** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,DC 20549**

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**FORM 10-Q**

 

x                               **QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLYPERIOD ENDED SEPTEMBER 25, 2007**

 

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

 

**Commission File Number 000-29643**

 

**GRANITE CITY FOOD & BREWERYLTD.**

(Exact Name of Registrantas Specified in Its Charter)

 

| **Minnesota**                                              |       | **41-1883639**      |
|------------------------------------------------------------|------------|---------------------|
| (State or Other  Jurisdiction                              |       | (I.R.S. Employer    |
| of Incorporation or  Organization)                         | ** ** | Identification No.) |
|                                                       |       |                |
|                                                       |       |                |
| **5402  Parkdale Drive, Suite 101**                        |
| **Minneapolis,  Minnesota 55416**                          |
| **(952)  215-0660**                                        |
| (Address of Principal  Executive Offices and Issuer’s |
| Telephone Number,  including Area Code)                    |

 

 

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes x     No o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large acceleratedfiler  o        Acceleratedfiler  o        Non-acceleratedfiler  x

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No x

 

As of November 1, 2007, theissuer had outstanding 16,097,335****shares of common stock.

 

 

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**TABLE OF CONTENTS**
|                  |                                                                                                                                     |   |
|-----------------------|------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                  |                                                                                                                                     |   |
| **PART I**            | **FINANCIAL  INFORMATION**                                                                                                               |   |
|                  |                                                                                                                                     |   |
| ITEM 1                | Financial  Statements                                                                                                                    |   |
|                  |                                                                                                                                     |   |
|                  | Condensed  Consolidated Balance Sheets as of September 25, 2007and December 26, 2006                                                     |   |
|                  |                                                                                                                                     |   |
|                  | Condensed Consolidated Statements of Operations for  the Thirteen and Thirty-nine weeks ended September 25, 2007 and September 26,  2006 |   |
|                  |                                                                                                                                     |   |
|                  | Condensed Consolidated Statements of Cash Flows for  the Thirty-nine weeks ended September 25, 2007 and September 26, 2006               |   |
|                  |                                                                                                                                     |   |
|                  | Notes to Condensed Consolidated Financial Statements                                                                                     |   |
|                  |                                                                                                                                     |   |
| ITEM 2                | Management’s Discussion and Analysis of Financial  Condition and Results of Operations.                                             |   |
|                  |                                                                                                                                     |   |
| ITEM 3                | Quantitative  and Qualitative Disclosures about Market Risk                                                                              |   |
|                  |                                                                                                                                     |   |
| ITEM 4                | Controls and  Procedures                                                                                                                 |   |
|                  |                                                                                                                                     |   |
| **PART II**           | **OTHER INFORMATION**                                                                                                                    |   |
|                  |                                                                                                                                     |   |
| ITEM 1                | Legal  Proceedings                                                                                                                       |   |
|                  |                                                                                                                                     |   |
| ITEM 1A               | Risk  Factors                                                                                                                            |   |
|                  |                                                                                                                                     |   |
| ITEM 2                | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                             |   |
|                  |                                                                                                                                     |   |
| ITEM 3                | Defaults upon  Senior Securities                                                                                                         |   |
|                  |                                                                                                                                     |   |
| ITEM 4                | Submission of  Matters to a Vote of Security Holders                                                                                     |   |
|                  |                                                                                                                                     |   |
| ITEM 5                | Other  Information                                                                                                                       |   |
|                  |                                                                                                                                     |   |
| ITEM 6                | Exhibits                                                                                                                                 |   |
|                  |                                                                                                                                     |   |
| **SIGNATURES**        |                                                                                                                                     |   |
|                  |                                                                                                                                     |   |
| **INDEX TO EXHIBITS** |                                                                                                                                     |

** **

i

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| **PART I          ** | **FINANCIAL INFORMATION** | ** ** |
|------------------------------------------------------------------------|---------------------------|------------|
| ** **                                                             | ** **                | ** ** |
| **ITEM 1  Financial Statements**                                  | ** **                | ** ** |

** **

**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

** **
| ** **                                                                                                                                                                        | ** ** | **September 25,  2007** | ** ** | **December 26,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **ASSETS:**                                                                                                                                                                       | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current assets:                                                                                                                                                                   |       |                    |       |                   |       |
| Cash and cash  equivalents                                                                                                                                                        |       | $                       | 6,483,988  |                   | $          | 7,671,750 |   |
| Inventory                                                                                                                                                                         |       | 537,138                 |       | 511,146                |       |
| Prepaids and  other                                                                                                                                                               |       | 512,700                 |       | 393,803                |       |
| Total current  assets                                                                                                                                                             |       | 7,533,826               |       | 8,576,699              |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Prepaid rent,  net of current portion                                                                                                                                             |       | 459,872                 |       | 503,267                |       |
| Property and  equipment, net                                                                                                                                                      |       | 61,106,795              |       | 54,018,124             |       |
| Intangible  assets and other                                                                                                                                                      |       | 795,555                 |       | 760,420                |       |
| Total assets                                                                                                                                                                      |       | $                       | 69,896,048 |                   | $          | 63,858,510 |   |
|                                                                                                                                                                              |       |                    |       |                   |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY:**                                                                                                                                   | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current  liabilities:                                                                                                                                                             |       |                    |       |                   |       |
| Accounts payable                                                                                                                                                                  |       | $                       | 4,761,472  |                   | $          | 2,289,433 |   |
| Accrued expenses                                                                                                                                                                  |       | 4,313,924               |       | 5,104,730              |       |
| Deferred rent,  current portion                                                                                                                                                   |       | 184,982                 |       | 143,928                |       |
| Long-term debt,  current portion                                                                                                                                                  |       | 277,692                 |       | 259,940                |       |
| Capital lease  obligations, current portion                                                                                                                                       |       | 976,287                 |       | 1,885,388              |       |
| Total current  liabilities                                                                                                                                                        |       | 10,514,357              |       | 9,683,419              |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Deferred rent,  net of current portion                                                                                                                                            |       | 2,095,772               |       | 1,603,557              |       |
| Long-term debt,  net of current portion                                                                                                                                           |       | 1,805,197               |       | 2,004,986              |       |
| Capital lease  obligations, net of current portion                                                                                                                                |       | 33,935,620              |       | 37,501,605             |       |
| Total  liabilities                                                                                                                                                                |       | 48,350,946              |       | 50,793,567             |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Commitments and  contingencies                                                                                                                                                    |       |                    |       |                   |       |
| Shareholders’ equity:                                                                                                                                                        |       |                    |       |                   |       |
| Common stock,  $0.01 par value, 90,000,000 shares authorized; 16,059,165 and 13,370,331  shares issued and outstanding at September 25, 2007 and December 26, 2006,  respectively |       | 160,592                 |       | 133,703                |       |
| Additional  paid-in capital                                                                                                                                                       |       | 42,678,377              |       | 29,122,306             |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Accumulated  deficit                                                                                                                                                              |       | (21,293,867             | )          | (16,191,066            | )          |
| Total  shareholders’ equity                                                                                                                                                  |       | 21,545,102              |       | 13,064,943             |       |
|                                                                                                                                                                              |       |                    |       |                   |       |
| Total  liabilities and shareholders’ equity                                                                                                                                  |       | $                       | 69,896,048 |                   | $          | 63,858,510 |   |

 

See notes tocondensed consolidated financial statements.

 

1

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**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

** **
| ** **                                              | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|---------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                              | ** ** | **September 25,  2007**  | ** ** | **September 26,  2006**     | ** ** | **September 25,  2007** | ** ** | **September 26,  2006** | ** ** |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Restaurant  revenues                                    |       | $                        | 19,584,040 |                        | $          | 15,028,065 |   | $ | 56,220,186 |   | $ | 41,337,502 |   |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Cost of sales:                                          |       |                     |       |                        |       |   |   |   |   |
| Food, beverage  and retail                              |       | 5,969,977                |       | 4,522,565                   |       | 16,889,600 |   | 12,295,648 |   |
| Labor                                                   |       | 7,046,219                |       | 5,404,636                   |       | 20,197,394 |   | 14,662,268 |   |
| Direct  restaurant operating                            |       | 2,845,705                |       | 1,856,222                   |       | 7,779,859 |   | 5,103,711 |   |
| Occupancy                                               |       | 1,210,115                |       | 850,788                     |       | 3,485,007 |   | 2,328,316 |   |
| Total cost of  sales                                    |       | 17,072,016               |       | 12,634,211                  |       | 48,351,860 |   | 34,389,943 |   |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Pre-opening                                             |       | 732,679                  |       | 866,193                     |       | 1,244,861 |   | 1,940,567 |   |
| General and  administrative                             |       | 2,050,251                |       | 1,640,752                   |       | 5,689,249 |   | 4,711,686 |   |
| Depreciation and  amortization                          |       | 1,159,885                |       | 877,988                     |       | 3,402,613 |   | 2,444,933 |   |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Operating loss                                          |       | (1,430,791               | )          | (991,079                    | )          | (2,468,397 | ) | (2,149,627 | ) |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Interest:                                               |       |                     |       |                        |       |   |   |   |   |
| Income                                                  |       | 87,131                   |       | 16,803                      |       | 189,616 |   | 72,967 |   |
| Expense                                                 |       | (910,637                 | )          | (607,890                    | )          | (2,813,915 | ) | (1,669,567 | ) |
| Net interest  expense                                   |       | (823,506                 | )          | (591,087                    | )          | (2,624,299 | ) | (1,596,600 | ) |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Loss before  income tax                                 |       | (2,254,297               | )          | (1,582,166                  | )          | (5,092,696 | ) | (3,746,227 | ) |
| Income tax  provision                                   |       | (5,157                   | )          | (10,110                     | )          | (10,105 | ) | (10,610 | ) |
| Net loss                                                |       | $                        | (2,259,454 | )                           | $          | (1,592,276 | ) | $ | (5,102,801 | ) | $ | (3,756,837 | ) |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Loss per common  share, basic and diluted               |       | $                        | (0.14      | )                           | $          | (0.12 | ) | $ | (0.33 | ) | $ | (0.28 | ) |
|                                                    |       |                     |       |                        |       |   |   |   |   |
| Weighted average  shares outstanding, basic and diluted |       | 16,038,302               |       | 13,242,173                  |       | 15,329,517 |   | 13,231,742 |   |

 

See notes tocondensed consolidated financial statements.

