10-Q 1 t10q-7318.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005 ------------- | | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to _______________ Commission file number 1-13636 MENDOCINO BREWING COMPANY, INC. (Exact name of Registrant as Specified in its Charter) CALIFORNIA 68-0318293 (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 1601 AIRPORT ROAD, UKIAH, CA 95482 (Address of principal executive offices) (707) 463-6610 (Registrant's Telephone Number, Including Area Code) Not Applicable (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X ] APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: The number of shares of the issuer's common stock outstanding as of June 30, 2005 is 11,473,914.
PART I ITEM 1. FINANCIAL STATEMENTS. MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (UNAUDITED) ASSETS JUNE 30, DECEMBER 31, 2005 2004 CURRENT ASSETS Cash $ 524,900 $ 526,600 Accounts receivable, allowance for doubtful 7,752,600 8,477,200 accounts of $36,500 and $27,500 Inventories 1,148,200 1,185,400 Prepaid expenses 753,200 347,300 ----------- ----------- Total Current Assets: 10,178,900 10,536,500 ----------- ----------- PROPERTY AND EQUIPMENT 13,306,200 13,533,900 ----------- ----------- OTHER ASSETS Deposits and other assets 195,800 205,100 Intangibles net of amortization 82,200 87,600 ----------- ----------- Total Other Assets: 278,000 292,700 ----------- ----------- Total Assets: $23,763,100 $24,363,100 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Line of credit $ 3,846,500 $ 3,282,200 Note payable 576,200 576,200 Accounts payable 5,376,800 5,897,600 Accrued liabilities 1,365,800 1,402,900 Legal dispute settlement 200,000 911,800 Income taxes payable 192,400 134,100 Current maturities of obligation under long-term debt 388,000 400,300 Current maturities of obligation under capital lease 123,600 146,500 ----------- ----------- Total Current Liabilities: 12,069,300 12,751,600 NOTES TO RELATED PARTY 2,473,300 2,010,100 Long term debt, less current maturities 3,013,100 3,384,800 OBLIGATIONS UNDER CAPITAL LEASE, less current maturities 26,400 62,600 ----------- ----------- Total Liabilities: 17,582,100 18,209,100 ----------- ----------- -1-
COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY Preferred stock, Series A, no par value, with aggregate liquidation preference of $227,600; 10,000,000 shares authorized, 227,600 shares issued and outstanding 227,600 227,600 Common stock, no par value: 30,000,000 shares authorized, 11,473,914 and 11,266,874 shares 14,747,300 14,648,600 issued and outstanding Accumulated comprehensive income 108,900 194,300 Accumulated deficit (8,902,800) (8,916,500) ----------- ----------- Total Stockholders' Equity 6,181,000 6,154,000 ----------- ----------- Total Liabilities and Stockholders' Equity: $23,763,100 $24,363,100 =========== =========== The accompanying notes are an integral part of these financial statements. -2-
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED SIX MONTHS ENDED June 30 June 30 2005 2004 2005 2004 ---- ---- ---- ---- SALES $ 8,408,800 $ 8,374,600 $ 15,814,900 $ 15,320,600 EXCISE TAXES 168,200 187,500 317,400 330,300 ------------- ------------- ------------- ------------- NET SALES 8,240,600 8,187,100 15,497,500 14,990,300 COST OF GOODS SOLD 5,538,400 5,372,500 10,524,800 10,007,300 ------------- ------------- ------------- ------------- GROSS PROFIT 2,702,200 2,814,600 4,972,700 4,983,000 ------------- ------------- ------------- ------------- OPERATING EXPENSES Marketing 1,276,800 1,478,400 2,593,000 2,806,700 General and administrative 969,300 922,400 1,872,500 1,906,500 ------------- ------------- ------------- ------------- 2,246,100 2,400,800 4,465,500 4,713,200 ------------- ------------- ------------- ------------- Income from operations 456,100 413,800 507,200 269,800 ------------- ------------- ------------- ------------- Other income (expense) Other income 36,400 5,100 41,000 9,100 Profit (Loss) on sale of equipment (5,900) 15,600 (9,200) 14,000 Interest expense (233,000) (210,700) (453,600) (422,700) ------------- ------------- ------------- ------------- (202,500) (190,000) (421,800) (399,600) ------------- ------------- ------------- ------------- INCOME (LOSS) before income taxes 253,600 223,800 85,400 (129,800) PROVISION FOR INCOME TAXES 41,500 57,400 71,700 78,200 ------------- ------------- ------------- ------------- Net INCOME (Loss) $ 212,100 $ 166,400 $ 13,700 $ (208,000) ------------- ------------- ------------- ------------- OTHER COMPREHENSIVE INCOME / (LOSS), net of tax (76,100) (36,400) (85,400) 25,700 ------------- ------------- ------------- ------------- Foreign Currency Translation Adjustment COMPREHENSIVE Income (LOSS) $ 136,000 $ 130,000 $ (71,700) $ (182,300) ============= ============= ============= ============= NET INCOME (LOSS) PER COMMON SHARE $ 0.02 $ 0.01 $ 0.00 $ (0.02) ============= ============= ============= ============= DILUTED NET INCOME (LOSS) PER COMMON SHARE $ 0.02 $ 0.01 $ 0.00 $ (0.02) ============= ============= ============= ============= The accompanying notes are an integral part of these financial statements. -3-
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30 2004 2004 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income (Loss) $ 13,700 $ (208,000) Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation and amortization 453,800 536,400 Allowance for doubtful accounts 9,000 49,000 Loss (Profit) on sale of assets 9,200 (14,000) Changes in: Accounts receivable 275,300 16,900 Inventories 37,200 16,500 Prepaid expenses (425,300) 148,100 Deposits and other assets 30,900 (38,700) Accounts payable (264,900) (16,600) Accrued liabilities (611,900) (437,300) Income taxes payable 69,900 (189,900) ----------- ----------- Net cash from operating activities: (403,100) (137,600) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, equipment, and leasehold improvements (396,700) (280,100) Proceeds from new distributors -- -- Proceeds from sale of fixed assets 73,100 23,200 ----------- ----------- Net cash from investing activities: (323,600) (256,900) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Net borrowing on line of credit 704,600 807,500 Repayment on long-term debt (331,000) (381,500) Borrowings on related party debt 463,200 41,600 Payments on obligation under long term lease (59,100) (56,900) ----------- ----------- Net cash from financing activities: 777,700 410,700 ----------- ----------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (52,700) 12,900 ----------- ----------- NET CHANGE IN CASH (1,700) 29,100 ----------- ----------- CASH, beginning of period 526,600 554,300 ----------- ----------- CASH, end of period $ 524,900 $ 583,400 =========== =========== SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the period for: Interest $ 390,400 $ 319,300 Income taxes $ - $ 100,300 Non-cash investing activity Seller Financed equipment $ 29,500 $ 26,500 The accompanying notes are an integral part of these financial statements. -4-
