-----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, Nli1axehUl7VJ0AzEBZfkZiWBxNW04w1FRTlCnqjjM9E1u4cnJ5CZZjbML6od1uI Vfgwj7RxzPfeyqRVooOeTg== 0001188112-05-001587.txt : 20050901 0001188112-05-001587.hdr.sgml : 20050901 20050901140205 ACCESSION NUMBER: 0001188112-05-001587 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20041231 FILED AS OF DATE: 20050901 DATE AS OF CHANGE: 20050901 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: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 001-13636 FILM NUMBER: 051064188 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 10-K/A 1 t10ka-7500.txt 10-K/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A AMENDMENT NO. 1 (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 or | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ COMMISSION FILE NUMBER 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) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, NO PAR VALUE 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] The aggregate market value of the Common Stock held by non-affiliates of the registrant (based on the average of the closing bid and asked prices for such stock, as reported by the Nasdaq OTC Bulletin Board on June 30, 2004) was $554,327.95. The number of shares of the registrant's Common Stock outstanding as of March 30, 2005 was 11,473,914. DOCUMENTS INCORPORATED BY REFERENCE None MENDOCINO BREWING COMPANY, INC. ANNUAL REPORT ON FORM 10-K TABLE OF CONTENTS PAGE PART I. ITEM 1. BUSINESS 1 ITEM 2. PROPERTIES 10 ITEM 3. LEGAL PROCEEDINGS 11 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 11 ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY PART II. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 12 ITEM 6. SELECTED FINANCIAL DATA 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 27 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 27 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES 28 ITEM 9A. CONTROLS AND PROCEDURES 28 PART III. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 29 ITEM 11. EXECUTIVE COMPENSATION 31 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS 33 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 35 ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 37 PART IV. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 38 i Explanatory Note This Form 10-K/A amends and restates Mendocino Brewing Company, Inc.'s (the "Company") Annual Report on Form 10-K for the year ended December 31, 2004, filed May 13, 2005 (the "Original Annual Report"). The Company has restated its previously issued consolidated statement of operations and comprehensive income as of and for the year ended December 31, 2004 to reflect the correct classification of a legal dispute settlement expense as an other (non-operating) expense. Since the date of filing of the Original Annual Report, the Company has determined that this item should be classified as an operating expense and has modified its statement of operations accordingly. This reclassification does not affect the net income for the year 2004. The Company also updated Item 9A, Controls and Procedures to ensure that it encompasses the entire definition of disclosure controls and procedures set forth in Exchange Act Rules 13a-15(e) and 15d-15e. The Items of the Original Annual Report which are amended and restated are as follows: Item 1 Financial Statements - (including the consolidated statement of operations and comprehensive income, Notes 16 and 17), Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations, and Item 9A Controls and Procedures. Further, this Form 10-K/A contains new Exhibits 31.1 and 31.2 dated the date of the filing of this Form 10-K/A. The remaining Items contained within this Form 10-K/A consist of all other Items originally contained in the Original Annual Report. This Form 10-K/A does not reflect events occurring after the filing of the Original Annual Report, nor modify or update those disclosures in any way other than as required to reflect the effects of the restatement. FORWARD-LOOKING INFORMATION Various portions of this Annual Report on Form 10-K, including but not limited to the sections captioned "Description of Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operation," 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. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking information due to numerous factors, including but not limited to availability of financing for operations, successful performance of internal operations, the impact of competition, changes in distributor relationships or performance, and other risks discussed elsewhere in this Form 10-K and from time to time in the Company's Securities and Exchange Commission (the "Commission") filings and reports. 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. Readers are cautioned not to place undue reliance on these forward-looking statements. PART I ITEM 1. BUSINESS OVERVIEW Mendocino Brewing Company, Inc., a California corporation, was founded in 1983. It was 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 it has been recognized for its innovations in the brewpub concept, its craft brew style and its distinctive labels. (In this Annual 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.) The Company operates in two market and geographic areas, domestic (the United States) and European (including Austria, Belgium, Denmark, Ireland, Italy, the Netherlands, France, Finland, Germany, Greece, Iceland, Liechtenstein, Luxembourg, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom as well as Canada (the "European Territory"). The Company's domestic operations consist primarily of brewing and marketing a variety of proprietary craft beers, including among others Red Tail Ale, Blue Heron Pale Ale, Black Hawk Stout, Eye of the Hawk Select Ale, White Hawk Original IPA, and Raptor Red Lager, and a licensed international specialty beer, Kingfisher Premium Lager. For domestic distribution, the Company brews its brands in its own facilities, which are located in Ukiah, California and Saratoga Springs, New York, and these beers are distributed in 36 states and the District of Columbia. The Company's European operations, which are conducted through its wholly-owned subsidiary United Breweries International (U.K.) Limited ("UBI") and UBI's own subsidiary UBSN, Ltd. ("UBSN"), consist primarily of the marketing and distribution of Kingfisher Premium Lager throughout the European Territory, and to a lesser extent the marketing and distribution of Sun Lik Chinese Lager in the U.K., in both cases through ethnic restaurants (Indian for Kingfisher Premium Lager and Chinese for Sun Lik), chain retail grocers, liquor stores, and other retail outlets (such as convenience stores). The Company holds the license to brew and distribute Kingfisher Premium Lager from United Breweries Limited ("UB Limited"), an Indian corporation. The Company's Chairman of the Board, Dr. Vijay Mallya, is also the Chairman of the Board of UB Limited. 1 Shepherd Neame, Ltd. ("Shepherd Neame"), a prominent English brewer, holds the license to brew and distribute Sun Lik (in the U.K. only) from an unrelated entity, the San Miguel Corporation; and in September 2001 Shepherd Neame granted UBSN a sublicense to distribute this beer (also in the U.K. only). All of the Company's beers sold in the European market and Canada are brewed in England under contract by Shepherd Neame. Although UBSN is the sole distributor of Kingfisher Premium Lager in the U.K., Ireland, continental Europe, and Canada, and of Sun Lik in the U.K., it does not physically distribute its products to its ultimate trade customers, relying instead on specialist restaurant trade distributors in the U.K. and Shepherd Neame, acting as UBSN's agent, on a commission basis, for the supermarket and liquor and convenience store trade. COMPANY BACKGROUND MBC first bottled its flagship brand, Red Tail Ale, in December 1983, and made its initial public offering in February 1995. The Company completed construction of its brewery in Ukiah, California in May 1997. This facility, which has a current annual capacity of 60,000 brewers' barrels ("bbl."), was designed to enable the Company's production to be expanded to 200,000 bbl. per year with the addition of necessary equipment. The Company's New York subsidiary, Releta Brewing Company, LLC, d/b/a Ten Springs Brewery ("Releta"), which is located in Saratoga Springs, New York, commenced production in its leased facilities in February 1998, with an initial capacity of 60,000 bbl. per year expandable to 150,000 bbl. per year. In July 1998, the Company purchased certain of the assets of Carmel Brewing Company, Inc., a California corporation ("Carmel Brewing"), such as trademarks, trade names, and other brand related assets as well as certain point of sales and brewing ingredient inventory. On August 13, 2001, the Company acquired United Breweries International (U.K.) Limited ("UBI") together with UBI's own subsidiary UBSN, Ltd. ("UBSN"), from Inversiones Mirabel, S. A., a Panamanian corporation ("Inversiones"), in exchange for MBC stock valued at approximately $5,500,000 (the "UBI Acquisition"). The UBI Acquisition was considered to be a related-party transaction because at the time Inversiones was owned by a trust in which the Company's Chairman, Dr. Mallya, may be deemed to be a beneficial owner. The Company operates UBI and UBSN primarily in the marketing, sale, and distribution of Kingfisher Premium Lager in the Company's European Territory, and in the marketing and distribution of Sun Lik Chinese Lager in the U.K. Kingfisher Premium Lager, which is the flagship brand of UB Limited, an India-based brewing and distribution company, is a recognized international brand, with wide distribution outside the Company's market areas. As a result of the UBI Acquisition, the Company now holds, in addition to UBI and UBSN, the United States brewing and distribution rights for Kingfisher Premium Lager. The Company brews Kingfisher Premium Lager for U.S. distribution to the United States in both of its U.S. brewing facilities -- Saratoga Springs and Ukiah. The Company has engaged Shepherd Neame to brew Kingfisher Premium Lager for distribution in European Territory, and Sun Lik Chinese Lager for distribution in the U.K. only. (The Company does not brew or distribute Sun Lik Chinese Lager outside the United Kingdom.) INDUSTRY OVERVIEW DOMESTIC MARKET The U.S. domestic beer market falls into a number of market categories, including among others low-priced, premium, super premium, lite, import, and specialty/craft beers. Domestically, the Company competes in the specialty/craft category, which is estimated to be in the range of 6 million barrels per year and comprised approximately 3% of total U.S. beer sales in both 2004 and 2003. Craft beers are typically 2 all malt, characterized by their full flavor, and are usually produced using methods similar to those of traditional European brews. The Company refers to the United States as its "Domestic Territory." EUROPEAN TERRITORY The Company's European Territory includes Austria, Belgium, Denmark, Ireland, Italy, the Netherlands, France, Finland, Germany, Greece, Iceland, Liechtenstein, Luxembourg, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom as well as Canada, although during both 2004 and 2003 Company sales in the United Kingdom constituted approximately 91% of all the Company's sales in the European Territory. The category in which the Company competes in Europe is primarily the Indian restaurant niche, although the Company does distribute its beers through other licensed premises and through other retail outlets such as supermarkets, liquor stores, and licensed shops and convenience stores. In the U.K., this market niche is estimated to be in the range of 150,000 to 175,000 bbl. per year. Management believes that, for Europe as a whole, this market niche is substantially larger. The Company offers two brands of beer in its European Territory: Kingfisher Premium Lager (both within and outside the U.K.) and Sun Lik Chinese Lager (in the U.K. only). With approximately 7,000 premises in the U.K., the Indian restaurant niche is substantially larger than the equivalent Chinese restaurant market, which currently includes only about 3,500 premises in the U.K. The Company believes that the market share of Kingfisher Premium Lager in this niche has remained stable at approximately 22% in this market niche over the last three years. Both in the U.S. and in the European Territory, the rate at which the sales in the craft and specialty categories grow will have a material affect on the Company's business, financial condition, and results of operations. Actual industry performance will depend on many factors that are outside the control of the Company. BUSINESS OF THE COMPANY 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 annual gross sales (by revenue). With the Company's acquisition of UBI and UBSN 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 63% of the Company's gross sales during 2004 (as compared to 58% in 2003), with the Company's United States operations, including manufacturing and distribution of beer as well as retail sales accounting for the remainder. During both 2004 and 2003, food and merchandise retail sales (substantially all of which took place at the Hopland tavern in Ukiah, California) continued to decrease as a percentage of overall sales, amounting to less than 1% in 2004 and less than 2% in 2003. With the closure of the restaurant at Hopland, Management expects that retail sales will in the future continue to represent an insignificant portion of overall sales. (See Note 16 to "Notes to Financial Statements," below.) THE HOPLAND TAVERN ALE HOUSE AND MERCHANDISE STORE The historic Hopland tavern ale house and merchandise store is a marketing tool for the Company's domestic market. Located on a tourist route in Hopland, California, 100 miles north of San Francisco, the Hopland Brewery opened in 1983 as the first new brewpub in California and the second in the United States since the repeal of Prohibition. 3 Beverages served at the Hopland tavern include Red Tail Ale, Blue Heron Pale Ale, Black Hawk Stout, Eye of the Hawk Select Ale, Peregrine Golden Ale, White Hawk IPA, and a seasonal brew on tap, along with local wines and soft drinks. The adjacent merchandise store sells the Company's brews and merchandise such as hand-screened label T-shirts, posters, engraved glasses and mugs, logo caps and other brewery-related gifts. In October 2003, the Company closed the restaurant located at the Hopland property. Management decided to close the restaurant because the space available for renewal at the end of the term of the current lease was limited, and the restaurant has traditionally done less business during the winter months. However, the Company continues to operate the tavern and merchandise stores. There was no significant cost incurred by the Company in shutting down the restaurant facility. Sales attributed to tavern and merchandise store were $ 211,200, $423,500 and $511,400 for the years 2004, 2003 and 2002 respectively. PRODUCTS For distribution in the United States, the Company brews seven principal ales, one wheat beer, three lagers, one stout and a root beer on a year-round basis, and two seasonal ales, all of which are brewed at the Company's proprietary facilities in Ukiah, California, and Saratoga Springs, New York. In the European Territory, the Company distributes only two beverages, Kingfisher Premium Lager and Sun Lik Chinese Lager, both of which are brewed for the Company by Shepherd Neame. (See below under "Licenses and Franchise Agreements" and Item III, Section 13 - Certain Relationships and Related Transactions - Shepherd Neame.") The Company's principal products are as follows. o RED TAIL ALE, a full flavored amber ale, is the Company's flagship brand. It is available year-round in 12 oz. six-packs and twelve-packs, half-barrel kegs, and 5 gallon kegs. o BLUE HERON PALE ALE is a golden ale with a full body and a distinctive hop character. It is available year-round in 12 oz. six-packs and twelve-packs, half-barrel kegs, and 5 gallon kegs. o BLACK HAWK STOUT is a rich bodied stout with big traditional flavors. It is available year-round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. o EYE OF THE HAWK SELECT ALE is a strong rich bodied amber ale. It is available year round in 12 oz. six-packs, half-barrel kegs, and 5 gallon kegs. o WHITE HAWK ORIGINAL IPA is a heavily hopped ale with distinctive hop character and bold malt flavor. It is available year round in 12 oz. six-packs and half-barrel kegs. o KINGFISHER PREMIUM LAGER is a conventionally fermented specialty lager with a smooth crisp taste. In the domestic market, Kingfisher is currently available year around in 12 oz. six-packs, 22 oz. bottles, and on-draft. In the European market, it is available year-round, in 330ml and 660ml bottles in multi-packs in the U.K., Ireland, and continental Europe and in 330ml bottles in Canada, as well as in a variety of keg sizes. In the U.K., it is also available on draft through Indian restaurants. o RAPTOR RED LAGER is a traditional lager, with a smooth light feel and a crisp dry finish. It is currently available year round only on the West Coast in 12-oz. six packs and half-barrel kegs. DISTRIBUTION METHODS In the United States, the Company's bottled products are sold through distributors to consumers at supermarkets, warehouse stores, liquor stores, taverns and bars, restaurants, and convenience stores. 4 Most of the Company's brands are also available on draft. The Company's products are delivered to retail outlets by independent distributors whose principal business is the distribution of beer and in some cases other alcoholic beverages, and who typically also distribute one or more national beer brands. Together with its distributors, the Company 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 a variety of ales and lagers directly to consumers at the tavern and merchandise store in Hopland, California. In the European Territory, the Company's products are distributed primarily through sales by Indian restaurants. Such sales represent approximately 95% of the Company's total European sales volume, with the remaining sales coming through other ethnic restaurants (primarily Chinese) and in sales by supermarkets, liquor stores, and licensed shops and convenience stores. In the U.K., Kingfisher has maintained a market share of approximately 22% of the Indian restaurant market, through sales by some 7,000 Indian restaurants and other licensed premises. The majority of the Company's sales in these restaurants are through its approximately 3,500 on-tap draft installations. UBI also exports Kingfisher to 16 European markets outside of the U.K. and to Canada, and its growth in those markets typically develops alongside the growth of Indian restaurants in those markets. The Company does not physically distribute its products to its ultimate trade customers in the European Territory, relying instead on specialist restaurant trade distributors and Shepherd Neame, acting as UBSN's agent on a commission basis, for the supermarket and liquor and convenience store trade. SEASONALITY DOMESTIC OPERATIONS: Sales of Company's products are somewhat seasonal, with first and fourth quarters historically being slow. The volume of sales in any given year and region may also be affected by local weather conditions. It is not clear to what extent seasonality will affect the Company as it expands its capacity and its geographic markets. EUROPEAN OPERATIONS: Beer consumption in the United Kingdom, Ireland, and continental Europe has historically increased during the winter months. Although it is not clear to what extent seasonality and the expansion of its geographic markets will affect the Company, it is believed that the seasonality difference between the United States and United Kingdom-European markets will benefit the Company overall by smoothing out its income stream over the course of the year. Results of any market segment or geographic area for any given quarter may not necessarily be indicative of results that may be achieved in the same market segment or geographic area in other quarters or full fiscal year. COMPETITION In the United States, the Company competes against a variety of brewers in the craft beer segment, including brewpubs, microbrewers, regional craft brewers, and craft beer products of major national breweries. Additionally, the entire craft beer segment competes to some extent with other segments of the U.S. beer market, including major national brands like Budweiser and Miller and imported beers such as Heineken and Becks. The U.K. lager market is dominated by major international brands such as Carling, Budweiser, Becks, and Holsten Pils, both in the restaurant and pub segment and in sales through supermarkets and other retail outlets. The Company's products are marketed both through Indian and other restaurants and through major supermarket chains, smaller chains, and individual stores. In all these sectors, the Company faces competition from other ethnic and international brands produced by local and large international brewers. The Company's flagship brand in the European Territory is Kingfisher Premium Lager, which has maintained a market share of approximately 22% of the U.K. Indian restaurant market during each of the last three years. The Company vigorously promotes Kingfisher as the No.1. selling premium Indian Lager 5 brand in the U.K. and continental Europe. The profile of this brand has been raised significantly through the Company's continued promotion of Kingfisher World Curry Week in support of the charity "Action Against Hunger" that works in the Indian sub-continent and south east Asia. The Company's products face tough competition both in the United States and on its European Territory. Increased competition in either market could hinder distribution of the Company's products, and have a material adverse effect on the Company's business, financial condition, and results of operations. SOURCES AND AVAILABILITY OF RAW MATERIALS Production of the Company's beverages requires quantities of various agricultural products, including barley for malt, hops, malt, and malted wheat for beer. The Company fulfills its commodities requirements by purchases from various sources, including both contractual arrangements and on the open market. In its European Territory, these purchases are made directly by or for Shepherd Neame, which brews the Company's products on a contract basis. Although the Company believes that adequate supplies of these agricultural products are available at the present time, it cannot predict future availability or prices of such products and materials. The commodity markets have experienced and will continue to experience price fluctuations. The price and supply of raw materials will be determined by, among other factors, the level of crop production, weather conditions, export demand, and government regulations and legislation affecting agriculture. The Company does not use any hedges or unconditional purchase obligations to purchase these products. The Company's major suppliers in the United States are Great Western Malting Co., Yakima, Washington, and Briess Malting, Milwaukee, Wisconsin (malt); Yakima Chief, Inc., Sunnyside, Washington and S S Steiner, Inc, New York, New York (hops); Gamer Packaging Inc. Minneapolis, Minnesota (bottles and crown corks); Inland Paper Board and Packaging, Inc., Antioch, California and Empire State Container, Inc. Syracuse, New York (cartons); Sierra Pacific Packaging, Oroville, California and Caraustar, Ashland, Ohio (carriers); and Inland Printing Company Inc., Lacrosse, Wisconsin and DWS Printing Associates, Bay Shore, NY(labels). The Company's major supplier in Europe is Shepherd Neame, which brews on a contract basis all of the Company's products that are sold in Europe. The Company does not directly purchase any material amounts of agricultural commodities or other products in Europe. DEPENDENCE ON MAJOR CUSTOMERS Sales to the Company's top five customers in 2004 totaled $7,942,000, or approximately 25%, of the Company's total sales, as compared to $7,088,800 or 25% of total sales for 2003 and $6,718,100 or 26% of total sales for 2002. In the Company's domestic market, sales to its principal customer, Alta Marketing, constituted during 2004 approximately 10.2% of the Company's domestic sales (or approximately 3.8% of its total sales), as compared to approximately 10.1% of its domestic sales (or approximately 4.2% of total sales) in 2003. In 2002, sales to the Company's largest U.S. customer (then Golden Gate Distribution) constituted and 12.7% of domestic sales (and approximately 5.7% of total sales). Sales during 2004 to the Company's principal European customer, Shepherd Neame, represented approximately 15.3% of the Company's European Territory sales (or approximately 9.6% of the Company's total sales) for the year, as compared to approximately 15.5% and 14.6% of European Territory sales (or approximately 9% and 8% of total sales) in 2003 and 2002 respectively. No other individual customer accounted for more than 5% of the Company's total sales during 2004, 2003 or 2002. TRADEMARKS The Company has U.S. federal trademark registrations on the principal register of the United States Patent and Trademark Office for the following marks: MENDOCINO BREWING COMPANY 6 word mark (Reg. No. 2,441,141), RED TAIL ALE word mark (Reg. No. 2,032,382), RED TAIL design mark (Reg. No. 2,011,817), BLUE HERON PALE ALE design mark (Reg. No. 2,011,816), EYE OF THE HAWK SELECT ALE word mark (Reg. No. 1,673,594), EYE OF THE HAWK SPECIAL EDITION ANNIVERSARY ALE design mark (Reg. No. 2,011,815), YULETIDE PORTER word mark (Reg. No. 1,666,891), BREWSLETTER word mark (Reg. No. 1,768,639), PEREGRINE GOLDEN ALE word mark (Reg. No. 2,475,222), HOPLAND BREWERY word mark (Reg. No. 2,509,464), BLACK EYE ALE word mark (Reg. No. 2,667,078), and SUN LAGER PREMIUM HANDCRAFTED BREW word and design mark (Reg. No. 2,583,446). The Company uses the BLUE HERON word mark under a concurrent use agreement with Bridgeport Brewing Company which gives the Company the exclusive right to use the BLUE HERON word mark throughout the United States with the exception of Oregon, Idaho, Washington, and Montana. Bridgeport Brewing Company, the other concurrent use party, has the exclusive right to use the BLUE HERON word mark in those states. The Company's use of the BLACK HAWK STOUT word mark is, by agreement with Hiram Walker & Sons, Inc., subject to the restriction that it be used solely to identify and distinguish malt beverage products namely, beer, ale and stout, and only in conjunction with the words "Mendocino Brewing Company." The Company's United States federal trademark registrations for the BLUE HERON word mark (Cancelled Reg. No. 1,820,076) and BLACK HAWK STOUT word mark (Cancelled Reg. No. 1,791,807) were cancelled as a result of alleged technical deficiencies in registration compliance filings. The Company continues to use the BLUE HERON and BLACK HAWK STOUT word marks and claims common law trademark rights in and to such marks. The Company presently has pending applications on file with the United States Patent and Trademark Office for the re-registration of the BLUE HERON word mark. The Company claims common law trademark rights in and to the WHITE HAWK ORIGINAL IPA word mark and WHITE HAWK ORIGINAL IPA word and design mark. The Company has applied to register the WHITE HAWK ORIGINAL IPA word and design mark with the United States Patent and Trademark Office (Ser. No. 78/304,844) and the application is currently pending. Similarly, the Company claims common law trademark rights in and to the RAPTOR RED LAGER word mark and RAPTOR RED LAGER word and design mark. The Company has applied to register the RAPTOR RED LAGER word and design mark with the United States Patent and Trademark Office (Ser. No. 78/304,831) and the application is currently pending. Additionally, the Company claims common law trademark rights in and to the TALON BARLEY WINE ALE word mark and TALON BARLEY WINE ALE word and design mark and intends to register the marks with the United States Patent and Trademark Office. The Company has acquired the trademark CARMEL BREWING COMPANY and any other variation of the same as used by Carmel Brewing Company and claims common law trademark rights in and to all such marks. The Company has also acquired the rights to use the RAZOR EDGE word mark through a License Agreement with Beverage Mates, Ltd. However, the Company is currently not using the RAZOR EDGE mark, and it is unclear whether it will use the mark in the future. The RAZOR EDGE License Agreement expires in 2008, but will be automatically renewed unless specifically terminated. License fees are calculated based on sales of the product. The Company has not had any material sales of this brand since 2001. Releta has federal trademark registrations on the principal register of the United States Patent and Trademark Office for the FAT BEAR word mark (Reg. No.2,267,709), TEN SPRINGS word mark (Reg. No. 2,243,852), and WHITEFACE word mark (Reg. No. 2,322,226). Releta has a federal trademark registration on the supplemental register of the United States Patent and Trademark Office for the SARATOGA CLASSIC PILSNER word mark (Reg. No. 2,396,601). 7 LICENSE AND FRANCHISE AGREEMENTS In August 2001, the Company acquired UBI and its wholly-owned subsidiary UBSN, which hold the exclusive brewing and distribution rights for Kingfisher Premium Lager in the U.K., Ireland, continental Europe, and Canada through a Licensing Agreement with United Breweries Limited ("UB Limited"); and to Sun Lik Chinese Lager in the U.K. as a sub-licensee of Shepherd Neame, which holds a license to this trademark through a Licensing Agreement with San Miguel Corporation. (See Part III, Item 13 -- "Certain Relationships and Related Transactions," below.) In July 2001 MBC entered into a Kingfisher Trademark and Trade Name License Agreement with Kingfisher America, Inc., pursuant to which MBC obtained a royalty-free, exclusive license to use the Kingfisher trademark and trade name in connection with the brewing and distribution of beer in the United States. Under its terms, this agreement is currently scheduled to remain in effect until October of 2013. Since 1998, UBI and UBSN have licensed to Shepherd Neame the exclusive right to brew, keg, bottle, can, label, and package all beers and related products sold under the Kingfisher trademark in the .K., Ireland, and continental Europe. (See Part III, Item 13 -- "Certain Relationships and Related Transactions - Shepherd Neame - Brewing Agreement," below.) In April 2004, the Company entered into a licensing agreement with Frank's Famous Foods ("FFF") and granted non exclusive license to FFF the trademark and trade name Red Tail Ale in the manufacture and sale of barbecue sauces ("Sauce"). FFF would pay a royalty varying between $1.50 to $3.00 per case of Sauce sold. GOVERNMENTAL REGULATION The Company's United States operations are subject to licensing by both state and Federal governments, as well as to regulation by a variety of state and local governments and agencies. The Company is licensed to manufacture and sell beer by the Departments of Alcoholic Beverage Control in California and New York. A federal permit from the United States 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. The Company's production operations must also comply with the Occupational Safety and Health Administration's workplace safety and worker health regulations and comparable state laws. Management believes that the Company is presently in compliance with the aforementioned laws and regulations. In addition, the Company has implemented its own voluntary safety program. The Hopland tavern is regulated by the Mendocino County Health Department, which requires an annual permit and conducts spot inspections to monitor compliance with applicable health codes. In the United States, taxation of alcohol has increased significantly in recent years. Currently, the Federal tax rate is $7.00 per bbl. for up to 60,000 bbl. per year and $18.00 per bbl. for over 60,000 bbl. The California tax rate is $6.20 per bbl. The State of New York presently imposes an excise tax of $3.88 per bbl. on brewers for over 100,000 bbl. per year. The Company's European operations are subject to regulation by U.K. and European laws, as well as by the laws of various individual countries in which UBI distributes its products. Because Shepherd Neame is contracted to perform the brewing operations for the European market, Shepard Neame is subject to the various laws of the European countries regarding production, bottling, packaging, and labeling in lieu of the Company. The Company does not anticipate any significant increase in its applicable taxes in its European markets during 2004. 8 COMPLIANCE WITH ENVIRONMENTAL LAWS The Company is subject to various federal, state, and local environmental laws which regulate the use, storage, handling, and disposal of various substances. The Company's waste products consist of water, spent grains, hops, and glass and cardboard. The Company has instituted a recycling program for its office paper, newspapers, magazines, glass, and cardboard at minimal cost to the Company. The Company sells or gives away its spent grain to local cattle ranchers. The Company has not purchased any special equipment and does not incur any identifiable fees in connection with its environmental compliance at its Hopland site. The Company has built its own wastewater treatment plant for the Ukiah facility. As a consequence, the Company is not currently 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 may be required to pay additional fees. The estimated cost of the wastewater treatment facility was $900,000, and the estimated cost of operating the plant is between $6,000 and $10,000 per month. The cost may increase with increased production. The Company has contracted to have the liquid sediment that remains from the treated wastewater trucked to a local composting facility for essentially the cost of transportation. The Company obtained a Mendocino County Air Quality Control Permit to operate the natural gas fired boiler in Ukiah; this permit is valid until August 30, 2005. Management expects this permit to be renewed. The Saratoga Springs facility is subject to various federal, state, and local environmental laws which regulate use, storage and disposal of various materials. The Company's solid waste products consist of spent grain, cardboard, glass, and liquid waste. As for solid waste, the Company has instituted at this facility a recycling program for cardboard, office papers and glass at a minimal cost to the Company. The Company sells spent grain to local cattle dairy farms. The Company pays approximately $1,600 per month towards sewer fees for liquid waste. The sewer discharge from the brewery is monitored and is within the standards set by the Saratoga County Sewer Department. The Company follows and operates under the rules and regulations of the New York Department of Environmental Conservation for Air Pollution Control. Various states in which the Company sells its products in the U.S., including California and New York, have adopted certain restrictive packaging laws and regulations for beverages that require deposits on packages. The Company continues to do business in these states, and such laws have not had a significant effect on the Company's sales. The adoption of similar legislation by Congress or a substantial number of states or additional local jurisdictions might require the Company to incur significant capital expenditures to comply. In Europe, various countries require information to be displayed on packaging in the national language. In general, European packaging regulations are covered by specifications provided by the European Union, with which the Company believes itself to be in compliance. Trade with Canada is subject to, and in compliance with, the regulation of the provincial Liquor Boards. The Company has not received any notice from any governmental agency that it is a potentially responsible person under any environmental law. EMPLOYEES As of December 31, 2004, MBC employed 56 full-time and 11 part-time individuals in the United States, including 11 in management and administration, 42 in brewing and production operations, 2 in retail and tavern operations and 12 in sales and marketing positions. In England, UBI and UBSN together employed twelve people in sales and marketing and five in managerial and administrative positions. Management believes that the Company's relations with its employees are generally good. On February 28, 2003, approximately 21 employees engaged in brewing, bottling, warehousing, and shipping at the Ukiah brewery elected Teamsters Local No. 896, International Brotherhood of 9 Teamsters, AFL-CIO ("Union") to represent them as a collective bargaining agent. The Company and the Union executed a collective bargaining agreement effective November 17, 2003 through July 31, 2008. All of such 21 employees' positions henceforth must be held and filled by members of the union. ITEM 2. PROPERTIES. In the United States, the Company owns nine acres of land in Ukiah, California on which its Ukiah brewery is operated. This facility is adequate for Company's current capacity and also has space for future expansion. Savings Bank of Mendocino County currently holds a first deed of trust on this property in connection with a loan advanced to the Company. (See PART II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") - Liquidity and Capital Resources - Long-Term Debt," below.) The principal amount outstanding on the loan as of December 31, 2004 was $2,299,400. CIT Group holds a second deed of trust on this property, securing a working capital facility granted to the Company. The amount owed to CIT Group by the Company under this credit facility was $1,563,300 as of December 31, 2004. (See MD&A -" Liquidity and Capital Resources -- Other Loans and Credit Facilities - CIT Group/Credit Finance Line of Credit," below). The Company owes approximately $720,100 to the County in overdue property taxes and accrued interest (See MD&A -" Liquidity and Capital Resources -- Other Loans and Credit Facilities - Overdue Property Taxes," below). The Company has estimated the life of the building at 40 years and depreciates the cost of the building on a straight-line method over its anticipated life. The Company does not depreciate the cost of the land. The Company's tax basis on the Ukiah facility is $10,206,300. Various other assets incorporated in this facility are being depreciated, on a straight-line basis, at between 10 and 20 years. Property taxes are currently assessed on the Ukiah property at a rate of 1.1%, for an annual tax of $112,300. The Company leases a 2,275 square foot building in Hopland on which the Hopland tavern ale house and merchandise store are located. The lease on this property expires in August 2010. The Company also leases 3.66 acres in Saratoga Springs, New York, on which Ten Springs Brewery operates under a lease. In November 2004, the lessor leased additional space for the use by the brewery as a warehouse and extended the term of the lease until November 2019. The Company has the option to renew the lease for two successive terms of five years if it is not in default at the time each option to extend the lease is exercised. The Company's Ukiah and Releta facilities have both been operating at significantly less than full capacity. The brewery in Ukiah, California has a current annual bottling capacity of approximately 90,000 brewers' barrels ("bbl.") on a single shift basis, whereas the annual sales from this facility were approximately 43,400 bbl., or 48% of maximum production capacity, in 2004, as compared with 47,300, or 53%, in 2003, and 47,400, or 53%, in 2002. The brewery at Saratoga Springs, New York has a n annual bottling capacity of approximately 60,000 bbl. per year a on single shift basis, although its annual sales from this facility were approximately 16,300 bbl., or 27% of its maximum capacity, in 2004, as compared with 13,600, or 23%, in 2003, and 11,200, or 19%, in 2002.. Despite their under-utilization, both of these breweries incur costs for maintenance, property taxes, and other costs which are more consistent with their maximum capacities than they are with the current utilization levels of these facilities. This places demands on the Company's capital, liquidity, and management resources. places demands upon the Company's resources. Failure to adequately meet those demands may have a material adverse affect on the Company's business, financial condition, and results of operations.. The Company leases certain equipment and vehicles under capital and operating leases which expire at varying times from September 2005 to April 2008. Additionally, the Company leases equipment under various smaller leases. As these leases expire, it is anticipated that the equipment will be acquired pursuant to the terms of the leases and the vehicles will be surrendered. 10 In the U.K., UBSN's lease for office premises located at Faversham, Kent, in England expired in November 2004 but has been extended on quarterly basis. UBSN is currently negotiating a new lease. The Company does not own or lease any other material properties in Europe. The Company considers its land, buildings, improvements, and equipment to be well maintained and in good condition, and adequate to meet the operating demands placed upon them. In the opinion of Management, all of these properties are adequately covered by insurance. ITEM 3. LEGAL PROCEEDINGS. Effective March 28, 2003, the Company terminated a written distribution agreement with the House of Daniels, Inc., dba Golden Gate Distributing Company ("GGDC"). On April 1, 2003, GGDC filed an action in Marin County Superior Court, naming the Company and Mr. Mark Anderson (who is employed by the Company as a sales manager) as defendants, and seeking actual and punitive damages in an amount not stated in the complaint (the "Action"). GGDC's Action asserted claims for breach of contract, breach of the covenant of good faith and fair dealing, unfair business practices, and negligent and intentional interference with economic relationships, all arising out of the allegedly wrongful termination of the GGDC distribution agreement. On January 21, 2004, GGDC filed an amended complaint, naming as additional defendants Dr. Vijay Mallya, the Company's Chairman; United Breweries of America, Inc., one of its principal shareholders("UBA"); and the distribution companies now servicing the territory formerly handled by GGDC("Subsequent Distributors"). Effective on or about November 1, 2004, the Company entered into a Settlement Agreement and Release (the "Settlement Agreement") with respect to the Action. The Settlement Agreement releases the claims asserted in, arising out of, or related to the Action by GGDC against the Company and the other defendants, and by the Company against GGDC. Under the terms of the Settlement Agreement, the Company is required to pay GGDC a total of $900,000 in settlement of all claims asserted by GGDC in the Action (the "Settlement Amount"). Payment is to be made in three installments: $400,000 by January 31, 2005; $300,000 by June 30, 2005; and the remaining $200,000 by December 31, 2005. UBA has guaranteed the payment, in full, of each of the installment payments included in the Settlement Amount. The Company made the first payment of $400,000 on March 4, 2005 along with applicable interest as per the terms of settlement. The Settlement Agreement entered into with GGDC released the claims asserted in, arising out of, or related to the Action by GGDC against the Company and the other defendants, and by the Company against GGDC; it does not, however, release, or even cover, the cross-claims asserted against the Company by the Subsequent Distributors. The Company entered into another Settlement Agreement and Release, effective as of December 9, 2004, with the Subsequent Distributors (the "Distributors' Settlement Agreement"), under the terms of which the cross-claims asserted against the Company by the Subsequent Distributors was also released. Under the terms of the Distributors' Settlement Agreement, the Company agreed to pay the Subsequent Distributors a total of $34,250 in settlement of all claims. As of the date of this report, $31,486, has already been deducted from invoices otherwise payable to the Company. The remaining $2,764 is expected to be deducted, in one remaining installment on April 29, 2005, from then-outstanding invoices, at which time the entire settlement amount will have been paid in full. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. During 2004, two of MBC's former directors, Mr. Neame and Mr. Townshend, resigned from the Board. Thereafter, the Board of Directors acted to reduce the size of the Board from eight to seven members. All six of the remaining Board members agreed to stand for re-election, and Scott Heldfond, a San Francisco-based businessman, was nominated to fill the remaining place on the Board. MBC held its 2004 Annual Meeting of Shareholders on January 14, 2005. At that meeting, MBC's shareholders voted 11 to elect all seven of the Board's nominees for Director. The votes cast for each of the nominees were as follows. There were no broker non-votes; ballots for a total of 1,191,193 shares were not cast with respect to any candidate. Director's Name Votes for Withheld --------------------------------------------------------- Vijay Mallya 10,006,069 69,612 H. Michael Laybourn 10,041,264 34,417 Jerome G. Merchant 10,019,169 56,512 Sury Rao Palamand 10,006,069 69,612 Kent D. Price 10,007,869 67,812 Yashpal Singh 10,005,669 70,012 Scott R. Heldfond 10,008,569 67,112 The Company's shareholders also voted to ratify the selection of Moss Adams, LLP as independent certified accountants to audit the Company's financial statements for the fiscal year ending December 31, 2004. The votes were cast as follows: for, 10,019,583; against, 33,815; abstain, 22,283. There were no broker non-votes; ballots for a total of 1,191,193 shares were not cast with respect to the selection of Moss Adams, LLP. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. MARKET INFORMATION Since May of 2002, the Company's Common Stock has been quoted on the Nasdaq OTC Bulletin Board, under the symbol "MENB". The table below sets forth, for the fiscal quarters indicated, the reported high and low bid prices for the Company's Common Stock, as reported on the OTC Bulletin Board. The information listed below reflects inter-dealer bids, without retail mark-up, mark-down, or commission, and may not represent actual transactions. High Low ---- --- 2004 ---- First Quarter $0.20 $0.20 Second Quarter $0.21 $0.20 Third Quarter $0.21 $0.20 Fourth Quarter $0.25 $0.11 2003 ---- First Quarter $0.27 $0.16 Second Quarter $0.22 $0.16 Third Quarter $0.35 $0.16 Fourth Quarter $0.20 $0.18 The Company had approximately 2,334 holders of its common stock of record as of March 31, 2005. The Company has never paid a cash dividend on its Common Stock and Management does not expect the Company to pay cash dividends in the foreseeable future. The Company's credit agreements provide that the Company may 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 similar restrictions will remain in effect for as long as the Company has significant bank financing. 12 The holders of the Company's 227,600 outstanding shares of Series A Preferred Stock (which is not listed for trading on any market or to the Company's knowledge quoted on any bulletin board or other public quotation system) 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 must be canceled after the holders of these shares 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. SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS As of December 31, 2004, the Company had authorized and issued equity compensation in the following amounts.