 

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**GRANITECITY FOOD & BREWERY LTD.**

# **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
| ** **                                                                                 | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                 | ** ** | **September 25,  2007**     | ** ** | **September 26,  2006** | ** ** |
|                                                                                       |       |                        |       |   |   |
| Cash flows from  operating activities:                                                     |       |                        |       |   |   |
| Net loss                                                                                   |       | $                           | (5,102,801 | ) | $ | (3,756,837 | ) |
| Adjustments to  reconcile net loss to net cash  used in  operating activities:        |       |                        |       |   |   |
| Depreciation and  amortization                                                             |       | 3,402,613                   |       | 2,444,933 |   |
| Stock option  compensation expense                                                         |       | 786,994                     |       | 550,848 |   |
| Loss on disposal  of asset                                                                 |       | 89,525                      |       | 2,746 |   |
| Deferred rent                                                                              |       | 514,380                     |       | 356,168 |   |
| Changes in  operating assets and liabilities:                                              |       |                        |       |   |   |
| Inventory                                                                                  |       | (25,992                     | )          | (133,826 | ) |
| Prepaids and  other                                                                        |       | (75,502                     | )          | (937,712 | ) |
| Accounts payable                                                                           |       | (162,028                    | )          | 900,277 |   |
| Accrued expenses                                                                           |       | (790,806                    | )          | 132,740 |   |
| Net cash used in  operating activities                                                     |       | (1,363,617                  | )          | (440,663 | ) |
|                                                                                       |       |                        |       |   |   |
| Cash flows from  investing activities:                                                     |       |                        |       |   |   |
| Purchase of:                                                                               |       |                        |       |   |   |
| Property and  equipment                                                                    |       | (5,634,505                  | )          | (5,673,006 | ) |
| Intangible  assets and other                                                               |       | (16,395                     | )          | (131,419 | ) |
| Net cash used in  investing activities                                                     |       | (5,650,900                  | )          | (5,804,425 | ) |
|                                                                                       |       |                        |       |   |   |
| Cash flows from  financing activities:                                                     |       |                        |       |   |   |
| Payments on  capital lease obligations                                                     |       | (6,787,174                  | )          | (642,087 | ) |
| Payments on long  term-debt                                                                |       | (182,037                    | )          | (177,907 | ) |
| Proceeds (cost  incurred) from issuance of stock                                           |       | 12,795,966                  |       | (9,443 | ) |
| Net cash  provided by (used in) financing activities                                       |       | 5,826,755                   |       | (829,437 | ) |
|                                                                                       |       |                        |       |   |   |
| Net decrease in  cash                                                                      |       | (1,187,762                  | )          | (7,074,525 | ) |
| Cash and cash  equivalents, beginning                                                      |       | 7,671,750                   |       | 9,836,231 |   |
| Cash and cash  equivalents, ending                                                         |       | $                           | 6,483,988  |   | $ | 2,761,706 |   |
|                                                                                       |       |                        |       |   |   |
| Supplemental  disclosure of non-cash investing and financing activities:                   |       |                        |       |   |   |
| Land, buildings  and equipment acquired under capital lease agreements                     |       | $                           | 2,312,088  |   | $ | 8,053,638 |   |
| Property and  equipment, intangibles and stock issuance costs included in accounts payable |       | $                           | 2,634,067  |   | $ | 1,602,251 |   |
| Income taxes  paid                                                                         |       | $                           | 10,105     |   | $ | 10,610 |   |

 

See notes tocondensed consolidated financial statements.

 

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** **

**GRANITE CITY FOOD & BREWERYLTD.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

Thirteen andThirty-nine weeks ended September 25, 2007 and September 26, 2006

 

**1.     Summary of significant accounting policies**

 

Background

GraniteCity Food & Brewery Ltd. (the “Company”) develops and operates ModernAmerican casual dining restaurants known as Granite City Food &Brewery®.   The restaurant theme isupscale casual dining with a wide variety of menu items that are prepared freshdaily, combined with freshly brewed hand-crafted beers finished on-site.  The first Granite City restaurant opened inSt. Cloud, Minnesota in July 1999 and the Company subsequently expanded toother Midwest markets, opening its 21st restaurant on October 30, 2007.  The Company also operates a beer productionfacility which is used to provide raw material support to its restaurants tocreate consistent quality and operational efficiencies in the production of itsproprietary beer.  In 2007, the Companywas granted a patent by the United States Patent Office for its brewingprocess.

 

The Company’s expansionstrategy focuses on development of restaurants in markets where managementbelieves the Company’s concept will have broad appeal and attractiverestaurant-level economics.

 

Principles of consolidation and presentation

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America and regulations of the Securities and ExchangeCommission.  Accordingly, they do notinclude all the information and footnotes required by U.S. generally acceptedaccounting principles for complete financial statements.  These statements include the accounts andoperations of the Company and its subsidiary corporations under which itsKansas locations are operated.  Fifty-onepercent of the stock of each of the subsidiary corporations is owned by aresident of Kansas and the Company owns the remainder of the stock of eachcorporation.  Each resident-owner of thestock of these entities has entered into a buy-sell agreement with eachcorporation providing, among other things, that transfer of the shares isrestricted and that the shareholder must sell his shares to the corporation uponcertain events, including termination of employment (if employed by theCompany) or any event which disqualifies the resident-owner from owning theshares under applicable laws and regulations of the state.  The Company has entered into a masteragreement with each separate corporation that permits the operation of therestaurants and leases to each corporation the Company’s property andfacilities.  Each corporation pays all ofits operating expenses and obligations, and the Company retains, as considerationfor the operating arrangements and the lease of property and facilities, thenet profit from its operations.  TheCompany has determined that the foregoing ownership structure will cause theseseparate corporations to be treated as variable interest entities in which theCompany has a controlling financial interest for the purpose of FASBInterpretation 46 (R), *Consolidation of VariableInterest Entities. *As such,the corporations are consolidated with the Company’s financial statements andthe Company’s financial statements do not reflect a minority ownership in thoseseparate corporations.  All references tothe Company in these financial statements relate to the consolidated entity.

 

In the opinion ofmanagement, all adjustments, consisting of normal recurring adjustments, whichare necessary for a fair statement of its financial position as of September25, 2007 and the results of operations for the interim periods ended September25, 2007 and September 26, 2006 have been included.

 

The balance sheet at December 26, 2006, has been derived from theaudited financial statements at that date, but does not include all of theinformation and notes required by generally accepted accounting principles forcomplete financial statements.  Certain information and note disclosuresnormally included in the Company’s annual financial statements have beencondensed or omitted.  These condensedfinancial statements should be 

 

4

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read inconjunction with the financial statements and notes thereto included in theCompany’s Annual Report on Form 10-K for the fiscal year ended December 26,2006, filed with the Securities and Exchange Commission on February 21, 2007.

 

The results ofoperations for the thirty-nine weeks ended September 25, 2007 are not necessarily indicative ofthe results to be expected for the entire year.

 

Reclassification

Certain reclassifications have been made to the financial statementsfor the third quarter and first three quarters of 2006 in order for them toconform to the presentation of the financial statements for the third quarterand first three quarters of 2007.  Thesereclassifications have no effect on the accumulated deficit or net losspreviously reported.

 

Revenue recognition

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

Cash and cash equivalents

The Company maintains its cash at financial institutions in Minnesota,South Dakota, Kansas and Ohio.  At timesthe bank balances exceed the limits insured by federal agencies.  The Company considers all highly liquidinstruments with maturities of three months or less at the time of issuance tobe cash equivalents.

 

Stock-based compensation

The Company records stock-based compensation in accordance with theprovisions of Financial Accounting Standards Board (“FASB”) Statement ofFinancial Accounting Standard (“SFAS”) No. 123 (revised 2004) (“SFAS 123(R)”),*Share-Based Payment*, and SECStaff Accounting Bulletin No. 107 (“SAB 107”), *Share-BasedPayment,* requiring the measurement and recognition of allshare-based compensation under the fair value method.  The Company implemented SFAS 123(R) using themodified prospective method, effective December 28, 2005, the first day of its2006 fiscal year.

 

Accounting for leases

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

Earnings (loss) per share

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

 

5

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Recent accounting pronouncements

In July 2006, the FinancialAccounting Standards Board (“FASB”) issued FASB Interpretation No. 48, *“Accounting for Uncertainty in Income Taxes,”* (“FIN 48,”)which clarifies the accounting and disclosures for uncertainty in income taxesrecognized in the financial statements in accordance with SFAS No. 109, *“Accounting for Income Taxes.”*  FIN 48 also provides guidance on thede-recognition of uncertain tax positions, financial statement classification,accounting for interest and penalties, accounting for interim periods and addsnew disclosure requirements.  The adoptionof FIN 48 did not have a material impact on the Company’s financial statementsor disclosures.  As of December 26, 2006and September 25, 2007 the Company did not recognize any assets or liabilitiesfor unrecognized tax benefits relative to uncertain tax positions.  Upon review of the Company’s net operatingloss carryforwards, management believes it is more likely than not that theCompany’s tax positions taken will be sustained.  Any interest or penalties resulting fromexaminations will be recognized as a component of the income tax provision.  However, since there are no unrecognized taxbenefits as a result of tax positions taken, there are no accrued interest andpenalties.

 

In September 2006, the FASBissued SFAS No. 157, *Fair ValueMeasurements*(“SFAS 157”). SFAS 157 provides guidance for using fair value to measure assetsand liabilities.  The standard expandsrequired disclosures about the extent to which companies measure assets andliabilities at fair value, the information used to measure fair value, and theeffect of fair value measurements on earnings. SFAS 157 is effective forfiscal years beginning after November 15, 2007.  The Company is currently evaluating theimpact of adopting SFAS 157 on its consolidated financial statements.

