SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[x] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1996
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to________________________
Commission file number: 1-13636
Mendocino Brewing Company, Inc.
(Name of small business issuer in its charter)
California 68-0318293
(State or other jurisdiction of (I.R.S. Employee Identification No.)
incorporation or organization)
13351 South Highway 101, Hopland, CA 95449
(Address of principal executive offices) (Zip code)
Issuer's telephone number: (707) 744-1015
Securities registered under Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, without par value The Pacific Stock Exchange
Securities registered under Section 12(g) of the Act:
Not applicable
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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. Yes X No
- -
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year: $4,004,700
The aggregate market value of the voting stock held by non-affiliates
computed by reference to the last reported sale price of such stock as of April
2, 1997 was $10,416,000.
The number of shares the issuer's common stock outstanding as of March 31,
1997 is 2,322,222. (Does not include 300,000 shares issued subject to
substantial restrictions as security for a forbearance. Also does not include
approximately 16,000 shares, subscriptions for which the Company had received
but not accepted as of March 31, 1997.)
Transitional Small Business Disclosure Format Yes No X
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PART I
Item 1. Business.
Overview
Mendocino Brewing Company, Inc. brews Red Tail Ale, Blue Heron Pale
Ale, Black Hawk Stout, and three other ales, one stout, and one porter for the
domestic craft beer market. A "craft beer" is a full-flavored beer brewed in the
traditional style. Mendocino Brewing is one of the first of the modern craft
brewers, having opened the first new brewpub in California and the second in the
United States since the repeal of Prohibition, and has been recognized for its
innovations in the brewpub concept, its craft brew style, its distinctive
labels, and its role in industry associations. Mendocino Brewing's objective is
to transform itself from the country's leading microbrewery (based on annual
sales from 1990 through 1995 among brewers with annual capacity of less than
15,000 bbl.) to a major national craft brewer offering among the highest quality
craft beers available anywhere in America.
Mendocino Brewing is building a new brewery in Ukiah, California (110
miles north of San Francisco). Management presently expects to begin producing
test brews at the new facility in April 1997. The new brewery will have an
initial annual capacity of approximately 60,000 bbl., which is more than four
times the Company's annual capacity from 1993 through the first nine months of
1995 of 13,600 bbl. Ultimately, the facility can expand to 200,000 bbl. per
year.
Company Background
Mendocino Brewing Company was originally formed in March 1983 as a
California limited partnership (the "Partnership"). On January 1, 1994, the
business was incorporated by transferring all of the Partnership's assets,
including its name, to a newly formed California corporation in exchange for all
of the Common and Preferred Stock of the corporation. The Partnership
distributed these shares to its partners on January 3, 1994. As used hereafter,
references to the "Company" and "Mendocino Brewing" include the business
operations of the Partnership before its incorporation.
Mendocino Brewing first bottled its flagship brand, Red Tail Ale, in
December 1983. In February 1995, Mendocino Brewing completed a $3.6 million
direct public offering at $6 per share. The Company purchased nine acres of land
in Ukiah, California in 1995 and broke ground on the new brewery in September
1995. Seeking to maximize the capacity of the Hopland facility in the interim,
the Company added an additional bottling tank in the Fall of 1995, which
permitted the Company to begin 24 hour brewing operations. This increased the
annual capacity of the Hopland facility to 18,000 bbl., technically taking the
Company out of the microbrewery category. The Company's products are sold in
over 1,500 retail outlets in Northern California and in selected locations
throughout the United States. See "Product Distribution."
Mendocino Brewing is recognized for its contributions to the craft
brewing industry and enjoys a national and international reputation. The
Company's distinctive and award winning Red Tail Ale label is frequently
featured in calendars, posters, and literature concerning the craft beer
industry. Although introduced only this summer, the equally distinctive Blue
Heron Pale Ale label has also won awards and is featured in the 1997 Brew
Art(TM) calendar published by Ronnie Sellers Productions of Kennebunk, Maine.
The Company enjoys good visibility within the industry, due in part to the
leadership its officers have provided within various industry trade groups. See
"Management."
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Industry Overview
Domestic Beer Market. According to Modern Brewery Age's 1996
Statistical Report, overall domestic beer sales in 1996 was 178 million bbl. (up
0.6% from 1995). A barrel equals approximately 13.78 cases or 331 twelve ounce
bottles; 178 million bbl. is therefore the approximate equivalent of 59.0
billion 12 oz. bottles of beer.
<TABLE>
The U.S. beer market may be divided into five segments:
<CAPTION>
1995 Est. Representative Suggested
Segment Market Share Top Brands Retail Price/6-pack
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<S> <C> <C> <C>
Low-Priced 60.0% Busch, Milwaukee's Best, Old Milwaukee $2.80
Premium 31.4% Budweiser, Miller Lite, Bud Light, Coors Light $4.05
Super-Premium 1.2% Michelob, Lowenbrau $4.67
Import 5.5% Heineken, Guinness, Bass $7.90
Domestic Craft 1.9% Samuel Adams, Pete's, Sierra Nevada, Red Tail Ale $5.99 to $6.99
</TABLE>
Domestic Craft Beer Segment. While overall beer sales have been
basically flat for several years, domestic craft beer sales have increased at a
rate of approximately 40% per year for several years, slowing a bit in 1996.
Many industry analysts predict that craft beer sales will continue to increase
until they achieve a market share of 5%-6% by the year 2000.
Craft beers are characterized by their full-flavor and are usually
produced along traditional European brewing styles. The majority of craft beers
are ales, although some are malt lagers. Wheat beers and fruit flavored ales and
lagers have enjoyed recent popularity among craft beer consumers.
Competition
The craft beer category consists of:
o Contract brews -- any style brew produced by one brewer for sale under
the label of someone else who does not have a brewery or whose brewery
does not have sufficient capacity.
o Regional craft brews -- "hand-crafted" brews, primarily ales, sold
under the label of the brewery that produced it.
o Microbrews -- "hand-crafted" brews, primarily ales, sold under the
label of the brewery that produced it, if the capacity of the brewery
does not exceed 15,000 bbl. per year.
o Large brewer craft-style brews -- a brand brewed by a national brewer
which may only imitate the style of a craft beer. These craft-style
brews are often sold under the label of a brewery that does not exist
or the label of a brewpub with no bottling capacity. The term "phantom
brewery" is sometimes used to describe such brands.
o Brewpub brews -- "hand-crafted" brews produced for sale and consumption
at the brewery, which is normally connected with a restaurant/saloon.
Brewpub brews are not normally sold for off-site consumption in
significant quantities.
Mendocino Brewing competes against all of the above brewers primarily
on the basis of product quality and image.
Of the approximately 3.7 million bbl. of craft beer produced in America
in 1995 (detailed 1996 statistical information is not currently available),
contract brews (led by Samuel Adams Boston Lager, Pete's Wicked Ale, and their
respective related brands) accounted for approximately 1.5 million bbl., or 41%
of the total; regional craft brands (led by Sierra Nevada, Redhook, Pyramid
(Hart Brewing, Inc.), Anchor, and Full Sail) represented approximately 1.25
million bbl., or 34% of the total; and microbrews (led by Red Tail Ale)
represented approximately 910,000 bbl., or 25% of the total. Because Mendocino
Brewing's annual production exceeded 15,000 bbl. by less than 150 bbl. in 1995,
some industry publications have classified the Company as a regional craft
brewer for that year.
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<TABLE>
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1995 & 1996 Domestic Craft Beer Market
<CAPTION>
1995 1996
Largest Craft Brewers in Mendocino Total Sales Annual Total Sales Annual
Brewing's Primary & Target Markets (x 1,000 bbl.) Growth (x 1,000 bbl.) Growth
- --------------------------------------------------- -------------- -------- --------------- ----------
<S> <C> <C> <C> <C>
1 Boston Beer Co. (Boston, MA) 960 37% 1210 26%
2 Pete's Brewing Co. (Palo Alto, CA) 348 91 426 22
3 Sierra Nevada Brewing Co. (Chico, CA) 201 31 267 33
4 Redhook Ale Brewery (Seattle, WA) 158 69 225 42
5 Hart Brewing Co. (Kalma, WA) 123 71 128 4
6 Widmer Brewing Co. (Portland, OR) 70 40 122 75
7 Anchor Brewing Co. (S.F., CA) 105 1 108 3
8 Full Sail Brewing Co. (Hood River, OR) 70 36 79 12
9 Portland Brewing Co. (Portland, OR) 63 82 67 6
10 Bridgeport Brewing Co. (Portland, OR) 19 6 20 6
11 Mendocino Brewing Co. (Hopland, CA) 14 8 17 13
Remaining Domestic Craft Brewers (approx. 1200) 1,663 44 N/A N/A
-----
Total Domestic Specialty Segment Production 3,780 44% N/A N/A
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</TABLE>
Source: Modern Brewery Age
Products
Mendocino Brewing brews three ales and a stout year-round, three
seasonal ales, and a seasonal porter:
o RED TAIL ALE, a full flavored amber ale, is the flagship brand of
Mendocino Brewing.
o BLUE HERON PALE ALE is a golden ale with a full body and a distinctive
hop character.
o BLACK HAWK STOUT is the fullest in flavor and body of the Company's
brews.
o EYE OF THE HAWK SELECT ALE is a high gravity deep amber summer ale.
o YULETIDE PORTER is a deep brown Holiday brew with a traditionally rich,
creamy flavor.
o PEREGRINE PALE ALE is brewed year-round with a more delicate flavor and
character.
o SPRINGTIDE ALE is brewed around St. Patrick's Day and appears as a
fresh, flowery, spicy golden ale.
o FROLIC SHIPWRECK ALE 1850, a Scottish-style ale brewed around July, was
introduced in 1994 as a fund-raiser for the Mendocino County Museum to
commemorate the wreck of the clipper ship Frolic, with its cargo of
Scottish ale, on the Mendocino coast in 1850. Salvage efforts were
abandoned when workers, upon sighting the previously unreported big
trees of Mendocino County, launched the timber industry which has
characterized the area ever since.
Mendocino Brewing uses an ale yeast strain that was first introduced at
New Albion Brewing Co. in the late 1970s. Management knows of no other brewery
that ferments its beer with this particular strain of yeast. The Company
maintains the yeast strain under laboratory conditions at two separate
locations. Mendocino Brewing is among a minority of brewers who use whole hop
flowers instead of processed hop pellets in their brewing processes. This
technique contributes to the distinctive characteristics of the brews. The
Company adds active fermenting beer (Krausen) after the beer is bottled, which
produces a pleasant amount of natural carbonation. The thin layer of brewer's
yeast in the bottom of the bottle is a natural characteristic of bottle
conditioned ale.
Mendocino Brewing's distinctive brews have been very well received in
the market and within the industry. Eye of the Hawk Select Ale won a gold medal
at the 1991 Great American Beer Festival after winning a silver in 1990, and
also won a bronze in 1992. Blue Heron Pale Ale was awarded a Gold Medal with a
Special Award of Excellence from the Underground Wine Journal in February 1997
in a competition among 183 ales from across the United States and won a bronze
medal at the 1991 Great American Beer Festival.
The Hopland Brewery Brewpub and Merchandise Store
To date, Mendocino Brewing's major marketing tool has been the Hopland
Brewery brewpub and merchandise store. Located on a major tourist route in
Hopland, California, 100 miles north of San Francisco, the
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Hopland Brewery, which opened in 1983, was the first brewpub to open in
California and the second in the United States since the repeal of Prohibition.
The brewpub is housed in a 100 year-old brick building that was once
known as the Hop Vine Saloon. The inside walls are trimmed with the original
turn-of-the-century ornamental stamped tin. Works of local artists are featured
on a rotating basis. The bar is hand-crafted, early California style blond oak
and brass that complements the tradition of the tavern and the Company's brews.
The pub includes a dart room and a stage. Patrons can view the brewing process
through windows in the adjoining brewhouse. An outdoor Beer Garden includes a
shaded grape arbor, flowers, trellised hops in the summer, picnic tables, and a
sandbox for the kids.
Beverages served include Red Tail Ale, Blue Heron Pale Ale, Black Hawk
Stout, Peregrine Pale Ale, and a seasonal brew on tap, along with local wines,
Hopland Seltzer Water, local apple juice, and soft drinks. The brewpub also
features hand pumped cask conditioned ales. The menu features home-style
cooking, spicy beer sausages, legendary hamburgers, Red Tail chili, fresh
salads, snacks, vegetarian entrees, and daily specials at moderate prices. The
brewpub operates days and evenings, with live music on Saturdays and for special
events, such as the Company's annual Anniversary Party in August and its
Oktoberfest in October.
The adjacent Merchandise Store sells off-sale packages of the Company's
brews (including gift packs) and merchandise such as hand-screened label
T-shirts, posters, engraved glasses and mugs, logo caps, books about brewing,
gift packs, and other brewery-related gifts.
Management had planned to continue bottling operations at the Hopland
facility until the Company could no longer keep up with demand, and then
transfer bottling operations to the Ukiah facility. Until that time, production
at the Ukiah facility was to consist solely of draft beer. Based on preliminary
sales data for January and March, 1997, it appears that bottling operations will
need to move to Ukiah as quickly as practical. The Company will continue to
operate the Hopland facility to provide special occasion draft beers for the
brewpub; to research, develop, and test-market new craft brews; and as a brewing
education and training site.
Strategy
Mendocino Brewing's objective is to transform itself from the country's
leading microbrewery (based on annual sales from 1990 through 1995) to a
nationally known and respected craft brewer that offers among the highest
quality craft beers available anywhere in America. Management perceives that the
continued growth in the domestic craft beer segment (see "-Industry Overview")
has given rise to a qualitative shift in the public's awareness of craft beers,
and that this shift now gives the Company an opportunity to enter new markets at
a time when many consumers are discovering craft brews for the first time.
Management believes that an important step is to position Mendocino Brewing's
products as offering superior quality with very high perceived value and
distinctive brand images, even when compared with other craft brews. Management
plans to accomplish this objective by making the Company's most popular brews
available in 12 oz. six packs and draft, increasing the Company's brand
development efforts, and entering new geographic markets. In completing the
plans for the new brewery, Management also concluded that it could position
itself better in the market and realize certain cost efficiencies and overall
cost reductions by designing a plant with an initial capacity of 60,000 bbl. per
year (20% greater than originally planned) and an ultimate capacity of 200,000
bbl. per year (54% greater than originally planned).
New Product Offerings
Until recently, Mendocino Brewing's capacity limitations and marketing
considerations dictated that the bulk of the Company's production be Red Tail
Ale in 12 oz. six packs. Draft beer has been limited to production for sale at
the Hopland Brewery, and other brews, such as Blue Heron Pale Ale, Black Hawk
Stout, Eye of the Hawk Select Ale, Yuletide Porter, and Frolic Shipwreck Ale
1850, have been available only in limited quantities of 750 ml or 22 oz.
bottles. A key element of the Company's strategy is to make more of its products
available in 12 oz. six-packs and draft. The new products are:
o Blue Heron Pale Ale 12 oz. Six-Packs. Blue Heron Pale Ale is now
available at selected retail outlets in 12 oz. six packs. The bottles
and carrier pack feature a colorful new label depicting a Great Blue
Heron preparing for flight against a soft, misty background of the
Russian River (which flows through Hopland) and surrounding hills. The
design has already won the prestigious 1996 Northern California Addy
award and the silver medal in the 1996 International Brand Packaging
Award competition sponsored by Graphic
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<PAGE>
Design: USA magazine. The label is also featured in the 1997 Brew
Art(TM) calendar published by Ronnie Sellers Productions of Kennebunk,
Maine.
o Black Hawk Stout 12 oz. Six-Packs. Management plans to introduce Black
Hawk Stout in 12 oz. six-packs following completion of its new label
development, which Management expects to occur in 1997. This forward
looking statement is subject to risks and uncertainties. Among other
things, tasks such as completing the new brewery may divert
Management's attention from matters such as label development. The
speed with which new Black Hawk Stout labels are developed will also
depend, in part, on the amount of proceeds raised in the Company's
current direct public offering. The Black Hawk Stout label presently
consists of the basic Mendocino Brewing Company logo with the words
BLACK HAWK STOUT and is distributed in 22 oz. bottles in limited
quantities.
o Draft brews in half barrel kegs. Management presently intends to make
draft production of Red Tail Ale, Blue Heron Pale Ale, and Black Hawk
Stout in half barrel kegs the first priority of the new brewery. The
Company is designing special tap handles and other marketing materials
for its draft products. Historically in the beer industry, introducing
draft products into restaurants and other establishments has driven
bottle sales which in turn has increased demand for draft products in
locations not served. These forward looking statements are subject to
risks and uncertainty. Among other things, there is no assurance that
sale of the Company's brews will help it achieve the critical mass that
Management seeks.
Brand Development
Management believes that consumers of the Company's brews are like the
typical craft beer consumer described in the H.C. Wainwright & Co. industry
report of October 12, 1995. According to this report, the typical craft beer
consumer is interested in "upscale and diversified" products with a "distinctive
brand image" and "full flavored taste." Craft beer consumers also tend to be
consumers of gourmet coffees, fine wines, all-natural products, and other
"affordable luxuries." A survey conducted by ICR of Media, PA found that the
following percentages of people had tried a craft beer:
o 25% of all U.S. beer drinkers
o 23% of women beer drinkers
o 26% of male beer drinkers
o 51% of people with annual incomes of $75,000+
o Greater than 50% of college educated people
o 38% of adults 25-34 years old
o 10% of adults 45 years and older
o 32% of beer drinkers in the Northeast
o 28% of beer drinkers in the West
o 26% of beer drinkers in the Midwest
o 17% of beer drinkers in the South
One of the ways Mendocino Brewing projects its quality and corporate
values to consumers is through its Red Tail Ale, Blue Heron Pale Ale, and Eye of
the Hawk Select Ale labels. The Company has used nationally-known wildlife
artists including Randy Johnson and Lee Jayred for its label designs. In 1990,
Mendocino Brewing received the Paperboard Packaging Council's Silver Award for
Excellence in Packaging and Award for Excellence in Graphic Design and a
Northern California Addy Award for its Red Tail Ale packaging. In 1996, the
Company received a Northern California Addy Award and a silver medal in the
International Band Packaging Award competition sponsored by Graphic Design: USA
magazine for its Blue Heron Pale Ale packaging. It is Management's experience
that distributors and retailers realize the importance of superior packaging
graphics and appreciate the Company's offerings for that reason.
Management believes that the Red Tail Ale label successfully
communicates the value of Mendocino Brewing's products with the label's
respectful depiction of a red tail hawk flaring its wings as it prepares to land
with clusters of hops and barley in its talons. The illustrations Mendocino
Brewing uses with its Blue Heron Pale Ale and Eye of the Hawk Select Ale labels
are intended to evoke similar responses, as will be the illustration for Black
Hawk Stout when introduced.
