**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,DC 20549**

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**FORM 10-Q**
| **x**  | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED  SEPTEMBER 26, 2006** |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|   | ** **                                                                                                                                      |
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                   |

 

**CommissionFile Number 000-29643**

**GRANITE CITY FOOD & BREWERYLTD.**

(Exact Name ofRegistrant as Specified in Its Charter)

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

 

**5402 Parkdale Drive, Suite 101**

**Minneapolis, Minnesota  55416**

**(952) 215-0660**

(Address of PrincipalExecutive Offices and Issuer’s

Telephone Number,including Area Code)

Indicate by checkmark whether the registrant:  (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes x     No o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  See definitionof “accelerated filer and large accelerated filer” in Rule 12b-2 of theExchange Act.  (Check one):
|  | Large accelerated filer o | Accelerated filer o | Non-accelerated filer x |
|--|---------------------------|---------------------|-------------------------|

 

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

Yes o    No x

As of November 6, 2006, the issuer had outstanding 13,253,642 shares ofcommon stock.

 

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**TABLE OFCONTENTS**
|                        | ** **                                                                                                                               |
|------------------------|------------------------------------------------------------------------------------------------------------------------------------------|
| **PART I**             | **FINANCIAL INFORMATION**                                                                                                                |
| ** **             | ** **                                                                                                                               |
| ITEM 1                 | Financial Statements                                                                                                                     |
|                   |                                                                                                                                     |
|                   | Condensed  Consolidated Balance Sheets as of September 26, 2006 and December 27, 2005                                                    |
|                   |                                                                                                                                     |
|                   | Condensed  Consolidated Statements of Operations for the Thirteen and Thirty-nine Weeks  ended September 26, 2006 and September 27, 2005 |
|                   |                                                                                                                                     |
|                   | Condensed  Consolidated Statements of Cash Flows for the Thirty-nine Weeks ended  September 26, 2006 and September 27, 2005              |
|                   |                                                                                                                                     |
|                   | Notes to  Condensed Consolidated Financial Statements                                                                                    |
|                   |                                                                                                                                     |
| ITEM 2                 | Management’s  Discussion and Analysis of Financial Condition and Results of Operations.                                             |
|                   |                                                                                                                                     |
| ITEM 3                 | Quantitative  and Qualitative Disclosures about Market Risk                                                                              |
|                   |                                                                                                                                     |
| ITEM 4                 | Controls and  Procedures                                                                                                                 |
|                   |                                                                                                                                     |
| **PART II**            | **OTHER INFORMATION**                                                                                                                    |
| ** **             | ** **                                                                                                                               |
| ITEM  1                | Legal  Proceedings                                                                                                                       |
|                   |                                                                                                                                     |
| ITEM 1A                | Risk Factors                                                                                                                             |
|                   |                                                                                                                                     |
| ITEM 2                 | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                             |
|                   |                                                                                                                                     |
| ITEM 3                 | Defaults upon  Senior Securities                                                                                                         |
|                   |                                                                                                                                     |
| ITEM 4                 | Submission of  Matters to a Vote of Security Holders                                                                                     |
|                   |                                                                                                                                     |
| ITEM  5                | Other  Information                                                                                                                       |
|                   |                                                                                                                                     |
| ITEM 6                 | Exhibits                                                                                                                                 |
|                   |                                                                                                                                     |
| **SIGNATURES**         |                                                                                                                                     |
| ** **             |                                                                                                                                     |
| **INDEX  TO EXHIBITS** |

 

i

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**PART I     FINANCIALINFORMATION**

**ITEM 1  Financial Statements**

**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**
| ** **                                                                                                                                                                        | ** ** | **September 26,** | ** ** | **December 27,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| **ASSETS:**                                                                                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                   |       |                   |       |                  |       |
| Cash                                                                                                                                                                              |       | $                      | 2,761,706  |                  | $          | 9,836,231 |   |
| Inventory                                                                                                                                                                         |       | 377,006                |       | 243,180               |       |
| Prepaids and  other                                                                                                                                                               |       | 664,864                |       | 218,960               |       |
| Total current  assets                                                                                                                                                             |       | 3,803,576              |       | 10,298,371            |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Prepaid rent,  net of current portion                                                                                                                                             |       | 491,808                |       | —                |       |
| Property and  equipment, net                                                                                                                                                      |       | 46,501,376             |       | 33,767,282            |       |
| Intangible  assets and other                                                                                                                                                      |       | 695,478                |       | 416,937               |       |
| Total assets                                                                                                                                                                      |       | $                      | 51,492,238 |                  | $          | 44,482,590 |   |
|                                                                                                                                                                              |       |                   |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY:**                                                                                                                                   | ** ** | ** **             | ** ** | ** **            | ** ** |
| Current  liabilities:                                                                                                                                                             |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                  |       | $                      | 3,529,635  |                  | $          | 1,007,437 |   |
| Accrued expenses                                                                                                                                                                  |       | 3,269,525              |       | 3,156,455             |       |
| Deferred rent,  current portion                                                                                                                                                   |       | 105,116                |       | 76,437                |       |
| Long-term debt,  current portion                                                                                                                                                  |       | 257,455                |       | 241,747               |       |
| Capital lease  obligations, current portion                                                                                                                                       |       | 771,670                |       | 679,738               |       |
| Total current  liabilities                                                                                                                                                        |       | 7,933,401              |       | 5,161,814             |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Deferred rent,  net of current portion                                                                                                                                            |       | 1,617,437              |       | 1,119,458             |       |
| Long-term debt,  net of current portion                                                                                                                                           |       | 2,068,565              |       | 2,262,180             |       |
| Capital lease  obligations, net of current portion                                                                                                                                |       | 25,734,759             |       | 18,585,630            |       |
| Total  liabilities                                                                                                                                                                |       | 37,354,162             |       | 27,129,082            |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Commitments and  contingencies                                                                                                                                                    |       |                   |       |                  |       |
| Shareholders’  equity:                                                                                                                                                       |       |                   |       |                  |       |
| Common stock,  $0.01 par value, 90,000,000 shares authorized; 13,253,642 and 13,226,526  shares issued and outstanding at September 26, 2006 and December 27, 2005,  respectively |       | 132,536                |       | 132,265               |       |
| Additional  paid-in capital                                                                                                                                                       |       | 28,422,223             |       | 27,881,089            |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Accumulated  deficit                                                                                                                                                              |       | (14,416,683            | )          | (10,659,846           | )          |
| Total  shareholders’ equity                                                                                                                                                  |       | 14,138,076             |       | 17,353,508            |       |
|                                                                                                                                                                              |       |                   |       |                  |       |
| Total  liabilities and shareholders’ equity                                                                                                                                  |       | $                      | 51,492,238 |                  | $          | 44,482,590 |   |

 

See notes to condensed consolidated financialstatements.

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**GRANITECITY FOOD & BREWERY LTD.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**
| ** **                                                                                          | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                          | ** ** | **September 26,**             | ** ** | **September 27,**                | ** ** | **September 26,** | ** ** | **September 27,** | ** ** |
| ** **                                                                                          | ** ** | **2006**                           | ** ** | **2005**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Restaurant  revenues                                                                                |       | $                                  | 15,028,065 |                                  | $          | 9,705,060 |   | $ | 41,337,502 |   | $ | 26,109,648 |   |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Cost of sales:                                                                                      |       |                               |       |                                  |       |   |   |   |   |
| Food, beverage and retail                                                                           |       | 4,522,565                          |       | 2,975,397                             |       | 12,295,648 |   | 7,863,715 |   |
| Labor                                                                                               |       | 5,404,636                          |       | 3,540,867                             |       | 14,662,268 |   | 9,291,407 |   |
| Direct restaurant operating                                                                         |       | 1,856,222                          |       | 1,199,186                             |       | 5,103,711 |   | 3,192,631 |   |
| Occupancy                                                                                           |       | 850,788                            |       | 478,898                               |       | 2,328,316 |   | 1,338,683 |   |
| Total cost of sales                                                                                 |       | 12,634,211                         |       | 8,194,348                             |       | 34,389,943 |   | 21,686,436 |   |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Pre-opening                                                                                         |       | 866,193                            |       | 297,509                               |       | 1,940,567 |   | 525,620 |   |
| General and  administrative (includes non-cash compensation of $143,364, $0, $550,848 and  $12,780) |       | 1,650,862                          |       | 1,312,890                             |       | 4,722,296 |   | 3,447,934 |   |
| Depreciation and  amortization                                                                      |       | 877,988                            |       | 560,600                               |       | 2,444,933 |   | 1,496,384 |   |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Operating loss                                                                                      |       | (1,001,189                         | )          | (660,287                              | )          | (2,160,237 | ) | (1,046,726 | ) |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Interest:                                                                                           |       |                               |       |                                  |       |   |   |   |   |
| Income                                                                                              |       | 16,803                             |       | 23,284                                |       | 72,967 |   | 92,630 |   |
| Expense                                                                                             |       | (607,890                           | )          | (364,319                              | )          | (1,669,567 | ) | (1,009,202 | ) |
| Net interest expense                                                                                |       | (591,087                           | )          | (341,035                              | )          | (1,596,600 | ) | (916,572 | ) |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Net loss                                                                                            |       | $                                  | (1,592,276 | )                                     | $          | (1,001,322 | ) | $ | (3,756,837 | ) | $ | (1,963,298 | ) |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Loss per common  share, basic and diluted                                                           |       | $                                  | (0.12      | )                                     | $          | (0.09 | ) | $ | (0.28 | ) | $ | (0.17 | ) |
|                                                                                                |       |                               |       |                                  |       |   |   |   |   |
| Weighted average shares  outstanding, basic and diluted                                             |       | 13,242,173                         |       | 11,653,538                            |       | 13,231,742 |   | 11,629,651 |   |

 

See notes to condensedconsolidated financial statements.

