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Pyramid Breweries 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
e10vq
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2005
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For the transition period from            to            .
Commission file number 0-27116
 
PYRAMID BREWERIES INC.
(Exact name of registrant as specified in its charter)
     
Washington   91-1258355
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
91 South Royal Brougham Way,
Seattle, WA 98134

(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (206) 682-8322
 
     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 þ No o.
     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes o No þ
     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
     Common stock, par value of $.01 per share: 8,798,975 shares of Common Stock outstanding as of September 30, 2005
 
 

 


PYRAMID BREWERIES INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
TABLE OF CONTENTS
         
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 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 32.1
 EXHIBIT 32.2

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PART I
Item 1 — FINANCIAL STATEMENTS
PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
                 
    September 30,     December 31,  
    2005     2004  
    (Unaudited)          
    (in thousands)  
CURRENT ASSETS:
               
Cash and cash equivalents
  $     $  
Accounts receivable, net of $20,000 and $32,000 allowance
    3,359       2,191  
Inventories
    1,926       2,129  
Prepaid expenses and other
    367       324  
 
           
Total current assets
    5,652       4,644  
Fixed assets, net
    27,297       28,859  
Goodwill
    415       415  
Intangibles
    175       209  
Other assets
    838       189  
 
           
Total assets
  $ 34,377     $ 34,316  
 
           
 
               
CURRENT LIABILITIES:
               
Accounts payable
  $ 2,958     $ 2,776  
Accrued expenses
    2,933       2,682  
Refundable deposits
    698       582  
Line of credit
          400  
Current portion of long-term financing
    98       83  
Note payable — current
    20       20  
Deferred rent — current
    75       75  
Dividends payable
          193  
 
           
Total current liabilities
    6,782       6,811  
Long-term financing, net of current
    7,697       7,117  
Deferred rent, net of current
    564       615  
 
           
Total liabilities
  $ 15,043     $ 14,543  
 
           
 
               
COMMITMENTS AND CONTINGENCIES
               
 
               
STOCKHOLDERS’ EQUITY:
               
Preferred stock, 10,000,000 shares authorized, none issued
           
Common stock, $.01 par value; 40,000,000 shares authorized, 8,799,000 and 8,776,000 shares issued and outstanding
    88       88  
Additional paid-in capital
    37,251       37,214  
Deferred stock-based compensation
    (336 )     (384 )
Accumulated deficit
    (17,669 )     (17,145 )
 
           
Total stockholders’ equity
    19,334       19,773  
 
           
Total liabilities and stockholders’ equity
  $ 34,377     $ 34,316  
 
           
The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amount)
                                 
    Three Month Period Ended     Nine Month Period Ended  
    September 30,     September 30,  
    2005     2004     2005     2004  
Gross sales
  $ 14,284     $ 11,745     $ 38,454     $ 30,971  
Less excise taxes
    758       532       2,007       1,475  
 
                       
Net sales
    13,526       11,213       36,447       29,496  
Cost of sales
    10,587       9,044       29,008       23,577  
 
                       
Gross margin
    2,939       2,169       7,439       5,919  
Selling, general and administrative expenses
    2,910       2,592       8,299       7,285  
 
                       
Operating income (loss)
    29       (423 )     (860 )     (1,366 )
Other income, net
    411       3       340       99  
 
                       
Income (loss) before income taxes
    440       (420 )     (520 )     (1,267 )
Provision for income taxes
    (1 )           (4 )     (3 )
 
                       
Net income (loss)
  $ 439     $ (420 )   $ (524 )   $ (1,270 )
 
                       
 
                               
Basic and diluted net income (loss) per share
  $ 0.05     $ (0.05 )   $ (0.06 )   $ (0.15 )
Weighted average basic shares outstanding
    8,799,000       8,615,000       8,790,000       8,512,000  
Weighted average diluted shares outstanding
    9,156,000       8,615,000       8,790,000       8,512,000  
Cash dividend declared per share
  $     $ 0.022     $     $ 0.088  
The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    Nine Month Period Ended September 30,  
    (in thousands)  
    2005     2004  
OPERATING ACTIVITIES:
               
