-----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, I6s6t5WAY5I9eygHGiVcYlEGOi29Lc0Yj76aIeLilIWGa7tKZTJzlUsq5Oy7TgQM l0rUZJ9N2wOsGXB01uzpPQ== 0001188112-06-002518.txt : 20060814 0001188112-06-002518.hdr.sgml : 20060814 20060814165403 ACCESSION NUMBER: 0001188112-06-002518 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20060630 FILED AS OF DATE: 20060814 DATE AS OF CHANGE: 20060814 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13636 FILM NUMBER: 061031505 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-Q 1 t11110.txt FORM-10Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006 ------------- |_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ---------------------- ------------------ Commission file number 1-13636 MENDOCINO BREWING COMPANY, INC. (Exact name of Registrant as Specified in its Charter) CALIFORNIA 68-0318293 (State or Other Jurisdiction of (IRS Employer Incorporation or Organization) Identification No.) 1601 AIRPORT ROAD, UKIAH, CA 95482 (Address of principal executive offices) (707) 463-6610 (Registrant's Telephone Number, Including Area Code) NOT APPLICABLE (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, see definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (check one) Large Accelerated Filer |_| Accelerated Filer |_| Non-Accelerated Filer |X| Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X ] APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: The number of shares of the issuer's common stock outstanding as of August 14, 2006 is 11,473,914. 1 PART I ITEM 1. FINANCIAL STATEMENTS. ---------------------
MENDOCINO BREWING COMPANY, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) JUNE 30, DECEMBER 31, 2006 2005 -------------------- -------------------- ASSETS (unaudited) (audited) CURRENT ASSETS Cash $ 175,500 $ 247,700 Accounts receivable, allowance for doubtful accounts of $608,800 and $54,900, respectively 7,470,200 7,051,500 Inventories 1,270,200 1,151,400 Prepaid expenses 757,300 548,500 -------------------- -------------------- Total Current Assets 9,673,200 8,999,100 -------------------- -------------------- PROPERTY AND EQUIPMENT 13,207,600 13,185,600 -------------------- -------------------- OTHER ASSETS Deferred income taxes 124,800 116,000 Deposits and other assets 165,700 179,200 Intangibles net of amortization 74,100 77,500 -------------------- -------------------- Total Other Assets 364,600 372,700 -------------------- -------------------- Total Assets $ 23,245,400 $ 22,557,400 ==================== ==================== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Lines of credit $ 4,494,100 $ 3,774,000 Note payable 576,200 576,200 Accounts payable 6,302,500 5,491,800 Accrued liabilities 1,760,200 1,714,800 Current maturities of notes to related parties 110,900 103,100 Current maturities of obligations under long-term debt 289,600 284,400 Current maturities of obligations under capital leases 129,100 131,600 -------------------- -------------------- Total Current Liabilities 13,662,600 12,075,900 LONG-TERM LIABILITIES Notes to related party 3,194,100 3,171,000 Long term debt, less current maturities 2,096,900 2,314,900 Obligations under capital lease less current maturities 146,500 121,500 -------------------- -------------------- Total Long-Term Liabilities 5,437,500 5,607,400 Total Liabilities 19,100,100 17,683,300 -------------------- -------------------- STOCKHOLDERS' EQUITY Preferred stock, Series A, no par value, with aggregate liquidation preference of $227,600;10,000,000 shares authorized, 227,600 shares issued and outstanding 227,600 227,600 Common stock, no par value:30,000,000 shares authorized, 11,473,914 shares issued and outstanding 14,747,300 14,747,300 Accumulated comprehensive income 87,000 130,400 Accumulated deficit (10,916,600) (10,231,200) -------------------- -------------------- Total Stockholders' Equity 4,145,300 4,874,100 -------------------- -------------------- Total Liabilities and Stockholders' Equity $ 23,245,400 $ 22,557,400 ==================== ==================== See accompanying notes to these condensed financial statements.
2 MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED June 30 June 30 2006 2005 2006 2005 ------------ ------------ ------------ ------------ SALES $ 8,504,200 $ 8,408,800 $ 15,932,300 $ 15,814,900 EXCISE TAXES 175,600 168,200 331,600 317,400 ------------ ------------ ------------ ------------ NET SALES 8,328,600 8,240,600 15,600,700 15,497,500 COST OF GOODS SOLD 5,846,900 5,538,400 10,860,200 10,524,800 ------------ ------------ ------------ ------------ GROSS PROFIT 2,481,700 2,702,200 4,740,500 4,972,700 ------------ ------------ ------------ ------------ OPERATING EXPENSES Marketing and distribution 1,104,700 1,276,800 2,363,200 2,593,000 General and administrative 1,562,100 969,300 2,538,200 1,872,500 ------------ ------------ ------------ ------------ TOTAL OPERATING EXPENSES 2,666,800 2,246,100 4,901,400 4,465,500 ------------ ------------ ------------ ------------ INCOME (LOSS) FROM OPERATIONS (185,100) 456,100 (160,900) 507,200 ------------ ------------ ------------ ------------ OTHER INCOME (EXPENSE) Other income 14,200 36,400 16,600 41,000 Profit (Loss) on sale of equipment -- (5,900) (1,100) (9,200) Interest expense (285,200) (233,000) (539,600) (453,600) ------------ ------------ ------------ ------------ TOTAL OTHER EXPENSES (271,000) (202,500) (524,100) (421,800) ------------ ------------ ------------ ------------ INCOME (LOSS) BEFORE INCOME TAXES (456,100) 253,600 (685,000) 85,400 PROVISION FOR INCOME TAXES 400 41,500 400 71,700 ------------ ------------ ------------ ------------ NET INCOME (LOSS) $ (456,500) $ 212,100 $ (685,400) $ 13,700 ------------ ------------ ------------ ------------ OTHER COMPREHENSIVE (LOSS), net of tax Foreign Currency Translation Adjustment (37,100) (76,100) (43,400) (85,400) ------------ ------------ ------------ ------------ COMPREHENSIVE INCOME (LOSS) $ (493,600) $ 136,000 $ (728,800) $ (71,700) ============ ============ ============ ============ NET INCOME (LOSS) PER COMMON SHARE $ ( 0.04) $ 0.02 $ (0.06) $ 0.00 ============ ============ ============ ============ DILUTED NET INCOME (LOSS) PER COMMON SHARE $ (0.04) $ 0.02 $ (0.06) $ 0.00 ============ ============ ============ ============
See accompanying notes to these condensed financial statements. 3
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30 2006 2005 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (Loss) $(685,400) $ 13,700 Adjustments to reconcile net income (loss) to net cash from operating activities: Depreciation and amortization 471,200 453,800 Allowance for doubtful accounts 554,300 9,000 Loss (Profit) on sale of assets 1,100 9,200 Interest accrued on related party notes 87,100 63,200 Changes in: Accounts receivable (517,700) 275,300 Inventories (118,800) 37,200 Prepaid expenses (181,000) (425,300) Deposits and other assets (28,800) 30,900 Accounts payable 503,800 (264,900) Accrued liabilities (13,600) (611,900) Income taxes payable -- 69,900 --------- --------- Net cash used in operating activities: 72,200 (339,900) --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of property, equipment, and leasehold (287,300) (396,700) improvements Proceeds from sale of fixed assets 3,600 73,100 --------- --------- Net cash used in investing activities: (283,700) (323,600) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net borrowing on line of credit 548,100 704,600 Repayment on long-term debt (320,200) (331,000) Borrowings on related party debt -- 400,000 Payments on obligation under capital leases (82,900) (59,100) --------- --------- Net cash used in financing 145,000 714,500 --------- --------- activities: EFFECT OF EXCHANGE RATE CHANGES ON CASH (5,700) (52,700) --------- --------- NET CHANGE IN CASH (72,200) (1,700) --------- (1,700) CASH, beginning of period 247,700 526,600 CASH, end of period $ 175,500 $ 524,900 ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION Cash paid during the period for: Interest $ 452,500 $ 390,400 ========= ========= Income taxes $ 400 $ -- ========= ========= Non-cash investing activity Seller Financed equipment $ 90,900 $ 29,500 ========= ========= See accompanying notes to these condensed financial statements.
4 MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2006 (UNAUDITED) 1. DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------------------------------------ DESCRIPTION OF OPERATIONS - ------------------------- Mendocino Brewing Company, Inc., ("the Company" or "MBC"), has operating subsidiaries, Releta Brewing Company, ("Releta"), and United Breweries International, Limited (UK), ("UBIUK"). In the United States, MBC and its subsidiary, Releta, 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, and MBC holds the license to distribute Kingfisher Lager in the US. The Company's UK subsidiary, 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. BASIS OF PRESENTATION AND ORGANIZATION - --------------------------------------- The financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The financial statements and notes are representations of the management and the Board of Directors, who are responsible for their integrity and objectivity. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, except as otherwise indicated, considered necessary for a fair presentation of the financial condition, results of operations and cash flows for the periods presented. These condensed unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's most recent Annual Report on Form 10-K, - 5 - as filed with the Securities and Exchange Commission, which contains additional financial and operating information and information concerning the significant accounting policies followed by the Company. Operating results for the six months ended June 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006 or any future period. SIGNIFICANT ACCOUNTING POLICIES There have been no significant changes in the Company's significant accounting policies during the six months ended June 30, 2006 as compared to what was previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2005, except for the adoption of SFAS No. 123 (revised 2004). CASH AND CASH EQUIVALENTS, SHORT AND LONG-TERM INVESTMENTS - ----------------------------------------------------------- For purposes of cash flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents, those with original maturities not greater than three months and current maturities less than twelve months from the balance sheet date are considered short-term investments, and those with maturities greater than twelve months from the balance sheet date are considered long-term investments. Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents. Substantially all of the Company's cash and cash equivalents are deposited with large commercial banks in the US and the UK. DEFERRED FINANCING COSTS - ------------------------ Costs relating to obtaining financing are capitalized and amortized over the term of the related debt using the straight-line method. Deferred financing costs were $40,500, and the related accumulated amortization at June 30, 2006 was $23,000. Amortization of deferred financing costs charged to operations was $1,400 for the six months ended June 30, 2006, and 2005. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations. 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. Wholesale distributors account for substantially all accounts receivable; therefore, this risk concentration is limited due to the number of distributors and the laws - 6 - regulating the financial affairs of distributors of alcoholic beverages. As of June 30, 2006, the Company has approximately $158,100 in cash deposits and $5,580,200 of accounts receivable due from customers located in the United Kingdom. INCOME TAXES - ------------ The Company accounts for its income taxes using the Financial Accounting Standards Board Statements of Financial Accounting Standards No. 109, "Accounting for Income Taxes," which requires the establishment of a deferred tax asset or liability for the recognition of future deductible or taxable amounts and operating loss and tax credit carryforwards. Deferred tax expense or benefit is recognized as a result of timing differences between the recognition of assets and liabilities for book and tax purposes during the year. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are recognized for deductible temporary differences and operating loss, and tax credit carryforwards. A valuation allowance is established to reduce that deferred tax asset if it is "more likely than not" that the related tax benefits will not be realized. Management believes that sufficient uncertainty exists regarding the future realization of deferred tax assets and, accordingly, a full valuation allowance has been provided against net deferred tax assets. Tax expense has taken into account any change in the valuation allowance for deferred tax assets where the realization of various deferred tax assets is subject to uncertainty. STOCK-BASED COMPENSATION - ------------------------ Prior to the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)"), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"). Under the intrinsic value method that was used to account for stock-based awards prior to January 1, 2006, which had been allowed under the original provisions of Statement 123, no stock compensation expense had been recognized in the Company's statement of operations as the exercise price of the Company's stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant. On January 1, 2006, the Company adopted SFAS 123(R) which requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors, including employee stock options and employee stock purchases, based on estimated fair values. SFAS 123(R) supersedes the Company's previous accounting for share-based awards under APB 25 for periods beginning in 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R). The - 7 - Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of the beginning of the Company's current year. The Company's financial statements as of and for the six months ended June 30, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company's financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock compensation expense recognized during the period is based on the value of share-based awards that are expected to vest during the period. Stock compensation expense recognized in the Company's statement of operations for 2006 includes compensation expense related to share-based awards granted prior to January 1, 2006 that vested during the current period based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123. Stock compensation expense during the current period also includes compensation expense for the share-based awards granted subsequent to January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). As stock compensation expense recognized in the statement of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the Company's pro forma information required under SFAS 123 for the periods prior to 2006, forfeitures were estimated and factored into the expected term of the options. The Company's determination of estimated fair value of share-based awards utilizes the Black-Scholes option-pricing model. The Black-Scholes model is affected by the Company's stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company's expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. SFAS 123(R) requires the calculation of the beginning balance of the pool of excess tax benefits (additional paid in capital pool or "APIC pool") available to absorb tax deficiencies recognized subsequent to its adoption. SFAS 123(R) states that this beginning APIC pool shall include the net excess tax benefits that would have arisen had the company adopted the original Statement 123. FASB Staff Position ("FSP") 123(R)-3 provides a simplified method for determining this APIC pool, which the Company may elect to adopt up to one year from its initial adoption of SFAS 123(R). The Company has not yet determined whether to elect the simplified method for determining its APIC pool as provided in FSP No. 123(R)-3. STOCK-BASED COMPENSATION NON-EMPLOYEES - -------------------------------------- The company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No 123(R) and Emerging Issues Task Force - 8 - ("EITF") No 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services. In 2006 and 2005, the Company did not grant any options or warrants. Additionally, as of January 1, 2005, all outstanding stock options were fully vested. BASIC AND DILUTED EARNINGS (LOSS) PER SHARE - ------------------------------------------- In accordance with SFAS No. 128, "Earnings Per Share," the basic earnings (loss) per share is computed by dividing the loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. Basic net loss per share excludes the dilutive effect of stock options or warrants and convertible notes. Diluted net loss per share was the same as basic net loss per share for the three and six months ended June 30, 2006, since the effect of any potentially dilutive securities is excluded, as they are anti-dilutive due to the Company's net losses. In 2006, all potentially dilutive securities were non-dilutive.
Three months ended Six months ended ------------------------------------ ---------------------------------- 6/30/2006 6/30/2005 6/30/2006 6/30/2005 ---------------- ---------------- ---------------- -------------- Net income (loss) $ (456,500) 212,100 $ (685,400) 13,700 Weighted average common shares outstanding 11,473,914 11,473,914 11,473,914 11,473,914 Basic net income (loss) per share $ (0.04) 0.02 $ (0.06) 0.00 Diluted net income (loss) per share Net Income (loss) $ (456,500) 212,100 $ (685,400) 13,700 Interest expense on convertible notes $ - 35,000 - 63,200 payable Income for purpose of computing diluted $ (456,500) 247,100 $ (685,400) 76,900 net income per share Weighted average common shares outstanding 11,473,914 11,473,914 11,473,914 11,473,914 Diluted stock option - - - - Assumed conversion of convertible notes - - - - payable Weighted average common shares outstanding 11,473,914 11,473,914 11,473,914 11,473,914 for the purpose of computing diluted net income (loss) per share Diluted net income (loss) per share $ (0.04) 0.02 $ (0.06) 0.00
- 9 - The potential shares, which are excluded from the determination of basic and diluted net loss per share as their effect is anti-dilutive, are as follows:
----------------------------------------------------- June 30, 2006 June 30, 2005 ------------------------ ------------------------- Options to purchase common stock 240,385 340,385 Convertible note 1,759,500 1,648,881 ------------------------ ------------------------- Potential equivalent shares excluded 1,517,318 1,989,266 ======================== ==========================
Diluted net loss per share for the six months ended June 30, 2006 does not include the effect of 240,385 common shares related to options (none of which were in-the-money with a weighted average exercise price of $0.52) because their effect is anti-dilutive. Diluted net loss per share for the six months ended June 30, 2006 also does not include the effect of 1,759,500 common shares related to the 10% Convertible Notes with an average conversion price of $1.50 per share. Diluted net income per share for the six months ended June 30, 2005 does not include the effect of 340,385 common shares related to options (none of which were in-the-money with a weighted average exercise price of $0.73) because their effect is anti-dilutive. Diluted net loss per share for the six months ended June 30, 2005 also does not include the effect of 1,648,881 common shares related to the 10% Convertible Notes with an average conversion price of $1.50 per share. 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 June 30, 2006 and December 31, 2005, and the statements of operations were translated at the average exchange rates for the quarters and six months ended June 30, 2006 and 2005. 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 June 30, 2006 and December 31, 2005, and its cash flows were translated at the average exchange rates for the six months ended June 30, 2006 and 2005. 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 includes having the Company make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. The amounts estimated could differ from actual results. Significant estimates include the allowance for bad debts, depreciation and amortization periods, and the future utilization of deferred tax assets. The Company has determined that deferred tax assets associated with net operating loss carryforwards in the US may expire prior to utilization. The Company has placed a valuation allowance on these assets in the US. - 10 - 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. The components of other comprehensive income for the three months and six months ended June 30, 2006 and 2005 are reflected as a separate item in the statement of operations. REPORTABLE SEGMENTS - ------------------- The Company manages its operations through three business segments: brewing operations, tavern and tasting room operations (domestic) and distributor operations (European Territory). The international business segment sells the Company's products outside the U.S. The Company evaluates performance based on net operating profit. Where applicable, portions of the administrative function expenses are allocated between the operating segments. The operating segments do not share manufacturing or distribution facilities. In the event any materials and/or services are provided to one operating segment by the other, the transaction is valued according to the company's transfer policy, which approximates market price. The costs of operating the manufacturing plants are captured discretely within each segment. The Company's property, plant and equipment, inventory, and accounts receivable are captured and reported discretely within each operating segment. RECLASSIFICATIONS - ----------------- Certain amounts in the prior periods presented have been reclassified to conform to the current period financial statement presentation. These reclassifications have no effect on previously reported net loss. RECENT ACCOUNTING PRONOUNCEMENTS - -------------------------------- In February 2006, FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments". SFAS No. 155 amends SFAS No 133, "Accounting for Derivative Instruments and Hedging Activities", and SFAF No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 155, permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interest in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the - 11 - form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on the qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of the Company's first fiscal year that begins after September 15, 2006. The Company does not believe adoption of SFAS No. 155 will have any material effect on its unaudited condensed consolidated financial position, results of operations or cash flows. In March 2006, the FASB issued SFAS No. 156, ACCOUNTING FOR SERVICING OF FINANCIAL ASSETS--AN AMENDMENT OF FASB STATEMENT NO. 140. Companies are required to apply SFAS No. 156 as of the first annual reporting period that begins after September 15, 2006. The Company does not believe adoption of SFAS No. 156 will have a material effect on its unaudited condensed consolidated financial position, results of operations or cash flows. In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 provides guidance for the recognition, derecognition and measurement in financial statements of tax positions taken in previously filed tax returns or tax positions expected to be taken in tax returns. FIN 48 requires an entity to recognize the financial statement impact of a tax position when it is more likely than not that the position will be sustained upon examination. If the tax position meets the more-likely-than-not recognition threshold, the tax effect is recognized at the largest amount of the benefit that is greater than fifty percent likely of being realized upon ultimate settlement. The Company will be required to adopt FIN 48 as of January 1, 2007, with any cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of FIN 48 and has not yet determined the effect on its earnings or financial position. 2. LIQUIDITY AND MANAGEMENT PLANS ------------------------------ At June 30, 2006, the Company had cash and cash equivalents of $175,500, a working capital deficit of $ 3,989,400 and an accumulated deficit of $10,916,600. Additionally, the Company has a history of past losses as infrastructure costs were incurred in advance of obtaining customers. Management has taken several actions to ensure that the Company will have sufficient cash for its working capital needs through June 30, 2007, including obtaining a secured line of credit, and reductions in discretionary expenditures, and additional debt financing. The Company refinanced a real estate loan on July 3, 2006 for $3,000,000 and repaid then outstanding loans from Savings Bank of Mendocino County ("SBMC"). In addition, the Company borrowed $350,000 from - 12 - SBMC and paid off the entire outstanding amount due for its delinquent property taxes. Management believes that these actions will enable the Company to meet its working capital needs through June 30, 2007. The Company is pursuing other refinancing opportunities to augment working capital. 3. INVENTORIES ----------- Inventories are stated at the lower of average cost or market and consist of the following: 30-JUN-06 31-DEC-05 ---------- ---------- Raw Materials $ 473,600 $ 447,900 Beer-in-process 189,900 143,900 Finished Goods 588,200 539,800 Merchandise 18,500 19,800 ---------- ---------- TOTAL $1,270,200 $1,151,400 ========== ========== 4. LINE OF CREDIT AND NOTE PAYABLE ------------------------------- 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 had an initial term of twelve months, but could 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. On May 6, 2005, the Company used the entire immediately available amount drawable from BFI to pay off the balance remaining outstanding under the CIT Group Line of Credit discussed below. BFI advanced the Company $200,000 under a promissory note on December 31, 2005 payable in weekly installments of $6,665 commencing in January 2006. BFI also advanced the Company an additional amount of $289,938 under another promissory note on April 5, 2006. This note is payable commencing in April 2006 in 18 weekly installments of $3,335 and 22 weekly installments of $10,000. A final installment of $9,908 is due on the maturity date, January 19, 2007. The BFI borrowings carry an interest rate equal to the greater of 9.5%, or the prime rate - 13 - 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%. The borrowings are secured by the collateral set forth in the loan and security agreement entered between MBC and BFI. 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 repaid in full in consecutive monthly installments of $24,700. The Company used the proceeds from the BFI Facility to pay off the entire amount outstanding on May 6, 2005. 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 extended the loan until May 31, 2006. The rate of interest on the loan is prime plus 3%. This loan was repaid on June 3, 2006 using the proceeds received from the Grand Pacific Financing Corporation real estate loan described below. On July 3, 2006, SBMC extended a temporary loan in the principal amount of $350,000 for a period of six months in order to settle the delinquent property taxes, such loan is secured against the equipment at Ukiah brewery. Nedbank Limited, a South African registered company, provided a credit facility of GBP 1,250,000 to UBSN Ltd. ("UBSN"), a wholly-owned subsidiary of United Breweries International (UK) Ltd. ("UBI"), which is in turn wholly-owned by the Company. This facility included a revolving short-term loan, overdraft protection, and foreign exchange services. It was secured by all of the assets of UBSN. On April 26, 2005, the balance remaining outstanding on the Nedbank facility was settled in full using the proceeds from the RBS facility (discussed below). On April 26, 2005, Royal Bank of Scotland ("RBS") provided an invoice discounting facility for a maximum amount of GBP 1,750,000 based on 80% prepayment against qualified accounts receivable related to UBSN's United Kingdom customers. The initial term of the facility was for a period of one year after which the facility may be terminated by either party by providing the other party with six months notice. The facility carries an interest rate of 1.38% above RBS base rate and a service charge of 0.10% of each invoice discounted. The amount outstanding on this line of credit as of June 30, 2006 was approximately $2,571,400. The Company's credit agreement with RBS contains certain financial - 14 - covenants that require, among other things, maintenance of minimum amounts and ratios of working capital; minimum amounts of tangible net worth; and maximum ratio of indebtedness to tangible net worth. As of June 30, 2006, certain financial covenants have not been met, and the bank has agreed in writing to continue RBS's lending relationship with UBSN.
