UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1998.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from __________________
to ___________________
Commission File Number: 0-27800
Frederick Brewing Co.
-----------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Maryland 52-1769647
- --------------------------------------------- -----------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
4607 Wedgewood Boulevard, Frederick, Maryland 21703
- --------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(301) 694-7899
------------------------------------------------
(Issuer's telephone number, including area code)
Not Applicable
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Common Stock, $0.00004 Par Value 7,411,031
- -------------------------------- -----------------------------
(Title of Each Class) (Number of Shares Outstanding
as of March 31, 1998)
Transitional Small Business Disclosure Format (Check one):
Yes [ ] No [X]
<PAGE>
FREDERICK BREWING CO.
--------------------
INDEX TO FORM 10-QSB
--------------------
PART I. FINANCIAL INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
Three Months Ended March 31, 1998 and 1997 3
CONSOLIDATED BALANCE SHEET (UNAUDITED)
March 31, 1998 4
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31, 1998 and 1997 5
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS 7
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
ITEM 1. LEGAL PROCEEDINGS 14
ITEM 2. CHANGES IN SECURITIES 14
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 14
ITEM 5. OTHER INFORMATION 14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 15
SIGNATURES
- --------------------------------------------------------------------------------
SIGNATURE PAGE 16
2
<PAGE>
Frederick Brewing Company
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Three Months Three Months
Ended March 31, Ended March 31,
--------------- ---------------
1998 1997
--------------- ---------------
(Unaudited)
<S> <C> <C>
Gross sales $1,014,837 $265,814
Less: Depletions, allowances, and excise taxes 95,121 51,541
---------- -----------
Net sales 919,716 214,273
Cost of sales 804,802 397,466
---------- -----------
Gross profit (loss) 114,914 (183,193)
Selling, general and administrative expenses 747,340 496,070
---------- -----------
Operating loss (632,426) (679,263)
Gain on sale of equipment (2,660) (61,336)
Interest expense, net 106,238 27,575
---------- -----------
Net loss (736,004) (645,502)
Preferred stock deemed dividend requirements (28,627) (1,325,828)
---------- -----------
Net loss attributable to common shareholders $(764,631) $(1,971,330)
========== ===========
Basic and diluted loss per common share:
Net loss before preferred stock dividend (0.12) (0.33)
requirements
Preferred stock dividend requirements (.01) (0.68)
---------- -----------
Net loss per common share (0.13) (1.01)
========== ===========
Weighted average common shares 6,048,454 1,954,876
========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
Frederick Brewing Company
Consolidated Balance Sheet
<TABLE>
<CAPTION>
March 31,
1998
-----------
(Unaudited)
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents $800,583
Trade receivables, net of allowance for doubtful accounts of 624,194
$35,544
Inventories, net 713,528
Prepaid expenses and other current assets 288,983
-----------
Total current assets 2,427,288
Property and equipment, net 8,584,880
Intangibles, net 392,415
Deferred public relations costs, net 1,063,438
Goodwill, net 2,748,975
Other assets 251,235
-----------
Total assets $15,468,231
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $276,286
Capital lease obligations, current portion 85,504
Accounts payable 867,966
Accrued liabilities 453,768
-----------
Total current liabilities 1,683,524
Long-term debt 2,135,642
Capital lease obligations 2,866,344
-----------
Total liabilities 6,685,510
-----------
Stockholders' equity:
Preferred stock - $.01 par value, 1,000,000 shares authorized:
Cumulative, convertible Series A, 1828 shares issued and 683,840
outstanding,
Convertible Series C, 829 shares issued and outstanding 491,500
Convertible Series D, 218 shares issued and outstanding 218,000
Convertible Series E, 2,700 shares issued and outstanding 2,325,000
Common stock - $0.00004 par value, 9,000,000 shares authorized,
7,411,031 shares issued and outstanding 296
Additional paid-in capital 16,391,907
Accumulated deficit (11,827,822)
-----------
Total stockholders' equity 8,782,721
-----------
Total liabilities and stockholders' equity $15,468,231
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
Frederick Brewing Company
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Three Months Three Months
Ended March 31, Ended March 31,
-----------------------------------
