference provisionsduring the term of his employment and for a certain period thereafter. As of November 8,2010, 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 beresponsible for all costs related to the 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

 

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lease rate for fee-simple land and buildingdevelopments will be 9.5% and the Company will have the right of first offer topurchase these restaurants.  Additionally,in the event United Properties sells one of the buildings that it develops forthe Company at an amount in excess of the threshold agreed to by the parties inthe agreement, then the Company will share in the profits of that sale.  The Company assumes no liability in the eventUnited Properties sells a building at a loss. The Company is not bound to authorize the construction of restaurantsduring that time period, but generally cannot use another developer to developor own a restaurant as long as the development agreement is in effect.  The Company can, however, use anotherdeveloper if United Properties declines to build a particular restaurant.  The Company currently has no sites underdevelopment.

 

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 September 28,2010, the Company’s future obligations under such contracts aggregatedapproximately $726,000.

 

**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.   Asof September 28, 2010, no options to purchase common stock wereoutstanding under the plan, which expired July 28, 2007.

 

As of September 28, 2010, options to purchase 17,500 shares ofcommon stock were outstanding under the 1997 Director Stock Option Plan, whichexpired July 29, 2007.  All suchoptions are fully vested and exercisable for five years from the date ofgrant.  On May 2, 2007, the Company’sboard of directors agreed that until the adoption of any future equity plan fornon-employee directors, awards of stock options for the purchase of 2,500shares of common stock per year, exercisable for a period of ten years, shouldbe made to each non-employee director on the anniversary of his election to theboard under the 2002 Equity Incentive Plan. In May 2010, the Company’s board of directors agreed to increasesuch annual issuance to non-employee directors from 2,500 to 5,000 shares ofcommon 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 shares authorized for issuanceas of September 28, 2010 was 1,125,000. As of September 28, 2010, there were options outstanding under theplan for the purchase of 923,888 shares. Although vesting schedules vary, option grants under this plan generallyvest over a three or four-year period and options are exercisable for no morethan ten years from the date of grant.

 

A summary of the status of the Company’s stock options as of September 28,2010 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                                                     |       | 127,721    |       | 1.36                                       |       | 9.2 years                                           |       |                                |       |
| Exercised                                                   |       | —     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                   |       | (98,391    | )          | 17.49                                      |       |                                                |       |                                |       |
| Outstanding at December 29, 2009                       |       | 394,019    |       | $                                          | 16.07      |                                                | 6.6 years  |                                | $          | 78,467 |   |
|                                                        |       |       |       |                                       |       |                                                |       |                                |       |
| Granted                                                     |       | 603,497    |       | 2.22                                       |       | 9.7 years                                           |       |                                |       |
| Exercised                                                   |       | —     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                   |       | (56,128    | )          | 11.46                                      |       |                                                |       |                                |       |
| Outstanding at September 28, 2010                      |       | 941,388    |       | $                                          | 7.46       |                                                | 8.3 years  |                                | $          | 54,707 |   |
|                                                        |       |       |       |                                       |       |                                                |       |                                |       |
| Options exercisable at December 29, 2009               |       | 198,659    |       | $                                          | 23.01      |                                                | 5.2 years  |                                |       |   |
| Options exercisable at September 28, 2010              |       | 383,746    |       | $                                          | 14.26      |                                                | 6.7 years  |                                | $          | 17,456 |   |
|                                                        |       |       |       |                                       |       |                                                |       |                                |       |
| Weighted-average fair value of options granted  during 2010 |       | $          | 1.97       |                                       |       |                                                |       |                                |       |   |
|                                                             |            |            |            |                                            |            |                                                     |            |                                     |            |  |  |  |

 

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The aggregate intrinsic value in the table above represents the totalpretax intrinsic value (the difference between the closing price of the Company’sstock on 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 September 28,2010, there was approximately $953,683 of total unrecognized compensation costrelated to unvested share-based compensation arrangements, of which $188,724 isexpected to be recognized during the remainder of fiscal year 2010, $501,688 infiscal year 2011, $203,262 in fiscal year 2012, $55,484 in fiscal year 2013 and$4,525 in fiscal year 2014.

 

The following table summarizes information about stock optionsoutstanding at September 28, 2010:

 
| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                              | ** ** | ** **                   | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                              | ** ** | **Number of**           | ** ** | **Remaining**                | ** ** | **Average** | ** ** | **Number of** | ** ** | **Average** | ** ** |
| **Range of  Exercise Prices** | ** ** | **Options  Outstanding**     | ** ** | **Contractual  Life**        | ** ** | **Exercise  Price** | ** ** | **Options  Exercisable** | ** ** | **Exercise  Price** | ** ** |
|                                    |       |                         |       |                         |       |   |   |   |   |   |   |
| $1.00 - $6.00                           |       | 699,530                      |       | 9.5 years                    |       | $ | 2.13 |   | 171,431 |   | $ | 2.11 |   |
| $6.01 - $12.00                          |       | 22,497                       |       | 6.6 years                    |       | $ | 10.17 |   | 13,954 |   | $ | 9.91 |   |
| $12.01 - $18.00                         |       | 43,073                       |       | 5.3 years                    |       | $ | 14.16 |   | 26,350 |   | $ | 14.64 |   |
| $18.01 - $24.00                         |       | 55,330                       |       | 5.0 years                    |       | $ | 21.94 |   | 55,330 |   | $ | 21.94 |   |
| $24.01 - $30.00                         |       | 75,464                       |       | 4.9 years                    |       | $ | 26.03 |   | 71,297 |   | $ | 26.07 |   |
| $30.01 - $36.00                         |       | 28,828                       |       | 1.7 years                    |       | $ | 31.14 |   | 28,718 |   | $ | 31.14 |   |
| $36.01 - $42.00                         |       | 16,666                       |       | 6.5 years                    |       | $ | 37.20 |   | 16,666 |   | $ | 37.20 |   |
| Total                                   |       | 941,388                      |       | 8.3 years                    |       | $ | 7.46 |   | 383,746 |   | $ | 14.26 |   |

