UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2003.
-------------------
o TRANSITION report under section 13 or 15(d) of the exchange act
For the transition period from to
----------- -----------
Commission file number 1-13636
Mendocino Brewing Company, Inc.
(Exact name of small business issuer as specified in its charter)
California 68-0318293
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
1601, Airport Road, Ukiah, CA 95482
(Address of principal executive offices)
(707) 463-2087
(Issuer's telephone number)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes __ No __
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: The number of shares of the issuer's
common stock outstanding as of September 30, 2003 is 11,266,874.
Transitional Small Business Disclosure Format (check one):
Yes No X
--- ---
PART I
ITEM 1. FINANCIAL STATEMENTS.
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2003
(UNAUDITED)
ASSETS
------
CURRENT ASSETS
Cash $ 579,300
Accounts receivable 5,849,100
Inventories 1,346,700
Prepaid expenses 372,500
-----------
Total Current Assets: 8,147,600
-----------
PROPERTY AND EQUIPMENT
OTHER ASSETS 13,795,500
-----------
Deposits and other assets 195,800
Intangibles net of amortization 97,000
-----------
Total Other Assets: 292,800
-----------
Total Assets: $22,235,900
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable $ 4,057,300
Accrued liabilities 1,590,300
Income taxes payable 352,600
Current maturities of obligation under capital lease 656,500
Current maturities of obligation under long-term debt 771,500
Line of credit 2,340,400
-----------
Total Current Liabilities: 9,768,600
Notes to related party 1,900,500
Long term debt, less current maturities 3,699,200
Obligations under capital lease, less current maturities 183,200
-----------
Total Liabilities: 15,551,500
-----------
STOCKHOLDERS' EQUITY
Preferred stock, Series A, no par value, with aggregate liquidation
preference of 227,600 $227,600; shares authorized, issued
and outstanding 227,600
Common stock, no par value: 30,000,000 shares authorized, 11,266,874 14,648,600
shares issued and outstanding
Accumulated comprehensive loss (5,200)
Accumulated deficit (8,186,600)
-----------
Total Stockholders' Equity 6,684,400
-----------
Total Liabilities and Stockholders' Equity: $22,235,900
===========
The accompanying notes are an integral part of these financial statements.
1
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF
INCOME AND COMPREHENSIVE INCOME
(UNAUDITED)
----------------------------------- ------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
September 30 September 30
----------------------------------- ------------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net Sales $ 7,628,300 $ 6,989,400 $ 20,611,300 $ 18,502,800
Cost of goods sold 5,101,600 4,557,900 13,913,100 12,254,800
----------- ----------- ------------ ------------
Gross Profit 2,526,700 2,431,500 6,698,200 6,248,000
----------- ----------- ------------ ------------
Operating expenses
Marketing, General and Administrative 1,939,400 1,902,900 5,729,300 5,454,600
----------- ----------- ------------ ------------
Income from operations 587,300 528,600 968,900 793,400
----------- ----------- ------------ ------------
Other income (expense)
Other Income 143,700 62,400 154,400 74,900
Interest Expense (202,200) (207,700) (610,000) (631,700)
----------- ----------- ------------ ------------
(58,500) (145,300) (455,600) (556,800)
----------- ----------- ------------ ------------
INCOME BEFORE INCOME TAXES 528,800 383,300 513,300 236,600
PROVISION FOR INCOME TAX 93,400 62,600 205,400 143,200
----------- ----------- ------------ ------------
NET INCOME $ 435,400 $ 320,700 $ 307,900 $ 93,400
----------- ----------- ------------ ------------
OTHER COMPREHENSIVE INCOME (LOSS),
net of tax
Foreign Currency Translation Adjustment 11,700 (3,500) 30,100 500
----------- ----------- ------------ ------------
COMPREHENSIVE Income $ 447,100 $ 317,200 $ 338,000 $ 93,900
=========== =========== ============ ============
NET INCOME PER COMMON SHARE $0.04 $0.03 $0.03 $0.01
===== ===== ===== =====
DILUTED NET INCOME
PER COMMON SHARE $0.04 $0.03 $0.03 $0.01
===== ===== ===== =====
The accompanying notes are an integral part of these financial statements.
2
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
----------------------------------
NINE MONTHS ENDED
September 30
----------------------------------
2003 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 307,900 $ 93,400
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization 842,100 844,100
Loss on sale of assets 1,200 14,800
Stock issued for services - 172,100
Changes in:
Accounts receivable 83,200 (52,400)
Inventories 127,600 (104,000)
Prepaid expenses 32,900 (77,600)
Deposits and other assets (2,500) (47,900)
Accounts payable (1,101,500) (91,200)
Accrued liabilities (9,800) (55,800)
----------- ----------
Net cash from operating activities: 281,100 695,500
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, equipment, and leasehold
improvements (445,100) (362,300)
Proceeds from sale of fixed assets 10,900 17,900
Proceeds from new distributors 655,200 -
----------- ----------
Net cash from investing activities: 221,000 (344,400)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on line of credit 180,900 300,900
Principal payments on long-term debt (404,800) (694,100)
Net borrowing on long-term debt 403 700 -
Payments on obligation under capital lease (190,500) (154,400)
Proceeds from notes payable to related parties 64,200 70,900
Disbursement in excess of deposit (134,300) 112,500
----------- ----------
Net cash from financing activities: (80,800) (364,200)
----------- ----------
Effect of exchange rate change on cash 11,200 (12,000)
----------- ----------
INCREASE / (DECREASE) IN CASH 432,500 (25,100)
----------- ----------
CASH, beginning of period 146,800 89,800
----------- ----------
CASH, end of period $ 579,300 $ 64,700
=========== ==========
Supplemental cash flow information includes the following:
Cash paid during the period for:
Interest $ 545,800 $ 527,400
----------- ----------
Income tax $ 299,900 $ 142,800
=========== ==========
The accompanying notes are an integral part of these financial statements.
3
MENDOCINO BREWING COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 - Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United
States. For further information, refer to the consolidated financial statements
and footnotes thereto included in the Company's annual report on Form 10-KSB for
the year ended December 31, 2002. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included. Operating
results for the nine months ended September 30, 2003, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2003.
The Company has adopted EITF - 01-09 "Accounting for Consideration Given by a
Vendor to a Customer (including a Reseller of the Vendor's Products)". This EITF
requires that certain cash consideration paid to customers for services or
placement fees are to be reported as a reduction in revenue rather than as an
expense. The Company has reclassified these items on the income statements as a
reduction in revenue and as a corresponding reduction in marketing and selling
expenses. This reclassification has no impact on net income.
Note 2 - Line of Credit
The CIT Group/Credit Finance, Inc. ("CIT") has provided the Company with a
$3,500,000 maximum line of credit with an advance rate of 80% of the qualified
accounts receivable and 60% of inventory at an interest rate equal to the prime
rate of Chase Manhattan Bank of New York plus 2.25% payable monthly. The line of
credit was scheduled to mature on November 30, 2003 but has been extended on a
month to month basis. The line of credit is secured by all accounts receivable,
general intangibles, inventory, and equipment of the Company except for the
specific equipment and fixtures of the Company leased from FINOVA Capital
Corporation, as well as by a second deed of trust on the Company's Ukiah land
improvements.