The popularity of Mendocino Brewing's logos and trademarks is evidenced
by the sale of merchandise bearing these marks at the Hopland Brewery
merchandise store and through the merchandise catalogue the Company
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introduced in 1994. As part of its marketing efforts, therefore, the Company
intends to implement a brand marketing development program that will emphasize:
o Point-of-sale promotional materials including brochures, signage, table
tents, coasters, tap handles, and glassware.
o Clothing (caps, T-shirts, polo shirts, sweatshirts, etc.).
o Signage for distributor trucks to create "moving billboards." Mendocino
Brewing's emphasis on separate, distinctive illustrations for its
various brands enables it to produce a variety of images to create
consumer interest.
o World Wide Web Page. Mendocino Brewing's web page is located at
http://mendobrew.com and features information about the Company and the
Hopland Brewery brewpub and merchandise store, the Company's brewing
process, the Company's brands, the Hopland area, Company merchandise,
and shareholder information. The web page address is featured
prominently on Company marketing materials and can be accessed through
the Real Beer web site.
o Continued use of the Brewsletter beyond its current mailing list of
12,000. The Brewsletter is a newsletter Mendocino Brewing publishes and
distributes to educate subscribers about the brewing industry and the
Company's products and to promote the Company's image and corporate
values.
o Strong visual presence at beer shows and tasting competitions,
including the Great America Beer Festival in Denver, the Portland
Brewers Festival, and the KQED Beer Festival in San Francisco.
Regional Expansion
The Company's products are distributed widely in California and in
limited quantities at selected accounts in the metropolitan areas of Washington
D.C., Boston, Seattle, Phoenix, Chicago, Milwaukee, New York, and Atlanta, and
throughout North Carolina, Texas, Oregon, Nevada, and Colorado. The Company
plans to add distributors in New Jersey, Maryland, Virginia, and the
metropolitan areas of Minneapolis/St. Paul and Philadelphia in the near future.
Northern California is the Company's most important market, and Management
anticipates that it will remain so for the foreseeable future. The Company's
three largest distributors, Golden Gate Distributing (Sonoma and Marin
Counties), Bay Area Distributing (the East San Francisco Bay Area), and A&D
Distributing (South San Francisco area) accounted for 18%, 14%, and 10%,
respectively, of the Company's wholesale distribution in 1996. The percentage of
the Company's sales for which these distributors have accounted has decreased,
and will continue to decrease, as the Company adds new distributors and supplies
them with more product. These forward-looking statements are subject to risks
and uncertainties. There is no assurance that the Company will be able to add
additional distributors or that its products will be well-received in targeted
markets. Management believes that regional identification assists the Company in
Northern California and may assist the Company's local competitors in other
regional markets.
Pricing Strategy
Mendocino Brewing's products are priced at or near the top of the
market and have been for several years. Recently, the Company decided to pass on
to consumers some of the economies resulting from increased capacity and reduced
the suggested retail price for a six-pack of Red Tail Ale from $7.43 to $6.99.
The suggested retail price for a six-pack of Blue Heron Pale Ale is also $6.99.
The Company has noticed that the price range of 12 oz. six-packs of the major
craft brew brands has narrowed in the last two years and appears to be
converging on $6.50 per six pack, with no major craft brew brand at less than
$6.45 per six pack. There is no assurance that craft beer prices will continue
at these levels. Nevertheless, Management believes that the Company's products
will continue to command prices that will be on at least a par with other major
regional craft brewers. These forward looking statements are subject to risks
and uncertainties. Retail prices are subject to many factors most of which are
beyond the control of the Company. These factors include general economic
conditions, competition and consolidation, and ability to anticipate and respond
to evolving consumer preferences and attitudes toward adult beverages.
Management anticipates that the Company will periodically give temporary price
reductions through special promotions in response to market conditions. Frequent
price reductions can condition consumers to expect such reductions, which may
increase or reduce overall unit sales depending on the circumstances.
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Social Responsibility
Part of Mendocino Brewing's mission is to be viewed as a community,
regional, and national asset and as a positive example of how a business should
be operated. Management believes that the Company's customers require products
with high intrinsic value; that product quality alone is not sufficient; and
that a product must distinguish itself from the competition with the values it
communicates. These values include commitment to employees, community
involvement, and environmental responsibility. Management attempts to instill
these values in Company personnel and operations and to communicate to customers
the commitment of the Company to act responsibly. The Company encourages
employees and distributors to share ownership and mission with Management as
well as a sense of pride in the Company's products. Although part of the
Company's strategy is to grow through expanded sales, it promotes its brews as
beverages of moderation whose distinctive taste and high quality give the
consumer satisfaction.
New Brewery
Mendocino Brewing is completing a 62,000 sq. ft. custom designed
facility on nine acres of land in Ukiah, California, approximately 10 miles
north of the original brewery. The facility was approximately 89% complete as of
March 31, 1997, and is expected to begin producing test brews in April. The
facility is planned to feature new fermenting tanks, kegs, and packaging and
other miscellaneous equipment to be installed with the Company's existing
bottling line. Certain features of the new brewery have been specially designed
for the Company's brewing methods, such as equipment for using whole hops and
designated space for bottle conditioning. The facility will initially open with
an annual capacity of 60,000 bbl. per year. The Company had originally planned a
50,000 bbl. facility, but was able to take advantage of certain economies by
revising its plans to a capacity of 60,000 bbl. per year (20% greater than
originally planned). The facility has been designed to allow for expansion in
stages up to a maximum capacity of 200,000 bbl. per year (54% greater than
originally planned). The Company also elected to construct an extensive water
treatment facility as part of its commitment to the environment and to reduce
the over-all cost of disposing of its waste water.
Product Distribution
Mendocino Brewing's beers are sold through distributors to consumers in
bottles at supermarkets, warehouse stores, liquor stores, taverns and bars,
restaurants, and convenience stores. The Company intends to make Red Tail Ale,
Blue Heron Pale Ale, and Black Hawk Stout available in draft form and may sell
to additional kinds of outlets, such as sporting events. The Company's products
are delivered to retail outlets by independent distributors whose principal
business is the distribution of beer and in some cases other alcoholic
beverages, and who typically also distribute one or more national beer brands.
The Company, together with its distributors, markets its products to retail
outlets and relies on its distributors to provide regular deliveries, to
maintain retail shelf space, and to oversee timely rotation of inventory. The
Company also offers its products directly to consumers at the Hopland Brewery
brewpub and merchandise store. Of the Company's total beer sales for 1996, 89%
(77% of total sales) constituted sales to independent distributors and 11% (9%
of total sales) constituted sales at the Hopland Brewery brewpub and merchandise
store. Beer sales (wholesale and retail combined) constituted 86% of the
Company's total sales in 1996, with food and merchandise retail and catalogue
sales constituting the balance. As the Company's sales increase, Management
expects sales to independent distributors to increase materially as a percentage
of total sales.
Suppliers
The Company's major suppliers are Great Western Malting Co., Yakima,
Washington (malt); John I. Haas, Co., New York, New York (hops); and California
Glass Company, Oakland, California and Vitro Packaging, Inc., Dallas, Texas
(bottles). The City of Ukiah will supply power and water to the new brewery.
Employees
As of December 31, 1996, the Company employed 43 full-time and 39
part-time individuals including 10 in management and administration, 24 in
brewing operations, and 48 in retail and brewpub operations. Upon the completion
of its expansion, Management expects the Company to have increased four current
employees to full-time status and to have hired five additional management and
administrative employees, three marketing employees and five employees in
operations. Management believes that the Company's relations with its employees
is
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excellent. None of its work force is unionized. The Company has agreed with the
City of Ukiah that for two years it will give preference in its hiring to
residents of Mendocino County.
Patents and Trademarks
The Company has federal trademark registrations of the MENDOCINO
BREWING COMPANY word mark (Reg. No. 1,785,745), RED TAIL ALE word mark (Reg. No.
2,032,382), RED TAIL DESIGN (Reg. No. 2,011,817), BLUE HERON word mark (Reg. No.
1,820,076), BLUE HERON PALE ALE DESIGN (Reg. No. 2,011,816), PEREGRINE PALE ALE
word mark (Reg. No. 1,667,796), EYE OF THE HAWK SELECT ALE word mark (Reg. No.
1,673,594), EYE OF THE HAWK SELECT ALE DESIGN (Reg. No. 2,011,818), EYE OF THE
HAWK SPECIAL EDITION ANNIVERSARY ALE AND DESIGN (Reg. No. 2,011,815), BLACK HAWK
STOUT word mark (Reg. No. 1,791,807), YULETIDE PORTER word mark (Reg. No.
1,666,891), and BREWSLETTER word mark (Reg. No. 1,768,639).
The registration of the word mark BLUE HERON is a concurrent use
registration which gives the Company the exclusive right to use the word mark
BLUE HERON throughout the United States with the exception of Oregon, Idaho,
Washington, and Montana. BridgePort Brewing Company, the other concurrent owner,
has the exclusive right to use the word mark BLUE HERON in those states. The
BridgePort Pale Ale label used outside of Oregon, Idaho, Washington, and Montana
depicts a blue heron wading in a marsh although the words BLUE HERON do not
appear.
Mendocino Brewing's use of the word mark BLACK HAWK STOUT is, by
agreement with Hiram Walker & Sons, Inc., subject to the restriction that it be
used only in conjunction with the words "Mendocino Brewing Company".
Mendocino Brewing does not consider its recipes, techniques, processes,
yeast strain, or equipment to be proprietary or necessary to protect.
Government Regulation
Mendocino Brewing is licensed to manufacture and sell beer by the
California Department of Alcoholic Beverage Control ("ABC"). A "Small Beer
Manufacturer's License" allows the Company to brew up to 1,000,000 bbl. per
year, to conduct wholesale sales, and to sell beer and wine for consumption both
on and off the premises. A federal permit from the Bureau of Alcohol, Tobacco,
and Firearms ("BATF") allows the Company to manufacture fermented malt
beverages. To keep these licenses and permits in force the Company must pay
annual fees and submit timely production reports and excise tax returns. Prompt
notice of any changes in the operations, ownership, or company structure must
also be made to these regulatory agencies. BATF must also approve all product
labels, which must include an alcohol use warning. These agencies require that
individuals owning equity securities in aggregate of 10% or more in the Company
be investigated as to their suitability.
Taxation of alcohol has increased significantly in recent years.
Currently, the Federal tax rate is $7.00 per bbl. for up to 60,000 bbl. per year
and $18.00 per bbl. for over 60,000 bbl. The California tax rate is $6.20 per
bbl.
The Hopland Brewery's brewpub is regulated by the Mendocino County
Health Department, which requires an annual permit and conducts spot inspections
to monitor compliance with applicable health codes.
The Company's production operations must also comply with the
Occupational Safety and Health Administration's workplace safety and worker
health regulations and applicable state laws thereunder. Management believes
that the Company presently is in compliance with the aforementioned laws and
regulations and has implemented its own voluntary safety program.
Environmental Regulation
The Company is subject to various federal, state, and local
environmental laws which regulate the use, storage, handling, and disposal of
various substances.
-8-
<PAGE>
The Company's waste products consist of water, spent grains and hops,
and glass and cardboard. The Company has instituted a recycling program for its
office paper, newspapers, magazines, glass, and cardboard at minimal cost to the
Company. The Company pays approximately $1,000 per month in sewage fees relating
to waste water from its Hopland facility. The Company gives its spent grain to
local cattle ranchers, who pick up the spent grain at their expense. The Company
has not purchased any special equipment and does not incur any identifiable fees
in connection with its environmental compliance at its Hopland site.
Management anticipates that Mendocino Brewing will continue its
recycling program at the new brewery. Because of the increased quantities
involved, Management expects the Company to sell the spent grain from the Ukiah
location to ranchers and/or dairy farmers rather than give it away. The Company
has built its own wastewater treatment plant for the Ukiah facility. As a
consequence, the Company will not be required to incur sewer hook-up fees at
that location. If the Company's discharge exceeds 55,000 gallons per day, which
Management does not expect to occur until annual capacity exceeds 100,000 bbl.,
the Company will be required to pay additional fees. The estimated cost of the
wastewater treatment facility is approximately $900,000, and the estimated cost
of operating the plant is between $6,000 and $10,000 per month. The cost may
increase with increased production. The Company is exploring various methods of
recycling treated wastewater and could realize some revenue from doing so. The
Company has contracted to have the liquid sediment that remains from the treated
wastewater to be trucked to a local composting facility for essentially the cost
of transportation. A Mendocino County Air Quality Control Permit will be
required to operate the natural gas fired boiler at the new facility.
The Company has not received any notice from any governmental agency
that it is a potentially responsible person under any environmental law.
Research and Development
In 1995 the Company performed some research into low-alcohol and
non-alcoholic ale. Research and development activity 1996 was minimal. The
Company intends to use its original brewing facility at the Hopland Brewery to
develop and test market new brews after completion of the new facility.
Qualified Small Business Issuer
Federal and California tax laws provide a 50% exclusion of any gain
from the sale of "qualified small business stock." For shares to qualify for the
exclusion, several tests must be met. For instance, the shares must be purchased
directly from the Company, not in any later trading market, and the shares must
be held for at least five years.
A "qualified small business" must not have more than $50 million in
assets, at least 80% of which are used in a qualified trade or business
throughout the holding period. A "qualified trade or business" does not include
"operating a hotel, motel, restaurant, or similar business." It is uncertain
whether the Company's operation of the Hopland Brewery brewpub currently
prevents it from meeting the definition of "qualified small business", as the
brewing equipment in Hopland is presently used in both wholesale and retail
operations and no applicable regulations have been published to assist in making
such determination. Management believes, after consulting with its accountants,
that completing the new brewery will reduce the assets of the Company used in
the operation of the brewpub to well below 20%, but Management does not intend
to request any opinions or rulings on this issue at the present time.
The Company intends to submit reports if and to the extent any are
required under federal law to make the 50% exclusion from capital gains
available, and submitted such a report in California for 1995, the first year in
which California required such a report. Given the absence of applicable
regulations, there is no assurance that California taxing authorities will agree
with the information contained in the report. There are limitations on the
persons who may use any exclusion. Prospective investors should consult their
own tax advisors concerning the possible applicability of these exclusions.
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<PAGE>
Item 2. Description of Property.
The Company currently leases a 15,500 square foot building in Hopland.
The lease expires on September 1, 2004. Additionally, the Company leases a 4,000
sq. ft. portion of a warehouse, located approximately two miles from the Hopland
facility. The Company owns nine acres of land in Ukiah, California on which the
Company is completing its new brewery.
Item 3. Legal Proceedings.
The Company is not currently involved in any material litigation or
proceeding. The Company has received a written claim by a terminated distributor
that its termination was improper notwithstanding the language of the written
distribution agreement permitting either party to terminate by giving 30 days
written notice. No legal action has been instituted with respect to this claim
as of the date of this Report. Management does not believe that there is any
merit to the claim.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of the security holders
during the fourth quarter of 1996.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
<TABLE>
Mendocino Brewing's Common Stock was listed on the Pacific Stock
Exchange (symbol MBR) on February 21, 1995. The high and low closing sales
prices for the Common Stock on the Pacific Stock Exchange are set forth below
for the quarters indicated:
<CAPTION>
1995 1996
-------------------------------------------------- ---------------------------------------------------
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High $13.50 $9.25 $8.75 $8.12 $7.38 $10.82 $10.00 $8.38
Low $7.62 $7.12 $7.75 $7.00 $5.50 $5.82 $7.38 $5.75
</TABLE>
There were approximately 2,435 shareholders of record as of January 6,
1997. Management intends to retain Mendocino Brewing's earnings for use in the
business and does not expect the Company to pay cash dividends in the
foreseeable future. The Company's credit agreements provide that the Company
shall not declare or pay any dividend or other distribution on its Common Stock
(other than a stock dividend) or purchase or redeem any Common Stock, without
the lender's prior written consent. Management anticipates that such
restrictions will remain in effect for as long as the Company has significant
bank financing, including the long-term debt on the Ukiah real estate. The
holders of the Company's 227,600 outstanding shares of Series A Preferred Stock
are entitled to aggregate cash dividends and liquidation proceeds of $1.00 per
share before any dividend may be paid with respect to the Common Stock. The
Series A Preferred Shares are canceled after they have received their $1.00 per
share aggregate dividend. Management does not have any present intention to
declare or pay a dividend on the Series A Preferred Stock.
Item 6. Management's Discussion and Analysis.
The following discussion and analysis should be read in conjunction
with the Financial Statements and the Notes thereto and other financial
information included elsewhere in this Report. The discussion of results and
trends does not necessarily imply that these results and trends will continue.
-10-
<PAGE>
Overview
Mendocino Brewing's financial performance during 1996 was been
characterized by increased sales and gross profits from brewing operations and
decreased cost of goods sold as a percentage of net sales, offset by increased
marketing expenses, administrative expenses attributable to the Company's
expansion plan and the cost of being a public company, and the aggregate net
effect of certain one-time gains, certain one-time losses, and decreasing
interest earnings from the net proceeds of the Company's initial public
offering. Management attributes the increase in sales to the implementation of
new marketing strategies, including new point of sale materials and additional
field sales representatives, beginning in the second quarter of 1996.
Improvements to brewing operations in September 1995 increased capacity by 32%
and significantly reduced cost of goods as a percentage of sales.
Comparing 1996 to 1995, net sales were up 7.7%, gross profit was up
12.2%, and. cost of goods sold was down 2.0% as a percentage of net sales. In
1996, the bankruptcy of a distributor, increased promotional and labor expenses
associated with the operation of the Hopland Brewery brewpub and merchandise
store, and increased marketing expenses resulted in a 36.8% increase in
operating expenses. While Management plans to continue marketing expenses at a
high level and plans to continue promotional expenses at the Hopland Brewery
brewpub at current levels, the Company will not incur any additional losses
(approximately $33,000) attributable to the bankrupt distributor. Management's
decision to write off $47,600 in expenses incurred in exploring a long-term
alliance with a mid-western distribution company (classified as "other
expense"), when combined with a $117,500 decrease in net interest earnings as
the Company spent the cash proceeds from the public offering for equipment and
building construction, resulted in a $123,800 loss for 1996 compared to income
of $173,700 for the same period in 1995.
Results of Operations
The following tables set forth, as a percentage of net sales, certain
items included in Mendocino Brewing's Statements of Income. See Financial
Statements and Notes thereto.
Year Ended December 31,
-----------------------
1996 1995
------ ------
Statements of Income Data:
Sales ......................................... 104.30% 104.73%
Less excise taxes ............................. 4.30 4.73
------ ------
Net sales ..................................... 100.00 100.00
Costs of goods sold ........................... 49.74 51.77
------ ------
Gross profit .................................. 50.26 48.23
Operating expenses ............................ 54.75 43.10
------ ------
Income (loss) from operations ................. (4.49) 5.13
Other income (expense) ........................ (0.77) 4.03
------ ------
Income (loss) before income taxes ............. (5.26) 9.16
Provision for (benefit from) income taxes ..... (2.04) 4.29
------ ------
Net income (loss) ............................. (3.22)% 4.87%
====== ======
At December 31,
-------------------------------
1996 1995
--------------- ------------
Balance Sheet Data:
Cash and cash equivalents .............. $ 494,800 $1,696,100
Working capital ........................ (3,616,800) 959,100
Property and equipment ................. 9,270,300 3,954,100
Deposits and other assets .............. 304,100 71,000
Total assets ........................... 11,144,600 6,514,000
Long-term debt ......................... -- 554,900
Obligation under capital lease ......... 1,863,000 --
Total liabilities ...................... 6,844,200 2,089,800
Shareholder's equity ................... 4,300,400 4,424,200
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<PAGE>
Sales. Net sales increased 7.7% from $3,566,500 in 1995 to $3,839,700
in 1996. Management attributes the growth in sales to the implementation of new
marketing strategies, including new point of sale materials and additional field
sales representatives, beginning in the second quarter of 1996. A decrease in
sales in the first and fourth quarters of 1996 compared to 1995 was offset by an
increase in sales in the second and third quarters of 1996 compared to 1995.