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $(736,004) $(645,502)
Adjustments to reconcile net loss to net cash
for operating activities:
Depreciation and amortization 236,277 44,638
Amortization of deferred public relations 68,062 -
costs
Gain on sale of equipment (2,660) -
Change in operating assets and liabilities:
Trade receivables (176,812) 119,654
Inventories (200,270) 38,169
Prepaid expenses and other current assets (185,507) (800,960)
Other assets (31,678) 42,226
Accounts payable 344,032 (8,998)
Accrued liabilities (24,676) -
------------ ------------
Net cash used for operating activities (709,236) (1,210,773)
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment (185,489) (746,428)
Purchase of intangibles - (67,652)
Purchase of business, net of cash acquired (834,611) -
Proceeds from sale of equipment 16,800 -
------------ ------------
Net cash used for investing activities (1,003,300) (814,080)
------------ ------------
Cash flows from financing activities:
Proceeds from long-term debt - 531,343
Payments on debt obligations (73,094) (147,319)
Payments on capital leases (14,192) (3,312)
Proceeds from issuance of preferred stock, net - 4,090,090
Restricted cash (12,475) 603,730
------------ ------------
Net cash used for financing activities (99,761) 5,074,532
------------ ------------
Net increase (decrease) in cash and cash equivalents (1,812,297) 3,049,679
Cash and cash equivalents, beginning of period 2,612,880 48,990
------------ -------------
Cash and cash equivalents, end of period $800,583 $3,098,669
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE>
FREDERICK BREWING CO.
Notes to Consolidated Financial Statements
March 31, 1998
(Unaudited)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Regulation
S-B. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. However, in the opinion of management, all adjustments, consisting
of normal recurring accruals, considered necessary for a fair presentation of
the interim financial position and the interim results of operations of the
Company have been included.
Operating results for the three month period ended March 31, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998, or for any other period. For information relating to the
financial position and the results of operations of the Company as of and for
the year ended December 31, 1997, refer to the financial statements included in
the Company's Annual Report on Form 10-KSB for the year ended December 31, 1997
and in its 1997 Annual Report to shareholders.
Note 2 - Principles of Consolidation
The consolidated financial statements as of and for the three months ended
March 31, 1998 include the accounts of the Company and its wholly-owned
subsidiaries, Wild Goose Brewery, Inc. (Wild Goose) and Brimstone Brewing
Company, Inc. (Brimstone), from their dates of acquisition during the first
quarter of 1998. (see Note 5) All significant intercompany accounts and
transactions have been eliminated in consolidation.
Note 3 - Property and Equipment
Property and equipment at March 31, 1998 consisted of the following:
Brewing Equipment $4,456,661
Capital lease - building 3,000,000
Leasehold improvements 1,376,120
Automobiles and trucks 184,204
Furniture and fixtures 130,292
-------
Total 9,147,277
Less accumulated depreciation
and amortization (562,397)
---------
Property and equipment, net $8,584,880
==========
Note 4 - Deferred public relations costs
Deferred public relations costs consist of $650,000 cash paid in advance
and $670,000, representing the estimated fair value of 500,000 warrants issued
to a third party for public and investor relations services to be rendered over
a five-year service period. These amounts are being amortized on a straight-line
basis over the five-year term of the service contract. Amortization expense was
$68,062 for the three months ended March 31, 1998.
Note 5 - Acquisitions
In January 1998, the Company acquired 100% of the outstanding equity
securities (comprised of 50,000 shares of preferred stock and 10,000 shares of
common stock) of Wild Goose and all of the brands, formulas, copyrights,
trademarks and related intangible assets of Brimstone.
6
<PAGE>
Notes to Financial Statements
March 31, 1998
(Unaudited)
Note 5 - Acquisitions (cont.)
The consideration paid for Wild Goose consisted of the issuance of
1,192,086 shares of the Company's common stock with an aggregate value of
$2,419,935 plus the repayment of approximately $532,000 in notes payable and the
assumption of other liabilities. Pursuant to the Agreement, 123,153 shares of
the common stock are being withheld by the Company to account for any
undisclosed liabilities or uncollectible accounts which may be discovered prior
to November 29, 1998.