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE 1 - BASIS OF PRESENTATION As used herein, the term "the Company" and its variants is generally used to refer to Mendocino Brewing Company, Inc. and its subsidiaries, while the term "MBC" is used to refer to Mendocino Brewing Company, Inc. as an individual entity standing alone. The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2004. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three months ended June 30, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. NOTE 2 - LINE OF CREDIT The Company had available a $3,500,000 line of credit secured by substantially all of the assets of the Releta Brewing Company, LLC, accounts receivable and inventory of the Ukiah Brewery, certain securities pledged by a stockholder, and a second position on the real property of the Ukiah Brewery. The Company used the proceeds from the BFI Line of Credit (discussed below) and paid off the entire amount outstanding under this line of credit on May 6, 2005. On May 5, 2005, the Company entered into a receivables and inventory-based line of credit transaction with BFI Business Finance ("BFI"), pursuant to which BFI has provided the Company with a $2,000,000 maximum revolving line of credit with an advance rate based on 80% of MBC's qualified accounts receivable, 70% of Releta's qualified accounts receivable, and 50% of the eligible inventory carried by both MBC and Releta (the "BFI Line of Credit"). At the same time, BFI also advanced the Company $53,740 under a promissory note. On May 6, 2005, the Company used the entire immediately available amount drawable under these facilities to pay off the balance remaining outstanding under the CIT Line of Credit (discussed above). On June 30, 2005 BFI advanced the Company $200,000 under a promissory note repayable in 30 weekly installments. The total amount outstanding on these facilities as of June 30, 2005 was $1,576,700. On December 31, 2003, Savings Bank of Mendocino County ("SBMC") extended a temporary loan in the principal amount of $576,200 to MBC in -5- order to finance a buy-out of equipment leased through Finova Capital Corporation. The lender has committed to extend the loan until May 2006. The rate of interest on the loan is prime plus 3%. Nedbank Limited, a South African registered company, provided a credit facility of GBP 1,250,000 to UBSN Ltd. ("UBSN"), a wholly-owned subsidiary of United Breweries International (UK) Ltd. ("UBI"), which is in turn wholly-owned by the Company. This facility included a revolving short-term loan, overdraft protection, and foreign exchange services. It was available until terminated by Nedbank, and was secured by all of the assets of UBSN. On April 6, 2005, the balance remaining outstanding on the Nedbank facility was settled in full using the proceeds from the RBS facility (discussed below). On April 26, 2005, Royal Bank of Scotland ("RBS") provided an invoice discounting facility for a maximum amount of GBP 1,750,000 based on 80% prepayment against qualified accounts receivable related to UBSN's United Kingdom customers. The initial term of the facility is for a period of one year after which the facility can be terminated by either party by providing the other party a notice of six months. The facility carries an interest rate of 1.38% above RBS base rate and a service charge of 0.10% of each invoice discounted. The amount outstanding on this line of credit as of June 30, 2005 was approximately $2,269,800. NOTE 3 - LONG TERM DEBT, NOTE PAYABLE, AND NOTES TO RELATED PARTIES The Company has a note outstanding in the principal amount of $2,700,000 in favor of Savings Bank of Mendocino County ("SBMC"), with interest at the five-year treasury constant maturity index plus 4.17%, currently 7.24%. The note requires monthly payments of principal and interest of $24,400. The note matures in December 2012 with a balloon payment of $932,600, and is secured by real property located in Ukiah, California. The amount outstanding on this note as of June 30, 2005 was approximately $2,235,100. As of June 30, 2005, the balance of the delinquent property taxes due on the Company's Ukiah property was approximately $430,900. Pursuant to an agreement with Mendocino County, the remaining balance of the overdue taxes should be paid in three annual installments, due on or before April 10, 2006, 2007, and 2008, each representing 20% or more of the original overdue balance, along with accrued interest calculated at 18% per year. The Company made a payment on April 8, 2005 of $143,600, or 20% of the original amount outstanding, together with interest accrued until March 2005. UBSN has engaged Shepherd Neame Limited ("Shepherd Neame") to brew Kingfisher Lager for the Company's European and Canadian markets. As consideration for the extension of the brewing contract, Shepherd Neame advanced a loan of GBP 600,000 to UBSN, repayable in ten annual -6- installments of GBP 60,000, commencing in June 2003. The loan carries an interest rate of 5% per year. The amount outstanding on this loan as of June 30, 2005 was approximately GPB 410,000 ($735,100 in US Dollars). On August 31, 1999, MBC and United Breweries of America, Inc. ("UBA"), one of the Company's principal shareholders, entered into a Master Line of Credit Agreement, which was subsequently amended in April 2000 and February 2001 (the "Credit Agreement"). The terms of the Credit Agreement provide the Company with a line of credit in the principal amount of up to $1,600,000. The notes bear interest at the prime rate plus 1.5%, subject to a maximum of 10% per annum, and each note originally matured 18 months from the date of the particular advance. The Company and UBA have executed an Extension of Term of Notes under Master Line of Credit Agreement, which confirms the Company's and UBA's extension of the terms of the UBA notes for a period ending on August 31, 2005. The Company expects the maturity dates to be extended again. On December 28, 2001, the Company and UBA entered into a Confirmation of Waiver which confirms that as of August 13, 2001, UBA waived its rights with regard to all conversion rate protection as set forth in the UBA notes. Although technically UBA has the right to demand payment within 60 days of the extension date, it is currently precluded from doing so because the notes are subordinated to the long-term debt agreement with SBMC and the BFI Line of Credit. Because of the subordination, the Company has shown these notes as long term debt. UBA loaned the Company another $400,000 on March 1, 2005, in connection with which the Company then issued to UBA another convertible note maturing 18 months from that date. All of the notes are convertible, at UBA's option, into common stock at $1.50 per share. As of June 30, 2005, the aggregate principal balance due under these Notes was $1,915,400; interest accrued on the Notes is approximately $557,900. These notes are subordinated to the credit facilities extended to the Company by BFI and SBMC pursuant to subordination agreements executed by UBA. As per the terms of the subordination agreements, UBA is precluded from demanding repayment of the notes due unless the BFI and SBMC facilities are settled in full. The BFI Line of Credit matures in May 2006 and the SBMC facility matures in the year 2012. Therefore, the Company will not require the use of working capital to repay any of the UBA notes until the BFI and SBMC facilities are repaid. The Company also expects the maturity dates of all of the notes to UBA to be extended, although there is no current agreement to do so. Accordingly, the entire amount due under the notes is classified as a long term liability. -7- NOTE 4 -- RELATED PARTY TRANSACTIONS MBC and its subsidiaries have entered into or amended several agreements with affiliated and related entities. Among these were a Market Development Agreement, a Distribution Agreement, and a Brewing License Agreement between MBC and UBSN; a Distribution Agreement between UBI and UBSN; a Trademark Licensing Agreement between MBC and Kingfisher of America, Inc.; and a License Agreement between UBI and UB Limited. Additional information about these transactions may be found in the Company's annual report on Form 10-K for the year ended December 31, 2004. The following table reflects the value of the transactions for six months ended June 30, 2005 and 2004. ------------------------------------------------ -------------- -------------- 2005 2004 ------------------------------------------------ -------------- -------------- Interest expenses associated with UBA convertible notes payable $63,300 41,600 ------------------------------------------------ -------------- -------------- ------------------------------------------------ -------------- -------------- ------------------------------------------------ -------------- -------------- NOTE 5 - NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE Basic earnings per share (EPS) is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing income available to shareholders by the weighted average number of common shares and common equivalent shares outstanding, which include dilutive stock options and notes payable convertible in common stock. Common equivalent shares associated with stock options and convertible notes payable have been excluded from the periods as the potentially dilutive shares would be antidilutive.