Number of securities Number of remaining available securities to be for future issuance issued upon under equity exercise of Weighted-average compensation outstanding exercise price of plans(excluding options warrants outstanding options, securities reflected and rights warrants and rights in column (a)) Plan Category (a) (b) (c) Equity compensation plans approved by 340,385 $0.73 -- security holders Equity compensation plans not * * 343,960 approved by security holders Total 340,385 $0.73 343,960
---------------- * See " Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities," below for a description of the Company's Director's Compensation Plan. RECENT SALES OF UNREGISTERED SECURITIES 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 in respect of compensation due for the years 2002, 2003, and 2004. 13 Effective as of January 31, 2005, therefore, stock grants based on the book value of the Company's Common Stock were approved under the Directors' Stock Grant Plan in respect of compensation due to Directors Michael Laybourn, Sury Rao Palamand, and Kent Price for their service on the Board and various Board Committees during 2002 and 2003, in each case assuming a fair market value of $0.56 per share for shares so granted with respect to 2002 and $0.58 per share for shares so granted with respect to 2003. Mr. Laybourn received stock grants totaling 15,978 shares for his services in 2002 and 15,585 for such services in 2003; Mr. Palamand received grants totaling 21,303 shares for 2002 and 22,513 shares for 2003; and Mr. Price received grants totaling 24,853 shares for 2002 and 24,245 shares for 2003. Management believes that the issuance of such shares was exempt from registration pursuant to Section 4(2) of the Act because of the limited number of recipients and the fact that each of the recipients has significant business experience, financial sophistication, and intimate knowledge of and familiarity with the business of the Company. 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 II, Item 7, below, 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 December 31, 2004, the outstanding principal and interest on the UBA Notes totaled approximately $2,010,050, and the UBA Notes were convertible into 1,340,034 shares of the Company's Common Stock. (The New Note could currently be converted into an additional 266,667 shares.) 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. ISSUER PURCHASE OF EQUITY SECURITIES None. 14 ITEM 6 SELECTED FINANCIAL DATA. In August of 2001, the Company acquired all the outstanding stock of United Breweries International (U.K.) Limited ("UBI"), which had as a wholly-owned subsidiary UBSN, Ltd. ("UBSN"), in exchange for 5,000,000 shares of MBC's Common Stock. Since it was considered a related party transaction, this acquisition was required to be reported on an "as-if pooled" basis. The Company's consolidated financial statements have been presented as if the acquisition of UBI had occurred on January 1, 2000.
STATEMENT OF OPERATIONS DATA ----------------------------- ------------------------------------------------------------------------------- YEARS ENDED ----------------------------- ------------------------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------------------------- --------------- --------------- --------------- --------------- --------------- Sales $ 32,157,900 $ 28,864,300 $ 26,085,100 $ 24,638,600 $ 22,432,900 ----------------------------- --------------- --------------- --------------- --------------- --------------- Less Excise Taxes 652,400 673,900 651,600 666,000 563,700 ----------------------------- --------------- --------------- --------------- --------------- --------------- Net Sales 31,505,500 28,190,300 25,433,500 23,602,300 21,869,200 ----------------------------- --------------- --------------- --------------- --------------- --------------- Cost of goods sold 21,045,500 19,145,500 16,892,800 15,907,500 14,043,300 ----------------------------- --------------- --------------- --------------- --------------- --------------- Gross Profit 10,460,000 9,044,800 8,540,700 8,065,000 7,825,900 ----------------------------- --------------- --------------- --------------- --------------- --------------- Operating Expenses 10,006,200 8,067,300 7,312,000 7,822,200 7,162,900 ----------------------------- --------------- --------------- --------------- --------------- --------------- Depreciation & Amortization 1,031,300 1,127,100 1,049,000 1,083,300 1,169,600 ----------------------------- --------------- --------------- --------------- --------------- --------------- Net income (Loss) (468,900) 46,900 (1,729,800) (2,843,600) (115,200) ----------------------------- --------------- --------------- --------------- --------------- --------------- Net income (Loss) per common share (0.04) 0.00 (0.15) (0.26) (0.01) ----------------------------- --------------- --------------- --------------- --------------- --------------- Common shares outstanding 11,266,874 11,266,874 11,266,874 11,083,228 11,080,498 ----------------------------- --------------- --------------- --------------- --------------- --------------- BALANCE SHEET DATA ----------------------------- ------------------------------------------------------------------------------- DECEMBER 31, ----------------------------- ------------------------------------------------------------------------------- 2004 2003 2002 2001 2000 ----------------------------- --------------- --------------- --------------- --------------- --------------- Cash and Cash equivalent $ 526,600 554,300 146,800 89,800 208,300 ----------------------------- --------------- --------------- --------------- --------------- --------------- Working capital (2,215,100) (1,795,600) (2,673,00) (2,470,500) (1,738,300) ----------------------------- --------------- --------------- --------------- --------------- --------------- Property and equipment 13,533,900 13,874,800 14,159,400 14,640,600 14,862,300 ----------------------------- --------------- --------------- --------------- --------------- --------------- Deposit and other assets 205,100 188,600 73,600 87,500 87,400 ----------------------------- --------------- --------------- --------------- --------------- --------------- Total assets 24,363,100 23,471,700 22,289,600 23,947,400 24,883,000 ----------------------------- --------------- --------------- --------------- --------------- --------------- Long term debt 3,384,800 3,730,300 3,290,200 3,775,100 4,165,900 ----------------------------- --------------- --------------- --------------- --------------- --------------- Capital lease 62,600 204,100 193,900 925,000 1,396,900 ----------------------------- --------------- --------------- --------------- --------------- --------------- Total liabilities 18,209,100 16,965,100 15,943,200 16,085,800 14,488,900 ----------------------------- --------------- --------------- --------------- --------------- --------------- Accumulated deficit (8,916,500) (8,447,600) (8,494,500) (6,764,700) (3,859,000) ----------------------------- --------------- --------------- --------------- --------------- --------------- Shareholders equity 6,154,000 6,506,600 6,346,400 7,861,600 10,394,100 ----------------------------- --------------- --------------- --------------- --------------- ---------------
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 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 15 discussion of results and trends does not necessarily imply that these results and trends will continue. With respect to certain forward-looking statements contained in the following discussion, please refer to the paragraph captioned "Forward Looking Statements" set forth immediately prior to Part I of this Annual Report, above. 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 a majority of our inventories; o The intrinsic value method, or APB Opinion No. 25, to account for our common stock incentive awards; o A full valuation allowance of deferred tax assets for net operating loss carryforwards that are expected to expire prior to utilization; o The carrying value of certain plant and equipment in not impaired under FASB 144 based on expected future cash flows from operations; These accounting policies are applied consistently for all years presented. Our operating results would be affected if other alternatives were used. Information about the impact on our operating results is included in the footnotes to our consolidated financial statements. OVERVIEW The Company reported a net loss for the year 2004, primarily as a result of increased legal expenses and one-time settlement expenses relating to a legal dispute. (See Part I, Item 3 - "Legal Proceedings," above.) The Company's losses were partially offset by increased sales in the European Territory and a favorable exchange rate. The Company's United States brewing operations sales were 59,616 bbl during 2004., as compared to 60,871 bbl. and 58,616 bbl. sold in 2003 and 2002 respectively. Sales out of the Ukiah facility amounted to 43,358 bbl., 47,315 bbl. and 47,440 bbl. respectively for the years 2004, 2003 and 2002. Sales out of the Saratoga Springs facility amounted to 16,258 bbl., 13,556 bbl., and 11,176 bbl. for the years 2004, 2003 and 2002 respectively. During the year 2004, the Company bottled 1,157 bbl (none in 2003 and 2002) of cider products for California Cider Company. The Company sold 67,493 bbl. in its European Territory during 2004 as compared to 64,115 bbl. and 57,072 bbl. sold during 2003 and 2002 respectively. Sales to the United Kingdom customers were 61,564 bbl., 58,501 bbl. and 51,426 bbl. during 2004, 2003 and 2002 respectively. Sales to continental Europe and Canada customers were 5,929 bbl., 5,614 bbl. and 5,646 bbl. during 2004, 2003 and 2002 respectively. 16 The Company introduced a few new products during 2004. During the first quarter, the Company launched Talon Barley Wine Ale in 22 oz. bottles on the West Coast, followed by a second launch in the East Coast during the fourth quarter. UBSN also launched Kingfisher natural spring water in the Indian restaurant trade in February. In July, the Company entered into a bottling contract with California Cider Company to bottle their cider products. During the fourth quarter, the Company launched Winter Ale Special Edition in 12 oz. six packs on the East Coast. RESULTS OF OPERATIONS YEAR 2004 COMPARED TO YEAR 2003 NET SALES As used herein, the term "net sales" refers to gross sales less excise taxes. Overall net sales for 2004 were $31,505,500, an increase of $3,315,200, or 11.76%, as compared to $28,190,300 in 2003. Sales volume and price increases in the European Territory contributed to the increase in sales. DOMESTIC OPERATIONS: Net U.S. sales were $11,245,600 in 2004, compared to $11,341,500 for 2003, representing a decrease of 0.8%. Sales volume of beer for the year decreased by 1,255 barrels, to 59,616 barrels a decrease of 2.1% as compared to 60,871 barrels in 2003. The decrease was mainly due to reduction in contract brands which decreased by 1,532 bbl, decreases in the sale of the Company's brands (other than Kingfisher) by 654 bbl, offset partially by increase in sale of Kingfisher Premium Lager by 931 bbl. During 2004, the Company bottled 1,157 bbl of cider products for California Cider Company on a contract basis. The decrease in overall net sales during 2004 was mainly due to decrease of $214,000 in retail sales at the Hopland tavern ale house and merchandise store, a decrease of 50.3% when compared to retail sales of $425,300 during 2003, due to closure of the restaurant located at the Hopland in the year 2003. Net sales associated with wholesale shipment of beer and bottling cider increased by $118,000 during the year 2004, an increase of 1.08% compared to 2003. EUROPEAN TERRITORY: Net sales in the Company's European Territory were $20,259,900 ((pound)11,052,900) in 2004, compared to $16,848,800 ((pound) 10,310,700) during 2003. The increase is attributed to increase in sales volume and increase in sales prices effected in April 2004 in the United Kingdom. Because of exchange rate fluctuations, when the net sales results are compared in dollars they amount to an increase of 20.3%, as compared to 2003, while when measured in Pounds Sterling, the increase is only 7.2%. The Company sold 67,493 bbl. in its European Territory during 2004, an increase of 3,378 bbl. or 5.3%, as compared to 64,115 bbl. sold during 2003. COST OF GOODS SOLD: Overall cost of goods sold during 2004 was $21,045,500, as compared to $19,145,500 during 2003, an increase of $1,900,000, or 9.9%. As a percentage of net sales, costs of goods sold was 66.8% in 2004, as compared to 67.9% during 2003. (The foregoing amounts are calculated in U.S. dollars, and do not take into account the effect of exchange rate fluctuations on the actual costs of goods sold in the Company's European Territory.) DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in the United States during 2004 was 66.4%, as compared to 70.3% during the year 2003, representing a decrease of 3.9%. The decrease was due mainly to decrease in depreciation and retail operation costs because of the closure of the restaurant in Hopland. The Company relies heavily on natural gas to operate its brewing operations, and electricity to operate its bottling and refrigeration units. Any significant increase in the use or charges of these utilities could significantly impact operations. EUROPEAN TERRITORY: As a percentage of net sales, cost of goods sold in the United Kingdom during 2004 was 67.5%, as compared to 66.8% during 2003 (in each case as calculated in U.S. dollars, 17 after taking into account the effects of exchange rate fluctuations). The increase was mainly due to exchange rate fluctuations and price increase by Shepherd Neame. GROSS PROFIT As a result of the higher sales volumes, price increases, and exchange rate fluctuations described above, gross profit for 2004 (expressed in dollars) grew to approximately $10,460,000, an increase of approximately $1,415,200, or 15.6%, as compared to gross profit of $9,044,800 achieved in 2003. As a percentage of net sales, the Company's overall gross profit during the year 2004 increased to 33.2%, as compared to 32.1% for 2003, largely as a result of increases in sales volume and sales revenue. OPERATING EXPENSES Operating expenses for the year 2004 were $10,006,200, an increase of $1,938,900, or 24%, as compared to $8,067,300 for 2003. Operating expenses consist of marketing and distribution expenses, general and administrative expenses, and retail operating expenses. MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and distribution expenses consist of salesmen's salaries and commissions, advertising costs, product and sales promotion costs, travel expenses, and related costs. For 2004, such expenses were $5,841,200, an increase of $1,417,300, or 32%, as compared to $4,423,900 in 2003. As a percentage of net sales, the Company's marketing and distribution expenses increased to 18.5% in 2004, as compared to 15.7% in 2003. DOMESTIC OPERATIONS: Domestic marketing and distribution expenses in 2004 were $1,561,900, an increase of $222,200, or 16.6%, as compared to the $1,339,700 incurred during 2003. These expenses were equal to 13.9% of U.S. net sales during the year 2004, as compared to 11.8% during 2003. This increase is primarily due to salary increases effected during the beginning of the year 2004 and increase in the Company's U.S. sales staff during the last quarter of the year 2003, which resulted in increased compensation, travel, entertainment and sampling expenses during the year 2004. EUROPEAN TERRITORY: Marketing and distribution expenses in the European Territory during 2004 were $4,279,300, an increase of $1,195,100, or 38.8%, as compared to $3,084,200 during 2003. As a percentage of net sales in the United Kingdom, such expenses increased to 21.1% during 2004, as compared to 18.3% during 2003 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). The increase was due primarily to increased advertising and promotional activities, including marketing and sales promotion expenses; higher personnel costs; personnel costs and sales commissions due to increased sales in supermarkets and convenient stores; startup costs associated with launch of Kingfisher Natural Spring Water; freight costs due to higher sales and distribution; and increases in the costs of repair and replacement of beer dispensing equipment installed in bars by the Company. These increases were partially offset by decreases in freight costs due to a reduction in export sales, and other miscellaneous distribution expenses. GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and administrative expenses were $3,774,900 for 2004, representing an increase of $454,900, or 13.7%, over $3,320,000 for 2003. These expenses were equal to 12% of net sales for 2004, as compared to 11.8% of net sales for 2003. DOMESTIC OPERATIONS. Domestic general and administrative expenses were $1,955,200 for 2004, representing an increase of $121,600, or 6.6%, over $1,833,600 for 2003. The increase was primarily due to $88,600 in increased legal expenses caused by a legal dispute with a distributor and $65,200 in loan and lease fee related to Company's refinancing efforts. This increase was partly offset by 18 decreases primarily in director's remuneration, bad debt, rent, certain one time professional fees incurred in the year 2003 and bank charges. EUROPEAN TERRITORY. General and administrative expenses related to the European Territory were $1,819,700 for 2004, representing an increase of $333,300, or 22.4%, as compared to $1,486,400 for 2003. These increases were led by higher remuneration costs, and increased depreciation expenses. RETAIL OPERATING EXPENSES: Retail operating expenses for 2004 were $139,500, representing a decrease of $183,900, or 56.7%, from $323,400 in 2003. As a percentage of net sales, retail operating expenses decreased to 0.4% as compared to 1.1% for the year 2003. The decrease in retail operating expenses consisted mainly of decreases in labor expenses as a result of reduced hours of operation of the tavern and closure of the restaurant. LEGAL DISPUTE SETTLEMENT: The Company settled a legal dispute with a former distributor in the year 2004. The amount of the settlement represents a one-time expense. (Please refer to Part I, Item 3, Legal Proceedings above for details). OTHER EXPENSES Other expenses totaled $800,900 in 2004, representing an increase of $135,000, or 20.3%, when compared to $665,900 in 2003. The primary cause of the increase was that in 2003 the Company received a one-time payment of $122,000 as a result of the early termination of a brewing contract by Wolavers Enterprises, LLC. The Company received no such benefit in 2004 to offset its other expenses. INCOME TAXES The Company's provision for income taxes was $121,800 for 2004, a drop of $142,900, or 54%, as compared to $264,700 for 2003. The provision for taxes includes $118,000 related to the estimated amount of taxes that will be imposed by taxing authorities in the United Kingdom. As of December 31, 2004, the Company had approximately $10,928,400, $3,522,400 and $1,767,300 of Federal, California, and New York net operating losses, respectively, available to carry forward. Of the Federal and New York net operating losses, approximately $1,963,100 will expire in 2013, and the remainder will expire through 2024. The State of California has suspended the ability to use net operating loss carryforwards until 2005. The Company anticipates that any taxable income in California during this period will be offset by investment tax credits. The California net operating losses begin to expire in 2005 and will continue to expire through 2012. The Company also has $141,400 of California Manufacturers' Investment Tax Credits that can be carried forward to offset future taxes until they begin to expire in 2007. The Company has recorded a valuation allowance of $3,375,000 on deferred tax assets for net operating loss carryforwards that may expire prior to utilization. Management believes that the Company could still utilize the deferred tax assets in the ordinary course of business, but due to the significant time period that may elapse before utilization, Management has decided that a valuation allowance was necessary. The Company is implementing various strategies to achieve profits sufficient to utilize these assets. NET INCOME The Company's net loss for 2004 was $468,900, a decrease of $515,800 as compared to a net income of $46,900 for the year 2003. After providing for a foreign currency translation adjustment of $116,300 for 2003 ($113,300 for 2003), the Company's comprehensive 2004 loss was $352,600, as compared to an income of $160,200 in 2003. 19 YEAR 2003 COMPARED TO YEAR 2002 NET SALES Overall net sales for 2003 were $28,190,300, an increase of $2,756,800, or 10.8%, as compared to $25,433,500 in 2002. Sales volume and (in the European Territory) price increases contributed to the increase in sales. DOMESTIC OPERATIONS: Net U.S. sales were $11,341,500 in 2003, compared to $11,017,900 for 2002, representing an increase of 2.9%. Sales volume for the year increased by 2,255 barrels, to 60,871 barrels an increase of 3.84% as compared to 58,616 barrels in 2002 The growth reflects increases in the sale of the Company's brands (other than Kingfisher) by 1,307 bbl., contract brands by 857 bbl, and by 91 bbl. of Kingfisher Premium Lager. The increase in overall net sales during 2003 was achieved mainly by higher wholesale shipments, which represented an increase of $409,700 over the wholesale shipments during 2002. Retail sales for the year decreased by $86,100, to $425,300, a decrease of 16.84% when compared to retail sales of $511,400 during 2002. EUROPEAN TERRITORY: Net sales in the Company's European Territory were $16,848,800 ((pound)10,310,700) in 2003, compared to $14,415,600 ((pound)9,594,400) during 2002. Because of exchange rate fluctuations, when the net sales results are compared in dollars they amount to an increase of 16.88%, as compared to 2002, while when measured in Pounds Sterling, the increase is only 7.47%. During 2003, the Company sold 61,040 barrels in its European Territory, an increase of 3,968 barrels, or 6.9%, as compared to 57,072 barrels during 2002. The Company increased its selling prices in all its European Territory markets by approximately 2.5% in March 2003, and about 1.7% of the increase in net sales is attributable to those price hikes. COST OF GOODS SOLD: Overall cost of goods sold during 2003 was $19,145,500, as compared to $16,892,800 during 2002, an increase of $2,252,700, or 13.34%. As a percentage of net sales, costs of goods sold was 67.9% in 2003, as compared to 66.4% during 2002. (The foregoing amounts are calculated in U.S. dollars, and do not take into account the effect of exchange rate fluctuations on the actual costs of goods sold in the Company's European Territory.) DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in the United States during 2003 was 70.3%, as compared to 67.1% during the year 2002, representing an increase of 3.2%. During 2003, there were increases in the price of packaging material (mainly bottles), rent, and insurance costs. The Company relies heavily on natural gas to operate its brewing operations, and electricity to operate its bottling and refrigeration units. Any significant increase in the use or charges of these utilities could significantly impact operations. EUROPEAN TERRITORY: Cost of goods sold in 2003 was $11,249,900 ((pound)6,884,500), as compared to similar costs of $9,470,700 ((pound)6,303,300) in 2002. As a percentage of net sales, cost of goods sold in the United Kingdom during 2003 was 66.8%, as compared to 65.9% during 2002 (in each case as calculated in U.S. dollars, after taking into account the effects of exchange rate fluctuations). The increase was mainly due to exchange rate fluctuations and price increase by Shepherd Neame. GROSS PROFIT As a result of the higher sales volumes, price increases, and exchange rate fluctuations described above, gross profit for 2003 (expressed in dollars) grew to approximately $9,044,800, an increase of approximately $504,100, or 5.9%, as compared to gross profit of $8,540,700 achieved in 2002. As a 20 percentage of net sales, however, the Company's overall gross profit during the year 2003 decreased to 32.1%, as compared to 33.6% for 2002, largely as a result of increases in costs of goods sold and excise taxes. OPERATING EXPENSES Operating expenses for the year 2003 were $8,067,300, an increase of $755,300, or 10.3%, as compared to $7,312,000 for 2002. Operating expenses consist of marketing and distribution expenses, general and administrative expenses, and retail operating expenses. MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and distribution expenses were $4,423,900, an increase of $179,500, or 4.2%, as compared to $4,244,400 in 2002. As a percentage of net sales, the Company's marketing and distribution expenses decreased to 15.7% in 2003, as compared to 16.7% in 2002. DOMESTIC OPERATIONS: Domestic marketing and distribution expenses in 2003 were $1,339,700, a decrease of $42,600, or 3.09%, as compared to the $1,382,300 incurred during 2002. These expenses were equal to only 11.8% of U.S. net sales during the year 2003, as compared to 12.6% during 2002. This decrease is primarily due to a reduction in the Company's U.S. sales staff, which resulted in lower compensation, travel, entertainment and sampling expenses. Partially offsetting these reductions were increases in the Company's sales promotion expenses, including media advertising costs and point of sales materials. EUROPEAN TERRITORY: Marketing and distribution expenses in the European Territory during 2003 were $3,084,200, an increase of $222,100, or 7.76%, as compared to $2,862,100 during 2002. As a percentage of net sales in the United Kingdom, such expenses decreased to 18.31% during 2003, as compared to 19.85% during 2002 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). The increase was due primarily to increased promotional activities, including marketing and sales promotion expenses, which increased by $190,000, to $932,000 in 2003 as compared to $742,000 in 2002; higher personnel costs; personnel costs and sales commissions due to increased sales in supermarkets and convenient stores; increased distribution and promotional expenses relating to Sun Lik beer; and increases in the costs of repair and replacement of beer dispensing equipment installed in bars by the Company. These increases were partially offset by decreases in freight costs due to a reduction in export sales, and other miscellaneous distribution expenses. GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and administrative expenses were $3,320,000 for 2003, representing an increase of $587,700, or 21.5%, over $2,732,300 for 2002. These expenses were equal to 11.8% of net sales for 2003, as compared to 10.7% of net sales for 2002. DOMESTIC OPERATIONS. Domestic general and administrative expenses were $1,833,600 for 2003, representing an increase of $189,400, or 11.5%, over $1,644,200 for 2002. The increase was primarily due to $289,800 in increased legal and professional expenses caused by negotiation of a collective bargaining agreement at the Company's Ukiah, California, facility, and a legal dispute with a distributor. This increase was partly offset by decreases in bad debt, rent, certain lease fees and bank charges, investor related expenses, and travel expenses. EUROPEAN TERRITORY. General and administrative expenses related to the European Territory were $1,486,400 for 2003, representing an increase of $418,300, or 39.2%, as compared to $1,068,100 for 2002. These increases were led by $181,200 in higher personnel costs and $110,000 in increased depreciation expenses. 21 RETAIL OPERATING EXPENSES: Retail operating expenses for 2003 were $323,400, representing a decrease of $11,900, or 3.5%, from $335,300 in 2002. As a percentage of net sales, retail operating expenses decreased to 1.1% as compared to 1.3% for the year 2002. The decrease in retail operating expenses consisted mainly of decreases in labor expenses as a result of reduced hours of operation of the tavern and closure of the associated restaurant. OTHER EXPENSES Other expenses totaled $665,900 in 2003, representing a decrease of $69,500, or 9.5%, when compared to $735,400 in 2002. The decrease was primarily a result of lower interest expenses and miscellaneous income. INCOME TAXES The Company's provision for income taxes was $264,700 for 2003, a drop of $1,958,400, or 88.1%, as compared to $2,223,100 for 2002. The provision for taxes includes $263,400 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 2003 was $46,900, an improvement of $1,775,700 as compared to a net loss of $1,729,800 for the year 2002. After providing for a foreign currency translation adjustment of $113,300 for 2003 ($42,500 for 2002), the Company's comprehensive 2003 income was $160,200, as compared to a loss of $1,687,300 in 2002. 22 LIQUIDITY AND CAPITAL RESOURCES Unused capacity at the Ukiah and Saratoga Springs facilities (see part I, Item 2, Properties," above) has continued to place demands on the Company's working capital. Beginning approximately in the second quarter of 1997, the time at which the Ukiah brewery commenced operations, proceeds from operations have not been able to provide sufficient working capital. 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. The Company does not currently have sufficient funds available to repay certain loans as they become due. So far, the lenders have extended their loans to facilitate refinancing. Subsequent to year-end, the Company successfully extended a debt and secured commitment from the lender for extension of the loan until May 2006 (see "OTHER LOANS AND CREDIT FACILITIES - Savings Bank of Mendocino Temporary Loan," below). It also obtained a new $2,000,000 secured revolving credit Facility and a loan of $31,240 (See "BFI LOAN AND LINE OF CREDIT," below.) The proceeds from this new loan and line of credit were used to pay off the outstanding loan from CIT Group on May 6, 2005. Additionally, one of the Company's majority stock holders has guaranteed to provide financial support to avoid possible default action by Savings Bank of Mendocino County. 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 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 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%. At the same time, BFI also advanced the Company $31,240 under a promissory note (the "BFI Note" and, together with the BFI Line of Credit, the "BFI Facility"). The BFI Note is interest-only until September of 2005; principal under the BFI Note is payable in four equal monthly installments commencing in September 2005. On May 6, 2005, the Company used the entire immediately available amount drawable under the BFI Facility to pay off the balance remaining outstanding under the CIT Group Line of Credit discussed below (see "OTHER LOANS AND CREDIT FACILITIES -- CIT GROUP/CREDIT FINANCE LINE OF CREDIT"). 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 executed an Extension of Term of Notes 23 under Master Line of Credit Agreement in February 2002, which was later amended in August 2002, and again in March, August 2003 and August 2004 (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 14, 2005. Because these notes are subordinated to the BFI Facility and the SMBC Temporary Loan (discussed below), the Company does not expect to make payments on the notes within the next year. The Company also expects the maturity dates of the UBA Notes to be extended again, although it has received no written assurance that this will be the case. The outstanding principal amount of the 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 December 31, 2004, the outstanding principal and interest on the notes was convertible into 1,340,034 shares of the Company's Common Stock. 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. UBA has made thirteen (13) separate advances to the Company under the Credit Agreement, pursuant to a series of individual eighteen (18) month promissory notes issued by the Company to UBA (the "UBA Notes"). The aggregate outstanding principal amount of the UBA Notes as of February 28, 2005 was $1,515,371, and the accrued but unpaid interest thereon was equal to approximately $511,494. These amounts reflect an increase of approximately $105,300 in the interest currently due on the UBA Notes, as compared to December 31, 2003. The UBA Notes and the New Note (which is on essentially the same terms as are 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 or New 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 or New Note upon maturity, it has the option to extend the term of such notes for any period of time mutually agreed upon by UBA and the Company. During the extended term of any 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. (For further information about the Credit Agreement please refer to "PART III, Item 13 - Certain Relationships and Related Transactions -Master Line of Credit Agreement," below.) 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 $24,443 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. The amount outstanding as of December 31, 2004 on this facility was $2,299,400. EQUIPMENT LEASE: From 1996 until 2003, Finova Capital Corporation ("Finova") leased new brewing equipment with an original total cost of approximately $1.78 million to MBC, with monthly rental payments of approximately $27,100 each. During 2003, the Company exercised its option to purchase the equipment at a cost of approximately $576,200. OTHER LOANS AND CREDIT FACILITIES. 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. As of December 31, 2004, the total amount outstanding on the line of credit was approximately $1,563,300. The Company used the proceeds from the BFI Facility to pay off the entire amount outstanding on May 6, 2005. 24 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 MBC in 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 BANK LIMITED OPTION FACILITY: Nedbank Limited (formerly Necor Bank Limited), a South African registered company, has provided UBSN with a multi-currency option facility of 1,250,000 Pounds Sterling. This overdraft facility is secured by all of the assets of UBSN. The amount outstanding on this line of credit as of December 31, 2004 was approximately $1,729,500. SHEPHERD NEAME LOAN: Shepherd Neame has a contract with UBSN to brew Kingfisher Premium Lager for the Company's European and Canadian markets. As consideration for extending the brewing contract, Shepherd Neame advanced a loan of (pound)600,000 (Pounds Sterling) to UBSN, repayable in annual installments of (pound)60,000 (Pounds Sterling) per year, commencing in June 2003. The loan carries a fixed interest rate of 5% per year. (For more information about this loan please see "PART III -- Certain Relationships and Related Transactions -- Loan Agreement Between UBSN and Shepherd Neame," below.) WEIGHTED AVERAGE INTEREST: The weighted average interest rates paid on the Company's U.S. debts was 7.85% for the year 2004 compared to 7.38% and 8.19% (including the long term capital lease of equipment by Finova Capital Corporation Inc.) for the year 2003 and 2002 respectively. For loans primarily associated with Company's European territory, the weighted average rate paid was 5.9% ,6.42% and 6.94% in 2004, 2003 and 2002 respectively. KEG MANAGEMENT ARRANGEMENT: The Company entered into a five-year keg management agreement with MicroStar Keg Management LLC as of September 1, 2004. 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, on any given month, the agreement is not extended and terminates, the Company is required to purchase a certain number of kegs from MicroStar. The Company 25 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 on termination of contract is likely to have a material adverse effect on the Company. CURRENT RATIO: The Company's ratio of current assets to current liabilities on December 31, 2004 was 0.83 to 1.0 and its ratio of total assets to total liabilities was 1.3 to 1.0. On December 31, 2003, the Company's ratio of current assets to current liabilities was 0.84 to 1.0 and its ratio of total assets to total liabilities was 1.4 to 1.0. On December 31, 2002, the Company's ratio of current assets to current liabilities was 0.64 to 1.0 and its ratio of total assets to total liabilities was 1.4 to 1.0. OVERDUE PROPERTY TAXES: As of June 30, 2003, the delinquent property taxes due on the Company's Ukiah property, including penalties and interest, totaled $710,600, representing overdue taxes for the period from April 1999 to June 2003. On July 31, 2003, the Company entered into a payment plan to settle these issues, pursuant to which it made an initial payment to the County of $143,000. In April 2005, the Company made payment of the 2005 installment, plus interest, for a total payment of $324,600. The remaining balance of the overdue taxes will 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. 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 issues (including payments due under the payment plan) could have, or have had, 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 $2,587,000. Under UBI's line of credit agreement, distributions and other payments to the Company from its subsidiary are limited to approximately $200,000 per year. RELATED PARTY TRANSACTIONS: In the last several years, MBC and its subsidiaries have entered into or amended several agreements with affiliated and related entities. Among these have been a Brewing Agreement and a Loan Agreement between UBSN and Shepherd Neame; 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. (For more information on all of these agreements please see "PART III - Item 13 - -- Certain Relationships and Related Transactions," below.) CONTRACTUAL OBLIGATIONS The following chart sets forth the Company's contractual obligations as of December 31, 2004.