The consideration paid for Brimstone consisted of 80,000 shares of the
Company's common stock valued at $162,000. Both the Wild Goose and Brimstone
acquisitions were accounted for under the purchase method of accounting.
The purchase price for each acquisition has been allocated to the assets
acquired and liabilities assumed, based on their estimated fair values. Results
of operations for Wild Goose and Brimstone are included with those of the
Company subsequent to the date of acquisition. The excess of the purchase price
over the net assets acquired has been recorded as goodwill and will be amortized
over 10 years.
Results for the three months ended March 31, 1998 reflect that all
production of Brimstone and Wild Goose products was transferred to the Company's
facility in January and February, respectively, that operations at the Wild
Goose brewery ceased as of the effective date of the acquisition (January 29,
1998) and that the Company's gross sales from the dates of acquisition to March
31, 1998 included $43,000 of Brimstone products and $272,000 of Wild Goose
products.
The following unaudited pro forma summary presents the consolidated results
of operations as if the acquisitions had been completed at the beginning of the
periods presented and does not purport to be indicative of what would have
occurred had the acquisitions actually been made as of such date or of results
which may occur in the future.
Three months ended Three months ended
March 31, 1998 March 31, 1997
-------------- --------------
Net sales $920,000 $691,000
Net loss $736,000 $719,000
Net loss per common share $(0.12) $(0.97)
Note 6 - Income Taxes
The Company accounts for income taxes under the asset and liability method.
The Company has not recorded a provision for income taxes for the three month
periods ended March 31, 1998 and 1997 based on the fact that the Company has
incurred net operating losses during those periods. The Company has provided a
full valuation allowance against its net deferred tax asset as of March 31,
1998.
Note 7 - Net Loss per Common Share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," which requires the
presentation of basic earnings per share and diluted earnings per share for all
years presented. Basic earnings per share is based on the weighted average
number of outstanding common shares for the period. Diluted earnings per share
adjusts the weighted average for the potential dilution that could occur if
stock options, warrants, or other convertible securities were exercised or
converted into common stock. Diluted earnings per share equals basic earnings
per share for 1998 and 1997 because the effects of such items were
anti-dilutive.
7
<PAGE>
Notes to Financial Statements
March 31, 1998
(Unaudited)
Note 8 - New Accounting Standards
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," and Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related information," in June 1997, which are both effective for
the year ending December 31, 1998. SFAS No. 130 establishes standards for
reporting comprehensive income in a full set of general purpose financial
statements either in the income statement or in a separate statement. SFAS No.
131 establishes standards for reporting information about operating segments,
including related disclosures about products and services, geographic areas and
major customers. The Company has adopted SFAS No. 130 during the first quarter
of 1998 and has no items of comprehensive income to report.
Note 9 - Issuance of Common Stock upon Conversion of Preferred Stock
During the three months ended March 31, 1998, the Company issued 2,671,089
shares of common stock upon the conversion of 1,271 shares of Series C and 827
shares of Series D Preferred Stock. The Company also reserved 1,100,000 shares
of common stock for issuance to former equity holders of Wild Goose (see Note 5
- - Acquisitions). As a result, virtually all of the Company's 9,000,000
authorized shares of common stock have either been issued or reserved for later
issuance. The company has executed agreements with the holders of 449 shares of
Series C and 208 shares of Series D Preferred Stock to honor requests for
conversion into 1,138,142 shares of common stock as soon as additional common
stock is authorized by the Company's shareholders. A proposal to amend the
Company's Articles of Incorporation to authorize the issuance of up to
20,000,000 shares of common stock will be voted upon at the Company's annual
meeting of shareholders, scheduled for May 14, 1998.
8
<PAGE>
PART I. - FINANCIAL INFORMATION
Item 1. Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Three Months Ended March 31, 1998 and
1997
Overview of Significant Activities and Expenses
A net loss of ($736,004), or ($0.13) per share, was incurred during the
first quarter of 1998 compared to net loss of ($645,502) or ($0.33) per share,
for the corresponding quarter of 1997.