Net loss
  $ (524 )   $ (1,270 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    2,050       1,973  
Stock-based compensation expense
    48       3  
Accretion of discount on long-term debt
          4  
(Gain) loss on sales of fixed assets
    (415 )     10  
Deferred rent
    (51 )     (116 )
Changes in operating assets and liabilities:
               
Accounts receivable
    (1,168 )     (597 )
Inventories
    203       (417 )
Prepaid expenses and other
    (69 )     147  
Accounts payable and accrued expenses
    453       1,575  
Refundable deposits
    116       50  
 
           
Net cash provided by operating activities
    643       1,362  
 
           
INVESTING ACTIVITIES:
               
Proceeds from the sale and maturities of investments
          192  
Proceeds from sales of fixed assets
    783       11  
Acquisitions of fixed assets
    (815 )     (769 )
Acquisitions of Portland Brewing Company assets
          (1,416 )
Acquisitions of Berkeley faciltiy land and building
          (195 )
 
           
Net cash used in investing activities
    (32 )     (2,177 )
 
           
FINANCING ACTIVITIES:
               
Proceeds from the sale of common stock and option exercises
    37       203  
Note payable
    (55 )      
Deferred financing fees
          (68 )
Borrowings on short-term note payable to related party
          200  
Cash dividends paid
    (193 )     (944 )
(Cash paid) net borrowings on line of credit
    (400 )     231  
Purchase and retirement of common stock
          (365 )
 
           
Net cash used in financing activities
    (611 )     (743 )
 
           
Decrease in cash and cash equivalents
          (1,558 )
Cash and cash equivalents at beginning of period
          1,558  
 
           
Cash and cash equivalents at end of period
  $     $  
 
           
The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation:
     Pyramid Breweries Inc. (the “Company”), a Washington corporation, is engaged in the brewing, marketing and selling of craft beers and premium sodas. As of September 30, 2005, the Company also operated five restaurants adjacent to its breweries under the Pyramid Alehouse and MacTarnahan’s Taproom brand names. The Company’s products are produced at breweries in Seattle, Washington; Portland, Oregon; and in Berkeley, Walnut Creek and Sacramento, California, and as of September 30, 2005, the Company’s products were distributed in approximately 40 states, Canada, Japan and Singapore. The Company sells its beer through a network of selected independent distributors and alehouse locations primarily in Washington, Oregon and California. The Company’s core beer brands include Pyramid and MacTarnahan’s, and its other smaller product lines are reported under the Allied Brand designation and include Thomas Kemper Beer. The Company also manufactures a line of gourmet sodas under the Thomas Kemper Soda Company label.
     The Company formed an entity, PBC Acquisition LLC, for the express purpose of acquiring certain assets from Portland Brewing Company which it completed in July 2004 (the “Portland Acquisition”). The Company also established Gilman Street Property LLC as a single purpose entity to act as the legal owner of the Berkeley Alehouse and Brewery property located at 901 Gilman Street, Berkeley, California which it purchased effective July 2004.The assets of these entities are consolidated into the Company’s unaudited condensed consolidated financial statements for financial reporting purposes.
     The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all material adjustments, consisting only of those of a normal recurring nature, considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows at the dates and for the periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year. For a presentation including all disclosures required by generally accepted accounting principles, these financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2004, included in the Annual Report on Form 10-K, as amended.
Stock-Based Compensation
     At September 30, 2005, the Company has stock-based compensation plans which are described more fully in Note 18 of the Audited Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, as amended. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123 “Accounting for Stock-Based Compensation” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”. Accordingly, no compensation cost has been recognized for the fair value of options issued under the Employee and Director Plans (the Plans), except that the Company has recorded a compensation expense of $16,000 and $48,000 for the three and nine months ended September 30, 2005, respectively, related to its commitment to grant 175,000 shares of restricted stock, and an additional 175,000 shares if certain performance criteria are met, to its CEO over a six year period as per the terms of his employment agreement. If we had measured compensation costs for the options granted under the fair value based method prescribed by SFAS No. 123, net income (loss) and basic and diluted net income (loss) per share would have been adjusted, or increased as follows (in thousands, except for per share amounts):