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**GRANITECITY FOOD & BREWERY LTD.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**
| ** **                                                                                 | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                 | ** ** | **September 26,**                | ** ** | **September 27,** | ** ** |
| ** **                                                                                 | ** ** | **2006**                              | ** ** | **2005** | ** ** |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from  operating activities:                                                     |       |                                  |       |   |   |
| Net loss                                                                                   |       | $                                     | (3,756,837 | ) | $ | (1,963,298 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities:               |       |                                  |       |   |   |
| Depreciation and amortization                                                              |       | 2,444,933                             |       | 1,496,384 |   |
| Stock option compensation expense                                                          |       | 550,848                               |       | 12,780 |   |
| Loss on disposal of asset                                                                  |       | 2,746                                 |       | 50,475 |   |
| Deferred rent                                                                              |       | 356,168                               |       | (64,224 | ) |
| Changes in operating assets and liabilities:                                               |       |                                  |       |   |   |
| Inventory                                                                                  |       | (133,826                              | )          | (46,000 | ) |
| Prepaids and other                                                                         |       | (937,712                              | )          | (80,570 | ) |
| Accounts payable                                                                           |       | 900,277                               |       | (176,136 | ) |
| Accrued expenses                                                                           |       | 132,740                               |       | (78,672 | ) |
| Net cash used in operating activities                                                      |       | (440,663                              | )          | (849,261 | ) |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from  investing activities:                                                     |       |                                  |       |   |   |
| Purchase of:                                                                               |       |                                  |       |   |   |
| Property and equipment                                                                     |       | (5,673,006                            | )          | (4,135,825 | ) |
| Intangible assets and other                                                                |       | (131,419                              | )          | (19,136 | ) |
| Net cash used in investing activities                                                      |       | (5,804,425                            | )          | (4,154,961 | ) |
|                                                                                       |       |                                  |       |   |   |
| Cash flows from  financing activities:                                                     |       |                                  |       |   |   |
| Payments on capital lease obligations                                                      |       | (642,087                              | )          | (445,544 | ) |
| Payments on long term-debt                                                                 |       | (177,907                              | )          | (168,554 | ) |
| Payment of dividends                                                                       |       | —                                |       | (41,068 | ) |
| (Cost incurred)/proceeds from issuance of stock                                            |       | (9,443                                | )          | 230,094 |   |
| Net cash used in financing activities                                                      |       | (829,437                              | )          | (425,072 | ) |
|                                                                                       |       |                                  |       |   |   |
| Net decrease in  cash                                                                      |       | (7,074,525                            | )          | (5,429,294 | ) |
| Cash, beginning  of period                                                                 |       | 9,836,231                             |       | 9,297,247 |   |
| Cash, end of  period                                                                       |       | $                                     | 2,761,706  |   | $ | 3,867,953 |   |
|                                                                                       |       |                                  |       |   |   |
| Supplemental  disclosure of non-cash investing and financing activities:                   |       |                                  |       |   |   |
| Land and buildings acquired under capital lease  agreements                                |       | $                                     | 8,053,638  |   | $ | 5,715,333 |   |
| Equipment and  intangibles purchased and included in accounts payable and accrued expenses |       | $                                     | 1,602,251  |   | $ | 174,068 |   |

 

See notes to condensed consolidated financialstatements.

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**GRANITECITY FOOD & BREWERY LTD.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

Thirteen and thirty-nine weeks ended September 26,2006 and September 27, 2005

**1.     General**

Background:

Granite City Food &Brewery Ltd. (the “Company”) develops and operates casual dining restaurantsknown as Granite City Food & Brewery®.  The restaurant theme is upscale casual dining with a wide variety ofmenu items that are prepared fresh daily, combined with freshly brewedhand-crafted beers finished on-site.  Thefirst Granite City restaurant opened in St. Cloud, Minnesota in July 1999 andthe Company subsequently expanded to other Midwest markets while pursuing itsnational expansion plans.  The Companyopened restaurants in Omaha, Nebraska and Roseville, Minnesota in October 2006and November 2006, respectively, bringing the total number of restaurants itoperates to 17.  The Company alsooperates a beer production facility which is used to provide raw materialsupport to its restaurants to create consistent quality and operationalefficiencies.

The Company’s expansion strategy focuses ondevelopment of restaurants in markets where management believes the Company’sconcept will have broad appeal and attractive restaurant-level economics.

Basisof Presentation:

The accompanying unaudited condensedconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America andregulations of the Securities and Exchange Commission.  Accordingly, they do not include all theinformation and footnotes required by U.S. generally accepted accounting principlesfor complete financial statements.  Inthe opinion of management, all adjustments, consisting of normal recurringadjustments, which are necessary for a fair statement of its financial positionas of September 26, 2006 and the results of operations for the interim periodsended September 26, 2006 and September 27, 2005 have been included.

The balance sheet at December 27, 2005 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-KSB for the fiscal year endedDecember 27, 2005, filed with the Securities and Exchange Commission on March27, 2006.

The results ofoperations for the thirteen and thirty-nine weeks ended September 26, 2006 arenot necessarily indicative of the results to be expected for the entire year.

**2.     Summary of Significant Accounting Policies**

Stock-BasedCompensation:

On December 16, 2004, the FASB issued Statement of FinancialAccounting Standards (“SFAS”) No. 123 (revised 2004) (“SFAS 123(R)”),*Share-Based Payment*, which is arevision of SFAS 123, *Accounting forStock-Based Compensation*. SFAS 123(R) supersedes AccountingPrinciples Board (“APB”) Opinion No. 25, *Accounting forStock Issued to Employees,*and amends SFAS No. 95, *Statement of Cash Flows*.  Generally, SFAS 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the income statement based on their fair values determinedat the date of grant.  On April 14,2005, the Securities and Exchange Commission adopted a new rule that amendedthe compliance dates for

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SFAS 123(R).  The Companyadopted SFAS 123(R) using the modified prospective method effective December28, 2005, the first day of its 2006 fiscal year.

In all prior periods, the Company accounted for stock-basedcompensation awards to employees using the intrinsic value method prescribed byAPB Opinion No. 25 and, as such, generally recognized no compensation cost foremployee stock options.  Accordingly, theadoption of SFAS 123(R)’s fair value method affects the Company’s reportedresults of operations, although it does not affect the Company’s overallfinancial position.  If the Company hadbeen accounting for stock-based compensation under SFAS 123(R) during thethird quarter of fiscal year 2005, the impact of that standard would haveapproximated the impact of SFAS 123 as described in the pro formadisclosure set forth below:
|                                                                                                                                             | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                                  | ** ** | **September 27,**             | ** ** | **September 27,**                | ** ** |
| ** **                                                                                                                                  | ** ** | **2005**                           | ** ** | **2005**                              | ** ** |
| Net income  (loss):                                                                                                                         |       |                               |       |                                  |       |
| As reported                                                                                                                                 |       | $                                  | (1,001,322 | )                                     | $          | (1,963,298 | ) |
| Less: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | $                                  | (446,552   | )                                     | $          | (828,097 | ) |
| Pro forma                                                                                                                                   |       | $                                  | (1,447,874 | )                                     | $          | (2,791,395 | ) |
|                                                                                                                                        |       |                               |       |                                  |       |
| Net income  (loss) per common share                                                                                                         |       |                               |       |                                  |       |
| Basic and diluted as reported                                                                                                               |       | $                                  | (0.09      | )                                     | $          | (0.17 | ) |
| Basic and  diluted pro forma                                                                                                                |       | $                                  | (0.12      | )                                     | $          | (0.24 | ) |

 

The fair value ofoptions at date of grant was estimated using the Black-Scholes option-pricingmodel with the following assumptions for the third quarter of 2005:  (a) no dividend yield, (b) 47.5% expectedvolatility, (c) expected life of options of five to ten years and (d) arisk-free interest rate of 4.1% to 4.3%.

During the thirdquarter of 2006, the Company granted an aggregate of 190,000 options,estimating the fair value of such options using the Black-Scholesoption-pricing model with the following assumptions:  (a) no dividend yield, (b) 24.5% to 36.4%expected volatility, (c) expected life of options of five to ten years and (d)a risk-free interest rate of 4.78% to 5.00%. The Company recorded total stock-based compensation expense of $143,364and $550,848 in the first thirteen and thirty-nine weeks of fiscal year 2006,respectively.  See Note 7 for furtherdiscussion of the Company’s stock-based compensation.

Accounting for Leases:

On October 6, 2005, theFASB issued Staff Position No. FAS 13-1, *Accounting for Rental Costs Incurred During a Construction Period*.  Generally, the staff position requirescompanies to expense rental costs incurred during a construction period.  The Company was required to adopt FASB StaffPosition No. FAS 13-1 beginning in fiscal year 2006, and as a result,included $263,881 and $531,290 of such rental costs in pre-opening expenseduring the third quarter and first three quarters of fiscal year 2006,respectively.  The non-cash portion of suchpre-opening rent expense was $197,931 and $420,086 in the third quarter of 2006and first three quarters of 2006, respectively. Prior to the adoption of FASB Staff Position No. FAS 13-1, the Companydid not expense rental costs during the construction period, but rathercapitalized such costs as then permitted under GAAP.  The Company believes the adoption of thestaff position will increase average per-unit pre-opening costs by $50,000 to$250,000 depending upon the lease term and length of construction period.

Principles of consolidation and presentation:

The Company’s consolidated financial statements include the accountsand operations of the Company and its subsidiary corporations under which itsKansas locations are operated.  Fifty-onepercent of the stock of each of the subsidiary corporations is owned by aGranite City restaurant manager and the Company owns the

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remainder of the stock of each corporation.  Each manager-owner of the stock of theseentities has entered into a buy-sell agreement with each corporation providing,among other things, that transfer of the shares is restricted and that theshareholder must sell his shares to the corporation upon certain events,including termination of employment or any event which disqualifies the managerfrom owning the shares under applicable laws and regulations of the state.  The Company has entered into a masteragreement with each separate corporation that permits the operation of therestaurants and leases to each corporation the Company’s property andfacilities.  Each corporation pays all ofits operating expenses and obligations, and the Company retains, asconsideration for the operating arrangements and the lease of property andfacilities, the net profit from its operations. The Company has determined that the foregoing ownership structure willcause these separate corporations to be treated as variable interest entitiesin which the Company has a controlling financial interest for the purpose ofFASB Interpretation 46 (R), *Consolidation of VariableInterest Entities*(FIN46R). As such, the corporations are consolidated with the Company’s financialstatements and the Company’s financial statements do not reflect a minorityownership in those separate corporations. All references to the Company in these financial statements relate tothe consolidated entity.

Reclassification:

Certain reclassifications have been made to the financial statementsfor the third quarter and first three quarters of 2005 in order for them toconform to the presentation of the financial statements for the third quarterand first three quarters of 2006.  Thesereclassifications have no effect on the accumulated deficit or net losspreviously reported.

Recent accounting pronouncements:

In July 2006, the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN48,”) which clarifies the accounting and disclosures for uncertainty in incometaxes recognized in the financial statements in accordance with SFAS No. 109, “Accountingfor Income Taxes.” FIN 48 also provides guidance on the de-recognition ofuncertain tax positions, financial statement classification, accounting forinterest and penalties, accounting for interim periods and adds new disclosurerequirements. FIN 48 is effective for fiscal years beginning after December 15,2006. We are evaluating the impact the adoption of FIN 48 will have on ourconsolidated financial statements.