Weighted average common shares outstanding were 6,048,454 during the first
quarter of 1998 and 1,954,876 for the three months ended March 31, 1997. The
increase in the shares outstanding for the first three months ended March 31,
1998 relates primarily to the conversion of certain of the Company's Preferred
shares into Common Stock during 1997 and the first quarter of 1998.
The Company's gross sales increased 281.8% to $1,014,837 during the first
quarter of 1998 over the similar period of 1997. This growth is attributed to
increases in production that were made possible through the operation of the
Company's new facility and upgraded brewing and packaging equipment, coupled
with a concentrated marketing and promotional effort and sales of Hempen Ale and
Hempen Gold, which were introduced during the second and third quarters,
respectively, of 1997.
Management believes caution should be exercised in comparing first quarter
results for 1997 and 1998. The first quarter of 1997 differed from subsequent
periods in that the Company moved its production and other operations into the
new brewery late in the period.
Because the automated packaging equipment at the new brewery did not become
fully operational until July of 1997, the Company was unable to produce
sufficient quantities of all of its products to meet demand in the first
quarter, which artificially depressed sales and inflated production costs. Also,
the first quarter 1997 results reflect lower depreciation and interest expenses
because the new brewery was not put into service until late in the quarter and
the Company had not fully drawn down the loans used to finance the construction
of the new brewery. Consequently, comparisons of revenue, production costs,
interest expense and operating losses between the first quarters of 1997 and
1998 should not be relied upon as fully indicative of trends in the Company's
business or prospects.
Nevertheless, management also believes that initiatives begun during the
first quarter of 1998 will positively effect sales, production costs, general
and administrative expenses in future periods. The addition of the Wild Goose
and Brimstone brands to the Company's product portfolio, the ongoing expansion
of Hempen product distribution into new markets and new on-premise promotional
programs for the Blue Ridge brand should contribute to future sales growth,
which would improve plant utilization, lower per barrel production overhead
costs and improve gross margins. A restructuring of the sales department, which
eliminated some sales positions in outlying markets, has refocused sales efforts
to the Company's core markets, and will reduce salary and travel-related
expenses beginning in the second quarter of 1998. Production equipment and
scheduling changes implemented at the end of the first quarter of 1998 are
expected to yield additional production cost reductions in future periods. The
Company also continues to seek additional brand licenses and acquisitions and is
in active discussions with the owners of several suitable brands, with the goals
of further increasing the Company's revenues and the utilization of its brewing
capacity as well as increasing its market share in areas outside its core market
territory. While management believes these initiatives will be successful, the
can be no assurances that this will be the case, nor that the expected
improvements in performance will occur during any particular period.
The increase is also due to March sales of the recently acquired Wild Goose
and Brimstone brands. These brands accounted for approximately $315,000 (31%) of
the Company's gross sales during the first quarter of 1998. Delays in installing
and commissioning the new facility had depressed sales during the first quarter
of 1997.
9
<PAGE>
Management's Discussion and Analysis
For the Three Months Ended March 31, 1998 and 1997
Review of Operations
The following table sets forth certain items derived from the Company's
Statements of Operations, expressed as a percentage of net sales, for the three
month periods ended March 31, 1998 and 1997.
<TABLE>
<CAPTION>
Percentage of Sales for the Periods Ended March 31,
---------------------------------------------------
Three Months
1998 1997
---- ----
(Unaudited)
<S> <C> <C>
Gross sales . . . . . . . . . . . . . . . . . . . 110.3% 124.1%
Less returns, depletions and excise taxes . . . . 10.3 24.1
Net sales . . . . . . . . . . . . . . . . . . . . 100.0 100.0
Cost of sales . . . . . . . . . . . . . . . . . . 87.5 185.5
Gross profit (loss). . . . . . . . . . . . . . . . 12.5 (85.5)
Selling, general, and administrative expenses. . . 81.3 231.5
---- -----
Operating loss . . . . . . . . . . . . . . . . . . (68.8) (317.0)
Gain on sale of equipment . . . . . . . . . . . . 0.0 (28.6)
Interest expense, net . . . . . . . . . . . . . . 11.2 12.9
Other (income) . . . . . . . . . . . . . . . . . . 0.0 0.0
--- ---
Net loss . . . . . . . . . . . . . . . . . . . . . (80.0) (301.3)
====== =======
</TABLE>
Sales
Gross sales for the 1998 and 1997 first quarters were $1,014,837 and
$265,814, respectively, an increase of $749,023 or 281.8%, in 1998 compared to
1997.
