-----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, UiS2+x+v8T2KLtmJk72SjKLvR/zmWFeXC7aM4a2uouw0TBzH4PFF99ILwYCUYpvw OaTayoPy7g8XsHa935wfhw== 0000950005-97-000413.txt : 19970416 0000950005-97-000413.hdr.sgml : 19970416 ACCESSION NUMBER: 0000950005-97-000413 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970415 SROS: PSE 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: 1934 Act SEC FILE NUMBER: 001-13636 FILM NUMBER: 97580779 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 FORM 10KSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB (Mark One) [x] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________________ to________________________ Commission file number: 1-13636 Mendocino Brewing Company, Inc. (Name of small business issuer in its charter) California 68-0318293 (State or other jurisdiction of (I.R.S. Employee Identification No.) incorporation or organization) 13351 South Highway 101, Hopland, CA 95449 (Address of principal executive offices) (Zip code) Issuer's telephone number: (707) 744-1015 Securities registered under Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, without par value The Pacific Stock Exchange Securities registered under Section 12(g) of the Act: Not applicable (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No - - Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B not contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] State issuer's revenues for its most recent fiscal year: $4,004,700 The aggregate market value of the voting stock held by non-affiliates computed by reference to the last reported sale price of such stock as of April 2, 1997 was $10,416,000. The number of shares the issuer's common stock outstanding as of March 31, 1997 is 2,322,222. (Does not include 300,000 shares issued subject to substantial restrictions as security for a forbearance. Also does not include approximately 16,000 shares, subscriptions for which the Company had received but not accepted as of March 31, 1997.) Transitional Small Business Disclosure Format Yes No X - - PART I Item 1. Business. Overview Mendocino Brewing Company, Inc. brews Red Tail Ale, Blue Heron Pale Ale, Black Hawk Stout, and three other ales, one stout, and one porter for the domestic craft beer market. A "craft beer" is a full-flavored beer brewed in the traditional style. Mendocino Brewing is one of the first of the modern craft brewers, having opened the first new brewpub in California and the second in the United States since the repeal of Prohibition, and has been recognized for its innovations in the brewpub concept, its craft brew style, its distinctive labels, and its role in industry associations. Mendocino Brewing's objective is to transform itself from the country's leading microbrewery (based on annual sales from 1990 through 1995 among brewers with annual capacity of less than 15,000 bbl.) to a major national craft brewer offering among the highest quality craft beers available anywhere in America. Mendocino Brewing is building a new brewery in Ukiah, California (110 miles north of San Francisco). Management presently expects to begin producing test brews at the new facility in April 1997. The new brewery will have an initial annual capacity of approximately 60,000 bbl., which is more than four times the Company's annual capacity from 1993 through the first nine months of 1995 of 13,600 bbl. Ultimately, the facility can expand to 200,000 bbl. per year. Company Background Mendocino Brewing Company was originally formed in March 1983 as a California limited partnership (the "Partnership"). On January 1, 1994, the business was incorporated by transferring all of the Partnership's assets, including its name, to a newly formed California corporation in exchange for all of the Common and Preferred Stock of the corporation. The Partnership distributed these shares to its partners on January 3, 1994. As used hereafter, references to the "Company" and "Mendocino Brewing" include the business operations of the Partnership before its incorporation. Mendocino Brewing first bottled its flagship brand, Red Tail Ale, in December 1983. In February 1995, Mendocino Brewing completed a $3.6 million direct public offering at $6 per share. The Company purchased nine acres of land in Ukiah, California in 1995 and broke ground on the new brewery in September 1995. Seeking to maximize the capacity of the Hopland facility in the interim, the Company added an additional bottling tank in the Fall of 1995, which permitted the Company to begin 24 hour brewing operations. This increased the annual capacity of the Hopland facility to 18,000 bbl., technically taking the Company out of the microbrewery category. The Company's products are sold in over 1,500 retail outlets in Northern California and in selected locations throughout the United States. See "Product Distribution." Mendocino Brewing is recognized for its contributions to the craft brewing industry and enjoys a national and international reputation. The Company's distinctive and award winning Red Tail Ale label is frequently featured in calendars, posters, and literature concerning the craft beer industry. Although introduced only this summer, the equally distinctive Blue Heron Pale Ale label has also won awards and is featured in the 1997 Brew Art(TM) calendar published by Ronnie Sellers Productions of Kennebunk, Maine. The Company enjoys good visibility within the industry, due in part to the leadership its officers have provided within various industry trade groups. See "Management." -1- Industry Overview Domestic Beer Market. According to Modern Brewery Age's 1996 Statistical Report, overall domestic beer sales in 1996 was 178 million bbl. (up 0.6% from 1995). A barrel equals approximately 13.78 cases or 331 twelve ounce bottles; 178 million bbl. is therefore the approximate equivalent of 59.0 billion 12 oz. bottles of beer. The U.S. beer market may be divided into five segments:
1995 Est. Representative Suggested Segment Market Share Top Brands Retail Price/6-pack - -------------------------------------------------------------------------------------------------------------------- Low-Priced 60.0% Busch, Milwaukee's Best, Old Milwaukee $2.80 Premium 31.4% Budweiser, Miller Lite, Bud Light, Coors Light $4.05 Super-Premium 1.2% Michelob, Lowenbrau $4.67 Import 5.5% Heineken, Guinness, Bass $7.90 Domestic Craft 1.9% Samuel Adams, Pete's, Sierra Nevada, Red Tail Ale $5.99 to $6.99
Domestic Craft Beer Segment. While overall beer sales have been basically flat for several years, domestic craft beer sales have increased at a rate of approximately 40% per year for several years, slowing a bit in 1996. Many industry analysts predict that craft beer sales will continue to increase until they achieve a market share of 5%-6% by the year 2000. Craft beers are characterized by their full-flavor and are usually produced along traditional European brewing styles. The majority of craft beers are ales, although some are malt lagers. Wheat beers and fruit flavored ales and lagers have enjoyed recent popularity among craft beer consumers. Competition The craft beer category consists of: o Contract brews -- any style brew produced by one brewer for sale under the label of someone else who does not have a brewery or whose brewery does not have sufficient capacity. o Regional craft brews -- "hand-crafted" brews, primarily ales, sold under the label of the brewery that produced it. o Microbrews -- "hand-crafted" brews, primarily ales, sold under the label of the brewery that produced it, if the capacity of the brewery does not exceed 15,000 bbl. per year. o Large brewer craft-style brews -- a brand brewed by a national brewer which may only imitate the style of a craft beer. These craft-style brews are often sold under the label of a brewery that does not exist or the label of a brewpub with no bottling capacity. The term "phantom brewery" is sometimes used to describe such brands. o Brewpub brews -- "hand-crafted" brews produced for sale and consumption at the brewery, which is normally connected with a restaurant/saloon. Brewpub brews are not normally sold for off-site consumption in significant quantities. Mendocino Brewing competes against all of the above brewers primarily on the basis of product quality and image. Of the approximately 3.7 million bbl. of craft beer produced in America in 1995 (detailed 1996 statistical information is not currently available), contract brews (led by Samuel Adams Boston Lager, Pete's Wicked Ale, and their respective related brands) accounted for approximately 1.5 million bbl., or 41% of the total; regional craft brands (led by Sierra Nevada, Redhook, Pyramid (Hart Brewing, Inc.), Anchor, and Full Sail) represented approximately 1.25 million bbl., or 34% of the total; and microbrews (led by Red Tail Ale) represented approximately 910,000 bbl., or 25% of the total. Because Mendocino Brewing's annual production exceeded 15,000 bbl. by less than 150 bbl. in 1995, some industry publications have classified the Company as a regional craft brewer for that year. -2- - ---------------------------------------------------------------------------------------------------------------- 1995 & 1996 Domestic Craft Beer Market
1995 1996 Largest Craft Brewers in Mendocino Total Sales Annual Total Sales Annual Brewing's Primary & Target Markets (x 1,000 bbl.) Growth (x 1,000 bbl.) Growth - --------------------------------------------------- -------------- -------- --------------- ---------- 1 Boston Beer Co. (Boston, MA) 960 37% 1210 26% 2 Pete's Brewing Co. (Palo Alto, CA) 348 91 426 22 3 Sierra Nevada Brewing Co. (Chico, CA) 201 31 267 33 4 Redhook Ale Brewery (Seattle, WA) 158 69 225 42 5 Hart Brewing Co. (Kalma, WA) 123 71 128 4 6 Widmer Brewing Co. (Portland, OR) 70 40 122 75 7 Anchor Brewing Co. (S.F., CA) 105 1 108 3 8 Full Sail Brewing Co. (Hood River, OR) 70 36 79 12 9 Portland Brewing Co. (Portland, OR) 63 82 67 6 10 Bridgeport Brewing Co. (Portland, OR) 19 6 20 6 11 Mendocino Brewing Co. (Hopland, CA) 14 8 17 13 Remaining Domestic Craft Brewers (approx. 1200) 1,663 44 N/A N/A ----- Total Domestic Specialty Segment Production 3,780 44% N/A N/A - -----------------------------------------------------------------------------------------------------------------
Source: Modern Brewery Age Products Mendocino Brewing brews three ales and a stout year-round, three seasonal ales, and a seasonal porter: o RED TAIL ALE, a full flavored amber ale, is the flagship brand of Mendocino Brewing. o BLUE HERON PALE ALE is a golden ale with a full body and a distinctive hop character. o BLACK HAWK STOUT is the fullest in flavor and body of the Company's brews. o EYE OF THE HAWK SELECT ALE is a high gravity deep amber summer ale. o YULETIDE PORTER is a deep brown Holiday brew with a traditionally rich, creamy flavor. o PEREGRINE PALE ALE is brewed year-round with a more delicate flavor and character. o SPRINGTIDE ALE is brewed around St. Patrick's Day and appears as a fresh, flowery, spicy golden ale. o FROLIC SHIPWRECK ALE 1850, a Scottish-style ale brewed around July, was introduced in 1994 as a fund-raiser for the Mendocino County Museum to commemorate the wreck of the clipper ship Frolic, with its cargo of Scottish ale, on the Mendocino coast in 1850. Salvage efforts were abandoned when workers, upon sighting the previously unreported big trees of Mendocino County, launched the timber industry which has characterized the area ever since. Mendocino Brewing uses an ale yeast strain that was first introduced at New Albion Brewing Co. in the late 1970s. Management knows of no other brewery that ferments its beer with this particular strain of yeast. The Company maintains the yeast strain under laboratory conditions at two separate locations. Mendocino Brewing is among a minority of brewers who use whole hop flowers instead of processed hop pellets in their brewing processes. This technique contributes to the distinctive characteristics of the brews. The Company adds active fermenting beer (Krausen) after the beer is bottled, which produces a pleasant amount of natural carbonation. The thin layer of brewer's yeast in the bottom of the bottle is a natural characteristic of bottle conditioned ale. Mendocino Brewing's distinctive brews have been very well received in the market and within the industry. Eye of the Hawk Select Ale won a gold medal at the 1991 Great American Beer Festival after winning a silver in 1990, and also won a bronze in 1992. Blue Heron Pale Ale was awarded a Gold Medal with a Special Award of Excellence from the Underground Wine Journal in February 1997 in a competition among 183 ales from across the United States and won a bronze medal at the 1991 Great American Beer Festival. The Hopland Brewery Brewpub and Merchandise Store To date, Mendocino Brewing's major marketing tool has been the Hopland Brewery brewpub and merchandise store. Located on a major tourist route in Hopland, California, 100 miles north of San Francisco, the -3- Hopland Brewery, which opened in 1983, was the first brewpub to open in California and the second in the United States since the repeal of Prohibition. The brewpub is housed in a 100 year-old brick building that was once known as the Hop Vine Saloon. The inside walls are trimmed with the original turn-of-the-century ornamental stamped tin. Works of local artists are featured on a rotating basis. The bar is hand-crafted, early California style blond oak and brass that complements the tradition of the tavern and the Company's brews. The pub includes a dart room and a stage. Patrons can view the brewing process through windows in the adjoining brewhouse. An outdoor Beer Garden includes a shaded grape arbor, flowers, trellised hops in the summer, picnic tables, and a sandbox for the kids. Beverages served include Red Tail Ale, Blue Heron Pale Ale, Black Hawk Stout, Peregrine Pale Ale, and a seasonal brew on tap, along with local wines, Hopland Seltzer Water, local apple juice, and soft drinks. The brewpub also features hand pumped cask conditioned ales. The menu features home-style cooking, spicy beer sausages, legendary hamburgers, Red Tail chili, fresh salads, snacks, vegetarian entrees, and daily specials at moderate prices. The brewpub operates days and evenings, with live music on Saturdays and for special events, such as the Company's annual Anniversary Party in August and its Oktoberfest in October. The adjacent Merchandise Store sells off-sale packages of the Company's brews (including gift packs) and merchandise such as hand-screened label T-shirts, posters, engraved glasses and mugs, logo caps, books about brewing, gift packs, and other brewery-related gifts. Management had planned to continue bottling operations at the Hopland facility until the Company could no longer keep up with demand, and then transfer bottling operations to the Ukiah facility. Until that time, production at the Ukiah facility was to consist solely of draft beer. Based on preliminary sales data for January and March, 1997, it appears that bottling operations will need to move to Ukiah as quickly as practical. The Company will continue to operate the Hopland facility to provide special occasion draft beers for the brewpub; to research, develop, and test-market new craft brews; and as a brewing education and training site. Strategy Mendocino Brewing's objective is to transform itself from the country's leading microbrewery (based on annual sales from 1990 through 1995) to a nationally known and respected craft brewer that offers among the highest quality craft beers available anywhere in America. Management perceives that the continued growth in the domestic craft beer segment (see "-Industry Overview") has given rise to a qualitative shift in the public's awareness of craft beers, and that this shift now gives the Company an opportunity to enter new markets at a time when many consumers are discovering craft brews for the first time. Management believes that an important step is to position Mendocino Brewing's products as offering superior quality with very high perceived value and distinctive brand images, even when compared with other craft brews. Management plans to accomplish this objective by making the Company's most popular brews available in 12 oz. six packs and draft, increasing the Company's brand development efforts, and entering new geographic markets. In completing the plans for the new brewery, Management also concluded that it could position itself better in the market and realize certain cost efficiencies and overall cost reductions by designing a plant with an initial capacity of 60,000 bbl. per year (20% greater than originally planned) and an ultimate capacity of 200,000 bbl. per year (54% greater than originally planned). New Product Offerings Until recently, Mendocino Brewing's capacity limitations and marketing considerations dictated that the bulk of the Company's production be Red Tail Ale in 12 oz. six packs. Draft beer has been limited to production for sale at the Hopland Brewery, and other brews, such as Blue Heron Pale Ale, Black Hawk Stout, Eye of the Hawk Select Ale, Yuletide Porter, and Frolic Shipwreck Ale 1850, have been available only in limited quantities of 750 ml or 22 oz. bottles. A key element of the Company's strategy is to make more of its products available in 12 oz. six-packs and draft. The new products are: o Blue Heron Pale Ale 12 oz. Six-Packs. Blue Heron Pale Ale is now available at selected retail outlets in 12 oz. six packs. The bottles and carrier pack feature a colorful new label depicting a Great Blue Heron preparing for flight against a soft, misty background of the Russian River (which flows through Hopland) and surrounding hills. The design has already won the prestigious 1996 Northern California Addy award and the silver medal in the 1996 International Brand Packaging Award competition sponsored by Graphic -4- Design: USA magazine. The label is also featured in the 1997 Brew Art(TM) calendar published by Ronnie Sellers Productions of Kennebunk, Maine. o Black Hawk Stout 12 oz. Six-Packs. Management plans to introduce Black Hawk Stout in 12 oz. six-packs following completion of its new label development, which Management expects to occur in 1997. This forward looking statement is subject to risks and uncertainties. Among other things, tasks such as completing the new brewery may divert Management's attention from matters such as label development. The speed with which new Black Hawk Stout labels are developed will also depend, in part, on the amount of proceeds raised in the Company's current direct public offering. The Black Hawk Stout label presently consists of the basic Mendocino Brewing Company logo with the words BLACK HAWK STOUT and is distributed in 22 oz. bottles in limited quantities. o Draft brews in half barrel kegs. Management presently intends to make draft production of Red Tail Ale, Blue Heron Pale Ale, and Black Hawk Stout in half barrel kegs the first priority of the new brewery. The Company is designing special tap handles and other marketing materials for its draft products. Historically in the beer industry, introducing draft products into restaurants and other establishments has driven bottle sales which in turn has increased demand for draft products in locations not served. These forward looking statements are subject to risks and uncertainty. Among other things, there is no assurance that sale of the Company's brews will help it achieve the critical mass that Management seeks. Brand Development Management believes that consumers of the Company's brews are like the typical craft beer consumer described in the H.C. Wainwright & Co. industry report of October 12, 1995. According to this report, the typical craft beer consumer is interested in "upscale and diversified" products with a "distinctive brand image" and "full flavored taste." Craft beer consumers also tend to be consumers of gourmet coffees, fine wines, all-natural products, and other "affordable luxuries." A survey conducted by ICR of Media, PA found that the following percentages of people had tried a craft beer: o 25% of all U.S. beer drinkers o 23% of women beer drinkers o 26% of male beer drinkers o 51% of people with annual incomes of $75,000+ o Greater than 50% of college educated people o 38% of adults 25-34 years old o 10% of adults 45 years and older o 32% of beer drinkers in the Northeast o 28% of beer drinkers in the West o 26% of beer drinkers in the Midwest o 17% of beer drinkers in the South One of the ways Mendocino Brewing projects its quality and corporate values to consumers is through its Red Tail Ale, Blue Heron Pale Ale, and Eye of the Hawk Select Ale labels. The Company has used nationally-known wildlife artists including Randy Johnson and Lee Jayred for its label designs. In 1990, Mendocino Brewing received the Paperboard Packaging Council's Silver Award for Excellence in Packaging and Award for Excellence in Graphic Design and a Northern California Addy Award for its Red Tail Ale packaging. In 1996, the Company received a Northern California Addy Award and a silver medal in the International Band Packaging Award competition sponsored by Graphic Design: USA magazine for its Blue Heron Pale Ale packaging. It is Management's experience that distributors and retailers realize the importance of superior packaging graphics and appreciate the Company's offerings for that reason. Management believes that the Red Tail Ale label successfully communicates the value of Mendocino Brewing's products with the label's respectful depiction of a red tail hawk flaring its wings as it prepares to land with clusters of hops and barley in its talons. The illustrations Mendocino Brewing uses with its Blue Heron Pale Ale and Eye of the Hawk Select Ale labels are intended to evoke similar responses, as will be the illustration for Black Hawk Stout when introduced. The popularity of Mendocino Brewing's logos and trademarks is evidenced by the sale of merchandise bearing these marks at the Hopland Brewery merchandise store and through the merchandise catalogue the Company -5- introduced in 1994. As part of its marketing efforts, therefore, the Company intends to implement a brand marketing development program that will emphasize: o Point-of-sale promotional materials including brochures, signage, table tents, coasters, tap handles, and glassware. o Clothing (caps, T-shirts, polo shirts, sweatshirts, etc.). o Signage for distributor trucks to create "moving billboards." Mendocino Brewing's emphasis on separate, distinctive illustrations for its various brands enables it to produce a variety of images to create consumer interest. o World Wide Web Page. Mendocino Brewing's web page is located at http://mendobrew.com and features information about the Company and the Hopland Brewery brewpub and merchandise store, the Company's brewing process, the Company's brands, the Hopland area, Company merchandise, and shareholder information. The web page address is featured prominently on Company marketing materials and can be accessed through the Real Beer web site. o Continued use of the Brewsletter beyond its current mailing list of 12,000. The Brewsletter is a newsletter Mendocino Brewing publishes and distributes to educate subscribers about the brewing industry and the Company's products and to promote the Company's image and corporate values. o Strong visual presence at beer shows and tasting competitions, including the Great America Beer Festival in Denver, the Portland Brewers Festival, and the KQED Beer Festival in San Francisco. Regional Expansion The Company's products are distributed widely in California and in limited quantities at selected accounts in the metropolitan areas of Washington D.C., Boston, Seattle, Phoenix, Chicago, Milwaukee, New York, and Atlanta, and throughout North Carolina, Texas, Oregon, Nevada, and Colorado. The Company plans to add distributors in New Jersey, Maryland, Virginia, and the metropolitan areas of Minneapolis/St. Paul and Philadelphia in the near future. Northern California is the Company's most important market, and Management anticipates that it will remain so for the foreseeable future. The Company's three largest distributors, Golden Gate Distributing (Sonoma and Marin Counties), Bay Area Distributing (the East San Francisco Bay Area), and A&D Distributing (South San Francisco area) accounted for 18%, 14%, and 10%, respectively, of the Company's wholesale distribution in 1996. The percentage of the Company's sales for which these distributors have accounted has decreased, and will continue to decrease, as the Company adds new distributors and supplies them with more product. These forward-looking statements are subject to risks and