-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DrmamS5D2ZCmhaFLLkFKK7ljN9lIkkFND1Ln5bNwihePKoNXDzZRzpKt26nRzydS 8xW/J1UUQfpKX1VuR5OUhw== 0000950005-00-000500.txt : 20000331 0000950005-00-000500.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950005-00-000500 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MENDOCINO BREWING CO INC CENTRAL INDEX KEY: 0000919134 STANDARD INDUSTRIAL CLASSIFICATION: MALT BEVERAGES [2082] IRS NUMBER: 680318293 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 001-13636 FILM NUMBER: 589005 BUSINESS ADDRESS: STREET 1: 13351 S HWY 101 CITY: HOPLAND STATE: CA ZIP: 95449 BUSINESS PHONE: 7077441015 MAIL ADDRESS: STREET 1: 13351 S HWY 101 CITY: HOPLAND STATE: CA ZIP: 95449 10KSB 1 ANNUAL REPORT FOR FISCAL YEAR ENDED 12-31-99 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, 1999 [ ] 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: $9,240,000 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, 2000 was: $1,727,877 The number of shares the issuer's Common Stock outstanding as of March 15, 2000 is: 5,530,177 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] 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, Eye of the Hawk Select Ale, Peregrine Golden Ale and two 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, LLC. ("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. 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. Subsequently, the Company drew approximately $994,000 on the credit facility. In mid 1999, the Company induced UBA to convert the $994,000 drawn on the credit facility, together with approximately $61,000 of accrued interest, into 938,171 shares of common stock of the Company. After being offered an inducement by the Company, UBA agreed to convert all amounts drawn through August 30, 1999 into common stock of the Company. Further, in early 1999, the credit facility was terminated. In mid 1999, UBA agreed to provide the Company with a new credit facility of up to $800,000 to fund the operations of the Company. Subsequently, the Company has requested that UBA increase the amount of the credit facility to $1,200,000. As of December 31, 1999, the Company has drawn $565,127 on the credit facility. On March 29, 2000 the Company announced that it intends to enter into two concurrent related party transactions with affiliates of UBA. In the first transaction, the Company intends to acquire UBSN Ltd. UK, which is the European distributor of the UB Group's flagship brand, Kingfisher Premium Lager. In the second transaction, the Company intends to acquire the distribution rights to Kingfisher Premium Lager Beer in the United States from United Breweries International, UK Ltd. 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 2 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 six segments: Segment Representative Brands - ------- --------------------- Low-Priced Busch, Milwaukee's Best, Old Milwaukee Premium Budweiser, Coors Genuine Draft Premium Lite Miller Lite, Bud Light, Coors Light Super-Premium Michelob, Lowenbrau, Killians European Import Heineken, Guinness, Bass, Becks Domestic Craft Samuel Adams, Sierra Nevada, Red Tail Ale The Company competes in the domestic craft beer segment, which comprises approximately 2.5% 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 between 5% and 10% per year since 1996. 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. 3 Large brewer a brand brewed by a national brewer which may only craft-style brews 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 1999. 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 four ales and a stout year-round, one seasonal ale, and one seasonal porter: * RED TAIL ALE, a full flavored amber ale, is the flagship brand of Mendocino Brewing. It is available year-round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. * BLUE HERON PALE ALE is a golden ale with a full body and a distinctive hop character. It is available year-round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. * BLACK HAWK STOUT is the fullest in flavor and body of the Company's brews. It is available year-round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. * EYE OF THE HAWK SELECT ALE is a high gravity deep amber summer ale. It is available year round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. * PEREGRINE GOLDEN ALE is brewed year-round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. * YULETIDE PORTER is a deep brown Holiday brew with a traditionally rich, creamy flavor. It is available in November and December. * 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. * CARMEL WHEAT BEER is a light-bodied and delicately flavored beer characterized by its cloudy Hefeweizen appearance, refreshing floral aromas and subtle wheat flavor. It is available year-round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. 4 * CARMEL PALE ALE is a full, smooth flavored ale that imparts a malty and spicy character to the palate. It is available year-round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. * FAT BEAR STOUT is a full-bodied brew characterized by smooth roasty flavors and malty aromas. It is only available in the East Coast in 12 oz. six-packs and half-barrel kegs. * WHITEFACE PALE ALE is a robust and spicy American style ale crafted with the finest malts and perfect blend of hops. It is only available in the East Coast in 12 oz. six-packs and half-barrel kegs. * SARATOGA CLASSIC PILSNER is a crisp, full-flavored, German-style pilsner with a clean hoppy finish. It is only available in the East Coast in 12 oz. six-packs and half-barrel kegs. * OLDE SARATOGA ROOT BEER is an exceptionally rich creamy premium gourmet root beer crafted with all natural ingredients and cane sugar. It is only available in the East Coast in quarter-barrel kegs. 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 1999, products of the Company continued to win praise for their quality. Red Tail Ale and Eye of the Hawk Select Ale were adjudged as exceptional and Black Hawk Stout and Frolic Ale as highly recommended in their respective categories by the Beverage Testing Institute of Chicago, Illinois, which conducts comprehensive testing and tasting of all leading brands in different categories. 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. 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 5 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. Beverages served include Red Tail Ale, Blue Heron Pale Ale, Black Hawk Stout, Eye of the Hawk Select Ale, 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, Delaware, District of Columbia, Florida, Georgia, Idaho, Kansas, Illinois, Louisiana, Maryland, Massachusetts, Minnesota, Missouri, Nevada, Nebraska, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Vermont, Washington, Wisconsin, Wyoming and Virginia. The Company plans to add Michigan, Connecticut, and Maine in the near future. Northern California is the Company's primary market and Southern California currently is the second largest market. 