MENDOCINO
BREWING COMPANY
1997
ANNUAL REPORT
[PICTURE OMITTED]
HOPLAND, CALIFORNIA
<PAGE>
BOARD OF DIRECTORS:
Vijay Mallya
Chairman of the Board
Michael Laybourn
Robert Neame
Kent Price
Sury Rao Palamand
Jerome Merchant
Yashpal Singh
[PICTURE OMITTED]
OFFICERS:
Vijay Mallya
Chief Executive Officer
Michael Laybourn
President
Jerome Merchant
Chief Financial Officer
Yashpal Singh
Chief Operating Officer
P A Murali
Corporate Secretary
<PAGE>
Dear fellow shareholders, customers, and friends,
This is the shareholder letter report for 1997, reporting the progress we have
made and how we are doing.
In 1997, MBC decided to invest in the future with an aggressive move to
finance the growth that we believe MBC is capable of achieving. It was a very
busy year for us. The priorities were finding funding for our growth,
commissioning the equipment in our new brewery, learning to brew with our new
system, and selling the beer we are capable of producing. We were on line in May
1997 and our first product was draft beer for the many accounts and customers
that have asked us for draft beer over the years.
[PICTURES OMITTED]
We also negotiated an alliance with United Breweries of America, which
brought in cash, additional management expertise, and a new brewery located in
Saratoga Springs, New York. I am very pleased with the transition and can say
that we are becoming much more efficient and financially stronger than before.
We are now better able to give the proper support to our distributors. We have
added new board members with many years of brewing and financial experience,
providing us opportunities that we did not have before.
Vijay Mallya, our new Chairman and CEO, will help continue the legend of
the Mendocino Brewing Company.
<PAGE>
As you know, MBC was an early pioneer in America's craft movement, being
the first brewpub in California and the second in the nation. Dr. Mallya feels
MBC has created some truly classic beers and wants to continue building our
reputation for the highest quality. He is committed to helping these brands grow
and bring this company to its rightful place in the craft brewing industry.
The addition of new board members saw the departure of others, and I
particularly want to thank Norman Franks, Michael Lovett, Eric Bradley, and Dan
Moldenhauer for their service and the contributions they made to your company.
[PICTURES OMITTED]
In the negotiations with UBA, I asked for management expertise as well as
cash. UBA has brought in excellent managers to help with financial management
and to increase productivity. We have already achieved gains in both areas.
MBC is continuing to implement its marketing plan. Market share and profits
will not only rely on producing a quality product, but will require that we
implement a strong sales strategy and hire a high quality sales staff. Our
investments in marketing and sales staff are paying off as sales increase. Total
wholesale shipments (in bbl.) for 1997 were up more than 51% over 1996, and 1998
YTD shipments are up over 1997. We were also implementing new production
efficiencies. As part of its investment, UBA contributed a second brewery on the
east coast. Ten Springs Brewing Company in Saratoga Springs, New York is a new
facility, similar in size to our California brewery, and will create shipping
and brewing efficiencies.
<PAGE>
There were many costs associated with the start-up and transition of our
brewing operations to the new brewery in Ukiah, much of which are reflected in
our 1997 financial position. There was a net loss of $1,139,700. The net loss
was the result primarily of the increased overhead associated with the operation
of two breweries, increased marketing expenses, and certain one time occurrences
during the fiscal year 1997.
Please continue to keep us informed -- you are all our customers and we
need to know what you think. E-mail address: [email protected]
[PICTURES OMITTED]
In summary, MBC is excited about the opportunity to produce and sell more
products and increase company value. I thank you shareholders for believing in
us and for having the high intelligence to enjoy our products.
Codially,
/s/ Michael Laybourn
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Michael Laybourn,
President
MBC
<PAGE>
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, 1997
[ ] 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
<TABLE>
Mendocino Brewing Company, Inc.
(Name of small business issuer in its charter)
<CAPTION>
<S> <C>
California 68-0318293
(State or other jurisdiction of incorporation or organization) (I.R.S. Employee Identification No.)
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
</TABLE>
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: $4,843,900
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 March
18, 1998 was $6,124,113.
The number of shares the issuer's common stock outstanding as of March 24,
1998 is 4,463,385.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Registrant's 1998 Annual Meeting of
Shareholders to be filed not later than April 30, 1998 are incorporated by
reference in Part III of this Form 10-K.
Transitional Small Business Disclosure Format Yes No X
--- ---
<PAGE>
PART I
This Report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results could differ materially from those projected in the
forward-looking statements as a result of the risk related factors set forth
herein.
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. 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.
In May 1997, Mendocino Brewing placed in operation a new brewery in
Ukiah, California (110 miles north of San Francisco) with an initial annual
capacity of approximately 60,000 bbl., which was more than four times the
Company's annual capacity from 1993 through the first nine months of 1995 of
13,600 bbl. The facility was designed to enable its production to be expanded to
200,000 bbl. per year with the addition of necessary equipment.
In October 1997, Mendocino Brewing entered into an Investment Agreement
with United Breweries of America, Inc. ("UBA"). UBA is affiliated with The UB
Group, which is a global producer of beer and spirits. Pursuant to the
Investment Agreement, UBA provided the Company with an additional $4 million
cash equity and transferred to the Company its subsidiary, Releta Brewing
Company LLC, which owns a brewery in Saratoga Springs, New York. The Company has
named the Saratoga Springs brewery "Ten Springs Brewery." Ten Springs Brewery
commenced production in February 1998 and has an initial capacity of 60,000 bbl.
per year expandable to 150,000 bbl. per year.
In December 1997, the Savings Bank of Mendocino County converted its
$2.7 million construction loan to a long term loan. This conversion, combined
with the cash equity contributed by UBA, reduced the Company's working capital
deficit from $3,616,800 at September 30, 1997 to $357,400 at December 31, 1997.
The transaction with UBA has resulted in substantial changes in the
management of the Company. Vijay Mallya, the world wide chairman of The UB
Group, has joined the Company in the capacity as Chief Executive Officer and
Chairman of the Board; Yashpal Singh, who has many years of experience in
operating breweries the size of the Company's two new breweries, has joined the
Company as Chief Operating Officer; and financial personnel experienced in the
budgeting, cash management, and reporting techniques and requirements of The UB
Group have been added. Michael Laybourn remains the President of the Company and
Donald Barkley remains the Company's Master Brewer.
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 began production at the new brewery in May
1997. In October 1997, the Company raised an additional $4 million in cash
through a private placement with UBA, which also contributed Ten Springs Brewery
to the Company as a new subsidiary. The Company's products are sold in selected
locations throughout the United States. See "Product Distribution."
<PAGE>
Industry Overview
The U.S. beer market may be divided into five segments:
Segment Representative Brands
- ------- ---------------------
Low-Priced Busch, Milwaukee's Best, Old Milwaukee
Premium Budweiser, Miller Lite, Bud Light, Coors Light
Super-Premium Michelob, Lowenbrau
European Import Heineken, Guinness, Bass
Domestic Craft Samuel Adams, Pete's, Sierra Nevada, Red Tail Ale
The Company competes in the domestic craft beer segment, which
comprises approximately 2% of total U.S. beer sales. Craft beers are
characterized by their full-flavor and are usually produced along traditional
European brewing styles. While U.S. beer sales were basically flat for several
years, domestic craft beer sales increased at a rate of approximately 40% per
year for several years through 1996. Segment growth was about 5% in 1997.