 

**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 thisagreement, the Company issued five-year warrants for the purchase of 36,960shares of common stock at an exercise price of $39.00 per share to suchinvestors and five-year warrants for the purchase of 9,239 shares of commonstock at an exercise price of $39.00 per share to the Company’s placementagent. Such warrant agreements with the investors and placement agent for thistransaction contain certain anti-dilution provisions.  Pursuant to these provisions, the number ofshares purchasable upon exercise of these warrants and the related purchaseprice both required adjustment upon the issuance of warrants in the firstquarter of 2009, at an exercise price less than the thresholds set forth in thesecurity purchase agreement.  Theexercise price of each existing warrant was multiplied by a 

 

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fraction,the numerator of which was the sum of the number of shares of common stockoutstanding immediately prior to such issuance, plus the number of shares ofcommon stock which the offering price for such shares of common stock wouldpurchase at the closing price of our common stock on the closing date of thissecurities purchase agreement; and the denominator of which was the sum of thenumber of shares of common stock outstanding immediately prior to such issuanceplus the number of such new securities so issued.  As a result of the issuance of common stockin October 2009 at a price per share less than the thresholds set forth inthe security purchase agreement, further anti-dilution adjustments wererequired.  As a result of theseadjustments, the number of shares purchasable under these warrants at September 28,2010 was 110,956 and the exercise price was $16.24 per share.  On October 21, 2010, all such warrantsexpired unexercised.

 

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.  The aggregate number of shares underlyingsuch warrants was 201,028 and the weighted average exercise price was $1.60 pershare.  Pursuant to the provisions ofsuch 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 each warrant issued prior to such issuance wasmultiplied by a fraction, the numerator of which was the sum of the number ofshares of common stock outstanding immediately prior to such issuance ofwarrants, plus the number of shares of common stock which the offering pricefor such shares of common stock would purchase at the warrant exercise price ineffect immediately prior to such issuance; and the denominator of which was thesum of the number of shares of common stock outstanding immediately prior tosuch issuance plus the number of such new securities so issued.  As a result of these adjustments, the numberof shares purchasable under these warrants came to be 201,125 and the weightedaverage exercise price was $1.60 per share. In June 2010, a warrant for the purchase of 1,678 shares wasexercised at an exercise price of $1.58 per share.  As of September 28, 2010, warrants forthe purchase of 199,447 shares remained unexercised.

 

Pursuantto the Harmony bridge loan agreement entered into in March 2009, theCompany issued to the investors five-year warrants for the purchase of anaggregate of 53,332 shares of common stock at a price of $1.52 per share.  Such warrants became exercisable September 30,2009, and remained unexercised at September 28, 2010.

 

As of October 21, 2010, warrants for the purchase of an aggregateof 252,779 shares of common stock were outstanding and exercisable.  The weighted average exercise price of suchwarrants was $1.58 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 and is provided to allemployees who meet the eligibility requirements.  A participant can elect to contribute up to100% of his/her compensation subject to IRS limits.  Prior to fiscal year 2009, the Company madeno contribution to the plan.  Beginningin fiscal year 2009, the Company elected to match 10% of such contributions upto 6% of the participant’s compensation. In fiscal year 2009, the Company contributed $12,761 under the plan, andin the first three quarters of 2010, the Company contributed an additional$10,485 under the plan.  The Companyexpects to contribute approximately $3,500 under the plan during the remainderof fiscal year 2010.

 

**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, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  You are cautioned not to attribute unduecertainty to such forward-looking statements, which are qualified in theirentirety by the cautions and risks described herein.  Please refer to the “Risk Factors” section ofour Annual*

 

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*Reporton Form 10-K, filed with the Securities and Exchange Commission on March 22,2010, and the “Risk Factors” section of our Quarterly Report on Form 10-Q,filed with the Securities and Exchange Commission on May 10, 2010 and the “RiskFactors” section of this document for additional factors known to us that maycause actual results to vary.*

 

**Overview**

 

Weare a Modern American upscale casual restaurant chain.   As of September 28, 2010, we operated26 restaurants in 11 Midwestern states featuring on-premises breweries,substantially all of which operate under the name of Granite CityFood & Brewery®.  We believe ourmenu features high quality yet affordable family favorite menu items preparedfrom made-from-scratch recipes and served in generous portions.  We believe that the sophisticated yetunpretentious restaurants, proprietary food and beverage products, attractiveprice points and high service standards combine for a great diningexperience.  The location of eachrestaurant in operation and the month and year of its opening appear in thefollowing chart:

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

 

InAugust 2008, we ceased operations at our restaurant in Rogers, Arkansas(see Note 4 to our condensed consolidated financial statements).  However, we are currently bound by the termsof 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 believe that this brewing process improvesthe economics of microbrewing as it eliminates the initial stages of brewingand storage at multiple locations, thereby reducing equipment and developmentcosts at new restaurant locations. Additionally, having a common starting point, the beer productioncreates consistency of taste for our product from restaurant torestaurant.  The initial product producedat our beer production facility is transported by truck to the fermentationvessels at each of our 

 

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restaurantswhere the brewing process is completed. In 2007, we were granted a patent bythe United States Patent Office for this brewing process.  We believe that our current beer productionfacility, which opened in June 2005, has the capacity to service up to 35restaurant locations.