uncertainties. There is no assurance that the Company will be able to add additional distributors or that its products will be well-received in targeted markets. Management believes that regional identification assists the Company in Northern California and may assist the Company's local competitors in other regional markets. Pricing Strategy Mendocino Brewing's products are priced at or near the top of the market and have been for several years. Recently, the Company decided to pass on to consumers some of the economies resulting from increased capacity and reduced the suggested retail price for a six-pack of Red Tail Ale from $7.43 to $6.99. The suggested retail price for a six-pack of Blue Heron Pale Ale is also $6.99. The Company has noticed that the price range of 12 oz. six-packs of the major craft brew brands has narrowed in the last two years and appears to be converging on $6.50 per six pack, with no major craft brew brand at less than $6.45 per six pack. There is no assurance that craft beer prices will continue at these levels. Nevertheless, Management believes that the Company's products will continue to command prices that will be on at least a par with other major regional craft brewers. These forward looking statements are subject to risks and uncertainties. Retail prices are subject to many factors most of which are beyond the control of the Company. These factors include general economic conditions, competition and consolidation, and ability to anticipate and respond to evolving consumer preferences and attitudes toward adult beverages. Management anticipates that the Company will periodically give temporary price reductions through special promotions in response to market conditions. Frequent price reductions can condition consumers to expect such reductions, which may increase or reduce overall unit sales depending on the circumstances. -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 believes that the Company's customers require products with high intrinsic value; that product quality alone is not sufficient; and that a product must distinguish itself from the competition with the values it communicates. These values include commitment to employees, community involvement, and environmental responsibility. Management attempts to instill these values in Company personnel and operations and to communicate to customers the commitment of the Company to act responsibly. The Company encourages employees and distributors to share ownership and mission with Management as well as a sense of pride in the Company's products. Although part of the Company's strategy is to grow through expanded sales, it promotes its brews as beverages of moderation whose distinctive taste and high quality give the consumer satisfaction. New Brewery Mendocino Brewing is completing a 62,000 sq. ft. custom designed facility on nine acres of land in Ukiah, California, approximately 10 miles north of the original brewery. The facility was approximately 89% complete as of March 31, 1997, and is expected to begin producing test brews in April. The facility is planned to feature new fermenting tanks, kegs, and packaging and other miscellaneous equipment to be installed with the Company's existing bottling line. Certain features of the new brewery have been specially designed for the Company's brewing methods, such as equipment for using whole hops and designated space for bottle conditioning. The facility will initially open with an annual capacity of 60,000 bbl. per year. The Company had originally planned a 50,000 bbl. facility, but was able to take advantage of certain economies by revising its plans to a capacity of 60,000 bbl. per year (20% greater than originally planned). The facility has been designed to allow for expansion in stages up to a maximum capacity of 200,000 bbl. per year (54% greater than originally planned). The Company also elected to construct an extensive water treatment facility as part of its commitment to the environment and to reduce the over-all cost of disposing of its waste water. Product Distribution Mendocino Brewing's beers are sold through distributors to consumers in bottles at supermarkets, warehouse stores, liquor stores, taverns and bars, restaurants, and convenience stores. The Company intends to make Red Tail Ale, Blue Heron Pale Ale, and Black Hawk Stout available in draft form and may sell to additional kinds of outlets, such as sporting events. The Company's products are delivered to retail outlets by independent distributors whose principal business is the distribution of beer and in some cases other alcoholic beverages, and who typically also distribute one or more national beer brands. The Company, together with its distributors, markets its products to retail outlets and relies on its distributors to provide regular deliveries, to maintain retail shelf space, and to oversee timely rotation of inventory. The Company also offers its products directly to consumers at the Hopland Brewery brewpub and merchandise store. Of the Company's total beer sales for 1996, 89% (77% of total sales) constituted sales to independent distributors and 11% (9% of total sales) constituted sales at the Hopland Brewery brewpub and merchandise store. Beer sales (wholesale and retail combined) constituted 86% of the Company's total sales in 1996, with food and merchandise retail and catalogue sales constituting the balance. As the Company's sales increase, Management expects sales to independent distributors to increase materially as a percentage of total sales. Suppliers The Company's major suppliers are Great Western Malting Co., Yakima, Washington (malt); John I. Haas, Co., New York, New York (hops); and California Glass Company, Oakland, California and Vitro Packaging, Inc., Dallas, Texas (bottles). The City of Ukiah will supply power and water to the new brewery. Employees As of December 31, 1996, the Company employed 43 full-time and 39 part-time individuals including 10 in management and administration, 24 in brewing operations, and 48 in retail and brewpub operations. Upon the completion of its expansion, Management expects the Company to have increased four current employees to full-time status and to have hired five additional management and administrative employees, three marketing employees and five employees in operations. Management believes that the Company's relations with its employees is -7- excellent. None of its work force is unionized. The Company has agreed with the City of Ukiah that for two years it will give preference in its hiring to residents of Mendocino County. Patents and Trademarks The Company has federal trademark registrations of the MENDOCINO BREWING COMPANY word mark (Reg. No. 1,785,745), RED TAIL ALE word mark (Reg. No. 2,032,382), RED TAIL DESIGN (Reg. No. 2,011,817), BLUE HERON word mark (Reg. No. 1,820,076), BLUE HERON PALE ALE DESIGN (Reg. No. 2,011,816), PEREGRINE PALE ALE word mark (Reg. No. 1,667,796), EYE OF THE HAWK SELECT ALE word mark (Reg. No. 1,673,594), EYE OF THE HAWK SELECT ALE DESIGN (Reg. No. 2,011,818), EYE OF THE HAWK SPECIAL EDITION ANNIVERSARY ALE AND DESIGN (Reg. No. 2,011,815), BLACK HAWK STOUT word mark (Reg. No. 1,791,807), YULETIDE PORTER word mark (Reg. No. 1,666,891), and BREWSLETTER word mark (Reg. No. 1,768,639). The registration of the word mark BLUE HERON is a concurrent use registration which gives the Company the exclusive right to use the word mark BLUE HERON throughout the United States with the exception of Oregon, Idaho, Washington, and Montana. BridgePort Brewing Company, the other concurrent owner, has the exclusive right to use the word mark BLUE HERON in those states. The BridgePort Pale Ale label used outside of Oregon, Idaho, Washington, and Montana depicts a blue heron wading in a marsh although the words BLUE HERON do not appear. Mendocino Brewing's use of the word mark BLACK HAWK STOUT is, by agreement with Hiram Walker & Sons, Inc., subject to the restriction that it be used only in conjunction with the words "Mendocino Brewing Company". Mendocino Brewing does not consider its recipes, techniques, processes, yeast strain, or equipment to be proprietary or necessary to protect. Government Regulation Mendocino Brewing is licensed to manufacture and sell beer by the California Department of Alcoholic Beverage Control ("ABC"). A "Small Beer Manufacturer's License" allows the Company to brew up to 1,000,000 bbl. per year, to conduct wholesale sales, and to sell beer and wine for consumption both on and off the premises. A federal permit from the Bureau of Alcohol, Tobacco, and Firearms ("BATF") allows the Company to manufacture fermented malt beverages. To keep these licenses and permits in force the Company must pay annual fees and submit timely production reports and excise tax returns. Prompt notice of any changes in the operations, ownership, or company structure must also be made to these regulatory agencies. BATF must also approve all product labels, which must include an alcohol use warning. These agencies require that individuals owning equity securities in aggregate of 10% or more in the Company be investigated as to their suitability. Taxation of alcohol has increased significantly in recent years. Currently, the Federal tax rate is $7.00 per bbl. for up to 60,000 bbl. per year and $18.00 per bbl. for over 60,000 bbl. The California tax rate is $6.20 per bbl. The Hopland Brewery's brewpub is regulated by the Mendocino County Health Department, which requires an annual permit and conducts spot inspections to monitor compliance with applicable health codes. The Company's production operations must also comply with the Occupational Safety and Health Administration's workplace safety and worker health regulations and applicable state laws thereunder. Management believes that the Company presently is in compliance with the aforementioned laws and regulations and has implemented its own voluntary safety program. Environmental Regulation The Company is subject to various federal, state, and local environmental laws which regulate the use, storage, handling, and disposal of various substances. -8- The Company's waste products consist of water, spent grains and hops, and glass and cardboard. The Company has instituted a recycling program for its office paper, newspapers, magazines, glass, and cardboard at minimal cost to the Company. The Company pays approximately $1,000 per month in sewage fees relating to waste water from its Hopland facility. The Company gives its spent grain to local cattle ranchers, who pick up the spent grain at their expense. The Company has not purchased any special equipment and does not incur any identifiable fees in connection with its environmental compliance at its Hopland site. Management anticipates that Mendocino Brewing will continue its recycling program at the new brewery. Because of the increased quantities involved, Management expects the Company to sell the spent grain from the Ukiah location to ranchers and/or dairy farmers rather than give it away. The Company has built its own wastewater treatment plant for the Ukiah facility. As a consequence, the Company will not be required to incur sewer hook-up fees at that location. If the Company's discharge exceeds 55,000 gallons per day, which Management does not expect to occur until annual capacity exceeds 100,000 bbl., the Company will be required to pay additional fees. The estimated cost of the wastewater treatment facility is approximately $900,000, and the estimated cost of operating the plant is between $6,000 and $10,000 per month. The cost may increase with increased production. The Company is exploring various methods of recycling treated wastewater and could realize some revenue from doing so. The Company has contracted to have the liquid sediment that remains from the treated wastewater to be trucked to a local composting facility for essentially the cost of transportation. A Mendocino County Air Quality Control Permit will be required to operate the natural gas fired boiler at the new facility. The Company has not received any notice from any governmental agency that it is a potentially responsible person under any environmental law. Research and Development In 1995 the Company performed some research into low-alcohol and non-alcoholic ale. Research and development activity 1996 was minimal. The Company intends to use its original brewing facility at the Hopland Brewery to develop and test market new brews after completion of the new facility. Qualified Small Business Issuer Federal and California tax laws provide a 50% exclusion of any gain from the sale of "qualified small business stock." For shares to qualify for the exclusion, several tests must be met. For instance, the shares must be purchased directly from the Company, not in any later trading market, and the shares must be held for at least five years. A "qualified small business" must not have more than $50 million in assets, at least 80% of which are used in a qualified trade or business throughout the holding period. A "qualified trade or business" does not include "operating a hotel, motel, restaurant, or similar business." It is uncertain whether the Company's operation of the Hopland Brewery brewpub currently prevents it from meeting the definition of "qualified small business", as the brewing equipment in Hopland is presently used in both wholesale and retail operations and no applicable regulations have been published to assist in making such determination. Management believes, after consulting with its accountants, that completing the new brewery will reduce the assets of the Company used in the operation of the brewpub to well below 20%, but Management does not intend to request any opinions or rulings on this issue at the present time. The Company intends to submit reports if and to the extent any are required under federal law to make the 50% exclusion from capital gains available, and submitted such a report in California for 1995, the first year in which California required such a report. Given the absence of applicable regulations, there is no assurance that California taxing authorities will agree with the information contained in the report. There are limitations on the persons who may use any exclusion. Prospective investors should consult their own tax advisors concerning the possible applicability of these exclusions. -9- Item 2. Description of Property. The Company currently leases a 15,500 square foot building in Hopland. The lease expires on September 1, 2004. Additionally, the Company leases a 4,000 sq. ft. portion of a warehouse, located approximately two miles from the Hopland facility. The Company owns nine acres of land in Ukiah, California on which the Company is completing its new brewery. Item 3. Legal Proceedings. The Company is not currently involved in any material litigation or proceeding. The Company has received a written claim by a terminated distributor that its termination was improper notwithstanding the language of the written distribution agreement permitting either party to terminate by giving 30 days written notice. No legal action has been instituted with respect to this claim as of the date of this Report. Management does not believe that there is any merit to the claim. Item 4. Submission of Matters to a Vote of Security Holders. There were no matters submitted to a vote of the security holders during the fourth quarter of 1996. PART II Item 5. Market for Common Equity and Related Stockholder Matters. Mendocino Brewing's Common Stock was listed on the Pacific Stock Exchange (symbol MBR) on February 21, 1995. The high and low closing sales prices for the Common Stock on the Pacific Stock Exchange are set forth below for the quarters indicated:
1995 1996 -------------------------------------------------- --------------------------------------------------- 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter High $13.50 $9.25 $8.75 $8.12 $7.38 $10.82 $10.00 $8.38 Low $7.62 $7.12 $7.75 $7.00 $5.50 $5.82 $7.38 $5.75
There were approximately 2,435 shareholders of record as of January 6, 1997. Management intends to retain Mendocino Brewing's earnings for use in the business and does not expect the Company to pay cash dividends in the foreseeable future. The Company's credit agreements provide that the Company shall not declare or pay any dividend or other distribution on its Common Stock (other than a stock dividend) or purchase or redeem any Common Stock, without the lender's prior written consent. Management anticipates that such restrictions will remain in effect for as long as the Company has significant bank financing, including the long-term debt on the Ukiah real estate. The holders of the Company's 227,600 outstanding shares of Series A Preferred Stock are entitled to aggregate cash dividends and liquidation proceeds of $1.00 per share before any dividend may be paid with respect to the Common Stock. The Series A Preferred Shares are canceled after they have received their $1.00 per share aggregate dividend. Management does not have any present intention to declare or pay a dividend on the Series A Preferred Stock. Item 6. Management's Discussion and Analysis. The following discussion and analysis should be read in conjunction with the Financial Statements and the Notes thereto and other financial information included elsewhere in this Report. The discussion of results and trends does not necessarily imply that these results and trends will continue. -10- Overview Mendocino Brewing's financial performance during 1996 was been characterized by increased sales and gross profits from brewing operations and decreased cost of goods sold as a percentage of net sales, offset by increased marketing expenses, administrative expenses attributable to the Company's expansion plan and the cost of being a public company, and the aggregate net effect of certain one-time gains, certain one-time losses, and decreasing interest earnings from the net proceeds of the Company's initial public offering. Management attributes the increase in sales to the implementation of new marketing strategies, including new point of sale materials and additional field sales representatives, beginning in the second quarter of 1996. Improvements to brewing operations in September 1995 increased capacity by 32% and significantly reduced cost of goods as a percentage of sales. Comparing 1996 to 1995, net sales were up 7.7%, gross profit was up 12.2%, and. cost of goods sold was down 2.0% as a percentage of net sales. In 1996, the bankruptcy of a distributor, increased promotional and labor expenses associated with the operation of the Hopland Brewery brewpub and merchandise store, and increased marketing expenses resulted in a 36.8% increase in operating expenses. While Management plans to continue marketing expenses at a high level and plans to continue promotional expenses at the Hopland Brewery brewpub at current levels, the Company will not incur any additional losses (approximately $33,000) attributable to the bankrupt distributor. Management's decision to write off $47,600 in expenses incurred in exploring a long-term alliance with a mid-western distribution company (classified as "other expense"), when combined with a $117,500 decrease in net interest earnings as the Company spent the cash proceeds from the public offering for equipment and building construction, resulted in a $123,800 loss for 1996 compared to income of $173,700 for the same period in 1995. Results of Operations The following tables set forth, as a percentage of net sales, certain items included in Mendocino Brewing's Statements of Income. See Financial Statements and Notes thereto. Year Ended December 31, ----------------------- 1996 1995 ------ ------ Statements of Income Data: Sales ......................................... 104.30% 104.73% Less excise taxes ............................. 4.30 4.73 ------ ------ Net sales ..................................... 100.00 100.00 Costs of goods sold ........................... 49.74 51.77 ------ ------ Gross profit .................................. 50.26 48.23 Operating expenses ............................ 54.75 43.10 ------ ------ Income (loss) from operations ................. (4.49) 5.13 Other income (expense) ........................ (0.77) 4.03 ------ ------ Income (loss) before income taxes ............. (5.26) 9.16 Provision for (benefit from) income taxes ..... (2.04) 4.29 ------ ------ Net income (loss) ............................. (3.22)% 4.87% ====== ====== At December 31, ------------------------------- 1996 1995 --------------- ------------ Balance Sheet Data: Cash and cash equivalents .............. $ 494,800 $1,696,100 Working capital ........................ (3,616,800) 959,100 Property and equipment ................. 9,270,300 3,954,100 Deposits and other assets .............. 304,100 71,000 Total assets ........................... 11,144,600 6,514,000 Long-term debt ......................... -- 554,900 Obligation under capital lease ......... 1,863,000 -- Total liabilities ...................... 6,844,200 2,089,800 Shareholder's equity ................... 