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, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________________ to ___________________
Commission file number: 1-13636
Mendocino Brewing Company, Inc.
(Name of small business issuer in its charter)
California 68-0318293
(State or other jurisdiction of (I.R.S. Employee Identification No.)
incorporation or organization)
13351 South Highway 101, Hopland, CA 95449
(Address of principal executive offices) (Zip code)
Issuer's telephone number: (707) 744-1015
Securities registered under Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, without par value
The Pacific Exchange
Securities registered under Section 12(g) of the Act:
Not applicable
(Title of class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B not contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year: $6,918,800
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 9, 1999
was $1,810,490.
The number of shares the issuer's Common Stock outstanding as of March 15, 1999
is 4,497,059.
DOCUMENT INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Registrant's 1999 Annual Meeting of
Shareholders to be filed not later than April 30, 1999 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. Description of Business.
Overview
Mendocino Brewing Company, Inc. brews Red Tail Ale, Blue Heron Pale
Ale, Black Hawk Stout, Peregrine Golden Ale and three seasonals 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 the Company's production to be
expanded to 200,000 bbl. per year with the addition of necessary equipment.
The Company's subsidiary, Releta Brewing Company L.L.C. ("Releta")
d/b/a Ten Springs Brewery, located in Saratoga Springs, New York, commenced
production in February 1998 with an initial capacity of 60,000 bbl. per year
expandable to 150,000 bbl. per year. In July 1998, the Company purchased all
brand related assets of Carmel Brewing Company, Inc., a California corporation
("Carmel Brewing"), in exchange for unregistered shares of the Company's Common
Stock having an aggregate value of $100,000 based on a per share price of $3.00.
However, on the transaction date, the market value of the 33,334 shares of
Common Stock issued to Carmel Brewing was only $45,834. The transaction also
involved the acquisition by the Company of certain point of sales and brewing
ingredient inventory from Carmel Brewing, and the lease by the Company from
Carmel Brewing of certain bottling line equipment and certain kegs on a
short-term basis. The Carmel brands were launched from the Ukiah facility.
During 1998, the Company's largest shareholder, United Breweries of
America, Inc. ("UBA"), agreed to provide the Company with a credit facility of
up to $2,000,000. The advances have a conversion feature into unregistered
shares of the Company's Common Stock. UBA has advanced a total of $994,000
(including interest) as of December 31, 1998.
In September 1998, the CIT Group/Credit Finance, Inc., located in
Chicago, Illinois provided the Company with a $3,000,000 maximum line of credit.
An amount totaling $1,483,968 was advanced to the Company as an initial term
loan, which is repayable in immediately available funds in sixty consecutive
monthly installments, each in the amount of $24,733, commencing on March 24,
1999.
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
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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 Releta to the
Company as a new subsidiary. The Company's products are sold in selected
locations throughout the United States. See "Product Distribution."
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 less than 2% in 1998.
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.
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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 1998. 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.
Products
Mendocino Brewing has historically brewed three ales and a stout
year-round, three seasonal ales, and a seasonal porter:
o RED TAIL ALE, a full flavored amber ale, is the flagship brand
of Mendocino Brewing. It is available year-round in 12 oz.
six-packs and half-barrel kegs.
o 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.
o 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.
o EYE OF THE HAWK SELECT ALE is a high gravity deep amber summer
ale. It is available year round in 12 oz. six-packs and
half-barrel kegs.
o ULETIDE PORTER is a deep brown Holiday brew with a
traditionally rich, creamy flavor. It is available in November
and December.
o PEREGRINE GOLDEN ALE is brewed year-round with a more delicate
flavor and character. It is available year-round at the
Hopland Brewery in draft form and April through October in 12
oz. bottles.
o 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.
o FROLIC SHIPWRECK ALE 1850, a Scottish-style ale brewed around
July, was introduced in 1994 as a fund-raiser for the
Mendocino County Museum to commemorate the wreck of the
clipper ship Frolic, with its cargo of Scottish ale, on the
Mendocino coast in 1850. Salvage efforts were abandoned when
workers, upon sighting the previously unreported big trees of
Mendocino County, launched the timber industry which has
characterized the area ever since. It is available at the
Hopland Brewery on draft.
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o FAT BEAR STOUT is a full-bodied brew characterized by smooth
roasty flavors and malty aromas.
o WHITEFACE PALE ALE is a robust and spicy American style ale
crafted with the finest malts and perfect blend of hops.
o SARATOGA CLASSIC PILSNER is a crisp, full-flavored,
German-style pilsner with a clean hoppy finish. All three are
brewed with fresh pure water from the ancient springs of
Saratoga.
o CARMEL WHEAT BEER is a light-bodied and delicately flavored
beer characterized by its cloudy Hefeweizen appearance,
refreshing floral aromas and subtle wheat flavor.
o CARMEL PALE ALE is a full, smooth flavored ale that imparts a
malty and spicy character to the palate.
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. Bottle-conditioned beers are
considered as classic styles.
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. In 1998 the Company received four
more medals at world beer championships.
The Saratoga Springs facility presently performs some contract brewing
services for other brands including Brooklyn beers.
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 children.
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Beverages served include Red Tail Ale, Blue Heron Pale Ale, Black Hawk
Stout, Peregrine Golden 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,
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 quarterly 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, Florida, Georgia, Idaho, Kansas, Illinois, Louisiana, Maryland,
Massachusetts, Missouri, Minnesota, Nevada, New Jersey, Nebraska, New Mexico,
New York, North Carolina, Oregon, Pennsylvania, South Carolina, Texas,
Washington, Wisconsin, Wyoming and Virginia. The Company plans to add Michigan,
New Hampshire, Tennessee, and Vermont, in the near future. Northern California
is the Company's primary market and Southern California currently is the second
market.
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. All
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brands 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 90% of
the Company's total sales in 1998, with food and merchandise retail and
catalogue sales constituting the balance. Sales to the top five customers
totaled $3,029,000 and $2,192,000 for the years ended December 31, 1998 and
1997, respectively representing 44% and 45% of sales.
Suppliers
The Company's major suppliers are Great Western Malting Co., Yakima,
Washington, and Briess Malting, Milwaukee, Wisconsin (malt); John I. Haas, Co.,
New York, New York (hops); Ball Foster Glass, Muncie, Indiana (bottles); Gaylord
Container Corporation, Antioch, California (cartons); Sierra Pacific Packaging,
Oroville, California (carriers); and Inline Labeling Inc., North Charleston,
South Carolina (labels).
