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EX-32.2 - MENDOCINO BREWING CO INCex32-2.htm
EX-32.1 - MENDOCINO BREWING CO INCex32-1.htm
EX-31.2 - MENDOCINO BREWING CO INCex31-2.htm
EX-31.1 - MENDOCINO BREWING CO INCex31-1.htm

 

 

 

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, 2016

 

or

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _________________________ to _________________________

 

Commission file number 1-13636

 

Mendocino Brewing Company, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

California   68-0318293
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)

 

1601 Airport Road, Ukiah, California   95482
(Address of principal executive offices)   (Zip Code)

 

(707) 463-2627

(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer [  ]    Accelerated filer [  ]    Non-accelerated filer [  ]    Smaller reporting company [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:

 

The number of shares of Mendocino Brewing Company, Inc.’s common stock outstanding as of November 13, 2016 was 12,611,133.

 

 

 

 
 

 

MENDOCINO BREWING COMPANY, INC.

 

INDEX 

 

      Page
PART I. FINANCIAL INFORMATION  
       
  ITEM 1. Financial Statements 3
       
    Condensed consolidated balance sheets as of September 30, 2016 (unaudited) and December 31, 2015 3
       
    Condensed consolidated statements of operations and comprehensive income (loss) for the three and nine months ended September 30, 2016 and 2015 (unaudited) 4
       
    Condensed consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015 (unaudited) 5
       
    Notes to condensed consolidated financial statements (unaudited) 6
       
  ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 23
       
  ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 37
       
  ITEM 4. Controls and Procedures 37
       
PART II. OTHER INFORMATION  
       
  ITEM 3. Defaults Upon Senior Securities 38
       
  ITEM 6. Exhibits 38
       
SIGNATURES 39

 

2
 

 

PART I

 

Item 1. Financial Statements.

 

MENDOCINO BREWING COMPANY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

   September 30, 2016   December 31, 2015 
   (Unaudited)     
ASSETS          
Current Assets          
Cash  $84,700   $129,600 
Accounts receivable, net   3,051,900    3,835,500 
Inventories   1,472,100    1,547,000 
Prepaid expenses   627,100    759,900 
Total Current Assets   5,235,800    6,272,000 
           
Property and Equipment, net   9,844,200    10,588,200 
Deposits and other assets   188,300    175,800 
           
Total Assets  $15,268,300   $17,036,000 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
           
Current Liabilities          
Secured lines of credit  $1,059,900   $1,663,400 
Accounts payable   4,534,200    4,489,000 
Accrued liabilities   2,173,000    1,908,700 
Notes payable to related party   2,605,500    2,119,600 
Subordinated convertible notes to related party   3,752,000    3,680,100 
Current maturities of secured notes payable   2,977,600    3,378,600 
Current maturities of long-term debt to related party   108,500    491,500 
Current maturities of obligations under capital leases   21,300    23,100 
Current maturities of severance payable   269,600    119,700 
Total Current Liabilities   17,501,600    17,873,700 
           
Long-Term Liabilities          
Capital lease obligations, less current maturities   56,900    79,200 
Severance payable   629,200    678,400 
Total Long-Term Liabilities   686,100    757,600 
           
Total Liabilities   18,187,700    18,631,300 
           
Commitments and contingencies   -    - 
           
Stockholders’ Deficit          
Preferred stock, Series A, no par value, with liquidation preference of $1 per share; 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, 12,611,133 shares issued and outstanding   15,100,300    15,100,300 
Accumulated other comprehensive income   483,300    472,400 
Accumulated deficit   (18,730,600)   (17,395,600)
Total Stockholders’ Deficit   (2,919,400)   (1,595,300)
           
Total Liabilities and Stockholders’ Deficit  $15,268,300   $17,036,000 

 

See accompanying notes to these condensed consolidated financial statements.

 

3
 

 

MENDOCINO BREWING COMPANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

 

   THREE MONTHS ENDED
September 30
   NINE MONTHS ENDED
September 30
 
   2016   2015   2016   2015 
Sales  $6,968,200   $8,539,300   $21,659,700   $23,611,400 
Excise taxes   136,300    140,100    374,000    379,500 
Net sales   6,831,900    8,399,200    21,285,700    23,231,900 
Cost of goods sold   4,638,500    5,620,700    14,687,900    15,868,400 
Gross profit   2,193,400    2,778,500    6,597,800    7,363,500 
Operating expenses                    
Marketing   1,286,900    1,511,500    3,782,700    4,371,500 
General and administrative   1,220,700    1,111,600    3,713,600    3,327,000 
Total operating expenses   2,507,600    2,623,100    7,496,300    7,698,500 
(Loss) income from operations   (314,200)   155,400    (898,500)   (335,000)
Other income (expense)                    
Other income   1,400    7,400    13,200    51,000 
Interest expense   (159,200)   (153,200)   (448,100)   (462,300)
Total other expenses   (157,800)   (145,800)   (434,900)   (411,300)
Income (loss) before income taxes   (472,000)   9,600    (1,333,400)   (746,300)
Provision for income taxes   -    -    1,600    3,800 
Net (loss) income  $(472,000)  $9,600   $(1,335,000)  $(750,100)
Foreign currency translation income (loss)   2,900    (2,000)   10,900    (4,900)
Comprehensive (loss) income  $(469,100)  $7,600   $(1,324,100)  $(755,000)
Net income (loss) per common share –                
Basic  $(0.04)  $0.00   $(0.11)  $(0.06)
Diluted  $(0.04)  $0.00   $(0.11)  $(0.06)
Weighted average common shares outstanding –                    
Basic   12,611,133    12,611,133    12,611,133    12,611,133 
Diluted   12,611,133    15,067,357    12,611,133    12,611,133 

 

See accompanying notes to these condensed consolidated financial statements.

 

4
 

 

MENDOCINO BREWING COMPANY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Nine Months Ended 
   September 30, 
   2016   2015 
CASH FLOWS FROM OPERATING ACTIVITIES:          
Net loss  $(1,335,000)  $(750,100)
Adjustments to reconcile net loss to net cash used in
operating activities:
          
Depreciation and amortization   839,800    889,200 
Provision for doubtful accounts   (1,700)   13,000 
           
Changes in operating assets and liabilities:          
Interest accrued on related party debt   157,800    124,800 
Accrued severance payable   100,700    - 
Accounts receivable   432,400    716,000 
Inventories   67,300    316,600 
Prepaid expenses   70,500    (2,900)
Deposits and other assets   38,800    (30,900)
Accounts payable   278,800    (389,800)
Accrued liabilities   370,800    269,300 
Net cash provided by operating activities   1,020,200    1,155,200 
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Purchases of property and equipment   (205,900)   (403,800)
Net cash used in investing activities   (205,900)   (403,800)
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Net repayment on lines of credit   (489,500)   (998,400)
Borrowing on note payable   400,000    1,000,000 
Repayment on long-term debt   (749,200)   (784,100)
Payments on obligations under long term leases   (15,400)   (12,200)
Net cash (used in) financing activities   (854,100)   (794,700)
           
EFFECT OF EXCHANGE RATE CHANGES ON CASH   (5,100)   (9,500)
           
NET CHANGE IN CASH   (44,900)   (52,800)
           
CASH, beginning of period   129,600    145,100 
           
CASH, end of period  $84,700   $92,300 
           
SUPPLEMENTARY CASH FLOW INFORMATION          
Cash paid during the period for:          
Income taxes  $1,600   $3,800 
Interest  $290,300   $337,500 
           
NON CASH INVESTING AND FINANCING ACTIVITIES          
Seller financed asset  $-   $96,000 

 

See accompanying notes to these condensed consolidated financial statements.

 

5
 

 

MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Description of Operations and Summary of Significant Accounting Policies

 

Description of Operations

 

Mendocino Brewing Company, Inc. (the “Company” or “MBC”) was formed in 1983 in California, and has two operating subsidiaries: Releta Brewing Company, LLC (“Releta”), and United Breweries International (UK) Limited (“UBIUK”). In the United States (the “US”), MBC and 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 majority of sales for MBC in the US 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. Generally, product shipments are made directly from the breweries to wholesalers or distributors in accordance with state and local laws.

 

MBC’s United Kingdom (the “UK”) subsidiary, UBIUK, is a holding company for Kingfisher Beer Europe Limited (“KBEL”). KBEL is a distributor of alcoholic beverages, mainly Kingfisher Lager Beer, in the UK and Europe. The offices of KBEL are located in Maidstone, Kent in the UK. In addition, during the period covered by this quarterly report (the “Quarterly Report”), through UBIUK, the Company had production and distribution rights to Kingfisher Premium Lager in Canada and the United States. The Company has the right to use the Kingfisher mark and the name “Kingfisher Brewing Company” in connection with the brewing and distribution of assorted beers in the United States pursuant to an agreement with Kingfisher America, Inc. Generally, sales are made through distributors.

 

All of the Company’s beers sold in Europe (except for beers sold in Germany) are procured under a contract with Heineken UK Limited (“HUK”). This contract expires in October 2018. KBEL is the distributor of Kingfisher Premium Lager to specialty restaurant trade distributors, liquor and convenience stores in the United Kingdom, Ireland, and continental Europe, but does not physically distribute the Company’s products to customers. KBEL relies on HUK for distribution of the product in Europe in exchange for a fee paid to HUK, except for in Germany where beers are manufactured and distributed pursuant to a separate contract with a different entity. In addition, HUK has the exclusive right to sell Kingfisher Premium Lager, for a royalty fee payable to KBEL, to certain large retail customers, including, but not limited to, Sainsbury’s, Asda, and Tesco.

 

Subsequent Events

 

The Company evaluates events that occur subsequent to the balance sheet date of periodic reports, but before financial statements are issued for periods ending on such balance sheet dates, for possible adjustment to such financial statements or other disclosure. This evaluation generally occurs through the date on which the Company’s financial statements are electronically prepared for filing with the Securities and Exchange Commission (“SEC”).

 

Principles of Consolidation

 

The consolidated financial statements present the accounts of MBC and its wholly-owned subsidiaries, Releta and UBIUK. All material intracompany and inter-company balances, profits and transactions have been eliminated.

 

Basis of Presentation and Organization

 

The accompanying unaudited condensed consolidated financial statements for the nine months ended September 30, 2016 and 2015 have been prepared in accordance with accounting principles generally accepted in the US. These condensed 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, as filed with the SEC, which contains additional financial and operating information and information concerning significant accounting policies followed by the Company. The financial statements and notes are representations of the Company’s management (“Management”) and its board of directors (the “Board of Directors”), who are responsible for their integrity and objectivity.

 

6
 

 

Going Concern

 

The Company’s consolidated financial statements for fiscal year 2015 were prepared on a going concern basis. The continuation of the Company as a going concern is dependent upon continued financial support from Catamaran Services, Inc. (“Catamaran”) and/or United Breweries Holdings, Ltd., an Indian public limited company (“UBHL”), its ability to obtain other debt or equity financing, and generating profitable operations from the Company’s future operations. However, management cannot provide any assurances that the Company will be successful in accomplishing any of its plans. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern.

 

Operating results from the nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 or any future period.

 

Reclassifications

 

Certain items in the financial statements for the prior year have been reclassified to conform to the current year presentation. These reclassifications had no effect on net income or equity.

 

SIGNIFICANT ACCOUNTING POLICIES

 

There have been no significant changes in the Company’s significant accounting policies during the nine months ended September 30, 2016 compared to what was previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

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.

 

Revenue Recognition

 

The Company recognizes revenue from the brewing and distribution operations in accordance with Accounting Standards Codification 605 of the Financial Accounting Standards Board. The Company recognizes revenue from product sales, net of discounts.

 

The Company recognizes revenue only when all of the following criteria have been met:

 

  Persuasive evidence of an arrangement exists;
     
  Delivery has occurred or services have been rendered;
     
  The fee for the arrangement is fixed or determinable; and
     
  Collectability is reasonably assured.

 

“Persuasive Evidence of an Arrangement” – The Company documents all terms of an arrangement in a written contract or purchase order signed by the customer prior to recognizing revenue.

 

7
 

 

“Delivery Has Occurred or Services Have Been Performed” – The Company delivers the products prior to recognizing revenue or performs services as per contractual terms. Product is considered delivered upon delivery to a customer’s designated location and services are considered performed upon completion of the Company’s contractual obligations.

 

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

 

“Collectability is Reasonably Assured” – The Company determines that collectability is reasonably assured prior to recognizing revenue. Collectability is assessed on a customer-by-customer basis based on criteria outlined by Management. The Company does not enter into arrangements unless collectability is reasonably assured at the outset. Existing customers are subject to ongoing credit evaluations based on payment history and other factors. If it is determined during the arrangement that collectability is not reasonably assured, revenue is recognized on a cash basis.

 

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

 

Revenues from the Company’s brewpub and gift store are recognized when sales have been completed.

 

Allowance for Doubtful Accounts

 

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic and industry trends and changes in customer payment terms. Balances over 90 days past due and other higher risk amounts are reviewed individually for collectability. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on Management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.

 

Inventories

 

Inventories are stated at the lower of average cost, which approximates the first-in, first-out method, or market (net realizable value). The Company regularly reviews its inventories for the presence of obsolete product attributed to age, seasonality and quality. Inventories that are considered obsolete are written off or adjusted to carrying value.