 

DHWLeasing, L.L.C. (“DHW”), the beneficial owner of approximately 63.3% of ourcommon stock, gained control of our company in October 2009.  The members of DHW are Donald A. Dunham, Jr.and Charles J. Hey, both of whom are directors of ours.  Mr. Dunham, who is also the sole memberof Dunham Capital Management, LLC (“DCM”) and 70% owner of 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 as the “Dunham Entities.” As of September 28, 2010, Mr. Dunham beneficially ownedapproximately 64.3% of our common stock, including the shares held by DHW.  DCM and DEM are entities that either are thelandlord or the general partner in various limited partnerships that own realestate leased to our company.  Mr. Dunham,as an individual, also owns a limited partnership interest in one of thelimited partnerships that own real estate leased to our company.

 

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, ourproperty and equipment rent.  We haveimplemented marketing initiatives designed to increase brand awareness and helpdrive guest traffic.  We believe theseinitiatives contributed to the increase in sales and guest traffic in the firstthree quarters of 2010.

 

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 thirdquarter of 2010 and 2009 each included 338 operating weeks, which is the sum ofthe actual number of weeks each restaurant operated.  The first three quarters of 2010 and 2009included 1,014 and 1,008 operating weeks, respectively.  The six additional operating weeks in thefirst three quarters of 2010 were related to our Indianapolis, Indianarestaurant which opened in February 2009. Because we have opened new restaurants at various times throughout theyears, we provide this statistical measure to enhance the comparison ofrevenues from period to period as changes occur in the number of units we areoperating.

 

Ourrestaurant revenue is comprised almost entirely of the sales of food andbeverages.  The sale of retail itemstypically represents 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 and administrativeexpenses are comprised of expenses associated with all corporate andadministrative 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.

 

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**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 thirty-nine weeks ended September 28,2010 and September 29, 2009:

 
| ** **                        | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|-----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **September 28,**        | ** ** | **September 29,**           | ** ** | **September 28,** | ** ** | **September 29,** | ** ** |
| ** **                        | ** ** | **2010**                 | ** ** | **2009**                    | ** ** | **2010** | ** ** | **2009** | ** ** |
|                              |       |                     |       |                        |       |   |   |   |   |
| Restaurant revenue                |       | 100.0                    | %          | 100.0                       | %          | 100.0 | % | 100.0 | % |
|                              |       |                     |       |                        |       |   |   |   |   |
| Cost of sales:                    |       |                     |       |                        |       |   |   |   |   |
| Food, beverage and retail         |       | 27.7                     |       | 27.9                        |       | 27.6 |   | 27.5 |   |
| Labor                             |       | 34.3                     |       | 35.3                        |       | 34.3 |   | 35.1 |   |
| Direct restaurant operating       |       | 15.7                     |       | 15.2                        |       | 14.7 |   | 14.8 |   |
| Occupancy                         |       | 9.0                      |       | 7.8                         |       | 9.4 |   | 7.4 |   |
| Total cost of sales               |       | 86.7                     |       | 86.1                        |       | 86.0 |   | 84.8 |   |
|                              |       |                     |       |                        |       |   |   |   |   |
| Pre-opening                       |       | —                   |       | —                      |       | — |   | 0.3 |   |
| General and administrative        |       | 7.1                      |       | 6.5                         |       | 7.1 |   | 9.1 |   |
| Depreciation and amortization     |       | 6.8                      |       | 8.2                         |       | 6.6 |   | 8.0 |   |
| Exit or disposal activities       |       | 0.6                      |       | 0.8                         |       | 0.6 |   | 1.2 |   |
| Loss (gain) on disposal of assets |       | 0.1                      |       | 0.0                         |       | (0.1 | ) | 0.1 |   |
| Operating loss                    |       | (1.2                     | )          | (1.7                        | )          | (0.1 | ) | (3.4 | ) |
|                              |       |                     |       |                        |       |   |   |   |   |
| Interest:                         |       |                     |       |                        |       |   |   |   |   |
| Income                            |       | 0.0                      |       | 0.0                         |       | 0.0 |   | 0.0 |   |
| Expense                           |       | (4.2                     | )          | (6.4                        | )          | (3.8 | ) | (7.3 | ) |
| Net interest expense              |       | (4.2                     | )          | (6.4                        | )          | (3.8 | ) | (7.3 | ) |
|                              |       |                     |       |                        |       |   |   |   |   |
| Net loss                          |       | (5.4                     | )%         | (8.0                        | )%         | (4.0 | )% | (10.7 | )% |

 

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 Exchange Commission onMarch 22, 2010.

 

**Resultsof operations for the thirteen and thirty-nine weeks ended September 28, 2010and September 29, 2009**

 

**Revenue**

 

Wegenerated $22,271,547 and $21,478,123 of revenue during the third quarter of2010 and 2009, respectively.  The 3.7%increase in revenue was due primarily to the 3.5% increase in guest traffic inthe third

 

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quarterof 2010 compared to the third quarter of 2009. Comparable restaurant revenue, which includes restaurants in operationover 18 months, increased 4.0% from the third quarter of 2009 to the thirdquarter of 2010 due to an increase in guest traffic of 3.7%.  The average weekly revenue per restaurant atour comparable restaurants increased $2,534 from $63,104 in the third quarterof 2009 to $65,638 in the third quarter of 2010.

 

Duringthe first three quarters of 2010 and 2009, we generated revenue of $67,729,980and $65,004,189, respectively.  The 4.2%increase in first three quarters revenue was primarily the result of anincrease in guest traffic of approximately 5.5%.  The first three quarters of 2010 included sixadditional restaurant operating weeks compared to the same period in 2009.  Comparable restaurant revenue increased 3.9%from the first three quarters of 2009 to the first three quarters of 2010primarily due to an increase in guest traffic of approximately 5.0%.  Average weekly revenue per comparablerestaurant increased $2,479 from $64,257 in the first three quarters of 2009 to$66,736 in the first three quarters of 2010.

 

Throughout2009 and particularly in the last half of the year, we began a discounting anda 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 three quarters of 2010, and our average check increased slightly in thirdquarter of 2010 compared to the third quarter of 2009.

