UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

Commission File Number 000-29643

GRANITE CITY FOOD & BREWERY LTD.

(Exact Name of Registrant as Specified in Its Charter)

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 be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

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

(Do not check if smaller reporting company)

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

As of May 1, 2007, the issuer had outstanding 16,197,849 shares of common stock.

TABLE OF CONTENTS

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PART I              FINANCIAL INFORMATION

ITEM 1  Financial Statements

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

See notes to condensed consolidated financial statements.

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GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See notes to condensed consolidated financial statements.

2

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to condensed consolidated financial statements.

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GRANITE CITY FOOD & BREWERY LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Thirteen weeks ended March 25, 2008 and March 27, 2007

1.     Summary of significant accounting policies

Background

Granite City Food & Brewery Ltd. (the “Company”) develops and operates Modern American casual dining restaurants known as Granite City Food & Brewery®.   The restaurant theme is upscale casual dining with a wide variety of menu items that are prepared fresh daily, combined with freshly brewed hand-crafted beers finished on-site.  The first Granite City restaurant opened in St. Cloud, Minnesota in July 1999 and the Company subsequently expanded to other Midwest markets, opening its 25^th restaurant on February 12, 2008.  The Company also operates a beer production facility which is used to provide raw material support to its restaurants to create consistent quality and operational efficiencies in the production of its proprietary beer.  In 2007, the Company was granted a patent by the United States Patent Office for its brewing process.

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

Principles of consolidation and presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.  These statements include the accounts and operations of the Company and its subsidiary corporations under which its Kansas locations are operated.  Fifty-one percent of the stock of each of the subsidiary corporations is owned by a resident of Kansas and the Company owns the remainder of the stock of each subsidiary corporation.  Each resident-owner of the stock of these entities has entered into a buy-sell agreement with each corporation providing, among other things, that transfer of the shares is restricted and that the shareholder must sell his shares to the corporation upon certain events, including termination of employment (if employed by the Company) or any event that disqualifies the resident-owner from owning the shares under applicable laws and regulations of the state.  The Company has entered into a master agreement with each separate subsidiary corporation that permits the operation of the restaurants and leases to each corporation the Company’s property and facilities.  Each corporation pays all of its operating expenses and obligations, and the Company retains, as consideration for the operating arrangements and the lease of property and facilities, all the net profits, as defined, if any, from its operations.  The Company has determined that the foregoing ownership structure will cause these separate corporations to be treated as variable interest entities in which the Company has a controlling financial interest for the purpose of Financial Accounting Standards Board (FASB) Interpretation 46 (R), Consolidation of Variable Interest Entities.  As such, the corporations are consolidated with the Company’s financial statements and the Company’s financial statements do not reflect a minority ownership in those separate corporations.  All references to the Company in these notes to the condensed consolidated financial statements relate to the consolidated entity.

In the opinion of management, all adjustments, consisting of normal recurring adjustments, which are necessary for a fair statement of its financial position as of March 25, 2008 and the results of operations for the interim periods ended March 25, 2008 and March 27, 2007 have been included.

The balance sheet at December 25, 2007, has been derived from the audited financial statements at that date, but does not include all of the information and notes required by generally accepted accounting principles for complete financial statements.  Certain information and note disclosures normally included in the Company’s

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annual financial statements have been condensed or omitted.  These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 25, 2007, filed with the Securities and Exchange Commission on March 10, 2008.

The results of operations for the thirteen weeks ended March 25, 2008 are not necessarily indicative of the results to be expected for the entire year.

Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America and regulations of the Securities and Exchange Commission requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period.  Significant estimates include estimates related to asset lives, lease accounting and revenue recognition.  Actual results could differ from these estimates.

Reclassifications

Certain minor reclassifications have been made to the financial statements for the first quarter of 2007 in order for them to conform to the presentation of the financial statements for the first quarter of 2008.  These reclassifications have no effect on the accumulated deficit or net loss previously reported.

Revenue recognition

Revenue is derived from the sale of prepared food and beverage and select retail items.  Revenue is recognized at the time of sale and is reported on the Company’s statement of operations net of sales taxes collected.  Revenue derived from gift card sales is recognized at the time the gift card is redeemed. Until the redemption of gift cards occurs, the outstanding balances on such cards are included in accrued expenses in the accompanying consolidated balance sheets.  The Company periodically recognizes gift card breakage which represents the portion of its gift card obligation for which management believes the likelihood of redemption by the customer is remote, based upon historical redemption patterns.

Cash and cash equivalents

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

Stock-based compensation

The Company records stock-based compensation in accordance with the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard (SFAS) No. 123 (revised 2004) (“SFAS 123R”), Share-Based Payment, and SEC Staff Accounting Bulletin No. 107, Share-Based Payment, requiring the measurement and recognition of all share-based compensation under the fair value method.

The fair value of options at date of grant was estimated using the Black-Scholes option-pricing model with the following assumptions for the first quarter of 2008 and 2007:

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Earnings (loss) per share

Basic net income (loss) per share is computed based on the weighted average number of shares of common stock outstanding during the interim period.  Diluted net loss per share is not presented since the effect would be anti-dilutive due to the losses.  Calculations of the Company’s net loss per common share for the quarters ended March 25, 2008 and March 27, 2007 are set forth in the following table:

Recent accounting pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  SFAS No. 157 became effective for financial statements issued for the Company’s fiscal year 2008, subject to a one-year delay for nonfinancial assets.  In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 (“SFAS 159”), which will permit the option of choosing to measure certain eligible items at fair value at specified election dates and report unrealized gains and losses in earnings, providing SFAS 157 is also adopted.  The adoption of SFAS 157 and SFAS 159 have not had, nor do we expect them to have, a material impact on the Company’s consolidated financial statements.