4,300,400 4,424,200 -11- Sales. Net sales increased 7.7% from $3,566,500 in 1995 to $3,839,700 in 1996. Management attributes the growth in sales to the implementation of new marketing strategies, including new point of sale materials and additional field sales representatives, beginning in the second quarter of 1996. A decrease in sales in the first and fourth quarters of 1996 compared to 1995 was offset by an increase in sales in the second and third quarters of 1996 compared to 1995. Management attributes the decrease in the first quarter of 1996 to delays in implementing the new marketing plan, the increases in the second and third quarters of 1996 to the new marketing plan, and the decrease in the fourth quarter to a wholesale price reduction in September 1996 (see "Business - Pricing Strategy") plus a decrease in case shipments of 1.7%. Management attributes approximately half of the sales increases in the second and third quarters to increased sales to existing distributors and the other half to geographic expansion. Retail sales at the Hopland Brewery brewpub and merchandise store were down 2.4% for 1996 compared to 1995. Management attributes the decline in sales at the Hopland Brewery brewpub and merchandise store to slower off-premise bottled beer sales (due to increased availability of MBC products outside of Hopland) offset by increased food sales. Cost of goods sold. Cost of goods sold decreased as a percentage of net sales by 2.0 percentage points from 1995 to 1996. The implementation of 24-hour brewing in September 1995 significantly improved production efficiencies. Management negotiated a reduction in the cost of bottles starting in the third quarter of 1995. Gross profit. Gross profit increased 12.2% from $1,720,000 in 1995 to $1,930,000 in 1996. Operating expenses. Operating expenses increased 36.8% from $1,537,300 in 1995 to $2,102,400 in 1996. Several factors contributed to the increases. Marketing expenses increased by $404,500 from 1995 to 1996. Management attributes the increases to $120,400 in increased point of sale and other promotional and advertising costs, $77,400 in increased marketing and sales labor, $54,000 to additional periodic price discounts to distributors, $48,700 in increased travel and lodging expenses incurred in developing new geographic markets, $47,200 to increased distribution expense, $32,900 to the write-off of a bad debt from a bankrupt distributor, and $23,900 in net miscellaneous expenses. Most of the foregoing expenses were incurred in connection with the Company's expansion plan. Management expects the Company to further increase marketing expenses through 1997. General and administrative expense increased from 1995 to 1996 by $71,600 consisting of $47,200 in increased labor costs, $27,800 in increased legal fees, $18,400 in un-reimbursed glass recycling fees, and $14,100 in costs associated with being a public company, offset by a decrease in profit-sharing retirement plan contribution of $30,000 and a net decrease of $5,900 in other costs. Finally, operating expenses at the Hopland Brewery brewpub and merchandise store increased from 1995 to the comparable period in 1996 by $89,000 due primarily to $55,500 in additional labor costs, $17,900 in increased promotional expenses, and $15,600 in net miscellaneous expenses. Impact of Inventory Aging Policies. During the time that Mendocino Brewing's distributors were on allocation, the Company shipped all of its product promptly upon production. Product freshness was not an issue. Inventories of packaged beer increased when the Company initially increased its capacity in late 1995 and early 1996 before implementing its new marketing plan. The Company does not use preservatives in its products, and accordingly the packaged beer has a shelf life of approximately 120 days from the release date. The Company's policy is to sell product to distributors with sufficient remaining shelf life to ensure that the beer will be fresh when sold to the consumer. Product that remains unsold after 120 days is returned to the Company for destruction or other disposition. In accordance with these policies, in the third quarter of 1996, the Company wrote-down its inventories by $51,000 representing approximately 6,000 cases of product remaining from its initial overproduction. The write-down was reflected as an increase in cost of goods sold. Other income (expense). Other income (expense) decreased by $173,600 in 1996 compared to the same period for 1995 primarily as a result of a decrease of $117,500 in net interest earnings as cash from the initial direct public offering was used for the expansion project, a write-off of $38,300 in professional expenses and $9,300 in product development costs incurred in exploring a long-term alliance with a mid-western distribution company, and the non-recurrence of $15,300 in one-time refunds of workers' compensation premiums. These expenses were offset by $3,600 in income from disposition of unneeded assets and $3,200 additional miscellaneous income. -12- Provision for (benefit from) income taxes. The Company recognized a benefit from income taxes in 1996 of $78,200 compared to a tax provision of $173,700 for the same period in 1995. See "Notes to Financial Statements, Note 1 - - Description of Operations and Summary of Significant Accounting Policies and Note 12 - Income Taxes." Net income (loss). For 1996 compared to the same period for 1995, net income was down $297,500 for a net loss of $123,800 compared to net income of $173,700 due to a $565,000 increase in operating expense and a $173,600 decrease in other income (expense) which more than offset a $210,000 increase in gross profit and a $231,100 reduction in the provision for income taxes. Segment Information Mendocino Brewing's business presently consists of two segments. The first is brewing for wholesale to distributors and other retailers. This segment accounted for 76.6% of the Company's 1996 annual sales. The second segment consists of brewing beer for sale along with food and merchandise at the Company's brewpub and retail merchandise store, the Hopland Brewery. This segment accounted for 23.4% of the Company's 1996 annual sales, 9.3% of which consisted of the sale of draft and bottled beer, and the remaining 14.1% of which consisted of sales of food and merchandise. Wholesale and retail beer sales in both segments combined comprised 85.9% of the Company's annual sales in 1996. See "Notes to Financial Statements, Note 13 - Segment Information." Mendocino Brewing is now in the process of increasing its brewing capacity by more than three times (18,000 bbl. to 60,000 bbl.). Proceeds from the sale of all of the stock offered in the Company's current direct public stock offering would permit the Company to expand its operations to up to 75,000 bbl. per year, an aggregate increase from the Company's current capacity of 18,000 bbl. of more than four times. (See "Business: New Brewery") As the Company does not intend to expand its brewpub operations, Management expects that retail sales, as a percentage of total sales, will decrease proportionally to the expected increase in the Company's wholesale sales. Seasonality Beer consumption nationwide has historically increased by approximately 20% during the summer months. Mendocino Brewing's wholesale distributors were on allocation while the Company's annual capacity was capped at 13,600 bbl., so seasonality had little effect on wholesale sales through late 1995. It is not clear to what extent seasonality will affect the Company as it expands its capacity and its geographic markets. The Company brews four seasonal beers: Springtide Ale in March, Eye of the Hawk Select Ale from July through October, Frolic Shipwreck Ale 1850 in July, and Yuletide Porter in November and December. These seasonal beers tend to augment sales during the periods in which they are available. Retail operations, which depend largely on tourist traffic, historically have been higher in the third and fourth quarters. Financing the New Brewery. New Brewery Cost. The presently estimated cost of the new brewery at its initial annual capacity of 60,000 bbl. is $11.4 million. This includes $0.8 million for the land, $7.1 million for improvements to the real estate, $3.1 million for equipment, and $0.4 million for financing costs. Increasing the initial annual capacity of the new brewery to 75,000 bbl. will require an additional expenditure for equipment of approximately $0.5 million. Of this amount, approximately $9.84 million has been paid or provided for from cash raised in the Company's initial direct public offering and the proceeds of debt described below and cash from operations. The balance of approximately $1.56 - $2.06 million will have to be funded from the proceeds of the Company's current direct public offering, cash from operations, and/or other sources as described below. Construction Financing. Mendocino Brewing has obtained a $2.7 million construction loan secured by a first priority deed of trust on the Ukiah land and improvements and the proceeds of the current direct public offering from the Savings Bank of Mendocino County along with a written commitment to convert the construction loan to a 15 year term loan upon successful completion of the new brewery, subject to certain conditions. As of March 31, 1997, approximately 89% of the construction loan had been funded. The construction loan bears interest at the lender's prime plus 2% (initially 10.25%), payable monthly. The lender has agreed to extend the due date to July 1, 1997, and the necessary documentation is pending. Assuming that the loan is extended, the current commitment provides that upon -13- conversion, the loan will bear interest at the then prevailing 5 Year Treasury Constant Maturity Index (but not less than 10%), with a maximum for the first five years at 2% above the initial fully indexed rate, and a maximum during the remaining term of the loan at 3% above the initial fully indexed rate at the beginning of the remaining term. The minimum annual interest rate is 8%. The loan will be over 25 years with a balloon payment upon maturity. The lender's commitment letter states that the lender will convert the unpaid principal at maturity to a fully amortized 10-year loan subject to terms and conditions to be agreed upon at that time. The commitment letter proposes to require the Company to pledge all proceeds of the Company's current direct public offering in excess of $2.5 million as collateral for the 15-year term loan, with the provision that the lender will release the funds from the pledge to purchase additional equipment if the Company is meeting its sales and revenue objectives. Equipment Lease. FINOVA Capital Corporation has also agreed to lease new brewing equipment with a total cost of approximately $2.07 million to Mendocino Brewing for a term of 7 years with monthly rental payments of approximately $29,000 each. The lease commenced in December 1996. As of March 31, 1997, approximately 81% of the lease had been funded. The balance of the funds are deemed to have been advanced but are held by FINOVA as cash collateral pending acquisition of certain additional equipment. Before that time, FINOVA advanced $750,000 to the Company with interest at the Citibank prime plus 3%. At expiration of the initial term of the lease, the Company may purchase the equipment at its then current fair market value but not less than 25% nor more than 30% of the original cost of the equipment, or at the Company's option, may extend the term of the lease for an additional year at approximately $45,600 per month with an option to purchase the equipment at the end of the year at then current fair market value. The lease is not pre-payable. Seller Financing of Ukiah Real Estate. The seller of the Ukiah land has a note, secured by a third priority deed of trust on the land, with a remaining principal balance as of December 31, 1996 of approximately $262,600 at 9% annual interest payable in monthly installments of principal and interest of $2,380 with the balance due at maturity on June 27, 1997. WestAmerica Loan. WestAmerica Bank of Santa Rosa, California has loaned Mendocino Brewing $600,000 secured by Mendocino Brewing's accounts receivable and inventory. The loan is fully funded and bears interest at a variable interest rate of prime plus 1.5% payable monthly and matures on April 27, 1997. WestAmerica Bank has not indicated to the Company whether it will renew the loan or on what terms. The Company has an outstanding commitment letter from WestAmerica Bank to convert the $600,000 term loan to a revolving line of credit with an advance rate of 80% of qualified accounts receivable and 25% of inventory. Conversion of the loan by WestAmerica Bank will likely depend, among other things, on whether WestAmerica Bank renews the loan at maturity. As the Company's sales continue to expand, the amount of inventory and receivables financing available should increase proportionately, assuming an otherwise sound financial condition. These forward looking statements are subject to risks and uncertainties. Even if the Company's accounts receivable and inventory grows in quantity, credit may be unavailable for other reasons relating to the Company's business, financial condition, and results of operations, the craft brew industry, the lending industry, or economic conditions in general. To the extent that the loan is not extended or refinanced, the Company will be required to repay the loan out of cash from operations, the net proceeds of the Company's current direct public offering, or the proceeds of another debt or equity financing, a strategic alliance, or a joint venture. Vendor Financing. The general contractor for the new brewery, BDM Construction Co., Inc. ("BDM"), has agreed to defer up to $900,000 in fees otherwise owed or to become payable on December 31, 1996, subject to performance by BDM of its obligations under the construction contract, until January 31, 1997 with interest at 12% per annum. As of December 31, 1996, $300,000 had been deferred under this arrangement. Additional amounts payable to BDM after January 31, 1997 are outstanding and no modifications have been made to the deferral arrangement to address the current circumstances. The deferral arrangement is secured by a second priority deed of trust on the Ukiah land and improvements, and by 300,000 shares of Mendocino Brewing's Common Stock. In the event of default, BDM is required to proceed against the Common Stock before initiating any proceeding against the real estate. The Common Stock collateral was issued to BDM by the Company pursuant to Section 4(2) of the Securities Act of 1933 subject to the restrictions (a) that the shares shall be canceled if the amounts owed BDM are paid in full, (b) that if full amount owed BDM is not paid, the shares must be sold in a commercially reasonable manner as specified in the California Commercial Code, and (c) that any shares not needed to be sold to -14- satisfy the obligation to BDM shall be canceled. Under California law, BDM may not retain the shares in satisfaction of the obligation without the written consent of the Company given after an event of default. Management had planned to pay the Company's obligation to BDM out of the proceeds of the Company's current direct public offering, but the Company has not yet raised net proceeds sufficient to do so. See "New Brewery Cost." BDM has the right to require the Company to register the shares issued for its account for sale to the public. As of April 9, 1997, BDM has not taken any action to enforce the Company's obligations to it. To the extent that the proceeds of the Company's current direct public offering are insufficient, the Company will be required to pay the obligation out of cash from operations, proceeds from the sale of the shares held as collateral, or the proceeds of another debt or equity financing, strategic alliance, or a joint venture. Other Financing. Mendocino Brewing has entered into a keg management agreement with MicroStar Keg Management LLC. Under this arrangement, MicroStar provides the Company with half-barrel kegs for which the Company pays a filling fee. Distributors return the kegs to MicroStar instead of the Company. MicroStar then supplies the Company with additional kegs. If the agreement terminates, the Company is required to purchase a certain number of kegs from MicroStar. The Company would probably finance the purchase through debt or lease financing, if available. Remaining Costs. To finance the anticipated cost of the new brewery (approximately $1.56 million for a 60,000 bbl. brewery and $2.06 million for a 75,000 bbl. brewery) management initiated the direct public offering which is currently under way. If the proceeds from such offering are not sufficient and timely, financing will need to be provided by vendors, future operations, other debt or equity financing, or a strategic alliance or joint venture or expansion plans and operations will need to be deferred or curtailed. As of April 9, 1997, the Company did not have any enforceable commitment for the necessary additional financing. Liquidity and Capital Resources Generally. The expansion now underway has had and will continue to have a material impact on Mendocino Brewing's assets, liabilities, commitments for capital expenditures, and liquidity. Capital resources for the expansion plan have been supplied by the net proceeds of Mendocino Brewing's initial public offering and debt and equipment financing as described above. Working capital for day to day business operations has historically been provided primarily through operations. Proceeds from operations are not expected to provide sufficient working capital for day to day operations as the Company expands. New Brewery. See "-- Financing the New Brewery" above. Debt to Equity Ratio. Upon completion of the new brewery, Mendocino Brewing will have long-term debt and equipment financing commitments (including current portions) of at least $5.0 million. The exact amount to be financed will depend on the results of the Company's current direct public offering, the amount and type of any additional equipment purchased, and the extent to which the Company obtains debt or lease financing for additional equipment. On a pro forma basis, as of December 31, 1996 assuming that the Company's $2.7 million short-term construction loan had instead been a long term loan, the Company's ratio of long-term debt to shareholder's equity, which was actually 0.47 to 1, would have been 1.11 to 1. Impact of Expansion on Cash Flow. Mendocino Brewing must make timely payment of its debt and lease commitment to continue in operation. Increased capacity will also place additional demands on the Company's working capital to pay the cost of additional sales and marketing activities and staff, production personnel, and administrative staff and to fund increased purchases of supplies. There will be a lag between the time the Company must incur some or all of these costs and the time the Company realizes revenue from increased sales. Working capital to fund these expenses will have to be provided by trade terms offered by suppliers and vendors, the proceeds of the Company's current direct public offering, additional debt or equity from other sources, and/or deferral of certain expenses. As of April 9, 1997, the Company did not have any enforceable commitment for the necessary additional financing. Direct Public Offering. In February 1997 the Company commenced a direct public offering of 600,000 shares of common stock at an offering price of $8.50. As of March 31, 1997, the Company had received subscriptions for approximately 16,000 shares ($136,000). -15- Strategic Alliances and Joint Ventures. The rapid growth of the craft beer industry has been characterized in part by a variety of consolidations, strategic alliances, and joint ventures. Mendocino Brewing and its President, Michael Laybourn, are very visible within the craft brew segment because of the Company's place in the history of modern craft brewing, the distinctiveness of its Red Tail Ale and Blue Heron Pale Ale labels, and Mr. Laybourn's leadership positions in industry trade groups. See "Management." From time to time Mendocino Brewing has received indications of interest in forming a strategic alliance, joint venture, or other relationship. To date, only one such proposal evolved beyond a term sheet before the Company withdrew from negotiations. The Company is, however, carrying on discussions with certain parties that could result in a strategic alliance or joint venture. The Company's primary goal in any such arrangement would be to obtain additional capital to expand the capacity of the new brewery to 200,000 bbl. per year and enter into an arrangement for sharing the expanded brewery capacity to provide optimal utilization of overhead and thereby reduce unit costs and/or access additional channels of domestic and/or international distribution. Creating additional value for shareholders is an important objective of these goals, but providing liquidity by way of a sale or merger is not. Nevertheless, a sale or merger of the Company is among the possible consequences of such discussions. The Company offers no assurances or estimates of the possibility that the Company might enter into such a strategic alliance or joint venture at any time in the foreseeable future. Item 7. Financial Statements. The information required by this item is set forth at Pages F-1 through F-15 to this Report. Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure. None. PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act. Executive Officers, Directors, and Significant Employees The executive officers, directors, and significant employees of the Company, and their ages as of March 31, 1997, are as follows: Name Age Position - ------------------- ----- --------------------------------------------------- H. Michael Laybourn 58 Chief Executive Officer, President, and Chairman of the Board Norman H. Franks 50 Chief Financial Officer, Vice President, Treasurer, and Director Michael F. Lovett 50 Marketing Director, Secretary, and Director Eric G. Bradley* 59 Director Daniel R. Moldenhauer* 63 Director Thomas I. Palmtag 53 National Sales Manager John Scahill 57 Facilities Manager Donald Barkley 43 Master Brewer - ---------- *Member of the Compensation and Audit Committees H. Michael Laybourn, co-founder, has served as the Company's Chief Executive Officer and President since its inception in 1982. Mr. Laybourn was elected a director in November 1993 when the Company began the process of converting from a limited partnership to a corporation and Chairman of the Board in June 1994. Before co-founding Mendocino Brewing, Mr. Laybourn co-owned and operated Thunder Road Design and Construction. Mr. Laybourn is a Vice President of the California Small Brewers Association and Chairman of the Board of Directors of the Brewers Association of America. Mr. Laybourn holds a Bachelor of Fine Arts degree from Arizona State University. -16- Norman H. Franks, co-founder, has served as the Company's Chief Financial Officer and Vice President since its inception in 1982. Mr. Franks was elected a director in November 1993 when the Company began the process of converting from a limited partnership to a corporation. Before co-founding Mendocino Brewing, Mr. Franks co-owned and operated Thunder Road Design and Construction. Mr. Franks holds a Bachelor of Science degree in mechanical engineering from the University of California, Berkeley. Michael F. Lovett joined the Company in 1983 as Assistant Master Brewer and became Marketing Director in 1987, serving since that time under that or other titles. Mr. Lovett was elected a director in November 1993 when the Company began the process of converting from a limited partnership to a corporation and was appointed Secretary in June 1994. Between 1980 and 1983, Mr. Lovett was Vice President Quality Control of New Albion Brewing Co. From 1976 to 1980, Mr. Lovett was Production Superintendent at Farm Foods in San Francisco. He is the immediate past Membership Chairman and a past Technical Chairman of the Master Brewers Association of the Americas. Mr. Lovett holds a B.A. degree in Psychology from San Francisco State College. Eric G. Bradley became a director in June 1994. Mr. Bradley has been a business and financial consultant since 1988. For the preceding 20 years, he was employed by Kaiser Aluminum & Chemical Corp., in positions rising from Division Controller to Business Manager. Mr. Bradley is a Fellow of the Institute of Chartered Accountants (UK) and a Certified Personal Financial Planner. Daniel R. Moldenhauer became a director in June 1994. Mr. Moldenhauer is a management consultant. He was president of Conex Products Inc. of Dublin, California from 1988 to 1990, a company formed from assets divested by Kaiser Aluminum & Chemical Corp. and later sold to Coleman Cable Systems. Mr. Moldenhauer served in several capacities with Kaiser Aluminum & Chemical Corp. from 1971 to 1988, most recently as general manager of a subsidiary. Thomas I. Palmtag joined the Company in January 1997 as National Sales Manager. Immediately before joining the Company, he served as President of two regional beer distributors, Colorado Beverage Distributing Co., Inc. of Colorado Springs (1994 - 1995) and Mesa Distributing Company, Inc. of San Diego (1993 - 1994), both Miller distributors owned by Liquid Investments, Inc. in San Diego. From 1980 to 1993, Mr. Palmtag served in various capacities for Coast Distributing Company in San Diego, an Anheuser-Busch distributor, most recently as Vice President and General Manager (1984 - 1993). From 1977 through 1980 Mr. Palmtag was employed as a Marketing Manager and Sales Manager for Anheuser-Busch in Riverside and Sylmar, California. From 1967 through 1977 he was employed in various capacities for beer distributors in Illinois and California. Mr. Palmtag holds a B.S. degree from the University of Wisconsin. John Scahill, co-founder, has served as the Company's Facilities Manager since its inception. Before co-founding the Company Mr. Scahill was a self-employed rancher. Mr. Scahill has a background in construction and counseling and holds a B.S. degree in sociology from the University of California, Berkeley. Donald Barkley joined the Company in 1983 as Master Brewer. Immediately before joining the Company, Mr. Barkley was the Head Brewer and Plant Manager at New Albion Brewing Co. from 1981 to 1983. Mr. Barkley joined New Albion Brewing Co. in 1978 and held several positions. In 1993 Mr. Barkley was the President and representative to the national board of governors of the Master Brewers Association of the Americas, Northern California District. Mr. Barkley holds a B.S. degree in fermentation science from the University of California, Davis. Director Term of Office Directors are elected at each annual meeting of shareholders to serve until their successors are elected and qualified at the next annual meeting of shareholders. Item 10. Executive Compensation. The following table sets forth, for the fiscal years ended December 31, 1995 and December 31, 1996, annual compensation, including salary, bonuses, and certain other compensation, paid by the Company to the Company's Chief Executive Officer, Chief Financial Officer, and to all executive officers as a group. None of the Company's other executive officers' total compensation exceeded $100,000 for fiscal 1996. -17-
Annual Compensation Fiscal ------------------- All Other Name and Principal Position Year Salary Bonus Compensation* - --------------------------- ------ ---------- --------- ------------- H. Michael Laybourn............................ 1995 $ 89,016 $ 22,255 $ 9,804 Chief Executive Officer 1996 89,016 0 7,053 Norman H. Franks............................... 1995 79,008 23,702 5,835 Chief Financial Officer 1996 79,008 0 3,567 All executive officers as a group.............. 1995 233,464 55,758 20,701 (3 persons) 1996 233,464 10,792 13,662 - ---------- * Includes an allowance for health insurance, life insurance, disability insurance, and participation in the Company's profit sharing retirement plan (annual discretionary contributions by the Company of up to 15% of gross compensation).