Management expects industry performance for 1998 to be no better than that of
1997. The rate at which the domestic craft beer segment continues to grow will
have a material affect on the Company's business, financial condition, and
results of operations. Actual industry segment performance depends on many
factors that are outside the control of the Company.
Competition
The craft beer category consists of:
* 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.
* Regional craft brews -- "hand-crafted" brews, primarily ales, sold
under the label of the brewery that produced it.
* 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.
* 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.
* 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 to some
degree and also against other segments of the U.S. beer market. Competition for
retail shelf-space also increased in 1997. Increased competition could hinder
distribution of the Company's products and have a material adverse effect on the
Company's business, financial condition, and results of operations.
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<PAGE>
Products
Mendocino Brewing has historically brewed three ales and a stout
year-round, three seasonal ales, and a seasonal porter:
* RED TAIL ALE, a full flavored amber ale, is the flagship brand of
Mendocino Brewing. It is available year-round in 12 oz six-packs and
half-barrel kegs.
* BLUE HERON PALE ALE is a golden ale with a full body and a distinctive
hop character. It is available year-round in 12 oz six-packs and
half-barrel kegs.
* BLACK HAWK STOUT is the fullest in flavor and body of the Company's
brews. It is also available year-round in 12 oz six-packs and
half-barrel kegs.
* EYE OF THE HAWK SELECT ALE is a high gravity deep amber summer ale. It
is available during summer months in 22 oz bottles.
* YULETIDE PORTER is a deep brown Holiday brew with a traditionally rich,
creamy flavor. It is available in November and December in 22 oz
bottles.
* PEREGRINE PALE ALE is brewed year-round with a more delicate flavor and
character. It is available year-round at the Hopland Brewery in draft
form.
* SPRINGTIDE ALE is brewed around St. Patrick's Day and appears as a
fresh, flowery, spicy golden ale. It is only available at the Hopland
Brewery in draft form.
* 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. It is available at the Hopland
Brewery and nearby retail outlets in 22 oz bottles.
Mendocino Brewing's brands use an ale yeast strain that was first
introduced at New Albion Brewing Co. in the late 1970s. Mendocino Brewing is
among a minority of brewers who use whole hops 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. In October 1997, Mendocino Brewing Company
was awarded three medals at the World Beer Championships, one of the largest and
most comprehensive beer competitions in the world. The Company received a Gold
Medal for Red Tail Ale, a Silver Medal for Eye of the Hawk Select Ale, and a
Bronze Medal for Black Hawk Stout. 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. 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.
Ten Springs Brewery presently performs some contract brewing services
for other brands. At present, the income from such services is not material.
The Hopland Brewery Brewpub and Merchandise Store
To date, Mendocino Brewing's major marketing tools have been the
Hopland Brewery brewpub and merchandise store, its Brewsletter newsletter, and
its distinctive labels. Located on a major tourist route in Hopland, California,
100 miles north of San Francisco, the Hopland Brewery opened in 1983 as the
first new brewpub 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.
An outdoor Beer Garden includes a shaded grape arbor, flowers, trellised hops in
the summer, picnic tables, and a sandbox for the kids.
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<PAGE>
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, and soft drinks. The brewpub also features hand pumped
cask conditioned ales. The menu features home-style cooking, sausages, legendary
hamburgers, Red Tail chili, fresh salads, snacks, vegetarian entrees, and daily
specials. The brewpub operates days and evenings, with live music for special
events, such as the Company's annual Anniversary Party in August and its
Oktoberfest in October. The Company brews special occasion draft beers at the
Hopland Brewery, and uses or plans to use the facility for research and
development, test-marketing, and as a brewing education and training site.
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.
The Brewsletter newsletter is published four to six times a year and is
available on the Company's web site at www.mendobrew.com. The Brewsletter
contains articles about the Company, the beer industry, and beer brewing and a
calendar of events for the Hopland Brewery. The Brewsletter is circulated to the
Company's shareholders and persons who have signed the guest registry at the
Hopland Brewery.
One of the ways Mendocino Brewing projects its quality and corporate
values to consumers is through its Red Tail Ale, Blue Heron Pale Ale, Black Hawk
Stout, 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 Brand Packaging Award competition sponsored by
Graphic Design: USA magazine for its Blue Heron Pale Ale packaging. In 1997, the
Company's Eye of the Hawk Select Ale label won First Place at the Second
International Label competition in the Beer Label category.
Regional Distribution
The Company's products are distributed widely in California and in
limited quantities at selected accounts in Arizona, Colorado, District of
Columbia, Georgia, Idaho, Illinois, Louisiana, Maryland, Massachusetts, Nevada,
New Jersey, Nebraska, New Mexico, New York, North Carolina, Oregon, South
Carolina, Texas, Washington, Wisconsin, and Wyoming. The Company plans to add
Minnesota, Pennsylvania, and Virginia in the near future. Northern California is
the Company's most important market at this time, and Management anticipates
that it will remain so for the foreseeable future.
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 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.
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. Red Tail Ale, Blue Heron Pale Ale, and
Black Hawk Stout are also available in draft. 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. Mendocino Brewing,
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. Beer sales (wholesale and retail combined) constituted 88% of
the Company's total sales in 1997, with food and merchandise retail and
catalogue sales constituting the balance. Sales to the top five customers
totaled $2,192,000 and $1,788,900 for the years ended December 31, 1997 and
1996, respectively representing 55% and 58% of brewing operation sales.
Suppliers
The Company's major suppliers are Great Western Malting Co., Yakima,
Washington (malt); John I. Haas,
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<PAGE>
Co., New York, New York (hops); and California Glass Company, Oakland,
California and Vitro Packaging, Inc., Dallas, Texas (bottles).
Employees
As of December 31, 1997, the Company employed 50 full-time and 39
part-time individuals including 14 in management and administration, 31 in
brewing operations, and 44 in retail and brewpub operations. Management believes
that the Company's relations with its employees are excellent. None of its work
force is unionized. The Company has agreed with the City of Ukiah that for two
years from the opening of the Ukiah brewery that it will give preference in its
hiring to residents of Mendocino County.
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 Company has also
applied for intent to use registrations of the trademarks NORTH COUNTRY ALES,
WHITE FACE, WHITEFACE, FAT BEAR, and NORTHERN EXPOSURE.
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".
Before it was acquired by UBA and contributed to the Company, the
Saratoga Springs brewery brewed and bottled ales sold under the following
trademarks: NORTH COUNTRY ALES, WHITE FACE, WHITEFACE, FAT BEAR, and NORTHERN
EXPOSURE. Intent to use applications have been filed with the U.S. Patent and
Trademark Office for those marks following their abandonment by their previous
owner.
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
Departments of Alcoholic Beverage Control in California and New York. 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.
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<PAGE>
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.
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 sells or gives away its
spent grain to local cattle ranchers. 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.
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 in
Ukiah.
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
Research and development activity in 1997 was minimal.