Three Months Ended Six Months Ended ------------------ ---------------- 6/30/2005 6/30/2004 6/30/2005 6/30/2004 ---------------------------------------------------------------------------- Net income (loss) $ 212,100 $ 166,400 $ 13,700 $ (208,000) ================== ================== =================== ================== Weighted average common shares outstanding 11,473,914 11,266,874 11,473,914 11,266,874 ================== ================== =================== ================== Basic net income (loss) per share $ 0.02 $ 0.01 $ 0.00 $ (0.02) ================== ================== =================== ================== Diluted net income (loss) per share Net income (loss) $ 212,100 $ 166,400 $ 13,700 $ (208,000) Interest expense on convertible notes 35,000 21,000 63,200 -- payable ------------------ ------------------ ------------------- ------------------ Income for the purpose of computing diluted net income per share $ 247,100 $ 187,400 $ 76,900 $ (208,000) ================== ================== =================== ==================
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Weighted average common shares outstanding 11,473,914 11,266,874 11,473,914 11,266,874 Dilutive stock options -- -- -- -- Assumed conversion of convertible notes -- -- -- -- payable ------------------ ------------------ ------------------- ------------------ Weighted average common shares outstanding for the purpose of computing diluted net income (loss) per share 11,473,914 11,266,874 11,473,914 11,266,874 ================== ================== =================== ================== Diluted net income (loss) per share $ 0.02 $ 0.01 $ 0.00 $ (0.02)
NOTE 6 - INVENTORY JUNE 30, 2005 DECEMBER 31, 2004 Raw Materials $ 356,800 $ 357,500 Beer-in-process 181,500 140,100 Finished Goods 583,300 664,700 Merchandise 26,600 23,100 ---------- ---------- TOTAL $1,148,200 $1,185,400 ========== ========== NOTE 7 - STOCKHOLDERS' EQUITY The following table summarizes equity transactions during the six months ended June 30, 2005.
SERIES A PREFERRED STOCK COMMON STOCK OTHER -------------------------- ---------------------------- COMPREHENSIVE ACCUMULATED TOTAL SHARES AMOUNT SHARES AMOUNT INCOME / (LOSS) DEFICIT EQUITY ------------- ------------ ------------- -------------- ----------------- --------------- -------------- Balance, December 31, 2004 227,600 $ 227,600 11,266,874 $ 14,648,600 $194,300 $ (8,916,500) $ 6,154,000 Stock issued for services 207,040 98,700 98,700 Net Income 13,700 13,700 Currency Translation Adjustment (85,400) (85,400) Balance, June 30, 2005 227,600 $ 227,600 11,473,914 $ 14,747,300 $108,900 $ (8,902,800) $ 6,181,000 ============= ============ ============= ============== ================= =============== ==============
-9- NOTE 8 - STOCK BASED COMPENSATION The Company had a stock-based employee compensation plan that allowed the Company to grant options to purchase up to 1,000,000 shares of the Company's common stock. The plan expired in 2004. The Company accounts for the options that had been issued from this plan under the recognition and measurement principles of APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related Interpretations. NOTE 9. SEGMENT INFORMATION The Company's business segments are brewing operations, distributing operations in the United Kingdom, and retail sales at the Hopland Brewery and the tasting room at Saratoga Springs. A summary of each segment is as follows:
Six months ended June 30, 2005 Domestic European Retail Corporate & Operations Territory Operations Others Total Sales $ 5,732,000 $ 9,988,200 $ 94,700 $ -- $15,814,900 Operating Profit 181,000 318,000 8,200 -- 507,200 Identifiable Assets 12,908,100 8,302,100 102,900 2,450,000 23,763,100 Depreciation & 235,200 200,200 2,500 15,900 453,800 amortization Capital Expenditures 34,200 362,500 -- -- 396,700 Six months ended June 30, 2004 Domestic European Retail Corporate & Operations Territory Operations Others Total Sales $ 5,740,800 $ 9,488,800 $ 91,000 $ -- $ 15,320,600 Operating Profit/(Loss) 15,600 258,700 (4,500) -- 269,800 Identifiable Assets 13,394,000 7,105,000 95,100 2,564,900 23,159,000 Depreciation & 302,000 216,600 2,500 15,300 536,400 amortization Capital Expenditures 26,500 253,600 -- -- 280,100
-10- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity, and cash flows of the Company for the six months ended June 30, 2005, compared to the six months ended June 30, 2004. This discussion should be read in conjunction with the Consolidated Financial Statements and Notes included in the company's Annual Report on Form 10-K for the year ended December 31, 2004. In this Report, the term "the Company" and its variants is generally used to refer to Mendocino Brewing Company, Inc. and its subsidiaries, while the term "MBC" is used to refer to Mendocino Brewing Company, Inc. as an individual entity standing alone. FORWARD LOOKING STATEMENTS Various portions of this Quarterly Report, including but not limited to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations," contain forward-looking information. Such information involves risks and uncertainties that are based on current expectations, estimates and projections about the Company's business, Management's beliefs, and assumptions made by Management. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and variations of those and similar words are intended to identify such forward-looking information. Any forward-looking statements made by the Company are intended to provide investors with additional information with which they may assess the Company's future potential. All forward-looking statements are based on assumptions about an uncertain future and are based on information available at the date such statements are issued. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking information due to numerous factors, including but not limited to: changes in the pricing environment for the Company's products; changes in demand for malt beverage products in different Company markets; changes in distributor relationships or performance, changes in customer preference for the Company's malt beverage products; regulatory or legislative changes; the impact of competition, changes in raw materials prices; availability of financing for operations, changes in interest rates; changes in the company's European beer and/or restaurant business, and other risks discussed elsewhere in this Quarterly Report and from time to time in the Company's other filings and reports made with the Securities and Exchange Commission (the "Commission"). In addition, such statements could be affected by general industry and market conditions and growth rates, and in general domestic and European economic and political conditions. The Company undertakes no obligation to update these forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made or to publicly release the results of any revision to these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements. -11- CRITICAL ACCOUNTING POLICIES In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes that the following discussion addresses the Company's most critical accounting policies, which are those that are most important to the portrayal of the Company's financial condition and results. The Company constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate. Historically, actual results have not significantly deviated from those determined using the necessary estimates inherent in the preparation of financial statements. Estimates and assumptions include, but are not limited to, customer receivables, inventories, assets held for sale, fixed asset lives, contingencies and litigation. The Company has also chosen certain accounting policies when options were available, including: o The first-in, first-out (FIFO) method to value the majority of the Company's inventories. o The Company follows Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," in accounting for its employee stock options using the intrinsic value based method. o The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company's evaluation is based on an estimate of the