Director Compensation The Company's inside directors do not receive any cash compensation for their service on the Board of Directors. Outside directors receive $600 per meeting. No additional fees are paid for attending Compensation or Audit Committee meetings. Directors may be compensated for certain expenses in connection with their attendance at Board meetings. Since July 1996, Director Daniel R. Moldenhauer has acted as a project management consultant for the Company with respect to its ongoing construction project. Employment Agreements and Change in Control Arrangements The Company has entered into employment agreements with its President, Chief Financial Officer, and Marketing Director. The agreements call for minimum annual base salary of $89,000, $79,000, and $55,000 respectively. The agreements provide for bonus awards of a percentage of their respective base salaries upon the satisfaction of performance objectives established by the Compensation Committee (subject to the inherent oversight powers of the Board) and approved by the employee. The agreements specify that the performance objectives must be reasonably attainable, must not be probable of attainment without significant effort, and must reflect or indicate that value has been created for the shareholders. The Compensation Committee may award a bonus regardless of whether previously specified objectives are realized if, as a result of an employee's efforts or leadership, the Company has achieved other goals that reflect or indicate that value has been created for the shareholders. The agreements also require the Company to grant options to purchase up to 20,000, 20,000, and 10,000 shares, respectively, of Company Common Stock pursuant to the Company's 1994 Stock Option Plan at exercise prices of $9.2125, $9.2125, and $8.375 per share, respectively. The options vest in equal monthly increments over five years. The option agreements have terms of 5 years, 5 years, and 10 years, respectively. The options were granted in January 1997. The agreements do not provide for any benefits as a result of resignation or retirement. The Board of Directors has discussed the subject of, and might in the future grant, retirement benefits to Mendocino Brewing's founders in addition to their participation in the Company's profit sharing plan. The agreements provide for severance benefits in the form of 36, 36, and 18 months, respectively, of salary continuation if the Company actually or constructively terminates the employee's employment without cause as defined in the agreement. If the actual or constructive termination occurs within one year after a change in control as defined in the agreement, the agreements provide for an additional lump sum benefit of up to $500,000, $500,000, and $250,000 respectively. Any amount payable pursuant to these severance provisions will be deferred indefinitely and without interest to the extent the amount would otherwise constitute an excess parachute payment as defined in Section 280G of the Internal Revenue Code. Amounts so deferred may be paid at such time in the future, if any, that no portion of the payment will be considered an excess parachute payment. -18- Item 11. Security Ownership of Certain Beneficial Owners and Management. The following table sets forth certain information known to the Company regarding the beneficial ownership of the Company's Common Stock and Series A Preferred Stock as of March 31, 1997, and as adjusted to reflect the sale of the shares offered in the Company's current direct public offering, for (a) each shareholder known by the Company to own beneficially 5% or more of the outstanding shares of its Common Stock or Series A Preferred Stock; (b) each director; and (c) all directors and executive officers of the Company as a group. Except as otherwise noted, Management believes that the beneficial owners of the Common Stock and Series A Preferred Stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. COMMON STOCK:
Shares Percentage of Shares Outstanding(1) Directors, Executive Officers, Beneficially March 31, 1997 Pro Forma(2) and 5% Shareholders Owned 2,322,222 shares 2,922,222 shares ------------------------------- ------------- ---------------- ---------------- H. Michael Laybourn*................ 272,367 11.73% 9.32% Norman H. Franks*(3)................ 244,512 10.53% 8.36% Michael F. Lovett*(4)............... 93,034 4.01% 3.18% Eric G. Bradley..................... 1,000 0.04% 0.03% 1056 Park Lane, Piedmont, CA 94610 Daniel R. Moldenhauer............... 500 0.02% 0.02% 662 St. Ives Court Walnut Creek, CA 94598 John Scahill*....................... 248,809 10.71% 8.51% All directors and executive officers as a group (5 persons) .. 611,413 26.33% 20.92% SERIES A PREFERRED STOCK: Shares Directors, Executive Officers, Beneficially Percentage of and 5% Shareholders Owned Shares Outstanding ------------------------------ ------------ ------------------- H. Michael Laybourn.................. 6,100 2.68% All directors and executive officers as a group (five persons) 6,100 2.68% * c/o Mendocino Brewing Company, Inc. 13351 Hwy. 101 South Hopland, CA 95449-0400 - ---------- 1 Does not include 300,000 shares issued to BDM Construction Co., Inc. ("BDM") as security for the payment of up to $900,000 owed or to be owed to BDM for general contractor services in connection with the new brewery. BDM presently has the power to vote the 300,000 shares. Does not include 16,000 shares, subscripitions for which the Company had received but not accepted as of March 31, 1997. 2 Assumes sale of all 600,000 shares offered pursuant to the Company's currant direct public offering. 3 Does not include 145 shares owned by Mr. Franks wife. Mr. Franks discliams any beneficial ownership of shares held in the name of his wife. 4 Mr. Lovett's shares are pledged to a commercial bank as security for a personal loan.
-19- Item 12. Certain Relationships and Related Transactions. There have been no transactions during the last two years, and there are now no proposed transactions, involving more than $60,000 between the Company and any executive officer, director, nominee, 5% beneficial owner of any class of the Company's securities, or member of the immediate family of any of the foregoing persons, in which one or the foregoing individuals or entities had a material interest, except as follows: On October 11, 1996, in recognition of Mr. Laybourn's personal guaranty of the equipment lease with FINOVA Capital Corporation described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financing the New Brewery - Equipment Lease," the Company agreed to grant President Michael Laybourn a 5-year option to purchase 12,500 shares of Common Stock of the Company at an exercise price of $8.80 per share. The option was granted in January 1997. Mr. Laybourn's guaranty automatically terminated when FINOVA made the final payment for the purchase price of the equipment to the manufacturer. The Company has entered into written employment agreements with its President, Chief Financial Officer, and Marketing Director as described in "Management -- Employment Agreements and Change in Control Arrangements." It is the Company's policy that all transactions with officers, directors, nominees, 5% beneficial owners of any class of the Company's securities, and members of the immediate families of any of the foregoing persons be on terms no less favorable to the Company than could be obtained from unaffiliated third parties. The Company's bylaws provide that the Board of Directors may approve loans of money or property to, and guaranties of the obligations of, officers of the corporation, and may adopt employee benefit plans authorizing such loans and guaranties to officers of the corporation, if the vote of any interested director or directors is not counted and the Board determines that such loan, guaranty, or plan may reasonably be expected to benefit the corporation. Item 13. Exhibits and Reports on Form 8-K. Exhibit Number Description of Document - ------- ------------------------------- 3.1 (A) Articles of Incorporation, as amended, of the Company 3.2 (B) Bylaws of the Company (Incorporated by referenced from the Company's Report on Form 10-KSB for the annual period ended December 31, 1994 previously filed with the Commission.) 4.1 Articles 5 and 6 of the Articles of Incorporation, as amended, of the Company (Reference is made to Exhibit 3.1.) 4.2 Article 10 of the Restated Articles of Incorporation, as amended, of the Company (Reference is made to Exhibit 3.2.) 4.3 (A) Form of Common Stock Certificate (Incorporated by reference from the Company's Registration Statement dated June 15, 1994, as amended, previously filed with the Commission, Registration No. 33-78390-LA.) 10.1 (A) Mendocino Brewing Company Profit Sharing Plan. 10.2 (A) Wholesale Distribution Agreement between the Company and Bay Area Distributing. 10.3 (A) Wholesale Distribution Agreement between the Company and Golden Gate Distributing. 10.4 (F) Letter of Intent with Vitro Packaging, Inc. 10.5 (A) Sales Contract between the Company and John I. Hass, Inc. 10.6 (A) Lease Agreement between the Company and Kohn Properties. 10.7 (A) Lease Agreement between the Company and Associated Vintage Group, Inc. 10.8 (F) Commitment letter from Savings Bank of Mendocino County (previously filed as Exhibit 19.9). 10.9 (A) Letter of intent from California Statewide Certified Development Corporation. -20- Exhibit Number Description of Document - ------- ------------------------------- 10.10 (A) 1994 Stock Option Plan (previously filed as Exhibit 99.6). 10.11 (C) Commercial Real Estate Purchase Contract and Receipt for Deposit (previously filed as Exhibit 19.2). 10.12 (B) Proposal from Warren Capital Corporation. 10.13 (C) Brewery Fixtures Construction Agreement with Enerfab, Inc. (previously filed as Exhibit 19.3). 10.14 (D) Installment Note between Ukiah Redevelopment Agency and Langley et al. (previously filed as Exhibit 19.5). 10.15 (E) Agreement to Implement Condition of Approval No. 37 of the Site Development Permit 95-19 with the City of Ukiah, California (previously filed as Exhibit 19.6). 10.16 (F) Standard Form of Agreement Between Owner and Architect for Designated Services between the Company and Victor Lopes. 10.17 (F) Liquid Sediment Removal Services Agreement with Cold Creek Compost, Inc. 10.18 (F) Promissory Note for $76,230 in favor of Langley et al. 10.19 (G) Construction agreement with BDM Construction Company, Inc. 10.20 (G) $60,000 Note payable to BDM Construction Company, Inc. 10.21 (G) Agreement to modify note and deed of trust dated June 6, 1995 with Langley, et al. 10.22 (G) Agreement to modify note dated June 6, 1995 with Langley, et al. 10.23 (G) Amendment to installment note payable to Langley, et al. 10.24 (G) Manufacturing Business Expansion and Relocation Agreement with the City of Ukiah. 10.25 (G) Manufacturing Business Expansion and Relocation Agreement with the Ukiah Redevelopment Agency. 10.26 (G) Consulting Agreement with Daniel R. Moldenhauer. 10.27 (H) Business Loan Agreement with WestAmerica Bank. 10.28 (J) Change in Terms Agreement with WestAmerica Bank. 10.29 (J) Letter Agreement Concerning Use of Proceeds with WestAmerica Bank. 10.30 (J) Commitment Letter from WestAmerica Bank. 10.31 (J) Business Loan Agreement with the Savings Bank of Mendocino County. 10.32 (J) Construction Loan Agreement with the Savings Bank of Mendocino County. 10.33 (J) $2,700,000 Note in favor of the Savings Bank of Mendocino County. 10.34 (J) Assignment of Deposit Account in favor of the Savings Bank of Mendocino County. 10.35 (J) Commitment Letter from the Savings Bank of Mendocino County. 10.36 (J) Equipment Lease with FINOVA Capital Corporation. 10.37 (J) Tri-Election Rider to Equipment Lease with FINOVA Capital Corporation. 10.38 (J) Master Lease Schedule with FINOVA Capital Corporation. 10.39 (J) Advance and Subordination Agreement among the Company, FINOVA Capital Corporation, and Enerfab, Inc. 10.40 (J) $900,000 Note in favor of BDM Construction Co., Inc. 10.41 (J) Letter Agreement Concerning Use of Proceeds with BDM Construction Co., Inc. 10.42 (J) Employment Agreement with H. Michael Laybourn. -21- Exhibit Number Description of Document - ------- ------------------------------- 10.43 (J) Employment Agreement with Norman H. Franks. 10.44 (J) Employment Agreement with Michael F. Lovett. 10.45 (J) Employment Agreement with John Scahill. 10.46 (A) 1994 Stock Option Plan (previously filed as Exhibit 99.6) 19.1 Keg Management Agreement with MicroStar Keg Management LLC. 19.2 Form of Change in Terms Agreement with the Savings Bank of Mendocino County 27 Financial Data Schedule - -------------------------------- (A) Incorporated by reference from the Company's Registration Statement dated June 15, 1994, as amended, previously filed with the Commission, Registration No. 33-78390-LA. (B) Incorporated by referenced from the Company's Report on Form 10-KSB for the annual period ended December 31, 1994 previously filed with the Commission. (C) Incorporated by referenced from the Company's Report on Form 10-QSB for the quarter period ended March 31, 1995 previously filed with the Commission. (D) Incorporated by referenced from the Company's Report on Form 10-QSB for the quarter period ended June 30, 1995 previously filed with the Commission. (E) Incorporated by referenced from the Company's Report on Form 10-QSB for the quarter period ended September 30, 1995 previously filed with the Commission. (F) Incorporated by referenced from the Company's Report on Form 10-KSB for the annual period ended December 31, 1995 previously filed with the Commission. (G) Incorporated by referenced from the Company's Report on Form 10-QSB for the quarter period ended June 30, 1996 previously filed with the Commission. (H) Incorporated by referenced from the Company's Report on Form 10-QSB/A No. 1 for the quarter period ended June 30, 1996 previously filed with the Commission. (J) Incorporated by reference from the Company's Registration Statement dated February 6, 1997, as amended, previously filed with the Commission, Registration No. 333-15673. The registrant did not file any Reports on Form 8-K during the last quarter of the period covered by this report. -22- SIGNATURES Pursuant to the requirements of Section 13 of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereto duly authorized. (Registrant) Mendocino Brewing Company, Inc. By: /s/ H. Michael Laybourn ------------------------------- H. Michael Laybourn, Chairman of the Board and Chief Executive Officer Date: April 15, 1997 Pursuant to the requirements of Section 13 of the Exchange Act, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Norman H. Franks ------------------------------- Norman H. Franks, Director and Chief Financial Officer Date: April 14, 1997 By: /s/ Michael F. Lovett ------------------------------- Michael F. Lovett, Director Date: April 14, 1997 By: ------------------------------- Eric G. Bradley, Director Date: April _________ , 1997 By: ------------------------------- Daniel R. Moldenhauer, Director Date: April _________ , 1997 -23- - -------------------------------------------------------------------------------- MENDOCINO BREWING COMPANY, INC. INDEPENDENT AUDITOR'S REPORT AND FINANCIAL STATEMENTS DECEMBER 31, 1996 AND 1995 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CONTENTS PAGE INDEPENDENT AUDITOR'S REPORT...............................................F - 1 FINANCIAL STATEMENTS Balance sheets........................................................F - 2 Statements of operations..............................................F - 4 Statements of stockholders' equity....................................F - 5 Statements of cash flows..............................................F - 6 Notes to financial statements.........................................F - 7 - -------------------------------------------------------------------------------- INDEPENDENT AUDITOR'S REPORT To the Board of Directors Mendocino Brewing Company, Inc. We have audited the accompanying balance sheets of Mendocino Brewing Company, Inc., as of December 31, 1996 and 1995, and the related statements of operations, stockholders' equity and cash flows for each of the two years ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Mendocino Brewing Company, Inc., as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the two years ended December 31, 1996, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has significant costs associated with the construction of its new brewery and other debt that will become due in 1997. While the Company is presently pursuing various strategies, it does not have any current commitments for additional capital or financing to meet the payment demands, if made. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regards to these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/Moss Adams LLP Santa Rosa, California January 31, 1997, except for Note 2 as to which the date is March 31, 1997 Page F - 1 MENDOCINO BREWING COMPANY, INC. BALANCE SHEETS - -------------------------------------------------------------------------------- December 31, 1996 1995 - -------------------------------------------------------------------------------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 494,800 $ 1,696,100 Accounts receivable 317,400 458,900 Inventories 380,500 256,200 Prepaid expenses 58,600 47,100 Refundable income taxes 71,900 -- Deferred income taxes 23,100 15,500 ----------- ----------- Total current assets 1,346,300 2,473,800 ----------- ----------- PROPERTY AND EQUIPMENT 9,270,300 3,954,100 ----------- ----------- OTHER ASSETS Label development costs, net of amortization 17,400 15,100 Deferred stock offering costs 202,000 11,400 Deposits and other assets 304,100 59,600 Deferred income taxes 4,500 -- ----------- ----------- 528,000 86,100 ----------- ----------- Total assets $11,144,600 $ 6,514,000 =========== =========== The accompanying notes are an integral part of these financial statements. - -------------------------------------------------------------------------------- Page F - 2 MENDOCINO BREWING COMPANY, INC. BALANCE SHEETS (Continued) - -------------------------------------------------------------------------------------------------------------
December 31, 1996 1995 - ------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Line of credit $ 600,000 $ -- Accounts payable 567,600 105,700 Accrued wages and related expense 118,200 129,800 Accrued construction costs 744,500 1,182,300 Accrued liabilities 16,100 22,300 Accrued profit sharing -- 30,000 Income taxes payable -- 34,200 Current maturities of long-term debt 2,765,400 10,400 Current maturities of obligation under capital lease 151,300 -- ----------- ----------- Total current liabilities 4,963,100 1,514,700 LONG-TERM DEBT, less current maturities -- 554,900 OBLIGATION UNDER CAPITAL LEASE, less current maturities 1,863,000 -- DEFERRED INCOME TAXES 18,100 20,200 ----------- ----------- Total liabilities 6,844,200 2,089,800 ----------- ----------- STOCKHOLDERS' EQUITY Preferred stock, Series A, no par value, with aggregate liquidation preference of $227,600; 227,600 shares authorized, issued and outstanding 227,600 227,600 Common stock, no par value; 20,000,000 shares authorized, 2,322,222 shares issued and outstanding 3,869,600 3,869,600 Retained earnings 203,200 327,000 ----------- ----------- Total stockholders' equity 4,300,400 4,424,200 ----------- ----------- Total liabilities and stockholders' equity $11,144,600 $ 6,514,000 =========== =========== The accompanying notes are an integral part of these financial statements. - ------------------------------------------------------------------------------------------------------------- Page F - 3