2.              Fair value of financial instruments

At March 25, 2008 and December 25, 2007, the fair value of cash and accounts payable approximate their carrying value due to the short-term nature of the instruments.  The fair value of the capital lease obligations and long-term debt is estimated at its carrying value based upon current rates available to the Company.

3.              Non-current assets

Property and equipment

Property and equipment are recorded at cost and depreciated over the estimated useful lives of the related assets.  The cost of leasehold improvements is depreciated over the initial term of the related lease.  Depreciation is computed on the straight-line method for financial reporting purposes and accelerated methods for income tax purposes.  Amortization of assets acquired under capital lease is included in depreciation expense.  The following is a summary of the Company’s property and equipment at March 25, 2008 and December 25, 2007:

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

Intangible and other assets

Intangible and other assets consisted of the following:

4.        Accrued expenses

Accrued expenses consisted of the following:

5.        Deferred rent payable

The Company leases most of its restaurant properties.  Leases are accounted for under the provisions of SFAS No. 13 and SFAS No. 98, Accounting for Leases, as well as other subsequent amendments and authoritative literature including FASB Staff Position No. FAS 13-1, Accounting for Rental Costs Incurred During a Construction Period.  For leases that contain rent escalation clauses, the Company records the total rent payable during the lease term and recognizes expense on a straight-line basis over the initial lease term, including the “build-out” or “rent-holiday” period where no rent payments are typically due under the terms of the lease.  Any difference between minimum rent and straight-line rent is recorded as deferred rent payable.  Additionally, pursuant to Emerging Issues Task Force No. 98-09, Accounting for Contingent Rent, contingent rent expense based on a percentage of revenue is accrued and recorded to the extent it is expected to exceed minimum base rent per the lease agreement, based on estimates of probable levels of revenue during the contingency period.  Deferred rent payable also includes a tenant improvement allowance the Company received, which is being amortized as a reduction of rent expense on a straight-line basis over the initial term of the lease.

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Deferred rent payable consists of the following:

6.        Long-term debt

As of the end of the first quarter of fiscal year 2008, the Company had two outstanding long-term loans with an independent financial institution the proceeds of which it used to purchase equipment for its restaurants in Des Moines and Davenport, IA.  These loans are secured only by the personal property and fixtures at the respective locations.  In addition to these two loan agreements, the Company has a long-term loan outstanding with the same independent financial institution secured by the tangible personal property and fixtures at the Fargo, ND restaurant.  Such loan is guaranteed by Steven J. Wagenheim, the Company’s president, chief executive officer and one of its directors.  As of March 25, 2008 and December 25, 2007, the balances, interest rates and maturity dates of these loans were:

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

7.        Capital leases

As of March 25, 2008, the Company had 23 capital lease agreements related to its restaurant properties, 21 of which originated with its developer.  The land portion of these leases is classified as an operating lease while the building portion of these leases is classified as a capital lease because its present value was greater than 90% of the estimated fair value at the beginning of the lease and/or the lease term represents 75% or more of the expected life of the property.  The Company also has a land and building lease agreement for its beer production facility.

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This ten-year lease allows the Company to purchase the facility at any time for $1.00 plus the unamortized construction costs.  Because the construction costs will be fully amortized through payment of rent during the base term, if the option is exercised at or after the end of the initial ten-year period, the option price will be $1.00.  As such, the lease is classified as a capital lease.  For information regarding leases entered into subsequent to March 25, 2008, see Note 12.

As of March 25, 2008, the Company had capital lease agreements that it used to finance the equipment at nine of its restaurants.  These leases are classified as capital leases as a bargain purchase option exists on each lease.

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

Minimum future lease payments under all capital leases as of March 25, 2008 are:

The foregoing table considers additional lease commitments commencing after March 25, 2008.  Amortization expense related to the assets held under capital leases is included with depreciation expense on the Company’s statements of operations.

8.        Commitments and contingencies

The Company will need to expend additional capital in connection with its long-term expansion plans.  Based on the Company’s April 21, 2008 cash position of $5.3 million, and the December 2007 $16.0 million DHW Equipment Lease Commitment (see below), of which approximately $8.0 million lease financing remained available as of April 21, 2008, as well as cash generated from operations, management believes that the Company will have sufficient funds to complete planned restaurant openings into 2010 and maintain sufficient working capital for operations.  However, the Company may require further funding to open additional restaurants

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depending upon the number of planned openings, cost of capital, availability of developer financing or landlord tenant improvement funding, adverse sales trends, and the Company’s ability to generate positive cash flow.  If sources of liquidity are insufficient to fund expected capital needs, or the Company’s needs are greater than anticipated, the Company will be required to raise additional funds in the future through the incurrence of indebtedness or public or private sales of equity securities.  As of March 25, 2008, management continued to pursue debt financing alternatives in order to solidify the Company’s expansion plans.