 

Deferred Financing Costs

 

Costs relating to obtaining financing are capitalized and amortized over the term of the related debt. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations. Deferred financing costs related to a borrowing made in June 2011 were $225,000. Amortization of deferred financing costs charged to operations was $22,500 and $33,800 for the nine months ended September 30, 2016 and 2015. respectively.

 

8
 

 

Concentration of Credit Risks

 

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents, and accounts receivable. Substantially all of the Company’s cash and cash equivalents are deposited with commercial banks in the US and the UK that have minimal credit risk. Accounts receivable are generally unsecured and customers are subject to an initial credit review and ongoing monitoring. Wholesale distributors account for substantially all accounts receivable; therefore, this risk concentration is limited due to the number of distributors and the laws regulating the financial affairs of distributors of alcoholic beverages. The Company has approximately $200 in cash deposits and $1,831,700 of accounts receivable due from customers located in the UK as of September 30, 2016.

 

Income Taxes

 

The Company accounts for income taxes in accordance with ASC 750 which requires an asset and liability approach for financial accounting and reporting for income taxes and allows recognition and measurement of deferred tax assets based upon the likelihood of realization of tax benefits in future years. Under the asset and liability approach, deferred taxes are provided for the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. 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. The Company periodically assesses uncertain tax positions that the Company has taken or expects to take on a tax return, including a decision whether to file or not to file a return in a particular jurisdiction. The Company evaluated its tax positions and determined that there were no uncertain tax benefits as of September 30, 2016 and December 31, 2015.

 

Basic and Diluted Earnings (Loss) per Share

 

The basic earnings (loss) per share is computed by dividing the earnings (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period. Basic net earnings (loss) per share exclude the dilutive effect of stock options or warrants and convertible notes. If the Company’s operations result in net loss for any period, diluted net loss per share would be the same as basic net loss per share, since the effect of any potentially dilutive securities would be anti-dilutive. Therefore, the conversion of the related party convertible notes (see “Subordinated Convertible Notes Payable to Related Party” below) has been excluded from the Company’s calculation of net loss per share. The computations of basic and dilutive net loss per share are as follows:

 

   Three months ended   Nine months ended 
   9/30/2016   9/30/2015   9/30/2016   9/30/2015 
Net (loss) income  $(472,000)   9,600   $ (1,335,000)   (750,100)
Weighted average common shares outstanding   12,611,133    12,611,133    12,611,133    12,611,133 
Basic net income (loss) per share  $(0.04)   0.00   $ (0.11)   (0.06)
Interest expense on convertible notes  $-    22,900   $ -    - 
Income (loss) for computing diluted net income per share  $(472,000)   32,500   $(1,335,000)   (750,100)
Incremental shares from assumed exercise of dilutive securities   -    2,456,224    -    - 
Dilutive potential common shares   12,611,133    15,067,357    12,611,133    12,611,133 
Diluted net income (loss) per share  $ (0.04)   0.00   $ (0.11)   (0.06)

 

9
 

 

Foreign Currency Translation

 

The Company has subsidiaries located in the UK, where the local currency, the UK Pound Sterling, is the functional currency. Financial statements of these subsidiaries are translated into US dollars using period-end exchange rates for assets and liabilities and average exchange rates during the period for revenues and expenses. Cumulative translation adjustments associated with net assets or liabilities are reported in non-owner changes in equity. Any exchange rate gains or losses related to foreign currency transactions are recognized in the income statement as incurred, in the same financial statement caption as the underlying transaction, and are not material for any year shown. Cash flows are translated at the average exchange rates for the nine months then ended. Changes in cash resulting from the translations are presented as a separate item in the statements of cash flows.

 

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.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the US 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.

 

Reportable Segments

 

The Company manages its operations through two business segments: (i) brewing operations and tasting room operations in the US and distributor operations in Canada (the “North American Territory”) and (ii) distributor operations in Europe, including the UK (the “Foreign Territory”). 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.

 

Recent Accounting Pronouncements

 

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) that clarifies how to apply revenue recognition guidance related to whether an entity is a principal or an agent. ASU 2016-08 clarifies that the analysis must focus on whether the entity has control of the goods or services before they are transferred to the customer and provides additional guidance about how to apply the control principle when services are provided and when goods or services are combined with other goods or services. The effective date for ASU 2016-08 is the same as the effective date of ASU 2014-09 as amended by ASU 2015-14, for annual reporting periods beginning after December 15, 2017, including interim periods within those years. The Company has not yet determined the impact of ASU 2016-08 on its consolidated financial statements.

 

10
 

 

ASU 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” was issued in June 2016 and clarifies the objective of the collectability criterion, presentation of taxes collected from customers, non-cash consideration, contract modifications at transition, completed contracts at transition and how guidance in Topic 606 is retrospectively applied. The amendments do not change the core principle of the guidance in Topic 606. The effective dates are the same as those for Topic 606.

 

2. Liquidity and Management Plans

 

MB Financial Credit and Security Agreement

 

On June 23, 2011, MBC and Releta entered into a Credit and Security Agreement (as amended, the “Credit and Security Agreement”) with Cole Taylor Bank, an Illinois banking corporation (“Cole Taylor”). Cole Taylor merged into MB Financial Bank, an Illinois banking corporation (“MB Financial”) on August 18, 2014. As used in this Report, “Lender” shall refer to Cole Taylor prior to August 18, 2014 and to MB Financial, as successor in interest to Cole Taylor, on or after August 18, 2014. The Credit and Security Agreement provided a credit facility with a maturity date of June 23, 2016 of up to $10,000,000 consisting of a $4,119,000 revolving facility (the “Revolver”), a $1,934,000 machinery and equipment term loan, a $2,947,000 real estate term loan and a $1,000,000 capital expenditure line of credit. The applicable interest rates were as follows: (a) with respect to the Revolver, the Wall Street Journal prime rate plus a margin of 1.00%, (b) with respect to the machinery and equipment term loan and the capital expenditure term loan, the Wall Street Journal prime rate plus a margin of 1.50%, and (c) with respect to the real estate term loan, the Wall Street Journal prime rate plus a margin of 2.00%. As described below, effective September 1, 2013, Lender was charging a default interest rate equal to two percent (2%) per annum in excess of the interest rate otherwise payable under the Credit and Security Agreement. As described below, effective July 22, 2016, Lender increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest) on all loans. As described below, the Second Amendment (as defined below) (among other things) reduces the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by 2% each month. The advance rates are used in the calculation of the borrowing base of each of MBC and Releta, which is used in the determination of the amount available to each of MBC and Releta pursuant to the Revolver. Under the terms of the Credit and Security Agreement, if such availability is less than $0, or if certain components of the borrowing base of each of MBC and Releta fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable. The Credit and Security Agreement binds the Company to certain financial covenants including maintaining prescribed minimum tangible net worth and prescribed minimum fixed charges coverage. There is a prepayment penalty if we prepay all of our obligations prior to the maturity date. The credit facility is secured by a first priority security interest in all of MBC’s and Releta’s personal property and a first priority mortgage on our Ukiah, California real property, among other MBC and Releta assets.

 

The Credit and Security Agreement requires MBC and Releta to maintain certain minimum fixed charge coverage ratios for trailing twelve month periods and minimum tangible net worth. The minimum tangible net worth MBC and Releta are required to maintain is subject to increase based on the net income of MBC and Releta. On March 29, 2013, MBC, Releta, and Lender entered into a First Amendment to the Credit and Security Agreement to clarify the method by which the fixed charge coverage ratio is calculated, with retrospective application.

 

The required fixed charge coverage ratio for the trailing twelve month periods ended March 31, 2013 onwards fell short of the required ratio. The tangible net worth fell short of the required amount for the period beginning June 1, 2013 onwards.

 

On September 18, 2013, MBC and Releta received a notice (the “Default Notice”) from Lender regarding its intention to exercise certain rights with respect to events of default of the Company pursuant to the Credit and Security Agreement and, effective September 1, 2013, began charging a default interest rate equal to 2% per annum in excess of the interest rate otherwise payable under the Credit and Security Agreement.

 

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On April 18, 2014, MBC and Releta received a second notice (the “Second Default Notice”) from Lender regarding its intention to exercise certain rights with respect to events of default of the Company pursuant to the Credit and Security Agreement. The Second Default Notice required MBC and Releta to engage a consultant to perform a viability analysis and prepare a revised projection for 2014, to be delivered to Lender on or before April 30, 2014. MBC and Releta engaged a consultant and delivered a revised projection on April 30, 2014. As stated in the Second Default Notice, the Company continued to be in default on the fixed charge coverage ratio for each measurement period beginning March 31, 2013 through February 28, 2014. The required fixed charge coverage ratio was initially required to be at least 1.05 to 1.00, but as of July 31, 2013, the required fixed charge coverage ratio increased to 1.10 to 1.00 pursuant to the terms of the Credit and Security Agreement. The Second Default Notice also stated that the tangible net worth of MBC and Releta continued to fall short of the required amount as measured through February 28, 2014.

 

Effective August 20, 2014, pursuant to a notice to MBC and Releta dated August 18, 2014 (the “Third Default Notice”) which referred to MBC’s and Releta’s continued failure to meet the required fixed charge coverage ratio and the tangible net worth requirement, Lender notified MBC and Releta that it would reduce the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by 2% each month. The advance rates are used in the calculation of the borrowing base of each of MBC and Releta, which is used in the determination of the amount available to each of MBC and Releta pursuant to the Revolver. Under the terms of the Credit and Security Agreement, if such availability is less than $0, or if certain components of the borrowing base of each of MBC and Releta fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable.

 

On January 21, 2015, MBC, Releta, and Lender entered into a Second Amendment (the “Second Amendment”) to the Credit and Security Agreement. The Second Amendment reduced the maximum amount of the Revolver from $4,119,000 to $2,500,000. The Second Amendment also changed the definition of borrowing base (including by lowering certain advance rates) such that the calculation of the borrowing base will result in a lower number than it would have if calculated prior to the effectiveness of the Second Amendment. The Second Amendment also reduced the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by two percent (2%) and continues to reduce each by an additional two percent (2%) on the 20th day of each month thereafter. The advance rates are used in the calculation of the borrowing base of each borrower, which is used in the determination of the amount available to each borrower pursuant to the Revolver. As stated above, if such availability is less than $0, or if certain components of the borrowing base fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable.

 

Effective June 20, 2016, MBC, Releta, and Lender entered into a Third Amendment (the “Third Amendment”) to the Credit and Security Agreement. The Third Amendment extended the maturity date of the Credit and Security Agreement from June 23, 2016 to July 23, 2016. The Third Amendment also reduced the Revolver from $2,500,000 to $1,250,000. Effective July 22, 2016, MBC, Releta, and Lender entered into a Fourth Amendment (the “Fourth Amendment”) to the Credit and Security Agreement. The Fourth Amendment extended the maturity date of the Credit and Security Agreement from July 23, 2016 to September 21, 2016 and increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest). Effective September 21, 2016, MBC, Releta, and Lender entered into a Fifth Amendment to the Credit and Security Agreement which extended the maturity date of the Credit and Security Agreement from September 21, 2016 to October 21, 2016. Effective October 18, 2016, MBC, Releta, and Lender entered into a Sixth Amendment to the Credit and Security Agreement which extended the maturity date of the Credit and Security Agreement from October 21, 2016 to December 31, 2016. Lender has absolutely no commitment and has made no agreement to extend the maturity date beyond December 31, 2016. The Sixth Amendment also confirms the continuance of certain events of default under the Credit and Security Agreement.

 

As of September 30, 2016, pursuant to the Credit and Security Agreement, the fixed charge coverage ratio was required to be 1.15 to 1. The Company calculated that the fixed charge coverage ratio as of September 30, 2016 was -1.02 to 1. The Company calculated that the required tangible net worth of MBC and Releta was $6,181,400 as of September 30, 2016 and the actual tangible net worth on such date was $3,317,200. The Company does not anticipate that it will regain compliance with the required fixed charge coverage ratio or the minimum tangible net worth, as required by the Credit and Security Agreement.

 

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The Credit and Security Agreement provides that the failure of MBC and Releta to observe any covenant will constitute an event of default under the Credit and Security Agreement. Lender has not waived the events of default described in the Default Notice, the Second Default Notice or the Third Default Notice and has reserved the right to all other available rights and remedies under the Credit and Security Agreement, certain other related documents and applicable law. An event of default shall be deemed continuing until waived in writing by Lender. Under the Credit and Security Agreement, upon the occurrence of an event of default, all of MBC’s and Releta’s obligations under the Credit and Security Agreement may, at Lender’s option, be declared, and immediately shall become, due and payable, without notice of any kind. Lender could declare the full amount owed under the Credit and Security Agreement due and payable at any time for any reason or no reason. Since executing the Sixth Amendment, the Company has not received any notice or other communication from Lender that it intends to exercise any other remedies available to it under the Credit and Security Agreement in connection with the events of default. As noted above, effective July 22, 2016, Lender increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest). The Company estimates this increase in interest rate will result in the payment by the Company to Lender of additional interest of approximately $9,000 per month. The exercise of additional remedies by Lender may have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate. The Credit and Security Agreement expires on December 31, 2016. There is no guarantee that MBC and Releta will be able to obtain alternate financing on terms favorable to the Company or on any terms. If the Company is unable to obtain alternate financing, it will have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

UBHL

 

In response to the losses incurred in connection with the Company’s operations, UBHL issued a letter of comfort to the Company’s accountants on March 5, 2015 (the “Letter of Comfort”) to confirm that UBHL had agreed to provide funding on an as needed basis to ensure that the Company is able to meet its financial obligations as and when they fall due. The Letter of Comfort does not specify either the terms of UBHL’s support, or a maximum dollar limit and is not a legally binding agreement or guarantee. However, to date, UBHL, through a related party, Catamaran, has provided loans for working capital needs as described above. UBHL’s financial support is contingent upon compliance with any applicable exchange control requirements, other applicable laws, and regulations relating to the transfer of funds from India. The Letter of Comfort does not specify any time limit for extending support. If it becomes necessary to seek UBHL’s financial assistance under the Letter of Comfort or otherwise and UBHL does not provide such financial assistance to MBC, it may result in a material adverse effect on the Company’s financial position and on its ability to continue to operate. UBHL controls the Company’s two largest shareholders, United Breweries of America, Inc. (“UBA”) and Inversiones Mirabel, S.A., a Panamanian corporation (“Inversiones”), and as such, is the Company’s indirect majority shareholder. The Company’s Chairman of the Board, Dr. Vijay Mallya, is also the Chairman of the board of directors of UBHL.