future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. Long-lived asset are written down to their estimated net fair value calculated using a discounted future cash flow analysis in the event of an impairment. If circumstances related to the Company's long-lived assets change, the Company's valuation of the long-lived assets could materially change. o The Company evaluates the realizability of its deferred tax assets quarterly by assessing the need for and amount of the valuation allowance. This evaluation is based on an assessment of the Company's ability to generate future U.S. taxable income. Results of operations in recent years are considered in the assessment. The Company records a valuation allowance for the portion of its deferred tax assets that do not meet the recognition criteria of SFAS No. 109, "Accounting for Income Taxes." If circumstances related the Company's ability to generate future U.S. taxable income -12- change, the Company's evaluation of its deferred tax assets could materially change. o The Company has adopted EITF - 01-09 "Accounting for Consideration Given by a Vendor to a Customer (including a Reseller of the Vendor's Products)". This EITF requires that certain cash consideration paid to customers for services or placement fees are to be reported as a reduction in revenue rather than as an expense. The Company has reclassified these items on the income statement as a reduction in revenue and as a corresponding reduction in marketing and selling expenses. This reclassification has no impact on net income. These accounting policies are applied consistently for all years presented. The Company's operating results would be affected if other alternatives were used. Information about the impact on operating results is included in the footnotes to the Company's consolidated financial statements. SEGMENT INFORMATION Prior to 2001, the Company's business operations were exclusively located in the United States, where it was divided into two segments, manufacturing and distribution of beer, which accounted for the majority of the Company's gross sales, and retail sales (primarily at the Company's Hopland, California, tavern and merchandise store) which generally accounted for less than 5% of gross sales (by revenue). With the Company's acquisition of United Breweries International (UK) , Ltd. ("UBI") in August 2001, however, the Company gained a new business segment, distribution of beer outside the United States, primarily in the U.K. and Ireland, continental Europe, and Canada (the "European Territory"). This segment accounted for 62% of the Company's gross sales during the first six months of the year 2005 (as compared to 62% for the same period during 2004), with the Company's United States operations, including manufacturing and distribution of beer as well as retail sales accounting for the remaining 38%. With expanded wholesale distribution of beer, 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 Sales of the Company's products are somewhat seasonal. Historically, sales (by volume) in all geographic areas have been comparatively low during the first quarter of the calendar year in both the US market and the Company's European Territory. In the US, sales have been stronger during the second and third quarters and slower again during the fourth quarter, while in the Company's European Territory the fourth quarter has generated the highest -13- sales volume. The volume of sales in any given area may also be affected by local weather conditions. Because of the seasonality of the Company's business, results for any one quarter are not necessarily indicative of the results that may be achieved for the full fiscal year. SUMMARY OF FINANCIAL RESULTS The Company ended the first six months of the year 2005 with a net income of $13,700, as compared to a net loss of $208,000 for the same period in 2004. As set forth more fully under "Results of Operations," below, during the first six months of the year 2005 the Company experienced an increase in gross sales of $494,300, or 3.2% as compared to the corresponding period in 2004. Costs of goods sold increased by $517,500, or 5.2%, marketing costs decreased by $213,700, or 7.6%, general and administrative costs decreased by $34,000, or 1.8%, and interest expenses increased by $30,900, or 7.3%. RESULTS OF OPERATIONS The following tables set forth, as a percentage of net sales, certain items included in the Company's Statements of Operations. See the accompanying Financial Statements and Notes thereto.
THREE MONTHS ENDED SIX MONTHS ENDED STATEMENTS OF OPERATIONS DATA: JUNE 30, JUNE 30, ------------------------------------- -------------------------------- 2005 2004 2005 2004 % % % % - - - - Sales 102.04 102.29 102.05 102.20 Less Excise taxes 2.04 2.29 2.05 2.20 NET SALES 100.00 100.00 100.00 100.00 Costs of Sales 67.21 65.62 67.91 66.76 GROSS PROFIT 32.79 34.38 32.09 33.24 Marketing 15.49 18.06 16.73 18.72 General and Administrative Expense 11.76 11.27 12.08 12.72 PROFIT FROM OPERATIONS 5.53 5.05 3.28 1.80 Other Income / (Expense) 0.37 0.25 0.20 0.15 Interest Expense (2.83) (2.57) (2.93) (2.82) Income/(Loss) before income taxes 3.07 2.73 0.55 (0.87) Provision for income taxes 0.50 0.70 0.46 0.52 NET INCOME / (LOSS) 2.57 2.03 0.09 (1.39) Other Comprehensive Income / (loss) (0.92) (0.44) (0.55) 0.17 COMPREHENSIVE INCOME / (LOSS) 1.65 1.59 (0.46) (1.22)
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--------------------------------- SIX MONTHS ENDED JUNE 30, --------------------------------- 2005 2004 BALANCE SHEET DATA: $ $ - - Cash and Cash Equivalents 524,900 583,400 Working Capital (1,890,400) (2,090,500) Property and Equipment 13,306,200 13,632,400 Deposits and Other Assets 278,000 284,200 Total Assets 23,763,100 23,159,000 Long-term Debt (less current maturities) 3,013,100 3,409,200 Capital Lease (less current maturities) 26,400 129,500 Total Liabilities 17,582,100 16,834,700 Accumulated Deficit (8,902,800) (8,655,600) Stockholder's equity 6,181,000 6,324,300
THREE MONTHS ENDED JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004 NET SALES Overall net sales for the second quarter of 2005 were $8,240,600, an increase of $53,500, or 0.65%, compared to $8,187,100 for the second quarter of 2004. The increase was mainly due to increased sales, increased prices for products in the United Kingdom, and exchange rate fluctuations. Domestic Operations: Net sales for the second quarter of 2005 were $2,992,500 compared to $3,165,000 for the same period in 2004, a decrease of $172,500, or 5.45%. The sales volume decreased to 15,691 barrels in the second quarter of 2005 from 16,883 barrels in second quarter of 2004; a net decrease of 1,192 barrels, or 7.06%. The bulk of the decrease (1,099 barrels) was made up of sales of the Company's domestic brands. Sales of contract brands decreased by 113 barrels, but sales of Kingfisher brands increased by 20 barrels. EUROPEAN TERRITORY: Net sales for the second quarter of 2005 were $5,248,100 (GBP 2,823,900) compared to $5,022,100 (GBP 2,777,800) during the corresponding period of 2004, an increase of $226,000, or 4.5%. During the second quarter of 2005, UBSN sold 17,059 barrels, compared to 16,743 barrels during the second quarter of 2004, representing an increase of 316 barrels, or 1.89%. Exchange rate fluctuations increased the financial effect of the Company's growth in sales in its European Territory. When measured from period to period exclusively in Pounds Sterling (which is the basic currency of account for the European Territory), the Company's net sales in its European Territory increased by only 1.66%. -15- COST OF GOODS SOLD Cost of goods sold as a percentage of net sales during the second quarter of 2005 was 67.21%, as compared to 65.62% during the corresponding period of 2004, mainly due to increased costs in the United States. DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in the United States during the second quarter of 2005 was 64.71%, as compared to 63.55% during the corresponding period of 2004. This slight increase of 1.16% is mainly the result of increases in packaging materials and wages, which were partly