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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 SEPTEMBER 30, 2004
| | Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
------------ ------------
Commission file number 1-13636
MENDOCINO BREWING COMPANY, INC.
(Exact name of Registrant as Specified in its Charter)
CALIFORNIA 68-0318293
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
1601 AIRPORT ROAD, UKIAH, CA 95482
(Address of principal executive offices)
(707) 463-6610
(Registrant's Telephone Number, Including Area Code)
Not Applicable
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X ]
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: The number of shares of the
issuer's common stock outstanding as of October 31, 2004 is 11,266,874.
PART I
ITEM 1. FINANCIAL STATEMENTS.
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
ASSETS
SEPTEMBER 30, DECEMBER 31,
2004 2003
CURRENT ASSETS
Cash $ 322,400 $ 554,300
Accounts receivable, net of allowance for doubtful 7,094,100 7,017,700
accounts of $16,400 and $37,800
Inventories 1,334,400 1,186,100
Prepaid expenses 421,700 555,500
------------- -------------
Total Current Assets: 9,172,600 9,313,600
------------- -------------
PROPERTY AND EQUIPMENT 13,605,900 13,874,800
------------- -------------
OTHER ASSETS
Deposits and other assets 186,400 188,600
Intangibles net of amortization 88,700 94,700
------------- -------------
Total Other Assets: 275,100 283,300
------------- -------------
Total Assets: $ 23,053,600 $ 23,471,700
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Line of credit $ 2,541,600 $ 1,974,800
Note payable 576,200 576,200
Accounts payable 5,118,200 5,340,100
Accrued liabilities 1,026,600 1,275,100
Accrued legal settlement 900,000 655,200
Income taxes payable 473,900 465,100
Current maturities of obligation under long-term 521,600 693,700
debt
Current maturities of obligation under capital
lease 148,000 129,000
------------- -------------
Total Current Liabilities: 11,306,100 11,109,200
NOTES TO RELATED PARTY 1,985,500 1,921,500
Long term debt, less current maturities 3,374,400 3,730,300
OBLIGATIONS UNDER CAPITAL LEASE, less current
maturities 93,200 204,100
------------- -------------
Total Liabilities: 16,759,200 16,965,100
------------- -------------
2
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, Series A, no par value, with
aggregate liquidation preference of
$227,600; 10,000,000 shares authorized,
227,600 shares issued and outstanding 227,600 227,600
Common stock, no par value: 30,000,000 shares
authorized, 11,266,874 shares issued and
outstanding 14,648,600 14,648,600
Accumulated comprehensive income 107,800 78,000
Accumulated deficit (8,689,600) (8,447,600)
------------- -------------
Total Stockholders' Equity 6,294,400 6,506,600
------------- -------------
Total Liabilities and Stockholders' Equity: $ 23,053,600 $ 23,471,700
============= =============
The accompanying notes are an integral part of these financial statements.
3
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPT 30, SEPT 30,
2004 2003 2004 2003
---- ---- ---- ----
SALES $ 8,154,500 $ 7,830,500 $23,475,100 $21,125,800
EXCISE TAXES 176,200 202,200 506,500 514,500
----------- ----------- ----------- -----------
NET SALES 7,978,300 7,628,300 22,968,600 20,611,300
COST OF GOODS SOLD 5,181,800 5,101,600 15,189,100 13,913,100
----------- ----------- ----------- -----------
GROSS PROFIT 2,796,500 2,526,700 7,779,500 6,698,200
----------- ----------- ----------- -----------
OPERATING EXPENSES
Marketing 1,536,800 1,182,700 4,343,500 3,463,000
General and
Administrative 825,900 756,700 2,732,400 2,266,300
----------- ----------- ----------- -----------
2,362,700 1,939,400 7,075,900 5,729,300
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS
OTHER INCOME (EXPENSE) 433,800 587,300 703,600 968,900
----------- ----------- ----------- -----------
Other income 8,600 143,700 17,700 154,400
Profit on sale of equipment 1,100 -- 15,100 --
Legal dispute settlement (216,400) -- (216,400) --
Interest expense (217,700) (202,200) (640,400) (610,000)
----------- ----------- ----------- -----------
(424,400) (58,500) (824,000) (455,600)
----------- ----------- ----------- -----------
INCOME (LOSS) BEFORE INCOME TAXES 9,400 528,800 (120,400) 513,300
PROVISION FOR INCOME TAXES 43,400 93,400 121,600 205,400
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (34,000) $ 435,400 $ (242,000) $ 307,900
----------- ----------- ----------- -----------
4
OTHER COMPREHENSIVE
INCOME /(LOSS), net of tax
Foreign Currency Translation
Adjustment 4,100 11,700 29,800 30,100
----------- ----------- ----------- -----------
COMPREHENSIVE Income (LOSS) $ (29,900) $ 447,100 $ (212,200) $ 338,000
=========== =========== =========== ===========
NET INCOME (LOSS)
PER COMMON SHARE $ (0.00) $ (0.04) $ (0.02) $ 0.03
=========== =========== =========== ===========
DILUTED NET INCOME (LOSS)
PER COMMON SHARE $ (0.00) $ (0.04) $ (0.02) $ 0.03
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
5
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,
--------------------------------------
2004 2003
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss) $ (242,000) $ 307,900
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Depreciation and amortization 768,800 842,100
Allowance for doubtful accounts 16,400 --
Profit (Loss) on sale of assets (15,100) 1,200
Changes in:
Accounts receivable 18,300 83,200
Inventories (148,300) 127,600
Prepaid expenses 139,000 32,900
Deposits and other assets (30,300) (2,500)
Accounts payable (271,200) (1,101,500)
Accrued liabilities (15,000) (9,800)
Income taxes payable 2,400 --
---------- ----------
Net cash from operating activities: 223,000 281,100
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment, and leasehold
improvements (486,800) (445,100)
Proceeds from new distributors -- 655,200
Proceeds from sale of fixed assets 24,300 10,900
---------- ----------
Net cash from investing activities: (462,500) 221,000
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowing on line of credit 557,900 180,900
Borrowing on long term debt -- 403,700
Principal payment on long-term debt (542,200) (404,800)
Borrowings on related party debt 64,000 64,200
Payments on obligation under long term lease (91,900) (190,500)
Disbursements in excess of deposits -- (134,300)
---------- ----------
Net cash from financing activities: (12,200) (80,800)
---------- ----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 19,800 11,200
---------- ----------
NET CHANGE IN CASH (231,900) 432,500
---------- ----------
CASH, beginning of period 554,300 146,800
---------- ----------
CASH, end of period $ 322,400 $ 579,300
========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Interest $ 576,400 $ 545,800
Income taxes $ 100,200 $ 299,900
Non-cash investing activity
Seller Financed equipment $ 26,500 $ 28,500
The accompanying notes are an integral part of these financial statements.
6
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
As used herein, the term "the Company" and its variants is generally used to
refer to Mendocino Brewing Company, Inc. and its subsidiaries, while the term
"MBC" is used to refer to Mendocino Brewing Company, Inc. as an individual
entity standing alone.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's annual report on Form
10-KSB for the year ended December 31, 2003. In the opinion of management, all
adjustments considered necessary for a fair presentation have been included.
Operating results for the nine months ended September 30, 2004, are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004.