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 owns nine acres of land in Ukiah, California on which its Ukiah
brewery is operated. The Company currently leases a 15,500 square foot building
in Hopland on which the Hopland Brewery is located. The lease expires in August
2004. The Company leases 3.66 acres on which Ten Springs Brewery operates under
a lease expiring October 2002. Additionally, the Company leases certain
equipment and vehicles under operating leases which expire through March 1999.
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.
The Company held its annual meeting of shareholders in Ukiah,
California, on Wednesday, December 3, 1997. Votes were cast for the election of
directors to serve until their successors are elected at the next annual meeting
of the Company as follows
Candidate Votes For Votes Withheld
- --------- --------- --------------
Vijay Mallya 1,780,923 6,936
H. Michael Laybourn 1,781,383 6,476
O'Neil Nalavadi 1,781,023 6,836
Jerome G. Merchant 1,779,223 8,636
Yashpal Singh 1,780,923 6,936
Eric G. Bradley 1,779,133 8,726
Daniel R. Moldenhauer 1,779,333 8,526
The shareholders also ratified the appointment of Moss Adams LLP as the
Company's independent auditors for 1997 by a vote of 1,781,157 for, 1,060
against, and 5,642 abstain.
As was disclosed in the Company's proxy statement for the 1997 annual
meeting, Messrs. Bradley and Moldenhauer had already agreed to resign effective
December 31, 1997 at the time they were elected. In January 1998, O'Neil
Nalavadi also resigned. The Board of Directors has appointed Robert Neame, Kent
Price, and Sury Rao Palamand to fill the vacancies created by these resignations
until the next annual meeting of the shareholders of the Company.
-7-
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
<TABLE>
Mendocino Brewing's Common Stock is listed on the Pacific Exchange
(symbol MBR). The high and low closing sales prices for the Common Stock on the
Pacific Exchange are set forth below for the quarters indicated:
<CAPTION>
1996 1997
-------------------------------------------------- ---------------------------------------------------
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 $7.38 $10.82 $10.00 $8.38 $8.00 $7.25 $5.50 $4.37
Low $5.50 $5.82 $7.38 $5.75 $6.00 $4.50 $3.62 $3.06
</TABLE>
There were approximately 2,508 shareholders of record as of January 6,
1998. 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.
Overview
In May 1997, Mendocino Brewing placed in operation a new brewery in
Ukiah, California (110 miles north of San Francisco) with an initial annual
capacity of approximately 60,000 bbl. The facility was designed to enable its
production to be expanded to 200,000 bbl. per year with the addition of
necessary equipment.
In October 1997, Mendocino Brewing entered into an Investment Agreement
with United Breweries of America, Inc. ("UBA"). UBA is affiliated with The UB
Group, which is a global producer of beer and spirits. Pursuant to the
Investment Agreement, UBA provided the Company with an additional $4 million
cash equity and transferred to the Company its subsidiary, Releta Brewing
Company LLC, which owns a brewery in Saratoga Springs, New York. The Company has
named the Saratoga Springs brewery "Ten Springs Brewery." Ten Springs Brewery
commenced production in February 1998 and has an initial capacity of 60,000 bbl.
per year expandable to 150,000 bbl. per year.
In December 1997, the Savings Bank of Mendocino County converted its
$2.7 million construction loan to a long term loan. This conversion, combined
with the cash equity contributed by UBA, reduced the Company's working capital
deficit from $3,616,800 at September 30, 1997 to $357,400 at December 31, 1997.
Net sales for 1997 increased by 19.5% over 1996 due primarily to
increased marketing efforts. Production (measured in barrels) increased by 54%
from 13,391 bbl. in 1996 to 20,557 bbl. in 1997. The Company ended the year with
a net loss of $1,139,700. Increased fixed costs associated with the new brewery,
higher marketing expenses during the year, the fixed costs of Ten Springs
Brewery, increased interest expenses of $401,900, and a one time write off of
$141,000 in public offering expenses (classified as "Other Expenses"),
contributed to the net loss of $1,139,700 for the year ended December 31, 1997.
-8-
<PAGE>
<TABLE>
Results of Operations
The following tables set forth, as a percentage of net sales, certain
items included in Mendocino Brewing's Statements of Operations. See Financial
Statements and Notes thereto.
<CAPTION>
Year Ended December 31,
---------------------------------------------
1997 1996
------------------ -----------
<S> <C> <C>
Statements of Operations Data:
Sales........................................... 105.53% 104.30%
Less excise taxes............................... 5.53 4.30
------ ------
Net Sales....................................... 100.00 100.00
Cost of goods sold.............................. 72.16 49.74
------ ------
Gross profit.................................... 27.84 50.26
Operating expenses.............................. 56.26 54.75
------ ------
Loss from operations............................ (28.42) (4.49)
Other expense................................... (11.85) (0.77)
------ ------
Loss before income taxes........................ (40.27) (5.26)
Benefit from income taxes....................... (15.44) (2.04)
------ ------
Net loss........................................ (24.83)% (3.22)%
====== ======
</TABLE>
<TABLE>
<CAPTION>
At December 31,
-----------------------------------------------
1997 1996
------------------ ----------
<S> <C> <C>
Balance Sheet Data:
Cash and cash equivalents....................... $ 706,300 $ 494,800
Working capital................................. (357,400) (3,616,800)
Property and equipment.......................... 15,642,500 9,270,300
Deposits and other assets....................... 42,000 304,100
Total assets.................................... 18,026,400 11,144,600
Long-term debt.................................. 2,663,300 --
Obligation under capital lease.................. 1,578,900 1,863,000
Total liabilities............................... 6,368,100 6,844,200
Retained earnings (deficit)..................... (936,500) 203,200
Stockholder's equity............................ 11,658,300 4,300,400
</TABLE>
Net Sales. Net sales for 1997 increased by 19.5% from $3,839,700 in
1996 to $4,590,000 in 1997. Management attributes the growth in sales to the
implementation of new marketing strategies, including new point of sale
materials and the commencement of operations at the new brewery in Ukiah in May
1997. Wholesale beer shipments (measured in barrels) increased by 54% in 1997
when compared to 1996. Increases attributable to additional unit sales were
offset in part by a wholesale price reduction implemented in September 1996.
Management attributes approximately 60% of sales increase to increased sales to
existing distributors and geographic expansion begun in late 1996 and the
remaining 40% to sales of draft beer from the new brewery in Ukiah which
commenced operations in May 1997. Retail sales at the Hopland brewpub and
merchandise store increased 5.4% during 1997. Management attributes the increase
to merchandise sales resulting from tourist traffic generated by the Company's
marketing efforts.
Cost of goods sold. Cost of goods sold as a percentage of net sales
increased by 22.4 percentage points in 1997 to 72.2% when compared to 49.7% in
1996. Managment attributes the increase to a combination of a wholesale price
reduction resulting in decreased sales dollars, higher fixed and production
costs due to the underutilization of the new brewing facility in Ukiah and the
Ten Springs Brewery in Saratoga Springs, New York and certain start-up costs
associated with the new brewery. The Company did not realize any material amount
of revenue from Ten Springs Brewery during 1997, as the brewery did not become
operational until February 1998.