On January 17, 2003, CIT amended the facility, thereby increasing the maximum
credit available from $3,000,000 to $3,500,000, and providing a term loan of
$750,000 consisting of the original balance of $346,300 and a new term loan of
$403,700. The new term loan is repayable in 30 equal consecutive monthly
installments of $24,700, commencing February 1, 2003, with a final payment of
$8,000. As of September 30, 2003, the amount outstanding on the term loan was
approximately $552,100. Based on the Company's current level of qualified
accounts receivable and inventory, the Company has drawn the maximum amount
permitted under the line of credit. As of September 30, 2003, the total amount
outstanding on the line of credit was approximately $1,403,400.
Nedcor Bank Limited, a South African registered company, has provided a credit
facility of GBP 1,250,000 to UBSN Ltd. ("UBSN"), a wholly-owned subsidiary of
United Breweries International (UK) Ltd. ("UBI"), which is in turn wholly-owned
by the Company. This facility includes a revolving short-term loan, overdraft
protection, and foreign exchange services. It is only available until terminated
by Nedcor Bank, and is secured by all of the assets of UBSN. The
4
amount outstanding on this line of credit as of September 30, 2003, was
approximately $937,000.
Note 3 - Long Term Debt and Notes to Related Parties
The Company has a note outstanding in the principal amount of $2,700,000 in
favor of Savings Bank of Mendocino County ("SBMC"), with interest at the
five-year treasury constant maturity index plus 4.17%, currently 7.24%. The note
requires monthly payments of principal and interest of $24,400. The note matures
in December 2012 with a balloon payment of $932,600, and is secured by real
property located in Ukiah, California.
The Company owes the County of Mendocino $574,500, which represents overdue
taxes for the period from April of 1999 to June of 2003. Under the payment plan
executed with the County, this amount is payable in four annual installments on
or before April 10 of each year, commencing from the year 2005, along with
accrued interest calculated at 18% per year. Failure to timely pay any
installment or current property taxes may result in the County selling the
Company's Ukiah property to satisfy this outstanding debt.
UBSN has engaged Shepherd Neame Limited ("Shepherd Neame"), a related party, to
brew Kingfisher Lager for the Company's European and Canadian markets. As
consideration for the extension of the brewing contract, Shepherd Neame advanced
a loan of GBP 600,000 to UBSN, repayable in ten annual installments of GBP
60,000, commencing in June 2003. At the time of the filing this report, GBP
600,000 was roughly equal to $1,000,000, therefore, each payment of 60,000 GBP
would be approximately equal to $100,000. The loan carries an interest rate of
5% per year.
The Company has issued unsecured convertible notes in favor of United Breweries
of America, Inc. ("UBA") in the amount of approximately $1,515,400 as of
September 30, 2003. The notes bear interest at the prime rate plus 1.5%, subject
to a maximum of 10% per annum, and each note originally matured 18 months from
the date of the particular advance. The notes were extended to mature on August
14, 2004. The notes are convertible, at UBA's option, into common stock at $1.50
per share. Interest accrued on the notes as of September 30, 2003, is
approximately $385,100. Because these notes are subordinated to the CIT line of
credit and SBMC note, the Company does not expect to make payments on the notes
within the next year. The Company expects the maturity dates to be extended
again and has shown the amount as long-term debt.
Note 4 - Income Taxes
As of September 30, 2003, the Company has available for carry-forward Federal,
California and New York net operating losses. The losses will expire as follows:
5
NET OPERATING LOSS
------------------------------------------------------
Date of Expiration FEDERAL CALIFORNIA NEW YORK
------------------ ------- ---------- --------
2005 $ - $2,417,000 $ -
2010 - 250,900 -
2011 - 153,700 -
2012 1,802,300 - 277,400
2018 2,758,800 - 424,700
2019 2,153,100 - 320,300
2020 965,600 - 134,200
2021 1,041,100 - 160,200
2022 806,800 - 124,200
---------- ---------- ----------
$9,527,700 $2,821,600 $1,441,000
========== ========== ==========
The Company also has $ 49,800 of California Manufacturer's Investment Tax
Credits that can be carried forward to offset future taxes until they begin to
expire in 2007. The valuation allowance for all deferred tax assets has been
provided because management believes that it is more likely than not that the
assets may expire prior to utilization.
Temporary differences and carry forwards which give rise to deferred tax assets
and liabilities on September 30, 2003, are as follows:
Accounts receivables allowance $19,100
Benefits from net operating loss carry forwards 3,751,600
Inventory 8,000
Accruals 15,400
Valuation allowance (3,414,900)
Depreciation and amortization (253,800)
Investment in UBI 328,300
Undistributed earnings of UBI (566,000)
Others 112,300
Note 5 -- Related party Transactions
During 2001 and 2002, MBC and its subsidiaries entered into or amended several
agreements with affiliated and related entities. Among these were a Brewing
Agreement and a Loan Agreement between UBSN and Shepherd Neame; a Market
Development Agreement, a Distribution Agreement, and a Brewing License Agreement
between MBC and UBSN; a Distribution Agreement between UBI and UBSN; a Trademark
Licensing Agreement between MBC and Kingfisher of America, Inc.; and a License
Agreement between UBI and UB Limited.
6
Additional information about these transactions is contained in the Company's
annual report on Form 10-KSB for the year ended December 31, 2002, and such
information is incorporated herein by reference.
The following table reflects the value of the transactions for the nine months
ended September 30, 2003 and 2002, and the balances outstanding at September 30,
2003 and 2002.
- ---------------------------------------------------------- -------------- -------------
2003 2002
- ---------------------------------------------------------- -------------- -------------
Sales to Shepherd Neame $ 1,777,600 $ 1,466,000
- ---------------------------------------------------------- -------------- -------------
Purchases from Shepherd Neame 7,915,800 6,571,700
- ---------------------------------------------------------- -------------- -------------
Reimbursement of expenses of Shepherd Neame 608,300 539,100
- ---------------------------------------------------------- -------------- -------------
Interest expenses associated with UBA convertible notes 64,200 70,800
- ---------------------------------------------------------- -------------- -------------
Accounts payable to Shepherd Neame 2,736,400 2,317,700
- ---------------------------------------------------------- -------------- -------------
Accounts receivable from Shepherd Neame 727,300 189,900
- ---------------------------------------------------------- -------------- -------------
Note 6 - Net Income Per Common and Common Equivalent Share
Basic earnings per share (EPS) is computed by dividing income available to
common stockholders by the weighted average number of common shares outstanding
during the period. Diluted EPS is computed by dividing income available to
shareholders by the weighted average number of common shares and common
equivalent shares outstanding, which include dilutive stock options and notes
payable convertible in common stock. Common equivalent shares associated with
stock options and convertible notes payable have been excluded from periods with
a net loss as the potentially dilutive shares would be antidilutive.