MENDOCINO BREWING COMPANY, INC. STATEMENTS OF OPERATIONS - -------------------------------------------------------------------------------- Years Ended December 31, 1996 1995 - -------------------------------------------------------------------------------- SALES $ 4,004,700 $ 3,735,100 LESS EXCISE TAXES 165,000 168,600 ----------- ----------- NET SALES 3,839,700 3,566,500 COST OF GOODS SOLD 1,909,700 1,846,500 ----------- ----------- GROSS PROFIT 1,930,000 1,720,000 ----------- ----------- OPERATING EXPENSES Retail Operating 738,200 649,200 Marketing 682,300 277,800 General and administrative 681,900 610,300 ----------- ----------- 2,102,400 1,537,300 ----------- ----------- INCOME (LOSS) FROM OPERATIONS (172,400) 182,700 ----------- ----------- OTHER INCOME (EXPENSE) Interest income 11,600 132,800 Other income (expense) (41,200) 14,800 Interest expense -- (3,700) ----------- ----------- (29,600) 143,900 ----------- ----------- INCOME (LOSS) BEFORE INCOME TAXES (202,000) 326,600 PROVISION FOR(BENEFIT FROM) INCOME TAXES (78,200) 152,900 ----------- ----------- NET INCOME (LOSS) $ (123,800) $ 173,700 =========== =========== EARNINGS (LOSS) PER SHARE $ (0.05) $ 0.08 =========== =========== WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 2,322,222 2,307,074 =========== =========== The accompanying notes are an integral part of these financial statements. - -------------------------------------------------------------------------------- Page F - 4 MENDOCINO BREWING COMPANY, INC. STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended December 31, 1996 and 1995
- --------------------------------------------------------------------------------------------------------------------------- Series A Preferred Stock Common Stock -------------------------- -------------------------- Retained Total Shares Amount Shares Amount Earnings Equity ----------- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 1994 227,600 $ 227,600 2,220,445 $ 3,342,400 $ 153,300 $ 3,723,300 Issuance of common stock -- -- 101,777 527,200 -- 527,200 Net income -- -- -- -- 173,700 173,700 ----------- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 1995 227,600 227,600 2,322,222 3,869,600 327,000 4,424,200 Net loss -- -- -- -- (123,800) (123,800) ----------- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 1996 227,600 $ 227,600 2,322,222 $ 3,869,600 $ 203,200 $ 4,300,400 =========== =========== =========== =========== =========== =========== The accompanying notes are an integral part of these financial statements. - --------------------------------------------------------------------------------------------------------------------------- Page F - 5
MENDOCINO BREWING COMPANY, INC. STATEMENTS OF CASH FLOWS - -----------------------------------------------------------------------------------------------------------------------
Years Ended December 31, 1996 1995 - ----------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (123,800) $ 173,700 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 51,900 49,300 Loss (gain) on sale of assets (3,600) 500 Deferred income taxes (14,200) 20,600 Changes in: Accounts receivable 141,500 (165,000) Inventories (124,300) (54,200) Prepaid expenses (11,500) (33,600) Refundable income taxes (71,900) -- Accounts payable 461,900 (39,000) Accrued wages and related expense (11,600) 45,600 Accrued liabilities (6,200) 1,700 Accrued profit sharing (30,000) (15,000) Income taxes payable (34,200) 21,800 ----------- ----------- Net cash provided by operating activities 224,000 6,400 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, equipment and leasehold improvements (4,817,500) (2,923,300) Other assets (255,600) (16,400) Proceeds from sale of fixed assets 10,300 500 ----------- ----------- Net cash used by investing activities (5,062,800) (2,939,200) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Net borrowings on line of credit 600,000 -- Borrowings on long term debt 2,502,800 -- Principal payments on long-term debt (302,800) (11,700) Reimbursement from obligation under capital lease 1,523,800 -- Payments on obligation under capital lease (57,900) -- Accrued construction costs (437,800) 1,182,300 Proceeds from sale of common stock -- 568,900 Deferred stock offering costs (190,600) (11,400) ----------- ----------- Net cash provided by financing activities 3,637,500 1,728,100 ----------- ----------- DECREASE IN CASH AND CASH EQUIVALENTS (1,201,300) (1,204,700) CASH AND CASH EQUIVALENTS, beginning of year 1,696,100 2,900,800 ----------- ----------- CASH AND CASH EQUIVALENTS, end of year $ 494,800 $ 1,696,100 =========== =========== The accompanying notes are an integral part of these financial statements. - ----------------------------------------------------------------------------------------------------------------------- Page F - 6
MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of operations - Mendocino Brewing Company, located in Hopland, California, operates a microbrewery producing beer and malt beverages for the specialty beer market, and a brew pub and gift store. The majority of sales are in California. Inventories - Inventories are stated at the lower-of-average cost or market. Property and equipment - Property and equipment are stated at cost and depreciated or amortized using straight-line and accelerated methods over the assets' estimated useful lives. Capitalized interest was $214,900 and $15,200 in 1996 and 1995, respectively. Costs of maintenance and repairs are charged to expense as incurred; significant renewals and betterments are capitalized. Estimated useful lives are as follows: Machinery and equipment 5 - 7 years Furniture and fixtures 5 - 7 years Leasehold improvements 7 - 30 years Amortization - Label development costs are amortized on the straight-line method over a one-year period. Deferred stock offering costs - Deferred stock offering costs consist of legal and other costs incurred as part of the Company's public offering of common stock. Deposits and other assets - Deposits and other assets consist primarily of refundable deposits on the planned acquisition of brewing equipment during 1997. Concentration of credit risks - Financial instruments that potentially subject the Company to credit risk consist principally of trade receivables and interest-bearing deposits in excess of FDIC limits. The Company's interest-bearing deposits are placed with major financial institutions. Wholesale distributors account for substantially all accounts receivable; therefore, this concentration risk is limited due to the number of distributors and state laws regulating the financial affairs of distributors of alcoholic beverages. Income taxes - The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, "Accounting For Income Taxes", which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under FAS 109, the Company is allowed to currently recognize future tax deductions of expenses previously recorded for financial reporting purposes. Cash equivalents - The Company considers all highly liquid investments with a current maturity of three months or less to be cash equivalents. Earnings per share - Earnings per share were computed by dividing net income by the weighted average number of common shares outstanding. There were no common stock equivalents. - -------------------------------------------------------------------------------- Page F - 7 MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Use of estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires the Company make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. The amounts estimated could differ from actual results. Advertising - Advertising costs are expensed as incurred. Advertising expenses for the years ended December 31, 1996 and 1995, were $93,900 and $42,000, respectively. Fair value of financial instruments - The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximates fair value. Long-term debt: Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, the fair value of long-term debt approximates cost. Accrued construction costs - Accrued construction costs consist of expenses incurred for the construction of the new brewery including equipment. Reclassifications - Certain reclassifications have been made to the 1995 financial statements to conform to the 1996 presentation. NOTE 2 - GOING CONCERN AND MANAGEMENT'S PLANS In September 1995, the Company began construction of its new brewery with an expected completion date of mid-1996. The brewery was to be paid by a combination of financing and the proceeds from the Company's initial public stock offering. At the outset of construction, the projected total cost of the project, including land, building, equipment and other costs, was $9,200,000. The project is nearing completion, with the expectation that the Company will begin brewing and selling beer in April 1997. However, due to a change increasing the size and capacity of the brewery, cost overruns, and time delays, the cost rose to an expected total of $11,400,000. The project is being paid for and financed as follows: o $3,300,000 proceeds from the initial stock offering o $2,700,000 construction loan to bank. The bank has provided a commitment letter to convert the debt to permanent financing. o $2,100,000 in equipment financing as a capital lease o $800,000 to an individual for the acquisition of land. The current balance of $262,600 is due in September 1997. o $600,000 bank line of credit secured by accounts receivable and inventory, maturing April 1997. o $900,000 to the general contractor - -------------------------------------------------------------------------------- Page F - 8 MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 2 - GOING CONCERN AND MANAGEMENT'S PLANS (Continued) o $550,000 of estimated remaining costs are associated with Phase II of the project and are expected to be deferred until funds are available to pay for this work o $136,000 from funds collected from the current stock offering through March 31, 1997 o $314,000 balance is due to the general contractor and other vendors with no current source of funding other than future operations While the Company is pursuing various strategies, as outlined below, it does not have any current commitments for additional capital or financing to meet the payment demands of the obligations due in 1997, if those demands are made. Management's plans to meet these obligations include the following strategies: o Sales are expected to increase substantially with the opening of the brewery resulting in positive cash flow from operations o Increase efforts to attract investors to its current public stock offering o Negotiate extensions of due dates for debt due in 1997 o Actively pursue other sources of equity or debt financing through the identification of a strategic alliance or joint venture partner If management is unsuccessful in fully realizing its plans, there may be uncertainty about the Company's ability to continue as a going concern. These financial statements do not include any adjustments that might result from the outcome of this uncertainty. NOTE 3 - INVENTORIES 1996 1995 -------- -------- Raw Materials $121,800 $ 91,400 Work-in-process 81,700 89,500 Finished goods 139,800 37,200 Merchandise 37,200 38,100 -------- -------- $380,500 $256,200 ======== ======== - -------------------------------------------------------------------------------- Page F - 9 MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 4 - PROPERTY AND EQUIPMENT 1996 1995 ---------- ---------- Construction in progress $5,719,600 $ 921,700 Equipment in progress 2,573,600 2,031,800 Land 810,900 810,900 Machinery and equipment 557,500 537,900 Leasehold improvements 129,000 129,000 Furniture and fixtures 19,800 19,800 ---------- ---------- 9,810,400 4,451,100 Less accumulated depreciation and amortization 540,100 497,000 ---------- ---------- $9,270,300 $3,954,100 ========== ========== NOTE 5 - LINE OF CREDIT The Company has available a $600,000 line of credit with interest at the bank's index rate plus 1.5%. The bank's commitment under the line of credit matures April 1997. The agreement is secured by accounts receivable and inventory. NOTE 6 - LONG-TERM DEBT
1996 1995 ---------- --------- Note payable (construction loan) to bank, with interest at the banks interest rate plus 2%; maturing June 1997; secured by substantially all of the Company's assets $2,202,800 $ - Note payable to contractor, with interest at 12%; due the later of January 31, 1997 or 30 days after completion of the brewery; secured by common stock and a second deed of trust on the brewery and subordinated to bank debt 300,000 - Note payable to an individual, due in monthly payments of $2,380, including interest at 9%; maturing June 1997, with a balloon payment of $260,500; secured by real property and subordinated to bank debt 262,600 489,100 - ----------------------------------------------------------------------------------------------- Page F - 10
MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 6 - LONG-TERM DEBT (Continued) 1996 1995 ---------- ---------- Note payable to an individual, due in full December 1998, including accrued interest at 9%, secured by real property -- 76,200 ---------- ---------- 2,765,400 565,300 Less current maturities 2,765,400 10,400 ---------- ---------- $ -- $ 554,900 ========== ========== NOTE 7 - OBLIGATION UNDER CAPITAL LEASE During the year the Company entered into a capital lease agreement with a financial institution for the assets related to the brewing equipment in progress. The total assets under the capital lease are $2,073,000. The agreement is secured by the new brewery equipment. Future minimum lease payments for equipment under this capital lease agreement are as follows:
Year Ending December 31, 1997 $ 346,600 1998 378,100 1999 378,100 2000 378,100 2001 378,100 Thereafter 1,280,400 -------------------- 3,139,400 Less amounts representing interest 1,125,100 -------------------- Present value of minimum lease payments 2,014,300 Less current maturities 151,300 -------------------- $ 1,863,000 ==================== - --------------------------------------------------------------------------------------------------- Page F - 11
MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 8 - PROFIT-SHARING PLAN The Company has a profit-sharing retirement plan under which it may make employer contributions at the discretion of the Board of Directors, although no such contributions are required. Employer contributions vest over a period of six years. The plan covers substantially all full-time employees meeting certain minimum age and service requirements. Contributions were $0 and $30,000 for the years ended December 31, 1996 and 1995, respectively. NOTE 9 - COMMITMENTS The Company leases its facilities under a noncancellable operating lease expiring August 2004. The monthly lease payment is $2,068, to be adjusted annually by increases in the Consumer Price Index, as defined in the lease agreement. Additionally, the Company leases certain equipment under a noncancellable operating lease which expires in 1997. Total rent expense was $50,700 and $34,000 for the years ended December 31, 1996 and 1995, respectively. Future minimum lease payments are as follows: Year Ending December 31, 1997 $ 26,800 1998 24,800 1999 24,800 2000 24,800 2001 24,800 Thereafter 66,100 ---------- $192,100 ========== Employment agreements - Five key employees have employment agreements that provide, in part, a minimum annual base salary; stock options (see Note 12); and severance benefits that include 18 to 36 months of salary continuance and, if severance occurs within one year of a change in control, as defined, a lump sum benefit of from $250,000 to $500,000. The aggregate annual base salary for the five key employees is $317,100. The total lump sum benefit the Company is obligated to pay in the event of a defined change in control is $1,750,000. Keg management agreement - In January 1997, the Company entered into a keg management agreement with MicroStar Keg Management LLC. Under this arrangement, MicroStar provides half-barrel kegs for which the Company pays a filling fee. The agreement is effective April 1, 1997, for a five year period. Mendocino Brewing Company has the option to terminate the agreement with 30 days notice. If terminated, the Company is required to purchase a certain number of kegs from MicroStar. - -------------------------------------------------------------------------------- Page F - 12 MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 10 - BREWERY CONSTRUCTION In late 1995, the Company began construction of its new brewery in Ukiah, California. At this time, the total cost of the brewery including land, building and equipment is estimated to be $11.4 million. Funding for the brewery is from a combination of proceeds from the stock sale, private party financing for the land, bank financing for the building and a capital lease for the equipment. Test brewing is expected to begin in April 1997. NOTE 11 - STOCKHOLDERS' EQUITY Common Stock Before January 1, 1994, the Company conducted business in the form of a limited partnership. On January 1, 1994, the Company issued 1,722,222 share of no-par value common stock to the partnership in exchange for the assets of the partnership. The partnership distributed the stock to its partners on January 3, 1994. As of December 31, 1995, 600,000 additional shares of stock had been sold at $6 per share for total gross proceeds of $3,600,000. These proceeds were reduced by $286,700 of offering costs. All shares of stock authorized to sell in the first public offering have been issued. Subsequent to December 31, 1996, the Company began offering an additional 600,000 shares of stock for sale in a second offering. Preferred Stock The Company has authorized 2,000,000 shares of preferred stock, of which 227,600 have been designated as Series A. At the time of the incorporation of the partnership, the Company issued 227,600 shares of non-voting, no-par value Series A Preferred Stock in exchange for partnership assets. The partnership distributed the Series A Preferred Stock to its partners on January 3, 1994. Series A shareholders are entitled to receive cash dividends and/or liquidation proceeds equal in the aggregate to $1.00 per share before any cash dividends are paid on the Common Shares or any other series of Preferred Shares. When the entire Series A dividend/liquidation proceeds have been paid, the Series A Shares shall automatically be canceled and cease to be outstanding. NOTE 12 - STOCK OPTION PLAN Under the 1994 Stock Option Plan, the Company may issue options to purchase up to 200,000 shares of the Company's Common Stock. The plan provides for both incentive stock options, as defined in Section 422 of the Internal Revenue Code, and options that do not qualify as incentive stock options. The Plan shall terminate upon the earlier of (a) the tenth anniversary of its adoption by the Board or (b) the date on which all shares are available for issuance under the Plan have been issued. The exercise price of incentive options must be no less then the fair-market value of such stock at the date the option is granted, while the exercise price of nonstatutory options will be no less than 85% of the fair-market value per share on the date of grant. With respect to options granted to a person possessing more than 10% of the combined voting power of all classes of the Company's stock, the exercise price will be no less than 110% of the fair-market value of such share at the grant date. As of December 31, 1996, no options had been granted, exercised, or canceled under the Plan. - -------------------------------------------------------------------------------- Page F - 13 MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - -------------------------------------------------------------------------------- NOTE 12 - STOCK OPTION PLAN In January 1997, the Company granted 70,000 options to five key employees ranging in price from $8.38 to $9.21 per share. The options become exercisable at 20% a year and expire between five and ten years. The Company also granted an option to the Company's president to purchase 12,500 shares at $8.80. The option expires in 2002. NOTE 13 - INCOME TAXES 1996 1995 --------- --------- Current Federal $ -- $ 103,700 State 800 28,600 Benefit of net operating loss carryback (64,800) -- --------- --------- (64,000) 132,300 --------- --------- Deferred Current (7,600) (3,700) Non-current (6,600) 24,300 --------- --------- (14,200) 20,600 --------- --------- $ (78,200) $ 152,900 ========= ========= The difference between the actual income tax provision and the tax provision computed by applying the statutory federal income tax rate to earnings before taxes is attributable to the following: 1996 1995 --------- --------- Income tax provision (benefit) at 34% $ (68,700) $ 105,300 State taxes 800 28,100 Adjustment due to lower federal rates 5,000 (1,100) Recognition of future tax (deductions) (15,300) 20,600 --------- --------- $ (78,200) $ 152,900 ========= ========= - -------------------------------------------------------------------------------- Page F - 14 MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 ------------------------------------------------------------------------------- NOTE 13 - INCOME TAXES (Continued) Temporary differences and carryforwards which give rise to deferred tax assets and liabilities are as follows: Inventories $ 3,200 $ 3,000 Accruals 21,700 13,700 Other (1,800) (1,200) -------- -------- Current deferred tax asset $ 23,100 $ 15,500 ======== ======== Depreciation and amortization $ (2,900) $ -- Benefit of net operating loss carryforward 7,400 -- -------- -------- Non-current deferred tax asset $ 4,500 -- ======== ======== Depreciation and amortization $ 25,300 $ 21,000 Other (7,200) (800) -------- -------- Non-current deferred tax liability $ 18,100 $ 20,200 ======== ======== At December 31, 1996, the Company has available for carryforward approximately $85,000 of California net operating losses that expire in 2011. The benefit from this loss carryforward has been recorded, resulting in a deferred tax asset. A valuation allowance is not provided since the Company believes it is more likely than not that the loss carryforwards will be utilized. NOTE 14 - SEGMENT INFORMATION The Company's business segments are brewing operations and a retail establishment known as the Hopland Brewery. A summary of each segment is as follows:
Year Ending December 31, 1996 ------------------------------------------------------------------------ Brewing Hopland Corporate Operations Brewery and other Total -------------- ----------------- ------------------ -------------- Sales $ 3,067,300 $ 937,400 $ -- $ 4,004,700 Operating profits 591,100 (81,600) -- 509,500 Identifiable assets 9,873,600 97,900 1,173,100 11,144,600 Depreciation and amortization 26,200 7,800 17,900 51,900 Capital expenditures 5,339,800 -- 19,500 5,359,300 - ------------------------------------------------------------------------------------------------------------- Page F - 15
MENDOCINO BREWING COMPANY, INC. NOTES TO FINANCIAL STATEMENTS (Continued) December 31, 1996 and 1995 - ------------------------------------------------------------------------------- NOTE 14 - SEGMENT INFORMATION (Continued) Year Ending December 31, 1995 ----------------------------------------------- Brewing Hopland Corporate Operations Brewery and other Total ---------- -------- ---------- ---------- Sales $2,775,500 $959,600 $ - $3,735,100 Operating profits 758,400 34,600 - 793,000 Identifiable assets 4,633,900 109,500 1,770,600 6,514,000 Depreciation and amortization 30,700 8,300 10,300 49,300 Capital expenditures 3,655,900 25,500 3,900 3,685,300 NOTE 15 - STATEMENT OF CASH FLOWS Supplemental cash flow information includes the following: 1996 1995 ---------- ---------- Cash paid during the year for: Interest $180,400 $ 18,900 Income taxes $ 60,700 $113,500 Non-cash investing and financing activities for the year ended December 31, 1996, consisted of a note payable that was refinanced, and acquiring fixed assets of $548,500 through a capital lease. NOTE 16 - MAJOR CUSTOMERS Sales to the top five customers totaled $1,788,900 and $1,914,000 for the years ended December 31, 1996 and 1995, respectively representing 58% and 70% of brewing operation sales. - -------------------------------------------------------------------------------- Page F - 16 EX-19.1 2 MANAGEMENT AGREEMENT KEG MANAGEMENT AGREEMENT This Keg Management Agreement ("Agreement") dated effective as of February 21, 1997, is between MicroStar Keg Management, L.L.C., a Delaware Limited Liability Company whose address is P. O. Box 3129 Redmond, Washington 98073 ("MicroStar") and Mendocino Brewing Company, Inc., a California corporation, whose address is 13351 South Highway 101, Hopland, California 95449 (referred to herein and in the Exhibits hereto either as "Brewing Company" or "Mendocino"). RECITATIONS AND DEFINITIONS 1. MicroStar is engaged in the logistical management of stainless steel kegs, primarily for the craft beer/micro-brewing industry and has developed proprietary concepts, arrangements and systems for the ownership, licensing of the use of, tracking and retrieval of kegs. 2. Brewing Company is engaged in the business of brewing premium and/or special quality or custom beers and desires to more efficiently service existing markets while simultaneously expanding its business in both existing and potential new market areas. 3. Brewing Company desires to utilize the services of MicroStar in order to avoid the capital outlay and manpower/administrative costs and risks associated with keg ownership, thereby enabling Brewing Company to direct additional resources to its brewing business. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX 4. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX 5. For purposes of this Agreement the term "kegs" shall mean and refer to beer kegs that are straight-sided with a single opening and an American Sankey-type neck, having a full U.S. half-barrel (15.5 gallon) capacity, with minimum chime (skirt) thickness of 2.00 mm and minimum sidewall (body/shell) thickness of 1.32 mm which have not been used to store or transport wine, and which are capable of being cleaned to Brewing Company's reasonable satisfaction by using the procedures specified in this Agreement. In consideration of the premises and of the mutual covenants and agreements of the parties as hereinbelow set forth, the parties have agreed as follows: Section 1. Procurement of Kegs, Delivery, and Acceptance. 1.1. Purchase Agreement. a. MicroStar will acquire from Brewing Company any kegs which Brewing Company now or hereafter may own and desire to make subject to this Agreement, provided that such kegs conform to the definition of "keg" set forth in this Agreement and are of a condition and quality acceptable to MicroStar. The purchase price for any and all kegs purchased from Brewing Company shall be separately agreed upon in writing after verification of condition and quality and the quantity of kegs shall be subject to acquisition audit verification by MicroStar. The final acquisition inventory of kegs shall be approved in writing by authorized representatives of MicroStar and Brewing Company. Payment by MicroStar for the kegs so purchased from Brewing Company shall be made when MicroStar has verified that such kegs may be sold and assigned to MicroStar free of any lien or encumbrance and the subject kegs have been physically marked by MicroStar with its proprietary markings, which shall be done at Brewing Company's facilities in lots no smaller than one hundred (100) kegs. Placement of physical markings shall be performed by MicroStar's field personnel as expeditiously as possible and shall be initiated no more frequently than once per month, until all kegs so sold by Brewing Company to MicroStar shall have been identified. An appropriate Bill of Sale identifying the kegs acquired by MicroStar shall be executed and delivered contemporaneously with the payment by MicroStar. b. In the event that Brewing Company does not presently own kegs (as herein defined) or does not own a sufficient quantity of kegs to conduct and/or expand its business, or in the event that Brewing Company does not desire to subject its entire existing inventory of owned kegs to this Agreement, Brewing Company shall provide MicroStar with a projection of its anticipated keg requirements during the period April 1, 1997 through June 30, 1997. Contemporaneously, with the furnishing of such ninety (90) day projection, Brewing Company shall submit its initial request for deliveries of kegs and MicroStar will thereupon obtain and provide the requisite quantity of kegs in accordance with the provisions of Section 2.2 hereof. 1.2. Incidents of Ownership and Control All kegs purchased by MicroStar from Brewing Company and/or otherwise obtained and provided by MicroStar for purposes of this Agreement shall be owned and subject to the exclusive right of control and disposition of MicroStar, subject however to the rights of Brewing Company hereunder as a licensee of the right to use such kegs for the purposes and in the manner contemplated by this Agreement. Brewing Company agrees to execute, at the request of MicroStar, an appropriate statement for filing in the Uniform Commercial Code records of each state in which MicroStar kegs are utilized hereunder for the purpose of providing notice of the existence of this Agreement and of MicroStar's ownership of all kegs licensed for Brewing Company's use hereunder. MicroStar shall prepare the statements and file them at MicroStar's sole expense. After termination of this Agreement, MicroStar shall promptly execute such termination statements as Mendocino may reasonably request and which Mendocino shall file at Mendocino's sole expense. KEG MANAGEMENT AGREEMENT Page 2 Section 2. License of Keg Use 2.1 Basic Use Fee Brewing Company shall pay a use fee of XXXXXXXXXXXXXXXXXXXXXXX X per keg, per filling, which shall be invoiced and payable on net thirty (30) day terms for each keg delivered to the Brewing Company location(s) designated by Brewing Company. Except as specifically provided below, MicroStar shall pay all freight and insurance costs associated with the transporting of empty kegs to Mendocino and shall bear all risk of loss of the empty kegs during transit. With respect to kegs so utilized by Brewing Company which are filled by Brewing Company and delivered to the regional wholesalers identified in Exhibit "A-1" hereto (whose proximity of location to Brewing Company facilitates MicroStar's retrieval administration) the use fee shall be adjusted by rebate or credit to Brewing Company in the amount of XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX per keg. If applicable, Brewing Company may further specify on Exhibit "A-2" of this Agreement up to three (3) local wholesalers which currently impose no freight charge upon Brewing Company for the return of kegs, provided that (i) the wholesalers so designated agree to extend such free keg return arrangements to the keg deliveries to be made pursuant to this agreement, (ii) the timing, quantities and other arrangements relating to such keg returns are and remain consistent with the specific delivery terms prescribed by MicroStar, and (iii) Brewing Company agrees to assume and be responsible for any and all cost of freight for the return of all kegs from such designated local wholesalers. For each full keg sold by Brewing Company to such designated local wholesalers, the applicable adjustment by rebate or credit to Brewing Company will be XXXXXXXXXXXXXXXXXXXX per keg (resulting in an effective use fee to Brewing Company hereunder of XXXXXXXXXXXXXXXXXXXX per keg). In the event that any one of the above specified requirements for status as a designated local wholesaler ceases to be applicable, then effective on the date such requirement is no longer satisfied, the affected wholesaler shall automatically be regarded as a regional wholesaler covered by Exhibit "A-1" of this Agreement. With respect to kegs used by Brewing Company in on-site pub operations or self-distributed by Brewing Company, the use fee shall be XXXXXXXXXXXXXXXXXXXX per keg, per filling. Invoices for such fees will be based upon the monthly report of sales submitted by Brewing Company to applicable state authorities in relation to its on-site pub operations or self-distributed sales, a copy of which shall be furnished to MicroStar at the time such report is filed. The use fee is subject to an increase of up to XXXXXXXXXXXXXXXXX during any given twelve (12) consecutive month time period in the event of an increase of XXXXXXXXXXXXXXXXXXXXXXXXX or more in national or applicable regional trucking charges incurred by MicroStar in relation to the performance of this Agreement during any such twelve (12) consecutive month time period. MicroStar shall provide written notice thirty (30) days in advance of any increase to the use fee. 2.2 Delivery of Kegs per Brewing Company's Requirements Brewing Company shall notify MicroStar of Brewing Company's specific keg delivery date requirements by written notice, including facsimile transmittal or other notification arrangements approved in writing by Brewing Company and MicroStar, to be received not less than thirty (30) days prior to Brewing Company's requested delivery dates. Such notice shall include a specification of all requested keg quantities in lots of two hundred (200) or more. KEG MANAGEMENT AGREEMENT Page 3 MicroStar will forward a written confirmation of its receipt of Brewing Company's notice of requirements by facsimile or U.S. Mail prior to the close of the business day following the date of MicroStar's receipt of such notice. Brewing company shall use its best efforts to ensure that Brewing Company's inventory of MicroStar kegs does not exceed Brewing Company's actual thirty (30) day requirements. In the event that Brewing Company's requirements at any time or for any reason (e.g. seasonal product demand, business expansion, etc.) will exceed its most recently specified prior requirements by twenty percent (20%) or more and/or relate to deliveries to new locations of Brewing Company or wholesalers, Brewing Company shall be required to provide ninety (90) days advance written notice to MicroStar of such requirements. MicroStar shall endeavor to effectuate the delivery of the requested kegs to Brewing Company at its designated locations within the continental United States in accordance with Brewing Company's timely notification of keg requirements. All kegs delivered hereunder shall conform to the keg standard specified herein and shall not have been utilized to store or transport wine. Delivery shall be deemed to conform to the requirements of this Agreement if the actual time of delivery is within seventy-two (72) hours prior or subsequent to the specifically requested delivery time and the quantities so delivered (not counting any delivered kegs which are not in good and useable condition as determined by inspection by Mendocino) are within a ten percent (10%) variance of the specifically requested quantity of kegs. In the event that MicroStar is unable to meet the foregoing requirements of a conforming delivery to Brewing Company, MicroStar shall perform as soon as possible thereafter and shall impose no use fee with respect to any such non-conforming keg shipment. In the event that any non-conforming kegs are delivered to Mendocino, Mendocino shall segregate and securely store such kegs until MicroStar has arranged, at MicroStar's expense, for the pick-up and transportation of such kegs, which pick-up and transportation arrangements shall be concluded and implemented within thirty (30) days of the date of any such non-conforming delivery. The parties acknowledge and agree that non-conforming delivery(ies) give Brewing Company a right to terminate this Agreement pursuant to the terms of Section 11.6 of this Agreement. If Mendocino in its judgment would suffer a significant impairment by MicroStar's inability to meet the requirements of a conforming keg shipment, Mendocino may at its option purchase kegs from any source to fulfill the shortage. If after such an event(s) Mendocino elects not to terminate this agreement pursuant to Section 11.6, MicroStar must purchase and take ownership of the kegs from Mendocino for purposes of this agreement at Mendocino's cost which includes shipping and handling. Section 3. Arrangements and Agreements with Wholesalers 3.1. Notification and Compliance Obligations of Brewing Company a. Brewing Company will join with MicroStar in the issuance of a notice to all wholesalers to which Brewing Company delivers product in kegs subject to this Agreement that such kegs shipped by Brewing Company are owned by MicroStar as of the effective date specified in such notice (being the date on which keg ownership was acquired by MicroStar hereunder). Such notice will further evidence the authority of MicroStar to collect and administer the deposits required to be made by wholesalers in accordance with this Agreement, to perform audits as contemplated by this Agreement, and to retrieve all kegs delivered to the wholesaler. The form of notice of terms and conditions applicable to wholesalers is attached KEG MANAGEMENT AGREEMENT Page 4 hereto as Exhibit "B" and is intended to apprise wholesalers of the rights and responsibilities of MicroStar pursuant to this agreement and to express and evidence the agreement of wholesalers to the specified terms and conditions applicable to wholesalers. Brewing Company will require in pertinent negotiations and agreements with its wholesalers that all wholesalers agree to remit to MicroStar a security deposit based upon the amount of XXXXXXXXXXXXXXXXXXXXXXXX per keg, to be billed by and paid to MicroStar to cover the loss (based on a charge of XXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXX per keg) of any keg owned by MicroStar that cannot be located by such wholesaler. Execution of Exhibit "B" by Brewing Company and a wholesaler constitutes compliance with the foregoing sentence. As set forth in the form of notice of terms and conditions attached as Exhibit "B", wholesalers shall be required to acknowledge that periodic charges to and withdrawals from the security deposit will be made by MicroStar for kegs that cannot be located and that credit memos will be issued whenever kegs are returned and whenever kegs previously classified as lost are located. Wholesalers will be invoiced in the amount of XXXXXXX as a "loss" call whenever any loss is charged to the deposit and will receive a credit memo and refund of a previously billed lost keg charge whenever such "lost" keg for which a loss charge was made is located and returned. b. Pursuant to the notice of terms and conditions to wholesalers, all wholesalers shall be required to provide a monthly written report of movement of MicroStar kegs in a form prescribed by MicroStar, including inventory by brewer (including Brewing Company and any other brewers contracting with MicroStar who deliver product to the affected wholesaler), empty kegs on hand and kegs in the retail system. Wholesalers shall also agree to respond to weekly verbal inquiries by MicroStar representatives concerning the extent of empty MicroStar kegs in the wholesaler's system. MicroStar shall be authorized to conduct periodic audits of the wholesaler's inventory of MicroStar kegs, including kegs in the retail system, which audits will be performed either quarterly or semi-annually, depending upon the extent of the wholesaler's inventory and any discrepancies ascertained as a result of prior audits, etc. c. In the event that a wholesaler to whom Brewing Company delivers product fails to remit the security deposit of XXXXXXXXXXXXXXXXXXXXXXXX per keg to MicroStar within ninety (90) days after MicroStar's date of invoice for such deposit, then Brewing Company agrees to promptly issue Brewing Company's own invoice to the affected wholesaler and to use reasonable efforts to collect the applicable deposit and remit the same to MicroStar. Upon making such payments, Brewing Company shall then be subrogated to the claims that MicroStar had against the wholesaler. d. With respect to any on-site pub sales and/or self-distributed sales, Brewing Company shall be subject to all of the terms, obligations, and conditions applicable to wholesalers, including but not limited to deposits, loss fees, audits, etc., as set forth in this Agreement. Section 4. Trademark License Brewing Company hereby licenses to MicroStar, for the limited purposes of producing mandatory self-adhesive producing brewer/product labels and without direct monetary KEG MANAGEMENT AGREEMENT Page 5 compensation from MicroStar, Brewing Company's registered trademarks, trade names, slogans, and trade dress to the extent that any of these are depicted on the label. Brewing Company will have the ownership of and copyright in any artwork created for the label(s). MicroStar may not use such copyrighted artwork for purposes other than the mandatory labels, and MicroStar obtains no other rights to Brewing Company's registered trademarks, trade names, slogans, and trade dress or their use. Except