Gross profit. Gross profit decreased by 33.8% during 1997 to $1,277,900
in comparison to $1,930,000 in 1996. As a percentage of net sales, gross profit
decreased 22.4 percentage points to 27.8% in 1997 as compared to 50.2% in 1996.
The decrease in gross profit as a percentage of net sales is attributable to the
increase in cost of goods sold and a wholesale price reduction implemented in
late 1996.
-9-
<PAGE>
Operating expenses. Operating expenses were $2,582,400 in 1997,
representing an increase of 22.8% when compared to $2,102,400 in 1996. Operating
expenses consist of retail operating expenses, marketing and distribution
expenses and general and Administrative expenses.
Retail operating expenses were $704,000 representing a decrease of
$34,200 or 4.6% over 1996. The decrease consisted of a reduction in labor costs
of $10,400, a reduction in repairs and maintenance expense of $9,400, and a
decrease in net other expenses of $14,400.
Marketing and distribution expenses were $846,200 in 1997, representing
an increase of 24% compared to $682,300 in 1996. As a percentage of net sales,
marketing and distribution expenses represented 18.4% in 1997 as compared to
17.8% in 1996. Point of sale, promotional/advertising, packaging, and label
development costs increased by $111,300. Marketing and sales labor increased by
$85,300. Travel and lodging incurred in supporting new geographic markets
increased by $40,000. Distribution expenses decreased by $44,800 primarily
because of reduced warehouse rental expense. Other net expenses decreased by
$27,900.
General and Administrative expenses were $1,032,200 in 1997
representing an increase of $350,300 over the expenses incurred in 1996. General
and administrative expenses increased by 51.4% over 1996 and as a percentage of
net sales represented 22.5% in 1997 as against 17.8% in 1996. Professional fees
increased by $81,700. Taxes and insurance costs associated with the new
breweries in Ukiah and Saratoga Springs increased by $124,900. Travel and
lodging expenses increased by $57,700. Labor costs increased by $27,200. Costs
associated with being a public company increased by $17,700. Net other costs
increased by $41,100.
Net interest expense. Net interest expense in 1997 was $401,900 as
against interest income of $11,600 in 1996. The total interest expense incurred
during 1997 was $665,300 out of which capitalized interest accounted for
$263,400 in 1997 as against $214,900 in 1996.
Other expense. Other expense, not including net interest expense, in
1997 was $149,500 as against $41,200 in 1996 representing an increase of
$108,300.
In February 1997 the Company commenced a direct public offering of
600,000 shares of common stock at an offering price of $8.50. In August 1997,
the offering was terminated after having sold 19,516 shares for $164,700. All
sales occurred before June 30, 1997. The Company incurred $305,300 of offering
costs related to the offering. Of that amount, $164,700 was offset against the
stock sale proceeds in stockholders' equity and the balance of $141,000 was
expensed.
Other net expenses increased by $5,600. These expenses were offset by a
non recurring write off in 1996 of $38,300 in costs associated with a proposed
alliance.
Net loss. Increased overhead as the Company commenced operation at the
new brewery in Ukiah, fixed expenses associated with the brewery in Saratoga
Springs, increased marketing expenses, the charge for interest expense after
commencement of operations at the new brewery in Ukiah, and the net effect of
certain one time occurrences, offset by a tax benefit of $708,900, resulted in a
net loss in 1997 of $1,139,700 as against the net loss of $123,800 in 1996.
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 80% of the Company's 1997 gross 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 20% of the Company's 1997 gross annual sales. See "Notes
to Financial Statements, Note 13 - Segment Information."
With expanded wholesale beer production in both Ukiah and Saratoga
Springs, 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. It is not clear to what extent seasonality will
affect the Company as it expands its capacity and its geographic markets.
-10-
<PAGE>
Capital Demands.
Ten Springs Brewery did not commence brewing operations until February
1998 and will not realize any material amount of revenues for several weeks. The
Company expects both the Ukiah brewery and Ten Springs Brewery to operate at
significantly less than full capacity during all or part of 1998.
The Company has yet to complete the build-out of its administrative
space or the exterior landscaping of the Ukiah brewery. The Ukiah brewery is
presently operating under a temporary certificate of occupancy from the City of
Ukiah. Completion of construction is a condition to the issuance of a final
certificate of occupancy. Failure to complete construction and obtain a final
certificate of occupancy could have a material adverse effect on the Company's
business, financial condition, and results of operations.
Both breweries have placed demands upon the Company's assets,
liabilities, commitments for capital expenditures, and liquidity. Failure to
adequately meet those demands may have a material adverse affect on the
Company's business, financial condition, and results of operations.
Liquidity and Capital Resources
Long Term Debt. Mendocino Brewing has obtained a $2.7 million long term
loan secured by a first priority deed of trust on the Ukiah land and
improvements. The loan is payable in monthly installments of $24,443 including
interest at the Treasury Constant Maturity Index plus 4.17%, currently 5.83%,
maturing December 2012 with a balloon payment of $1,872,300 secured by
substantially all the assets of the Company, other than Ten Springs Brewery.
Shareholder Commitment. United Breweries of America, Inc. ("UBA"), the
Company's largest shareholder, has agreed in principle to provide the Company
with a credit facility of up to $2 million, to be funded in installments of up
to $300,000 each. The advances are secured by Ten Springs Brewery. The advances
bear interest at prime plus 1.5% and are due and payable 18 months after the
date of the advance. It is anticipated the advances will have a conversion
feature into unregistered shares of the Company's common stock. The final
structure of the conversion feature is currently being reviewed pending what is
most financially beneficial for the Company. The arrangement was approved by a
committee consisting of director Michael Laybourn (the President of the Company)
and independent directors Kent Price and Sury Rao Palamond on February 19, 1998.
Although formal documentation of the arrangement is pending, UBA had advanced
the first installment of $300,000 to the Company as of March 25, 1998.
Equipment Lease. FINOVA Capital Corporation has leased new brewing
equipment with a total cost of approximately $1.78 million to Mendocino Brewing
for a term of 7 years (beginning December 1996) with monthly rental payments of
approximately $27,100 each. 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 $39,000 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, 1997 of approximately $93,000 at 9% annual
interest payable at maturity in December 1998 per a verbal agreement with the
spokesman for the lending group.
Revolving Credit Facility. WestAmerica Bank of Santa Rosa, California
has provided a $600,000 maximum revolving line of credit with an advance rate of
80% of the qualified accounts receivable and 25% of the inventory at an interest
rate of the bank's index rate plus 1.5% payable monthly, maturing May 31, 1998.
To the extent that the loan is not extended or refinanced, the Company will be
required to repay the loan. Failure to find a lender to refinance the loan could
have a material adverse effect on the Company's business, financial condition,
and results of operations.
Keg Management Arrangement. The Company 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
-11-
<PAGE>
purchase a certain number of kegs from MicroStar. The Company would probably
finance the purchase through debt or lease financing, if available.
The Company's ratio of current assets to current liabilities on
December 31, 1997 was 0.83 to 1.0 and its ratio of assets to liabilities was
2.83 to 1.0.
Impact of Expansion on Cash Flow.