Employees
As of December 31, 1998, the Company employed 54 full-time and 23
part-time individuals including 15 in management and administration, 35 in
brewing operations, 17 in retail and brewpub operations and 11 in sales and
marketing positions. Management believes that the Company's relations with its
employees are excellent. The Company does not have any labor contracts with any
of its employees. 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), BREWSLETTER word mark (Reg. No. 1,768,639), and RAZOR EDGE (Reg. No.
1,708,518). The Company has also applied for intent to use registrations of the
trademarks NORTH COUNTRY ALES, WHITE FACE, WHITEFACE, FAT BEAR, NORTHERN
EXPOSURE, TEN SPRINGS, and SARATOGA CLASSIC PILSNER.
The Company has also acquired the trademark, whether registered or
unregistered of CARMEL BREWING COMPANY and any other variation of the name
Carmel Brewing Company used by Carmel Brewing.
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.
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The Company'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".
The Company also acquired use of the word mark RAZOR EDGE through a
License Agreement with Beverage Mates, Ltd. This Agreement gives the Company an
exclusive license for ten years to use the mark in connection with the
manufacture, production, labeling and packaging of Beverage Mates' products
throughout the United States with the exception of Florida, North Carolina, and
South Carolina, until certain agreements pertaining to these states permit the
Company to sell in such states.
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 State of New York presently imposes an excise tax of $4.96 per bbl. on
brewers for over 100,000 bbls. per year.
The Hopland Brewery's brewpub is regulated by the Mendocino County
Health Department, which requires an annual permit and conducts spot inspections
to monitor compliance with applicable health codes.
The Company's production operations must also comply with the
Occupational Safety and Health Administration's workplace safety and worker
health regulations and applicable state laws thereunder. Management believes
that the Company presently is in compliance with the aforementioned laws and
regulations and has implemented its own voluntary safety program.
Environmental Regulation
The Company is subject to various federal, state, and local
environmental laws which regulate the use, storage, handling, and disposal of
various substances.
The Company's waste products consist of water, spent grains, 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 earned the distinction
of being a 1998 Waste Reduction Awards Program (WRAP) winner which is sponsored
by the California Environmental Protection Agency and Integrated Waste
Management Board.
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
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annual capacity exceeds 100,000 bbl., the Company will be required to pay
additional fees. The estimated cost of the wastewater treatment facility was
$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 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 Saratoga Springs facility is subject to various state, federal and
local environmental laws which regulate use, storage and disposal of various
materials. The Company's solid waste products consist of spent grain, cardboard,
glass and liquid waste. As for solid waste, the Company has instituted at this
facility a recycling program for cardboard, office papers and glass at a minimal
cost to the Company. The Company sells spent grain to local cattle dairy farms.
The Company pays approximately $650.00 per month towards sewer fees for liquid
waste. The sewer discharge from the brewery is monitored and is within the
standards set by Saratoga County Sewer Department. The Company follows and
operates under rules and regulations of New York Department of Environmental
Conservation for Air Pollution Control.
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 1998 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 was 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 in Ukiah and acquiring the brewery in Saratoga
Springs has reduced 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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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 in Saratoga Springs, New York, 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 2000. The Company leases certain brewing
equipment from FINOVA Capital Corporation which expires November 11, 2003.
Item 3. Legal Proceedings.
The Company is engaged in ordinary and routine litigation incidental to
its business. Management does not anticipate that any amounts which it may be
required to pay by reason thereof will have a material effect on the Company's
financial position.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the
fourth quarter of fiscal 1998.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
<TABLE>
Mendocino Brewing's Common Stock is listed on the Pacific Exchange,
Inc. (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>
1998 1997
--------------------------------------------------- -----------------------------------------------------
1st 2nd 3rd 4th 1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
<S> <C> <C> <C> <C> <C> <C> <C> <C>
High $3.31 $2.75 $1.68 $1.18 $8.00 $7.25 $5.50 $4.37
Low $2.00 $1.18 $1.06 $.56 $6.00 $4.50 $3.62 $3.12
</TABLE>
There were approximately 2,479 shareholders of record as of March 15,
1999. 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.
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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 July 1998, the Company purchased all brand related assets of Carmel
Brewing in exchange for unregistered shares of the Company's Common Stock having
an aggregate value of $100,000 based on a per share price of $3.00. However, on
the transaction date, the market value of the 33,334 shares of Common Stock
issued to Carmel Brewing was only $45,834. The Carmel brands were successfully
launched from the Ukiah facility.
Pursuant to the October 1997 Investment Agreement between the Company
and UBA, UBA agreed to provide, or arrange for the provision of funding for the
working capital requirements of Releta. UBA has fulfilled this commitment by
making available to the Company a credit facility of up to $2,000,000 for
working capital purposes. The advances bear interest at a rate of 1.5% per annum
above the prime rate offered by the Bank of America in San Francisco,
California. Each advance on the credit facility is evidenced by a convertible
note in the amount of the advance. As of December 31, 1998, the Company has made
11 draws on the credit facility. As of December 31, 1998, the aggregate amount
drawn on the line of credit, together with interest accrued thereon, is equal to
$994,000, which corresponds to the right of UBA to acquire up to 662,683 shares
of Common Stock of the Company at a conversion price of $1.50 per share.
The CIT Group/Credit Finance, Inc., has provided the Company with a
$3,000,000 maximum line of credit with an advance rate of 80% of the qualified
accounts receivable and 60% of the inventory at an interest rate of prime rate
of Chase Manhattan Bank in New York plus 2.25% payable monthly, maturing
September 23, 2000. The line of credit is secured by all accounts, general
intangibles, inventory, and equipment of the Company except for the specific
equipment and fixtures of the Company subject to a lien in favor of Finova
Capital Corporation, as well as by a second deed of trust on the property of the
Company in Mendocino County, California. An amount totaling $1,483,968 was
advanced to the Company as an initial term loan, which is repayable in
immediately available funds in sixty consecutive monthly installments, each in
the amount of $24,773, commencing on March 24, 1999. The initial term loan was
used to repay all amounts outstanding on the loan from WestAmerica Bank totaling
$600,000.
In November 1998, the Company signed an agreement with Beverage Mates
Ltd. for licensing their brand Razor Edge for a period of ten years with an
option to acquire the brand rights at the end of three years at a price
determined by a formula based on earnings of the brand.