The Company's line of credit from CIT Group and its temporary loan from Savings
Bank of Mendocino (both of which are more fully described in the Notes below and
in Item 2 of this Part I under the heading "Liquidity and Capital Resources --
Other Loans and Credit Facilities") are scheduled to fall due on December 31 and
December 1, 2004, respectively. A failure to replace, renegotiate, or extend
either of these agreements would have a significant adverse impact on the
Company's liquidity and operations. Although management has been able to do so
in the past, there can be no assurance that the Company will have access to the
same or equivalent sources of funds in the future, either on a comparable basis
or on any other terms acceptable to the Company.
The Company has a stock-based employee compensation plan that allows the Company
to grant options to purchase up to 1,000,000 shares of the Company's common
stock. The Company accounts for this plan under the recognition and measurement
principles of APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and
related Interpretations. No stock-based employee compensation cost is reflected
in net loss, as all options granted under these plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
No options were granted or exercised in 2004 or 2003.
On April 4, 2004, the Company received a commitment from United Breweries of
America, Inc. ("UBA"), one of its major shareholders, to the effect that UBA
would provide the Company with such financial assistance as may be in UBA's
power to prevent or avoid any default under either the Company's line of credit
with CIT Group/Credit Finance, Inc. ("CIT Group") or its temporary loan from
Savings Bank of Mendocino County when they become due. The terms of any such
assistance have not yet been determined, however.
Effective on or about November 1, 2004, the Company entered into an agreement
with House of Daniels, Inc., dba Golden Gate Distributing Company ("GGDC") to
settle a previously disclosed legal dispute (discussed in Part II, Item 1 of
this Quarterly Report). The Company had earlier received payments from the new
distributors that were to reimburse the Company for certain costs related to
changes in distributors. These payments were reflected in prior financial
statements as a deferred gain because of the uncertainty surrounding the
litigation. This treatment was intended to remain in place until such time as
the litigation with GGDC was completed. As a result of the settlement agreement,
the Company has accrued a liability of $900,000 to GGDC. This liability is in
excess of the payments from the new distributors, with
7
the $216,400 difference reflected as an expense for the three months ended
September 30, 2004.
NOTE 2 - LINE OF CREDIT
The CIT Group has provided the Company a $3,000,000 maximum line of credit with
an advance rate of 80% of the qualified accounts receivable and 60% of the
inventory at a current interest rate equal to the prime rate of Chase Manhattan
Bank of New York plus 4.25 % payable monthly, originally scheduled to mature on
September 23, 2002. The line of credit is secured by all accounts receivable,
general intangibles, inventory, and equipment of the Company except for the
specific equipment and fixtures of the Company acquired from Finova Capital
Corporation, as well as by a second deed of trust on the Company's Ukiah land
improvements. Of the line of credit, $1,484,000 was advanced to the Company as
an initial term loan, which was repayable in sixty consecutive monthly
installments of principal, each in the amount of $24,700.
In a series of amendments beginning on January 17, 2003, CIT Group increased the
maximum credit available to $3,500,000, provided a term loan of $750,000
consisting of the original balance of $346,300 and a new term loan of $403,700
repayable in 30 equal consecutive monthly installments of $24,700, commencing
February 1, 2003, with a final payment of $8,000, and increased the term loan
repayment to $10,000 per week. On October 31, 2004, CIT Group extended the
facility to expire on December 31, 2004. Based on the Company's current level of
accounts receivable and inventory, the Company has drawn the maximum amount
permitted under the line of credit. As of September 30, 2004, the total amount
outstanding on the line of credit was approximately $1,621,500.
Nedbank Limited, a South African registered company, has 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 includes a revolving short-term loan, overdraft
protection, and foreign exchange services. It is available until terminated by
Nedbank, and is secured by all of the assets of UBSN. The amount outstanding on
this line of credit as of September 30, 2004 was approximately $1,060,700.
NOTE 3 - LONG TERM DEBT, NOTE PAYABLE, AND NOTES TO RELATED PARTIES
The Company has a note outstanding in the principal amount of $2,700,000 in
favor of Savings Bank of Mendocino County ("SBMC"), with interest at the
five-year treasury constant maturity index plus 4.17%, currently 7.24%. The note
requires monthly payments of principal and interest of $24,400. The note matures
in December 2012 with a balloon payment of $932,600, and is secured by real
property located in Ukiah, California.
On December 31, 2003, SBMC extended a temporary loan in the principal amount of
$576,200 to the Company in order to finance a buy-out of equipment leased
through Finova Capital Corporation. This loan, which is due for repayment on
December 1, 2004, is secured by the existing assets of the Company and the
assets released by Finova on lease termination. The current rate of interest on
the loan is 8%.
The Company owes the County of Mendocino $574,500, which represents overdue
taxes for the period from April of 1999 to June of 2003. Under the payment plan
executed with the County, this amount is payable in four annual installments on
or before April 10 of each year, commencing in 2005, along with accrued interest
calculated at 18% per year. Failure to timely pay any installment or any current
property taxes may result in the County selling the Company's Ukiah property to
satisfy this outstanding debt.
8
UBSN has engaged Shepherd Neame Limited ("Shepherd Neame"), a related party, to
brew Kingfisher Lager for the Company's European and Canadian markets. As
consideration for the extension of the brewing contract, Shepherd Neame advanced
a loan of GBP 600,000 to UBSN, repayable in ten annual installments of GBP
60,000, commencing in June 2003. At the time of the filing this report, GBP
600,000 was approximately equal to $1,085,400, therefore, each payment of 60,000
GBP would be approximately equal to $108,500. The loan carries an interest rate
of 5% per year.
The Company has issued unsecured convertible notes in favor of UBA in the amount
of approximately $1,515,400 as of September 30, 2003. The notes bear interest at
the prime rate plus 1.5%, subject to a maximum of 10% per annum, and each note
originally matured 18 months from the date of the particular advance. The notes
have since been extended to mature on August 31, 2005. The notes are
convertible, at UBA's option, into common stock at $1.50 per share. Interest
accrued on the notes as of September 30, 2004, is approximately $470,100.
Because these notes are subordinated to the CIT line of credit and SBMC note,
the Company does not expect to make payments on the notes within the next year.
The Company expects the maturity dates to be extended again and has shown the
amount as long-term debt.
NOTE 4 -- RELATED PARTY TRANSACTIONS
During 2001, MBC and its subsidiaries entered into or amended several agreements
with affiliated and related entities. Among these were a Brewing Agreement and a
Loan Agreement between UBSN and Shepherd Neame Limited; a Market Development
Agreement, a Distribution Agreement, and a Brewing License Agreement between MBC
and UBSN; a Distribution Agreement between UBI and UBSN; a Trademark Licensing
Agreement between MBC and Kingfisher of America, Inc.; and a License Agreement
between UBI and UB Limited. Additional information about these transactions may
be found in the Company's annual report on Form 10-KSB for the year ended
December 31, 2003.
The following table reflects the value of the foregoing transactions for the
nine months ended September 30, 2004 and 2003 and the account balances
outstanding at September 30, 2004 and 2003.