Three months ended Nine months ended
------------------ -----------------
9/30/2003 9/30/2002 9/30/2003 9/30/2002
----------------- ---------------- ---------------- ---------------
Net income $ 435,400 $ 320,700 $ 307,900 $ 93,400
================= ================ ================ ===============
Weighted average common shares outstanding
11,266,874 11,266,874 11,266,874 11,266,874
================= ================ ================ ===============
Basic net income per share $ 0.04 $ 0.03 $ 0.03 $ 0.01
================= ================ ================ ===============
Diluted net income (loss) per share
Net income $ 435,400 $ 320,700 $ 307,900 $ 93,400
Interest expense on convertible notes 20,900 23,900 64,200 70,800
payable
----------------- ---------------- ---------------- ---------------
Income for the purpose of computing
diluted net income per share $ 456,300 $ 344,600 $ 372,100 $ 164,200
================= ================ ================ ===============
Weighted average common shares outstanding
11,266,874 11,266,874 11,266,874 11,266,874
Dilutive stock options - - - -
Assumed conversion of convertible notes
payable 1,267,012 1,209,048 1,267,012 1,209,048
----------------- ---------------- ---------------- ---------------
Weighted average common shares outstanding
for the purpose of computing diluted net
income per share 12,533,886 12,475,922 12,533,886 12,475,922
================= ================ ================ ===============
Diluted net income per share $ 0.04 $ 0.03 $ 0.03 $ 0.01
================= ================ ================ ===============
7
Note 7. - Inventory September 30, 2003
------------------
Raw materials $ 463,000
Beer in process 196,700
Finished goods 666,300
Merchandise 20,700
-----------
$ 1,346,700
===========
Note 8. Property And Equipment September 30, 2003
------------------
Buildings $ 7,202,300
Machinery and equipment 8,246,100
Equipment under capital lease 2,521,300
Land 810,900
Leasehold improvements 1,432,400
Equipment in progress 202,100
Vehicles 100,300
Furniture and fixtures 200,300
-----------
20,715,700
Less: Accumulated depreciation and amortization 6,920,200
-----------
$13,795,500
===========
Note 9 - Stockholders' Equity
The following table summarizes equity transactions during the nine months ended
September 30, 2003:
SERIES A
PREFERRED STOCK COMMON STOCK OTHER
--------------------- -------------------------- COMPREHENSIVE ACCUMULATED TOTAL
SHARES AMOUNT SHARES AMOUNT INCOME /(LOSS) DEFICIT EQUITY
---------- ---------- ------------ ------------- ---------------------------------- --------------
Balance,
December 31, 2002 227,600 $ 227,600 11,266,874 $ 14,648,600 $ (35,300) $ (8,494,500) $6,346,400
Net Income 307,900 307,900
Currency Translation
Adjustment 30,100 30,100
---------- ---------- ------------ ------------- ----------------- ---------------- --------------
Balance,
September 30, 2003 227,600 $ 227,600 11,266,874 $ 14,648,600 (5,200) $ (8,186,600) $6,684,400
========== ========== ============ ============= ================= ================ ==============
8
Note 10 - Stock Based Compensation
The Company has a stock-based employee compensation plan that allows the Company
to grant options to purchase up to 1,000,000 shares of the Company's common
stock. The Company accounts for this plan under the recognition and measurement
principles of APB Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and
related Interpretations. No stock-based employee compensation cost is reflected
in net income, as all options granted under these plans had an exercise price
equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net loss and loss per share if the
Company had applied the fair value recognition provisions of FASB Statement No.
123, ACCOUNTING FOR STOCK-BASED COMPENSATION, to stock-based compensation.
- --------------------------------------------------- --------------------------------- -------------------------------
Three months ended Nine months ended
September 30, September 30,
- --------------------------------------------------- --------------------------------- -------------------------------
2003 2002 2003 2002
- --------------------------------------------------- ---------------- ---------------- ---------------- --------------
Net Income as reported $435,400 $320,700 $307,900 $93,400
- --------------------------------------------------- ---------------- ---------------- ---------------- --------------
Deduct: Total stock-based employee compensation (99,100)
expense determined under fair value based methods
for all awards, net of tax related
effects
- --------------------------------------------------- ---------------- ---------------- ---------------- --------------
Pro forma Net Income (Loss) $435,400 $320,700 $307,900 $(5,700)
- --------------------------------------------------- ---------------- ---------------- ---------------- --------------
Earning Per Share
- --------------------------------------------------- ---------------- ---------------- ---------------- --------------
Basic and diluted (as reported) $ 0.04 $ 0.03 $ 0.03 $ 0.01
- --------------------------------------------------- ---------------- ---------------- ---------------- --------------
Basic and diluted (pro forma) $ 0.04 $ 0.03 $ 0.03 $(0.01)
- --------------------------------------------------- ---------------- ---------------- ---------------- --------------
Note 11. Segment Information
The Company's three business segments are (i) brewing operations, (ii)
distributing operations in the United Kingdom, and (iii) retail sales at the
Hopland Brewery and the tasting room at Saratoga Springs. A summary of each
segment is as follows:
Nine months ended September 30, 2003
Brewing Distributing Retail Corporate & Total
Operations Operations Operations Others
Net Sales $ 8,386,400 $ 11,844,300 $ 380,600 $ - $ 20,611,300
Operating Profit/(Loss) 252,100 738,600 (21,800) - 968,900
Identifiable Assets 13,890,000 5,297,500 97,000 2,951,400 22,235,900
Depreciation & 552,000 272,000 4,700 13,400 842,100
amortization
Capital Expenditures 101,600 343,500 - - 445,100
9
Nine months ended September 30, 2003
Brewing Distributing Retail Corporate & Total
Operations Operations Operations Others
Net Sales $ 8,137,100 $ 9,968,500 $ 397,200 $ - $ 18,502,800
Operating Profit/(Loss) 296,100 490,000 7,300 - 793.400
Identifiable Assets 14,626,400 4,495,300 83,200 4,112,200 23,317,100
Depreciation & 573,300 236,900 4,400 29,500 844,100
amortization
Capital Expenditures 126,800 232,800 - 2,700 362,300
Note 12 - Legal Disputes
Effective March 28, 2003, the Company terminated a written distribution
agreement with the House of Daniels, Inc., dba Golden Gate Distributing Company
("GGD"), in accordance with the provisions of the agreement, upon 30 days'
written notice to GGD. On April 1, 2003, GGD filed an action in Marin County
Superior Court, claiming that the termination of the agreement was wrongful and
sued the Company for breach of contract, breach of the covenant of good faith
and fair dealing, unfair business practices, negligent and intentional
interference with economic relationships.
The Company believes that it had sufficient cause to terminate the agreement,
and that, by failing to perform according to the contract, GGD has breached its
contract with the Company. The Company filed a cross-complaint against GGD
asserting these claims and seeking the appropriate remedies, including
compensatory and punitive damages. The Company and GGD have agreed to a
non-binding mediation, which is currently scheduled to be held on December 4,
2003. Based on the facts and the Company's beliefs set forth above, the Company
has not provided for any liability for the claims of GGD.
However, during the second quarter of the year 2003, the Company received
$655,200 from two new distributors in exchange for the Company's business in the
former territory of GGD. Normally the changing of distributors occurs outside of
the Company, and the new distributors pay the old distributors for developing
the territory. Because of the dispute between the Company and GGD, the Company
determined that the new distributors should pay these funds directly to the
Company. The Company will use these funds to pay off any obligation owed to GGD
once the legal matters have been settled.