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    Three Month Period Ended   Nine Month Period Ended
    September 30,   September 30,
    2005   2004   2005   2004
Net income (loss) as reported
  $ 439     $ (420 )   $ (524 )   $ (1,270 )
Add: Stock-based compensation cost as reported
    16       13       48       3  
Less: Stock-based compensation cost determined under the fair value based method
    (23 )     (32 )     (83 )     (124 )
     
Net income (loss) as adjusted
  $ 432     $ (439 )   $ (559 )   $ (1,391 )
 
                               
Basic and diluted net income (loss) per share as reported
  $ 0.05     $ (0.05 )   $ (0.06 )   $ (0.15 )
Basic and diluted net income (loss) per share as adjusted
  $ 0.05     $ (0.05 )   $ (0.06 )   $ (0.16 )
     The fair value of options granted was estimated using the Black-Scholes option-pricing model, assuming no dividends and the following other assumptions:
                                 
    Three Month Period Ended   Nine Month Period Ended
    September 30,   September 30,
    2005   2004   2005   2004
Average risk-free interest rates
    4.3 %     1.7 %   3.9% to 4.3 %   1.7 %
Average expected life (in years)
    5       5         5     5  
Volatility
    29.0 %     51.0 %   29.0% to 51.0 %   51.0 %
Revenue Recognition
     The Company recognizes revenue from the sale of wholesale beer and soda products at the time of shipment, when the title of the Company’s products passes to the customer in accordance with distributor sales agreements and collectibility is probable. The Company’s revenue from its alehouses is comprised of food, beverage and merchandise, and is recognized at the time of sale.
Net Income (Loss) Per Share
     Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period excluding any dilutive effects of options and unvested restricted stock awards. Diluted earnings per share assumes the exercise or vesting of other dilutive securities, such as options and restricted stock using the treasury stock method. Diluted net income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding plus additional common shares that would be outstanding from in-the-money stock options, which as of September 30, 2005 and 2004, approximated 357,000 and 174,000, respectively. As of September 30, 2005 and 2004, options to purchase approximately 385,000 and 197,000 shares of common stock were outstanding were not included in the nine months’ computation of EPS because their effects are antidilutive.
Recently Issued Accounting Pronouncements
     In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123R, “Share-Based Payment (Revised 2004),” which requires companies to recognize in the income statement the fair value of all employee share-based payments, including grants of employee stock options as well as compensatory employee stock purchase plans. In March 2005, the Securities and Exchange Commission, or SEC, issued Staff Accounting Bulletin (SAB) No. 107 which expresses views of the SEC staff regarding the interaction between SFAS No. 123R and certain SEC rules and regulations. In April 2005, the SEC issued a press release that amends the required adoption date of SFAS No. 123R as no later than the first fiscal year beginning after June 15, 2005, which will be effective for the Company January 1, 2006. Although the Company has not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, the Company is evaluating the requirements under SFAS 123R including the valuation methods and support for the assumptions that underlie the valuation of the awards, as well as the transition methods (modified prospective transition method or the modified retrospective transition method) and does not expect the adoption to have a significant impact on the consolidated statements of operations and net income (loss) per share.
     In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” and changes the requirements of the accounting for and reporting of a change in accounting principle. SFAS 154 also carries forward the guidance in APB Opinion No. 20 regarding reporting a correction of an error and a change in accounting estimate. The provisions of this statement are applicable for accounting changes and error corrections made in fiscal years beginning after December 15, 2005. The Company does not expect the provisions of this statement to have a material impact on its financial position, results of operations or cash flows.