- ----------------------------------------------------- ----------------- ----------------
2004 2003
- ----------------------------------------------------- ----------------- ----------------
Sales to Shepherd Neame $1,886,000 $ 1,777,600
- ----------------------------------------------------- ----------------- ----------------
Purchases from Shepherd Neame 9,660,300 7,915,800
- ----------------------------------------------------- ----------------- ----------------
Expense reimbursement to Shepherd Neame 864,900 608,300
- ----------------------------------------------------- ----------------- ----------------
Interest expenses associated with UBA convertible 64,000 64,200
notes payable
- ----------------------------------------------------- ----------------- ----------------
Accounts payable to Shepherd Neame 3,054,200 2,736,400
- ----------------------------------------------------- ----------------- ----------------
Account receivable from Shepherd Neame 564,600 727,300
- ----------------------------------------------------- ----------------- ----------------
NOTE 5 - NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Basic earnings per share (EPS) is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted EPS is computed by dividing income available to
shareholders by the weighted average number of common shares and common
equivalent shares outstanding, which include dilutive stock options and notes
payable convertible in common stock. Common equivalent shares associated with
stock options and convertible notes payable have been excluded from periods with
a net loss as the potentially dilutive shares would be antidilutive.
9
Three Months Ended Nine Months Ended
------------------ -----------------
9/30/2004 9/30/2003 9/30/2004 9/30/2003
-----------------------------------------------------------------------
Net income (loss) $ (34,000) $ 435,400 $ (242,000) $ 307,900
=======================================================================
Weighted average common shares outstanding 11,266,874 11,266,874 11,266,874 11,266,874
=======================================================================
Basic net income (loss) per share $ (0.00) $ 0.04 $ (0.02) $ 0.03
=======================================================================
Diluted net income (loss) per share
Net income (loss) $ (34,000) $ 435,400 $ (242,000) $ 307,900
Interest expense on convertible notes
payable -- 20,900 -- 64,200
-----------------------------------------------------------------------
Income for the purpose of computing
diluted net income per share $ (34,000) $ 456,300 $ (242,000) $ 372,100
=======================================================================
Weighted average common shares outstanding 11,266,874 11,266,874 11,266,874 11,266,874
Dilutive stock options -- -- -- --
Assumed conversion of convertible notes
payable -- 1,267,012 -- 1,267,012
-----------------------------------------------------------------------
Weighted average common shares outstanding
for the purpose of computing diluted net
income (loss) per share 11,266,874 12,533,886 11,266,874 12,533,886
=======================================================================
Diluted net income (loss) per share $ (0.00) $ 0.04 $ (0.02) $ 0.03
NOTE 6 - INVENTORY
September 30, 2004 December 31, 2003
Raw Materials $ 358,700 $ 459,600
Beer-in-process 204,800 190,400
Finished Goods 746,700 510,000
Merchandise 24,200 26,100
----------- ----------
TOTAL $ 1,334,400 $1,186,100
=========== ==========
NOTE 7 - STOCKHOLDERS' EQUITY
The following table summarizes equity transactions during the nine months ended
September 30, 2004.
10
SERIES A
PREFERRED STOCK COMMON STOCK OTHER
--------------------- -------------------------- COMPREHENSIVE ACCUMULATED TOTAL
SHARES AMOUNT SHARES AMOUNT INCOME/(LOSS) DEFICIT EQUITY
---------- --------- ------------ ------------ -------------- ------------ -------------
Balance,
December 31, 2003 227,600 $ 227,600 11,266,874 $ 14,648,600 $ 78,000 $ (8,447,600) $ 6,506,600
Net Loss (242,000) (242,000)
Currency
Translation
Adjustment 29,800 29,800
Balance,
September 30, 2004 227,600 $ 227,600 11,266,874 $ 14,648,600 $ 107,800 $ (8,689,600) $ 6,294,400
========== ========= ============ ============ ============== ============ =============
NOTE 8. SEGMENT INFORMATION
The Company's business segments are its domestic operations (brewing and sales
in the United States), European territory (sales and distribution operations in
Europe and Canada), and retail operations (retail sales at the Hopland Brewery
in Ukiah, California and the tasting room at Saratoga Springs, New York). A
summary of each segment is as follows:
Nine months ended September 30, 2004
----------------------------------------------------------------------------
Domestic European Retail Corporate & Total
Operations Territory Operations Others
Sales $ 8,872,000 $14,444,300 $158,800 $ -- $ 23,475,100
Operating
Profit/(Loss) 266,900 432,100 4,600 -- 703,600
Identifiable Assets 13,436,200 7,219,800 100,500 2,297,100 23,053,600
Depreciation &
amortization 418,400 331,100 3,800 15,500 768,800
Capital Expenditures 26,500 460,300 -- -- 486,800
11
Nine months ended September 30, 2003
----------------------------------------------------------------------------
Domestic European Retail Corporate & Total
Operations Territory Operations Others
Sales $ 8,900,900 $ 11,844,300 $380,600 $ -- $ 21,125,800
Operating Profit/(Loss) 252,100 738,600 (21,800) -- 968,900
Identifiable Assets 13,890,000 5,297,500 97,000 2,951,400 22,235,900
Depreciation & 552,000 272,000 4,700 13,400 842,100
amortization
Capital Expenditures 101,600 343,500 -- -- 445,100
NOTE 9 - LEGAL DISPUTES
Effective on or about November 1, 2004, the Company entered into a Settlement
Agreement and Release (the "Settlement Agreement") with respect to a civil
action (the "Action") brought against the Company and others by House of
Daniels, Inc., dba Golden Gate Distributing Company ("GGDC"), arising out of the
Company's termination, during 2003, of a written distribution agreement with
GGDC. In addition to the Company, GGDC had also sued United Breweries of
America, Inc. ("UBA"), one of the Company's principal shareholders; Dr. Vijay
Mallya, who is the Chairman of the Board of the Company and of UBA; Mark
Anderson, the Company's West Coast Sales Manager; and two distribution companies
that were contracted by the Company to service between them the territory
formerly handled by GGDC (the "Subsequent Distributors").
In the course of the Action, a cross-complaint was filed against GGDC by the
Company, and cross-complaints were filed against the Company by the Subsequent
Distributors. The Settlement Agreement releases the claims asserted in, arising
out of, or related to the Action by GGDC against the Company and the other
defendants, and by the Company against GGDC. The Settlement Agreement does not
release, or even cover, the cross-claims asserted against the Company by the
Subsequent Distributors; however the Company does not believe that any amounts
payable in connection with such claims are likely to be material.
Under the terms of the Settlement Agreement, the Company is required to pay GGDC
a total of $900,000 in settlement of all claims (the "Settlement Amount").
Payment is to be made in three installments: $400,000 by January 31, 2005;
$300,000 by June 30, 2005; and the remaining $200,000 by December 31, 2005. No
other payments are called for by any party to the Action. UBA has guaranteed the
payment, in full, of each of the installment payments included in the Settlement
Amount.
See Note 1 for a discussion of the accounting treatment for the losses
associated with the Action.
12
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 nine months ended September 30, 2004, compared to
the nine months ended September 30, 2003 and the year ended December 31, 2003.
This discussion should be read in conjunction with the Consolidated Financial
Statements and Notes included in the company's Annual Report on Form 10-KSB for
the year ended December 31, 2003.
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 ("SEC") 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.
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.