offset by a decrease in depreciation. EUROPEAN TERRITORY: Cost of goods sold as a percentage of net sales in the United Kingdom during the second quarter of 2005 was 69.03%, as compared to 67.4% during corresponding period in 2004 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation), representing an increase as a percentage of net sales of 1.63%. The increase in prices for the Company's products did not fully offset the cost increases in the United Kingdom. GROSS PROFIT As a result of the higher cost of goods described above, gross profit for the second quarter of 2005 decreased to $2,702,200, from $2,814,600 during the corresponding period of 2004, representing a decrease of 3.99%. As a percentage of net sales, the gross profit during the second quarter of 2005 decreased to 32.79% from 34.38% for the second quarter of 2004. OPERATING EXPENSES Operating expenses for the second quarter of the year 2005 were $2,246,100, a decrease of $154,700, or 6.44%, as compared to $2,400,800 for the corresponding period of the year 2004. Operating expenses consist of marketing and distribution expenses and general and administrative expenses. MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and distribution expenses consist of salaries and commissions, advertising costs, product and sales promotion costs, travel expenses and related costs and the Company's tavern and tasting room expenses. Such expenses for the second quarter of 2005 were $1,276,800, as compared to $1,478,400 for the second quarter of 2004, representing a decrease of 13.64%. DOMESTIC OPERATIONS: Expenses for the second quarter of 2005 were $333,000 compared to $410,800 during the corresponding period of 2004, representing a decrease of $77,800. As a percentage of net sales in the United States, the expenses decreased to 11.13% during the second quarter of 2005, compared to 12.98% during the corresponding period of 2004. The decreases were mainly due to reduced salary and travel costs resulting from a temporary reduction in staff that occurred in the first half of 2005. EUROPEAN TERRITORY: Expenses for the second quarter of 2005 were -16- $943,800 compared to $1,067,600 during the corresponding period of 2004, representing a decrease of $123,800. As a percentage of net sales in the United Kingdom, the expenses decreased to 17.98% during the second quarter of 2005 compared to 21.26% during the corresponding period of 2004 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). The decrease resulted mainly from lower freight costs and decreased dispensing equipment maintenance expenses. GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and administrative expenses were $969,300 for the second quarter of the year 2005, representing a marginal increase of $46,900, over $922,400 for the corresponding period in 2004. These expenses were equal to 11.76% of net sales for the second quarter of the year 2005, as compared to 11.27% for the corresponding period in 2004. DOMESTIC OPERATIONS. Domestic general and administrative expenses were $482,600 for the second quarter of the year 2005, representing a decrease of $65,500, or 11.95%, from $548,100 for the second quarter of the year 2004. The decrease was primarily due to a decrease in legal expenses, because a material legal dispute with a distributor was settled in 2004. EUROPEAN TERRITORY. General and administrative expenses related to the European Territory were $486,700 for the second quarter of the year 2005, representing an increase of $112,400, or 30%, when compared to $374,300 for the second quarter of the year 2004 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). These increases were mainly due to increases in salary and travel costs, exchange rate differences, and the Company's provision for bad debts. OTHER EXPENSES Other expenses for the second quarter of 2005 totaled $202,500, representing an increase of $12,500, or 6.58%, when compared to the second quarter of 2004. The increase was mainly due to higher interest expenses as a result of increased borrowings under the lines of credit. INCOME TAXES The Company has a provision for income taxes of $41,500 for the second quarter of 2005, compared to $57,400 for the second quarter of 2004. The provision for taxes related to the estimated amount of taxes that will be imposed by taxing authorities in the United Kingdom. NET PROFIT The Company's net profit for the second quarter of 2005 was $212,100, as compared to profit of $166,400 for the second quarter of 2004. After providing for a negative foreign currency translation adjustment of $76,100 during the second quarter of 2005 (as compared to a negative adjustment of $36,400 for the same period in 2004), the comprehensive profit for the second quarter of 2005 was $136,000, compared to a profit of $130,000 for the same period in 2004. -17- SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004 NET SALES Overall net sales for the first six months of the year 2005 were $15,497,500, an increase of $507,200, or 3.38%, compared to $14,990,300 for the same period in 2004. The increase was mainly due to increased sales in the United Kingdom, increased prices for the Company's products in the United Kingdom customers, and exchange rate fluctuations. DOMESTIC OPERATIONS: Domestic net sales for first six months of the year 2005 were $5,509,300 compared to $5,501,500 for the same period in 2004, a marginal increase of $7,800. Although the Company sold less of its own brand products, this decrease was offset by revenue from contract bottling of cider. The sales volume decreased to 29,061 barrels during the first six months of the year 2005 from 29,655 barrels in the first six months of the year 2004, representing a decrease of 594 barrels. Sales of Kingfisher brands decreased by 33 barrels, and sales of contract brands decreased by 5 barrels. The remainder of the decrease was made up of the Company's brands. EUROPEAN TERRITORY: Net sales for the first six months of the year 2005 were $9,988,200 (GBP 5,331,300) compared to $9,488,800 (GBP 5,205,900) during the corresponding period of 2004, an increase of 5.26%. During the first six months of the year 2005, UBSN sold 32,351 barrels compared to 31,886 barrels during the first six months of the year 2004, an increase of 465 barrels, or 1.46%. Exchange rate fluctuations when measured in United States dollars increased the growth percentage as compared to last year. Hence, when the net sales results are compared in Pounds Sterling, there is an increase of 2.41%. COST OF GOODS SOLD Cost of goods sold as a percentage of net sales during the first six months of the year 2005 was 67.91%, as compared to 66.76% during the corresponding period of 2004 mainly due to increased costs in the United States. DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in the United States during first six months of the year 2005 was 67.55%, as compared to 66.77%, during the corresponding period of 2004, representing an increase as a percentage of net sales of 0.78% that was mainly due to a increase in packaging material costs that was partly offset by a decrease in depreciation expenses. EUROPEAN TERRITORY: Cost of goods sold as a percentage of net sales in the United Kingdom during the first six months of the year 2005 was 68.52%, as -18- compared to 67.18% during the corresponding period in 2004 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation), due to cost increases that were not fully offset by price increases. GROSS PROFIT As a result of the higher cost of goods described above, gross profit for the first six months of the year 2005 decreased to $4,972,700, from $4,983,000 during the corresponding period of 2004, representing a decrease of 0.21%. As a percentage of net sales, the gross profit during the first six months of 2005 decreased to 32.09% from that of 33.24% during the corresponding period in 2004. OPERATING EXPENSES Operating expenses for the first six months of the year 2005 were $4,465,500, a decrease of $247,700, or 5.26%, as compared to $4,713,200 for the corresponding period of the year 2004. Operating expenses consist of marketing and distribution expenses