 

On February 3, 2016, the board of directors of UBHL approved debt financing to the Company in the form of a $1,000,000 bridge loan. The Company has not received any proceeds against this UBHL $1,000,000 bridge loan. If UBHL does not consummate this financing, it would have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

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Catamaran Notes

 

On January 22, 2014, Catamaran, a related party, provided a loan to MBC in the principal amount of $500,000 evidenced by a promissory note. On April 24, 2014, Catamaran provided a second loan in the principal amount of $500,000 on terms similar to the previous note. On February 5, 2015, Catamaran provided a third loan in the principal amount of $500,000 on terms similar to the previous notes. On June 30, 2015, Catamaran provided a fourth loan in the principal amount of $500,000 on terms similar to the previous notes, and the Company received the proceeds against this note on July 6, 2015. Each time Catamaran provided a loan, the Company received a letter from Lender permitting the Company to obtain such loans subject to certain conditions, including that no portion of such loans would be payable until either (a) certain obligations of the Company to Lender pursuant to the Credit and Security Agreement were satisfied in full, or (b) such payment was a Permitted Payment. A “Permitted Payment” with respect to the notes dated January 22, 2014, April 24, 2014, and February 5, 2015 means a payment made from an equity investment by the Company’s majority shareholder in excess of $500,000. A “Permitted Payment” with respect to the note dated June 30, 2015 means a payment made from an equity investment by the Company’s majority shareholder. On March 14, 2016, Catamaran provided a fifth loan in the principal amount of $325,000 on terms substantially similar to the previous notes, except that the definition of “Permitted Payment” was revised to mean, for purposes of this fifth note, a payment made from a bridge loan by the Company’s majority shareholder in excess of $600,000. On March 30, 2016, Catamaran provided a sixth loan in the principal amount of $75,000 on terms substantially similar to the fifth note. All Catamaran notes are payable within six months following the date of the notes, and if the Company is not able to satisfy its obligations on these notes within the six month period following the date of the notes, the notes shall be automatically extended for additional six month terms until they are paid. If Catamaran ceases to provide ongoing financial support to the Company, and the Company is unable to obtain alternate financing, it would have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

Interest shall accrue from the date of the applicable Catamaran note on the unpaid principal at a rate equal to the lesser of (i) one and one-half percent (1.5%) per annum above the prime rate offered from time to time by the Bank of America Corporation in San Francisco, California, or (ii) ten percent (10%) per annum, until the principal is fully paid.

 

The Catamaran notes may be prepaid without penalty at the option of the Company; however, no payments on the Catamaran notes may be made unless such payment is a “Permitted Payment” or certain existing obligations of the Company to Lender pursuant to the Credit and Security Agreement have been satisfied in full. The Catamaran notes may not be amended without the prior written consent of Lender.

 

Gordian Group

 

On December 9, 2015, the Company engaged Gordian Group, LLC (“Gordian Group”) to serve as the Company’s exclusive investment banker to assist the Company in evaluating, exploring and, if deemed appropriate by the Company, pursuing and implementing certain strategic and financial options and transactions that may be available to the Company, including in connection with a possible debt or equity capital financing, merger, consolidation, joint venture or other business combination involving, or sale of substantially all or a material portion of the assets (outside of the ordinary course of business) or outstanding securities of, the Company and/or its subsidiaries, and/or the acquisition of substantially all or a material portion of the assets or outstanding securities of another entity (each, a “Financial Transaction”). Gordian Group is a New York-based independent investment banking firm. While the Company has commenced evaluating its available options, no conclusion as to any specific option or transaction has been reached, nor has any specific timetable been fixed for this effort, and there can be no assurance that any viable strategic or financial option or transaction will be presented, implemented or consummated. The Company intends to use proceeds of the Financial Transaction, if any, in part, to repay the amount owed to Lender when it becomes due.

 

At September 30, 2016, the Company had cash and cash equivalents of $84,700, an accumulated deficit of $18,730,600, and a working capital deficit of $12,265,800 due to losses incurred, debts payable to Lender and notes payable to related parties. In addition, the book value of the Company’s assets was lower than the book value of its liabilities at September 30, 2016.

 

Management has taken several actions to reduce the Company’s working capital needs through September 30, 2017, including reducing manpower and pursuing additional brewing contracts in an effort to utilize a portion of excess production capacity. The Company is pursuing a Financial Transaction through Gordian Group as described above. The Company has relied upon the continued loans from Catamaran to support operations. The current revenue from operations is insufficient to meet the working capital needs of the Company over the next 12 months. The Company has requested UBHL to make a capital infusion.

 

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If UBHL or other sources do not provide sufficient financial assistance to MBC, it will result in a material adverse effect on the Company’s financial position and on its ability to continue to operate and it may have to raise funds by selling some of its operating assets. In addition, the Company’s lenders may seek to satisfy any outstanding obligations through recourse against the applicable pledged collateral which includes the Company’s real and personal property in the United States and the United Kingdom. The loss of any material pledged asset would have a material adverse effect on the Company’s financial condition and its ability to continue to operate.

 

Vijay Mallya, the Company’s Chairman and indirect majority shareholder is presently subject to certain legal proceedings in India, which may impair the Company’s ability to obtain financing from UBHL and other potential funding sources.

 

3. Inventories

 

Inventories are stated at the lower of average cost or market and consist of the following:

 

   September 30, 2016   December 31, 2015 
Raw Materials  $526,500   $628,100 
Beer-in-process   342,600    312,200 
Finished Goods   542,000    541,400 
Merchandise   61,000    65,300 
TOTAL  $1,472,100   $1,547,000 

 

4. Secured Lines of Credit

 

MB Financial Credit and Security Agreement

 

The borrowings under the Credit and Security Agreement are collateralized, with recourse, by MBC’s and Releta’s trade receivables and inventory located in the US. This facility carries interest (including default interest) at the Wall Street Journal prime rate plus 6%) and is secured by substantially all of the assets of Releta and MBC. The amount outstanding on this line of credit as of September 30, 2016 was approximately $391,900. Included in the Company’s balance sheet as at September 30, 2016 are account balances totaling $1,220,200 of accounts receivable and $1,408,800 of inventory collateralized to Lender under this facility. The Credit and Security Agreement expires on December 31, 2016.

 

RBS Facility

 

On April 26, 2005, Royal Bank of Scotland Commercial Services Limited (“RBS”) provided an approximately $2.8 million (£1,750,000) invoice discounting facility to KBEL based on 80% prepayment against qualified accounts receivable related to KBEL’s UK customers. The facility carried an interest rate of 1.38% above the RBS base rate and a service charge of 0.10% of each invoice discounted. On July 20, 2016, KBEL used the proceeds from the Santander Facility provided by Santander UK plc (“Santander”), as described below, to repay the entire amount owed on the RBS invoice discounting facility.

 

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Santander Facility

 

On July 20, 2016, KBEL entered into a Sales Finance Agreement with Santander (the “Santander Facility”) pursuant to which Santander provided KBEL with an approximately $2,306,000 (£1,750,000) maximum revolving line of credit (the “Review Limit”) with advances permitted up to 85% of KBEL’s qualified accounts receivable. This facility has a minimum maturity of twelve months, but will be automatically extended unless terminated by either party upon three months’ written notice. If the Santander Facility terminates on or before the first anniversary, KBEL must pay as breakage costs 3% of the Review Limit. The Santander Facility carries an interest rate of 2.1% above the Santander base rate and a fixed service charge of approximately $1,300 (£1,000) per month. The Santander Facility binds KBEL to certain financial covenants relating to accounts receivable including turnover ratios, maximum dilution, and ageing, while also requiring KBEL to maintain a minimum level of net tangible assets. KBEL used the proceeds from the Santander Facility to repay the entire amount owed on the RBS invoice discounting facility. The amount outstanding on this line of credit as of September 30, 2016 was approximately $668,000. Included in the Company’s balance sheet at September 30, 2016 are account balances totaling $1,831,700 of accounts receivable collateralized to the Santander Facility.

 

5. Notes Payable to Related Party

 

Notes payable to a related party consist of notes payable to Catamaran dated January 22, 2014, April 24, 2014, February 5, 2015, June 30, 2015, March 14, 2016, and March 30, 2016 for a total value of $2,605,500 including accrued interest of $205,500 as of September 30, 2016. Catamaran Holdings, Ltd. (“Holding”), the sole shareholder of Catamaran, has directors in common with Inversiones, one of the major shareholders of MBC. The indirect beneficial owner of Inversiones is UBHL. Dr. Vijay Mallya, the Chairman of the Board of Directors of the Company is also the Chairman of the Board of Directors of UBHL.

 

The Catamaran notes are payable within six months following the date of the notes, and if the Company is not able to satisfy its obligations on these notes within the six month period following the date of the notes, the notes shall be automatically extended for additional six month terms until they are paid. Each time Catamaran provided a loan, the Company received a letter from Lender permitting the Company to obtain such loans subject to certain conditions, including that no portion of such loans would be payable until either (a) certain obligations of the Company to Lender pursuant to the Credit and Security Agreement were satisfied in full, or (b) such payment was a Permitted Payment. A “Permitted Payment” with respect to the notes dated January 22, 2014, April 24, 2014, and February 5, 2015 means a payment made from an equity investment by the Company’s majority shareholder in excess of $500,000. A “Permitted Payment” with respect to the note dated June 30, 2015 means a payment made from an equity investment by the Company’s majority shareholder. On March 14, 2016, Catamaran provided a fifth loan in the principal amount of $325,000 on terms substantially similar to the previous notes, except that the definition of “Permitted Payment” was revised to mean, for purposes of this fifth note, a payment made from a bridge loan by the Company’s majority shareholder in excess of $600,000. On March 30, 2016, Catamaran provided a sixth loan in the principal amount of $75,000 on terms substantially similar to the fifth note. If Catamaran ceases to provide ongoing financial support to the Company, and the Company is unable to obtain alternate financing, it would have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

Interest shall accrue from the date of the applicable Catamaran note on the unpaid principal at a rate equal to the lesser of (i) one and one-half percent (1.5%) per annum above the prime rate offered from time to time by the Bank of America Corporation in San Francisco, California, or (ii) ten percent (10%) per annum, until the principal is fully paid.

 

The Catamaran notes may be prepaid without penalty at the option of the Company; however, no payments on the Catamaran notes may be made unless such payment is a “Permitted Payment” or certain existing obligations of the Company to Lender pursuant to the Credit and Security Agreement have been satisfied in full. The Catamaran notes may not be amended without the prior written consent of Lender.

 

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6. Subordinated Convertible Notes Payable to Related Party

 

Subordinated convertible notes to a related party included notes payable to UBA (the “UBA Notes”) for a total value of $3,752,000 as of September 30, 2016, including interest at the prime rate plus 1.5% per year, but not to exceed 10%. Thirteen of the UBA Notes are convertible into common stock at a rate of $1.50 per share and one UBA Note is convertible at a rate of $1.44 per share. The UBA Notes have been extended until June 2017 and have automatic renewals after such maturity date for successive one year terms, provided that either the Company or UBA may elect not to extend the term upon written notice given to the other party no more than 60 days and no fewer than 30 days prior to the expiration of the applicable term. Under the terms of the UBA Notes, UBA may demand payment within 60 days following the end of the extension period. UBA has agreed to subordinate the UBA Notes to the Company’s debt agreements with MB Financial, as successor-in-interest to Cole Taylor, which mature in December 2016. Therefore, the Company will not require the use of working capital to repay any of the UBA Notes until the MB Financial facility is repaid. The UBA notes include $1,836,600 and $1,764,700 of accrued interest at September 30, 2016 and December 31, 2015, respectively.