Equipment leases

Between March 27, 2008 and April 21, 2008, DHW Leasing, L.L.C. (“DHW”) purchased and leased to the Company equipment at four of its restaurants under the terms and conditions of the Equipment Lease Commitment the Company entered into with DHW in December 2007.  The value of the equipment financed at each restaurant is approximately $1.0 million.  The annual interest rate on one five-year lease is 10.65%.  The Company will pay 10.3% annual interest on the other three leases for 12 months, at which time the interest rate will be locked in at the then 5-year Treasury bill rate plus 8.3%.  The Company has the option to purchase the leased equipment for $1.00 upon payment in full of all rent payments due under each lease.  While Mr. Wagenheim owns a 20% membership interest in DHW and has agreed to personally guarantee 20% of DHW’s indebtedness to its lenders, he will not receive a guarantee fee or other payment in connection with this DHW financing.

Litigation

From time to time, lawsuits are threatened or filed against the Company in the ordinary course of business.  Such lawsuits typically involve claims from customers, former or current employees, and others related to issues common to the restaurant industry.  A number of such claims may exist at any given time.  Although there can be no assurance as to the ultimate disposition of these matters, it is management’s opinion, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operation, liquidity or financial condition of the Company.

9.              Common stock

Exercise of warrants and options

On December 31, 2007, a director of the Company exercised a stock option for the purchase of 15,000 shares of common stock at an exercise price of $2.27 per share.  These options were issued pursuant to the 1997 Director Stock Option Plan and had an expiration date of January 1, 2008.

On January 31, 2008, the Company issued 10,153 shares of common stock upon the cashless exercise of a warrant for the purchase of 23,996 shares of common stock originally issued March 20, 2003 to one of the agents for its private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of March 20, 2008.

On March 5, 2008, the Company issued 7,070 shares of common stock upon the cashless exercise of a warrant for the purchase of 23,996 shares of common stock originally issued March 20, 2003 to one of the agents for its private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of March 20, 2008.

On March 7, 2008, the Company issued 6,681 shares of common stock upon the cashless exercise of a warrant for the purchase of 25,842 shares of common stock originally issued March 20, 2003 to one of the agents for its private placement of Series A Convertible Preferred Stock and warrants.  The foregoing warrant had an exercise price of $1.58 per share and an expiration date of March 20, 2008.

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10.       Stock plans

In July 1997, the Company adopted the 1997 Stock Option Plan for employees and non-employees, including consultants to the Company, to purchase the Company’s common stock at an exercise price that equals or exceeds the fair market value on the date of grant.   As of March 25, 2008, options to purchase 316,500 shares of common stock were outstanding under the plan, which expired July 28, 2007.  All options outstanding under this plan are fully vested and are exercisable for ten years from the date of grant.

As of March 25, 2008, options to purchase 300,000 shares of common stock were outstanding under the 1997 Director Stock Option Plan (“DSOP”), which expired July 29, 2007.  Under this plan, the Company automatically granted an option to each outside director on the date such person became a director for the purchase of 15,000 shares of common stock and thereafter on each successive anniversary of the grant of the first option for the purchase of 15,000 shares.  On May 2, 2007, the Company’s board of directors agreed that until the adoption of any future equity plan for non-employee directors, awards of stock options for the purchase of 15,000 shares of common stock per year should continue to be made to each non-employee director on the anniversary of his election to the Board under the 2002 Equity Incentive Plan.  The board further resolved that such awards are to have the same terms and conditions as those made under the DSOP; provided, however, that they are to be exercisable for a period of ten years rather than five years.

In August 2002, the Company adopted the 2002 Equity Incentive Plan for employees, prospective employees, officers and members of the Company’s board of directors, as well as consultants and advisors to the Company, to purchase shares of the Company’s common stock at an exercise price that equals or exceeds the fair market value on the date of grant.  The number of shares authorized for issuance as of March 25, 2008 was 2,649,743, of which 1,113,743 shares remained available for future issuance and options to purchase 1,460,300 shares were outstanding.  Although vesting schedules may vary, option grants under this plan generally vest evenly over a three or four-year period and options are exercisable for no more than ten years from the date of grant.

A summary of the status of the Company’s stock options as of March 25, 2008 is presented below:

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The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the closing price of the Company’s stock on March 25, 2008 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 25, 2008.  As of March 25, 2008, there was approximately $716,487 of total unrecognized compensation cost related to unvested share-based compensation arrangements, of which $363,844 is expected to be recognized during the remainder of fiscal year 2008, $292,859 in fiscal year 2009, $51,617 in fiscal year 2010 and $8,167 in fiscal year 2011.

The following table summarizes information about stock options outstanding at March 25, 2008:

11.  Common stock warrants

In November 2002, the Company completed a private placement of Series A Convertible Preferred Stock and warrants to purchase common stock.  As part of the agreement between the Company and its private placement agents, the agents received five-year warrants to purchase an aggregate of 288,604 shares of common stock at an exercise price of $1.58 per share. During the first quarter of fiscal year 2008, the Company issued an aggregate of 23,904 shares of common stock upon the cashless exercise of such warrants for the purchase of an aggregate of 73,834 shares of common stock.  No such agent warrants relating to this private placement remain outstanding.