6 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 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 95.6% of the Company's total sales in 1999, with food and merchandise retail and catalogue sales constituting the balance. Sales to the top five customers totaled $4,191,700 and $3,029,000 for the years ended December 31, 1999 and 1998, respectively representing 45% and 44% of sales. Suppliers The Company's major suppliers are Great Western Malting Co., Yakima, Washington, and Briess Malting, Milwaukee, Wisconsin (malt); Lupofresh Inc. Wapato, Washington (hops); Ball Foster Glass, Muncie, Indiana (bottles); Gaylord Container Corporation, Antioch, California (cartons); Sierra Pacific Packaging, Oroville, California (carriers); and Inland Printing Company Inc., Lacrosse, Wisconsin (labels). Employees As of December 31, 1999, the Company employed 63 full-time and 8 part-time individuals including 11 in management and administration, 32 in brewing and production operations, 16 in retail and brewpub operations and 12 in sales and marketing positions. Management believes that the Company's relations with its employees are excellent. The Company does not have any union labor contracts with any of its employees. Trademarks The Company has federal trademark registrations of the MENDOCINO BREWING COMPANY word mark (Reg. No. 1,785,745), RED TAIL ALE word mark (Reg. No. 2,032,382), RED TAIL DESIGN (Reg. No. 2,011,817), BLUE HERON word mark (Reg. No. 1,820,076), BLUE HERON PALE ALE DESIGN (Reg. No. 2,011,816), PEREGRINE PALE ALE word mark (Reg. No. 1,667,796), EYE OF THE HAWK SELECT ALE word mark (Reg. No. 1,673,594), EYE OF THE HAWK SELECT ALE DESIGN (Reg. No. 2,011,818), EYE OF THE HAWK SPECIAL EDITION ANNIVERSARY ALE AND DESIGN (Reg. No. 2,011,815), BLACK HAWK STOUT word mark (Reg. No. 1,791,807), YULETIDE PORTER word mark (Reg. No. 1,666,891), and BREWSLETTER word mark (Reg. No. 1,768,639). 7 Releta has federal trademark registrations of the FAT BEAR word mark (Reg. No. 2,267,709), TEN SPRINGS word mark (Reg. No. 2,243,852), and WHITEFACE word mark (Reg. No. 2,322,226), Releta has also applied for intent to use registrations of the trademarks NORTH COUNTRY ALES 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. 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, together with the amendment completed in 1999, 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 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 $4.19 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. 8 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 $550 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 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 $870 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 1999 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 9 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. 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 1999. PART II Item 5. Market for Common Equity and Related Stockholder Matters. 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: 10 1999 1998 ---------------------------------- ---------------------------------- 1st 2nd 3rd 4th 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter ------- ------- ------- ------- ------- ------- ------- ------- High $1.50 $2.00 $2.13 $1.25 $3.31 $2.75 $1.68 $1.18 Low $0.56 $1.06 $0.88 $0.63 $2.00 $1.18 $1.06 $0.56 The Company had approximately 2,431 shareholders of record as of March 15, 2000. Management intends to retain Mendocino Brewing's earnings for use in the business and does not expect the Company to pay cash dividends in the foreseeable future. The Company's credit agreements provide that the Company shall not declare or pay any dividend or other distribution on its Common Stock (other than a stock dividend) or purchase or redeem any Common Stock, without the lender's prior written consent. Management anticipates that such restrictions will remain in effect for as long as the Company has significant bank financing, including the long-term debt on the Ukiah real estate. The holders of the Company's 227,600 outstanding shares of Series A Preferred Stock are entitled to aggregate cash dividends and liquidation proceeds of $1.00 per share before any dividend may be paid with respect to the Common Stock. The Series A Preferred Shares are canceled after they have received their $1.00 per share aggregate dividend. Management does not have any present intention to declare or pay a dividend on the Series A Preferred Stock. Item 6. Management's Discussion and Analysis. The following discussion and analysis should be read in conjunction with the Financial Statements and the Notes thereto and other financial information included elsewhere in this Report. The discussion of results and trends does not necessarily imply that these results and trends will continue. Forward-Looking Information The Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-KSB contain forward-looking information. The forward-looking information involves risks and uncertainties that are based on current expectations, estimates and projections about the Company's business, Management's beliefs and assumptions made by Management. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and variations of such words and similar expressions are intended to identify such forward-looking information. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking information due to numerous factors, including, but not limited to, availability of financing for operations, successful performance of internal operations, impact of competition, changes in distributor relationships or performance and other risks detailed below as well as those discussed elsewhere in this Form 10-KSB and from time to time in the Company's Securities and Exchange Commission filings and reports. In addition, such statements could be affected by general industry and market conditions and growth rates, and general domestic economic conditions. Readers are cautioned not to place undue reliance on these forward-looking statements, which are valid as of the date of this filing. Overview The year was highlighted by introduction of new products and new packaging in both the Ukiah and Saratoga Springs facilities. 11 In Ukiah, Carmel Pale Ale and Peregrine Golden Ale products were launched during the second quarter of the year. New packaging for Carmel Wheat, Red Tail 12 pack and Eye of the Hawk Millennium Edition was introduced. In Saratoga Springs, a new non-alcoholic brew of OLDE SARATOGA CLASSIC ROOT BEER was launched during the third quarter. All the new products have been well received in the market. The licensed brand Razor Edge also rolled out during the first quarter of the year from both the Ukiah and Saratoga Springs facilities. In addition, bottling line equipment such as a carrier erector and bulk glass handling equipment were installed in Ukiah and Saratoga facilities, respectively, which has brought about reductions in manpower. At the Ukiah facility, two additional 240 bbl fermentation tanks were installed to satisfy greater production and flexibility demand. 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 "1998 Facility"). By mid 1999, the Company had borrowed $994,000 drawn on the credit facility and slightly more than $61,000 of interest had accrued thereon. Subsequently, UBA agreed to convert all of the outstanding convertible notes (together with all accrued but unpaid interest) into common stock after the Board of Directors of the Company offered UBA an inducement to convert. As a result of the conversion, UBA became the majority owner of Company. In mid-1999, the 1998 Facility was terminated, and a new credit facility (the "1999 Facility") in the maximum amount of $800,000 was offered to the Company on substantially the same terms as the 1998 Facility. On August 31, 1999, the Company and UBA entered into a Master Line of Credit Agreement setting forth the terms of the 1999 Facility. Pursuant to the terms of the Master Line of Credit Agreement, advances on the credit facility bear interest at the prime rate of the Bank of America in San Francisco plus 1.5%, up to a maximum of 10%, and is due and payable quarterly. The principal amount of each advance, together with any accrued but