13
Historically, actual results have not significantly deviated from those
determined using the necessary estimates inherent in the preparation of
financial statements. Estimates and assumptions include, but are not limited to,
customer receivables, inventories, assets held for sale, fixed asset lives,
contingencies and litigation. The Company has also chosen certain accounting
policies when options were available, including:
o The first-in, first-out (FIFO) method to value the majority of
the Company's inventories.
o The Company follows Accounting Principles Board Opinion No. 25
(APB 25), "Accounting for Stock Issued to Employees," in
accounting for its employee stock options using the fair value
based method.
o The Company reviews its long-lived assets for impairment
whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable. The
Company's evaluation is based on an estimate of the future
undiscounted cash flows of the related asset or asset grouping
over the remaining life in measuring whether the assets are
recoverable. Long-lived asset are written down to their
estimated net fair value calculated using a discounted future
cash flow analysis in the event of an impairment. If
circumstances related to the Company's long-lived assets change,
the Company's valuation of the long-lived assets could
materially change.
o The Company evaluates the realizability of its deferred tax
assets quarterly by assessing the need for and amount of the
valuation allowance. This evaluation is based on an assessment
of the Company's ability to generate future U.S. taxable income.
Results of operations in recent years are considered in the
assessment. The Company records a valuation allowance for the
portion of its deferred tax assets that do not meet the
recognition criteria of SFAS No. 109, "Accounting for Income
Taxes." If circumstances related the Company's ability to
generate future U.S. taxable income change, the Company's
evaluation of its deferred tax assets could materially change.
o The Company accrues contingent losses when management determines
it is probable that a liability has been incurred or that an
asset has been impaired and the amount of the loss can be
reasonably determined.
These accounting policies are applied consistently for all years
presented. The Company's operating results would be affected if other
alternatives were used. Information about the impact on operating results is
included in the footnotes to the Company's consolidated financial statements.
SEGMENT INFORMATION
Prior to 2001, the Company's business operations were exclusively
located in the United States, where they were divided into two segments:
manufacturing and distribution of beer, which accounted for the majority of the
Company's gross sales; and retail sales (primarily at the Company's Hopland,
California, tavern and merchandise store) which generally accounted for less
than 5% of gross sales (by revenue). With the Company's acquisition of United
Breweries International (UK), Ltd. ("UBI") in August 2001, however, the Company
gained a new business segment, distribution of beer outside the United States,
primarily in the U.K. and Ireland, continental Europe, and Canada (the "European
Territory"). This segment accounted for 62% of the Company's gross sales during
the first nine months of 2004 (as compared to 56% for the same period during
2003), with the Company's United States operations, including manufacturing and
distribution of beer as well as retail sales accounting for the remaining 38%.
14
With expanded wholesale distribution of beer and closure of the restaurant in
Hopland, 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 nine months of 2004 with a net loss of
$242,000, as compared to a net income of $307,900 for the same period in 2003.
As set forth more fully under "Results of Operations," below, during the first
nine months of 2004 the Company experienced an increase in gross sales of
$2,349,300, or 11.1% during the period, but this increase was offset by higher
costs of goods sold (which increased by $1,276,000, or 9.2%), marketing costs
(which increased by $880,500, or 25.4%), and general and administrative costs
(which increased by $466,100, or 20.6%), all of which contributed to the net
loss for the period.
15
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.
STATEMENTS OF OPERATIONS DATA: THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------
2004 2003 2004 2003
% % % %
- - - -
Sales 102.21 102.65 102.21 102.50
Less Excise taxes 2.21 2.65 2.21 2.50
NET SALES 100.00 100.00 100.00 100.00
Costs of Sales 64.95 66.88 66.13 67.50
GROSS PROFIT 35.05 33.12 33.87 32.50
Marketing 19.26 15.50 18.91 16.80
General and Administrative Expense 10.35 9.92 11.90 11.00
PROFIT FROM OPERATIONS 5.44 7.70 3.06 4.70
Other Income / (Expense) 0.12 1.88 0.14 0.75
Legal dispute settlement (2.71) 0.00 (0.94) 0.00
Interest Expense (2.73) (2.65) (2.79) (2.96)
Profit/(Loss) before income taxes 0.12 6.93 (0.52) 2.49
Provision for income taxes 0.54 1.22 0.53 1.00
NET PROFIT / (LOSS) (0.43) 5.71 (1.05) 1.49
Other Comprehensive Income 0.05 0.15 0.13 0.15
COMPREHENSIVE PROFIT / (LOSS) (0.37) 5.86 (0.92) 1.64
16
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
2004 2003
BALANCE SHEET DATA: $ $
Cash and Cash Equivalents 322,400 579,300
Working Capital (2,133,500) (1,621,000)
Property and Equipment 13,605,900 13,795,500
Deposits and Other Assets 275,100 292,800
Total Assets 23,053,600 22,235,900
Long-term Debt (less current 3,374,400 3,699,200
maturities)
Capital Lease (less current 93,200 183,200
maturities)
Total Liabilities 16,759,200 15,551,600
Accumulated Deficit (8,689,600) (8,186,600)
Stockholder's equity 6,294,400 6,684,400
THREE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 2003
NET SALES
Overall net sales for the third quarter of 2004 were $7,978,300, an
increase of $350,000, or 4.6%, compared to $7,628,300 for the third quarter of
2003. The increase was mainly due to increased sales in the European territory.
DOMESTIC OPERATIONS: Net sales for the third quarter of 2004 were
$3,022,800 compared to $3,439,400 for the same period in 2003, a decrease of
$416,600, or 12.1%. The sales volume decreased to 16,010 barrels in third
quarter of 2004 from 18,333 barrels in the third quarter 2003, representing a
decrease of 2,323 barrels, or 12.67%. Of the decrease, sale of the Company's
domestic brands decreased by 742 barrels; the sale of Kingfisher brands
decreased by 155 barrels, and sales of contract brands decreased by 1,426
barrels.
EUROPEAN TERRITORY: Net sales for the third quarter of 2004 were
$4,955,500 (GBP 2,724,000) compared to $4,188,900 (GBP 2,601,200) during the
corresponding period of 2003, an increase of $766,600, or 18.3%. During the
third quarter of 2004, UBSN sold 16,186 barrels, compared to 15,419 barrels
during the third quarter of 2003, representing an increase of 767 barrels, or
5%. Exchange rate fluctuations increased the financial effect of the Company's
growth in sales in its European Territory. When measured from period to period
exclusively in Pounds Sterling (which is the basic currency of account for the
European Territory), the Company's net sales in its European Territory increased
by only 4.72%.
COST OF GOODS SOLD
Cost of goods sold as a percentage of net sales during the third quarter
of 2004 was 64.95%, as compared to 66.88% during the corresponding period of
2003 mainly due to reduced costs in the United States.
DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in
the United States during the third quarter of 2004 was 63.47%, as compared to
67.11%, during the corresponding period of 2003, representing a decrease of
3.64% due mainly to a decrease in depreciation and retail operation costs
because of the closure of the restaurant in Hopland.
17
EUROPEAN TERRITORY: Cost of goods sold as a percentage of net sales in
the European Territory during the third quarter of 2004 was 66.31%, as compared
to 67.29% during corresponding period in 2003 (in each case as calculated in
U.S. dollars, after taking into account the effects of the exchange rate
calculation), representing increase of 0.98%.
GROSS PROFIT
Gross profit for the third quarter of 2004 increased to $2,796,500, from
$2,526,700 during the corresponding period of 2003, representing an increase of
10.68%. As a percentage of net sales, the gross profit during the third quarter
of 2004 increased to 35.05% from that of 33.12% for the third quarter of 2003.