In May 2003, the Company entered into a two-year financial advisory services agreement. As part of the agreement between the Company and the financial consultant, the consultant received five-year warrants to purchase an aggregate of 35,000 shares of common stock at exercise prices ranging from $2.85 to $5.40 per share.  As of March 25, 2008, none of such warrants had been exercised.

In September 2004, the Company entered into a securities purchase agreement with certain accredited investors for the sale of approximately $8.5 million of common stock and warrants.  Under this agreement, the Company issued five-year warrants for the purchase of 1,045,844 shares of common stock at an exercise price of $5.00 per share.  The Company may call for the mandatory exercise of such warrants if certain conditions are met.  As part of this private placement, the Company sold to its placement agents, for $100, five-year warrants to purchase an aggregate of 130,730 shares of common stock at an exercise price of $5.00 per share.  As of March 25, 2008, none of such warrants had been exercised.

In October 2005, the Company entered into a securities purchase agreement with certain accredited investors for the sale of approximately $5.34 million of common stock and warrants.  Under this agreement, the Company issued five-year warrants for the purchase of 221,762 shares of common stock at an exercise price of $6.50 per share to such investors and five-year warrants for the purchase of 55,436 shares of common stock at an exercise

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price of $6.50 to the Company’s placement agent. As of March 25, 2008, none of such warrants had been exercised.

During the first quarter of fiscal year 2008, no warrants were issued and no warrants expired unexercised.  As of March 25, 2008, warrants for the purchase of 1,485,165 shares were outstanding and exercisable.  The weighted average exercise price of such warrants was $5.25 per share.

12.  Subsequent Events

South Bend and Indianapolis, Indiana lease agreements

In March and April 2008, the Company entered into 20-year net lease agreements relating to restaurants its anticipates opening in South Bend, Indiana in the third quarter of 2008 and Indianapolis, Indiana in the fourth quarter of 2008, respectively, under the terms specified in the development agreement with Dunham Capital Management L.L.C. (“Dunham”) for the development of restaurants.  The restaurants will be constructed for the Company on a build-to-suit basis.  Basic terms of the leases include annual rent equal to 10.5% of the construction cost plus the land lease and contingent rent based on a percentage of revenue.  The base rent will escalate 10% at the end of each five-year period.  The term of each lease will commence when operations begin and the Company will be responsible for any real-estate taxes and all operating costs.  Rental costs associated with the operating lease incurred during the construction period are recognized as pre-opening costs and escalated rent will be recognized as expense on a straight-line basis over the term of each lease.

Development agreement with United Properties Investment LLC (“United Properties”)

In April 2008, the Company entered into a development agreement with United Properties for the development of up to 22 restaurants to be built between 2009 and 2012.  As the Company’s developer, United Properties will be responsible for all costs related to the land and building of each restaurant.  The annual lease rate for fee-simple land and building developments will be 9.5% and the Company will have the right of first offer to purchase these restaurants.  Additionally, in the event United Properties sells one of the buildings that it develops for the Company at a cap rate agreed to by the parties in the agreement, then the Company will share in the profits of that sale.  The Company assumes no liability in the event United Properties sell a building at a loss.

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

This discussion and analysis contains various non-historical forward-looking statements within the meaning of Section 21E of the Exchange Act.  Although we believe that, in making any such statement, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected.  When used in the following discussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates” and similar expressions, as they relate to us or our management, are intended to identify such forward-looking statements.  You are cautioned not to attribute undue certainty to such forward-looking statements, which are qualified in their entirety by the cautions and risks described herein.  Please refer to the “Risk Factors” section of our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 10, 2008, for additional factors known to us that may cause actual results to vary.

Overview

We are a Modern American upscale casual restaurant chain. As of March 25, 2008, we operated 25 restaurants in 12 Midwestern states, substantially all of which feature on-premises breweries, operating under the name of Granite City Food & Brewery®.  We believe our menu features high quality yet affordable family favorite menu items prepared from made-from-scratch recipes and served in generous portions.  We believe that the sophisticated yet unpretentious restaurants, proprietary food and beverage products, attractive price points and high service standards combine for a great dining experience.  The location of each restaurant and the month and year of its opening appear in the following chart:

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We operate a centrally-located beer production facility in Ellsworth, Iowa which facilitates the initial stage of our brewing process using our patented brewing process.  We believe that this brewing process improves the economics of microbrewing as it eliminates the initial stages of brewing and storage at multiple locations, thereby reducing equipment and development costs at new restaurant locations.  Additionally, having a common starting point, the beer production creates consistency of taste for our product from unit to unit.  The initial product produced at our beer production facility is transported by truck to the fermentation vessels at each of our restaurants where the brewing process is completed. In 2007, we were granted a patent by the United States Patent Office for this brewing process.  We believe that our current beer production facility, which opened in June 2005, has the capacity to service up to 35 restaurant locations.

We operate Granite City University, where our managers are trained under the instruction of full-time, dedicated trainers.  Our seven to fourteen-week training program consists of both “hands on” as well as classroom training for all aspects of management.  All salaries of our managers in training and our trainers as well as all related costs incurred at Granite City University are recorded as a component of our general and administrative costs.