Net sales for 1998 increased by 42.3% over 1997 due primarily to
increased marketing efforts. Production and sales in 1998 (measured in barrels,
brewed and shipped out of Ukiah and Saratoga Springs facilities, including
brands being brewed under contract) increased by 82.5% and 81.5%, respectively,
when compared to 1997. Production in 1998 increased to 37,514 barrels as
compared to 20,557 barrels in 1997. Sales in 1998 increased to 35,882 barrels as
compared to 19,773 barrels in 1997. The Company ended the year with a net loss
of $1,562,300. Increased fixed costs associated with the breweries, higher
selling, general and administrative expenses and increased interest expenses,
contributed to the net loss of $1,562,300 for the year ended December 31, 1998.
11
<PAGE>
Results of Operations
<TABLE>
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
---------------------------------------------
1998 1997
<S> <C> <C>
Statements of Operations Data: % %
Sales 105.95 105.53
Less Excise taxes 5.95 5.53
------- -------
Net Sales 100.00 100.00
Costs of Goods Sold 75.16 72.16
------- -------
Gross Profit 24.84 27.84
Operating Expenses 56.59 56.26
Loss from Operations (31.75) (28.42)
Other Income/(expense) (9.61) (11.85)
Loss before income taxes (41.36) (40.27)
Benefit from income taxes (17.44) (15.44)
------- -------
Net Loss (23.92) (24.83)
======= =======
---------------------------------------------
Year Ended December 31
---------------------------------------------
1998 1997
Balance Sheet Data: $ $
Cash and Cash Equivalents 42,000 706,300
Working Capital (630,700) (357,400)
Property and Equipment 15,259,800 15,642,500
Deposits and Other Assets 34,600 42,000
Total Assets 18,923,200 18,026,400
Long-term Debt 4,753,200 2,663,300
Obligation Under Capital Lease 1,525,800 1,578,900
Total Liabilities 8,781,400 6,368,100
Accumulated Deficit (2,498,800) (936,500)
Shareholder's equity 10,141,800 11,658,300
</TABLE>
Net Sales
Net sales for 1998 increased by 42.3% from $4,590,000 in 1997 to
$6,529,700 in 1998. The sales volume increased to 35,882 barrels during 1998
from 19,773 barrels in 1997 representing an increase of 81.5%. Of the total
sales of barrels in 1998, the sales out of the Ukiah facility accounted for
28,340 barrels and the shipments from the Releta facility was 7,542 barrels.
Management attributes the growth in sales to new marketing strategies including
new point of sale materials and increased sales personnel. The increase in
overall net sales was achieved solely by higher wholesale shipments during 1998
when compared to 1997. In view of Management's focus on wholesale beer sales,
retail sales for
12
<PAGE>
the year 1998 decreased by $302,200 while the wholesale beer sales for the year
1998 increased by $2,377,100.
Cost of Goods Sold
Cost of goods sold as a percentage of net sales increased by 3% in 1998
to 75.16% when compared to that of 72.16% in 1997. During 1998, depreciation
increased by $382,900, rentals increased by $100,000, property taxes increased
by $140,000 and utilities increased by $133,750. Management attributes the
increase to higher fixed costs and to under utilization of the brewing
facilities in Ukiah, California and Saratoga Springs, New York.
Gross Profit
Gross profit increased by 26.9% during 1998 to $1,621,700 in comparison
to $1,277,900 in 1997. However, in view of higher cost of sales explained above,
the gross profit as a percentage of net sales decreased by 3% during 1998 to
24.84% in 1998 from 27.84% in 1997.
Operating Expenses
Operating expenses were $3,695,000 in 1998, representing an increase of
43% when compared to $2,582,400 in 1997. Operating expenses consist of retail
operating expenses, marketing and distribution expenses and general and
administrative expenses.
Retail operating expenses for 1998 were $481,900 when compared to
$704,000 in 1997. This represented a decrease of 31.5% from 1997. As a
percentage of net sales, the Retail operating expenses were 7.38% in 1998 as
compared to 15.3% in 1997. The decrease consisted of a reduction in labor by
$109,000, a reduction in supplies by $30,100, decrease in marketing and
advertisement costs by $77,000, reduction in utilities by $7,700 and net of
other expenses decreased by $1,700.
Marketing and distribution expenses were $1,311,700 in 1998,
representing an increase of 55% compared to $846,200 in 1997. As a percentage of
net sales, marketing and distribution expenses represented 20.1% in 1998 as
compared to 18.4% in 1997. The increase in marketing and distribution expenses
comprised of an increase in marketing labor costs by $401,600, travel and
entertainment costs by $38,200, cost of point of sales material increased by
$87,300, event sponsorship costs increased by $50,400, and 15th anniversary
costs accounted for $16,200. The above increases were offset by decreases in
freight costs by $71,900, warehouse rent by $15,000, supplies by $3,900, auto
expenses by $9,000, decrease of $20,000 being settlement expenses in connection
with the termination of a distributor and net of all other expenses decreased by
$8,400.
General and Administrative expenses were $1,901,400 in 1998 as compared
to $1,032,200 in 1997 representing an increase of $869,200. As a percentage of
net sales general and administrative expenses represented an increase of 6.6% in
1998 to 29.1% as compared to 22.5% in 1997. The increase of general and
administrative expenses comprised of an increase in labor costs by $507,650,
travel and entertainment costs by $97,300, legal and professional costs by
$216,900, depreciation by $50,950 and net of all other expenses decreased by
$3,600. The increases in 1998, when compared to 1997, are attributable to more
employees and the addition of breweries located in Ukiah and Saratoga Springs.
Other Income/(Expense)
The other income/(expense) for the year 1998 was $627,800 as compared
to $544,100 in 1997. The increase of $83,700 was mainly attributable to an
increase in interest expense to the extent of
13
<PAGE>
$234,400 in 1998 offset by non recurrence of a write-off of deferred offering
costs to the extent of $141,000 in 1997.
Benefit From Income Taxes
The benefit from income taxes for the year 1998 was $1,138,800 as
compared to $708,900 in 1997. The benefit from income taxes is due to the
expected future benefit of carrying forward of net operating losses and other
timing differences.
As of December 31, 1998, the Company has available for carryforward
approximately $4,700,000, $1,830,000 and $551,000 of Federal, California and New
York net operating losses. Approximately $940,000 of the Federal and New York
net operating losses will expire in 2012, the remaining portion will expire in
2018. The California net operating losses expire beginning 2001 through 2003.
The Company also has $43,500 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.