unpaid interest on such advance, is due 18 months after the date of such advance. UBA can, at its option, convert the principal and any accrued but unpaid interest into unregistered shares of the Company's common stock at a rate of one share of common stock for each $1.50 of principal and unpaid interest. As of December 31, 1999, the Company has made 5 draws on the credit facility. As of December 31, 1999, the aggregate amount drawn on the line of credit, together with interest accrued thereon, is equal to $576,284, which corresponds to the right to acquire up to 384,189 shares of common stock of the Company. Net sales for 1999 increased by 33.2% over 1998 due primarily to increased and improved marketing efforts. Production and sales in 1999 (measured in barrels, brewed and shipped out of Ukiah and Saratoga Springs facilities, including brands being brewed under contract) increased by 30.5% and 31.4% respectively, when compared to 1998. Production in 1999 increased to 48,973 barrels as compared to 37,514 barrels in 1998. Sales in 1999 increased to 47,154 barrels as compared to 35,882 barrels in 1998. The Company ended the year with a net loss of $1,306,300. Increased fixed costs associated with the breweries, higher selling and marketing expenses, increased interest expenses and induced conversion expense, contributed to the net loss of $1,306,300 for the year ended December 31, 1999. 12 On March 29, 2000 the Company announced that it intends to enter into two concurrent related party transactions with affiliates of UBA. In the first transaction, the Company intends to acquire UBSN Ltd. UK, which is the European distributor of the UB Group's flagship brand, Kingfisher Premium Lager. In the second transaction, the Company intends to acqire the distribution right to Kingfisher Premium Lager Beer in the United States from United Breweries International, UK Ltd. Results of Operations The following tables set forth, as a percentage of net sales, certain items included in Mendocino Brewing's Statements of Operations. See Financial Statements and Notes thereto. ---------------------- Year Ended December 31 ---------------------- 1999 1998 Statements of Operations Data: % % ------ ------ Sales 106.22 105.95 Less Excise taxes 6.22 5.95 ------ ------ Net Sales 100.00 100.00 Costs of Sales 66.31 75.16 ------ ------ Gross Profit 33.69 24.84 ------ ------ Retail Operating Expenses 4.80 7.38 Marketing Expense 19.44 20.09 General and Administrative Expenses 18.99 29.12 ------ ------ Total Operating Expenses 43.23 56.59 ------ ------ Loss from Operations (9.54) (31.75) Other Expense (4.13) 0.10 Interest Expense (9.73) (9.71) ------ ------ Loss before income taxes (23.40) (41.36) Benefit from income taxes (8.39) (17.44) ------ ------ Net Loss (15.02) (23.92) ====== ====== ----------------------------- Year Ended December 31 ----------------------------- 1999 1998 Balance Sheet Data: $ $ ---------- ----------- Cash and Cash Equivalents 0 42,000 Working Capital (1,500,400) (630,700) Property and Equipment 14,727,200 15,259,800 Deposits and Other Assets 22,900 34,600 Total Assets 19,629,900 18,923,200 Long-term Debt 4,165,900 4,753,200 Obligation Under Capital Lease 1,396,900 1,525,800 Total Liabilities 9,327,500 8,781,400 Accumulated Deficit (3,805,100) (2,498,800) Shareholder's equity 10,257,400 10,141,800 Net Sales Net sales for 1999 increased by 32.2% from $6,529,700 in 1998 to $8,698,600 in 1999. The sales volume increased to 47,154 barrels during 1999 from 35,882 barrels in 1998, representing an 13 increase of 31.4%. Of the total sales of barrels in 1999, the sales out of the Ukiah facility accounted for 37,156 barrels and the shipments from Saratoga Springs facility was 9,998 barrels. Management attributes the increased sales to improved 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 1999 when compared to 1998. In view of management's focus on wholesale beer sales, retail sales for the year 1999 decreased by $102,400 while the wholesale beer sales for the year 1999 increased by $2,423,600. Cost of Goods Sold Cost of goods sold as a percentage of net sales decreased in 1999 to 66.31% when compared to that of 75.16% in 1998. During 1999, as a percentage of net sales as compared to 1998, depreciation decreased from 10.64% in 1998 to 7.96% in 1999, property taxes decreased from 2.13% in 1998 to 1.49% in 1999, labor costs decreased from 12.48% in 1998, to 11.61% in 1999, utilities decreased from 4.59% in 1998 to 3.89% in 1999, wastewater decreased from 0.47% in 1998 to 0.26% in 1999, repair & maintenance decreased from 1.31% in 1998 to 1.21% in 1999, telephone decreased from 0.19% in 1998 to 0.09% in 1999, equipment rental decreased from 0.46% in 1998 to 0.26% in 1999, thereby contributing to the decrease of 8.85% of the cost of goods sold as a percentage of net sales for the year of 1999. Management attributes the balance of the decrease to higher sales volumes thereby lowering per barrel production costs at both the Ukiah and Saratoga breweries. Gross Profit As a result of the higher net sales as explained above, gross profit increased in 1999 to $2,930,700 from $1,621,700 for the comparable period of 1998, representing an increase of 81%. As a percentage of net sales, the gross profit during 1999 increased to 33.69% from that of 24.84% for the corresponding period of 1998. Operating Expenses Operating expenses were $3,760,800 in 1999, as compared to $3,695,000 for 1998, representing an increase of 1.78%. Operating expenses consist of retail operating expenses, marketing and distribution expenses, and general and administrative expenses. Retail operating expenses for 1999 were $417,500 compared to $481,900 in 1998. This represents a decrease of $64,400 or 13.36% from 1998. As a percentage of net sales, retail operating expenses decreased to 4.80% in 1999 as compared to 7.38% for 1998. The decrease in retail operating expenses consisted of a decrease in labor costs of $66,200 and an increase in other net expenses of $1,800. Marketing and distribution expenses were $1,691,100 for 1999, representing an increase of 29% compared to $1,311,700 in 1998. As a percentage of net sales, marketing and distribution expenses represented 19.44% in 1999 as compared to 20.09% in 1998. The increase in marketing and distribution expenses consisted of an increase in marketing and sales labor of $128,400; telephone expenses increased by $9,500; sales promotions expenses increased by $162,500; point of sale expenses increased by $31,900; media advertising increased by $12,900; auto expenses increased by $8,500; travel and entertainment decreased by $8,300; freight increased by $32,500; and an increase in other net expenses of $1,500. 