In February 2007, the FASBissued SFAS 159, *The Fair Value Option forFinancial Assets and Financial Liabilities (as amended*(“SFAS 159”)*,* which permits entities to choose tomeasure many financial instruments and certain other items at fair value.  The standard provides companies with theopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting provisions.  Theprovisions of SFAS 159 are effective for fiscal years beginning after November 15,2007.  The Company is currentlyevaluating the impact of adopting SFAS 159 on its financial statements.

In May 2007, the FASBissued FASB Staff Position No. FIN 48-1, *Definitionof Settlement in FASB Interpretation No. 48*(the “FSP”).  The FSP provides guidance about how anenterprise should determine whether a tax position is effectively settled forthe purpose of recognizing previously unrecognized tax benefits.  Under the FSP, a tax position could beeffectively settled on completion of examination by a taxing authority if theentity does not intend to appeal or litigate the result and it is remote thatthe taxing authority would examine or re-examine the tax position.  Application of the FSP was upon the initialadoption date of FIN 48.  The FSP did nothave a material impact on the Company’s consolidated financial statements.

**2.****             ****Non-currentassets**

 

Property and equipment

Property and equipment are recorded at cost and depreciated over theestimated useful lives of the related assets. The cost of leasehold improvements is depreciated over the initial termof the related lease.  Depreciation iscomputed on the straight-line method for financial reporting purposes andaccelerated methods for income tax purposes. Amortization of assets acquired under capital lease is included indepreciation expense.  The following is asummary of the Company’s property and equipment at September 25, 2007 andDecember 26, 2006:

 

6

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| ** **                     | ** ** | **September 25, 2007** | ** ** | **December 26, 2006** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
|                           |       |                   |       |                  |       |
|                           |       | $                      | 18,000     |                  | $          | 18,000 |   |
| Buildings                      |       | 36,111,702             |       | 33,851,945            |       |
| Leasehold  improvements        |       | 8,325,161              |       | 8,220,963             |       |
| Equipment and  furniture       |       | 22,565,116             |       | 20,728,013            |       |
| Construction in  progress*     |       | 6,843,947              |       | 624,422               |       |
|                           |       | 73,863,926             |       | 63,443,343            |       |
| Less accumulated  depreciation |       | 12,757,131             |       | 9,425,219             |       |
|                           |       | $                      | 61,106,795 |                  | $          | 54,018,124 |   |

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*Construction inprogress includes the following approximate amounts for items yet to be placedin service:

 

| ** **                                          | ** ** | **September 25, 2007** | ** ** | **December 26, 2006** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| Architecture  fees for future locations             |       | $                      | 410,000    |                  | $          | 100,000 |   |
| Equipment at  future locations                      |       | 6,340,000              |       | 400,000               |       |
| Equipment at the  beer production facility          |       | —                 |       | 125,000               |       |
| Cost to secure  property leases at future locations |       | 95,000                 |       | —                |       |
|                                                     |            |                        |            |                       |            |  |  |

 

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

 

| ** **                            | ** ** | **September 25, 2007** | ** ** | **December 26, 2006** | ** ** |
|---------------------------------------|------------|------------------------|------------|-----------------------|------------|
| Land                                  |       | $                      | 18,000     |                  | $          | 18,000 |   |
| Building                              |       | 36,123,702             |       | 33,851,945            |       |
| Equipment and  leasehold improvements |       | 1,654,864              |       | 7,807,724             |       |
|                                  |       | 37,796,566             |       | 41,677,669            |       |
| Less accumulated  depreciation        |       | 4,836,946              |       | 3,718,654             |       |
|                                  |       | $                      | 32,959,620 |                  | $          | 37,959,015 |   |

 

Intangible assets and other

            Intangible assets andother assets consisted of the following:

 

| ** **                     | ** ** | **September 25, 2007** | ** ** | **December 26, 2006** | ** ** |
|--------------------------------|------------|------------------------|------------|-----------------------|------------|
| Intangible  assets:            |       |                   |       |                  |       |
| Liquor licenses                |       | $                      | 264,415    |                  | $          | 264,415 |   |
| Trademarks                     |       | 132,671                |       | 109,741               |       |
| Other:                         |       |                   |       |                  |       |
| Capitalized loan  costs        |       | 250,379                |       | 205,054               |       |
| Security  deposits             |       | 271,017                |       | 279,427               |       |
|                           |       | 918,482                |       | 858,637               |       |
| Less accumulated  amortization |       | 122,927                |       | 98,217                |       |
|                           |       | $                      | 795,555    |                  | $          | 760,420 |   |

 

7

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**3.        Accrued expenses**

 

Accrued expenses consisted of the following:

 

| ** **                        | ** ** | **September 25, 2007** | ** ** | **December 26, 2006** | ** ** |
|-----------------------------------|------------|------------------------|------------|-----------------------|------------|
| Payroll related                   |       | $                      | 1,639,746  |                  | $          | 2,205,712 |   |
| Deferred revenue  from gift cards |       | 928,634                |       | 1,355,773             |       |
| Sales taxes                       |       | 568,043                |       | 493,772               |       |
| Interest                          |       | 297,732                |       | 278,131               |       |
| Real estate  taxes                |       | 376,159                |       | 245,299               |       |
| Insurance                         |       | —                 |       | 89,646                |       |
| Other                             |       | 503,610                |       | 436,397               |       |
|                              |       | $                      | 4,313,924  |                  | $          | 5,104,730 |   |

 

**4.        Long-term debt**

 

As of the end of the third quarter of fiscal year 2007, the Company hadtwo outstanding long-term loans with an independent financial institution forthe purchase of equipment for its restaurants located in Des Moines andDavenport.  These loans are secured onlyby the personal property and fixture property at the respective locations.  In addition to these two loan agreements, theCompany has a long-term loan outstanding with the same independent financialinstitution secured by the tangible personal property and fixtures at the Fargorestaurant.  Such loan is guaranteed bySteven J. Wagenheim, the Company’s president, chief executive officer and oneof its directors.  As of September 25,2007, the balances, interest rates and maturity dates of these loans were:

 

| ** **            | ** ** | **Des Moines**  | ** ** | **Davenport**   | ** ** | **Fargo**       | ** ** |
|-----------------------|------------|-----------------|------------|-----------------|------------|-----------------|------------|
| Loan balance          |       | $373,172        |       | $409,520        |       | $1,300,197      |       |
| Annual interest  rate |       | 10.25%          |       | 10.25%          |       | 8.75%           |       |
| Maturity date         |       | August 27, 2010 |       | January 6, 2011 |       | August 15, 2011 |       |

 

**5.        Capital leases**

 

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

 

Minimum futurelease payments under all capital leases as of September 25, 2007 are:

 

| ** **                                   | ** ** | **Capital** | ** ** |
|----------------------------------------------|------------|-------------|------------|
| **Year ended:**                              | ** ** | **Leases**  | ** ** |
| 2007                                         |       | $           | 1,110,333  |   |
| 2008                                         |       | 4,366,113   |       |
| 2009                                         |       | 4,313,324   |       |
| 2010                                         |       | 4,137,121   |       |
| 2011                                         |       | 4,027,598   |       |
| Thereafter                                   |       | 57,927,763  |       |
| Total minimum  lease payments                |       | 75,882,252  |       |
|                                         |       |        |       |
| Less amount  representing interest           |       | 40,970,345  |       |
| Present value of  net minimum lease payments |       | 34,911,907  |       |
| Less current  portion                        |       | 976,287     |       |
| Long-term  portion of obligations            |       | $           | 33,935,620 |   |

 

8

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

 

**6.        Commitments andcontingencies**

 

Litigation

            From time totime, lawsuits are threatened or filed against the Company in the ordinarycourse of business.  Such lawsuitstypically involve claims from customers, former or current employees, andothers related to issues common to the restaurant industry.  A number of such claims may exist at anygiven time.  Although there can be noassurance as to the ultimate disposition of these matters, it is management’sopinion, based upon the information available at this time, that the expectedoutcome of these matters, individually or in the aggregate, will not have amaterial adverse effect on the results of operation, liquidity or financialcondition of the Company.

 

Rogers, Arkansas and East Peoria, Illinois

In October 2007, the Company commenced 20-year net lease agreementsrelating to restaurants it opened in Rogers, Arkansas and East Peoria, Illinoisunder the terms specified in the development agreement with Dunham CapitalManagement L.L.C. (“Dunham”) for the development of restaurants.  Each restaurant was constructed for theCompany on a build-to-suit basis.  Theannual rent of each is equal to 10.5% of the construction cost including landcost and escalates 10% at the end of each five-year period.  The Company is responsible for anyreal-estate taxes and all operating costs. The term of each lease commenced when operations began and may beextended at the Company’s option for up to five additional five-year periods onthe same terms and conditions.  Theportion of the rent related to the land of each lease will be classified as anoperating lease while the building portion of each will be classified as acapital lease.  Rental costs associatedwith these operating leases incurred during the construction period were recognizedas pre-opening costs and escalating rent will be recognized as expense on astraight-line basis over the terms of the leases.

 

Orland Park, Illinois and Creve Coeur, Missouri

In February and June 2007, the Company entered into 20-year net leaseagreements relating to restaurants it anticipates opening during the fourthquarter of 2007 in Orland Park, Illinois and Creve Coeur, Missouri,respectively, under the terms specified in the development agreement withDunham.  Each restaurant will be constructedfor the Company on a build-to-suit basis. The annual rent of each will be equal to 10.5% of the construction costincluding land cost and will escalate 10% at the end of each five-yearperiod.  The Company will be responsiblefor any real-estate taxes and all operating costs.  The term of each lease will commence whenoperations begin and may be extended at the Company’s option for up to fiveadditional five-year periods on the same terms and conditions.  Rental costs associated with the operatingleases incurred during the construction period are recognized as pre-openingcosts and escalated rent will be recognized as expense on a straight-line basisover the term of the leases.