OPERATING EXPENSES
Operating expenses for the third quarter of 2004 were $2,362,700, an
increase of $423,300, or 21.83%, as compared to $1,939,400 for the corresponding
period of 2003. Operating expenses consist of marketing and distribution
expenses and general and administrative expenses.
MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and
distribution expenses consist of salaries and commissions, advertising costs,
product and sales promotion costs, travel expenses and related costs and
Company's tavern and tasting room expenses. Such expenses for the third quarter
of 2004 were $1,536,800, as compared to $1,182,700 for the third quarter of
2003, representing an increase of $354,100, or 29.94%. Increases in the
Company's marketing expenses were driven by heavier competition, particularly in
the Company's European Territory, and the Company believes that trend is likely
to continue for the next few quarters at least.
DOMESTIC OPERATIONS: Expenses for the third quarter of 2004 were
$474,200 compared to $467,400 during the corresponding period of 2003,
representing an increase of $6,800, or 1.45%. As a percentage of net sales in
the United States, the expenses increased to 15.69% during the third quarter of
2004, compared to 13.59% during the corresponding period of 2003. There were
increases in salary and travel costs during the third quarter of 2004 compared
to the corresponding period of 2003 due to increased salaries, increased
advertising and promotional expenses which increases were partially offset by
reductions in tavern and tasting room expenses due to closure of the Company's
Hopland restaurant.
EUROPEAN TERRITORY: Expenses for the third quarter of 2004 were
$1,062,600 compared to $715,300 during the corresponding period of 2003,
representing an increase of $347,300, or 48.55%. As a percentage of net sales in
the European Territory, the expenses increased to 21.44% during the third
quarter of 2004 compared to 17.08% during the corresponding period of 2003 (in
each case as calculated in U.S. dollars, after taking into account the effects
of the exchange rate calculation). The increase resulted mainly from higher
staffing levels and associated travel costs, increased advertising and
promotional expenses, and higher freight expenses.
GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and
administrative expenses were $825,900 for the third quarter of 2004,
representing an increase of $69,200, or 9.14%, over $756,700 for the
corresponding period in 2003. These expenses were equal to 10.35% of net sales
for the third quarter of 2004, as compared to 9.92% for corresponding period in
2003.
DOMESTIC OPERATIONS. Domestic general and administrative expenses were
$392,300 for the third quarter of 2004, representing a decrease of $51,600, or
11.62%, over $443,900 for the third quarter of 2003. The decrease was primarily
due to one time professional expense incurred
18
in 2003 relating to Company's property tax appeal.
EUROPEAN TERRITORY. General and administrative expenses related to the
European Territory were $433,600 for the third quarter of 2004, representing an
increase of $120,800, or 38.62%, as compared to $312,800 for the third quarter
of 2003 (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 higher salary costs, higher audit and taxation costs and increased
depreciation expenses.
OTHER EXPENSES
Other expenses for the third quarter of 2004 totaled $424,400,
representing an increase of $365,900 when compared to the third quarter of 2003.
The increase was mainly due to one time legal dispute settlement expenses of
$216,400 (discussed in Part II, Item 1 of this Quarterly Report) incurred in the
third quarter of 2004. Additionally, during the third quarter of 2003 the
Company had the benefit of a one-time payment of $122,000 as a result of the
early termination of a brewing contract by Wolavers Enterprises, LLC, which
event was not repeated in 2004.
INCOME TAXES
The Company has a provision for income taxes of $43,400 for the third
quarter of 2004, compared to $93,400 for the third quarter of 2003. The increase
related to the estimated amount of taxes that will be imposed by taxing
authorities in the European Territory.
NET LOSS
The Company's net loss for the third quarter of 2004 was $34,000, as
compared to income of $435,400 for the third quarter of 2003. After providing
for a positive foreign currency translation adjustment of $4,100 during the
third quarter of 2004 (as compared to a positive adjustment of $11,700 for the
same period in 2003), the comprehensive loss for the third quarter of 2004 was
$29,900, compared to income of $447,100 for the same period in 2003.
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 2003
NET SALES
Overall net sales for the first nine months of 2004 were $22,968,600, an
increase of $2,357,300, or 11.44%, compared to $20,611,300 for the same period
in 2003. The increase was mainly due to increased sales in the European
territory, increased selling prices for the European Territory customers and
exchange rate fluctuations. UBSN launched Kingfisher natural spring water in the
Indian restaurant trade in February 2004, which also contributed to increased
sales during the first nine months of 2004. This increase was partly offset by
reduction in retail sales due to closure of the Company's Hopland restaurant.
DOMESTIC OPERATIONS: Domestic net sales for first nine months of 2004
were $8,524,300 compared to $8,767,000 for the same period in 2003, a decrease
of $242,700, or 2.77% mainly due to decrease of $221,800 in retail sales due to
closure of Company's Hopland restaurant. The sales volume decreased to 45,665
barrels during the first nine months of 2004 from 46,656 barrels in the first
nine months of 2003, representing a decrease of 991 barrels, or 2.12%. Of the
decrease, sale of Company's brands decreased by 28 barrels; Kingfisher volume
increased by 378 barrels and contract brands sale decreased by 1,341 barrels.
EUROPEAN TERRITORY: Net sales for the first nine months of 2004 were
$14,444,300 (GBP
19
7,929,900) compared to $11,844,300 (GBP 7,353,500) during the corresponding
period in 2003, an increase of 21.95%. During the first nine months of 2004,
UBSN sold 48,011 barrels compared to 45,918 barrels during the first nine months
of 2003, an increase of 2,093 barrels, or 4.56%. Exchange rate fluctuations
increased the financial effect of the Company's growth in sales in its European
Territory. When measured from period to period exclusively in Pounds Sterling
(which is the basic currency of account for the European Territory), the
Company's net sales in its European Territory increased by only 7.84%.
COST OF GOODS SOLD
Cost of goods sold as a percentage of net sales during the first nine
months of 2004 was 66.13%, as compared to 67.50% during the corresponding period
of 2003, due mainly to decreased costs in the United States.
DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in
the United States during first nine months of 2004 was 65.6%, as compared to
68.81%, during the corresponding period of 2003, representing a decrease of
3.21% mainly due to a decrease in depreciation and retail operation costs
because of closure of the Hopland restaurant.
EUROPEAN TERRITORY: Cost of goods sold as a percentage of net sales in
the European Territory during the first nine months of 2004 was 66.88%, as
compared to 67.04% during the corresponding period in 2003 (in each case as
calculated in U.S. dollars, after taking into account the effects of the
exchange rate calculation), representing a marginal decrease of 0.16%.
GROSS PROFIT
Gross profit for the first nine months of 2004 increased to $7,779,500,
from $6,698,200 during the corresponding period of 2003, representing an
increase of 16.14%. As a percentage of net sales, the gross profit during the
first nine months of 2004 increased to 33.87% from that of 32.5% during the
corresponding period in 2003.
OPERATING EXPENSES
Operating expenses for the first nine months of 2004 were $7,075,900, an
increase of $1,346,600, or 23.5%, as compared to $5,729,300 for the
corresponding period of 2003. Operating expenses consist of marketing and
distribution expenses and general and administrative expenses.
