Mendocino Brewing Company, Inc., ("the Company", "MBC", "we" or "us"), was formed in 1983 in California and has two operating subsidiaries: Releta Brewing Company, LLC, ("Releta"), and United Breweries International (U.K.) Limited ("UBIUK"). In the United States (“US”), MBC and its subsidiary, Releta, operate two breweries that produce beer for the specialty "craft" segment of the beer market. The breweries are located in Ukiah, California and Saratoga Springs, New York. The majority of sales for the Company in the US are in California. We brew several brands, of which Red Tail Ale is the flagship brand. In addition, we perform contract brewing for several other brands, and hold the license to produce and distribute Kingfisher Premium Lager Beer in the US and Canada. In accordance with state and local laws, product shipments are generally made directly from the breweries to the wholesalers or distributors in accordance with state and local laws.

Our United Kingdom (“UK”) subsidiary, UBIUK, is a holding company for Kingfisher Beer Europe Limited, (“KBEL”) which, prior to March 30, 2011, was known as UBSN Limited (“UBSN”). KBEL is the distributor of Kingfisher Premium Lager Beer in the UK and Europe. The distributorship is located in Maidstone, Kent in the UK.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with US generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US generally accepted accounting principles for complete annual financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the financial condition, results of operations and cash flows for the periods presented. Except as otherwise noted, such adjustments consist only of normal recurring adjustments. These condensed financial statements should be read in conjunction with the audited consolidated financial statements included in our most recent Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, which contains additional financial and operating information and information concerning the significant accounting policies followed by us. The financial statements and notes are representations of the management and the Board of Directors, who are responsible for their integrity and objectivity.

We consider all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Other investments with maturities less than twelve months from the balance sheet date are considered short-term investments, and those with maturities greater than twelve months from the balance sheet date are considered long-term investments.

We consider the recorded value of certain of its financial assets and liabilities, which consist primarily of cash and cash equivalents, accounts receivable, other current assets, accounts payable and accrued expenses, to approximate the fair value of the respective assets and liabilities at September 30, 2011 and December 31, 2010 based upon the short-term nature of the assets and liabilities. Based on borrowing rates currently available to us for loans with similar terms, the carrying value of short and long term notes payable approximate fair value.

"The Fee for the Arrangement is Fixed or Determinable" – Prior to recognizing revenue, an amount is either fixed or determinable under the terms of the written contract. The price is negotiated at the outset of the arrangement and is not subject to refund or adjustment during the initial term of the arrangement.

"Collectability is Reasonably Assured" – Collectability is assessed on a customer-by-customer basis based on criteria outlined by our management. We do not enter into arrangements unless collectability is reasonably assured at the outset. Existing customers are subject to ongoing credit evaluations based on payment history and other factors. If it is determined during the arrangement that collectability is not reasonably assured, revenue is recognized on a cash basis.

We record certain consideration paid to customers for services or placement fees as a reduction in revenue rather than as an expense. We report these items on the income statement as a reduction in revenue and as a corresponding reduction in marketing and selling expenses.

We have agreements with Shepherd Neame Limited ("Shepherd Neame") to produce, market and distribute Kingfisher Premium Lager Beer in the UK. See Notes 6 and 9 of the Financial Statements regarding transactions with Shepherd Neame. We invoice Shepherd Neame based on an agreed transfer price per unit, which is subject to revision upon reconciliations based on contractual formulas.

We use the allowance method to account for uncollectible accounts receivable. Our estimate is based on historical collection experience and a review of the current status of accounts receivable. We review our accounts receivable balances by customer for accounts greater than 90 days old and make a determination regarding the collectability of the accounts based on specific circumstances and the payment history that exists with such customers. We also take into account our prior experience, the customer’s ability to pay and an assessment of the current economic conditions in determining the net realizable value of our receivables. We also review our allowances for doubtful accounts in aggregate for adequacy following this assessment. Accordingly, we believe that our allowances for doubtful accounts fairly represent the underlying collectability risks associated with our accounts receivable.