5. LONG-TERM DEBT -------------- Maturities of long-term debt for succeeding years are as follows: June 30, 2006 December 31, 2005 -------------------------- --------------------- 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. (This note was repaid in full on July 3, 2006) $ 2,099,300 $ 2,168,400 Payable to the County of Mendocino in two annual installments of $143,600, maturing April 2008. (This note was repaid in full on July 3, 2006) 287,200 430,900 -------------------------- --------------------- 2,386,500 2,599,300 Less current maturities 289,600 284,400 -------------------------- --------------------- $ 2,096,900 $ 2,314,900 ========================== =====================
On July 3, 2006, MBC obtained a $3.0 million loan from Grand Pacific Financing Corporation("GP"), 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 $27,261 including interest at the rate of 1.75% over the prime rate published by The Wall Street Journal, maturing July 2, 2011 with a balloon payment. The amount of the balloon payment will vary depending on the change in interest rates over the term of the loan. MBC used the proceeds of the loan to repay in full all the then outstanding loans owed to SBMC. 6. NOTES TO RELATED PARTY ---------------------- SUBORDINATED CONVERTIBLE NOTES PAYABLE - -------------------------------------- Notes payable to a related party consist of unsecured 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 were extended until August 2005. UBA may demand payment within 60 days of the end of the extension period but is precluded from doing so - 15 - because the notes are subordinated to long-term debt agreements with Savings Bank of Mendocino County and the BFI line of credit. The BFI Line of Credit matures in May 2007 and the SBMC facility matures in the year 2012. Therefore, the Company will not require the use of working capital to repay any of the UBA notes until the BFI and SBMC facilities are repaid. Accordingly, the entire amount due under the Notes is classified as a long term liability. The amount outstanding on the notes was $2,639,300 and $2,552,200 including $723,900 and $636,800 of accrued interest at June 30, 2006 and December 31, 2005. 5% NOTES PAYABLE - ---------------- Notes payable also includes an unsecured loan from Shepherd Neame Limited payable in annual installments of $100,400 with interest at 5% per year beginning in June 2003 and maturing in December 2012. The amount outstanding (including current maturity) on the note was $665,700 and $721,900 at June 30, 2006 and December 31, 2005. 7. COMMITMENTS AND CONTINGENCIES ----------------------------- LEGAL - ----- The Company is periodically involved in legal actions and claims that arise as a result of events that occur in the normal course of operations. The Company is not currently aware of any legal proceedings or claims that the Company believes will have, individually or in the aggregate, a material adverse effect on the Company's financial position or results of operations. OPERATING LEASES - ---------------- The Company leases many of its operating and office facilities for various terms under long-term, non-cancelable operating lease agreements. The leases expire at various dates through 2009 and provide for renewal options ranging from month-to-month to five year terms. In the normal course of business, it is expected that these leases will be renewed or replaced by leases on other properties. The leases provide for increases in future minimum annual rental payments based on defined increases which are generally meant to correlate with the Consumer Price Index, subject to certain minimum increases. Also, the agreements generally require the Company to pay executory costs (real estate taxes, insurance and repairs). The Company and its subsidiaries have various lease agreements for the brewpub and gift store in Hopland, California; a sales office in Petaluma, 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 leases begin expiring in 2007. - 16 - 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 filling and use 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. 8. RELATED-PARTY TRANSACTIONS -------------------------- MBC and its subsidiaries have entered into or amended several agreements with affiliated and related entities. Among these were a Market Development Agreement, a Distribution Agreement, and a Brewing License Agreement between MBC and UBSN; a Distribution Agreement between UBI and UBSN; a Trademark Licensing Agreement between MBC and Kingfisher of America, Inc.; and a License Agreement between UBI and UB Limited. UBSN is a party to a brewing agreement and a loan agreement with Shepherd Neame Limited ("Shepherd Neame"). Additional information about these transactions may be found in the Company's annual report on Form 10-K for the year ended December 31, 2005. The following table reflects the value of the transactions for the six months ended June 30, 2006 and 2005 and the balances outstanding as of June 30, 2006 and 2005.
2006 2005 ------------------ ------------------ Sales to Shepherd Neame $ 1,573,600 $ 1,497,600 Purchases from Shepherd Neame $ 6,886,100 $ 8,119,700 Expense reimbursement to Shepherd Neame $ 481,700 $ 557,300 Interest expense associated with UBA convertible notes payable $ 87,100 $ 63,200 Accounts payable to Shepherd Neame $ 4,236,700 $ 3,202,200 Accounts receivable from Shepherd Neame $ 632,500 $ 439,400
9. STOCKHOLDERS' EQUITY -------------------- The following table summarizes equity transactions during the six months ended June 30, 2006.
SERIES A PREFERRED STOCK COMMON STOCK OTHER ------------------------ ---------------------------- COMPREHENSIVE INCOME / ACCUMULATED TOTAL SHARES AMOUNT SHARES AMOUNT (LOSS) DEFICIT EQUITY -------- ------------ ---------- -------------- --------------- -------------- ------------- Balance, December 31, 2005 227,600 $ 227,600 11,473,914 $ 14,747,300 $ 130,400 $ (10,231,200) $ 4,874,100 Net Loss - - - - - (685,400) (685,400) Currency Translation Adjustment - - - - (43,400) - (43,400) -------- ------------ ---------- -------------- --------------- -------------- ------------- Balance, June 30, 227,600 $ 227,600 11,473,914 $ 14,747,300 $ 87,000 $ (10,916,600) $ 4,145,300 2006 ======== ============ ========== ============== =============== ============== =============
- 17 - The following table summarizes equity transactions during the six months ended June 30, 2005.
SERIES A PREFERRED STOCK COMMON STOCK OTHER ------------------------ ---------------------------- COMPREHENSIVE INCOME / ACCUMULATED TOTAL SHARES AMOUNT SHARES AMOUNT (LOSS) DEFICIT EQUITY -------- ------------ ---------- -------------- --------------- -------------- ------------- Balance, December 31, 2004 227,600 $ 227,600 11,266,874 $ 14,648,600 $ 194,300 $ (8,916,500) $ 6,154,000 Common stock issued for conversion of debt - - 207,040 98,700 - - 98,700 Net Income - - - - 13,700 13,700 Currency Translation Adjustment - - - - (85,400) - (85,400) -------- ------------ ---------- -------------- --------------- -------------- ------------- Balance, June 30, 2005 227,600 $ 227,600 11,473,914 $ 14,747,300 $ 108,900 $ (8,902,800) $ 6,181,000 ======== ============ ========== ============== =============== ============== =============
Independent outside members of the Board of Directors are compensated for attending Board of Directors and committee meetings. 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. 10. 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 and expire on January 3, 2007. - 18 - GENERAL OPTION INFORMATION The following is a summary of changes to outstanding stock options during the six months ended June 30, 2006:
WEIGHTED AVERAGE AGGREGATE NUMBER OF WEIGHTED AVERAGE REMAINING INTRINSIC SHARE OPTIONS EXERCISE PRICE CONTRACTUAL TERM VALUE -------------- ------------------ ------------------ ------------- Outstanding at December 31, 2005 240,385 $ 0.52 1.00 $ - Granted - - - - Exercised - - - - Forfeited or expired - - - - -------------- ------------------ ------------------ ------------- Outstanding at June 30, 2006 240,385 0.52 0.50 - -------------- ------------------ ------------------ ------------- Vested and expected to vest at June 30, 2006 240,385 0.52 0.50 - -------------- ------------------ ------------------ ------------- Options exercisable at June 30, 2006 240,385 $ 0.52 0.50 $ - ============== ================== ================== =============
The aggregate intrinsic value is nil as of June 30, 2006, based on the Company's closing stock price of $0.19 on that date, and accordingly there is no pretax intrinsic value, which would have been received by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of June 30, 2006 was none. As of June 30, 2006, there was no unrecognized compensation cost. VALUATION AND EXPENSE INFORMATION UNDER SFAS 123(R) There was no stock compensation related to employee stock options under SFAS 123(R) for the six months ended June 30, 2006. In 2006, the Company has not issued any stock based compensation. PRO FORMA INFORMATION UNDER SFAS 123 FOR PERIOD PRIOR TO 2006 The following table illustrates the effect on net income and income per share for the six months ended June 30, 2005 if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. 2005 ------- Net income - as reported $13,700 Compensation expense -- ------- Net income - pro forma $13,700 ======= Income per share - pro forma $ 0.00 ======= 11. SEGMENT INFORMATION ------------------- The Company's business presently consists of three segments. The first is brewing for wholesale to distributors and other retailers. The second consists of distributing alcoholic beverages to retail establishments and restaurants in the United Kingdom and Europe. The third segment consists of beer for sale along with merchandise at the Company's brewpub and retail merchandise store located at the - 19 - Hopland Brewery and at Saratoga Springs brewery. A summary of each segment is as follows:
Six months ended June 30, 2006 Domestic European Retail Corporate & Total Operations Territory Operations Others Sales $ 6,250,400 $ 9,591,300 $ 90,600 $ -- $ 15,932,300 Operating Profit (Loss) 468,300 (640,400) 11,200 -- (160,900) Identifiable Assets 12,737,000 7,976,200 62,100 2,470,100 23,245,400 Depreciation & amortization 220,100 234,800 2,300 14,000 471,200 Capital Expenditures 91,600 286,600 -- -- 378,200
Six months ended June 30, 2005 Domestic European Retail Corporate & Total Operations Territory Operations Others Sales $ 5,732,000 $ 9,988,200 $ 94,700 $ -- $15,814,900 Operating Profit 181,000 318,000 8,200 -- 507,200 Identifiable Assets 12,908,100 8,302,100 102,900 2,450,000 23,763,100 Depreciation & 235,200 200,200 2,500 15,900 453,800 amortization Capital Expenditures 34,200 362,500 -- -- 396,700
- 20 - 12. UNRESTRICTED NET ASSETS ----------------------- The Company's wholly-owned subsidiary, UBI, has undistributed earnings of approximately $604,300 as of June 30, 2006. Under UBSN's line of credit agreement with RBS, distributions and other payments to the Company from its subsidiary are not permitted if the retained earnings drop below approximately $1,750,000. Condensed financial information of the parent company, Mendocino Brewing Company, Inc. together with its other subsidiary, Releta Brewing Company is as follows:
June 30, 2006 December 31, 2005 -------------------------- ------------------------------- (unaudited) (audited) Assets Cash $ 17,400 $ 11,500 Accounts receivable 1,890,000 1,388,500 Inventories 1,270,200 1,151,400 Other current assets 321,300 212,600 -------------------------- ------------------------------- Total current assets 3,498,900 2,764,000 Investment in UBI 1,225,000 1,225,000 Property and equipment 11,539,400 11,682,900 Other assets 230,900 245,700 -------------------------- ------------------------------- Total assets $ 16,494,200 $ 15,917,600 ========================== =============================== Liabilities and Stockholders' Equity Line of credit and note payable $ 2,498,900 $ 2,181,000 Accounts payable 1,888,800 1,486,000 Accrued liabilities 981,200 892,900 Current maturities of debt and leases 318,300 352,800 -------------------------- ------------------------------- Total current liabilities 5,687,200 4,912,700 Intercompany payable to UBI 1,158,300 1,319,500 Long-term debt and capital leases 2,106,900 2,332,700 Notes payable to related party 2,639,300 2,552,300 -------------------------- ------------------------------- Total liabilities 11,591,700 11,117,200 -------------------------- ------------------------------- Stockholders' equity Common stock 14,747,300 14,747,300 Preferred stock 227,600 227,600 Accumulated deficit (10,072,400) (10,174,500) -------------------------- ------------------------------- Total stockholders' equity 4,902,500 4,800,400 -------------------------- ------------------------------- Total liabilities and stockholders' equity $ 16,494,200 $ 15,917,600 ========================== ===============================
- 21 -
12. UNRESTRICTED NET ASSETS (CONTINUED) ------------------------------------ STATEMENTS OF OPERATIONS QUARTER ENDED JUNE 30 SIX MONTHS ENDED JUNE 30 --------------------------------------------------------------------------- 2006 2005 2006 2005 --------------------------------------------------------------------------- (unaudited) (unaudited) (unaudited) (unaudited) Net sales $ 3,157,800 $ 2,992,500 $ 6,009,400 $ 5,509,300 Cost of goods sold 2,178,700 1,936,400 4,142,900 3,721,700 Selling, marketing, and retail expenses 294,100 333,000 608,100 686,500 General and administrative expenses 456,800 482,600 828,900 952,500 --------------------------------------------------------------------------- Income (loss) from operations 228,200 240,500 429,500 148,600 Other income and (expense) 44,200 66,500 77,800 101,000 Interest expense 206,900 177,500 404,800 363,300 Dividend from subsidiary 149,900 149,900 Provision for taxes 400 400 1,800 --------------------------------------------------------------------------- Net profit (loss) $ 65,100 $ 279,400 $ 102,100 $ 34,400 ===========================================================================
Statements of Cash Flows SIX MONTHS ENDED JUNE 30 -------------------------------------------------- 2006 2005 -------------------------------------------------- (unaudited) (unaudited) Cash flows from operating activities $ 201,200 $(543,100) Purchase of property and equipment (91,600) (34,200) Net borrowing (repayment) on line of credit 317,900 24,000 Repayment on long term debt (212,800) (218,600) Payment on obligation under capital lease (47,500) (59,100) Borrowing on related party note 400,000 Net change in payable to UBI (161,300) 152,800 -------------------------------------------------- Increase (decrease) in cash 5,900 (278,200) Cash, beginning of period 11,500 286,000 -------------------------------------------------- Cash, end of period $ 17,400 $ 7,800 ==================================================
13. SUBSEQUENT EVENTS ----------------- On July 3, 2006, Grand Pacific Financing Corporation provided a loan of $3,000,000 for a term of five years secured by a first deed of trust on the Ukiah real property. MBC utilized the proceeds to repay the loans due to SBMC. The unsecured convertible notes owed to UBA are subordinated to the Grand Pacific Financing Corporation loan. On July 3, 2006, SBMC provided a temporary loan of $350,000 for a term of six months secured by equipment at the Ukiah brewery. MBC utilized the proceeds to settle delinquent property taxes in full. - 22 - ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ----------------------------------------------------------------------- OF OPERATIONS. -------------- The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition and liquidity/cash flows of the Company for the six months and three months ended June 30, 2006, compared to the six months and three months ended June 30, 2005. This discussion should be read in conjunction with the Consolidated Financial Statements and Notes included in the company's Annual Report on Form 10-K for the year ended December 31, 2005. In this Report, the term "the Company" and its variants is generally used to refer to Mendocino Brewing Company, Inc. and its subsidiaries, while the term "MBC" is used to refer to Mendocino Brewing Company, Inc. as an individual entity standing alone. FORWARD LOOKING STATEMENTS Various portions of this Quarterly Report, including but not limited to the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations," contain forward-looking information. Such information involves risks and uncertainties that are based on current expectations, estimates and projections about the Company's business, Management's beliefs, and assumptions made by Management. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and variations of those and similar words are intended to identify such forward-looking information. Any forward-looking statements made by the Company are intended to provide investors with additional information with which they may assess the Company's future potential. All forward-looking statements are based on assumptions about an uncertain future and are based on information available at the date such statements are issued. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking information due to numerous factors, including but not limited to: changes in the pricing environment for the Company's products; changes in demand for malt beverage products in different Company markets; changes in distributor relationships or performance, changes in customer preference for the Company's malt beverage products; regulatory or legislative changes; the impact of competition, changes in raw materials prices; availability of financing for operations, changes in interest rates; changes in the company's European beer and/or restaurant business, and other risks discussed elsewhere in this Quarterly Report and from time to time in the Company's 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. The Company undertakes no obligation to update these forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward-looking statements are made or to publicly release the results of any revision to these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements. - 23 - CRITICAL ACCOUNTING POLICIES In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes that the following discussion addresses the Company's most critical accounting policies, which are those that are most important to the portrayal of the Company's financial condition and results. The Company constantly re-evaluates these significant factors and makes adjustments where facts and circumstances dictate. Historically, actual results have not significantly deviated from those determined using the necessary estimates inherent in the preparation of financial statements. Estimates and assumptions include, but are not limited to, customer receivables, inventories, assets held for sale, fixed asset lives, contingencies and litigation. The Company has also chosen certain accounting policies when options were available, including: o The first-in, first-out (FIFO) method to value the majority of the Company's inventories. o The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company's evaluation is based on an estimate of the future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. Long-lived assets are written down to their estimated net fair value calculated using a discounted future cash flow analysis in the event of an impairment. If circumstances related to the Company's long-lived assets change, the Company's valuation of the long-lived assets could materially change. o The Company evaluates the realizability of its deferred tax assets quarterly by assessing the need for and amount of the valuation allowance. This evaluation is based on an assessment of the Company's ability to generate future U.S. taxable income. Results of operations in recent years are considered in the assessment. The Company records a valuation allowance for the portion of its deferred tax assets that do not meet the recognition criteria of SFAS No. 109, "Accounting for Income Taxes." If circumstances related to the Company's ability to generate - 24 - future U.S. taxable income change, the Company's evaluation of its deferred tax assets could materially change. o The Company has adopted EITF - 01-09 "Accounting for Consideration Given by a Vendor to a Customer (including a Reseller of the Vendor's Products)". This EITF requires that certain cash consideration paid to customers for services or placement fees are to be reported as a reduction in revenue rather than as an expense. The Company has reclassified these items on the income statement as a reduction in revenue and as a corresponding reduction in marketing and selling expenses. This reclassification has no impact on net income. CHANGES IN 2006 On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires the measurement and recognition of compensation expense for all share-based awards made to employees and directors, including employee stock options and employee stock purchases, based on estimated fair values. Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Under the intrinsic value method, which had been allowed under the original provisions of Statement 123, no stock compensation expense had been recognized in the Company's statement of operations as the exercise price of the Company's stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant. These accounting policies are applied consistently for all periods presented. The Company's operating results would be affected if other alternatives were used. Information about the impact on operating results is included in the footnotes to the Company's consolidated financial statements. SEGMENT INFORMATION Prior to 2001, the Company's business operations were exclusively located in the United States, where it was divided into two segments, manufacturing and distribution of beer, which accounted for the majority of the Company's gross sales, and retail sales (primarily at the Company's Hopland, California, tavern and merchandise store) which generally accounted for less than 5% of gross sales (by revenue). With the Company's acquisition of United Breweries International (UK) , Ltd. ("UBI") in August 2001, however, the Company gained a new business segment, - 25 - 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 60% and 63% of the Company's gross sales during the first six months of the year 2006 and 2005 respectively, with the Company's United States operations, including manufacturing and distribution of beer as well as retail sales (the "Domestic Territory") accounting for the remaining 40% and 37% during the first six months of the year 2006 and 2005, respectively. With expanded wholesale distribution of beer and the closure of the restaurant at the Hopland facility, Management expects that retail sales, as a percentage of total sales, will decrease proportionally to the expected increase in the Company's wholesale sales. SEASONALITY Sales of the Company's products are somewhat seasonal. Historically, sales volumes in all geographic areas have been comparatively low during the first quarter of the calendar year in both the US market and the Company's European Territory. In the US, sales volumes have been stronger during the second and third quarters and slower again during the fourth quarter, while in the Company's European Territory the fourth quarter has generated the highest sales volume. The volume of sales in any given area may also be affected by local weather conditions. Because of the seasonality of the Company's business, results for any one quarter are not necessarily indicative of the results that may be achieved for the full fiscal year. SUMMARY OF FINANCIAL RESULTS The Company ended the first six months of the year 2006 with a net loss of $685,400, as compared to net income of $13,700 for the same period in 2005. As set forth more fully under "Results of Operations," below, during the first six months of the year 2006 the Company experienced an increase in gross sales of $117,400, or 0.74% as compared to the corresponding period in 2005. Costs of goods sold increased by $335,400, or 3.2%, marketing costs decreased by $229,800, or 8.86%, general and administrative costs increased by $665,700, or 35.5%, and interest expenses increased by $86,000, or 18.96%. RESULTS OF OPERATIONS The following tables set forth, as a percentage of net sales, certain items included in the Company's Statements of Operations. See the accompanying Financial Statements and Notes thereto.