 

Woodbury, Minnesota

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

 

Toledo, Ohio and Ft. Wayne, Indiana

In August 2007, the Company entered into 20-year net lease agreementsrelating to restaurants it anticipates opening in Ft. Wayne, Indiana in thefourth quarter of 2007 and in Toledo, Ohio in the first quarter of 2008 

 

9

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under the terms specified in the development agreement withDunham.  The restaurants will beconstructed for the Company on a build-to-suit basis.  Basic terms of the leases include annual rentequal to 10.5% of the construction cost plus the land lease and percentagerent.  The base rent will escalate 10% atthe end of each five-year period.  Theterm of each lease will commence when operations begin and the Company will beresponsible for any real-estate taxes and all operating costs.  Rental costs associated with the operatinglease incurred during the construction period are recognized as pre-openingcosts and escalated rent will be recognized as expense on a straight-line basisover the term of the lease.

 

**7.****             ****Commonstock**

 

Sale of stock

On March 8, 2007, the Company entered into a stock purchase agreementwith accredited investors under which it sold 2,617,334 shares of common stockat a price of $5.35 per share.  TheCompany obtained gross proceeds of $14,002,737, paid its placement agents cashcommissions aggregating $1,050,205 and paid expenses aggregating $181,675.  Pursuant to the conditions of the stockpurchase agreement, the Company used approximately $6.0 million of the$12,770,857 net proceeds to retire the entire balance of equipment lease debtobtained from DHW pursuant to the master lease agreement entered into inSeptember 2006.  The members of DHW areDonald A. Dunham, Charles J. Hey and Steven J. Wagenheim.  Mr. Wagenheim is the Company’s president,chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interestin DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders. Theremaining net proceeds from this placement are being used to fund expansion ofthe Company’s restaurant operations.

 

Exercise of warrants and options

On April 3, 2007, the Company issued 4,102 shares of common stock uponthe cashless exercise of a warrant for the purchase of 5,538 shares of commonstock originally issued November 27, 2002 to one of the agents for the Company’sprivate placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise priceof $1.58 per share and an expiration date of November 27, 2007.

 

On May 2, 2007, the Company issued 19,353 shares of common stock uponthe cashless exercise of a warrant for the purchase of 25,842 shares of commonstock originally issued December 20, 2002 to one of the agents for the Company’sprivate placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise priceof $1.58 per share and an expiration date of December 20, 2007.

 

On May 21, 2007,an employee of the Company exercised a stock option for the purchase of 700shares of common stock at an exercise price of $4.31 per share.  The foregoing option was issued pursuant tothe Company’s 2002 Equity Incentive Plan and had an expiration date of March15, 2015.

 

On May 22, 2007,an employee of the Company exercised a stock option for the purchase of 2,500shares of common stock at an exercise price of $1.65 per share.  The foregoing option was issued outside theCompany’s plans and had an expiration date of December 26, 2011.

 

On August 8, 2007, theCompany issued 26,302 shares of common stock upon the cashless exercise of awarrant for the purchase of 38,170 shares of common stock originally issuedOctober 1, 2002 to one of the agents for its private placement of Series AConvertible Preferred Stock and warrants. The foregoing warrant had an exercise price of $1.58 per share and anexpiration date of October 1, 2007.

 

On August 8, 2007, the Company issued 3,543 shares of common stock uponthe cashless exercise of a warrant for the purchase of 5,142 shares of commonstock originally issued November 27, 2002 to one of the agents for its privateplacement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise priceof $1.58 per share and an expiration date of November 27, 2007.

 

10

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On August 9, 2007,a director of the Company exercised a stock option for the purchase of 15,000shares of common stock at an exercise price of $1.26 per share.  These options were issued pursuant to the1997 Director Stock Option Plan and had an expiration date of August 18, 2007.

 

**8.****             ****Stockplans**

 

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.   As of September 25, 2007,options to purchase 316,500 shares of common stock were outstanding under theplan.  No additional options will beissued pursuant to the terms of this plan which expired July 28, 2007.  All options outstanding under this plan arefully vested and are exercisable for ten years from the date of grant.

 

As of September25, 2007, options to purchase 330,000 shares of common stock were outstandingunder the 1997 Director Stock Option Plan (“DSOP”).  No additional options will be issued pursuantto the terms of this plan which expired July 29, 2007.  Under this plan, the Company automaticallygranted an option to each outside director on the date such person became adirector for the purchase of 15,000 shares of common stock and thereafter oneach successive anniversary of the grant of the first option for thepurchase of 15,000 shares.  Each optionvests one year after the option was granted and is exercisable for five yearsfrom the date of grant. Options were granted at fair market value.  On May 2, 2007, the Company’s board ofdirectors agreed that until the adoption of any future equity plan fornon-employee directors, award of stock options for the purchase of 15,000shares of common stock per year should continue to be made to each non-employeedirector on the anniversary of his election to the Board under the 2002 EquityIncentive Plan.  The board further resolved that such awards are to havethe same terms and conditions as those made under the DSOP; provided, however,that they are to be exercisable for a period of ten years rather than fiveyears.

 

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 25, 2007 was 1,826,264, of which286,264 shares remained available for future issuance and 1,464,300 wereoutstanding.  Although vesting schedulesmay vary, option grants under this plan generally vest evenly over a three orfour-year period and options are exercisable for no more than ten years fromthe date of grant.  OnOctober 30, 2007, our shareholders approved an amendment to this plan thatincreased the total number of shares for which awards may be granted by500,000.

 

A summary of the status of the Company’s stock options as of September 25, 2007 is presented below:

| ** **                                                  | ** ** | ** ** | ** ** | ** **         | ** ** | **Weighted**         | ** ** | ** **    | ** ** |
|-------------------------------------------------------------|------------|------------|------------|--------------------|------------|----------------------|------------|---------------|------------|
| ** **                                                  | ** ** | ** ** | ** ** | **Weighted**       | ** ** | **Average**          | ** ** | **Aggregate** | ** ** |
| ** **                                                  | ** ** | ** ** | ** ** | **Average**        | ** ** | **Remaining**        | ** ** | **Intrinsic** | ** ** |
| **Fixed Options**                                           | ** ** | **Shares** | ** ** | **Exercise Price** | ** ** | **Contractual Life** | ** ** | **Value**     | ** ** |
| Outstanding at  December 26, 2006                           |       | 1,595,000  |       | $                  | 3.70       |                 | 6.1 years  |          |       |   |
| Granted                                                     |       | 613,000    |       | 5.28               |       | 6.8 years            |       |          |       |
| Exercised                                                   |       | (18,200    | )          | 1.43               |       | —               |       |          |       |
| Forfeited                                                   |       | (30,000    | )          | 5.17               |       | —               |       |          |       |
| Outstanding at  September 25, 2007                          |       | 2,159,800  |       | $                  | 4.15       |                 | 5.8 years  |          | $          | 933,002 |   |
|                                                        |       |       |       |               |       |                 |       |          |       |
| Options  exercisable at December 26, 2006                   |       | 1,076,502  |       | $                  | 3.46       |                 | 5.6 years  |          |       |   |
| Options  exercisable at September 25, 2007                  |       | 1,467,804  |       | $                  | 3.69       |                 | 5.5 years  |          | $          | 890,552 |   |
|                                                        |       |       |       |               |       |                 |       |          |       |
| Weighted-average  fair value of options granted during 2007 |       | $          | 3.43       |               |       |                 |       |          |       |   |
|                                                             |            |            |            |                    |            |                      |            |               |            |  |  |  |

 

11

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The fair value of options at date of grant was estimated using theBlack-Scholes option pricing model with the following assumptions:  (a) no dividend yield, (b) 58.13% to 66.86% expectedvolatility, (c) expected life of options of five to ten years and (d) arisk-free interest rate of 4.46% to 4.80%.

 

The aggregate intrinsic value in the table above represents the totalpretax intrinsic value (the difference between the closing price of the Company’sstock on September 25, 2007 and the exercise price, multiplied by the number ofin-the-money options) that would have been received by the option holders hadall option holders exercised their options on September 25, 2007.  As of September 25, 2007, there wasapproximately $1,590,431 of total unrecognized compensation cost related tounvested share-based compensation arrangements, of which $320,535 is expectedto be recognized during the remainder of fiscal year 2007, $761,572 in fiscalyear 2008, $419,293 in fiscal year 2009, $75,825 in fiscal year 2010 and$13,206 in fiscal year 2011.

 

If all options outstanding at September 25, 2007 were exercised forcash, proceeds to the Company would be approximately $9.0 million.

 

The following table summarizes information about stock optionsoutstanding at September 25, 2007:

 

| ** **          | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **          | ** ** | **Number of**           | ** ** | **Weighted**            | ** ** | ** ** | ** ** | **Number of** | ** ** | ** ** | ** ** |
| ** **          | ** ** | **Options**             | ** ** | **Average**             | ** ** | **Weighted** | ** ** | **Options** | ** ** | **Weighted** | ** ** |
| **Range of**        | ** ** | **Outstanding**         | ** ** | **Remaining**           | ** ** | **Average** | ** ** | **Exercisable** | ** ** | **Average** | ** ** |
| **Exercise Prices** | ** ** | **9/25/2007**           | ** ** | **Contractual Life**    | ** ** | **Exercise Price** | ** ** | **9/25/2007** | ** ** | **Exercise Price** | ** ** |
|                |       |                    |       |                    |       |   |   |   |   |   |   |
| $ 1.00 - $2.00 |       | 140,500                 |       | 3.8 years               |       | $ | 1.64 |   | 140,500 |   | $ | 1.64 |   |
| $ 2.01 - $3.00 |       | 180,000                 |       | 4.6 years               |       | $ | 2.41 |   | 180,000 |   | $ | 2.41 |   |
| $ 3.01 - $4.00 |       | 698,000                 |       | 5.2 years               |       | $ | 3.89 |   | 591,002 |   | $ | 3.90 |   |
| $ 4.01 - $5.00 |       | 607,300                 |       | 7.2 years               |       | $ | 4.37 |   | 526,302 |   | $ | 4.38 |   |
| $ 5.01 - $6.00 |       | 384,000                 |       | 4.4 years               |       | $ | 5.20 |   | 30,000 |   | $ | 5.02 |   |
| $ 6.01 - $7.00 |       | 150,000                 |       | 9.6 years               |       | $ | 6.20 |   | — |   | $ | — |   |
| Total               |       | 2,159,800               |       | 5.8 years               |       | $ | 4.15 |   | 1,467,804 |   | $ | 3.69 |   |

 

In November 2002, the Company completed a private placement of Series AConvertible Preferred Stock and warrants to purchase common stock.  As part of the agreement between the Companyand its private placement agents, the agents received five-year warrants topurchase an aggregate of 288,604 shares of common stock at an exercise price of$1.58 per share. During the second and third quarters of fiscal year 2007, theCompany issued an aggregate of 53,300 shares of common stock upon the cashlessexercise of such warrants for the purchase of an aggregate of 74,692 shares ofcommon stock.  As of September 25, 2007,166,910 of the agent warrants remained exercisable.