 

7. Secured Notes Payable

 

Maturities of secured notes payable for succeeding years are as follows:

 

   September 30, 2016   December 31, 2015 
Loan from MB Financial, payable in monthly installments of $12,300, plus interest (including default interest) at 9.5%with a balloon payment of approximately $2,128,900 in December 2016; secured by substantially all assets of Releta and MBC.  $2,165,700   $2,276,200 
           
Loans from MB Financial, payable in monthly installments of $32,300 plus interest (including default interest) at 9.5% (with a balloon payment of approximately $715,100 in December 2016; secured by substantially all assets of Releta and MBC.   811,900    1,102,400 
    2,977,600    3,378,600 
           
Less current maturities   2,977,600    3,378,600 
   $-   $- 

 

8. Long-Term Debt – Related Party

 

   September 30, 2016   December 31, 2015 
Loan from Heineken UK Limited, payable in quarterly installments of $108,500, plus interest at UK prime plus 5% maturing on October 9, 2016, secured by licensing rights pursuant to a Sub-License Agreement.  $108,500   $491,500 
           
Less current maturities   108,500    491,500 
Non-current loan payable  $-   $- 

 

On April 18, 2013, KBEL entered into a Loan Agreement (the “HUK Loan Agreement”) with HUK pursuant to which HUK provided KBEL with a secured term loan of £1,000,000 on October 9, 2013 to be repaid in twelve equal quarterly installments of £83,333.33, commencing from January 9, 2014 and to be repaid in full by October 9, 2016. Interest on the HUK loan is payable quarterly in arrears on the outstanding balance of the loan at the rate of 5% above the Bank of England base rate. Prepayment is permitted. Upon an Event of Default, as defined in the HUK Loan Agreement, if HUK and KBEL fail to agree on a payment plan acceptable to HUK, HUK may, among other remedies, declare the loan immediately due and repayable or exercise its right to an exclusive license pursuant to the Sub License Agreement, as described and defined in the HUK Loan Agreement.

 

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On October 9, 2016, KBEL paid the final installment and settled the loan in full.

 

9. Capital Lease Obligations

 

The Company leases certain assets under an agreement that is classified as a capital lease. The future minimum lease payments required under the capital lease and the present values of net minimum lease payments as of September 30, 2016 are as follows:

 

Three months Ending December 31, 2016  $6,500 
Year Ending December 31, 2017   26,000 
Year Ending December 31, 2018   19,500 
Year Ending December 31, 2019   19,500 
Year Ending December 31, 2020   19,100 
    90,600 
Less amounts representing interest   (12,400)
Present value of minimum lease payments   78,200 
Less current maturities   (21,300)
Non-current leases payable  $56,900 

 

10. Severance Payable

 

The Company is a party to a Separation and Severance Agreement (the “Separation Agreement”) with Mr. Yashpal Singh, its President and Chief Executive Officer. Pursuant to the terms of the Separation Agreement, upon Mr. Singh’s (i) termination of employment for Good Reason (as defined in the Separation Agreement), (ii) termination of employment at the end of the employment term, (iii) death, (iv) disability or (v) termination by the Company without Cause (as defined in the Separation Agreement), he shall be entitled to certain severance benefits and payments. The severance payment shall equal the product of 2.5 times his average monthly base salary (calculated over the twelve (12) month period preceding the termination event), multiplied by the number of years (on a pro-rated basis) he had been employed by the Company at the Termination Date (as defined in the Separation Agreement); provided, however, that the severance payment may not exceed thirty (30) months of Mr. Singh’s average monthly base salary (calculated over the twelve (12) months preceding his termination date). Payments due to Mr. Singh under the Separation Agreement shall be paid in equal monthly installments by the Company over a 20 month period. Mr. Singh’s current employment contract ends on December 31, 2016. The receipt of payments is contingent on Mr. Singh executing a release of claims for the benefit of the Company. As of September 30, 2016, the Company has accrued $898,800 against this obligation.

 

Pursuant to a resolution adopted on September 10, 2013 by the Company’s Board of Directors, the Company entered into a Separation and Severance Agreement with Mr. Mahadevan Narayanan, the Company’s Chief Financial Officer and Secretary on April 12, 2016. Pursuant to the terms of the agreement, upon Mr. Narayanan’s (i) termination of employment for Good Reason (as defined in the agreement), (ii) death, (iii) disability or (iv) termination by the Company without Cause (as defined in the agreement), he shall be entitled to certain severance benefits and payments. The severance payment shall equal the product of 2.5 times his average monthly base salary (calculated over the twelve (12) month period preceding the termination event), multiplied by the number of years (on a pro-rated basis) he had been employed by the Company at the Termination Date (as defined in the agreement); provided, however, that the severance payment may not exceed thirty (30) months of Mr. Narayanan’s average monthly base salary (calculated over the twelve (12) months preceding his termination date). If Mr. Narayanan’s employment is terminated without Cause, in addition to the severance payment described above, he shall also receive either (i) 365 days prior written notice or (ii) a lump sum payment equal to twelve (12) months of his base salary at the rate in place at the Termination Date (the “Notice Payment”). Payments due to Mr. Narayanan under the Separation Agreement shall be paid in equal monthly installments by the Company over a 20 month period. The receipt of payments is contingent on Mr. Narayanan executing a release of claims for the benefit of the Company. As of September 30, 2016, the Company has not accrued any amount against this contingency. As of September 30, 2016, the Company estimated the obligation to be $486,800 excluding any Notice Payment.

 

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11. Commitments and Contingencies

 

Purchase of raw materials

 

Production of the Company’s beverages requires quantities of various processed agricultural products, including malt and hops for beer. The Company fulfills its commodities requirements through purchases from various sources, some through contractual arrangements and others on the open market.

 

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’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims as well as the perceived merits of the amount of relief sought or expected to be sought therein.

 

On September 26, 2014, The New Buffalo Brewing Co., Inc. (“NBB”) initiated an action against Releta in the Supreme Court of the State of New York for the County of Erie to recover damages for alleged breaches of a Brewing Production Agreement between NBB and Releta dated September 6, 2013 (the “Brewing Production Agreement”), as well as for a declaration rescinding and nullifying the Brewing Production Agreement, and, in case of Releta’s failure to answer or appear, damages resulting from the alleged breaches, rescission of the Brewing Production Agreement, attorneys’ fees and any other relief deemed proper by the court. In a demand letter to Releta dated October 16, 2014, NBB demanded payment of the sum of $500,000. The Company has engaged a law firm in New York to respond. The trial date is set for January 17, 2017.

 

On June 3, 2015, IAE International Aero Engines AG (“IAE”) served the Company with a complaint (the “Complaint”), filed in Marin County Superior Court, California (the “Court”), which requests, among other things, (i) that the Court recognize and enforce a foreign judgment against an Indian corporate entity (which is an affiliate of the Company), the alleged judgment debtor, and (ii) that such judgment be made enforceable against any assets of the Company (and of the other defendants) that are located in California, on the alleged ground that the Company (along with the other defendants) is an “alter ego” of the alleged judgment debtor. Along with the Complaint, IAE also served the Company with an ex parte application for a right to attach order and a writ of attachment, and, in the alternative, a temporary protective order (collectively, the “ex parte application”) to, among other things, stop the Company from making certain transfers to related parties other than in the ordinary course of business.

 

The ex parte application came up for hearing before the Court on June 5, 2015 and was continued to June 9, 2015. At the conclusion of the continued hearing on June 9, 2015, the Court denied the ex parte application for a writ of attachment and dissolved a short-term, limited temporary protective order that had been in place during the four-day continuance.

 

The Company believes that the allegations in the Complaint are without merit and will continue to vigorously defend against the lawsuit. On June 29, 2016, the Company filed a Motion for Judgment on the Pleadings, requesting that the Court dismiss, with prejudice, one of the two causes of action pled against it. That motion was granted by the Court on September 6, 2016, leaving only one cause of action against the Company. Trial is expected to commence on March 14, 2017.

 

19
 

 

As discussed in more detail in the Company’s Current Report on Form 8-K filed on June 9, 2015, the Company discussed with the Lender the allegations set forth in the Complaint and the ex parte application and, as of the date of this Quarterly Report, the Company has not received any notice or other communication from the Lender that the Lender intends to exercise any of the remedies available to it under the Credit and Security Agreement in connection therewith.

 

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 condition or ability to continue to operate.

 

Operating Leases

 

The Company leases some of its operating and office facilities for various terms under long-term, non-cancelable operating lease agreements. The leases expire at various dates between 2016 and 2020 and provide for renewal options ranging from month-to-month to five years. In the normal course of business, it is expected that these leases will be renewed or replaced by leases on similar 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 certain costs, including real estate taxes, insurance and repairs.

 

MBC and its subsidiaries have various lease agreements for the brewpub and gift store in Ukiah, California, the brewery at Releta’s Saratoga Springs, New York facility, a building in the UK, and certain equipment. The New York lease includes a renewal option for three additional five-year periods, which Releta intends to exercise, and some leases are adjusted annually for changes in the Consumer Price Index.

 

12. Related-Party Transactions

 

The Company conducts business with United Breweries of America, Inc. (“UBA”), which owns approximately 25% of the Company’s common stock. KBEL also had significant transactions with HUK, a related party with respect to one of MBC’s Board members, beginning in October 2013.

 

The following table reflects the value of such transactions during the nine months ended September 30, 2016 and 2015 and the balances outstanding as of September 30, 2016 and December 31, 2015.

 

TRANSACTIONS  September 30, 2016   September 30, 2015 
Purchases from HUK  $7,341,400   $8,239,200 
Expense reimbursement including interest to HUK  $637,900   $715,200 
Interest expense related to UBA convertible notes  $71,900   $68,100 
Interest expenses related to Catamaran notes  $85,900   $56,700 
Borrowing from Catamaran  $2,400,000   $2,000,000 

 

ACCOUNT BALANCES  September 30, 2016   December 31, 2015 
Accounts payable and accrued liability to HUK  $1,581,500   $1,669,400 
Notes payable to Catamaran  $2,605,500   $2,119,600 
Notes payable to UBA  $3,752,000   $3,680,100 

 

13. Segment Information

 

The Company’s business presently consists of two segments – the North American Territory and the Foreign Territory. The Company’s operations in the North American Territory consist primarily of brewing and marketing proprietary craft beers. For distribution in the North American Territory, the Company brews its brands in its own facilities, which are located in Ukiah, California and Saratoga Springs, New York. The Company’s operations in the Foreign Territory, which are conducted through its wholly-owned subsidiary UBIUK and UBIUK’s wholly-owned subsidiary KBEL, consist primarily of the marketing and distribution of Kingfisher Premium Lager in the Foreign Territory.

 

20
 

 

A summary of each segment is as follows:

 

   Nine months ended September 30, 2016 
   North
American
Territory
   Foreign
Territory
   Total 
             
Net Sales  $8,292,000   $12,993,700   $21,285,700 
Operating Income (Loss)  $(1,131,400)  $232,900   $(898,500)
Identifiable Assets  $11,995,600   $3,272,700   $15,268,300 
Depreciation & Amortization  $496,100   $343,700   $839,800 
Capital Expenditures  $6,200   $199,700   $205,900 

 

   Nine months ended September 30, 2015 
   North
American Territory
   Foreign
Territory
   Total 
             
Net Sales  $8,787,700   $14,444,200   $23,231,900 
Operating Income (Loss)  $(629,000)  $294,000   $(335,000)
Identifiable Assets  $12,969,300   $4,121,300   $17,090,600 
Depreciation & Amortization  $505,200   $384,000   $889,200 
Capital Expenditures  $70,400   $333,400   $403,800 

 

14. Unrestricted Net Assets

 

The Company’s wholly-owned subsidiary, UBIUK, had undistributed losses of $129,900 as of September 30, 2016. Under KBEL’s line of credit agreement with RBS, distributions and other payments to MBC from KBEL were not permitted if retained earnings dropped below $1,301,500. Condensed financial information of MBC, together with its other subsidiary, Releta, is as follows:

 

Balance Sheets

 

   September 30, 2016   December 31, 2015 
   (unaudited)    
Balance Sheets          
           
Assets          
Cash and cash equivalents  $84,500   $61,300 
Accounts receivable, net   1,220,200    1,121,300 
Inventories   1,408,800    1,490,100 
Other current assets   182,700    199,800 
Total current assets   2,896,200    2,872,500 
           
Investment in subsidiary   1,225,000    1,225,000 
Property and equipment   8,911,100    9,378,500 
Intercompany (payable) receivable   (229,400)   284,000 
Other assets   188,300    175,800 
Total assets  $12,991,200   $13,935,800 
           
Liabilities          
Line of credit  $391,900   $453,100 
Accounts payable   2,664,900    2,640,400 
Accrued liabilities   1,357,000    1,021,000 
Note payable to related party   2,605,500    2,119,600 
Subordinated convertible notes to related party   3,752,000    3,680,100 
Current maturities of debt, leases and severance   3,254,800    3,505,900 
Total current liabilities   14,026,100    13,420,100 
           
Long-term capital leases   9,600    14,000 
Severance payable   629,200    678,400 
Total liabilities   14,664,900    14,112,500 
           
Stockholders’ deficit          
Common stock   15,100,300    15,100,300 
Preferred stock   227,600    227,600 
Accumulated deficit   (17,001,600)   (15,504,600)
Total stockholders’ deficit   (1,673,700)   (176,700)
Total liabilities and stockholders’ deficit  $12,991,200   $13,935,800 

 

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Statements of Operations  Three months ended
September 30
   Nine months ended
September 30
 
   2016   2015   2016   2015 
   (unaudited)   (unaudited)   (unaudited)   (unaudited) 
Net sales  $2,746,700   $3,247,500   $8,292,000   $8,787,700 
Cost of goods sold   (2,255,600)   (2,547,100)   (6,816,500)   (7,141,000)
Sales, marketing, and retail expenses   (300,900)   (317,800)   (882,300)   (993,500)
General and administrative expenses   (549,600)   (426,600)   (1,729,900)   (1,287,300)
Loss from operations   (359,400)   (44,000)   (1,136,700)   (634,100)
                     
Other income   1,400    7,400    13,200    51,000 
Interest expense   (133,900)   (117,500)   (371,900)   (365,000)
Provision for taxes   -    -    (1,600)   (3,800)
Net loss  $(491,900)  $(154,100)  $(1,497,000)  $(951,900)

 

Statements of Cash Flows  Nine months ended September 30 
   2016   2015 
   (unaudited)   (unaudited) 
Cash flows from operating activities  $(417,400)  $297,400 
Purchase of property and equipment   (6,200)   (70,400)
Net repayment on line of credit   (61,200)   (875,200)
Borrowing on note payable   400,000    1,000,000 
Repayment on long term debt   (401,000)   (401,000)
Payment on obligation under capital lease   (4,400)   (4,100)
Net change in payable to UBIUK   513,400    83,300 
Increase in cash   23,200    30,000 
Cash, beginning of period   61,300    61,500 
Cash, end of period  $84,500   $91,500 

 

15. Income Taxes

 

In the nine months ended September 30, 2016 and 2015, the Company recorded tax expenses related to state franchise taxes only, and did not record income tax expenses due to the availability of deferred tax assets to offset any taxable income in the US (at the federal and state level to the extent applicable) and the UK. The Company has established a full valuation allowance against the Company’s deferred tax assets based on an assessment that the criteria that deferred tax assets will more likely than not be realized has not yet been met. During the nine months ended September 30, 2016 and 2015, the Company’s effective tax rates were de minimis.