Management attributes the decrease in the first quarter of 1996 to delays in
implementing the new marketing plan, the increases in the second and third
quarters of 1996 to the new marketing plan, and the decrease in the fourth
quarter to a wholesale price reduction in September 1996 (see "Business -
Pricing Strategy") plus a decrease in case shipments of 1.7%. Management
attributes approximately half of the sales increases in the second and third
quarters to increased sales to existing distributors and the other half to
geographic expansion. Retail sales at the Hopland Brewery brewpub and
merchandise store were down 2.4% for 1996 compared to 1995. Management
attributes the decline in sales at the Hopland Brewery brewpub and merchandise
store to slower off-premise bottled beer sales (due to increased availability of
MBC products outside of Hopland) offset by increased food sales.
Cost of goods sold. Cost of goods sold decreased as a percentage of net
sales by 2.0 percentage points from 1995 to 1996. The implementation of 24-hour
brewing in September 1995 significantly improved production efficiencies.
Management negotiated a reduction in the cost of bottles starting in the third
quarter of 1995.
Gross profit. Gross profit increased 12.2% from $1,720,000 in 1995 to
$1,930,000 in 1996.
Operating expenses. Operating expenses increased 36.8% from $1,537,300
in 1995 to $2,102,400 in 1996. Several factors contributed to the increases.
Marketing expenses increased by $404,500 from 1995 to 1996. Management
attributes the increases to $120,400 in increased point of sale and other
promotional and advertising costs, $77,400 in increased marketing and sales
labor, $54,000 to additional periodic price discounts to distributors, $48,700
in increased travel and lodging expenses incurred in developing new geographic
markets, $47,200 to increased distribution expense, $32,900 to the write-off of
a bad debt from a bankrupt distributor, and $23,900 in net miscellaneous
expenses. Most of the foregoing expenses were incurred in connection with the
Company's expansion plan. Management expects the Company to further increase
marketing expenses through 1997. General and administrative expense increased
from 1995 to 1996 by $71,600 consisting of $47,200 in increased labor costs,
$27,800 in increased legal fees, $18,400 in un-reimbursed glass recycling fees,
and $14,100 in costs associated with being a public company, offset by a
decrease in profit-sharing retirement plan contribution of $30,000 and a net
decrease of $5,900 in other costs. Finally, operating expenses at the Hopland
Brewery brewpub and merchandise store increased from 1995 to the comparable
period in 1996 by $89,000 due primarily to $55,500 in additional labor costs,
$17,900 in increased promotional expenses, and $15,600 in net miscellaneous
expenses.
Impact of Inventory Aging Policies. During the time that Mendocino
Brewing's distributors were on allocation, the Company shipped all of its
product promptly upon production. Product freshness was not an issue.
Inventories of packaged beer increased when the Company initially increased its
capacity in late 1995 and early 1996 before implementing its new marketing plan.
The Company does not use preservatives in its products, and accordingly the
packaged beer has a shelf life of approximately 120 days from the release date.
The Company's policy is to sell product to distributors with sufficient
remaining shelf life to ensure that the beer will be fresh when sold to the
consumer. Product that remains unsold after 120 days is returned to the Company
for destruction or other disposition. In accordance with these policies, in the
third quarter of 1996, the Company wrote-down its inventories by $51,000
representing approximately 6,000 cases of product remaining from its initial
overproduction. The write-down was reflected as an increase in cost of goods
sold.
Other income (expense). Other income (expense) decreased by $173,600 in
1996 compared to the same period for 1995 primarily as a result of a decrease of
$117,500 in net interest earnings as cash from the initial direct public
offering was used for the expansion project, a write-off of $38,300 in
professional expenses and $9,300 in product development costs incurred in
exploring a long-term alliance with a mid-western distribution company, and the
non-recurrence of $15,300 in one-time refunds of workers' compensation premiums.
These expenses were offset by $3,600 in income from disposition of unneeded
assets and $3,200 additional miscellaneous income.
-12-
<PAGE>
Provision for (benefit from) income taxes. The Company recognized a
benefit from income taxes in 1996 of $78,200 compared to a tax provision of
$173,700 for the same period in 1995. See "Notes to Financial Statements, Note 1
- - Description of Operations and Summary of Significant Accounting Policies and
Note 12 - Income Taxes."
Net income (loss). For 1996 compared to the same period for 1995, net
income was down $297,500 for a net loss of $123,800 compared to net income of
$173,700 due to a $565,000 increase in operating expense and a $173,600 decrease
in other income (expense) which more than offset a $210,000 increase in gross
profit and a $231,100 reduction in the provision for income taxes.
Segment Information
Mendocino Brewing's business presently consists of two segments. The
first is brewing for wholesale to distributors and other retailers. This segment
accounted for 76.6% of the Company's 1996 annual sales. The second segment
consists of brewing beer for sale along with food and merchandise at the
Company's brewpub and retail merchandise store, the Hopland Brewery. This
segment accounted for 23.4% of the Company's 1996 annual sales, 9.3% of which
consisted of the sale of draft and bottled beer, and the remaining 14.1% of
which consisted of sales of food and merchandise. Wholesale and retail beer
sales in both segments combined comprised 85.9% of the Company's annual sales in
1996. See "Notes to Financial Statements, Note 13 - Segment Information."
Mendocino Brewing is now in the process of increasing its brewing
capacity by more than three times (18,000 bbl. to 60,000 bbl.). Proceeds from
the sale of all of the stock offered in the Company's current direct public
stock offering would permit the Company to expand its operations to up to 75,000
bbl. per year, an aggregate increase from the Company's current capacity of
18,000 bbl. of more than four times. (See "Business: New Brewery") As the
Company does not intend to expand its brewpub operations, Management expects
that retail sales, as a percentage of total sales, will decrease proportionally
to the expected increase in the Company's wholesale sales.
Seasonality
Beer consumption nationwide has historically increased by approximately
20% during the summer months. Mendocino Brewing's wholesale distributors were on
allocation while the Company's annual capacity was capped at 13,600 bbl., so
seasonality had little effect on wholesale sales through late 1995. It is not
clear to what extent seasonality will affect the Company as it expands its
capacity and its geographic markets. The Company brews four seasonal beers:
Springtide Ale in March, Eye of the Hawk Select Ale from July through October,
Frolic Shipwreck Ale 1850 in July, and Yuletide Porter in November and December.
These seasonal beers tend to augment sales during the periods in which they are
available. Retail operations, which depend largely on tourist traffic,
historically have been higher in the third and fourth quarters.
Financing the New Brewery.
New Brewery Cost. The presently estimated cost of the new brewery at
its initial annual capacity of 60,000 bbl. is $11.4 million. This includes $0.8
million for the land, $7.1 million for improvements to the real estate, $3.1
million for equipment, and $0.4 million for financing costs. Increasing the
initial annual capacity of the new brewery to 75,000 bbl. will require an
additional expenditure for equipment of approximately $0.5 million. Of this
amount, approximately $9.84 million has been paid or provided for from cash
raised in the Company's initial direct public offering and the proceeds of debt
described below and cash from operations. The balance of approximately $1.56 -
$2.06 million will have to be funded from the proceeds of the Company's current
direct public offering, cash from operations, and/or other sources as described
below.
Construction Financing. Mendocino Brewing has obtained a $2.7 million
construction loan secured by a first priority deed of trust on the Ukiah land
and improvements and the proceeds of the current direct public offering from the
Savings Bank of Mendocino County along with a written commitment to convert the
construction loan to a 15 year term loan upon successful completion of the new
brewery, subject to certain conditions. As of March 31, 1997, approximately 89%
of the construction loan had been funded. The construction loan bears interest
at the lender's prime plus 2% (initially 10.25%), payable monthly. The lender
has agreed to extend the due date to July 1, 1997, and the necessary
documentation is pending. Assuming that the loan is extended, the current
commitment provides that upon
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<PAGE>
conversion, the loan will bear interest at the then prevailing 5 Year Treasury
Constant Maturity Index (but not less than 10%), with a maximum for the first
five years at 2% above the initial fully indexed rate, and a maximum during the
remaining term of the loan at 3% above the initial fully indexed rate at the
beginning of the remaining term. The minimum annual interest rate is 8%. The
loan will be over 25 years with a balloon payment upon maturity. The lender's
commitment letter states that the lender will convert the unpaid principal at
maturity to a fully amortized 10-year loan subject to terms and conditions to be
agreed upon at that time. The commitment letter proposes to require the Company
to pledge all proceeds of the Company's current direct public offering in excess
of $2.5 million as collateral for the 15-year term loan, with the provision that
the lender will release the funds from the pledge to purchase additional
equipment if the Company is meeting its sales and revenue objectives.
Equipment Lease. FINOVA Capital Corporation has also agreed to lease
new brewing equipment with a total cost of approximately $2.07 million to
Mendocino Brewing for a term of 7 years with monthly rental payments of
approximately $29,000 each. The lease commenced in December 1996. As of March
31, 1997, approximately 81% of the lease had been funded. The balance of the
funds are deemed to have been advanced but are held by FINOVA as cash collateral
pending acquisition of certain additional equipment. Before that time, FINOVA
advanced $750,000 to the Company with interest at the Citibank prime plus 3%. At
expiration of the initial term of the lease, the Company may purchase the
equipment at its then current fair market value but not less than 25% nor more
than 30% of the original cost of the equipment, or at the Company's option, may
extend the term of the lease for an additional year at approximately $45,600 per
month with an option to purchase the equipment at the end of the year at then
current fair market value. The lease is not pre-payable.
Seller Financing of Ukiah Real Estate. The seller of the Ukiah land has
a note, secured by a third priority deed of trust on the land, with a remaining
principal balance as of December 31, 1996 of approximately $262,600 at 9% annual
interest payable in monthly installments of principal and interest of $2,380
with the balance due at maturity on June 27, 1997.
WestAmerica Loan. WestAmerica Bank of Santa Rosa, California has loaned
Mendocino Brewing $600,000 secured by Mendocino Brewing's accounts receivable
and inventory. The loan is fully funded and bears interest at a variable
interest rate of prime plus 1.5% payable monthly and matures on April 27, 1997.
WestAmerica Bank has not indicated to the Company whether it will renew the loan
or on what terms. The Company has an outstanding commitment letter from
WestAmerica Bank to convert the $600,000 term loan to a revolving line of credit
with an advance rate of 80% of qualified accounts receivable and 25% of
inventory. Conversion of the loan by WestAmerica Bank will likely depend, among
other things, on whether WestAmerica Bank renews the loan at maturity. As the
Company's sales continue to expand, the amount of inventory and receivables
financing available should increase proportionately, assuming an otherwise sound
financial condition. These forward looking statements are subject to risks and
uncertainties. Even if the Company's accounts receivable and inventory grows in
quantity, credit may be unavailable for other reasons relating to the Company's
business, financial condition, and results of operations, the craft brew
industry, the lending industry, or economic conditions in general. To the extent
that the loan is not extended or refinanced, the Company will be required to
repay the loan out of cash from operations, the net proceeds of the Company's
current direct public offering, or the proceeds of another debt or equity
financing, a strategic alliance, or a joint venture.
Vendor Financing. The general contractor for the new brewery, BDM
Construction Co., Inc. ("BDM"), has agreed to defer up to $900,000 in fees
otherwise owed or to become payable on December 31, 1996, subject to performance
by BDM of its obligations under the construction contract, until January 31,
1997 with interest at 12% per annum. As of December 31, 1996, $300,000 had been
deferred under this arrangement. Additional amounts payable to BDM after January
31, 1997 are outstanding and no modifications have been made to the deferral
arrangement to address the current circumstances. The deferral arrangement is
secured by a second priority deed of trust on the Ukiah land and improvements,
and by 300,000 shares of Mendocino Brewing's Common Stock. In the event of
default, BDM is required to proceed against the Common Stock before initiating
any proceeding against the real estate. The Common Stock collateral was issued
to BDM by the Company pursuant to Section 4(2) of the Securities Act of 1933
subject to the restrictions (a) that the shares shall be canceled if the amounts
owed BDM are paid in full, (b) that if full amount owed BDM is not paid, the
shares must be sold in a commercially reasonable manner as specified in the
California Commercial Code, and (c) that any shares not needed to be sold to
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<PAGE>
satisfy the obligation to BDM shall be canceled. Under California law, BDM may
not retain the shares in satisfaction of the obligation without the written
consent of the Company given after an event of default. Management had planned
to pay the Company's obligation to BDM out of the proceeds of the Company's
current direct public offering, but the Company has not yet raised net proceeds
sufficient to do so. See "New Brewery Cost." BDM has the right to require the
Company to register the shares issued for its account for sale to the public. As
of April 9, 1997, BDM has not taken any action to enforce the Company's
obligations to it. To the extent that the proceeds of the Company's current
direct public offering are insufficient, the Company will be required to pay the
obligation out of cash from operations, proceeds from the sale of the shares
held as collateral, or the proceeds of another debt or equity financing,
strategic alliance, or a joint venture.
Other Financing. Mendocino Brewing has entered into a keg management
agreement with MicroStar Keg Management LLC. Under this arrangement, MicroStar
provides the Company with half-barrel kegs for which the Company pays a filling
fee. Distributors return the kegs to MicroStar instead of the Company. MicroStar
then supplies the Company with additional kegs. If the agreement terminates, the
Company is required to purchase a certain number of kegs from MicroStar. The
Company would probably finance the purchase through debt or lease financing, if
available.
Remaining Costs. To finance the anticipated cost of the new brewery
(approximately $1.56 million for a 60,000 bbl. brewery and $2.06 million for a
75,000 bbl. brewery) management initiated the direct public offering which is
currently under way. If the proceeds from such offering are not sufficient and
timely, financing will need to be provided by vendors, future operations, other
debt or equity financing, or a strategic alliance or joint venture or expansion
plans and operations will need to be deferred or curtailed. As of April 9, 1997,
the Company did not have any enforceable commitment for the necessary additional
financing.
Liquidity and Capital Resources
Generally. The expansion now underway has had and will continue to have
a material impact on Mendocino Brewing's assets, liabilities, commitments for
capital expenditures, and liquidity. Capital resources for the expansion plan
have been supplied by the net proceeds of Mendocino Brewing's initial public
offering and debt and equipment financing as described above. Working capital
for day to day business operations has historically been provided primarily
through operations. Proceeds from operations are not expected to provide
sufficient working capital for day to day operations as the Company expands.
New Brewery. See "-- Financing the New Brewery" above.
Debt to Equity Ratio. Upon completion of the new brewery, Mendocino
Brewing will have long-term debt and equipment financing commitments (including
current portions) of at least $5.0 million. The exact amount to be financed will
depend on the results of the Company's current direct public offering, the
amount and type of any additional equipment purchased, and the extent to which
the Company obtains debt or lease financing for additional equipment. On a pro
forma basis, as of December 31, 1996 assuming that the Company's $2.7 million
short-term construction loan had instead been a long term loan, the Company's
ratio of long-term debt to shareholder's equity, which was actually 0.47 to 1,
would have been 1.11 to 1.
Impact of Expansion on Cash Flow. Mendocino Brewing must make timely
payment of its debt and lease commitment to continue in operation. Increased
capacity will also place additional demands on the Company's working capital to
pay the cost of additional sales and marketing activities and staff, production
personnel, and administrative staff and to fund increased purchases of supplies.
There will be a lag between the time the Company must incur some or all of these
costs and the time the Company realizes revenue from increased sales. Working
capital to fund these expenses will have to be provided by trade terms offered
by suppliers and vendors, the proceeds of the Company's current direct public
offering, additional debt or equity from other sources, and/or deferral of
certain expenses. As of April 9, 1997, the Company did not have any enforceable
commitment for the necessary additional financing.
Direct Public Offering. In February 1997 the Company commenced a direct
public offering of 600,000 shares of common stock at an offering price of $8.50.
As of March 31, 1997, the Company had received subscriptions for approximately
16,000 shares ($136,000).
-15-
<PAGE>
Strategic Alliances and Joint Ventures. The rapid growth of the craft
beer industry has been characterized in part by a variety of consolidations,
strategic alliances, and joint ventures. Mendocino Brewing and its President,
Michael Laybourn, are very visible within the craft brew segment because of the
Company's place in the history of modern craft brewing, the distinctiveness of
its Red Tail Ale and Blue Heron Pale Ale labels, and Mr. Laybourn's leadership
positions in industry trade groups. See "Management." From time to time
Mendocino Brewing has received indications of interest in forming a strategic
alliance, joint venture, or other relationship. To date, only one such proposal
evolved beyond a term sheet before the Company withdrew from negotiations. The
Company is, however, carrying on discussions with certain parties that could
result in a strategic alliance or joint venture. The Company's primary goal in
any such arrangement would be to obtain additional capital to expand the
capacity of the new brewery to 200,000 bbl. per year and enter into an
arrangement for sharing the expanded brewery capacity to provide optimal
utilization of overhead and thereby reduce unit costs and/or access additional
channels of domestic and/or international distribution. Creating additional
value for shareholders is an important objective of these goals, but providing
liquidity by way of a sale or merger is not. Nevertheless, a sale or merger of
the Company is among the possible consequences of such discussions. The Company
offers no assurances or estimates of the possibility that the Company might
enter into such a strategic alliance or joint venture at any time in the
foreseeable future.
Item 7. Financial Statements.
The information required by this item is set forth at Pages F-1 through
F-15 to this Report.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
With Section 16(a) of the Exchange Act.
Executive Officers, Directors, and Significant Employees
The executive officers, directors, and significant employees of the
Company, and their ages as of March 31, 1997, are as follows:
Name Age Position
- ------------------- ----- ---------------------------------------------------
H. Michael Laybourn 58 Chief Executive Officer, President, and Chairman of
the Board
Norman H. Franks 50 Chief Financial Officer, Vice President, Treasurer,
and Director
Michael F. Lovett 50 Marketing Director, Secretary, and Director
Eric G. Bradley* 59 Director
Daniel R. Moldenhauer* 63 Director
Thomas I. Palmtag 53 National Sales Manager
John Scahill 57 Facilities Manager
Donald Barkley 43 Master Brewer
- ----------
*Member of the Compensation and Audit Committees
H. Michael Laybourn, co-founder, has served as the Company's Chief
Executive Officer and President since its inception in 1982. Mr. Laybourn was
elected a director in November 1993 when the Company began the process of
converting from a limited partnership to a corporation and Chairman of the Board
in June 1994. Before co-founding Mendocino Brewing, Mr. Laybourn co-owned and
operated Thunder Road Design and Construction. Mr. Laybourn is a Vice President
of the California Small Brewers Association and Chairman of the Board of
Directors of the Brewers Association of America. Mr. Laybourn holds a Bachelor
of Fine Arts degree from Arizona State University.