14 General and administrative expenses were $1,652,200 in 1999, as compared to $1,901,400 in 1998 representing a decrease of $249,200. As a percentage of net sales, the general and administrative expenses represented a decrease of 10.2% in 1999 to 18.9% as compared to 29.1% in 1998. The decrease of general and administrative expenses consisted of a decrease in professional and legal fees of $225,100, supplies decreased by $10,400, travel and entertainment decreased by $100,800, labor (which includes directors compensation of $102,600 for 1999) increased by $87,700; and all other expenses decreased by $600. Other Income/(Expense) The other income/(expense) for the year 1999 was $1,205,700 as compared to $627,800 in 1998. The increase of $577,900 was due to an increase in interest expense of $210,500, an increase of $263,900 in induced conversion expense for convertible debt, an increase in other expenses of $103,500 relative to potential acquisitions that were not consummated, and miscellaneous income of $8,000. Benefit From Income Taxes The benefit from income taxes for the year 1999 was $729,500 as compared to $1,138,800 in 1998. The benefit from income taxes is due to the expected future benefit of carrying forward net operating losses and other timing differences. As of December 31, 1999, the Company has available for carryforward approximately $6,747,000, $2,551,000 and $794,000 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 and the remaining through 2019. The California net operating losses expire beginning in 2001 through 2004. The Company also has $28,000 of California Manufactures Investment Tax Credits that can be carried forward to future taxes and begin to 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 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 on December 31, 1999 are as follows: Benefits from net operating loss carryforwards $ 2,590,800 Investment tax credit carryforwards 28,000 Inventory 6,900 Accruals 39,700 Depreciation and amortization (78,600) Other (103,400) ----------- Net deferred income taxes 2,483,400 Deferred income taxes expected to be utilized in 2000 43,100 ----------- Deferred income taxes $ 2,440,300 ----------- 15 Net Loss The net loss for the year 1999 was $1,306,300 as compared to $1,562,300 for the year 1998. As a percentage of net sales, the net loss for the year 1999 represented 15.0% when compared to 23.9% in 1998. Segment Information Mendocino Brewing's business presently consists of two segments. The first is brewing for wholesale to distributors and other retailers. This segment accounted for 94% of the Company's total gross sales during 1999. 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 6% of the Company's total gross sales during 1999. With expanded wholesale beer production in both Ukiah and Saratoga Springs, Management expects that retail sales, as a percentage of total sales, will decrease proportionally to the expected increase in the Company's wholesale sales. Seasonality Beer consumption nationwide has historically increased by approximately 20% during the summer months. It is not clear to what extent seasonality will affect the Company as it expands its capacity and its geographic markets. 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 2000. 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 5.83%, 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 (the "1998 Facility"). In mid-1999, the 1998 Facility was terminated, and a new credit facility (the "1999 Facility") in the maximum amount of $800,000 was 16 offered to the Company on substantially the same terms as the 1998 Facility. On August 31, 1999, the Company and UBA entered into a Master Line of Credit Agreement setting forth the terms of the 1999 Facility. Pursuant to the terms of the Master Line of Credit Agreement, advances on the credit facility bear interest at the prime rate of the Bank of America in San Francisco plus 1.5%, up to a maximum of 10%, and is due and payable quarterly. The principal amount of each advance, together with any accrued but unpaid interest on such advance, is due 18 months after the date of such advance. Each advance made on the line of credit will be evidenced by a convertible note. Each convertible note includes a conversion feature whereby UBA could, at its option, convert the principal and any accrued but unpaid interest into unregistered shares of the Company's common stock on or after the maturity date, at a rate of one share of common stock for each $1.50 of principal and unpaid interest. The arrangement was approved by the independent directors (Robert Neame, Kent Price and Sury Rao Palamand) on August 30, 1999. As of December 31, 1999, the Company has made five draws on the credit facility. The aggregate amount drawn, together with interest accrued, equaled $576,284 which corresponds to the right of UBA to acquire up to 384,189 shares of Common Stock of the Company at a conversion price of $1.50 per share. Conversion of Certain Promissory Notes. On August 30, 1999, UBA agreed to convert all of the outstanding convertible notes (together with all accrued but unpaid interest) issued to UBA under the 1998 Facility. By their terms the convertible notes were convertible at $1.50 per share. However, the Board of Directors of the Company offered to induce UBA to convert the notes into common stock at a price of $1.125, which was the then-current price of the Company's common stock as traded on the Pacific Exchange. The total amount converted was approximately $1,055,442, which is equal to 938,171 shares of common stock. As a result of the conversion, UBA became the majority owner of Company, holding 55.8% of the issued and outstanding shares of common stock. Further, as a result of the conversion, the Company recognized an expense of $263,900 for the induced conversion. The induced conversion was approved by the independent directors (Robert Neame, Kent Price and Sury Rao Palamand) on August 30, 1999. 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. 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 the 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 leased from FINOVA Capital Corporation, as well as by a second deed of trust on the Company's Ukiah land improvements. $1,484,000 of the line of credit was advanced to the Company as an initial term loan, which is repayable in sixty consecutive monthly installments of principal, each in the amount of $24,700. The Company commenced repayment of the term loan in March 1999 and approximately $1,236,600 of the term loan was outstanding as of December 31, 1999. Based on the Company's current level of accounts receivable and inventory, the Company has drawn the maximum amount permitted under the line of credit. As of December 31, 1999, the total amount outstanding on the line of credit was $2,396,400. 17 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 and use 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. However, there can be no assurances that the Company will be able to finance the purchase of kegs and the failure to purchase the necessary kegs from MicroStar is likely to have a material adverse effect on the Company. Current Ratio. The Company's ratio of current assets to current liabilities on December 31, 1999 was 0.61 to 1.0 and its ratio of total assets to total liabilities was 2.09 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. To fund its operating deficits, the Company has relied upon lines of credit and other credit facilities. However, there can be no assurances that the Company will have access to any such sources of funds in the future, and the inability to secure sufficient funds will have a materially adverse effect on the Company. Year 2000 Year 2000 issues could affect the performance of the Company's business. While not all Year 2000 date-related disruption scenarios have passed, through the date of this filing, the Company has experienced no material disruptions or other significant problems. There is a possibility of disruptions in the future including errors that could still arise in the Company's internal and network information systems because of their failure to correctly recognize and process date information after the calendar change from 1999 to 2000, or their inability to properly process the date February 29, 2000. The Company also may yet experience supplier-related Year 2000 problems. If any of these Year 2000 problems occur, the Company's operations could be significantly hampered. The Company is continuing to monitor and mitigate its exposure as appropriate, but based on currently available information, the Company continues to believe that Year 2000-related disruptions or other problems, if any, will not have a significant adverse impact on the Company's operational results or financial condition. However, the Company cannot be certain that Year 2000 issues will not have a material adverse impact since it is still early in 2000. Item 7. Financial Statements. The information required by this item is set forth at Pages F-1 through F-17 to this Report. 