 

The Company’s major tax jurisdictions are (i) US (federal), (ii) California (state), (iii) New York (state) and (iv) UK. Tax returns remain open to examination by the applicable governmental authorities for tax years 2012 through 2015. The federal and state taxing authorities may choose to audit tax returns for prior years due to significant tax attribute carryforwards for those prior years. However, such audits will be limited to adjustments to such carryforward tax attributes. The Company is not currently being audited in any tax jurisdiction.

 

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 three and nine months ended September 30, 2016, compared to the three and nine months ended September 30, 2015. 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, 2015.

 

In the rest of this Quarterly Report on Form 10-Q, the terms “we”, “us”, “our”, and “the Company” and its variants are 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 on Form 10-Q, including but not limited to the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contain forward-looking statements. Forward-looking statements involve 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 statements. 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 as of the date such statements are issued. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements 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 the prices of raw materials, availability of financing for operations, changes in interest rates, changes in the Company’s European beer business, and other risks discussed elsewhere in this Quarterly Report on Form 10-Q and from time to time in the Company’s Securities and Exchange Commission (“SEC”) filings and reports. In addition, such statements could be adversely affected by general industry and market conditions and growth rates, and general domestic, Canadian 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 revisions to these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements.

 

Segment Information

 

Prior to August 2001, the Company’s business operations were exclusively located in the US, and consisted of the manufacture and distribution of beer. With the Company’s acquisition of United Breweries International (UK), Ltd. (“UBIUK”) in August 2001, the Company gained a new business segment ― distribution of beer outside the US, primarily in the United Kingdom (the “UK”) and continental Europe (collectively, the “Foreign Territory”). This segment accounted for 60% and 61% of the Company’s gross sales during the first nine months of 2016 and 2015 respectively, with the US and Canada (the “North American Territory”) accounting for the remaining 40% and 39% during the first nine months of 2016 and 2015 respectively.

 

Seasonality

 

Sales of the Company’s products are somewhat seasonal. Historically, sales volumes in both the Company’s North American and Foreign Territories have been comparatively low during the first quarter of the calendar year. The volume of sales in any given area may also be adversely 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 2016 with a net loss of $1,335,000, as compared to a net loss of $750,100 for the same period in 2015. As set forth more fully under the section captioned “Results of Operations” below, during the first nine months of 2016, the Company experienced a decrease in net sales of $1,946,200 compared to the same period in 2015. Compared to the first nine months of 2015, costs of goods sold decreased by $1,180,500, operating expenses decreased by $202,200, and net other expenses increased by $23,600 in the first nine months of 2016, all of which contributed to the Company’s results for the period.

 

23
 

 

RESULTS OF OPERATIONS

 

Three Months Ended September 30, 2016 Compared To Three Months Ended September 30, 2015

 

Net Sales

 

Our overall net sales for the third quarter of 2016 were $6,831,900, compared to $8,399,200 for the third quarter of 2015, a decrease of $1,567,300, or 18.7%. The decrease was due to a reduction in sales volume and exchange rate fluctuation.

 

North American Territory: Our net sales in the North American Territory for the third quarter of 2016 were $2,746,700 compared to $3,247,500 for the same period in 2015, a decrease of $500,800, or 15.4%, mainly due to decreased sales volume. The sales volume decreased to 13,100 barrels in the third quarter of 2016 from 16,500 barrels in the third quarter of 2015; a net decrease of 3,400 barrels, or 20.6% mainly due to competitive pressure and lower demand. We continue to solicit opportunities to enter into non-binding contract brewing arrangements to address the low production capacity utilization rates in our Ukiah, California and Saratoga Springs, New York brewing facilities.

 

Foreign Territory: Net sales in the Foreign Territory for the third quarter of 2016 were $4,085,200 compared to $5,151,700 during the corresponding period of 2015, a decrease of $1,066,500, or 20.7% when measured in US Dollars. The decrease in sales was primarily due to exchange rate fluctuations. When measured in UK Pounds Sterling, the functional currency of Foreign Territory, net sales decreased by 6.8% during the third quarter of the year 2016 compared to corresponding period of 2015.

 

Cost of Goods Sold

 

Cost of goods sold as a percentage of net sales during the third quarter of 2016 was 67.9%, as compared to 66.9% during the corresponding period of 2015.

 

North American Territory: Cost of goods sold as a percentage of net sales in the North American Territory during the third quarter of 2016 was 82.1%, compared to 78.4% during the corresponding period of 2015, mainly due to lower sales volume. Utilization of our production capacity has a direct impact on cost. Generally, when facilities are operating at a lower percentage of production capacity, cost is unfavorably affected because fixed and semi-variable operating costs, such as depreciation and production costs, are spread over a smaller volume base. Our production capacity is currently under-utilized, and the lower sales volume in 2016 caused further decreases in productivity.

 

Foreign Territory: Cost of goods sold as a percentage of net sales in the Foreign Territory during the third quarter of 2016 was 58.4%, as compared to 60.5% during the corresponding period in 2015 due to exchange rate fluctuations.

 

Gross Profit

 

Due to the reduction in sales revenue, gross profit for the third quarter of 2016 was $2,193,400 compared to $2,778,500 during the corresponding period of 2015, a decrease of $585,100 or 21.1%. As a percentage of net sales, gross profit during the third quarter of 2016 decreased to 32.1% from 33.1% for the third quarter of 2015.

 

Operating Expenses

 

Operating expenses for the third quarter of 2016 were $2,507,600, a decrease of $115,500, or 4.4%, as compared to $2,623,100 for the corresponding period of 2015. Operating expenses consist of marketing and distribution expenses and general and administrative expenses.

 

Marketing and Distribution Related Expenses: Our marketing and distribution related expenses for the third quarter of 2016 were $1,286,900, as compared to $1,511,500 for the third quarter of 2015, representing a decrease of $224,600 or 14.9%.

 

North American Territory: Marketing and distribution related expenses in the North American Territory for the third quarter of 2016 were $300,900 compared to $317,800 during the corresponding period of 2015, representing a decrease of $16,900 or 5.3% due to a reduction in manpower. As a percentage of net sales in the North American Territory, such expenses increased to 11% during the third quarter of 2016, compared to 9.8% during the corresponding period of 2015.

 

24
 

 

Foreign Territory: Marketing and distribution related expenses in the Foreign Territory for the third quarter of 2016 were $986,000 compared to $1,193,700 during the corresponding period of 2015, representing a decrease of $207,700, or 17.4% mainly due reduction in manpower and exchange rate fluctuation. As a percentage of net sales in the Foreign Territory, marketing and distribution expenses increased to 24.1% during the third quarter of 2016 compared to 23.1% during the corresponding period of 2015.

 

General And Administrative Expenses: Our general and administrative expenses were $1,220,700 for the third quarter of 2016, representing an increase of $109,100 or 9.8%, from $1,111,600 for the corresponding period in 2015.

 

North American Territory: General and administrative expenses in the North American Territory were $549,600 for the third quarter of 2016, representing an increase of $123,000, or 28.8%, compared to $426,600 for the third quarter of 2015. The increase was mainly due to increase in salary to administrative employees, increased accrual related to directors compensation due to increase in number of directors and meetings. As a percentage of net sales in the North American Territory, expenses increased to 20% during the third quarter of 2016, compared to 13.1% during the third quarter of 2015.

 

Foreign Territory: General and administrative expenses related to the Foreign Territory were $671,100 for the third quarter of the year 2016, representing a decrease of $13,900 or 2%, when compared to $685,000 for the third quarter of 2015. The decrease was mainly due to exchange rate fluctuation. As a percentage of net sales in the Foreign Territory, expenses increased to 16.4% during the third quarter of 2016 compared to 13.3% during the third quarter of 2015.

 

Other Expenses

 

Net other expenses for the third quarter of 2016 totaled $157,800, representing an increase of $12,000, or 8.2%, when compared to $145,800 for the third quarter of 2015 due to increases in interest rates on borrowings related to the North American Territory.

 

Income Taxes

 

We made no income tax provision for the third quarter of 2016 or 2015.

 

Net Income / Loss

 

Our net loss for the third quarter of 2016 was $472,000, compared to net income of $9,600 for the third quarter of 2015. After providing for a positive foreign currency translation adjustment of $2,900 during the third quarter of 2016 (as compared to a negative foreign currency adjustment of $2,000 for the same period in 2015), our comprehensive loss for the third quarter of 2016 was $469,100, compared to comprehensive income of $7,600 for the same period in 2015. As stated above, the primary reason for the decrease in income was the reduction in sales revenue during the period.

 

Nine Months Ended September 30, 2016 Compared To Nine Months Ended September 30, 2015

 

Net Sales

 

Our overall net sales for the first nine months of 2016 were $21,285,700, a decrease of $1,946,200, or 8.4%, compared to net sales of $23,231,900 for the same period in 2015.

 

North American Territory: North American Territory net sales for the first nine months of 2016 were $8,292,000 compared to $8,787,700 for the same period in 2015, a decrease of $495,700 or 5.6%. Our North American Territory sales volumes decreased to 40,200 barrels during the first nine months of 2016 from 43,600 barrels in the first nine months of 2015, representing a decrease of 3,400 barrels or 7.7% due to reduction in MBC brands. We continue to solicit opportunities to enter into non-binding contract brewing arrangements to address the low production capacity utilization rates in our Ukiah, California and Saratoga Springs, New York brewing facilities, and anticipate that fluctuations in the availability of such contract brewing arrangements will continue to impact our net sales in the North American Territory.

 

25
 

 

Foreign Territory: Net sales for the first nine months of 2016 were $12,993,700 compared to $14,444,200 during the corresponding period of 2015, a decrease of $1,450,500 or 10%. The decrease is mainly due to exchange rate fluctuation. When measured in UK Pounds Sterling, the functional currency of the UK, net sales decreased by 1.2%.

 

Cost of Goods Sold

 

Cost of goods sold as a percentage of net sales during the first nine months of 2016 was 69%, as compared to 68.3% during the corresponding period of 2015.

 

North American Territory: Cost of goods sold as a percentage of net sales in the North American Territory during the first nine months of 2016 was 82.2%, as compared to 81.3%, during the corresponding period of 2015. Generally, when facilities are operating at a lower percentage of production capacity, cost is unfavorably affected because fixed and semi-variable operating costs, such as depreciation and production costs, are spread over a smaller volume base. Our production capacity is currently under-utilized.

 

Foreign Territory: Cost of goods sold as a percentage of net sales in the Foreign Territory during the first nine months of 2016 was 60.6%, as compared to 60.5% during the corresponding period in 2015.

 

Gross Profit

 

As a result of a decrease in sales revenue, gross profit for the first nine months of 2016 decreased to $6,597,800, from $7,363,500 during the corresponding period of 2015, a decrease of $765,700 or 10.4%. As a percentage of net sales, the gross profit during the first nine months of 2016 decreased to 31% from 31.7% during the corresponding period in 2015.

 

Operating Expenses

 

Operating expenses for the first nine months of 2016 were $7,496,300, a decrease of $202,200, or 2.6%, as compared to $7,698,500 for the corresponding period of the year 2015. Operating expenses consist of marketing and distribution expenses and general and administrative expenses.

 

Marketing and Distribution Related Expenses: Our marketing and distribution related expenses for the first nine months of 2016 were $3,782,700, as compared to $4,371,500 for the same period in 2015, representing a decrease of $588,800 or 13.5%.

 

North American Territory: Marketing and distribution related expenses in the North American Territory for the first nine months of 2016 were $882,300 compared to $993,500 during the corresponding period of 2015, representing a decrease of $111,200 or 11.2% mainly due to a reduction in manpower. These expenses equaled 10.6% of net sales in the North American Territory during the first nine months of the year 2016, compared to 11.3% during the corresponding period of 2015.

 

Foreign Territory: Marketing and distribution related expenses in the Foreign Territory for the first nine months of 2016 were $2,900,400 compared to $3,378,000 during the corresponding period of 2015, representing a decrease of $477,600 or 14.1% mainly due to exchange rate fluctuation. As a percentage of net sales in the Foreign Territory, marketing and distribution expenses decreased to 22.3% for the first nine months of 2016 as compared to 23.4% for the first nine months of 2015.