-16-
<PAGE>
Norman H. Franks, co-founder, has served as the Company's Chief
Financial Officer and Vice President since its inception in 1982. Mr. Franks was
elected a director in November 1993 when the Company began the process of
converting from a limited partnership to a corporation. Before co-founding
Mendocino Brewing, Mr. Franks co-owned and operated Thunder Road Design and
Construction. Mr. Franks holds a Bachelor of Science degree in mechanical
engineering from the University of California, Berkeley.
Michael F. Lovett joined the Company in 1983 as Assistant Master Brewer
and became Marketing Director in 1987, serving since that time under that or
other titles. Mr. Lovett was elected a director in November 1993 when the
Company began the process of converting from a limited partnership to a
corporation and was appointed Secretary in June 1994. Between 1980 and 1983, Mr.
Lovett was Vice President Quality Control of New Albion Brewing Co. From 1976 to
1980, Mr. Lovett was Production Superintendent at Farm Foods in San Francisco.
He is the immediate past Membership Chairman and a past Technical Chairman of
the Master Brewers Association of the Americas. Mr. Lovett holds a B.A. degree
in Psychology from San Francisco State College.
Eric G. Bradley became a director in June 1994. Mr. Bradley has been a
business and financial consultant since 1988. For the preceding 20 years, he was
employed by Kaiser Aluminum & Chemical Corp., in positions rising from Division
Controller to Business Manager. Mr. Bradley is a Fellow of the Institute of
Chartered Accountants (UK) and a Certified Personal Financial Planner.
Daniel R. Moldenhauer became a director in June 1994. Mr. Moldenhauer
is a management consultant. He was president of Conex Products Inc. of Dublin,
California from 1988 to 1990, a company formed from assets divested by Kaiser
Aluminum & Chemical Corp. and later sold to Coleman Cable Systems. Mr.
Moldenhauer served in several capacities with Kaiser Aluminum & Chemical Corp.
from 1971 to 1988, most recently as general manager of a subsidiary.
Thomas I. Palmtag joined the Company in January 1997 as National Sales
Manager. Immediately before joining the Company, he served as President of two
regional beer distributors, Colorado Beverage Distributing Co., Inc. of Colorado
Springs (1994 - 1995) and Mesa Distributing Company, Inc. of San Diego (1993 -
1994), both Miller distributors owned by Liquid Investments, Inc. in San Diego.
From 1980 to 1993, Mr. Palmtag served in various capacities for Coast
Distributing Company in San Diego, an Anheuser-Busch distributor, most recently
as Vice President and General Manager (1984 - 1993). From 1977 through 1980 Mr.
Palmtag was employed as a Marketing Manager and Sales Manager for Anheuser-Busch
in Riverside and Sylmar, California. From 1967 through 1977 he was employed in
various capacities for beer distributors in Illinois and California. Mr. Palmtag
holds a B.S. degree from the University of Wisconsin.
John Scahill, co-founder, has served as the Company's Facilities
Manager since its inception. Before co-founding the Company Mr. Scahill was a
self-employed rancher. Mr. Scahill has a background in construction and
counseling and holds a B.S. degree in sociology from the University of
California, Berkeley.
Donald Barkley joined the Company in 1983 as Master Brewer. Immediately
before joining the Company, Mr. Barkley was the Head Brewer and Plant Manager at
New Albion Brewing Co. from 1981 to 1983. Mr. Barkley joined New Albion Brewing
Co. in 1978 and held several positions. In 1993 Mr. Barkley was the President
and representative to the national board of governors of the Master Brewers
Association of the Americas, Northern California District. Mr. Barkley holds a
B.S. degree in fermentation science from the University of California, Davis.
Director Term of Office
Directors are elected at each annual meeting of shareholders to serve
until their successors are elected and qualified at the next annual meeting of
shareholders.
Item 10. Executive Compensation.
The following table sets forth, for the fiscal years ended December 31,
1995 and December 31, 1996, annual compensation, including salary, bonuses, and
certain other compensation, paid by the Company to the Company's Chief Executive
Officer, Chief Financial Officer, and to all executive officers as a group. None
of the Company's other executive officers' total compensation exceeded $100,000
for fiscal 1996.
-17-
<PAGE>
<TABLE>
<CAPTION>
Annual Compensation
Fiscal ------------------- All Other
Name and Principal Position Year Salary Bonus Compensation*
- --------------------------- ------ ---------- --------- -------------
<S> <C> <C> <C> <C>
H. Michael Laybourn............................ 1995 $ 89,016 $ 22,255 $ 9,804
Chief Executive Officer 1996 89,016 0 7,053
Norman H. Franks............................... 1995 79,008 23,702 5,835
Chief Financial Officer 1996 79,008 0 3,567
All executive officers as a group.............. 1995 233,464 55,758 20,701
(3 persons) 1996 233,464 10,792 13,662
- ----------
<FN>
* Includes an allowance for health insurance, life insurance, disability
insurance, and participation in the Company's profit sharing retirement
plan (annual discretionary contributions by the Company of up to 15% of
gross compensation).
</FN>
</TABLE>
Director Compensation
The Company's inside directors do not receive any cash compensation for
their service on the Board of Directors. Outside directors receive $600 per
meeting. No additional fees are paid for attending Compensation or Audit
Committee meetings. Directors may be compensated for certain expenses in
connection with their attendance at Board meetings. Since July 1996, Director
Daniel R. Moldenhauer has acted as a project management consultant for the
Company with respect to its ongoing construction project.
Employment Agreements and Change in Control Arrangements
The Company has entered into employment agreements with its President,
Chief Financial Officer, and Marketing Director. The agreements call for minimum
annual base salary of $89,000, $79,000, and $55,000 respectively. The agreements
provide for bonus awards of a percentage of their respective base salaries upon
the satisfaction of performance objectives established by the Compensation
Committee (subject to the inherent oversight powers of the Board) and approved
by the employee. The agreements specify that the performance objectives must be
reasonably attainable, must not be probable of attainment without significant
effort, and must reflect or indicate that value has been created for the
shareholders. The Compensation Committee may award a bonus regardless of whether
previously specified objectives are realized if, as a result of an employee's
efforts or leadership, the Company has achieved other goals that reflect or
indicate that value has been created for the shareholders.
The agreements also require the Company to grant options to purchase up
to 20,000, 20,000, and 10,000 shares, respectively, of Company Common Stock
pursuant to the Company's 1994 Stock Option Plan at exercise prices of $9.2125,
$9.2125, and $8.375 per share, respectively. The options vest in equal monthly
increments over five years. The option agreements have terms of 5 years, 5
years, and 10 years, respectively. The options were granted in January 1997.
The agreements do not provide for any benefits as a result of
resignation or retirement. The Board of Directors has discussed the subject of,
and might in the future grant, retirement benefits to Mendocino Brewing's
founders in addition to their participation in the Company's profit sharing
plan.
The agreements provide for severance benefits in the form of 36, 36,
and 18 months, respectively, of salary continuation if the Company actually or
constructively terminates the employee's employment without cause as defined in
the agreement. If the actual or constructive termination occurs within one year
after a change in control as defined in the agreement, the agreements provide
for an additional lump sum benefit of up to $500,000, $500,000, and $250,000
respectively. Any amount payable pursuant to these severance provisions will be
deferred indefinitely and without interest to the extent the amount would
otherwise constitute an excess parachute payment as defined in Section 280G of
the Internal Revenue Code. Amounts so deferred may be paid at such time in the
future, if any, that no portion of the payment will be considered an excess
parachute payment.
-18-
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information known to the Company
regarding the beneficial ownership of the Company's Common Stock and Series A
Preferred Stock as of March 31, 1997, and as adjusted to reflect the sale of the
shares offered in the Company's current direct public offering, for (a) each
shareholder known by the Company to own beneficially 5% or more of the
outstanding shares of its Common Stock or Series A Preferred Stock; (b) each
director; and (c) all directors and executive officers of the Company as a
group. Except as otherwise noted, Management believes that the beneficial owners
of the Common Stock and Series A Preferred Stock listed below, based on
information furnished by such owners, have sole investment and voting power with
respect to such shares, subject to community property laws where applicable.
<TABLE>
COMMON STOCK:
<CAPTION>
Shares Percentage of Shares Outstanding(1)
Directors, Executive Officers, Beneficially March 31, 1997 Pro Forma(2)
and 5% Shareholders Owned 2,322,222 shares 2,922,222 shares
------------------------------- ------------- ---------------- ----------------
<S> <C> <C> <C>
H. Michael Laybourn*................ 272,367 11.73% 9.32%
Norman H. Franks*(3)................ 244,512 10.53% 8.36%
Michael F. Lovett*(4)............... 93,034 4.01% 3.18%
Eric G. Bradley..................... 1,000 0.04% 0.03%
1056 Park Lane, Piedmont, CA 94610
Daniel R. Moldenhauer............... 500 0.02% 0.02%
662 St. Ives Court
Walnut Creek, CA 94598
John Scahill*....................... 248,809 10.71% 8.51%
All directors and executive
officers as a group (5 persons) .. 611,413 26.33% 20.92%
SERIES A PREFERRED STOCK:
Shares
Directors, Executive Officers, Beneficially Percentage of
and 5% Shareholders Owned Shares Outstanding
------------------------------ ------------ -------------------
H. Michael Laybourn.................. 6,100 2.68%
All directors and executive
officers as a group (five persons) 6,100 2.68%
* c/o Mendocino Brewing Company, Inc.
13351 Hwy. 101 South
Hopland, CA 95449-0400
<FN>
- ----------
1 Does not include 300,000 shares issued to BDM Construction Co., Inc. ("BDM")
as security for the payment of up to $900,000 owed or to be owed to BDM for
general contractor services in connection with the new brewery. BDM
presently has the power to vote the 300,000 shares. Does not include 16,000
shares, subscripitions for which the Company had received but not accepted
as of March 31, 1997.
2 Assumes sale of all 600,000 shares offered pursuant to the Company's currant
direct public offering.
3 Does not include 145 shares owned by Mr. Franks wife. Mr. Franks discliams
any beneficial ownership of shares held in the name of his wife.
4 Mr. Lovett's shares are pledged to a commercial bank as security for a
personal loan.
</FN>
</TABLE>
-19-
<PAGE>
Item 12. Certain Relationships and Related Transactions.
There have been no transactions during the last two years, and there
are now no proposed transactions, involving more than $60,000 between the
Company and any executive officer, director, nominee, 5% beneficial owner of any
class of the Company's securities, or member of the immediate family of any of
the foregoing persons, in which one or the foregoing individuals or entities had
a material interest, except as follows:
On October 11, 1996, in recognition of Mr. Laybourn's personal guaranty
of the equipment lease with FINOVA Capital Corporation described in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financing the New Brewery - Equipment Lease," the Company agreed to
grant President Michael Laybourn a 5-year option to purchase 12,500 shares of
Common Stock of the Company at an exercise price of $8.80 per share. The option
was granted in January 1997. Mr. Laybourn's guaranty automatically terminated
when FINOVA made the final payment for the purchase price of the equipment to
the manufacturer.
The Company has entered into written employment agreements with its
President, Chief Financial Officer, and Marketing Director as described in
"Management -- Employment Agreements and Change in Control Arrangements."
It is the Company's policy that all transactions with officers,
directors, nominees, 5% beneficial owners of any class of the Company's
securities, and members of the immediate families of any of the foregoing
persons be on terms no less favorable to the Company than could be obtained from
unaffiliated third parties. The Company's bylaws provide that the Board of
Directors may approve loans of money or property to, and guaranties of the
obligations of, officers of the corporation, and may adopt employee benefit
plans authorizing such loans and guaranties to officers of the corporation, if
the vote of any interested director or directors is not counted and the Board
determines that such loan, guaranty, or plan may reasonably be expected to
benefit the corporation.
Item 13. Exhibits and Reports on Form 8-K.
Exhibit
Number Description of Document
- ------- -------------------------------
3.1 (A) Articles of Incorporation, as amended, of the Company
3.2 (B) Bylaws of the Company (Incorporated by referenced from the
Company's Report on Form 10-KSB for the annual period ended
December 31, 1994 previously filed with the Commission.)
4.1 Articles 5 and 6 of the Articles of Incorporation, as
amended, of the Company (Reference is made to Exhibit 3.1.)
4.2 Article 10 of the Restated Articles of Incorporation, as
amended, of the Company (Reference is made to Exhibit 3.2.)
4.3 (A) Form of Common Stock Certificate (Incorporated by reference
from the Company's Registration Statement dated June 15,
1994, as amended, previously filed with the Commission,
Registration No. 33-78390-LA.)
10.1 (A) Mendocino Brewing Company Profit Sharing Plan.
10.2 (A) Wholesale Distribution Agreement between the Company and Bay
Area Distributing.
10.3 (A) Wholesale Distribution Agreement between the Company and
Golden Gate Distributing.
10.4 (F) Letter of Intent with Vitro Packaging, Inc.
10.5 (A) Sales Contract between the Company and John I. Hass, Inc.
10.6 (A) Lease Agreement between the Company and Kohn Properties.
10.7 (A) Lease Agreement between the Company and Associated Vintage
Group, Inc.
10.8 (F) Commitment letter from Savings Bank of Mendocino County
(previously filed as Exhibit 19.9).
10.9 (A) Letter of intent from California Statewide Certified
Development Corporation.
-20-
<PAGE>
Exhibit
Number Description of Document
- ------- -------------------------------
10.10 (A) 1994 Stock Option Plan (previously filed as Exhibit 99.6).
10.11 (C) Commercial Real Estate Purchase Contract and Receipt for
Deposit (previously filed as Exhibit 19.2).
10.12 (B) Proposal from Warren Capital Corporation.
10.13 (C) Brewery Fixtures Construction Agreement with Enerfab, Inc.
(previously filed as Exhibit 19.3).
10.14 (D) Installment Note between Ukiah Redevelopment Agency and
Langley et al. (previously filed as Exhibit 19.5).
10.15 (E) Agreement to Implement Condition of Approval No. 37 of the
Site Development Permit 95-19 with the City of Ukiah,
California (previously filed as Exhibit 19.6).
10.16 (F) Standard Form of Agreement Between Owner and Architect for
Designated Services between the Company and Victor Lopes.
10.17 (F) Liquid Sediment Removal Services Agreement with Cold Creek
Compost, Inc.
10.18 (F) Promissory Note for $76,230 in favor of Langley et al.
10.19 (G) Construction agreement with BDM Construction Company, Inc.
10.20 (G) $60,000 Note payable to BDM Construction Company, Inc.
10.21 (G) Agreement to modify note and deed of trust dated June 6, 1995
with Langley, et al.
10.22 (G) Agreement to modify note dated June 6, 1995 with Langley, et
al.
10.23 (G) Amendment to installment note payable to Langley, et al.
10.24 (G) Manufacturing Business Expansion and Relocation Agreement
with the City of Ukiah.
10.25 (G) Manufacturing Business Expansion and Relocation Agreement
with the Ukiah Redevelopment Agency.
10.26 (G) Consulting Agreement with Daniel R. Moldenhauer.
10.27 (H) Business Loan Agreement with WestAmerica Bank.
10.28 (J) Change in Terms Agreement with WestAmerica Bank.
10.29 (J) Letter Agreement Concerning Use of Proceeds with WestAmerica
Bank.
10.30 (J) Commitment Letter from WestAmerica Bank.
10.31 (J) Business Loan Agreement with the Savings Bank of Mendocino
County.
10.32 (J) Construction Loan Agreement with the Savings Bank of
Mendocino County.
10.33 (J) $2,700,000 Note in favor of the Savings Bank of Mendocino
County.
10.34 (J) Assignment of Deposit Account in favor of the Savings Bank of
Mendocino County.
10.35 (J) Commitment Letter from the Savings Bank of Mendocino County.
10.36 (J) Equipment Lease with FINOVA Capital Corporation.
10.37 (J) Tri-Election Rider to Equipment Lease with FINOVA Capital
Corporation.
10.38 (J) Master Lease Schedule with FINOVA Capital Corporation.
10.39 (J) Advance and Subordination Agreement among the Company, FINOVA
Capital Corporation, and Enerfab, Inc.
10.40 (J) $900,000 Note in favor of BDM Construction Co., Inc.
10.41 (J) Letter Agreement Concerning Use of Proceeds with BDM
Construction Co., Inc.
10.42 (J) Employment Agreement with H. Michael Laybourn.
-21-
<PAGE>
Exhibit
Number Description of Document
- ------- -------------------------------
10.43 (J) Employment Agreement with Norman H. Franks.
10.44 (J) Employment Agreement with Michael F. Lovett.
10.45 (J) Employment Agreement with John Scahill.
10.46 (A) 1994 Stock Option Plan (previously filed as Exhibit 99.6)
19.1 Keg Management Agreement with MicroStar Keg Management LLC.
19.2 Form of Change in Terms Agreement with the Savings Bank of
Mendocino County
27 Financial Data Schedule
- --------------------------------
(A) Incorporated by reference from the Company's Registration
Statement dated June 15, 1994, as amended, previously filed
with the Commission, Registration No. 33-78390-LA.
(B) Incorporated by referenced from the Company's Report on Form
10-KSB for the annual period ended December 31, 1994
previously filed with the Commission.
(C) Incorporated by referenced from the Company's Report on Form
10-QSB for the quarter period ended March 31, 1995 previously
filed with the Commission.
(D) Incorporated by referenced from the Company's Report on Form
10-QSB for the quarter period ended June 30, 1995 previously
filed with the Commission.
(E) Incorporated by referenced from the Company's Report on Form
10-QSB for the quarter period ended September 30, 1995
previously filed with the Commission.
(F) Incorporated by referenced from the Company's Report on Form
10-KSB for the annual period ended December 31, 1995
previously filed with the Commission.
(G) Incorporated by referenced from the Company's Report on Form
10-QSB for the quarter period ended June 30, 1996 previously
filed with the Commission.
(H) Incorporated by referenced from the Company's Report on Form
10-QSB/A No. 1 for the quarter period ended June 30, 1996
previously filed with the Commission.
(J) Incorporated by reference from the Company's Registration
Statement dated February 6, 1997, as amended, previously
filed with the Commission, Registration No. 333-15673.
The registrant did not file any Reports on Form 8-K during the last quarter of
the period covered by this report.
-22-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereto duly authorized.
(Registrant) Mendocino Brewing Company, Inc.
By: /s/ H. Michael Laybourn
-------------------------------
H. Michael Laybourn, Chairman
of the Board and Chief
Executive Officer
Date: April 15, 1997
Pursuant to the requirements of Section 13 of the Exchange Act, this report
has been signed by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
By: /s/ Norman H. Franks
-------------------------------
Norman H. Franks, Director and
Chief Financial Officer
Date: April 14, 1997
By: /s/ Michael F. Lovett
-------------------------------
Michael F. Lovett, Director
Date: April 14, 1997
By:
-------------------------------
Eric G. Bradley, Director
Date: April _________ , 1997
By:
-------------------------------
Daniel R. Moldenhauer, Director
Date: April _________ , 1997
-23-
<PAGE>
- --------------------------------------------------------------------------------
MENDOCINO BREWING COMPANY, INC.