**3.****             ****Property and Equipment**

The cost of property and equipment is depreciated over the estimateduseful lives of the related assets.  Thecost of leasehold improvements is depreciated over the initial term of therelated lease.  Depreciation is computedon the straight-line method for financial reporting purposes and acceleratedmethods for income tax purposes. Amortization of assets acquired under capital lease is included indepreciation expense.  The following is asummary of the Company’s property and equipment at September 26, 2006 andDecember 27, 2005:
|                                | ** ** | **September 26, 2006** | ** ** | **December 27, 2005** | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
|                           |       |                             |       |                            |       |
| Land                           |       | $                                | 18,000     |                            | $          | 18,000 |   |
| Buildings                      |       | 27,145,648                       |       | 19,718,797                      |       |
| Leasehold  improvements        |       | 7,283,857                        |       | 6,204,704                       |       |
| Equipment and  furniture       |       | 17,177,839                       |       | 11,921,513                      |       |
| Construction in  progress*     |       | 3,290,462                        |       | 1,893,731                       |       |
|                           |       | 54,915,806                       |       | 39,756,745                      |       |
|                           |       |                             |       |                            |       |
| Less accumulated  depreciation |       | 8,414,430                        |       | 5,989,463                       |       |
|                           |       | $                                | 46,501,376 |                            | $          | 33,767,282 |   |

 

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*Construction inprogress includes the following approximate amounts for items yet to be placedin service:
| St. Louis Park equipment                  |   | $ | 428,000 |   |
|-------------------------------------------|--------|---|---------|--------|
| Madison  equipment                        |   | $ | 441,000 |   |
| Omaha equipment                           |   | $ | 844,000 |   |
| Roseville  equipment                      |   | $ | 978,000 |   |
| St. Cloud  leasehold improvements         |   | $ | 547,000 |   |
| Future  locations’ architecture fees |   | $ | 33,000  |   |
| Corporate furniture and  office equipment |   | $ | 19,000  |   |

 

Included in property and equipment are the following assets held undercapital leases:
|                                | ** ** | **September 26, 2006** | ** ** | **December 27, 2005** | ** ** |
|--------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Land                           |       | $                                | 18,000     |                            | $          | 18,000 |   |
| Buildings                      |       | 27,145,648                       |       | 19,718,797                      |       |
| Equipment                      |       | 1,546,657                        |       | 1,546,657                       |       |
|                           |       | 28,710,305                       |       | 21,283,454                      |       |
| Less accumulated  depreciation |       | 3,312,994                        |       | 2,307,298                       |       |
|                           |       | $                                | 25,397,311 |                            | $          | 18,976,156 |   |

 

**4.        Capital Leases**

Minimum future leasepayments under all capital leases as of September 26, 2006 are:
|                                             | ** ** | **Capital** | ** ** |
|---------------------------------------------|------------|-------------|------------|
| **Year ended:**                        | ** ** | **Leases**  | ** ** |
| 2006                                        |       | $           | 756,148    |   |
| 2007                                        |       | 3,024,591   |       |
| 2008                                        |       | 2,947,837   |       |
| 2009                                        |       | 2,892,902   |       |
| 2010                                        |       | 2,897,709   |       |
| Thereafter                                  |       | 39,815,601  |       |
| Total minimum lease payments                |       | 52,334,788  |       |
|                                        |       |        |       |
| Less amount representing interest           |       | 25,828,359  |       |
| Present value of net minimum lease payments |       | 26,506,429  |       |
| Less current portion                        |       | 771,670     |       |
| Long-term  portion of obligations           |       | $           | 25,734,759 |   |

 

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

**5.        Commitments andContingencies**

The following commitments and contingencies commenced or will commencesubsequent to the quarter ended September 26, 2006:

Omaha, Nebraska Lease:

In October 2006, the Company commenced leasing its Omaha, Nebraskarestaurant under a 20-year net lease agreement based on the terms specified inits development agreement with Dunham Capital Management L.L.C. (“Dunham”) forthe development of restaurants.  Therestaurant was constructed for the Company on a build-to-suit basis.  The annual rent is $315,500 of which $220,500is classified as a capital lease and $95,000 plus percentage rent is classifiedas an operating lease.  The Company willbe responsible for any real-estate 

7

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taxes and all operating costs and the lease may be extended at theCompany’s option for up to five additional five-year periods on the same termsand conditions, except the rent may increase based on a formula using theConsumer Price Index during any such extension. Rental costs associated with the operating lease that were incurredduring the construction period were recognized as pre-opening costs, andincluded in income from continuing operations.

Roseville, Minnesota Lease:

In November 2006, the Company commenced leasing its Roseville,Minnesota restaurant under a 20-year net lease agreement based on the termsspecified in its development agreement with Dunham.  The restaurant was constructed for theCompany on a build-to-suit basis.  Theannual rent is $403,500 of which $115,500 will be classified as a capital leaseand $288,000 will be classified as an operating lease.  The Company will be responsible for anyreal-estate taxes and all operating costs. Rental costs associated with the operating lease that were incurredduring the construction period were recognized as pre-opening costs, andincluded in income from continuing operations.

Madison, Wisconsin Lease:

In May 2006, the Company entered into a 20-year net lease related tothe restaurant it plans to open in Madison, Wisconsin under the terms specifiedin its development agreement with Dunham. The restaurant will be constructed for the Company on a build-to-suitbasis.  The annual rent will be equal to10.5% of the construction cost including land cost.  The Company will be responsible for anyreal-estate taxes and all operating costs. The term of the lease will commence when operations begin and may beextended at the Company’s option for up to two additional five-year periods onthe same terms and conditions, except the rent may increase based on a formulausing the Consumer Price Index during any such extension.  Rental costs associated with the operatinglease that are incurred during the construction period are being recognized aspre-opening costs, and included in income from continuing operations.

Equipment Lease Financing:

In August 2006, the Company entered into a master lease agreement withCarlton Financial Corporation (“Carlton”) pursuant to which it may “financelease” up to $3,000,000 of equipment purchases for three future restaurantlocations.  On September 28, 2006, theCompany entered into a lease schedule and amendment to this master lease,pursuant to which it is leasing equipment for its restaurant in St. Louis Parkvalued at $821,158 for an initial lease term of 39 months.  The monthly lease payments are $25,924 plusall fees, assessments, sales, use, property and other taxes imposed uponCarlton.  The Company has provided Carlton with a refundable securitydeposit of $164,220 as well as a security interest in certain otherequipment.  At the end of the initial lease term, the Company may (a)purchase Carlton’s interest in all, but not less than all, of the equipment fora purchase price equal to the greater of (1) the fair market value of theequipment, or (2) the original cost of the equipment, or (b) renew such leasefor 12 months at a monthly lease payment of $11,223 and take ownership of theequipment thereafter for $1.00.  TheCompany’s president and chief executive officer was required to personallyguarantee payments to be made to Carlton under the lease financing and theCompany’s board of directors agreed to compensate him for such guarantee.  The amount of annual compensation will be 3%of the balance of such lease and will be calculated and accrued based on theweighted average daily balance of the lease at the end of each monthlyaccounting period.

In September 2006, the Company entered into an Equipment LeaseCommitment and Master Equipment Lease with DHW Leasing, L.L.C. (“DHW”),relating to the lease of furniture, fixtures and equipment for futurerestaurants.  Under the terms of theEquipment Lease Commitment, DHW has agreed to purchase and lease to the Companyequipment costing up to $16 million to equip future restaurant locations.  Each lease is expected to be for equipmentcosting between $800,000 and $1.4 million per restaurant.  Payments due DHW will be based upon afive-year amortization of the purchase price with interest equal to the DHWbank base rate plus a blended 5.4% rate.   The equipment lease contains other customary terms and conditions andthe Company will have the option to purchase the leased equipment for $1.00upon payment in full of all rent payments due under each lease.  Although the Company is not obligated toenter into any equipment leases with DHW, management intends to enter intoequipment leases with DHW for the foreseeable future.  The members of DHW are Donald A. Dunham,Charles J. Hey and Steven J. Wagenheim. Mr. Wagenheim is the 

8

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Company’s president, chief executive officer and one of itsdirectors.  Mr. Wagenheim owns a 20%membership interest in DHW and has agreed to personally guarantee 20% of DHW’sindebtedness to its lenders.  Mr.Wagenheim’s participation in the income and profits of DHW will not exceed 3%of the average principal balance of the amount guarantied for the term of theguarantied debt.

In October 2006, the Company entered into two sales-lease backagreements for the assets at the Kansas City and Olathe, Kansas locationspursuant to the terms of the DHW leasing agreement.  The amount financed on each of thesefive-year agreements was $1.0 million and the Company is required to makemonthly payments of $23,139 on each lease agreement.  The effective interest rate on each lease isapproximately 13.75% annually.  TheCompany is finalizing additional lease financing under the DHW agreement forassets held at its West Wichita, Omaha, Roseville and Madison locations.

Development Agreement:

In connection with the DHW transaction referenced above, on September19, 2006, the Company also entered into an amendment of its developmentagreement dated October 22, 2002 with Dunham relating to the development of upto 22 restaurants.  Under the terms ofthe amendment, in lieu of future adjustments to restaurant leases, lease rateswould be increased by 10% commencing on the fifth anniversary of each lease andon each five-year anniversary thereafter. The future lease rate increases will apply to leases under theDevelopment Agreement in Omaha, Madison and Roseville, as well as futureleases.

**6.        Long-term Debt**

In August 2003, the Company obtained a $750,000 loan from anindependent financial institution for the purchase of equipment for itsrestaurant located in Des Moines, and in January 2004, the Company obtained a$750,000 loan from the same financial institution for the purchase of equipmentat its restaurant in Davenport.  As ofSeptember 26, 2006, the balances, interest rates and maturity dates of theseloans were:

|                       | ** ** | **Des Moines** | ** ** | **Davenport**   | ** ** |
|-----------------------|------------|---------------------|------------|-----------------|------------|
| Loan balance          |       | $                   | 476,894    |            | $          | 506,735 |   |
| Annual interest  rate |       | 10.250              | %          | 6.125           | %          |
| Maturity date         |       | August 27, 2010     |       | January 6, 2011 |       |
|                       |            |                     |            |                 |            |  |  |

 

These loans were each secured by substantially all of the Company’spersonal property.    In June 2006, theCompany entered into amendments to the security agreements of each of theseloans.  As a result of these amendments,each loan is secured only by the personal property and fixture property at itsrespective location.  All other terms andconditions of these loans remain the same as the original agreements.

In August 2006, the Company entered into an amendment to a loanagreement with an independent financial institution.  The amendment extended the maturity date of a$1,500,000 loan originally obtained in 2001 to finance the construction andequipping of the Company’s restaurant in Fargo, from February 2007 to August2011.  As of September 26, 2006, the loan balance was $1,342,339 and theannual interest rate was 8.75%.  The bank also released its securityinterest in all collateral for the loan other than tangible personal propertyand fixtures located at or used in the operation of the Fargo site, and thebank released the guaranties of Arthur E. Pew III, one of the Company’sdirectors, and William E. Burdick, one of the Company’s former directors. Steven J. Wagenheim, the Company’s president, chief executive officer and oneof its directors, remains a guarantor.

**7.****             ****Stock Plans**

In July 1997, theCompany adopted the 1997 Stock Option Plan for employees and non-employees,including consultants to the Company, to purchase the Company’s common stock atan exercise price that equals or exceeds the fair market value on the date ofgrant.   The number of shares authorizedfor issuance under the plan as of September 26, 2006 was 400,000, of which35,500 shares remained available for future issuance.  Although vesting schedules may vary, optiongrants under this plan generally vest evenly over a four-year period andoptions are exercisable for no more than ten years from the date of grant.

The Company hasreserved 590,000 shares of common stock for issuance under the 1997 DirectorStock Option Plan, of which 133,500 remained available for issuance atSeptember 26, 2006.  Under this plan, theCompany automatically grants an option to each outside director on the datesuch person becomes a director for the purchase of 15,000 shares of commonstock and thereafter on each successive anniversary of the grant of the first

9

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option for thepurchase of 15,000 shares.  Each optionvests one year after the option is granted and is exercisable for five yearsfrom the date of grant. Options are granted at fair market value.