- 26 - STATEMENTS OF OPERATIONS DATA: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, -------------------------------------------------------------------- 2006 2005 2006 2005 % % % % - - - - Sales 102.11 102.04 102.13 102.05 Less Excise taxes 2.11 2.04 2.13 2.05 NET SALES 100.00 100.00 100.00 100.00 Costs of Sales 70.20 67.21 69.61 67.91 GROSS PROFIT 29.80 32.79 30.39 32.09 Marketing 13.26 15.49 15.15 16.73 General and Administrative Expense 18.76 11.76 16.27 12.08 PROFIT (LOSS) FROM OPERATIONS (2.22) 5.53 (1.03) 3.28 Other Income / (Expense) 0.17 0.37 0.10 0.20 Interest Expense (3.42) (2.83) (3.46) (2.93) Income/(Loss) before income taxes (5.47) 3.07 (4.39) 0.55 Provision for income taxes 0.00 0.50 0.00 0.46 NET INCOME / (LOSS) (5.47) 2.57 (4.39) 0.09 Other Comprehensive Income / (loss) (0.45) (0.92) (0.28) (0.55) COMPREHENSIVE INCOME / (LOSS) (5.92) 1.65 (4.67) (0.46)
---------------------------------------- SIX MONTHS ENDED JUNE 30, ---------------------------------------- 2006 2005 BALANCE SHEET DATA: $ $ - - Cash and Cash Equivalents 175,500 524,900 Working Capital (3,989,400) (1,890,400) Property and Equipment 13,207,600 13,306,200 Deposits and Other Assets 364,600 278,000 Total Assets 23,245,400 23,763,100 Long-term Debt (less current maturities) 2,096,900 2,386,600 Capital Lease (less current maturities) 146,500 26,400 Note payable to related parties 3,194,100 3,099,800 Total Liabilities 19,100,100 17,582,100 Accumulated Deficit (10,916,600) (8,902,800) Stockholder's equity 4,145,300 6,181,000
THREE MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE MONTHS ENDED JUNE 30, 2005 NET SALES Overall net sales for the second quarter of 2006 were $8,328,600, an increase of $88,000, or 1.07%, compared to $8,240,600 for the second quarter of 2005. The increase was mainly due to increased sales and increased selling prices. Domestic Operations: Net sales for the second quarter of 2006 were $3,157,800 compared to $2,992,500 for the same period in 2005, an increase of $165,300, or 5.52%. The sales volume increased to 16,755 barrels in the second quarter of 2006 from 15,691 barrels in the second quarter of 2005; a net increase of 1,064 barrels, or 6.78%. The increase was mainly due to an increase of 1,213 barrels of contract brands. Sales of the Company's domestic brands decreased by 243 barrels, however sales of Kingfisher brands increased by 94 barrels. - 27 - EUROPEAN TERRITORY: Net sales for the second quarter of 2006 were ------------------ $5,170,800 (GBP 2,836,900) compared to $5,248,100 (GBP 2,823,900) during the corresponding period of 2005, a decrease of $77,300, or 1.47%. During the second quarter of 2006, UBSN sold 17,153 barrels, compared to 17,059 barrels during the second quarter of 2005, representing an increase of 94 barrels, or 0.55%. Exchange rate fluctuations decreased the financial effect of the Company's growth in sales in its European Territory. When measured from period to period exclusively in Pounds Sterling (which is the basic currency of account for the European Territory), the Company's net sales in its European Territory increased by 0.46%. COST OF GOODS SOLD Cost of goods sold as a percentage of net sales during the second quarter of 2006 was 70.20%, as compared to 67.21% during the corresponding period of 2005, due to increased costs in the United States and in the United Kingdom. DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in ------------------- the United States during the second quarter of 2006 was 68.99%, as compared to 64.71% during the corresponding period of 2005. This increase of 4.28% is mainly the result of increases in raw and packaging material prices and maintenance and wages, which were partly offset by a decrease in depreciation. EUROPEAN TERRITORY: Cost of goods sold as a percentage of net sales in ------------------ the United Kingdom during the second quarter of 2006 was 71.41%, as compared to 69.03% during the corresponding period in 2005 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation), representing an increase as a percentage of net sales of 2.38%. The increase in prices for the Company's products did not fully offset the cost increases in the United Kingdom. GROSS PROFIT As a result of the higher cost of goods sold described above, gross profit for the second quarter of 2006 decreased to $2,481,700, from $2,702,200 during the corresponding period of 2005, representing a decrease of 8.16%. As a percentage of net sales, gross profit during the second quarter of 2006 decreased to 29.8% from 32.79% for the second quarter of 2005. - 28 - OPERATING EXPENSES Operating expenses for the second quarter of the year 2006 were $2,666,800, an increase of $420,700, or 18.73%, as compared to $2,246,100 for the corresponding period of the year 2005. Operating expenses consist of marketing and distribution expenses and general and administrative expenses. MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and distribution expenses consist of salaries and commissions, advertising costs, product and sales promotion costs, travel expenses and related costs and the Company's tavern and tasting room expenses. Such expenses for the second quarter of 2006 were $1,104,700, as compared to $1,276,800 for the second quarter of 2005, representing a decrease of 13.48%. DOMESTIC OPERATIONS: Expenses for the second quarter of 2006 were ------------------- $294,100 compared to $333,000 during the corresponding period of 2005, representing a decrease of $38,900. or 11.68%. As a percentage of net sales in the United States, the expenses decreased to 9.32% during the second quarter of 2006, compared to 11.13% during the corresponding period of 2005. The decrease was mainly due to reduced salary and travel costs resulting from a reduction in staff that occurred in the first half of 2005. EUROPEAN TERRITORY: Expenses for the second quarter of 2006 were ------------------ $810,600 compared to $943,800 during the corresponding period of 2005, representing a decrease of $133,200 or 14.11%. As a percentage of net sales in the United Kingdom, the expenses decreased to 15.68% during the second quarter of 2006 compared to 17.98% during the corresponding period of 2005 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). The decrease resulted mainly from lower freight costs and one-time advertisement campaign expenses incurred in June 2005, partly offset by increase in salaries. GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and administrative expenses were $1,562,100 for the second quarter of the year 2006, representing an increase of $592,800 or 61.16%, over $969,300 for the corresponding period in 2005. These expenses were equal to 18.76% of net sales for the second quarter of the year 2006, as compared to 11.76% for the corresponding period in 2005. DOMESTIC OPERATIONS. Domestic general and administrative expenses were ------------------- $456,800 for the second quarter of the year 2006, representing a decrease of $25,800, or 5.35%, from $482,600 for the second quarter of the year 2005. The decrease was primarily due to the transfer of certain parts of common corporate overhead costs to UBSN and reduction in legal expenses which were partly offset by increases in salaries and loan fees. EUROPEAN TERRITORY. General and administrative expenses related to the ------------------ European Territory were $1,105,300 for the second quarter of the year 2006, representing an increase of $618,600 or 127.10%, when compared to $486,700 - 29 - for the second quarter of the year 2005 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). The increase was mainly due to a provision against bad debts of $554,300 created on account of a customer who earlier had provided a personal guaranty, later filed for liquidation of their operations and a part of common corporate overheads being transferred by MBC to UBSN. OTHER EXPENSES Other expenses for the second quarter of 2006 totaled $271,000, representing an increase of $68,500, or 33.83%, when compared to the second quarter of 2005. The increase was mainly due to higher interest expenses as a result of increased borrowings under the lines of credit and increases in interest rates. INCOME TAXES The Company has a provision for income taxes of $400 for the second quarter of 2006, compared to $41,500 for the second quarter of 2005. The provision for taxes related to the estimated amount of taxes that will be imposed by taxing authorities in the United States. NET PROFIT / LOSS The Company's net loss for the second quarter of 2006 was $456,500, as compared to net profit of $212,100 for the second quarter of 2005. After providing for a negative foreign currency translation adjustment of $37,100 during the second quarter of 2006 (as compared to a negative currency translation adjustment of $76,100 for the same period in 2005), the comprehensive loss for the second quarter of 2006 was $493,600, compared to a net profit of $136,000 for the same period in 2005. SIX MONTHS ENDED JUNE 30, 2006 COMPARED TO SIX MONTHS ENDED JUNE 30, 2005 NET SALES Overall net sales for the first six months of the year 2006 were $15,600,700, an increase of $103,200, or 0.67%, compared to $15,497,500 for the same period in 2005. DOMESTIC OPERATIONS: Domestic net sales for first six months of the year ------------------- 2006 were $6,009,400 compared to $5,509,300 for the same period in 2005, an increase of $500,100 or 9.08%. The sales volume increased to 32,061 barrels during the first six months of the year 2006 from 29,061 barrels in the first six months of the year 2005, representing an increase of 3,000 barrels. Sales of the Company's brands increased by 209 barrels, sales of the Kingfisher brands increased by 852 barrels, and sales of contract brands increased by 1,939 barrels. EUROPEAN TERRITORY: Net sales for the first six months of the year 2006 ------------------- were $9,591,300 (GBP 5,357,700) compared to $9,988,200 (GBP 5,331,300) - 30 - during the corresponding period of 2005, a decrease of 3.97%. During the first six months of the year 2006, UBSN sold 32,554 barrels compared to 32,351 barrels during the first six months of the year 2005, an increase of 203 barrels, or 0.63%. Exchange rate fluctuations when measured in United States dollars decreased the growth percentage as compared to last year. Hence, when the net sales results are compared in Pounds Sterling, there is an increase of 0.5%. COST OF GOODS SOLD Cost of goods sold as a percentage of net sales during the first six months of the year 2006 was 69.61%, as compared to 67.91% during the corresponding period of 2005. DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in -------------------- the United States during the first six months of the year 2006 was 68.94%, as compared to 67.55%, during the corresponding period of 2005, representing an increase as a percentage of net sales of 1.39% that was mainly due to an increase in raw and packaging material costs, an increase in the price of natural gas and higher maintenance expenses that were partly offset by a decrease in depreciation expenses. EUROPEAN TERRITORY: Cost of goods sold as a percentage of net sales in ------------------- the United Kingdom during the first six months of the year 2006 was 70.56%, as compared to 68.52% during the corresponding period in 2005 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation), due to cost increases that were not fully offset by price increases. GROSS PROFIT As a result of the higher cost of goods sold described above, gross profit for the first six months of the year 2006 decreased to $4,740,500, from $4,972,700 during the corresponding period of 2005, representing a decrease of 4.67%. As a percentage of net sales, the gross profit during the first six months of 2006 decreased to 30.39% from that of 32.09% during the corresponding period in 2005. OPERATING EXPENSES Operating expenses for the first six months of the year 2006 were $4,901,400, an increase of $435,900, or 9.76%, as compared to $4,465,500 for the corresponding period of the year 2005. Operating expenses consist of marketing and distribution expenses and general and administrative expenses. MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and distribution expenses consist of salaries and commissions, advertising costs, product and sales promotion costs, travel expenses and related costs and the Company's tavern and tasting room expenses. Such expenses for the first six months of the year 2006 were $2,363,200, as compared to $2,593,000 for the same period in 2005, representing a decrease of 8.86%. - 31 - DOMESTIC OPERATIONS: Expenses for the first six months of the year 2006 -------------------- were $608,100 compared to $686,500 during the corresponding period of 2005, representing a decrease of $78,400 or 11.42%. As a percentage of net sales in the United States, these expenses decreased to 10.12% during the first six months of the year 2006, compared to 12.46% during the corresponding period of 2005. The decreased expenses included lower salary and travel costs due to a temporary decrease in staffing and decreases in promotional expenses and point of sale items. EUROPEAN TERRITORY: Expenses for the first six months of the year 2006 ------------------ were $1,755,100 compared to $1,906,500 during the corresponding period of 2005, representing a decrease of $151,400 or 7.95%. As a percentage of net sales in the United Kingdom, the expenses decreased to 18.3% during the first six months of the year 2006 compared to 21.03% during the corresponding period of 2005 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). The decrease resulted mainly from lower freight costs and onetime advertisement campaign expenses incurred during June 2005, offset by increases in personnel costs due to increases in salaries. GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and ----------------------------------- administrative expenses were $2,538,200 for the first six months of the year 2006, representing an increase of $665,700 or 35.55%, over $1,872,500 for the corresponding period in 2005. These expenses were equal to 16.27% of net sales for the first six months of the year 2006, as compared to 12.08% for the corresponding period in 2005. DOMESTIC OPERATIONS. Domestic general and administrative expenses were ------------------- $828,900 for the first six months of the year 2006, representing a decrease of $123,600, or 12.98%, from $952,500 for the same period in 2005. The decrease was primarily due to the transfer of a part of common corporate overhead costs to UBSN and one time legal expenses in the year 2005 associated with a material legal dispute with a distributor that was settled in 2004. EUROPEAN TERRITORY. General and administrative expenses related to the ------------------ European Territory were $1,709,300 for the first six months of the year 2006, representing an increase of $789,300 or 85.79%, as compared to $920,000 for the same period in 2005 (in each case as calculated in U.S. dollars, after taking into account the effects of the exchange rate calculation). These increases were mainly due to a provision against bad debts of $554,300 created on account of a customer who earlier had provided a personal guaranty, later filed for liquidation of their operations and a part of common corporate overhead costs being transferred to UBSN by MBC and increases in salaries and depreciation. - 32 - OTHER EXPENSES Other expenses for the first six months of the year 2006 totaled $524,100 representing an increase of $102,300 when compared to the same period in 2005. The increase is mainly due to higher interest expenses as a result of increased borrowings under the lines of credit and higher interest rates. INCOME TAXES The Company has a provision for income taxes of $400 for its domestic operations and nil for its operations in the United Kingdom for the first six months of the year 2006, compared to a provision for income taxes of $1,800 for its domestic operations and $69,900 for its operations in the United Kingdom for the corresponding period in 2005. The provision for taxes is related to the estimated amount of taxes that will be imposed by taxing authorities in the United States and United Kingdom. NET INCOME / LOSS The Company's net loss for the first six months of the year 2006 was $685,400, as compared to net income of $13,700 for the first six months of the year 2005. After providing for a negative foreign currency translation adjustment of $43,400 during the first six months of 2006 (as compared to a negative adjustment of $85,400 for the same period in 2005), the comprehensive loss for the first six months of the year 2006 was $728,800, compared to a loss of $71,700 for the same period in 2005. LIQUIDITY AND CAPITAL RESOURCES Unused capacity at the Ukiah and Saratoga Springs facilities 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's European operations operated at a loss during the first six months of the year 2006. The Company has entered into a substantial number of loan agreements, 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. - 33 - 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 had an initial term of twelve months, and has been extended for an additional twelve-month period, and may automatically extend for an unlimited number of additional twelve-month periods. However, BFI 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. 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%. On May 6, 2005, the Company used the entire immediately available amount drawable under the BFI Facility to pay off the remaining outstanding balance under a CIT Group Line of Credit. BFI advanced the Company $200,000 under a promissory note on December 31, 2005. The BFI Note is payable in weekly installments of $6,665, and the Company began paying such installments in January 2006. BFI also advanced the Company an additional $289,937.70 under another promissory note on April 5, 2006. This note is payable in 17 weekly installments of $3,335.00 and 22 weekly installments of $10,000. The Company began paying such weekly installments in April 2006. A final installment of $9,908 is due on the maturity date, January 19, 2007. This note is secured by the collateral set forth in the Loan and Security agreement. MASTER LINE OF CREDIT. On August 31, 1999, MBC and United Breweries of America, Inc. ("UBA"), one of the Company's principal shareholders, entered into a Master Line of Credit Agreement, which was subsequently amended in April 2000 and February 2001 (the "Credit Agreement"). The terms of the Credit Agreement provide the Company with a line of credit in the principal amount of up to $1,600,000. The Company and UBA have executed an Extension of Term of Notes under Master Line of Credit Agreement (the "Extension Agreement"). The Extension Agreement confirms the Company's and UBA's extension of the terms of the UBA Notes for a period ending on August 31, 2005. Although this date has passed, the Company has had discussions with UBA and anticipates that the terms of the UBA Notes will be extended again. - 34 - As of the date of this filing, UBA has made thirteen (13) separate advances to the Company under the Credit Agreement and one additional advance on substantially the same terms as those under the Credit Agreement, pursuant to a series of individual eighteen-month promissory notes issued by the Company to UBA (the "UBA Notes"). The aggregate outstanding principal amount of the UBA Notes as of June 30, 2006 was $1,915,400, and the accrued but unpaid interest thereon was equal to approximately $723,900, for a total of $2,639,300. 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 June 30, 2006, the outstanding principal and interest on the notes was convertible into 1,759,500 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. 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 Notes, 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 Notes 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. These UBA Notes are subordinated to credit facilities extended to the Company by BFI and SBMC under a subordination agreement executed by UBA. As per the terms of the subordination agreement, UBA is precluded from demanding repayment of the notes due unless the BFI and SBMC facilities are settled in full. Although the SBMC facilities were settled in full in July 2006, the UBA Notes are also subordinated to the loan with Grand Pacific Financing Corporation as of July 2006. Hence the Company does not expect to make payments on any of these UBA Notes within the next year. LONG TERM DEBT: MBC 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 was payable in partially amortizing monthly installments of $24,443 including interest at the rate of 7.24%, maturing - 35 - December 2012 with a balloon payment in the amount of $932,600. The interest rate was adjustable on every five year anniversary of the agreement to the Treasury Constant Maturity Rate plus 4.17%. The amount of the balloon payment varied depending on the change in interest rates over the term of the loan. In addition to the Ukiah land and facility, this loan was secured by certain other assets of the Company (other than the Releta facility), including, without limitation, most of the Company's equipment. This loan was fully settled on July 3, 2006 out of the proceeds from a new loan which the Company received from Grand Pacific Financing Corporation. The Grand Pacific Financing Corporation loan is secured against the Ukiah real property. OTHER LOANS AND CREDIT FACILITIES. 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 extended the loan until May 31, 2006. The rate of interest on the loan is prime plus 3%. This loan was repaid in full on July 3, 2006. ROYAL BANK OF SCOTLAND FACILITY: In April 2005, Royal Bank of Scotland ("RBS") provided UBSN with a GBP 1,750,000 maximum revolving line of credit with an advance rate based on 80% of UBSN's qualified accounts receivable. UBSN utilized the proceeds of this facility to settle a credit facility with Nedbank Limited, a South African registered company, on April 26, 2005. This facility had a minimum maturity of twelve months, but was automatically extended. The facility will continue to be extended for additional twelve month periods unless terminated by either party upon six months' written notice. 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. WEIGHTED AVERAGE INTEREST: The weighted average interest rates paid on the Company's U.S. debts was 10.89% for the first six months of the year 2006 and 8.64% for the corresponding period in 2005. For loans primarily associated with the Company's European territory, the weighted average rate paid was 6.02% for the first six months of the year 2006 and 6.2% for the corresponding period in 2005. KEG MANAGEMENT ARRANGEMENT: The Company entered into a five-year keg management agreement with MicroStar Keg Management LLC effective as of - 36 - 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. If such a termination were to occur, the Company anticipates that it would finance the purchase through additional 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 the agreement is likely to have a material adverse effect on the Company. CURRENT RATIO: The Company's ratio of current assets to current liabilities on June 30, 2006 was 0.71 to 1.0 and its ratio of total assets to total liabilities was 1.22 to 1.0. On June 30, 2005, 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 1.35 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 $718,100, 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 $143,600. In April 2006, the Company made payment of the 2006 installment, plus interest, for a total payment of $221,200. The remaining balance of the overdue taxes was paid in full on July 3, 2006 using the proceeds of a loan granted to the Company by Grand Pacific Financing Corporation. RESTRICTED NET ASSETS: The Company's wholly-owned subsidiary, UBI, has undistributed earnings of approximately $604,300 as of June 30, 2006. Under UBSN's line of credit agreement with RBS, distributions and other payments to the Company from its subsidiary are not permitted if UBSN's retained earnings drop below approximately $1,750,000. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ---------------------------------------------------------- As of June 30, 2006, the Company did not hold derivative instruments, or engage in hedging activities, of any material value or in any material amount, whether for trading or for hedging purposes. The Company has some interest-related market risk due to floating interest rate debt totaling $6,373,400 as of June 30, 2006. INTEREST RATE RISK ------------------ The Company had total debt as of June 30, 2006 of $10,037,900 of which $6,985,700 was subject to variable rates of interest (either prime or LIBOR plus 1.5% or prime plus 3% or prime plus 3.75%). Its long-term debt (including current - 37 - portion) as of June 30, 2006 totaled $4,967,600, of which $3,052,200 had fixed rates of interest and the balance of $1,915,400 was subject to variable rates. Short term debts which were subject to variable rates amounted to $5,070,300. At current borrowing levels, an increase in prime and LIBOR rates of 1% would result in an annual increase of $69,900 in interest expense on the Company's variable rate loans. FOREIGN CURRENCY RATE FLUCTUATIONS ---------------------------------- The Company's earnings and cash flows at its subsidiaries UBI and UBSN are subject to fluctuations due to changes in foreign currency rates. The Company believes that changes in the foreign currency exchange rate would not have a material adverse effect on its results of operations as the majority of its foreign transactions are delineated in UBI's functional currency, the British Pound. ITEM 4. CONTROLS AND PROCEDURES ----------------------- The Company's management, including the Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") has evaluated the effectiveness of the design, maintenance, and operation of the Company's "disclosure controls and procedures" as of the end of the period covered by this report. Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by the Company in its reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized, and reported within the time periods specified in the Commission's rules and forms. Disclosure controls and procedures are also designed to ensure that information that the Company is required to disclose in its reports under the Exchange Act is accumulated and communicated to the Company's management, including its CEO and CFO, as appropriate to allow timely decisions regarding the required disclosure. 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 Annual Report on Form 10-K. Management's review of the disclosure controls and procedures includes a review of their objectives, design, implementation, and results. Based on this evaluation, the CEO and CFO believe that, subject to the limitations set forth below, the Company's disclosure controls and procedures were effective in providing reasonable assurance that the information required to be disclosed in the Company's reports under the Exchange Act is recorded, processed, summarized, and reported within the time specified by the Commission, and that material information pertaining to the - 38 - Company is timely communicated to the Company's management (including the CEO and CFO). Management is not aware of any changes in the Company's internal or other controls over financial reporting identified in connection with that evaluation that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Please refer to the certifications of the Company's Chief Executive Officer and Chief Financial Officer (which are attached to this report as Exhibits 31.1 and 31.2) for additional information regarding the Company's controls and procedures. LIMITATIONS ON CONTROLS ----------------------- Disclosure controls and procedures, no matter how well designed and implemented, can provide only reasonable assurance of achieving the Company's disclosure objectives. The likelihood of achieving such objectives is affected by limitations inherent in such controls and procedures, including the fact that human judgment in decision making can be faulty and that breakdowns in internal controls can occur because of human failures such as simple errors or mistakes or intentional circumvention of the established process. PART II OTHER INFORMATION ITEM 5. (A) On July 3, 2006 the closing of a loan agreement between the Company and Grand Pacific Financing Corporation ("Grand Pacific")occured. Under the loan agreement Grand Pacific provided the Company with a loan of $3,000,000 for a term of five years secured by a first deed of trust on the Company's Ukiah real property. In addition, on July 3, 2006, Savings Bank of Mendocino County extended a temporary loan to the Company in the principal amount of $350,000 pursuant to the terms of a promissory note dated June 6, 2006. ITEM 6. 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 10.3 (A) Wholesale Distribution Agreement between the Company and Bay Area Distributing. 10.4 [Intentionally omitted] 10.5 (B) Liquid Sediment Removal Services Agreement with Cold Creek Compost, Inc. 10.6 [Intentionally omitted] 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. - 39 - Exhibit Number DESCRIPTION OF DOCUMENT - ------ ----------------------- 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 [Intentionally omitted] 10.17 [Intentionally omitted] 10.18 [Intentionally omitted] 10.19 (K) Investment Agreement with United Breweries of America, Inc. 10.20 [Intentionally omitted] 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. 10.30 [Intentionally omitted] 10.31 [Intentionally omitted] 10.32 [Intentionally omitted] 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 - 40 - Exhibit Number DESCRIPTION OF DOCUMENT - ------ ----------------------- 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 America, 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 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. - 41 - Exhibit Number DESCRIPTION OF DOCUMENT - ------ ----------------------- 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 [Intentionally omitted] 10.65 (V) Commitment Letter from United Breweries of America, Inc. dated March 31, 2004. 10.66 [Intentionally omitted] 10.67 (W) Revised Promissory Note in favor of Savings Bank of Mendocino County, dated as of July 20, 2004 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) Second Agreement dated October 9, 1998 between UBSN, Ltd. and Shepherd Neame, Ltd. 10.71 [Intentionally omitted] 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 10.75 (CC) Loan and Security Agreement (Accounts Receivable and Inventory Line of Credit) dated May 5, 2005 between the Company and BFI Business Finance 10.76 (DD) Invoice Discounting Agreement between The Royal Bank of Scotland Commercial Services Limited and UBSN Limited, dated April 26, 2005 10.77 (FF) Secured Promissory Note in favor of BFI Business Finance, dated December 27, 2005 10.78 (FF) Secured Promissory Note in favor of BFI Business Finance, dated April 5, 2006 10.79 * Loan Agreement between Mendocino Brewing Company, Inc. and Grand Pacific Financing Corporation, dated June 28,2006 10.80 * Promissory Note in favor of Grand Pacific Financing Corporation, dated June 28, 2006. 10.81 * Promissory Note in favor of Savings Bank of Mendocino County dated June 6, 2006. 14.1 (V) Code of Ethics 31.1 * Certification of Chief Executive Officer pursuant to Rule 13a-14(a) 31.2 * Certification of Chief Financial Officer pursuant to Rule 13a-14(a) 32.1 * Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 * Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 NOTES: Each Exhibit listed above that is annotated with one or more of the following letters is incorporated by reference from the following sources: - 42 - (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 (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 13D 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 - 43 - (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 (CC) The Company's Annual Report on Form 10-K/A for the period ended December 31, 2004 (DD) The Company's Quarterly Report on form 10-Q for the period ended June 30, 2005 (EE) The Company's Quarterly Report on form 10-Q for the period ended September 30, 2005 (FF) The Company's Annual Report on Form 10-K for the period ended December 31, 2005 * filed herewith - 44 - SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MENDOCINO BREWING COMPANY, INC. Dated: August 14, 2006 /s/ YASHPAL SINGH ------------------- Yashpal Singh President, Director and Chief Executive Officer Dated: August 14, 2006 /s/ N. MAHADEVAN ------------------ N. Mahadevan Chief Financial Officer and Secretary - 45 - EXHIBIT INDEX 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 10.3 (A) Wholesale Distribution Agreement between the Company and Bay Area Distributing. 10.4 [Intentionally omitted] 10.5 (B) Liquid Sediment Removal Services Agreement with Cold Creek Compost, Inc. 10.6 [Intentionally omitted] 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 [Intentionally omitted] 10.17 [Intentionally omitted] 10.18 [Intentionally omitted] 10.19 (K) Investment Agreement with United Breweries of America, Inc. 10.20 [Intentionally omitted] 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. 10.30 [Intentionally omitted] 10.31 [Intentionally omitted] - 46 - Exhibit Number DESCRIPTION OF DOCUMENT - ------ ----------------------- 10.32 [Intentionally omitted] 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 America, 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 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. - 47 - Exhibit Number DESCRIPTION OF DOCUMENT - ------ ----------------------- 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 [Intentionally omitted] 10.65 (V) Commitment Letter from United Breweries of America, Inc. dated March 31, 2004. 10.66 [Intentionally omitted] 10.67 (W) Revised Promissory Note in favor of Savings Bank of Mendocino County, dated as of July 20, 2004 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) Second Agreement dated October 9, 1998 between UBSN, Ltd. and Shepherd Neame, Ltd. 10.71 [Intentionally omitted] 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 10.75 (CC) Loan and Security Agreement (Accounts Receivable and Inventory Line of Credit) dated May 5, 2005 between the Company and BFI Business Finance - 48 - Exhibit Number DESCRIPTION OF DOCUMENT - ------ ----------------------- 10.76 (DD) Invoice Discounting Agreement between The Royal Bank of Scotland Commercial Services Limited and UBSN Limited, dated April 26, 2005 10.77 (FF) Secured Promissory Note in favor of BFI Business Finance, dated December 27, 2005 10.78 (FF) Secured Promissory Note in favor of BFI Business Finance, dated April 5, 2006 10.79 * Loan Agreement between Mendocino Brewing Company, Inc. and Grand Pacific Financing Corporation, dated June 28, 2006. 10.80 * Promissory Note in favor of Grand Pacific Financing Corporation, dated June 28, 2006. 10.81 * Promissory Note in favor of Savings Bank of Mendocino County, dated June 6, 2006. 14.1 (V) Code of Ethics 31.1 * Certification of Chief Executive Officer pursuant to Rule 13a-14(a) 31.2 * Certification of Chief Financial Officer pursuant to Rule 13a-14(a) 32.1 * Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 * Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 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 - 49 - (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 (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 13D 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 (CC) The Company's Annual Report on Form 10-K/A for the period ended December 31, 2004 (DD) The Company's Quarterly Report on form 10-Q for the period ended June 30, 2005 (EE) The Company's Quarterly Report on form 10-Q for the period ended September 30, 2005 (FF) The Company's Annual Report on Form 10-K for the period ended December 31, 2005 * filed herewith - 50 - EX-10.79 2 ex10-79.txt EXHIBIT-10.79 LOAN AGREEMENT This Loan Agreement (the "Agreement") is made this 28th day of June 2006, by and between MENDOCINO BREWING COMPANY, INC., a California corporation ("Borrower"), and GRAND PACIFIC FINANCING CORPORATION, a California corporation ("Lender"). RECITALS -------- A. Borrower has applied to Lender for a loan in the maximum principal amount of Three Million and No/100 Dollars ($3,000,000.00) ("Loan") for the purpose of (i) refinancing Borrower's existing indebtedness secured by the Property (as hereinafter defined), and (ii) financing Borrower's working capital. B. Lender has agreed to make the Loan to Borrower for such purpose upon the terms and conditions set forth herein. NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: ARTICLE I --------- DEFINITIONS AND INTERPRETATIONS ------------------------------- 1.1 DEFINITIONS - ------------- For purposes of this Agreement, the following terms shall have the following meanings: The definitions set forth in the Recitals or elsewhere in this Agreement are incorporated herein by reference. "ADVANCE" shall mean any advance or disbursement of Loan Proceeds by Lender pursuant to this Agreement. "ADVANCE DATE" shall mean the date of each Advance. "AFFILIATE" shall mean any Person, directly or indirectly, related to, in control of, controlled by, or under the common control of, Borrower, or of a successor thereof, whether through merger, consolidation, transfer of assets or otherwise. "AGREEMENT" shall mean this Loan Agreement, either as originally executed or as it may from time to time be supplemented, extended, renewed, modified, or amended. "AGREEMENT TO FURNISH INSURANCE" shall mean the Agreement To Furnish Insurance duly executed by Borrower in form and content as required by Lender. 1 "ANTI-MONEY LAUNDERING LAWS" shall mean the USA Patriot Act of 2001, the Bank Secrecy Act, as amended through the date hereof, Executive Order 1 3324--Blocking Property and Prohibiting Transactions with Persons Who Commit, Threaten to Commit, or Support Terrorism, as amended through the date hereof, and other federal laws and regulations and executive orders administered by the United States Department of the Treasury, Office of Foreign Assets Control ("OFAC") which prohibit, among other things, the engagement in transactions with, and the provision of services to, certain foreign countries, territories, entities and individuals (such individuals include specially designated nationals, specially designated narcotics traffickers and other parties subject to OFAC sanction and embargo programs), and such additional laws and programs administered by OFAC which prohibit dealing with individuals or entities in certain countries regardless of whether such individuals or entities appear on any of the OFAC lists. "APPRAISAL" shall mean an appraisal of the Property, or any portion thereof, performed and prepared for Lender at Borrower's sole expense by a duly licensed or certified appraiser designated by Lender and possessing all qualifications required by Lender and applicable Laws, setting forth the appraiser's opinion and determination of the fair market value of the Property; said Appraisal shall be prepared in full narrative form meeting all requirements and approaches to value as shall be necessary or appropriate in order to comply with all customary and generally accepted appraisal standards within the appraisal industry and in accordance with Lender's requirements, and to Lender's satisfaction and amount of the Loan to the appraised value of the Property does not exceed sixty six and 67/100 percent (66.67%). "APPROVED LEASE" shall mean a lease between Borrower and any tenant for all or any portion of the Property, which lease is substantially in a form pre-approved by Lender, the terms of which are satisfactory to Lender, and which tenant is satisfactory to Lender. "ASSETS" shall have the meaning usually given that term in accordance with GAAP, but shall exclude sums due to Borrower from Affiliates (other than subsidiaries). "BUSINESS DAY" shall mean Monday through Friday, excluding any day of the year on which banks are required or authorized to close in California. "COLLATERAL" shall mean all real and personal property of Borrower described in the Deed of Trust in which Lender has been and may hereafter be granted a lien or security interest to secure payment and performance of Borrower's obligations under the Loan. "CONTINUING GUARANTY" shall mean that certain agreement or agreements by that title, if required by Lender, duly executed by Guarantor, unconditionally and irrevocably guaranteeing payment and performance of Borrower's obligations to Lender in connection with the Loan, as such agreement or agreements are originally executed and as such agreement or agreements may from time to time be reaffirmed, supplemented, modified or amended. 2 "DEBT SERVICE" shall mean all scheduled payments of principal and interest payable by Borrower to Lender under the Note. "DEBT SERVICE COVERAGE RATIO" shall mean, at any given time, the ratio of (a) EBITDA to (b) Debt Service. "DEED OF TRUST" shall mean that certain Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing dated as of the date herein, duly executed and acknowledged by Borrower, for the benefit of Lender, to secure the Loan and encumbering the Property and other assets and rights as therein provided, together with all such riders and exhibits thereto as Lender shall require. "EBITDA" shall mean, at any given time, the sum of (a) the Net Operating Income, (b) all depreciation and amortization expenses deducted in determining the Net Operating Income, and (c) the aggregate amount of federal and state income taxes on or measured by income of Borrower that were deducted in determining the Net Operating Income, all as determined in accordance with GAAP. "ENVIRONMENTAL INDEMNITY" shall mean that certain Hazardous Substances Indemnity Agreement duly executed by Borrower and/or Guarantor, as required by Lender, pursuant to which such parties shall indemnify and defend Lender from and against any loss or liability, direct or indirect, with respect to the presence or release of any hazardous or toxic material in, on, about or under the Property. "EVENT OF DEFAULT" shall mean any of those events specified in Article V hereof. "FINANCIAL STATEMENTS" shall mean balance sheets, income statements, reconciliations of capital structure, statements of sources and applications of funds, and income tax returns, all prepared in accordance with GAAP. "FISCAL YEAR" shall mean Borrower's fiscal year, ending on December 31 of each calendar year. "GAAP" shall mean generally accepted accounting principles consistently maintained and applied throughout the period indicated and consistent with the prior financial practice of the Person providing such financial information. "GOVERNMENTAL AGENCY" shall mean any governmental or quasi-governmental agency, authority, board, bureau, commission, department, instrumentality or public body, court, administrative tribunal, or public utility. "GROSS INCOME" shall mean, for any given time, either: (i) the total of all revenue, rents or other income which are received or generated by Borrower in connection with the possession, use, operation and/or management of the Property, as applicable, including, without limitation, percentage rentals and rentals representing pass-throughs of operating costs or cost increases to the applicable tenants; PROVIDED, HOWEVER, that Gross Income shall exclude any security deposits received from any of the tenants unless and until the same are applied to rental obligations of the tenant in accordance with the terms 3 of the applicable lease. All rentals which are to be included in Gross Income shall be computed on a cash basis and shall include all amounts actually received; or (ii) in the event Borrower and/or Guarantor, as applicable, are in possession of and occupy the entirety of the Property, any and all revenues, income, receipts and money received by or on behalf of, and moneys due to Borrower and/or Guarantor, solely from Borrower's and/or Guarantor's use, operation, management and/or conduct of its business on the Property, including, without limitation, (a) gross revenues derived from its operation and possession of the Property, (b) grants, bequests, donations and contributions, exclusive of any gifts, grants, bequests, donations and contributions to the extent specifically restricted by the donor to a particular purpose inconsistent with their use from the repayment of Loan, and (c) proceeds derived from (1) accounts receivable, (2) inventory and other tangible and intangible property, (3) contract rights and other rights and assets now or hereafter owned by Borrower and/or Guarantor in connection with its business on the Property. "GUARANTOR" shall mean Releta Brewing Company LLC, a Delaware limited liability company. "HAZARD INSURANCE DISCLOSURE" shall mean the Hazard Insurance Disclosure duly executed by Borrower in form and content as required by Lender. "INSURANCE POLICIES" shall mean any of the policies of insurance specified in Section 4.1 hereof. "LAWS" shall mean, collectively, all federal, state, and local laws, rules, regulations, ordinances, and codes. "LOAN" shall mean the loan described in the Recitals and in Article III of this Agreement. "LOAN CLOSING" shall mean the date on which the Loan closes in accordance with Section 3.2 of this Agreement. "LOAN CLOSING COSTS" shall mean all title insurance premiums and recording charges, tax service contract fees, and all out-of-pocket fees and costs incurred by Lender in connection with the appraisal, inspection, assessment, evaluation, insuring, and testing of the Property, and all fees and costs incurred by Lender in connection with the negotiation and preparation of the Loan Documents, including attorneys' fees, and closing of the Loan as herein provided, including, but without limitation, the Loan Fee. "LOAN DOCUMENTS" shall mean this Agreement, the Note, Deed of Trust, Financing Statements, Continuing Guaranty, Environmental Indemnity, Agreement to Furnish Insurance, Hazard Insurance Disclosure and such other documents as Lender may reasonably require Borrower to give to Lender as evidence of and/or security for and/or guaranty of the Loan. 4 "LOAN FEE" shall mean the sum of $30,000.00 payable by Borrower to Lender for the granting of the Loan. "LOAN PROCEEDS" shall mean funds advanced by Lender to Borrower for purposes set forth in Article III hereof. "MATURITY DATE" shall mean June 28, 2011, as set forth in the Note, at which time the entire principal balance of the Loan, plus accrued interest thereon, is and shall be due and payable as provided in this Agreement and the Note, subject to acceleration as provided in the Loan Documents. which Gross Income exceeds Operating Expenses. "NOTE" shall mean the Promissory Note of Borrower in the amount of the Loan payable to the order of Lender, duly executed by Borrower, as required by Lender to evidence the Loan. "OFAC PROHIBITED PERSON" shall mean a country, territory, individual or person (a) listed on, included within or associated with any of the countries, territories, individuals or entities referred to on The Office of Foreign Assets Control's List of Specially Designated Nationals and Blocked Persons or any other prohibited person lists maintained by governmental authorities, or otherwise included within or associated with any of the countries, territories, individuals or entities referred to in or prohibited by OFAC or any other Anti-Money Laundering Laws, or (b) which is obligated or has any interest to pay, donate, transfer or otherwise assign any property, money, goods, services, or other benefits from the Property directly or indirectly, to any countries, territories, individuals or entities on or associated with anyone on such list or in such laws. "OPERATING EXPENSES" shall mean, at any given time, the sum of either of the following expenses, as applicable: (i) (a) all taxes and assessments (including, without limitation, bond assessments) imposed on the Property (but excluding taxes and assessments which any tenant is required to pay directly to the applicable taxing authority so long as such tenant's payment of such taxes is correspondingly excluded from Gross Income); (b) all amounts paid by Borrower on account of insurance premiums for insurance carried in connection with the Property; (c) all other expenses which are properly charged against income according to GAAP and which are incurred by Borrower with respect to the ownership and operation of the Property, including, without limitation, management expenses, cleaning expenses, leasing expenses, maintenance and repair costs, utility expenses, HVAC costs, material costs, cost of services, license fees and business taxes; and (d) all depreciation and amortization expenses allocable to the Property; provided, however, that Operating Expenses shall exclude Debt Service; or (ii) in the event that Borrower and/or Guarantor, as applicable, are in possession of and occupy the Property in its entirety, the current expenses of operation, maintenance, and conducting of Borrower's and/or Guarantor's, as applicable, business, including, without 5 limitation, wages, salaries, benefits and bonuses to personnel, the cost of goods, materials and supplies used for current business operations and maintenance, security costs, utility expenses, all taxes and assessments, including, without limitation, bond assessments (but, as to Borrower, excluding taxes and assessments which Guarantor is required to pay directly to the applicable taxing authority so long as Guarantor's payment of such taxes is correspondingly excluded from Borrower's Gross Income), insurance premiums, trash removal, cost of goods sold, advertising, insurance premiums, rental payments for real or personal property (other than capital lease payments), and charges for the accumulation of appropriate reserves for current expenses that are not recurrent monthly but may reasonably be expected to-be incurred in accordance with GAAP; PROVIDED, HOWEVER, Operating Expenses shall not include Debt Service, or any allowance for depreciation, renewals or replacement of capital assets or any other noncash charges. "ORGANIZATIONAL DOCUMENTS" shall mean, if Borrower or Guarantor is other than a natural person, the duly filed, certified and/or executed documents or instruments evidencing or confirming the lawful formation and existence of Borrower and/or Guarantor, and all written consents and certifications required by Lender from persons having management and/or ownership interests in Borrower and/or Guarantor. "PERMITTED ENCUMBRANCES" shall mean only those matters and exceptions to title approved by Lender shown in the preliminary report of title and all supplements thereto of the Title Company covering the Property. "PERSON" shall mean an individual, corporation, limited liability company, partnership, joint venture, trust or unincorporated organization or a Governmental Agency. "PROPERTY" shall mean the real property described in Exhibit "A" hereto and in the Deed of Trust and all present and future improvements thereon and appurtenances attached thereto. "SNDA" shall mean a subordination, nondisturbance and attornment agreement by a tenant on the Property, in form and content satisfactory to Lender. "TENANT ESTOPPEL" shall mean a tenant estoppel certificate by a tenant on the Property, in form and content satisfactory to Lender. "TITLE COMPANY" shall mean the title insurer designated by Lender, in its sole opinion and judgment, which shall issue the Title Policy. "TITLE POLICY" shall mean an ALTA Loan Policy (1970 Policy Form), written as such at Loan Closing and issued by the Title Company, with liability equal to the full amount of the Loan, in favor of Lender, as insured, insuring the lien of the Deed of Trust to be a valid first lien on the Property subject only to the Permitted Encumbrances. The Title Policy shall have such endorsements thereto as Lender shall require. If required by Lender, the title insurance coverage will provide for reinsurance. 