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     In June 2005, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 05-6, “Determining the Amortization Period for Leasehold Improvements,” which requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized over the lesser of the useful life of the assets or a term that includes renewals that are reasonably assured at the date of the business combination or purchase. EITF 05-6 is effective for periods beginning after July 1, 2005. The provisions of this consensus did not have a material impact on the Company’s financial position, results of operations or cash flows.
Liquidity
     During the nine months ended September 30, 2005, the Company’s working capital improved, but still remained negative at $1.1 million. The impact of the integration costs of the Portland Acquisition and underutilized brewing capabilities negatively impacted the working capital. The Company’s operating activities for the nine months ended September 30, 2005, provided $643,000 compared to $1.4 million for same period last year.
     Although the Company has no cash and a working capital deficit as of September 30, 2005, because the beverage segment operates with relatively short accounts receivable terms and the alehouse segment operates as a cash business, the Company typically tends to collect within 30 days of a sale or immediately upon sale. Therefore, the Company generally does not require significant cash on hand to meet operating needs. Further, management believes that the Company has adequate financing to conduct its operations.
     Management believes that the 2005 consolidation of the majority of the Company’s Seattle brewery production into the recently acquired Portland brewery will reduce production costs and help to meet rising demand for Pyramid branded products. The Company plans to continue its focus on initiatives to further improve operating results which include driving growth of its core brand families in order to deliver revenue growth, increasing capacity utilization while decreasing fixed production costs, judicious use of marketing investment in programs which deliver positive returns, and achieving further operating efficiencies in the breweries to reduce costs and improve margin delivery. The Company will continue to evaluate opportunities for continued improvements and financial performance. However, management anticipates utilizing the funds under the Company’s line of credit during the seasonally slow winter months, and it is possible that some or all of the Company’s cash requirements may not be met by these activities, which would require the Company to seek additional capital from other sources. Alternative sources of capital may not be available to the Company on attractive terms or at all.
Reclassification
     Certain reclassifications have been made to the prior year balances to conform to the current year presentation.
2. Sale of Equipment
     In August 2005, the Company sold substantially all equipment located in the Seattle,Washington brewing facility, as part of the cost reduction initiatives related to consolidating production operations. Assets sold for $652,000, net of commissions, consisted of brewing and production equipment. Additionally, the Company sold excess kegs from the Portland brewing facility for $131,000. The total net book values for the excess equipment approximated $368,000. The Company reported a gain of approximately $415,000 net of sales commissions and fees in the three months ending September 30, 2005.
3. Inventories
     Inventories consist of the following (in thousands):
                 
    September 30,     December 31,  
    2005     2004  
Raw materials
  $ 851     $ 905  
Work in process
    190       191  
Finished goods
    885       1,033  
 
           
 
  $ 1,926     $ 2,129  
 
           
     Raw materials primarily include ingredients, flavorings and packaging. Work in process includes beer held in fermentation prior to the filtration and packaging processes. Finished goods primarily include product ready for shipment, as well as promotional merchandise held for sale. Inventory levels experience fluctuations in carrying levels and values based largely on seasonality.

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4. Fixed Assets
     Fixed assets consist of the following (in thousands):
                 
    September 30,     December 31,  
    2005     2004  
Land
  $ 6,181     $ 6,181  
Buildings
    11,895       11,895  
Brewery and retail equipment
    18,432       19,328  
Furniture and fixtures
    1,106       1,106  
Leasehold improvements
    6,060       5,899  
Construction in progress
    201       208  
 
           
 
    43,875       44,617  
 
Less: accumulated depreciation and amortization
    (16,578 )     (15,758 )
 
           
 