In August 2002,the Company adopted the 2002 Equity Incentive Plan for employees, prospectiveemployees, officers and members of the Company’s board of directors, as well asconsultants and advisors to the Company, to purchase shares of the Company’scommon stock at an exercise price that equals or exceeds the fair market valueon the date of grant.  The number ofshares authorized for issuance as of September 26, 2006 was 1,558,839, of which544,504 shares remained available for future issuance.  Although vesting schedules may vary, optiongrants under this plan generally vest evenly over a three or four-year periodand options are exercisable for no more than ten years from the date of grant.

A summary of the status of the Company’s stock options as of September26, 2006 is presented below:
|                                                                    | ** ** | ** ** | ** ** | ** **              | ** ** | **Weighted**              | ** ** | ** **    | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|-------------------------|------------|---------------------------|------------|---------------|------------|
| ** **                                                         | ** ** | ** ** | ** ** | **Weighted**            | ** ** | **Average**               | ** ** | **Aggregate** | ** ** |
| ** **                                                         | ** ** | ** ** | ** ** | **Average**             | ** ** | **Remaining**             | ** ** | **Intrinsic** | ** ** |
| **Fixed Options**                                             | ** ** | **Shares** | ** ** | **Exercise Price** | ** ** | **Contractual Life** | ** ** | **Value**     | ** ** |
| Outstanding at  December 27, 2005                                  |       | 1,590,000  |       | $                       | 3.58       |                      | 6.7  years |          |       |   |
| Granted                                                            |       | 323,000    |       | 4.11                    |       | 9.0  years                |       |          |       |
| Exercised                                                          |       | (65,000    | )          | 2.36                    |       | —                    |       |          |       |
| Forfeited                                                          |       | (166,666   | )          | 4.19                    |       | —                    |       |          |       |
| Outstanding at  September 26, 2006                                 |       | 1,681,334  |       | $                       | 3.66       |                      | 6.4  years |          | $          | 881,610 |   |
|                                                               |       |       |       |                    |       |                      |       |          |       |
| Options  exercisable at December 27, 2005                          |       | 1,015,750  |       | $                       | 3.29       |                      | 5.9  years |          |       |   |
| Options  exercisable at September 26, 2006                         |       | 1,156,336  |       | $                       | 3.44       |                      | 5.6  years |          | $          | 843,970 |   |
|                                                               |       |       |       |                    |       |                      |       |          |       |
| Weighted-average fair  value of options granted during the quarter |       | $          | 3.99       |                    |       |                      |       |          |       |   |
|                                                                    |            |            |            |                         |            |                           |            |               |            |  |  |  |

 

The aggregate intrinsic value in the table above represents the totalpretax intrinsic value (the difference between the closing price of the Company’sstock on September 26, 2006 and the exercise price, multiplied by the number ofin-the-money options) that would have been received by the option holders hadall option holders exercised their options on September 26, 2006.  As of September 26, 2006, there wasapproximately $634,535 of total unrecognized compensation cost related tounvested share-based compensation arrangements, of which $325,029 is expectedto be recognized during the remainder of fiscal year 2006, $262,182 in fiscalyear 2007, $47,030 in fiscal year 2008 and $295 in fiscal year 2009.

The following table summarizes information about stock optionsoutstanding at September 26, 2006:
| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | **Number of**           | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Options**                  | ** ** | **Average**                  | ** ** | **Weighted** | ** ** | **Options** | ** ** | **Weighted** | ** ** |
| **Range of**        | ** ** | **Outstanding**              | ** ** | **Remaining**                | ** ** | **Average** | ** ** | **Exercisable** | ** ** | **Average** | ** ** |
| **Exercise Prices** | ** ** | **at 9/26/2006**        | ** ** | **Contractual Life**    | ** ** | **Exercise Price** | ** ** | **at 9/26/2006** | ** ** | **Exercise Price** | ** ** |
|                     |       |                         |       |                         |       |   |   |   |   |   |   |
| $1.00 - $1.99            |       |                         | 182,000    |                         | 4.1  years |   | $ | 1.56 |   | 182,000 |   | $ | 1.56 |   |
| $2.00 - $2.99            |       |                         | 215,000    |                         | 5.5  years |   | $ | 2.40 |   | 215,000 |   | $ | 2.40 |   |
| $3.00 - $3.99            |       |                         | 398,000    |                         | 8.0  years |   | $ | 3.79 |   | 205,000 |   | $ | 3.77 |   |
| $4.00 - $4.99            |       |                         | 766,334    |                         | 6.2  years |   | $ | 4.24 |   | 434,336 |   | $ | 4.16 |   |
| $5.00 - $5.99            |       |                         | 120,000    |                         | 6.8  years |   | $ | 5.01 |   | 120,000 |   | $ | 5.01 |   |
|                     |       |                         |       |                         |       |   |   |   |   |   |   |   |
| Total                    |       |                         | 1,681,334  |                         | 6.4 years  |   | $ | 3.66 |   | 1,156,336 |   | $ | 3.44 |   |

 

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In November 2002, the Company completed a private placement of Series AConvertible Preferred Stock and warrants to purchase common stock.  As part of the agreement between the Companyand its private placement agents, the agents received five-year warrants topurchase an aggregate of 288,604 shares of common stock at an exercise price of$1.58 per share. As of September 26, 2006, 282,707 of the agent warrantsremained exercisable.

In May 2003, the Company entered into a two-year financial advisoryservices agreement. As part of the agreement between the Company and thefinancial consultant, the consultant received five-year warrants to purchase anaggregate of 35,000 shares of common stock at exercise prices ranging from$2.85 to $5.40 per share.  As ofSeptember 26, 2006, none of such warrants had been exercised.

In September 2004, the Company entered into a securities purchase agreementwith certain accredited investors, whereby the Company issued 1,045,844five-year warrants exercisable at $5.00 per share.  The Company may call for the mandatoryexercise of such warrants if certain conditions are met.  As part of this private placement, theCompany sold to its placement agents, for $100, five-year warrants to purchasean aggregate of 130,730 shares of common stock at an exercise price of $5.00per share.  As of September 26, 2006,none of such warrants had been exercised.

In October 2005, the Company entered into a securities purchaseagreement with certain accredited investors for the sale of approximately $5.34million of common stock and warrants. Under this agreement, the Company issued five-year warrants for thepurchase of 221,762 shares of common stock at an exercise price of $6.50 pershare to such investors and five-year warrants for the purchase of 55,436shares of common stock at an exercise price of $6.50 to our placement agent. Asof September 26, 2006, none of such warrants had been exercised.

During the first three quarters of fiscal year 2006, no warrants wereissued or exercised, and no warrants expired. As of September 26, 2006, 1,771,479 warrants were outstanding andexercisable.  The weighted averageexercise price of such warrants is $4.66 per share.

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

*This discussion and analysis contains variousnon-historical forward-looking statements within the meaning of Section 21E ofthe Exchange Act.  Although we believethat, in making any such statement, our expectations are based on reasonableassumptions, any such statement may be influenced by factors that could causeactual outcomes and results to be materially different from thoseprojected.  When used in the followingdiscussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,”“estimates” and similar expressions, as they relate to us or our management,are intended to identify such forward-looking statements.  You are cautioned not to attribute unduecertainty to such forward-looking statements, which are qualified in theirentirety by the cautions and risks described herein.  Please refer to our Annual Report on Form10-KSB for the fiscal year ended December 27, 2005, filed with the Securitiesand Exchange Commission on March 27, 2006, for additional factors known to usthat may cause actual results to vary.*

**Overview**

We operate 17 upscalecasual dining restaurants featuring on-premises breweries under the nameGranite City Food & Brewery®.  Withthe exception of the building at our Fargo location, we lease the land andbuilding at each of our restaurants.  Thelocation of each restaurant and the month and year of its opening appear in thefollowing chart:

11

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| Unit | ** ** | **Location**               | ** ** | **Opened** |
|------|------------|----------------------------|------------|------------|
| 1    |       | St. Cloud,  Minnesota      |       | Jun-99     |
| 2    |       | Sioux Falls,  South Dakota |       | Dec-00     |
| 3    |       | Fargo, North  Dakota       |       | Nov-01     |
| 4    |       | Des Moines, Iowa           |       | Sep-03     |
| 5    |       | Cedar Rapids,  Iowa        |       | Nov-03     |
| 6    |       | Davenport, Iowa            |       | Jan-04     |
| 7    |       | Lincoln, Nebraska          |       | May-04     |
| 8    |       | Maple Grove,  Minnesota    |       | Jun-04     |
| 9    |       | East Wichita,  Kansas      |       | Jul-05     |
| 10   |       | Eagan, Minnesota           |       | Sep-05     |
| 11   |       | Kansas City,  Missouri     |       | Nov-05     |
| 12   |       | Kansas City,  Kansas       |       | Jan-06     |
| 13   |       | Olathe, Kansas             |       | Mar-06     |
| 14   |       | West Wichita,  Kansas      |       | Jul-06     |
| 15   |       | St. Louis Park,  Minnesota |       | Sep-06     |
| 16   |       | Omaha, Nebraska            |       | Oct-06     |
| 17   |       | Roseville,  Minnesota      |       | Nov-06     |

 

We developed theforegoing restaurants using proceeds from the sale of our securities, buildingand equipment financing and cash flow from operations.  We built units 4-9, 11-14 and 16-17 basedupon the prototype we developed in early 2003. In 2004 and 2005, we retrofitted units 1-3 to conform to this prototypemodel.  In 2005 and 2006, we developedunits 10 and 15, respectively, which were conversions of existing restaurants.  With the exception of units 1-3 and 15, wedeveloped all of our units under our multi-site development agreement with acommercial developer that provides us with assistance in site selection,construction management and financing for new restaurants.  Under this agreement, we lease the land andbuilding of each new restaurant from our developer.

In June 2005, we opened our beer production facility in Ellsworth, Iowato facilitate the initial stage of our brewing process— the production ofnon-alcoholic wort— using our patent-pending brewing process.  Until we opened our beer production facility,our first two units, which were built with fully equipped and functioningbreweries, supplied hand-crafted beers to all existing units.  We believe that our brewing process and theuse of a centrally located beer production facility improves the economics ofmicrobrewing as it eliminates the initial stages of brewing and storage atmultiple locations, thereby reducing equipment and development costs at new restaurantlocations.  Additionally, having a commonstarting point for the production of wort creates consistency of taste for ourproduct from unit to unit. The wort produced at our beer production facility istransported via truck to the fermentation vessels at each of our restaurantswhere the brewing process is completed. We believe that our current beer production facility has the capacity toservice 30 to 35 restaurant locations.

The training of each of our managers takes place under the instruction offull-time, dedicated trainers at Granite City University, located within ourMaple Grove restaurant.  Our eight-weektraining program consists of both “hands on” as well as classroom training forall aspects of management.  All costsrelated to Granite City University, including trainer and trainee salaries aswell as trainee meals and lodging expenses, are recorded as a component ofcorporate general and administrative costs.