as expressly provided, no right, property, license, permission or interest of any kind in or to the use of any trademark, trade name, color combination, insignia or device owned or used by Brewing Company is or is intended to be given or transferred to or acquired by MicroStar by the execution, performance or nonperformance of this Agreement or any part of it. MicroStar shall not permit any other brewer or product producer to distribute its products in any keg bearing Brewing Company's logo, label, or other identifying mark. Section 5. Confidentiality; SEC Reporting MicroStar and Brewing Company must hold in strictest confidence and may not disclose to others or use other than for purposes of this Agreement any data, reports, writings and communications and any other information provided to, learned by or made available to them by the other party in the course of this Agreement (collectively referred to as "Information") except as the other party expressly authorizes in writing. Mendocino may file a copy of this Agreement as an exhibit to any filing required of Mendocino under federal or state securities laws, with dollar amounts and XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXX omitted pursuant to a confidentiality request to the extent permitted by the agency with which the report is filed. Both MicroStar and Brewing Company acknowledge that all Information provided or learned by them in connection with this Agreement constitutes trade secret data and/or proprietary information of great value. Both MicroStar and Brewing Company agree not to use such Information in any way for their own benefit. This obligation of strict confidentiality is also applicable to each party's employees. It continues for so long as the information remains confidential. In the event that either party receives notice of an attempt by anyone to obtain a court order compelling any disclosure of any Information, they shall immediately notify the other party. Nothing in this section in any way restricts or impairs either party's right to use, disclose or otherwise deal with any Information or data which: 1) at the time of disclosure is generally available to the public or thereafter become available to the public by publication or otherwise through no act of that party; 2) that party can demonstrate was within its possession prior to the time of disclosure and was not acquired directly or indirectly from the other party or any person, firm or corporation acting on its behalf, or 3) is independently made available as a matter of right to either party by a third party who is under no confidentiality obligation to the other party. Section 6: Indemnity KEG MANAGEMENT AGREEMENT Page 6 Each party must indemnify and hold harmless the other party, the other party's parents, subsidiaries and affiliated companies, and all of their respective officers, managers, directors, employees and agents from any and all liabilities, damages, claims, suits, judgments, costs and expenses (including reasonable attorney's fees and court costs), directly or indirectly incurred in relation to third party claims against a party hereto as a result of: 1) the actions, including but not limited to negligence, of that party relating to this Agreement and the performance of this Agreement; 2) the breach of any of the provisions of this Agreement by that party; 3) alleged patent, trademark or copyright infringement or any claims by third persons based upon or arising out of or in connection with any statements, illustrations, research data, advertising, product claims, representations or warranties of that party for the purposes of this Agreement; 4) any and all claims, demands, actions, and causes of action which are hereafter made or brought against that party by any person for the recovery of damage for the injury, illness, or death of any person which is caused or alleged to have been caused by any services/products provided by the other party hereto. These obligations survive the termination of this Agreement. Section 7. Insurance MicroStar and Brewing Company each must carry and maintain at their own expense and in full force and effect at all times during the term of this Agreement and for one (1) year thereafter Commercial General Liability Insurance with a limit of liability of no less than XXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX. The insurance coverage required under this section must: 1) include contractual liability coverage which specifically insures the hold harmless and indemnification provisions of Section 6 of this Agreement; 2) be secured and maintained under an occurrence form policy or coverage form reasonably acceptable to the other party's insurance department; 3) be placed with an insurer of recognized responsibility; 4) name the other party and affiliated companies as "additional named insured" and 5) provide for at least thirty (30) days advance written notice to the other party of any cancellation or any material change in the coverage; 6) provide transit coverage for shipments authorized by such party and the bill of lading will be so termed. KEG MANAGEMENT AGREEMENT Page 7 Neither party may cancel any insurance policy maintained pursuant to the requirements of this paragraph without the prior written consent of the other. Upon written request, a certificate of insurance will be sent to the requesting party. Section 8. Term and Exclusivity of Agreement 8.1. Term of Agreement This Agreement shall be for an initial term of five (5) years. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXX In the event that no such election to terminate is made, the five (5) year term of this Agreement shall commence on October 1, 1997 or on the first day of the month next following the month in which Mendocino's monthly keg requirements hereunder first exceed five thousand (5,000) kegs. 8.2. Exclusivity of Arrangements Except in the instance of Brewing Company's retention of any pre-existing owned keg inventory for its own local market use, during the initial and any extended term of this Agreement, Brewing Company shall use MicroStar as the exclusive source of all beer kegs utilized in its brewing operation. Without limitation of and subject to the foregoing, Brewing Company agrees that during the term of this agreement or any extension hereof, Brewing Company shall not conclude or enter into any agreement or understanding with any third-party regarding sale of any of its Sankey kegs or regarding the purchase, lease or licensing of any kegs (whether of the Sankey type or otherwise) for use in Brewing Company's business, except as provided in the last paragraph of Section 2.2. Section 9: Cleaning of Kegs 9.1. Cleaning Responsibilities of Brewing Company Brewing Company acknowledges the responsibility to clean all kegs delivered to Brewing Company by MicroStar in accordance with the minimum washing standards for either a sterilizing sequence (steam) or a sanitizing sequence (oxine) and to implement the quality control checks prescribed by MicroStar, as specifically set forth in Exhibit "C" hereto. Section 10: Information and Records/Accounting Procedures KEG MANAGEMENT AGREEMENT Page 8 10.1. Responsibilities of Brewing Company During the term of this Agreement, Brewing Company shall provide MicroStar with copies of all bills of lading from all of its brewery locations for all draft beer shipments to wholesalers within twenty-four (24) hours of the time of shipment. Additionally, Brewing Company shall maintain accurate records reflecting monthly beginning and ending inventories of kegs, keg locations and verification of deliveries of kegs from MicroStar to Brewing Company and of all deliveries to wholesalers, and shall provide copies of such records to MicroStar on a monthly basis. Brewing Company agrees to report all requisite information on such forms as MicroStar may from time-to-time prescribe and furnish for such purposes. Brewing Company shall not knowingly utilize any MicroStar-owned kegs in its operations which are not specifically subject to this agreement. Brewing Company shall be charged the sum of XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX per keg for any keg subject to this agreement which an audit substantiates to have been lost while under Brewing Company's control. 10.2. Responsibilities of MicroStar MicroStar shall provide to Brewing Company such information and records as may be appropriate to substantiate all use fees, and all charges and credits associated with the deposit arrangements to be established between Brewing Company and wholesalers in accordance with the provisions of Section 3.1.b. hereof. 10.3. Audit Rights of the Parties MicroStar and Brewing Company each shall have the right to review and audit at reasonable intervals the records and information maintained or acquired by the other party hereto for the purpose of determining, verifying or analyzing any deliveries, retrievals, charges or credits arising in the course of performance of this Agreement. Audits shall be conducted during normal business hours with 24 hours advance notice given during normal business hours. Any expenses incurred by a party in relation to record keeping or reporting of information contemplated by this Agreement, shall be borne by the party charged with maintaining such records and providing such information. Expenses incurred by a party in relation to audits performed hereunder shall be borne by the party undertaking such audit. 10.4. Accounting Procedures The initial accounting procedures formulated by MicroStar are set forth in Exhibit "D" hereto. MicroStar may only supplement or revise the procedures as set forth in Exhibit "D" hereto with the express written consent of Brewing Company. The accounting procedures are not intended to impose any material obligation on Brewing Company that is not set forth in the body of this Agreement. In the event of any conflict between the accounting procedures and this Agreement, this Agreement shall control. Section 11: Miscellaneous KEG MANAGEMENT AGREEMENT Page 9 11.1. Amendment and Supplementation This Agreement and the Exhibits hereto may be amended or supplemented only by a written instrument executed by MicroStar and Brewing Company. 11.2. Independent Contractor This Agreement does not constitute or give rise to a partnership between the parties. All operations by each party under the terms of this Agreement are carried on by it as independent contractor and not as an agent for the other. 11.3. Third-Party Beneficiary Status To the extent necessary to accord MicroStar the full scope of entitlements, rights and authorities in relation to Brewing Company's agreements and arrangements with wholesalers as contemplated hereby, MicroStar shall be recognized as a third-party beneficiary of such agreements and arrangements. Brewing Company is an intended third-party beneficiary or all provisions of this Agreement concerning limitations on the use of the kegs by others and limitations on the use of Brewing Company's trademarks, labels, and logos. 11.4. Force Majeure Subject to the rights and obligations of the parties under Section 11.6, in the event that any obligation hereunder, other than the obligation to remit any payment due hereunder, cannot be timely performed due to circumstances beyond the reasonable control of a party hereto, the time period for the performance of such obligation shall be reasonably extended until the conditions precluding, impairing or delaying performance have been resolved. Notwithstanding the foregoing, as a general and overarching principle, nothing in this Agreement precludes Brewing Company from obtaining the use of kegs from other sources during any period during which MicroStar fails to provide sufficient quantities of kegs to Brewing Company. 11.5. Producing Brewer/Product Label MicroStar has designed a pro forma producing brewer/product label for participants in the MicroStar program. Utilizing the basic MicroStar - prescribed form, Brewing Company will be responsible for preparing a final label form and requesting and obtaining a Certificate of Label approval ("COLA") from the Bureau of Alcohol, Tobacco and Firearms. Additionally, Brewing Company will be responsible for requesting and obtaining any and all requisite approvals from the requisite authorities in states where Brewing Company's products are is distributed in MicroStar kegs. Copies of Certificates or other evidence of Federal and State label approval, as applicable, shall be furnished to MicroStar upon request. Brewing Company shall duly affix the MicroStar prescribed self-adhesive label in a manner which completely covers any prior producer or brewer label and expressly agrees not to ship its products in any kegs which reflect the label of a prior producer/brewer utilizing such keg. MicroStar shall impose an identical obligation on all future users of kegs with whom MicroStar contracts, and KEG MANAGEMENT AGREEMENT Page 10 shall use MicroStar's reasonable best efforts to obtain similar agreements with all existing users of MicroStar kegs. 11.6. Changes in Economic Conditions/Right of Termination In the event that as a result of business or economic developments occurring after the effective date hereof, including without limitation any determination by Brewing Company that the economic consequences of this Agreement are unacceptable, and any decision by Brewing Company to cease or diminish production of draft beer, the transactions contemplated by this Agreement cannot be implemented or continued by a party hereto without undue cost, loss or detriment to such party, the party experiencing such adverse consequences shall have the right, upon notification to the other party of the particulars of such developments, to cancel this Agreement effective thirty (30) days after the giving of such written notice. In the event of any such termination, Brewing Company shall repurchase kegs from MicroStar in a quantity equal to three times the average monthly keg deliveries to Brewing Company effectuated during the immediately preceding six (6) month period (the "Keg Purchase Quantity") at prices set forth in Exhibit "E" based on the age of the keg. The kegs to be purchased pursuant to this Section 11.6 shall be such kegs as are then currently available for disposition by MicroStar and it is understood by the parties hereto that the age of the kegs which may then be available cannot presently be ascertained. The requisite quantities of kegs shall be delivered monthly in prorated portions by MicroStar at its sole cost, risk and expense to Brewing Company's designated location(s) over an approximate three (3) month period. After confirmation of delivery of conforming kegs, a Bill of Sale will be delivered assigning title to the kegs to Brewing Company free and clear of any lien or security interest and Brewing Company shall contemporaneously remit payment for all kegs so purchased. If the foregoing right of termination is exercised by MicroStar, MicroStar shall, upon the request of Brewing Company, allow this Agreement to remain in effect for sixty (60) days after the otherwise applicable effective date of termination in order to afford Brewing Company an opportunity to arrange financing for the purchase of the kegs Brewing Company is obligated to purchase hereunder. In such event, the quantity of kegs subject to the purchase obligation shall be delivered monthly in prorated portions to Brewing Company's designated location(s) over an approximate three (3) month period commencing at the end of such sixty (60) day extension. In the event of Brewing Company's exercise of the foregoing right of termination for economic reasons, Brewing Company agrees not to utilize the services of any company engaged in performing the same or substantially similar services to those of MicroStar for a period of three (3) years from the date of such termination. XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX 11.7. Choice of Law KEG MANAGEMENT AGREEMENT Page 11 This Agreement and the performance hereof shall be construed in accordance with, and governed by the internal laws of the state of California. 11.8. Ad Valorem or Use Taxes Any ad valorem, personal property, use or similar taxes imposed as a result of Brewing Company's physical custody or use of MicroStar-owned kegs shall be the responsibility of Brewing Company. MicroStar shall not seek reimbursement from Brewing Company of any personal property or similar taxes paid by MicroStar. 11.9. Notices Notices and communications required or permitted hereunder shall be in writing and any communication hereunder shall be deemed to be duly made if actually delivered, transmitted by facsimile, or mailed, prepaid to the parties as follows: MicroStar Keg Management, L.L.C. Mendocino Brewing Company, Inc. 8567 154th Ave. N.E. 13351 South Highway 101 Redmond, Washington 98052 Hopland, California 95449 Attention: Robert M. Imeson Attention: Michael Laybourn FAX (206) 883-6300 and Norman H. Franks FAX (707) 744-1910 MicroStar shall send a copy of any notice to Mendocino, at the same time and in the same or equivalent manner, to: Enterprise Law Group, Inc. Menlo Oaks Corporate Center 4400 Bohannon Drive, Suite 280 Menlo Park, California 94025-1041 Attention: Wayland M. Brill, Esq./Nelson D. Crandall, Esq. (415) 462-4747 (FAX) (415) 462-4700 (Voice) A party may change its address for purposes of this Section 11.9 by giving the other party written notice of the new address in the manner set forth above. 11.10. Captions The headings and captions in this Agreement are for convenience only and shall not be considered a part of or affect the construction or interpretation of any provision of this Agreement. 11.11. Exhibits KEG MANAGEMENT AGREEMENT Page 12 All Exhibits attached to or referred to in this Agreement are incorporated into and made a part of this Agreement. However, in the event of a conflict, the terms of this Agreement shall supersede those of an Exhibit hereto. THIS AGREEMENT is executed on the date set forth below each party's respective signature. MICROSTAR KEG MANAGEMENT, L.L.C. By: /s/ Michael H. Leede ----------------------------- Name: Michael H. Leede --------------------------- Title: Manager --------------------------- Date: February 28, 1997 --------------------------- MENDOCINO BREWING COMPANY, INC. By: /s/ Norman H. Franks ----------------------------- Name: Norman H. Franks --------------------------- Title: Vice President and Chief --------------------------- Financial Officer --------------------------- Date: --------------------------- KEG MANAGEMENT AGREEMENT Page 13 EXHIBIT "A-1" TO KEG MANAGEMENT AGREEMENT List of Regional Wholesalers EXHIBIT "A-2" TO KEG MANAGEMENT AGREEMENT List of Local Wholesalers EXHIBIT "B" TO KEG MANAGEMENT AGREEMENT MICROSTAR KEG MANAGEMENT, L.L.C. P. O. Box 3129 Redmond, Washington 98073 ____________________, 1997 TO: ALL WHOLESALERS PURCHASING FROM Mendocino Brewing Company, Inc., ("MENDOCINO") RE: KEG MANAGEMENT AGREEMENT CONCLUDED BETWEEN ____________ AND MICROSTAR KEG MANAGEMENT, L.L.C.; TERMS AND CONDITIONS APPLICABLE TO WHOLESALERS Mendocino delivers its products in kegs to ____________________ ("Wholesaler"). Mendocino and MicroStar Keg Management, L.L.C. ("MicroStar") hereby notify Wholesaler that effective ________________, 1997 all shipments from Mendocino will be made in kegs owned by MicroStar and subject to MicroStar's administration and retrieval rights and responsibilities under a Keg Management Agreement between Mendocino and MicroStar dated , 1997 ("the Keg Management Agreement"). Pursuant to the Keg Management Agreement, Mendocino is required to obtain Wholesaler's agreement to the terms and conditions applicable to the MicroStar-owned kegs and to the administrative services being performed by MicroStar for Mendocino. The pertinent requirements applicable to Wholesaler are as follows: 1) Deposits. A deposit computed based upon the amount of XXXXXX per keg ("the Deposit") for each MicroStar keg delivered to Wholesaler will be billed to Wholesaler by MicroStar and shall be payable directly to MicroStar. The Deposit shall serve as security to MicroStar against the loss of any keg owned by MicroStar, based on a charge of XXXXXXX per keg, for any keg the location of which cannot be ascertained. Periodic charges to and withdrawals from the Deposit will be made for kegs which cannot be located. Similarly, credit memos will be issued by MicroStar whenever kegs are returned and whenever kegs previously classified as lost are located. Wholesaler will be invoiced in the amount of XXXXXXX as a loss call whenever any loss is charged to the Deposit and will receive a credit memo from MicroStar and refund of the loss call whenever a previously lost keg for which a loss charge was made is located and returned. 