As reported in the Company's prior Quarterly Report on Form 10-QSB, UBSN has
been involved in a dispute with the United Kingdom Commissioners of Customs and
Excise (the "Commissioners") regarding the recoverability of Value Added Tax on
certain materials. The
10
dispute began in March of 2002, when the Commissioners issued a Notice of
Assessment to UBSN. The Company has been informed that as of September 1, 2003,
all claims against UBSN have been withdrawn, and the reported dispute has been
resolved on that basis.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion summarizes the significant factors affecting the
consolidated operating results, financial condition, liquidity and cash flows of
the Company for the nine months ended September 30, 2003, compared to the nine
months ended September 30, 2002, and the year ended December 31, 2002. This
discussion should be read in conjunction with the Consolidated Financial
Statements and Notes included in the company's Annual Report on Form 10-KSB for
the year ended December 31, 2002.
This discussion contains statements regarding the company's expectations
concerning its future operations, earnings and outlook. These statements are
forward-looking statements that involve significant risks and uncertainties, and
accordingly, no assurances can be given that such expectations will be correct.
These expectations are based upon many assumptions that the Company believes to
be reasonable, but such assumptions may ultimately prove to be inaccurate or
incomplete, in whole or in part. Important factors that could cause actual
results to differ (favorably or unfavorably) from the expectations stated in
this discussion include, among others, changes in or to the following: the
pricing environment for the Company's products; demand for malt beverage
products in the Company's markets; customer preference for the Company's malt
beverage products; regulations or laws; raw materials prices; interest rates;
and the Company's European beer and/or restaurant business. The Company
disclaims any obligation to update any of these forward-looking statements. If
the Company determines to update any forward-looking statement, it will do so
publicly. No private statements by the Company or its personnel should be
interpreted as updating forward-looking statements.
CRITICAL ACCOUNTING POLICIES
In the ordinary course of business, the Company has made a number of estimates
and assumptions relating to the reporting of results of operations and financial
condition in the preparation of its financial statements in conformity with
accounting principles generally accepted in the United States of America. Actual
results could differ significantly from those estimates under different
assumptions and conditions. The Company believes that the following discussion
addresses the Company's most critical accounting policies, which are those that
are most important to the portrayal of the Company's financial condition and
results. The Company constantly re-evaluates these significant factors and makes
adjustments where facts and circumstances dictate. Historically, actual results
have not significantly deviated from those determined using the necessary
estimates inherent in the preparation of financial statements. Estimates and
assumptions include, but are not limited to, customer receivables, inventories,
assets held for sale, fixed asset lives, contingencies and litigation. The
Company has also chosen to follow certain accounting policies when options were
available, including:
o The first-in, first-out (FIFO) method to value the majority of the
Company's inventories.
11
o The intrinsic value method, or APB Opinion No. 25, to account for incentive
awards of Company common stock.
o A full valuation allowance of deferred tax assets for net operating loss
carry forwards that are expected to expire prior to utilization.
o The carrying value of certain plant and equipment is not impaired under
FASB 144 based on expected future cash flows from operations.
o The decision by the Company not to accrue any amounts in connection with
the litigation involving GGD, based on the Company's belief that it will
prevail in the litigation.
These accounting policies are applied consistently for all years presented.
The Company's operating results would be affected if other alternatives were
used. Information about the impact on operating results is included in the
footnotes to the Company's consolidated financial statements.
OVERVIEW
MBC was originally formed in March 1983 and launched its flagship brand, Red
Tail Ale, in August 1983. The Company is celebrating its 20th anniversary during
the year 2003. During the second quarter of the year 2003, the Company launched
Red Tail Ale in a commemorative 22 oz. bottle. This limited edition bottle has a
`Red Tail Ale - Reggae on the River' label designed by artist Jesse Miller, and
is distributed in select markets in California and Oregon. During the second
quarter, the Company started brewing products of Monterey County Ales, Inc. at
its breweries located in Ukiah and Saratoga Springs. `Raptor Red Lager', a new
craft lager beer sold in the West Coast market, was introduced during the third
quarter of the year 2003. In October 2003, the Company closed the restaurant
located at the Hopland property. Management decided to close the restaurant
because the space available for renewal at the end of the term of the current
lease is limited, and the restaurant has traditionally done less business during
the winter months. However, the Company continues to operate the bar and
merchandise stores.
Management is pleased to report that the Company has reported a profit for the
second consecutive fiscal quarter. The Company's brewing operation's sales in
the United States during the first nine months of the year 2003 increased to
46,656 barrels, an increase of 1,204 barrels, or 2.65%, over the 45,452 barrels
sold in the first nine months of the year 2002. Management considers this
increase significant in light of the current industry environment, poor economy,
and significant decline in business experienced by the restaurant and tourism
industry. During the first nine months of the year 2003, UBSN sold 43,613
barrels in the United Kingdom, Europe and Canada, compared to 40,241 barrels
during the corresponding period in the year 2002.
The Company ended the first nine months of 2003 with net income of $307,900.
That figure is comprised of net income of $428,800 from the Company's European
operations, and a net loss of $120,900 from the Company's domestic operations.
During the same period in 2002, the Company's European operations generated a
net income of $237,300 and domestic operations generated a net loss of $143,900,
resulting in an overall net income of only $93,400. As set forth more fully
under "Results of Operations," below, the majority of the overall gain in net
income can be attributed to increases in sales, both in Europe and domestically,
and the increase in the prices of the Company's products in Europe.
12
RESULTS OF OPERATIONS
The following tables set forth, as a percentage of net sales, certain items
included in the Company's Statements of Operations. See the accompanying
Financial Statements and Notes thereto.
13
---------------------------------
NINE MONTHS ENDED SEPTEMBER 30
---------------------------------
2003 2002
STATEMENTS OF OPERATIONS DATA: % %
- -
NET SALES 100.00 100.00
Costs of Sales 67.50 66.23
------ ------
GROSS PROFIT 32.50 33.77
------ ------
Marketing, General and Administrative Expense 27.80 29.48
PROFIT FROM OPERATIONS 4.70 4.29
Other (Income) (0.75) (0.40)
Interest Expense 2.96 3.41
------ ------
Profit before Income Taxes 2.49 1.28
Provision for Income Taxes 1.00 0.77
------ ------
NET INCOME 1.49% 0.51%
====== ======
Other Comprehensive Income 0.15 0.00
====== ======
COMPREHENSIVE INCOME 1.64% 0.51%
====== ======
--------------------------------
NINE MONTHS ENDED SEPTEMBER 30
--------------------------------
2003 2002
BALANCE SHEET DATA: $ $
- -
Cash and Cash Equivalents 579,300 64,700
Working Capital (1,621,000) (4,079,000)
Property and Equipment 13,795,500 14,206,600
Deposits and Other Assets 292,800 2,198,100
Total Assets 22,235,900 23,317,100
Long-term Debt 3,699,200 3,463,800
Obligation Under Capital Lease 183,200 734,300
Total Liabilities 15,551,600 15,189,500
Accumulated Deficit (8,186,600) (6,671,300)
Stockholder's equity 6,684,400 8,127,600
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 2002
NET SALES
Overall net sales for the third quarter of 2003 were $7,628,300, an
increase of $638,900, or 9.14%, compared to $6,989,400 for the third quarter of
2002. Of the increase, sales from the Company's domestic operations accounted
for $119,400 of the increase and sales from European operations made up the
remainder.