 

General and Administrative Expenses: Our general and administrative expenses were $3,713,600 for the first nine months of the year 2016, representing an increase of $386,600 or 11.6%, from $3,327,000 for the corresponding period in 2015.

 

North American Territory: Domestic general and administrative expenses in the North American Territory were $1,729,900 for the first nine months of 2016, representing an increase of $442,600, or 34. 4%, from $1,287,300 for the same period in 2015 due to increases in salaries of administrative employees, increase in legal expenses associated with raising funds and accrued compensation to Directors on account of an increase in number of meetings. As a percentage of net sales in the North American Territory, expenses increased to 20.9% during the first nine months of 2016, compared to 14.6% during the corresponding period in 2015.

 

26
 

 

Foreign Territory: General and administrative expenses related to the Foreign Territory were $1,983,700 for the first nine months of 2016, representing a decrease of $56,000 or 2.7%, as compared to $2,039,700 for the same period in 2015. As a percentage of net sales in the Foreign Territory, expenses increased to 15.3% during the first nine months of 2016, compared to 14.1% during the corresponding period in 2015.

 

Other Expenses

 

Net other expenses for the first nine months of 2016 totaled $434,900 representing an increase of $23,600 or 5.7% when compared to $411,300 for the same period in 2015. The increase was mainly due to lower other income.

 

Income Taxes

 

We had a provision of $1,600 for income taxes for the first nine months of 2016 compared to a provision of $3,800 for the corresponding period in the year 2015.

 

Net Loss

 

Our net loss for the first nine months of 2016 was $1,335,000, as compared to net loss of $750,100 for the first nine months of 2015. After providing for a positive foreign currency translation adjustment of $10,900 during the first nine months of 2016 (as compared to a negative foreign currency translation adjustment of $4,900 for the same period in 2015), comprehensive loss for the first nine months of 2016 was $1,324,100, compared to comprehensive loss of $755,000 for the same period in 2015. As stated above, the primary reason for the loss in 2016 was the drop in sales revenues during the period.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Unused capacity at our Ukiah, California and Saratoga Springs, New York facilities has continued to place demands on our working capital. Historically, our operations have not generated sufficient cash flows to provide us with sufficient working capital. However, we believe that the liquidity we would derive from a related party loan, cash flows attributable to our operations, and a Financial Transaction (as defined below), if consummated, would be sufficient to fund our capital expenditures, debt maturities and other business needs for the next twelve months. We normally generate our liquidity and capital resources primarily through operations and available debt financing.

 

The continuation of the Company as a going concern is dependent upon continued financial support from Catamaran and/or UBHL, its ability to obtain other debt or equity financing, and generating profitable operations from the Company’s future operations. However, management cannot provide any assurances that the Company will be successful in accomplishing any of such goals. These factors raise substantial doubt regarding the Company’s ability to continue as a going concern.

 

Vijay Mallya, the Company’s Chairman and indirect majority shareholder is presently subject to certain legal proceedings in India, which may impair the Company’s ability to obtain financing from UBHL and other potential funding sources.

 

On December 9, 2015, the Company engaged Gordian Group, LLC (“Gordian Group”) to serve as the Company’s exclusive investment banker to assist the Company in evaluating, exploring and, if deemed appropriate by the Company, pursuing and implementing certain strategic and financial options and transactions that may be available to the Company, including a possible debt or equity capital financing, merger, consolidation, joint venture or other business combination involving, or sale of substantially all or a material portion of the assets (outside of the ordinary course of business) or outstanding securities of, the Company and/or its subsidiaries, and/or the acquisition of substantially all or a material portion of the assets or outstanding securities of another entity (each, a “Financial Transaction”). Gordian Group is a New York-based independent investment banking firm. While the Company has commenced evaluating its available options, no conclusion as to any specific option or transaction has been reached, nor has any specific timetable been fixed for this effort, and there can be no assurance that any viable strategic or financial option or transaction will be presented, implemented or consummated. The Company intends to use proceeds of the Financial Transaction, if any, in part to repay the amount owed to Lender when it becomes due.

 

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UBHL Support. In response to the losses incurred in connection with the Company’s operations, UBHL issued a letter of comfort to the Company’s accountants on March 5, 2015 (the “Letter of Comfort”) to confirm that UBHL had agreed to provide funding on an as needed basis to ensure that the Company is able to meet its financial obligations as and when they fall due. The Letter of Comfort does not specify either the terms of UBHL’s support, or a maximum dollar limit and is not a legally binding agreement or guarantee. UBHL’s financial support is contingent upon compliance with any applicable exchange control requirements, other applicable laws, and regulations relating to the transfer of funds from India. The Letter of Comfort does not specify any time limit for extending support. If it becomes necessary to seek UBHL’s financial assistance under the Letter of Comfort or otherwise and UBHL does not provide such financial assistance to MBC, it may result in a material adverse effect on the Company’s financial condition and on its ability to continue to operate. UBHL controls the Company’s two largest shareholders, UBA and Inversiones, and as such, is the Company’s indirect majority shareholder. The Company’s Chairman of the Board, Dr. Vijay Mallya, is also the Chairman of the board of directors of UBHL.

 

On February 3, 2016, the board of directors of UBHL approved debt financing to the Company in the form of a $1,000,000 bridge loan. The Company has not received any proceeds against this UBHL $1,000,000 bridge loan. If UBHL does not consummate this financing, it would have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

Catamaran Notes. On January 22, 2014, Catamaran, a related party, provided a loan to MBC in the principal amount of $500,000 evidenced by a promissory note. On April 24, 2014, Catamaran provided a second loan in the principal amount of $500,000 on terms similar to the previous note. On February 5, 2015, Catamaran provided a third loan in the principal amount of $500,000 on terms similar to the previous notes. On June 30, 2015, Catamaran provided a fourth loan in the principal amount of $500,000 on terms similar to the previous notes, and the Company received the proceeds against this note on July 6, 2015. Each time Catamaran provided a loan, the Company received a letter from Lender permitting the Company to obtain such loans subject to certain conditions, including that no portion of such loans would be payable until either (a) certain obligations of the Company to Lender pursuant to the Credit and Security Agreement were satisfied in full, or (b) such payment was a Permitted Payment. A “Permitted Payment” with respect to the notes dated January 22, 2014, April 24, 2014, and February 5, 2015 means a payment made from an equity investment by the Company’s majority shareholder in excess of $500,000. A “Permitted Payment” with respect to the note dated June 30, 2015 means a payment made from an equity investment by the Company’s majority shareholder. On March 14, 2016, Catamaran provided a fifth loan in the principal amount of $325,000 on terms substantially similar to the previous notes, except that the definition of “Permitted Payment” was revised to mean, for purposes of this fifth note, a payment made from a bridge loan by the Company’s majority shareholder in excess of $600,000. On March 30, 2016, Catamaran provided a sixth loan in the principal amount of $75,000 on terms substantially similar to the fifth note. All Catamaran loans are payable within six months following the date of the notes, and if the Company is not able to satisfy its obligations on these notes within the six month period following the date of the notes, the notes shall be automatically extended for additional six month terms until they are paid. If Catamaran ceases to provide ongoing financial support to the Company, and the Company is unable to obtain alternate financing, it would have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

Interest shall accrue from the date of the applicable Catamaran note on the unpaid principal at a rate equal to the lesser of (i) one and one-half percent (1.5%) per annum above the prime rate offered from time to time by the Bank of America Corporation in San Francisco, California, or (ii) ten percent (10%) per annum, until the principal is fully paid.

 

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The Catamaran notes may be prepaid without penalty at the option of the Company; however, no payments on the Catamaran notes may be made unless such payment is a “Permitted Payment” or certain existing obligations of the Company to Lender pursuant to the Credit and Security Agreement have been satisfied in full. The Catamaran notes may not be amended without the prior written consent of Lender.

 

MB Financial Credit and Security Agreement

 

On June 23, 2011, MBC and Releta entered into a Credit and Security Agreement (as amended, the “Credit and Security Agreement”) with Cole Taylor Bank, an Illinois banking corporation (“Cole Taylor”). Cole Taylor merged into MB Financial Bank, an Illinois banking corporation (“MB Financial”) on August 18, 2014. As used in this Report, “Lender” shall refer to Cole Taylor prior to August 18, 2014 and to MB Financial, as successor in interest to Cole Taylor, on or after August 18, 2014. The Credit and Security Agreement provided a credit facility with a maturity date of June 23, 2016 of up to $10,000,000 consisting of a $4,119,000 revolving facility (the “Revolver”), a $1,934,000 machinery and equipment term loan, a $2,947,000 real estate term loan and a $1,000,000 capital expenditure line of credit. The applicable interest rates were as follows: (a) with respect to the Revolver, the Wall Street Journal prime rate plus a margin of 1.00%, (b) with respect to the machinery and equipment term loan and the capital expenditure term loan, the Wall Street Journal prime rate plus a margin of 1.50%, and (c) with respect to the real estate term loan, the Wall Street Journal prime rate plus a margin of 2.00%. As described below, effective September 1, 2013, Lender was charging a default interest rate equal to two percent (2%) per annum in excess of the interest rate otherwise payable under the Credit and Security Agreement. As described below, effective July 22, 2016 Lender increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest) on all loans. As described below, the Second Amendment (as defined below) (among other things) reduces the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by 2% each month. The advance rates are used in the calculation of the borrowing base of each of MBC and Releta, which is used in the determination of the amount available to each of MBC and Releta pursuant to the Revolver. Under the terms of the Credit and Security Agreement, if such availability is less than $0, or if certain components of the borrowing base of each of MBC and Releta fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable. The Credit and Security Agreement binds the Company to certain financial covenants including maintaining prescribed minimum tangible net worth and prescribed minimum fixed charges coverage. There is a prepayment penalty if we prepay all of our obligations prior to the maturity date. The credit facility is secured by a first priority security interest in all of MBC’s and Releta’s personal property and a first priority mortgage on our Ukiah, California real property, among other MBC and Releta assets.

 

The Credit and Security Agreement requires MBC and Releta to maintain certain minimum fixed charge coverage ratios for trailing twelve month periods and minimum tangible net worth. The minimum tangible net worth MBC and Releta are required to maintain is subject to increase based on the net income of MBC and Releta. On March 29, 2013, MBC, Releta, and Lender entered into a First Amendment to the Credit and Security Agreement to clarify the method by which the fixed charge coverage ratio is calculated, with retrospective application.

 

The required fixed charge coverage ratio for the trailing twelve month periods ended March 31, 2013 onwards fell short of the required ratio. The tangible net worth fell short of the required amount for the period beginning June 1, 2013 onwards.

 

On September 18, 2013, MBC and Releta received a notice (the “Default Notice”) from Lender regarding its intention to exercise certain rights with respect to events of default of the Company pursuant to the Credit and Security Agreement and, effective September 1, 2013, began charging a default interest rate equal to 2% per annum in excess of the interest rate otherwise payable under the Credit and Security Agreement.

 

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On April 18, 2014, MBC and Releta received a second notice (the “Second Default Notice”) from Lender regarding its intention to exercise certain rights with respect to events of default of the Company pursuant to the Credit and Security Agreement. The Second Default Notice required MBC and Releta to engage a consultant to perform a viability analysis and prepare a revised projection for 2014, to be delivered to Lender on or before April 30, 2014. MBC and Releta engaged a consultant and delivered a revised projection on April 30, 2014. As stated in the Second Default Notice, the Company continued to be in default on the fixed charge coverage ratio for each measurement period beginning March 31, 2013 through February 28, 2014. The required fixed charge coverage ratio was initially required to be at least 1.05 to 1.00, but as of July 31, 2013, the required fixed charge coverage ratio increased to 1.10 to 1.00 pursuant to the terms of the Credit and Security Agreement. The Second Default Notice also stated that the tangible net worth of MBC and Releta continued to fall short of the required amount as measured through February 28, 2014.

 

Effective August 20, 2014, pursuant to a notice to MBC and Releta dated August 18, 2014 (the “Third Default Notice”) which referred to MBC’s and Releta’s continued failure to meet the required fixed charge coverage ratio and the tangible net worth requirement, Lender notified MBC and Releta that it would reduce the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by 2% each month. As noted above, the advance rates are used in the calculation of the borrowing base of each of MBC and Releta, which is used in the determination of the amount available to each of MBC and Releta pursuant to the Revolver. As noted above, under the terms of the Credit and Security Agreement, if such availability is less than $0, or if certain components of the borrowing base of each of MBC and Releta fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable.

 

On January 21, 2015, MBC, Releta, and Lender entered into a Second Amendment (the “Second Amendment”) to the Credit and Security Agreement. The Second Amendment reduced the maximum amount of the Revolver from $4,119,000 to $2,500,000. The Second Amendment also changed the definition of borrowing base (including by lowering certain advance rates) such that the calculation of the borrowing base will result in a lower number than it would have if calculated prior to the effectiveness of the Second Amendment. The Second Amendment also reduced the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by two percent (2%) and continues to reduce each by an additional two percent (2%) on the 20th day of each month thereafter. The advance rates are used in the calculation of the borrowing base of each borrower, which is used in the determination of the amount available to each borrower pursuant to the Revolver. As stated above, if such availability is less than $0, or if certain components of the borrowing base fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable.