2) Audits. Wholesaler shall be required to provide a monthly written report of the movement of MicroStar kegs in the form(s) prescribed by MicroStar, including inventory by brewer (including Mendocino and any other brewers contracting with MicroStar who deliver product to Wholesaler), empty kegs on hand and kegs in the retail system. Wholesaler also agrees to respond to weekly verbal inquiries by MicroStar representatives concerning the extent of empty MicroStar kegs in Wholesaler's system. MicroStar shall be authorized to conduct periodic audits of Wholesaler's inventory of MicroStar kegs, including kegs in the retail system, which audits will be performed either quarterly or semi-annually, depending upon the extent of Wholesaler's inventory and any discrepancies ascertained as a result of prior audits, etc. Wholesaler's acceptance of deliveries of MicroStar kegs from Mendocino will evidence Wholesaler's agreement to the foregoing terms, conditions and policies. Please confirm receipt of this notice and Wholesaler's agreement to the foregoing terms by signing below and returning a copy of this notice and agreement to MicroStar at the address shown above. Mendocino Brewing Company, Inc. MICROSTAR KEG MANAGEMENT, L.L.C. By: By: ----------------------------- ----------------------------- ACKNOWLEDGED AND AGREED TO AS OF THE DATE FIRST ABOVE WRITTEN: WHOLESALER: By: ----------------------------- EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT MINERAL WASHING/STERILIZING SEQUENCE (STEAM) WASH HEAD Purge out ullage beer with air until clear. 3 sec. Pre-rinse keg with fresh or recovered water. 8 sec. Purge out ore-rinse water with air. 5 sec. Hot caustic or acid wash. 12 sec. Low flow hot caustic or acid wash 12 sec. Purge out hot caustic or acid to recovery tank with air. 6 sec. Final rinse keg with hot water. 12 sec. Low flow hot water rinse. 12 sec. Purge out hot water rinse with steam. 18 sec. Pressurize to 20 p.s.i.g. with steam. 1 sec. Release pressure from process head. 1 sec. STERILIZE HOLD STATION Steam 60 sec. RACKING HEAD Steam conn. head and keg neck. 5 sec. Steam pressure release from keg. 5 sec. Gas purge keg. 8 sec. Counter pressurize to 20 p.s.i.g. 2 sec. Product fill. 50 sec. Spear out. 1 sec. Water scavenge and/or gas scavenge. 5 sec. Page 1 of 5 EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT MINERAL WASHING/SANITIZING SEQUENCE (OXINE) WASH HEAD Purge out ullage beer with air until clear. 3 sec. Pre-rinse keg with Oxine water. 8 sec. Purge out Oxine water with air. 5 sec. Hot caustic or acid wash. 12 sec. Low flow hot caustic or acid wash 12 sec. Purge out hot caustic or acid to recovery tank with air. 6 sec. Final rinse keg with Oxine water. 12 sec. Low flow Oxine water rinse. 12 sec. Oxine water fill. 18 sec. Spear out. 1 sec. Purge head. 1 sec. SANITIZE HOLD STATION Oxine sanitize hold. 60 sec. RACKING HEAD Gas purge Oxine water from keg. 10 sec. Gas counter pressurize to 20 p.s.i.g. 2 sec. Product fill. 50 sec. Spear out. 1 sec. Oxine water scavenge and/or gas scavenge 4 sec. Page 2 of 5 EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT KEG PLANT QUALITY CONTROL CHECKS A. DETERGENT TANK TITRATION The detergent set, detergent tank(s), Quality Control checks should be made before starting and at least twice during each eight (8) hour operating shift. Adjust frequency to meet the Quality Control department "comfort level". The acid titration level (phosphoric) should be in the range of 0.25% to maximum of 0.4% v/v and alkali titration level (caustic) in the range of 1.5 to 2.0% v/v. B. KEG WATER CARRY-OVER AND TITRATION CHECKS 1) After the keg has completed the wash head(s) sequence(s), the keg must be allowed to continue through the sterilizing sequence and then rejected (stopped) immediately prior to commencing the racking head(s) sequence(s). When the keg is retrieved at the discharge end of the machine, the keg can be cooled down by placing a cold water hose over the outer surfaces (if steam is used). A Quality Control keg coupler or funnel coupler (with the C02 and beer check valves removed) is then used to tap the keg. The keg must be inverted to remove the contents via the C02 port of the coupler by allowing the keg to drain or forcing the contents out with air or C02. The condensate or rinse residuals in a 50 liter or 1/2 half barrel keg normally measures between 40 to 80 ml.. A limit of 100 ml. should be set as a maximum allowable limit. If the levels are in excess of these amounts then the machine operation must be checked together with that of the steam quality and relevant steam main condensate traps. 2) The condensate obtained from the keg can be titrated to ensure that there is no acid and/or alkali carry-over from the wash heads. NOTE 1: For this check the pH. of the condensate should be a known factor if steam is used for purging. NOTE 2: This check should be carried out once a day for each machine lane and then reduced to the Quality Control department "comfort level". 3) Another keg is used to do a similar check after it has been allowed to complete the sequences through the racker head(s) up to the point of immediately prior to commencing the beer filling sequence. Reject the keg prior to starting the beer filling sequence and remove the conveyor after discharging from the machine. When checking for the quantity of condensate present in the keg, it should be less than 15 ml. Page 3 of 5 EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT NOTE: This check should be carried out once a day for each machine lane and then reduced to the Quality Control department "comfort level". C. MICROBIOLOGICAL CHECKS TO THE KEG Introduce a liter of sterile liquid, (preferably beer), into a keg having completed the sequence as described in Procedure 3) above, via a sterilized keg valve and "funnel" coupler. This allows the keg to be checked for microbial integrity by removing 250 ml. of the sterile liquid into a sterile flask. Split the sample into two, 100 ml. samples via Millipore type membranes, plate and incubate the membranes on agar suitable for aerobic and anaerobic organisms. Methods of doing this vary slightly. The main objective, however, is to ensure that consistency in sampling is maintained, i.e. having introduced the sterile liquid into the keg, each keg should be rotated a set number of times to ensure all surfaces have been covered equally before it is extracted. A known quantity should always go into the keg and a known quantity should always be extracted, filtered and plated. NOTE 1: This procedure should be carried out at least once every two weeks. NOTE: 2: Funnel couplers can be purchased via IDD to suit your keg valve type. D. AFTER A C.I.P. SEQUENCE After the C.I.P. sequence, the process mains, bright beer tank and racker connection head(s), can be swabbed and checked for visual cleanliness to ensure that the cleaning operation frequencies are effective and adequate. NOTE: This should be carried out at least once a week. E. BEER STABILITY SAMPLING Samples are taken from the bright beer tank and keg at a frequency laid down by the brewery Quality Control department. A suitable stability test is to set aside a keg of beer from the leg line after filling and "forcing" the contents by leaving the keg in an environment of 70(degree) F. (21(degree)C). Taste, odor and clarity tests can then be taken after 72 hours and at regular durations thereafter as desired to suit the Quality Control departments standards. SUMMARY It is possible to determine the following about the keg machine function and cleaning procedures from the aforementioned. Page 4 of 5 EXHIBIT "C" TO KEG MANAGEMENT AGREEMENT 1) The wash water and detergent is being cleared from the keg by the final C02 or steam purge sequence on the final wash head. 2) The final rinse water on the final wash head is removing the detergent residual from the keg. 3) The C02 purge is removing the condensate trace from the keg on the racker head prior to filling with beer. 4) The microbial integrity, via steam sterilizing or Oxine (Cl02) sanitizing of the keg is being achieved. 5) The separate plant C.I.P. sequence is effective in removing all traces of beer protein and other residuals from the keg plant connection head(s) and piping system(s). 6) The cleanliness and microbial integrity is being maintained by the separate plant C.I.P. regime. If you have any questions, please contact Jeff Gunn at IDD Process & Packaging, Inc. 1-800-621-4144 or 805-529-9890. Page 5 of 5 MICROSTAR KEG MANAGEMENT, L.L.C. ACCOUNTING PROCEDURES These accounting procedures are subject to the terms and conditions of the Keg Management Agreement between MicroStar and Brewing Company. In the event of any conflict between these accounting procedures and the Keg Management Agreement (for this purpose, not including this Exhibit as part of such Agreement) the Agreement shall control. Standard Accounting procedures: Procedure: The ongoing standard policy is as follows: 1. Brewing Company shall order kegs 30 days prior to any requested delivery date. Brewing Company will be required to provide ninety (90) days advance written notice to MicroStar for all orders which are 20% or more in excess of normal order quantity. All orders will be confirmed by fax or US mail by close of next business day. All Order(s) shall be deemed incomplete if not confirmed by MicroStar. 2. Brewing Company will be invoiced XXXXXX per keg upon the receipt of each delivery of kegs (30 day terms). This invoicing is generated by shipment date and cross checked with the bill of lading returned by Brewing Company and trucking company invoice. In the event of delinquent payment of any invoice, MicroStar has the right to suspend deliveries of kegs and/or to require future payments to be made prior to delivery of kegs. 3. Brewing Company must provide MicroStar with a bill of lading for all shipments from Brewing Company to its wholesaler(s) within 24 hours of shipment. This bill of lading will be required for inventory control and will generate an invoicing of deposit to wholesaler. Brewing Company is held responsible for lost/unaccounted for kegs under Brewing Company's control (subject to XXXX per lost keg fee). 4. If Brewing Company effectuates a shipment to agreed upon regional wholesaler(s) identified in Exhibit "A-1" to the Keg Management Agreement, a XXXXX credit rebate will be provided to Brewing Company by MicroStar. If applicable, Brewing Company may further specify on Exhibit "A-2" to the Keg Management Agreement up to three (3) local wholesalers which currently impose no freight charge upon Brewing Company for the return of kegs, provided that (i) the wholesalers so designated agree to extend such free keg return arrangements to the keg deliveries to be made pursuant to this agreement, (ii) the timing, quantities and other arrangements relating to such keg returns are and remain consistent with the specific delivery terms prescribed by MicroStar, and (iii) Brewing Company agrees to assume and be responsible for any and all cost of freight for the return of all kegs from such designated local wholesalers. For each full keg sold by Brewing Company to such designated local wholesalers, the applicable adjustment by rebate or credit to Brewing Company will be XXXXXXXXXXXXXXXXXXXX per keg (resulting in an effective use fee to Brewing Company of XXXXXXXXXXXXXXXXXXXX per keg). In the event that any one of the above specified requirements for status as a designated local wholesaler ceases to be applicable, then effective on the date such EXHIBIT "D" TO KEG MANAGEMENT AGREEMENT Page 2 requirement is no longer satisfied, the affected wholesaler shall automatically be regarded as a regional wholesaler covered by Exhibit "A-1" to the Keg Management Agreement. This information concerning local shipments and return of kegs from specific wholesalers shall be cross checked against the bill of lading and/or the signed loading report. Such credit will be applied to Brewing Company's next invoice for kegs or, if a net credit is generated, the credit will be refunded during normal processing within 30 days. With respect to kegs used by Brewing Company in on-site pub operations or self-distributed sales, the use fee shall be XXXXXXXXXXXXXXXXXXXX per keg, per filling. Invoices for such fees will be based upon the monthly report of sales submitted by Brewing Company to applicable state authorities in relation to its on-site pub operations or self-distributed sales, a copy of which shall be furnished to MicroStar at the time such report is filed. 5. MicroStar will invoice wholesaler for a deposit of XXXXXX per keg from the bill of lading or, if no bill of lading, a signed loading report as provided by Brewing Company. 6. MicroStar will credit wholesaler for each empty keg shipped from the wholesaler by and at the direction of MicroStar. The credit will be generated by the bill of lading on shipment and will be corrected for any errors for incorrect shipments including wrong kegs being shipped, mistakes in number of kegs and the damage of kegs at wholesaler level. The information on shipment errors will be provided by Brewing Company upon Brewing Company's receipt of such kegs. 7. Brewing Company is required to provide a written monthly keg movement report including opening inventory, number of kegs received from MicroStar during the month, shipments out (summarized by wholesaler) and ending inventory. Brewing Company will also provide MicroStar or its representative with state and federal tax reports for purpose of cross checking shipments upon request. 8. Brewing Company shall be subject to inspection and audit of inventory by MicroStar during Brewing Company's normal business hours with 24 hour notice (to be given during normal business hours). 9. Brewing Company will be responsible for inventorying kegs received from MicroStar as to the number of kegs received, verification of MicroStar ownership of kegs and identification of any damaged kegs. 10. Wholesaler refund credits will be adjusted for wrong kegs shipped to Brewing Company or damage which occurs at its level. EXHIBIT "D" TO KEG MANAGEMENT AGREEMENT Page 2 EXHIBIT "E" TO KEG MANAGEMENT AGREEMENT Mendocino Brewing Company, Inc. 13351 South Highway 101, Hopland, California 95449 Attention: Mr. Michael Lovett RE: Keg Purchase Terms Pursuant to Section 11.6 of Keg Management Agreement MicroStar Keg Management, L.L.C. ("MicroStar") and Mendocino Brewing Company, Inc. ("Mendocino") are parties to a Keg Management Agreement dated effective _______________, 1997. The following table specifies the prices at which individual kegs are to be valued for purchase by Mendocino pursuant to Section 11.6 of the Keg Management Agreement:
=================================================================================================== AGE OF KEGS (YEARS) VALUE --------------------------------------------------------------------------------------------------- XXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXXXXX XXXXXX --------------------------------------------------------------------------------------------------- XXXXXXXXX XXX ===================================================================================================
The specified values are subject to verification by Mendocino of each keg's condition at time of purchase as being in good working order in compliance with all applicable laws and regulations and prevailing industry standards, and without unusual or excessive wear and/or unusual or excessive body, neck, valve or chimb damage. Mendocino Brewing Company, Inc. Page 2 This joint memorandum is subject to the terms and conditions of the Keg Management Agreement between MicroStar and Brewing Company. In the event of any conflict between this joint memorandum and the Keg Management Agreement (for this purpose, not including this Exhibit as part of such Agreement), the Agreement shall control. The kegs to be purchased pursuant to Section 11.6 shall be such kegs as are then currently available for disposition by MicroStar Keg Management, L.L.C. and it is understood by the parties hereto that the age of the kegs which may then be available cannot presently be ascertained. Mendocino may refuse to purchase any keg that does not conform to the above conditions. The requisite quantities of kegs shall be delivered monthly in prorated portions by MicroStar Keg Management, L.L.C. to Mendocino designated location over an approximate three (3) month period. After confirmation of delivery of conforming kegs, a Bill of Sale will be delivered assigning title to Mendocino free and clear of any lien or security interest and Mendocino shall contemporaneously remit payment for all kegs so purchased. This joint memorandum shall serve to confirm that the foregoing valuations shall apply in the case of a purchase right/obligation accruing upon termination. EXHIBIT "E" TO KEG MANAGEMENT AGREEMENT EX-19.2 3 CHANGE IN TERMS AGREEMENT CHANGE IN TERMS AGREEMENT Borrower: Mendocino Brewing Company, Inc. Lender: SAVINGS BANK OF PO Box 400 MENDOCINO COUNTY Hopland, CA 95449 MAIN OFFICE P.O. Box 3600 200 North School Street Ukiah, CA 95482 Principal Amount: $2,700,000 Date of Agreement: April 1. 1997 DESCRIPTION OF EXISTING INDEBTEDNESS. EXISTING LOAN NUMBER: 8010962256 IN THE ORIGINAL AMOUNT OF $2.700,000.00 DATED 9/25/95 WITH AN OUTSTANDING BALANCE ON IN THE AMOUNT OF $2,700,000.00, WITH INTEREST PAID TO 4/1/97. DESCRIPTION OF COLLATERAL. 1. The outstanding obligation continues to be secured by a security interest in the property described in a Deed of Trust dated 9/25/97 in Book 2366,, Page 544 of Official Records, Mendocino County. DESCRIPTION OF CHANGE IN TERMS. 1. Final maturity of the loan is hereby extended to 7/1/97. 2. Interest continues to be payable monthly commencing on 5/01/97 and monthly thereafter. CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of the original obligation or obligations, including all agreements evidenced or securing the obligations(s), remain unchanged and In full force and effect. Consent by Lender to this Agreement does not waive Lender's right to absolute performance of the obligation(s) as changed, nor obligate Lender to make any future change in terms. Nothing in this Agreement will constitute a satisfaction of the obligation(s). It Is the intention of Lender to retain as liable parties all makers and endorsers of the original obligation(s), including accommodation parties, unless a party is expressly released by Lender in writing. Any maker or endorser, including accommodation makers, will not be released by virtue of this Agreement. If any person who signed the original obligation does not sign this Agreement below, then all persons signing below acknowledge that this Agreement is given conditionally, based on the representation to Lender that the non-signing party consents to the changes and provisions of this Agreement or otherwise will not be released by it. This waiver applies not only to any initial extension, modification or release, but also to all such subsequent actions. PRIOR TO SIGNING THIS AGREEMENT, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS AGREEMENT. BORROWER AGREES TO THE TERMS OF THE AGREEMENT AND ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THE AGREEMENT. BORROWER: Mendocino Brewing Company, Inc. By: __________________________________ By: ______________________________ Michael Laybourn, Chief Executive Officer Norman Franks, Chief Financial Officer EX-27 4 FINANCIAL DATA SCHEDULE
5 The audited financial statements of Mendocino Brewing Company, Inc. as at December 31, 1997 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 494,800 0 317,400 0 380,500 1,346,300 9,810,400 540,100 11,144,600 4,963,100 0 3,869,600 0 227,600 203,200 11,144,600 3,839,700 4,004,700 1,909,700 4,177,000 41,300 0 11,600 (202,000) (78,200) (123,800) 0 0 0 (123,800) (0.05) 0
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