Mendocino Brewing must make timely payment of its debt and lease
commitment to continue in operation. Increased capacity has placed 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. The Company has been required to
incur some or all of these costs before the Company can realize revenue from
increased sales. Working capital for day to day business operations had
historically been provided primarily through operations. Beginning approximately
with the second quarter of 1997, the time at which the Ukiah brewery commenced
operations, proceeds from operations have not been able to provide sufficient
working capital for day to day operations. The investment agreement with UBA
provided approximately $700,000 in working capital. In addition, UBA has agreed
to provide funding for the working capital requirements of the Saratoga Springs
brewery in an amount not to exceed $1 million until October 24, 1999 or until
the brewery's operations are profitable, whichever comes first.
Item 7. Financial Statements.
The information required by this item is set forth at Pages F-1 through
F-18 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.
The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed pursuant to Regulation 14A
no later than April 30, 1998.
Item 10. Executive Compensation.
The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed pursuant to Regulation 14A
no later than April 30, 1998.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed pursuant to Regulation 14A
no later than April 30, 1998.
-12-
<PAGE>
Item 12. Certain Relationships and Related Transactions.
The information required by this item is incorporated by reference from
the Company's definitive proxy statement to be filed pursuant to Regulation 14A
no later than April 30, 1998.
<TABLE>
Item 13. Exhibits and Reports on Form 8-K.
<CAPTION>
Exhibit
Number Description of Document
- ------- -------------------------------
<S> <C>
3.1 (A) Articles of Incorporation, as amended, of the Company
3.2 (B) Bylaws of the Company
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.)
10.1 (A) Mendocino Brewing Company Profit Sharing Plan.
10.2 (A) 1994 Stock Option Plan (previously filed as Exhibit 99.6).
10.3 (M) Employment Agreement with H. Michael Laybourn.
10.4 (A) Wholesale Distribution Agreement between the Company and Bay Area Distributing.
10.5 (A) Wholesale Distribution Agreement between the Company and Golden Gate Distributing.
10.6 (A) Sales Contract between the Company and John I. Hass, Inc.
10.7 (F) Liquid Sediment Removal Services Agreement with Cold Creek Compost, Inc.
10.8 (A) Lease Agreement between the Company and Kohn Properties.
10.9 (C) Commercial Real Estate Purchase Contract and Receipt for Deposit (previously filed as
Exhibit 19.2).
10.10 (D) Installment Note between Ukiah Redevelopment Agency and Langley et al. (previously filed as
Exhibit 19.5).
10.11 (F) Promissory Note for $76,230 in favor of Langley et al.
10.12 (G) Agreement to modify note and deed of trust dated June 6, 1995 with Langley, et al.
10.13 (G) Agreement to modify note dated June 6, 1995 with Langley, et al.
10.14 (G) Amendment to installment note payable to Langley, et al.
10.15 (N) Commercial Lease Between Stewart's Ice Cream Company, Inc. and Releta Brewing Company LLC.
10.16 (M) Agreement between United Breweries of America, Inc. and Releta Brewing Company LLC regarding
payment of certain liens.
10.17 (K)+ Keg Management Agreement with MicroStar Keg Management LLC.
10.18 (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).
10.19 (G) Manufacturing Business Expansion and Relocation Agreement with the City of Ukiah.
10.20 (G) Manufacturing Business Expansion and Relocation Agreement with the Ukiah Redevelopment
Agency.
-13-
<PAGE>
Exhibit
Number Description of Document
- ------- -------------------------------
10.21 $2,700,000 Note in favor of the Savings Bank of Mendocino County.
10.22 Hazardous Substances Certificate and Indemnity with the Savings Bank of Mendocino County.
10.23 Business Loan Agreement with WestAmerica Bank.
10.24 $600,000 Note in favor of the WestAmerica Bank.
10.25 (J) Equipment Lease with FINOVA Capital Corporation.
10.26 (J) Tri-Election Rider to Equipment Lease with FINOVA Capital Corporation.
10.27 (J) Master Lease Schedule with FINOVA Capital Corporation.
10.28 (L) Investment Agreement with United Breweries of America, Inc.
10.29 (L) Shareholders' Agreement Among the Company, United Breweries of America, Inc., Michael
Laybourn, Norman Franks, Michael Lovett, John Scahill, and Don Barkley
10.30 (L) Registration Rights Agreement Among the Company, United Breweries of America, Inc., Michael
Laybourn, Norman Franks, Michael Lovett, John Scahill, and Don Barkley
27 Financial Data Schedule
<FN>
- --------------------------------
(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 quarterly 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 quarterly 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 quarterly 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 quarterly 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 quarterly 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.
(K) Incorporated by referenced from the Company's Report on
Form 10-KSB for the annual period ended December 31, 1996
previously filed with the Commission.
(L) Incorporated by reference from the Schedule 13D filed with
the Commission on November 3, 1997 by United Breweries of
America, Inc. and Vijay Mallya.
(M) Incorporated by reference from the Company's Report on Form
10-QSB for the quarterly period ended September 30, 1997.
(N) Incorporated by reference from the Company's Report on Form
10-QSB/A No. 1 for the quarterly period ended September 30,
1997.
+ Portions of this Exhibit were omitted pursuant to an
application for an order declaring confidential treatment
filed with the Securities and Exchange Commission.
</FN>
</TABLE>
-14-
<PAGE>
The Registrant filed a report on Form 8-K on November 5, 1997 (amended November
18, 1997) relating to the Investment Agreement with UBA and the acquisition of
Ten Springs Brewery. The Report contained a description of the Investment
Agreement with UBA responsive to Item 1 of Form 8-K (Changes of Control of
Registrant) and a description of the acquisition of Ten Springs Brewery by way
of acquisition of the outstanding interests in Releta Brewing Company LLC,
responsive to Item 2 of form 8-K (Acquisition or Disposition of Assets). No
financial statements were filed.
-15-
<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/ Vijay Mallya
---------------------------------------------------
Vijay Mallya, Chief Executive Officer
Date: March 31, 1998
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/ Vijay Mallya
---------------------------------------------------
Vijay Mallya, Chief Executive Officer and Director
Date: March 31, 1998
By: /s/ H. Michael Laybourn
---------------------------------------------------
H. Michael Laybourn, President and Director
Date: March 31, 1998
By: /s/ Yashpal Singh
---------------------------------------------------
Yashpal Singh, Chief Operating Officer and Director
Date: March 31, 1998
By: /s/ Jerome G. Merchant
---------------------------------------------------
Jerome G. Merchant, Chief Financial Officer and
Director
Date: March 31, 1998
By: /s/ P.A. Murali
---------------------------------------------------
P.A. Murali, Controller
Date: March 31, 1998
-16-
<PAGE>
- --------------------------------------------------------------------------------
MENDOCINO BREWING COMPANY, INC.,
AND SUBSIDIARY
INDEPENDENT AUDITOR'S REPORT
AND
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
<PAGE>
- --------------------------------------------------------------------------------
CONTENTS
PAGE
INDEPENDENT AUDITOR'S REPORT............................................. F - 1
CONSOLIDATED 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 consolidated balance sheets of Mendocino
Brewing Company, Inc., and subsidiary as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the two years ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial position of Mendocino Brewing
Company, Inc., and subsidiary as of December 31, 1997 and 1996, and the results
of its operations and its cash flows for each of the two years ended December
31, 1997, in conformity with generally accepted accounting principles.