18 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 2000 Annual Meeting of Shareholders (the "2000 Proxy Statement") called to be held in June 2000, which the Company intends to file with the Commission in April 2000, and such information is incorporated herein by reference. Item 10. Executive Compensation. The information required by Item 10 will be contained in the 2000 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 2000 Proxy Statement, and such information is incorporated herein by reference. Item 12. Certain Relationships and Related Transactions. On March 29, 2000, the Company announced that it intends to enter into two concurrent related-party transactions. In the first transaction, the Company will acquire UBSN Ltd. by acquiring all of the issued and outstanding shares of United Breweries International UK, Ltd. ("UBI UK, Ltd."), which is the parent company of UBSN Ltd. In the transaction, the Company has offered to issue approximately 5,000,000 shares of the Company's common stock in exchange for the shares of UBI UK, Ltd. Upon the closing of the transaction, UBI UK Ltd. will become a wholly-owned subsidiary of the Company. The closing of the transaction is expected to occur in late May 2000, or as soon thereafter as the various conditions to closing have been satisfied or waived. The closing of the transaction, the obligation of the Company to proceed with the acquisition of the shares of UBI UK, Ltd., and the precise number of shares of common stock to be issued are subject to the satisfaction or waiver of certain conditions including: (i) the approval of the proposed acquisition by the Board of Directors of the Company; (ii) the approval of the transaction by the shareholders of the Company; (iii) the approval by the Securities and Exchange Commission of the Company's Proxy Statement with respect to the transaction; and (iv) the receipt by the Company of a "fairness opinion", in a form satisfactory to the Board of Directors of the Company, regarding the transaction from Sage Capital LLC. In a second and concurrent transaction, the Company will obtain the distribution rights to the "Kingfisher" brand of beer in the United States from UBI UK, Ltd. As compensation, the Company will issue additional shares of its common stock based on a valuation established in the fairness opinion obtained from Sage Capital LLC. Under the terms of the distribution agreement, the Company will also have an option to brew "Kingfisher" brand beer in the United States, for distribution primarily in the United States, on mutually agreed terms and conditions. However, in order to commence the brewing and distribution of the "Kingfisher" beer, the Company will have to obtain a license to use the "Kingfisher" trademark from Kingfisher of America Inc ("KAI"). The Company will be solely responsible for obtaining that trademark license, at its sole expense, and there are no assurances that such license will be obtained. The transactions described above are related party transactions because the corporation that owns all of the shares of UBI UK, Ltd. is held by a trust, which is controlled by fiduciaries who may exercise discretion in favor of Dr. Mallya, amongst others. Dr. Vijay Mallya is the Chairman and Chief Executive Officer of the Company. Further, KAI is owned by a foreign corporation, the shares of which are controlled by fiduciaries who may exercise discretion in favor of Dr. Mallya, amongst others. Additional information required by Item 12 will be contained in the 2000 Proxy Statement, and such information is incorporated herein by reference. 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). 10.4 (A) Wholesale Distribution Agreement between the Company and Bay Area Distributing. 10.5 (A) Wholesale Distribution Agreement between the Company and Golden Gate Distributing. 10.7 (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). 10.15 (N) Commercial Lease between Stewart's Ice Cream Company, Inc. and Releta Brewing Company LLC. 19 Exhibit Number Description of Document ------ ----------------------- 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. 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. 10.41 (U) Employment Agreement with Yashpal Singh. 10.42 (U) Employment Agreement with P.A. Murali. 10.43 (V) Master Loan Agreement between the Company and the United Breweries of America Inc. 10.44 (V) Convertible Note in favor of the 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. 20 Exhibit Number Description of Document ------ ----------------------- (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. (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. (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. (T) Incorporated by reference from the Company's Report on Form 10-KSB for the annual period ended December 31, 1998, previously filed with the Commission. (U) Incorporated by reference from the Company's Report on Form 10-QSB for the quarterly period ended June 30, 1999. (V) Incorporated by reference from the Amendment No. 5 to Schedule 13D filed with the Commission on September 15, 1999, by United Breweries of America, Inc. and Vijay Mallya. + Portions of this Exhibit were omitted pursuant to an application for an order declaring confidential treatment filed with the Securities and Exchange Commission. The Registrant filed a report on Form 8-K on March 29, 2000 announcing the Company's acquisition of UBSN and the U.S. distribution rights to Kingfisher Premium Lager Beer from UBI, UK Ltd., responsive to Item 5 of Form 8-K (Other Events). No financial statements were filed. 21 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 30, 2000 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 30, 2000 By: /s/ Yashpal Singh ---------------------------------------- Yashpal Singh, President, Chief Operating Officer and Director Date: March 30, 2000 By: /s/ Jerome G. Merchant ---------------------- Jerome G. Merchant, Director Date: March 30, 2000 By: /s/ P.A. Murali ---------------------------------------- P.A. Murali, Secretary and Chief Financial Officer Date: March 30, 2000 22 - -------------------------------------------------------------------------------- MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY INDEPENDENT AUDITOR'S REPORT AND CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999 AND 1998 - -------------------------------------------------------------------------------- CONTENTS PAGE INDEPENDENT AUDITOR'S REPORT...............................................F - 1 CONSOLIDATED FINANCIAL STATEMENTS Balance sheets........................................................F - 2 Statements of operations..............................................F - 4 Statements of stockholders' equity....................................F - 5 Statements of cash flows..............................................F - 6 Notes to financial statements.........................................F - 7 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, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years ended December 31, 1999. 