 

In May 2003, the Company entered into a two-year financial advisoryservices agreement. As part of the agreement between the Company and thefinancial consultant, the consultant received five-year warrants to purchase anaggregate of 35,000 shares of common stock at exercise prices ranging from$2.85 to $5.40 per share.  As ofSeptember 25, 2007, none of such warrants had been exercised.

 

12

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In September 2004, the Company entered into a securities purchaseagreement with certain accredited investors for the sale of approximately $8.5million of common stock and warrants. Under this agreement, the Company issued five-year warrants for thepurchase of 1,045,844 shares of common stock at an exercise price of $5.00 pershare.  The Company may call for themandatory exercise 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 25, 2007,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 the Company’s placementagent. As of September 25, 2007, none of such warrants had been exercised.

 

During the first three quarters of fiscal year 2007, no warrants wereissued and no warrants expired.  As ofSeptember 25, 2007, 1,655,682 were outstanding and exercisable.  The weighted average exercise price of suchwarrants was $4.88 per share.

 

If all warrants outstanding at September 25, 2007 were exercised for cash,proceeds to the Company would be approximately $8.1 million.

 

**ITEM2       Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

*Thisdiscussion and analysis contains various non-historical forward-lookingstatements within the meaning of Section 21E of the Exchange Act.  Although we believe that, in making any suchstatement, our expectations are based on reasonable assumptions, any suchstatement may be influenced by factors that could cause actual outcomes andresults to be materially different from those projected.  When used in the following discussion, thewords “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates” andsimilar expressions, as they relate to us or our management, are intended toidentify such forward-looking statements. You are cautioned not to attribute undue certainty to suchforward-looking statements, which are qualified in their entirety by thecautions and risks described herein. Please refer to the “Cautionary Statement” section of our Current Reporton Form 8-K, filed with the Securities and Exchange Commission on May 4, 2007,for additional factors known to us that may cause actual results to vary.*

 

**Overview**

 

                We are a ModernAmerican upscale casual restaurant chain. As of November 1, 2007, we operated 21 restaurants in ten Midwesternstates featuring on-premises breweries under the name of Granite City Food& Brewery®.  We believe our menufeatures high quality yet affordable family favorite menu items prepared frommade-from-scratch recipes and served in generous portions. We believe that thesophisticated yet unpretentious restaurants, proprietary food and beverageproducts, attractive price points and high service standards combine for agreat dining experience.  The location ofeach restaurant and the month and year of its opening appear in the followingchart:

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

 

We developed the foregoingrestaurants using proceeds from the sale of our securities, building andequipment financing and cash flow from operations.  We built units 4-9, 11-14 and 16-21 basedupon the prototype we developed in early 2003. In 2004 and 2005, we retrofitted units 1-3 to conform to this prototypemodel.  In 2005 and 2006, we developedunits 10 and 15, respectively, which were conversions of existingrestaurants.  With the exception of units1-3 and 15, we developed all of our units under our multi-site developmentagreement with a commercial developer that provides us with assistance in siteselection, construction management and financing for new restaurants.  Under this agreement, we lease the land andbuilding of each new restaurant from our developer.

In March 2007, we enteredinto a stock purchase agreement with accredited investors under which we sold2,617,334 shares of common stock at a price of $5.35 per share.  We obtained gross proceeds of $14,002,737,paid our placement agents cash commissions aggregating $1,050,205 and paidexpenses aggregating $181,675.  Pursuantto the conditions of the stock purchase agreement, we used approximately $6.0million of the $12,770,857 net proceeds to retire the entire balance ofequipment lease debt we had obtained from DHW pursuant to the master leaseagreement we entered into in September 2006. The members of DHW are Donald A. Dunham, Charles J. Hey and Steven J.Wagenheim.  Mr. Wagenheim is our company’spresident, chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interestin DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders.  The remaining net proceeds from thisplacement are being used to fund the expansion of our restaurant operations.

We operate a beer production facility which facilitates the initialstage of our brewing process using our patented brewing process.  We believe that this brewing process, whichwe refer to as “Beverage Leverage,” and the use of a centrally located beer productionfacility improve the economics of microbrewing as they eliminate the initialstages of brewing and storage at multiple locations, thereby reducing equipmentand development costs at new restaurant locations.  Additionally, having a common starting point,the beer production creates consistency of taste for our product from unit tounit.  The initial product produced atour beer production facility is transported by truck to the fermentationvessels at each of our restaurants where the brewing process is 

 

14

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completed. In 2007, we were granted a patent by the United StatesPatent Office for this brewing process. We believe that our current beerproduction facility, which opened in June 2005, has the capacity to service upto 35 restaurant locations.

 

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

We utilize a new store opening team whichconsists of experienced restaurant managers who are dedicated to the opening ofour new restaurants.  Generally, thisteam arrives at a new restaurant site two to three months in advance of therestaurant opening date and coordinates all staffing and training matters forthat new restaurant.  We believe that adedicated team delivers a more disciplined opening process and ensuresadherence to our company’s exacting standards and culture.

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

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

Thethirteen and thirty-nine weeks ended September 25, 2007 included 246 and 714restaurant weeks, respectively, which is the sum of the actual number of weekseach restaurant operated. The thirteen and thirty-nine weeks ended September25, 2006 included ­­­180 and 500 restaurant weeks, respectively.  The source of the additional restaurant weeksin fiscal year 2007 is shown in the following chart:

| ** **                        | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** |
|-----------------------------------|------------|--------------------------|------------|-----------------------------|
| **Location**                      | ** ** | **September 25, 2007**   | ** ** | **September 25,2007**       |
| Kansas City, Kansas               |       | 0                        |       | 5                           |
| Olathe, Kansas                    |       | 0                        |       | 13                          |
| West Wichita                      |       | 3                        |       | 29                          |
| St. Louis Park, Minnesota         |       | 12                       |       | 38                          |
| Omaha, Nebraska                   |       | 13                       |       | 39                          |
| Roseville, Minnesota              |       | 13                       |       | 39                          |
| Madison, Wisconsin                |       | 13                       |       | 39                          |
| Rockford, Illinois                |       | 12                       |       | 12                          |
| Total Additional Restaurant Weeks |       | 66                       |       | 214                         |

 

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.

Our restaurant revenues arecomprised almost entirely of the sales of food and beverages.  The sale of retail items, such as cigarettesand promotional items, typically represents less than one percent of totalrevenue.  Product costs include the costsof food, beverages and retail items. Labor costs include direct hourly and management wages, taxes andbenefits for restaurant employees. Direct and occupancy costs include restaurant supplies, marketing costs,rent, utilities, real estate taxes, repairs and maintenance and other relatedcosts.  

 

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Pre-opening costs consist of direct costs related to hiring andtraining the initial restaurant workforce, the salaries and related costs ofour dedicated new store opening team, rent expense incurred during theconstruction period and other direct costs associated with opening newrestaurants. General and administrative expenses are comprised of expensesassociated with all corporate and administrative functions that supportexisting operations, which include management and staff salaries, employeebenefits, travel, information systems, training, market research, professionalfees, supplies and corporate rent. Depreciation and amortization includesdepreciation on capital expenditures at the restaurant and corporate levels andamortization of intangibles that do not have indefinite lives. Interest expenserepresents the cost of interest expense on debt and capital leases net of interestincome on invested assets.

 

**Resultsof operations as a percentage of sales**

The following tablecompares operating results expressed as a percentage of total revenue for thethirteen and thirty-nine weeks ended September 25, 2007 and September 26, 2006.

 
| ** **                     | ** ** | **Thirteen Weeks Ended** | ** ** | **Thirty-nine Weeks Ended** | ** ** |
|--------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **September 25,**        | ** ** | **September 26**            | ** ** | **September 25,** | ** ** | **September 26** | ** ** |
| ** **                     | ** ** | **2007**                 | ** ** | **2006**                    | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                     | ** ** | ** **               | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Restaurant  revenues           |       | 100.0                    | %          | 100.0                       | %          | 100.0 | % | 100.0 | % |
|                           |       |                     |       |                        |       |   |   |   |   |
| Cost of sales:                 |       |                     |       |                        |       |   |   |   |   |
| Food, beverage  and retail     |       | 30.5                     |       | 30.1                        |       | 30.0 |   | 29.7 |   |
| Labor                          |       | 36.0                     |       | 36.0                        |       | 35.9 |   | 35.5 |   |
| Direct  restaurant operating   |       | 14.5                     |       | 12.4                        |       | 13.8 |   | 12.3 |   |
| Occupancy                      |       | 6.2                      |       | 5.7                         |       | 6.2 |   | 5.6 |   |
| Total cost of  sales           |       | 87.2                     |       | 84.1                        |       | 86.0 |   | 83.2 |   |
|                           |       |                     |       |                        |       |   |   |   |   |
| Pre-opening                    |       | 3.7                      |       | 5.8                         |       | 2.2 |   | 4.7 |   |
| General and  administrative    |       | 10.5                     |       | 10.9                        |       | 10.1 |   | 11.4 |   |
| Depreciation and  amortization |       | 5.9                      |       | 5.8                         |       | 6.1 |   | 5.9 |   |
|                           |       |                     |       |                        |       |   |   |   |   |
| Operating loss                 |       | (7.3                     | )          | (6.6                        | )          | (4.4 | ) | (5.2 | ) |
|                           |       |                     |       |                        |       |   |   |   |   |
| Interest:                      |       |                     |       |                        |       |   |   |   |   |
| Income                         |       | 0.4                      |       | 0.1                         |       | 0.3 |   | 0.2 |   |
| Expense                        |       | (4.6                     | )          | (4.0                        | )          | (5.0 | ) | (4.0 | ) |
| Net interest  expense          |       | (4.2                     | )          | (3.9                        | )          | (4.7 | ) | (3.9 | ) |
|                           |       |                     |       |                        |       |   |   |   |   |
| Net loss                       |       | (11.5                    | )%         | (10.5                       | )%         | (9.1 | )% | (9.1 | )% |

 

Certain percentageamounts do not sum due to rounding.