MARKETING AND DISTRIBUTION EXPENSES: The Company's marketing and
distribution expenses consist of salaries and commissions, advertising costs,
product and sales promotion costs, travel expenses and related costs and
Company's tavern and tasting room expenses. Such expenses for the first nine
months of 2004 were $4,343,500, as compared to $3,463,000 for the same period in
2003, representing an increase of 25.43%. Increases in the Company's marketing
expenses were driven by heavier competition, particularly in the Company's
European Territory, and the Company believes that trend is likely to continue
for the next few quarters at least.
DOMESTIC OPERATIONS: Expenses for the first nine months of 2004 were
$1,285,300 compared to $1,269,900 during the corresponding period of 2003,
representing an increase of $15,400. As a percentage of net sales in the United
States, these expenses increased to 15.08% during the first nine months of 2004,
compared to 14.49% during the corresponding period of 2003. The increased
expenses included higher salary and travel costs due to increased staffing (both
in New York and California) and an increase in promotional expenses; all of
which were partially offset by reductions in tavern and tasting room expenses
due to closure of the Hopland restaurant.
EUROPEAN TERRITORY: Expenses for the first nine months of 2004 were
$3,058,200
20
compared to $2,193,100 during the corresponding period of 2003, representing an
increase of $865,100. As a percentage of net sales in the European Territory,
the expenses increased to 21.17% during the first nine months of 2004 compared
to 18.52% during the corresponding period of 2003 (in each case as calculated in
U.S. dollars, after taking into account the effects of the exchange rate
calculation). The increase is mainly on account of higher staffing and
associated travel costs, increases in advertising and promotional expenses,
higher freight on increased sales, and higher dispensing equipment maintenance
expenses.
GENERAL AND ADMINISTRATIVE EXPENSES: The Company's general and
administrative expenses were $2,732,400 for the first nine months of 2004,
representing an increase of $466,100 or 20.57%, over $2,266,300 for the
corresponding period in 2003. These expenses were equal to 11.9% of net sales
for first nine months of 2004, as compared to 11.1% for the corresponding period
in 2003.
DOMESTIC OPERATIONS. Domestic general and administrative expenses were
$1,438,700 for the first nine months of 2004, representing an increase of
$145,000, or 11.21%, over $1,293,700 for the same period in 2003. The increase
was primarily due to increased legal expenses caused by a legal dispute with a
distributor (discussed in Part II, Item 1 of this Quarterly Report) and higher
loan and lease fees on loan extensions and refinancing efforts.
EUROPEAN TERRITORY. General and administrative expenses related to the
European Territory were $1,293,700 for the first nine months of 2004,
representing an increase of $321,100, or 33%, as compared to $972,600 for the
same period in 2003 (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 higher salary costs and audit fees, increased depreciation expenses,
and start-up costs associated with the distribution and sale of Kingfisher
natural spring water.
OTHER EXPENSES
Other expenses for the first nine months of 2004 totaled $824,000,
representing an increase of $368,400 when compared to the same period in 2003.
The increase was mainly due to one time legal dispute settlement expenses of
$216,400 (discussed in Part II, Item 1 of this Quarterly Report) incurred in the
third quarter of 2004. Additionally, during the third quarter of 2003 the
Company had the benefit of a one-time payment of $122,000 as a result of the
early termination of a brewing contract by Wolavers Enterprises, LLC, which
event was not repeated in 2004.
INCOME TAXES
The Company has a provision for income taxes of $121,600 for the first
nine months of 2004, compared to $205,400 for the same period in 2003. The
provision for taxes is related to the estimated amount of taxes that will be
imposed by taxing authorities in the European Territory.
NET LOSS
The Company's net loss for the first nine months of 2004 was $242,000,
as compared to profit of $307,900 for the first nine months of 2003. After
providing for a positive foreign currency translation adjustment of $29,800
during the first nine months of 2004 (as compared to a positive adjustment of
$30,100 for the same period in 2003), the comprehensive loss for the first nine
months of 2004 was $212,200, compared to a profit of $338,000 for the same
period in 2003.
CAPITAL DEMANDS
The Company's Ukiah and Releta facilities are both operating at
significantly less than
21
full capacity (as they have been for some time), placing continuing demands upon
the Company's assets and liquidity. Failure to adequately meet those demands may
have a material adverse affect on the Company's business, financial condition,
and results of operations.
The Company has yet to complete the build-out of its administrative
space and the exterior landscaping of its Ukiah facility, and does not plan to
revisit completion of the project until it has the available funds to do so. If,
in the future, the Company decides to complete the construction and landscaping,
the remaining work and the currently cost thereof are estimated to be as
follows: covering the parking lot with asphalt, approximately $30,000; building
a concrete sidewalk to one of the entrances of the brewery building,
approximately $10,000.
PROCEEDS FROM OPERATIONS INSUFFICIENT TO SUSTAIN OPERATIONS
The Company must make timely payment of its debt and lease commitments
to continue its operations. Beginning at about the time when the Ukiah brewery
commenced operations (the second quarter of 1997), proceeds from operations have
not been able to provide sufficient working capital for day to day operations.
To fund its operating deficits, the Company has relied upon lines of credit and
other credit facilities (see "Liquidity and Capital Resources," below). These
loans and lines of credit have typically been short-term in nature, which has
required the Company to obtain periodic extensions or refinancings of these
facilities. As discussed more fully below, the Company has recently received
extensions of certain of these facilities, and is currently seeking to refinance
certain of them. Although management has had success in negotiating these credit
facilities in the past, there can be no assurance that the Company will be able
to do so in the future (either at a price the Company will be able to sustain or
at any price), or that the Company will have access to any alternative sources
of funds in the future. Failure to secure sufficient funds will have a
materially adverse effect on the Company. On or about November 1, 2004, the
Company entered into a Settlement Agreement and Release with respect to certain
business-related litigation. The Settlement Agreement calls for the Company to
make payments totaling $900,000 during 2005. These payments have been partially
provided for out of funds received during 2003 and previously treated as
deferred gain, See Note 1 of the Notes to Financial Statements, above, and Part
II, Section 1 "Legal Proceedings," below for a more complete description of the
settlement amount.
LIQUIDITY AND CAPITAL RESOURCES
The Company has entered into a substantial number of loans, lines of
credit, other credit facilities, and lease agreements over the last several
years, with the result that a substantial majority of its assets are encumbered
and it is carrying a relatively large debt burden. 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 impossible,
at least in the short term, for the Company to continue its operations.
In particular, the Company's temporary loan from Savings Bank of
Mendocino and its line of credit from CIT Group (both of which are more fully
described below under "Other Loans and Credit Facilities") are now scheduled to
fall due on December 1 and December 31, 2004, respectively. A failure to
replace, renegotiate, or extend either of these agreements would have a
significant adverse impact on the Company's liquidity and operations. Although
management has been able to do so in the past, there can be no assurance that
the Company will have access to the same or equivalent sources of funds in the
future, either on a comparable basis or on any other terms acceptable to the
Company.
22
On April 4, 2004, the Company received a commitment from United
Breweries of America, Inc. ("UBA"), one of its major shareholders, to the effect
that UBA would provide the Company with such financial assistance as may be in
UBA's power to prevent or avoid any default under either the CIT Group line of
credit or the temporary loan from Savings Bank of Mendocino County when they
become due. The terms of any such assistance have not yet been determined,
however.