Our new store opening team, which consists of experienced restaurantmanagers, is responsible for the opening of each of our new restaurants.  Generally, this team arrives at a newrestaurant site two to three months in advance of the restaurant opening dateand coordinates all staffing and training matters for that new restaurant.  We believe that a dedicated team delivers amore disciplined opening process and ensures adherence to our 

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company’sexacting standards and culture.  Weintend to develop a second new store opening team during the coming months inorder to keep up with our aggressive future growth plans.

We believe that our operating results will fluctuate significantlybecause of several factors, including the timing of new restaurant openings andrelated expenses, profitability of new restaurants, changes in food and laborcosts, increases or decreases in comparable restaurant sales, general economicconditions, consumer confidence in the economy, changes in consumerpreferences, competitive factors, the skill and experience of ourrestaurant-level management teams and weather conditions.  Additionally, we expect to incur the mostsignificant portion of pre-opening costs associated with a new restaurantwithin the two months immediately preceding, and the month of, the opening ofsuch restaurant.

Thethirteen and twenty-nine weeks ended September 26, 2006 included 180 and 500restaurant weeks, respectively, which is the sum of the actual number of weekseach restaurant operated. The thirteen and thirty-nine weeks ended September27, 2005 included 117 and 325 restaurant weeks, respectively.  The source of the additional restaurant weeksin fiscal year 2006 is shown in the following chart:
| Location                           | ** ** | **Thirteen Weeks   Ended  September 26, 2006** | ** ** | **Thirty-nine Weeks   Ended  September 26, 2006** | ** ** |
|------------------------------------|------------|--------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| Wichita, Kansas                    |       | 1                                                                  |       | 26                                                                    |       |
| Eagan, Minnesota                   |       | 12                                                                 |       | 38                                                                    |       |
| Kansas City,  Missouri             |       | 13                                                                 |       | 39                                                                    |       |
| Kansas City,  Kansas               |       | 13                                                                 |       | 35                                                                    |       |
| Olathe, Kansas                     |       | 13                                                                 |       | 26                                                                    |       |
| West Wichita                       |       | 10                                                                 |       | 10                                                                    |       |
| St. Louis Park,  Minnesota         |       | 1                                                                  |       | 1                                                                     |       |
| Total Additional  Restaurant Weeks |       | 63                                                                 |       | 175                                                                   |       |

 

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

Ourrestaurant revenues are comprised almost entirely of the sales of food andbeverages.  The sale of retail items,such as cigarettes and promotional items, typically represents less than onepercent of total revenue.  Product costsinclude the costs of food, beverages and retail items.  Labor costs include direct hourly andmanagement wages, management bonus, taxes and benefits for restaurantemployees.  Direct restaurant operatingcosts include restaurant supplies, marketing costs, utilities, repairs andmaintenance and other related costs. Occupancy costs include rent on our operating leases, real estate taxesand insurance.  Pre-opening costs consistof direct costs related to hiring and training the initial restaurantworkforce, the salaries and related costs of our dedicated new store openingteam, rental costs incurred during the construction period, and other directcosts associated with opening new restaurants. General and administrative expenses are comprised of expenses associatedwith all corporate and administrative functions that support existingoperations which include management and staff salaries and bonuses, employeebenefits, travel, information systems, training, market research, professionalfees, supplies, corporate rent and excess production costs at our beerproduction facility.  Depreciation andamortization includes depreciation on capital expenditures at the restaurantand corporate levels and amortization of intangibles that do not haveindefinite lives.  Other income andexpense represents the cost of interest expense on debt and capital leases,interest income on invested assets and gain/loss on disposal of assets.

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**Resultsof Operations**

The following table compares operating resultsexpressed as a percentage of total revenue for the thirteen and thirty-nineweeks ended September 26, 2006 and September 27, 2005.
| ** **                                                                                 | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                 | ** ** | **September 26,**             | ** ** | **September 27,**                | ** ** | **September 26,** | ** ** | **September 27,** | ** ** |
| ** **                                                                                 | ** ** | **2006**                           | ** ** | **2005**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                                       |       |                               |       |                                  |       |   |   |   |   |
| Restaurant revenues                                                                        |       | 100.0                              | %          | 100.0                                 | %          | 100.0 | % | 100.0 | % |
|                                                                                       |       |                               |       |                                  |       |   |   |   |   |
| Cost of sales:                                                                             |       |                               |       |                                  |       |   |   |   |   |
| Food, beverage  and retail                                                                 |       | 30.1                               |       | 30.7                                  |       | 29.7 |   | 30.1 |   |
| Labor                                                                                      |       | 36.0                               |       | 36.5                                  |       | 35.5 |   | 35.6 |   |
| Direct  restaurant operating                                                               |       | 12.4                               |       | 12.4                                  |       | 12.3 |   | 12.2 |   |
| Occupancy                                                                                  |       | 5.7                                |       | 4.9                                   |       | 5.6 |   | 5.1 |   |
| Total cost of  sales                                                                       |       | 84.1                               |       | 84.4                                  |       | 83.2 |   | 83.1 |   |
|                                                                                       |       |                               |       |                                  |       |   |   |   |   |
| Pre-opening                                                                                |       | 5.8                                |       | 3.1                                   |       | 4.7 |   | 2.0 |   |
| General and  administrative (including non-cash compensation of 1.0%, 0.0%, 1.3% and 0.1%) |       | 11.0                               |       | 13.5                                  |       | 11.4 |   | 13.2 |   |
| Depreciation and  amortization                                                             |       | 5.8                                |       | 5.8                                   |       | 5.9 |   | 5.7 |   |
|                                                                                       |       |                               |       |                                  |       |   |   |   |   |
| Operating income (loss)                                                                    |       | (6.7                               | )          | (6.8                                  | )          | (5.2 | ) | (4.0 | ) |
|                                                                                       |       |                               |       |                                  |       |   |   |   |   |
| Interest:                                                                                  |       |                               |       |                                  |       |   |   |   |   |
| Income                                                                                     |       | 0.1                                |       | 0.2                                   |       | 0.2 |   | 0.4 |   |
| Expense                                                                                    |       | (4.0                               | )          | (3.8                                  | )          | (4.0 | ) | (3.9 | ) |
| Net interest  expense                                                                      |       | (3.9                               | )          | (3.5                                  | )          | (3.9 | ) | (3.5 | ) |
|                                                                                       |       |                               |       |                                  |       |   |   |   |   |
| Net loss                                                                                   |       | (10.6                              | )%         | (10.3                                 | )%         | (9.1 | )% | (7.5 | )% |

 

Certain percentage amounts do not sum due to rounding.

**Resultsof Operations for the Thirteen and Thirty-nine Weeks Ended September 26, 2006and September 27, 2005**

**Revenue**

We generated $15,028,065 and $9,705,060 of revenuesduring the third quarter of 2006 and 2005, respectively.  During the first three quarters of 2006 and2005, we generated revenues of $41,337,502 and $26,109,648, respectively.  Average weekly sales increased from $82,949per week in the third quarter of 2005 to $83,498 per week in the third quarterof 2006.  Average weekly sales increasedfrom $80,337 to $82,675 per week in the first three quarters of 2006 comparedto the first three quarters of 2005. Comparable restaurant sales, which include restaurants in operation over18 months, increased 3.4% and 4.6% in the third quarter and first threequarters of 2006 over the same such periods of 2005, respectively.  The thirty-nine weeks ended September 26,2006 included 500 restaurant weeks, which is the sum of the actual number ofweeks each restaurant operated.

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The thirty-nine weeksended September 27, 2005 included 325 restaurant weeks.  The increase in sales of 58.3% for the firstthree quarters of the fiscal year 2006 over the first three quarters of fiscalyear 2005 was the result of 175 additional restaurant weeks in 2006 and theincrease in comparable restaurant sales due to the increase in guest traffic atour restaurants.

We anticipate that restaurant revenues will vary fromquarter to quarter.  We anticipateseasonal fluctuations in restaurant revenues due in part to increased outdoorseating and generally favorable weather conditions at our locations during thesummer months.  We expect the timing ofnew restaurant openings to cause fluctuations in restaurant revenues.  Additionally, consumer confidence in theeconomy and changes in consumer preferences may affect our future revenues.

**Restaurant Costs**

***Food and Beverage***

Our food and beverage costs decreased 0.6% as apercentage of revenue from 30.7% in the third quarter of 2005 to 30.1% in thethird quarter of 2006.  These costsdecreased 0.4% as a percentage of revenue from 30.1% in the first threequarters of 2005 to 29.7% in the first three quarters of 2006.  These decreases were due primarily to ourstaff members becoming more experienced in our disciplined preparationand production methods, thereby generating less waste.  Lower per-unit product prices due to highervolume company-wide purchasing also contributed to these decreases.

We expect that our food andbeverage costs will vary going forward due to numerous variables, includingseasonal changes in food and beverage costs and guest preferences.  We periodically create new menu offerings andintroduce new craft brewed beers based upon guest preferences.  Although such menu modifications may temporarilyresult in increased food and beverage costs, we believe we are able to offsetsuch increases with our weekly specials which provide variety and value to ourguests.  Our varieties of craft brewedbeer, which we believe we can produce at lower cost than beers we purchase forresale, also enable us to keep our food and beverage costs low while fulfillingguest requests and building customer loyalty. As we open additional restaurants, we believe we will experience increasedpurchasing power, partially offsetting food and beverage cost increases, andmaintain or reduce our food and beverage costs as a percentage of revenue.  Additionally, as we add new restaurants, webelieve our brewing process will allow us to keep our high quality beerproducts intact while leveraging our fixed production costs, thereby enhancingoverall company profitability.

***Labor***

Our labor costs expressed as a percentage of revenuedecreased 0.5% from 36.5% in the third quarter of 2005 to 36.0% in the thirdquarter of 2006.  These costs decreased0.1% as a percentage of revenue from 35.6% in the first three quarters of 2005to 35.5% in the first three quarters of 2006. We have experienced increases in labor costs as minimum wageshave increased and as we have been required to compete more aggressively formanagement and hourly employees at our new restaurants.  However, our higher revenues company-wide andeffective labor management have generally offset these higher costs as apercentage of revenue.

We expect that labor costswill vary as we add new restaurants. Minimum wage laws, local labor laws and practices, as well asunemployment rates vary from state to state and will affect our labor costs, aswill hiring and training expenses at our new restaurants.  We believe that retaining good employees andmore experienced staff ensures high quality guest service and reduces hiringand training costs.

***Direct Restaurant Operating***

Our direct restaurant operating expenses as apercentage of revenue remained at 12.4% in the third quarter of 2006.  These expenses increased 0.1% as a percentageof revenues from 12.2% in the first three quarters of 2005 to 12.3% in thefirst three quarters of 2006.  Operatingsupplies, repairs and maintenance, promotions and restaurant-leveladministrative expense represent the majority of our direct restaurantoperating expenses, a 

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portion of which is fixedor indirectly variable.  While werealized a slight decrease in kitchen and janitorial supplies, we saw anincrease in expenses related to credit card acceptance, repairs and maintenanceand utilities.