/s/ Moss Adams LLP
Santa Rosa, California
March 4, 1998
Page F - 1
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
- --------------------------------------------------------------------------------
ASSETS
1997 1996
----------- -----------
CURRENT ASSETS
Cash $ 706,300 $ 494,800
Accounts receivable 329,700 317,400
Inventories 544,100 380,500
Prepaid expenses 42,600 58,600
Refundable income taxes 106,300 71,900
Deferred income taxes 39,500 23,100
----------- -----------
Total current assets 1,768,500 1,346,300
----------- -----------
PROPERTY AND EQUIPMENT 15,642,500 9,270,300
----------- -----------
OTHER ASSETS
Deferred income taxes 573,400 4,500
Deposits and other assets 42,000 304,100
Deferred stock offering costs -- 202,000
Label development costs, net of amortization -- 17,400
----------- -----------
615,400 528,000
----------- -----------
Total assets $18,026,400 $11,144,600
=========== ===========
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 2
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (Continued)
December 31, 1997 and 1996
- --------------------------------------------------------------------------------
<TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES
Line of credit $ 600,000 $ 600,000
Accounts payable 728,300 567,600
Accounts payable-related party 80,200 --
Accrued wages and related expense 169,700 118,200
Accrued construction costs 500 744,500
Accrued liabilities 248,300 16,100
Current maturities of long-term debt 130,400 2,765,400
Current maturities of obligation under capital lease 168,500 151,300
------------ ------------
Total current liabilities 2,125,900 4,963,100
LONG-TERM DEBT, less current maturities 2,663,300 --
OBLIGATION UNDER CAPITAL LEASE, less
current maturities 1,578,900 1,863,000
DEFERRED INCOME TAXES -- 18,100
------------ ------------
Total liabilities 6,368,100 6,844,200
------------ ------------
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,
4,463,385 and 2,322,222 shares issued and outstanding
at December 31, 1997 and 1996, respectively 12,367,200 3,869,600
Retained earnings (deficit) (936,500) 203,200
------------ ------------
Total stockholders' equity 11,658,300 4,300,400
------------ ------------
Total liabilities and stockholders' equity $ 18,026,400 $ 11,144,600
============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 3
</FN>
</TABLE>
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1997 and 1996
- --------------------------------------------------------------------------------
1997 1996
----------- -----------
SALES $ 4,843,900 $ 4,004,700
LESS EXCISE TAXES 253,900 165,000
----------- -----------
NET SALES 4,590,000 3,839,700
COST OF GOODS SOLD 3,312,100 1,909,700
----------- -----------
GROSS PROFIT 1,277,900 1,930,000
----------- -----------
OPERATING EXPENSES
Retail operating 704,000 738,200
Marketing 846,200 682,300
General and administrative 1,032,200 681,900
----------- -----------
2,582,400 2,102,400
----------- -----------
LOSS FROM OPERATIONS (1,304,500) (172,400)
----------- -----------
OTHER INCOME (EXPENSE)
Interest income 7,300 11,600
Other expense (149,500) (41,200)
Interest expense (401,900) --
----------- -----------
(544,100) (29,600)
----------- -----------
LOSS BEFORE INCOME TAXES (1,848,600) (202,000)
BENEFIT FROM INCOME TAXES (708,900) (78,200)
----------- -----------
NET LOSS $(1,139,700) $ (123,800)
=========== ===========
LOSS PER COMMON SHARE $ (0.40) $ (0.05)
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 2,870,478 2,322,222
=========== ===========
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 4
<PAGE>
<TABLE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997 and 1996
- --------------------------------------------------------------------------------
<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, 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
Issuance of common stock, net of
$164,700 issuance costs -- -- 19,516 -- -- --
Stock issued for services at $6.18
per share -- -- 2,000 12,200 -- 12,200
Issuance of common stock, net of
$514,600 issuance costs -- -- 943,176 3,485,400 -- 3,485,400
Stock issued for 100% ownership
in Releta Brewing Co. -- -- 1,176,471 5,000,000 -- 5,000,000
Net loss -- -- -- -- (1,139,700) (1,139,700)
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 1997 227,600 $ 227,600 4,463,385 $ 12,367,200 $ (936,500) $ 11,658,300
============ ============ ============ ============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 5
</FN>
</TABLE>
<PAGE>
<TABLE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(1,139,700) $ (123,800)
Adjustments to reconcile net loss to net
cash provided (used) by operating activities:
Depreciation and amortization 359,300 51,900
Gain on sale of assets -- (3,600)
Deferred income taxes (603,400) (14,200)
Stock issued for services 12,200 --
Changes in:
Accounts receivable 130,800 141,500
Inventories (78,400) (124,300)
Prepaid expenses 16,000 (11,500)
Refundable income taxes (34,400) (71,900)
Accounts payable - trade and related party 240,900 461,900
Accrued wages and related expense 51,500 (11,600)
Accrued liabilities 232,200 (6,200)
Accrued profit sharing -- (30,000)
Income taxes payable -- (34,200)
----------- -----------
Net cash (used) provided by operating activities (813,000) 224,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold
improvements (1,922,800) (4,817,500)
Increase in other assets (27,900) (255,600)
Proceeds from sale of fixed assets -- 10,300
----------- -----------
Net cash used by investing activities (1,950,700) (5,062,800)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on line of credit -- 600,000
Borrowings on long-term debt 1,097,200 2,502,800
Principal payments on long-term debt (1,068,900) (302,800)
Reimbursement from obligation under capital lease 147,400 1,523,800
Payments on obligation under capital lease (143,900) (57,900)
Reduction in accrued construction costs (744,000) (437,800)
Proceeds from sale of common stock 4,164,700 --
Deferred stock offering costs (477,300) (190,600)
----------- -----------
Net cash provided by financing activities 2,975,200 3,637,500
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 211,500 (1,201,300)
CASH AND CASH EQUIVALENTS, beginning of year 494,800 1,696,100
----------- -----------
CASH AND CASH EQUIVALENTS, end of year $ 706,300 $ 494,800
=========== ===========
<FN>
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 6
</FN>
</TABLE>
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Description of operations - Mendocino Brewing Company and its subsidiary operate
two breweries, which are in the business of producing beer and malt beverages
for the specialty "craft" segment of the beer market, as well as own and operate
a brew pub and gift store. The breweries are in two locations, one in Ukiah,
California and the other in Saratoga Springs, New York. The brew pub and gift
store are located in Hopland, California. The majority of sales for Mendocino
Brewing Company are in California. The company began operations at the Saratoga
Springs, New York facility in December 1997. The company will brew several
brands of which Red Tail Ale will be the Flagship brand. In addition, the
Company will perform contract brewing for several other brands.
Principles of consolidation - The consolidated financial statements present the
accounts of Mendocino Brewing Company, Inc., and its wholly-owned subsidiary,
Releta Brewing Company LLC., which operates in Saratoga Springs, New York. All
material inter-company balances and transactions have been eliminated.
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 $263,400 and $214,900
in 1997 and 1996, respectively. Costs of maintenance and repairs are charged to
expense as incurred; significant renewals and betterments are capitalized.