14
DOMESTIC OPERATIONS. Domestic net sales for first nine months of 2003 were
$3,439,400 compared to $3,320,000 for the same period in 2002, a 3.6% increase.
The sales volume increased to 18,333 barrels in the third quarter of 2003 from
17,593 barrels in the third quarter of 2002, representing an increase of 740
barrels or 5.34%. Of the increase, sales of the Company's brands decreased by
497 barrels; sales of Kingfisher increased by 24 barrels; and sales of contract
brands increased by 1,213 barrels. The increase in overall net sales during the
third quarter of 2003 was mainly due to an increase in wholesale shipments.
Retail sales for the third quarter of 2003 showed a decrease of $7,100 over the
same period in 2002.
EUROPEAN OPERATIONS: Net sales for the third quarter of 2003 were
$4,188,900 (GBP 2,601,200), compared to $3,669,400 (GBP 2,329,300) during the
corresponding period of 2002, an increase of 14.16%. During the third quarter of
2003, UBSN sold 15,419 barrels compared to 14,463 barrels during the same period
in 2002. Exchange rate fluctuations when measured in United States dollars
increased the amount of growth as compared to last year, hence when the net
sales results are compared in Pounds Sterling, there is an increase of only
11.67%.
COST OF GOODS SOLD
Cost of goods sold as a percentage of net sales during the third quarter of 2003
was 66.88%, as compared to 65.21% during the corresponding period of 2002.
DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in the
United States during the third quarter of 2003 was 67.11%, as compared to 64.24%
during the corresponding period of 2002, representing an increase of 2.87%,
mainly due to increases in the price of raw materials and increased insurance
costs.
EUROPEAN OPERATIONS: Cost of goods sold as a percentage of net sales in the
United Kingdom during the third quarter of 2003 was 67.29%, as compared to
66.85% during the corresponding period in 2002 (in each case as calculated in
U.S. dollars, after taking into account the effects of the exchange rate
calculation), representing a slight increase of 0.44%.
GROSS PROFIT
As a result of the higher net sales described above, gross profit for the third
quarter of the year 2003 increased to $2,526,700, from $2,431,500 during the
corresponding period of 2002, representing an increase of 3.92%. As a percentage
of net sales, the gross profit during the third quarter of 2003 decreased to
33.12% from that of 34.79% for the third quarter of 2002.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Marketing, general and administrative expenses for the third quarter of 2003
were $1,939,400, an increase of 1.9% as compared to $1,902,900 for the third
quarter of 2002.
DOMESTIC OPERATIONS: Expenses for the third quarter of 2003 were $911,300
compared to $897,100 during the corresponding period of 2002, representing a
decrease of $14,200. As a percentage of net sales in the United States, the
expenses decreased to 26.50% during the third quarter of 2003, compared to
27.02% during the corresponding period of 2002.
15
EUROPEAN OPERATIONS: Expenses for the third quarter of 2003 were $1,028,100
compared to $1,005,800 during the corresponding period of 2002, representing an
increase of $22,300. As a percentage of net sales in the United Kingdom, the
expenses decreased to 24.69% during the third quarter of 2003 compared to 27.61%
during the corresponding period of 2002 (in each case as calculated in U.S.
dollars, after taking into account the effects of the exchange rate
calculation). The increase is mainly attributable to increases in operational
costs and legal and professional fees.
OTHER EXPENSES
Other expenses for the third quarter of 2003 totaled $58,500, representing a
decrease of $86,800 when compared to the third quarter of 2002. The other
expenses consist of interest expenses, miscellaneous income, and acquisition
costs. Interest expenses decreased by $5,500 because of the reduction in long
term debts and reduction in interest rates. Other income increased by $81,300
mainly due to income received from the early termination of a brewing contract
by Wolaver's Enterprises, LLC.
INCOME TAXES
The Company has a provision for income taxes of $93,400 for the third quarter of
2003, compared to $62,600 for the third quarter of 2002. The provision for taxes
relates to the estimated amount of taxes that will be imposed by taxing
authorities in the United Kingdom.
NET INCOME
The Company's net income for the third quarter of 2003 was $435,400, as compared
to $320,700 for the third quarter of 2002. After providing for a foreign
currency translation adjustment of $11,700 during the third quarter of 2003
($3,500 for 2002), the comprehensive income for 2003 was $447,100, compared to
$317,200 in 2002.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 2002
NET SALES
Overall net sales for the first nine months of 2003 were $20,611,300, an
increase of $2,108,500, or 11.39%, compared to $18,502,800 for the first nine
months of 2002. Of the increase, the Company's domestic operations sales
increased by $232,700 and European operation's sales increased by $1,875,800.
DOMESTIC OPERATIONS. Domestic net sales for first nine months of 2003 were
$8,767,000 compared to $8,534,300 for the same period in 2002, a 2.73% increase.
The sales volume increased to 46,656 barrels in first nine months of 2003 from
45,452 barrels in the first nine months of 2002, representing an increase of
1,204 barrels or 3.07%. Of the increase, sales of the Company's brands increased
by 750 barrels; sales of Kingfisher decreased by 173 barrels, and sales of
contract brands increased by 627 barrels. The increase in overall net sales
during the first nine months of 2003 was mainly due to an increase in wholesale
shipments. Retail sales for the first nine months of 2003 showed a decrease of
$16,600 over the same period in 2002.
EUROPEAN OPERATIONS: Net sales for the first nine months of 2003 were
$11,844,300
16
(GBP 7,353,500) compared to $9,968,500 (GBP 6,708,700) during the corresponding
period of 2002, an increase of 18.82%. Slightly more than half of this increase
is the result of exchange rate fluctuations, which inflated the Company's
European sales results (achieved primarily in Pounds Sterling) when they are
converted to in United States Dollars. When net sales for the period are
compared in Pounds Sterling, the increase is only 9.61%. Aside from exchange
rate fluctuations, the increase is primarily the result of price increases by
UBSN which took effect on March 1, 2003, coupled with increased sales in Europe
during the first nine months of 2003. During the period, UBSN sold 43,613
barrels, an increase of 8.4% compared to the 40,241 barrels sold during the same
period in 2002.
COST OF GOODS SOLD
Cost of goods sold as a percentage of net sales during the first nine months of
2003 was 67.50%, as compared to 66.23% during the corresponding period of 2002.
This slight increase is largely due to increased costs in the United States.
DOMESTIC OPERATIONS: Cost of goods sold as a percentage of net sales in the
United States during the first nine months of 2003 was 68.81%, as compared to
67.31% during the corresponding period of 2002, representing an increase of
1.5%. Management attributes this to increases in the price of raw materials,
insurance costs, and sales of products packaged in bottles, which are more
costly than products packaged in kegs.