- ---------------------------------------- ---------------------------------------------------------------------------- Contractual Obligations Payments due by period ---------------------------------------------------------------------------- Total Less than 1 1-3 years 3-5 years More than 5 year years - ---------------------------------------- ----------------- ------------- -------------- -------------- -------------- Long Term Debt Obligations $ 3,785,100 400,300 809,300 711,100 1,864,400 - ---------------------------------------- ----------------- ------------- -------------- -------------- -------------- Capital Lease Obligations $ 209,100 146,500 62,600 - - - ---------------------------------------- ----------------- ------------- -------------- -------------- -------------- Operating Lease Obligations $ 863,800 181,200 341,100 331,600 9,900 - ---------------------------------------- ----------------- ------------- -------------- -------------- -------------- Purchase Obligations - - - - - - ---------------------------------------- ----------------- ------------- -------------- -------------- -------------- Other Long Term Liabilities $ 2,010,100 - - - 2,010,100 - ---------------------------------------- ----------------- ------------- -------------- -------------- -------------- Total $ 6,868,100 728,000 1,213,000 1,042,700 3,884,400 - ---------------------------------------- ----------------- ------------- -------------- -------------- --------------
26 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of December 31, 2004, 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's direct exposure to risks arises out of changes in interest rates, foreign currency exchange rate fluctuations and commodity prices. INTEREST RATE RISK The Company had total debt as of December 31, 2004 of $9,158,900, of which $5,384,500 was subject to variable rates of interest (either prime or LIBOR plus 1.5% or prime plus 3% or prime plus 4.25%). Its long-term debt (including current portion) as of December 31, 2004 totaled $5,300,500 of which$3,774,400 had fixed rates of interest and the balance of $1,526,100 were subject to variable rates. Short term debts amounted to $3,858,400, all of 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 $53,800 in interest expense on the Company's variable rate loans. FOREIGN CURRENCY RATE FLUCTUATIONS The Company's primary operating subsidiary, UBSN, operates in its European Territory, and primarily in the United Kingdom, where both its income and its expenses are denominated in British Pounds. The ultimate value to the Company of its sales in the European Territory may be either magnified or diminished depending on the trading value of the British Pound as against the U.S. Dollar, the Company's principal reporting currency. The net effect of that part of the Company's consolidated cash flows and earnings which is derived from UBSN is therefore subject to fluctuations due to changes in the value of the British Pound as compared with the U.S. Dollar. UBSN and its immediate corporate parent, UBI, contributed approximately 63% of the Company's total sales and 69.7% of its net operating income in 2004, as compared to approximately 58.4% and 100%, respectively, in 2003 and approximately 55.3% and 80.1%, respectively, in 2002. See Part II, Item 7 -- "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations," above, for a more direct discussion of these effects. The Company does not attempt to hedge against currency fluctuations. The Company utilizes the rates published by the Board of Governors of the Federal Reserve System to convert European operational results and cash flow into U.S. Dollars. On that basis, the average annual rates of exchange for converting Pounds Sterling into Dollars during the years 2004, 2003, and 2002 were $1.833, $1.634 and $1.502 respectively, representing an increase in the value of the British Pound (as compared to the Dollar) of 12.18% for 2004 as compared to 2003 and 8.79% for 2003 as compared to 2002. Similarly, the exchange rates used to convert the value of the assets and liabilities of UBI and UBSN from Pound Sterling to U.S. Dollars as at December 31, 2004, 2003, and 2002 were $1.916, $1.784, and $1.61 respectively. These year-end valuations represent an increase in the value of the British Pound, as against the U.S. Dollar, of 7.4% as of December 31, 2003 as compared to December 31, 2003, and of 10.8% as of December 31, 2003 as compared to December 31, 2002. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. With the exception of the chart set forth below, the information required by this item is set forth at Pages F-1 through F-17 to this Annual Report. The following chart sets forth, on a quarterly basis, certain financial information about the Company's results of operations for the 2004 and 2003 fiscal years. 27
- ------------------- ----------------------------------------------------- ---------------------------------------------------- 2004 2003 - ------------------- ----------------------------------------------------- ---------------------------------------------------- Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 - ------------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------ ------------ Net Sales $6,803,200 $8,187,100 $7,978,300 $8,536,900 $5,870,100 $7,112,900 $7,628,300 $7,579,000 - ------------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------ ------------ Gross profit 2,168,400 2,814,600 2,769,500 2,707,500 1,875,500 2,296,000 2,526,700 2,346,600 - ------------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------ ------------ Net income (loss) (374,400) 166,400 (34,000) (226,900) (289,400) 161,900 435,400 (261,000) - ------------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------ ------------ Basic Earnings (Loss) per share $(.03) $.01 $(.00) $(.02) $(.03) $.01 $.04 $(.02) - ------------------- ------------ ------------ ------------- ------------- ------------- ------------ ------------ ------------
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. ITEM 9A. 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 December 31, 2004, 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. 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, as of the end of the period covered by this report, 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. 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. ITEM 9B. OTHER INFORMATION. None. 28 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The following table sets forth the names, ages as of February 28, 2005 , and certain information regarding each of the Company's current Directors and executive officers:
Director Name Age Position(s) Since ---- --- ----------- ----- Scott R. Heldfond 60 Director 2005 Michael Laybourn 66 Director 1993 Vijay Mallya, Ph.D. 50 Director and Chairman of the Board 1997 Jerome G. Merchant*+ 43 Director 1997 Mahadevan Narayanan 47 Chief Financial Officer and Secretary Sury Rao Palamand, Ph.D.*+ 73 Director 1998 Kent D. Price*+ 61 Director 1998 Yashpal Singh 59 Director, President, and Chief Executive Officer 1997 * Member of the Audit/Finance Committee. + Member of the Compensation Committee.
R H B (Bobby) Neame and David Townshend resigned from MBC's Board of Directors in November 2004. Scott R. Heldfond was elected a s a director at the Annual Meeting of Shareholders held on January 14, 2005. Scott R. Heldfond became a director in January 2005. Since 1999, Mr. Heldfond has been a Managing Partner of eSEED Capital, LLC, a technology-focused merchant bank, and the Executive Director of Nasdaq Insurance, LLC, a national insurance brokerage and consulting firm. From 1995 to 1999, he was the President and Chief Executive Officer of Frank Crystal & Co., a New York-based insurance company. Mr. Heldfond also currently serves as a Director of HomeGain, Inc., a private venture backed company, and UBICS, a NASDAQ traded firm that provides information technology staffing and solutions for domestic and international businesses. He is a Commissioner, and the President, of the Health Services Commission of the City and County of San Francisco, in addition to serving as an advisor to or on the Board of Directors of a number of local, statewide, and national charitable and community service organizations. Mr. Heldfond received his undergraduate degree from the University of California, Berkeley, and a J.D. from the University of San Francisco Law School. H. Michael Laybourn, co-founder of the Company, served as the Company's President from its inception in 1982 through December, 1999, and as its Chief Executive Officer from inception through October 1997. 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 served as Chairman of the Board from June 1994 through October 1997. Mr. Laybourn is a former Vice President of the California Small Brewers Association and a former 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. Vijay Mallya, Ph.D., became Chairman of the Board in October 1997 and was its Chief Executive Officer till January 2005. Dr. Mallya is Chairman of UBICS, Inc., United Breweries Limited, UB Engineering Limited, Mangalore Chemicals and Fertilizers Ltd., Herbertsons Limited, McDowell & Co. 29 Ltd., and other affiliated companies (collectively the "UB Group"). (See "Security Ownership of Certain Beneficial Owners and Management," below.) United Breweries Limited and McDowell & Co., Ltd. are two of Asia's leading beer and spirits companies. The UB Group has annual sales in excess of (U.S.) $1 Billion. He also sits on boards of several foreign companies and organizations including companies comprising the UB Group, The Institute of Economic Studies (India), and the Federation of the Indian Chamber of Commerce and Industries. Dr. Mallya was recently elected to serve as a member of the Upper House of the Indian Parliament. Dr. Mallya holds a Bachelor of Commerce degree from the University of Calcutta in India and an honorary Doctorate in Business Administration from the University of California, Irvine. Jerome G. Merchant became a Director in October 1997 and was Chief Financial Officer of the Company from November 1997 to October, 1998. Mr. Merchant currently serves as the Strategic Planning Consultant to the Chairman's Office of the Company and has served in such capacity since July 1996. Between April 1993 and December 2003, Mr. Merchant served in various capacities for Cal Fed Investments, a wholly owned subsidiary of Cal Fed Bank. His responsibilities included due diligence review and monitoring of investment products for Cal Fed Investments. As a result of the acquisition of Cal Fed Bank by Citigroup, since January 2003 Mr. Merchant has been serving as a Vice President and Regional Sales Director for Citigroup. Mr. Merchant received his Bachelor of Science degree in Managerial Economics-Finance from the University of California, Davis. Mahadevan Narayanan joined the company in early 2001 as Secretary, Corporate Controller and Chief Financial Officer. Before joining the Company, he served the United Breweries Group in India for the prior 17 years in various financial and accounting capacities. Mr. Mahadevan was most recently employed as Senior Manager of Accounting Services of Herbertsons Ltd. for the past six years. He holds a Bachelor of Science degree in Mathematics from Madurai Kamaraj University in India and is an associate member of the Institute of Chartered Accountants of India. Sury Rao Palamand, Ph.D., became a Director in January 1998. Dr. Palamand is the president of Summit Products, Inc., a beverage development firm serving the beverage industry; Chairman of the Southend Management, LLC which owns and operates a chain of restaurant breweries in the States of North Carolina, South Carolina, and Florida; and President of the Historic Lemp Brewery, LLC, which develops micro breweries and restaurants. From 1966 to 1989, Dr. Palamand served as Director, Beer and New Beverage Development for Anheuser-Busch Companies, Inc. Dr. Palamand holds a Master of Science in Chemistry from the University of Bombay, India and a Master of Science and Doctorate in Food and Flavor Technology from the Ohio State University, Columbus Ohio, U.S.A. Kent D. Price became a Director in January 1998. He is currently the President and CEO of Robert Kent and Company, an investment and consulting company. Additionally, he is currently the Chairman of Fluid, Inc., President of Parker Price Venture Capital, and a Director of Capital Markets Company. From August 1994 until July 1998, he was employed by IBM Banking, Finance and Securities Industries as General Manager of Securities and Capital Markets. From 1993 through August 1994, he served as Chairman and Chief Executive Officer of the Bank of San Francisco. He currently serves as a Director of The San Francisco Company, which is the holding company for the Bank of San Francisco. He also sits on the board of the American Bridge Company. Mr. Price received a Bachelor of Arts in history and politics and a Master of Arts in Slavic studies from the University of Montana and attended Oxford University as a Rhodes Scholar. Yashpal Singh, President of the Company since January 2000, became a Director in October 1997 and has served as its Executive Vice President and Chief operating Officer since May 1998. Mr. Singh became the Chief Executive Officer in January 2005. From May 1997 to March 1998, Mr. Singh served as Executive Vice-President- Operations for UBA, an affiliate of the Company (see "Security Ownership of Certain Beneficial Owners and Management," below). In that capacity, he was responsible for UBA's United States brewing operations. Between 1992 and 1997, Mr. Singh also served as Senior Vice President-Operations for United Breweries Ltd., an Indian Corporation, where he was responsible for 30 the operations of 12 breweries, instituting new projects, and technical and operational evaluation of potential acquisition opportunities worldwide. Mr. Singh has over 38 years of experience in the brewing industry. Mr. Singh holds a Bachelors degree in Science from Punjab University in India, and has graduate training in the fields of Brewing, Malting, and Mineral Water Technology. Mr. Singh is an associate member of the Institute of Brewing, London; a member of the Master Brewers Association of America; and was a former executive member of the Managing Committee of the All India Brewer's Association. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Based solely on its review of the Forms 4 and 5 furnished to the Company during and with respect to the year 2004, the Company is not aware of any person that was a Director, officer, or greater than 10% beneficial owner of the Company that failed to file on a timely basis reports required by Section 16(a) of the Exchange Act during the most recent fiscal year. Three of the Company's Directors, Michael Laybourn, Sury Rao Palamand and Kent Price each failed to file on a timely basis a report required by Section 16(a) of the Exchange Act with respect to the issuance of shares of Company stock issued to them in January 2005 as compensation for their attendance at Board and Committee meetings held during 2002 and 2003. In addition, the Company has recently become aware that the same three Directors failed to file any report required under Section 16(a) of the Exchange Act with respect to issuance of shares of Company stock, and / or stock options, issued to them in January 2002, although the ownership of such shares and options were in each case reflected in the Company's Annual Reports on Form 10 KSB for 2003 and in Proxy Statements for the 2003 and 2004 Annual Meetings of Shareholders. Mr. Laybourn, Mr. Palamand and Mr. Price have since disclosed the required information through the filing of Form 4, "Statement of Changes in Beneficial Ownership". AUDIT COMMITTEE FINANCIAL EXPERT The Company's Board of Directors believes that at least one member of the Company's Audit Committee - Mr. Kent D. Price - is both an independent Director and qualifies as an "audit committee financial expert" as that term is defined in the regulations of the Securities and Exchange Commission. CODE OF ETHICS The Company has adopted a Code of Ethics that applies to its Chief Executive Officer, Chief Financial Officer, and principal accounting officer. The Code of Ethics is posted on the Company's Internet website at www.mendobrew.com. Any person desiring a free copy of the Code of Ethics should send a written request to the Company's Secretary, N. Mahadevan at the Company's principal executive offices located at 1601 Airport Road, Ukiah, CA 95482. ITEM 11. EXECUTIVE COMPENSATION. The following table sets forth the annual compensation, including salary, bonuses, and certain other compensation, paid by the Company to its Chief Executive Officer and most highly-compensated executive officers and employees during each of the fiscal years ended December 31, 2004, 2003 and 2002. None of the Company's other executive officers received total compensation in excess of $100,000 in any of those years. Dr. Vijay Mallya resigned as the Chief Executive Officer with effect from January 14, 2005. Mr. Yashpal Singh was appointed as President and Chief Executive Officer from that date. 31
SUMMARY COMPENSATION TABLE Annual Compensation Long Term Compensation ------------------- ---------------------- Awards Payouts ------ ------- (a) (b) (c) (d) (e) (f) (g) (h) (i) Other Restricted Securities Annual Stock Underlying LTIP All Other Name and Principal Compen- Award(s) Options/ Payouts Compen- Position Year Salary ($) Bonus ($) Sation($) ($) Sars (#) ($) Sation($) -------- ---- ---------- --------- --------- --- -------- --- --------- Vijay Mallya Chairman of the 2004 248,310* Board and Chief Executive Officer 2003 158,129* 2002 $120,000 Yashpal Singh 2004 120,000 43,300 14,914** President 2003 118,875 41,887 13,538** 2002 115,500 37,035 11,539** Mark Anderson Sales Manager 2004 83,160 27,589 10,108 2003 79,200 27,091 7,847 2002 79,200 27,606 6,421 * Includes (pound)70,000 (approximately $128,310 in U.S. Dollars at average exchange rate for the year 2004) paid to Dr. Mallya by UBI during the year 2004, as compensation for promoting the Company's products in the European Territory outside the U.K. ** The value of the executive's medical benefits makes up approximately 80% of each of these amounts.
COMPENSATION OF DIRECTORS In the past, the Company has compensated each non-employee Director for his attendance at the meetings of the Board of Directors and for his attendance at meetings of committees of the Board of Directors, annually granting each non-employee Director both (a) that number of shares of the Company's common stock which had a fair market value of $3,000 for each board meeting, and $1,000 for each committee meeting he attended during the prior year and (b) options to purchase that number of shares of the Company's common stock which had a fair market value of $25,000. In the last two years, however, noting the drop in the trading or quoted price for the Company's stock to less than $1.00 per share, the Board of Directors agreed to receive Company's shares in lieu of compensation valued at book cost as of the end of each year or a value of $1.00 per share whichever is higher and has suspended the Company's stock option. The Compensation Committee is currently considering a proposal to significantly modify the previous stock option plan, and it is expected that one or more new plans and guidelines may be adopted later in the year. 32 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. 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 February 28, 2005, 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 noted, the Company 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. Shares Beneficially Approximate Name and Address Owned(1) Percentage ---------------- -------- ---------- COMMON STOCK United Breweries of America, Inc.+ 3,087,818(2) 26.9% Inversiones Mirabel S.A. 5,500,000(2) 47.9% Hong Kong Bank Building 6th Floor, Samuel Lewis Avenue P O Box 6-4298, El Dorado Panama City, Panama Vijay Mallya, Ph.D.+ 8,587,818(3) 74.8% H. Michael Laybourn + 354,254(4) 3.3% Kent D Price 180,097(4) 1.8% c/o Robert Kent and Company Wood Island #308 60 E. Sir Francis Drake Blvd. Larkspur, CA 94939 Sury Rao Palamand, Ph.D. 147,500(4) 1.5% 50 Crestwood Executive Center, Suite 207 St. Louis, MO 63126 Jerome G. Merchant+ 195,964(4) 1.5% Yashpal Singh++ -- -- Scott R. Heldfond -- -- 2039, Broderick St. San Francisco, CA 94115 All Directors and executive officers 3 as a group (7 persons) 9,523,444(5) 82% 33 SERIES A PREFERRED STOCK H. Michael Laybourn + 6,100 2.7% All Directors and executive officers as a group (7 persons) 6,100 2.7% - ------------------ + 2400, Bridgeway, Suite 290, Sausalito, CA 94965 ++ 1601 Airport Road, Ukiah, CA 95402 (1) Applicable percentages of ownership are based on 11,473,914 shares of Common Stock outstanding. Shares of Common Stock subject to a contract of purchase or options currently exercisable or exercisable within 60 days after the date of this Statement are deemed outstanding for computing the percentage ownership of the person obligated to purchase the shares or holding the options, but are not deemed outstanding for computing the percentage of any other person. (2) Does not include 1,351,243 shares issuable to UBA upon conversion of certain convertible notes issued by MBC to UBA to terminate an existing Master Line of Credit Agreement and convert certain outstanding Notes into shares of Common Stock (see "PART III - Item 13, Certain Relationships and Related Transactions," below). Also does not include 266,667 shares issuable upon conversion of a convertible note issued to UBA on March 2, 2005, convertible after a period of 18 months. Substantially all of the shares of both UBA and Inversiones are held by United Breweries of America, BVI ("UBA-BVI"). See below under "Announcement of Interest by United Breweries (Holdings) Limited" for information about a potential transaction involving UBA-BVI. (3) Includes all shares held by the Company's two largest shareholders, United Breweries of America, Inc. ("UBA") and Inversiones Mirabel. S.A., a Panamanian corporation "Inversiones"). Dr. Mallya may be deemed to be a beneficial owner of UBA and Inversiones because they are both controlled by Golden Eagle Trust, an Isle of Mann trust which in turn is controlled by persons who may exercise discretion in Dr. Mallya's favor among others. Does not include 1,351,243 shares issuable upon conversion of certain convertible notes issued to UBA to terminate an existing Master Line of Credit Agreement and convert certain outstanding Notes into shares of Common Stock. (See "PART III - Item 13, Certain Relationships and Related Transactions," below). Also does not include 266,667 shares issuable upon conversion of a convertible note issued to UBA on March 2, 2005, convertible after a period of 18 months. (4) Includes 68,077 shares subject to options that are exercisable or will be exercisable within 60 days. (5) Includes 272,308 shares subject to options that are exercisable or will be exercisable within 60 days. Does not include shares which may be obtained upon the conversion of those notes described in footnotes (2) and (3), above. ANNOUNCEMENT OF INTEREST BY UNITED BREWERIES HOLDINGS LTD. On September 30, 2002, the shareholders of United Breweries Holdings, Ltd. (formerly Kingfisher Properties & Holdings, Ltd.) ("UBHL"), a corporation based and incorporated in India and publicly-held in that country, approved resolutions authorizing UBHL's board of directors to consider a transaction by which UBHL would acquire some or all of the Company's outstanding shares. 34 Dr. Mallya, the Company's Chairman of the Board, is also the Chairman of the Board of UBHL. On March 1, 2005, UBHL formally submitted to the High Court of Karnataka at Bangalore, India (the "High Court"), as required under Indian law, a plan of reorganization (the "Plan") by which UBHL would, in addition to merging with a number of its existing wholly-owned subsidiaries, acquire indirect control of approximately 74.8% of the Company's outstanding shares. The acquisition would take the form of a merger between UBHL and United Breweries of America, BVI, a British Virgin Islands corporation ("UBA-BVI"), which is the corporate parent of both Inversiones Mirabel, S.A., a Panamanian corporation which holds approximately 47.9% of the Company's outstanding shares ("Inversiones"), and United Breweries of America, Inc., a Delaware corporation ("UBA"), which holds approximately 26.9% of the Company's outstanding shares. In the proposed Merger, UBA-BVI would be merged with and into UBHL. Pursuant to an order of the High Court, the shareholders of UBHL, held a Special Meeting on April 27, 2005. The results of the voting at the Special Meeting are not expected to be made public prior to a hearing before the High Court now scheduled for May 27, 2005. UBA also holds a number of convertible Company notes with a balance of $2,426,865 as of March 30, 2005, all of which are convertible (some currently) into shares of MBC's Common Stock. If all of these notes were converted into shares of the Company's Common Stock now, UBA would hold approximately 35.9% of the Company's Common Stock, and the combined holdings of UBA and Inversiones would amount to approximately 78% of the Company's outstanding Common Stock. Consummation of the Plan, both as it affects the Company's shares and with respect to the other entities involved, is subject to a number of contingencies, including among others: compliance with various applicable Indian and British Virgin Island laws and regulations; ratification by the High Court; and approval of the Indian Foreign Investment Promotion Board and/or the Reserve Bank of India with respect to the issuance of UBHL shares under the Plan. At present, therefore, it is unclear when (if ever) the Plan and the Merger may be consummated. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. MASTER LINE OF CREDIT AGREEMENT On August 31, 1999, the Company and UBA entered into a Master Line of Credit Agreement, which as subsequently amended in April of 2000, and February of 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. As of the date of this filing, UBA has made thirteen (13) separate advances to the Company under the Credit Agreement, pursuant to a series of individual eighteen (18) month promissory notes issued by the Company to UBA (the "UBA Notes"). As of February 28, 2003, the aggregate outstanding principal amount of the UBA Notes was $1,515,371, and the accrued but unpaid interest thereon was equal to approximately $494,700. (For more information on the Master Line of Credit Agreement, please refer to Item 7 - Management's Discussion and Analysis of Financial Information and Results of Operations - Liquidity and Capital Resources," above.) LICENSE OF THE KINGFISHER TRADEMARK UBI licenses the trademark Kingfisher (the "Mark") from UB Limited, pursuant to a License Agreement dated October 9, 1998 and amended pursuant to a Supplemental Agreement dated October 22, 2001 (together, the "License Agreement"). Under the terms of the License Agreement, UB Limited has granted UBI and UBSN the exclusive right to use the Mark in a number of European countries, including among others Austria, Belgium, Italy, France, Germany, Ireland, the Netherlands, Spain, Sweden and the United Kingdom, as well as in Canada (collectively, the "Licensed Territory"). UB Limited, which owns the Mark, is responsible for maintaining the registration of the Mark in all relevant market areas. The License Agreement, which will expire on October 9, 2013, also provides that neither party may transfer its rights or obligations thereunder to any other person or entity unless the transferee enters into an agreement to be bound by the obligations of the transferor. 35 In July 2001 MBC entered into a Kingfisher Trademark and Trade Name License Agreement with Kingfisher America, Inc., a Delaware corporation affiliated with UB Limited, pursuant to which MBC obtained a royalty-free, exclusive license to use the Kingfisher trademark and trade name in connection with the brewing and distribution of beer in the United States. Under its terms, this agreement will remain in effect for so long as the Distribution Agreement (described below) between UBI and UBSN does. Currently, that agreement is scheduled to expire in October 2013. Because the Company's Chairman of the Board, Dr. Vijay Mallya, is also the Chairman of the Board of UB Limited, the transactions represented by these license agreements may be deemed to be related party transactions. SHEPHERD NEAME, LTD. As described more fully below, the Company's principal European subsidiary, UBSN, Ltd. ("UBSN"), is a party to a Brewing Agreement and a Loan Agreement with Shepherd Neame, Ltd., a major English brewer ("Shepherd Neame"). During most of 2004 (as in prior years), Shepherd Neame and the Company may be deemed to have been related parties, because Mr. R.H.B. Neame (Shepherd Neame's Chairman of the Board) was also a Director of MBC, and Mr. David Townshend (a senior Shepherd Neame employee) was serving as the President of UBSN (pursuant to an agreement between UBSN and Shepherd Neame) as well as a Director of MBC. BREWING AGREEMENT On October 9, 1998, UBI and UBSN entered into a Brewing Agreement with Shepherd Neame, and on October 24, 2001, this agreement was amended by a Supplemental Agreement (as so amended, the "Brewing Agreement"). The Brewing Agreement, which was entered into (and amended) in conjunction with the Loan Agreement described below, grants Shepherd Neame the exclusive right to brew, keg, bottle, can, label, and package all beers and related products sold under the Kingfisher trademark in the United Kingdom, and with respect to the distribution of such products elsewhere in the European Territory, UBI and UBSN further agreed that they would require any other distributor of such products (subject to applicable laws and regulations) both to obtain such products directly from a company related to UBI or its subsidiaries and to refrain from seeking customers, or establishing a distribution network for such products, in the United Kingdom. In exchange, Shepherd Neame agreed to brew and/or supply Kingfisher Premium Lager and related products to UBSN for destinations within (and, with the consent of Shepherd Neame, outside) the United Kingdom. The price UBSN pays to Shepherd Neame for brewing Kingfisher Premium Lager for distribution in the United Kingdom is set by a formula which varies according to the applicable duty on Kingfisher Premium Lager and other factors. LOAN AGREEMENT Concurrently with the Brewing Agreement described above, UBSN and Shepherd Neame entered into a Loan Agreement, under which on or about October 24, 2001, Shepherd Neame advanced to UBSN (pound)600,000 (Pounds Sterling) (the full amount available under the Loan Agreement), at a fixed interest rate of 5%, for general corporate purposes. This loan is payable in ten annual installments of (pound)60,000 (Pounds Sterling) each, commencing on June 30, 2003 and continuing on each anniversary thereof until the Loan is fully repaid. Any remaining balance of principal or interest will become due and payable (and the loan will terminate) on June 30, 2013. It would be an event of default under the Loan Agreement, and the lender would have the right, at will, not only to cancel the Loan Agreement and accelerate all sums due under it, but also to terminate the Brewing Agreement, if UBSN were to terminate or default under the Brewing Agreement, or if either of the License Agreements that UBI and UBSN have entered into with UB Limited (see "License of the Kingfisher Trademark, above) are terminated (except in accordance with their terms or in connection with the parties' entry into an equivalent Brewing Agreement). 36 DISTRIBUTION AGREEMENT UBI entered into a Distribution Agreement with its wholly-owned subsidiary UBSN on October 9, 1998. Under this agreement, which was subsequently amended by a Supplemental Agreement dated as of October 24, 2001 (together, the "Distribution Agreement"), UBI granted UBSN an exclusive sublicense for the distribution of all lager and other beer products brewed or prepared for sale in the Company's European Territory, and a sublicense to use the Kingfisher trademark and trade name, to manufacture, package, market, distribute, and sell beer and other products using the Kingfisher trademark and logo, and to enter into the Brewing Agreement described below. The Distribution Agreement, which also requires UBSN to pay UBI a royalty fee of 50 British pence (approximately $0.92, at the average exchange rates during 2004) for every 100 liters (26 gallons) of beer brewed for sale in the European Territory, will expire (unless its term is extended) in October 2013. MARKET DEVELOPMENT AGREEMENT Effective October 26, 2001, MBC and UBSN entered into a Market Development, General and Administrative Services Agreement (the "Market Development Agreement"), under the terms of which UBSN engaged MBC to perform a variety of advertising, promotional, and other market development activities in the United States, in connection with Kingfisher beer and related consumer products (the "Products"), provide certain legal and business management support services to UBSN, and provide assistance with the establishment and management of distribution channels for the Products in the United States. In consideration for the services received under this agreement, UBSN agreed to pay MBC service fees amounting in the aggregate to $1,500,000 over the period from 2001 through 2003. Such payments amounted to $1,000,000 during calendar 2001, $300,000 during 2002, and $200,000 during 2003. No such payments were made during 2004, or are anticipated to be made in the future. The Market Development Agreement will continue in force during the term of the Distribution Agreement described above. BREWING LICENSE AGREEMENT Concurrently with the Market Development Agreement described above, MBC entered into a Brewing License Agreement with UBSN, under the terms of which UBSN granted to MBC an exclusive license to brew and distribute Kingfisher Premium Lager in the United States, in exchange for a royalty, payable to UBSN, of eighty cents ($0.80) for each case of Kingfisher Premium Lager brewed by MBC under this agreement. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. The Company has appointed Moss Adams, L.L.P. ("Moss Adams"), as its independent auditors perform the audit of the Company's financial statements. All audit and other services performed by Moss Adams on behalf of the Company are approved in advance by the Audit Committee, on a case-by-case basis. AUDIT FEES. The aggregate fees billed by Moss Adams for the audit of the Company's annual consolidated financial statements for the years ended December 31, 2003 and 2004 were $69,251 and $92,754, respectively; fees of an additional $15,868 and $26,955 were billed to the Company during 2003 and 2004, respectively, in connection with Moss Adams' review of its financial statements in connection with the Company's Quarterly Reports on Form 10-QSB and 10-Q for those years. Such fees represented 79% and 82%, respectively, of the total fees for services rendered to the Company by Moss Adams during 2003 and 2004. AUDIT RELATED FEES. Moss Adams billed $2,146 and $2,888 in fees to the Company in 2003 and 2004 for assurance or related services. TAX FEES. The aggregate fees billed during 2003 and 2004 for products and services provided by Moss Adams, other than those described in the foregoing paragraphs, were $18,865 and $15,837, 37 respectively. Such fees represented 17% and 11%, respectively of the total fees for services rendered to the Company by Moss Adams during 2003 and 2004. ALL OTHER FEES. The aggregate fees billed to the Company for all other services rendered by Moss Adams for the years ended December 31, 2003 and 2004 were $970 and $7,138, respectively. Such fees represented 9% and 5% respectively of the total fees for services rendered to the Company by Moss Adams during 2003 and 2004. The Audit Committee has concluded that the provision of the services described above is not incompatible with maintaining the independence of Moss Adams as the Company's principal accountants. The Company is not aware that any significant amount of the work done during the course of Moss Adams' audit of the Company's 2004 Financial Statements was performed by persons other than Moss Adams' full-time, permanent, employees. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES. (a) DOCUMENTS FILED AS PART OF THIS REPORT The following documents are filed as part of this Report: (1) Audited financial statements and financial statement schedules Report of Moss Adams LLP, Independent Auditors Consolidated Balance Sheets as of December 31, 2004 and 2003 Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2004, 2003, and 2002 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2004, 2003, and 2002 Consolidated Statements of Cash Flow for the Years Ended December 31, 2004, 2003, and 2002 Notes to Financial Statements (2) FINANCIAL STATEMENT SCHEDULES. Those financial statement schedules required to be filed by Item 8 of this Annual Report on Form 10-K are listed above. All other financial statement schedules are omitted because they were not required or the required information is included in the Financial Statements or Notes thereto. (3) LIST OF EXHIBITS. Exhibit Number Description of Document ------ ----------------------- 3.1 (T) Articles of Incorporation of the Company, as amended. 3.2 (T) Bylaws of the Company, as amended. 10.1 (A) Mendocino Brewing Company Profit Sharing Plan. 10.2 (T) Amended 1994 Stock Option Plan 38 (3) LIST OF EXHIBITS (Continued) Exhibit Number Description of Document ------ ----------------------- 10.3 (A) Wholesale Distribution Agreement between the Company and Bay Area Distributing. 10.4 (A) Wholesale Distribution Agreement between the Company and Golden Gate Distributing. 10.5 (B) Liquid Sediment Removal Services Agreement with Cold Creek Compost, Inc. 10.6 (A) Lease Agreement between the Company and Kohn Properties. 10.7 (C) Commercial Real Estate Purchase Contract and Receipt for Deposit (previously filed as Exhibit 19.2). 10.8 (D) Commercial Lease between Stewart's Ice Cream Company, Inc. and Releta Brewing Company LLC. 10.9 (E) Agreement between United Breweries of America Inc. and Releta Brewing Company LLC regarding payment of certain liens. 10.10 (F) Keg Management Agreement with MicroStar Keg Management LLC. 10.11 (G) 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). 10.12 (H) Manufacturing Business Expansion and Relocation Agreement with the City of Ukiah. 10.13 (H) Manufacturing Business Expansion and Relocation Agreement with the Ukiah Redevelopment Agency. 10.14 (I) $2,700,000 Note in favor of the Savings Bank of Mendocino County. 10.15 (I) Hazardous Substances Certificate and Indemnity with the Savings Bank of Mendocino County. 10.16 (J) Equipment Lease with Finova Capital Corporation. 10.17 (J) Tri-Election Rider to Equipment Lease with Finova Capital Corporation. 10.18 (J) Master Lease Schedule with Finova Capital Corporation. 10.19 (K) Investment Agreement with United Breweries of America, Inc. 10.20 (K) Shareholders' Agreement Among the Company, United Breweries of America, Inc., H. Michael Laybourn, Norman Franks, Michael Lovett, John Scahill, and Don Barkley. 10.21 (K) Registration Rights Agreement Among the Company, United Breweries of America, Inc., H. Michael Laybourn, Norman Franks, Michael Lovett, John Scahill, and Don Barkley. 10.22 (L) Indemnification Agreement with Vijay Mallya. 10.23 (L) Indemnification Agreement with Michael Laybourn. 10.24 (L) Indemnification Agreement with Jerome Merchant. 10.25 (L) Indemnification Agreement with Yashpal Singh. 10.27 (L) Indemnification Agreement with Robert Neame. 10.28 (L) Indemnification Agreement with Sury Rao Palamand. 10.29 (L) Indemnification Agreement with Kent Price. 39 (3) LIST OF EXHIBITS (Continued) Exhibit Number Description of Document ------ ----------------------- 10.30 (M) Loan and Security Agreement between the Company, Releta Brewing Company LLC and The CIT Group/Credit Finance, Inc. regarding a $3,000,000 maximum line of credit. 10.31 (M) Patent, Trademark and License Mortgage by the Company in favor of The CIT Group/Credit Finance, Inc. 10.32 (M) Patent, Trademark and License Mortgage by Releta Brewing Company LLC in favor of The CIT Group/Credit Finance, Inc. 10.33 (N) Employment Agreement with Yashpal Singh. 10.35 (O) Master Loan Agreement between the Company and the United Breweries of America Inc. 10.36 (O) Convertible Note in favor of the United Breweries of America Inc. dated Sept. 7, 1999 10.37 (P) Convertible Note in favor of the United Breweries of America Inc. dated October 21, 1999 10.38 (P) Convertible Note in favor of the United Breweries of America Inc. dated November 12, 1999 10.39 (P) Convertible Note in favor of the United Breweries of America Inc. dated December 17, 1999 10.40 (P) Convertible Note in favor of the United Breweries of America Inc. dated December 31, 1999 10.41 (P) Convertible Note in favor of the United Breweries of America Inc. dated February 16, 2000 10.42 (P) Convertible Note in favor of the United Breweries of America Inc. dated February 17, 2000 10.43 (P) Convertible Note in favor of the United Breweries of America Inc. dated April 28, 2000 10.44 (P) First Amendment to Master Loan Agreement between the Company and United Breweries of Comerica, Inc., dated April 28, 2000 10.45 (Q) Convertible Note in favor of the United Breweries of America Inc. dated September 11, 2000 10.46 (Q) Convertible Note in favor of the United Breweries of America Inc. dated September 30, 2000 10.47 (Q) Convertible Note in favor of the United Breweries of America Inc. dated December 31, 2000 10.48 (Q) Convertible Note in favor of the United Breweries of America Inc. dated February 12, 2001 10.49 (R) Convertible Note in favor of the United Breweries of America Inc. dated July 1, 2001 40 (3) LIST OF EXHIBITS (Continued) Exhibit Number Description of Document ------ ----------------------- 10.50 (S) Confirmation of Waiver Between Mendocino Brewing Company, Inc. and United Breweries of America, Inc., dated as of December 28, 2001 10.51 (S) Extension of Term of Notes Under Master Line of Credit Agreement between Mendocino Brewing Company, Inc. and United Breweries of America, Inc., dated February 14, 2002 10.52 (T) License Agreement between United Breweries Limited and United Breweries International (U.K.), Limited 10.53 (T) Supplemental Agreement to License Agreement between United Breweries Limited and United Breweries International (U.K.), Limited 10.54 (T) Distribution Agreement between United Breweries International (U.K.), Limited. and UBSN, Ltd. 10.55 (T) Supplemental Agreement to Distribution Agreement between United Breweries International (U.K.), Limited. and UBSN, Ltd. 10.56 (T) Market Development, General and Administrative Services Agreement between Mendocino Brewing Company, Inc. and UBSN, Ltd. 10.57 (T) Contract to Brew and Supply Kingfisher Products among Shepherd Neame, Limited, United Breweries International (U.K.), Limited. and UBSN, Ltd. 10.58 (T) Supplemental Agreement to Contract to Brew and Supply Kingfisher Products among Shepherd Neame, Limited, United Breweries International (U.K.), Limited. and UBSN, Ltd. 10.59 (T) Loan Agreement between Shepherd Neame, Limited and UBSN, Ltd. 10.60 (T) Brewing License Agreement between UBSN, Ltd. and Mendocino Brewing Company, Inc. 10.61 (T) Kingfisher Trade Mark and Trade Name License Agreement between Kingfisher of America, Inc. and Mendocino Brewing Company, Inc. 10.62 (U) First Amendment to Extension of Term of Notes Under Master Line of Credit Agreement between Mendocino Brewing Company, Inc. and United Breweries of America, Inc., dated November 13, 2002. 