 

Weexpect that restaurant revenue will vary from quarter to quarter.  Continued seasonal fluctuations in restaurantrevenue are due in part to increased outdoor seating and weatherconditions.  Due to the honeymoon effectthat periodically occurs with the opening of a restaurant, we expect the timingof any future restaurant openings to cause fluctuations in restaurantrevenue.  Additionally, other factorsoutside of our control, such as timing of holidays, consumer confidence in theeconomy and changes in consumer preferences may affect our future revenue.

 

**Restaurantcosts**

 

***Food and beverage***

 

Ourfood and beverage costs, as a percentage of revenue, decreased 0.2% to 27.7% inthe third quarter of 2010 from 27.9% in the third quarter of 2009.  Such costs increased 0.1% as a percentage ofrevenue to 27.6% in the first three quarters of 2010 from 27.5% in the firstthree quarters of 2009.  While we didexperience slight cost increases, primarily in bottled beer, fish, chicken andproduce, such costs were offset in part by decreases in wine and liquorcosts.  While pricing negotiations withour suppliers have reduced our exposure to commodity price increases, we doexpect that our food and beverage costs will continue to vary going forward dueto numerous variables, including seasonal changes in food and beverage costsfor which we do not have contracted pricing, fluctuations within commodity-pricedgoods and guest preferences.  Weperiodically create new menu offerings and introduce new craft brewed beersbased upon guest preferences.  Althoughsuch menu modifications may temporarily result in increased food and beveragecost, we believe we are able to offset such increases with our weekly specialswhich provide variety and value to our guests. Our varieties of craft brewed beer, which we believe we can produce atlower cost than beers we purchase for resale, also enable us to keep our foodand beverage costs low while fulfilling guest requests and building customerloyalty.

 

***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 aggregate dollarsand as a percentage of revenue.

 

Ourlabor costs, as a percentage of revenue, decreased 1.0% to 34.3% in the thirdquarter of 2010 from 35.3% in the third quarter of 2009.  Such costs decreased 0.8% as a percentage ofrevenue to 34.3% in the first three quarters of 2010 from 35.1% in the firstthree quarters of 2009.  We have notopened additional restaurants

 

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sincethe first quarter of 2009, and therefore did not incur additional labor coststypically associated with newly opened restaurants in the first three quartersof 2010.  Additionally, we have trainedour managers on a number of operational metrics and initiatives focused onmanager 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 increased 0.5% to 15.7% in thethird quarter of 2010 from 15.2% in the third quarter of 2009, due primarily toincreases in marketing and printing costs. Such costs decreased 0.1% as a percentage of revenue to 14.7% in thefirst three quarters of 2010 from 14.8% in the first three quarters of2009.  Decreases in costs of utilities,paper and plastic and uniforms were offset in part by the increase inadvertising and promotion costs as we continued the marketing initiatives webegan in 2009.

 

Wecontinue to seek ways to reduce our direct operating costs going forwardincluding additional pricing negotiations with suppliers and the elimination ofwaste.

 

***Occupancy***

 

Our occupancy costs, which include both fixed and variable portions ofrent, common area maintenance charges, property insurance and property taxes,increased 1.2% as a percentage of revenue to 9.0% in the third quarter of 2010from 7.8% in the third quarter of 2009. Such costs increased 2.0% as a percentage of revenue to 9.4% in thefirst three quarters of 2010 from 7.4% in the first three quarters of2009.  Our occupancy cost increasedsignificantly in the fourth quarter of 2009 as leases at nine of the restaurantswe operate were converted from capital leases to operating leases as a resultof lease amendments entered into in October 2009.  As capital leases, a portion of the leaseexpense was recorded as interest expense and reduction of liability.  As operating leases, all lease expense isrecorded as an occupancy cost included in rent expense.  Also included in our rent expense is thedifference between our current rent payments and straight-line rent expenseover the initial lease term.  Thisnon-cash rent expense of $640,446 and $475,074 is included in occupancy costsin the first three quarters of 2010 and 2009, respectively.  The $165,372 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 withDonald A. Dunham, Jr. and entities affiliated with him (collectively, the “DunhamLandlords”), changing the rental amount and extending the term of eachlease.  The amended terms caused 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 was classified asinterest expense and a reduction of liability in the third quarter of2010.  As we continue to renegotiate ourleases, we anticipate that more leases will be converted from operating leasesto capital leases, further reducing occupancy costs and increasing interestexpense.

 

**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.

 

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Inthe first three quarters of 2009, our pre-opening costs of $211,262 wererelated to the restaurant 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 threequarters of 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 productionfacility, and salaries and expenses of our new restaurant opening team when notdedicated to 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 increased $191,215 to $1,588,399 in the thirdquarter of 2010 from $1,397,184 in the third quarter of 2009.  As a percentage of revenue, general andadministrative expenses increased 0.6% in the third quarter of 2010 compared tothe third quarter of 2009.  In the thirdquarter of 2009, we reclassified approximately $501,000 in transaction costsincurred in the first half of 2009 from general and administrative expense todeferred transaction cost, due to the closing of the transaction in October 2009whereby we extinguished approximately $15.0 million of our debt in exchange forequity.  In addition, in preparation forour annual meeting of shareholders held in August 2010, we experienced anincrease in legal costs and investor relation costs. Non-cash stock-basedcompensation included in general and administrative expense was $66,934 and$33,628 in the third quarter of 2010 and 2009, respectively.  General and administrative expenses decreased$1,088,810 to $4,803,441 in the first three quarters of 2010 from $5,892,251 inthe first three quarters of 2009.  As apercentage of revenue, such expenses decreased 2.0% in the first three quartersof 2010 from the first three quarters of 2009. The primary sources of such year-to-date decrease were expenses relatedto recruiting, consulting, compensation, legal and travel expense.  Non-cash stock-based compensation included ingeneral and administrative expense was $275,659 and $114,971 in the first threequarters of 2010 and 2009, respectively.