 

**Results of operations for the thirteenand thirty-nine weeks ended September 25, 2007 and September 26, 2006**

 

**Revenue**

 

We generated $19,584,040 and $15,028,065 of revenuesduring the third quarter of 2007 and 2006, respectively. This 30.3% increasewas primarily the result of 66 additional operating weeks, which is the sum ofthe actual number of weeks each restaurant operated, due to the fiverestaurants we opened during the third and 

 

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fourth quarters of 2006 and the restaurant we opened in Rockford in thethird quarter of 2007. Comparable restaurant revenues, which includerestaurants in operation over 18 months, increased 2.7% from the third quarterof 2006 to the third quarter of 2007 primarily due to a 2.1% price increasethat took effect in late November 2006. Average weekly revenue per comparablerestaurant increased $2,168 from $81,542 in the third quarter of 2006 to$83,710 in the third quarter of 2007.

 

During the firstthree quarters of 2007 and 2006, we generated revenues of $56,220,186 and$41,337,502, respectively.  The increase infirst three quarters revenues of 36.0% was primarily the result of theadditional restaurant operating weeks related to the five restaurants thatopened during the third and fourth quarters of 2006.  The first three quarters of 2007 included 714restaurant operating weeks, while the first three quarters of 2006 included 500operating weeks.  Comparable restaurantrevenues increased 2.5% in the first three quarters of 2007 over the firstthree quarters of 2006.  The increase incomparable restaurant revenues was due primarily to a 2.1% price increase thattook effect in late November 2006. Average weekly revenue per comparable restaurant increased $1,725 from$80,755 in the first three quarters of 2006 to $82,480 in the first threequarters of 2007.

We anticipate thatrestaurant revenues will vary from quarter to quarter.  We anticipate seasonal fluctuations inrestaurant revenues due in part to increased outdoor seating and generallyfavorable weather conditions at many of our locations during the summermonths.   Due to the honeymoon effectthat periodically occurs with the opening of a restaurant, we expect the timingof new restaurant openings to cause fluctuations in restaurant revenues.  Additionally, consumer confidence in theeconomy and changes in consumer preferences may affect our future revenues.

**Restaurantcosts**

***Foodand beverage***

Our food andbeverage costs increased 0.4% as a percentage of revenue from 30.1% in thethird quarter of 2006 to 30.5% in the third quarter of 2007.  These costs increased 0.3% as a percentage ofrevenue from 29.7% in the first three quarters of 2006 to 30.0% in the firstthree quarters of 2007.  Food andbeverage costs increased as a percentage of revenues largely due to theincrease in the cost of meat and dairy.

We expect that our food and beverage costs will vary going forward dueto numerous variables, including seasonal changes in food and beverage costs,and guest preferences.  We periodicallycreate new menu offerings and introduce new craft brewed beers based upon guestpreferences.  Although such menumodifications may temporarily result in increased food and beverage cost, webelieve we are able to offset such increases with our weekly specials whichprovide variety and value to our guests. Our varieties of craft brewed beer, which we believe we can produce atlower cost than beers we purchase for resale, also enable us to keep our foodand beverage costs low while fulfilling guest requests and building customerloyalty.  We expect food and beveragecosts at our newer restaurants to be higher initially due to inefficienciesthat are part of the start-up process of a new restaurant.  However, as we open additional restaurants,we believe we will experience increased purchasing power company-wide,partially offsetting food and beverage cost increases, thereby enabling us tomaintain or reduce our food and beverage costs as a percentage of revenue.  Additionally, as we add new restaurants, webelieve our Beverage Leverage brewing process will allow us to keep our highquality beer products intact while leveraging our fixed production costs,thereby enhancing overall profitability.

***Labor***

Labor expenses consist of restaurant managementsalaries, hourly staff payroll costs, other payroll-related items includingpartner and management bonuses, and non-cash stock-based compensation expense. Ourexperience to date has been that staff labor costs associated with a newlyopened restaurant, for approximately its first four to six months of operation,are greater than what can be expected after that time, both in aggregatedollars and as a percentage of revenues.

 

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Our labor costs, as a percentage of revenues, remained steady at 36.0%in the third quarter of 2007 and 2006. These costs increased 0.4% as a percentage of revenues from 35.5% in thefirst three quarters of 2006 to 35.9% in the first three quarters of 2007 duein part to minimum wage increases which took effect at some of our markets inthe second quarter 2007 and non-cash stock-based compensation of $34,190 and$116,258 in the third quarter and first three quarters of 2007, respectively,resulting from stock options issued in the first three quarters of 2007.

We expect that labor costs will vary as we add new restaurants.  Minimum wage laws, local labor laws andpractices, as well as unemployment rates vary from state to state and willaffect our labor costs, as will hiring and training expenses at our newunits.  We believe that retaining goodemployees and more experienced staff ensures high quality guest service and mayreduce hiring and training costs.

***Direct restaurant operating***

Operatingsupplies, repairs and maintenance, utilities, promotions and restaurant-leveladministrative expense represent the majority of our direct restaurantoperating expenses, a substantial portion of which is fixed or indirectlyvariable.  Our direct restaurantoperating expenses as a percentage of revenue increased 2.1% from 12.4% in thethird quarter of 2006 to 14.5% in the third quarter of 2007.  These expenses increased 1.5% as a percentageof revenues from 12.3% in the first three quarters of 2006 to 13.8% in thefirst three quarters of 2007.  Weexperienced an increase in expenses related to hiring and training, janitorialand guest supplies, advertising and promotions and loss on disposal of assetsattributable to certain upgrades primarily at our mature properties.

***Occupancy***

Our occupancy costs, whichinclude both fixed and variable portions of rent, common area maintenancecharges, property insurance and property taxes, increased 0.5% as a percentageof revenues from 5.7% in the third quarter of 2006 to 6.2% in the third quarterof 2007.  These costs increased 0.6% as apercentage of revenues from 5.6% in the first three quarters of 2006 to 6.2% inthe first three quarters of 2007.  Theseincreases were due to higher rent expense and property tax, offset in part by adecrease in property and casualty insurance.

**Pre-o**pening

Pre-opening costs, which areexpensed as incurred, consist of expenses related to hiring and training theinitial restaurant workforce, wages and expenses of our dedicated new storeopening teams, rental costs incurred during the construction period and certainother direct costs associated with opening new restaurants.  Pre-opening costs, excludingconstruction-period rent, are primarily incurred in the month of, and twomonths prior to, the restaurant opening.

Pre-opening costs decreased$133,514 from $866,193 in the third quarter of 2006 to $732,679 in the thirdquarter of 2007.  Included in suchexpense was $236,456 and $197,931 of non-cash rental costs incurred duringconstruction periods in the third quarters of 2007 and 2006, respectively.  Pre-opening costs in the third quarter of2007 were made up primarily of costs incurred during construction periods ofthe restaurants we opened in Rockford in July 2007 and Rogers and East Peoriain October 2007 as well as the restaurants we plan to open later this year inOrland Park and Creve Coeur.  Pre-openingcosts in the third quarter of 2006 related primarily to the two restaurant weopened in the third quarter and three opened in the fourth quarters of thatyear.  Pre-opening costs decreased$695,706 from $1,940,567 in the first three quarters of 2006 to $1,244,861 inthe first three quarters of 2007. Included in such expense was $505,149 and $420,086 of non-cash rentalcosts incurred during construction periods in the first three quarters of 2007and 2006, respectively.

**Generaland administrative**

General and administrativeexpenses include all salaries and benefits, including non-cash stock-basedcompensation, associated with our corporate staff that is responsible foroverall restaurant quality, future expansion into new locations, financialcontrols and reporting, restaurant management recruiting, training at

 

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Granite City University, excess capacity costs related to our beerproduction facility, and salaries and expenses of our new store opening teamwhen it is not dedicated to a particular restaurant opening. Other general andadministrative expenses also include advertising, professional fees, investorrelations, office administration, centralized accounting system costs, andtravel by our corporate management.

 

General and administrative expenses increased $409,499 from $1,640,752in the third quarter of 2006 to $2,050,251 in the third quarter of 2007.  These expenses increased $977,563 from$4,711,686 in the first three quarters of 2006 to $5,689,249 in the first threequarters of 2007.  The primary sources ofsuch increase were expenses related to stock-based compensation, legal,investor relations, consulting related to compliance with the Sarbanes-Oxley Act,recruiting, insurance and payroll.  Theseincreases were partially offset by decreases in accounting fees, marketingcosts and travel expense.  Non-cashstock-based compensation expense included in general and administrative expensewas $320,535 and $143,364 in the third quarter of 2007 and 2006,respectively.  Such non-cash expense was$786,994 in the first three quarters of 2007 compared to $550,848 in the sameperiod in 2006.

Despite the foregoing increases in general and administrative expenses,the increase in restaurant revenues associated with additional locations andthe increase in comparable sales caused our general and administrative expensesto decrease 0.4% as a percentage of revenue from 10.9% in the third quarter of2006 to 10.5% in the third quarter of 2007. These expenses decreased 1.3% as a percentage of revenue from 11.4% inthe first three quarters of 2006 to 10.1% in the first three quarters of 2007.