10.63 (U) Second Amendment to Extension of Term of Notes Under Master Line of Credit Agreement between Mendocino Brewing Company, Inc. and United Breweries of America, Inc., dated March, 2003. 10.64 (V) Amendment to Loan and Security Agreement between Mendocino Brewing Company, Inc. and Releta Brewing Company, LLC and the CIT Group/Business Credit, Inc., dated January 17, 2003. 10.65 (V) Commitment Letter from United Breweries of America, Inc. dated March 31, 2004. 10.66 (W) Extension of Loan and Security Agreement between the Company, Releta Brewing Company LLC and The CIT Group/Credit Finance, Inc., dated July 1, 2004 10.67 (W) Revised Promissory Note in favor of Savings Bank of Mendocino County, dated as of July 20, 2004 41 (3) LIST OF EXHIBITS (Continued) Exhibit Number Description of Document ------ ----------------------- 10.68 (X) Fourth Amendment to Extension of Term of Notes Under Master Line of Credit Agreement between Mendocino Brewing Company, Inc. and United Breweries of America, Inc., dated as of August 14, 2004 10.69 (Y) Settlement Agreement and Release between the Company and House of Daniels, Inc., dba Golden Gate Distributing Company, dated as of November 1, 2004 10.70 (Z) Secondment Agreement dated October 9, 1998 between UBSN, Ltd. and Shepherd Neame, Ltd. 10.71 (Z) Agreement to Extend Loan and Security Agreement between the Company, Releta Brewing Company LLC and The CIT Group/Credit Finance, Inc., dated October 31, 2004 10.72 (Z) Revised Promissory Note in favor of Savings Bank of Mendocino County, dated as of November 1 2004 10.73 (AA) Settlement Agreement and Release, effective as of December 9, 2004 10.74 (BB) Convertible Promissory Note of Mendocino Brewing Company, Inc. in favor of United Breweries of America, Inc., dated March 2, 2005 14.1 (V) Code of Ethics NOTES: Each Exhibit listed above that is annotated with one or more of the following letters is incorporated by reference from the following sources: (A) The Company's Registration Statement dated June 15, 1994, as amended, previously filed with the Commission, Registration No. 33-78390-LA. (B) The Company's Annual Report on Form 10-KSB for the period ended December 31, 1995. (C) The Company's Quarterly Report on Form 10-QSB for the period ended March 31, 1995. (D) The Company's Quarterly Report on Form 10-QSB/A No. 1 for the period ended September 30, 1997. (E) The Company's Quarterly Report on Form 10-QSB for the quarterly period ended September 30, 1997. (F) The Company's Annual Report on Form 10-KSB for the period ended December 31, 1996 (G) The Company's Quarterly Report on Form 10-QSB for the period ended September 30, 1995 (H) The Company's Quarterly Report on Form 10-QSB for the period ended June 30, 1996 (I) The Company's Annual Report on Form 10-KSB for the period ended December 31, 1997 (J) The Company's Registration Statement dated February 6, 1997, as amended, Registration No. 33-15673 (K) Schedule 13D filed November 3, 1997, by United Breweries of America, Inc. and Vijay Mallya (L) The Company's Quarterly Report on Form 10-QSB for the period ended June 30, 1998 (M) The Company's Quarterly Report on Form 10-QSB for the period ended September 30, 1998 (N) The Company's Quarterly Report on Form 10-QSB for the period ended June 30, 1999 42 (O) Amendment No. 5 to Schedule 13D filed September 15, 1999, by United Breweries of America, Inc. and Vijay Mallya. (P) Amendment No. 6 to Schedule l3D filed May 12, 2000, by United Breweries of America, Inc. and Vijay Mallya. (Q) Amendment No. 7 to Schedule 13D filed February 22, 2001, by United Breweries of America, Inc. and Vijay Mallya. (R) Amendment No. 8 to Schedule 13D filed August 22, 2001, by United Breweries of America, Inc and Vijay Mallya. (S) The Company's Current Report on Form 8-K filed as of February 19, 2002 (T) The Company's Annual Report on Form 10-KSB for the period ended December 31, 2001 (U) Amendment No. 9 to Schedule 13D filed March 31, 2003, by United Breweries of America, Inc. and Vijay Mallya (V) The Company's Annual Report on Form 10-KSB for the year ended December 31, 2003 (W) The Company's Quarterly Report on Form 10-Q for the period ended June 30, 2004 (X) Amendment No. 11 to Schedule 13D, jointly filed by United Breweries of America, Inc. and Dr. Vijay Mallya on August 16, 2004 (Y) The Company's Current Report on Form 8-K filed as of November 1, 2004 (Z) The Company's Quarterly Report on Form 10-Q for the period ended September 30, 2004 (AA) The Company's Current Report on Form 8-K filed as of November 25, 2004 (BB) The Company's Current Report on Form 8-K filed as of March 2. 2005 (b) EXHIBITS ATTACHED The following Exhibits are attached to this Annual Report on Form 10-K: Exhibit Number Description of Document - ------ ----------------------- 10.75 Loan and Security Agreement (Accounts Receivable & Inventory Line of Credit) dated May 5, 2005 between the Company and BFI Business Finance 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) 32.1 Certification of Chief Executive Officer Pursuant to U.S.C. 1350 32.2 Certification of Chief Financial Officer Pursuant to U.S.C. 1350 (c) EXCLUDED FINANCIAL STATEMENTS. None. 43 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) f the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized. (Registrant) MENDOCINO BREWING COMPANY, INC. By: /s/ Yashpal Singh ------------------------------ Yashpal Singh Its President, Director and Chief Executive Officer Date: August 31, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. (Registrant) MENDOCINO BREWING COMPANY, INC. By: /s/ Yashpal Singh ------------------------------ Yashpal Singh Its President, Director and Chief Executive Officer Date: August 31, 2005 By: /s/ Scott R. Heldfond ------------------------------ Scott R. Heldfond, Director Date: August 31, 2005 By: /s/ Jerome G. Merchant ------------------------------ Jerome G. Merchant, Director Date: August 31, 2005 By: /s/ N. Mahadevan ------------------------------ N. Mahadevan Its Secretary and Chief Financial Officer Date: August 31, 2005 By: /s/ H. Michael Laybourn, ------------------------------ H. Michael Laybourn, Director Date: August 31, 2005 44 By: /s/ Kent Price ------------------------------ Kent Price, Director Date: August 31, 2005 By: /s/ Sury Rao Palamand, ------------------------------ Sury Rao Palamand, Director Date: August 31, 2005 45 - -------------------------------------------------------------------------------- CONTENTS PAGE REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM......................F-1 CONSOLIDATED FINANCIAL STATEMENTS Balance sheets..........................................................F-2 Statements of operations and comprehensive income.......................F-3 Statements of stockholders' equity......................................F-4 Statements of cash flows................................................F-5 Notes to financial statements...........................................F-6 - -------------------------------------------------------------------------------- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders Mendocino Brewing Company, Inc. We have audited the accompanying consolidated balance sheets of Mendocino Brewing Company, Inc., as of December 31, 2004 and 2003, and the related consolidated statements of operations and comprehensive income, stockholders' equity and cash flows for each of the three years ended December 31, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). 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 our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mendocino Brewing Company, Inc., as of December 31, 2004 and 2003, and the results of its operations and cash flows for each of the three years ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. /s/ MOSS ADAMS LLP Santa Rosa, California February 4, 2005, except for Notes 2 and 5, as to which the date is May 6, 2005 PAGE F-1
MENDOCINO BREWING COMPANY, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2004 AND 2003 - --------------------------------------------------------------------------------------------------------- ASSETS 2004 2003 --------------- --------------- CURRENT ASSETS Cash $ 526,600 $ 554,300 Accounts receivable, net of allowance for doubtful accounts of $47,500 and $37,800 8,477,200 7,017,700 Inventories 1,185,400 1,186,100 Prepaid expenses 347,300 555,500 --------------- --------------- Total current assets 10,536,500 9,313,600 --------------- --------------- PROPERTY AND EQUIPMENT 13,533,900 13,874,800 --------------- --------------- OTHER ASSETS Deposits and other assets 205,100 188,600 Intangibles, net of amortization 87,600 94,700 --------------- --------------- 292,700 283,300 --------------- --------------- Total assets $ 24,363,100 $ 23,471,700 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Line of credit $ 3,282,200 $ 1,974,800 Note payable 576,200 576,200 Accounts payable 5,897,600 5,340,100 Accrued liabilities 1,402,900 1,275,100 Legal dispute settlement 911,800 655,200 Income taxes payable 134,100 465,100 Current maturities of long-term debt 400,300 693,700 Current maturities of capital lease obligations 146,500 129,000 --------------- --------------- Total current liabilities 12,751,600 11,109,200 NOTES TO RELATED PARTY - SUBORDINATED 2,010,100 1,921,500 LONG-TERM DEBT, less current maturities 3,384,800 3,730,300 CAPITAL LEASE OBLIGATIONS, less current maturities 62,600 204,100 --------------- --------------- Total liabilities 18,209,100 16,965,100 --------------- --------------- 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, 11,266,874 shares issued and outstanding 14,648,600 14,648,600 Accumulated comprehensive income 194,300 78,000 Accumulated deficit (8,916,500) (8,447,600) --------------- --------------- Total stockholders' equity 6,154,000 6,506,600 --------------- --------------- Total liabilities and stockholders' equity $ 24,363,100 $ 23,471,700 =============== =============== SEE ACCOMPANYING NOTES. - --------------------------------------------------------------------------------------------------------- PAGE F-2
MENDOCINO BREWING COMPANY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 - ------------------------------------------------------------------------------------------------------------- 2004 2003 2002 ---------------- ---------------- ---------------- SALES $ 32,157,900 $ 28,864,200 $ 26,085,100 LESS EXCISE TAXES 652,400 673,900 651,600 ---------------- ---------------- ---------------- NET SALES 31,505,500 28,190,300 25,433,500 COST OF GOODS SOLD 21,045,500 19,145,500 16,892,800 ---------------- ---------------- ---------------- GROSS PROFIT 10,460,000 9,044,800 8,540,700 ---------------- ---------------- ---------------- OPERATING EXPENSES Retail operating 139,500 323,400 335,300 Marketing 5,841,200 4,423,900 4,244,400 General and administrative 3,774,900 3,320,000 2,732,300 Legal dispute settlement 250,600 - - ---------------- ---------------- ---------------- 10,006,200 8,067,300 7,312,000 ---------------- ---------------- ---------------- INCOME FROM OPERATIONS 453,800 977,500 1,228,700 ---------------- ---------------- ---------------- OTHER INCOME (EXPENSE) Miscellaneous income 36,800 162,900 200,200 Profit (loss) on sale of equipment 15,600 (300) (9,200) Interest expense (853,300) (828,500) (926,400) ---------------- ---------------- ---------------- (800,900) (665,900) (735,400) ---------------- ---------------- ---------------- INCOME (LOSS) BEFORE INCOME TAXES (347,100) 311,600 493,300 PROVISION FOR INCOME TAXES 121,800 264,700 2,223,100 ---------------- ---------------- ---------------- NET INCOME (LOSS) (468,900) 46,900 (1,729,800) OTHER COMPREHENSIVE INCOME Foreign currency translation adjustment 116,300 113,300 42,500 ---------------- ---------------- ---------------- COMPREHENSIVE INCOME (LOSS) $ (352,600) $ 160,200 $ (1,687,300) ================ ================ ================ NET INCOME (LOSS) PER COMMON SHARE - Basic and diluted $ (0.04) $ 0.00 $ (0.15) ================ ================ ================ WEIGHTED AVERAGE COMMON SHARES OUTSTANDING - basic and diluted 11,266,874 11,266,874 11,173,686 ================ ================ ================ SEE ACCOMPANYING NOTES. - ------------------------------------------------------------------------------------------------------------- PAGE F-3
MENDOCINO BREWING COMPANY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 - -------------------------------------------------------------------------------------------------------------------------------- SERIES A PREFERRED STOCK COMMON STOCK ACCUMULATED ---------------------- ------------------------- COMPREHENSIVE ACCUMULATED TOTAL SHARES AMOUNT SHARES AMOUNT INCOME (LOSS) DEFICIT EQUITY ---------- ----------- ----------- ------------- --------------- -------------- ------------ Balance, December 31, 2001 227,600 $ 227,600 11,083,228 $ 14,476,500 $ (77,800) $ (6,764,700) $ 7,861,600 Stock issued for services - - 135,665 125,100 - - 125,100 Stock issued to Board of Directors - - 47,981 47,000 - - 47,000 Currency translation adjustment - - - - 42,500 - 42,500 Net loss - - - - - (1,729,800) (1,729,800) ---------- ----------- ----------- ------------- --------------- -------------- ------------ Balance, December 31, 2002 227,600 227,600 11,266,874 14,648,600 (35,300) (8,494,500) 6,346,400 Currency translation adjustment - - - - 113,300 - 113,300 Net income - - - - - 46,900 46,900 ---------- ----------- ----------- ------------- --------------- -------------- ------------ Balance, December 31, 2003 227,600 227,600 11,266,874 14,648,600 78,000 (8,447,600) 6,506,600 ---------- ----------- ----------- ------------- --------------- -------------- ------------ Currency translation adjustment - - - - 116,300 - 116,300 Net loss - - - - - (468,900) (468,900) ---------- ----------- ----------- ------------- --------------- -------------- ------------ Balance, December 31, 2004 227,600 $ 227,600 11,266,874 $ 14,648,600 $ 194,300 $ (8,916,500) $ 6,154,000 ========== =========== =========== ============= =============== ============== ============ SEE ACCOMPANYING NOTES. - -------------------------------------------------------------------------------------------------------------------------------- PAGE F-4
MENDOCINO BREWING COMPANY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002 - --------------------------------------------------------------------------------------------------------------- 2004 2003 2002 ---------------- --------------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (468,900) $ 46,900 $ (1,729,800) Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation and amortization 1,031,300 1,127,400 1,049,000 Allowance for doubtful accounts 8,000 (122,700) 18,700 Loss (profit) on sale of assets (15,600) 300 9,200 Deferred income taxes - - 1,922,600 Stock issued for services - - 44,000 Changes in: Accounts receivable (1,004,900) (519,800) 4,800 Inventories 700 288,200 (199,700) Prepaid expenses 224,200 (124,200) (68,100) Deposits and other assets (27,800) (5,800) 13,800 Accounts payable 125,700 155,800 (21,000) Accrued liabilities 338,200 334,200 12,500 Income taxes payable (192,500) (24,400) 170,200 ---------------- --------------- --------------- Net cash from operating activities 18,400 1,155,900 1,226,200 ---------------- --------------- --------------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property and equipment (597,800) (728,600) (368,100) Proceeds from new distributors - 655,200 - Proceeds from sale of fixed assets 24,300 15,200 23,700 ---------------- --------------- --------------- Net cash from investing activities (573,500) (58,200) (344,400) ---------------- --------------- --------------- CASH FLOWS FROM FINANCING ACTIVITIES Net repayments (borrowings) on line of credit 1,211,500 347,600 (350,900) Borrowings on long-term debt - 403,700 - Principal payments on long-term debt (704,200) (734,700) (356,400) Payments on obligations under capital lease (124,000) (680,900) (359,000) Disbursements in excess of deposits - (134,300) 134,300 Proceeds from notes payable to related party 88,600 85,200 93,500 ---------------- --------------- --------------- Net cash from financing activities 471,900 (713,400) (838,500) ---------------- --------------- --------------- EFFECT OF EXCHANGE RATE CHANGES ON CASH 55,500 23,200 13,700 ---------------- --------------- --------------- NET CHANGE IN CASH (27,700) 407,500 57,000 CASH, beginning of year 554,300 146,800 89,800 ---------------- --------------- --------------- CASH, end of year $ 526,600 $ 554,300 $ 146,800 ================ =============== =============== SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the year for: Interest $ 764,700 $ 743,300 $ 950,600 Income taxes $ 314,200 $ 305,600 $ 147,700 Non-cash investing and financing activities: Seller financed equipment $ 15,400 $ 173,900 $ 117,400 Accounts payable converted to note payable $ - $ 752,600 $ - SEE ACCOMPANYING NOTES. - --------------------------------------------------------------------------------------------------------------- PAGE F-5
MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1 - DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF OPERATIONS - Mendocino Brewing Company, Inc. (the Company), and its subsidiary, Releta Brewing Company, operate two breweries that produce beer and malt beverages for the specialty "craft" segment of the beer market. The breweries are located in Ukiah, California and Saratoga Springs, New York. The Company also owns and operates a brewpub and gift store located in Hopland, California. The majority of sales for Mendocino Brewing Company are in California. The Company brews several brands, of which Red Tail Ale is the flagship brand. In addition, the Company performs contract brewing for several other brands. The Company's subsidiary, United Breweries International, Limited (UK) (UBIUK), is a holding company for UBSN Limited. UBSN is a distributor of alcoholic beverages, mainly Kingfisher Lager, in the United Kingdom and Europe. The distributorship is located in Faversham, Kent in the United Kingdom. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements present the accounts of Mendocino Brewing Company, Inc., and its wholly-owned subsidiaries, Releta Brewing Company, LLC, and UBIUK. All material inter-company balances, profits, and transactions have been eliminated. INVENTORIES - Inventories are stated at the lower-of-average cost or market. PROPERTY AND EQUIPMENT - Property and equipment are stated at cost and depreciated or amortized using straight-line and accelerated methods over the assets' estimated useful lives. Leasehold improvements are amortized over the shorter of the life of the related asset or the life of the lease. Costs of maintenance and repairs are charged to expense as incurred; significant renewals and betterments are capitalized. Long-lived assets are assessed for impairment whenever events or changes in circumstances indicate the assets' carrying amount may not be recoverable. The evaluation is based on an estimate of the future undiscounted net cash flows of the related asset or asset grouping over the assets' remaining life. Long-lived assets that are assessed to be impaired are reduced to their estimated net fair value. Estimated useful lives of property and equipment are as follows: Building 40 years Machinery and equipment 3 - 40 years Equipment under capital lease 3 - 20 years Leasehold improvements 7 - 20 years Vehicles 2 - 5 years Furniture and fixtures 5 - 10 years INTANGIBLES - Intangibles consist of receipts, trade names, trademarks, and other intangibles. Intangibles that are amortized have a gross carrying value of $104,400 and accumulated amortization of $80,300 and are amortized using the straight-line method over 20 years, which is the estimated useful life of the intangibles. Amortization is approximately $8,600 per year. Assets determined to have indefinite lives are no longer amortized in accordance with SFAS No. 142, GOODWILL AND OTHER INTANGIBLES, but are tested for impairment on an annual basis. The carrying amount of intangibles not subject to amortization is $63,500 for December 31, 2004 and 2003. CONCENTRATION OF CREDIT RISKS - Financial instruments that potentially subject the Company to credit risk consist principally of trade receivables, cash deposits in excess of FDIC limits, and assets located in the United Kingdom. The Company's cash deposits are placed with major financial institutions. At December 31, 2004, $420,000 of the Company's cash is being restricted to use by the bank which is holding the amount as collateral for a note payable classified as current. 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. The Company has approximately $240,600 in cash deposits and $6,907,500 of accounts receivable due from customers located in the United Kingdom. INCOME TAXES - The provision for income taxes is based on pre-tax earnings reported in the financial statements and adjusted for requirements of current tax law plus the change in deferred taxes. Deferred tax assets and liabilities are recognized using enacted tax rates and reflect the expected future tax consequences of temporary differences between the recorded amounts of assets and liabilities for financial reporting purposes and the tax basis of such assets and liabilities, and the future benefits from net operating loss carryforwards. SHIPPING COSTS - Shipping costs are included in marketing expense and totaled $978,600, $576,500, and $600,200 for the years ended December 31, 2004, 2003, and 2002. - -------------------------------------------------------------------------------- PAGE F-6 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- REVENUE RECOGNITION - The Company recognizes revenue from the brewing and distribution operations when the product is shipped. Revenues from the brewpub and gift store are recognized when services have been completed. STOCK-BASED COMPENSATION - The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion (APB) No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and complies with the disclosure provisions of Statement of Financial Accounting Standards (SFAS) No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. Under APB No. 25, compensation expense is the excess, if any, of the fair value of the Company's stock at a measurement date over the amount that must be paid to acquire the stock. SFAS No. 123 requires a fair value method to be used when determining compensation expense for stock options and similar equity instruments. SFAS No. 123 permits a company to continue to use APB No. 25 to account for stock-based compensation to employees, but pro forma disclosures of net income and earnings per share must be made as if SFAS No. 123 had been adopted in its entirety. Stock options issued to non-employees are valued under the provisions of SFAS No. 123. Had compensation cost for the Company's options been determined based on the methodology prescribed under SFAS No. 123, the Company's net loss and loss per share would have been as follows:
2004 2003 2002 --------------- --------------- --------------- Net income (loss) - as reported $ (468,900) $ 46,900 $ (1,729,800) Compensation expense - - 99,100 --------------- --------------- --------------- Net income (loss) - pro forma $ (468,900) $ 46,900 $ (1,828,900) =============== =============== =============== Income (loss) per share - pro forma $ (0.04) $ 0.00 $ (0.16)
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
2004 2003 2002 --------------- --------------- --------------- Dividends N/A N/A None Expected volatility N/A N/A 107% Risk free interest rate N/A N/A 4.50% Expected life N/A N/A 5 years
INCOME (LOSS) PER COMMON SHARE - Income (loss) per common share is computed using the weighted average number of common shares outstanding. A diluted earnings per share number is not presented because the inclusion of common stock equivalents in the computation would be antidilutive. Common stock equivalents associated with convertible notes and stock options, which are exercisable into 1,680,419, 1,710,290, and 1,653,474 of common stock at December 31, 2004, 2003, and 2002, could potentially dilute earnings per share in future years. FOREIGN CURRENCY TRANSLATION - The assets and liabilities of UBIUK were translated at the United Kingdom pound sterling - U.S. dollar exchange rates in effect at December 31, 2004 and 2003, and the statements of operations were translated at the average exchange rates for the years then ended. 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 December 31, 2004 and 2003, and its cash flows were translated at the average exchange rates for the years then ended. Changes in cash resulting from the translations are presented as a separate item in the statements of cash flows. USE OF ESTIMATES - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to 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 future utilization of deferred tax assets. The Company has determined that deferred tax assets associated with net operating loss carryforwards may expire prior to utilization. The Company has placed a valuation allowance on these assets. - -------------------------------------------------------------------------------- PAGE F-7 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- ACCOUNTS RECEIVABLE - Accounts receivable are reported at net realizable value. The Company has established an allowance for doubtful accounts based on factors pertaining to the credit risk of specific customers, historical trends, and other information. Delinquent accounts are written-off when it is determined that the amounts are uncollectible. ADVERTISING - Advertising costs are expensed as incurred and were $1,674,000, $1,196,100, and $972,400 for the years ended December 31, 2004, 2003, and 2002. FAIR VALUE OF FINANCIAL INSTRUMENTS - The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Long-term debt: Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities, the fair value of long-term debt approximates cost. COMPREHENSIVE INCOME (LOSS) - Comprehensive income (loss) is composed of the Company's net income (loss) and changes in equity from non-stockholder sources. The accumulated balances of these non-stockholder sources are reflected as a separate item in the equity section of the balance sheet. RECENT ACCOUNTING PRONOUNCEMENTS - In December 2004, the FASB issued SFAS No. 123 (revised 2004) (SFAS 123R), SHARE-BASED PAYMENT, which replaces SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION and supersedes APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values, beginning with the first interim or annual period after June 15, 2005, with early adoption encouraged. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. The Company is currently evaluating the requirements of SFAS 123R, but it is expected that adoption of SFAS 123R will have an immaterial impact on the Company's consolidated results of operations. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. This statement clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe adoption of Statement 151 will have a material effect on its consolidated financial position, results of operations or cash flows. NOTE 2 - LIQUIDITY AND MANAGEMENT PLANS Subsequent to December 31, 2004, the Company successfully refinanced a debt that matured in April 2005 and secured a commitment from another lender for extension of their loan until May 2006. Additionally, one of the Company's majority stockholders has guaranteed to provide financial support to avoid any possible default action by Savings Bank of Mendocino County. The Company is pursuing other refinancing opportunities to augment working capital, as well as exploring the prospect of expatriating excess earnings from its subsidiary. (Please see Note 5.) 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 $31,240 under a promissory note (the "BFI Note" and, together with the BFI Line of Credit, the "BFI Facility"). On May 6, 2005, the Company used the entire immediately available amount drawable under the BFI Facility to pay off the balance remaining outstanding under the CIT Line of Credit. NOTE 3 - INVENTORIES 2004 2003 --------------- --------------- Raw materials $ 357,500 $ 459,600 Work-in-process 140,100 190,400 Finished goods 664,700 510,000 Merchandise 23,100 26,100 --------------- --------------- $ 1,185,400 $ 1,186,100 =============== =============== - -------------------------------------------------------------------------------- PAGE F-8 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 4 - PROPERTY AND EQUIPMENT
2004 2003 ----------------- ----------------- Machinery and equipment $ 10,744,400 $ 10,323,800 Buildings 7,202,300 7,202,300 Equipment under capital lease 772,600 573,300 Land 810,900 810,900 Leasehold improvements 1,432,400 1,432,400 Vehicles 419,800 100,300 Furniture and fixtures 129,000 167,800 Equipment in progress 80,800 256,800 ----------------- ----------------- 21,592,200 20,867,600 Less accumulated depreciation and amortization 8,058,300 6,992,800 ----------------- ----------------- $ 13,533,900 $ 13,874,800 ================= =================
The Company has property and equipment located in the United Kingdom with a net book value of approximately $1,385,800. NOTE 5 - LINE OF CREDIT AND NOTE PAYABLE Commencing in September 1998, The CIT Group/Credit Finance, Inc. made available to the Company a $3,500,000 line of credit, with interest at the prime rate plus 2.25% secured by substantially all of the assets of the Releta Brewing Company, LLC, accounts receivable, inventory, certain securities pledged by a stockholder, and a second position on the real property of Mendocino Brewing Company. The Company had $1,552,700 and $1,209,300 outstanding as of December 31, 2004 and 2003. The Company used the proceeds from the BFI Facility and paid off the entire amount due on May 6, 2005. (Please see Note 2.) On December 31, 2003, Savings Bank of Mendocino County ("SBMC") extended the Company a temporary note of $576,200 to finance the end of term buy-out of certain equipment previously leased from Finova Capital Corporation. This note is secured against existing collateral held by the Bank in addition to assets that were originally under capital lease. SMBC has committed to extend this loan until May 2006. UBSN Limited has available a (pound)1,250,000 (approximately $2,395,000 at December 31, 2004) line of credit with interest at the bank's base rate plus 1.5%. The bank's commitment under the line of credit is available on an on-going basis until further notice. The agreement is secured by substantially all of the assets of UBSN limited. The subsidiary had (pound)902,600 and (pound)429,100 ($1,729,500 and $765,500) outstanding as of December 31, 2004 and 2003. The agreement restricts dividends to approximately (pound)100,000 ($191,600 at December 31, 2004) per year. NOTE 6 - LONG-TERM DEBT
2004 2003 ----------------- ----------------- Note to a bank; payable in monthly installments of $24,400, including interest at the Treasury Constant Maturity Index, plus 4.17% (currently 7.24%); maturing December 2012, with a balloon payment; secured by substantially all of the assets of Mendocino Brewing Company $ 2,299,400 $ 2,421,300 Note to a financial institution; payable in weekly installments of $10,000, plus interest at the prime rate plus 2.25%; maturing January 2005; secured by substantially all assets of the Releta Brewing Company, certain securities pledged by a stockholder, accounts receivable, inventory, and a second position on the remaining assets of Mendocino Brewing Company 10,700 464,700
- -------------------------------------------------------------------------------- PAGE F-9 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
2004 2003 ----------------- ----------------- Payable to Mendocino County in four annual installments of $143,600, plus interest at 18%, beginning April 2005; maturing April 2008 574,500 574,500 Note payable to Sheperd Neame, Ltd., a related party; payable in annual installments of $110,000, plus interest at 5% beginning June 2003; maturing December 2012; unsecured 900,500 963,500 ----------------- ----------------- 3,785,100 4,424,000 Less current maturities 400,300 693,700 ----------------- ----------------- $ 3,384,800 $ 3,730,300 ================= =================
Maturities of long-term debt for succeeding years are as follows: Year Ending December 31, ------------------------ 2005 $ 400,300 2006 399,400 2007 409,900 2008 421,300 2009 289,800 Thereafter 1,864,400 ---------------- $ 3,785,100 ================ NOTE 7 - CAPITAL LEASE OBLIGATIONS The Company leases brewing and office equipment under capital lease agreements with various financial institutions. Future minimum lease payments under these capital lease agreements are as follows: Year Ending December 31, ------------------------ 2005 $ 171,700 2006 60,300 2007 13,100 2008 3,500 2009 - ---------------- 248,600 Less amounts representing interest 39,500 ---------------- Present value of minimum lease payments 209,100 Less current maturities 146,500 ---------------- $ 62,600 ================ NOTE 8 - NOTES TO RELATED PARTY - SUBORDINATED Notes payable to a related party consist of convertible notes to United Breweries of America (UBA), with interest at the prime rate plus 1.5%, but not to exceed 10% per year. The notes are convertible into common stock at $1.50 per share. The notes have been extended until August 2005. UBA may demand payment within 60 days of the end of the extension period but is precluded from doing so because the notes are subordinated to long-term debt agreements with Savings Bank of Mendocino County. Because of the subordination, the Company has shown these notes as long term. The notes include $494,700 and $406,100 of accrued interest at December 31, 2004 and 2003. The notes are unsecured and subordinated to bank debt. Subsequent to year end, the Company borrowed an additional $400,000 on the same terms as the notes above. - -------------------------------------------------------------------------------- PAGE F-10 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 9 - PROFIT-SHARING PLAN Subsequent to December 31, 2004, the Company terminated its profit sharing plan. Contributions to the Plan were made at the discretion of the Board of Directors, and any contributions vested over a six year period. The plan covered substantially all full-time employees that met certain minimum age and service requirements. No contributions were made to the Plan for the years ended December 31, 2004, 2003, and 2002. NOTE 10 - COMMITMENTS AND CONTINGENCIES OPERATING LEASES - The Company and its subsidiaries have various lease agreements for the brewpub and gift store in Hopland, California; land at its Saratoga Springs, New York, facility; a building in the United Kingdom; and certain personal property. The land lease includes a renewal option for two additional five-year periods, which the Company intends to exercise, and some leases are adjusted annually for changes in the consumer price index. The land lease also contains an option to purchase. The leases begin expiring in 2005. Rent expense charged to operations was $202,700, $210,500, and $221,300 for the years ended December 31, 2004, 2003, and 2002. Future minimum lease payments under these agreements are as follows: Year Ending December 31, ------------------------ 2005 $ 181,200 2006 173,300 2007 167,800 2008 165,800 2009 165,800 ---------------- $ 853,900 ================ KEG MANAGEMENT AGREEMENT - In September 2004, the Company renewed the keg management agreement with MicroStar Keg Management LLC. Under this arrangement, MicroStar provides all kegs for which the Company pays a service fee between $5 and $15, depending on territory. The agreement is effective for five years ending in September 2009. If the agreement is terminated, the Company is required to purchase three times the average monthly keg usage for the preceding six-month period from MicroStar at purchase prices ranging from $54 to $84 per keg. The Company expects to continue this relationship. Rental expense associated with this agreement was $91,400, $76,200, and $84,400 for the years ended December 31, 2004, 2003, and 2002. NOTE 11 - RELATED-PARTY TRANSACTIONS The Company conducts business with United Breweries of America (UBA), which owns approximately 76% of the Company's common stock through common ownership. Additionally, UBSN Limited has significant transactions with Sheperd Neame, Ltd., which is related to a former Board member. The Company also has transactions with AUBI, a company affiliated with one of the Board members. The following table reflects balances outstanding and the value of the transactions with these related parties for the years ended December 31, 2004, 2003, and 2002. - -------------------------------------------------------------------------------- PAGE F-11 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
2004 2003 2002 --------------- --------------- --------------- TRANSACTIONS Sales to Sheperd Neame, Ltd. $ 3,099,500 $ 2,536,000 $ 2,110,200 Purchases from Sheperd Neame, Ltd. 14,541,100 11,240,000 9,470,700 Expense reimbursements to Sheperd Neame, Ltd. 1,239,300 743,000 710,600 Interest expense associated to UBA convertible notes payable (see Note 8) 88,500 85,200 93,500 Interest paid to Sheperd Neame, Ltd. (see Note 6) 46,300 46,600 52,300 ACCOUNT BALANCES Accounts payable and accrued liabilities to 4,160,300 3,510,100 3,004,200 Sheperd Neame, Ltd. Accounts receivable and prepayments from 841,700 660,600 224,400 Sheperd Neame, Ltd. Amounts payable to AUBI 20,000 20,000 20,000
NOTE 12 - MAJOR CUSTOMERS Sales to the top five customers totaled $7,942,000, $7,088,800, and $6,718,100 for the years ended December 31, 2004, 2003, and 2002, which represents 25%, 25%, and 26% of sales for the years ended December 31, 2004, 2003, and 2002. NOTE 13 - STOCKHOLDERS' EQUITY Independent outside members of the Board of Directors are compensated for attending Board of Directors and committee meetings. Compensation is with common stock. Expenses related to this compensation totaled $27,000, $45,000, and $47,000 for the years ended December 31, 2004, 2003, and 2002. Stock has been issued for the years 2003 and 2002 subsequent to the year ended December 31, 2004. PREFERRED STOCK - Ten million shares of preferred stock have been authorized, of which 227,600 are designated as Series A. 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 stock or any other series of preferred stock. When the entire Series A dividend/liquidation proceeds have been paid, the Series A shares are automatically canceled and will cease to be outstanding. Only a complete corporate dissolution will cause a liquidation preference to be paid. NOTE 14 - STOCK OPTION PLAN Under the 1994 Stock Option Plan, which expired during 2004, the Company could issue options to purchase up to 1,000,000 shares of common stock. The Plan provided for both incentive stock options, as defined in Section 422 of the Internal Revenue Code, and options that did not qualify as incentive stock options. The exercise price of incentive options was no less than the fair-market value of the Company's stock at the date the option was granted, while the exercise price of non-statutory options was no less than 85% of the fair-market value per share on the date of grant. Options granted to a person possessing more than 10% of the combined voting power of all classes of the Company's stock had an exercise price of no less than 110% of the fair-market value of the Company's stock at the date of grant. During 2002, 240,385 non-statutory stock options with a five-year term were issued to the independent members of the Board of Directors at the market price on the date of grant. All options were exercisable at the date of grant. There were no options issued during 2003 or 2004. The exercise prices range from $.52 to $1.25 per option. Options for 88,888 expired during 2004. Outstanding options expire through January 2007, with 100,000 options expiring in 2005, and 240,385 options expiring in 2007. - -------------------------------------------------------------------------------- PAGE F-12 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The following table summarizes the number of options granted and exercisable and the weighted average exercise prices: SHARES UNDER WEIGHTED-AVERAGE OPTION EXERCISE PRICE --------------- ----------------- Balance at December 31, 2001 188,888 $ 1.19 Options granted 240,385 $ 0.52 --------------- Balance at December 31, 2002 429,273 $ 0.82 --------------- Balance at December 31, 2003 429,273 $ 0.82 Options expired (88,888) $ 1.13 --------------- Balance at December 31, 2004 340,385 $ 0.73 =============== NOTE 15 - INCOME TAXES The continuing losses in the U.S. operations has resulted in the Company determining that the deferred tax assets associated with net operating loss carryforwards and investment tax credits may expire prior to utilization. The Company recorded a valuation allowance of $3,375,000 for deferred tax assets. The Company also has $57,900 of California Manufacturers' Investment Tax Credits that can be carried forward to reduce future taxes. These credits begin expiring in 2008.