We utilize a new store opening team which consists of experienced restaurant managers who are dedicated to the opening of our new restaurants.  This team generally arrives at a new restaurant site two to three months in advance of the restaurant opening date and coordinates all staffing and training matters for that new restaurant.  However, due to opening six restaurants in a period of approximately 120 days, the team was not able

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to train at each location for our typical two to three-month time period in connection with our most recent openings.  We believe that a dedicated team delivers a more disciplined opening process and ensures adherence to our company’s exacting standards and culture.

We have developed our restaurants using proceeds from the sale of our securities, building and equipment financing and cash flow from operations.  We built units 4-9, 11-14 and 16-25 based upon the prototype we developed in early 2003.  In 2004 and 2005, we retrofitted units 1-3 to conform to this prototype model. In 2005 and 2006, we developed units 10 and 15, respectively, which were conversions of existing restaurants.  With the exception of units 1-3 and 15, we developed all of our units under our multi-site development agreement with a commercial developer that provides us with assistance in site selection, construction management and financing for new restaurants.  Under the development agreement, we lease the land and building of each new restaurant from the developer.

In April 2008, we entered into a development agreement with United Properties Investment LLC (“United Properties”) for the development of up to 22 restaurants to be built between 2009 and 2012.  As our developer, United Properties will be responsible for all costs related to the land and building of each restaurant.  The development agreement provides for a cooperative process between United Properties and our management for the selection of restaurant sites and the development of restaurants on those sites, scheduling for the development and construction of each restaurant once a location is approved.  We will lease each restaurant developed under this agreement from United Properties.

We believe that our operating results will fluctuate significantly because of several factors, including the timing of new restaurant openings and related expenses, profitability of new restaurants, changes in food and labor costs, increases or decreases in comparable restaurant sales, general economic conditions, consumer confidence in the economy, changes in consumer preferences, competitive factors, the skill and experience of our restaurant-level management teams and weather conditions.

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

The thirteen weeks ended March 25, 2008 and March 27, 2007 included 310 and 234 restaurant weeks, respectively, which is the sum of the actual number of weeks each restaurant operated. The source of the additional restaurant weeks in the first quarter of fiscal year 2008 is shown in the following chart:

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

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

Results of operations as a percentage of sales

The following table sets forth results of our operations expressed as a percentage of sales for the thirteen weeks ended March 25, 2008 and March 27, 2007.

Certain percentage amounts do not sum due to rounding.

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Critical Accounting Policies

Our critical accounting policies are those that require significant judgment.  There have been no material changes to the critical accounting policies previously reported in our 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 10, 2008.

Results of operations for the thirteen weeks ended March 25, 2008 and March 27, 2007

Revenue

We generated $24,019,485 and $18,182,192 of revenue during the first quarters of fiscal years 2008 and 2007, respectively.  The increase in the first quarter revenue of 32.1% was primarily the result of the additional restaurant operating weeks related to the seven restaurants that opened in late 2007 and early 2008.  The first quarter of 2008 included 310 restaurant operating weeks while the first quarter of 2007 included 234 operating weeks.  Average weekly revenue decreased from $77,702 per week in 2007 to $77,482 per week in 2008 for all the restaurants in operation during the quarter.  Comparable restaurant revenue, which includes restaurants in operation over 18 months, increased 1.8% from the first quarter of 2007 to the first quarter of 2008 primarily due to a 4.0% price increase that took effect in October 2007 and another 4.0% price increase that took effect in March 2008, offset by a decrease in guest traffic.  Average weekly revenue per comparable restaurant increased $1,402 from $78,213 in the first quarter of 2007 to $79,615 in the first quarter of 2008.

We expect that restaurant revenue will vary from quarter to quarter.  We anticipate continued seasonal fluctuations in restaurant revenue due in part to increased outdoor seating and generally favorable weather conditions at many of our locations during the summer months.  Due to the honeymoon effect that periodically occurs with the opening of a restaurant, we expect the timing of new restaurant openings to cause fluctuations in restaurant revenue.  Additionally, consumer confidence in the economy and changes in consumer preferences may affect our future revenue.  We believe that decreased consumer confidence negatively impacted the restaurant industry as a whole during the first quarter of 2008.

Restaurant costs

Food and beverage

Our food and beverage costs, as a percentage of revenue, increased 1.6% to 31.3% in the first quarter of 2008 from 29.7% in the first quarter of 2007.  The increase was primarily due to new store-openings and the increase in the cost of dairy, chicken, fish, bread, general groceries and beer.  In order to offset these increases in commodity costs, we have taken steps to increase our oversight of inventory and kitchen management.  Additionally, we believe the price increase of approximately 4.0% which became effective in March 2008 will help to address such commodity price increases.  We will continue to monitor our prices in an effort to address future commodity price increases.

We expect that our food and beverage costs will vary going forward due to numerous variables, including seasonal changes in food and beverage costs, and guest preferences.  We periodically create new menu offerings and introduce new craft brewed beers based upon guest preferences.  Although such menu modifications may temporarily result in increased food and beverage cost, we believe we are able to offset such increases with our weekly specials which provide variety and value to our guests.  Our varieties of craft brewed beer, which we believe we can produce at lower cost than beers we purchase for resale, also enable us to keep our food and beverage costs low while fulfilling guest requests and building customer loyalty.  We expect food and beverage costs at our newer restaurants to be higher initially due to inefficiencies that 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 to maintain or reduce our food and beverage costs as a percentage of revenue.  Additionally, as we add new restaurants, we believe our brewing process will allow us to keep our high quality beer products intact while leveraging our fixed production costs, thereby enhancing overall profitability.