The Company recognizes deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in the
financial statements or tax returns, including the future benefit of its
carryforwards. Temporary differences and carryforwards which give rise to
deferred assets at December 31, 1998 are as follows:
Benefits from net operating loss carryforwards $1,700,800
Investment tax credit carryforwards 43,500
Inventory 6,600
Accruals 141,800
Depreciation and amortization (35,300)
Other (104,900)
-----------
Net deferred income taxes 1,752,500
Deferred income taxes expected to be utilized in 1999 138,300
-----------
Deferred income taxes $1,614,200
-----------
Net Loss
The net loss for the year 1998 was $1,562,300 as compared to $1,139,700
for the year 1997. As a percentage of net sales, the net loss for the year 1998
represented 23.9% when compared to 24.8% in 1997.
Segment Information
The Company's business presently consists of two segments. The first is
brewing for wholesale to distributors and other retailers. This segment
accounted for 90.1% of the Company's total gross sales during 1998. The second
segment consists of brewing beer for sale along with food and merchandise at the
Company's brewpub and retail merchandise store located at the Hopland Brewery.
This segment accounted for 9.9% of the Company's total gross sales during 1998.
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.
14
<PAGE>
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.
Capital Demands
The Releta facility commenced brewing operations in February 1998. The
Company expects both the Ukiah and Releta facilities to operate at significantly
less than full capacity during all or part of 1999. 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.
The Company has yet to complete the build-out of its administrative
space and the exterior landscaping of the Ukiah facility. 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.
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 4.59%,
maturing December 2012 with a balloon payment in the amount of $1,872,300
secured by some of the assets of the Company (other than the Releta facility),
including, without limitation, a first priority deed of trust on the Ukiah land
and improvements, fixtures and most of the equipment of the Company.
Shareholder Commitment. UBA, the Company's largest shareholder, agreed
to provide the Company with a credit facility of up to $2 million. Each advance
will bear interest at the prime rate plus 1.5% and is due and payable 18 months
after the date of the advance. The advances will have a conversion feature into
unregistered shares of the Company's Common Stock. The entire principal balance,
together with all unpaid interest, is convertible into Common Stock of the
Company, on or after the maturity date at a rate of one share of Common Stock
for each $1.50 principal and unpaid interest. 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,
and the terms of the credit facility were finalized by the Board of Directors on
October 6, 1998. UBA has advanced $994,000 (including interest) to the Company
as of December 31, 1998, evidenced by several promissory notes.
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.
15
<PAGE>
Credit Facility. The CIT Group/Credit Finance, Inc., has provided the
Company with a $3,000,000 maximum line of credit with an advance rate of 80% of
the qualified accounts receivable and 60% of the inventory at an interest rate
of prime rate of Chase Manhattan Bank of New York plus 2.25% payable monthly,
maturing September 23, 2000. The line of credit is secured by all accounts,
general intangibles, inventory, and equipment of the Company except for the
specific equipment and fixtures of the Company subject to a lien in favor of
Finova Capital Corporation, as well as by a second deed of trust on the property
of the Company in Mendocino County, California. An amount totaling $1,483,968
was advanced to the Company as an initial term loan, which is repayable in
immediately available funds in sixty consecutive monthly installments, each in
the amount of $24,733, commencing on March 24, 1999. The initial term loan was
used to repay all amounts outstanding on the loan from WestAmerica Bank totaling
$600,000.
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 purchase a certain number of kegs from
MicroStar. The Company would probably finance the purchase through debt or lease
financing, if available.
Current Ratio. The Company's ratio of current assets to current
liabilities on December 31, 1998 was 0.75 to 1.0 and its ratio of assets to
liabilities was 2.15 to 1.0.
Impact of Expansion on Cash Flow. Mendocino Brewing must make timely
payment of its debt and lease commitments to continue in operation. Unused
capacity at the Ukiah and Saratoga Springs facilities has placed additional
demands on the Company's working capital. 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. UBA agreed to provide a loan of up to
$2 million for working capital purposes. In addition, pursuant to the Investment
Agreement dated October 24, 1997, between the Company and UBA, UBA has agreed to
provide, directly or indirectly, funding for the working capital requirements of
the Releta facility in the amount of $1 million until October 24, 1999 or until
the brewery's operations are profitable, whichever comes first. UBA, through its
affiliated entities, has fulfilled this obligation by facilitating the CIT
Group/Credit Finance $3 million loan transaction.
Year 2000 Readiness
Many currently-installed computer systems and software products are
coded to accept only two digit entries in the date code field. Beginning in the
year 2000, these date code fields will need to accept four digit entries in
order to distinguish 21st century dates from 20th century dates. On January 1,
2000, many computer, and embedded systems, may recognize the year "00" as 1900
rather than 2000. Because many computer functions are date-sensitive, this error
may cause systems to process data inaccurately or shut down if they do not
recognize the date. If not corrected, this could result in a system failure or
miscalculations causing disruptions of operations.
The Company has taken steps to ensure its operations will not be
adversely impacted by potential year 2000 computer failures. The Company has
completed a review of the Company's computer software programs, hardware
components, and other systems, and believes that any cost to be incurred to
ensure its systems are year 2000 compliant will not be significant.
16
<PAGE>
The Company believes that its most significant internal risk posed by
the year 2000 problem is the possibility of a failure of equipment involved in
its brewing processes. If the brewing processes equipment were to fail, the
Company would have to implement manual processes, which may slow production
levels that would affect the Company's sales volume. The programmable logic
controller connected to the brewing equipment and the processes are not date
sensitive. A testing of the brewing house facility computer operations indicated
that all of the computer systems are year 2000 compliant; however, there can be
no assurance that problems may not arise relevant to year 2000.
The third parties whose year 2000 problems could have the greatest
effect on the Company are believed by the Company to be banks that maintain the
Company's depository accounts, the company that processes the Company's payroll,
and the Company's suppliers and distributors. The Company has not confirmed the
state of year 2000 readiness of these parties.
The Company is in the process of establishing a "contingency plan" to
address potential year 2000 problems and is currently considering the extent to
which it will develop a formal contingency plan.
Item 7. Financial Statements.
The information required by this item is set forth at Pages F-1 through
F-21 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 Item 9 will be contained in the Company's
Definitive Proxy Statement for its 1999 Annual Meeting of Shareholders (the
"1999 Proxy Statement") called to be held in April 1999, which the Company
intends to file with the Commission in March 1999, and such information is
incorporated herein by reference.
Item 10. Executive Compensation.