EUROPEAN OPERATIONS: Cost of goods sold as a percentage of net sales in the
United Kingdom during the first nine months of 2003 was 67.04%, as compared to
65.92% during corresponding period in 2002 (in each case as calculated in U.S.
dollars, after taking into account the effects of the exchange rate
calculation), representing a slight increase of 0.43%.
GROSS PROFIT
As a result of the higher net sales described above, gross profit for the first
nine months of the year 2003 increased to $6,698,200, from $6,248,000 during the
corresponding period of 2002, representing an increase of 7.2%. As a percentage
of net sales, the gross profit during the first nine months of 2003 decreased to
32.50% from that of 33.77% for the first nine months of 2002.
MARKETING, GENERAL AND ADMINISTRATIVE EXPENSES
Marketing, general and administrative expenses for the first nine months of 2003
were $5,729,300, as compared to $5,454,600 for the first nine months of 2002,
representing an increase of 5.04%.
DOMESTIC OPERATIONS: Expenses for the first nine months of 2003 were
$2,563,600 compared to $2,547,800 during the corresponding period of 2002,
representing an increase of $15,800. As a percentage of net sales in the United
States, the expenses decreased to 29.24% during the first nine months of 2003,
compared to 29.85% during the corresponding period of 2002. The increase in
expenses is mainly because of increases in legal costs on contractual disputes,
insurance costs, and sales promotion expenses. However, these increases in
expenses were mostly offset by savings caused by the Company's reduction of
other expenses.
EUROPEAN OPERATIONS: Expenses for the first nine months of 2003 were
$3,165,700
17
compared to $2,906,800 during the corresponding period of 2002, representing an
increase of $258,900. As a percentage of net sales in the United Kingdom, the
expenses decreased to 26.73% during the first nine months of 2003 compared to
29.16% during the corresponding period of 2002 (in each case as calculated in
U.S. dollars, after taking into account the effects of the exchange rate
calculation). The increase is mainly caused by greater expenditures for
manpower, travel, commissions, advertising, and promotions.
OTHER EXPENSES
Other expenses for the first nine months of 2003 totaled $455,600, representing
a decrease of $101,200 when compared to the first nine months of 2002. The other
expenses consist of interest expenses and miscellaneous income. Interest
expenses decreased by $21,700 because of reductions in long term debts, interest
rates, and the outstanding balance on the line of credit. Miscellaneous income
increased by $79,500.
INCOME TAXES
The Company has a provision for income taxes of $205,400 for the first nine
months of 2003, compared to $143,200 for the first nine months of 2002. The
provision for taxes relates to the estimated amount of taxes that will be
imposed by taxing authorities in the United Kingdom.
NET INCOME
The Company's net income for the first nine months of 2003 was $307,900, as
compared to net income of $93,400 for the first nine months of 2002. After
providing for a foreign currency translation adjustment of $30,100 for the first
nine months of 2003 (this amount was only $500 in 2002), the comprehensive
income for 2003 was $338,000, compared to $93,900 in 2002.
CAPITAL DEMANDS
Both the Ukiah and Releta facilities continue to operate at significantly less
than full capacity. Both breweries have placed demands upon the Company's assets
and liquidity. Failure to adequately meet those demands may have a material
adverse affect on the Company's business, financial condition, and results of
operations.
The Company has yet to complete the build-out of its administrative space and
the exterior landscaping of the Ukiah facility. Completion of the construction
is a condition to the issuance of a final certificate of occupancy. However, the
Ukiah brewery has been operating under a temporary certificate of occupancy from
the City of Ukiah since 1998 with no adverse consequences. The Company does not
plan to revisit completion of the project until it has the available funds to do
so. If, in the future, the Company decides to complete the landscaping, the
remaining work and the estimated cost thereof are as follows: covering the
parking lot with asphalt, approximately $30,000; building a concrete sidewalk to
one of the entrances of the brewery building, approximately $10,000.
PROCEEDS FROM OPERATIONS INSUFFICIENT TO SUSTAIN OPERATIONS
The Company must make timely payment of its debt and lease commitments to
continue its operations. Unused capacity at the Ukiah and Saratoga Springs
facilities has placed demands on
18
the Company's working capital. Beginning in approximately the second quarter of
1997, the time at which the Ukiah brewery commenced operations, proceeds from
operations have not been able to provide sufficient working capital for day to
day operations. To fund its operating deficits, the Company has relied upon
lines of credit and other credit facilities (see "Liquidity and Capital
Resources," below). Although Management has had success in negotiating these
credit facilities in the past, there can be no assurance that the Company will
be able to do so in the future, either at any price or at a price the Company
will be able to sustain, or that the Company will have access to any alternative
sources of funds in the future. Failure to secure sufficient funds will have a
materially adverse effect on the Company.
BREWING CONTRACT WITH WOLAVER'S ENTERPRISES, LLC.
During September 2000 the Company entered into an agreement with Wolaver's
Enterprises, LLC, ("Wolaver's") a Florida limited liability company, to brew
their line of organic beers on a contract basis. The Company produced 3,500
barrels of Wolaver's brand beer during year 2002. In July 2002, Wolaver's
informed the Company that it had merged with Otter Creek Brewing Company in
Middlebury, Vermont. Because of the merger, Wolaver's requested termination of
the brewing contract, and the Company agreed to terminate the brewing contract
effective as of December 31, 2002. During the third quarter of 2003, Wolaver's
agreed to pay to the Company, on account of its early termination of its brewing
contract, the amount of $122,000 in 49 equal monthly installments. Termination
of the Wolaver's contract increased the Company's unused brewing capacity. The
Company will continue to look for opportunities to utilize its brewing
facilities at a greater capacity.
LIQUIDITY AND CAPITAL RESOURCES
MASTER LINE OF CREDIT. On August 31, 1999, the Company and UBA entered into a
Master Line of Credit Agreement, which was subsequently amended in April of
2000, and February of 2001 (the "Credit Agreement"). The terms of the Credit
Agreement provide the Company with a line of credit in the principal amount of
up to $1,600,000.
UBA has made thirteen (13) separate advances to the Company under the Credit
Agreement, pursuant to a series of individual eighteen (18) month promissory
notes issued by the Company to UBA (the "UBA Notes"). As of September 30, 2003,
the aggregate outstanding principal amount of the UBA Notes was $1,515,371, and
the accrued but unpaid interest thereon was equal to approximately $385,200.
The UBA Notes require the Company to make quarterly interest payments to UBA on
the first day of April, July, October, and January. To date, UBA has permitted
the Company to capitalize all accrued interest, therefore, the Company has
borrowed the maximum amount available under the facility. Upon maturity of any
UBA Note, unless UBA has given the Company prior instructions to commence
repayment of the outstanding principal balance, the outstanding principal and
accrued but unpaid interest on such Note may be converted, at the option of UBA,
into shares of the Company's common stock. If UBA does not elect to so convert
any UBA Note upon maturity, it has the option to extend the term of such UBA
Note for any period of time mutually agreed upon by UBA and the Company. During
the extended term of any UBA Note, UBA has the right to require the Company to
repay the outstanding principal balance, along with the accrued and unpaid
interest thereon, to UBA within sixty (60) days. The UBA Notes are subordinated
to the loan from Savings Bank of Mendocino County and the CIT line of credit and
any repayment of the UBA Notes must be first approved by these lenders.