 

Effective June 20, 2016, MBC, Releta, and Lender entered into a Third Amendment (the “Third Amendment”) to the Credit and Security Agreement. The Third Amendment extended the maturity date of the Credit and Security Agreement from June 23, 2016 to July 23, 2016. The Third Amendment also reduced the Revolver from $2,500,000 to $1,250,000. Effective July 22, 2016, MBC, Releta, and Lender entered into a Fourth Amendment (the “Fourth Amendment”) to the Credit and Security Agreement. The Fourth Amendment extended the maturity date of the Credit and Security Agreement from July 23, 2016 to September 21, 2016 and increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest). Effective September 21, 2016, MBC, Releta, and Lender entered into a Fifth Amendment to the Credit and Security Agreement which extended the maturity date of the Credit and Security Agreement from September 21, 2016 to October 21, 2016. Effective October 18, 2016, MBC, Releta, and Lender entered into a Sixth Amendment to the Credit and Security Agreement which extended the maturity date of the Credit and Security Agreement from October 21, 2016 to December 31, 2016. Lender has absolutely no commitment and has made no agreement to extend the maturity date beyond December 31, 2016. The Sixth Amendment also confirms the continuance of certain events of default under the Credit and Security Agreement.

 

As of September 30, 2016, pursuant to the Credit and Security Agreement, the fixed charge coverage ratio was required to be 1.15 to 1. The Company calculated that the fixed charge coverage ratio as of September 30, 2016 was -1.02 to 1. The Company calculated that the required tangible net worth of MBC and Releta was $6,181,400 as of September 30, 2016 and the actual tangible net worth on such date was $3,317,200. The Company does not anticipate that it will regain compliance with the required fixed charge coverage ratio or the minimum tangible net worth, as required by the Credit and Security Agreement.

 

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The Credit and Security Agreement provides that the failure of MBC and Releta to observe any covenant will constitute an event of default under the Credit and Security Agreement. Lender has not waived the events of default described in the Default Notice, the Second Default Notice or the Third Default Notice and has reserved the right to all other available rights and remedies under the Credit and Security Agreement, certain other related documents and applicable law. An event of default shall be deemed continuing until waived in writing by Lender. Under the Credit and Security Agreement, upon the occurrence of an event of default, all of MBC’s and Releta’s obligations under the Credit and Security Agreement may, at Lender’s option, be declared, and immediately shall become, due and payable, without notice of any kind. Lender could declare the full amount owed under the Credit and Security Agreement due and payable at any time for any reason or no reason. Since executing the Sixth Amendment, the Company has not received any notice or other communication from Lender that it intends to exercise any other remedies available to it under the Credit and Security Agreement in connection with the events of default. As noted above, effective July 22, 2016, Lender increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest). The Company estimates this increase in interest rate will result in the payment by the Company to Lender of additional interest of approximately $9,000 per month. The exercise of additional remedies by Lender may have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate. The Credit and Security Agreement expires on December 31, 2016. There is no guarantee that MBC and Releta will be able to obtain alternate financing on terms favorable to the Company or on any terms. If the Company is unable to obtain alternate financing, it will have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

At September 30, 2016, the Company had cash and cash equivalents of $84,700, an accumulated deficit of $18,730,600, and a working capital deficit of $12,265,800 due to losses incurred, debts payable to Lender and notes payable to related parties. In addition, the book value of the Company’s assets was lower than the book value of its liabilities at September 30, 2016.

 

HUK Facility. On April 18, 2013, KBEL entered into a loan agreement with HUK pursuant to which HUK agreed to provide KBEL with a secured term loan facility of £1,000,000 to be made available, subject to the fulfillment of certain conditions precedent, on October 9, 2013, to be repaid in full by October 9, 2016. KBEL availed itself of the loan on October 9, 2013. The Loan Agreement with HUK is described under the section captioned “Description Of Our Indebtedness” below. On October 9, 2016, KBEL paid the final installment and settled the loan in full.

 

Our available cash is insufficient to fund ongoing business operations, and therefore we need to raise additional funds through bank credit arrangements, or public or private equity or debt financings as described above. If we are not able to obtain bank credit arrangements or to effect an equity or debt financing on terms acceptable to us or at all, this will have a material adverse effect on the Company’s financial condition and ability to continue to operate. For example, MB Financial may seek to satisfy any outstanding obligations through recourse against the applicable pledged collateral which may include our real property, fixed assets and current assets. The loss of any material pledged asset would likely have a material adverse effect on the Company’s financial condition and ability to continue to operate.

 

We have several loans, lines of credit, other credit facilities and lease agreements which are currently outstanding (collectively, “Indebtedness”). We currently make timely payments of principal and interest relating to the Indebtedness as they fall due and anticipate that we will continue to make such timely payments in the immediate future. However, if we fail to maintain any of the financial covenants under the various agreements governing Indebtedness (such as the defaults under the Credit and Security Agreement described above), fail to make timely payments of amounts due under the Indebtedness, or commit any other breach resulting in an event of default under the agreements governing Indebtedness, such events of default (including cross-defaults) could have a material adverse effect on our financial condition and ability to continue to operate. If our existing debt were accelerated and terminated, we would need to obtain replacement financing, the lack of which would have a material adverse effect on our financial condition and ability to continue to operate. In addition, the Company’s lenders may seek to satisfy any outstanding obligations through recourse against the applicable pledged collateral which may include our real property and fixed and current assets. The loss of any material pledged asset would likely have a material adverse effect on the Company’s financial condition and ability to continue to operate.

 

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Management has taken several actions to reduce the Company’s working capital needs through June 30, 2017, including reducing discretionary expenditures, reducing manpower, securing additional brewing contracts in an effort to utilize a portion of its excess production capacity and appointing Gordian Group for a potential Financial Transaction. The current revenue from operations are insufficient to meet the working capital needs of the Company over the next 12 months. The Company has requested UBHL to make a capital infusion.

 

If UBHL or other sources do not provide sufficient financial assistance to MBC, it will result in a material adverse effect on the Company’s financial condition and on its ability to continue to operate and we may have to raise funds by selling some of the Company’s operating assets. In addition, the Company’s lenders may seek to satisfy any outstanding obligations through recourse against the applicable pledged collateral which includes the Company’s real and personal property in the United States and the United Kingdom. The loss of any material pledged asset would have a material adverse effect on the Company’s financial condition and its ability to continue to operate.

 

Vijay Mallya, the Company’s Chairman and indirect majority shareholder is presently subject to certain legal proceedings in India, which may impair the Company’s ability to obtain financing from UBHL and other potential funding sources.

 

Cash Flow Results

 

Net cash provided by operating activities for the nine months ended September 30, 2016, was $1,020,200, compared $1,155,200 for the nine months ended September 30, 2015. During the first nine months ended September 30, 2016, accounts receivable decreased by $432,400 mainly due to increased collections in the Foreign Territory. Accounts payable during the first nine months ended September 30, 2016 increased by $278,800, mainly due to increase in the accounts payable in our Foreign Territory. Our inventory decreased by $67,300 during the first nine months of 2016 due to lower production in North American Territory. Accrued liabilities increased by $370,800 during the first nine months of 2016 mainly due to an increase in provisions for directors compensation.

 

Net cash used in investing activities totaled $205,900 for the first nine months of 2016, compared to $403,800 during the corresponding period in 2015, due to decreased purchases of beer dispensing equipment.

 

Net cash used in financing activities during the first nine months of 2016 totaled $854,100, compared to net cash used in financing activities during the first nine months of 2015 of $794,700, as a result of borrowing against notes payable to Catamaran in the North American Territory, decrease in use of the revolving lines of credit and repayment of debts to MB Financial and HUK.

 

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Description of Our Indebtedness

 

MB Financial Facility

 

On June 23, 2011, MBC and Releta entered into a Credit and Security Agreement (as amended, the “Credit and Security Agreement”) with Cole Taylor Bank, an Illinois banking corporation (“Cole Taylor”). Cole Taylor merged into MB Financial Bank, an Illinois banking corporation (“MB Financial”) on August 18, 2014. As used in this Report, “Lender” shall refer to Cole Taylor prior to August 18, 2014 and to MB Financial, as successor in interest to Cole Taylor, on or after August 18, 2014. The Credit and Security Agreement provided a credit facility with a maturity date of June 23, 2016 of up to $10,000,000 consisting of a $4,119,000 revolving facility (the “Revolver”), a $1,934,000 machinery and equipment term loan, a $2,947,000 real estate term loan and a $1,000,000 capital expenditure line of credit. The applicable interest rates were as follows: (a) with respect to the Revolver, the Wall Street Journal prime rate plus a margin of 1.00%, (b) with respect to the machinery and equipment term loan and the capital expenditure term loan, the Wall Street Journal prime rate plus a margin of 1.50%, and (c) with respect to the real estate term loan, the Wall Street Journal prime rate plus a margin of 2.00%. As described below, effective September 1, 2013, Lender was charging a default interest rate equal to two percent (2%) per annum in excess of the interest rate otherwise payable under the Credit and Security Agreement. As described below, effective July 22, 2016 Lender increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest) on all loans. As described below, the Second Amendment (among other things) reduces the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by 2% each month. The advance rates are used in the calculation of the borrowing base of each of MBC and Releta, which is used in the determination of the amount available to each of MBC and Releta pursuant to the Revolver. Under the terms of the Credit and Security Agreement, if such availability is less than $0, or if certain components of the borrowing base of each of MBC and Releta fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable. The Credit and Security Agreement binds the Company to certain financial covenants including maintaining prescribed minimum tangible net worth and prescribed minimum fixed charges coverage. There is a prepayment penalty if we prepay all of our obligations prior to the maturity date. The credit facility is secured by a first priority security interest in all of MBC’s and Releta’s personal property and a first priority mortgage on our Ukiah, California real property, among other MBC and Releta assets.

 

The Credit and Security Agreement requires MBC and Releta to maintain certain minimum fixed charge coverage ratios for trailing twelve month periods and minimum tangible net worth. The minimum tangible net worth MBC and Releta are required to maintain is subject to increase based on the net income of MBC and Releta. On March 29, 2013, MBC, Releta, and Lender entered into a First Amendment to the Credit and Security Agreement to clarify the method by which the fixed charge coverage ratio is calculated, with retrospective application.

 

The required fixed charge coverage ratio for the trailing twelve month periods ended March 31, 2013 onwards fell short of the required ratio. The tangible net worth fell short of the required amount for the period beginning June 1, 2013 onwards.

 

On September 18, 2013, MBC and Releta received a notice (the “Default Notice”) from Lender regarding its intention to exercise certain rights with respect to events of default of the Company pursuant to the Credit and Security Agreement and, effective September 1, 2013, began charging a default interest rate equal to 2% per annum in excess of the interest rate otherwise payable under the Credit and Security Agreement.

 

On April 18, 2014, MBC and Releta received a second notice (the “Second Default Notice”) from Lender regarding its intention to exercise certain rights with respect to events of default of the Company pursuant to the Credit and Security Agreement. The Second Default Notice required MBC and Releta to engage a consultant to perform a viability analysis and prepare a revised projection for 2014, to be delivered to Lender on or before April 30, 2014. MBC and Releta engaged a consultant and delivered a revised projection on April 30, 2014. As stated in the Second Default Notice, the Company continued to be in default on the fixed charge coverage ratio for each measurement period beginning March 31, 2013 through February 28, 2014. The required fixed charge coverage ratio was initially required to be at least 1.05 to 1.00, but as of July 31, 2013, the required fixed charge coverage ratio increased to 1.10 to 1.00 pursuant to the terms of the Credit and Security Agreement. The Second Default Notice also stated that the tangible net worth of MBC and Releta continued to fall short of the required amount as measured through February 28, 2014.

 

Effective August 20, 2014, pursuant to a notice to MBC and Releta dated August 18, 2014 (the “Third Default Notice”) which referred to MBC’s and Releta’s continued failure to meet the required fixed charge coverage ratio and the tangible net worth requirement, Lender notified MBC and Releta that it would reduce the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by 2% each month. The advance rates are used in the calculation of the borrowing base of each of MBC and Releta, which is used in the determination of the amount available to each of MBC and Releta pursuant to the Revolver. Under the terms of the Credit and Security Agreement, if such availability is less than $0, or if certain components of the borrowing base of each of MBC and Releta fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable.

 

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On January 21, 2015, MBC, Releta, and Lender entered into a Second Amendment (the “Second Amendment”) to the Credit and Security Agreement. The Second Amendment reduced the maximum amount of the Revolver from $4,119,000 to $2,500,000. The Second Amendment also changed the definition of borrowing base (including by lowering certain advance rates) such that the calculation of the borrowing base will result in a lower number than it would have if calculated prior to the effectiveness of the Second Amendment. The Second Amendment also reduced the advance rate for (i) eligible finished goods and raw material inventory and (ii) eligible work-in progress inventory by two percent (2%) and continues to reduce each by an additional two percent (2%) on the 20th day of each month thereafter. The advance rates are used in the calculation of the borrowing base of each borrower, which is used in the determination of the amount available to each borrower pursuant to the Revolver. As stated above, if such availability is less than $0, or if certain components of the borrowing base fall below certain limits in relation to outstanding revolving loans, such difference shall be immediately due and payable.