2004 2003 2002 ----------------- ----------------- ----------------- Provision for income taxes Federal $ - $ - $ - United Kingdom 118,000 263,400 298,400 States 3,800 16,300 8,900 Benefit of state investment tax credit carryforwards - (15,000) (6,800) ----------------- ----------------- ----------------- 121,800 264,700 300,500 Change in deferred income taxes - - 1,922,600 ----------------- ----------------- ----------------- $ 121,800 $ 264,700 $ 2,223,100 ================= ================= =================
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:
2004 2003 2002 ----------------- ----------------- ----------------- Income tax provision (benefit) at 34% $ (232,400) $ 105,800 $ 167,700 State income tax (benefit) (15,000) 12,900 20,300 United Kingdom income tax 118,000 263,500 298,400 Recognition of future tax revenues or expenses (6,500) 26,800 (39,000) Valuation allowance 257,700 (144,300) 1,775,700 ----------------- ----------------- ----------------- $ 121,800 $ 264,700 $ 2,223,100 ================= ================= =================
- -------------------------------------------------------------------------------- PAGE F-13 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Temporary differences and carryforwards that give rise to deferred tax assets and liabilities are as follows:
2004 2003 ----------------- ----------------- Accruals $ 83,200 $ 73,000 Depreciation and amortization (490,000) (317,500) Benefit of net operating loss carryforward 4,190,000 3,758,900 Undistributed earnings of United Breweries International (UK), Ltd. (800,300) (800,300) Investment in United Breweries International (UK) Ltd. 321,600 328,400 Other 70,500 74,800 ----------------- ----------------- 3,375,000 3,117,300 Less valuation allowance (3,375,000) (3,117,300) ----------------- ----------------- $ - $ - ================= ================= Valuation allowance - beginning of year $ 3,117,300 $ 3,261,600 Valuation allowance - end of year 3,375,000 3,117,300 ----------------- ----------------- Change in valuation allowance $ 257,700 $ (144,300) ================= =================
Net operating losses available for carryforward will expire as follows:
DATE OF EXPIRATION FEDERAL CALIFORNIA NEW YORK ------------------ ------------------- -------------------- -------------------- 2004 $ - $ 761,300 $ - 2005 - 961,200 - 2006 - 694,700 - 2012 $ - $ 250,900 $ - 2013 1,686,100 229,300 277,000 2014 - 625,000 - 2018 2,758,800 - 453,300 2019 2,153,100 - 341,800 2020 965,600 - 143,300 2021 1,041,100 - 171,000 2022 615,800 - 100,800 2023 - - - 2024 1,707,900 - 280,100 ------------------- -------------------- -------------------- $ 10,928,400 $ 3,522,400 $ 1,767,300 =================== ==================== ====================
NOTE 16 - SEGMENT INFORMATION The Company's business presently consists of three segments. The first is brewing for wholesale to distributors and other retailers. This segment accounted for 36%, 43%, and 46% of the Company's gross sales during 2004, 2003 and 2002. The second consists of distributing alcoholic beverages to retail establishments and restaurants in the United Kingdom and Europe. This segment accounted for approximately 63%, 55%, and 52% of the Company's gross sales during 2004, 2003, and 2002. The third segment consists of beer for sale along with food and merchandise at the Company's brewpub and retail merchandise store located at the Hopland Brewery. This segment accounted for 2% of the Company's gross sales during 2004, 2003, and 2002. A summary of each segment is as follows: - -------------------------------------------------------------------------------- PAGE F-14 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2004 ------------------------------------------------------------------------------------------ BREWING TAVERN & DISTRIBUTOR CORPORATE OPERATIONS TASTING ROOM OPERATIONS AND OTHER TOTAL ---------------- ---------------- ---------------- ----------------- ---------------- Sales $ 11,686,800 $ 211,200 $ 20,259,900 - $ 32,157,900 Operating income (49,900) 12,800 490,900 - 453,800 Identifiable assets 13,166,900 99,400 8,729,400 2,367,400 24,363,100 Depreciation and amortization 535,800 5,000 459,300 31,200 1,031,300 Capital expenditures 38,700 - 559,100 - 597,800 YEAR ENDED DECEMBER 31, 2003 ------------------------------------------------------------------------------------------ BREWING TAVERN & DISTRIBUTOR CORPORATE OPERATIONS TASTING ROOM OPERATIONS AND OTHER TOTAL ---------------- ---------------- ---------------- ----------------- ---------------- Sales $ 11,590,100 $ 425,300 $ 16,848,800 $ - $ 28,864,200 Operating income (Loss) (19,400) (31,400) 1,028,300 - 977,500 Identifiable assets 13,695,200 102,400 6,676,900 1,336,700 21,811,200 Depreciation and amortization 736,500 6,000 358,800 26,100 1,127,400 Capital expenditures 268,600 - 459,200 - 727,800 YEAR ENDED DECEMBER 31, 2002 ------------------------------------------------------------------------------------------ BREWING TAVERN & DISTRIBUTOR CORPORATE OPERATIONS TASTING ROOM OPERATIONS AND OTHER TOTAL ---------------- ---------------- ---------------- ----------------- ---------------- Sales $ 11,158,100 $ 511,400 $ 14,415,600 $ - $ 26,085,100 Operating income 221,400 22,800 984,500 - 1,228,700 Identifiable assets 14,500,800 99,600 5,973,100 1,716,100 22,289,600 Depreciation and amortization 758,900 5,700 246,500 37,900 1,049,000 Capital expenditures 133,900 - 350,900 2,700 487,500
NOTE 17 - UNRESTRICTED NET ASSETS The net assets of the Company's subsidiary, UBSN, are restricted by bank covenants that allows the payment of dividends to its parent company, Mendocino Brewing Company, of one-third of UBSN's annual profits after taxes but limited to no more than (pound)100,000 (approximately $191,000) per year. Condensed financial information of the parent company, Mendocino Brewing Company, Inc., is as follows: - -------------------------------------------------------------------------------- PAGE F-15 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
BALANCE SHEETS 2004 2003 ----------------- ------------------ Assets Cash $ 286,000 $ 301,500 Accounts receivable 1,569,700 1,457,100 Inventories 1,185,400 1,186,100 Other current assets 170,200 250,300 ----------------- ------------------ Total current assets 3,211,300 3,195,000 Investment in subsidiary 1,225,000 1,225,000 Property and equipment 12,148,100 12,678,700 Other assets 274,300 260,500 ----------------- ------------------ Total assets $ 16,858,700 $ 17,359,200 ================= ================== Liabilities Line of credit and note payable $ 1,552,700 $ 1,785,500 Accounts payable 1,757,000 1,857,000 Intercompany payable 1,177,500 1,204,000 Accrued liabilities 752,600 1,269,000 Legal dispute settlement 911,800 - Current maturities of debt and leases 431,800 715,600 ----------------- ------------------ Total current liabilities 6,583,400 6,831,100 Long-term debt and capital leases 3,238,100 3,078,000 Notes payable to related party 2,010,100 1,921,500 ----------------- ------------------ Total liabilities 11,831,600 11,830,600 ----------------- ------------------ Stockholders' equity Common stock 14,648,600 14,648,600 Preferred stock 227,600 227,600 Accumulated deficit (9,849,100) (9,347,600) ----------------- ------------------ Total stockholders' equity 5,027,100 5,528,600 ----------------- ------------------ Total liabilities and stockholders' equity $ 16,858,700 $ 17,359,200 ================= ==================
- -------------------------------------------------------------------------------- PAGE F-16 MENDOCINO BREWING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS 2004 2003 2002 --------------- --------------- --------------- Net sales $ 11,245,600 $ 11,341,500 $ 11,018,000 Cost of goods sold 7,467,000 7,972,600 7,473,300 Selling, marketing, and retail expenses 1,701,400 1,663,100 1,717,600 General and administrative expenses 1,955,200 1,833,600 1,664,200 Legal dispute settlement 250,600 - - --------------- --------------- --------------- Income (loss) from operations (128,600) (127,800) 162,900 --------------- --------------- --------------- Other income and (expense) Interest expense (725,900) (727,800) (816,900) Other income (expense) 356,800 487,600 365,100 Provision for taxes (3,800) (1,300) (1,924,700) --------------- --------------- --------------- (372,900) (241,500) (2,376,500) --------------- --------------- --------------- Net loss $ (501,500) $ (369,300) $ (2,213,600) =============== =============== =============== STATEMENTS OF CASH FLOWS 2004 2003 2002 --------------- --------------- --------------- Cash flows from operating activities $ 374,200 $ (237,500) $ 537,400 --------------- --------------- --------------- Cash flow from investing activities Purchase of property and equipment (38,700) (268,600) (17,200) Proceeds from new distributors - 655,200 - Proceeds from sale of assets 16,700 - 1,500 --------------- --------------- --------------- Net cash flow from investing activities (22,000) 386,600 (15,700) --------------- --------------- --------------- Cash flow from financing activities Net borrowings on line of credit 343,400 101,800 65,900 Borrowings (repayments) on long-term debt (575,900) 554,800 (348,500) Payment on obligation under capital lease (124,000) (697,100) (359,000) Net change in intercompany payable (99,800) 107,700 - Proceeds on notes from related party 88,600 85,200 93,500 --------------- --------------- --------------- Net cash flow from financing activities (367,700) 152,400 (548,100) --------------- --------------- --------------- Net change in cash (15,500) 301,500 (26,400) Cash, beginning of year 301,500 - 26,400 --------------- --------------- --------------- Cash, end of year $ 286,000 $ 301,500 $ - =============== =============== =============== Cash dividends received from subsidiary $ 215,100 $ 155,800 $ - =============== =============== ===============
- -------------------------------------------------------------------------------- PAGE F-17 EX-10.75 2 tex10_75-7500.txt EX-10.75 LOAN AND SECURITY AGREEMENT (Accounts Receivable & Inventory Line of Credit) This Loan and Security Agreement (Accounts Receivable & Inventory Line of Credit), is entered into as of MAY 5, 2005, between BFI BUSINESS FINANCE, a California corporation (the "Lender"), with its headquarters' office located at 1655 The Alameda, San Jose, CA 95126 and MENDOCINO BREWING COMPANY, INC., A CALIFORNIA CORPORATION (SOMETIMES, "MENDOCINO") AND RELETA BREWING COMPANY LLC, A DELAWARE LIMITED LIABILITY COMPANY (SOMETIMES, "RELETA") (Mendocino and Releta are sometimes hereinafter collectively referred to as "Borrower"). Mendocino's sole places of business (if it has only one), chief executive office (if it has more than one place of business) or residence (if an individual) located at 1601 AIRPORT ROAD, UKIAH, CALIFORNIA 95482 (the "Chief Executive Office" for Mendocino), and Releta's sole places of business (if it has only one), chief executive office (if it has more than one place of business) or residence (if an individual) located at 131 EXCELSIOR AVENUE, SARATOGA SPRINGS, NEW YORK 12866 (the "Chief Executive Office" for Releta) . RECITALS A. Borrower has requested Lender to make loans to Borrower for business purposes. B. Lender is willing to make such loans to Borrower, on the terms and conditions set forth in this Agreement, and Borrower agrees to make the payments required by this Agreement and to comply with the other terms and conditions of this Agreement. AGREEMENT For good and valuable consideration, receipt of which is hereby acknowledged, the parties agree as set forth below. 1. DEFINITIONS AND CONSTRUCTION. 1.1. DEFINITIONS. As used in this Agreement, the following terms shall have the following definitions: "ACCOUNTING PERIOD" has the meaning given in Section 9.4 hereof. "ACCOUNT DEBTOR" means a person obligated on an Account, Chattel Paper, or General Intangible. "ACCOUNTS" means all currently existing and hereafter arising accounts as defined in the Code, as such definition may be changed from time to time, and shall include, but not be limited to a right to payment of a monetary obligation for property sold or services rendered, and any and all credit insurance, guaranties, or security therefor. "ADDENDUM" means that certain Addendum A hereto, if applicable. "ADVANCE(S)" has the meaning given in Section 2.1.1 hereof. "ADMINISTRATIVE FEE" has the meaning given in Section 2.2.10 hereof. "AFFILIATE" means, when used with respect to any Person, any other Person which, directly or indirectly, controls or is controlled by or is under common control with such Person. For purposes of this definition, "control" (including the correlative meanings of the terms "controlled by" and "under common control with"), with respect to any Person, shall mean possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or by contract or otherwise. "AGREEMENT" means this Loan and Security Agreement (Accounts Receivable & Inventory Line of Credit) together with all addenda, exhibits and schedules hereto, as the same now exists or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced. "ALLOWABLE AMOUNT" means the lesser of the Borrowing Base and the Maximum Amount. "A R BORROWING BASE" has the meaning set forth in the definition of Borrowing Base. "AUTHENTICATE" shall have the meaning given in the Code, as such definition may be amended from time to time, which means to sign, execute, or otherwise adopt a symbol, or encrypt or similarly process a record in whole or in part, with the present intention of the authenticating person to identify the person and adopt or accept a record. "AUTHORIZED OFFICER" means any officer or employee of Borrower as set forth in that certain Signature Authorization of even date herewith, as it may be amended from time to time. Page 1 of 32 "AVERAGE DAILY BALANCE" means the average of the Daily Balance, which shall be calculated taking into account that no payment made by check shall be deemed to be made until THREE (-3-) BUSINESS DAYS after receipt of Lender of such checks to allow for clearance thereof, as provided in Section 3.3 hereof. "BANKRUPTCY CODE" means Title 11 of the United States Code, as amended and any successor statute. "BASIC TERM" has the meaning set forth in Section 6.1 hereof. "BORROWER" has the meaning set forth in the preamble to this Agreement, individually and collectively. "BORROWER'S BOOKS" means all of Borrower's books and records including ledgers, records indicating, summarizing, or evidencing Borrower's properties or assets (including, without limitation, the Collateral) or liabilities, all information relating to Borrower's business operations or financial condition, and all computer programs, disc or tape files, printouts, runs, or other computer prepared information, and the equipment containing such information. "BORROWING BASE" means the sum of the following: (a) EIGHTY PERCENT (80%) IN THE CASE OF MENDOCINO AND SEVENTY PERCENT (70%) IN THE CASE OF RELETA of the Net Face Amount of Prime Accounts, but in any event not in an aggregate amount in excess of the Maximum Account Advance (the "A R Borrowing Base"); plus (b) FIFTY PERCENT (50%) of the Current Market Cost of raw materials that constitute Eligible Inventory; plus FIFTY PERCENT (50%) of the Current Market Cost of finished goods that constitute Eligible Inventory, but in any event not in an aggregate amount in excess of the Maximum Inventory Advance (the "Inventory Borrowing Base"). "BUSINESS DAY" means any day which is not a Saturday, Sunday, or other day on which national banks are authorized or required to close. "CERCLA" has the meaning given in the definition of Environmental Laws. "CHATTEL PAPER" has the meaning given in the Code, as such definition may be amended from time to time, which defines Chattel Paper as a record or records that evidence both (a) a monetary obligation; and (b) a security interest in (1) specific goods; (2) a security interest in specific goods and software used in the goods; (3) a security interest in specific goods and license of software used in the goods; or (4) a lease of specific goods and license of software used in the goods. "CHIEF EXECUTIVE OFFICE" has the meaning set forth in the preamble to this Agreement. "CLEARANCE DAYS" has the meaning given in Section 3.3 hereof. "CLOSING DATE" means the date of the initial advance hereunder. "CODE" or "UCC" means the California Uniform Commercial Code, or any successor statute, as amended from time to time, which is also known as the UCC. "COLLATERAL" means all of the personal property and Trade Fixtures now owned or hereafter acquired by Borrower whether now existing or hereafter arising and wherever located, including without limitation: (a) all Accounts; (b) all Chattel Paper including without limitation Electronic Chattel Paper; (c) all Inventory; (d) all Equipment; (e) all Trade Fixtures; (f) all Fixtures, but only if connected with Real Property Collateral (g) all Instruments; (h) all Financial Assets, including without limitation, Investment Property; (i) all Documents; (j) all Deposit Accounts; (k) all Letter of Credit Rights; (l) all General Intangibles including without limitation copyrights, trademarks, and patents, Payment Intangibles and Software; (m) all Supporting Obligations; (n) any Commercial Tort Claim listed on any schedule provided herewith or hereafter; (o) all returned or repossessed goods arising from or relating to any Accounts or Chattel Paper; (p) all certificates of title and certificates of origin or manufacturers statements of origin relating to any of the foregoing, now owned or hereafter acquired; (q) all property similar to any of the foregoing hereafter acquired by Borrower; (r) all ledger sheets, files, records, documents, instruments, and other books and records (including without limitation related electronic data processing Software) evidencing an interest in or relating to the above; (s) all money, cash or cash equivalents; and (t) to the extent not otherwise included in the foregoing, all proceeds, products, insurance claims, and other rights to payment and all accessions to, replacements for, attachments to, substitutions for, and rents and profits of, and noncash proceeds of, each of the foregoing. Notwithstanding any contrary term of this Agreement, Collateral shall not include any waste or other materials that have been or may be designated as toxic or hazardous. "COLLATERAL ACCOUNT" has the meaning give in Section 3.7.2 hereof. "COLLATERAL CONTROL ACCOUNT" has the meaning given in Section 3.7.3 hereof. "COLLATERAL STATE" has the meaning given in Section 9.14 hereof. Page 2 of 32 "COMMERCIAL TORT CLAIM" has the meaning give in the Code, as such definition may be amended from time to time, which means a claim arising in tort with respect to which the claimant is an organization or if the claimant is an individual, the claim arose in (a) the course of the claimant's business or professions; and (b) does not include damages arising out of personal injury to or death of an individual. "CUMULATIVE MINIMUM ANNUAL INTEREST PAYMENT" has the meaning given in Section 2.2.2 hereof. "CURRENT MARKET COST" means, as determined by Lender in good faith, the lower of (a) cost of Inventory, computed on a first-in-first-out basis in accordance with GAAP; or (b) market value of Inventory. "DAILY BALANCE" means the principal amount of any Obligations owed at the end of a given day. "DEEMED PRIME RATE" shall have the meaning given in the definition of Prime Rate. "DEFAULT RATE" has the meaning given in Section 2.2.4 hereof. "DELINQUENT ACCOUNTS" shall mean Accounts which remain uncollected for more than ninety (90) days from the invoice date. "DEPOSIT" has the meaning given in Section 2.2.11 hereof. "DEPOSIT ACCOUNT(S)" has the meaning given in the Code, as such definition may be amended from time to time, including without limitation, a demand, time, savings, passbook or similar account maintained with a bank. "DILUTION RATE" shall mean the percentage rate at which Borrower's Prime Accounts are subject to reduction due to credits, returns, and allowances. "DOCUMENTATION FEE/LEGAL DEPOSIT " shall have the meaning set forth in Section 2.2.11 hereof. "Documents" has the meaning given in the Code, as such definition may be amended from time to time. "ELECTRONIC CHATTEL PAPER" has the meaning given in the Code, as such definition may change from time to time, which defines Electronic Chattel Paper as Chattel Paper evidenced by a record or records consisting of information stored in an electronic medium. "ELIGIBLE INVENTORY" means: (a) Inventory acceptable to Lender, in its reasonable and sole discretion, for lending purposes; (b) Inventory held for sale or lease in the ordinary course of Borrower's business; (c) Inventory located at Borrower's Chief Executive Office or Warehouse, provided however, that if any such location is owned by a party other than Borrower, Lender shall have obtained from the owner thereof an agreement relative to Lender's rights with respect to such Inventory, in form and content satisfactory to Lender; (d) Inventory in which Lender has a first priority, perfected security interest; (e) Inventory not subject to a security interest, lien, or other encumbrance in favor of any other Person; (f) Inventory of good and merchantable quality that is free from defect and that is not slow moving, obsolete, returned, perishable, or manufactured under a license agreement; (g) Inventory owned and in the lawful possession of Borrower; (h) Inventory which does not consist of packaging and shipping materials; and (i) Inventory that does not consist of supplies used or consumed in Borrower's business or work-in-process. General criteria for Eligible Inventory may be established and revised from time to time by Lender in good faith. Any Inventory that is not Eligible Inventory shall nevertheless be part of the Collateral. "ENVIRONMENTAL LAWS" means all federal, state, local and foreign statutes, laws, regulations, ordinances, rules, judgments, orders, decrees, permits, concessions, grants, franchises, licenses, agreements or other governmental restrictions relating to the environment or to emissions, discharges or releases of pollutants, contaminants, petroleum or petroleum products, chemicals or industrial, toxic or hazardous substances or wastes into the environment, including ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, petroleum or petroleum products, chemicals, or industrial, toxic or hazardous substances or wastes or Page 3 of 32 the clean-up or other remediation thereof, including without limitation 42 U.S.C. 9601 (14), Comprehensive Environmental Response, Compensation and Liability Act of 1980 set forth at 42 U.S.C. 9601 et seq. ("CERCLA"), or the Resource Conservation and Recovery Act of 1986 set forth at 42 U.S.C. 9601 et seq. ("RCRA") and all successor statutes and amendments thereto. "EPA" means the United States Environmental Protection Agency. "Equipment" means all of Borrower's now owned and hereafter acquired equipment as defined in the Code, as such definition may be amended from time to time, and wherever located, and shall include, but not be limited to, all goods (other than inventory, farm products, or consumer goods) including without limitation machinery, computers and computer hardware and software (whether owned or licensed), vehicles, tools, furniture, Trade Fixtures (but not including Fixtures unless Real Property Collateral has been pledged to Lender), all attachments, accessions and property now or hereafter affixed thereto or used in connection therewith, and substitutions and replacements thereof, wherever located. "ERISA" shall have the meaning given in Section 9.19. "EVENT OF DEFAULT" means those events described in Section 11 hereof. "FEIN" shall have the meaning given in Section 8.1.15. "FINANCIAL ASSETS" has the meaning given in the Code, which defines Financial Assets as any of the following: (a) a security; (b) an obligation of a person or a share, participation, or other interest in a person or in property or an enterprise of a person, that is, or is of a type, dealt in or traded on financial markets or that is recognized in any area in which it is issued or dealt in as a medium for investment; and (c) any property that is held by a securities intermediary for another person in a securities account that has expressly agreed with the other person that the property is to be treated as a financial asset. "FIXTURES" has the meaning given in the Code, as such definition may be amended from time to time, which defines Fixtures as goods that have become so related to particular real property that an interest in them arises under property law, but shall not include Trade Fixtures. "GAAP" means generally accepted accounting principles set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and pronouncements of the Financial Accounting Standards Board (or any successor authority) that are applicable as of the date of determination. "GENERAL INTANGIBLES" means general intangibles as defined in the Code, as such definition may be amended from time to time, (and shall include, but not be limited to, registered and unregistered patents, trademarks, service marks, copyrights, trade names, applications for the foregoing, trade secrets, goodwill, processes, drawings, blueprints, customer lists, licenses, whether as licensor or licensee, choses in action and other claims and existing and future leasehold interests in Equipment, Payment Intangibles and Software), all whether arising under the laws of the United States of America or any other country. "GOOD FAITH DEPOSIT" shall have the meaning set forth in Section 2.2.11 hereof. "GUARANTOR" means, individually and collectively, - -------N/A-------. "GUARANTY" means that certain General Continuing Guaranty or those certain General Continuing Guaranties, signed by Guarantor concurrently with the execution of this Agreement and the Loan Documents and/or the Term Loan Documents, as amended from time to time hereafter. "HAZARDOUS SUBSTANCES" and "HAZARDOUS WASTES" means all or any of the following: (a) substances that are defined or listed in, or otherwise classified pursuant to, any applicable laws or regulations as "hazardous substances," "hazardous materials," "hazardous wastes," "toxic substances," or any other formulation intended to define, list, or classify substances by reason of deleterious properties such as ignitability, corrosivity, reactivity, carcinogenicity, reproductive toxicity, or "EP toxicity"; (b) oil, petroleum, or petroleum derived substances, natural gas, natural gas liquids, synthetic gas, drilling fluids, produced waters, and other wastes associated with the exploration, development, or production of crude oil, natural gas, or geothermal resources; (c) any flammable substances or explosives or any radioactive materials; and (d) asbestos in any form or electrical equipment which contains any oil or dielectric fluid containing levels of polychlorinated biphenyls in excess of fifty (50) parts per million. "INDEBTEDNESS" means all of the following: (a) all indebtedness for borrowed money (whether by loan or the issuance and sale of debt securities); Page 4 of 32 (b) that portion of obligations with respect to capital leases that is properly classified as a liability on a balance sheet in conformity with GAAP; (c) acceptances, bonds, indentures, notes payable, and drafts accepted representing extensions of credit whether or not representing obligations for borrowed money; (d) any obligation owed for all or any part of the deferred purchase price of property or services if the purchase price is due more than six (6) months from the date the obligation is incurred or is evidenced by a note or similar written instrument; (e) all indebtedness secured by any lien on any property or asset owned or held by Borrower regardless of whether the indebtedness secured thereby shall have been assumed by Borrower or is nonrecourse to the credit of Borrower; (f) contingent obligations to the extent such obligations are no longer contingent but become absolute and remain unpaid; (g) all obligations, contingent or otherwise, relative to the face amount of any letter of credit, letter of credit guaranties, bankers acceptances, interest rate swaps, controlled disbursement accounts, or other financial products; (h) any unfunded obligation of Borrower or any of its subsidiaries to a Multiemployer Plan required to be accrued by GAAP; and (i) obligations of Borrower guaranteeing or intended to guarantee (whether guaranteed, endorsed, co-made, discounted, or sold with recourse to Borrower), any indebtedness, lease, dividend, letter of credit, or other obligation of any other Person. "INSOLVENCY PROCEEDING" means any case, proceeding, or matter commenced by or against any Person under any provision of the Bankruptcy Code or under any other bankruptcy or insolvency law, including assignments for the benefit of creditors, formal or informal moratoria, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other similar relief. "INSTRUMENT" has the meaning given in the Code, as such definition may be amended from time to time, which defines an Instrument as a negotiable instrument or any other writing that evidences a right to payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in the ordinary course of business is transferred by delivery with any necessary endorsement or assignment. Instrument shall include but not be limited to promissory notes. "INVENTORY" means all present and future inventory, as defined in the Code, as such definition may be amended from time to time, in which Borrower has any interest and wherever located, and shall include but not be limited to, goods held for sale or lease or to be furnished under a contract of service and all of Borrower's present and future raw materials, work in process, finished goods, and packing and shipping materials, wherever located, and any documents of title representing any of the above. "INVENTORY BORROWING BASE" has the meaning set forth in the definition of Borrowing Base. "INVESTMENT PROPERTY" has the meaning given in the Code, as such definition may be amended from time to time, which defines Investment Property as securities, security accounts, commodity contracts, or commodity accounts. "IRC" means the Internal Revenue Code of 1986, as amended, and the regulations thereunder. "LENDER" has the meaning set forth in the preamble to this Agreement. "LENDER EXPENSES" includes without limitation all of the following: (a) costs or expenses (including without limitation taxes, photocopying, notarization, telecommunication, insurance premiums, and postage) paid by Lender; (b) costs and expenses required to be paid by Borrower under any of the Loan Documents that are paid or advanced by Lender; (c) documentation, filing, recording, publication, appraisal (including periodic Collateral appraisals) and search fees assessed, paid, or incurred by Lender in connection with Lender's transactions with Borrower; (d) costs and expenses incurred by Lender in the disbursement of funds to Borrower (by wire transfer or otherwise); (e) charges paid or incurred by Lender resulting from the dishonor of checks; costs and expenses paid or incurred by Lender to correct any default or enforce any provision of the Loan Documents, or in gaining possession of, maintaining, handling, preserving, storing, shipping, selling, preparing for sale, or advertising to sell the Collateral or any portion thereof, irrespective of whether a sale is consummated; Page 5 of 32 (f) costs and expenses paid or incurred by Lender in examining Borrower's Books; and (g) costs and expenses of third party claims or any other suit paid or incurred by Lender in enforcing or defending the Loan Documents and adjusting or settling disputes and claims with Account Debtors with respect to the Accounts; and Lender's reasonable attorneys' fees and expenses (whether for legal services incurred by and expenses from outside counsel and/or from in-house counsel) incurred in advising, structuring, drafting, reviewing, administering, amending, terminating, enforcing (including attorneys' fees and expenses incurred in such adjusted or settled disputes and claims, and in connection with a "workout," a "restructuring," or an Insolvency Proceeding concerning Borrower or any Guarantor of the Obligations, irrespective of whether suit is brought). The attorneys' fees incurred by Lender in any Insolvency Proceeding shall include, without limitation, those incurred in connection with debtor-in-possession financing, motions for relief from automatic stay, and actions to determine dischargeability, and defending, or concerning the Loan Documents. "LETTER OF CREDIT RIGHTS" has the meaning given in the Code, as such definition may be amended from time to time, which defines Letter of Credit Rights as a right to payment or performance under a letter of credit, whether or not beneficiary has demanded or is at the time entitled to demand payment or performance. "LOAN DOCUMENTS" means collectively, this Agreement, the Term Loan Documents, the Guaranty, and all notes, other guarantees, security agreements, subordination agreements, and other agreements, documents and instruments now or at any time hereafter executed and/or delivered by Borrower or any Obligor in connection with this Agreement or otherwise, as the same now exist or may hereafter be amended, modified, supplemented, extended, renewed, restated or replaced. "LOAN FEE" has the meaning given in Section 2.2.9 hereof. "MATERIAL ADVERSE CHANGE" means a material adverse change in any one or more of the following: (a) Borrower's, any subsidiary's, or any Guarantor's assets, operations, business, or financial condition, or business or financial or financial prospects; (b) Borrower's ability to pay and perform the Obligations when due; (c) any property in which Lender holds a Security Interest; (d) the perfection or priority of any such Security Interest; or (e) Lender's rights and remedies under any Loan Documents. "MAXIMUM ACCOUNT ADVANCE" means TWO MILLION and 00/100 Dollars ($2,000,0000.00). "MAXIMUM AMOUNT" means TWO MILLION and 00/100 Dollars ($2,000,000.00). "MAXIMUM INVENTORY ADVANCE" means the lesser of SIX HUNDRED THOUSAND and 00/100 Dollars ($600,000.00) or FIFTY PERCENT (50%) of the A R Borrowing Base. "MINIMUM MONTHLY INTEREST PAYMENT" has the meaning given in Section 2.2.3 hereof. "NET FACE AMOUNT" means, with respect to an Account, the gross face amount of such Account less all trade discounts or other deductions to which the Account Debtor is entitled. "OBLIGATIONS" means (a) the due and punctual payment of all amounts due or to become due under this Agreement; (b) the performance of all obligations of Borrower under the Loan Documents; and (c) all present and future obligations owing by Borrower to Lender whether or not for the payment of money, whether or not evidenced by any note or other instrument, whether direct or indirect, absolute or contingent, due or to become due, joint or several, primary or secondary, liquidated or unliquidated, secured or unsecured, original or renewed or extended, whether arising before, during or after the commencement of any bankruptcy case in which Borrower is a debtor, (each, a "Insolvency Proceeding"), including but not limited to Lender Expenses and any obligations arising pursuant to letters of credit or acceptance transactions or any other financial accommodations; and all principal, interest, fees, charges, Lender Expenses, attorneys' fees and accountants' fees chargeable to Borrower or incurred by Lender in connection with the Loan Documents. Except to the extent otherwise provided, this Agreement does not secure any obligation described above which is secured by a consensual lien on real property. "OBLIGOR" means Borrower and all Guarantors. "OLD LENDER" means THE CIT GROUP/BUSINESS CREDIT, INC. "OVERADVANCE" means the amount by which the Obligations exceed the Allowable Amount. "PAYMENT INTANGIBLES" means a General Intangible under which the Account Debtor's principal obligation is a monetary obligation. "PERMITTED INDEBTEDNESS" means Indebtedness evidenced by this Agreement or the Loan Documents and the Indebtedness set forth in the latest financial statements of Borrower submitted to Lender on or prior to the Closing Date or secured by Permitted Liens or refinancings, renewals, or extensions of the foregoing, provided (a) the terms and conditions of such refinancings, renewals, or extensions do not materially impair the prospects of repayment of the Obligations by Borrower; (b) the net cash proceeds of such refinancings, renewals, or extensions do not result in an increase in the aggregate principal amount of the Indebtedness so refinanced, renewed, or extended; (c) such refinancings, renewals, or extensions do not result in a shortening of the average weighted maturity of the Indebtedness so refinanced, renewed, or extended; and (d) that to the extent that the Indebtedness that is refinanced was subordinated in right of payment to the Obligations, then the subordination terms and conditions of the refinancing of the Indebtedness must be at least as favorable to Lender as those applicable to the refinanced Indebtedness; Page 6 of 32 "PERMITTED LIENS" means all of the following: (a) liens and security interests held by Lender or agreed to by Lender in the Term Loan Documents; (b) liens for unpaid taxes of Borrower that are not yet due and payable; (c) liens and security interests granted against Equipment disclosed in writing by Borrower to Lender and consented to by Lender in writing; (d) purchase money security interests and liens of lessors under capital leases to the extent that the acquisition or lease of the underlying asset was permitted under this Agreement, and so long as the security interest or lien only secures the purchase price of the asset; (e) easements, rights of way, reservations, covenants, conditions, restrictions, zoning variances, and other similar encumbrances that do not materially interfere with the use or value of the property subject thereto; and (f) obligations and duties as lessee under any lease existing on the date of this Agreement. "PERSON" means and includes natural persons, corporations, limited partnerships, general partnerships, joint ventures, limited liability companies, limited liability partnerships, trusts, land trusts, business trusts, or other organizations, irrespective of whether they are legal entities, and governments and agencies and political subdivisions thereof. "POST OFFICE BOX" has the meaning given in Section 3.7.2 hereof. "PREMISES" means the locations of Borrower consisting of its Chief Executive Office and any and all Warehouses. "PREPAYMENT" has the meaning given in Section 6.3 hereof. "PREPAYMENT FEE" means the fee described in Section 6.3 hereof. "PRIME ACCOUNTS" means those Accounts of Borrower that meet all of the following criteria: (a) are acceptable to Lender; (b) are creditworthy; (c) have been validly assigned as Collateral to Lender, giving Lender a first priority security interest therein and in all proceeds thereof; (d) as of the date of determining whether an Account is "prime" or not, no invoice is more than sixty (60) days past due or remains uncollected more than ninety (90) days from the date of such invoice; (e) strictly comply with all Borrower's warranties and representations to Lender; (f) have been created by absolute sales of Borrower's merchandise or services; (g) are genuine, bona fide and collectible; (h) Borrower will have good, unencumbered and absolute title to Collateral free of all third party claims; (i) are not subject to any dispute, right of offset, counterclaim, or right of cancellation or return; (j) all property giving rise to such Accounts will have been delivered from Borrower's Premises to, and unconditionally accepted by, each Account Debtor; (k) Borrower has performed all things required of Borrower by the terms of all agreements or purchase orders giving rise to such Accounts; (l) are due and unconditionally payable on terms of thirty (30) days or less, or on such other terms (as may be acceptable to Lender) which are expressly set forth on the face of all invoices, copies of which shall be delivered to Lender, and no account will then be past due; (m) are not Accounts with respect to which goods are placed on consignment, guaranteed sale, or other terms by which the payment by the Account Debtor may be conditional; (n) are not Accounts with respect to which the Account Debtor is an officer, employee, partner, joint venturer or agent of Borrower; CAlsa (rev. 02.14.2005) Page 8 of 32 Initial Here .. Page 7 of 32 (o) are not Accounts with respect to which the Account Debtor is a resident of a country other than the United States of America; (p) are not Accounts with respect to which the Account Debtor is the United States of America or any department, agency or instrumentality of the United States of America; (q) are not Accounts with respect to which the Account Debtor is any state of the United States of America or any city, county, town, municipality or division thereof; (r) are not Accounts with respect to which the Account Debtor disputes liability or makes any claim, or have any defense, crossclaim, counterclaim or offset; (s) are not Accounts with respect to which any Insolvency Proceeding is filed by or against the Account Debtor, or if an Account Debtor becomes insolvent, fails or goes out of business; (t) are not Accounts with respect to which Borrower is or may become liable to the Account Debtor for goods sold or services rendered by the Account Debtor to Borrower; (u) are not Accounts which in the aggregate from one Account Debtor constitutes twentyfive percent (25%) of total Accounts, but the portion not in excess of such percentage may be deemed Prime Accounts; and (v) are not Accounts from any one Account Debtor of which twenty-five percent (25%) is ninety (90) days old or older. "PRIME RATE" means the variable rate of interest announced as the "prime" rate in the Western Edition of the Wall Street Journal which is in effect from time to time; provided that the Prime Rate shall at all times be deemed to be not less than five and seventy five hundredths percent (5.75%) per annum (the "Deemed Prime Rate"). "RCRA" has the meaning given in the definition of Environmental Laws. "REAL PROPERTY COLLATERAL" means that or those certain item(s) of real property pledged by Borrower and/or Guarantor respectively, pursuant to this Agreement and the Loan Documents. "RENEWAL TERM" shall have the meaning given in Section 6.1. "REPORT OF ASSIGNMENT" means the form with which invoices are transmitted to Lender. "SOFTWARE" has the meaning given in the Code, which defines Software as a computer program and any supporting information provided in connection with a transaction relating to the program. "SOLVENT" means that a Person is able to pay its debts and other liabilities, contingent obligations and other commitments as they mature in the normal course of business, and such Person does not intend to, and does not believe that it will, incur debts beyond such Person's ability to pay as such debts mature. In computing the amount of contingent liabilities at any time, it is intended that such liabilities will be computed at the amount that, in light of all the facts and circumstances existing at such time, represents the amount that reasonably can be expected to become an actual or matured liability. "SUPPORTING OBLIGATIONS" has the meaning given in the Code, as such definition may be amended from time to time, which defines a Supporting Obligation as a letter-of-credit right or secondary obligation that supports the payment or performance of an Account, Chattel Paper, a Document, a General Intangible, an Instrument, or a Financial Asset, including without limitation, Investment Property. "TERM LOAN" means the loan extended by Lender to Borrower pursuant to the Term Loan Documents described in Section 24.15 hereof, if applicable. "TERM LOAN DOCUMENTS" means those documents described in Section 24.15 hereof, if any, and all amendments and renewals thereof. "TERMINATION NOTICE" has the meaning given in Section 6.1 hereof. "TRADE FIXTURES" means equipment and furnishings which are used in Borrower's business or operations which become affixed to the Premises or other location, but which can be removed without causing undue damage to such Premises, or to such other location. "UCC" has the meaning given in the definition of Code. "VOIDABLE TRANSFER" has the meaning given in Section 24.11 hereof. "WAREHOUSE" means that or those warehouse(s) located at - ----------N/A----------. 