6 1.2 ACCOUNTING TERMS - All accounting terms not specifically defined herein shall be construed in accordance with GAAP, and all financial data submitted pursuant to this Agreement shall be prepared in accordance with GAAP, unless Lender agrees to another manner of preparation. 1.3 USE OF DEFINED TERMS - Any defined terms used in the plural shall include the singular, and the masculine gender shall include the feminine and/or neuter, and such terms shall encompass all members of the relevant class. 1.4 SCHEDULES AND EXHIBITS - All schedules and exhibits to this Agreement, either as originally existing or as the same may from time to time be supplemented, modified or amended, are incorporated herein by reference. 1.5 REFERENCES - Any reference to this Agreement or any other document shall include such document, both as originally executed, and as it may from time to time be amended, supplemented and modified. References herein to Articles, Sections and Exhibits shall be construed as references to this Agreement unless a different document is named. 1.6 OTHER TERMS - The term "document" is used in its broadest sense and encompasses agreements, certificates, opinions, consents, instruments and other written material of every kind. The terms "including" and "include" shall mean "including (include), without limitation." ARTICLE II ---------- REPRESENTATIONS AND WARRANTIES OF BORROWER ------------------------------------------ Borrower hereby represents and warrants to Lender as of the date of this Agreement, the date of Loan Closing, each Advance Date, and each and every date during the existence of the Loan, or any portion thereof, as the context admits or requires, that: 2.1 BORROWER'S CAPACITY - Borrower is a corporation, duly organized and existing under the laws of the State of California, duly qualified to do business in any state in which the nature of its business requires it to be so qualified, and is lawfully empowered and possesses the capacity to enter into and carry out the provisions of this Agreement. 2.2 VALIDITY OF LOAN DOCUMENTS - The Loan Documents are in all respects valid and binding upon Borrower according to their terms, subject to all Laws, including, without limitation, equitable principles, insolvency Laws, and other matters applying to creditors generally; PROVIDED, HOWEVER, that the implementation of such Laws do not and will not affect the ultimate realization of the obligations and security afforded thereby. The execution and delivery by Borrower of and the performance by Borrower of all its obligations under the Loan Documents have been duly authorized by all necessary action and do not and will not: 7 2.2.1 Require any consent or approval not heretofore obtained of any other Person holding any interest in or entitled to receive any interest issued or to be issued by Borrower or otherwise; or 2.2.2 Violate any provision of the Organizational Documents or any other agreements to which Borrower is bound; or 2.2.3 Result in or require the creation or imposition of any mortgage, deed of trust, pledge, lien, security interest, claim, charge, right of others, or other encumbrance of any nature (other than under the Loan Documents) upon or with respect to any property now owned or leased or hereafter acquired by Borrower; or 2.2.4 To the best of Borrower's knowledge, violate any order, writ, judgment, injunction, decree, determination, or award, or violate any provision of any Laws; or 2.2.5 Result in a breach of or constitute a default under, cause or permit the acceleration of any obligation owed under, or require any consent under any indenture or loan or credit agreement or any other agreement, lease, or instrument to which Borrower is a party or by which Borrower or any property of Borrower is bound or affected. 2.3 NO DEFAULT - Borrower is not in default under any order, writ, judgment, injunction, decree, determination, award, indenture, agreement, lease, or instrument of the type described in Section 2.2 above. 2.4 NO GOVERNMENTAL APPROVALS REQUIRED - To the best of Borrower's knowledge, no authorization, consent, approval, order, license, exemption from, or filing, registration, or qualification with, any Governmental Agency is or will be required to authorize, or is otherwise required in connection with: 2.4.1 The execution, delivery and the performance by Borrower of all or any of its obligations under the Loan Documents; or 2.4.2 The creation of the liens, security interests, or other charges or encumbrances described in the Loan Documents, except that filing and/or recording with Governmental Agencies may be required to perfect such liens, security interests, or other charges or encumbrances. 2.5 TAX LIABILITY - Borrower has timely filed all tax returns (federal, state, and local) required to be filed and has paid all taxes shown thereon to be due and all property taxes due, including interest and penalties, if any, except as set forth in SCHEDULE 2.8 attached hereto. 2.6 FINANCIAL STATEMENTS - All Financial Statements of Borrower, Guarantor and any Persons having an interest in Borrower (if Borrower is other than a natural person) which have heretofore been submitted to Lender fairly present the financial positions of Borrower, Guarantor and of such other Persons at the respective 8 dates of their preparation. Since the dates of such financial statements, there have been no material adverse changes in the financial conditions of Borrower, Guarantor and of such other Persons. 2.7 PENDING LITIGATION - There are no actions, suits, or proceedings pending, or to the knowledge of Borrower, threatened against or affecting Borrower, Guarantor or the Property, or involving the validity or enforceability of any of the Loan Documents or the priority of the lien thereof, at Law or in equity, or before or by any Governmental Agency, except actions, suits, and proceedings that are fully covered by insurance or which, if adversely determined, would not substantially impair the ability of Borrower or Guarantor to perform each and every one of their obligations under and by virtue of the Loan Documents; and neither Borrower nor Guarantor is in default with respect to any order, writ, injunction, decree, or demand of any court or any Governmental Agency. 2.8 VIOLATIONS OF LAWS - There are no material violations or notices of violations of any Laws relating to the Property or any of the Collateral, except as set forth on SCHEDULE 2.8 attached hereto. 2.9 COMPLIANCE WITH ZONING ORDINANCES AND SIMILAR LAWS - To the best of Borrower's knowledge, the Property complies with all applicable Laws and all permits and approvals issued thereunder, affecting the Property, the sale, operation, leasing or financing of the Property and the intended occupancy, use and enjoyment of the Property, including, but not limited to, applicable subdivision Laws, licenses and permits, building codes, zoning ordinances, flood disaster, environmental protection and equal employment regulations and appropriate supervising boards of fire underwriters and similar agencies. Borrower shall not seek, make or consent to any change in the zoning, conditions of use, or any other applicable land use permits, approvals or regulations pertaining to the Property, or any portion thereof, which would constitute a violation of the warranties and representations herein contained, or would change the nature of the use or occupancy of the Property. 2.10 AVAILABILITY OF UTILITIES - All utility services necessary for the proper operation of the Property for its intended purposes are available at the Property. 2.11 CONDITION OF PROPERTY - The Property is not now damaged or injured as a result of any fire, explosion, accident, flood, or other casualty, nor subject to any action in eminent domain. 2.12 BROKERAGE COMMISSIONS - No brokerage commissions are or will be owed by Borrower in connection with the Loan, or if there are commissions due or payable, the same will be paid by Borrower. Borrower agrees to and shall indemnify Lender from all liability, claims, or losses arising by reason of any such brokerage commissions related to any or all acts of Borrower in connection with the Loan. This provision shall survive the repayment of the Loan and shall continue in full force and effect so long as the possibility of such liability, claims or losses exists. 9 2.13 ENVIRONMENTAL IMPACT STATEMENT - All required environmental impact statements as required by any Governmental Agency having jurisdiction over the Property have been duly filed and approved. 2.14 ACCESS - The Property fronts on a publicly maintained road or street and has both legal and practical access to the same. 2.15 LEASES - Subject to Section 4.14 of this Agreement, Borrower will not, without the written consent of Lender, enter into a lease for all or any portion of the Property, except for Approved Leases. 2.16 [Intentionally omitted]. 2.17 AIR RIGHTS - Borrower has not and will not transfer, assign, convey, hypothecate or encumber any of the air rights pertaining to the Property. 2.18 COMPLIANCE WITH ENVIRONMENTAL LAWS - Borrower will not use, store, manufacture, generate, transport to or from, or dispose of any toxic substances, hazardous materials, hazardous wastes, radioactive materials, flammable explosives, or related material on or in connection with the Property or the business of Borrower on the Property in violation of any and all applicable Laws. Borrower will not permit any lessee on any property to use, store, manufacture, generate, transport to or from, or dispose of any toxic substances, hazardous materials, hazardous waste, radioactive materials, flammable explosives, related material on or in connection with the Property or the business on the Property in violation of any and all applicable Laws. ("Toxic substances," "hazardous materials," and "hazardous waste" shall include, but not be limited to, such substances, materials and wastes which are or become regulated under applicable Laws or which are classified as hazardous or toxic under applicable Laws.) 2.19 SOLVENCY - Borrower is and shall continue to be able to pay its debts as they mature and the realizable value of its Assets is, and at all times that it may have obligations hereunder shall continue to be, sufficient to satisfy any and all obligations hereunder. 2.20 PERMITS - Borrower possesses all licenses, approvals, permits, franchises, patents, copyrights, trademarks, and trade names, or rights thereto, that are necessary to own the Property and conduct business on the Property substantially as now conducted and as presently proposed to be conducted, and to the best of Borrower's knowledge, Borrower is not in material violation of any valid rights of others with respect to the foregoing. 2.21 FULL DISCLOSURE - All information in the loan application, Financial Statement, certificate, or other document and all information prepared and delivered by Borrower to Lender in obtaining the Loan is correct and complete in all material respects, and there are no omissions therefrom that result in such information being incomplete, incorrect, or misleading in any material adverse respect as of the date thereof. All information in any loan application, financial statement, certificate or other document 10 prepared and delivered to Lender on behalf of Borrower by Persons other than Borrower or its Affiliates, and all other information prepared and delivered to Lender on behalf of Borrower by Persons other than Borrower or its Affiliates in applying for the Loan is correct and complete in all material respects, and there are no omissions therefrom that result in any such information being incomplete, incorrect, or misleading in any material adverse respect as of the date thereof. 2.22 USE OF PROCEEDS; MARGIN STOCK - The proceeds of each Advance will be used by Borrower solely for the purposes specified in this Agreement. None of such proceeds will be used for the purpose of purchasing or carrying any "margin stock" as defined in Regulation U or G of the Board of Governors of the Federal Reserve System (12 C.F.R. Part 221 and 207), or for the purpose of reducing or retiring any indebtedness which was originally incurred to purchase or carry a margin stock or for any other purpose which might constitute this transaction a "purpose credit" within the meaning of such Regulation U or G. Borrower is not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock. Neither Borrower nor any Person acting on behalf of Borrower has taken or will take any action which might cause any Loan Documents to violate Regulation U or G or any other regulations of the Board of Governors of the Federal Reserve System or to violate Section 7 of the Securities Exchange Act of 1934, or any rule or regulation thereunder, in each case as now in effect or as the same may hereafter be in effect. Borrower and Borrower's Affiliates own no "margin stock". 2.23 GOVERNMENTAL REGULATION - Borrower is not subject to regulation under the Public Utility Holding Company Act of 1935, the Federal Power Act, the Investment Company Act of 1940, the Interstate Commerce Act (as any of the preceding have been amended), or any other Law which regulates the incurring by Borrower of indebtedness, including but not limited to laws relating to common or contract carriers or the sale of electricity, gas, steam, water, or other public utility services. 2.24 NO CONDEMNATION - No condemnation proceedings are pending, or to the best of Borrower's knowledge, threatened against the Property. 2.25 INSOLVENCY PROCEEDING - Neither Borrower nor Guarantor (i) is the subject of any bankruptcy, reorganization or insolvency proceedings or any assignment for the benefit of creditors; or (ii) has been the subject of any bankruptcy, reorganization or insolvency proceedings or any assignment for the benefit of creditors during the past six (6) years. 2.26 BUILDING PERMITS - All building permits, by every name, required for the Property have been obtained. 11 ARTICLE III ----------- THE LOAN -------- 3.1 THE LOAN - The Loan will be in an amount not exceeding the principal sum of Three Million and No/100 Dollars ($3,000,000.00) 3.2 LOAN CLOSING 3.2.1 The Loan will close if, and only if, on or before July 7,2006, Borrower shall, at its sole expense, deposit or cause to be deposited with Lender, the following in form and substance satisfactory to Lender, in Lender's sole opinion and judgment, duly executed by the party to be charged and acknowledged where required: (a) The Loan Fee; (b) The Note; (c) The Deed of Trust; (d) The Continuing Guaranty; (e) The Title Policy or evidence of a commitment therefor. The Title Policy shall show no blanket exceptions for anything a survey would show; (f) If required by Lender, the survey or surveys prepared by a licensed surveyor satisfactory to Lender, certified to the Title Company and to Lender and its successors, nominees, and assigns, and showing all easements. The survey shall be conducted in compliance with ALTA standards as applied in California and shall be certified to the Title Company, Lender, and Borrower in form and content acceptable to Lender; (g) One or more Financing Statements; (h) If required by Lender, UCC search certificates showing the Financing Statements to be subject only to such prior filings as are acceptable to Lender, in its sole opinion and judgment; (i) True and correct copies of: Borrower's and Guarantor's Organizational Documents, certificate(s) of fictitious business name, and financial statements, all of which documents must be first reviewed and approved by Lender, its counsel, or both; (j) Such resolutions or other authorizations as Lender shall require of Borrower, Guarantor and any Person holding an interest in Borrower or Guarantor, authorizing the Loan or such other matters as Lender shall require; 12 (k) If applicable, a Tenant Estoppel and SNDA from all existing Major Tenants (as defined in subsection 4.14(b) below) and any other tenants on the Property as required by Lender; (l) The Environmental Indemnity; (m) The Agreement to Furnish Insurance; (n) The Hazard Insurance Disclosure; (o) Review and approval of all current leases, including, without limitation, executed copies of the Approved Leases; (p) The Appraisal; (q) A Phase I, and, if indicated, a Phase II environmental survey, by a qualified environmental engineer, indicating an absence of environmental concerns in regard to the Property, satisfactory in all respects to Lender, in Lender's sole opinion and judgment; (r) If required by Lender, verification and approval of (A) all plans and specifications for the Property and (B) all permits, approvals and authorizations required to operate and use the Property; (s) Lender and Borrower shall have created and set up necessary accounts for impounding property taxes, as determined by Lender in its sole opinion and judgment; (t) Review and approval of Borrower's Financial Statements and tax returns satisfactory to Lender; (u) Review and approval of Guarantor's Financial Statements and tax returns satisfactory to Lender; (v) If required by Lender, property inspection prepared by an inspection company approved by Lender; (w) If required by Lender, a certificate of occupancy (or equivalent) and/or certificate of completion (or equivalent) for the Property; (x) Such soils and/or geology reports as Lender may require, which reports shall be satisfactory in all respects to Lender, in its sole and absolute discretion, prepared by such geologists, engineers and/or other consultants as are approved by Lender; (y) Such management, license, partnership and other significant agreements, construction contracts, all engineering plans, consultant reports, sales contracts, reciprocal easements, covenants, conditions and restrictions, permits, licenses and operating agreements as Lender may reasonably request; and 13 (z) Such additional assignments, agreements, certificates, reports, approvals, instruments, documents, financing statements, consents, and opinions as Lender may reasonably request, including, but not limited to any zoning variances, conditional use permits, development agreements or other land use requirements Borrower shall be required to obtain in connection with the operation of the Property and any and all subordination agreements and tenant estoppel certificates as Lender, in its reasonable discretion, shall require Borrower to obtain from tenants of the Property, if applicable. 3.3 LOAN PURPOSE - The Loan Proceeds disbursed shall be used by Borrower solely for (i) (A) refinancing Borrower's existing indebtedness secured by the Property, and (B) financing Borrower's working capital, (ii) paying, at Loan Closing, the Loan Fee and all other Loan Closing Costs, and (iii) paying, at or after Loan Closing, such fees, costs and other amounts as Lender shall, in Lender's sole and absolute discretion, approve in writing, but only to the extent of the Loan Proceeds. Borrower shall be responsible for paying any of the foregoing from its own funds in the event the Loan Proceeds are insufficient to do so. 3.4 LOAN FEE - The Loan Fee shall be paid by Borrower to Lender at Loan Closing from the Loan Proceeds, and will be in addition to all other fees mentioned in this Agreement. The Loan Fee shall be deemed fully earned and non-refundable when paid, whether or not any Loan Proceeds are disbursed at any time. 3.5 LOAN TERM - The term of the Loan will commence on the date of Loan Closing and the Loan will mature upon the Maturity Date, subject to acceleration as provided in this Agreement and the other Loan Documents. 3.6 INTEREST RATE - The interest rate will be as set forth in the Note. 3.7 REPAYMENT - In addition to other provisions set forth herein, repayment of the Loan will be required as follows: 3.7.1 Interest and principal payments under the Loan shall be due and payable to Lender pursuant to the provisions of the Note. 3.7.2 Borrower hereby authorizes Lender, if and to the extent any payment of principal or interest or sum otherwise due hereunder is not promptly made pursuant to the Note, and to the extent of any obligation of Borrower to Lender under this Agreement or any other agreement, to charge against any account of Borrower with Lender an amount equal to the principal and accrued interest from time to time due and payable to Lender under the Note or otherwise. 3.7.3 All payments hereunder or under the Note shall be made by Borrower without any offset or deduction for or on account of any present or future taxes, 14 imposts or duties, of whatever nature, imposed or levied by or on behalf of any Governmental Agency. If at any time, whether by reason of any present or future Law or other requirement, Borrower shall be compelled by such Law or other requirement to deduct or withhold such taxes, imposts or duties, Borrower shall pay such additional amounts to Lender as may be necessary such that every net payment under this Agreement and the Note on which Borrower is obligated, after such deduction or withholding, will not be less than the amount required hereunder or thereunder. 3.7.4 Whenever any payment to be made under this Agreement and the Note shall be due on a day other than a Business Day of Lender, such payment may be made on the next succeeding Business Day, and such extension of time shall in such cases be included in the computation of payment of interest hereunder and under the Note. 3.8 DEPOSIT ACCOUNT - If required by Lender, Borrower hereby grants, assigns, pledges and hypothecates to Lender all of Borrower's right, title and interest in and to all deposit accounts maintained by Borrower with Lender, as security for each and all of the obligations of Borrower to Lender under the Loan Documents. 3.9 NO AUTOMATIC SET-OFF - The existence of any sum or sums being on deposit with Lender shall in no way constitute a set-off against or be deemed to compensate the obligations of the Loan or any payment or performance due under the Loan Documents or this Agreement, unless and until Lender, by affirmative action, shall so apply said accounts or any portion thereof, and then only to the extent thereof as so designated by Lender. 3.10 RELIANCE BY LENDER AND ACQUITTANCE - Lender may conclusively assume that the statements, facts, information, and representations contained herein and/or in any affidavits, orders, receipts, or other written instrument(s) that are filed with Lender or exhibited to it, are true and correct, and Lender may rely thereon without any investigation or inquiry, and any payment made by Lender in reliance thereon shall be a complete release in its favor for all sums so paid. ARTICLE IV ---------- BORROWER'S COVENANTS -------------------- 4.1 INSURANCE - Borrower shall obtain and at all times maintain property/casualty and liability insurance in amount, form and issued by a company or companies reasonably satisfactory to Lender, as required under the Deed of Trust and/or the Agreement to Furnish Insurance. 4.2 RIGHT OF ENTRY - Subject to the terms of the Deed of Trust, Lender and Lender's employees or agents shall have the right at all times to enter upon the Property for whatever purpose Lender deems appropriate, including, without limitation, inspection of the premises and the posting of such notices and other written or printed material thereon as Lender may deem appropriate or desirable. 15 4.3 PRESERVE ITS EXISTENCE - Borrower, if other than a natural person, will, so long as Borrower remains obligated on the Loan, do all things necessary to preserve and keep in full force and effect its organizational status and will comply with all Laws, orders and decrees of any Governmental Agency or court applicable to Borrower or to the Property. 4.4 LENDER MAY EXAMINE BOOKS AND RECORDS - Lender shall have the right, from time to time, acting by and through its employees or agents, to examine the books, records, and accounting data of Borrower, and to make extracts therefrom or copies thereof. Borrower shall promptly make such books, records, and accounting data available to Lender, as stated above, upon written request, and upon like request shall promptly advise Lender, in writing, of the location of such books, records, and accounting data. 4.5 PAYMENT OF TAXES - Except to the extent Lender pays property taxes with respect to the Property pursuant to Section 2 of the Deed of Trust, Borrower shall pay and discharge all taxes, assessments, and governmental charges or levies imposed upon Borrower or upon its income or profits, or upon any properties belonging to it prior to the date on which penalties attach thereto, and all lawful claims which, if unpaid, might become a lien or charge of a material nature upon any of its properties; PROVIDED, THAT Borrower shall not be required to pay any such tax, assessment, charge, levy or claim which is being contested in good faith and by proper proceedings if it maintains adequate reserves with respect thereto. 4.6 COMPLY WITH APPLICABLE LAWS - Borrower shall comply with all applicable restrictive covenants, zoning and subdivision ordinances and building codes, all health and environmental Laws and all other applicable Laws, directions, orders and notices of violations issued by any Governmental Agency relating to or affecting the premises or the business or activity being conducted thereon whether by Borrower or by any occupant thereof, including, without limitation, any and all Laws relating to hazardous or toxic waste or waste products or hazardous substances. Further, Borrower shall indemnify and hold Lender and the Trustee under the Deed of Trust harmless from the failure by Borrower to comply with such Laws to the full extent provided for herein. 