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Labor

Labor expense consists of restaurant management salaries, hourly staff payroll costs, other payroll-related items including partner and management bonuses, and non-cash stock-based compensation expense.  Our experience to date has been that staff labor costs associated with a newly opened restaurant, for approximately its first four to six months of operation, are greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenue.

Our labor costs, as a percentage of revenue, increased 2.6% to 38.9% in the first quarter of 2008 from 36.3% in the first quarter of 2007 due primarily to new store-openings and minimum wage increases, turnover and the addition of a new position at each restaurant to oversee inventory and kitchen management in an effort to address the increases in commodity costs.  Although the immediate effect of these personnel additions was to increase labor costs, we believe we will realize an overall decrease in costs of goods in the long term that will more than offset this labor increase.

We expect that labor costs will vary as we add new restaurants.  Minimum wage laws, local labor laws and practices, as well as unemployment rates vary from state to state and will affect our labor costs, as will hiring and training expenses at our new units.  We believe that retaining good employees and more experienced staff ensures high quality guest service and may reduce hiring and training costs.

Direct restaurant operating

Operating supplies, repairs and maintenance, utilities, promotions and restaurant-level administrative expense represent the majority of our direct restaurant operating expense, a substantial portion of which is fixed or indirectly variable.  Our direct restaurant operating expense as a percentage of revenue increased 1.5% to 14.9% in the first quarter of 2008 from 13.4% in the first quarter of 2007 primarily due to new store-openings as well as increased cost of utilities and expenses related to repair and maintenance at our mature properties.  Additionally, expenses related to acceptance of credit and debit cards increased due to increased usage.

Occupancy

Our occupancy costs, which include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes, remained at 6.4% as a percentage of revenue in the first quarter of 2008 and 2007.  While rent expense increased slightly, it was offset by a decrease in property and casualty insurance.

Pre-opening

Pre-opening costs, which are expensed as incurred, consist of expenses related to hiring and training the initial restaurant workforce, wages and expenses of our dedicated new store opening teams, rental costs incurred during the construction period and certain other direct costs associated with opening new restaurants.  Pre-opening costs, excluding construction-period rent, are primarily incurred in the month of, and two months prior to, the restaurant opening.

Pre-opening costs increased $487,532 to $583,373 in the first quarter of 2008 from $95,841 in the first quarter of 2007.  Included in such expense was $40,154 and $88,992 of non-cash rental costs incurred during construction periods in the first quarters of 2008 and 2007, respectively.  Pre-opening costs in 2008 consisted primarily of costs related to the three restaurants we opened in the first quarter, while pre-opening expenses in the first quarter of 2007 represented primarily the non-cash construction period rent related to the restaurant we opened in the later part of that year.

General and administrative

General and administrative expense includes all salaries and benefits, including non-cash stock-based compensation, associated with our corporate staff that is responsible for overall restaurant quality, future expansion into new locations, financial controls and reporting, restaurant management recruiting, training at

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Granite City University, excess capacity costs related to our beer production facility, and salaries and expenses of our new store opening team when it is not dedicated to a particular restaurant opening.  Other general and administrative expense includes advertising, professional fees, investor relations, office administration, centralized accounting system costs and travel by our corporate management.

General and administrative expense increased $968,220 to $2,704,525 in the first quarter of 2008 from $1,736,305 in the first quarter of 2007.  As a percentage of revenue, general and administrative expenses increased 1.8% from 9.5% in the first quarter of 2007 to 11.3% in the first quarter of 2008.  The primary sources of such increase were expenses related to increased staff levels related to growth, recruiting, relocation and consulting costs, as well as accounting services, marketing and occupancy expense.  We undertook an ambitious recruiting plan to upgrade our overall restaurant management teams, particularly in our Kansas/Missouri markets.  These increases were partially offset by decreases in insurance, non-cash stock-based compensation and repair and maintenance expense. Non-cash stock based compensation included in general and administrative expense was $103,585 and $136,236 in the first quarters of 2008 and 2007, respectively.

As we continue to expand our restaurant chain, we will closely monitor our general and administrative expense while seeking to preserve an infrastructure that remains suitable for our anticipated growth.  We plan to add personnel as needed, specifically district operators, to provide better oversight of operations and we plan to continue to improve our recruiting, training and retention initiatives.  While our general and administrative expense may increase in the near term as we reinforce our current infrastructure, we expect such expense will decrease as a percentage of revenue in the long term due to economies of scale.

Depreciation and amortization

Depreciation and amortization expense increased $441,323 to $1,561,646 in the first quarter of 2008 from $1,120,323 in the first quarter of 2007, due principally to the additional depreciation related to new restaurants.  As a percentage of revenue, depreciation expense increased 0.3% to 6.5% in the first quarter of 2008 from 6.2% in the first quarter of 2007.

Interest

Net interest expense consists of interest expense on capital leases and long-term debt, net of interest earned from cash on hand.  Interest expense increased $443,261 to $1,488,826 in the first quarter of 2008 from $1,045,565 in the first quarter of 2007.  The increase was due to additional capital leases as a result of new restaurants.  Interest income decreased $17,268 in the first quarter of 2008 compared to the first quarter of 2007 due to the reduction of cash on hand.