1.2. Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with GAAP. When used herein, the term "financial statements" shall include the notes and Page 8 of 32 schedules thereto. Whenever the term "Borrower" is used in respect of a financial covenant or a related definition, it shall be understood to mean Borrower on a consolidated basis unless the context clearly requires otherwise. 1.3. Code. All other terms contained in this Agreement, which are not specifically defined herein, shall have the meanings provided in the Code to the extent the same are used herein. 1.4. Construction. Unless the context of this Agreement clearly requires otherwise, references to the plural include the singular, references to the singular include the plural, the term "including" is not limiting, and the term "or" has, except where otherwise indicated, the inclusive meaning represented by the phrase "and/or." The words "hereof," "herein," "hereby," "hereunder," and similar terms in this Agreement refer to this Agreement as a whole and not to any particular provision of this Agreement. Any section, subsection, clause, schedule, and exhibit references are to this Agreement unless otherwise specified. Any reference in this Agreement or in the Loan Documents to this Agreement or any of the Loan Documents shall include all alterations, amendments, changes, extensions, modifications, renewals, replacements, substitutions, and supplements, thereto and thereof, as applicable. 1.5. Authenticated Documents Any reference herein to a "writing", a "written document", or an executed document shall also mean an "Authenticated" writing or document or "Authentication" unless Lender shall otherwise require an original writing. 1.6. Schedules and Exhibits. All of the schedules and exhibits attached to this Agreement shall be deemed incorporated herein by reference as though set forth in full herein. 2. Loan and Terms of Payment. 2.1. Revolving Advances Against Accounts and Inventory. 2.1.1. Advances Not to Exceed Borrowing Base. Subject to the terms and conditions of this Agreement, from the Closing Date until termination of this Agreement, Lender shall, from time to time, at the request of Borrower, make advances (the "Advances") to Borrower so long as, before and after such Advance, the Obligations do not exceed the Allowable Amount. Amounts borrowed pursuant to this Section may be repaid and, subject to the terms and conditions of this Agreement, reborrowed at any time during the term of this Agreement. 2.1.2. Reduction of Advance Rates. Lender may, in its discretion, from time to time, upon not less than five (5) days' prior notice to Borrower, reduce the Borrowing Base to the extent that Lender determines in good faith that: (a) the Dilution Rate with respect to the Accounts for any period (based on the ratio of (1) the aggregate amount of reductions in Accounts other than as a result of payments in cash to (2)) the aggregate amount of total sales) has increased in any material respect or may be reasonably anticipated to increase in any material respect above historical levels; (b) the general creditworthiness of Account Debtors has declined; (c) the number of days of the turnover of the Inventory for any period has changed in any material respect; (d) the liquidation value of the Eligible Inventory, or any category thereof, has decreased; or (e) the nature and quality of the Inventory has deteriorated. In determining whether to reduce the Borrowing Base, Lender may consider events, conditions, contingencies, or risks that are also considered in determining Prime Accounts or Eligible Inventory 2.1.3. Authorization for Advances. Subject to the terms and conditions of this Agreement, Lender is authorized to make Advances (a) upon telephonic, facsimile or other instructions received from anyone purporting to be an Authorized Officer of Borrower; or (b) at the sole discretion of Lender, and notwithstanding any other provision in this Agreement, if necessary to meet any Obligations, including but not limited to any interest not paid when due. Notwithstanding anything to the contrary contained herein, Lender shall not be obligated to make an Advance if, before or as a result thereof, the Obligations shall exceed the Allowable Amount. 2.1.4. Establish Deposit Account; Provide Control Agreement. Borrower agrees to establish and maintain a single designated Deposit Account for the purpose of receiving the proceeds of the Advances requested by Borrower and made by Lender hereunder. Unless otherwise agreed by Lender and Borrower, any Advance requested by Borrower and made by Lender hereunder shall be made to such designated Deposit Account. Borrower agrees to provide Lender with a control agreement in form and substance acceptable to Lender, signed by the bank or financial institution at which the Deposit Account is located. If Borrower's bank or financial institution refuses to or does not cooperate in executing such control agreement, Borrower shall move its account to a financial institution willing to execute a control agreement. 2.2. Interest: Rates, Payments, Fees, and Calculations. 2.2.1. Interest Rates. (a) On Advances Against Accounts. All Advances against Accounts hereunder shall bear interest, on the Average Daily Balance, at a PER ANNUM rate of THREE AND SEVENTY FIVE HUNDREDTHS PERCENT 3.75% in excess of (1) the Prime Rate; or (2) the Deemed Prime Rate, whichever is higher. (b) On Advances Against Inventory. All Advances against Inventory hereunder shall bear interest, on the Average Daily Balance, at a PER ANNUM rate of THREE AND SEVENTY FIVE HUNDREDTHS PERCENT 3.75% in excess of (1) the Prime Rate; or (2) the Deemed Prime Rate, whichever is higher. 2.2.2. Cumulative Minimum Annual Interest Payment. Interest payable under this Agreement, on a cumulative annual basis, shall not be less than ----------N/A---------- AND 00/100 DOLLARS ($---------- N/A----------) (the "Cumulative Minimum Annual Interest Payment"). Page 9 of 32 2.2.3. Minimum Monthly Interest Payment. Interest together with the Administrative Fee payable under this Agreement on a monthly basis, shall not be less than FIVE THOUSAND NINE HUNDRED FIFTY EIGHT AND 35/100 DOLLARS ($5,958.35) (the "Minimum Monthly Interest Payment"). 2.2.4. Default Rate. All Obligations shall bear interest, from and after the occurrence and during the continuance of an Event of Default, at a rate equal to an additional THREE PERCENT (3.00%) PER ANNUM in excess of the applicable interest rate as set forth in Section 2.2.1 (the "Default Rate"). Lender's failure to assess interest at the Default Rate as provided hereunder shall not be deemed a waiver by Lender to charge such Default Rate. Lender reserves the right, and Borrower hereby acknowledges that Lender may, recalculate interest at the Default Rate. 2.2.5. Interest Payments. Subject to Section 2.2.4, interest on the Obligations shall be payable monthly, in arrears, shall be computed at the applicable interest rate as set forth in Section 2.2.1, and shall be due on the last day of each month following the accrual thereof. INTEREST SHALL BE PAYABLE COMMENCING ON JUNE 1, 2005. Any interest not paid when due shall be compounded by becoming a part of the Obligations, and such interest shall thereafter accrue interest at the rate then applicable hereunder. 2.2.6. Calculation of Interest. All interest charged hereunder shall be computed on the basis of a three hundred sixty (360) day year for the actual number of days elapsed. Notwithstanding anything to the contrary contained herein, any interest rate calculated hereunder shall be rounded up to the closest one-quarter of one percent (1/4 of 1%), with no adjustments made for rate changes of less than one-quarter of one percent (1/4 of 1%). Lender shall, for the purpose of the computation of interest due hereunder, add the Clearance Days to any payments by check, which is acknowledged by the parties to constitute an integral aspect of the pricing of Lender's facility to Borrower, and shall apply irrespective of the characterization of whether receipts are owned by Borrower or Lender. Should any check not be honored when presented for payment, then Borrower shall be deemed not to have made such payment, and interest shall be recalculated accordingly. 2.2.7. Computation upon Change in Prime Rate. In the event the Prime Rate changes, the applicable interest rate hereunder automatically and immediately shall be increased or decreased by an amount equal to such change in the Prime Rate. 2.2.8. Principal Payments. Commencing on - ----------N/A---------- and continuing on the first (1st) day of every month through ----------N/A----------, Borrower shall make equal monthly principal payments in the sum of ----------N/A---------- DOLLARS ($----------N/A----------). 2.2.9. Loan Fee. At the time of funding hereof, annually (every twelve (12) months) thereafter, and while any Obligations remain outstanding to Lender, Borrower agrees to pay Lender a loan fee equal to ONE PERCENT (1.00%) of the Maximum Amount (the "Loan Fee"). 2.2.10. Administrative Fee. While any Obligations remain outstanding to Lender, on or before the first (1st) day of each month, Borrower agrees to pay Lender an administrative fee equal to FOUR TENTHS OF ONE PERCENT (0.40%) PER MONTH of the Average Daily Balance during the preceding month (the "Administrative Fee"). 2.2.11. Deposits and Fees for Lender Expenses. Borrower shall pay to Lender the Lender Expenses incurred by Lender in connection with the negotiation and preparation of this Agreement and the Loan Documents, including but not limited to Lender. (a) Lender has received or will receive a deposit in the amount of THREE THOUSAND AND 00/100 DOLLARS ($3,000.00) (the "Good Faith Deposit") to be applied against such Lender Expenses consisting of hard costs. Any unpaid portion of the Good Faith Deposit shall be due and payable at the funding hereof. In the event that such Lender Expenses are less than the Good Faith Deposit, any such excess amount will be applied to the Loan Fee and then to Administrative Fee, or if the Loan Fee and Administrative Fee have been paid in full, such excess amount shall be refunded to Borrower. (b) Lender has received or will receive a documentation fee/legal deposit in the amount of THREE THOUSAND and 00/100 Dollars ($3,000.00) to be applied against Lender Expenses consisting of document preparation and legal fees and costs, (the "Documentation Fee/Legal Deposit"). Any unpaid portion of the Documentation Fee/Legal Deposit shall be due and payable at the funding hereof. 2.2.12. Semi-Annual Audit Fees. Borrower shall pay to Lender on demand SEMIANNUAL AUDIT FEES OF SEVEN HUNDRED FIFTY AND 00/100 DOLLARS ($750.00) each, plus actual out of pocket costs related to each audit. 3. Payment of Advances. 3.1. Delivery to Lender. Borrower shall remit to Lender all payments received by Borrower on Accounts pledged to Lender. Borrower shall pay, on demand, (a) the Net Face Amount of all Delinquent Accounts; or (b) the Net Face Amount of Accounts more than sixty (60) days past due. Borrower shall pay the entire unpaid balance of the Obligations immediately upon: (a) the occurrence of an Event of Default; or (b) in the case of termination, as set forth in Section 6.1, whether by notice, lapse of time or otherwise, whichever occurs first. Page 10 of 32 3.2. Application of Payments. Payments received shall be applied first against fees and Lender Expenses, if any, then against interest and then against principal. To the extent Borrower uses Advances under this Agreement to purchase any Collateral, Borrower's repayment of the Advances shall apply on a "first-infirst- out" basis so that the portion of the Advances used to purchase a particular item of Collateral shall be paid in the chronological order in which Borrower purchased the Collateral. 3.3. Clearance Days. Payments made by check shall be deemed to be made THREE (-3-) BUSINESS DAYS after receipt by Lender of such check to allow for, and subject to clearance of such check (the "Clearance Days"). 3.4. Overadvances. In the event of an Overadvance, as applicable, such event shall not limit, waive or otherwise affect any rights of Lender in that circumstance or on any future occasions and Borrower shall, upon demand by Lender, which may be made at any time or from time to time, immediately repay to Lender the entire amount of the Overadvance. 3.5. Payment of Obligations. Notwithstanding anything to the contrary contained in this Agreement, no payment received by Lender shall constitute payment thereof unless and until final payment thereof has been received. 3.6. Statements of Obligations. Lender shall render statements to Borrower of the Obligations, including principal, interest, fees, and an itemization of all charges and expenses constituting Lender Expenses owing, and such statements shall be conclusively presumed to be correct and accurate and constitute an account stated between Borrower and Lender unless, within thirty (30) days after receipt thereof by Borrower, Borrower shall have delivered to Lender by registered or certified mail at its address specified herein, written objection thereto describing the error or errors contained in any such statements. 3.7. Notification of Accounts. Lender and Borrower have agreed to the terms set forth below with respect to notification of Accounts. 3.7.1. Right of Lender to Notify Accounts. Lender may, at any time, irrespective of whether an Event of Default has occurred, without notice to or the assent of Borrower: (a) notify any Account Debtor that the underlying Account has been assigned to Lender by Borrower and that payment thereof is to be made to the order of and directly and solely to Lender; and (b) send, or cause to be sent by its designee, written or telephonic requests (which may identify the sender by a pseudonym) for verification of any Account directly to the appropriate Account Debtor or any bailee with respect thereto. At Lender's request, all invoices and statements sent to any Account Debtor or any bailee shall state that the relevant Account has been assigned to Lender and that any payments in respect thereof are payable directly and solely to Lender. 3.7.2. Collateral Account. Borrower shall direct, at Borrower's expense and in the manner requested by Lender from time to time, that remittances and all other collections and proceeds of Accounts and other Collateral be (a) deposited into a lock box account (the "Collateral Account") maintained in Lender's name as set forth in EXHIBIT A; or (b) sent to Lender or a post office box (the "Post Office Box") designated by or in the name of Lender, or in the name of Borrower, but as to which access is limited solely to Lender also as set forth in EXHIBIT A. In connection with the Collateral Account, Borrower shall execute such lockbox agreement as Lender shall require. Borrower shall maintain with Lender, and Borrower hereby grants to Lender a security interest in, the Deposit Account representing the Collateral Account, over which Borrower shall have no control and into which the proceeds of all Collateral shall be deposited immediately upon their receipt. 3.7.3. Collateral Control Account. Lender may, on occasion, agree to permit Borrower to maintain a Deposit Account in addition to the Collateral Account (the "Collateral Control Account"), provided (a) Lender has received a control agreement in form and substance acceptable to Lender, which is fully executed by the financial institution where such account is located; and (b) such account is a blocked account to which only Lender may have access. A description of said Collateral Control Account is set forth in EXHIBIT A hereto. 3.7.4. Procedure Regarding Mail Delivered to the Post Office Box. All mail delivered to the Post Office Box shall be opened by Lender, checks contained therein shall be endorsed by Lender, and all such items shall be deposited by Lender into the Collateral Account. 3.7.5. Wire Transfers. Borrower shall direct all Account Debtors on Accounts who make payments by electronic transfer of funds to wire such funds directly to the Collateral Account. 3.7.6. Monies Held in Trust. Borrower shall hold in trust for Lender all amounts Borrower may receive in payment of or relating to any Accounts despite directions to make payment to the Post Office Box or the Collateral Account, and immediately deliver such payments to Lender in their original form as received, with proper endorsements. Borrower and all of its Affiliates, subsidiaries, shareholders, directors, employees or agents shall, acting as trustee for Lender, receive, as the property of Lender, any monies, checks, notes, drafts, or any other payment relating to and/or proceeds of Accounts or other Collateral which come into their possession or under their control and immediately upon receipt thereof, shall deposit or cause the same to be deposited in the Collateral Account, or remit the same or cause the same to be remitted, in kind, to Lender. In no event shall the same be commingled with Borrower's own funds. Borrower shall continue to remit such payments to Lender until such time as Borrower's Obligations have been paid in full. 3.7.7. Authorization. Notwithstanding any other provision of this Agreement, Borrower irrevocably authorizes Lender to transfer into the Collateral Account any funds in payment of or relating Page 11 of 32 to the Accounts that have been deposited into other deposit accounts with Lender or that Lender has otherwise received. 3.7.8. Lender's Right to Items in Collateral Account. Lender shall have all right, title and interest in all of the items contained from time to time in the Collateral Account and their proceeds. 3.7.9. Lender Has Sole Control Over Account. Neither Borrower, nor any Person or entity claiming through Borrower shall have any right in or control over the use of, or any right to withdraw any amount from the Collateral Account which shall be under Lender's sole control. Unless the instruments so deposited in the Collateral Account are dishonored, or unless Lender shall in Lender's discretion have remitted the amount thereof to Borrower, Lender shall credit the amount thereof against Borrower's Obligations to Lender. 3.7.10. Lender Authorization. (a) Borrower hereby irrevocably authorizes Lender and any designee of Lender, at Borrower's sole expense, to exercise at any time in Lender's or such designee's discretion all or any of the following powers as attorney in fact of Borrower until all of the Obligations have been paid in full: (1) receive, take, endorse, assign, deliver, accept and deposit, in the name of Lender or Borrower, any and all cash, checks, commercial paper, drafts, remittances and other instruments and documents relating to the Collateral or the proceeds thereof (whether checks or other forms of payment are (i) in the name of Borrower; (ii) any other name under which it now does business or does business in the future;(iii) or names of its products now or in the future, and Borrower additionally agrees not to make any protest of any kind against Lender for negotiating such checks or other items described herein); (2) take or bring, in the name of Lender or Borrower, all steps, actions, suits or proceedings deemed by Lender necessary or desirable to effect collection of or other realization upon the Accounts and other Collateral; (3) after an Event of Default, extend the time of payment of, compromise or settle for cash, credit, return of merchandise, and upon any terms or conditions, any and all Accounts or other Collateral which includes a monetary obligation and discharge or release any Account Debtor or other obligor (including filing of any public record releasing any lien granted to Borrower by such Account Debtor), without affecting any of the Obligations; (4) execute in the name of Borrower and file against Borrower in favor of Lender financing statements or amendments with respect to the Collateral; (5) pay any sums necessary to discharge any lien or encumbrance which is senior to Lender's security interest in the Collateral, which sums shall be included as Obligations hereunder; (6) at any time, irrespective of whether an Event of Default has occurred, without notice to or the assent of Borrower, notify any Account Debtor obligated with respect to any Account, that the underlying Account has been assigned to Lender by Borrower and that payment thereof is to be made to the order of and directly and solely to Lender; (7) after an Event of Default, change the address for delivery of mail to Borrower and to receive and open mail addressed to Borrower; (8) send requests for verification of Accounts; (9) to make, settle, and adjust all claims under Borrower's policies of insurance and make all determinations and decisions with respect to such policies of insurance; (10) to settle and adjust disputes and claims respecting the Accounts directly with Account Debtors, for amounts and upon terms which Lender determines to be reasonable; (11) Lender may cause to be executed and delivered any documents and releases which Lender determines to be necessary; and (12) qualify Borrower to do business in any state. (b) Borrower authorizes Lender to accept, indorse and deposit on behalf of Borrower any checks tendered by an Account Debtor "in full payment" of its obligation to Borrower. Borrower shall not assert against Lender any claim arising therefrom, irrespective of whether such action by Lender affects an accord and satisfaction of Borrower's claims, under ss.3-311 of the Code, or otherwise. (c) BORROWER HEREBY RELEASES AND EXCULPATES LENDER, LENDER'S OFFICERS, EMPLOYEES, AGENTS, DESIGNEES, ATTORNEYS, AND ACCOUNTANTS FROM ANY AND ALL LIABILITY ARISING FROM ANY ACTS UNDER THIS AGREEMENT OR RELATED TO THIS AGREEMENT IN ANY MANNER OR IN FURTHERANCE THEREOF, WHETHER OF OMISSION OR COMMISSION, AND WHETHER BASED UPON ANY ERROR OF JUDGMENT OR MISTAKE OF LAW OR FACT AND WHETHER BASED UPON ANY LEGAL THEORY, INCLUDING WITHOUT LIMITATION, BREACH OF CONTRACT, TORT CLAIMS, BREACH OF DUTY CLAIMS AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS, EXCEPT FOR LIABILITY DIRECTLY CAUSED BY LENDER'S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT. IN NO EVENT SHALL LENDER HAVE ANY LIABILITY TO BORROWER FOR LOST PROFITS OR OTHER SPECIAL OR CONSEQUENTIAL DAMAGES. 4. Audits. Lender shall have the right to conduct audits of Borrower's Accounts, Inventory, and Borrower's Books on a semi-annual basis during the term of this Agreement. The cost of each audit shall be paid by Borrower, which cost per audit shall not exceed the sum set forth in Section 2.2.12. Borrower shall pay such cost within five (5) Business Days of receipt of invoice and if such cost is not paid by such date, Lender may charge such cost against the Obligations at such time or if not charged at such time, upon termination. In addition, upon the occurrence of an Event of Default, Lender may conduct such additional audits as it deems appropriate, also at Borrower's cost, but not subject to any limitation contained in Section 2.2.12. 4.1. Delivery of Collateral. At such times as Lender may request and in the manner specified by Lender, Borrower shall deliver to Lender or Lender's representative original invoices, agreements, proof of rendition of services and delivery of goods and other documents evidencing or relating to the transactions which gave rise to any of the Collateral, together with customer statements, schedules describing the proceeds or statements of account and confirmatory assignments to Lender of the proceeds in form and substance satisfactory to Lender and duly executed by Borrower. Without limiting the provisions of any other section of this Agreement, Borrower will promptly notify Lender, in writing, of Borrower's granting of credits, discounts, allowances, deductions, return authorizations or the like with respect to any proceeds. In no event shall any such schedule or confirmatory assignment (or the absence thereof or omission of any proceeds therefrom) limit or in any way be construed as a waiver, limitation, or modification of the liens or rights of Lender or the warranties, representations, Page 12 of 32 and covenants of Borrower under this Agreement. In addition, in the event that any Collateral, including proceeds, is evidenced by or consists of Chattel Paper, Documents, Instruments, or Financial Assets, including without limitation, Investment Property, Borrower shall, immediately upon written request therefor from Lender, endorse and assign such Chattel Paper, Documents, Instruments, or Financial Assets, including without limitation, Investment Property over to Lender and deliver actual physical possession of such Chattel Paper, Documents, Instruments, or Financial Assets, including without limitation, Investment Property to Lender with, if applicable, stock powers in blank executed by Borrower. 5. Conditions Precedent to Advances. 5.1. Conditions Precedent to Initial Advance. The obligation of Lender to make the initial Advance is subject to the fulfillment, to the satisfaction of Lender and its counsel, of each of the conditions set forth below on or before the Closing Date. 5.1.1. Lien in First Position. Lender shall be satisfied that its lien against the Collateral is a first priority perfected security interest. 5.1.2. UCC Search. Lender shall have received searches with results reflecting the filing of its financing statements and fixture filings. 5.1.3. Documents Contemplated Herein. Lender shall have received all of the Loan Documents, duly executed, and each such document shall be in full force and effect. 5.1.4. Authorization. Lender shall have received such certificate of authorization, corporate resolution, unanimous written consent, or other writing as Lender deems appropriate under the circumstances, duly executed by the secretary, general partner, managing member, or other appropriate representative of Borrower, authorizing the execution and delivery of this Agreement and the other Loan Documents to which Borrower is a party and authorizing one or more specific officers, general partners, managing members, or other persons to execute and deliver same to Lender. 5.1.5. Bylaws, etc. Lender shall have received copies of Borrower's By-laws and Articles, Certificate of Incorporation, Articles of Organization, Partnership Agreement, Trust Agreement, or Operating Agreement all duly certified as appropriate, as amended, modified, or supplemented to the Closing Date. 5.1.6. Certificate From State of California (for Mendocino);and New York and Delaware (for Releta). Lender shall have received a certificate of status, corporate or otherwise, with respect to Borrower dated as of a date acceptable to Lender, by the Secretary of State of California for Mendocino; and New York and Delaware for Releta , which certificate shall indicate that Borrower is in good standing in such state. 5.1.7. Certificates From States Other Than California (for Mendocino); and New York and Delaware (for Releta). Lender shall have received certificates of status, corporate or otherwise, with respect to Borrower dated as of a date acceptable to Lender, issued by the Secretary of State of the states in which its failure to be duly qualified or licensed would have a Material Adverse Change in the financial condition or properties and assets of Borrower, and shall indicate that Borrower is in good standing. 5.1.8. Insurance Policies and Endorsements. Lender shall have received the certified copies of the policies of insurance, together with the endorsements thereto, as further described in Section 9 hereof, as are required hereby, the form and substance of which shall be satisfactory to Lender and its counsel. 5.1.9. Certificates of Title. Lender shall have received duly executed certificates of title with respect to that portion of the Collateral that is subject to certificates of title, if any. 5.1.10. Evidence of Payment of Taxes. Lender shall have received satisfactory evidence that all returns required to be filed by Borrower have been timely filed and all taxes upon Borrower or its properties, assets, income and franchises (including real property taxes and payroll taxes) have been paid prior to delinquency, except such taxes that are the subject of a Permitted Protest. 5.1.11. Subordination Agreements. Lender shall have received subordination agreements in form satisfactory to Lender from all parties that Lender shall require. 5.1.12. Guaranty. Lender shall have received the duly executed Guaranty from Guarantor, and Guarantor shall have executed the Acknowledgment and Agreement by Guarantor set forth at the end of this Agreement. 5.1.13. Payment of All Fees and Lender Expenses. All fees and Lender Expenses required to be paid in connection with this Agreement shall have been paid. 5.1.14. Deed of Trust From Guarantor. Lender shall have received the Deed of Trust for the Real Property Collateral commonly known as - ----------N/A----------, which secures the obligations of Guarantor under the Guaranty and which shall be in ----------N/A---------- (----------N/A----------) PRIORITY against such Real Property Collateral. 5.1.15. Bailment Agreements; Waiver and Consents by Real Property Owner(s). Borrower shall execute and deliver, or cause to be executed and delivered to Lender such agreements, documents, and instruments in form and substance acceptable to Lender, as Lender may deem reasonably necessary or desirable Page 13 of 32 to protect its interests in the Collateral at the Premises, including without limitation, UCC-1 Financing Statements and Waivers and Consents by Real Property Owner(s) and/or Bailment and Security Agreements. The Inventory and Equipment shall not, at any time now or hereafter, be stored with a bailee, warehouseman, or similar party without Lender's prior written consent. Additionally, Borrower shall not open any new locations unless Borrower (a) gives Lender thirty (30) days' prior written notice of the intended opening of any such new location; and (b) executes and delivers, or causes to be executed and delivered, to Lender such agreements, documents, and instruments in form and substance acceptable to Lender, as Lender may deem reasonably necessary or desirable to protect its interests in the Collateral at such location, including without limitation, UCC-1 Financing Statements and Waiver and Consent by Real Property Owner(s) and/or Bailment and Security Agreements. 5.1.16. Pre-Funding Audit. Lender shall have performed a pre-funding audit of Borrower's Accounts and Inventory, with results satisfactory to Lender. 5.1.17. Key Person Life Insurance. Lender shall have received an assignment of Borrower's interest in the key person insurance on the life of ----------N/A---------- in the amount of ----------N/A----- ----- AND 00/100 DOLLARS ($----------N/A----------). 5.1.18. Assignment of Insurance Claims. Lender shall have received an assignment of Borrower's claim against its insurance company in the sum of approximately ----------N/A---------- AND 00/100 DOLLARS ($----------N/A----------). 5.1.19. Payment to Old Lender; Termination of Old Lender's Security Interest. Old Lender shall have been paid in full and Old Lender's security interest in any assets of Borrower and all Collateral shall have been terminated. 5.1.20. Control Agreements. Borrower shall execute, or cause to be executed, and Lender shall have received such control agreements, in form and substance satisfactory to Lender and its counsel, regarding Deposit Accounts, Investment Property, or such other Collateral as Lender may require. 5.1.21. Other Documents and Legal Matters. All other documents in connection with the transactions contemplated by this Agreement shall have been delivered or executed or recorded and shall be in form and substance satisfactory to Lender and its counsel, including without limitation a Report of Assignment of Invoices and all procedure requirements, whether pursuant to a procedure manual or otherwise, shall have been met. 5.2. Conditions Precedent to All Advances. The items set forth below shall be conditions precedent to all Advances hereunder and under the Loan Documents. 5.2.1. Representations and Warranties. The representations and warranties contained in this Agreement and the other Loan Documents shall be true and correct in all respects on and as of the date of such Advance, as though made on and as of such date (except to the extent that such representations and warranties relate solely to an earlier date). 5.2.2. No Event of Default. No Event of Default or event which with the giving of notice or passage of time would constitute an Event of Default shall have occurred and be continuing on the date of such Advance, nor shall either result from the making of the Advance. 5.2.3. No Injunction, etc. No injunction, writ, restraining order, or other order of any nature prohibiting, directly or indirectly, the making of such Advance shall have been issued and remain in force by any governmental authority against Borrower, Lender, or any Affiliate. 5.2.4. Procedural Requirements. Borrower shall have submitted a Report of Assignment and followed such other procedures as Lender may require pursuant to a procedure manual or otherwise. 6. Basic Term; Termination; Prepayment Fee. 6.1. Basic Term. This Agreement will be effective upon the Closing Date, will continue in full force and effect for TWELVE (12) MONTHS thereafter (the "Basic Term"), and shall be further automatically extended, for successive periods equal to the term of the Basic Term (each, a "Renewal Term"), unless Borrower shall have given the Lender written notice of its intention to terminate (a "Termination Notice") at least thirty (30) days prior to the anniversary of each Basic Term anniversary, whereupon this Agreement shall terminate as of the date fixed in the Termination Notice. Notwithstanding any contrary provisions herein, Lender reserves the right to terminate this Agreement at its sole discretion upon giving thirty (30) days' prior written notice to Borrower pursuant to provisions of Section 15 hereof. 6.2. Termination; Payments Due upon Termination. Upon termination of this Agreement whether pursuant to Section 6 or due to the occurrence of an Event of Default pursuant to Section 11, Borrower shall pay the Obligations to Lender. 6.3. Prepayment Fee. The Obligations may be prepaid by Borrower at any time and to the extent such Prepayment occurs, Borrower shall pay to Lender a sum equal to the amount of (a) the Cumulative Minimum Annual Interest Payment less interest paid during the Basic Term or Renewal Term; or (b) an amount equal to the Minimum Monthly Interest Payment times the number of months remaining in the Basic Term or Renewal Term, as applicable (the "Prepayment Fee"). In addition, Borrower shall also pay any prepayment penalties provided for in the Term Loan Documents or any other agreement with Lender. "Prepayment" includes Page 14 of 32 any payment or other reduction of the balance of the Obligations, regardless of whether susuch payment or other reduction (1) is voluntary or involuntary; (2) is occasioned by Lender's acceleration of the Obligations or demand hereunder; (3) is made by Borrower or other third party, including Guarantor; (4) results from Lender's receipt or collection of proceeds of its Collateral, including insurance proceeds and condemnation awards; (5) results from Lender's exercise of its right of setoff; and/or (6) is made during an Insolvency Proceeding, or is made pursuant to any plan of reorganization or liquidation. 6.4. Other Obligations Upon Termination of this Agreement. Upon termination of this Agreement whether pursuant to Section 6 or due to the occurrence of an Event of Default pursuant to Section 11, the Obligations owed under the Term Loan Documents or any other Loan Documents shall be accelerated and shall be due, owing and payable at such time, including without limitation, all Lender Expenses. 6.5. Rights upon Termination. No termination of this Agreement shall relieve or discharge Borrower of Borrower's duties, Obligations, or covenants hereunder, including without limitation the obligation to continue to turn over sales information and invoices, and Lender's continuing security interests in the Collateral shall remain in effect until all Obligations have been fully and finally discharged and Lender's obligation to provide Advances hereunder is terminated. 7. Creation of Security Interest. 7.1. Grant of Security Interest. In order to secure the payment and performance in full of all of the Obligations, Borrower hereby grants to Lender a continuing security interest in the Collateral. 7.2. Express Authority of Lender to Execute UCC Financing Statement(s). Notwithstanding any provision hereof, Lender is hereby expressly authorized to execute and file on behalf of Borrower, UCC Financing Statement(s), including but not limited to corrections, amendments, and modifications thereof, including, without limitation, the use of an abbreviated description of Collateral such as "All Assets of the Borrower" on any and all of the foregoing. 