On or about November 1, 2004, the Company entered into a Settlement
Agreement and Mutual Release with GGDC (the "Settlement Agreement") to settle a
legal dispute (more fully discussed in Part II, Item 1 of this Quarterly
Report). Under the Settlement Agreement, the Company has agreed to make payments
to GGDC totaling $900,000 in three installments during 2005. UBA has guaranteed
these payments. Failure to make timely payment of dues to GGDC may result in
GGDC enforcing its legal rights to collect the dues from the Company, which
could potentially make it impossible, at least in the short term, for the
Company to continue its operations.
MASTER LINE OF CREDIT. On August 31, 1999, MBC and United Breweries of
America, Inc. ("UBA"), one of the Company's principal shareholders, entered into
a Master Line of Credit Agreement (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, and originally included various conversion
protection provisions. As of the date of this filing, UBA has made thirteen (13)
separate advances to the Company under the Credit Agreement, pursuant to a
series of individual eighteen (18) month promissory notes issued by the Company
to UBA (the "UBA Notes"). The aggregate outstanding principal amount of the UBA
Notes as of September 30, 2004 was $1,515,400, and the accrued but unpaid
interest thereon was equal to approximately $470,100.
The UBA Notes require the Company to make quarterly interest payments to
UBA on the first day of April, July, October, and January. To date, UBA has
permitted the Company to capitalize all accrued interest; therefore, the Company
has borrowed the maximum amount available under the facility. Upon maturity of
any UBA Note, unless UBA has given the Company prior instructions to commence
repayment of the outstanding principal balance, the outstanding principal and
accrued but unpaid interest on such Note may be converted, at the option of UBA,
into shares of the Company's common stock. If UBA does not elect to so convert
any UBA Note upon maturity, it has the option to extend the term of such UBA
Note for any period of time mutually agreed upon by UBA and the Company. During
the extended term of any UBA Note, UBA has the right to require the Company to
repay the outstanding principal balance, along with the accrued and unpaid
interest thereon, to UBA within sixty (60) days.
The outstanding principal amount of the 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
September 30, 2004, the outstanding principal and interest on the notes was
convertible into 1,323,635 shares of the Company's Common Stock. On December 28,
2001, the Company and UBA entered into a Confirmation of Waiver which provides a
written confirmation 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 Company and UBA have entered into a series of agreements to extend
the term of the UBA Notes (the "Extension Agreement"). The latest of these
Extension Agreements, which was entered into as of August 9, 2004, extends the
term of the UBA Notes until August 31, 2005.
LONG TERM DEBT: MBC has obtained a $2.7 million loan from Savings Bank
of Mendocino County ("SBMC"), secured by a first priority deed of trust on the
Ukiah land, fixtures, and improvements. The loan is payable in partially
amortizing monthly installments of
23
$24,400 including interest at the rate of 7.24%, maturing December 2012 with a
balloon payment in the amount of $932,600. The interest rate is adjusted on
every five year anniversary of the agreement to the Treasury Constant Maturity
Rate plus 4.17%. The amount of the balloon payment will vary depending on the
change in interest rates over the years. In addition to the Ukiah land and
facility, this loan is secured by some of the other assets of the Company (other
than the Releta facility), including, without limitation, most of the Company's
equipment.
EQUIPMENT LEASE: From 1996 until 2003, Finova Capital Corporation
("Finova") leased new brewing equipment with an original total cost of
approximately $1.78 million to MBC, with monthly rental payments of
approximately $27,100 each. During 2003, the Company exercised its option to
purchase the equipment at a cost of approximately $576,200.
OTHER LOANS AND CREDIT FACILITIES.
CIT GROUP/CREDIT FINANCE LINE OF CREDIT. The CIT Group/Credit Finance,
Inc. has provided the Company a $3,000,000 maximum line of credit with an
advance rate of 80% of the qualified accounts receivable and 60% of the
inventory at a current interest rate equal to the prime rate of Chase Manhattan
Bank of New York plus 4.25 %, payable monthly, originally scheduled to mature on
September 23, 2002. The line of credit is secured by all accounts, general
intangibles, inventory, and equipment of the Company 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 the Company as an initial term
loan, which was repayable in sixty consecutive monthly installments of
principal, each in the amount of $24,700.
On January 17, 2003, the term of this facility was extended to November
30, 2003. At the same time, the maximum credit available was increased to
$3,500,000, and the Company was provided a term loan of $750,000 consisting of
the original balance of $346,300 and a new term loan of $403,700 repayable in 30
equal consecutive monthly installments of $24,700, commencing February 1, 2003,
with a final payment of $8,000. CIT Group subsequently amended and/or extended
the term of this facility on December 1, 2003, January 30, 2004, February 27,
2004, May 3, 2004, July 1, 2004, and October 31, 2004 in order to allow the
Company time to refinance. On July 1, 2004 CIT Group increased the term loan
repayment to $10,000 per week. On October 31, 2004, the term of this facility
was extended to December 31, 2004. Based on the Company's current level of
accounts receivable and inventory, the Company has drawn the maximum amount
permitted under the line of credit. As of September 30, 2004, the total amount
outstanding on the line of credit was approximately $1,621,500. Management
believes that it will be successful in refinancing this facility, but failure to
do so would have a significant impact on the Company's liquidity and operations.
SAVINGS BANK OF MENDOCINO TEMPORARY LOAN. On December 31, 2003, Savings
Bank of Mendocino County ("SBMC") extended a temporary loan in the principal
amount of $576,200 to the Company in order to finance the buy-out of equipment
leased through Finova Capital Corporation. This loan, which is currently due for
repayment on December 1, 2004, is secured by the existing assets of the Company
and the assets released by Finova on lease termination. The rate of interest on
the loan is 8%. Management believes that it will be successful in refinancing
this agreement, but failure to do so would have a significant impact on the
Company's liquidity and operations.
NEDBANK LIMITED OPTION FACILITY: Nedbank Limited, a South African
registered company ("Nedbank"), has provided UBSN with a multi-currency option
facility of 1,250,000 Pounds Sterling. This overdraft facility, which may be
terminated by Nedbank at any time (with or without default) on thirty days'
notice, is secured by all of the assets of UBSN. The amount
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outstanding on this line of credit as of September 30, 2004 was approximately
$1,060,700. The Company believes that Nedbank will continue to extend this
facility, although there can be no guarantee that it will not call the
outstanding balance at any time. A number of factors, including for instance
adverse changes in the Company's financial condition, changes in Nedbank's
lending policies unrelated to the Company, or adverse economic developments
generally, could cause Nedbank to decline to do so. If Nedbank were to exercise
its option to call the amount outstanding under this facility, the Company would
have to find an alternative lender or source of funds to repay the balance owing
to Nedbank. There can be no guarantee that the Company will be able to do so
within the time frame provided under its agreements with Nedbank.
SHEPHERD NEAME LOAN: Shepherd Neame has a contract with UBSN to brew
Kingfisher 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 7.75% for the first nine months of 2004 and 7.35%
(including the long term capital lease of equipment by Finova Capital
Corporation Inc.) for the corresponding period in 2003. For loans primarily
associated with Company's European territory, the weighted average rate paid was
6.75% for the first nine months of 2004 as compared to 5.80% for the
corresponding period in 2003.