Sales of the Wild Goose and Brimstone brands began late in the first
quarter of 1998 and contributed gross sales of $272,000 and $43,000,
respectively. First quarter shipping volumes were 5,706 and 1,606 barrels for
1998 and 1997, respectively, an increase of 4,100 barrels, or 255.3%. Revenues
per barrel for the first quarters of 1998 and 1997 were $178 and $165 per
barrel, respectively, an increase of $13 per barrel. The increase in the
revenues per barrel for the quarter reflects a change in the sales mix of the
Company's products from kegs to cases, which have a higher revenue per barrel
contribution, and sales of higher priced seasonal beers, including Blue Ridge
Subliminator Doppelbock, Wild Goose Springwheat, and Brimstone Irish Wake Stout,
none of which were sold by the Company in 1997. Because kegs sales for both Wild
Goose and Brimstone products have historically represented a larger proportion
of sales volumes, the sales mix in future peiods may be expected to shift toward
kegs, lowering revenue per barrel in future periods.
During the quarter, the Company continued to pursue geographical expansion
of its channels of distribution. The company began shipping to one new state and
expanded into the San Francisco bay area during the first quarter of 1998. In
addition, the Company entered the international market with a shipment to China
in March. During the first quarter, the Company added 49 new wholesale
distributors, including 46 new wholesalers who distribute the Wild Goose and
Brimstone brands, bringing the total number of wholesalers throughout its
current network to 139.
Returns, Depletions and Excise Taxes
Returns, depletion allowances and excise taxes were $95,121 and $51,541, or
10.3% and 24.1% of net sales, during the first quarters of 1998 and 1997,
respectively. The decrease as a percentage of net sales for the first quarter of
1998 and 1997 reflects the relative reduction of the Company's sales in states
where the Company is levied excise tax as a percentage of total sales. The
Federal government and all state governments impose excise taxes on all beer
sold. These taxes are levied on volume, regardless of the price or revenue
generated from those sales. Each state in which the Company distributes its
product has different beer excise tax rates and regulations, including some
states that require the distributor to pay such taxes instead of the producer.
10
<PAGE>
Management's Discussion and Analysis
For the Three Months Ended March 31, 1998 and 1997
Returns, Depletions and Excise Taxes (cont.)
Returns decreased 71% in the first quarter 1998 over 1997, largely due to
the Company's improved management of wholesaler inventories and the lengthened
shelf life of bottled beer produced at the new brewery. Depletion allowances are
payments made by the Company to its wholesale distributors as the Company's
contribution to promotional and incentive pricing programs offered to retail
customers by the wholesalers. These are typically based on volume purchases made
by retailers. Depletion allowances increased by $36,729 (3.6% of gross sales)
during the first quarter of 1998 over $10,198 (3.8% of gross sales) in the same
period in 1997, largely due to the substantial increase in sales.
Cost of Sales
First quarter cost of sales for 1998 and 1997 were $804,802 and $397,466
(or 87.5% and 185.5% of net sales, respectively), an increase of $407,336 or
102.5% over 1997. As a percentage of net sales, the cost of sales decreased to
87.5% in the first quarter of 1998 from 185.5% in the first quarter of 1997.
Due to bulk purchasing, primarily of malted barley, glass bottles and paper
packaging materials and improved labor productivity made possible by larger
batch sizes and higher degree of automation in the current brewery, direct
variable costs of production were $427,633 ($75 per barrel sold) for the first
quarter of 1998 compared to $272,324 ($170 per barrel sold) in the similar
period of 1997, during which most of the Company's beers were still being
produced at its original facility. These amounts represent a 57.0% increase in
variable cost of sales compared to a 281.8% increase in gross sales.