***Occupancy***

Our occupancy costs, which include rent on ouroperating leases, common area maintenance, property taxes and insurance,increased 0.8% as a percentage of revenues from 4.9% in the third quarter of2005 to 5.7% in the third quarter of 2006. These costs increased 0.5% as a percentage of revenues from 5.1% in thefirst three quarters of 2005 to 5.6% in the first three quarters of 2006.  Such increases were due primarily toincreased rent and property taxes.  Ouroccupancy costs do not include payments on the portion of each restaurant leasewhich is classified as a capital lease. Under Financial Accounting Standards Board (FASB) Statement No. 13, *Accounting for Leases,* these payments are classified as paymentsof principal and interest.  Such paymentsaggregated approximately $1,861,223 and $1,003,678 during the first threequarters of 2006 and 2005, respectively.

**Pre-**Opening

Pre-opening costs, which areexpensed as incurred, consist of expenses related to hiring and training theinitial restaurant workforce, wages and expenses of our dedicated new storeopening teams, rental costs incurred during the construction period and certainother direct costs associated with opening new restaurants including labor,food and beverage costs during training. Pre-opening costs in the third quarter of 2006 related to our WestWichita, St. Louis Park, Omaha and Roseville restaurants which we opened inJuly, September, October and November, respectively.  Additional pre-opening costs were incurredrelating to our Madison restaurant which is scheduled to open in December2006.  In the first three quarters offiscal year 2006, we included the following rental costs incurred during constructionperiods in pre-opening expense in accordance with FASB Staff Position No. FAS13-1, *Accounting for Rental Costs Incurred during aConstruction Period*(FSP FAS 13-1):
| Legends        |   | $       | 13,078  |   |
|----------------|--------|---------|---------|--------|
| Olathe         |   | 38,587  |    |
| West Wichita   |   | 43,935  |    |
| St. Louis Park |   | 128,186 |    |
| Omaha          |   | 39,255  |    |
| Roseville      |   | 135,324 |    |
| Madison        |   | 132,925 |    |
|           |   | $       | 531,290 |   |

 

The non-cash portion ofthis pre-opening rent expense was $420,086.

Based upon the costs oflabor, travel, lodging, training and rent incurred prior to opening, we expectpre-opening expenses to average between $400,000 and $425,000 per unit, ofwhich we anticipate approximately $50,000 to $250,000 to be construction-periodrent.  Pre-opening costs are primarilyincurred in the month of, and two months prior to, the restaurant opening.

**General andAdministrative**

General and administrative expenses include allsalaries and benefits associated with our corporate staff that is responsiblefor overall restaurant quality, future expansion into new locations, financialcontrols and reporting, restaurant management recruiting, training at GraniteCity University that we opened in February 2005, excess capacity costs relatedto our beer production facility that we opened in June 2005, and salaries andexpenses of our new store opening team when it is not dedicated to a particularrestaurant opening.  Other general andadministrative expenses include advertising, professional fees, officeadministration, centralized accounting system costs, and travel by ourcorporate management to the restaurant locations.

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General and administrative expenses increased$337,972 from $1,312,890 in the third quarter of 2005 to $1,650,862 in thethird quarter of 2006.  These expensesincreased $1,274,362 from $3,447,934 in the first three quarters of 2005 to$4,722,296 in the first three quarters of 2006. Of such increase, $459,351 represented payroll costs due to the increasein our corporate staff in the areas of accounting, IT, Granite City University,the beer production facility and our new store opening team.  Professional fees, includingconsulting, marketing, legal, accounting and investor relations, were approximately $416,816 higher in the firstthree quarters of 2006 than in the first three quarters of 2005.

In December 2004, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) No. 123 (revised 2004) (“SFAS 123(R)”),*Share-Based Payment*, which is arevision of SFAS 123, *Accounting forStock-Based Compensation*. Generally, effective with the first day of fiscal year 2006,SFAS 123(R) requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the income statementbased on their fair values determined at the date of grant.  In all prior periods, we accounted forstock-based compensation awards to employees using the intrinsic value methodprescribed by APB Opinion No. 25 and, as such, generally recognized nocompensation cost for employee stock options. In the third quarter and first three quarters of 2006, our general andadministrative expenses included approximately $143,364 and $550,848 innon-cash stock-based compensation expense, respectively.

Despite the foregoing increases in general andadministrative expenses, the increase in restaurant revenues associated withadditional locations and the increase in comparable sales caused our generaland administrative expenses to decrease as a percentage of revenue.  During the third quarter and first threequarters of 2006, these expenses decreased 2.5% and 1.8%, respectively, fromsuch periods in 2005.  As a percentage ofrevenue, general and administrative expense, excluding non-cash stock optioncompensation, was 10.0% and 13.5% in the third quarter of 2006 and 2005,respectively, and 10.1% and 13.1% in the first three quarters of 2006 and 2005,respectively.  As a percentage ofrevenue, non-cash stock option compensation was 1.0% and 0.0% in the thirdquarter of 2006 and 2005, respectively, and 1.3% and 0.1% in the first threequarters of 2006 and 2005, respectively.

Although general and administrative costs maycontinue to fluctuate as a percentage of restaurant revenues in the near term,we expect such expenses will decrease as a percentage of revenues in the longterm as we grow our restaurant chain.

**Depreciation and Amortization**

Depreciation andamortization expense increased $317,388 during the third quarter of 2006compared to the same period in 2005. During the first three quarters of 2006, such expense increased $948,549compared to the first three quarters of 2005, due principally to the additionaldepreciation related to the newly opened restaurants.  As a percentage of revenues, depreciationexpense increased 0.2% in the first three quarters of 2006.  Under Financial Accounting Standards Board(FASB) Statement No. 13, *Accounting for Leases*,amortization expense related to assets held under a capital lease, whichincludes substantially all of our restaurant buildings, is to be included withdepreciation and amortization expense. Amortization expense related to assets held under capital leases wasapproximately $1,007,454 and $574,150 in the first three quarters of 2006 and2005, respectively, and was included in depreciation and amortization expense.

**Interest**

Net interestexpense consists of interest expense on capital leases and long-term debt, netof interest earned from cash on hand. Interest expense related to capital leases and debt increased $243,571to $607,890 and increased $660,365 to $1,669,567 during the third quarter andfirst three quarters of 2006, respectively, due to the increase in capitalleases as a result of five additional restaurants.  Interest income related to available cashdecreased $6,481 to $16,803 and decreased $19,663 to $72,967 during the thirdquarter and first three quarters of 2006, respectively, due to the reduction ofcash on hand.  Management expects net interest expense willincrease as we pursue further expansion.

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**Liquidity and CapitalResources**

We have funded our capital requirements sinceinception through sales of securities, building and equipment financing andcash flow from operations.  As ofSeptember 26, 2006, we had $2,761,706 of cash and a $4,129,825 working capitaldeficit compared to $9,836,231 of cash and $5,136,557 of net working capital atDecember 27, 2005.

During the thirty-nine weeks ended September 26, 2006,we used $440,663 of net cash in operating activities, $5,804,425 in net cash topurchase equipment and other assets primarily for our new restaurants and thoserestaurants under construction, and made payments aggregating $819,994 on ourdebt and capital lease obligations. Additionally, during the first three quarters of 2006, we used $9,443 ofcash to pay expenses associated with the issuance of our common stock, net ofcash received through the exercise of options.

During the thirty-nine weeks ended September 27, 2005,we used $849,261 of net cash in operating activities, $4,154,961 in net cash topurchase equipment and other assets primarily for our Wichita, Eagan and KansasCity locations and our wort production facility, and made payments aggregating$614,098 on our debt and capital lease obligations.  Additionally, during the first three quartersof 2005, we paid cash dividends to shareholders of our preferred stockaggregating $41,068 and received net cash of $230,094 from the issuance of ourcommon stock upon the exercise of options and warrants.

Using the proceeds from thesale of our securities, building and equipment financing and cash flows fromoperations, we intend to continue expansion in markets where we believe ourconcept will have broad appeal and attractive restaurant-level economics.  We plan to continue using our prototypicalmodel as we open future restaurants under our multi-site development agreement;however, where appropriate, we will convert existing restaurants to our GraniteCity concept as we did with our Eagan location and our St. Louis Parklocation.  Additionally, we intend toexplore alternative restaurant designs to reduce the cost of our initial capitalinvestment and we may alter our prototypical model to meet various state andlocal regulatory requirements, including, but not limited to, pollution controlrequirements, liquor license ordinances and smoking regulations.

Based upon our existingprototype, we anticipate that pre-opening costs, the initial purchase offurniture, fixtures and equipment and our restaurant design costs will requirean investment by us of approximately $1.0 million to $1.4 million for each newrestaurant.  We anticipate that our newrestaurants will require an investment by our developer of approximately $3.5million to $4.5 million each for land and building.  We expect these costs will vary from onemarket to another based on real estate values, zoning regulations, labor marketsand other variables.

In January 2006,we opened a restaurant in Kansas City, Kansas.  We are leasing this property from our developer under a 20-year leaseagreement.   Our annual lease paymentsare $404,250 with $262,500 classified as a capital lease whereby the paymentsare recorded as principal and interest, and the remaining $141,750 classifiedas an operating lease with the payments recorded as fixed rent expense.  We have the option to extend this lease forup to five additional five-year periods or to purchase the restaurant real estatefor its fair market value during the last year of the original term.

In March 2006, weopened a restaurant in Olathe, Kansas.  We are leasing this property from our developer under a 20-year leaseagreement.   Our annual lease paymentsare $414,750 with $268,254 classified as a capital lease whereby the paymentsare recorded as principal and interest, and the remaining $146,496 classifiedas an operating lease with the payments recorded as fixed rent expense.  We have the option to extend this lease forup to five additional five-year periods or to purchase the restaurant realestate for its fair market value during the last year of the original term.

In March 2006, wecommenced leasing a property in St. Louis Park, Minnesota under a 10-yearoperating lease agreement.  Our annuallease payments are $148,625 plus percentage rent based upon restaurantsales.  This lease may be extended at our option for up tothree additional five-year periods.  Wepaid approximately $573,776 in lease acquisitions costs for this property.

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In July 2006, weopened a restaurant in West Wichita, Kansas. We are leasing this property from our developer under a 20-year leaseagreement.  Our annual lease payments are$315,000 with $217,350 classified as a capital lease whereby the payments arerecorded as principal and interest, and the remaining $97,650 classified as anoperating lease with the payments recorded as fixed rent expense.  We have the option to extend this lease forup to five additional five-year periods or to purchase the restaurant realestate for its fair market value during the last year of the original term.

In August 2006, we entered into a master lease agreement with Carltonpursuant to which we may “finance lease” up to $3,000,000 of equipmentpurchases for three future restaurant locations.  In September, 2006, we entered into a leaseschedule and amendment to this master lease, pursuant to which we are leasingequipment for our restaurant in St. Louis Park valued at $821,158 for aninitial lease term of 39 months.  Themonthly lease payments are $25,924 plus all fees, assessments, sales, use,property and other taxes imposed upon Carlton.  We have provided Carltonwith a refundable security deposit of $164,220 as well as a security interestin certain other equipment.  At the end of the initial lease term, we may(a) purchase Carlton’s interest in all, but not less than all, of the equipmentfor a purchase price equal to the greater of (1) the fair market value of theequipment, or (2) the original cost of the equipment, or (b) renew such leasefor 12 months at a monthly lease payment of $11,223 and take ownership of theequipment thereafter for $1.00.  Ourpresident and chief executive officer was required to personally guaranteepayments to be made to Carlton under the lease financing and the Company’sboard of directors agreed to compensate him for such guarantee.  The amount of annual compensation will be 3%of the balance of such lease and will be calculated and accrued based on theweighted average daily balance of the lease at the end of each monthlyaccounting period.