and general and administrative expenses. MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and distribution expenses consist of salaries and commissions, advertising costs, product and sales promotion costs, travel expenses and related costs and Company's tavern and tasting room expenses. Such expenses for the first six months of the year 2005 were $2,593,000, as compared to $2,806,700 for the same period in 2004, representing a decrease of 7.61%. DOMESTIC OPERATIONS: Expenses for the first six months of the year 2005 were $686,500 compared to $811,100 during the corresponding period of 2004, representing a decrease of $124,600. As a percentage of net sales in the United States, these expenses decreased to 12.46% during the first six months of the year 2005, compared to 14.75% during the corresponding period of 2004. The decreased expenses included lower salary and travel costs due to a temporary decrease in staff (both in New York and California) in the first half of 2005 year and decreases in promotional expenses and point of sale items. -19- EUROPEAN TERRITORY: Expenses for the first six months of the year 2005 were $1,906,500 compared to $1,995,600 during the corresponding period of 2004, representing a decrease of $89,100. As a percentage of net sales in the United Kingdom, the expenses increased to 21.03% during the first six months of the year 2005 compared to 21.03% during the corresponding period of 2004 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). The decrease resulted mainly from lower freight costs and decreased dispensing equipment maintenance expenses. UBSN started an advertisement campaign during June 2005, so promotional expenses are likely to increase during the rest of the year 2005. GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and administrative expenses were $1,872,500 for the first six months of the year 2005, representing a decrease of $34,000 or 1.78%, over $1,906,500 for the corresponding period in 2004. These expenses were equal to 12.08% of net sales for first six months of the year 2005, as compared to 12.72% for the corresponding period in 2004. DOMESTIC OPERATIONS. Domestic general and administrative expenses were $952,500 for the first six months of the year 2005, representing a decrease of $93,900, or 8.92%, from $1,046,400 for the same period in 2004. The decrease was primarily due to decreased legal expenses because a material legal dispute with a distributor was settled in 2004. EUROPEAN TERRITORY. General and administrative expenses related to the European Territory were $920,000 for the first six months of the year 2005, representing an increase of $59,900 or 6.96%, as compared to $860,100 for the same period in 2004 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). These increases were mainly due to increases in salaries. OTHER EXPENSES Other expenses for the first six months of the year 2005 totaled $421,800 representing an increase of $22,200 when compared to the same period in 2004. The increase is mainly due to higher interest expenses as a result of increased borrowings under the lines of credit. INCOME TAXES The Company has a provision for income taxes of $71,700 for the first six months of the year 2005, compared to $78,200 the same period in 2004. The provision for taxes is related to the estimated amount of taxes that will be imposed by taxing authorities in the United Kingdom. NET INCOME The Company's net income for the first six months of the year 2005 was $13,700, as compared to loss of $208,000 for the first six months of the year -20- 2004. After providing for a negative foreign currency translation adjustment of $85,400 during the first six months of 2005 (as compared to a positive adjustment of $25,700 for the same period in 2004), the comprehensive loss for the first six months of the year 2005 was $71,700, compared to a loss of $182,300 for the same period in 2004. LIQUIDITY AND CAPITAL RESOURCES The Company has entered into a substantial number of loans, lines of credit, other credit facilities, and lease agreements over the last several years. In order to continue its operations, the Company will have to make timely payments of its debt and lease commitments as they fall due. Any breach of a loan or lease which actually leads to default, or to an attempt by a creditor to exercise its rights in the Company's tangible or intangible assets, could potentially make it difficult, at least in the short term, for the Company to continue its operations. MASTER LINE OF CREDIT. On August 31, 1999, MBC and United Breweries of America, Inc. ("UBA"), one of the Company's principal shareholders, entered into a Master Line of Credit Agreement, which was subsequently amended in April 2000 and February 2001 (the "Credit Agreement"). The terms of the Credit Agreement provide the Company with a line of credit in the principal amount of up to $1,600,000. The Company and UBA have executed an Extension of Term of Notes under Master Line of Credit Agreement (the "Extension Agreement"). The Extension Agreement confirms the Company's and UBA's extension of the terms of the UBA Notes for a period ending on August 31, 2005. On December 28, 2001, the Company and UBA entered into a Confirmation of Waiver which confirms that as of August 13, 2001, UBA waived its rights with regard to all conversion rate protection as set forth in the UBA Notes. As of the date of this filing, UBA has made thirteen (13) separate advances to the Company under the Credit Agreement and one additional advance on substantially the same terms as those under the Credit Agreement, pursuant to a series of individual eighteen-month promissory notes issued by the Company to UBA (the "UBA Notes"). The aggregate outstanding principal amount of the UBA Notes as of June 30, 2005 was $1,915,400, and the accrued but unpaid interest thereon was equal to approximately $557,900, for a total of $2,473,300. The UBA Notes require the Company to make quarterly interest payments to UBA on the first day of April, July, October, and January. To date, UBA has permitted the Company to capitalize all accrued interest; therefore, the Company has borrowed the maximum amount available under the facility. Upon maturity of any UBA Note, unless UBA has given the Company prior instructions to commence repayment of the outstanding principal balance, the outstanding principal and accrued but unpaid interest on such Note may be converted, at the option of UBA, into shares of the Company's common stock. If UBA does not elect to so convert any UBA Note upon maturity, it has the -21- option to extend the term of such UBA Note for any period of time mutually agreed upon by UBA and the Company. During the extended term of any UBA Note, UBA has the right to require the Company to repay the outstanding principal balance, along with the accrued and unpaid interest thereon, to UBA within sixty (60) days. The outstanding principal amount of the UBA Notes and the unpaid interest thereon may be converted, at UBA's discretion, into shares of the Company's unregistered Common Stock at a conversion rate of $1.50 per share. As of June 30, 2005, the outstanding principal and interest on the UBA Notes was convertible into 1,648,867 shares of the Company's Common Stock. These UBA Notes are subordinated to credit facilities extended to the Company by BFI and SBMC under a subordination agreement executed by UBA. As per the terms of the subordination agreement, UBA is precluded from demanding repayment of the notes due unless the BFI and SBMC facilities are settled in full. Hence the Company does not expect to make payments on any of these UBA Notes within the next year. The Company also expects the maturity dates of these notes to be extended, although there is no current agreement to do so. LONG TERM DEBT: MBC has obtained a $2.7 million loan from Savings Bank of Mendocino County ("SBMC"), secured by a first priority deed of trust on the Ukiah land, fixtures, and improvements. The loan is payable in partially amortizing monthly installments of $24,400 including interest at the rate of 7.24%, maturing December 2012 with a balloon payment in the