This improvement was partially offset, however, by increased fixed
production overhead expenses associated with owning, maintaining and operating
the larger new brewery for the entire first quarter in 1998, compared to only
one month of the period in 1997. Production overhead expenses, principally
management and supervisory salaries, depreciation, utilities and equipment
rentals were $377,169 for the first quarter of 1998 compared to $125,142 for the
first quarter of 1997. This represents a 201.4% increase compared to a 281.8%
increase in gross sales. On a per barrel basis, however, fixed production costs
per barrel decreased to $66 in the first quarter of 1998 from $78 in 1997.
Management believes the current level of production overhead costs could be
maintained with only small increases even if production and sales increased to
two to four times current levels. This would have the effect of reducing the
cost of sales both as a percentage of sales and on a per barrel basis. While
management believes production and sales will continue to increase in future
periods, no assurances can be given that such increases will, in fact, occur.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses were $747,340 and
$496,070 in the first quarters of 1998 and 1997, respectively, an increase of
$251,270, or 50.7%.
The Company's SG&A expenses increased over the comparable period in 1997
primarily due to an increase in payroll, payroll related costs, travel, and
other expenses as new sales, marketing and accounting staff were added; and an
increase in advertising and promotional expenses, compared to the first quarter
of 1997.
Gain on Sales of Equipment
Gains on sales of equipment were $2,660 in the first quarter of 1998
compared with $61,336 in 1997.
Interest Expense (Net)
Net interest expense was $106,238 in the first quarter of 1998 compared
with $27,575 in 1997. Interest expense was offset by interest income from excess
cash invested until required for operating and capital investment purposes. A
substantial portion of interest expense incurred relates to the debt obligations
the Company has with First Union National Bank for the building and equipment
financing and with the U.S. Small Business Administration for additional
equipment financing.
11
<PAGE>
Management's Discussion and Analysis
For the Three Months Ended March 31, 1998 and 1997
Income Tax Provision
The Company has incurred net operating losses during both 1998 and 1997
and, accordingly, no provisions for income taxes have been provided on the
Statements of Operations. The Company has recorded a full valuation allowance
against the net deferred tax asset.
Liquidity and Capital Resources
Due to losses experienced during the start-up and expansion of the Company,
operations to date have been funded primarily from private and public placements
of common and preferred stock and by loans from stockholders and financial
institutions. As of March 31, 1998, the Company had working capital of
approximately $743,764. As of March 31, 1997, the Company had working capital of
approximately $2,800,000 primarily a result of the sale of preferred stock.
Net cash used in investing activities during the three months ended March
31, 1998 was $1,030,000 which was primarily used to repay the debt outstanding
on the books of Wild Goose Brewery, pursuant to the acquisition agreement. In
the three months ended March 31, 1997, net cash used in investing activities was
$814,080 which was primarily used to purchase capital assets.
Net cash used in financing activities during the three months ended March
31, 1998 was $99,761. This was used to pay down debt obligations and capital
leases. In the three months ended March 31, 1997 net cash provided by financing
activities was $5.1 million primarily representing net proceeds from the
issuance of preferred stock and proceeds from long term debt.
The Company does not currently have a working capital line of credit or any
other revolving credit.
During 1996, the Company entered into agreements to have a new brewery
built by Blue II, LLC, a limited liability company affiliated with certain
directors of the Company ("Blue II"). Blue II constructed the new brewery
building to the Company's specifications and is leasing the building to the
Company. On July 19, 1996, in connection with the purchase of the equipment to
be housed in the new brewery, the Company obtained a $1,500,000 revenue bond
from the Maryland Economic Development Corporation ("MEDCO") and a $969,000
bridge loan from a bank which has been repaid. The $1,500,000 revenue bond was
immediately assigned by MEDCO to a bank. In connection with the $1,500,000
revenue bond, the bank issued a note to the Company from the proceeds of the
revenue bond. There are certain restrictive covenants existing on the $1,500,000
note payable to the bank. Among those covenants is a cash flow to debt service
ratio for March 31, 1998. This covenant violation represents an event of default
on the note and also a cross default on a $3,000,000 loan obtained by Blue II
for the construction of the brewery for which the Company is a guarantor of the
Blue II loan. During the first quarter of 1998, for both the $1,500,000 loan and
$3,000,000 Blue II loan the bank has waived compliance with the cash flow to
debt service covenant for the calendar quarters ending March 31, 1998, June 30,
1998 and September 30, 1998. The bank has also modified this covenant for the
calendar quarter ending December 31, 1998 and for each quarter thereafter
whereby the Company must maintain a cash flow to debt service ratio of 1.0 to 1.