4.7 MAINTENANCE OF PROPERTIES AND PRESERVE EXISTENCE - Borrower shall maintain and preserve, or cause to be maintained and preserved, all of its properties, necessary or useful in the proper conduct of its business, including such as may be under lease, in good working order and condition, ordinary wear and tear excepted. Borrower, so long as Borrower remains obligated on the Loan, shall do all things necessary to preserve and keep in full force and effect Borrower's organizational status, and will comply with all Laws, orders and decrees of any Governmental Agency or court applicable to Borrower or to the Property. 4.8 BOOKS AND RECORDS; AUDIT AND EXAMINATION - Borrower shall keep and maintain all books and records in original form, as shall be required and as shall otherwise be appropriate, in Lender's opinion and judgment, pertaining to the performance by Borrower of its covenants and other obligations hereunder, and otherwise 16 pertaining to its operations and activities. Borrower shall at all times permit Lender to review, audit and examine all such books and records, either directly or through one or more auditors designated by Lender, including independent contractors. 4.9 REPORTING REQUIREMENTS - So long as Borrower shall have any obligation to Lender under this Agreement and/or the other Loan Documents, Borrower shall prepare, or cause to be prepared, and deliver, or cause to be delivered, to Lender the following Financial Statements and reports: (a) As soon as practicable and in any event within five (5) days after Borrower knows or should reasonably have known, of the commencement of any legal action against it, except actions seeking money judgments that are fully insured or bonded, a report of the commencement of such action containing a statement signed by an authorized signatory of Borrower setting forth details of such legal action and any action Borrower proposes to take with respect thereto; (b) Within five (5) days of the occurrence of any Event of Default or event which, with the giving of notice or lapse of time, or both, would constitute an Event of Default, a report regarding such Event of Default or event setting forth details and describing any action which Borrower proposes to take with respect thereto, signed by Borrower; (c) Any change in the name of Borrower or use of any trade names or trade styles not presently used; (d) As soon as possible, and in any event no later than sixty (60) days following June 30 and December 31 of each calendar year, and ninety (90) days following the end of each calendar year, during which the Loan has not been fully repaid and performed, and discharged, during the term of this Agreement, Borrower shall furnish to Lender semi-annual and annual profit and loss statement, operating statement and income and expense statements, respectively, presenting the financial condition and results of operations of the Property for the six (6) month and twelve (12) month period, as applicable, covered thereby; (e) Additionally, Borrower shall furnish to Lender, and cause Guarantor to furnish to Lender, copies of all signed income tax returns of Borrower and Guarantor within thirty (30) days after they are filed with the relevant taxing authorities; (f) [Intentionally omitted]; (g) Promptly upon receipt thereof, one (1) copy of any other report submitted to Borrower by independent accountants in connection with any annual, interim or special audit made by them of the books of Borrower; (h) Within ten (10) days of (i) any contact from any Governmental Agency concerning any environmental protection Laws, including, but not limited to, any notice of any proceeding or inquiry with respect to the presence of any hazardous waste, toxic substances or hazardous materials on the Property or the 17 migration thereof from or to other property, (ii) any and all claims made or threatened by any third Person against or relating to the Property concerning any loss or injury resulting from toxic substances, hazardous waste, or hazardous materials, or (iii) Borrower's discovery of any occurrence or condition on any property adjoining or in the vicinity of the Property that could cause the Property, or any part thereof, to be subject to any restrictions on the ownership, occupancy, transferability, or loss of the Property under any Law, Borrower shall deliver to Lender a report regarding such contact and setting forth in detail and describing any action which Borrower proposes to take with respect thereto, signed by Borrower; (i) Within five (5) Business Days of becoming aware of any developments or other information which may materially and adversely affect Borrower's Property or Borrower's financial condition or Borrower's ability to perform this Agreement or the other Loan Documents, telephonic or written notice (delivered via facsimile) specifying the nature of such development or information and such anticipated effect, which shall be promptly confirmed in writing; and (j) Financial Statements of Borrower or Guarantor and such other information respecting the business, properties or the condition or operations, financial or otherwise, of Borrower as Lender may from time to time request. 4.10 LIENS - Borrower shall not create, incur, assume or suffer to exist any involuntary lien, security interest or other charge or encumbrance (including the lien or retained security title of a conditional vendor) of any nature upon or with respect to the Property, or involuntarily cause the assignment or conveyance of any right to receive income, as provided in Section 4.11. 4.11 NO TRANSFER OR FURTHER ENCUMBRANCE - Borrower shall not, without the prior written consent of Lender: (a) [Intentionally omitted]; (b) Transfer the Property, or any interest therein; (c) Become a party to any transaction whereby the Property or any portion thereof, or all or any substantial part of the properties, assets or undertakings of Borrower (whether legally or beneficially owned by Borrower), would become the property of any other Person, whether by way of transfer, sale, conveyance, lease, sale and leaseback, or otherwise, except for the Approved Leases; or (d) Change the use of the Property. 4.12 PROTECTION OF LIENS - Borrower shall maintain the lien of the Deed of Trust as a first priority lien on the Property and take all actions, and execute and deliver to Lender all documents, reasonably required by Lender from time to time in connection therewith. 18 4.13 TITLE INSURANCE ENDORSEMENTS - Borrower shall deliver to Lender, at Borrower's sole expense and in form and content reasonably required by Lender from time to time, such endorsements to the Title Policy as Lender shall request. 4.14 APPROVED LEASES; TENANT ESTOPPEL AND SNDA. (a) Borrower shall only enter into Approved Leases for the Property. (b) Borrower shall, immediately upon execution by Borrower of any new lease with respect to the Property, provide Lender with (i) a true, correct and complete copy of such lease, as signed by all parties thereto, and (ii) a Tenant Estoppel and SNDA from a Major Tenant. "Major Tenant" shall mean a tenant under an Approved Lease for a portion of the Property which is at least twenty-five percent (25%) of the rentable square feet of the Property. (c) Borrower shall, immediately upon execution by Borrower of any modification or extension of an Approved Lease, provide Lender with a true, correct and complete copy of such modification or extension, as signed by all parties thereto. (d) In the event the Debt Service Coverage Ratio is less than 1.00 to 1.00, as determined by Lender using the actual Net Operating Income for the preceding reporting period, except for the exercise of an option to extend an Approved Lease or the modification or extension of an Approved Lease with terms that are either equal to, or more beneficial to, Borrower, Borrower shall not, without the written consent of Lender, modify or amend any Approved Leases. Borrower shall provide Lender with such records, documents and other evidence as Lender, in its sole and absolute discretion, shall request from time to time with respect to the Debt Service Coverage Ratio for the Property. (e) In the event the Debt Service Coverage Ratio is less than 1.00 to 1.00, as determined by Lender using the actual Net Operating Income for the preceding reporting period, Borrower shall not, without the written consent of Lender, enter into a new lease for all or any portion of the Property. Borrower shall provide Lender with such records, documents and other evidence as Lender, in its sole and absolute discretion, shall request from time to time with respect to the Debt Service Coverage Ratio for the Property. 4.15 TAXES AND OTHER DEBT - Except to the extent Lender pays property taxes with respect to the Property pursuant to Section 2 of the Deed of Trust, Borrower shall pay and discharge (a) before delinquency all taxes, assessments, and governmental charges or levies imposed upon it, upon its income or profits, or upon any property belonging to it; (b) when due all lawful claims (including, without limitation, claims for labor, materials, and supplies), which, if unpaid, might become a lien or encumbrance upon any of its assets or property; and (c) all its other obligations and indebtedness when due; provided, however, that Borrower may contest any of the foregoing in good faith and by appropriate proceedings diligently prosecuted by Borrower as long as Borrower 19 has adequate reserves to pay any adverse determination or has otherwise provided Lender evidence of a surety or bond to pay any adverse determination. 4.16 NAME, FISCAL YEAR, ACCOUNTING METHOD, AND LINES OF BUSINESS - Without the prior written consent of Lender, which consent shall not be unreasonably withheld, Borrower will not change its name, fiscal year, or method of accounting. Borrower will not directly or indirectly engage in any business other than the business in which Borrower is engaged on the date of this Agreement, discontinue any existing lines of business that are material to the business or operations of Borrower, or substantially alter its method of doing business. 4.17 [Intentionally omitted]. 4.18 [Intentionally omitted]. 4.19 DISTRIBUTIONS - Borrower shall not make, declare or permit any distribution to any shareholder, member, manager or partner of Borrower at any time that an Event of Default (or event that with the giving of notice or passage of time, or both, would constitute an Event of Default) has occurred and is continuing or if any such distribution would cause or contribute to an Event of Default (or event that with the giving of notice or passage of time, or both, would constitute an Event of Default). 4.20 TRANSACTIONS WITH AFFILIATES - Borrower will not enter into, or cause, suffer or permit to exist, any arrangement or contract with any of its Affiliates, including, without limitation, any management contract, unless such transaction is on terms that are no less favorable to Borrower than those that could have been obtained in a comparable transaction on an arms' length basis from a Person that is not an Affiliate. 4.21 DEPOSIT ACCOUNTS. If applicable, Borrower hereby grants, assigns, pledges and hypothecates to Lender all of Borrower's right, title and interest in and to all deposit accounts maintained by Borrower with Lender, as security for each and all of the obligations of Borrower to Lender under the Loan Documents. Borrower hereby authorizes Lender, at Lender's option, if and to the extent any payment of principal or interest or sum otherwise due hereunder is not promptly made pursuant to the Note, to charge against any account of Borrower with Lender pledged or assigned as collateral for the Loan, an amount equal to the principal and accrued interest from time to time due and payable to Lender under the Note or otherwise. 4.22 TERRORISM AND ANTI-MONEY LAUNDERING. Borrower warrants and agrees as follows: (a) As of the date hereof and throughout the term of the Loan: (i) Borrower; (ii) an Affiliate of Borrower; (iii) if Borrower is a privately held entity, any Person having a beneficial interest in Borrower; or (iv) any Person for whom Borrower is acting as agent or nominee in connection with this transaction, is not an OFAC Prohibited Person. 20 (b) To comply with applicable Anti-Money Laundering Laws and regulations, all payments by Borrower to Lender or from Lender to Borrower will only be made in Borrower's name and to and from a bank account of a bank based or incorporated in or formed under the laws of the United States or a bank that is not a "foreign shell bank" within the meaning of the U.S. Bank Secrecy Act (31 U.S.C. ss. 5311 et seq.), as amended, and the regulations promulgated thereunder by the U.S. Department of the Treasury, as such regulations may be amended from time to time. (c) To provide Lender at any time and from time to time during the term of the Loan with such information as Lender determines to be necessary or appropriate to comply with the Anti-Money Laundering Laws and regulations of any applicable jurisdiction, or to respond to requests for information concerning the identity of Borrower its Affiliate or any Person having a beneficial interest in Borrower, from any governmental authority, self-regulatory organization or financial institution in connection with its anti-money laundering compliance procedures, or to update such information. (d) The representations and warranties set forth in this Section 4.22 shall be deemed repeated and reaffirmed by Borrower as of each date that Borrower makes a payment to Lender under the Note, this Agreement and the other Loan Documents or receives any payment from Lender. Borrower agrees promptly to notify Lender in writing should Borrower become aware of any change in the information set forth in these representations. 4.23 MAINTAIN MINIMUM DEBT SERVICE COVERAGE RATIO - Borrower must maintain a Debt Service Coverage Ratio of 1.0 or greater for each calendar year or portion thereof during the term of the Loan. ARTICLE V --------- EVENTS OF DEFAULT ----------------- An "Event of Default" shall be deemed to have occurred hereunder if: 5.1 DEFAULT UNDER LOAN DOCUMENTS - Borrower shall fail to pay principal or interest, or both, when due under the terms of the Note; or Borrower shall fail to pay an amount owing under this Agreement or any of the other Loan Documents when due; or Borrower shall fail to perform or observe any term, covenant, or agreement contained in this Agreement or in any of the other Loan Documents, which failure may be cured by the payment of money, and, in any of such events, such failure shall continue for a period of ten (10) calendar days from the date such payment or performance was due; or Borrower shall fail to perform or observe any term, covenant or agreement contained in this Agreement or in any of the other Loan Documents, which failure cannot be cured by the payment of money and such failure shall continue for a period of thirty (30) calendar days after Lender shall have given a written notice to Borrower specifying such default; PROVIDED, HOWEVER, that if such default is curable but is of a nature that such cure cannot be completed within such thirty (30) day period, Borrower shall be allowed to cure such default if Borrower shall promptly commence such cure after receipt of such notice and diligently prosecutes the same to completion within sixty (60) days of the date 21 Lender gave written notice to Borrower specifying such default, (PROVIDED FURTHER, HOWEVER, that in no event shall such extension operate to extend the Maturity Date) and provided further, however, in the event that any Section of this Article V has a specific time period for curing any default, such specific time period shall control; or 5.2 BREACH OF WARRANTY - Any warranties made or agreed to be made in any of the Loan Documents or this Agreement shall be breached in any material respect or shall prove to be false or misleading in any respect when made; or 5.3 ACTION AGAINST BORROWER - Any suit shall be filed against Borrower, which, if adversely determined, could substantially impair the ability of Borrower to perform any or all of its obligations under and by virtue of this Agreement or any of the other Loan Documents, unless Borrower's counsel furnishes to Lender its opinion, to the satisfaction of Lender and Lender's counsel, that, in its judgment the suit is essentially without merit; or 5.4 LEVY UPON PROPERTY - A levy be made on the Property or any other Collateral under any process or any lien creditor commences suit to enforce a judgment lien against the Property or any Collateral, and such levy or action shall not be bonded against by sureties deemed by Lender to be sufficient in its sole opinion and judgment; or 5.5 FILING OF LIENS AGAINST THE PROPERTY - Any lien for labor, material, taxes or otherwise shall be filed against the Property and such lien shall not be either satisfied or bonded over within thirty (30) days of such filing in the full amount, to Lender's satisfaction; or 5.6 CROSS-DEFAULT; OTHER OBLIGATIONS - Borrower commits a breach or default in the payment or performance of any other obligation of Borrower, or breaches any warranty or representation of Borrower, under the provisions of any other instrument, agreement, guaranty, or document evidencing, supporting, or securing any other loan or credit extended by Lender, or by any affiliate of Lender, to Borrower, including, but not limited to, any and all term loans, revolving credits, or flooring lines of credit extended from time to time to Borrower; or 5.7 TRANSFER OF PROPERTY - Borrower shall voluntarily or by operation of Law, sell, transfer, convey, lease, or encumber the Property, or any interest therein (except as otherwise permitted under the Deed of Trust or this Agreement), or shall contract for such sale, transfer, conveyance, or encumbrance without the prior written consent of Lender, which consent Lender may either give or withhold in its sole and absolute opinion and judgment; or 5.8 INSOLVENCY - (i) Borrower shall fail to pay its debts as they become due, or shall make an assignment for the benefit of its creditors, or shall admit, in writing, its inability to pay its debts as they become due, or (ii) Borrower shall file a petition under any chapter of the United States Bankruptcy Code or any similar Law, now or hereafter existing, or shall become "insolvent" as that term is generally defined under the United States Bankruptcy Code, or shall in any involuntary bankruptcy case commenced 22 against it file an answer admitting insolvency or inability to pay its debts as they become due, or shall fail to obtain a dismissal of such case within sixty (60) calendar days after its commencement or shall convert the case from one chapter of the United States Bankruptcy Code to another chapter, or be the subject of an order for relief in such bankruptcy case, or be adjudged a bankrupt or insolvent, or shall have a custodian, trustee, or receiver appointed for, or have any court take jurisdiction of, its property, or any part thereof, in any voluntary or involuntary proceeding, including, but not limited to, those for the purpose of reorganization, arrangement, dissolution, or liquidation, and such custodian, trustee, or receiver shall not be discharged, or such jurisdiction shall not be relinquished, vacated, or stayed within sixty (60) calendar days after the appointment; or 5.9 BORROWER STATUS - Without Lender's prior written consent, Borrower shall be liquidated, dissolved, or fail to maintain its status as a going concern or there shall be a change in the makeup of Borrower; or 5.10 ATTACHMENT - Any proceeding shall be brought the object of which is that any part of Lender's commitment to make the advances hereunder shall at any time be subject or liable to attachment or levy during the course of the suit of any creditor of Borrower unless Borrower's counsel furnishes to Lender its opinion, to the satisfaction of Lender and Lender's counsel, that, in its reasonable judgment and after reasonable investigation, the suit is essentially without merit; or 5.11 EMINENT DOMAIN - The Property shall be the subject of an eminent domain proceeding or a taking adverse to the interest of Lender; or 5.12 DESTRUCTION - The Property is materially damaged or destroyed by fire or other casualty and the loss shall prove to be inadequately covered by insurance actually collected or in the process of collection; or 5.13 MISREPRESENTATION AND/OR NON-DISCLOSURE - Borrower has made certain statements and disclosures in order to induce Lender to make the Loan and enter into this Agreement, and, in the event Borrower has made material misrepresentations or failed to disclose any material fact, Lender may treat such misrepresentation or omission as a breach of this Agreement. Such action shall not affect any remedies Lender may have for such misrepresentation or non-disclosure, as such, or under its Deed of Trust for such misrepresentation or concealment; or 5.14 FINANCIAL CONDITION - There shall be any material adverse changes in Borrower's or Guarantor's financial condition; or 5.15 DEFAULT UNDER GUARANTY - Guarantor fails to perform any term, condition or agreement contained in the Continuing Guaranty or notifies Lender of an intention to revoke the Continuing Guaranty. 23 ARTICLE VI ---------- REMEDIES -------- 6.1 CEASE PAYMENT AND/OR ACCELERATE - Upon, or at any time after, the occurrence of an Event of Default and during the continuance thereof, all Loan Proceeds disbursed or advanced by Lender and all accrued and unpaid interest thereon shall, at the option of Lender, become immediately due and payable, and Lender shall be released from any and all obligations to Borrower under the terms of this Agreement. 6.2 ENFORCEMENT OF RIGHTS - Upon, or at any time after the occurrence of an Event of Default and during the continuance thereof, Lender may enforce any and all rights and remedies under the Loan Documents, the Deed of Trust and all other documents delivered in connection therewith and against any or all Collateral and may pursue all rights and remedies available at Law or in equity. 6.3 COLLATERAL - Upon, or at any time after the occurrence of an Event of Default and during the continuance thereof, Lender may, at its option, without notice to Borrower or any Affiliate of Borrower or without regard to the adequacy of the Collateral for the payment of the Loan, appoint one or more receivers of the Collateral, and Borrower hereby irrevocably consents to such appointment, with such receivers having all the usual powers and duties of receivers in similar cases, including the full power to maintain, sell, dispose and otherwise operate the Collateral upon such terms that may be approved by a court of competent jurisdiction. 6.4 RIGHTS AND REMEDIES NON-EXCLUSIVE - In addition to the specific rights and remedies hereinabove mentioned, Lender shall have the right to avail itself of any other rights or remedies to which it may be entitled under any then existing Laws including, but not limited to, the right to realize upon any or all of its security, and to do so in any order. Furthermore, the rights and remedies set forth above are not exclusive, and Lender may avail itself of any individual right or remedy set forth in this Agreement, or available under such Laws, without utilizing any other right or remedy. ARTICLE VII ----------- GENERAL CONDITIONS AND MISCELLANEOUS ------------------------------------ 7.1 NONLIABILITY OF LENDER - Borrower acknowledges and agrees that by accepting or approving anything required to be observed, performed, fulfilled, or given to Lender pursuant to the Loan Documents, including any certificate, statement of profit and loss, or other financial statement, survey, appraisal or insurance policy, Lender shall not be deemed to have warranted or represented the sufficiency, legality, effectiveness or legal effect of the same, or of any term, provision, or condition thereof, and such acceptance or approval thereof shall not be or constitute any warranty or representation to anyone with respect thereto by Lender. 7.2 NO THIRD PARTIES BENEFITTED - This Agreement is made for the purpose of defining and setting forth certain obligations, rights, and duties of Borrower and Lender in connection with the Loan and shall be deemed a supplement to the Note 24 and the Loan Documents, and shall not be construed as a modification of the Note or the Loan Documents, except as provided herein. It is made for the sole protection of Borrower and Lender, and Lender's successors and assigns. No other Person shall have any rights of any nature hereunder or by reason hereof or the right to rely hereon. In the event of a conflict between this Agreement and the Note, the provisions of the Note shall control. In the event of a conflict between this Agreement and the Deed of Trust, this Agreement shall control. 7.3 INDEMNITY BY BORROWER - Borrower hereby indemnifies and agrees to hold Lender and its directors, officers, agents, and employees (individually and collectively, the "Indemnitee(s)") harmless from and against: 7.3.1 Any and all claims, demands, actions, or causes of action that are asserted against any Indemnitee by any Person if the claim, demand, action, or cause of action, directly or indirectly, relates to a claim, demand, action, or cause of action that the Person has or asserts against Borrower; and 7.3.2 Any and all liabilities, losses, costs, or expenses (including court costs and attorneys' fees) that any Indemnitee suffers or incurs as a result of the assertion of any claim, demand, action, or cause of action specified in this Section 7.3. 