Inventory consists of raw materials, work in progress, and finished goods. Inventory is stated at the lower of cost or market using the average-cost method. Cost includes the acquisition cost of raw materials and components, direct labor, and manufacturing overhead. We periodically review our inventory for excess or quality issues. Should we conclude that we have inventory for which we cannot recover our costs as a result of such review, we would record a charge to cost of goods sold. We record write downs for excess and obsolete inventory equal to the difference between the cost of inventory and the estimated fair value based on assumptions about future product life-cycles, product demand and market conditions. If actual product life cycles, product demand and market conditions are less favorable than those projected by our management, additional inventory write-downs may be required.

Costs relating to obtaining financing are capitalized and amortized over the term of the related debt. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations. Deferred financing costs of $311,300 related to loans repaid in June 2011 were fully amortized as of June 30, 2011. Deferred financing costs related to new borrowing made in June 2011 were $225,000. Amortization of deferred financing costs charged to operations was $11,250 and $43,900 for the three and six months ended September 30, 2011, respectively. Amortization of deferred financing costs charged to operations was $16,300 and $49,000 for the three and nine months ended September 30, 2010, respectively.

Financial instruments that could subject us to credit risk consist principally of trade receivables, cash deposits in excess of FDIC limits, and assets located in the UK. Substantially all of our cash deposits are deposited with commercial banks in the US and the UK.

Wholesale distributors account for substantially all accounts receivable; therefore, this risk concentration is limited due to the number of distributors and the laws regulating the financial affairs of distributors of alcoholic beverages. We had approximately $43,400 in cash deposits and $2,320,400 of accounts receivable due from customers located in the UK as of September 30, 2011.

Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement bases and the respective tax bases of the assets and liabilities and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized, and have been provided for all periods presented.

The basic earnings (loss) per share is computed by dividing the earnings (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period. Basic net earnings (loss) per share exclude the dilutive effect of stock options or warrants and convertible notes. If our operations result in net loss for any period, diluted net loss per share would be the same as basic net loss per share, since the effect of any potentially dilutive securities would be anti-dilutive. Therefore, the conversion of the related party notes has been excluded from our calculation of net loss per share for the three and nine months ended September 30, 2010. The computations of basic and dilutive net loss per share are as follows:

	Three months ended					Nine months ended
	9/30/2011		9/30/2010			9/30/2011		9/30/2010
Net income (loss)	$	390,500		(321,800	)	$	566,600		(764,800	)
Weighted average common shares outstanding		12,461,993		12,427,262			12,438,839		12,427,262
Basic net income (loss) per share	$	0.03		(0.03	)	$	0.05		(0.06	)
Interest expense on convertible notes	$	22,900		—		$	68,000		—
Income for purpose of computing diluted net income per share	$	413,400		(321,800	)	$	634,600		(764,800	)
Incremental shares from assumed exercise of dilutive securities		2,211,332		—			2,211,332		—
Dilutive potential common shares		14,673,325		12,427,262			14,650,171		12,427,262
Diluted net earnings per share	$	0.03		(0.03	)	$	0.04		(0.06	)

The assets and liabilities of UBIUK were translated at the UK pound sterling - US dollar exchange rates in effect at September 30, 2011 and December 31, 2010, and the statements of operations were translated at the average exchange rates for each of the three and nine months ended September 30, 2011 and 2010. Gains and losses resulting from the translations were deferred and recorded as a separate component of consolidated stockholders' equity. Cash at UBIUK was translated at exchange rates in effect at September 30, 2011 and December 31, 2010, and its cash flows were translated at the average exchange rates for each of the three and nine months ended September 30, 2011 and 2010. Changes in cash resulting from the translations are presented as a separate item in the statements of cash flows.

The preparation of financial statements in conformity with accounting principles generally accepted in the US includes having us 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. Significant estimates include the allowance for bad debts, depreciation and amortization periods, and the future utilization of deferred tax assets.

We evaluate performance based on income from operations. Where applicable, portions of the administrative function expenses are allocated between the operating segments. The operating segments do not share manufacturing or distribution facilities. In the event any materials and/or services are provided to one operating segment by the other, the transaction is valued according to our transfer policy, which approximates market price. The costs of operating the manufacturing plants are captured discretely within each segment. Our property, plant and equipment, inventory, and accounts receivable are captured and reported discretely within each operating segment.