INDEPENDENT AUDITOR'S REPORT
AND
FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
CONTENTS
PAGE
INDEPENDENT AUDITOR'S REPORT...............................................F - 1
FINANCIAL STATEMENTS
Balance sheets........................................................F - 2
Statements of operations..............................................F - 4
Statements of stockholders' equity....................................F - 5
Statements of cash flows..............................................F - 6
Notes to financial statements.........................................F - 7
- --------------------------------------------------------------------------------
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Mendocino Brewing Company, Inc.
We have audited the accompanying balance sheets of Mendocino Brewing Company,
Inc., as of December 31, 1996 and 1995, and the related statements of
operations, stockholders' equity and cash flows for each of the two years ended
December 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Mendocino Brewing Company,
Inc., as of December 31, 1996 and 1995, and the results of its operations and
its cash flows for each of the two years ended December 31, 1996, in conformity
with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has significant costs associated with the
construction of its new brewery and other debt that will become due in 1997.
While the Company is presently pursuing various strategies, it does not have any
current commitments for additional capital or financing to meet the payment
demands, if made. These matters raise substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regards to these
matters are also described in Note 2. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/Moss Adams LLP
Santa Rosa, California
January 31, 1997, except for Note 2 as to which the date is March 31, 1997
Page F - 1
<PAGE>
MENDOCINO BREWING COMPANY, INC.
BALANCE SHEETS
- --------------------------------------------------------------------------------
December 31, 1996 1995
- --------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 494,800 $ 1,696,100
Accounts receivable 317,400 458,900
Inventories 380,500 256,200
Prepaid expenses 58,600 47,100
Refundable income taxes 71,900 --
Deferred income taxes 23,100 15,500
----------- -----------
Total current assets 1,346,300 2,473,800
----------- -----------
PROPERTY AND EQUIPMENT 9,270,300 3,954,100
----------- -----------
OTHER ASSETS
Label development costs, net of amortization 17,400 15,100
Deferred stock offering costs 202,000 11,400
Deposits and other assets 304,100 59,600
Deferred income taxes 4,500 --
----------- -----------
528,000 86,100
----------- -----------
Total assets $11,144,600 $ 6,514,000
=========== ===========
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 2
<PAGE>
<TABLE>
MENDOCINO BREWING COMPANY, INC.
BALANCE SHEETS (Continued)
- -------------------------------------------------------------------------------------------------------------
<CAPTION>
December 31, 1996 1995
- -------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
CURRENT LIABILITIES
Line of credit $ 600,000 $ --
Accounts payable 567,600 105,700
Accrued wages and related expense 118,200 129,800
Accrued construction costs 744,500 1,182,300
Accrued liabilities 16,100 22,300
Accrued profit sharing -- 30,000
Income taxes payable -- 34,200
Current maturities of long-term debt 2,765,400 10,400
Current maturities of obligation under capital lease 151,300 --
----------- -----------
Total current liabilities 4,963,100 1,514,700
LONG-TERM DEBT, less current maturities -- 554,900
OBLIGATION UNDER CAPITAL LEASE, less
current maturities 1,863,000 --
DEFERRED INCOME TAXES 18,100 20,200
----------- -----------
Total liabilities 6,844,200 2,089,800
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, Series A, no par value,
with aggregate liquidation preference
of $227,600; 227,600 shares authorized,
issued and outstanding 227,600 227,600
Common stock, no par value; 20,000,000 shares
authorized, 2,322,222 shares issued and
outstanding 3,869,600 3,869,600
Retained earnings 203,200 327,000
----------- -----------
Total stockholders' equity 4,300,400 4,424,200
----------- -----------
Total liabilities and stockholders' equity $11,144,600 $ 6,514,000
=========== ===========
<FN>
The accompanying notes are an integral part of these financial statements.
- -------------------------------------------------------------------------------------------------------------
</FN>
Page F - 3
</TABLE>
<PAGE>
MENDOCINO BREWING COMPANY, INC.
STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
Years Ended December 31, 1996 1995
- --------------------------------------------------------------------------------
SALES $ 4,004,700 $ 3,735,100
LESS EXCISE TAXES 165,000 168,600
----------- -----------
NET SALES 3,839,700 3,566,500
COST OF GOODS SOLD 1,909,700 1,846,500
----------- -----------
GROSS PROFIT 1,930,000 1,720,000
----------- -----------
OPERATING EXPENSES
Retail Operating 738,200 649,200
Marketing 682,300 277,800
General and administrative 681,900 610,300
----------- -----------
2,102,400 1,537,300
----------- -----------
INCOME (LOSS) FROM OPERATIONS (172,400) 182,700
----------- -----------
OTHER INCOME (EXPENSE)
Interest income 11,600 132,800
Other income (expense) (41,200) 14,800
Interest expense -- (3,700)
----------- -----------
(29,600) 143,900
----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES (202,000) 326,600
PROVISION FOR(BENEFIT FROM) INCOME TAXES (78,200) 152,900
----------- -----------
NET INCOME (LOSS) $ (123,800) $ 173,700
=========== ===========
EARNINGS (LOSS) PER SHARE $ (0.05) $ 0.08
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 2,322,222 2,307,074
=========== ===========
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 4
<PAGE>
<TABLE>
MENDOCINO BREWING COMPANY, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1996 and 1995
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Series A
Preferred Stock Common Stock
-------------------------- -------------------------- Retained Total
Shares Amount Shares Amount Earnings Equity
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1994 227,600 $ 227,600 2,220,445 $ 3,342,400 $ 153,300 $ 3,723,300
Issuance of common stock -- -- 101,777 527,200 -- 527,200
Net income -- -- -- -- 173,700 173,700
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1995 227,600 227,600 2,322,222 3,869,600 327,000 4,424,200
Net loss -- -- -- -- (123,800) (123,800)
----------- ----------- ----------- ----------- ----------- -----------
Balance, December 31, 1996 227,600 $ 227,600 2,322,222 $ 3,869,600 $ 203,200 $ 4,300,400
=========== =========== =========== =========== =========== ===========
<FN>
The accompanying notes are an integral part of these financial statements.
- ---------------------------------------------------------------------------------------------------------------------------
</FN>
Page F - 5
</TABLE>
<PAGE>
<TABLE>
MENDOCINO BREWING COMPANY, INC.
STATEMENTS OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------------------
<CAPTION>
Years Ended December 31, 1996 1995
- -----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income (loss) $ (123,800) $ 173,700
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 51,900 49,300
Loss (gain) on sale of assets (3,600) 500
Deferred income taxes (14,200) 20,600
Changes in:
Accounts receivable 141,500 (165,000)
Inventories (124,300) (54,200)
Prepaid expenses (11,500) (33,600)
Refundable income taxes (71,900) --
Accounts payable 461,900 (39,000)
Accrued wages and related expense (11,600) 45,600
Accrued liabilities (6,200) 1,700
Accrued profit sharing (30,000) (15,000)
Income taxes payable (34,200) 21,800
----------- -----------
Net cash provided by operating activities 224,000 6,400
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold
improvements (4,817,500) (2,923,300)
Other assets (255,600) (16,400)
Proceeds from sale of fixed assets 10,300 500
----------- -----------
Net cash used by investing activities (5,062,800) (2,939,200)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on line of credit 600,000 --
Borrowings on long term debt 2,502,800 --
Principal payments on long-term debt (302,800) (11,700)
Reimbursement from obligation under capital lease 1,523,800 --
Payments on obligation under capital lease (57,900) --
Accrued construction costs (437,800) 1,182,300
Proceeds from sale of common stock -- 568,900
Deferred stock offering costs (190,600) (11,400)
----------- -----------
Net cash provided by financing activities 3,637,500 1,728,100
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS (1,201,300) (1,204,700)
CASH AND CASH EQUIVALENTS, beginning of year 1,696,100 2,900,800
----------- -----------
CASH AND CASH EQUIVALENTS, end of year $ 494,800 $ 1,696,100
=========== ===========
<FN>
The accompanying notes are an integral part of these financial statements.
- -----------------------------------------------------------------------------------------------------------------------
</FN>
Page F - 6
</TABLE>
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Description of operations - Mendocino Brewing Company, located in Hopland,
California, operates a microbrewery producing beer and malt beverages for the
specialty beer market, and a brew pub and gift store. The majority of sales are
in California.
Inventories - Inventories are stated at the lower-of-average cost or market.
Property and equipment - Property and equipment are stated at cost and
depreciated or amortized using straight-line and accelerated methods over the
assets' estimated useful lives. Capitalized interest was $214,900 and $15,200 in
1996 and 1995, respectively. Costs of maintenance and repairs are charged to
expense as incurred; significant renewals and betterments are capitalized.
Estimated useful lives are as follows:
Machinery and equipment 5 - 7 years
Furniture and fixtures 5 - 7 years
Leasehold improvements 7 - 30 years
Amortization - Label development costs are amortized on the straight-line method
over a one-year period.
Deferred stock offering costs - Deferred stock offering costs consist of legal
and other costs incurred as part of the Company's public offering of common
stock.
Deposits and other assets - Deposits and other assets consist primarily of
refundable deposits on the planned acquisition of brewing equipment during 1997.
Concentration of credit risks - Financial instruments that potentially subject
the Company to credit risk consist principally of trade receivables and
interest-bearing deposits in excess of FDIC limits. The Company's
interest-bearing deposits are placed with major financial institutions.
Wholesale distributors account for substantially all accounts receivable;
therefore, this concentration risk is limited due to the number of distributors
and state laws regulating the financial affairs of distributors of alcoholic
beverages.
Income taxes - The Company accounts for income taxes under Statement of
Financial Accounting Standards No. 109, "Accounting For Income Taxes", which
requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Under FAS 109, the Company is allowed to currently
recognize future tax deductions of expenses previously recorded for financial
reporting purposes.
Cash equivalents - The Company considers all highly liquid investments with a
current maturity of three months or less to be cash equivalents.
Earnings per share - Earnings per share were computed by dividing net income by
the weighted average number of common shares outstanding. There were no common
stock equivalents.
- --------------------------------------------------------------------------------
Page F - 7
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
Use of estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires the Company make estimates and
assumptions affecting the reported amounts of assets, liabilities, revenues and
expenses, and disclosure of contingent assets and liabilities. The amounts
estimated could differ from actual results.
Advertising - Advertising costs are expensed as incurred. Advertising expenses
for the years ended December 31, 1996 and 1995, were $93,900 and $42,000,
respectively.
Fair value of financial instruments - The following methods and assumptions were
used by the Company in estimating its fair value disclosures for financial
instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet for
cash and cash equivalents approximates fair value.
Long-term debt: Based on the borrowing rates currently available to the Company
for loans with similar terms and average maturities, the fair value of long-term
debt approximates cost.
Accrued construction costs - Accrued construction costs consist of expenses
incurred for the construction of the new brewery including equipment.
Reclassifications - Certain reclassifications have been made to the 1995
financial statements to conform to the 1996 presentation.
NOTE 2 - GOING CONCERN AND MANAGEMENT'S PLANS
In September 1995, the Company began construction of its new brewery with an
expected completion date of mid-1996. The brewery was to be paid by a
combination of financing and the proceeds from the Company's initial public
stock offering. At the outset of construction, the projected total cost of the
project, including land, building, equipment and other costs, was $9,200,000.
The project is nearing completion, with the expectation that the Company will
begin brewing and selling beer in April 1997. However, due to a change
increasing the size and capacity of the brewery, cost overruns, and time delays,
the cost rose to an expected total of $11,400,000. The project is being paid for
and financed as follows:
o $3,300,000 proceeds from the initial stock offering
o $2,700,000 construction loan to bank. The bank has provided a commitment
letter to convert the debt to permanent financing.
o $2,100,000 in equipment financing as a capital lease
o $800,000 to an individual for the acquisition of land. The current balance of
$262,600 is due in September 1997.
o $600,000 bank line of credit secured by accounts receivable and inventory,
maturing April 1997.
o $900,000 to the general contractor
- --------------------------------------------------------------------------------
Page F - 8
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 2 - GOING CONCERN AND MANAGEMENT'S PLANS (Continued)
o $550,000 of estimated remaining costs are associated with Phase II of the
project and are expected to be deferred until funds are available to pay for
this work
o $136,000 from funds collected from the current stock offering through March
31, 1997
o $314,000 balance is due to the general contractor and other vendors with no
current source of funding other than future operations
While the Company is pursuing various strategies, as outlined below, it does not
have any current commitments for additional capital or financing to meet the
payment demands of the obligations due in 1997, if those demands are made.
Management's plans to meet these obligations include the following strategies:
o Sales are expected to increase substantially with the opening of the brewery
resulting in positive cash flow from operations
o Increase efforts to attract investors to its current public stock offering
o Negotiate extensions of due dates for debt due in 1997
o Actively pursue other sources of equity or debt financing through the
identification of a strategic alliance or joint venture partner
If management is unsuccessful in fully realizing its plans, there may be
uncertainty about the Company's ability to continue as a going concern. These
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
NOTE 3 - INVENTORIES
1996 1995
-------- --------
Raw Materials $121,800 $ 91,400
Work-in-process 81,700 89,500
Finished goods 139,800 37,200
Merchandise 37,200 38,100
-------- --------
$380,500 $256,200
======== ========
- --------------------------------------------------------------------------------
Page F - 9
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 4 - PROPERTY AND EQUIPMENT
1996 1995
---------- ----------
Construction in progress $5,719,600 $ 921,700
Equipment in progress 2,573,600 2,031,800
Land 810,900 810,900
Machinery and equipment 557,500 537,900
Leasehold improvements 129,000 129,000
Furniture and fixtures 19,800 19,800
---------- ----------
9,810,400 4,451,100
Less accumulated depreciation and amortization 540,100 497,000
---------- ----------
$9,270,300 $3,954,100
========== ==========
NOTE 5 - LINE OF CREDIT
The Company has available a $600,000 line of credit with interest at the bank's
index rate plus 1.5%. The bank's commitment under the line of credit matures
April 1997. The agreement is secured by accounts receivable and inventory.
<TABLE>
NOTE 6 - LONG-TERM DEBT
<CAPTION>
1996 1995
---------- ---------
<S> <C> <C>
Note payable (construction loan) to bank, with interest at the
banks interest rate plus 2%; maturing June 1997; secured by
substantially all of the Company's assets $2,202,800 $ -
Note payable to contractor, with interest at 12%; due the later
of January 31, 1997 or 30 days after completion of the brewery;
secured by common stock and a second deed of trust
on the brewery and subordinated to bank debt 300,000 -
Note payable to an individual, due in monthly payments of $2,380,
including interest at 9%; maturing June 1997, with a balloon
payment of $260,500; secured by real property and
subordinated to bank debt 262,600 489,100
- -----------------------------------------------------------------------------------------------
Page F - 10
</TABLE>
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 6 - LONG-TERM DEBT (Continued)
1996 1995
---------- ----------
Note payable to an individual, due in
full December 1998, including
accrued interest at 9%, secured
by real property -- 76,200
---------- ----------
2,765,400 565,300
Less current maturities 2,765,400 10,400
---------- ----------
$ -- $ 554,900
========== ==========
NOTE 7 - OBLIGATION UNDER CAPITAL LEASE
During the year the Company entered into a capital lease agreement with a
financial institution for the assets related to the brewing equipment in
progress. The total assets under the capital lease are $2,073,000. The agreement
is secured by the new brewery equipment.
<TABLE>
Future minimum lease payments for equipment under this capital lease agreement
are as follows:
<CAPTION>
Year Ending December 31,
<S> <C> <C>
1997 $ 346,600
1998 378,100
1999 378,100
2000 378,100
2001 378,100
Thereafter 1,280,400
--------------------
3,139,400
Less amounts representing interest 1,125,100
--------------------
Present value of minimum lease payments 2,014,300
Less current maturities 151,300
--------------------
$ 1,863,000
====================
- ---------------------------------------------------------------------------------------------------
Page F - 11
</TABLE>
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 8 - PROFIT-SHARING PLAN
The Company has a profit-sharing retirement plan under which it may make
employer contributions at the discretion of the Board of Directors, although no
such contributions are required. Employer contributions vest over a period of
six years. The plan covers substantially all full-time employees meeting certain
minimum age and service requirements. Contributions were $0 and $30,000 for the
years ended December 31, 1996 and 1995, respectively.
NOTE 9 - COMMITMENTS
The Company leases its facilities under a noncancellable operating lease
expiring August 2004. The monthly lease payment is $2,068, to be adjusted
annually by increases in the Consumer Price Index, as defined in the lease
agreement. Additionally, the Company leases certain equipment under a
noncancellable operating lease which expires in 1997. Total rent expense was
$50,700 and $34,000 for the years ended December 31, 1996 and 1995,
respectively. Future minimum lease payments are as follows:
Year Ending December 31,
1997 $ 26,800
1998 24,800
1999 24,800
2000 24,800
2001 24,800
Thereafter 66,100
----------
$192,100
==========
Employment agreements - Five key employees have employment agreements that
provide, in part, a minimum annual base salary; stock options (see Note 12); and
severance benefits that include 18 to 36 months of salary continuance and, if
severance occurs within one year of a change in control, as defined, a lump sum
benefit of from $250,000 to $500,000.
The aggregate annual base salary for the five key employees is $317,100. The
total lump sum benefit the Company is obligated to pay in the event of a defined
change in control is $1,750,000.
Keg management agreement - In January 1997, the Company entered into a keg
management agreement with MicroStar Keg Management LLC. Under this arrangement,
MicroStar provides half-barrel kegs for which the Company pays a filling fee.
The agreement is effective April 1, 1997, for a five year period. Mendocino
Brewing Company has the option to terminate the agreement with 30 days notice.
If terminated, the Company is required to purchase a certain number of kegs from
MicroStar.
- --------------------------------------------------------------------------------
Page F - 12
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 10 - BREWERY CONSTRUCTION
In late 1995, the Company began construction of its new brewery in Ukiah,
California. At this time, the total cost of the brewery including land, building
and equipment is estimated to be $11.4 million. Funding for the brewery is from
a combination of proceeds from the stock sale, private party financing for the
land, bank financing for the building and a capital lease for the equipment.
Test brewing is expected to begin in April 1997.
NOTE 11 - STOCKHOLDERS' EQUITY
Common Stock
Before January 1, 1994, the Company conducted business in the form of a limited
partnership. On January 1, 1994, the Company issued 1,722,222 share of no-par
value common stock to the partnership in exchange for the assets of the
partnership. The partnership distributed the stock to its partners on January 3,
1994. As of December 31, 1995, 600,000 additional shares of stock had been sold
at $6 per share for total gross proceeds of $3,600,000. These proceeds were
reduced by $286,700 of offering costs. All shares of stock authorized to sell in
the first public offering have been issued.
Subsequent to December 31, 1996, the Company began offering an additional
600,000 shares of stock for sale in a second offering.