The information required by Item 10 will be contained in the 1999 Proxy
Statement, and such information is incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 11 will be contained in the 1999 Proxy
Statement, and such information is incorporated herein by reference.
Item 12. Certain Relationships and Related Transactions.
The information required by Item 12 will be contained in the 1999 Proxy
Statement, and such information is incorporated herein by reference.
17
<PAGE>
Item 13. Exhibits and Reports on Form 8-K.
Exhibit
Number Description of Document
- ------- -----------------------
3.1 (A) Articles of Incorporation, as amended, of the Company
3.2 (B) Bylaws of the Company
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
3.1).
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. Haas,
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.
10.21 (O) $2,700,000 Note in favor of the Savings Bank of
Mendocino County.
10.22 (O) Hazardous Substances Certificate and Indemnity with the
Savings Bank of Mendocino County.
10.23 (J) Equipment Lease with FINOVA Capital Corporation.
10.24 (J) Tri-Election Rider to Equipment Lease with FINOVA
Capital Corporation.
10.25 (J) Master Lease Schedule with FINOVA Capital Corporation.
10.26 (L) Investment Agreement with United Breweries of America,
Inc.
18
<PAGE>
Exhibit
Number Description of Document
- ------- -----------------------
10.27 (L) Shareholders' Agreement Among the Company, United
Breweries of America, Inc., H. Michael Laybourn, Norman
Franks, Michael Lovett, John Scahill, and Don Barkley.
10.28 (L) Registration Rights Agreement Among the Company, United
Breweries of America, Inc., H. Michael Laybourn, Norman
Franks, Michael Lovett, John Scahill, and Don Barkley.
10.29 (Q) Indemnification Agreement with Vijay Mallya.
10.30 (Q) Indemnification Agreement with Michael Laybourn.
10.31 (Q) Indemnification Agreement with Jerome Merchant.
10.32 (Q) Indemnification Agreement with Yashpal Singh.
10.33 (Q) Indemnification Agreement with P.A. Murali.
10.34 (Q) Indemnification Agreement with Robert Neame.
10.35 (Q) Indemnification Agreement with Sury Rao Palamand.
10.36 (Q) Indemnification Agreement with Kent Price.
10.37 (R) Loan and Security Agreement between the Company, Releta
Brewing Company LLC and The CIT Group/Credit Finance,
Inc. regarding a $3,000,000 maximum line of credit.
10.38 (R) Patent, Trademark and License Mortgage by the Company in
favor of The CIT Group/Credit Finance, Inc.
10.39 (R) Patent, Trademark and License Mortgage by Releta Brewing
Company LLC in favor of The CIT Group/Credit Finance,
Inc.
10.40 (S) Promissory Notes in favor of United Breweries of
America, Inc.
27 Financial Data Schedule.
- ----------------------------
(A) Incorporated by reference from the Company's
Registration Statement dated June 15, 1994, as amended,
previously filed with the Commission, Registration No.
33-78390-LA.
(B) Incorporated by reference 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 reference 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 reference 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 reference 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 reference 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 reference from the Company's Report on
Form 10-QSB 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. 33-15673.
(K) Incorporated by reference 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.
19
<PAGE>
Exhibit
Number Description of Document
- ------- -----------------------
(N) Incorporated by reference from the Company's Report on
Form 10-QSB/A No. 1 for the quarterly period ended
September 30, 1997.
(O) Incorporated by reference from the Company's Report on
Form 10-KSB for the annual period ended December 31,
1997, previously filed with the Commission.
(Q) Incorporated by reference from the Company's Report on
Form 10-QSB for the quarterly period ended June 30,
1998.
(R) Incorporated by reference from the Company's Report on
Form 10-QSB for the quarterly period ended September 30,
1998.
(S) Incorporated by reference from Amendment No. 4 to
Schedule 13D filed with the Commission on February 18,
1999.
+ Portions of this Exhibit were omitted pursuant to an
application for an order declaring confidential
treatment filed with the Securities and Exchange
Commission.
No current reports on Form 8-K were filed by the Company during the fourth
quarter ended December 31, 1998.
20
<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 17, 1999
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 17, 1999
By: /s/ H. Michael Laybourn
---------------------------------------------------
H. Michael Laybourn, President and Director
Date: March 17, 1999
By: Yashpal Singh
---------------------------------------------------
Yashpal Singh, Chief Operating Officer and Director
Date: March 17, 1999
By: /s/ Jerome G. Merchant
---------------------------------------------------
Jerome G. Merchant, Director
Date: March 17, 1999
By: /s/ P.A. Murali
---------------------------------------------------
P.A. Murali, Chief Financial Officer
Date: March 17, 1999
21
<PAGE>
- --------------------------------------------------------------------------------
MENDOCINO BREWING COMPANY, INC.,
AND SUBSIDIARY
INDEPENDENT AUDITOR'S REPORT
AND
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
<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 - 8
- --------------------------------------------------------------------------------
<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, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the two years ended December 31, 1998. 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, 1998 and 1997, and the results
of its operations and its cash flows for each of the two years ended December
31, 1998, in conformity with generally accepted accounting principles.