 

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 tocontain our costs.  To the extent ourturnover increases above our expectations, additional costs above our budgetedfigures could 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 for the full fiscal year 2010 compared to 2009.

 

**Depreciationand amortization**

 

Depreciationand amortization expense decreased $247,890 to $1,512,449 in the third quarterof 2010 from $1,760,339 in the third quarter of 2009.  Such expense decreased $725,529 to $4,469,527in the first three quarters of 2010 from $5,195,056 in the first three quartersof 2009, due principally to the reclassification of the leases at nine of therestaurants we operate from capital leases to operating leases in October 2009.  As a percentage of revenue, depreciationexpense decreased 1.4% in the third quarter and first three quarters of 2010compared to the respective periods in 2009.

 

**Exit ordisposal activities**

 

InAugust 2008, we closed our Rogers, Arkansas restaurant.  Since opening in October 2007, the restaurantfailed to generate positive cash flow and had approximately $1.4 million of netloss.  We believe the closure of thisrestaurant has allowed management to focus capital and personnel resources onour other restaurants in order to increase future operating efficiencies andcash flow.  We are working to find areplacement tenant for the location, for which we are bound by a lease whichexpires in December 2018.  Costs incurredin the

 

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firstthree quarters of 2010 and 2009 in connection with this closure include coststo maintain the facility of approximately $338,460 and $401,241,respectively.  We will incur ongoingcosts such as utilities, landscape and maintenance and general liabilityinsurance until we are able to find a replacement tenant. We recorded anon-cash lease termination liability of $1,762,689 based on management’sestimate of the fair value of these obligations.  This required management to estimate thepresent value of the future minimum lease obligations offset by the estimatedsublease rentals that could be reasonably obtained for the property.  Amortization of this sublease liability was$99,333 and $14,915 in the first three quarters 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 September 28, 2010, andour ongoing costs to maintain the property were approximately $4,600 permonth.  As of September 28, 2010, ourfuture undiscounted cash payments under the terms of this lease wereapproximately $3.5 million.

 

Aspart of the Master Agreement we entered into with the Dunham Entities in February2009, we agreed to reimburse DCM for any out-of-pocket expenses incurred,reduced by net proceeds from the sale of the real estate or lease incomeassociated with the Rogers, Arkansas site and the site at Troy, Michigan uponwhich we decided not to build a restaurant. As September 28, 2010, the carrying cost of the land at the Troy,Michigan site approximated $16,000 per month and has been recorded in “exit anddisposal activities” in our statement of operations.  Reimbursement of costs related to thesesites, including the carrying cost of the related land, generally will beamortized and payable to DCM over a 60-month period commencing January 2011, ata 6% annual interest rate; however, in August 2010, our board of directorsagreed to reimburse DCM $100,000 of such expenses.  We further expect that if the property issold, we will reimburse DCM for the difference between the cost of the land andthe sale price.  Based on the results ofa recent appraisal, we accrued an additional $251,750 in the third quarter of2010.  As of September 28, 2010, ourmanagement believes it is probable we will need to reimburse DCM approximately$733,750 of such costs related to the Troy, Michigan site.  The actual amount due DCM could fluctuate dueto 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 $428,900 to $936,985 in the third quarter of2010 from $1,365,885 in the third quarter of 2009.  Such expense decreased $2,157,667 to$2,590,658 in the first three quarters of 2010 from $4,748,325 in the firstthree quarters of 2009.  These decreaseswere due to capital lease reductions from our landlords and equipment financersand the extinguishment of approximately $15.0 million of equipment lease debtthrough the issuance of common stock in October 2009.  Additionally, in October 2009, leases at nineof the restaurants we operate were converted from capital leases to operatingleases.  As a result, expense related tosuch leases that was recorded as interest expense in the first three quartersof 2009, was recorded as an occupancy cost included in rent in the first threequarters of 2010.  As we continue torenegotiate our leases, we anticipate that more leases will be converted fromoperating leases to capital leases, further reducing occupancy costs andincreasing interest expense.  Interestincome increased $5,889 in the third quarter of 2010 and $8,464 in the firstthree quarters of 2010 over the respective periods in 2009 due to the increasein cash on hand.

 

**Liquidityand capital resources**

 

Asof September 28, 2010, we had $1,949,564 of cash and a working capital deficitof $8,636,468 compared to $1,743,599 of cash and a working capital deficit of$8,529,947 at December 29, 2009.

 

Duringthe thirty-nine weeks ended September 28, 2010, we generated $1,682,910 of netcash from operating activities.  We used$497,788 of cash to purchase equipment and other assets and made paymentsaggregating $867,417 on our debt and capital lease obligations.  We used $114,223 of cash related to theissuance of common stock to DHW and made cash payments aggregating $175 toshareholders in lieu of receiving fractional shares related to our reversestock split. We received $2,658 of cash upon the exercise of a landlordwarrant.

 

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Duringthe thirty-nine weeks ended September 29, 2009, we obtained proceeds of$1,800,000 pursuant to a sales-leaseback capital lease agreement and a loanagreement and made payments aggregating $1,791,092 on our debt and capitallease obligations.  We used $456,579 ofnet cash in operating activities, $719,415 of net cash to purchase equipmentand other assets, and $938,164 of cash for costs related to the issuance ofcommon stock to DHW.