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, 1999 and 1998, and the results of its operations and its cash flows for each of the two years ended December 31, 1999, in conformity with generally accepted accounting principles. /s/ Moss Adams LLP Santa Rosa, California February 4, 2000 Page F-1 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 1999 and 1998 ================================================================================ ASSETS 1999 1998 ----------- ----------- CURRENT ASSETS Cash $ -- $ 42,000 Accounts receivable 1,040,300 679,900 Inventories 1,168,700 978,000 Prepaid expenses 57,200 33,500 Deferred income taxes 43,100 138,300 ----------- ----------- Total current assets 2,309,300 1,871,700 ----------- ----------- PROPERTY AND EQUIPMENT 14,727,200 15,259,800 ----------- ----------- OTHER ASSETS Deferred income taxes 2,440,300 1,614,200 Deposits and other assets 22,900 34,600 Intangibles, net of amortization 130,200 142,900 ----------- ----------- 2,593,400 1,791,700 ----------- ----------- Total assets $19,629,900 $18,923,200 =========== =========== The accompanying notes are an integral part of these financial statements. ================================================================================ Page F-2 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Continued) December 31, 1999 and 1998 ================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998 ------------ ------------ CURRENT LIABILITIES Disbursements in excess of deposits $ 9,600 $ -- Line of credit 1,159,800 -- Accounts payable 1,708,700 806,700 Accrued wages and related expense 204,600 210,800 Accrued liabilities 130,300 91,000 Current maturities of long-term debt 321,000 322,000 Current maturities of obligations under capital lease 275,700 221,300 Current maturities of notes payable to related party -- 850,600 ------------ ------------ Total current liabilities 3,809,700 2,502,400 LONG-TERM DEBT, less current maturities 3,589,600 3,871,800 LINE OF CREDIT -- 738,000 OBLIGATIONS UNDER CAPITAL LEASE, less current maturities 1,396,900 1,525,800 NOTES PAYABLE TO RELATED PARTY, less current maturities 576,300 143,400 ------------ ------------ Total liabilities 9,372,500 8,781,400 ------------ ------------ 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, 5,530,177 and 4,497,059 shares issued and outstanding at December 31, 1999 and 1998, respectively 13,834,900 12,413,000 Accumulated deficit (3,805,100) (2,498,800) ------------ ------------ Total stockholders' equity 10,257,400 10,141,800 ------------ ------------ Total liabilities and stockholders' equity $ 19,629,900 $ 18,923,200 ============ ============
The accompanying notes are an integral part of these financial statements. ================================================================================ Page F-3 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, 1999 and 1998 ================================================================================ 1999 1998 ----------- ----------- SALES $ 9,240,000 $ 6,918,800 LESS EXCISE TAXES 541,400 389,100 ----------- ----------- NET SALES 8,698,600 6,529,700 COST OF GOODS SOLD 5,767,900 4,908,000 ----------- ----------- GROSS PROFIT 2,930,700 1,621,700 ----------- ----------- OPERATING EXPENSES Retail operating 417,500 481,900 Marketing 1,691,100 1,311,700 General and administrative 1,652,200 1,901,400 ----------- ----------- 3,760,800 3,695,000 ----------- ----------- LOSS FROM OPERATIONS (830,100) (2,073,300) ----------- ----------- OTHER INCOME (EXPENSE) Induced conversion (263,900) -- Interest income 500 1,900 Other income (expense) (95,500) 2,900 Gain on sale of equipment -- 3,700 Interest expense (846,800) (636,300) ----------- ----------- (1,205,700) (627,800) ----------- ----------- LOSS BEFORE INCOME TAXES (2,035,800) (2,701,100) BENEFIT FROM INCOME TAXES (729,500) (1,138,800) ----------- ----------- NET LOSS $(1,306,300) $(1,562,300) =========== =========== BASIC LOSS PER COMMON SHARE $ (0.27) $ (0.35) =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 4,838,151 4,480,222 =========== =========== The accompanying notes are an integral part of these financial statements. ================================================================================ Page F-4 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1999 and 1998 ================================================================================
Series A Preferred Stock Common Stock -------------------- ------------------------- Accumulated Total Shares Amount Shares Amount (Deficit) Equity ------ ------ ------ ------ --------- ------ 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) ------- -------- --------- ----------- ----------- ----------- Balance, December 31, 1998 227,600 227,600 4,497,059 12,413,000 (2,498,800) 10,141,800 Related party debt converted to common stock at $1.125 per -- -- 938,171 1,319,300 -- 1,319,300 Stock issued for services -- -- 94,947 102,600 -- 102,600 Net loss -- -- -- -- (1,306,300) (1,306,300) ------- -------- --------- ----------- ----------- ----------- 227,600 $227,600 5,530,177 $13,834,900 $(3,805,100) $10,257,400 ======= ======== ========= =========== =========== ===========
The accompanying notes are an integral part of these financial statements. ================================================================================ Page F-5 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 1999 and 1998 ================================================================================ 1999 1998 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net loss $(1,306,300) $(1,562,300) Adjustments to reconcile net loss to net cash used by operating activities: Depreciation and amortization 794,600 779,400 Induced conversion expense 263,900 -- Gain on sale of assets -- (3,700) Deferred income taxes (730,900) (1,139,600) Stock issued for services 102,600 -- Accrued interest converted to stock 61,200 -- Changes in: Accounts receivable (360,400) (350,200) Inventories (190,700) (433,900) Prepaid expenses (23,700) 9,100 Deposits and other assets 11,700 (33,100) Refundable income taxes -- 106,300 Accounts payable 902,000 78,400 Accrued wages and related expense 39,300 41,100 Accrued liabilities (6,200) (157,800) ----------- ----------- Net cash used by operating activities (442,900) (2,666,300) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, equipment and leasehold improvements (99,800) (185,900) Increase in intangibles -- (63,100) Proceeds from sale of fixed assets -- 24,000 ----------- ----------- Net cash used by investing activities (99,800) (225,000) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Net borrowings on line of credit 421,800 138,000 Borrowings on long-term debt -- 1,433,600 Principal payments on long-term debt (283,200) (153,400) Payments on obligations under capital lease (223,800) (185,200) Disbursements in excess of deposits 9,600 -- Proceeds from notes payable to related party 576,300 994,000 ----------- ----------- Net cash provided by financing activities 500,700 2,227,000 ----------- ----------- DECREASE IN CASH (42,000) (664,300) CASH, beginning of year 42,000 706,300 ----------- ----------- CASH, end of year $ -- $ 42,000 =========== =========== The accompanying notes are an integral part of these financial statements. ================================================================================ Page F-6 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 brewpub and gift store. The breweries are in two locations, one in Ukiah, California and the other in Saratoga Springs, New York. The brewpub 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. 