/s/ Moss Adams LLP
Santa Rosa, California
January 29, 1999
Page F - 1
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
- --------------------------------------------------------------------------------
ASSETS
1998 1997
------------- -------------
CURRENT ASSETS
Cash $ 42,000 $ 706,300
Accounts receivable 679,900 329,700
Inventories 978,000 544,100
Prepaid expenses 33,500 42,600
Refundable income taxes - 106,300
Deferred income taxes 138,300 39,500
------------- -------------
Total current assets 1,871,700 1,768,500
------------- -------------
PROPERTY AND EQUIPMENT 15,259,800 15,642,500
------------- -------------
OTHER ASSETS
Deferred income taxes 1,614,200 573,400
Deposits and other assets 34,600 42,000
Intangibles, net of amortization 142,900 -
------------- -------------
1,791,700 615,400
------------- -------------
Total assets $ 18,923,200 $ 18,026,400
============= =============
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, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
CURRENT LIABILITIES
Line of credit $ - $ 600,000
Accounts payable 806,700 728,300
Accounts payable-related party - 80,200
Accrued wages and related expense 210,800 169,700
Accrued liabilities 91,000 248,800
Current maturities of long-term debt 322,000 130,400
Current maturities of obligations under capital lease 221,300 168,500
Current maturities of notes payable to related party 850,600 -
------------- -------------
Total current liabilities 2,502,400 2,125,900
LONG-TERM DEBT, less current maturities 3,871,800 2,663,300
LINE OF CREDIT 738,000 -
OBLIGATIONS UNDER CAPITAL LEASE, less
current maturities 1,525,800 1,578,900
NOTES PAYABLE TO RELATED PARTY, less
current maturities 143,400 -
------------- -------------
Total liabilities 8,781,400 6,368,100
------------- -------------
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,
4,497,059 and 4,463,385 shares issued and outstanding
at December 31, 1998 and 1997, respectively 12,413,000 12,367,200
Accumulated deficit (2,498,800) (936,500)
------------- -------------
Total stockholders' equity 10,141,800 11,658,300
------------- -------------
Total liabilities and stockholders' equity $ 18,923,200 $ 18,026,400
============= =============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
- --------------------------------------------------------------------------------
Page F - 3
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1998 and 1997
- --------------------------------------------------------------------------------
1998 1997
------------- -------------
SALES $ 6,918,800 $ 4,843,900
LESS EXCISE TAXES 389,100 253,900
------------- -------------
NET SALES 6,529,700 4,590,000
COST OF GOODS SOLD 4,908,000 3,312,100
------------- -------------
GROSS PROFIT 1,621,700 1,277,900
------------- -------------
OPERATING EXPENSES
Retail operating 481,900 704,000
Marketing 1,311,700 846,200
General and administrative 1,901,400 1,032,200
------------- -------------
3,695,000 2,582,400
------------- -------------
LOSS FROM OPERATIONS (2,073,300) (1,304,500)
------------- -------------
OTHER INCOME (EXPENSE)
Interest income 1,900 7,300
Other income (expense) 2,900 (149,500)
Gain on sale of equipment 3,700 -
Interest expense (636,300) (401,900)
------------- -------------
(627,800) (544,100)
------------- -------------
LOSS BEFORE INCOME TAXES (2,701,100) (1,848,600)
BENEFIT FROM INCOME TAXES (1,138,800) (708,900)
------------- -------------
NET LOSS $ (1,562,300) $ (1,139,700)
============= =============
BASIC LOSS PER COMMON SHARE $ (0.35) $ (0.40)
============= =============
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 4,480,222 2,870,478
============= =============
The accompanying notes are an integral part of these financial statements.
- --------------------------------------------------------------------------------
Page F - 4
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Series A
Preferred Stock Common Stock Retained
------------------------- ------------------------------- Earnings Total
Shares Amount Shares Amount (Deficit) Equity
----------- ------------ ------------- ---------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
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
Stock issued for asset acquisition - - 33,674 45,800 - 45,800
Net loss - - - - (1,562,300) (1,562,300)
----------- ------------ ------------- ---------------- --------------- ---------------
227,600 $227,600 4,497,059 $12,413,000 $(2,498,800) $10,141,800
=========== ============ ============= ================ =============== ===============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
- --------------------------------------------------------------------------------
Page F - 5
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,562,300) $ (1,139,700)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 779,400 359,300
Gain on sale of assets (3,700) -
Deferred income taxes (1,139,600) (603,400)
Stock issued for services - 12,200
Changes in:
Accounts receivable (350,200) 130,800
Inventories (433,900) (78,400)
Prepaid expenses 9,100 16,000
Deposits and other assets (33,100) -
Refundable income taxes 106,300 (34,400)
Accounts payable - trade and related party 78,400 240,900
Accrued wages and related expense 41,100 51,500
Accrued liabilities (157,800) 232,200
------------- -------------
Net cash used by operating activities (2,666,300) (813,000)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment and leasehold
improvements (185,900) (1,922,800)
Increase in intangibles (63,100) (27,900)
Proceeds from sale of fixed assets 24,000 -
------------- -------------
Net cash used by investing activities (225,000) (1,950,700)
------------- -------------
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
- --------------------------------------------------------------------------------
Page F - 6
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended December 31, 1998 and 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on line of credit 138,000 -
Borrowings on long-term debt 1,433,600 1,097,200
Principal payments on long-term debt (153,400) (1,068,900)
Payments on obligations under capital lease (185,200) (143,900)
Proceeds from notes payable to related party 994,000 -
Reduction in accrued construction costs - (744,000)
Reimbursement from obligations under capital lease - 147,400
Proceeds from sale of common stock - 4,164,700
Deferred stock offering costs - (477,300)
----------- ------------
Net cash provided by financing activities 2,227,000 2,975,200
----------- ------------
INCREASE (DECREASE) IN CASH (664,300) 211,500
CASH, beginning of year 706,300 494,800
----------- ------------
CASH, end of year $ 42,000 $ 706,300
=========== ============
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
</TABLE>
- --------------------------------------------------------------------------------
Page F - 7
<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 brews several brands,
of which Red Tail Ale is the Flagship brand. In addition, the Company performs
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 $0 and $263,400 in 1998
and 1997, 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 - 20 years
Intangibles - Intangibles consist of prepaid interest on the financing of the
Ukiah brewery and placement fees associated with debt. Amounts are amortized
using the straight line method over the lives of the debt.
During 1998 the Company purchased the brand rights, trademark and other
intangible assets of Carmel Brewing Co. for 33,674 shares of common stock. The
assets are being amortized over 40 years.
- --------------------------------------------------------------------------------
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)
Concentration of credit risks - Financial instruments that potentially subject
the Company to credit risk consist principally of trade receivables and cash
deposits in excess of FDIC limits. The Company's cash deposits are placed with
major financial institutions. Wholesale distributors account for substantially
all accounts receivable; therefore, this concentration risk is limited due to
the number of distributors and state laws regulating the financial affairs of
distributors of alcoholic beverages.
Income taxes - The 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.
Basic loss per share - Basic loss per share was 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. Debt convertible
into 662,682 shares of common stock at $1.50 per share, and 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, 1998 and 1997, were $214,700 and $153,900,
respectively.
- --------------------------------------------------------------------------------
Page F - 9
<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)
Fair value of financial instruments - The following methods and assumptions were
used by the Company in estimating its fair value disclosures for financial
instruments:
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.
New accounting pronouncements - The Financial Accounting Standards Board
("FASB") has issued SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities." It requires companies to record derivatives on the balance
sheet as assets or liabilities, measured at fair market value. Gains or losses
resulting from changes in the value of those derivatives are accounted for
depending on the use of the derivative and whether it qualifies for hedge
accounting. The key criterion for hedge accounting is that the hedging
relationship must be highly effective in achieving the offsetting changes in
fair value or cash flows. SFAS No. 133 is effective for all fiscal quarters of
fiscal years beginning after June 15, 1999. Management believes that the
adoption of SFAS No. 133 will have no material effect on its financial
statements.