7.3. Delivery of Additional Documentation Required. At any time upon the request of Lender, Borrower shall hereby authorize the preparation and filing by Lender and/or shall execute and deliver to Lender all financing statements, continuation financing statements, control agreements, fixture filings, security agreements, chattel mortgages, pledges, assignments, endorsements of certificates of title, applications for title, affidavits, reports, notices, schedules of Accounts, letters of authority, and all other documents that Lender may reasonably request, in form satisfactory to Lender, to perfect and continue the perfection of Lender's security interests in the Collateral, and in order to fully consummate all of the transactions contemplated hereby and under the Loan Documents. 8. Representations, Warranties, and Covenants. 8.1. Borrower's Representations, Warranties, and Covenants. So long as Borrower is indebted to Lender, Borrower warrants, represents, and agrees that the statements set forth herein are true and correct and shall remain so. 8.1.1. Borrower Sole Owner of Collateral; Personal Property; First Priority Security Interest. All Collateral is (a) solely owned by Borrower; (b) shall remain personal property at all times except to the extent granted in connection with the pledge of Real Property Collateral; and (c) all security interests against any Collateral given or caused to be given by Borrower to Lender are and will be first priority security interests thereon (except insofar as Borrower has notified Lender to the contrary in writing and Lender has consented to such prior security interest by a third party). 8.1.2. No Other Liens. Borrower has good and indefeasible title to the Collateral and the Collateral is free and clear of all liens, encumbrances, security interests, and adverse claims or restrictions on transfer or pledge except: (a) Permitted Liens; and (b) as disclosed in writing by Borrower to Lender; and further, (c) all such liens, encumbrances, security interests, and adverse claims that have either previously or concurrently herewith, been consented to in writing by Lender. 8.1.3. Condition of Collateral; No Transfer of Collateral. The Collateral is (a) kept in good condition and repair; (b) is not subject to waste; and (c) will not (except for sales of Inventory in the ordinary course of business) be sold, transferred, assigned or removed from the Premises without first obtaining Lender's prior written consent. 8.1.4. Facts, Figures and Representations True and Correct. All facts, figures, and representations given, or caused to be given, by Borrower to Lender in connection with the value of the Collateral or regarding each Advance or Account or pertaining to anything done under this Agreement shall be true and correct. 8.1.5. Books and Records. Borrower's Books and records fully and accurately reflect all of Borrower's assets and liabilities (absolute and contingent) and are kept in the ordinary course of business in accordance with GAAP. 8.1.6. Fair Market Value of Collateral. The fair market value of the Collateral is, and shall at all times be, not less than the value carried on Borrower's financial statements (less normal depreciation caused by ordinary wear and tear) and as represented to Lender. Page 15 of 32 8.1.7. Taxes. All taxes of any governmental or taxing authority due or payable by, or imposed or assessed against Borrower, have been paid and shall be paid in full before delinquency. 8.1.8. No Actions, Litigation, etc. Except as disclosed in writing by Borrower to Lender, (a) there are no actions or proceedings pending by or against Borrower or Guarantor before any court or administrative agency; and (b) Borrower does not have knowledge or belief of any pending, threatened, or imminent litigation, governmental investigations, or claims, complaints, actions, or prosecutions involving Borrower or any Guarantor of the Obligations, except for (1) ongoing collection matters in which Borrower is the plaintiff; and (2) matters arising after the date hereof that, if decided adversely to Borrower or Guarantor, would not (i)materially impair the prospect of repayment of the Obligations; or (ii) materially impair the value or priority of Lender's security interests in the Collateral. 8.1.9. Legal Power and Authority. Borrower has the legal power and authority to enter into this Agreement and the Loan Documents and to perform and discharge Borrower's Obligations hereunder and under the Loan Documents. The Persons signing this Agreement and the Loan Documents on behalf of Borrower are authorized to do so. 8.1.10. Payments on Accounts. Every payment falling due on Accounts assigned to Lender will be duly paid and received by Lender on or before the earlier of (a) ninety (90) days from the date of each invoice; or (b) sixty (60) days from the due date of each invoice. 8.1.11. Prime Accounts. All Accounts against which Borrower seeks Advances from Lender are now Prime Accounts and Borrower shall only seek Advances against Accounts if such Accounts are believed by Borrower to be Prime Accounts as defined above. 8.1.12. Eligible Inventory. All Inventory against which Borrower seeks Advances from Lender is and shall be Eligible Inventory as defined above. 8.1.13. Location of Inventory. Except as permitted herein, the Inventory is not and shall not be stored with a bailee, warehouseman, or similar party (without Lender's prior written consent) and is located and shall be located only at the Premises. 8.1.14. Inventory Records. Borrower now keeps, and hereafter at all times shall keep, correct and accurate records itemizing and describing the kind, type, quality, and quantity of the Inventory, and Borrower's cost therefor. 8.1.15. Location of Chief Executive Office; FEIN; Organizational Number. The Chief Executive Office of Borrower is located at the address indicated in the preamble to this Agreement. Borrower's Federal Employer Identification Number (the "FEIN") is 68-0318293 FOR MENDOCINO AND 68-0398450 FOR RELETA and the number assigned by California (for Mendocino) and Delaware (for Releta), the state of Borrower's organization, for Borrower's organizational identification number is CA C1876489 FOR MENDOCINO AND DE D2799258 FOR RELETA. 8.1.16. Due Organization and Qualification. Borrower is a duly formed, organized, and existing corporation, limited liability company, limited partnership, general partnership, or other legal entity in good standing, qualified, and licensed to do business in the state of its incorporation or formation and in any other state where the failure to be so licensed or qualified could reasonably be expected to have a Material Adverse Change to the business, operations, conditions (financial or otherwise), finances or prospects of Borrower, or on the value of the Collateral to Lender. 8.1.17. Due Authorization; No Conflict. The execution, delivery, and performance of the Loan Documents are within Borrower's powers, have been duly authorized, and are not in conflict with nor constitute a breach of any provision contained in Borrower's By-laws and Articles, Certificate of Incorporation, Articles of Organization, Partnership Agreement, Trust Agreement, or Operating Agreement, nor will they constitute an event of default under any material agreement to which Borrower is a party or by which its properties or assets may be bound. 8.1.18. Financial Statements Fairly Represent Borrower's Financial Condition; No Material Adverse Change in Financial Condition. All financial statements relating to Borrower or any Guarantor of the Obligations that have been delivered by Borrower to Lender have been prepared in accordance with GAAP and fairly present Borrower's (or such Guarantor's, as applicable) financial condition as of the date thereof and Borrower's results of operations for the period then ended. There has not been a Material Adverse Change in the financial condition of Borrower (or such Guarantor, as applicable) since the date of the latest financial statements submitted to Lender on or before the Closing Date. 8.1.19. Solvency. No transfer of property is being made by Borrower and no Obligation is being incurred by Borrower in connection with the transactions contemplated by this Agreement or the other Loan Documents with the intent to hinder, delay, or defraud either present or future creditors of Borrower. 8.1.20. Environmental Condition. Except as disclosed in writing by Borrower to Lender, none of Borrower's properties or assets has ever been used by Borrower or, to the best of Borrower's knowledge, by previous owners or operators in the disposal of, or to produce, store, handle, treat, release, or transport, any Hazardous Substances or Hazardous Wastes. None of the Premises of Borrower's properties or assets has ever been designated or identified in any manner pursuant to any Environmental Laws as a disposal site for Hazardous Substances or Hazardous Wastes, or a candidate for closure pursuant to any Environmental Laws. No Page 16 of 32 lien arising under any Environmental Laws has attached to any revenues or to any real or personal property owned or operated by Borrower. Borrower has not received a summons, citation, notice, or directive from the Environmental Protection Agency or any other federal or state governmental agency concerning any action or omission by Borrower resulting in the releasing or disposing of Hazardous Substances or Hazardous Wastes into the environment. Borrower is not using and neither Borrower nor to the best of Borrower's knowledge, any prior owner, occupant, or operator of the Premises has used Hazardous Substances or Hazardous Wastes at or upon, or in any way affecting, the Premises in any manner which violates or violated any Environmental Laws if such violation could, individually or in the aggregate, reasonably be expected to have a Material Adverse Change with respect to any of the Premises or property of Borrower or to result in a Material Adverse Change. 8.2. Reliance by Lender; Cumulative Representations and Warranties. Each warranty and representation contained in this Agreement automatically shall be deemed repeated with each Advance and shall be conclusively presumed to have been relied on by Lender regardless of any investigation made or information possessed by Lender. The warranties and representations set forth herein shall be cumulative and in addition to any and all other warranties and representations that Borrower now or hereafter shall give, or cause to be given, to Lender. 9. Affirmative Covenants. Borrower covenants and agrees that, so long as any credit hereunder shall be available and until full and final payment of the Obligations, and unless Lender shall otherwise consent in writing, the following statements shall be true and Borrower shall do all of the actions set forth below. 9.1. Preserve Good Standing. Borrower shall do all things necessary to preserve its good standing as a CORPORATION (FOR MENDOCINO) AND LIMITED LIABILITY COMPANY (FOR RELETA) under the laws of the states where Borrower is authorized to do business, specifically the state(s) of CALIFORNIA (FOR MENDOCINO); AND NEW YORK (FOR RELETA), and under the laws of California (for Mendocino) and Delaware (for Releta), the state of its organization. Further, Borrower shall maintain the state of California (for Mendocino) and Delaware (for Releta) as the state in which Borrower is organized or incorporated. 9.2. Preliminary Annual Financial Statements. Borrower shall provide Lender, as soon as possible after the end of each fiscal year of Borrower, and in any event within sixty (60) days thereafter, preliminary year end financial statements, including but not limited to, the balance sheet and income statement for such year. 9.3. Reviewed Annual Financial Statements. Borrower shall provide Lender, as soon as possible after the end of each fiscal year but in any event within one hundred twenty (120) days of the end of Borrower's fiscal year: (a) a complete copy of Borrower's financial statements, including but not limited to (1) the management letter, if any; (2) the balance sheet as of the close of the fiscal year; and (3) the income statement for such year, together with a statement of cash flows, reviewed by a firm of independent certified public accountants of recognized standing and acceptable to Lender, or if permitted by Lender in writing, by Borrower; and (b) a statement certified by the chief financial officer of Borrower that Borrower is in compliance with all the terms, conditions, covenants, and warranties of this Agreement. 9.4. Other Financial Statements. No later than thirty (30) days after the close of each month (each, an "Accounting Period"), Borrower shall provide Lender with Borrower's balance sheet as of the close of such Accounting Period and its income statement for that portion of the then current fiscal year through the end of such Accounting Period certified by Borrower's chief financial officer as being complete, correct, and fairly representing its financial condition and results of operations. 9.5. Tax Returns. Borrower shall provide Lender copies of each of Borrower's federal income tax returns, and any amendments thereto, within one hundred twenty (120) days after the end of Borrower's fiscal year. 9.6. Inventory Product Activity. Borrower shall provide Lender a full, complete, and accurate summary of all Borrower's inventory activity on a MONTHLY basis from Borrower within two (2) days of the end of the prior period and on a monthly basis from any and all public Warehouses within fifteen (15) days of the end of the prior month. 9.7. Monthly Accounts Payable Aging Report. Borrower shall provide Lender on a monthly basis with a full, complete, and accurate accounts payable aging report within fifteen (15) days of the end of the prior month. 9.8. Accounting System. Borrower shall maintain a standard and modern system of accounting in accordance with GAAP with ledger and account cards or computer tapes, discs, printouts, and records pertaining to the Collateral which contain information as from time to time may be reasonably requested by Lender. Borrower also shall keep proper books of account showing all sales, claims, and allowances on its Inventory. 9.9. Designation of Inventory. Borrower shall now and from time to time hereafter, but not less frequently than monthly, execute and deliver to Lender a written designation of Inventory specifying Borrower's cost and the wholesale market value of Borrower's raw materials, work in process, and finished goods, and further specifying such other information as Lender may reasonably request. 9.10. Taxes. All assessments and taxes, whether real, personal, or otherwise, due or payable by, or imposed, levied, or assessed against Borrower or any of its property have been paid, and shall hereafter be Page 17 of 32 paid in full, before delinquency or before the expiration of any extension period. Borrower shall make due and timely payment or deposit of all federal, state, and local taxes, assessments, or contributions required of it by law, and will execute and deliver to Lender, on demand, appropriate certificates and/or payroll and other tax receipts attesting to the payment thereof or deposit with respect thereto. Borrower will make timely payment or deposit of all payroll and other tax payments and withholding taxes required of it by applicable laws, including those laws concerning F.I.C.A., F.U.T.A., state disability, and local, state, and federal income taxes, and will, upon request, furnish Lender with proof satisfactory to Lender indicating that Borrower has made such payments or deposits. 9.11. Insurance. Borrower, at its expense, shall keep the Collateral insured against loss or damage by fire, theft, explosion, sprinklers, and all other hazards and risks, and in such amounts, as are ordinarily insured against by other owners in similar businesses. Borrower also shall maintain business interruption, public liability, product liability, and property damage insurance relating to Borrower's ownership and use of the Collateral, as well as insurance against larceny, embezzlement, and criminal misappropriation. Additionally, Borrower shall maintain Workers' Compensation insurance coverage for all employees. 9.12. Lender as Loss Payee. All such policies of insurance shall be in such form, with such companies, and in such amounts as may be reasonably satisfactory to Lender. All such policies of insurance (except those of public liability and property damage) shall contain a 438BFU lender's loss payable endorsement, or an equivalent endorsement in a form satisfactory to Lender, showing Lender as sole loss payee thereof, and shall contain a waiver of warranties, and shall specify that the insurer must give at least thirty (30) days' prior written notice to Lender before canceling its policy for any reason. Borrower shall deliver to Lender certified copies of such policies of insurance and evidence of the payment of all premiums therefor. All proceeds payable under any such policy shall be payable to Lender to be applied on account of the Obligations. 9.13. No Setoffs or Counterclaims. All payments hereunder and under the other Loan Documents made by or on behalf of Borrower shall be made without setoff or counterclaim and free and clear of, and without deduction or withholding for or on account of, any federal, state, or local taxes. 9.14. Location of Collateral, Inventory, and Equipment. Borrower shall keep the Collateral, including, but not limited to Inventory and Equipment, only at the Premises and Warehouse (assuming Bailment Agreement(s) have been signed) in the following state(s) California and New York (the "Collateral State"); provided, however, that with the prior written consent of Lender, Borrower may change the locations of the Collateral, including Inventory and Equipment after sending written notice to Lender not less than thirty (30) days prior to the date on which the Collateral, including but not limited to Inventory and Equipment is moved to such new location, (a) so long as such new location is within the continental United States; and (b) so long as, at the time of such written notification, Borrower authorizes (1) the filing of or provides any financing statements or fixture filings necessary to perfect and continue perfected Lender's security interests in such assets; and (2) also executes and delivers, or causes to be executed and delivered, to Lender such agreements, documents, and instruments as Lender may deem reasonably necessary or desirable to protect its interests in the Collateral, including but not limited to Inventory and Equipment, at such location, in form and substance satisfactory to Lender. 9.15. Control of Collateral. Borrower will cooperate with Lender in obtaining possession, where Lender chooses to perfect its security interest by possession in addition to the filing of a financing statement. Borrower will cooperate with Lender in obtaining control with respect to Collateral consisting of Deposit Accounts, Financial Assets, including without limitation, Investment Property, Letter of Credit Rights, and Electronic Chattel Paper. 9.16. Leases. Borrower shall pay when due all rents and other amounts payable under any leases to which Borrower is a party or by which Borrower's properties and assets are bound, unless such payments are the subject of a permitted protest. To the extent that Borrower fails timely to make payment of such rents and other amounts payable when due under its leases, Lender shall be entitled, in its discretion, and without the necessity of declaring an Event of Default, to reserve an amount equal to such unpaid amounts from the loan available to Borrower. 9.17. Change in Name. Borrower shall give Lender written notice immediately upon forming an intention to change its name or form or jurisdiction of business organization. 9.18. Inspection. Borrower shall permit Lender or any representatives thereof, during usual business hours, without notice to Borrower, to periodically: (a) have access to all Premises where any Collateral is located for the purposes of inspecting (and removing, if after the occurrence of an Event of Default) any of the Collateral, including Borrower's Books; (b) permit Lender or its designees to inspect, audit, make copies of, and make extracts from Borrower's Books as Lender may request. Borrower hereby irrevocably authorizes all accountants and third parties to disclose and deliver to Lender at Borrower's expense all financial information, books and records, work papers, management reports and other information in their possession relating to Borrower whether verbally, in writing (by record or authenticated record) or otherwise. 9.19. Employee Retirement Income Security Act. Borrower shall comply with all provisions of the Employee Retirement Income Security Act of 1974, and any successor statute, all as amended from time to time ("ERISA"), including regulations promulgated thereunder and interpretations published regarding same. 9.20. Environmental Issues. Borrower shall comply with the affirmative covenants set forth below with respect to environmental issues. 9.20.1 Borrower shall furnish to Lender promptly and in any event within thirty (30) days after receipt thereof, a copy of any notice, summons, citation, directive, letter or other communications from Page 18 of 32 the EPA or any other governmental agency or instrumentality concerning any intentional or unintentional action or omission on Borrower's part in connection with the handling, transporting, transferring, disposal or in the releasing, spilling, leaking, pumping, pouring, emitting, emptying or dumping of Hazardous Substances or Hazardous Wastes into the environment resulting in damage to the environment, fish, shellfish, wildlife, biota and any other natural resource; 9.20.2 Borrower shall furnish to Lender promptly and in any event within thirty (30) days after the receipt thereof, a copy of any notice of or other communication concerning the filing of a lien upon, against or in connection with Borrower, the Collateral or Borrower's real property by the EPA or any other governmental agency or instrumentality authorized to file such a lien pursuant to an environmental protection statute in connection with a fund to pay for damages and/or cleanup and/or removal costs arising from the intentional or unintentional action or omission of Borrower resulting from the disposal or in the releasing, spilling, leaking, pumping, pouring, emitting, emptying or dumping of Hazardous Substances or Hazardous Wastes into the environment; 9.20.3 Borrower shall furnish to Lender promptly and in any event within thirty (30) days after the receipt thereof, a copy of any notice, directive, letter or other communication from the EPA or any other governmental agency or instrumentality acting under the authority of an Environmental Law indicating that all or any portion of the Borrower's property or assets have been listed and/or that Borrower has been deemed by such agency to be the owner and operator of the facility that has failed to furnish to the EPA or other authorized governmental agency or instrumentality, all the information required by the RCRA, CERCLA or other applicable Environmental Laws; and 9.20.4 Borrower shall furnish to Lender promptly and in no event more than thirty (30) days after the filing thereof with the EPA or other governmental agency or instrumentality authorized as such pursuant to an environmental protection statute, copies of any and all information reports filed with such agency or instrumentality in connection with Borrower's compliance with RCRA, CERCLA, or other applicable Environmental Laws. 9.20.5 Borrower shall require and use its best efforts to ensure compliance by all operators and occupants of the Premises with all applicable Environmental Laws. 9.20.6 Borrower agrees to defend, indemnify, save, and hold Lender and its officers, employees, and agents harmless against all obligations, demands, claims, and liabilities claimed or asserted by any other Person arising out of or relating to discharges or releases of Hazardous Substances or Hazardous Wastes into the environment, including ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Hazardous substances or Hazardous Wastes or the clean-up or other remediation thereof, and all losses (including without limitation attorneys' fees and legal and other costs from outside counsel or in-house counsel) in any way suffered, incurred, or paid by Lender as a result of or in any way arising out of, following, or consequential thereto; provided, however, that no such indemnification shall apply with respect to any liability directly arising out of the gross negligence or willful misconduct on the part of Lender or any of its officers, employees and agents in connection with Hazardous Wastes or Hazardous Substances. 9.21. Reaffirmation and Continuing Nature of Representations, Warranties, and Covenants. The foregoing representations, warranties, and covenants shall be of a continuing nature and shall survive the termination of this Agreement and full payment and performance of the Obligations. They shall also be deemed to be repeated whenever Borrower makes a request for an Advance. 10. Negative Covenants. Borrower covenants and agrees that, so long as any credit hereunder shall be available and until full and final payment and performance of the Obligations, Borrower will not do any of the following or take any of the actions set forth herein, without Lender's prior written consent. 10.1. Returns; Allowances and Credits. Borrower shall not accept any returns or grant any allowances or credits to Account Debtors without notifying Lender at the time any credit is issued. 10.2. Credit Limit. Borrower shall not borrow any funds from any third party in an amount in excess of TEN THOUSAND AND 00/100 DOLLARS ($10,000.00) without Lender's prior written consent, which consent shall not be unreasonably denied. 10.3. Indebtedness. Except as permitted by Section 10.2, Borrower shall not create, incur, assume, permit, guarantee, or otherwise become or remain, directly or indirectly, liable with respect to any Indebtedness except Permitted Indebtedness. 10.4. Liens. Borrower shall not create, incur, assume, or permit to exist, directly or indirectly, any lien on or with respect to any of the Collateral or its property or assets, of any kind, whether now owned or hereafter acquired, or any income or profits therefrom except for Permitted Liens (including liens that are replacements of Permitted Liens to the extent that the original Indebtedness is refinanced and so long as the replacement liens secure only those assets or property that secured the original Indebtedness). 10.5. Restrictions on Fundamental Changes. Borrower shall not enter into any acquisition, merger, consolidation, reorganization, or recapitalization, or reclassify its capital stock, or liquidate, wind up, or dissolve itself (or suffer any liquidation or dissolution), or convey, sell, assign, lease, license, transfer, or otherwise dispose of, in one transaction or a series of transactions, all or any substantial part of its business, property, or assets, Page 19 of 32 whether now owned or hereafter acquired, or acquire by purchase or otherwise all or substantially all of the properties, assets, stock, or other evidence of beneficial ownership of any Person. 10.6. Extraordinary Transactions and Disposal of Assets. Borrower shall not enter into any transaction not in the ordinary and usual course of Borrower's business, including the sale, lease, license, or other disposition of, moving, relocation, or transfer, whether by sale or otherwise, of any of Borrower's properties or assets (other than sales of Inventory to buyers in the ordinary course of Borrower's business as currently conducted) except as permitted by this Agreement or the Loan Documents. 10.7. Change Name. Borrower shall not change Borrower's name, Federal Employer Identification Number, business structure, or identity, or add any new fictitious name. To that effect, Borrower shall not do business under any name other than MENDOCINO BREWING COMPANY, INC. and RELETA BREWING COMPANY LLC, Borrower's correct legal name, unless Borrower has provided to Lender evidence that it has taken such legal steps required with respect to fictitious or assumed names under the applicable laws of the jurisdictions in which Borrower is located and/or does business. Lender has received acceptable documentation indicating that Borrower will be doing business under the following additional name(s): LISTED ON SCHEDULE A: LIST OF FICTITIOUS NAMES, ATTACHED HERETO AND INCORPORATED HEREIN BY REFERENCE. 10.8. Guarantee. Borrower shall not guarantee or otherwise become in any way liable with respect to the obligations of any third Person except by endorsement of instruments or items of payment for deposit to the account of Borrower or which are transmitted or turned over to Lender. 10.9. Restructure. Borrower shall not make any change in Borrower's financial structure, the principal nature of Borrower's business operations, or the date of its fiscal year. 10.10. Consignments. Borrower shall not consign any Inventory or sell any Inventory on bill and hold, sale or return, sale on approval, or other conditional terms of sale. 10.11. Distributions. Borrower shall not make any distribution or declare or pay any dividends (whether in cash or stock) on, or purchase, acquire, redeem, or retire any of Borrower's capital stock, of any class, whether now or hereafter outstanding. 10.12. Accounting Methods. Borrower shall not modify or change its method of accounting or enter into, modify, or terminate any agreement currently existing, or at any time hereafter entered into with any third party accounting firm or service bureau for the preparation or storage of Borrower's accounting records without said accounting firm or service bureau agreeing to provide Lender information regarding the Collateral or Borrower's financial condition. Borrower waives the right to assert a confidential relationship, if any, it may have with any accounting firm or service bureau in connection with any information requested by Lender pursuant to or in accordance with this Agreement, and agrees that Lender may contact directly any such accounting firm or service bureau in order to obtain such information. 10.13. Investments. Borrower shall not directly or indirectly make or acquire any beneficial interest in (including stock, partnership interest, or other securities of), or make any loan, or capital contribution to, any Person. 10.14. Transactions With Affiliates. Borrower shall not directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for transactions that are in the ordinary course of Borrower's business, upon fair and reasonable terms, that are fully disclosed to Lender, and that are no less favorable to Borrower than would be obtained in arm's length transaction with a non-Affiliate. 10.15. Suspension. Borrower shall not suspend or go out of a substantial portion of its business. 10.16. Use of Proceeds. Borrower shall not use the proceeds of the Advances made hereunder for any purpose other than to, on the Closing Date, repay in full the outstanding principal, accrued interest, and accrued fees and/or expenses owing the Old Lender, and to pay transactional Lender Expenses incurred in connection with this Agreement. Thereafter, Borrower shall use the proceeds of the Advances made hereunder for any purpose consistent with the terms and conditions hereof, for its lawful and permitted business purpose, but subject to the terms and conditions of this Agreement. 10.17. Change in Location of Premises; Collateral and Third Party Control. Borrower covenants and agrees that it will not, without thirty (30) days' prior written notification to Lender, relocate its Premises to a new location. Further, Borrower agrees that at the time of such written notification, Borrower shall provide Lender any financing statements or fixture filings necessary to perfect and continue Lender's perfected security interests in the Collateral and authorize Lender to file same. In addition, Borrower agrees that it will not at any time store the Collateral with any bailee or warehouseman or in a third party owned facility without prior execution of an agreement between Lender and bailee or landlord in form and substance satisfactory to Lender. 10.18. Hazardous Substances or Hazardous Waste. Borrower shall not permit the Premises to be used to generate, manufacture, refine, transport, treat, store, handle, dispose, produce, or process Hazardous Substances or Hazardous Wastes, except in compliance with all applicable Environmental Laws. 10.19. Management Borrower shall not, and shall not permit any Subsidiary to, make any significant change in its management without a minimum thirty (30) days' prior written notice to Lender Page 20 of 32 11. Events Of Default. Any one or more of the events set forth below shall constitute an "Event of Default" under this Agreement and the Loan Documents. 11.1. Failure to Pay. Borrower or any Obligor fails to pay when due and payable or when declared due and payable, any portion of the Obligation whether of principal, interest, (including any interest which, but for the provisions of the Bankruptcy Code, would have accrued on such amounts), fees and charges due Lender, reimbursement of Lender Expenses, or other amounts constituting the Obligation. 11.2. Failure to Perform. Borrower fails or neglects to perform, keep, or observe any term, provision, condition, covenant, or agreement contained in this Agreement, any of the Loan Documents, or in any other present or future agreement between Borrowerand Lender. 11.3. Material Adverse Change. A Material Adverse Change has occurred. 11.4. Writ. Any of Borrower's properties or assets is attached, seized, subjected to a writ or distress warrant, or is levied upon, or comes into the possession of any third Person. 11.5. Insolvency Proceeding. An Insolvency Proceeding is commenced by or against Borrower or any Obligor. 11.6. Injunction Against Doing Business. Borrower is enjoined, restrained, or in any way prevented by court order from continuing to conduct all or any material part of its business affairs. 11.7. Notice of Lien or Levy. (a) A notice of lien, levy, or assessment is filed of record with respect to any of Borrower's properties or assets by the government of the United States, or any department, agency, or instrumentality thereof, or by any state, county, municipal, or governmental agency; or (b) any taxes or debts owing at any time hereafter to any one or more of such entities becomes a lien, whether choate or otherwise, upon any of Borrower's properties or assets and the same is not paid on the payment date thereof. 11.8. Judgment Lien. A judgment or other claim becomes a lien or encumbrance upon any material portion of Borrower's properties or assets. 11.9. Default in Third Party Agreements. Borrower defaults in any material agreement to which Borrower is a party with one or more third Persons resulting in a right by such third Persons, irrespective of whether exercised, to accelerate the maturity of Borrower's obligations thereunder. 11.10. Prohibited Payment on Subordination Agreement. Borrower makes any payment on account of Indebtedness that has been subordinated in right of payment to the payment of the Obligations, except to the extent such payment is permitted by the terms of the subordination provisions applicable to such Indebtedness. 11.11. Misstatement or Misrepresentation. Any misstatement or misrepresentation exists now or hereafter in any warranty, representation, statement, or report made to Lender by Borrower or any officer, employee, agent, or director of Borrower, or any such warranty or representation is withdrawn. 11.12. Limitation or Termination of Guaranties, Validity Agreements, etc. (a) The obligation of any Guarantor or other third Person under the Guaranty, Validity Agreement, or any of the other Loan Documents is limited or terminated by operation of law or by the Guarantor or other third Person thereunder; (b) any such Guarantor or other third Person becomes the subject of an Insolvency Proceeding; or (c) the termination, lapse, or ineffectiveness of any UCC Financing Statement filed in connection with or related to any collateral pledged in support of the Guaranty. 11.13. Prospect of Payment Materially Impaired. Lender shall believe that the prospect of (a) payment of the Loans; or (b) the performance of any of Borrower's material Obligations is materially impaired. 11.14. Termination, Lapse, or Ineffectiveness of UCC Filing. The termination, lapse of, or ineffectiveness of any UCC Financing Statement filed in connection with or related to any Collateral granted pursuant to this Agreement or any of the other Loan Documents. 11.15. Violation of any Environmental Law. (a) the failure by Borrower to comply with each, every and all of the requirements of RCRA, CERCLA or any other applicable Environmental Law on Borrower's property; (b) the receipt by Borrower of a notice from the EPA or any other governmental agency or instrumentality acting under the authority of any Environmental Law, indicating that a lien has been filed against any of the Collateral, or any of Borrower's other property by the EPA or any other governmental agency or instrumentality in connection with a fund as a result of damage arising from an intentional or unintentional action or omission by Borrower resulting from the disposal, releasing, spilling, leaking, pumping, pouring, emitting, emptying or dumping of Hazardous Substances or Hazardous Wastes into the environment; and (c) any other event or condition exists which might, in the opinion of Lender, under applicable environmental protection statutes, have a material adverse effect on the financial or operational condition of Borrower or the value of all or any material part of the Collateral or other property of Borrower. 12. Lender's Rights and Remedies. Borrower and Lender have agreed to the terms set forth below with respect to the rights and remedies of Lender. Page 21 of 32 12.1. Rights and Remedies. Upon the occurrence, and during the continuation, of an Event of Default, Lender may, at its election, without notice of its election and without demand, do any one or more of the actions set forth below, all of which are authorized by Borrower. 12.1.1. Accelerate Obligations. Lender may declare all Obligations, whether evidenced by this Agreement, by any of the other Loan Documents, or otherwise, immediately due and payable, without presentment, demand, protest, or notice of any kind, all of which are hereby expressly waived by Borrower. 12.1.2. Cease Advancing Money. Lender may cease advancing money or extending credit to or for the benefit of Borrower under this Agreement, the Loan Documents, or any other agreement between Borrower and Lender. 12.1.3. Terminate This Agreement. Lender may terminate this Agreement and any of the other Loan Documents as to any future liability or obligation of Lender, but without affecting Lender's rights and security interests in the Collateral and without affecting the Obligations. 12.1.4. Settle or Adjust Disputes. Lender may settle or adjust disputes and claims directly with Account Debtors to the Accounts for amounts and upon terms which Lender considers advisable, and in such cases, Lender will credit Borrower's loan account with only the net amounts received by Lender in payment of such disputed Accounts, after deducting all Lender Expenses incurred or expended in connection therewith. 12.1.5. Returned Inventory. Lender may cause Borrower to hold all returned Inventory in trust for Lender, segregate all returned Inventory from all other property of Borrower or in Borrower's possession and conspicuously label said returned Inventory as being the Collateral of Lender. 12.1.6. Make Payment; Do Acts. Lender may, without notice to or demand upon Borrower, Guarantor, or other guarantor, make such payments and do such acts as Lender considers necessary or reasonable to protect its security interests in the Collateral. Borrower agrees to assemble the Collateral if Lender so requires, and to make the Collateral available to Lender as Lender may designate. Borrower authorizes Lender to enter the Premises where the Collateral is located, to take and maintain possession of the Collateral, or any part of it, and to pay, purchase, contest, or compromise any encumbrance, charge, or lien that in Lender's determination appears to conflict with its security interests and to pay all expenses incurred in connection therewith. With respect to any of Borrower's owned Premises, Borrower hereby grants Lender a license to enter into possession of such Premises and to occupy the same, without charge, for up to one hundred twenty (120) days in order to exercise any of Lender's rights or remedies provided herein or in any of the other Loan Documents, at law, in equity, or otherwise. 