amount of $932,600. The interest rate is adjusted on every five year anniversary of the agreement to the Treasury Constant Maturity Rate plus 4.17%. The amount of the balloon payment will vary depending on the change in interest rates over the years. In addition to the Ukiah land and facility, this loan is secured by some of the other assets of the Company (other than the Releta facility), including, without limitation, most of the Company's equipment. OTHER LOANS AND CREDIT FACILITIES. BFI LOAN AND LINE OF CREDIT: On May 5, 2005, the Company entered into a receivables and inventory-based line of credit transaction with BFI Business Finance ("BFI"), pursuant to which BFI has provided the Company with a $2,000,000 maximum revolving line of credit with an advance rate based on 80% of MBC's qualified accounts receivable, 70% of Releta's qualified accounts receivable, and 50% of the eligible inventory carried by both MBC and Releta (the "BFI Line of Credit"). The BFI Line of Credit has an initial term of twelve months, but it can be automatically extended, at the Company's option, for an unlimited number of additional twelve-month periods. However, BFI also retains the right to terminate the BFI Line of Credit at any time, upon 30 days' notice. The minimum monthly interest payment commitment under the BFI Line of Credit is approximately $6,000, and there is no prepayment fee if the BFI Line of Credit remains outstanding for a minimum of six (6) months. The -22- BFI Facility carries an interest rate equal to the greater of 9.5%, or the prime rate announced in the Western edition of the Wall Street Journal plus 3.75 %, payable monthly. The facility is also subject to a monthly administrative fee of 0.40%. BFI also advanced the Company $200,000 under a promissory note (the "BFI Note" and, together with the BFI Line of Credit, the "BFI Facility"). The BFI Note is repayable in thirty weekly installment of $6,665 commencing in July 8 2005. On May 6, 2005, the Company used the entire available amount drawable under the BFI Facility to pay off the balance remaining outstanding under the CIT Group Line of Credit discussed below. CIT GROUP/CREDIT FINANCE LINE OF CREDIT: The CIT Group/Credit Finance, Inc. provided MBC a $3,000,000 maximum line of credit secured by all accounts, general intangibles, inventory, and equipment of MBC except for the specific equipment and fixtures of the Company leased from Finova Capital Corporation, as well as by a second deed of trust on the Company's Ukiah land improvements. $1,484,000 of the line of credit was advanced to MBC as an initial term loan, which was repayable in sixty consecutive monthly installments of principal, each in the amount of $24,700. The Company used the proceeds from the BFI Facility and paid off the entire amount outstanding on May 6, 2005. SAVINGS BANK OF MENDOCINO TEMPORARY LOAN: On December 31, 2003, Savings Bank of Mendocino County ("SBMC") extended a temporary loan in the principal amount of $576,200 to the Company in order to finance the buy-out of equipment leased through Finova Capital Corporation secured by the existing assets of the Company and the assets released by Finova upon lease termination. The rate of interest on the loan is bank's prime rate plus 3%. On April 27, 2005, SBMC formally committed to extend the loan until May 2006. NEDBANK LIMITED OPTION FACILITY: Nedbank Limited, a South African registered company ("Nedbank"), provided UBSN with a multi-currency option facility of 1,250,000 Pounds Sterling. This overdraft facility, which may be terminated by Nedbank at any time (with or without default) on thirty days' notice, was secured by all of the assets of UBSN. The agreement restricted the subsidiary from making distributions and payments to the parent in excess of approximately 100,000 Pounds Sterling annually (approximately $189,000). This facility was settled in full utilizing proceeds from RBS facility discussed below. ROYAL BANK OF SCOTLAND FACILITY: Royal Bank of Scotland provided UBSN with a GBP 1,750,000 maximum revolving line of credit with an advance rate based on 80% of UBSN's qualified accounts receivable. UBSN utilized the proceeds of this facility and settled the Nedbank facility (discussed above) on April 26, 2005. SHEPHERD NEAME LOAN: Shepherd Neame has a contract with UBSN to -23- brew Kingfisher Lager for the Company's European and Canadian markets. As consideration for extending the brewing contract, Shepherd Neame advanced a loan of 600,000 Pounds Sterling to UBSN, repayable in annual installments of 60,000 Pounds Sterling per year, commencing in June 2003. The loan carries a fixed interest rate of 5% per year. WEIGHTED AVERAGE INTEREST: The weighted average interest rates paid on the Company's U.S. debts was 8.64% for the first six months of the year 2005 and 7.61% for the corresponding period in 2004. For loans primarily associated with Company's European territory, the weighted average rate paid was 6.2% for the first six months of the year 2005 and 6.75% for the corresponding period in 2004. KEG MANAGEMENT ARRANGEMENT: The Company entered into a keg management agreement with MicroStar Keg Management LLC in September 2004 for a period of five years. Under this arrangement, MicroStar provides the Company with half-barrel kegs for which the Company pays a filling and use fee. Distributors return the kegs to MicroStar instead of the Company. MicroStar then supplies the Company with additional kegs. If the agreement is terminated, the Company is required to purchase a certain number of kegs from MicroStar. The Company would probably finance the purchase through debt or lease financing, if available. However, there can be no assurance that the Company will be able to finance the purchase of kegs. Failure to purchase the necessary kegs from MicroStar upon termination of the contract is likely to have a material adverse effect on the Company. OVERDUE PROPERTY TAXES: As of June 30, 2005, the balance of the delinquent property taxes due on the Company's Ukiah property was approximately $430,900. Pursuant to an agreement with Mendocino County, the remaining balance of the overdue taxes should be paid in three annual installments, due on or before April 10, 2006, 2007, and 2008, each representing 20% or more of the original overdue balance, along with accrued interest calculated at 18% per year. The Company made a payment on April 8, 2005 of $143,600, or 20% of the original amount outstanding, together with interest accrued until March 2005. Because of the large amount of taxes owed, and the County's ability to sell the Ukiah property to satisfy a delinquency, failure to settle these tax dues (including payments due under the payment plan) could have a serious adverse effect on the Company's business and financial condition. RESTRICTED NET ASSETS. The Company's wholly-owned subsidiary, UBI, has undistributed earnings of approximately $2,299,000 as of June 30, 2005. Under UBI's line of credit agreement, distributions and other payments to the Company from its subsidiary are limited to approximately $506,000 per year. CURRENT RATIO The Company's ratio of current assets to current liabilities on June 30, -24- 2005 was 0.84 to 1.0 and its ratio of total assets to total liabilities was 1.35 to 1.0. On June 30, 2004, the Company's ratio of current assets to current liabilities was 0.82 to 1.0 and its ratio of total assets to total liabilities was 1.38 to 1.0. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of June 30, 2005, the Company did not hold derivative instruments, or engage in hedging activities, of any material value or in any material amount, whether for trading or for hedging purposes. The Company has some interest-related market risk due to floating interest rate debt totaling $4,307,800 as of June 30, 2005. INTEREST RATE RISK The Company had total debt as of June 30, 2005 of $9,668,600, of which $6,267,500 was subject to variable rates of interest (either prime or LIBOR plus 1.38% or prime plus 3.75%). Its long-term debt (including current portion) as of June 30, 2005 totaled $5,316,500, of which $3,401,100 had fixed rates of interest and the balance of $1,915,400 were subject to variable rates. Short term debts amounted to $4,352,100 which were subject to variable rates. At current borrowing levels, an increase in prime and LIBOR rates of 1% would result in an annual increase of $62,700 in interest expense on the Company's variable rate loans. FOREIGN CURRENCY RATE FLUCTUATIONS The Company's earnings and cash flows at its subsidiaries UBI and UBSN are subject to fluctuations due to changes in foreign currency rates. The Company believes that changes in the foreign currency exchange rate would not have a material adverse effect on its results of operations as the majority of its foreign transactions are delineated in UBI's functional currency, the British Pound. ITEM 4. CONTROLS AND PROCEDURES The Company's management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO") has evaluated the effectiveness of the design, maintenance, and operation of the Company's "disclosure controls and procedures" as of the end of the period covered by this report. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by the Company in its reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized, and reported within the time periods specified in the Commission's rules and forms. Disclosure controls and procedures are also designed to ensure that information that the Company is required to disclose in its reports under the Exchange Act is accumulated and communicated to the Company's management, including its CEO and CFO, as appropriate to allow timely decisions regarding the required disclosure. -25- Certain aspects of the Company's internal control over financial reporting are included in the Company's disclosure controls and procedures, and are therefore included in management's evaluation. Management evaluates internal control over financial reporting on a quarterly basis to determine whether any changes have occurred. Internal control over financial reporting is also evaluated on an annual basis in connection with the preparation of the Company's Form 10-K. Management's review of the disclosure controls and procedures includes a review of their objectives, design, implementation, and results. Based on this evaluation, the CEO and CFO believe that, subject to the limitations set forth below, the Company's disclosure controls and procedures were effective in providing reasonable assurance that the information required to be disclosed in the Company's reports under the Exchange Act is recorded, processed, summarized, and reported within the time specified by the Commission, and that material information pertaining to the Company is timely communicated to the Company's management (including the CEO and CFO). Management is not aware of any changes in the Company's internal or other controls over financial reporting identified in connection with that evaluation that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Please refer to the certifications of the Company's Chief Executive Officer and Chief Financial Officer (which are attached to this report as Exhibits 31.1 and 31.2) for additional information regarding the Company's controls and procedures. LIMITATIONS ON CONTROLS Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving the Company's disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in such controls and procedures, including the fact that human judgment in decision making can be faulty and that breakdowns in internal controls can occur because of human failures such as simple errors or mistakes or intentional circumvention of the established process. Please refer to the certifications of the Company's Chief Executive Officer and Chief Financial Officer (which are attached to this report as Exhibits 31.1 and 31.2) for additional information regarding the Company's controls and procedures. -26- PART II OTHER INFORMATION ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The Company's policy with respect to compensation of outside Directors of MBC for their services as Directors is as follows: each outside Director receives $3,000 per Board meeting attended and $1,000 per committee meeting attended. Prior to 2003, the Company had a policy of granting shares of Common Stock in lieu of cash to non-employee directors at their option, as compensation for their attendance at meetings of the Board of Directors and of Committees of the Board on which they serve, based on a standard schedule of $3,000 per Board meeting attended and $1,000 per committee meeting attended. However, because the market value of the Company's Common Stock fell below fifty cents per share during the latter half of 2002, and has since remained consistently below $1.00 per share (at times falling below twenty cents per share) - which would have increased quite significantly the number of shares otherwise issuable to these Directors -- the Board of Directors adopted a Directors' Stock Grant Plan under which non-employee Directors would receive, as compensation for Board and Committee meetings attended, shares of the Company's Common Stock valued at the higher of the book or market value as on the last day of each year. Compensation due for the year 2004 is expected to be issued later this year in the form of shares at book value as of December 31, 2004. The Company's policy for compensation of its non-employee Directors has in the past included the annual issuance of options, pursuant to the Company's 1994 Stock Option Plan (the "Plan"), to purchase a number of shares of the Company's Common Stock having a fair market value of $25,000. The Plan expired in 2004, however, and to date no new option or similar plan has been adopted by the Board. The Board may adopt new plans and guidelines for adoption later in the year. Pursuant to a Master Line of Credit Agreement between the Company and United Breweries of America, Inc. (discussed in Part I, Item 2, above, under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources - Master Line of Credit Agreement"), the Company issued thirteen (13) promissory notes to United Breweries of America, Inc. ("UBA") between September, 1999, and July, 2001 (the "UBA Notes"). A fourteenth note, on the same terms as the others but in the amount of $400,000 (the "New Note"), was issued to UBA on March 2, 2005. The outstanding principal amount of the UBA Notes and the New Note, and the unpaid interest thereon may be converted, at UBA's discretion, into shares of the Company's unregistered Common Stock at a conversion rate of $1.50 per share. As of June 30, 2005, -27- the outstanding principal and interest on the UBA Notes (including the New Note) totaled approximately $2,473,300, and the UBA Notes were convertible into 1,648,867 shares of the Company's Common Stock. If the UBA Notes and the New Note were deemed to be securities, the Company's Management believes that the issuance of all such notes was exempt from registration pursuant to Section 4(2) of the Act because UBA, the sole offeree and recipient thereof, has significant business experience, financial sophistication, and knowledge of and familiarity with the business of the Company. Management believes that if these notes were eventually to be converted into shares of the Company's Common Stock, the issuance of such shares would also be exempt from registration pursuant to Section 4(2) of the Act. ITEM 6. EXHIBITS Number Description of Document ------ ----------------------- 10.1 Invoice Discounting Agreement between The Royal Bank of Scotland Commercial Services Limited and UBSN Limited, dated April 26, 2005 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -28- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Mendocino brewing company, inc. Dated: August 17, 2005 By: /s/ Yashpal Singh Yashpal Singh President, Director and Chief Executive Officer Dated: August 17, 2005 By: /s/ N. Mahadevan N. Mahadevan Chief Financial Officer and Secretary -29- EXHIBIT INDEX Exhibit No. Description ----------- ----------- 10.1 Invoice Discounting Agreement between The Royal Bank of Scotland Commercial Services Limited and UBSN Limited, dated April 26, 2005 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002