Liquidity and capital resources

As of March 25, 2008, we had $2,463,707 of cash and a working capital deficit of $7,002,978 compared to $7,076,835 of cash and a working capital deficit of $3,668,297 at December 25, 2007.

During the thirteen weeks ended March 25, 2008, we used $2,722,787 of net cash in operating activities and $1,436,476 of net cash to purchase equipment and other assets primarily related to the restaurants we opened in the first quarter of 2008. We made payments aggregating $487,911 on our debt and capital lease obligations and received $34,046 of net cash through the exercise of stock options.

During the thirteen weeks ended March 27, 2007, we used $1,415,062 of net cash in operating activities, $374,234 in net cash to purchase equipment and other assets, and made payments aggregating $6,349,328 on our debt and capital lease obligations.  Additionally, during the first quarter of 2007, we received net cash of $12,852,678 from the issuance of our common stock.

In March 2007, we entered into a stock purchase agreement with accredited investors under which we sold 2,617,334 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 paid expenses aggregating $181,675.  Pursuant to the conditions of the stock purchase agreement, we used approximately $6.0 million of the

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$12,770,857 net proceeds to retire the entire balance of equipment lease debt we had obtained from DHW pursuant to the master lease agreement 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’s president, chief executive officer and one of its directors.  Mr. Wagenheim owns a 20% membership interest in DHW and personally guaranteed 20% of DHW’s indebtedness to its lenders.  The remaining net proceeds from this placement were used to fund the expansion of our restaurant operations.

In April 2008, we entered into a development agreement with United Properties for the development of up to 22 restaurants to be built between 2009 and 2012.  As our developer, United Properties will be responsible for all costs related to the land and building of each restaurant.  The development agreement provides for a cooperative process between United Properties and our management for the selection of restaurant sites and the development of restaurants on those sites, scheduling for the development and construction of each restaurant once a location is approved.  We will lease each restaurant developed under this agreement from United Properties.

We intend to continue expansion in markets where we believe our concept will have broad appeal and attractive restaurant-level economics.  We plan to continue using our restaurant prototype as we open future restaurants; however, where appropriate, we will convert existing restaurants to our Granite City concept.  Additionally, we intend to explore alternative restaurant designs to reduce the cost of our initial capital investment and we may alter our prototype to meet various state and local regulatory requirements, including, but not limited to, pollution control requirements, liquor license ordinances and smoking regulations.  We intend to open two additional restaurants in 2008 and have signed lease agreements for these locations in South Bend and Indianapolis, Indiana.

Based upon our existing prototype, we anticipate that pre-opening costs and the initial purchase of furniture, fixtures and equipment will require an investment by us of approximately $1.0 million to $1.3 million for each new restaurant.  We anticipate that our new restaurants will require an investment by our developer of approximately $1.8 million to $2.3 million for the building and approximately $1.2 million to $1.5 million for the purchase of the land.  We expect these costs will vary from one market to another based on real estate values, zoning regulations, labor markets and other variables.

Pursuant to the terms of some of our lease agreements, our developer receives a construction allowance from the landlord which, in turn, is passed on to us as a reduction in the construction cost of a new restaurant.  Landlord contributions received related to restaurants developed in 2007 and 2008 ranged from $1.0 million to $1.5 million per location.  Our net capital investment is lower for a restaurant that receives a landlord contribution.  In some instances we elected to use our own cash for a portion of the building costs, resulting in lower minimum lease payments.

To finance restaurant openings in 2008, we entered into a master equipment lease with DHW in December 2007.  Details regarding such arrangement appear below under the caption “Commitments—Capital Leases.”

We will need to expend significant capital in connection with our expansion plans.  Utilizing the December 2007 $16.0 million DHW Equipment Lease Commitment, of which approximately $8.0 million lease financing remained available to us as of April 21, 2008, as well as cash generated from operations, we believe that we will have sufficient funds to complete our planned restaurant openings into 2010 and maintain sufficient working capital for our operations.  If we deviate from our planned openings, experience a change in our cost of capital, are unable to obtain developer financing or landlord contributions, experience adverse sales trends or are unable to generate positive cash flow, we may require further funding sooner than anticipated.  We are exploring opportunities to reduce our cash usage per restaurant by utilizing sites that offer lower costs of capital and real estate funding.  If our available sources of liquidity are insufficient to fund our expected capital needs, or our needs are greater than anticipated, we will be required to raise additional funds in the future through the incurrence of indebtedness or public or private sales of equity securities.  As of March 25, 2008, we continued to pursue debt financing alternatives in order to solidify our expansion plans.  If we do not generate sufficient cash flow from current operations or if financing is not available to us, we will have to curtail projected

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growth, which could materially adversely affect our business, financial condition, operating results and cash flows.

Our ability to fund our operations in future periods will depend upon our future operating performance, and more broadly, on the availability of equity and debt financing, which will be affected by prevailing economic conditions in our industry and financial, business and other factors, some of which are beyond our control.  We cannot assure you that we will obtain financing on favorable terms or at all.  If we elect to raise additional capital through the issuance and sale of equity securities, the sales may be at prices below the market price of our stock, and our shareholders may suffer significant dilution.  Debt financing, if available, may involve significant cash payment obligations, covenants and financial ratios that restrict our ability to operate and grow our business, and would cause us to incur additional interest expense and financing costs.