  $ 27,297     $ 28,859  
 
           
5. Accrued Expenses
     Accrued expenses consist of the following (in thousands):
                 
    September 30,     December 31,  
    2005     2004  
Salaries, wages and related accruals
  $ 933     $ 978  
Barrel taxes
    649       157  
Other accruals
    1,351       1,547  
 
           
 
  $ 2,933     $ 2,682  
 
           
6. Other Income, net
     Other income, net consists of the following (in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2005     2004     2005     2004  
Gain (loss) on sale of assets
  $ 415     $ 1     $ 415     $ (10 )
Interest expense
    (128 )     (94 )     (403 )     (96 )
Parking income
    74       77       178       161  
Sublease income
    61       36       172       36  
Loan fee amortization
    (13 )     (22 )     (27 )     (24 )
Interest income
    2       5       5       18  
Other income
                      14  
 
                       
Other income, net
  $ 411     $ 3     $ 340     $ 99  
 
                       
7. Line of Credit
     The Company has a $2.0 million line of credit agreement with its bank which has been extended to March 31, 2006 from the previous expiration of December 31, 2005. In February 2005, the Company modified its line of credit from 75% of eligible accounts receivable to 80%, temporarily increasing the availability of funds during the first half of the fiscal 2005. After June 30, 2005 the availability to borrow on the line is 75% of eligible accounts receivable. Under the revised terms of this agreement, the interest rate charged on the amounts outstanding has increased to prime plus 2% and a fee of 1/2 percent has been charged by the Bank. The Company granted the Bank security interest in the property and assets of the Company as well as the proceeds and the products of the collateral, namely cash, accounts receivable and inventory. The Company has also agreed to adhere to certain financial performance covenants and future dividends payments are subject to the Bank’s prior approval. The Company was in compliance with these covenants as of September 30, 2005.

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8. Debt
     In January 2005, the Company announced that it has entered into a long-term $7.9 million securitized financing arrangement with Morgan Stanley Mortgage Capital Inc., for the purpose of refinancing the Company’s existing $7.2 million short term note with Sugar Mountain Capital, LLC. The Company was required, as a term of the financing, to establish a wholly owned subsidiary as a single purpose entity, named Pyramid Gilman Street Property, LLC (the “Subsidiary”), to act as the legal owner of the property. The Subsidiary subsequently issued a long-term promissory note, dated January 27, 2005, which has been secured by a deed of trust against the Company’s Berkeley, California Brewery and Alehouse facility. The terms of the long-term financing, include monthly payments of principal and interest for a period of ten years, an annual interest rate of 5.8%, and a loan amortization period of thirty years. The promissory note is assumable and it generally does not allow for prepayments of principal other than through the regularly scheduled monthly payments. The loan is guaranteed by the Company and the financial statements of the Subsidiary are consolidated into the Company’s financial reports and filings. Other important terms of the financing include the requirement to place $500,000 of the proceeds of the loan in an interest bearing restricted reserve account and to deposit an additional $10,000 per month into an additional restricted reserve account until the balance of the second reserve account is at least $750,000. Additionally, the Company and its Subsidiary are required to create and fund a replacement reserve account for the purpose of funding capital repairs and replacements to the subject property. The replacement reserve account is funded by monthly payments of approximately $2,000 until the total amount of the replacement reserve is at least $62,500. The restricted reserve replacement reserve account balances are recorded as long-term other assets on the balance sheet.
     At September 30, 2005, future minimum payments are as follows (in thousands):
         
2005
  $ 24  
2006
    99  
2007
    105  
2008
    110  
2009
    118  
Thereafter
    7,338  
 
     
 
  $ 7,794  
 
     
9. Litigation and Contingencies
     The Company is involved from time to time in claims, proceedings and litigation arising in the ordinary course of business. The Company does not believe that any such claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company’s financial statements.
10. Segment Information
     The Company follows the provisions of SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information,” and reports segment information in the same format as reviewed by the Company’s management (the Management Approach), which is organized around differences in products and services.
     Products and Services
     The Company’s reportable segments include beverage operations and alehouses. Beverage operations include the production and sale of Company beverage products including both beer and soda. The alehouse segment consists of five full-service alehouses, which market and sell the full line of the Company’s beer and soda products as well as food and certain merchandise.
     Factors used to identify reportable segments
     The Company’s reportable segments are strategic business units that offer different products and services. These segments are managed separately because each business requires different production, management and marketing strategies.