Estimated useful lives are as follows:
Building 40 years
Machinery and equipment 5 - 40 years
Furniture and fixtures 5 - 10 years
Leasehold improvements 7 - 40 years
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. In 1997, the public stock offering was terminated and $164,600 of stock
offering costs were offset against the same amount of proceeds from the stock
sale. The balance of stock offering costs of $140,500 was expensed.
Deposits and other assets - Deposits and other assets consist primarily of
prepaid interest on the financing of the Ukiah brewery. Amounts are amortized
using the straight line method over the life of the mortgage.
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.
- --------------------------------------------------------------------------------
Page F - 7
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
Income taxes - The provision for income taxes is based on pre-tax earnings
reported in the financial statements, adjusted for requirements of current tax
law, plus the change in deferred taxes. Deferred tax assets and liabilities are
recognized using enacted tax rates and reflect the expected future tax
consequences of temporary differences between the recorded amounts of assets and
liabilities for financial reporting purposes and tax basis of such assets and
liabilities and future benefits from net operating loss carryforwards and other
expenses previously recorded for financial reporting purposes. Income taxes are
described further in Note 12.
Basic loss per share - In 1997, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share." In February 1998,
the Securities and Exchange Commission ("SEC") staff released Staff Accounting
Bulleting ("SAB") No. 98, "Computations of Earnings per Share." SAB No. 98
revises prior SEC guidance concerning presentation of loss per share information
for companies going public, and requires all companies to present earnings per
share for all periods for which income statement information is presented in
accordance with SFAS No. 128. Basic earnings per share were computed using the
weighted average number of common shares outstanding. Diluted loss per share was
computed using the weighted average number of common shares outstanding. Common
stock equivalents associated with 12,500 stock options, at a weighted average
price per share of $8.80, have been excluded from the weighted average shares
outstanding since the effect of these potentially dilutive securities would be
antidilutive.
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 antidilutive.
Advertising - Advertising costs are expensed as incurred. Advertising expenses
for the years ended December 31, 1997 and 1996, were $153,900 and $81,500,
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.
- --------------------------------------------------------------------------------
Page F - 8
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
New accounting pronouncements - In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting
comprehensive income and its components (revenues, expenses, gains and losses)
in financial statements. SFAS No. 130 requires classification of other
comprehensive income in a financial statement, and the display of the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997. The Company believes this pronouncement
will not have a material effect on its financial statements.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This pronouncement established standards
for reporting information about operating segments in annual financial
statements and requires that enterprises report selected information about
operating segments in interim financial reports to shareholders. SFAS No. 131
also establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS No. 131 is effective for fiscal years
beginning after December 15, 1997, although earlier application is encouraged.
The Company believes this pronouncement will not have a material effect on its
financial statements.
Reclassifications - Certain reclassifications have been made to the 1996
financial statements to conform to the 1997 presentation.
NOTE 2 - INVENTORIES
1997 1996
-------------------- --------------------
Raw Materials $ 165,000 $ 121,800
Work-in-process 101,700 81,700
Finished goods 210,800 139,800
Merchandise 66,600 37,200
-------------------- --------------------
$ 544,100 $ 380,500
==================== ====================
- --------------------------------------------------------------------------------
Page F - 9
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 3 - PROPERTY AND EQUIPMENT
1997 1996
----------- -----------
Buildings $ 7,711,100 $ --
Machinery and equipment 5,070,300 557,500
Equipment under capital lease 1,912,300 --
Land 810,900 810,900
Equipment in progress 177,700 2,573,600
Leasehold improvements 771,800 129,000
Furniture and fixtures 70,400 19,800
Construction in progress -- 5,719,600
----------- -----------
16,524,500 9,810,400
Less accumulated depreciation and amortization 882,000 540,100
----------- -----------
$15,642,500 $ 9,270,300
=========== ===========
NOTE 4 - 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 May
31, 1998. The agreement is secured by accounts receivable and inventory.
- --------------------------------------------------------------------------------
Page F - 10
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
<TABLE>
NOTE 5 - LONG-TERM DEBT
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Note payable to bank, in monthly installments of $24,400, including
interest at the Treasury Constant Maturity Index plus 4.17%,
currently 5.83%, maturing December 2012, with a balloon
payment of $1,872,300, secured by substantially all the assets of
the Company $2,700,000 $ --
Note payable (construction loan) to bank, with interest at the
banks interest rate plus 2%; matured January 1998;
the note was converted to permanent financing -- 2,202,800
Note payable to an individual, due December 31, 1998, including
interest at 9%; secured by real property and subordinated to
bank debt 93,700 262,600
Note payable to contractor, paid in full November 1997 -- 300,000
---------- ----------
2,793,700 2,765,400
Less current maturities 130,400 2,765,400
---------- ----------
$2,663,300 $ --
========== ==========
</TABLE>
Maturities of long-term debt for succeeding years are as follows:
Year Ending December 31,
------------------------
1998 $ 130,400
1999 28,100
2000 31,100
2001 34,400
2002 38,000
Thereafter 2,531,700
----------
$2,793,700
=========
- --------------------------------------------------------------------------------
Page F - 11
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 6 - OBLIGATION UNDER CAPITAL LEASE
During 1996, the Company entered into a capital lease agreement with a financial
institution for brewing equipment. The agreement is secured by the new brewery
equipment.
Future minimum lease payments for equipment under this capital lease agreement
are as follows:
Year Ending December 31,
------------------------
1998 $ 330,100
1999 330,100
2000 330,100
2001 329,800
2002 325,200
Thereafter 776,100
-------------
2,421,400
Less amounts representing interest 674,000
-------------
Present value of minimum lease payments 1,747,400
Less current maturities 168,500
-------------
$ 1,578,900
=============
NOTE 7 - 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. There were no contributions made for the
years ended December 31, 1997 and 1996.
- --------------------------------------------------------------------------------
Page F - 12
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 8 - COMMITMENTS
The Company leases its Hopland, California facility under a noncancellable
operating lease expiring August 2004. The monthly lease payment is $2,100, to be
adjusted annually by increases in the Consumer Price Index, as defined in the
lease agreement. The Company leases the land on which the New York brewery
operates under a noncancellable operating lease expiring October 2002. The lease
contains options, which management intends to exercise, to extend the lease for
three additional 5 year periods and contains an option to purchase the property.
The monthly lease payment is $8,800, to be adjusted annually by increases in
Consumer Price Index, as defined in the lease agreement. Additionally, the
Company leases certain equipment and vehicles under noncancellable operating
leases which expires through March 1999. Total rent expense was $142,100 and
$50,700 for the years ended December 31, 1997 and 1996, respectively. Future
minimum lease payments are as follows:
Year Ending December 31,
------------------------
1998 $ 130,200
1999 126,900
2000 125,800
2001 125,800
2002 109,100
Thereafter 51,600
-----------
$ 669,400
===========
Employment agreements - Five key employees have employment agreements that
provide, in part, severance benefits equal to the remaining amount of their
annual base salary. The aggregate annual base salary for the five key employees
is $374,400. In January and February of 1998, two employees terminated their
employment with the Company.
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.
NOTE 9 - MAJOR CUSTOMERS
Sales to the top five customers totaled $2,192,000 and $1,788,900 for the years
ended December 31, 1997 and 1996, respectively representing 55% and 58% of
brewing operation sales.