NOTE 2 - INVENTORIES
1998 1997
---------- ----------
Raw materials $ 276,800 $ 165,000
Work-in-process 210,500 101,700
Finished goods 438,900 210,800
Merchandise 51,800 66,600
---------- ----------
$ 978,000 $ 544,100
========== ==========
- --------------------------------------------------------------------------------
Page F - 10
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
<TABLE>
NOTE 3 - PROPERTY AND EQUIPMENT
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Buildings $ 7,711,100 $ 7,711,100
Machinery and equipment 5,263,700 5,055,000
Equipment under capital lease 2,117,400 1,912,300
Land 813,000 810,900
Leasehold improvements 777,600 771,800
Equipment in progress 123,500 177,700
Vehicles 69,300 15,300
Furniture and fixtures 37,900 70,400
------------- -------------
16,913,500 16,524,500
Less accumulated depreciation and amortization 1,653,700 882,000
------------- -------------
$ 15,259,800 $ 15,642,500
============= =============
</TABLE>
NOTE 4 - LINE OF CREDIT
The Company has available a $3,000,000 line of credit with interest at the prime
rate plus 2.25%. Approximately $1,484,000 was advanced to the Company in the
form of a term loan (see Note 5). The bank's commitment under the line of credit
matures September 2000. The agreement is secured by substantially all the assets
of the Releta Brewing Company, LLC, a second position on the assets of Mendocino
Brewing Co., accounts receivable, inventory and certain securities pledged by a
stockholder.
- --------------------------------------------------------------------------------
Page F - 11
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
<TABLE>
NOTE 5 - LONG-TERM DEBT
<CAPTION>
1998 1997
------------ ------------
<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 4.59%, maturing December 2012, with
a balloon payment, secured by substantially all the assets of
the Mendocino Brewing Company $ 2,679,900 $ 2,700,000
Note payable to financial institution, in monthly installments
of $24,700 plus interest at the prime rate plus 2.25%,
currently 10%, maturing March 2004, secured by
substantially all the assets of the Releta Brewing Company
a second position on the assets of Mendocino Brewing
Company, and certain securities pledged by a stockholder 1,484,000 -
Note payable, in monthly installments of $1,200, including
interest at 5.65%, maturing March 2001, secured by
vehicle 29,900 -
Note payable to an individual, paid in full - 93,700
------------ ------------
4,193,800 2,793,700
Less current maturities 322,000 130,400
------------ ------------
$ 3,871,800 $ 2,663,300
============ ============
Maturities of long-term debt for succeeding years are as follows:
Year Ending December 31,
------------------------
1999 $ 322,000
2000 377,900
2001 373,900
2002 377,100
2003 384,400
Thereafter 2,358,500
------------
$ 4,193,800
============
</TABLE>
- --------------------------------------------------------------------------------
Page F - 12
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 6 - OBLIGATIONS UNDER CAPITAL LEASE
The Company leases brewing and office equipment under various capital lease
agreements with various financial institutions.
<TABLE>
Future minimum lease payments under these capital lease agreements are as
follows:
<CAPTION>
Year Ending December 31,
------------------------
<S> <C> <C> <C>
1999 $ 382,500
2000 382,500
2001 374,600
2002 365,400
2003 797,100
Thereafter -
------------
2,302,100
Less amounts representing interest 555,000
------------
Present value of minimum lease payments 1,747,100
Less current maturities 221,300
------------
$ 1,525,800
============
NOTE 7 - NOTES PAYABLE TO RELATED PARTY
1998 1997
------------ ------------
Notes payable consists of convertible notes to United Breweries of
America, a related party, with interest at the prime rate
plus 1.5%, maturing 18 months after the advances,
unsecured, subordinated to bank debt; notes mature
through June 2000; notes are convertible to common
stock at $1.50 per share upon maturity $ 994,000 $ -
Less current maturities 850,600 -
------------ ------------
$ 143,400 $ -
============ ============
</TABLE>
- --------------------------------------------------------------------------------
Page F - 13
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 8 - PROFIT-SHARING PLAN
The Company has a profit-sharing retirement plan under which it may make
employer contributions at the discretion of the Board of Directors, although no
such contributions are required. Employer contributions vest over a period of
six years. The plan covers substantially all full-time employees meeting certain
minimum age and service requirements. There were no contributions made for the
years ended December 31, 1998 and 1997.
NOTE 9 - COMMITMENTS AND RELATED PARTY TRANSACTIONS
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 expire through March 1999. Total rent expense was $201,300 and
$142,100 for the years ended December 31, 1998 and 1997, respectively. Future
minimum lease payments are as follows:
Year Ending December 31,
------------------------
1999 $ 151,500
2000 144,800
2001 134,100
2002 112,700
2003 28,100
Thereafter 17,100
----------
$ 588,300
==========
- --------------------------------------------------------------------------------
Page F - 14
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 9 - COMMITMENTS AND RELATED PARTY TRANSACTIONS (Continued)
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 service fee
between $5 and $15, depending on volume. 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 three times the average monthly keg usage for the preceding
six-month period from Micro Star at purchase prices ranging from $54 to $84 per
keg. Rental expense associated with this agreement was $124,800 and $63,500 for
the years ended December 31, 1998 and 1997, respectively.
The Company reimburses certain expenses to United Breweries of America (UBA), a
related party, owning approximately 47% of the common stock, for consulting,
salaries, corporate financing and marketing activities. Total expenses for UBA
in 1998 and 1997 were $77,800 and $80,200. Interest expense associated with the
UBA notes was $64,900 for the year ended December 31, 1998.
NOTE 10 - CONTINGENCIES
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. In addition, certain hardware
components may not function properly as the year 2000 approaches. This could
result in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
Management has completed a review of the Company's computer software programs,
hardware components, and other systems, and believes that any costs to be
incurred to ensure its systems are Year 2000 compliant will not be significant.
NOTE 11 - MAJOR CUSTOMERS
Sales to the top five customers totaled $3,029,000 and $2,192,000 for the years
ended December 31, 1998 and 1997, respectively representing 44% and 45% of
sales.
- --------------------------------------------------------------------------------
Page F - 15
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 12 - 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 1997 statement of operations.
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 it's 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 13 - 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.