7.4 CHANGE IN LAWS - In the event of the enactment, after the date of this Agreement, of any Laws: (a) deducting from the value of property for the purpose of taxation any lien or security interest thereon; (b) imposing upon Lender the payment of the whole or any part of the taxes or assessments or charges or liens herein required to be paid by Borrower; (c) changing in any way the Laws relating to the taxation of deeds of trust or mortgages or security agreements, or debts secured by deeds of trust or mortgages or security agreements, or the interest of the mortgagee or secured party in the property covered thereby; or (d) changing the manner of collection of such taxes; then, to the extent any of the foregoing may affect the Deed of Trust or the indebtedness secured thereby or Lender, then, and in any such event, Borrower, upon demand by Lender, shall pay such taxes, assessments, charges, or liens, or reimburse Lender therefor. If Borrower shall be prohibited from paying such tax or from reimbursing Lender for the amount thereof, Borrower shall execute a modification to the Loan Documents and the Note, which modification shall increase the interest rate payable pursuant to the Note so as to permit Lender to maintain its yield as if such tax had not been imposed. If Borrower shall be prohibited from executing the above-referenced modifications, Lender may, in Lender's sole discretion, declare the principal of all amounts disbursed and owing under the Note, this Agreement, and the other Loan Documents (including all obligations secured by the Loan Documents) and all other indebtedness of Borrower to Lender, together with interest thereon, to be forthwith due and payable, regardless of any other specified maturity or due date. 7.5 POWER OF ATTORNEY - Borrower does hereby irrevocably appoint, designate, empower, and authorize Lender, as Borrower's agent, under power of attorney, coupled with an interest, to sign and file for record any financing statements, notices of 25 completion, notices of cessation of labor, or any other notice or written document that it may deem necessary to file or record to protect Lender's interests. 7.6 NONRESPONSIBILITY - Lender shall in no way be liable for any acts or omissions of Borrower or Borrower's agents or employees. 7.7 TIME IS OF THE ESSENCE - Time is of the essence of this Agreement and of each and every provision hereof. The waiver by Lender of any breach or breaches hereof shall not be deemed, nor shall the same constitute, a waiver of any subsequent breach or breaches. 7.8 BINDING EFFECT; ASSIGNMENT - This Agreement shall be binding upon and inure to the benefit of Borrower and Lender and their respective successors and assigns, except that Borrower may not assign its rights hereunder or any interest herein without the prior written consent of Lender. Lender shall have the absolute right at any time to assign, sell, transfer or otherwise dispose of, in whole or in part, its rights under this Agreement and to grant participations and syndications in the Loan, in whole or in part, to others without consent of Borrower or Guarantor, but all waivers or abridgements of Borrower's obligations that may be granted from time to time by Lender shall be binding upon such assignees or participants. Borrower shall, promptly upon demand, provide Lender or any such purchaser or participant, one or more written statements confirming Borrower's indebtedness to Lender and all obligations in connection with the Loan, including the existence of any default thereunder. 7.9 EXECUTION IN COUNTERPARTS - This Agreement and any other Loan Documents, except the Note and the Deed of Trust, may be executed in any number of counterparts, and any party hereto or thereto may execute any counterpart, each of which, when executed and delivered, will be deemed to be an original, and all of which counterparts of this Agreement or any other Loan Document, as the case may be, taken together will be deemed to be but one and the same instrument. The execution of this Agreement or any other Loan Document by any party or parties hereto or thereto will not become effective until counterparts hereof or thereof, as the case may be, have been executed by all the parties hereto or thereto. 7.10 INTEGRATION; AMENDMENTS; CONSENTS - This Agreement, together with the documents referred to herein constitutes the entire agreement of the parties touching upon the subject matter hereof, and supersedes any prior negotiations or agreements on such subject matter. No amendment, modification, or supplement of any provision of this Agreement or any of the other Loan Documents shall be effective unless in writing, signed by Lender and Borrower; and no waiver of any of Borrower's obligations under this Agreement or any of the other Loan Documents or consent to any departure by Borrower therefrom shall be effective unless in writing, signed by Lender, and then only in the specific instance and for the specific purpose given. 7.11 NEUTRAL INTERPRETATION - This Agreement is the product of the negotiations between the parties, and in the interpretation and/or enforcement hereof is not to be interpreted more strongly in favor of one party or the other. 26 7.12 COSTS, EXPENSES, AND TAXES - Borrower shall pay to Lender, on demand: 7.12.1 Attorneys' fees and out-of-pocket expenses incurred by Lender in connection with the negotiation, preparation, execution, delivery, and administration of this Agreement and any other Loan Document and any matter related thereto, including, but not limited to, the appraisal of the Property; 7.12.2 The costs and expenses of Lender in connection with the enforcement of this Agreement and any other Loan Document and any matter related thereto, including the reasonable fees and out-of-pocket expenses of any legal counsel, independent public accountants, and other outside experts retained by Lender and including all costs and expenses of enforcing any judgment or prosecuting any appeal of any judgment, order or award arising out of or in any way related to the Loan, this Agreement, or the Loan Documents; and 7.12.3 All costs, expenses, fees, premiums, and other charges relating to or arising from the Loan Documents or any transactions contemplated thereby or the compliance with any of the terms and conditions thereof, including, but not limited to, recording fees, filing fees, credit report fees, release or reconveyance fees, title insurance premiums, and the cost of realty tax service for the term of the Loan. Except as otherwise provided in the Environmental Indemnity, all sums paid or expended by Lender under the terms of this Agreement shall be considered to be, and shall be, a part of the Loan. All such sums, together with all amounts to be paid by Borrower pursuant to this Agreement, shall bear interest from the date of expenditure at the rate provided in the Note, shall be secured by the Loan Documents, and shall be immediately due and payable by Borrower upon demand. 7.13 SURVIVAL OF REPRESENTATIONS AND WARRANTIES - All representations and warranties of Borrower contained herein or in any and all other Loan Documents shall survive the making of the Loan and the execution and delivery of the Note, and are material and have been or will be relied upon by Lender, notwithstanding any investigation made by Lender or on behalf of Lender. For the purpose of this Agreement, all statements contained in any certificate, agreement, financial statement, appraisal or other writing delivered by or on behalf of Borrower pursuant hereto or to any other Loan Document or in connection with the transactions contemplated hereby or thereby shall be deemed to be representations and warranties of Borrower contained herein or in the other Loan Documents, as the case may be. 7.14 NOTICES - Except as provided in the Deed of Trust, all notices, requests, demands, directions, and other communications provided for hereunder and under any other Loan Document (a "Notice") must be in writing and must be mailed, delivered, or sent by facsimile transmission to the appropriate party at its respective address set forth below or, as to any party, at any other address as may be designated by it in a written notice sent to the other parties in accordance with this Section 7.14. Any notice given by facsimile transmission must be confirmed within forty-eight (48) hours by letter mailed 27 or delivered to the appropriate party at its respective address. If any notice is given by mail it will be effective three (3) calendar days after being deposited in the mails with first-class or airmail postage prepaid; if given by facsimile transmission, when sent; or if given by personal delivery, when delivered. 7.15 FURTHER ASSURANCES - Borrower shall, at its sole expense and without expense to Lender, do, execute, and deliver such further acts and documents as Lender from time to time may reasonably require for the purpose of assuring and confirming unto Lender the rights hereby created or intended, now or hereafter so to be, or for carrying out the intention or facilitating the performance of the terms of any Loan Document, or for assuring the validity of any security interest. 7.16 GOVERNING LAW - The Loan shall be deemed to have been made in California, and the Loan Documents shall be governed by and construed and enforced in accordance with the laws of the State of California. Without limiting the right of Lender to bring any action or proceeding against Borrower arising under any Loan Document in the courts of other jurisdictions, Borrower hereby irrevocably submits to the jurisdiction of the State of California for any action, suit or proceeding brought against Borrower under or in connection with any of the Loan Documents, and hereby irrevocably waives, to the fullest extent it may effectively do so, the defense of forum non conveniens. 7.17 SEVERABILITY OF PROVISIONS - Any provision in any Loan Document that is held to be inoperative, unenforceable, or invalid shall be inoperative, unenforceable, or invalid without affecting the remaining provisions, and to this end the provisions of all Loan Documents are declared to be severable. 7.18 JOINT AND SEVERAL OBLIGATIONS - If this Agreement is executed by more than one Person as Borrower, the obligations of each of such Persons hereunder shall be joint and several obligations. 7.19 CONSTRUCTION - Whenever the context of this Agreement requires, the singular shall include the plural and the masculine gender shall include the feminine and/or neuter. 7.20 HEADINGS - Article and section headings in this Agreement are included for convenience of reference only and are not part of this Agreement for any other purpose. 7.21 AGENCY - Nothing in this Agreement shall be construed to constitute the creation of a partnership or joint venture between Lender and Borrower. Lender is not an agent or representative of Borrower. 7.22 JURY TRIAL WAIVER - IN ANY ACTION BROUGHT BY LENDER, BORROWER OR ANY THIRD PARTY ARISING UNDER THIS AGREEMENT, THE NOTE, THE DEED OF TRUST, THE ENVIRONMENTAL INDEMNITY, THE CONTINUING GUARANTY OR ANY OF THE OTHER LOAN DOCUMENTS, OR ANY DOCUMENT OR INSTRUMENT EXECUTED IN CONNECTION THEREWITH, INCLUDING, WITHOUT LIMITATION, ANY ACTION BASED 28 UPON FRAUD, NEGLIGENCE, BREACH OF CONTRACT, WASTE, INTENTIONAL TORT OR NEGLIGENT TORT, BORROWER HEREBY WAIVES ANY RIGHT TO TRIAL BY JURY AND AGREES THAT SUCH ACTION SHALL BE TRIED BY THE COURT ONLY. BORROWER FURTHER AGREES TO EXECUTE AND TO FILE WITH ANY COURT IN WHICH ANY SUCH ACTION IS COMMENCED, ANY DOCUMENTS OR INSTRUMENTS NECESSARY TO EVIDENCE OR TO EFFECTUATE THIS WAIVER OF TRIAL BY JURY Borrower has initialed this Section 7.22 to further indicate its awareness and acceptance of each and every provision hereof. ----------------------- Borrower's Initials [SIGNATURE PAGE FOLLOWS] 29 IN WITNESS WHEREOF, Borrower and Lender have hereunto caused this Agreement to be executed as of the date first above written. LENDER: GRAND PACIFIC FINANCING CORPORATION, a California corporation By: ------------------------------------------------- Name: ----------------------------------------------- Its: ------------------------------------------------ Address: 1255 Corporate Center Drive, Suite PH10 Monterey Park, California 91754 BORROWER: MENDOCINO BREWING COMPANY, INC., a California corporation By:----------------------------- Name: Yashpal Singh Its: President Address: 1601 Airport Road Ukiah, California 95482 Attention: Yashpal Singh, President 30 EXHIBIT "A" LEGAL DESCRIPTION Real property in the City of Ukiah, County of Mendodno, State of California, described as follows: All that real property situated in Lot 73 of the Yokayo Rancho, Mendocino County, State of California, more particularly described as follows: Commencing at a city monument marking the intersection of Commerce Drive and Airport Park Boulevard as shown on a map flied in Map Case 2, Drawer 47, Page 24, Mendocino County Records; thence South 10(degree) 38' 41" East 3197.18 feet to a 1/2 inch pipe with a plastic plug stamped L.S. 4873 and the point of beginning; thence from a tangent that bears North 85(degree) 49' 29" East along a curve to the right with a radius of 264.00 feet, a central angle of 91(degree) 43' 34" and an arc length of 422.64 feet to a 1/2 inch pipe with a plastic plug stamped L.S. 4873; thence South 02(degree) 26' 58" East, 162.56 feet to a 1/2 Inch pipe with a plastic plug stamped L.S. 4873; thence South 69(degree) 12' 24" West, 627.94 feet to a 1/2 inch pipe with a plastic plug stamped LS. 4873 on the Easterly line of the Northwestern Pacific Railroad property; thence North 20(degree) 4T 36" West (Record North 21(degree) 32' 30" West) along the said Easterly line, 582.11 feet to a 1/2 inch pipe with a plastic plug stamped L.S. 4873; thence leaving the said Easterly line from a tangent that bears North 73(degree) 13' 23" East along a curve to the right with a radius of 2334.00 feet, a central angle of 12(degree) 36' 05" and an arc length of 513.33 feet to the point of beginning. (Being the same parcel of land as shown as Parcel 1 on the Parcel Map of Minor Subdivision No. 95-21 flied June 29, 1995 in the office of the recorder of said County in Map Case 2, Drawer 61, Pages 37 and 38) Together with a parcel of land beginning at a 1/2 Inch pipe with a plastic plug stamped LS. 4873 at the Southwest corner of the hereinabove described parcel of land, said point of beginning being on the Easterly line of said Northwestern Pacific Railroad; thence along the Southerly One of said hereinabove described parcel of land North 69(degree) 12' 24" East 310.00 feet; thence along a line which is parallel with the Easterly line of said railroad South 20(degree) 47' 36" East 140.52 feet; thence parallel with the Southerly line of said hereinabove described parcel of land South 69(degree) 12' 24" West 310.00 feet to the Easterly line of said railroad; thence along said Easterly line North 20(degree) 47' 36" West 140.52 feet to the point of beginning. 31 SCHEDULE 2.8 Borrower owed overdue taxes, including penalties and interest, on the Property for the period from April 1999 to June 2003. On July 31, 2003, Borrower entered into a payment plan to settle these issues. Borrower will pay all remaining amounts owed pursuant to such settlement, prior to or during Loan Closing. 32 EX-10.80 3 ex10-80.txt EXHIBIT-10.80 PROMISSORY NOTE $3,000,000.00 Monterey Park, California June 28, 2006 FOR VALUE RECEIVED, MENDOCINO BREWING COMPANY, INC., a California corporation ("Borrower"), promises to pay to GRAND PACIFIC FINANCING CORPORATION, a California corporation ("Lender"), or its order, at its office located at 1255 Corporate Center Dive, Suite PH10, Monterey Park, California 91754, or at such other place as the holder hereof may designate, in lawful money of the United States of America, the principal sum of Three Million and No/100 Dollars ($3,000,000.00), or so much thereof as shall have been advanced and is outstanding together with interest, on the outstanding principal balance, until paid in full in accordance with the terms, conditions and provisions as hereinafter set forth in this Promissory Note (this "Note"). SECURITY INSTRUMENTS. This Note is the "Note" as defined in that certain Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing, and/or that certain Loan Agreement (collectively, the "Security Instruments") of even date herewith, entered into by and between Borrower and Lender, as they may be amended from time to time, and is subject to all of the terms and conditions thereof. All terms not defined herein shall have the same meaning as in the Security Instruments. In the event of a conflict between the terms of this Note and the Security Instruments, the terms of this Note shall prevail. INTEREST RATE. Interest on the outstanding principal balance of this Note shall be computed and calculated based upon a three hundred sixty (360)-day year for the actual number of days elapsed and shall accrue at the per annum rate (the "Note Rate") of one and three-quarters of one percent (1.75%) over "The Wall Street Journal Prime Rate," as the rate may change from time to time. "The Wall Street Journal Prime Rate" is and shall mean the variable rate of interest, on a per annum basis, which is announced and/or published in the Money Rates section of THE WALL STREET JOURNAL from time to time as its prime rate. The Note Rate shall be redetermined whenever The Wall Street Journal Prime Rate changes. Borrower understands and acknowledges that The Wall Street Journal Prime Rate is one of Lender's base rates and only serves as a basis upon which effective rates of interest are calculated for loans making reference thereto and may not be the lowest of Lender's base rates. If The Wall Street Journal Prime Rate becomes unavailable during the term of this Note, Lender may designate a substitute index after notice to Borrower. PRINCIPAL AND INTEREST PAYMENTS. Commencing on August 1, 2006 ("Commencement Date"), and continuing on the same day of each and every calendar month thereafter until the Maturity Date (as hereinafter defined), Borrower shall pay to Lender a monthly installment payment of principal and interest in an amount equal to the then outstanding principal balance under this Note amortized over a twenty-five (25) year term based upon the Note Rate calculated in accordance with Lender's policies and practices in effect for loans of this type. Each time there is a change in the Note Rate, the amount of the monthly installment of principal and interest payment shall be adjusted to an amount which will result in the full 1 payment of the then outstanding balance of this Note at the Note Rate within twenty-five (25) years from the Commencement Date. Upon the Maturity Date, the entire outstanding principal balance due together with accrued and unpaid interest thereon and all other amounts due under this Note, Security Instruments and any other Loan Documents shall become due and payable in full. All payments due hereunder, including payments of principal and/or interest, shall be made to Lender in United States Dollars and shall be in the form of immediately available funds acceptable to the holder of this Note. APPLICATION OF PAYMENTS. All payments received by Lender from, or for the account of Borrower, due hereunder shall be applied by Lender, in its sole and absolute discretion, in the following manner, or in any other order or manner as Lender chooses: a. First. To pay any and all interest due, owing and accrued; b. Second. To pay the outstanding principal balance of this Note ; and c. Third. To pay any and all costs, advances, expenses or fees due, owing and, payable to Lender, or paid or incurred by Lender, arising from or out of this Note, the Security Instruments, Loan Agreement and any other Loan Documents. All records of payments received by Lender shall be maintained at Lender's office, and the records of Lender shall, absent manifest error, constitute prima facie evidence of the matters reflected therein. The failure of Lender to record any payment or expense shall not limit or otherwise affect the obligations of Borrower under this Note. MATURITY DATE. On June __, 2011 ("Maturity Date"), the entire unpaid principal balance, and all unpaid accrued interest thereon, shall be due and payable without demand or notice. In the event that Borrower does not pay this Note in full on the Maturity Date then, as of the Maturity Date and thereafter until paid in full, the interest accruing on the outstanding principal balance hereunder shall be computed, calculated and accrued on a daily basis at the Default Rate (as hereinafter defined). NO OFFSETS OR DEDUCTIONS. All payments under this Note shall be made by Borrower without any offset, decrease, reduction or deduction of any kind or nature whatsoever, including, but not limited to, any decrease, reduction or deduction for, or on account of, any offset, present or future taxes, present or future reserves, imposts or duties of any kind or nature, that are imposed or levied by or on behalf of any government or taxing agency, body or authority by or for any municipality, state or country. If at any time, present or future, Lender shall be compelled by any law, rule, regulation or any other such requirement which on its face or by its application requires or establishes reserves, or payment, deduction or withholding of taxes, imposts or duties to act such that it causes or results in a decrease, reduction or deduction (as described above) in payment received by Lender, then Borrower shall pay to Lender such additional amounts, as Lender shall deem necessary and appropriate, such that every payment 2 received under this Note, after such decrease, reserve, reduction, deduction, payment or required withholding, shall not be reduced in any manner whatsoever. DEFAULT. An Event of Default under the Security Instruments shall constitute a default under this Note (hereinafter "Default"). Upon the occurrence of a Default hereunder, Lender may, in its sole and absolute discretion, declare the entire unpaid principal balance, together with all accrued and unpaid interest thereon, and all other amounts and payments due hereunder or under the Loan Documents, immediately due and payable, without notice or demand. PREPAYMENT. Except as otherwise provided therein, Borrower shall have the right at any time following seven (7) calendar days prior written notice to Lender, to prepay any portion of the principal amount. During the first thirty-six (36) full calendar months after the date of this Note, Borrower shall be required to pay to Lender, as and for a prepayment premium, the Prepayment Fee (as hereinafter defined). The prepayment amount due on the prepayment date shall equal the SUM of: (i) all unpaid late payment processing fees and unreimbursed costs and expenses then outstanding; PLUS (ii) all accrued and unpaid interest as of the prepayment date; PLUS (iii) the principal amount of the Loan being prepaid, PLUS (iv) the Prepayment Fee. The "Prepayment Fee" shall be a fixed percentage of the outstanding principal balance of this Note being prepaid equal to the product obtained by multiplying the outstanding principal balance of this Note being prepaid as of the prepayment date by the applicable percentage set forth below, depending on the length of time between the date of this Note and the date when the prepayment will be made: IF PREPAYMENT OCCURS DURING THE PERCENTAGE MULTIPLIER IS ---------------------------- THE FOLLOWING PERIODS: ---------------------- From the date of this Note until the end 3% of the 12th full calendar month after the date of this Note. From the beginning of the 13th full 2% calendar month after the date of this Note until the end of the 24th full calendar month after the date of this Note. From the beginning of the 25th full 1% calendar month after the date of this Note until the end of the 36th full calendar month after the date of this Note. THE PREPAYMENT FEE SHALL APPLY NOT ONLY IN THE CASE OF VOLUNTARY PREPAYMENT, BUT ALSO IN THE EVENT THAT THIS NOTE BECOMES DUE AND PAYABLE IN FULL BY REASON OF ACCELERATION UPON THE OCCURRENCE OF A DEFAULT OR OTHERWISE, INCLUDING, WITHOUT LIMITATION, UPON 3 OCCURRENCE OF A TRANSFER OF THE PROPERTY SECURING THE SECURITY INSTRUMENTS, WHETHER VOLUNTARILY OR INVOLUNTARILY OR OTHERWISE. In such case, the Prepayment Fee shall be calculated as of the date of the Default or other event or condition triggering acceleration, and until paid in full shall accrue interest at the Default Rate. Whether prepayment is voluntary or involuntary, in no event shall the amount of the Prepayment Fee or the method of calculating the Prepayment Fee result in a reduction of the outstanding principal balance, accrued and unpaid interest or other amounts due as of the date of prepayment. Absent material and manifest error, Lender's determination of the Prepayment Fee shall be binding and conclusive on Borrower and anyone else having an interest in the determination. ANY SUCH PREPAYMENT SHALL NOT RESULT IN A REAMORTIZATION, DEFERRAL, POSTPONEMENT, SUSPENSION OR WAIVER OF ANY AND ALL OTHER PAYMENTS DUE UNDER THIS NOTE. Pursuant to California Civil Code Section 2954.10, Borrower has initialed this provision of the Note expressly waiving the right to prepay the Note except as expressly permitted herein. ------------ Initials DEFAULT RATE. From and after the occurrence of any Default in this Note whether by non-payment, maturity, acceleration, non-performance or otherwise, and until such Default has been cured, all outstanding amounts under this Note (including, but not limited to, interest, costs and late charges) shall bear interest at a per annum rate ("Default Rate") equal to five percent (5%) over the Note Rate. LATE CHARGES. Time is of the essence for all payments and other obligations due under this Note. Borrower acknowledges that if any payment required under this Note is not received by Lender within ten (10) calendar days no later than 12:00 p.m. Noon (Pacific Standard Time) from the date the same becomes due and payable, Lender will incur extra administrative expenses (i.e., in addition to expenses incident to receipt of timely payment) and the loss of the use of funds in connection with the delinquency in payment. Because, from the nature of the case, the actual damages suffered by Lender by reason of such