 

Effective June 20, 2016, MBC, Releta, and Lender entered into a Third Amendment (the “Third Amendment”) to the Credit and Security Agreement. The Third Amendment extended the maturity date of the Credit and Security Agreement from June 23, 2016 to July 23, 2016. The Third Amendment also reduced the Revolver from $2,500,000 to $1,250,000. Effective July 22, 2016, MBC, Releta, and Lender entered into a Fourth Amendment (the “Fourth Amendment”) to the Credit and Security Agreement. The Fourth Amendment extended the maturity date of the Credit and Security Agreement from July 23, 2016 to September 21, 2016 and increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest). Effective September 21, 2016, MBC, Releta, and Lender entered into a Fifth Amendment to the Credit and Security Agreement which extended the maturity date of the Credit and Security Agreement from September 21, 2016 to October 21, 2016. Effective October 18, 2016, MBC, Releta, and Lender entered into a Sixth Amendment to the Credit and Security Agreement which extended the maturity date of the Credit and Security Agreement from October 21, 2016 to December 31, 2016. Lender has absolutely no commitment and has made no agreement to extend the maturity date beyond December 31, 2016. The Sixth Amendment also confirms the continuance of certain events of default under the Credit and Security Agreement.

 

As of September 30, 2016, pursuant to the Credit and Security Agreement, the fixed charge coverage ratio was required to be 1.15 to 1. The Company calculated that the fixed charge coverage ratio as of September 30, 2016 was -1.02 to 1. The Company calculated that the required tangible net worth of MBC and Releta was $6,181,400 as of September 30, 2016 and the actual tangible net worth on such date was $3,317,200. The Company does not anticipate that it will regain compliance with the required fixed charge coverage ratio or the minimum tangible net worth, as required by the Credit and Security Agreement.

 

The Credit and Security Agreement provides that the failure of MBC and Releta to observe any covenant will constitute an event of default under the Credit and Security Agreement. Lender has not waived the events of default described in the Default Notice, the Second Default Notice or the Third Default Notice and has reserved the right to all other available rights and remedies under the Credit and Security Agreement, certain other related documents and applicable law. An event of default shall be deemed continuing until waived in writing by Lender. Under the Credit and Security Agreement, upon the occurrence of an event of default, all of MBC’s and Releta’s obligations under the Credit and Security Agreement may, at Lender’s option, be declared, and immediately shall become, due and payable, without notice of any kind. Lender could declare the full amount owed under the Credit and Security Agreement due and payable at any time for any reason or no reason. Since executing the Sixth Amendment, the Company has not received any notice or other communication from Lender that it intends to exercise any other remedies available to it under the Credit and Security Agreement in connection with the events of default. As noted above, effective July 22, 2016 Lender increased the interest rate under the Credit and Security Agreement to the Wall Street Journal prime rate plus 6% (including default interest). The Company estimates this increase in interest rate will result in the payment by the Company to Lender of additional interest of approximately $9,000 per month. The exercise of additional remedies by Lender may have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate. The Credit and Security Agreement expires on December 31, 2016. There is no guarantee that MBC and Releta will be able to obtain alternate financing on terms favorable to the Company or on any terms. If the Company is unable to obtain alternate financing, it will have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

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Master Line of Credit and UBA Notes

 

On August 31, 1999, MBC and UBA, one of our 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 us with a line of credit in the principal amount of up to $1,600,000. As of the date of this filing, UBA has made thirteen separate advances to us under the Credit Agreement and one additional advance on March 2, 2005, on substantially the same terms as those under the Credit Agreement, pursuant to a series of individual eighteen-month convertible promissory notes issued by us to UBA (the “UBA Notes”). Thirteen of the UBA Notes are convertible into common stock of the Company at a rate of $1.50 per share and one UBA Note is convertible at a rate of $1.44 per share. UBA has executed an Extension of Term of Notes under Master Line of Credit Agreement and an amendment to the March 2, 2005 note (together, the “Extension Agreements”). The Extension Agreements, as amended, confirm UBA’s extension of the terms of the UBA Notes for a period ending on June 30, 2017, with automatic renewals after such maturity date for successive one year terms, provided that either MBC or UBA may elect not to extend a term upon written notice given to the other party no more than 60 days and no fewer than 30 days prior to the expiration of the applicable term.

 

The UBA Notes require us to make quarterly interest payments to UBA on the first day of April, July, October, and January. To date, UBA has permitted us to capitalize all accrued interest; therefore, we have borrowed the maximum amount available under the facility. Upon maturity of any of the UBA Notes, unless UBA has given us prior instructions to commence repayment of the outstanding principal balance, the outstanding principal and accrued but unpaid interest on such UBA Notes may be converted, at the option of UBA, into shares of our common stock. During the extended term of the UBA Notes, UBA has the right to require us to repay the outstanding principal balance, along with the accrued and unpaid interest thereon, to UBA within 60 days. However, the UBA Notes are subordinated to credit facilities extended to us by Lender pursuant to a subordination agreement executed by UBA. Per the terms of the subordination agreement, UBA is precluded from demanding repayment of the UBA Notes unless and until the Lender’s facility is repaid in full.

 

The aggregate outstanding principal amount of the UBA Notes as of September 30, 2016 was $1,915,400, and the accrued but unpaid interest thereon was equal to approximately $1,836,600, for a total amount outstanding of $3,752,000.

 

As of September 30, 2016, the outstanding principal and interest on the UBA Notes was convertible into approximately 2,520,100 shares of our common stock. However, as the current market price of our common stock is substantially less than the conversion rate, voluntary conversion by UBA is unlikely.

 

Catamaran Notes:

 

On January 22, 2014, Catamaran, a related party, provided a loan to MBC in the principal amount of $500,000 evidenced by a promissory note. On April 24, 2014, Catamaran provided a second loan in the principal amount of $500,000 on terms similar to the previous note. On February 5, 2015, Catamaran provided a third loan in the principal amount of $500,000 on terms similar to the previous notes. On June 30, 2015, Catamaran provided a fourth loan in the principal amount of $500,000 on terms similar to the previous notes, and the Company received the proceeds against this note on July 6, 2015. Each time Catamaran provided a loan, the Company received a letter from Lender permitting the Company to obtain such loans subject to certain conditions, including that no portion of such loans would be payable until either (a) certain obligations of the Company to Lender pursuant to the Credit and Security Agreement (as defined below) were satisfied in full, or (b) such payment was a Permitted Payment. A “Permitted Payment” with respect to the notes dated January 22, 2014, April 24, 2014, and February 5, 2015 means a payment made from an equity investment by the Company’s majority shareholder in excess of $500,000. A “Permitted Payment” with respect to the note dated June 30, 2015 means a payment made from an equity investment by the Company’s majority shareholder. On March 14, 2016, Catamaran provided a fifth loan in the principal amount of $325,000 on terms substantially similar to the previous notes, except that the definition of “Permitted Payment” was revised to mean, for purposes of this fifth note, a payment made from a bridge loan by the Company’s majority shareholder in excess of $600,000. On March 30, 2016, Catamaran provided a sixth loan in the principal amount of $75,000 on terms substantially similar to the fifth note. The Catamaran loans are payable within six months following the date of the notes, and if the Company is not able to satisfy its obligations on these notes within the six month period following the date of the notes, the notes shall be automatically extended for additional six month terms until they are paid. If Catamaran ceases to provide ongoing financial support to the Company, and the Company is unable to obtain alternate financing, it would have a material adverse effect on the Company’s financial condition and the Company’s ability to continue to operate.

 

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Interest shall accrue from the date of the applicable Catamaran note on the unpaid principal at a rate equal to the lesser of (i) one and one-half percent (1.5%) per annum above the prime rate offered from time to time by the Bank of America Corporation in San Francisco, California, or (ii) ten percent (10%) per annum, until the principal is fully paid.

 

The Catamaran notes may be prepaid without penalty at the option of the Company; however, no payments on the Catamaran notes may be made unless such payment is a “Permitted Payment” or certain existing obligations of the Company to Lender pursuant to the Credit and Security Agreement have been satisfied in full. The Catamaran notes may not be amended without the prior written consent of Lender.

 

Other Loans, Credit Facilities and Commitments

 

Heineken Loan

 

On April 18, 2013, KBEL entered into a loan agreement with Heineken UK Limited (“HUK”) pursuant to which HUK agreed to provide KBEL with a secured term loan facility of £1,000,000 (the “HUK Loan Agreement”) which was made available, upon the fulfillment of certain conditions precedent, on October 9, 2013 and to be repaid in full by October 9, 2016. Interest on the loan is payable quarterly in arrears on the outstanding balance of the loan at the rate of 5% above the Bank of England base rate. Prepayment is permitted. Upon an event of default, as defined in the HUK Loan Agreement, if HUK and KBEL fail to agree on a payment plan acceptable to HUK, HUK may, among other remedies, declare the loan immediately due and repayable or exercise its right to an exclusive license pursuant to the Sub-License Agreement as described and defined in the HUK Loan Agreement. On October 9, 2016, KBEL paid the final installment and settled the loan in full.

 

Royal Bank of Scotland Facility

 

On April 26, 2005, RBS provided KBEL with an approximately $2.8 million (£1,750,000) maximum revolving line of credit with an advance rate based on 80% of KBEL’s qualified accounts receivable. On July 20, 2016, KBEL used the proceeds from the Invoice Discounting Facility provided by Santander (described below) to repay the amount owed in full to RBS and terminated this facility.

 

Santander Facility:

 

On July 20, 2016, KBEL entered into a Sales Finance Agreement with Santander, (the “Invoice Discounting Facility”) pursuant to which Santander provided KBEL with an approximately $2.8 million (£1,750,000) maximum revolving line of credit (the “Review Limit”) with advances permitted up to 85% of KBEL’s qualified accounts receivable. This facility has a minimum maturity of twelve months, but will be automatically extended unless terminated by either party upon three months’ written notice. If the Invoice Discounting Facility terminates on or before the first anniversary, KBEL must pay as breakage costs 3% of the Review Limit. The Invoice Discounting Facility carries an interest rate of 2.1% above the Santander base rate and a fixed service charge of approximately $1,300 (£1,000) per month. The Invoice Discounting Facility binds KBEL to certain financial covenants relating to accounts receivable including turnover ratios, maximum dilution, and ageing, while also requiring KBEL to maintain a minimum level of net tangible assets.

 

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Weighted Average Interest

 

The weighted average interest rates paid on our US indebtedness was 6% for the first nine months of 2016 and 2015. For loans primarily associated with our Foreign Territory, the weighted average rate paid was 4% and 5% for the first nine months of 2016 and 2015 respectively.

 

Current Ratio

 

On September 30, 2016, our ratio of current assets to current liabilities was 0.30 to 1.00 and our ratio of total assets to total liabilities was 0.84 to 1.00. On September 30, 2015, our ratio of current assets to current liabilities was 0.35 to 1.0 and our ratio of total assets to total liabilities was 0.93 to 1.0.

 

Restricted Net Assets

 

The Company’s wholly-owned subsidiary, UBIUK, had undistributed losses of $129,900 as of September 30, 2016. Under KBEL’s line of credit agreement with RBS, distributions and other payments to MBC from KBEL were not permitted if retained earnings dropped below $1,301,500.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Not required for smaller reporting companies.

 

Item 4. Controls and Procedures

 

Disclosure Controls And Procedures

 

Our Management team, under the supervision and with the participation of our chief executive officer (our principal executive officer) and our chief financial officer (our principal financial officer), evaluated the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the last day of the quarter ended September 30, 2016. The term disclosure controls and procedures means our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to Management, including our chief executive officer and chief financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2016.

 

Changes In Internal Control Over Financial Reporting

 

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

 

OTHER INFORMATION

 

Item 3. Defaults Upon Senior Securities

 

The discussion provided under the heading “Liquidity and Capital Resources” with respect to our default under the Credit and Security Agreement with MB Financial, as successor in interest to Cole Taylor, and the discussion under the subheading “MB Financial Facility,” under the heading “Description of Our Indebtedness,” both set forth in Item 2 of PART I of this Quarterly Report, are hereby incorporated by reference in their entirety.

 

Item 6. Exhibits

 

Exhibit Number   Description
     
10.1 (A) Fifth Amendment to Credit and Security Agreement, effective as of September 21, 2016, by and among MB Financial Bank, N.A., successor in interest to Cole Taylor Bank, Mendocino Brewing Company, Inc., a California corporation, and Releta Brewing Company LLC, a Delaware limited liability company.
     
10.2 (B) Sixth Amendment to Credit and Security Agreement, effective as of October 18, 2016, by and among MB Financial Bank, N.A., successor in interest to Cole Taylor Bank, Mendocino Brewing Company, Inc., a California corporation, and Releta Brewing Company LLC, a Delaware limited liability company.
     
31.1   Certification of Principal Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.*
     
31.2   Certification of Principal Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.*
     
32.1   Certification of Principal Executive Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.**
     
32.2   Certification of Principal Financial Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.**
     
101.INS   XBRL Instance Document
     
101.SCH   XBRL Taxonomy Extension Schema Document
     
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
     
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
     
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
     
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

 

 

* Filed herewith.

** Furnished herewith.

 

NOTE: Each Exhibit listed above that is annotated with one of the following letters is incorporated by reference from the following sources:

 

(A)

MBC’s Current Report on Form 8-K filed as of September 22, 2016.

   
(B)

MBC’s Current Report on Form 8-K filed as of October 24, 2016.

 

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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 14, 2016 By: /s/ Yashpal Singh
    Yashpal Singh
    President and Chief Executive Officer
    (Principal Executive Officer)
     
Dated: November 14, 2016 By: /s/ Mahadevan Narayanan
    Mahadevan Narayanan
    Chief Financial Officer and Secretary
    (Principal Financial and Accounting Officer)

 

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