In addition, the bank modified the current ratio covenant whereby the Company
must maintain a ratio of current assets to current liabilities of 1.0 to 1 as
of calendar quarter March 31, 1998 and each calendar quarter thereafter. The
Company anticipates it will be able to comply with these modified covenants. In
exchange for these covenant modifications, the maturity date on the loans was
revised to April 1, 1999, the interest rate increased to the prime rate plus
1.25% for the Company's loan and the prime rate plus 1.5% for the Blue II loan,
the Company is required to pay a loan modification fee of $25,000 payable in two
installments of $10,000 and $15,000 on June 30, 1998 and September 30, 1998,
respectively, and be responsible for all fees and expenses incurred by the bank
in connection with preparation of the modification and use its best efforts to
obtain replacement financing.
The Company and Blue II are currently negotiating with a local financial
institution and the current bondholder, the bond issuer and the guarantee agency
which may agree to purchase both MEDCO bonds, thereby re-financing the Company's
long-term debt. If such a refinancing occurs, it is likely that the interest
rates will rise, the Company's rent payment to Blue II will rise and the
Company's Chief Executive Officer and President will be required to provide
personal guarantees of the $1,500,000 bond and the Blue II building lease. While
management believes this debt refinancing will be completed during the second
quarter of 1998, no assurances can be given that this will occur.
12
<PAGE>
Management's Discussion and Analysis
For the Three Months Ended March 31, 1998 and 1997
Impact of Inflation
Although the Company has not attempted to calculate the effect of
inflation, management does not believe inflation has had a material effect on
its results of operations. Material increases in costs and expenses,
particularly packaging, raw material and labor costs, in the future, could have
a significant impact on the Company's operating results to the extent that the
effect of such increases cannot be transferred to its customers.
Impact of Year 2000 Issue
The Company is in the process of assessing its computer applications to
insure their functionality with respect to the "Year 2000" millenium change. At
present, the Company does not anticipate that material incremental costs will be
incurred in any single future year.
Forward-Looking Information
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for certain forward-looking statements made by the Company in its
disclosures to the public. There is certain information contained herein, in the
Company's press releases and in oral statements made by authorized officers of
the Company which are forward-looking statements, as defined by such Act. When
used herein, in the Company's press releases and in such oral statements, the
words "estimate," "project," "anticipate," "expect," "intend," "believe,"
"plans," and similar expressions are intended to identify forward-looking
statements. Because such forward-looking statements involve risks and
uncertainties, there are important factors that could cause actual results to
differ materially from those expressed or implied by such forward-looking
statements.
13
<PAGE>
PART II. - OTHER INFORMATION
For the Three Months Ended March 31, 1998 and 1997
FREDERICK BREWING CO.
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
During the three months ended March 31, 1998, the Company issued 2,671,089
shares of common stock upon the conversion of 1,271 shares of Series C and 827
shares of Series D Preferred Stock. The Company also reserved 1,100,000 shares
of common stock for issuance to former equity holders of Wild Goose (see Note 5
- - Acquisitions). As a result, virtually all of the Company's 9,000,000
authorized shares of common stock have either been issued or reserved for later
issuance. The company has executed agreements with the holders of 449 shares of
Series C and 208 shares of Series D Preferred Stock to honor requests for
conversion into 1,138,142 shares of common stock as soon as additional common
stock is authorized by the Company's shareholders. A proposal to amend the
Company's Articles of Incorporation to authorize the issuance of up to
1,900,000 shares of common stock will be voted upon at the Company's annual
meeting of shareholders, scheduled for May 14, 1998.