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 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, placement fees associated with debt and purchased intangibles. Amounts are amortized using the straight-line method over the lives of the debt and estimate useful lives of the intangibles. 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. ================================================================================ Page F-7 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Income taxes - The provision for income taxes is based on pre-tax earnings reported in the financial statements, adjusted for requirements of current tax law, plus the change in deferred taxes. Deferred tax assets and liabilities are recognized using enacted tax rates and reflect the expected future tax consequences of temporary differences between the recorded amounts of assets and liabilities for financial reporting purposes and tax basis of such assets and liabilities and future benefits from net operating loss carryforwards and other expenses previously recorded for financial reporting purposes. 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 384,189 shares of common stock at $1.50 per share, and 101,388 stock options, at a weighted average price per share of $2.07, 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. Advertising - Advertising costs are expensed as incurred. Advertising expenses for the years ended December 31, 1999 and 1998, were $243,200 and $214,700, respectively. Fair value of financial instruments - The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: 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. ================================================================================ Page F-8 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ NOTE 2 - INVENTORIES 1999 1998 ---------- ---------- Raw materials $ 363,600 $ 276,800 Work-in-process 210,100 210,500 Finished goods 562,500 438,900 Merchandise 32,500 51,800 ---------- ---------- $1,168,700 $ 978,000 ========== ========== NOTE 3 - PROPERTY AND EQUIPMENT 1999 1998 ----------- ----------- Buildings $ 7,738,700 $ 7,696,500 Machinery and equipment 5,381,100 5,263,700 Equipment under capital lease 2,265,700 2,117,400 Land 810,900 813,000 Leasehold improvements 792,200 792,200 Equipment in progress 66,900 123,500 Vehicles 69,300 69,300 Furniture and fixtures 37,900 37,900 ----------- ----------- 17,162,700 16,913,500 Less accumulated depreciation and amortization 2,435,500 1,653,700 ----------- ----------- $14,727,200 $15,259,800 =========== =========== 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, accounts receivable, inventory, certain securities pledged by a stockholder, and a second position on the real property of Mendocino Brewing Company. ================================================================================ Page F-9 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) - -------------------------------------------------------------------------------- NOTE 5 - LONG-TERM DEBT 1999 1998 ---------- ---------- Note payable to bank, in monthly installments of $24,400, including interest at the Treasury Constant Maturity Index, currently 5.83% plus 4.17%; maturing December 2012, with a balloon payment, secured by substantially all the assets of Mendocino Brewing Company $2,655,800 $2,679,900 Note payable to financial institution, in monthly installments of $24,700, plus interest at the prime rate plus 2.25%, currently 10.75%; maturing March 2004; secured by substantially all the assets of the Releta Brewing Company, certain securities pledged by a stockholder, accounts receivable, inventory and a second position on the other assets of Mendocino Brewing Company 1,236,600 1,484,000 Note payable, in monthly installments of $1,200, including interest at 5.65%; maturing March 2001; secured by vehicle 18,200 29,900 ---------- ---------- 3,910,600 4,193,800 Less current maturities 321,000 322,000 ---------- ---------- $3,589,600 $3,871,800 ========== ========== Maturities of long-term debt for succeeding years are as follows: Year Ending December 31, ------------------------ 2000 $ 321,000 2001 373,900 2002 377,100 2003 384,400 2004 145,000 2,309,200 ---------- Thereafter $3,910,600 ========== ================================================================================ Page F-10 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. Future minimum lease payments under these capital lease agreements are as follows: Year Ending December 31, ------------------------ 2000 $ 430,800 2001 422,000 2002 402,400 2003 824,900 Thereafter 15,600 ---------- 2,095,700 Less amounts representing interest 423,100 ---------- Present value of minimum lease payments 1,672,600 Less current maturities 275,700 ---------- $1,396,900 ========== NOTE 7 - NOTES PAYABLE TO RELATED PARTY 1999 1998 -------- -------- 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, upon maturity are convertible into common stock at $1.50 per share or may be repaid in 60 month ly installments, notes mature through June 2001, including $11,200 of accrued interest $576,300 $994,000 Less current maturities -- 850,600 -------- -------- $576,300 $143,400 ======== ======== 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, 1999 and 1998. ================================================================================ Page F-11 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ 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 that expire through August 2004. Total rent expense was $192,100 and $201,300 for the years ended December 31, 1999 and 1998, respectively. Future minimum lease payments are as follows: Year Ending December 31, ------------------------ 2000 $144,800 2001 134,100 2002 112,700 2003 29,300 2004 19,600 -------- $440,500 ======== 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, Inc. 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 MicroStar at purchase prices ranging from $54 to $84 per keg. Rental expense associated with this agreement was $101,800 and $124,800 for the years ended December 31, 1999 and 1998, respectively. The Company reimburses certain expenses to United Breweries of America Inc. (UBA), a related party, owning approximately 55% of the common stock, for consulting, salaries, corporate financing and marketing activities. Total expenses for UBA in 1999 and 1998 were $39,300 and $77,800. Interest expense associated with the UBA notes was $72,600 and $64,900 for the year ended December 31, 1999 and 1998, respectively. The Company currently has accrued expenses to related parties of $42,200 and $44,600 as December 31, 1999 and 1998, respectively. The Company pays a member of the Board of Directors $2,700 per month for consulting services. During the year the Company paid $32,400 for these consulting services. ================================================================================ Page F-12 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ NOTE 10 - CONTINGENCIES Because of the unprecedented nature of the Year 2000 Issue, its effects, if any, may not be identified until a future date. Management cannot assure that the Company has identified all Year 2000 Issues, that the Company's remediation efforts has been successful in whole or in part, or that parties with whom the Company does business will not be significantly impacted by Year 2000 Issues. NOTE 11 - MAJOR CUSTOMERS Sales to the top five customers totaled $4,191,700 and $3,029,000 for the years ended December 31, 1999 and 1998, respectively representing 45% and 44% of sales. NOTE 12 - STOCKHOLDERS' EQUITY Common Stock In August 1999, the Company offered UBA an incentive to convert their outstanding debt of $994,000 plus accrued interest of $61,400 to shares of common stock. Per the agreement, the notes were convertible at $1.50 per share at UBA's sole request. On the date of the conversion, the market price was significantly lower than the conversion price of $1.50 per share. In order to induce UBA to convert their entire debt, which has not matured, to common stock, the Company offered to convert the debt at the market price of the stock. As part of this transaction the Company recorded as an expense, $263,900 for the inducement of the conversion price at less than the $1.50 conversion price. Also in August 1999, the Company voted to compensate the independent outside members of the Board of Directors. The Company issued 94,947 shares to these board members as compensation and recognized $102,600 of compensation expense for the issuance of the common stock. Preferred Stock The Company has authorized 2,000,000 shares of preferred stock, of which 227,600 have been designated as Series A. At the time of the incorporation of the partnership, the Company issued 227,600 shares of non-voting, no-par value Series A Preferred Stock in exchange for partnership assets. The partnership distributed the Series A Preferred Stock to its partners on January 3, 1994. Series A shareholders are entitled to receive cash dividends and/or liquidation proceeds equal in the aggregate to $1.00 per share before any cash dividends are paid on the Common Shares or any other series of Preferred Shares. When the entire Series A dividend/liquidation proceeds have been paid, the Series A Shares shall automatically be canceled and cease to be outstanding. ================================================================================ Page F-13 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ 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. 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 1999, the Company issued 88,888 non-statutory stock options with a five-year term to the independent members of the Board of Directors at the market price on the date of the grant. 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 1999. Had compensation cost for the Company's options been determined based on the fair value at the grant date for awards in 1999 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: 1999 1998 ----------- ----------- Net loss - as reported $(1,306,300) $(1,572,400) Net loss - pro forma $(1,363,800) $(1,572,400) Loss per share - as reported $ (0.27) $ (0.35) Loss per share - pro forma $ (0.28) $ (0.35) 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 1999. There were no options granted in 1998. 1999 ------ Dividends None Expected volatility 120% Risk free interest rate 6.51% Expected life 5 years Options issued during 1999 have an estimated weighted average fair value of $1.08. ================================================================================ Page F-14 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ NOTE 13 - STOCK OPTION PLAN (Continued) The following table summarizes common stock option activity: Shares Under Weighted-Average Option Exercise Price ------ -------------- Balance, December 31, 1997 12,500 $ 8.80 Granted -- -- Exercised -- Canceled -- -- ------- Balance, December 31, 1998 12,500 8.80 Granted 88,888 1.13 Exercised -- Canceled -- -- ------- Balance, December 31, 1999 101,388 $ 2.07 ======= NOTE 14 - INCOME TAXES 1999 1998 Current Federal $ -- $ -- State 1,400 800 ----------- ----------- 1,400 800 ----------- ----------- Deferred Current 95,200 (98,800) Non-current (826,100) (1,040,800) ----------- ----------- (730,900) (1,139,600) ----------- ----------- $ (729,500) $(1,138,800) =========== =========== 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: 1999 1998 Income tax benefit at 34% $ (692,200) $ (925,200) State taxes 1,400 800 State tax benefit of net operating loss carry forward (96,900) (111,300) Recognition of future tax (deductions) 58,200 (103,100) ----------- ----------- $ (729,500) $(1,138,800) =========== =========== ================================================================================ Page F-15 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ NOTE 14 - INCOME TAXES (Continued) Temporary differences and carryforwards which give rise to deferred tax assets and liabilities are as follows: 1999 1998 ----------- ----------- Inventories $ 6,900 $ 6,600 Accruals 39,700 141,800 Other (3,500) (10,100) ----------- ----------- Current deferred tax asset $ 43,100 $ 138,300 =========== =========== Depreciation and amortization $ (78,600) $ (35,300) Investment tax credit carryforward 28,000 43,500 Benefit of net operating loss carryforward 2,590,800 1,700,800 Other (99,900) (94,800) ----------- ----------- Non-current deferred tax asset $ 2,440,300 $ 1,614,200 =========== =========== As of December 31, 1999, the Company has available for carryforward approximately $6,747,000, $2,551,000 and $794,000 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 2020. The California net operating losses expire beginning 2002 through 2004. The Company also has $28,000 of California Manufactures Investment Tax Credits that can be carried forward to reduce future taxes and expire in 2005. The benefit from these loss carryforwards and credits has been recorded, resulting in a deferred tax asset. A valuation allowance is not provided since the Company believes it is more likely than not that the loss carryforwards will be fully utilized. ================================================================================ Page F-16 MENDOCINO BREWING COMPANY, INC., AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) ================================================================================ NOTE 15 - 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 93% of the Company's total gross sales during 1999. 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 7% of the Company's total gross sales during 1999. A summary of each segment is as follows:
Year Ending December 31, 1999 ------------------------------------------------------------ Brewing Hopland Corporate Operations Brewery and other Total ---------- ------- --------- ----- Sales $ 8,657,000 $583,000 $ -- $ 9,240,000 Operating profit (loss) 855,700 (33,600) -- 822,100 Identifiable assets 15,816,900 79,000 3,734,000 19,629,900 Depreciation and amortization 710,100 6,500 78,000 794,600 Capital expenditures 244,000 800 4,100 248,900 Year Ending December 31, 1998 Year Ending December 31, 1998 ------------------------------------------------------------ Brewing Hopland Corporate Operations Brewery and other Total ---------- ------- --------- ----- 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
NOTE 16 - STATEMENT OF CASH FLOWS Supplemental cash flow information includes the following: 1999 1998 ---------- ---------- Cash paid during the year for: Interest $ 771,600 $ 623,400 Income taxes $ 1,400 $ 2,300 Non-cash investing and financing activities: Seller financed equipment $ 149,200 $ 224,300 Issuance of stock for intangibles $ -- $ 45,800 Transfer of liabilities to long-term debt $ -- $ 80,200 Induced conversion $1,319,300 $ -- Stock issued for services $ 102,600 $ -- ================================================================================ Page F-17 EX-27 2 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 0 0 1,040,300 0 1,168,700 2,309,300 17,162,700 (2,435,500) 19,629,900 3,809,700 0 0 227,600 13,834,900 (3,805,100) 19,629,900 8,698,600 8,698,600 5,767,900 9,528,700 359,400 0 846,800 (2,035,800) 729,500 (1,306,300) 0 0 0 (1,306,300) (0.27) (0.27)
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