KEG MANAGEMENT ARRANGEMENT: The Company entered into a keg management
agreement with MicroStar Keg Management LLC as of September 1, 2004. Under this
arrangement, MicroStar provides the Company with half-barrel kegs for which the
Company pays a filling and use fee. Distributors return the kegs to MicroStar
instead of the Company. MicroStar then supplies the Company with additional
kegs.
OVERDUE PROPERTY TAXES: As of September 30, 2004, the delinquent
property taxes due on the Company's Ukiah property, including penalties and
interest, totaled $695,100, representing the balance due for overdue taxes for
the period from April 1999 to June 2003. Pursuant to an agreement with Mendocino
County entered into in July of 2003, the balance of the overdue taxes will be
paid in four annual installments, due on or before April 10, 2005, 2006, 2007,
and 2008, each representing 20% or more of the original overdue balance, along
with accrued interest calculated at 18% per year. Because of the large amount of
taxes owed, and the County's ability to sell the Ukiah property to satisfy a
delinquency, failure to settle these tax dues (including payments due under the
payment plan) could have a serious adverse effect on the Company's business and
financial condition.
RESTRICTED NET ASSETS. The Company's wholly-owned subsidiary, UBI, has
undistributed earnings of approximately $2,498,300 as of September 30, 2004.
Under UBI's line of credit agreement, distributions and other payments to the
Company from its subsidiary are limited to approximately $200,000 per year.
CURRENT RATIO
The Company's ratio of current assets to current liabilities on
September 30, 2004 was 0.81 to 1.0 and its ratio of total assets to total
liabilities was 1.38 to 1.0. On September 30, 2003, the Company's ratio of
current assets to current liabilities was 0.83 to 1.0 and its ratio of total
assets to total liabilities was 1.54 to 1.0.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of September 30, 2004, the Company did not hold derivative
instruments, or engage in hedging activities, of any material value or in any
material amount, whether for trading or for hedging purposes. The Company has
some interest-related market risk due to floating interest rate debt totaling
$5,153,900 as of September 30, 2004.
INTEREST RATE RISK
The Company had total debt as of September 30, 2004 of $8,529,300, of
which $4,773,900 was subject to variable rates of interest (either prime or
LIBOR plus 1.5% or prime plus 3% or prime plus 4.25%). Its long-term debt
(including current portion) as of September 30, 2004 totaled $5,411,500, of
which $3,755,400 had fixed rates of interest and the balance of $1,656,100 were
subject to variable rates. Short term debts amounted to $3,117,800, all of which
were subject to variable rates. At current borrowing levels, an increase in
prime and LIBOR rates of 1% would result in an annual increase of $47,700 in
interest expense on the Company's variable rate loans.
FOREIGN CURRENCY RATE FLUCTUATIONS
The Company's earnings and cash flows at its subsidiaries UBI and UBSN
are subject to fluctuations due to changes in foreign currency rates. The
Company believes that changes in the foreign currency exchange rate would not
have a material adverse effect on its results of operations as the majority of
its foreign transactions are delineated in UBI's functional currency, the
British Pound.
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chairman of the Board, President, and Chief Financial
Officer have evaluated the effectiveness of the design, maintenance, and
operation of the Company's disclosure controls and procedures in effect during
the period of time covered by this report. Based on this evaluation, they
believe that the Company's disclosure controls and procedures were then
effective in providing reasonable assurance that relevant information is timely
identified and communicated, alerting them to material information required to
be disclosed in the Company's periodic reports filed with or submitted to the
SEC. Management is not aware of any material changes in the Company's internal
or other controls over financial reporting identified in connection with that
evaluation that have significantly affected, or are likely to affect, the
Company's internal controls over financial reporting.
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 1. LEGAL PROCEEDINGS.
In previous 2004 Quarterly Reports on Form 10-Q the Company has reported
a civil action brought against it and certain of its employees and related
parties by House of Daniels, Inc., dba Golden Gate Distributing Company
("GGDC"), arising out of the Company's termination, during 2003, of a written
distribution agreement with GGDC (the "Action"). In
26
addition to the Company, GGDC had also sued United Breweries of America, Inc.
("UBA"), one of the Company's principal shareholders; Dr. Vijay Mallya, who is
the Chairman of the Board of the Company and of UBA; Mark Anderson, the
Company's West Coast Sales Manager; and two distribution companies that were
contracted by the Company to service between them the territory formerly handled
by GGDC (the "Subsequent Distributors").
In the course of the Action, a cross-complaint was filed against GGDC by
the Company, and cross-complaints were filed against the Company by the
Subsequent Distributors.
Effective on or about November 1, 2004, the Company entered into a
Settlement Agreement and Release (the "Settlement Agreement") with respect to
the Action. The Settlement Agreement releases the claims asserted in, arising
out of, or related to the Action by GGDC against the Company and the other
defendants, and by the Company against GGDC. The Agreement does not release, or
even cover, the cross-claims asserted against the Company by the Subsequent
Distributors, however.
Under the terms of the Settlement Agreement, the Company is required to
pay GGDC a total of $900,000 in settlement of all claims asserted by GGDC in the
Action (the "Settlement Amount"). Payment is to be made in three installments:
$400,000 by January 31, 2005; $300,000 by June 30, 2005; and the remaining
$200,000 by December 31, 2005. No other payments are called for by any party to
the Action. UBA has guaranteed the payment, in full, of each of the installment
payments included in the Settlement Amount. (See Note 9 of the Notes to
Financial Statements, in Part I, Item 1, above, for information on the
accounting treatment accorded to this transaction.
ITEM 5. OTHER INFORMATION.
(a) On October 31, 2004, CIT Group agreed to extend until December
31, 2004 the term of its current line of credit to the Company. On November 1,
2004, Savings Bank of Mendocino County extended until December 1, 2004 the term
of a $576,200 temporary loan. For more information about these facilities see
Part I, Item 2 "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Financial Resources" under the captions
"CIT Group/Credit Finance Line of Credit" and "Savings Bank of Mendocino
Temporary Loan," above.
ITEM 6 EXHIBITS.
10.70 Secondment Agreement dated October 9, 1998 between UBSN, Ltd.
and Shepherd Neame, Ltd.
10.71 Agreement to Extend Loan and Security Agreement between the
Company, Releta Brewing Company LLC and The CIT Group/Credit
Finance, Inc., dated October 31, 2004.
10.72 Revised Promissory Note in favor of Savings Bank of Mendocino
County, dated as of November 1 2004.
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)
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32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MENDOCINO BREWING COMPANY, INC.
Dated: November 12, 2004 By: /s/ Dr. Vijay Mallya
---------------------------------
Dr. Vijay Mallya
Chairman of the Board and Chief
Executive Officer
Dated: November 12, 2004 By: /s/ N. Mahadevan
---------------------------------
N. Mahadevan
Chief Financial Officer and
Corporate Secretary
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EXHIBIT INDEX
NUMBER EXHIBIT TITLE
- ------ -------------
10.70 Secondment Agreement dated October 9, 1998 between UBSN, Ltd. and
Shepherd Neame, Ltd.
10.71 Agreement to Extend Loan and Security Agreement between the Company,
Releta Brewing Company LLC and The CIT Group/Credit Finance, Inc., dated
October 31, 2004.
10.72 Revised Promissory Note in favor of Savings Bank of Mendocino County,
dated as of November 1, 2004.
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
30