On December 28, 2001, the Company and UBA entered into a Confirmation of Waiver
which
19
provides a written confirmation that UBA had waived its rights as of August 13,
2001, with regard to all conversion rate protection set forth in the UBA Notes.
The Company and UBA executed an Extension of Term of Notes under Master Line of
Credit Agreement in February of 2002, which was later amended in August of 2002,
March of 2003, and August of 2003 (the "Extension Agreement"). The Extension
Agreement confirms the Company's and UBA's extension of the terms of the UBA
Notes for a period that ends on August 14, 2004.
LONG-TERM DEBT: MBC has obtained a $2.7 million loan from Savings Bank of
Mendocino County ("SBMC"), secured by a first priority deed of trust on the
Ukiah land, fixtures, and improvements. The loan is payable in monthly
installments of $24,443 including interest at the rate of 7.24%, maturing
December 2012 with a balloon payment in the amount of $932,600. The interest
rate is adjusted on every five year anniversary of the agreement to the treasury
constant maturity rate plus 4.17%. The amount of the balloon payment will vary
depending on the change in interest rates over the years. In addition to the
Ukiah land and facility, this loan is secured by some of the other assets of the
Company (other than the Releta facility), including, without limitation, most of
the Company's equipment.
EQUIPMENT LEASE: FINOVA Capital Corporation leased new brewing equipment with a
total cost of approximately $1.78 million to MBC for a term of seven years
(beginning December 1996) with monthly rental payments of approximately $27,100
each. The initial term of the lease expires in November 2003, and the Company
has the option to purchase the equipment by December 31, 2003, at its current
fair market value but not less than 25% nor more than 30% of the original cost
of the equipment. The Company has decided to exercise the purchase option, and
is in discussion with prospective lenders to finance the purchase. Failure to
secure financing sufficient to purchase the brewing equipment may have a
material adverse effect on the Company's operations.
OTHER LOANS AND CREDIT FACILITIES.
CIT GROUP/CREDIT FINANCE LINE OF CREDIT: In September 1998 The CIT Group/Credit
Finance, Inc. provided the Company a $3,000,000 maximum line of credit with an
advance rate of 80% of qualified accounts receivable and 60% of inventory at an
interest rate equal to the prime rate of Chase Manhattan Bank of New York plus
2.25% payable monthly. The line of credit is secured by all accounts, general
intangibles, inventory, and equipment of the Company except for the specific
equipment and fixtures of the Company leased from FINOVA Capital Corporation, as
well as by a second deed of trust on the Company's Ukiah land improvements.
$1,484,000 of the line of credit was advanced to the Company as an initial term
loan, which was repayable in sixty consecutive monthly installments of
principal, each in the amount of $24,700.
The facility was originally scheduled to mature on September 23, 2002, but on
January 17, 2003, the facility was amended to extend the term of the facility to
expire on November 30, 2003, which has been further extended, on a month to
month basis in order to allow the Company time to refinance. This amendment also
increased the maximum amount of available credit to $3,500,000, and provided a
term loan of $750,000 (consisting of the original balance of $346,300 and a new
term loan of $403,700) that is repayable in 30 equal consecutive monthly
installments of $24,700, commencing February 1, 2003, with a final payment of
$8,000. Based on the Company's current level of accounts receivable and
inventory, the Company has drawn the maximum amount permitted under the line of
credit. As of September 30, 2003, the total amount outstanding on the line of
credit was approximately $1,955,600. The Company is pursuing alternative
financing in order to repay this facility. The Company has been successful in
the past with obtaining financing but failure to arrange a new loan to replace
the CIT facility would have a material adverse effect on the Company.
20
NEDCOR BANK LIMITED OPTION FACILITY: Nedcor Bank Limited, a South African
registered company, has provided UBSN with a credit facility of GBP 1,250,000
(at the time of the filing of this report, GBP 1,250,000 is equal to
approximately $2,100,000). This overdraft facility includes a revolving
short-term loan, overdraft protection, and foreign exchange services. It is
available only until terminated by Nedcor Bank and has an interest rate of 1.5%
over Nedcor Bank's base rate, currently 5%, and is secured by all of the assets
of UBSN. The amount outstanding on this line of credit as of September 30, 2003
was approximately $937,000.
SHEPHERD NEAME LOAN: Shepherd Neame has a contract with UBSN to brew Kingfisher
Lager for the Company's European and Canadian markets. As consideration for
extending the brewing contract, Shepherd Neame advanced a loan of GBP 600,000 to
UBSN, repayable in annual installments of GBP 60,000 per year, commencing in
June 2003. UBSN has repaid GBP 60,000 as of September 2003 and the amount
outstanding as of September 30, 2003 is GBP 540,000. The loan carries an
interest rate of 5%.
INTEREST: The weighted average interest rates paid on the Company's U.S. debts
(including the long term capital lease of equipment by FINOVA Capital
Corporation Inc.) was 7.35% for the first nine months of the year 2003 and 8.43%
for the corresponding period of 2002.
KEG MANAGEMENT ARRANGEMENT: The Company has entered into a keg management
agreement with MicroStar Keg Management LLC. Under this arrangement, MicroStar
provides the Company with half-barrel kegs for which the Company pays a filling
and use fee. Distributors return the kegs to MicroStar instead of the Company.
MicroStar then supplies the Company with additional kegs. The agreement has been
extended on a monthly basis since September 2002. If, on any given month, the
agreement is not extended and terminates, the Company is required to purchase a
certain number of kegs from MicroStar. The Company would probably finance the
purchase through debt or lease financing, if available. However, there can be no
assurance that the Company will be able to finance the purchase of kegs. Failure
to extend the contract or failure to purchase the necessary kegs from MicroStar
on termination of contract is likely to have a material adverse effect on the
Company.
OVERDUE PROPERTY TAXES: As of June 30, 2003, the delinquent property taxes due
on the Company's Ukiah property, including penalties and interest, totaled
$710,600. This amount represents the overdue taxes for the period from April of
1999 to June of 2003. The Company entered into a payment plan on July 31, 2003
to settle the amount of overdue taxes. The Company made an initial payment of
$143,000 under the plan. The balance of the overdue taxes would then be paid in
four subsequent annual installments, on or before April 10 of each year,
commencing in the year 2005, of 20% or more of the original overdue balance,
along with accrued interest calculated at 18% per year. Because of the large
amount of taxes owed, and the County's ability to sell the Ukiah property to
satisfy a delinquency, failure to settle all current and future property taxes
(including payments due under the payment plan) may have a serious adverse
effect on the Company's business and financial condition.
RESTRICTED NET ASSETS. The Company's wholly-owned subsidiary, UBI, has
undistributed earnings of approximately $2,000,000. Under UBI's line of credit
agreement, distributions and other payments to the Company from its subsidiary
are limited to approximately $125,000 per year.