 

InDecember 2009, our board of directors approved a one-for-six-share-combinationof our common stock which became effective January 13, 2010.  As a result of this reverse stock split,every six shares of our common stock that were issued and outstanding as of January13, 2010, were automatically combined into one issued and outstanding sharewithout any change in the par value of such shares, and the number of authorizedbut unissued shares of our common stock were proportionally reduced. Aproportionate adjustment was also made to our outstanding stock options andwarrants.  No fractional shares wereissued 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 landlordslease property fail financially, the ramifications upon our company and ourcontinued occupancy of the leased restaurants would be uncertain.  We could lose the future revenue from anysuch affected locations and lose the value of our investment in improvementsthereon if we are unable to negotiate arrangements with new owners of theleased locations, or creditors or bankruptcy trustees of such landlords.

 

Forthe first three quarters of fiscal year 2010, we operated at a level thatallowed us to fund our existing operations. We believe this same level of sales and margins will allow us to fundour obligations for the foreseeable future. However, our ability to continue funding our operations and meet ourdebt service obligations continues to depend upon our operating performance,and more broadly, achieving budgeted revenue and operating margins, both ofwhich will be affected by prevailing economic conditions in the retail andcasual dining industries and other factors, which may be beyond ourcontrol.  If revenue or margins, or acombination of both, decrease to levels unsustainable for continuingoperations, we will require equity or debt financing to meet ongoingobligations.  The amount of any suchrequired funding would depend upon our ability to generate working capital.  Furthermore, we also believe that we willneed to begin increasing the number of units we operate to lessen turnovercosts as managers and other key personnel may otherwise seek new opportunitieswith growing restaurant chains.  We willneed to obtain equity or debt financing to fund this growth.  There can be no assurance that we will obtainfinancing on favorable terms or at all. If we raise additional capital through the issuance and sale of equitysecurities, the securities may be issued at prices below the market price ofour stock, and our shareholders may suffer significant dilution.  Debt financing, if available, may involvesignificant cash payment obligations, covenants and financial ratios thatrestrict our ability to operate and grow our business, and would cause us toincur 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.

 

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**Commitments**

 

*Long-termdebt:*

 

As of September 28, 2010, we had two long-term loans outstanding withan independent financial institution in Pierre, South Dakota, the proceeds ofwhich we used to purchase assets at our restaurants in Fargo, North Dakota andDes Moines, Iowa. These loans are secured by the tangible personal property andfixtures at the respective locations and are guaranteed by Steven J. Wagenheim,our president, chief executive officer and one of our directors.  As of September 28, 2010, one such loanbalance was $46,955, matures in January 2011 and carries an annual interestrate of 5.5%.  The other such loanbalance was $1,144,798, matures in August 2011 and carries an annual interestrate of 8.75%

 

As of September 28, 2010, the balance on our promissory note to anIndiana general partnership secured by the liquor license at our South Bend, Indianarestaurant was $242,939.  Such note maturesin September 2023 and carries an annual interest rate of 8.0%.

 

Asof September 28, 2010, we entered into a bridge loan agreement with a group ofaccredited investors, the proceeds of which were used for working capital.  The notes are secured by a mortgage againstthe lease, and security agreements against personal property and intangibles,relating to our Sioux Falls, South Dakota restaurant, including a grant of therights to use patents, trademarks and other intangibles associated with thatrestaurant.  Up to 20% of each bridgenote may be converted into common stock at a conversion price equal to $3.00per share.  The balance of the loan at September28, 2010 was $748,478, matures in December 2011 and carries an annual interestrate of 9.0%.

 

*CapitalLeases*:

 

Propertyleases

 

Asof September 28, 2010, we operated 19 restaurants under capital leaseagreements, of which one expires in 2020, one in 2021, two in 2022, three in2023, four in 2024, two in 2026, three in 2027 and three in 2030, all with renewableoptions for additional periods. Seventeen of these lease agreements originated with the DunhamLandlords.  Under certain of the leases,we may be required to pay additional contingent rent based upon restaurantsales.  At the inception and the amendmentdate of each of these leases, we evaluated the fair value of the land andbuilding separately pursuant to the FASB guidance on accounting forleases.  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.

 

Duringthe third quarter of 2010, we entered into amendments to five of our leaseswith the Dunham Landlords, changing the rental amount and extending the term ofeach lease.  The amended terms caused theclassification of four such leases to change from operating to capital(included above).  The fifth amendedlease was, and continues to be, a capital lease.  As a result of these amendments, we recordedadditional assets and capital lease liabilities of approximately $3.6 millionin the aggregate.  Such assets andliabilities were each reduced by a write off of approximately $1.2 million ofdeferred gain related to these properties.

 

Our board of directors has agreed to amend 12 more of our leases withthe Dunham Landlords, changing the rental amounts and terms of each lease.  Although the amendments were originally to beeffective September 1, 2010, such amendments were not executed as of September 28,2010.  The parties have agreed to the newrental payments beginning September 1, 2010 while finalizing the remainingterms and conditions of the lease amendments. Based on these preliminary understandings, we expect to convert fiveadditional operating leases to capital leases and purchase the propertyimprovements at two locations.  As such,we expect to record additional assets and liabilities of approximately $4.8million in the aggregate. Based on these preliminary understandings, we expectto permanently reduce annual rents by approximately $500,000 per year comparedto the original lease rates.

 

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InDecember 2004, we entered into a land and building lease agreement for our beerproduction facility.  This ten-year lease,which commenced February 1, 2005, allows us to purchase the facility at anytime 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 therestaurant we planned to open in Troy, Michigan.  However, in February 2009, we decided not tobuild on that site, and as part of an agreement with the Dunham Entities, wewill reimburse DCM for any out-of-pocket expenses incurred less net proceedsfrom the sale of the real estate or lease income associated with the site.

 

Equipmentleases

 

Asof September 28, 2010, we leased equipment at three of our restaurants pursuantto a lease agreement with Carlton Financial Corporation (“Carlton”). The valueof the equipment financed at each of the three locations ranges fromapproximately $0.8 million to $1.1 million, the annual interest rate on eachranges from 12.9% to 19.6% 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 payments to be made toCarlton under the lease financing and our board of directors agreed tocompensate him for such guarantee.