12.1.7. Setoff. Lender may, without notice to Borrower (such notice being expressly waived), and without constituting a retention of any Collateral in satisfaction of an Obligation (within the meaning of Sections 9620 and 9621 of the Code), set off and apply to the Obligations any and all (a) balances and deposits of Borrower held by Lender (including any amounts received in the Collateral Account); or (b) the Obligations at any time owing to or for the credit or the account of Borrower held by Lender. 12.1.8. Hold Monies. Lender may hold, as cash collateral, any and all balances and deposits of Borrower held by Lender, and any amounts received in the Collateral Account and Collateral Control Account, to secure the full and final repayment of all of the Obligations. 12.1.9. Deal with Collateral. Lender may collect, ship, reclaim, recover, store, finish, maintain, repair, dispose of, prepare for sale, advertise for sale, and sell (in the manner provided for herein) the Collateral. Lender is hereby granted a license or other right to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, trade names, trademarks, service marks, and advertising matter, or any property of a similar nature, as it pertains to the Collateral, in completing production of, advertising for sale, and selling any Collateral and Borrower's rights under all licenses and all franchise agreements shall inure to Lender's benefit. 12.1.10. Sell Collateral. Lender may sell the Collateral at either a public or private sale, or both, by way of one or more contracts or transactions, for cash or on terms, in such manner and at such places (including Borrower's Premises) as Lender determines is commercially reasonable. It is not necessary that the Collateral be present at any such sale. 12.1.11. Notice of Disposition of Collateral. Lender shall give notice of the disposition of the Collateral as follows: (a) Lender shall give Borrower and each holder of a security interest in the Collateral who has filed with Lender a written request for notice, a notice in writing of the time and place of public sale, or, if the sale is a private sale or some other disposition other than a public sale is to be made of the Collateral, then the time on or after which the private sale or other disposition is to be made; (b) the notice shall be personally delivered or mailed, postage prepaid, to Borrower at the address set forth herein, giving such notice as may be reasonable under the circumstance of (1) the date fixed for the sale; or (2) before the date on or after which the private sale or other disposition is to be made; except that no notice needs to be given prior to the disposition of any portion of the Collateral that is perishable or threatens to decline speedily in value or that is of a type customarily sold on a recognized market. Notice to Persons other than Borrower, Guarantor, or secured creditors reflected in a UCC search claiming an interest in the Collateral shall be Page 22 of 32 sent to such addresses as they have furnished to Lender or as is reflected in such UCC search as the case may be; and (c) if the sale is to be a public sale, Lender shall also give notice of the time and place by publishing a notice one (1) time giving such notice as may be reasonable under the circumstance before the date of the sale in a newspaper of general circulation in the county in which the sale is to be held. 12.1.12. Credit Bid. Lender may credit bid and purchase any and all of the Collateral at any public sale. 12.1.13. Deficiency; Excess. Any deficiency that exists after disposition of the Collateral as provided above will be paid immediately to Lender by Borrower. Any excess will be returned, without interest and subject to the rights of third Persons, by Lender to Borrower. 12.2. Remedies Cumulative. Lender shall have all rights, powers and remedies available under each of the Loan Documents, or accorded by law, including without limitation the right to resort to any or all Collateral for any credit accommodation from Lender under this Agreement or any other Loan Document and to exercise any or all of the rights of a beneficiary or secured party pursuant to applicable law. All rights, powers and remedies of Lender in connection with each of the Loan Documents or as accorded by Lender, may be exercised at any time by Lender and from time to time after the occurrence of an Event of Default, are cumulative and not exclusive, and shall be in addition to any other rights, powers or remedies provided by law or equity. 13. Taxes and Lender Expenses. If Borrower fails to pay any monies (whether taxes, rents, assessments, insurance premiums, or otherwise) due to third Persons, or fails to make any deposits or furnish any required proof of payment or deposit, all as required under the terms of this Agreement, then, to the extent that Lender determines that such failure by Borrower could have a Material Adverse Change with respect to Lender's interests in the Collateral, in its discretion and without prior notice except as provided in the Loan Documents, Lender may do any or all of the following: set up such reserves in Borrower's loan account and comply with any condition as Lender deems necessary to protect Lender from the exposure created by such failure; qualify Borrower in any state to collect Accounts; or obtain and maintain insurance policies of the type described herein, and take any action with respect to such policies as Lender deems prudent. Any such amounts paid by Lender shall be at Borrower's expense and shall constitute Lender Expenses. Any such payments made by Lender shall not constitute an agreement by Lender to make similar payments in the future or a waiver by Lender of any Event of Default under this Agreement. Lender need not inquire as to, or contest the validity of, any such expense, tax, security interest, encumbrance, or lien and the receipt of the usual official notice for the payment thereof shall be conclusive evidence that the same was validly due and owing. Such Lenders' Expenses may be charged to Borrower's account and if not charged or paid prior to such time, shall be charged upon termination. Unless Borrower provides Lender with evidence of the insurance coverage as required by this Agreement, Lender may purchase such insurance at Borrower's expense to protect Lender's interest. This insurance may, but need not, also protect Borrower's interest. If any Collateral becomes damaged, the insurance coverage that Lender purchases may not pay any claim Borrower makes or any claim made against Borrower. Borrower may later cancel this coverage after providing evidence that Borrower has obtained property coverage elsewhere. Borrower is responsible for the cost of any insurance purchased by Lender, which shall constitute a Lender Expense. The cost obtaining of this insurance may be added to Borrower's loan balance. If the cost is added to Borrower's loan balance, the Rate will apply to this added amount. The effective date of coverage may be the date on which Borrower's prior coverage lapsed or the date Borrower failed to provide proof of coverage. The insurance coverage that Lender purchases may be considerably more expensive than the insurance coverage that Borrower could obtain and may not satisfy any need for property damage coverage or any mandatory liability insurance requirements imposed by applicable law. 14. Waivers; Indemnification. 14.1. Waivers of Demand, Protest, etc. Borrower waives demand, protest, notice of protest, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of Accounts, Documents, Instruments, Chattel Paper, and guarantees at any time held by Lender on which Borrower may in any way be liable. 14.2. No Liability of Lender Re: Collateral. Lender shall not in any way or manner be liable or responsible for the safekeeping of the Collateral; any loss or damage thereto occurring or arising in any manner or fashion from any cause; any diminution in the value thereof; or any act or default of any carrier, warehouseman, bailee, forwarding agency, or other Person. All risk of loss, damage, or destruction of the Collateral shall be borne by Borrower. 14.3. Indemnification. Borrower agrees to defend, indemnify, save, and hold Lender and Lender's officers, employees, shareholders, directors, attorneys, and agents harmless against all obligations, demands, claims, and liabilities claimed or asserted by any other Person arising out of or relating to the transactions contemplated by this Agreement or any of the other Loan Documents; and all losses (including attorneys' fees and legal and other costs) in any way suffered, incurred, or paid by Lender as a result of or in any way arising out of, following, or consequential to the transactions contemplated by this Agreement or any of the other Loan Documents; provided, however, that no such indemnification shall apply with respect to any liability directly arising out of the gross negligence or willful misconduct on the part of Lender or any of Lender's officers, employees, shareholders, directors, attorneys, and agents. Page 23 of 32 14.4. No Liability for Failure to Make Advances. Borrower agrees Lender shall not be liable or responsible for any failure to make Advances (a) if in Lender's discretion Lender believes Borrower is not entitled to receive such Advances; (b) due to any accounting or administrative errors made by Lender so long as such errors are not in bad faith; or (c) due to any other failure by Lender unless the same arises directly from Lender's gross negligence or willful misconduct. 14.5. Best Efforts by Lender to Give Notice of Default. Lender agrees to use its best efforts to give Borrower prompt written notice of any default or Event of Default or alleged default by Borrower. 15. Notices. Unless otherwise provided in this Agreement, all notices or demands by any party relating to this Agreement or any of the other Loan Documents shall be in writing and (except for financial statements and other informational documents which may be sent by first-class mail, postage prepaid) shall be personally delivered or sent by overnight mail, registered or certified mail, postage prepaid, return receipt requested, or by prepaid telex, TWX, telefacsimile, or telegram (with messenger delivery specified) to Borrower or to Lender, as the case may be, at its address set forth below: IF TO BORROWER MENDOCINO: MENDOCINO BREWING COMPANY, INC. 1601 AIRPORT ROAD, UKIAH, CALIFORNIA 95482 Attn: YASHPAL SINGH & N. MAHADEVAN Telephone No.: (707) 463-6610 Facsimile No.: (707) 463-2465 IF TO BORROWER RELETA: RELETA BREWING COMPANY LLC 131 EXCELSIOR AVENUE, SARATOGA SPRINGS, NEW YORK 12866 Attn: YASHPAL SINGH & N. MAHADEVAN Telephone No.: (707) 463-6610 Facsimile No.: (707) 463-2465 IF TO LENDER: BFI BUSINESS FINANCE 1655 THE ALAMEDA, SAN JOSE, CALIFORNIA 95126 Attn: DAVID DROGOS, PRESIDENT Telephone No.: (408) 288-4010 Facsimile No.: (408) 288-4018/(408) 283-4867 The parties hereto may change the address at which they are to receive notices hereunder, by notice in writing in the foregoing manner given to the other. All notices or demands sent in accordance with this Section, other than notices by Lender in connection with Sections 9610, 9611, 9615, 9617, 9618, 9620, 9621, 9624 of the Code, shall be deemed received on the earlier of the date of actual receipt or three (3) days after the deposit thereof in the mail. Borrower acknowledges and agrees that notices sent by Lender in connection with the foregoing Sections of the Code shall be deemed sent when deposited in the mail or transmitted by telefacsimile or other similar method set forth above. 16. Choice of Law. This Agreement and all transactions contemplated hereunder and/or evidenced hereby shall be governed by, construed under, and enforced in accordance with the internal laws of the State of California, without giving effect to conflicts of law principles. 17. Venue. The parties agree that all actions or proceedings arising in connection with this Agreement and/or the Loan Documents shall be tried and litigated only in the State and Federal courts located in the County of Santa Clara, State of California or, at the sole option of Lender, in any other court in which Lender shall initiate legal or equitable proceedings and which has subject matter jurisdiction over the matter in controversy. Each of Borrower and Lender waives, to the extent permitted under applicable law, any right each may have to assert the doctrine of forum non conveniens or to object to venue to the extent any proceeding is brought in accordance with this section. 18. JURY TRIAL WAIVER. BORROWER AND LENDER HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN, INCLUDING, WITHOUT LIMITATION, CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL OTHER COMMON LAW OR STATUTORY CLAIMS. BORROWER AND LENDER REPRESENT THAT EACH HAS REVIEWED THIS WAIVER AND EACH KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, A COPY OF THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT. 19. Destruction of Borrower's Documents. All documents, schedules, invoices, agings, or other papers delivered to Lender, other than Borrower's Books or Collateral, may be destroyed or otherwise disposed of by Lender four (4) months after they are delivered to or received by Lender, unless Borrower requests, in writing, the return of said documents, schedules, or other papers and makes arrangements, at Borrower's expense, for their return. 20. Revocation of Borrower's Right to Sell Inventory Free and Clear of Lender's Security Interest. Lender may, upon the occurrence of an Event of Default, revoke Borrower's right to sell Inventory free and clear of Lender's security interest therein. Page 24 of 32 21. Disclaimer for Negligence. Lender shall not be liable for any claims, demands, losses or damages made, claimed or suffered by Borrower, except such as may arise through or could be caused directly by Lender's gross negligence or willful misconduct. 22. Limitation of Consequential Damages. Lender shall not be responsible for any lost profits of Borrower arising from any breach of contract, tort (excluding Lender's gross negligence or willful misconduct), or any other wrong arising from the establishment, administration, or collection of the Obligations. 23. Multiple Borrowers. If there is more than one Borrower as of the Closing Date or thereafter, the following provisions shall apply: 23.1. Each Borrower hereby waives its rights of subrogation, reimbursement, indemnification, and contribution and any other rights and defenses that are or may become available to any Borrower by reason of Sections 2787 to 2855, inclusive of the California Civil Code. 23.2. Each Borrower waives all rights and defenses it may have if any agreement with Lender is secured by real property. This means, among other things: (a) Lender may collect from any Borrower without first foreclosing on any real or personal property Collateral pledged by Borrower; and (b) if Lender forecloses on any Real Property Collateral pledged by any Borrower: (1) the amount of the debt may be reduced only by the price for which that Collateral is sold at the foreclosure sale, even if the Collateral is worth more than the sale price; and (2) Lender may collect from any Borrower even if Lender, by foreclosing on the Real Property Collateral, has destroyed any right any Borrower may have to collect from any other Borrower. This is an unconditional and irrevocable waiver of any rights and defenses any Borrower may have because Borrower's debt is secured by Real Property Collateral. These rights and defenses include, but are not limited to, any rights or defenses based upon Section 580a, 580b, 580d, or 726 of the California Code of Civil Procedure. 23.3. Each Borrower waives all rights and defenses arising out of an election of remedies by Lender, even though that election of remedies, such as a nonjudicial foreclosure with respect to security for a guaranteed obligation, has destroyed any Borrower's rights of subrogation and reimbursement against the principal by the operation of Section 580d of the California Code of Civil Procedure or otherwise, and each Borrower further waives any and all benefits or defenses, if any, arising directly or indirectly under any one or more of Sections 3116, 3118, 3119, 3419, 3605, 9610, 9611, 9615, 9617, 9618, 9620, 9621, 9624, 9625, or 9627 of the Code. 23.4. Each Borrower hereby agrees that it is jointly and severally, directly, and primarily liable to Bank for payment and performance in full of all duties, obligations, and liabilities under this Agreement and each other document, instrument, and agreement entered into by any Borrower with or in favor of Lender in connection herewith, and that such liability is independent of the duties, obligations, and liabilities of any other Borrower or any Guarantor of the Obligations, as applicable. Each reference herein to Borrower shall mean each and every Borrower that is a party hereto, individually and collectively, jointly and severally. 24. General Provisions. 24.1. Effectiveness. This Agreement shall be binding and deemed effective when executed by Borrower and Lender, with the acknowledgment and agreement portion executed by each Guarantor. 24.2. Successors and Assigns. This Agreement shall be binding on and inure to the benefit of the heirs, executors, administrators, legal representatives, successors and assigns of the parties; provided however, that Borrower may not assign or transfer its interest hereunder without the prior written consent of Lender, any prohibited assignment shall be void ab initio. Lender reserves the right to sell, assign, transfer, negotiate, or grant participations in all or any part of, or any interest in, Lender's rights and benefits under each of the Loan Documents executed herewith or hereafter. In connection therewith, Lender may disclose all documents and information which Lender now has or may hereafter acquire relating to any credit extended by Lender to Borrower, Borrower or its business, any Obligor or the business of any Obligor, or any Collateral. 24.3. Section Headings. Headings and numbers have been set forth herein for convenience only. Unless the contrary is compelled by the context, everything contained in each section applies equally to this entire Agreement. 24.4. Interpretation. This Agreement and all agreements relating to the subject matter hereof are the product of negotiation and preparation by and among each party and its respective attorneys, and shall be construed accordingly. The parties waive the provisions of California Civil Code ss.1654. 24.5. Severability of Provisions.. In the event any one or more of the provisions contained in this Agreement is held to be invalid, illegal or unenforceable in any respect, then such provision shall be ineffective only to the extent of such prohibition or invalidity, and the validity, legality, and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby. 24.6. Amendments in Writing. Neither this Agreement nor any provisions hereof may be changed, waived, discharged, or terminated, nor may any consent to the departure from the terms hereof be given, orally (even if supported by new consideration), but only by an instrument in writing signed by all parties to this Agreement. Any waiver or consent so given shall be effective only in the specific instance and for the specific purpose for which given. 24.7. Waiver. No failure to exercise and no delay in exercising any right, power, or remedy hereunder shall impair any right, power, or remedy which Lender may have, nor shall any such delay be construed Page 25 of 32 to be a waiver of any of such rights, powers, or remedies, or any acquiescence in any breach or default hereunder; nor shall any waiver by Lender of any breach or default by Borrower hereunder be deemed a waiver of any default or breach subsequently occurring. All rights and remedies granted to Lender hereunder shall remain in full force and effect notwithstanding any single or partial exercise of, or any discontinuance of action begun to enforce, any such right or remedy. The rights and remedies specified herein are cumulative and not exclusive of each other or of any rights or remedies which Lender would otherwise have. Any waiver, permit, consent or approval by Lender of any breach or default hereunder must be in writing and shall be effective only to the extent set forth in such writing and only as to that specific instance. 24.8. Survival. All representations, warranties, and agreements herein contained shall be effective so long as any portion of this Agreement remains executory. 24.9. Continuing Obligations. No termination of this Agreement or the other Loan Documents shall relieve or discharge Borrower of its respective duties, obligations and covenants until all Borrower's Obligations under this Agreement and the other Loan Documents have been fully and finally discharged and paid, and Lender's continuing security interest in the Collateral and the rights and remedies of Lender hereunder, under the other Loan Documents and applicable law and procedures established by Lender in connection with its lending operations from time to time, whether pursuant to a procedure manual or otherwise, shall remain in effect until all such Obligations have been fully and finally discharged and paid. 24.10. Counterparts; Telefacsimile Execution. This Agreement may be signed in any number of counterparts, each of which shall be an original, with the same effect as if all signatures were upon the same instrument. Delivery of an executed counterpart of the signature page to this Agreement by telefacsimile shall be effective as delivery of a manually executed counterpart of this Agreement, and any party delivering such an executed counterpart of the signature page to this Agreement by telefacsimile to any other party shall thereafter also promptly deliver a manually executed counterpart of this Agreement to such other party, provided that the failure to deliver such manually executed counterpart shall not affect the validity, enforceability, or binding effect of this Agreement. 24.11. Revival and Reinstatement of Obligations. If the incurrence or payment of the Obligations by Borrower or any Guarantor or the transfer by either or both of such parties to Lender of any property of either or both of such parties should for any reason subsequently be declared to be void or voidable under any state or federal law relating to creditors' rights, including provisions of the Bankruptcy Code relating to fraudulent conveyances, preferences, and other voidable or recoverable payments of money or transfers of property (individually or collectively, a "Voidable Transfer"), and if Lender is required to repay or restore, in whole or in part, any such Voidable Transfer, or elects to do so upon the reasonable advice of its counsel, then, as to any such Voidable Transfer, or the amount thereof that Lender is required or elects to repay or restore, and as to all reasonable costs, expenses, and attorneys' fees of Lender related thereto, the liability of Borrower or such Guarantor automatically shall be revived, reinstated, and restored and shall exist as though such Voidable Transfer had never been made. 24.12. Supplementary Terms. The terms and conditions of the Loan Documents shall supplement the terms hereof, except to the extent otherwise specifically provided herein. 24.13. Integration. This Agreement, together with the Loan Documents, embodies the entire agreement and understanding among and between the parties hereto, and supersedes all prior or contemporaneous agreements and understandings between said parties, verbal or written, express or implied, relating to the subject matter hereof. No promises of any kind have been made by Lender or any third party to induce Borrower to execute this Agreement. No course of dealing, course of performance or trade usage, and no parol evidence of any nature, shall be used to supplement or modify any terms of this Agreement. 24.14. Conflict With Other Agreements. Unless otherwise expressly stated in any other agreement between Lender and Borrower, if a conflict exists between the provisions of this Agreement and the provisions of such other agreement, the provisions of this Agreement shall control. 24.15. Term Loan Documents Executed Concurrently Herewith, If Any. Concurrently with the execution of this Agreement, Borrower may be executing an Equipment Security Agreement or other applicable security agreement and a Secured Promissory Note (the "Term Loan") and related documents (collectively, the "Term Loan Documents"). 25. Cross-Collateral. Any Collateral pledged to Lender to secure any obligation of Borrower shall also secure any other obligation of Borrower to Lender except that any Real Property Collateral pledged to secure any obligation of Borrower shall only secure any other obligation of Borrower if Lender specifically so agrees in writing. 26. Cross-Payment; Right to Reserve. Lender may, in its discretion, make Advances under one loan to make any payments due from Borrower to Lender under any other loan. Lender may also, in its sole discretion, reserve under one loan for amounts due under any other loan. Page 26 of 32 27. Cross-Defaults. An Event of Default under this Agreement shall be an Event of Default under each of the Loan Documents, and vice versa. This Agreement is subject to the terms and conditions set forth in ADDENDUM A attached hereto and made a part hereof. IN WITNESS WHEREOF, the parties hereto have caused this Loan and Security Agreement (Accounts Receivable & Inventory Line of Credit) to be executed as of the date first set forth above. MENDOCINO BREWING COMPANY, INC. By:________________________________________ Yashpal Singh Title: President & CEO RELETA BREWING COMPANY LLC. By:________________________________________ MENDOCINO BREWING COMPANY, INC., MEMBER By: Yashpal Singh, Its: President & CEO BFI BUSINESS FINANCE By:________________________________________ David Drogos Title: President Page 27 of 32 ACKNOWLEDGMENT AND AGREEMENT BY GUARANTOR(S) The Guarantor or Guarantors hereby acknowledge the terms and conditions of the foregoing Loan and Security Agreement (Accounts Receivable and Inventory Line of Credit) and agree to the terms thereof, and further agree to be bound by such terms, including, but not limited to, the terms regarding choice of law and venue and the waiver of the right to a jury trial. __________________________________________________ ----------N/A----------, Guarantor Page 28 of 32 ADDENDUM A TO LOAN AND SECURITY AGREEMENT Pursuant to this Addendum A to Loan and Security Agreement (this "Addendum"), the foregoing Loan and Security Agreement (the "Agreement") by and between BFI BUSINESS FINANCE ("Lender") and MENDOCINO BREWING COMPANY, INC., A CALIFORNIA CORPORATION (SOMETIMES, "MENDOCINO") AND RELETA BREWING COMPANY LLC, A DELAWARE LIMITED LIABILITY COMPANY (SOMETIMES, "RELETA") (Mendocino and Releta are sometimes hereinafter collectively referred to as "Borrower) is hereby amended and/or supplemented by the following terms and conditions, which are incorporated by this reference in the Agreement, as the following additional sections of the Agreement: 28. Notwithstanding any other provision of the Agreement, the term "Borrower" shall not include United Breweries International Limited, UBSN, Ltd., or any right title or interest held by either of them. 29. It shall be a condition precedent to Lender's obligation to make the initial Advance under the Agreement that Savings Bank of Mendocino County ("Savings Bank") shall have committed in writing to extending until May 30, 2006 the current obligations owed by Borrower to Savings Bank . 30. It shall be a condition precedent to Lender's obligation to make the initial Advance under the Agreement that Lender shall have received a letter from United Breweries of America Inc ("UBA") committing to pay on behalf of Mendocino the next two installment payments due on June 30, 2005 for $300,000.00 and on December 31, 2005 for $200,000.00, respectively to House of Daniels, Inc., dba Golden Gate Distributing Company ("GGDC") arising from that certain settlement agreement dated October 27, 2004 between Borrower and GGDC (the "GGDC Settlement Agreement"). Following each installment payment by UBA, Mendocino may execute a promissory note in favor of UBA in an original principal amount equal to such installment payment. Lender hereby consents to the execution of such promissory notes; provided that such promissory notes shall be subordinate to Lender pursuant to Subordination Agreement executed by UBA in favor of Lender in connection with this Agreement. 31. An event of default under the GGDC Settlement Agreement shall be an event of default under the Agreement. 32. Borrower shall timely make all payments required to be made under the terms of that certain Installment Plan of Redemption (the "Installment Plan") with the Treasurer-Tax Collector for Ukiah County, California. and shall provide Lender with evidence of making such payment within five (5) days of the date thereof. 33. Borrower represents and warrants that it has paid all sums currently owing under the Installment Plan . 34. Borrower represents and warrants that the current balance owing under the Installment Plan is Four Hundred Thirty Thousand Eight Hundred Seventy Four and 20/100 Dollars ($ 430,874.20). 35. Borrower is seeking to refinance that certain real property (the "Property") commonly known as 1601 Airport Road, Ukiah, California (the "Property Refinance") and the equipment owned by Releta (the "Equipment Refinance"), for which consent to refinance is hereby given. A portion of the proceeds resulting from the Property Refinance or the Equipment Refinance shall be used to pay all property taxes due and owed to Mendocino County under the Installment Plan, with evidence of same to be provided to BFI. 36. Any shortfall on the payoff to The CIT Group/Business Credit, Inc. ("CIT") resulting from the difference between CIT's payoff quote and the funds available to be advanced on the Funding Date to Borrower by Lender under the Agreement shall be reflected in a Secured Promissory Note to be executed by Mendocino and Releta concurrently with the execution of the Agreement. 37. No payments shall be made or any assets transferred by or from Mendocino or Releta to any of their respective subsidiaries or affiliates other than Mendocino or Releta. Mendocino and Releta shall not guarantee nor incur any liability for the obligations of any of their respective subsidiaries or affiliates. 38. It shall be a condition precedent to Lender's obligation to make the initial Advance under the Agreement that Lender shall have received Temporary Trademark License Agreements, each in form and content satisfactory to Lender, from Mendocino, Releta and Kingfisher Breweries America, Inc. 39. It shall be a condition precedent to Lender's obligation to make the initial Advance under the Agreement that USBN shall have executed and delivered to Lender an Agreement Regarding Brewing License in form and content satisfactory to Lender. 40. It shall be a condition precedent to Lender's obligation to make the initial Advance under the Agreement that GGDC shall have executed a Subordination Agreement in form and content satisfactory to Lender. 41. It shall be a condition precedent to Lender's obligation to make the initial Advance under the Agreement that Savings Bank of Mendocino shall have executed a Mutual Lien Subordination Agreement in form and content satisfactory to Lender. 42. It shall be a condition precedent to Lender's obligation to make the initial Advance under the Agreement that UBA shall have signed a Subordination Agreement in form and content satisfactory to Lender. CAlsa Page 29 of 32 43. Within thirty (30) days of the Closing Date, Borrower shall have executed a Deposit Pledge Agreement in connection with its bank accounts at a bank or other financial institution acceptable to Lender and such bank or financial institution shall have executed a Control Agreement in favor of Lender in connection with such bank accounts. 44. During the term of the Agreement, at such time as Borrower enters into any license agreements with third parties to use any trademarks, Borrower shall so advise Lender and within ten (10) days of the date thereof, such third party shall sign a Temporary Trademark License Agreement in favor of Lender in form and content satisfactory to Lender. 45. Lender hereby acknowledges that it has already received the Loan Fee in the sum of Twenty Thousand and 00/100 Dollars ($ 20,000.00). 46. Notwithstanding the provisions of Section 6.3, Lender will waive the Prepayment Fee after six (6) months from the Closing Date. 47. Within sixty (60) days from the Closing Date, Hiram Walker & Sons, Inc. ("Hiram Walker"), Bridgeport Brewing Company and any third parties which license to Borrower the right to use any trademark shall execute an agreement acknowledging that in the event of a liquidations by Lender of the assets of Borrower, Lender shall have the right to use on a temporary basis, the right to use any trade names that are the subject of an agreement between Borrower and such third party. 48. Notwithstanding any provisions to the contrary, the last sentence in Section 24.2 shall be modified to read as follows: "In connection therewith, subject to written non-disclosure agreements containing such protections for the Borrower as are customary and reasonable, Lender may disclose all documents and information which Lender now has or may hereafter acquire relating to any credit extended by Lender to Borrower, Borrower or its business, any Obligor or the business of any Obligor, or any Collateral." 49. In the event that the Property Refinance shall not have taken place by one hundred and twenty (120) days of the Closing, and if Lender deems itself insecure, Lender may require that Borrower grant Lender a deed of trust against the Property, which deed of trust shall be junior to that of Savings Bank of Mendocino. Page 30 of 32 EXHIBIT A COLLATERAL ACCOUNT Name: BFI Business Finance Bank: City National Bank Address: 2001 North Main Street, Suite 200 Walnut Creek, California 94596 COLLATERAL CONTROL ACCOUNT Name: N/A - Collateral Control Account Bank: ----------N/A---------- Address: ----------N/A---------- ----------N/A---------- POST OFFICE BOX Name: BFI Business Finance Address: P.O. Box 225 Santa Clara, California 95052-0225 Page 31 of 32 Schedule A List of Fictitious Names - -------------------------------------------------------------------------------- Mendocino Brewing Company & Releta Brewing Company LLC DBA's - -------------------------------------------------------------------------------- NAME HOW USED & OWNERSHIP - -------------------------------------- ----------------------------------------- Australian Brewing Company Mendocino DBA Expired (Feb 1, 2004) Releta DBA Filed 1/27/1999 - -------------------------------------- ----------------------------------------- Brooklyn Brewery Registered DBA for Releta - -------------------------------------- ----------------------------------------- CALIFORNIA CIDER CO Mendocino DBA Registered through April 1, 2009 - -------------------------------------- ----------------------------------------- CELEBRATED ALES BREWING CO Mendocino DBA Registered through October 1, 2004 - -------------------------------------- ----------------------------------------- Harlem Brewing Company Registered DBA for Releta - -------------------------------------- ----------------------------------------- Kingfisher America Registered DBA for Releta - -------------------------------------- ----------------------------------------- Kingfisher Brewing Company Mendocino DBA Registered through June 1, 2006 Releta DBA Filed 4/30/2001 - -------------------------------------- ----------------------------------------- Mendocino Brewing Company Registered DBA for Releta - -------------------------------------- ----------------------------------------- New Haven Brewing Registered DBA for Releta - -------------------------------------- ----------------------------------------- Olde Richmond Brewing Company Registered DBA for Releta - -------------------------------------- ----------------------------------------- Olde Saratoga Brewing Company Registered DBA for Releta - -------------------------------------- ----------------------------------------- Panorama Beer Co. Mendocino DBA Registered through September 1, 2005 - -------------------------------------- ----------------------------------------- River Trent Brewing Co. Mendocino DBA Registered through August 1, 2005 - -------------------------------------- ----------------------------------------- Sacketts Harbor Brewing Company Registered DBA for Releta Filed 1/27/1999 - -------------------------------------- ----------------------------------------- Saratoga Gaming & Racing Registered DBA for Releta Filed 3/16/2004 - -------------------------------------- ----------------------------------------- Shmaltz Brewing Company Mendocino DBA Registration through April 1, 2009, Registered DBA for Releta Filed 2/27/2003 - -------------------------------------- ----------------------------------------- Southampton Bottling Registered DBA for Releta Filed 8/10/2004 - -------------------------------------- ----------------------------------------- SPANISH PEAKS BREWING CO Mendocino DBA Registered through June 16, 2006, Registered DBA for Releta Filed 2/27/2003 - -------------------------------------- ----------------------------------------- Streich's Brewing Company Registered DBA for Releta Filed 10/16/2000 - -------------------------------------- ----------------------------------------- Ten Springs Brewing Company Registered DBA for Releta - -------------------------------------- ----------------------------------------- Trout Brook BrewHouse Releta DBA Filed 11/16/2000 - -------------------------------------- ----------------------------------------- Page 32 of 32 EX-21 3 tex21-7500.txt EX-21 Exhibit 21.1 Subsidiaries of the Registrant Mendocino Brewing Company, Inc. has the following subsidiaries. 1. United Breweries International (U.K.) Limited ("UBI"), a company organized under the laws of England and Wales 2. UBSN, Ltd. (a wholly-owned subsidiary of UBI).; a company organized under the laws of England and Wales and 3. Releta Brewing Company, LLC, d/b/a Ten Springs Brewery, a Delaware limited liability company EX-31.1 4 tex31_1-7500.txt EX-31.1 EXHIBIT 31.1 STATEMENT OF PRINCIPAL EXECUTIVE OFFICER I, Yashpal Singh, certify that: 1. I have reviewed this Amendment no. 1. to the Annual Report on Form 10-K/A of Mendocino Brewing Company, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date August 31, 2005 /s/ Yashpal Singh ------------------------------------------------ Yashpal Singh, President, Director and Chief Executive Officer EX-31.2 5 tex31_2-7500.txt EX-31.2 EXHIBIT 31.2 STATEMENT OF PRINCIPAL FINANCIAL OFFICER I, N. Mahadevan, certify that: 1. I have reviewed this Amendment no. 1 to the Annual Report on Form 10-K/A of Mendocino Brewing Company, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls over financial reporting. Date: August 31, 2005 /s/ N. Mahadevan ---------------------------------------- N. Mahadevan, Chief Financial Officer EX-32.1 6 tex32_1-7500.txt EX-32.1 EXHIBIT 32.1 CERTIFICATION PURSUANT TO TITLE 18, UNITED STATES CODE, SECTION 1350 In connection with the Amendment No. 1 to the Annual Report of Mendocino Brewing Company, Inc. (the "Company") on Form 10-K/A for the annual period ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Yashpal Singh, Chief Executive Officer of the Company, certify, pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Date: August 31, 2005 /s/ Yashpal Singh ---------------------------------------- Name: Yashpal Singh Title: President, Director and Chief Executive Officer EX-32.2 7 tex32_2-7500.txt EX-32.2 EXHIBIT 32.2 CERTIFICATION PURSUANT TO TITLE 18, UNITED STATES CODE, SECTION 1350 In connection with the Amendment No. 1 to the Annual Report of Mendocino Brewing Company, Inc. (the "Company") on Form 10-K/A for the annual period ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, N. Mahadevan, Chief Financial Officer of the Company, certify, pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. Date: August 31, 2005 /s/ N. Mahadevan ---------------------------------------- Name: N. Mahadevan Title: Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----