Preferred Stock
The Company has authorized 2,000,000 shares of preferred stock, of which 227,600
have been designated as Series A. At the time of the incorporation of the
partnership, the Company issued 227,600 shares of non-voting, no-par value
Series A Preferred Stock in exchange for partnership assets. The partnership
distributed the Series A Preferred Stock to its partners on January 3, 1994.
Series A shareholders are entitled to receive cash dividends and/or liquidation
proceeds equal in the aggregate to $1.00 per share before any cash dividends are
paid on the Common Shares or any other series of Preferred Shares. When the
entire Series A dividend/liquidation proceeds have been paid, the Series A
Shares shall automatically be canceled and cease to be outstanding.
NOTE 12 - STOCK OPTION PLAN
Under the 1994 Stock Option Plan, the Company may issue options to purchase up
to 200,000 shares of the Company's Common Stock. The plan provides for both
incentive stock options, as defined in Section 422 of the Internal Revenue Code,
and options that do not qualify as incentive stock options. The Plan shall
terminate upon the earlier of (a) the tenth anniversary of its adoption by the
Board or (b) the date on which all shares are available for issuance under the
Plan have been issued.
The exercise price of incentive options must be no less then the fair-market
value of such stock at the date the option is granted, while the exercise price
of nonstatutory options will be no less than 85% of the fair-market value per
share on the date of grant. With respect to options granted to a person
possessing more than 10% of the combined voting power of all classes of the
Company's stock, the exercise price will be no less than 110% of the fair-market
value of such share at the grant date. As of December 31, 1996, no options had
been granted, exercised, or canceled under the Plan.
- --------------------------------------------------------------------------------
Page F - 13
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- --------------------------------------------------------------------------------
NOTE 12 - STOCK OPTION PLAN
In January 1997, the Company granted 70,000 options to five key employees
ranging in price from $8.38 to $9.21 per share. The options become exercisable
at 20% a year and expire between five and ten years. The Company also granted an
option to the Company's president to purchase 12,500 shares at $8.80. The option
expires in 2002.
NOTE 13 - INCOME TAXES
1996 1995
--------- ---------
Current
Federal $ -- $ 103,700
State 800 28,600
Benefit of net operating loss carryback (64,800) --
--------- ---------
(64,000) 132,300
--------- ---------
Deferred
Current (7,600) (3,700)
Non-current (6,600) 24,300
--------- ---------
(14,200) 20,600
--------- ---------
$ (78,200) $ 152,900
========= =========
The difference between the actual income tax provision and the tax provision
computed by applying the statutory federal income tax rate to earnings before
taxes is attributable to the following:
1996 1995
--------- ---------
Income tax provision (benefit) at 34% $ (68,700) $ 105,300
State taxes 800 28,100
Adjustment due to lower federal rates 5,000 (1,100)
Recognition of future tax (deductions) (15,300) 20,600
--------- ---------
$ (78,200) $ 152,900
========= =========
- --------------------------------------------------------------------------------
Page F - 14
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
-------------------------------------------------------------------------------
NOTE 13 - INCOME TAXES (Continued)
Temporary differences and carryforwards which give rise to deferred tax assets
and liabilities are as follows:
Inventories $ 3,200 $ 3,000
Accruals 21,700 13,700
Other (1,800) (1,200)
-------- --------
Current deferred tax asset $ 23,100 $ 15,500
======== ========
Depreciation and amortization $ (2,900) $ --
Benefit of net operating loss carryforward 7,400 --
-------- --------
Non-current deferred tax asset $ 4,500 --
======== ========
Depreciation and amortization $ 25,300 $ 21,000
Other (7,200) (800)
-------- --------
Non-current deferred tax liability $ 18,100 $ 20,200
======== ========
At December 31, 1996, the Company has available for carryforward approximately
$85,000 of California net operating losses that expire in 2011. The benefit from
this loss carryforward has been recorded, resulting in a deferred tax asset. A
valuation allowance is not provided since the Company believes it is more likely
than not that the loss carryforwards will be utilized.
NOTE 14 - SEGMENT INFORMATION
<TABLE>
The Company's business segments are brewing operations and a retail
establishment known as the Hopland Brewery. A summary of each segment is as
follows:
<CAPTION>
Year Ending December 31, 1996
------------------------------------------------------------------------
Brewing Hopland Corporate
Operations Brewery and other Total
-------------- ----------------- ------------------ --------------
<S> <C> <C> <C> <C>
Sales $ 3,067,300 $ 937,400 $ -- $ 4,004,700
Operating profits 591,100 (81,600) -- 509,500
Identifiable assets 9,873,600 97,900 1,173,100 11,144,600
Depreciation and amortization 26,200 7,800 17,900 51,900
Capital expenditures 5,339,800 -- 19,500 5,359,300
- -------------------------------------------------------------------------------------------------------------
Page F - 15
</TABLE>
<PAGE>
MENDOCINO BREWING COMPANY, INC.
NOTES TO FINANCIAL STATEMENTS (Continued)
December 31, 1996 and 1995
- -------------------------------------------------------------------------------
NOTE 14 - SEGMENT INFORMATION (Continued)
Year Ending December 31, 1995
-----------------------------------------------
Brewing Hopland Corporate
Operations Brewery and other Total
---------- -------- ---------- ----------
Sales $2,775,500 $959,600 $ - $3,735,100
Operating profits 758,400 34,600 - 793,000
Identifiable assets 4,633,900 109,500 1,770,600 6,514,000
Depreciation and amortization 30,700 8,300 10,300 49,300
Capital expenditures 3,655,900 25,500 3,900 3,685,300
NOTE 15 - STATEMENT OF CASH FLOWS
Supplemental cash flow information includes the following:
1996 1995
---------- ----------
Cash paid during the year for:
Interest $180,400 $ 18,900
Income taxes $ 60,700 $113,500
Non-cash investing and financing activities for the year ended December 31,
1996, consisted of a note payable that was refinanced, and acquiring fixed
assets of $548,500 through a capital lease.
NOTE 16 - MAJOR CUSTOMERS
Sales to the top five customers totaled $1,788,900 and $1,914,000 for the years
ended December 31, 1996 and 1995, respectively representing 58% and 70% of
brewing operation sales.
- --------------------------------------------------------------------------------
Page F - 16
KEG MANAGEMENT AGREEMENT
This Keg Management Agreement ("Agreement") dated effective as of
February 21, 1997, is between MicroStar Keg Management, L.L.C., a Delaware
Limited Liability Company whose address is P. O. Box 3129 Redmond, Washington
98073 ("MicroStar") and Mendocino Brewing Company, Inc., a California
corporation, whose address is 13351 South Highway 101, Hopland, California 95449
(referred to herein and in the Exhibits hereto either as "Brewing Company" or
"Mendocino").
RECITATIONS AND DEFINITIONS
1. MicroStar is engaged in the logistical management of stainless steel kegs,
primarily for the craft beer/micro-brewing industry and has developed
proprietary concepts, arrangements and systems for the ownership, licensing of
the use of, tracking and retrieval of kegs.
2. Brewing Company is engaged in the business of brewing premium and/or special
quality or custom beers and desires to more efficiently service existing markets
while simultaneously expanding its business in both existing and potential new
market areas.
3. Brewing Company desires to utilize the services of MicroStar in order to
avoid the capital outlay and manpower/administrative costs and risks associated
with keg ownership, thereby enabling Brewing Company to direct additional
resources to its brewing business. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
4.
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
5. For purposes of this Agreement the term "kegs" shall mean and refer to beer
kegs that are straight-sided with a single opening and an American Sankey-type
neck, having a full U.S. half-barrel (15.5 gallon) capacity, with minimum chime
(skirt) thickness of 2.00 mm and minimum sidewall (body/shell) thickness of 1.32
mm which have not been used to store or transport wine, and which are capable of
being cleaned to Brewing Company's reasonable satisfaction by using the
procedures specified in this Agreement.
In consideration of the premises and of the mutual covenants and
agreements of the parties as hereinbelow set forth, the parties have agreed as
follows:
<PAGE>
Section 1. Procurement of Kegs, Delivery, and Acceptance.
1.1. Purchase Agreement.
a. MicroStar will acquire from Brewing Company any kegs which
Brewing Company now or hereafter may own and desire to make subject to this
Agreement, provided that such kegs conform to the definition of "keg" set forth
in this Agreement and are of a condition and quality acceptable to MicroStar.
The purchase price for any and all kegs purchased from Brewing Company shall be
separately agreed upon in writing after verification of condition and quality
and the quantity of kegs shall be subject to acquisition audit verification by
MicroStar. The final acquisition inventory of kegs shall be approved in writing
by authorized representatives of MicroStar and Brewing Company. Payment by
MicroStar for the kegs so purchased from Brewing Company shall be made when
MicroStar has verified that such kegs may be sold and assigned to MicroStar free
of any lien or encumbrance and the subject kegs have been physically marked by
MicroStar with its proprietary markings, which shall be done at Brewing
Company's facilities in lots no smaller than one hundred (100) kegs. Placement
of physical markings shall be performed by MicroStar's field personnel as
expeditiously as possible and shall be initiated no more frequently than once
per month, until all kegs so sold by Brewing Company to MicroStar shall have
been identified. An appropriate Bill of Sale identifying the kegs acquired by
MicroStar shall be executed and delivered contemporaneously with the payment by
MicroStar.
b. In the event that Brewing Company does not presently own
kegs (as herein defined) or does not own a sufficient quantity of kegs to
conduct and/or expand its business, or in the event that Brewing Company does
not desire to subject its entire existing inventory of owned kegs to this
Agreement, Brewing Company shall provide MicroStar with a projection of its
anticipated keg requirements during the period April 1, 1997 through June 30,
1997. Contemporaneously, with the furnishing of such ninety (90) day projection,
Brewing Company shall submit its initial request for deliveries of kegs and
MicroStar will thereupon obtain and provide the requisite quantity of kegs in
accordance with the provisions of Section 2.2 hereof.
1.2. Incidents of Ownership and Control
All kegs purchased by MicroStar from Brewing Company and/or
otherwise obtained and provided by MicroStar for purposes of this Agreement
shall be owned and subject to the exclusive right of control and disposition of
MicroStar, subject however to the rights of Brewing Company hereunder as a
licensee of the right to use such kegs for the purposes and in the manner
contemplated by this Agreement. Brewing Company agrees to execute, at the
request of MicroStar, an appropriate statement for filing in the Uniform
Commercial Code records of each state in which MicroStar kegs are utilized
hereunder for the purpose of providing notice of the existence of this Agreement
and of MicroStar's ownership of all kegs licensed for Brewing Company's use
hereunder. MicroStar shall prepare the statements and file them at MicroStar's
sole expense. After termination of this Agreement, MicroStar shall promptly
execute such termination statements as Mendocino may reasonably request and
which Mendocino shall file at Mendocino's sole expense.
KEG MANAGEMENT AGREEMENT
Page 2
<PAGE>
Section 2. License of Keg Use
2.1 Basic Use Fee
Brewing Company shall pay a use fee of XXXXXXXXXXXXXXXXXXXXXXX
X per keg, per filling, which shall be invoiced and payable on net thirty (30)
day terms for each keg delivered to the Brewing Company location(s) designated
by Brewing Company. Except as specifically provided below, MicroStar shall pay
all freight and insurance costs associated with the transporting of empty kegs
to Mendocino and shall bear all risk of loss of the empty kegs during transit.
With respect to kegs so utilized by Brewing Company which are filled by Brewing
Company and delivered to the regional wholesalers identified in Exhibit "A-1"
hereto (whose proximity of location to Brewing Company facilitates MicroStar's
retrieval administration) the use fee shall be adjusted by rebate or credit to
Brewing Company in the amount of XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX per keg. If
applicable, Brewing Company may further specify on Exhibit "A-2" of this
Agreement up to three (3) local wholesalers which currently impose no freight
charge upon Brewing Company for the return of kegs, provided that (i) the
wholesalers so designated agree to extend such free keg return arrangements to
the keg deliveries to be made pursuant to this agreement, (ii) the timing,
quantities and other arrangements relating to such keg returns are and remain
consistent with the specific delivery terms prescribed by MicroStar, and (iii)
Brewing Company agrees to assume and be responsible for any and all cost of
freight for the return of all kegs from such designated local wholesalers. For
each full keg sold by Brewing Company to such designated local wholesalers, the
applicable adjustment by rebate or credit to Brewing Company will be
XXXXXXXXXXXXXXXXXXXX per keg (resulting in an effective use fee to Brewing
Company hereunder of XXXXXXXXXXXXXXXXXXXX per keg). In the event that any one of
the above specified requirements for status as a designated local wholesaler
ceases to be applicable, then effective on the date such requirement is no
longer satisfied, the affected wholesaler shall automatically be regarded as a
regional wholesaler covered by Exhibit "A-1" of this Agreement. With respect to
kegs used by Brewing Company in on-site pub operations or self-distributed by
Brewing Company, the use fee shall be XXXXXXXXXXXXXXXXXXXX per keg, per filling.
Invoices for such fees will be based upon the monthly report of sales submitted
by Brewing Company to applicable state authorities in relation to its on-site
pub operations or self-distributed sales, a copy of which shall be furnished to
MicroStar at the time such report is filed. The use fee is subject to an
increase of up to XXXXXXXXXXXXXXXXX during any given twelve (12) consecutive
month time period in the event of an increase of XXXXXXXXXXXXXXXXXXXXXXXXX or
more in national or applicable regional trucking charges incurred by MicroStar
in relation to the performance of this Agreement during any such twelve (12)
consecutive month time period. MicroStar shall provide written notice thirty
(30) days in advance of any increase to the use fee.
2.2 Delivery of Kegs per Brewing Company's Requirements
Brewing Company shall notify MicroStar of Brewing Company's
specific keg delivery date requirements by written notice, including facsimile
transmittal or other notification arrangements approved in writing by Brewing
Company and MicroStar, to be received not less than thirty (30) days prior to
Brewing Company's requested delivery dates. Such notice shall include a
specification of all requested keg quantities in lots of two hundred (200) or
more.
KEG MANAGEMENT AGREEMENT
Page 3
<PAGE>
MicroStar will forward a written confirmation of its receipt of Brewing
Company's notice of requirements by facsimile or U.S. Mail prior to the close of
the business day following the date of MicroStar's receipt of such notice.
Brewing company shall use its best efforts to ensure that Brewing Company's
inventory of MicroStar kegs does not exceed Brewing Company's actual thirty (30)
day requirements. In the event that Brewing Company's requirements at any time
or for any reason (e.g. seasonal product demand, business expansion, etc.) will
exceed its most recently specified prior requirements by twenty percent (20%) or
more and/or relate to deliveries to new locations of Brewing Company or
wholesalers, Brewing Company shall be required to provide ninety (90) days
advance written notice to MicroStar of such requirements. MicroStar shall
endeavor to effectuate the delivery of the requested kegs to Brewing Company at
its designated locations within the continental United States in accordance with
Brewing Company's timely notification of keg requirements. All kegs delivered
hereunder shall conform to the keg standard specified herein and shall not have
been utilized to store or transport wine. Delivery shall be deemed to conform to
the requirements of this Agreement if the actual time of delivery is within
seventy-two (72) hours prior or subsequent to the specifically requested
delivery time and the quantities so delivered (not counting any delivered kegs
which are not in good and useable condition as determined by inspection by
Mendocino) are within a ten percent (10%) variance of the specifically requested
quantity of kegs. In the event that MicroStar is unable to meet the foregoing
requirements of a conforming delivery to Brewing Company, MicroStar shall
perform as soon as possible thereafter and shall impose no use fee with respect
to any such non-conforming keg shipment. In the event that any non-conforming
kegs are delivered to Mendocino, Mendocino shall segregate and securely store
such kegs until MicroStar has arranged, at MicroStar's expense, for the pick-up
and transportation of such kegs, which pick-up and transportation arrangements
shall be concluded and implemented within thirty (30) days of the date of any
such non-conforming delivery. The parties acknowledge and agree that
non-conforming delivery(ies) give Brewing Company a right to terminate this
Agreement pursuant to the terms of Section 11.6 of this Agreement.
If Mendocino in its judgment would suffer a significant
impairment by MicroStar's inability to meet the requirements of a conforming keg
shipment, Mendocino may at its option purchase kegs from any source to fulfill
the shortage. If after such an event(s) Mendocino elects not to terminate this
agreement pursuant to Section 11.6, MicroStar must purchase and take ownership
of the kegs from Mendocino for purposes of this agreement at Mendocino's cost
which includes shipping and handling.
Section 3. Arrangements and Agreements with Wholesalers
3.1. Notification and Compliance Obligations of Brewing
Company
a. Brewing Company will join with MicroStar in the issuance
of a notice to all wholesalers to which Brewing Company delivers product in kegs
subject to this Agreement that such kegs shipped by Brewing Company are owned by
MicroStar as of the effective date specified in such notice (being the date on
which keg ownership was acquired by MicroStar hereunder). Such notice will
further evidence the authority of MicroStar to collect and administer the
deposits required to be made by wholesalers in accordance with this Agreement,
to perform audits as contemplated by this Agreement, and to retrieve all kegs
delivered to the wholesaler. The form of notice of terms and conditions
applicable to wholesalers is attached
KEG MANAGEMENT AGREEMENT
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<PAGE>
hereto as Exhibit "B" and is intended to apprise wholesalers of the rights and
responsibilities of MicroStar pursuant to this agreement and to express and
evidence the agreement of wholesalers to the specified terms and conditions
applicable to wholesalers.
Brewing Company will require in pertinent negotiations and
agreements with its wholesalers that all wholesalers agree to remit to MicroStar
a security deposit based upon the amount of XXXXXXXXXXXXXXXXXXXXXXXX per keg, to
be billed by and paid to MicroStar to cover the loss (based on a charge of
XXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXX per keg) of any keg owned by
MicroStar that cannot be located by such wholesaler. Execution of Exhibit "B" by
Brewing Company and a wholesaler constitutes compliance with the foregoing
sentence. As set forth in the form of notice of terms and conditions attached as
Exhibit "B", wholesalers shall be required to acknowledge that periodic charges
to and withdrawals from the security deposit will be made by MicroStar for kegs
that cannot be located and that credit memos will be issued whenever kegs are
returned and whenever kegs previously classified as lost are located.
Wholesalers will be invoiced in the amount of XXXXXXX as a "loss" call whenever
any loss is charged to the deposit and will receive a credit memo and refund of
a previously billed lost keg charge whenever such "lost" keg for which a loss
charge was made is located and returned.
b. Pursuant to the notice of terms and conditions to
wholesalers, all wholesalers shall be required to provide a monthly written
report of movement of MicroStar kegs in a form prescribed by MicroStar,
including inventory by brewer (including Brewing Company and any other brewers
contracting with MicroStar who deliver product to the affected wholesaler),
empty kegs on hand and kegs in the retail system. Wholesalers shall also agree
to respond to weekly verbal inquiries by MicroStar representatives concerning
the extent of empty MicroStar kegs in the wholesaler's system. MicroStar shall
be authorized to conduct periodic audits of the wholesaler's inventory of
MicroStar kegs, including kegs in the retail system, which audits will be
performed either quarterly or semi-annually, depending upon the extent of the
wholesaler's inventory and any discrepancies ascertained as a result of prior
audits, etc.
c. In the event that a wholesaler to whom Brewing Company
delivers product fails to remit the security deposit of XXXXXXXXXXXXXXXXXXXXXXXX
per keg to MicroStar within ninety (90) days after MicroStar's date of invoice
for such deposit, then Brewing Company agrees to promptly issue Brewing
Company's own invoice to the affected wholesaler and to use reasonable efforts
to collect the applicable deposit and remit the same to MicroStar. Upon making
such payments, Brewing Company shall then be subrogated to the claims that
MicroStar had against the wholesaler.
d. With respect to any on-site pub sales and/or
self-distributed sales, Brewing Company shall be subject to all of the terms,
obligations, and conditions applicable to wholesalers, including but not limited
to deposits, loss fees, audits, etc., as set forth in this Agreement.