- --------------------------------------------------------------------------------
Page F - 16
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 13 - STOCK OPTION PLAN (Continued)
The exercise price of incentive options must be no less than 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. 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 option to
an officer for his personal guarantee of debt. The personal guarantee has since
been removed.
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:
1998 1997
------------- -------------
Net earnings - as reported $ (1,572,400) $ (1,139,700)
Net earnings - pro forma $ (1,572,400) $ (1,216,300)
Earnings per share - as reported $ (0.35) $ (0.40)
Earnings per share - pro forma $ (0.35) $ (0.42)
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 1998.
1997
-------------
Dividends None
Expected volatility 1000%
Risk free interest rate 5.35%
Expected life 5 years
Options issued during 1997 have an estimated weighted average fair value of
$6.13.
- --------------------------------------------------------------------------------
Page F - 17
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 13 - STOCK OPTION PLAN (Continued)
<TABLE>
The following table summarizes common stock option activity:
<CAPTION>
Shares Under Weighted-Average
Option Exercise Price
------------- ----------------
<S> <C> <C>
Balance, December 31, 1996 - $ -
Granted 82,500 8.95
Exercised -
Canceled (70,000) 8.97
-------------
Balance, December 31, 1997 12,500 $ 8.80
Granted - -
Exercised -
Canceled - -
-------------
Balance, December 31, 1998 12,500 $ 8.80
=============
NOTE 14 - INCOME TAXES
1998 1997
------------- ----------------
Current
Federal $ - $ -
State 800 800
Benefit of net operating loss carryback - (106,300)
------------- ----------------
800 (105,500)
------------- ----------------
Deferred
Current (98,800) (16,400)
Non-current (1,040,800) (587,000)
------------- ----------------
(1,139,600) (603,400)
------------- ----------------
$ (1,138,800) $ (708,900)
============= ================
</TABLE>
- --------------------------------------------------------------------------------
Page F - 18
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 14 - INCOME TAXES (Continued)
<TABLE>
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:
<CAPTION>
1998 1997
------------- -----------
<S> <C> <C>
Income tax benefit at 34% $ (925,200) $ (628,500)
State taxes 800 800
State tax benefit of net operating loss carry forward (111,300) (81,000)
Recognition of future tax (deductions) (103,100) (200)
------------- -----------
$ (1,138,800) $ (708,900)
============= ===========
Temporary differences and carryforwards which give rise to deferred tax assets
and liabilities are as follows:
1998 1997
------------- -----------
Inventories $ 6,600 $ 4,000
Accruals 141,800 38,500
Other (10,100) (3,000)
------------- -----------
Current deferred tax asset $ 138,300 $ 39,500
============= ===========
Depreciation and amortization $ (35,300) $ (18,600)
Investment tax credit carryforward 43,500 43,500
Benefit of net operating loss carryforward 1,700,800 593,500
Other (94,800) (45,000)
------------- -----------
Non-current deferred tax asset $ 1,614,200 $ 573,400
============= ===========
</TABLE>
- --------------------------------------------------------------------------------
Page F - 19
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 14 - INCOME TAXES (Continued)
At December 31, 1998, the Company has available for carryforward approximately
$4,700,000, $1,830,000 and $515,000 of federal, California and New York net
operating losses. Approximately $940,000 of the federal and New York net
operating losses will expire in 2012, the remaining portion will expire in 2018.
The California net operating losses expire beginning 2001 through 2003. The
Company also has $43,500 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.
NOTE 15 - SEGMENT INFORMATION
<TABLE>
The Company's business presently consists of two segments. The first is brewing
for wholesale to distributors and other retailers. This segment accounted for
90.1% of the Company's total gross sales during 1998. The second segment
consists of brewing beer for sale along with food and merchandise at the
Company's brewpub and retail merchandise store located at the Hopland Brewery.
This segment accounted for 9.9% of the Company's total gross sales during 1998.
A summary of each segment is as follows:
<CAPTION>
Year Ending December 31, 1998
---------------------------------------------------------------------------------
Brewing Hopland Corporate
Operations Brewery and other Total
----------------- ----------------- ----------------- ------------------
<S> <C> <C> <C> <C>
Sales $ 6,233,400 $ 685,400 $ - $ 6,918,800
Operating loss (89,200) (82,700) - (171,900)
Identifiable assets 16,056,500 67,100 2,799,600 18,923,200
Depreciation and amortization 694,900 6,100 78,400 779,400
Capital expenditures 296,400 - 114,100 410,500
Year Ending December 31, 1997
---------------------------------------------------------------------------------
Brewing Hopland Corporate
Operations Brewery and other Total
----------------- ----------------- ----------------- ------------------
Sales $ 3,856,300 $ 987,600 $ - $ 4,843,900
Operating loss (127,800) (144,500) - (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
</TABLE>
- --------------------------------------------------------------------------------
Page F - 20
<PAGE>
MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
- --------------------------------------------------------------------------------
NOTE 16 - STATEMENT OF CASH FLOWS
Supplemental cash flow information includes the following:
1998 1997
--------- -----------
Cash paid during the year for:
Interest $ 623,400 $ 644,400
Income taxes $ 2,300 $ 800
Non-cash investing and financing activities:
Seller financed equipment $ 224,300 $ 19,500
Issuance of stock for goodwill $ 45,800 $ -
Transfer of liabilities to long-term debt $ 80,200 $ -
Deposit offset against long-term debt $ - $ 290,000
Issuance of stock for stock in Releta $ - $ 5,000,000
- --------------------------------------------------------------------------------
Page F - 21
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 42,000
<SECURITIES> 0
<RECEIVABLES> 679,900
<ALLOWANCES> 0
<INVENTORY> 978,000
<CURRENT-ASSETS> 1,871,700
<PP&E> 16,913,500
<DEPRECIATION> 1,653,700
<TOTAL-ASSETS> 18,923,200
<CURRENT-LIABILITIES> 2,502,400
<BONDS> 0
0
227,600
<COMMON> 12,413,000
<OTHER-SE> (2,498,800)
<TOTAL-LIABILITY-AND-EQUITY> 18,923,200
<SALES> 6,529,700
<TOTAL-REVENUES> 6,918,800
<CGS> 4,908,000
<TOTAL-COSTS> 8,992,100
<OTHER-EXPENSES> (8,500)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 636,300
<INCOME-PRETAX> (2,701,100)
<INCOME-TAX> (1,138,800)
<INCOME-CONTINUING> (1,562,300)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,562,300)
<EPS-PRIMARY> (0.35)
<EPS-DILUTED> (0.35)
</TABLE>