In September 2006, we entered into an Equipment Lease Commitment andMaster Equipment Lease with DHW, relating to the lease of furniture, fixturesand equipment for future restaurants. Under the terms of the Equipment Lease Commitment, DHW has agreed topurchase and lease to us equipment costing up to $16 million to equip futurerestaurant locations.  Each lease isexpected to be for equipment costing a minimum of $800,000 and a maximum of $1.4million per restaurant.  Payments due DHWwill be based upon a five-year amortization of the purchase price with interestequal to the DHW bank base rate plus a blended 5.4% rate.    The equipment lease contains othercustomary terms and conditions and we will have the option to purchase theleased equipment for $1.00 upon payment in full of all rent payments due undereach lease.  Although we are notobligated to enter into any equipment leases with DHW, management intends toenter into equipment leases with DHW for the foreseeable future.  The members of DHW are Donald A. Dunham,Charles J. Hey and Steven J. Wagenheim. Mr. Wagenheim is our president, chief executive officer and one of ourdirectors.  Mr. Wagenheim owns a 20%membership interest in DHW and has agreed to personally guarantee 20% of DHW’sindebtedness to its lenders.  Mr.Wagenheim’s participation in the income and profits of DHW will not exceed 3%of the average principal balance of the amount guarantied for the term of theguarantied debt.

With our existing capital resources, cash generated from operations andthe proceeds from the equipment lease financings we entered into in August andSeptember 2006, we believe that we will have sufficient funds to complete our2006 and 2007 openings and provide sufficient working capital for ouroperations.  If we do not generate thecash needed from operations, we may have to reduce or delay our planned 2007openings.  We are continually evaluatingour development plans and we are exploring options relative to the pace of ourgrowth.  If we do not have enough fundsbased upon our expected cash flows from operations, we may be required toobtain additional financing through the sale of securities and/or increase ourborrowings.  We may not be able to accomplisheither of these alternatives on terms acceptable to us, or at all.

**Commitments and Contingent Liabilities**

*Development Agreement:*

We have entered into a development agreement with Dunham for thedevelopment of restaurants.  Dunham iscontrolled by Donald A. Dunham, Jr., who is a member of DHW and an affiliate ofGranite Partners, L.L.C., a beneficial owner of less than 2% of oursecurities.  The agreement gives Dunhamthe right to develop, 

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constructand lease up to 22 restaurants for us prior to December 31, 2012.  As of September 26, 2006, eleven restaurants,namely units 4-14, had been constructed for us under this developmentagreement.  We are not bound to authorizethe construction of restaurants during the term of the development agreement, butgenerally cannot use another developer to develop or own a restaurant as longas the development agreement is in effect. We can use another developer if Dunham declines to build a particularrestaurant, if the agreement is terminated because of a default by Dunham, orif our company is sold or merged into another company.  In the case of a merger or sale of ourcompany, the development agreement may be terminated.

The development agreement provides for a cooperative process betweenDunham and our company for the selection of restaurant sites and thedevelopment of restaurants on those sites, scheduling for the development andconstruction of each restaurant once a location is approved, and controls onthe costs of development and construction using bidding and guaranteed maximumcost concepts.  The development agreementprovides that restaurants will be leased to us on the basis of a triple netlease.  The rental rate of each leasewill be calculated using a variable formula which is based on approved andspecified costs of development and construction and an indexed interestrate.  Generally, the land portion ofeach lease is classified as an operating lease because the fair value of theland is more than 25% of the property to be leased.  The building portion of the lease isclassified as a capital lease because its present value is greater than 90% ofthe estimated fair value at the beginning of the lease.  The term of each lease is 20 years and may beextended at our option for up to five additional five-year periods, or we maypurchase the restaurant real estate for the fair market value during the lastyear of the original term.

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

Dunham also has the right to sell the underlying land and building tothird parties or assign our leases.  Asof September 26, 2006, Dunham had sold three of our restaurants sites to thirdparties.  The assignment or sale of alease by Dunham has had no material impact on our agreement.

*Operating and Capital Lease Relating to Restaurants:*

As of September 26, 2006, we operated 15 restaurants.  Thirteen of these restaurants operate underland and building lease agreements, whereby the land portion of the lease isclassified as an operating lease because the fair value of the land was morethan 25% of the leased property at the inception of each lease, and thebuilding portion of the lease is classified as a capital lease because itspresent value was greater than 90% of the estimated fair value at the beginningof the lease.  Of these 13 leases, oneexpires in 2020, two in 2023, four in 2024, three in 2025 and the remainingthree expire in 2026, all with renewable options for additional periods.  Under three of the leases, we are required topay additional percentage rent based upon restaurant sales.  As of September 26, 2006, future obligationsrelating to the land portion of these 13 leases aggregated $30,267,661 pluspercentage rent.  The scheduled rentincreases for the land during the life of each lease are recognized on astraight-line basis.  Future obligationsrelating to the building portion of these 13 leases aggregated $51,375,814 asof September 26, 2006.

In 2001, we entered into a 20-year operating lease for the land uponwhich we built our Fargo restaurant.  Asof September 26, 2006, future obligations under the terms of this leaseaggregated $1,089,800 plus percentage rent.

In March 2006, we entered into a lease agreement for the land andbuilding for our St. Louis Park restaurant. This lease expires in 2016 with renewal options for additionalperiods.  This lease is classified as anoperating lease as the present value of the minimum lease payments was lessthan 90% of the estimated fair value of the property at the beginning of thelease.  During the construction period,the rent expense for this lease was recognized as pre-opening expense.  As of September 26, 2006, future obligationsrelating to this operating lease aggregated $1,411,937 plus percentage rent.

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As of September 26, 2006, we had an additional capital lease obligationoutstanding of $238,970 for an equipment lease collateralized by equipment atour Sioux Falls location expiring in 2008.

As of September 26, 2006, we had entered into 20-year net leases withour developer for restaurants in Omaha, Roseville and Madison.  The annual rent for each of these leases isequal to 10.5% of the sum of the construction cost and land cost.  The term of the Omaha lease commenced when webegan operations October 17, 2006 and the term of the Roseville lease commencedwhen operations began November 3, 2006. Additionally, as of September 26, 2006, we had entered into the above-referenced equipment financing agreements with Carlton and DHW.  Neither the Carlton nor DHW facility had beenused as of the end of the third quarter. As such, no balance was due on either lease.

Our developer, in cooperation with our chief executive officer,continues to explore opportunities for the development of additional restaurantsites, and where necessary, enters into letters of intent or leases to securesuch sites on our behalf.

*Other Operating and Capital Leases:*

In December 2004, we entered into a land and building lease agreementfor our beer production facility.  Thisten-year lease commenced February 1, 2005, and is classified as a capital leaseas it contains a bargain purchase option. As of September 26, 2006, future obligations under the terms of thislease aggregated $720,004.

In August 2005, we entered into a 38-month lease agreement for officespace for our corporate offices.  Thelease commenced October 1, 2005.  Annualrent is $38,666 with scheduled annual increases throughout the term of thelease.  Such scheduled rent increases arerecognized on a straight-line basis over the term of the lease.  Future obligations under the terms of thislease aggregated $89,211 at September 26, 2006.

In November 2005, we entered into an agreement for a facility inMinneapolis, Minnesota which we use as a test kitchen.  Obligations under this three-year leaseagreement began November 1, 2005.  Theagreement calls for annual rent of $42,000 and has an option for a three-yearrenewal.  Future obligations under thislease aggregated $87,500 at September 26, 2006.

*Related Party Guaranties:*

Two of our directors, Steven J. Wagenheim and Arthur E. Pew III, andone former director, William E. Burdick have personally guaranteed certain ofour leases and loan agreements.  Inconnection with the $1.5 million loan we obtained in July 2001 to finance ourFargo restaurant, we entered into an agreement concerning guaranty whichprovides, among other things, that such guarantors will be indemnified from anyliabilities they may incur by reason of their guaranties of our indebtedness.In August 2006, Messrs. Burdick and Pew were released from their guarantiesrelated to this loan agreement.

At a meeting held in March 2004, our board of directors agreed tocompensate our president and chief executive officer for his personalguaranties of equipment loans entered into in August 2003 and January2004.  The amount of annual compensationis 3% of the balance of such loans.  Thisamount is calculated and accrued based on the weighted average daily balancesof such loans at the end of each monthly accounting period.  During the first three quarters of 2006 and2005, we recorded $23,601 and $27,972 of such compensation in general andadministrative expense, respectively, and paid $15,000 and $15,000 of suchcompensation, respectively.

In August 2006, we entered into a lease agreement with Carlton pursuantto which we may finance lease up to $3.0 million of equipment.  Mr. Wagenheim was required to personallyguarantee payment to be made to Carlton under this lease financingagreement.  The amount of annualcompensation will be 3% of the balance of such lease and will be calculated andaccrued based on the weighted average daily balance of the lease at the end ofeach monthly accounting period.

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In September 2006, we entered into an Equipment Lease Commitment andMaster Equipment Lease with DHW, relating to the lease of furniture, fixturesand equipment for future restaurants. Under the terms of the Equipment Lease Commitment, DHW has agreed topurchase and lease to us equipment costing up to $16 million to equip futurerestaurant locations.  Mr. Wagenheim ownsa 20% membership interest in DHW and has agreed to personally guarantee 20% ofDHW’s indebtedness to its lenders.  Mr.Wagenheim’s participation in the income and profits of DHW will not exceed 3%of the average principal balance of the amount guarantied for the term of theguarantied debt.

*Employment Agreement:*

In June 2005, we entered into a three-year employment agreement withSteven J. Wagenheim, our president and chief executive officer, who is also adirector of our company.  The agreementprovided for a minimum base salary of $225,000, commencing January 1, 2005,cash incentive compensation for 2005 ranging from $0 to $125,550 based onperformance, and a stock option for the purchase of 150,000 shares of commonstock.  In February 2006, we amended thecompensatory arrangements under the agreement by adopting our 2006 CEOCompensation Plan.  This plan providesfor a base salary of $275,000, commencing January 1, 2006, cash incentivecompensation for 2006 ranging from $0 to $167,400 based on performance, and astock option for the purchase of 100,000 shares of common stock.  In addition to annual compensation terms andother provisions, the agreement includes change in control provisions thatwould entitle him to receive severance pay equal to 18 months of salary ifthere is a change in control of our company and his employment terminates.