Section 4. Trademark License
Brewing Company hereby licenses to MicroStar, for the limited purposes
of producing mandatory self-adhesive producing brewer/product labels and without
direct monetary
KEG MANAGEMENT AGREEMENT
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<PAGE>
compensation from MicroStar, Brewing Company's registered trademarks, trade
names, slogans, and trade dress to the extent that any of these are depicted on
the label. Brewing Company will have the ownership of and copyright in any
artwork created for the label(s). MicroStar may not use such copyrighted artwork
for purposes other than the mandatory labels, and MicroStar obtains no other
rights to Brewing Company's registered trademarks, trade names, slogans, and
trade dress or their use. Except as expressly provided, no right, property,
license, permission or interest of any kind in or to the use of any trademark,
trade name, color combination, insignia or device owned or used by Brewing
Company is or is intended to be given or transferred to or acquired by MicroStar
by the execution, performance or nonperformance of this Agreement or any part of
it. MicroStar shall not permit any other brewer or product producer to
distribute its products in any keg bearing Brewing Company's logo, label, or
other identifying mark.
Section 5. Confidentiality; SEC Reporting
MicroStar and Brewing Company must hold in strictest confidence and may
not disclose to others or use other than for purposes of this Agreement any
data, reports, writings and communications and any other information provided
to, learned by or made available to them by the other party in the course of
this Agreement (collectively referred to as "Information") except as the other
party expressly authorizes in writing. Mendocino may file a copy of this
Agreement as an exhibit to any filing required of Mendocino under federal or
state securities laws, with dollar amounts and
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXX omitted pursuant to a
confidentiality request to the extent permitted by the agency with which the
report is filed. Both MicroStar and Brewing Company acknowledge that all
Information provided or learned by them in connection with this Agreement
constitutes trade secret data and/or proprietary information of great value.
Both MicroStar and Brewing Company agree not to use such Information in any way
for their own benefit. This obligation of strict confidentiality is also
applicable to each party's employees. It continues for so long as the
information remains confidential. In the event that either party receives notice
of an attempt by anyone to obtain a court order compelling any disclosure of any
Information, they shall immediately notify the other party.
Nothing in this section in any way restricts or impairs either party's
right to use, disclose or otherwise deal with any Information or data which:
1) at the time of disclosure is generally available to the public or
thereafter become available to the public by publication or
otherwise through no act of that party;
2) that party can demonstrate was within its possession prior to the
time of disclosure and was not acquired directly or indirectly
from the other party or any person, firm or corporation acting on
its behalf, or
3) is independently made available as a matter of right to either
party by a third party who is under no confidentiality obligation
to the other party.
Section 6: Indemnity
KEG MANAGEMENT AGREEMENT
Page 6
<PAGE>
Each party must indemnify and hold harmless the other party, the other
party's parents, subsidiaries and affiliated companies, and all of their
respective officers, managers, directors, employees and agents from any and all
liabilities, damages, claims, suits, judgments, costs and expenses (including
reasonable attorney's fees and court costs), directly or indirectly incurred in
relation to third party claims against a party hereto as a result of:
1) the actions, including but not limited to negligence, of that
party relating to this Agreement and the performance of this
Agreement;
2) the breach of any of the provisions of this Agreement by that
party;
3) alleged patent, trademark or copyright infringement or any claims
by third persons based upon or arising out of or in connection
with any statements, illustrations, research data, advertising,
product claims, representations or warranties of that party for
the purposes of this Agreement;
4) any and all claims, demands, actions, and causes of action which
are hereafter made or brought against that party by any person for
the recovery of damage for the injury, illness, or death of any
person which is caused or alleged to have been caused by any
services/products provided by the other party hereto.
These obligations survive the termination of this Agreement.
Section 7. Insurance
MicroStar and Brewing Company each must carry and maintain at their own
expense and in full force and effect at all times during the term of this
Agreement and for one (1) year thereafter Commercial General Liability Insurance
with a limit of liability of no less than XXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX.
The insurance coverage required under this section must:
1) include contractual liability coverage which specifically insures
the hold harmless and indemnification provisions of Section 6 of
this Agreement;
2) be secured and maintained under an occurrence form policy or
coverage form reasonably acceptable to the other party's insurance
department;
3) be placed with an insurer of recognized responsibility;
4) name the other party and affiliated companies as "additional named
insured" and
5) provide for at least thirty (30) days advance written notice to
the other party of any cancellation or any material change in the
coverage;
6) provide transit coverage for shipments authorized by such party
and the bill of lading will be so termed.
KEG MANAGEMENT AGREEMENT
Page 7
<PAGE>
Neither party may cancel any insurance policy maintained pursuant to
the requirements of this paragraph without the prior written consent of the
other. Upon written request, a certificate of insurance will be sent to the
requesting party.
Section 8. Term and Exclusivity of Agreement
8.1. Term of Agreement
This Agreement shall be for an initial term of five (5) years.
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXX In the event that no such election to terminate is made, the five (5)
year term of this Agreement shall commence on October 1, 1997 or on the first
day of the month next following the month in which Mendocino's monthly keg
requirements hereunder first exceed five thousand (5,000) kegs.
8.2. Exclusivity of Arrangements
Except in the instance of Brewing Company's retention of any
pre-existing owned keg inventory for its own local market use, during the
initial and any extended term of this Agreement, Brewing Company shall use
MicroStar as the exclusive source of all beer kegs utilized in its brewing
operation. Without limitation of and subject to the foregoing, Brewing Company
agrees that during the term of this agreement or any extension hereof, Brewing
Company shall not conclude or enter into any agreement or understanding with any
third-party regarding sale of any of its Sankey kegs or regarding the purchase,
lease or licensing of any kegs (whether of the Sankey type or otherwise) for use
in Brewing Company's business, except as provided in the last paragraph of
Section 2.2.
Section 9: Cleaning of Kegs
9.1. Cleaning Responsibilities of Brewing Company
Brewing Company acknowledges the responsibility to clean all
kegs delivered to Brewing Company by MicroStar in accordance with the minimum
washing standards for either a sterilizing sequence (steam) or a sanitizing
sequence (oxine) and to implement the quality control checks prescribed by
MicroStar, as specifically set forth in Exhibit "C" hereto.
Section 10: Information and Records/Accounting Procedures
KEG MANAGEMENT AGREEMENT
Page 8
<PAGE>
10.1. Responsibilities of Brewing Company
During the term of this Agreement, Brewing Company shall
provide MicroStar with copies of all bills of lading from all of its brewery
locations for all draft beer shipments to wholesalers within twenty-four (24)
hours of the time of shipment. Additionally, Brewing Company shall maintain
accurate records reflecting monthly beginning and ending inventories of kegs,
keg locations and verification of deliveries of kegs from MicroStar to Brewing
Company and of all deliveries to wholesalers, and shall provide copies of such
records to MicroStar on a monthly basis. Brewing Company agrees to report all
requisite information on such forms as MicroStar may from time-to-time prescribe
and furnish for such purposes.
Brewing Company shall not knowingly utilize any
MicroStar-owned kegs in its operations which are not specifically subject to
this agreement. Brewing Company shall be charged the sum of
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX per keg for any keg subject to this
agreement which an audit substantiates to have been lost while under Brewing
Company's control.
10.2. Responsibilities of MicroStar
MicroStar shall provide to Brewing Company such information
and records as may be appropriate to substantiate all use fees, and all charges
and credits associated with the deposit arrangements to be established between
Brewing Company and wholesalers in accordance with the provisions of Section
3.1.b. hereof.
10.3. Audit Rights of the Parties
MicroStar and Brewing Company each shall have the right to
review and audit at reasonable intervals the records and information maintained
or acquired by the other party hereto for the purpose of determining, verifying
or analyzing any deliveries, retrievals, charges or credits arising in the
course of performance of this Agreement. Audits shall be conducted during normal
business hours with 24 hours advance notice given during normal business hours.
Any expenses incurred by a party in relation to record keeping or reporting of
information contemplated by this Agreement, shall be borne by the party charged
with maintaining such records and providing such information. Expenses incurred
by a party in relation to audits performed hereunder shall be borne by the party
undertaking such audit.
10.4. Accounting Procedures
The initial accounting procedures formulated by MicroStar are
set forth in Exhibit "D" hereto. MicroStar may only supplement or revise the
procedures as set forth in Exhibit "D" hereto with the express written consent
of Brewing Company. The accounting procedures are not intended to impose any
material obligation on Brewing Company that is not set forth in the body of this
Agreement. In the event of any conflict between the accounting procedures and
this Agreement, this Agreement shall control.
Section 11: Miscellaneous
KEG MANAGEMENT AGREEMENT
Page 9
<PAGE>
11.1. Amendment and Supplementation
This Agreement and the Exhibits hereto may be amended or
supplemented only by a written instrument executed by MicroStar and Brewing
Company.
11.2. Independent Contractor
This Agreement does not constitute or give rise to a
partnership between the parties. All operations by each party under the terms of
this Agreement are carried on by it as independent contractor and not as an
agent for the other.
11.3. Third-Party Beneficiary Status
To the extent necessary to accord MicroStar the full scope of
entitlements, rights and authorities in relation to Brewing Company's agreements
and arrangements with wholesalers as contemplated hereby, MicroStar shall be
recognized as a third-party beneficiary of such agreements and arrangements.
Brewing Company is an intended third-party beneficiary or all provisions of this
Agreement concerning limitations on the use of the kegs by others and
limitations on the use of Brewing Company's trademarks, labels, and logos.
11.4. Force Majeure
Subject to the rights and obligations of the parties under
Section 11.6, in the event that any obligation hereunder, other than the
obligation to remit any payment due hereunder, cannot be timely performed due to
circumstances beyond the reasonable control of a party hereto, the time period
for the performance of such obligation shall be reasonably extended until the
conditions precluding, impairing or delaying performance have been resolved.
Notwithstanding the foregoing, as a general and overarching principle, nothing
in this Agreement precludes Brewing Company from obtaining the use of kegs from
other sources during any period during which MicroStar fails to provide
sufficient quantities of kegs to Brewing Company.
11.5. Producing Brewer/Product Label
MicroStar has designed a pro forma producing brewer/product
label for participants in the MicroStar program. Utilizing the basic MicroStar -
prescribed form, Brewing Company will be responsible for preparing a final label
form and requesting and obtaining a Certificate of Label approval ("COLA") from
the Bureau of Alcohol, Tobacco and Firearms. Additionally, Brewing Company will
be responsible for requesting and obtaining any and all requisite approvals from
the requisite authorities in states where Brewing Company's products are is
distributed in MicroStar kegs. Copies of Certificates or other evidence of
Federal and State label approval, as applicable, shall be furnished to MicroStar
upon request. Brewing Company shall duly affix the MicroStar prescribed
self-adhesive label in a manner which completely covers any prior producer or
brewer label and expressly agrees not to ship its products in any kegs which
reflect the label of a prior producer/brewer utilizing such keg. MicroStar shall
impose an identical obligation on all future users of kegs with whom MicroStar
contracts, and
KEG MANAGEMENT AGREEMENT
Page 10
<PAGE>
shall use MicroStar's reasonable best efforts to obtain similar agreements with
all existing users of MicroStar kegs.
11.6. Changes in Economic Conditions/Right of Termination
In the event that as a result of business or economic
developments occurring after the effective date hereof, including without
limitation any determination by Brewing Company that the economic consequences
of this Agreement are unacceptable, and any decision by Brewing Company to cease
or diminish production of draft beer, the transactions contemplated by this
Agreement cannot be implemented or continued by a party hereto without undue
cost, loss or detriment to such party, the party experiencing such adverse
consequences shall have the right, upon notification to the other party of the
particulars of such developments, to cancel this Agreement effective thirty (30)
days after the giving of such written notice. In the event of any such
termination, Brewing Company shall repurchase kegs from MicroStar in a quantity
equal to three times the average monthly keg deliveries to Brewing Company
effectuated during the immediately preceding six (6) month period (the "Keg
Purchase Quantity") at prices set forth in Exhibit "E" based on the age of the
keg. The kegs to be purchased pursuant to this Section 11.6 shall be such kegs
as are then currently available for disposition by MicroStar and it is
understood by the parties hereto that the age of the kegs which may then be
available cannot presently be ascertained. The requisite quantities of kegs
shall be delivered monthly in prorated portions by MicroStar at its sole cost,
risk and expense to Brewing Company's designated location(s) over an approximate
three (3) month period. After confirmation of delivery of conforming kegs, a
Bill of Sale will be delivered assigning title to the kegs to Brewing Company
free and clear of any lien or security interest and Brewing Company shall
contemporaneously remit payment for all kegs so purchased.
If the foregoing right of termination is exercised by
MicroStar, MicroStar shall, upon the request of Brewing Company, allow this
Agreement to remain in effect for sixty (60) days after the otherwise applicable
effective date of termination in order to afford Brewing Company an opportunity
to arrange financing for the purchase of the kegs Brewing Company is obligated
to purchase hereunder. In such event, the quantity of kegs subject to the
purchase obligation shall be delivered monthly in prorated portions to Brewing
Company's designated location(s) over an approximate three (3) month period
commencing at the end of such sixty (60) day extension. In the event of Brewing
Company's exercise of the foregoing right of termination for economic reasons,
Brewing Company agrees not to utilize the services of any company engaged in
performing the same or substantially similar services to those of MicroStar for
a period of three (3) years from the date of such termination.
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
11.7. Choice of Law
KEG MANAGEMENT AGREEMENT
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<PAGE>
This Agreement and the performance hereof shall be construed
in accordance with, and governed by the internal laws of the state of
California.
11.8. Ad Valorem or Use Taxes
Any ad valorem, personal property, use or similar taxes
imposed as a result of Brewing Company's physical custody or use of
MicroStar-owned kegs shall be the responsibility of Brewing Company. MicroStar
shall not seek reimbursement from Brewing Company of any personal property or
similar taxes paid by MicroStar.
11.9. Notices
Notices and communications required or permitted hereunder
shall be in writing and any communication hereunder shall be deemed to be duly
made if actually delivered, transmitted by facsimile, or mailed, prepaid to the
parties as follows:
MicroStar Keg Management, L.L.C. Mendocino Brewing Company, Inc.
8567 154th Ave. N.E. 13351 South Highway 101
Redmond, Washington 98052 Hopland, California 95449
Attention: Robert M. Imeson Attention: Michael Laybourn
FAX (206) 883-6300 and Norman H. Franks
FAX (707) 744-1910
MicroStar shall send a copy of any notice to Mendocino, at the
same time and in the same or equivalent manner, to:
Enterprise Law Group, Inc.
Menlo Oaks Corporate Center
4400 Bohannon Drive, Suite 280
Menlo Park, California 94025-1041
Attention: Wayland M. Brill, Esq./Nelson D. Crandall, Esq.
(415) 462-4747 (FAX)
(415) 462-4700 (Voice)
A party may change its address for purposes of this Section 11.9 by giving the
other party written notice of the new address in the manner set forth above.
11.10. Captions
The headings and captions in this Agreement are for
convenience only and shall not be considered a part of or affect the
construction or interpretation of any provision of this Agreement.
11.11. Exhibits
KEG MANAGEMENT AGREEMENT
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<PAGE>
All Exhibits attached to or referred to in this Agreement are
incorporated into and made a part of this Agreement. However, in the event of a
conflict, the terms of this Agreement shall supersede those of an Exhibit
hereto.
THIS AGREEMENT is executed on the date set forth below each party's
respective signature.
MICROSTAR KEG MANAGEMENT, L.L.C.
By: /s/ Michael H. Leede
-----------------------------
Name: Michael H. Leede
---------------------------
Title: Manager
---------------------------
Date: February 28, 1997
---------------------------
MENDOCINO BREWING COMPANY, INC.
By: /s/ Norman H. Franks
-----------------------------
Name: Norman H. Franks
---------------------------
Title: Vice President and Chief
---------------------------
Financial Officer
---------------------------
Date:
---------------------------
KEG MANAGEMENT AGREEMENT
Page 13
<PAGE>
EXHIBIT "A-1" TO KEG MANAGEMENT AGREEMENT
List of Regional Wholesalers
<PAGE>
EXHIBIT "A-2" TO KEG MANAGEMENT AGREEMENT
List of Local Wholesalers
<PAGE>
EXHIBIT "B" TO KEG MANAGEMENT AGREEMENT
MICROSTAR KEG MANAGEMENT, L.L.C.
P. O. Box 3129
Redmond, Washington 98073
____________________, 1997
TO: ALL WHOLESALERS PURCHASING FROM Mendocino Brewing Company, Inc.,
("MENDOCINO")
RE: KEG MANAGEMENT AGREEMENT CONCLUDED BETWEEN ____________ AND MICROSTAR
KEG MANAGEMENT, L.L.C.; TERMS AND CONDITIONS APPLICABLE TO WHOLESALERS
Mendocino delivers its products in kegs to ____________________ ("Wholesaler").
Mendocino and MicroStar Keg Management, L.L.C. ("MicroStar") hereby notify
Wholesaler that effective ________________, 1997 all shipments from Mendocino
will be made in kegs owned by MicroStar and subject to MicroStar's
administration and retrieval rights and responsibilities under a Keg Management
Agreement between Mendocino and MicroStar dated , 1997 ("the Keg Management
Agreement").
Pursuant to the Keg Management Agreement, Mendocino is required to obtain
Wholesaler's agreement to the terms and conditions applicable to the
MicroStar-owned kegs and to the administrative services being performed by
MicroStar for Mendocino. The pertinent requirements applicable to Wholesaler are
as follows:
1) Deposits. A deposit computed based upon the amount of XXXXXX per keg
("the Deposit") for each MicroStar keg delivered to Wholesaler will be billed to
Wholesaler by MicroStar and shall be payable directly to MicroStar. The Deposit
shall serve as security to MicroStar against the loss of any keg owned by
MicroStar, based on a charge of XXXXXXX per keg, for any keg the location of
which cannot be ascertained. Periodic charges to and withdrawals from the
Deposit will be made for kegs which cannot be located. Similarly, credit memos
will be issued by MicroStar whenever kegs are returned and whenever kegs
previously classified as lost are located. Wholesaler will be invoiced in the
amount of XXXXXXX as a loss call whenever any loss is charged to the Deposit and
will receive a credit memo from MicroStar and refund of the loss call whenever a
previously lost keg for which a loss charge was made is located and returned.