 

InJune 2007, we entered into a lease for an energy optimization system at ourMaple 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 19 property leases referenced above, 17 lease agreementsof which originated with the Dunham Landlords, are classified as operating leasesbecause the fair value of the land was 25% or more of the leased property atthe 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 September 28, 2010, we had obligationsunder the following operating leases:

 

Weoperate five restaurants under operating lease agreements with the DunhamLandlords.  Each lease expires in 2018and has renewable options for additional periods. Scheduled rent increasesduring the initial term are recognized on a straight-line basis.

 

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

 

Wemaintain our corporate office space under a lease agreement which expires in November2011.  Annual rent is $72,115 withscheduled annual increases throughout the term of the lease.  Such scheduled rent increases are recognizedon a straight-line basis over the term of the lease.

 

InMarch 2006, we entered into a lease agreement for the land and building for ourSt. 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 currently bound by the termsof a lease agreement which expires in 2018. As part of an agreement with the Dunham Entities, we will reimburse DCMfor any out-of-pocket expenses incurred less net proceeds from the sale of the

 

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realestate or lease income associated with this site.  The lease, as amended, is classified as anoperating lease as it does not meet the requirements for a capital lease.

 

*PersonalGuaranties:*

 

Ourboard of directors has agreed to compensate Steven J. Wagenheim, our president,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 entered intoa lease agreement with Carlton pursuant to which we financed approximately $3.0million of equipment.  Mr. Wagenheim wasrequired to personally guarantee payments to be made to Carlton under thislease financing agreement, for which our board of directors agreed tocompensate him.  The amount of annualcompensation for each of these guarantees is 3% of the balance of theobligation and is calculated and accrued based on the weighted average dailybalance of the obligation at the end of each monthly accounting period.  During the first three quarters of 2010 and2009, we recorded $25,454 and $45,837 of such compensation in general andadministrative expense, respectively, and paid $112,451 and $25,000 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 officer, providing for theiremployment on an at-will basis. Each agreement, as amended in June 2010,provides that the executive will have employment through October 6, 2012.  Each executive will be entitled to severancebenefits that include one year of base compensation if his employment isterminated without cause or for good reason, as defined therein, in addition tothe balance of the applicable term, if terminated prior to the end of suchterm.  Each employment agreement is automaticallyextended for a one-year term unless either our company or the executive givesat least 60 days’ notice to the other of an intent not to extend. If we electnot to extend the executive’s employment beyond October 6, 2012, or beyond theend of any applicable extension, and terminate executive’s employment, suchtermination will be deemed to be a termination without cause for purposes ofseverance benefits and the continuation of base compensation through the end ofthe applicable term.  The agreements alsoprovide for a base annual salary which may be increased by our board ofdirectors, incentive compensation as determined by our compensation committeefrom time to time, and participation in our 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 our company and his employment is involuntarilyterminated for any reason other than for cause, as defined in the agreement, ordeath or disability.  Each executive hasalso agreed to certain nondisclosure provisions during the term of hisemployment and any time thereafter, and certain non-competition,non-recruitment and/or non-interference provisions during the term of his employmentand for a certain period thereafter. As of November 8, 2010, the current annualbase salaries in effect for such executives under the foregoing employmentagreements were as follows: Mr. Wagenheim ($300,000), Mr. Gilbertson($225,000), and Mr. Gilanfar ($202,860).

 

*DevelopmentAgreement:*

 

In April 2008, we 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 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 of restaurantson those sites and scheduling for the development and construction of eachrestaurant once a location is approved.  The annual lease rate for fee-simple land andbuilding developments will be 9.5% and we will have the right of first offer topurchase these restaurants. Additionally, in the event United Properties sells one of the buildingsthat it develops for us at an amount in excess of the threshold agreed to bythe parties in the agreement, then we will share in the profits of thatsale.  We assume no liability in theevent United Properties sells a building at a loss.  We are not bound to authorize theconstruction of restaurants during that time period, but generally cannot useanother developer to develop or own a restaurant as long as the

 

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development agreement is in effect. We can, however, use another developer if United Properties declines tobuild a particular restaurant.  Wecurrently have no sites under 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.

 
| ** **                                      | ** ** | **Payment due by period** | ** **  |
|-------------------------------------------------|------------|---------------------------|-------------|
| ** **                                      | ** ** | ** **                | ** **  | **Fiscal Year** | ** ** | **Fiscal Years** | ** ** | **Fiscal Years** | ** ** | **Fiscal Years** | ** ** |
| **Contractual  Obligations**                    | ** ** | **Total**                 | ** **  | **2010** | ** ** | **2011-2012** | ** ** | **2013-2014** | ** ** | **Thereafter** | ** ** |
| Long-term debt, principal                       |       | $                         | 2,183,190   |   | $ | 51,435 |   | $ | 1,897,938 |   | $ | 9,617 |   | $ | 224,200 |   |
| Interest on long-term debt                      |       | 363,737                   |        | 47,126 |   | 143,155 |   | 36,692 |   | 136,765 |   |
| Capital lease obligations, including interest   |       | 63,433,728                |        | 1,199,989 |   | 9,002,536 |   | 8,547,231 |   | 44,683,972 |   |
| Operating lease obligations, including interest |       | 67,279,540                |        | 2,661,484 |   | 10,832,162 |   | 11,223,193 |   | 42,562,701 |   |
| Purchase contracts*                             |       | 725,510                   |        | 158,631 |   | 106,743 |   | 114,642 |   | 345,494 |   |
| Loan guarantee                                  |       | 30,962                    |        | 15,509 |   | 15,454 |   | — |   | — |   |
| Total obligations                               |       | $                         | 134,016,668 |   | $ | 4,134,174 |   | $ | 21,997,988 |   | $ | 19,931,376 |   | $ | 87,953,131 |   |

 

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*Whilewe are contractually obligated to make these purchases, we have the contractualright to defer such purchases into later years. However, if we defer such purchases into later years, we may incuradditional 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.