As we continue to expand our restaurant chain, we expect general andadministrative expenses will decrease as a percentage of revenues in the longterm due to economies of scale.

**Depreciation and amortization**

Depreciation andamortization expense increased $281,897 during the third quarter of 2007compared to the same period in 2006. These expenses increased $957,680 during the first three quarters of2007 compared to the first three quarters of 2006, due principally to theadditional depreciation related to new restaurants.  As a percentage of revenues, depreciationexpense increased as a percentage of revenue by 0.1% and 0.2% for the thirdquarter and first three quarters of 2007 over the same periods of 2006,respectively.

**Interest**

Net interest expense consists of interest expense oncapital leases and long-term debt, net of interest earned from cash onhand.  Interest expense increased$302,747 from $607,890 in the third quarter of 2006 to $910,637 in the thirdquarter of 2007, and increased $1,144,348 from $1,669,567 in the first threequarters of 2006 to $2,813,915 in the first three quarters of 2007.  The increases were due to increases incapital leases as a result of additional restaurants.  Interest income increased $70,327 and$116,649 for the third quarter and first three quarters of 2007 over the sameperiods of 2006, respectively, due to the proceeds from the saleof our common stock in March 2007.

 

**Liquidity and capitalresources**

As of September 25, 2007, we had $6,483,988 of cashand a working capital deficit of $2,980,531 compared to $7,671,750 of cash anda working capital deficit of $1,106,720 at December 26, 2006.

During thethirty-nine weeks ended September 25, 2007, we used $1,363,617 of net cash inoperating activities, $5,650,900 of net cash to purchase equipment and otherassets primarily related to our new restaurant expansion, and made paymentsaggregating $6,969,211 on our debt and capital lease obligations.  Of such capital lease payments, approximation$6.0 million represented a one-time payment to retire debt obtained from DHW,as detailed below.  Additionally, we receivednet cash of $12,795,966 from the issuance of our common stock, of whichapproximately $25,000 was received from the exercise of options and warrantswhile the remainder represented the net proceeds from the sale of common stockin March 2007, as detailed below.

 

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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 threequarters of 2006, we used $9,443 of cash to pay expenses associated with the issuanceof our common stock, net of cash received through the exercise of options.

 

In March 2007, we entered into a stock purchase agreement withaccredited investors under which we sold 2,617,334 shares of common stock at aprice of $5.35 per share.  We obtainedgross proceeds of $14,002,737, paid our placement agents cash commissionsaggregating $1,050,205 and paid expenses aggregating $181,675.  Pursuant to the conditions of the stockpurchase agreement, we used approximately $6.0 million of the $12,770,857 netproceeds to retire the entire balance of equipment lease debt we had obtainedfrom DHW pursuant to the master lease agreement we entered into in September2006.  The members of DHW are Donald A.Dunham, Charles J. Hey and Steven J. Wagenheim. Mr. Wagenheim is our company’s president, chief executive officer andone of its directors.  Mr. Wagenheim ownsa 20% membership interest in DHW and personally guaranteed 20% of DHW’sindebtedness to its lenders.  Theremaining net proceeds from this placement are being used to fund the expansionof our restaurant operations.

 

We intend to continue expansion in markets where we believe our conceptwill have broad appeal and attractive restaurant-level economics.  We plan to continue using our model as weopen future restaurants; however, where appropriate, we will convert existingrestaurants to our Granite City concept. Additionally, we intend to explore alternative restaurant designs toreduce the cost of our initial capital investment and we may alter our model tomeet various state and local regulatory requirements, including, but notlimited to, pollution control requirements, liquor license ordinances andsmoking regulations.  We opened arestaurant in Rockford, Illinois in July 2007 and one each in Rogers, Arkansasand East Peoria, Illinois in October 2007.  Because it is often difficult to recruit staffduring the holiday season, we intend to open two additional restaurants duringthe fourth quarter of 2007 along with two additional restaurants in the firstquarter of 2008.  Additionally, we haveentered into agreements or are in negotiation for locations in Illinois,Missouri, Ohio, Indiana and Minnesota.

 

Based upon our existing prototype, we anticipate that pre-opening costsand the initial purchase of furniture, fixtures and equipment will require aninvestment by us of approximately $1.0 million to $1.3 million for each newrestaurant.  We anticipate that our newrestaurants will require an investment by our developer of approximately $1.8million to $2.3 million for the building and approximately $1.2 million to $1.5million for the purchase of the land.  Weexpect these costs will vary from one market to another based on real estatevalues, zoning regulations, labor markets and other variables.  Pursuant to the terms of some of ouragreements, our developer receives construction allowances from the landlordwhich, in turn, are passed on to us as reductions in construction costs of ournew restaurants.  Landlord contributionsreceived related to restaurants developed in 2007 ranged from $1.0 million to$1.5 million per location.  As a result,the net capital investment is lower for restaurants that receive a landlordcontribution.  In some instances we mayelect to use our own cash for a portion of the building costs resulting inlower minimum lease payments.

 

We will need to expend significant capital inconnection with our expansion plans. With our existing capital resources, cashgenerated from operations, and the proceeds received from our sale of commonstock, we believe that we will have sufficient funds to complete our plannedrestaurant openings in the fourth quarter of 2007 and the first quarter of 2008and maintain sufficient working capital for our operations. We will requirefurther funding to open additional restaurants beyond the first quarter of2008. If our available sources of liquidity are insufficient to fund ourexpected capital needs, or our needs are greater than anticipated, we will berequired to raise additional funds through the incurrence of indebtedness orpublic or private sales of equity securities. At this time, we are activelypursuing debt financing in order to solidify our 2008 expansion plans. If we donot generate sufficient cash flow from current operations or if financing isnot available to us, we will have to curtail projected growth, which couldmaterially adversely affect our business, financial condition, operatingresults and cash flows.

 

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**Commitmentsand contingent liabilities**

 

*Capital Leases:*

As of September 25, 2007, we had 17 capital lease agreements related toour restaurants.  Of these leases, oneexpires in 2020, one in 2022, two in 2023, four in 2024, three in 2025, four in2026 and the remaining two in 2027, all with renewable options for additionalperiods. Fifteen of these lease agreements are with our developer. Under sevenof the leases, we are required to pay additional percentage rent based uponrestaurant sales. The land portion of these leases is classified as anoperating lease while the building portion of these leases is classified ascapital lease because either its present value was greater than 90% of theestimated fair value at the beginning of the lease or the lease term is 75% ormore of the estimated life of the property.

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

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

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

In June 2007, we entered into a lease for an energy optimization systemat our Maple Grove restaurant for approximately $30,000.  This five-year lease commenced June 28, 2007and contains a bargain purchase option.

*Operating Leases:*

The land portions of the 17 property leases referenced above, 15 of whichare lease agreements with our developer, are classified as operating leasesbecause the fair value of the land was 25% or more of the leased property atthe inception of each lease. All scheduled rent increases for the land duringthe initial term of each lease are recognized on a straight-line basis. Inaddition to such property leases, we have obligations under the followingoperating leases:

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

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

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

In March 2006,we entered into a lease agreement for the land and the building for our St.Louis Park restaurant.  This operatinglease expires in 2016 with renewal options for additional periods.

 

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We have also entered into lease agreements relating to restaurants inEast Peoria and Orland Park, Illinois, Rogers, Arkansas, Creve Coeur, Missouri,Ft. Wayne, Indiana and Toledo, Ohio under the terms specified in thedevelopment agreement with Dunham. Additionally, we entered into a lease agreement with an independentthird party for a restaurant in Woodbury, Minnesota.  Each restaurant will be constructed for us ona build-to-suit basis.  The annual rent ofeach will be equal to 10.5% of the construction costs paid by the developer includingland cost and will escalate 10% at the end of each five-year period.  The term of each lease will commence whenoperations begin and may be extended at our option for additional five-yearperiods on the same terms and conditions, except the rent for our Woodburylocation may increase based on a formula using the Consumer Price Index duringany such extension.  Rental costsassociated with the operating leases that are incurred during the constructionperiod are recognized as pre-opening costs, and escalated rent will berecognized as expense on a straight-line basis over the term of the leases.

*Personal Guaranties:*

Two of our directors and one former director have personally guaranteedcertain of our leases and loan agreements. At a meeting held in March 2004, our board of directors agreed to payour president and chief executive officer for his personal guaranties ofequipment loans entered into in August 2003 and January 2004.  The amount of the annual guarantee fee is 3%of the balance of such loans.  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 2007 and2006, we accrued $18,953 and $23,601 of such fees, respectively, and paid$50,000 and $15,000 of such fees, respectively.

In August 2006, we entered into a lease agreement with Carlton pursuantto which we may finance lease up to $3.0 million of equipment.  Mr. Wagenheim was required to personallyguarantee payment to be made to Carlton under this lease financing agreementand our board of directors agreed to pay him for such guarantee.  The amount of the annual guarantee fee is 3%of the balance of such lease and is calculated and accrued based on theweighted average daily balance of the lease at the end of each monthlyaccounting period.  Although we did notpay any of such fees during the first three quarters of 2007, $15,408 of suchexpense was recorded in general and administrative expense.

*Employment Agreements:*

                InJune 2005, we entered into a three-year employment agreement with StevenJ. Wagenheim, our president and chief executive officer, who is also a directorof our company.  The agreement provided for a minimum base salary of$225,000, commencing January 1, 2005, cash incentive compensation rangingfrom $0 to $125,550 based on performance, and a stock option for the purchaseof 150,000 shares of common stock.  In February 2006, we amended thecompensatory arrangements under the agreement to provide for an annual basesalary of $275,000, commencing January 1, 2006, cash incentivecompensation ranging from $0 to $167,400 based on performance, and a stockoption for the purchase of 100,000 shares of common stock.  In April 2007,we amended the compensatory arrangements under the agreement to provide for anannual base salary of $300,000, commencing April 1, 2007, cash incentivecompensation for 2007 ranging from $0 to $197,400 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 employmentagreement with Peter P. Hausback that provides for Mr. Hausback to serve as ourchief financial officer and principal accounting officer. The agreementprovides for a minimum annual base salary of $215,000 and the eligibility toparticipate in any performance-based cash bonus or equity award plans forsenior executives based upon goals established by the board or compensationcommittee. Mr. Hausback’s possible cash incentive compensation for fiscal years2006 and 2007 is up to $75,000 based upon performance. The employment agreementprovides that a severance payment equal to 12 months of base salary will bemade if Mr. Hausback’s employment is terminated in connection with a change ofcontrol, by our company without cause, or by the officer for good reason.