Item 3. Acquisitions
In January 1998, the Company acquired 100% of the outstanding equity
securities (comprised of 50,000 shares of preferred stock and 10,000 shares of
common stock) of Wild Goose Brewery, Inc. ("Wild Goose") and all of the brands,
formulas, copyrights, trademarks and related intangible assets of Brimstone
Brewing Co., Inc. ("Brimstone").
The consideration paid for Wild Goose consisted of the issuance of
1,192,086 shares of the Company's common stock with an aggregate value of
$2,419,935 plus the repayment of approximately $532,000 in notes payable and the
assumption of other liabilities.
The consideration paid for Brimstone consisted of 80,000 shares of the
Company's common stock valued at $162,000. Both the Wild Goose and Brimstone
acquisitions were accounted for under the purchase method of accounting.
The purchase price for each acquisition has been allocated to the assets
acquired and liabilities assumed, based on their estimated fair values. Results
of operations for Wild Goose and Brimstone are included with those of the
Company subsequent to the date of acquisition. The excess of the purchase price
over the net assets acquired has been recorded as goodwill and will be amortized
over 10 years.
Results for the three months ended March 31, 1998 reflect that all
production of Brimstone and Wild Goose products was transferred to the Company's
facility in January and February, respectively, that operations at the Wild
Goose brewery ceased as of the effective date of the acquisition (January 29,
1998) and that the Company's gross sales during the period included $43,000 of
Brimstone products and $272,000 of Wild Goose products.
Item 4. Defaults Upon Senior Securities
None.
Item 5. Submission of Matters to a Vote of Security Holders
Not applicable.
14
<PAGE>
Other Information
For the Three Months Ended March 31, 1998 and 1997
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits Filed:
Index to Exhibits
(I.) Press release,
(II.)
10 Material Contracts
i. Loan Modification Agreement by and
among First Union National Bank,
Blue II, LLC, Robert Schuerholz,
Nicholas P. Foris, Edward D. Scott,
and Vishnampet S. Jayanthimath dated as
of March 30, 1997;1
ii. Loan Modification Agreement by and
between First Union National Bank
and Frederick Brewing Co.1
27 Financial Data Schedule
99 Safe Harbor Under the Private Securities Litigation
Reform Act of 1995
(b) Reports on Form 8-K
The form 8-K filed February 12, 1998
- ------------------
1 Incorporated by reference to exhibits 10(ii) and 10(iii) to the Company's
Annual Report on Form 10-KSB, SEC File Number: 000-27800.
15
<PAGE>
SIGNATURES
In accordance with the requirements of the Securities and Exchange Act of
1934, the Registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Frederick Brewing Co.
Date May 6, 1998 ---------------------------
Kevin E. Brannon
Chairman of the Board and
Chief Executive Officer
Date May 6, 1998 ---------------------------
Leslie P. Harper
Chief Financial Officer
16
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000926978
<NAME> Frederick Brewing Co.
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<EXCHANGE-RATE> 1.000
<CASH> 800,583
<SECURITIES> 0
<RECEIVABLES> 659,738
<ALLOWANCES> (35,544)
<INVENTORY> 713,528
<CURRENT-ASSETS> 2,427,288
<PP&E> 9,147,277
<DEPRECIATION> (562,397)
<TOTAL-ASSETS> 15,468,231
<CURRENT-LIABILITIES> 1,683,524
<BONDS> 0
0
3,718,340
<COMMON> 354
<OTHER-SE> 5,378,163
<TOTAL-LIABILITY-AND-EQUITY> 15,468,231
<SALES> 919,716
<TOTAL-REVENUES> 919,716
<CGS> 804,802
<TOTAL-COSTS> 1,552,148
<OTHER-EXPENSES> (2,660)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 106,238
<INCOME-PRETAX> (736,004)
<INCOME-TAX> 0
<INCOME-CONTINUING> (736,004)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (736,004)
<EPS-PRIMARY> (.12)
<EPS-DILUTED> (.12)
</TABLE>