 

**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 QualitativeDisclosures 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 August 2011.  If it becomes necessaryto refinance such balloon balance, we may not be able to secure financing atthe same 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 purchasedbased upon market prices established with vendors.  To manage this risk in part, we have enteredinto fixed price purchase commitments, with terms typically up to one year, formany of our commodity requirements.  Wehave entered into contracts through 2016 with certain suppliers of rawmaterials (primarily hops) for minimum purchases both in terms of quantity andpricing.   As of September 28, 2010, ourfuture obligations under such contracts aggregated approximately $726,000.

 

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)and 15d-15(e)). Based on this evaluation, our Chief Executive Officer and ourChief Financial Officer concluded that, as of September 28, 2010, ourdisclosure controls 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 September 28, 2010 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II      OTHER INFORMATION**

 

**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 November 8, 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            Risk Factors**

 

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, with the exception ofthe following amended and restated risk factors:

 

**Risks Related to Our Business**

 

**We may be unable to recruit, motivate and retain qualified employees.**  Our success depends, in part, upon ourability to attract, motivate and retain a sufficient number of qualifiedemployees, including trained brewing personnel, restaurant managers, kitchenstaff and wait staff. Qualified individuals needed to fill these positions couldbe in short supply in one or more of our markets. In addition, our successdepends upon the skill and experience of our restaurant-level management teams.Our inability to recruit, motivate and retain such individuals may result inhigh employee turnover which could have a material adverse effect on ourbusiness, financial condition, results of operations and cash flows.Additionally, competition for qualified employees could require us to payhigher wages and provide additional benefits to attract sufficient employees,which could result in higher labor costs. Furthermore, we believe we will need to begin increasing the number ofunits we operate to lessen turnover costs as managers and other key personnelmay otherwise seek new opportunities with growing restaurant chains.

 

**The loss of key personnel could adversely affect our business.**  Our success depends to a significant extenton the performance and continued service of members of our senior managementand certain other key employees. Competition for employees with suchspecialized training and deep backgrounds in the restaurant industry is intenseand we cannot assure you that we will be successful in retaining suchpersonnel. In addition, we cannot assure you that employees will not leave orcompete against us. If the services of any member of management becomeunavailable for any reason, it could adversely affect our business andprospects.  Furthermore, we believe wewill need to begin increasing the number of units we operate to lessen turnovercosts as managers and other key personnel may otherwise seek new opportunitieswith growing restaurant chains.

 

**Risks Related to Future Restaurant Expansion**

 

**We have significant capital needs and cannot give assurance thatfinancing will be available to us to pursue any future expansion. **We require significantcapital for our operations and for any future expansion. We have discontinuedexpansion due to concerns over the economy and because we currently lack thecapital to develop additional restaurants. However, we believe we will need to begin increasing the number of unitswe operate to lessen turnover costs as managers and other key personnel mayotherwise seek new opportunities with growing restaurant chains.  Because our available sources of liquidityare insufficient to fund our expected capital needs, we would need to raiseadditional capital through sales of equity securities or debt to fundexpansion.

 

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Wecannot assure you that we will be able to obtain future financing on favorableterms or at all. If we elect to raise additional capital through the issuanceand sale of equity securities, the sales may be at prices below the marketprice of our common 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.  Until financing is available to us, to meetcurrent capital commitments and to fund ongoing operations, we have been requiredto suspend future growth, which could materially adversely affect our business,financial condition, results of operations and cash flows. Further, if debtfinancing does become available, we may be adversely affected by changes ininterest rates. Changes in interest rates could materially impact our operatingresults.

 

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

 

None.

 

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

 

None.

 

**ITEM 4               (Removed andReserved)**

 

**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:    November 9, 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         |       | Amended  and Restated Articles of Incorporation of the Company (incorporated by  reference to our Current Report on Form 8-K, filed on August 31, 2010 (File  No. 000-29643)).                                                                      |
|        |       |                                                                                                                                                                                                                                                |
| 3.2         |       | Amended  and Restated Bylaws of the Company, dated May 2, 2007 (incorporated by  reference to our Current Report on Form 8-K, filed on May 4, 2007 (File No. 000-29643)).                                                                           |
|        |       |                                                                                                                                                                                                                                                |
| 4.1         |       | Reference  is made to Exhibits 3.1 and 3.2.                                                                                                                                                                                                         |
|        |       |                                                                                                                                                                                                                                                |
| 4.2         |       | Specimen  common stock certificate (incorporated by reference to our Current Report on  Form 8-K, filed on September 20, 2002 (File No. 000-29643)).                                                                                                |
|        |       |                                                                                                                                                                                                                                                |
| 10.1        |       | Loan  Agreement between First Midwest Bank, Dunham Capital Management, L.L.C.,  Granite City Food & Brewery Ltd., and Donald Dunham, Jr., dated August 31,  2010.                                                                               |
|        |       |                                                                                                                                                                                                                                                |
| 10.2        |       | Granite  City Food & Brewery Ltd. Amended and Restated Equity Incentive Plan,  effective June 17, 2010 (incorporated by reference to our Definitive Proxy  Statement, filed on July 21, 2010 (File No. 000-29643)).                             |
|        |       |                                                                                                                                                                                                                                                |
| 10.3        |       | Amended  and Restated Employment and Severance Agreement by and between the Company  and Darius H. Gilanfar, dated August 9, 2010 (incorporated by reference to  our Quarterly Report on Form 10-Q, filed on August 10, 2010 (File No. 000-39643)). |
|        |       |                                                                                                                                                                                                                                                |
| 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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