2) Audits. Wholesaler shall be required to provide a monthly written
report of the movement of MicroStar kegs in the form(s) prescribed by MicroStar,
including inventory by brewer (including Mendocino and any other brewers
contracting with MicroStar who deliver product to Wholesaler), empty kegs on
hand and kegs in the retail system. Wholesaler also agrees to respond to weekly
verbal inquiries by MicroStar representatives concerning the extent of empty
MicroStar kegs in Wholesaler's system. MicroStar shall be authorized to conduct
periodic audits of Wholesaler's inventory of MicroStar kegs, including kegs in
the retail system, which audits will be performed either quarterly or
semi-annually, depending upon the extent of Wholesaler's inventory and any
discrepancies ascertained as a result of prior audits, etc.
Wholesaler's acceptance of deliveries of MicroStar kegs from Mendocino will
evidence Wholesaler's agreement to the foregoing terms, conditions and policies.
Please confirm receipt of this notice and Wholesaler's agreement to the
foregoing terms by signing below and returning a copy of this notice and
agreement to MicroStar at the address shown above.
Mendocino Brewing Company, Inc. MICROSTAR KEG MANAGEMENT, L.L.C.
By: By:
----------------------------- -----------------------------
ACKNOWLEDGED AND AGREED TO AS OF THE DATE FIRST ABOVE WRITTEN:
WHOLESALER:
By:
-----------------------------
<PAGE>
EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT
MINERAL WASHING/STERILIZING SEQUENCE (STEAM)
WASH HEAD
Purge out ullage beer with air until clear. 3 sec.
Pre-rinse keg with fresh or recovered water. 8 sec.
Purge out ore-rinse water with air. 5 sec.
Hot caustic or acid wash. 12 sec.
Low flow hot caustic or acid wash 12 sec.
Purge out hot caustic or acid to recovery tank with air. 6 sec.
Final rinse keg with hot water. 12 sec.
Low flow hot water rinse. 12 sec.
Purge out hot water rinse with steam. 18 sec.
Pressurize to 20 p.s.i.g. with steam. 1 sec.
Release pressure from process head. 1 sec.
STERILIZE HOLD STATION
Steam 60 sec.
RACKING HEAD
Steam conn. head and keg neck. 5 sec.
Steam pressure release from keg. 5 sec.
Gas purge keg. 8 sec.
Counter pressurize to 20 p.s.i.g. 2 sec.
Product fill. 50 sec.
Spear out. 1 sec.
Water scavenge and/or gas scavenge. 5 sec.
Page 1 of 5
<PAGE>
EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT
MINERAL WASHING/SANITIZING SEQUENCE (OXINE)
WASH HEAD
Purge out ullage beer with air until clear. 3 sec.
Pre-rinse keg with Oxine water. 8 sec.
Purge out Oxine water with air. 5 sec.
Hot caustic or acid wash. 12 sec.
Low flow hot caustic or acid wash 12 sec.
Purge out hot caustic or acid to recovery tank with air. 6 sec.
Final rinse keg with Oxine water. 12 sec.
Low flow Oxine water rinse. 12 sec.
Oxine water fill. 18 sec.
Spear out. 1 sec.
Purge head. 1 sec.
SANITIZE HOLD STATION
Oxine sanitize hold. 60 sec.
RACKING HEAD
Gas purge Oxine water from keg. 10 sec.
Gas counter pressurize to 20 p.s.i.g. 2 sec.
Product fill. 50 sec.
Spear out. 1 sec.
Oxine water scavenge and/or gas scavenge 4 sec.
Page 2 of 5
<PAGE>
EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT
KEG PLANT
QUALITY CONTROL CHECKS
A. DETERGENT TANK TITRATION
The detergent set, detergent tank(s), Quality Control checks should be made
before starting and at least twice during each eight (8) hour operating shift.
Adjust frequency to meet the Quality Control department "comfort level". The
acid titration level (phosphoric) should be in the range of 0.25% to maximum of
0.4% v/v and alkali titration level (caustic) in the range of 1.5 to 2.0% v/v.
B. KEG WATER CARRY-OVER AND TITRATION CHECKS
1) After the keg has completed the wash head(s) sequence(s), the keg must be
allowed to continue through the sterilizing sequence and then rejected (stopped)
immediately prior to commencing the racking head(s) sequence(s). When the keg is
retrieved at the discharge end of the machine, the keg can be cooled down by
placing a cold water hose over the outer surfaces (if steam is used). A Quality
Control keg coupler or funnel coupler (with the C02 and beer check valves
removed) is then used to tap the keg. The keg must be inverted to remove the
contents via the C02 port of the coupler by allowing the keg to drain or forcing
the contents out with air or C02. The condensate or rinse residuals in a 50
liter or 1/2 half barrel keg normally measures between 40 to 80 ml.. A limit of
100 ml. should be set as a maximum allowable limit. If the levels are in excess
of these amounts then the machine operation must be checked together with that
of the steam quality and relevant steam main condensate traps.
2) The condensate obtained from the keg can be titrated to ensure that there is
no acid and/or alkali carry-over from the wash heads.
NOTE 1: For this check the pH. of the condensate should be a known factor if
steam is used for purging.
NOTE 2: This check should be carried out once a day for each machine lane and
then reduced to the Quality Control department "comfort level".
3) Another keg is used to do a similar check after it has been allowed to
complete the sequences through the racker head(s) up to the point of immediately
prior to commencing the beer filling sequence. Reject the keg prior to starting
the beer filling sequence and remove the conveyor after discharging from the
machine. When checking for the quantity of condensate present in the keg, it
should be less than 15 ml.
Page 3 of 5
<PAGE>
EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT
NOTE: This check should be carried out once a day for each machine lane and then
reduced to the Quality Control department "comfort level".
C. MICROBIOLOGICAL CHECKS TO THE KEG
Introduce a liter of sterile liquid, (preferably beer), into a keg having
completed the sequence as described in Procedure 3) above, via a sterilized keg
valve and "funnel" coupler. This allows the keg to be checked for microbial
integrity by removing 250 ml. of the sterile liquid into a sterile flask. Split
the sample into two, 100 ml. samples via Millipore type membranes, plate and
incubate the membranes on agar suitable for aerobic and anaerobic organisms.
Methods of doing this vary slightly. The main objective, however, is to ensure
that consistency in sampling is maintained, i.e. having introduced the sterile
liquid into the keg, each keg should be rotated a set number of times to ensure
all surfaces have been covered equally before it is extracted. A known quantity
should always go into the keg and a known quantity should always be extracted,
filtered and plated.
NOTE 1: This procedure should be carried out at least once every two weeks.
NOTE: 2: Funnel couplers can be purchased via IDD to suit your keg valve type.
D. AFTER A C.I.P. SEQUENCE
After the C.I.P. sequence, the process mains, bright beer tank and racker
connection head(s), can be swabbed and checked for visual cleanliness to ensure
that the cleaning operation frequencies are effective and adequate.
NOTE: This should be carried out at least once a week.
E. BEER STABILITY SAMPLING
Samples are taken from the bright beer tank and keg at a frequency laid down by
the brewery Quality Control department. A suitable stability test is to set
aside a keg of beer from the leg line after filling and "forcing" the contents
by leaving the keg in an environment of 70(degree) F. (21(degree)C). Taste, odor
and clarity tests can then be taken after 72 hours and at regular durations
thereafter as desired to suit the Quality Control departments standards.
SUMMARY
It is possible to determine the following about the keg machine function and
cleaning procedures from the aforementioned.
Page 4 of 5
<PAGE>
EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT
1) The wash water and detergent is being cleared from the keg by the final C02
or steam purge sequence on the final wash head.
2) The final rinse water on the final wash head is removing the detergent
residual from the keg.
3) The C02 purge is removing the condensate trace from the keg on the racker
head prior to filling with beer.
4) The microbial integrity, via steam sterilizing or Oxine (Cl02) sanitizing
of the keg is being achieved.
5) The separate plant C.I.P. sequence is effective in removing all traces of
beer protein and other residuals from the keg plant connection head(s) and
piping system(s).
6) The cleanliness and microbial integrity is being maintained by the separate
plant C.I.P. regime.
If you have any questions, please contact Jeff Gunn at IDD Process & Packaging,
Inc. 1-800-621-4144 or 805-529-9890.
Page 5 of 5
<PAGE>
MICROSTAR KEG MANAGEMENT, L.L.C.
ACCOUNTING PROCEDURES
These accounting procedures are subject to the terms and conditions of
the Keg Management Agreement between MicroStar and Brewing Company. In
the event of any conflict between these accounting procedures and the
Keg Management Agreement (for this purpose, not including this Exhibit
as part of such Agreement) the Agreement shall control.
Standard Accounting procedures:
Procedure: The ongoing standard policy is as follows:
1. Brewing Company shall order kegs 30 days prior to any requested delivery
date. Brewing Company will be required to provide ninety (90) days advance
written notice to MicroStar for all orders which are 20% or more in excess
of normal order quantity. All orders will be confirmed by fax or US mail by
close of next business day. All Order(s) shall be deemed incomplete if not
confirmed by MicroStar.
2. Brewing Company will be invoiced XXXXXX per keg upon the receipt of each
delivery of kegs (30 day terms). This invoicing is generated by shipment
date and cross checked with the bill of lading returned by Brewing Company
and trucking company invoice. In the event of delinquent payment of any
invoice, MicroStar has the right to suspend deliveries of kegs and/or to
require future payments to be made prior to delivery of kegs.
3. Brewing Company must provide MicroStar with a bill of lading for all
shipments from Brewing Company to its wholesaler(s) within 24 hours of
shipment. This bill of lading will be required for inventory control and
will generate an invoicing of deposit to wholesaler. Brewing Company is
held responsible for lost/unaccounted for kegs under Brewing Company's
control (subject to XXXX per lost keg fee).
4. If Brewing Company effectuates a shipment to agreed upon regional
wholesaler(s) identified in Exhibit "A-1" to the Keg Management Agreement,
a XXXXX credit rebate will be provided to Brewing Company by MicroStar. If
applicable, Brewing Company may further specify on Exhibit "A-2" to the Keg
Management Agreement up to three (3) local wholesalers which currently
impose no freight charge upon Brewing Company for the return of kegs,
provided that (i) the wholesalers so designated agree to extend such free
keg return arrangements to the keg deliveries to be made pursuant to this
agreement, (ii) the timing, quantities and other arrangements relating to
such keg returns are and remain consistent with the specific delivery terms
prescribed by MicroStar, and (iii) Brewing Company agrees to assume and be
responsible for any and all cost of freight for the return of all kegs from
such designated local wholesalers. For each full keg sold by Brewing
Company to such designated local wholesalers, the applicable adjustment by
rebate or credit to Brewing Company will be XXXXXXXXXXXXXXXXXXXX per keg
(resulting in an effective use fee to Brewing Company of
XXXXXXXXXXXXXXXXXXXX per keg). In the event that any one of the above
specified requirements for status as a designated local wholesaler ceases
to be applicable, then effective on the date such
EXHIBIT "D" TO KEG MANAGEMENT AGREEMENT
Page 2
<PAGE>
requirement is no longer satisfied, the affected wholesaler shall
automatically be regarded as a regional wholesaler covered by Exhibit "A-1"
to the Keg Management Agreement. This information concerning local
shipments and return of kegs from specific wholesalers shall be cross
checked against the bill of lading and/or the signed loading report. Such
credit will be applied to Brewing Company's next invoice for kegs or, if a
net credit is generated, the credit will be refunded during normal
processing within 30 days. With respect to kegs used by Brewing Company in
on-site pub operations or self-distributed sales, the use fee shall be
XXXXXXXXXXXXXXXXXXXX per keg, per filling. Invoices for such fees will be
based upon the monthly report of sales submitted by Brewing Company to
applicable state authorities in relation to its on-site pub operations or
self-distributed sales, a copy of which shall be furnished to MicroStar at
the time such report is filed.
5. MicroStar will invoice wholesaler for a deposit of XXXXXX per keg from the
bill of lading or, if no bill of lading, a signed loading report as
provided by Brewing Company.
6. MicroStar will credit wholesaler for each empty keg shipped from the
wholesaler by and at the direction of MicroStar. The credit will be
generated by the bill of lading on shipment and will be corrected for any
errors for incorrect shipments including wrong kegs being shipped, mistakes
in number of kegs and the damage of kegs at wholesaler level. The
information on shipment errors will be provided by Brewing Company upon
Brewing Company's receipt of such kegs.
7. Brewing Company is required to provide a written monthly keg movement
report including opening inventory, number of kegs received from MicroStar
during the month, shipments out (summarized by wholesaler) and ending
inventory. Brewing Company will also provide MicroStar or its
representative with state and federal tax reports for purpose of cross
checking shipments upon request.
8. Brewing Company shall be subject to inspection and audit of inventory by
MicroStar during Brewing Company's normal business hours with 24 hour
notice (to be given during normal business hours).
9. Brewing Company will be responsible for inventorying kegs received from
MicroStar as to the number of kegs received, verification of MicroStar
ownership of kegs and identification of any damaged kegs.
10. Wholesaler refund credits will be adjusted for wrong kegs shipped to
Brewing Company or damage which occurs at its level.
EXHIBIT "D" TO KEG MANAGEMENT AGREEMENT
Page 2
<PAGE>
EXHIBIT "E" TO KEG MANAGEMENT AGREEMENT
Mendocino Brewing Company, Inc.
13351 South Highway 101,
Hopland, California 95449
Attention: Mr. Michael Lovett
RE: Keg Purchase Terms Pursuant
to Section 11.6 of Keg
Management Agreement
<TABLE>
MicroStar Keg Management, L.L.C. ("MicroStar") and Mendocino Brewing Company,
Inc. ("Mendocino") are parties to a Keg Management Agreement dated effective
_______________, 1997. The following table specifies the prices at which
individual kegs are to be valued for purchase by Mendocino pursuant to Section
11.6 of the Keg Management Agreement:
<CAPTION>
===================================================================================================
AGE OF KEGS (YEARS) VALUE
<S> <C> <C>
---------------------------------------------------------------------------------------------------
XXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXXXXX XXXXXX
---------------------------------------------------------------------------------------------------
XXXXXXXXX XXX
===================================================================================================
</TABLE>
The specified values are subject to verification by Mendocino of each
keg's condition at time of purchase as being in good working order in compliance
with all applicable laws and regulations and prevailing industry standards, and
without unusual or excessive wear and/or unusual or excessive body, neck, valve
or chimb damage.
<PAGE>
Mendocino Brewing Company, Inc.
Page 2
This joint memorandum is subject to the terms and conditions of the Keg
Management Agreement between MicroStar and Brewing Company. In the event of any
conflict between this joint memorandum and the Keg Management Agreement (for
this purpose, not including this Exhibit as part of such Agreement), the
Agreement shall control.
The kegs to be purchased pursuant to Section 11.6 shall be such kegs as
are then currently available for disposition by MicroStar Keg Management, L.L.C.
and it is understood by the parties hereto that the age of the kegs which may
then be available cannot presently be ascertained. Mendocino may refuse to
purchase any keg that does not conform to the above conditions. The requisite
quantities of kegs shall be delivered monthly in prorated portions by MicroStar
Keg Management, L.L.C. to Mendocino designated location over an approximate
three (3) month period. After confirmation of delivery of conforming kegs, a
Bill of Sale will be delivered assigning title to Mendocino free and clear of
any lien or security interest and Mendocino shall contemporaneously remit
payment for all kegs so purchased.
This joint memorandum shall serve to confirm that the foregoing
valuations shall apply in the case of a purchase right/obligation accruing upon
termination.
EXHIBIT "E" TO KEG MANAGEMENT AGREEMENT
CHANGE IN TERMS AGREEMENT
Borrower: Mendocino Brewing Company, Inc. Lender: SAVINGS BANK OF
PO Box 400 MENDOCINO COUNTY
Hopland, CA 95449 MAIN OFFICE P.O.
Box 3600 200 North
School Street
Ukiah, CA 95482
Principal Amount: $2,700,000 Date of Agreement: April 1. 1997
DESCRIPTION OF EXISTING INDEBTEDNESS. EXISTING LOAN NUMBER: 8010962256 IN THE
ORIGINAL AMOUNT OF $2.700,000.00 DATED 9/25/95 WITH AN OUTSTANDING BALANCE ON IN
THE AMOUNT OF $2,700,000.00, WITH INTEREST PAID TO 4/1/97.
DESCRIPTION OF COLLATERAL. 1. The outstanding obligation continues to be secured
by a security interest in the property described in a Deed of Trust dated
9/25/97 in Book 2366,, Page 544 of Official Records, Mendocino County.
DESCRIPTION OF CHANGE IN TERMS. 1. Final maturity of the loan is hereby extended
to 7/1/97. 2. Interest continues to be payable monthly commencing on 5/01/97 and
monthly thereafter.
CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of
the original obligation or obligations, including all agreements evidenced or
securing the obligations(s), remain unchanged and In full force and effect.
Consent by Lender to this Agreement does not waive Lender's right to absolute
performance of the obligation(s) as changed, nor obligate Lender to make any
future change in terms. Nothing in this Agreement will constitute a satisfaction
of the obligation(s). It Is the intention of Lender to retain as liable parties
all makers and endorsers of the original obligation(s), including accommodation
parties, unless a party is expressly released by Lender in writing. Any maker or
endorser, including accommodation makers, will not be released by virtue of this
Agreement. If any person who signed the original obligation does not sign this
Agreement below, then all persons signing below acknowledge that this Agreement
is given conditionally, based on the representation to Lender that the
non-signing party consents to the changes and provisions of this Agreement or
otherwise will not be released by it. This waiver applies not only to any
initial extension, modification or release, but also to all such subsequent
actions.
PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS
OF THIS AGREEMENT. BORROWER AGREES TO THE TERMS OF THE AGREEMENT AND
ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THE AGREEMENT.
BORROWER:
Mendocino Brewing Company, Inc.
By: __________________________________ By: ______________________________
Michael Laybourn, Chief Executive Officer Norman Franks, Chief Financial
Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
The audited financial statements of Mendocino Brewing Company, Inc. as at
December 31, 1997
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 494,800
<SECURITIES> 0
<RECEIVABLES> 317,400
<ALLOWANCES> 0
<INVENTORY> 380,500
<CURRENT-ASSETS> 1,346,300
<PP&E> 9,810,400
<DEPRECIATION> 540,100
<TOTAL-ASSETS> 11,144,600
<CURRENT-LIABILITIES> 4,963,100
<BONDS> 0
<COMMON> 3,869,600
0
227,600
<OTHER-SE> 203,200
<TOTAL-LIABILITY-AND-EQUITY> 11,144,600
<SALES> 3,839,700
<TOTAL-REVENUES> 4,004,700
<CGS> 1,909,700
<TOTAL-COSTS> 4,177,000
<OTHER-EXPENSES> 41,300
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,600
<INCOME-PRETAX> (202,000)
<INCOME-TAX> (78,200)
<INCOME-CONTINUING> (123,800)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (123,800)
<EPS-PRIMARY> (0.05)
<EPS-DILUTED> 0
</TABLE>