Commitments

Capital Leases:

As of March 25, 2008, we had 23 capital lease agreements related to our restaurant properties.  Of these leases, one expires in 2020, two in 2023, four in 2024, three in 2025, six in 2026, four in 2027 and the remaining three in 2028, all with renewable options for additional periods.  Twenty-one of these lease agreements originated with our developer.  Under 13 of the leases, we may be required to pay additional contingent rent based upon restaurant sales.  The land portion of these leases is classified as an operating lease while the building portion of these leases is classified as a capital lease because its present value was greater than 90% of the estimated fair value at the beginning of the lease and/or the lease term represents 75% or more of the expected life of the property.

In December 2004, we entered into a land and building lease agreement for our beer production facility.  This ten-year lease, which commenced February 1, 2005, allows us to purchase the facility at any time for $1.00 plus the unamortized construction costs.  Because the construction costs will be fully amortized through payment of rent during the base term, if the option is exercised at or after the end of the initial ten-year period, the option price will be $1.00.  As such, the lease is classified as a capital lease.

We entered into a sale-leaseback agreement for the equipment and leasehold improvements at the St. Cloud, MN and Sioux Falls, SD restaurants in June 2001 and a lease for equipment under agreements expiring in May 2008.  The annual interest rate on such lease is approximately 6.8%. Steven J. Wagenheim, our president, chief executive officer and one of our directors, and a former director of ours have personally guaranteed these leases.

In August 2006, we entered into a master lease agreement with Carlton Financial Corporation (“Carlton”) pursuant to which we could “finance lease” up to $3,000,000 of equipment purchases for three restaurant locations.  As of March 25, 2008, we had entered into three lease schedules and amendments to this master lease, pursuant to which we are leasing equipment for three locations for an initial lease term ranging from 36 to 39 months.  The value of the equipment financed at each of the three locations ranges from approximately $0.8 million to $1.1 million and the annual interest rate on each ranges from 12.9% to 19.6% annually.  We have provided Carlton with refundable security deposits aggregating $251,165 as well as a security interest in certain other equipment.  At the end of each initial lease term, we may (a) purchase Carlton’s interest in all, but not less than all, of the equipment for a purchase price equal to the greater of (1) the fair market value of the equipment, or (2) 15% of the original cost of the equipment, or (b) renew such lease for 12 months at a monthly lease payment of approximately one-half of the original monthly payment and take ownership of the equipment thereafter for $1.00.  Steven J. Wagenheim, our president, chief executive officer and one of our directors, was required to personally guarantee payments to be made to Carlton under the lease financing and our board of directors agreed to compensate him for such guarantee.  The amount of annual compensation is 3% of the balance of such lease and is calculated and accrued based on the weighted average daily balance of the lease at the end of each monthly accounting period.

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In December 2007, we entered into an Equipment Lease Commitment with DHW, relating to the lease of furniture, fixtures and equipment for current and future restaurants.  Under the terms of the Equipment Lease Commitment, DHW agreed to purchase and lease to us equipment costing up to $16.0 million.  Each five-year lease is intended to be for equipment costing a minimum of $0.8 million and a maximum of $1.25 million per restaurant.  Payments due DHW have an interest rate equal to the DHW bank base rate plus 4.8%.  Principal payments on the amounts borrowed depend upon the repayment schedule specified by the banks that have provided the financing commitments to DHW.  The lease financing is subject to the availability of financing commitments to DHW from its lenders.  We have the option to purchase the leased equipment for $1.00 upon payment in full of all rent payments due under each lease.  We are not obligated to enter into any equipment leases with DHW, although we intend to enter into equipment leases with DHW for the foreseeable future.  DHW is not obligated to provide equipment leases for restaurants that are not developed and constructed by Dunham Capital Management, L.L.C. (“Dunham”).  While Mr. Wagenheim owns a 20% membership interest in DHW and has agreed to personally guarantee 20% of DHW’s indebtedness to its lenders, he does not receive a guarantee fee or other payment in connection with this DHW financing.  As of April 21, 2008, DHW had purchased and leased to us equipment at eight of our restaurants under this Equipment Lease Commitment.  The value of the equipment financed at each restaurant is approximately $1.0 million and the current annual interest rate on each lease ranges from 10.3% to 12.3%.

In June 2007, we entered into a lease for an energy optimization system at our Maple Grove restaurant for approximately $30,000.  This five-year lease commenced June 28, 2007, carries an annual interest rate of approximately 11.9% and contains a bargain purchase option.

Operating Leases:

The land portions of the 23 property leases referenced above, 21 of which originated with our developer, are classified as operating leases because the fair value of the land was 25% or more of the leased property at the inception of each lease.  All scheduled rent increases for the land during the initial term of each lease are recognized on a straight-line basis.  In addition to such property leases, we have obligations under the following operating leases:

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

In August 2005, we entered into a 38-month lease agreement for office space for our corporate offices.  The lease commenced October 1, 2005.  In November 2007, we entered into an amendment to such lease to include additional space commencing December 1, 2007.  Pursuant to the amended lease, which expires in November 2011, annual rent is $96,613 with scheduled annual increases throughout the term of the lease.  Such scheduled rent increases are recognized on a straight-line basis over the term of the lease.

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

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