administrative expenses and loss of the use of funds would be impracticable or extremely difficult to ascertain, Borrower agrees that five percent (5%) of the amount of the delinquent payment shall be the amount of damages which Lender is entitled to receive upon Borrower's failure to make a payment of principal or interest when due, in compensation therefor. Therefore, Borrower shall, in such event, without further demand or notice, pay to Lender, as Lender's monetary recovery for such extra administrative expenses and loss of use of funds, liquidated damages in the amount of five percent (5%) of the amount of the delinquent payment. The provisions of this paragraph are intended to govern only the determination of damages in the event of a breach in the performance of Borrower to make timely payments hereunder. Nothing in this Note shall be construed as in any way giving Borrower the right, express or implied, to fail to make timely payments hereunder, whether upon payment of such damages or otherwise. The right of Lender to receive payment of such liquidated and actual damages, and receipt thereof, are without prejudice to the right of Lender to collect such delinquent payments and any other amounts 4 provided to be paid hereunder or under any of the Loan Documents, or to declare a default hereunder or under any of the Loan Documents. SECURITY AND ACCELERATION. This Note is secured by, among other things, the Security Instruments. The Security Instrument contains, among other provisions, a provision for the immediate acceleration of this Note upon the occurrence of any Default hereunder, any event of default under the Security Instruments, or upon any sale, transfer, conveyance, encumbrance and/or alienation of Borrower's right, title or interest (or any portion thereof) in the real or personal property described in the Security Instruments. Reference is made to the Security Instruments for the specific provisions thereof. COSTS AND EXPENSES. Borrower hereby agrees to pay any and all costs or expenses paid or incurred by Lender by reason of, as a result of, or in connection with this Note, the Security Instruments or any other Loan Documents, including, but not limited to, any and all attorneys' fees and related costs, whether such costs or expenses are paid or incurred in connection with the enforcement of this Note, the Security Instruments and the Loan Documents, or any of them, the protection or preservation of the collateral or security for this Note or any other rights, remedies or interests of Lender, whether or not suit is filed. Borrower's agreement to pay any and all such costs and expenses includes, but is not limited to, costs and expenses incurred in or in connection with any bankruptcy proceeding, in enforcing any judgment obtained by Lender and in connection with any and all appeals therefrom, and in connection with the monitoring of any bankruptcy proceeding and its effect on Lender's rights and claims for recovery of the amounts due hereunder, any proceeding concerning relief from the automatic stay, use of cash collateral, approval of a disclosure statement or confirmation of, or objections to confirmation of, any plan of reorganization. All such costs and expenses are immediately due and payable to Lender by Borrower whether or not demand therefor is made by Lender. WAIVERS. Borrower hereby waives grace, diligence, presentment, demand, notice of demand, dishonor, notice of dishonor, protest, notice of protest, any and all exemption rights against the indebtedness evidenced by this Note and the right to plead any statute of limitations as a defense to the repayment of all or any portion of this Note, and interest thereon, to the fullest extent allowed by law, and all compensation of cross-demands pursuant to CALIFORNIA CODE OF CIVIL PROCEDURE SECTION 431.70. No delay, omission or failure on the part of Lender in exercising any right or remedy hereunder shall operate as a waiver of such right or remedy or any other right or remedy of Lender. MAXIMUM LEGAL RATE. This Note is subject to the express condition that at no time shall Borrower be obligated, or required, to pay interest on the principal balance at a rate which could subject Lender to either civil or criminal liability as a result of such rate being in excess of the maximum rate which Lender is permitted to charge. If, by the terms of this Note, Borrower is, at any time, required or obligated to pay interest on the principal balance at a rate in excess of such maximum rate, then the rate of interest under this Note shall be deemed to be immediately reduced to such maximum rate and interest payable hereunder shall be computed at such maximum rate and any portion of all prior interest payments in excess of such maximum rate shall be applied, or shall retroactively be deemed to have been payments made, in reduction of the principal balance, as the case may be. 5 AMENDMENT; GOVERNING LAW; JURISDICTION. This Note may be amended, changed, modified, terminated or canceled only by a written agreement signed by the party against whom enforcement is sought for any such action. This Note shall be governed by, and construed under, the laws of the State of California. Borrower hereby irrevocably submits to the jurisdiction of the state court or federal court in any action, suit or proceeding brought against Borrower under or in connection with this Note or any of the other Security Instruments, and hereby irrevocably waives, to the fullest extent it may effectively do so, the defense of forum non convenience. AUTHORITY. Borrower, and each person executing this Note on Borrower's behalf, hereby represents and warrants to Lender that, by its execution below, Borrower has the full power, authority and legal right to execute and deliver this Note and that the indebtedness evidenced hereby constitutes a valid and binding obligation of Borrower without exception or limitation. In the event that this Note is executed by more than one person or entity, the liability hereunder shall be joint and several. BIFURCATION. Without consent or notice, Lender may assign to one or more banks or other entities all or a portion of its rights under this Note. In the event of an assignment of all of its rights, Lender may transfer this Note to the assignee. In the event of an assignment of a portion of its rights under this Note, Lender shall deliver to Borrower a new note to the order of the assignee in an amount equal to the principal amount assigned to the assignee and a new note to the order of Lender in an amount equal to the principal amount retained by Lender (collectively, the "New Notes"). Such New Notes shall be in the aggregate face amount equal to the original face amount of this Note, shall be dated the effective date of the assignment and otherwise shall be substantially identical to this Note. Upon receipt of the New Notes from Lender, Borrower shall execute such New Notes and, if requested by Lender, a splitter and/or a modification of the Security Instruments, in form and substance reasonably satisfactory to Lender, and at the expense of Borrower, promptly deliver such New Notes and splitter and/or modification of the Security Instruments to Lender. Upon receipt of the executed New Notes from Borrower, Lender shall cancel this Note to Borrower. Lender and the assignee shall make all appropriate adjustments in payments under this Note for periods prior to such effective date directly between themselves. In the event of an assignment of all or any portion of its rights hereunder, Lender may transfer and deliver all or any of the property then held by it as security under the Security Instruments and the assignee shall thereupon become vested with all the powers and rights therein given to Lender with respect thereto. After any such assignment or transfer, Lender shall be forever relieved and fully discharged from any liability or responsibility in the matter, and Lender shall retain all rights and powers hereby given with respect to property not so transferred. Lender may sell participations to one or more banks or other entities in or to all or a portion of its rights under this Note; provided, however, that unless notified otherwise by the assignee of the New Note, Lender shall remain the holder of this Note and accordingly Borrower shall continue to deal solely and directly with Lender in connection with Lender's rights under this Note. Lender, or the assignee of a New Note, may, in connection with any assignment or participation or proposed assignment or proposed participation, disclose to the assignee or participant or proposed assignee or proposed participant any information relating to Borrower furnished to Lender by or on behalf of Borrower. 6 IN WITNESS WHEREOF, Borrower has executed this Note as of the day and year first above written. BORROWER: MENDOCINO BREWING COMPANY, INC., a California corporation By: ___________________________ Name: Yashpal Singh Its: President 7 EX-10.81 4 ex10-81.txt EXHIBIT-10.81 SAVINGS BANK OF MENDOCINO COUNTY A FULL SERVICE COMMERCIAL BANK PROMISSORY NOTE BORROWER: MENDOCINO BREWING LENDER: SAVINGS BANK OF COMPANY, INC. MENDOCINO COUNTY 1601 AIRPORT RD MAIN OFFICE UKIAH, CA 95482 PO BOX 3600 200 N SCHOOL ST UKIAH, CA 95482 - -------------------------------------------------------------------------------- PRINCIPAL AMOUNT: $350,000.00 INITIAL RATE: 10.000% DATE OF NOTE: JUNE 6, 2006 PROMISE TO PAY. MENDOCINO BREWING COMPANY, INC. ("BORROWER") PROMISES TO PAY TO SAVINGS BANK OF MENDOCINO COUNTY ("LENDER"), OR ORDER, IN LAWFUL MONEY OF THE UNITED STATES OF AMERICA, THE PRINCIPAL AMOUNT OF THREE HUNDRED FIFTY THOUSAND & 00/100 DOLLARS ($350,000.00), TOGETHER WITH INTEREST ON THE UNPAID PRINCIPAL BALANCE FROM JUNE 6, 2006, UNTIL PAID IN FULL. PAYMENT. BORROWER WILL PAY THIS LOAN IN ONE PRINCIPAL PAYMENT OF $350,000.00 PLUS INTEREST ON DECEMBER 3, 2006. THIS PAYMENT DUE ON DECEMBER 3, 2006, WILL BE FOR ALL PRINCIPAL AND ALL ACCRUED INTEREST NOT YET PAID. IN ADDITION, BORROWER WILL PAY REGULAR MONTHLY PAYMENTS OF ALL ACCRUED UNPAID INTEREST DUE AS OF EACH PAYMENT DATE, BEGINNING JULY 1, 2006, WITH ALL SUBSEQUENT INTEREST PAYMENTS TO BE DUE ON THE SAME DAY OF EACH MONTH AFTER THAT. UNLESS OTHERWISE AGREED OR REQUIRED BY APPLICABLE LAW, PAYMENTS WILL BE APPLIED FIRST TO ANY ACCRUED UNPAID INTEREST; THEN TO PRINCIPAL; AND THEN TO ANY LATE CHARGES. INTEREST ON THIS NOTE IS COMPUTED ON A 365/365 SIMPLE INTEREST BASIS; THAT IS, BY APPLYING THE RATIO OF THE ANNUAL INTEREST RATE OVER THE NUMBER OF DAYS IN A YEAR (366 DURING LEAP YEARS), MULTIPLIED BY THE OUTSTANDING PRINCIPAL BALANCE, MULTIPLIED BY THE ACTUAL NUMBER OF DAYS THE PRINCIPAL BALANCE IS OUTSTANDING. BORROWER WILL PAY LENDER AT LENDER'S ADDRESS SHOWN ABOVE OR AT SUCH OTHER PLACE AS LENDER MAY DESIGNATE IN WRITING. VARIABLE INTEREST RATE. The interest rate on this Note is subject to change from time to time based on changes in an independent index which is the PRIME RATE AS PUBLISHED IN THE WALL STREET JOURNAL (the "Index"). The Index is not necessarily the lowest rate charged by Lender on its loans. If the Index becomes unavailable during the term of this loan, Lender may designate a substitute index after notice to Borrower. Lender will tell Borrower the current Index rate upon Borrower's request. The interest rate change will not occur more often than each TIME THE PRIME RATE CHANGES. Borrower understands that Lender may make loans based on other rates as well. THE INDEX CURRENTLY IS 8.000% PER ANNUM. THE INTEREST RATE TO BE APPLIED TO THE UNPAID PRINCIPAL BALANCE OF THIS NOTE WILL BE AT A RATE OF 1.500 PERCENTAGE POINTS OVER THE INDEX, ADJUSTED IF NECESSARY FOR ANY MINIMUM AND MAXIMUM RATE LIMITATIONS DESCRIBED BELOW, RESULTING IN AN INITIAL RATE OF 10.000% PER ANNUM. NOTWITHSTANDING THE FOREGOING, THE VARIABLE INTEREST RATE OR RATES PROVIDED FOR IN THIS NOTE WILL BE SUBJECT TO THE FOLLOWING MINIMUM AND MAXIMUM RATES. NOTICE: Under no circumstances will the interest rate on this Note be less than 10.000% per annum or more than the maximum rate allowed by applicable law. PREPAYMENT. Borrower agrees that all loan fees and other prepaid finance charges are earned fully as of the date of the loan and will not be subject to refund upon early payment (whether voluntary or as a result of default), except as otherwise required by law. Except for the foregoing, Borrower may pay without penalty all or a portion of the amount owed earlier than it is due. Early payments will not, unless agreed to by Lender in writing, relieve Borrower of Borrower's obligation to continue to make payments under the payment schedule. Rather, early payments will reduce the principal balance due. Borrower agrees not to send Lender payments marked "paid in full", "without recourse", or similar language. If Borrower sends such a payment, Lender may accept it without losing any of Lender's rights under this Note, and Borrower will remain obligated to pay any further amount owed to Lender. All written communications concerning disputed amounts, including any check or other payment instrument that indicates that the payment constitutes "payment in full" of the amount owed or that is tendered with other conditions or limitations or as full satisfaction of a disputed amount must be mailed or delivered to: Savings Bank of Mendocino County, Main Office, PO BOX 3600, 200 N SCHOOL ST, UKIAH, CA 95482. LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged $10.00. INTEREST AFTER DEFAULT. Upon default, the total sum due under this Note will bear interest at the interest rate on this Note. DEFAULT. Each of the following shall constitute an event of default ("Event of Default") under this Note: PAYMENT DEFAULT. Borrower fails to make any payment when due under this Note. OTHER DEFAULTS. Borrower fails to comply with or to perform any other term, obligation, covenant or condition contained in this Note or in any of the related documents or to comply with or to perform any term, obligation, covenant or condition contained in any other agreement between Lender and Borrower. FALSE STATEMENTS. Any warranty, representation or statement made or furnished to Lender by Borrower or on Borrower's behalf under this Note or the related documents is false or misleading in any material respect, either now or at the time made or furnished or becomes false or misleading at any time thereafter. INSOLVENCY. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower. CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self--help, repossession or any other method, by any creditor of Borrower or by any governmental agency against any collateral securing the loan. This includes a garnishment of any of Borrower's accounts, including deposit accounts, with Lender. However, this Event of Default shall not apply if there is a good faith dispute by Borrower as to the validity or reasonableness of the claim which is the basis of the creditor or forfeiture proceeding and if Borrower gives Lender written notice of the creditor or forfeiture proceeding and deposits with Lender monies or a surety bond for the creditor or forfeiture proceeding, in an amount determined by Lender, in its sole discretion, as being an adequate reserve or bond for the dispute. EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect to any Guarantor of any of the indebtedness or any Guarantor dies or becomes incompetent, or revokes or disputes the validity of, or liability under, any guaranty of the indebtedness evidenced by this Note. In the event of a death, Lender, at its option, may, but shall not be required to, permit the Guarantor's estate to assume unconditionally the obligations arising under the guaranty in a manner satisfactory to Lender, and, in doing so, cure any Event of Default. Page 2 PROMISSORY NOTE (CONTINUED) CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent (25%) or more of the common stock of Borrower. ADVERSE CHANGE. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of this Note is impaired. CURE PROVISIONS. If any default, other than a default in payment is curable and if Borrower has not been given a notice of a breach of the same provision of this Note within the preceding twelve (12) months, it may be cured if Borrower, after receiving written notice from Lender demanding cure of such default: (1) cures the default within fifteen (15) days; or (2) if the cure requires more than fifteen (15) days, immediately initiates steps which Lender deems in Lender's sole discretion to be sufficient to cure the default and thereafter continues and completes all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical. LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal balance on this Note and all accrued unpaid interest immediately due, and then Borrower will pay that amount. EXPENSES. If Lender institutes any suit or action to enforce any of the terms of this Note, Lender shall be entitled to recover such sum as the court may adjudge reasonable. Whether or not any court action is involved, and to the extent not prohibited by law, all reasonable expenses Lender incurs that in Lender's opinion are necessary at any time for the protection of its interest or the enforcement of its rights shall become a part of the loan payable on demand and shall bear interest at the Note rate from the date of the expenditure until repaid. Expenses covered by this paragraph include, without limitation, however subject to any limits under applicable law, Lender's expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), and appeals, to the extent permitted by applicable law. Borrower also will pay any court costs, in addition to all other sums provided by law. GOVERNING LAW. THIS NOTE WILL BE GOVERNED BY FEDERAL LAW APPLICABLE TO LENDER AND, TO THE EXTENT NOT PREEMPTED BY FEDERAL LAW, THE LAWS OF THE STATE OF CALIFORNIA WITHOUT REGARD TO ITS CONFLICTS OF LAW PROVISIONS. THIS NOTE HAS BEEN ACCEPTED BY LENDER IN THE STATE OF CALIFORNIA. CHOICE OF VENUE. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of MENDOCINO County, State of California. DISHONORED ITEM FEE. Borrower will pay a fee to Lender of $10.00 if Borrower makes a payment on Borrower's loan and the check or preauthorized charge with which Borrower pays is later dishonored. ADDITIONAL PROVISIONS. THIS NOTE IS SECURED BY A COMMERCIAL SECURITY AGREEMENT OF EVEN DATE HEREWITH. DISPUTE RESOLUTION. BORROWER AND LENDER DESIRE TO RESOLVE QUICKLY AND EFFICIENTLY ANY DISPUTES THAT MIGHT ARISE BETWEEN THEM. FOR ANY CONTROVERSY, CLAIM OR JUDICIAL ACTION ARISING FROM OR RELATING TO THIS NOTE OR ANY RELATED AGREEMENT, TRANSACTION OR CONDUCT, WHETHER SOUNDING IN CONTRACT, TORT OR OTHERWISE: JUDICIAL REFERENCE. WHERE AN ACTION IS PENDING BEFORE A COURT OF ANY JUDICIAL DISTRICT OF THE STATE OF CALIFORNIA, BORROWER AND LENDER SHALL EACH HAVE THE RIGHT TO REQUIRE THAT ALL QUESTIONS OF FACT OR LAW BE SUBMITTED TO GENERAL REFERENCE PURSUANT TO CALIFORNIA CODE OF CIVIL PROCEDURE SECTION 638 ET SEQ., AND ANY SUCCESSOR STATUTES THERETO. (1) A SINGLE REFEREE WHO IS A RETIRED SUPERIOR COURT JUDGE SHALL BE APPOINTED BY THE COURT PURSUANT TO CODE OF CIVIL PROCEDURE 640 AND SHALL PRESIDE OVER THE REFERENCE PROCEEDING. IF BORROWER AND LENDER DO NOT AGREE UPON THE REFEREE, EACH OF THEM MAY SUBMIT TO THE COURT UP TO THREE NOMINEES WHO ARE RETIRED SUPERIOR COURT JUDGES. (2) IT BORROWER AND LENDER DO NOT AGREE ON HOW THE PAYMENT OF THE REFEREE'S FEES AND EXPENSES WILL BE SHARED, THE COURT MAY APPORTION SUCH FEES AND EXPENSES BETWEEN BORROWER AND LENDER IN A FAIR AND REASONABLE MANNER THAT IS CONSISTENT WITH CODE OF CIVIL PROCEDURE SECTION 645.1. (3) BORROWER AND LENDER SHALL BE ENTITLED TO DISCOVERY, AND THE REFEREE SHALL OVERSEE DISCOVERY AND MAY ENFORCE ALL DISCOVERY ORDERS IN THE SAME MANNER AS ANY TRIAL COURT JUDGE. (4) THE REFEREE'S STATEMENT OF DECISION SHALL CONTAIN WRITTEN FINDINGS OF FACT AND CONCLUSIONS OF LAW, AND THE COURT SHALL ENTER JUDGMENT THEREON PURSUANT TO CODE OF CIVIL PROCEDURE SECTIONS 644(A) AND 645. THE DECISION OF THE REFEREE SHALL THEN BE APPEALABLE AS IF MADE BY THE COURT. NO PROVISION OF THIS SECTION SHALL LIMIT THE RIGHT OF ANY PARTY TO EXERCISE SELF-HELP REMEDIES, TO FORECLOSE AGAINST OR SELL ANY REAL OR PERSONAL PROPERTY COLLATERAL OR TO OBTAIN PROVISIONAL OR ANCILLARY REMEDIES, SUCH AS INJUNCTIVE RELIEF OR APPOINTMENT OF A RECEIVER, FROM A COURT OF COMPETENT JURISDICTION BEFORE, AFTER, OR DURING THE PENDENCY OF ANY REFERENCE PROCEEDING. THE EXERCISE OF A REMEDY DOES NOT WAIVE THE RIGHT OF EITHER PARTY TO RESORT TO REFERENCE. JURY TRIAL WAIVER. IN ANY ACTION PENDING BEFORE ANY COURT OF ANY JURISDICTION, BORROWER WAIVES, AND LENDER SHALL NOT HAVE, ANY RIGHT TO A JURY TRIAL. ATTORNEYS' FEES. In any action arising from or relating to this Note and subject to any limits under applicable law, the prevailing party shall be entitled to reasonable attorneys' fees in accordance with California Civil Code Section 1717. Whether or not an action is involved, the expenses of Lender described in the paragraph of this Note titled "Expenses" include, without limitation, attorneys' fees incurred by Lender. AMENDMENT TO PROMISSORY NOTES - RECOURSE AGAINST GENERAL PARTNERS OR JOINT VENTURERS. PARTNERSHIP OR JOINT VENTURER BORROWER. If Borrower is a partnership or joint venture, each of the general partners or joint venturers will be jointly and severally liable with Borrower under this Note and any related agreements and Lender may proceed against any or all of the general partners or joint venturers with regard to such liability without proceeding against the assets of Borrower or any of Borrower's other general partners or joint venturers. SUCCESSOR INTERESTS. The terms of this Note shall be binding upon Borrower, and upon Borrower's heirs, personal representatives, successors and assigns, and shall inure to the benefit of Lender and its successors and assigns. NOTIFY US OF INACCURATE INFORMATION WE REPORT TO CONSUMER REPORTING AGENCIES. Please notify us if we report any inaccurate information about your account(s) to a consumer reporting agency. Your written notice describing the specific inaccuracy(ies) should be sent to us at the following address: Savings Bank of Mendocino County 200 N SCHOOL ST UKIAH, CA 95482. GENERAL PROVISIONS. Lender may delay or forgo enforcing any of its rights or remedies under this Note without losing them. Borrower and any other person who signs, guarantees or endorses this Note, to the extent allowed by law, waive any applicable statute of limitations, presentment, demand for payment, and notice of dishonor. Upon any change in the terms of this Note, and unless otherwise expressly stated in writing, no party who signs this Note, whether as maker, guarantor, accommodation maker or endorser, shall be released from liability. All such parties agree that Lender may renew or extend (repeatedly and for any length of time) this loan or release any party or guarantor or collateral; or impair, fail to realize upon or perfect Lender's security interest in the collateral; and take any other action deemed necessary by Lender without the consent of or notice to anyone. All such parties also agree that Lender may modify this loan without the consent of or notice to anyone other than the party with whom the modification is made. The obligations under this Note are joint and several. Page 3 PROMISSORY NOTE (CONTINUED) PRIOR TO SIGNING THIS NOTE, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS NOTE, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS. BORROWER AGREES TO THE TERMS OF THE NOTE. BORROWER ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THIS PROMISSORY NOTE. BORROWER: MENDOCINO BREWING COMPANY, INC. BY: BY: YASHPAL SINGH, PRESIDENT OF MENDOCINO NARAYANA MAHADEVAN, BREWING CONTROLLERLTREASJSECTY. OF COMPANY, INC. MENDOCINO BREWING COMPANY, INC. EX-31.1 5 ex31-1.txt EXHIBIT-31.1 CERTIFICATIONS I, Yashpal Singh, certify that: 1. I have reviewed this quarterly report on Form 10-Q 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)) 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. [Intentionally omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]; 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 functions): 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 control over financial reporting. Date August 14, 2006 /s/ YASHPAL SINGH ---------------------- Yashpal Singh, President, Director and Chief Executive Officer EX-31.2 6 ex31-2.txt EXHIBIT-31.2 CERTIFICATIONS I, N. Mahadevan, certify that: 1. I have reviewed this quarterly report on Form 10-Q 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)) 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. [Intentionally omitted pursuant to SEC Release Nos. 33-8238 and 34-47986]; 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 functions): 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 control over financial reporting. Date: August 14, 2006 /s/ N. MAHADEVAN -------------------------- N. Mahadevan, Chief Financial Officer EX-32.1 7 ex32-1.txt EXHIBIT-32.1 CERTIFICATION PURSUANT TO TITLE 18, UNITED STATES CODE, SECTION 1350 In connection with the Quarterly Report of Mendocino Brewing Company, Inc. (the "Company") on Form 10-Q for the quarterly period ended June 30, 2006, 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, as amended; 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 14, 2006 /s/ YASHPAL SINGH --------------------------------- Name: Yashpal Singh Title: President, Director and Chief Executive Officer EX-32.2 8 ex32-2.txt EXHIBIT-32.2 CERTIFICATION PURSUANT TO TITLE 18, UNITED STATES CODE, SECTION 1350 In connection with the Quarterly Report of Mendocino Brewing Company, Inc. (the "Company") on Form 10-Q for the quarterly period ended June 30, 2006 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, as amended; 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 14, 2006 /s/ N. MAHADEVAN ------------------------------- Name: N. Mahadevan Title: Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----