- --------------------------------------------------------------------------------
Page F - 13
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 10 - STOCKHOLDERS' EQUITY
Common Stock
The Company began offering 600,000 shares of stock for sale in a second offering
beginning February 1997. The Company sold 19,516 shares of stock for total gross
proceeds of $164,600. In connection with this second offering, the Company
offset $164,600 of issuance costs against the proceeds from the sale of common
stock. The second offering was terminated in August 1997. The Company wrote off
approximately $140,500 of additional issuance costs which are included in
miscellaneous expense on the income statement.
In October 1997, the Company entered into an agreement with United Breweries of
America (UBA) whereby UBA purchased 2,119,647 shares of stock for $4,000,000
cash and all the outstanding shares of Releta Brewing Company, LLC, valued at
$5,000,000. In connection with this transaction, the Company paid $514,600 of
issuance costs associated with the shares of common stock purchased.
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 11 - 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 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. During 1997, the Company
issued 70,000 options to five key employees under the terms of their employment
contracts. As a part of the investment agreement with United Breweries of
America, these five employees signed new employment agreements which superseded
the old agreements and canceled the options. Also, during 1997, the Company
issued 12,500 options to an officer for his personal guarantee of debt. The
personal guarantee has since been removed.
- --------------------------------------------------------------------------------
Page F - 14
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 11 - STOCK OPTION PLAN (Continued)
The Company has adopted the disclosure only provision of Statement of Financial
Accounting Standards No. 123 (SFAS No. 123) "Accounting for Stock-Based
Compensation." Accordingly, no compensation expense has been recognized for
stock options issued during 1997. Had compensation cost for the Company's
options been determined based on the fair value at the grant date for awards in
1997 consistent with the provisions of SFAS No. 123, the Company's net earnings
and earnings per share would have reduced to the pro forma amounts indicated
below:
1997 1996
-------------- -------------
Net earnings - as reported $ (1,139,700) $ (123,800)
Net earnings - pro forma $ (1,216,300) $ (123,800)
Earnings per share - as reported $ (0.40) $ (0.05)
Earnings per share - pro forma $ (0.42) $ (0.05)
The fair value of each option is estimated on date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1997. There were no options granted in 1996.
1997
--------------
Dividends None
Expected volatility 100%
Risk free interest rate 5.35%
Expected life 5 years
Options issued during 1997 have an estimated weighted average fair value of
$6.13.
The following table summarizes common stock option activity:
Shares Under Weighted-Average
Option Exercise Price
----------------- -----------------------
Balance, December 31, 1996 - $ -
Granted 82,500 8.95
Exercised - -
Canceled (70,000) 8.97
-----------------
Balance, December 31, 1997 12,500 $ 8.80
=================
- --------------------------------------------------------------------------------
Page F - 15
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
<TABLE>
NOTE 12 - INCOME TAXES
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Current
Federal $ -- $ --
State 800 800
Benefit of net operating loss carryback (106,300) (64,800)
--------- ---------
(105,500) (64,000)
--------- ---------
Deferred
Current (16,400) (7,600)
Non-current (587,000) (6,600)
--------- ---------
(603,400) (14,200)
--------- ---------
$(708,900) $ (78,200)
========= =========
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:
1997 1996
--------- ---------
Income tax provision (benefit) at 34% $(628,500) $ (68,700)
Adjustment due to lower federal rates -- 5,000
State taxes 800 800
State tax benefit of net operating loss carry forward (81,000) (7,400)
Recognition of future tax (deductions) (200) (7,900)
--------- ---------
$(708,900) $ (78,200)
========= =========
</TABLE>
- --------------------------------------------------------------------------------
Page F - 16
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 12 - INCOME TAXES (Continued)
Temporary differences and carryforwards which give rise to deferred tax assets
and liabilities are as follows:
1997 1996
--------- ---------
Inventories $ 4,000 $ 3,200
Accruals 38,500 21,700
Other (3,000) (1,800)
--------- ---------
Current deferred tax asset $ 39,500 $ 23,100
========= =========
Depreciation and amortization $ (18,600) $ (2,900)
Investment tax credit carryforward 43,500 --
Benefit of net operating loss carryforward 593,500 7,400
Other (45,000) --
--------- ---------
Non-current deferred tax asset $ 573,400 $ 4,500
========= =========
Depreciation and amortization $ -- $ 25,300
Other -- (7,200)
--------- ---------
Non-current deferred tax liability $ -- $ 18,100
========= =========
At December 31, 1997, the Company has available for carryforward approximately
$1,500,000 and $920,000 of federal and California net operating losses. The
federal net operating losses will expire in 2012. The California net operating
losses expire through 2002. The Company also has $43,000 of California
Manufactures Investment Tax Credits that can be carried forward to reduce future
taxes and expire in 2005. The benefit from these loss carryforwards and credits
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 fully utilized.
- --------------------------------------------------------------------------------
Page F - 17
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 13 - 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, 1997
------------------------------------------------------------
Brewing Hopland Corporate
Operations Brewery and other Total
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Sales $ 3,856,300 $ 987,600 $ -- $ 4,843,900
Operating profit (loss) (261,900) (10,400) -- (272,300)
Identifiable assets 16,027,200 98,700 1,900,500 18,026,400
Depreciation and amortization 340,100 6,800 12,400 359,300
Capital expenditures 1,891,800 -- 31,000 1,922,800
Year Ending December 31, 1996
------------------------------------------------------------
Brewing Hopland Corporate
Operations Brewery and other Total
------------- ------------- ------------ -------------
Sales $ 3,067,300 $ 937,400 $ -- $ 4,004,700
Operating profit (loss) 591,100 (84,600) -- 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
</TABLE>
NOTE 14 - STATEMENT OF CASH FLOWS
Supplemental cash flow information includes the following:
1997 1996
---------- ----------
Cash paid during the year for:
Interest $ 644,400 $ 180,400
Income taxes $ 800 $ 60,700
Non-cash investing and financing activities:
Capital lease for equipment $ 19,500 $ 548,500
Deposit offset against long-term debt $ 290,000 $ --
Issuance of stock for stock in Releta $5,000,000 $ --
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Page F - 18
<PAGE>
ANNUAL MEETING:
THE COMPANY'S ANNUAL MEETING OF SHAREHOLDERS WILL BE HELD ON MAY 11, 1998 AT
1:00 P.M. (PDT) AT THE UKIAH VALLEY CONFERENCE CENTER, 200 SOUTH SCHOOL STREET,
UKIAH, CA 94582
[PICTURE OMITTED]
TRANSFER AGENT AND REGISTRAR
Boston EquiServe
Investor Relations MS 45-02-09
PO Box 644
Boston MA 02102-0644
(781) 575-3400
www.equiserve.com
AUDITORS
MOSS ADAMS, LLP
438 FIRST STREET, SUITE 320
SANTA ROSA, CA 95404
LEGAL COUNSEL
ENTERPRISE LAW GROUP, INC.
4400 BONANNON DRIVE, SUITE 280
MENLO PARK, CA 94025
<PAGE>
AMERICAN CLASSICS.
[PICTURE OMITTED]