In August 2006, we entered into an at-will employment agreementwith Peter P. Hausback that provides for Mr. Hausback to serve as our chieffinancial officer and principal accounting officer.  The agreement provides for a minimum annualbase salary of $215,000. Mr. Hausback is also eligible to participate in any performance-basedcash bonus or equity award plans for senior executives based upon goalsestablished by the board or compensation committee after reasonableconsultation with Mr. Hausback.  Theextent of Mr. Hausback’s participation in bonus plans for each of theyears 2006 and 2007 will be up to $75,000 based upon performance of duties andachievement of performance targets.  Theemployment agreement provides that a severance payment equal to 12 monthsof base salary will be made if Mr. Hausback’s employment is terminated inconnection with a change of control, by our company without cause, or by theofficer for good reason.

In August 2005, we entered into an at-will employment agreementwith Daniel H. Bauer that provided for Mr. Bauer to serve as our chief financialofficer and principal accounting officer. In August 2006, Mr. Bauer resigned from such position.  Mr. Bauer’s employment agreement containedterms substantially equivalent to those contained in Mr. Hausback’s employmentagreement, including substantially the same severance benefits.  Because Mr. Bauer’s severance benefits werenot yet effective and because his employment was not terminated in connectionwith a change of control, by our company without cause, or by the officer forgood reason, as defined, Mr. Bauer was ineligible for severance benefits uponthe termination of his employment.

*Summary of Contractual Obligations:*

The following table summarizes our obligations under contractualagreements as of September 26, 2006 and the time frame within which payments onsuch obligations are due.  This tabledoes not include amounts related to percentage rent as such future amounts arenot determinable.  In addition, whetherwe would incur any additional expense on our employment agreements depends uponthe existence of a change in control of the company.  Therefore, no percentage rent nor severanceexpense has been included in the following table.

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| ** **                                       | ** ** | **Payments due by period** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**                 | ** ** | **Total**                                 | ** ** | **Fiscal Year   2006** | ** ** | **Fiscal Years   2007-2008** | ** ** | **Fiscal Years   2009-2010** | ** ** | **Fiscal Years   Thereafter** | ** ** |
| Long-term debt,  principal                       |       | $                                         | 2,326,020  |   | $ | 62,386 |   | $ | 537,518 |   | $ | 591,891 |   | $ | 1,134,226 |   |
|  Interest on long-term debt                 |       | 664,988                                   |       | 44,116 |   | 314,487 |   | 238,352 |   | 68,034 |   |
| Capital lease  obligations, including interest   |       | 52,334,788                                |       | 756,148 |   | 5,972,428 |   | 5,790,611 |   | 39,815,601 |   |
| Operating lease  obligations, including interest |       | 32,946,109                                |       | 500,561 |   | 3,999,709 |   | 3,862,661 |   | 24,583,178 |   |
| Loan guarantee                                   |       | 98,556                                    |       | 34,693 |   | 42,284 |   | 14,089 |   | — |   |
| Total obligations                                |       | $                                         | 88,370,462 |   | $ | 1,397,903 |   | $ | 10,866,426 |   | $ | 10,497,603 |   | $ | 65,601,039 |   |

 

Certain amounts donot sum due to rounding.

Based on our cash position at September 26,2006, we believe we have sufficient capital to meet our current obligations.

**Critical Accounting Policies**

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

*Property and Equipment*

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

Our accounting policiesregarding property and equipment include certain management judgments regardingthe estimated useful lives of such assets and the determination as to whatconstitutes enhancing the value of or increasing the life of existing assets.  These judgments and estimates may producematerially different amounts of depreciation and amortization expense thanwould be reported if different assumptions were used.

We continually reassess our assumptions andjudgments and make adjustments when significant facts and circumstancesdictate.  Historically, actual resultshave not been materially different than the estimates we have made.

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*Stock-Based Compensation*

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

**Seasonality**

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

**Inflation**

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

**ITEM3   Quantitative and QualitativeDisclosures about Market Risk**

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

*Changesin Interest Rate:*

Pursuant to the terms of the loan we entered into in August 2003 forequipment at our Des Moines location, the interest rate increased from 6.125%to 10.25% effective August 28, 2006.  Asof September 26, 2006, the unpaid balance on this loan was $476,984.   In January 2007, the interest rate on theloan we entered into in January 2004 for equipment at our Davenport locationwill be adjusted to the greater of 5.5% or the then-current prime rate plus2%.  The effect of this interest rateadjustment will not be determinable until January 2007.

*Changesin Commodity Prices:*

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

Our company doesnot enter into derivative contracts either to hedge existing risks or forspeculative purposes.

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**ITEM 4   Controls and Procedures**

We maintain a system of disclosure controls and procedures that isdesigned to ensure that information required to be disclosed in our ExchangeAct reports is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such information isaccumulated and communicated to our management, including our Chief ExecutiveOfficer and Chief Financial Officer, as appropriate, to allow timely decisionsregarding required disclosures.

Under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, we conductedan evaluation of our disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)). Based on this evaluation, our Chief Executive Officer and our ChiefFinancial Officer concluded that, as of September 26, 2006, our disclosurecontrols and procedures were effective.

There were no changes in our internal controlover financial reporting that occurred during the quarter ended September 26,2006 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

**PART II          OTHERINFORMATION**
| **ITEM 1**  | **Legal Proceedings**                                                                                                                                                                                      |
|-------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  | ** **                                                                                                                                                                                                 |
|        | Not applicable.                                                                                                                                                                                            |
|        |                                                                                                                                                                                                       |
| **ITEM 1A** | **Risk Factors**                                                                                                                                                                                           |
| ** **  | ** **                                                                                                                                                                                                 |
|        | Please refer to the Cautionary Statement set forth  in our Annual Report on Form 10-KSB for the fiscal year ended December 27,  2005, filed with the Securities and Exchange Commission on March 27, 2006. |
|        |                                                                                                                                                                                                       |
| **ITEM 2**  | **Unregistered Sales of Equity Securities and Use  of Proceeds**                                                                                                                                           |
| ** **  | ** **                                                                                                                                                                                                 |
|        | Not applicable.                                                                                                                                                                                            |
|        |                                                                                                                                                                                                       |
| **ITEM 3**  | **Defaults upon Senior Securities**                                                                                                                                                                        |
| ** **  | ** **                                                                                                                                                                                                 |
|        | Not applicable.                                                                                                                                                                                            |
|        |                                                                                                                                                                                                       |
| **ITEM 4**  | **Submission of Matters to a Vote of Security  Holders**                                                                                                                                                   |
| ** **  | ** **                                                                                                                                                                                                 |
|        | Not applicable.                                                                                                                                                                                            |

 

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**ITEM 5                Other Information**

The 2006 annualmeeting of shareholders was held October 25, 2006 (after the period covered bythis report).  Two proposals weresubmitted for shareholder approval, both of which passed with voting results asfollows:

(1)           Election of Directors:
|                      | ** ** | **FOR**   | ** ** | **WITHHOLD** | ** ** |
|----------------------|------------|-----------|------------|--------------|------------|
| Steven J.  Wagenheim |       | 9,249,191 |       | 237,832      |       |
| Arthur E. Pew  III   |       | 9,233,043 |       | 253,980      |       |
| James G.  Gilbertson |       | 9,247,765 |       | 239,258      |       |
| Bruce H. Senske      |       | 9,249,691 |       | 237,332      |       |
| Eugene E.  McGowan   |       | 9,247,765 |       | 239,258      |       |
| Dermot F. Rowland    |       | 9,250,091 |       | 236,932      |       |

 

(2)           To ratify the appointment ofSchechter, Dokken, Kanter, Andrews & Selcer Ltd. as our independentregistered public accounting firm for the fiscal year ending December 26, 2006.
| FOR       | ** ** | **AGAINST** | ** ** | **ABSTAIN** | ** ** | **BROKER NON-VOTE** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|--------------------------|------------|
| 9,141,682 |       | 1,548       |       | 343,793     |       | 0                        |       |

 

**ITEM 6                Exhibits**

See “Index toExhibits.”

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|                                           | GRANITE CITY FOOD & BREWERY LTD. |
|-------------------------------------------|--------------------------------------|
|                                      |                                 |
|                                      |                                 |
| Date:    November 13, 2006 |                                 | By: | /s/ Peter P. Hausback |   |
|                                      |                                 | Peter P.  Hausback |
|                                      |                                 | Chief Financial  Officer |

 

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**INDEX TO EXHIBITS**
| Exhibit Number | ** ** | **Description**                                                                                                                                                                                                                                                                                                  |
|----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **     | ** ** | ** **                                                                                                                                                                                                                                                                                                       |
| 10.1           |       | Executive Employment Agreement dated August 14,  2006, between the Registrant and Peter P. Hausback (incorporated by reference  to our Current Report on Form 8-K, filed on August 14, 2006 (File No. 000-29643)).                                                                                     |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 10.2           |       | Master Lease Agreement by and between the Registrant  and Carlton Financial Corporation, dated August 16, 2006 (including form of  lease schedule and form of first amendment thereto) (incorporated by  reference to our Current Report on Form 8-K, filed on August 22, 2006  (File No. 000-29643)). |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 10.3           |       | Interim Funding Agreement by and between the  Registrant and Carlton Financial Corporation, dated August 16, 2006  (incorporated by reference to our Current Report on Form 8-K, filed on  August 22, 2006 (File No. 000-29643)).                                                                      |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 10.4           |       | Guaranty from Steven J. Wagenheim to Carlton  Financial Corporation, dated August 16, 2006 (incorporated by reference to  our Current Report on Form 8-K, filed on August 22, 2006 (File  No. 000-29643)).                                                                                             |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 10.5           |       | First Amendment to Loan Agreement by and between  First National Bank and the Registrant, effective August 16, 2006  (incorporated by reference to our Current Report on Form 8-K, filed on  August 22, 2006 (File No. 000-29643)).                                                                    |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 10.6           |       | Equipment Lease Commitment by and between DHW  Leasing, L.L.C. and Granite City Food & Brewery Ltd. dated September 19,  2006 (incorporated by reference to our Current Report on Form 8-K, filed  on September 22, 2006 (File No. 000-29643)).                                                    |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 10.7           |       | Master Equipment Finance Lease by and between DHW  Leasing, L.L.C. and Granite City Food & Brewery Ltd. dated September 19,  2006 (incorporated by reference to our Current Report on Form 8-K, filed  on September 22, 2006 (File No. 000-29643)).                                                |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 10.8           |       | Amendment to Development Agreement by and between  Donald A. Dunham, Jr., Dunham Capital Management, L.L.C. and Granite City  Food & Brewery Ltd. dated September 19, 2006 (incorporated by reference  to our Current Report on Form 8-K, filed on September 22, 2006 (File No. 000-29643)).       |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 31.1           |       | Certification by Steven J. Wagenheim, President and  Chief Executive Officer of the Company, pursuant to Exchange Act Rule  13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                    |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 31.2           |       | Certification by Peter P. Hausback, Chief Financial  Officer of the Company, pursuant to Exchange Act Rule 13a-14(a), as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                     |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 32.1           |       | Certification by Steven J. Wagenheim, President and  Chief Executive Officer of the Company, pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                          |
|           |       |                                                                                                                                                                                                                                                                                                             |
| 32.2           |       | Certification by Peter P. Hausback, Chief Financial  Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                          |

 

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