21
SUMMARY: The Company must make timely payment of its debt and lease commitments
to continue its operations. To fund its operating deficits over the past six
years, the Company has relied upon lines of credit and other credit facilities.
Management had success in negotiating these credit facilities in the past and
expects to successfully negotiate these facilities in the future. However, there
can be no assurance that the Company will have access to any such sources of
funds in the future, and the inability to secure sufficient funds will have a
materially adverse effect on the Company. Further, the CIT Group line of credit
is due for repayment on November 30, 2003, and the FINOVA Lease terminates in
November 2003. Failure to repay these facilities would have a material adverse
impact on the Company.
CURRENT RATIO
The Company's ratio of current assets to current liabilities on September 30,
2003 was 0.83 to 1.0 and its ratio of total assets to total liabilities was 1.43
to 1.0. On September 30, 2002, the Company's ratio of current assets to current
liabilities was 0.63 to 1.0 and its ratio of total assets to total liabilities
was 1.54 to 1.0.
UNION REPRESENTATION
On February 28, 2003, approximately 20 employees engaged in brewing, bottling,
warehousing, and shipping at the Ukiah brewery elected Teamsters Local No. 896,
International Brotherhood of Teamsters, AFL-CIO to represent them as a
collective bargaining agent. The Company concluded the negotiation of the
collective bargaining agreement on October 30, 2003. Upon the expected
ratification and subsequent execution of the agreement in November 2003, all of
such employees' positions must be held and filled by members of the union.
ITEM 3. CONTROLS AND PROCEDURES.
The Company's Management including the Chief Executive Officer, President and
Chief Financial Officer, have evaluated the effectiveness of the design,
maintenance, and operation of the Company's disclosure controls and procedures
during the period of time covered by this report. Management determined that the
Company's disclosure controls and procedures were effective in ensuring that
information required to be disclosed by the Company in the reports that it files
under the Exchange Act is accurate and is recorded, processed, summarized, and
reported within the time periods specified in the Commission's rules and forms.
Disclosure controls and procedures, no matter how well designed and implemented,
can provide only reasonable assurance of achieving an entity's disclosure
objectives. The likelihood of achieving such objectives is affected by
limitations inherent in disclosure controls and procedures. These include the
fact that human judgment in decision making can be faulty and that breakdowns in
internal controls can occur because of human failures such as simple errors or
mistakes or intentional circumvention of the established process.
There have been no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to the date of the
evaluation thereof, including any corrective actions with regard to significant
deficiencies and material weaknesses.
22
PART II
ITEM 1. LEGAL PROCEEDINGS.
------------------
Effective March 28, 2003, the Company terminated a written distribution
agreement with the House of Daniels, Inc., dba Golden Gate Distributing Company
("GGD"), in accordance with the provisions of the agreement, upon 30 days'
written notice to GGD. On April 1, 2003, GGD filed an action in Marin County
Superior Court, naming the Company and Mark Anderson (Mr. Anderson is employed
by the Company as a sales manager) as defendants. Because Mr. Anderson is an
employee of the Company, the Company may have some obligation to indemnify Mr.
Anderson for his costs and expenses in connection with these claims. GGD claims
that the termination of the agreement was wrongful and sued the Company for
breach of contract, breach of the covenant of good faith and fair dealing,
unfair business practices, negligent and intentional interference with economic
relationships.
The Company believes that it had sufficient cause to terminate the
agreement, and that, by failing to perform according to the contract, GGD has
breached its contract with the Company. The Company filed a cross-complaint
against GGD asserting these claims and seeking the appropriate remedies,
including compensatory and punitive damages. The Company and GGD have agreed to
a non-binding mediation, which is currently scheduled to be held on December 4,
2003.
During the second quarter of the year 2003, the Company received $655,200 from
two new distributors in exchange for the Company's business in the former
territory of GGD. Normally the changing of distributors occurs outside of the
Company, and the new distributors pay the old distributors for developing the
territory. Because of the dispute between the Company and GGD, the Company
determined that the new distributors should pay these funds directly to the
Company. The Company will use these funds to pay off any obligation owed to GGD
once the legal matters have been settled.
As reported in the Company's prior Quarterly Report on Form 10-QSB, UBSN has
been involved in a dispute with the United Kingdom Commissioners of Customs and
Excise (the "Commissioners") regarding the recoverability of Value Added Tax on
certain materials. The dispute began in March of 2002, when the Commissioners
issued a Notice of Assessment to UBSN. The Company has been informed that as of
September 1, 2003, all claims against UBSN have been withdrawn, and the reported
dispute has been resolved on that basis.
ITEM 2. CHANGES IN SECURITIES.
----------------------
None.
ITEM 3. DEFAULT UPON SENIOR SECURITIES.
-------------------------------
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
---------------------------------------------------
The Company's annual shareholders' meeting was held on October 27, 2003. At the
meeting, the company's shareholders voted to approve the reelection of all eight
current directors, and ratified the selection of Moss Adams, L.L.P. as the
Company's independent auditors for the current fiscal year. The results of the
voting are as follows:
23
Election of Directors FOR WITHHELD
-----------------------------------------------------------
Dr. Vijay Mallya 10,126,949 101,514
H. Michael Laybourn 10,126,674 101,789
Jerome G. Merchant 10,127,074 101,389
R.H.B. (Bobby) Neame 10,127,074 101,389
Sury Rao Palamand 10,126,949 101,514
Kent D. Price 10,127,074 101,389
Yashpal Singh 10,126,849 101,614
David R. Townshend 10,126,974 101,489
To ratify the selection of Moss Adams, L.L.P. as independent auditors of the
Company for the current fiscal year.
FOR AGAINST ABSTAIN
--------------------------------------------
10,139,536 23,195 65,732
ITEM 5. OTHER ITEMS.
------------
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
---------------------------------
(a) Exhibits. Page No.
31.1 Certification of Principal Executive Officer Pursuant to 27
Rule 13a-14(a) or Rule 15d-14(a)
31.2 Certification of Principal Financial Officer Pursuant to 28
Rule 13a-14(a) or Rule 15d-14(a)
32.1 Certification Pursuant to Title 18, U.S.C. Section 1350 29
32.2 Certification Pursuant to Title 18, U.S.C. Section 1350 30
(b) Current Reports on Form 8-K
---------------------------
None.
24
SIGNATURE
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
REGISTRANT:
MENDOCINO BREWING COMPANY, INC.
Dated: November 11, 2003 By: /s/ Dr. Vijay Mallya
---------------------------------------
Dr. Vijay Mallya
Chairman of the Board and Chief
Executive Officer
Dated: November 11, 2003 By: /s/ N. Mahadevan
---------------------------------------
N. Mahadevan
Chief Financial Officer and Secretary
25
EXHIBIT LIST
Page
----
No.
- ---
31.1 Certification of Principal Executive Officer Pursuant to 27
Rule 13a-14(a) or Rule 15d-14(a)
31.2 Certification of Principal Financial Officer Pursuant to 28
Rule 13a-14(a) or Rule 15d-14(a)
32.1 Certification Pursuant to Title 18, U.S.C. Section 1350 29
32.2 Certification Pursuant to Title 18, U.S.C. Section 1350 30
26