 

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*Development Agreement:*

We have entered into a development agreement with Dunham CapitalManagement L.L.C. (“Dunham”) for the development of our restaurants.  Dunham is controlled by Donald A. Dunham,Jr., who is a member of DHW Leasing, L.L.C. and an affiliate of GranitePartners LLC, a beneficial owner of approximately 1.1% of our securities.  The agreement gives Dunham the right todevelop, construct and lease up to 22 restaurants for us prior to December 31,2012.  We are not bound to authorize theconstruction 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.  As of November 1, 2007, 17 restaurants hadbeen constructed for us under this development agreement.

The development agreement provides for a cooperative process betweenDunham and our company for the selection of restaurant sites and thedevelopment of restaurants on those sites, scheduling for the development andconstruction of each restaurant once a location is approved, and controls onthe costs of development and construction using bidding and guaranteed maximumcost concepts.  The development agreementprovides that restaurants will be leased to us on the basis of a triple netlease.  The rental rate of each leasewill be calculated using a variable formula which is based on approved andspecified costs of development and construction and an indexed interestrate.  The term of each lease isgenerally 20 years with five five-year options to renew.

In September 2006, we entered into an amendment of this developmentagreement.  Under the terms of theamendment, in lieu of future adjustments to restaurant leases, lease rates willbe increased by 10% commencing on the fifth anniversary of each lease and on eachfive-year anniversary thereafter.  Thislease rate increase applies to all leases under the development agreemententered into after March 2006.

 

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

*Off-balance sheet arrangements:*

 

*               *Itis not our business practice to enter into off-balance sheet arrangements.

 

*Summary ofcontractual obligations:*

 

Thefollowing table summarizes our obligations under contractual agreements as ofSeptember 25, 2007 and the time frame within which payments on such obligationsare due.  This table does not includeamounts related to percentage rent as such future amounts are notdeterminable.  In addition, whether wewould incur any additional expense on our employment agreements depends uponthe existence of a change in control of the company.  Therefore, no percentage rent nor severanceexpense has been included in the following table.

 

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| ** **                                       | ** ** | **Payments due by period** | ** **  |
|--------------------------------------------------|------------|----------------------------|-------------|
| **Contractual Obligations**                      | ** ** | **Total**                  | ** **  | **Fiscal Year 2007** | ** ** | **Fiscal Years 2008-2009** | ** ** | **Fiscal Years 2010-2011** | ** ** | **Fiscal Years Thereafter** | ** ** |
| Long-term debt,  principal                       |       | $                          | 2,082,889   |   | $ | 74,372 |   | $ | 574,272 |   | $ | 1,434,244 |   | $ | — |   |
| Interest on  long-term debt                      |       | 548,913                    |        | 47,861 |   | 319,545 |   | 181,508 |   | — |   |
| Capital lease  obligations, including interest   |       | 75,882,252                 |        | 1,110,333 |   | 8,679,437 |   | 8,164,719 |   | 57,927,762 |   |
| Operating lease  obligations, including interest |       | 41,411,146                 |        | 627,645 |   | 4,944,765 |   | 4,913,428 |   | 30,925,308 |   |
| Loan guarantee                                   |       | 94,505                     |        | 42,272 |   | 48,903 |   | 3,330 |   | — |   |
| Total  obligations                               |       | $                          | 120,019,705 |   | $ | 1,902,482 |   | $ | 14,566,923 |   | $ | 14,697,229 |   | $ | 88,853,071 |   |

 

Certain amounts do notsum due to rounding.

 

Based on our cash position at September 25, 2007, webelieve we have sufficient capital to meet our current obligations.

 

**Critical accounting policies**

 

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

*Property and equipment*

 

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

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

We continually reassess our assumptions and judgmentsand make adjustments when significant facts and circumstances dictate. Historically,actual results have not been materially different than the estimates we havemade.

 

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*Leasing activities*

 

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

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

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

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

*Stock-based compensation*

 

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

*Revenue recognition*

 

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

**Seasonality**

 

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

**Inflation**

The primary inflationary factors affecting ouroperations are food, supplies and labor costs. A large number of our restaurantpersonnel are paid at rates based on the applicable minimum wage, and increasesin the minimum wage directly affect our labor costs. In the past, we have beenable to minimize the effect of these 

 

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increases through menu price increases and other strategies. To date,inflation has not had a material impact on our operating results.

 

**ITEM 3   Quantitative and Qualitative Disclosures aboutMarket Risk**

 

Our company is exposed tomarket risk from changes in interest rates on debt and changes in commodityprices.

 

*Changes in interest rate:*

 

Pursuantto the terms of the loan we entered into in January 2004 for equipment at ourDavenport location, the interest rate increased from 6.125% to 10.25% effectiveJanuary 1, 2007.  As of January 1, 2007,the unpaid balance on this loan was $481,190. The 412.5 basis point change in this rate, assuming consistent levels offloating rate debt, will have an impact of approximately $16,190 on annualinterest expense in fiscal year 2007.

 

*Changes in commodity prices:*

 

Manyof the food products we purchase are affected by commodity pricing and 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 isavailable 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 does notenter into derivative contracts either to hedge existing risks or for speculativepurposes.

 

**ITEM 4   Controls and Procedures**

*Evaluation of disclosure controlsand procedures*

 

We maintain a system of disclosure controlsand procedures that is designed to ensure that information required to bedisclosed in our Exchange Act reports is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms, andthat such information is accumulated and communicated to our management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding disclosures.

                Under the supervision and withthe participation of our management, including our Chief Executive Officer andChief Financial Officer, we conducted an evaluation of our disclosure controlsand procedures (as defined in Exchange Act Rules 13a-15(e)).  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of September 25, 2007,our disclosure controls and procedures were effective.

 

*Changesin internal control over financial reporting*

 

There were no changes in our internal control over financial reportingthat occurred during the quarter ended September 25, 2007, that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

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**PART II OTHERINFORMATION**

**ITEM 1   Legal Proceedings**

 

Not applicable.

**ITEM 1A                Risk Factors**

 

On May 4, 2007, we filedwith the SEC a Cautionary Statement pursuant to the Private SecuritiesLitigation Reform Act of 1995 for use as a readily available written documentto which reference may be made in connection with forward-looking statements,as defined in such act.  Our Cautionary Statement amended and restatedthe risk factors we previously presented in Item 1A of ourAnnual Report on Form 10-K for the fiscal year ended December 26, 2006. Our Cautionary Statement, which appears as Exhibit 99 to this report, isincorporated by reference in response to this Item 1A.  There have been no material changes withrespect to the risk factors disclosed in such Cautionary Statement.

 

**ITEM 2   Unregistered Sales of Equity Securities andUse of Proceeds**

 

(a)           On August 8, 2007, we issued 26,302 shares of common stockupon the cashless exercise of a warrant for the purchase of 38,170 shares ofcommon stock originally issued October 1, 2002 to one of the agents for ourprivate placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise priceof $1.58 per share and an expiration date of October 1, 2007.

 

On August 8, 2007, we issued 3,543 shares ofcommon stock upon the cashless exercise of a warrant for the purchase of 5,142shares of common stock originally issued November 27, 2002 to one of the agentsfor our private placement of Series A Convertible Preferred Stock andwarrants.  The foregoing warrant had anexercise price of $1.58 per share and an expiration date of November 27, 2007.

 

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

 

**ITEM 3   Defaults upon Senior Securities**

 

Not applicable.

 

**ITEM 4   Submission of Matters to a Vote of SecurityHolders**

 

Not applicable.

 

**ITEM 5   OtherInformation**

 

Not applicable.

 

**ITEM 6   Exhibits**

 

See “Index to Exhibits.”

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                                     |                                 |
|------------------------------------------|--------------------------------------|
|                                     | GRANITE CITY FOOD & BREWERY LTD. |
|                                     |                                 |   |
| Date:   November  9, 2007 | By:                                  | /s/ Peter P. Hausback |
|                                     |                                 | Peter P. Hausback |
|                                     |                                 | Chief Financial Officer |

 

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**INDEX TO EXHIBITS**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                    |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                                                                                                                                                               |
| 3.1         |       | Articles  of Incorporation of the Registrant, as amended (incorporated by reference to  our Quarterly Report on Form 10-QSB, filed on November 13, 2002 (File No.  000-29643)).                               |
|        |       |                                                                                                                                                                                                          |
| 3.2         |       | Amended  and Restated Bylaws of the Registrant, dated May 2, 2007 (incorporated by  reference to our Current Report on Form 8-K, filed on May 4, 2007 (File No.  000-29643)).                                 |
|        |       |                                                                                                                                                                                                          |
| 31.1        |       | Certification  by Steven J. Wagenheim, President and Chief Executive Officer of the Company,  pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302  of the Sarbanes-Oxley Act of 2002. |
|        |       |                                                                                                                                                                                                          |
| 31.2        |       | Certification  by Peter P. Hausback, Chief Financial Officer of the Company, pursuant to  Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                 |
|        |       |                                                                                                                                                                                                          |
| 32.1        |       | Certification  by Steven J. Wagenheim, President and Chief Executive Officer of the Company,  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.      |
|        |       |                                                                                                                                                                                                          |
| 32.2        |       | Certification by Peter P.  Hausback, Chief Financial Officer of the Company, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of  2002.                      |
|        |       |                                                                                                                                                                                                          |
| 99          |       | Cautionary Statement  (incorporated by reference to our Current Report on Form 8-K, filed on May 4,  2007 (File No. 000-29643)).                                                                              |

 

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