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     Measurement of segment profit and segment assets
     The accounting policies of the segments are the same as those described in the summary of critical accounting policies included in the notes to the financial statements included in the Company’s Form 10-K for the fiscal year ended December 31, 2004, as amended. The Company evaluates performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses. The Company records intersegment sales at cost.
     Segment profit and segment assets are as follows:
                                 
    Beverage            
    Operations   Alehouse   Other   Total
    (in thousands)
Quarter ended September 30, 2005
                               
Gross revenues from external customers
  $ 10,102     $ 4,182     $     $ 14,284  
Net revenues from external customers
    9,344       4,182             13,526  
Intersegment revenues
    167             (167 )      
Interest income
                2       2  
Depreciation and amortization
    417       212       67       696  
Operating income (loss)
    1,228       307       (1,506 )     29  
Capital expenditures
    101       30       30       161  
Total assets
    20,306       6,123       7,948       34,377  
 
                               
Quarter ended September 30, 2004
                               
Gross revenues from external customers
  $ 7,941     $ 3,804     $     $ 11,745  
Net revenues from external customers
    7,409       3,804             11,213  
Intersegment revenues
    161             (161 )      
Interest income
                5       5  
Depreciation and amortization
    382       203       46       631  
Operating income (loss)
    687       218       (1,328 )     (423 )
Capital expenditures operating
    209       108       68       385  
Capital expenditures acquisition
    8,750       1,140       195       10,085  
Total assets
    21,341       6,691       8,097       36,129  
 
                               
Nine months ended September 30, 2005
                               
Gross revenues from external customers
  $ 26,794     $ 11,660     $     $ 38,454  
Net revenues from external customers
    24,787       11,660             36,447  
Intersegment revenues
    470             (470 )      
Interest income
                5       5  
Depreciation and amortization
    1,266       639       193       2,098  
Operating income (loss)
    3,027       540       (4,427 )     (860 )
Capital expenditures
    514       157       69       740  
Total assets
    20,306       6,123       7,948       34,377  
 
                               
Nine months ended September 30, 2004
                               
Gross revenues from external customers
  $ 20,601     $ 10,370     $     $ 30,971  
Net revenues from external customers
    19,126       10,370             29,496  
Intersegment revenues
    397             (397 )      
Interest income
                18       18  
Depreciation and amortization
    1,186       634       153       1,973  
Operating income (loss)
    1,994       487       (3,847 )     (1,366 )
Capital expenditures operating
    415       200       154       769  
Capital expenditures acquisition
    8,750       1,140       195       10,085  
Total assets
    21,341       6,691       8,097       36,129  

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Other
     Other consists of interest income, general, administrative and marketing expense, corporate office assets and other reconciling items that are not allocated to segments for internal management reporting purposes. Other total assets include all assets except for accounts receivable, inventory, goodwill and fixed assets, which are presented by segment.
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
     The following table sets forth, for the periods indicated, certain selected unaudited operating data, expressed as a percentage of net sales.
SELECTED UNAUDITED OPERATING DATA
                                 
    Three Months Ended September 30,  
    (in thousands, except barrel & per share amounts)  
            % of             % of  
    2005     Net Sales     2004     Net Sales  
Gross sales
  $ 14,284             $ 11,745          
Less excise taxes
    758               532          
 
                       
Net sales
    13,526       100.0       11,213       100.0  
Cost of sales
    10,587       78.3       9,044       80.7  
 
                       
Gross margin
    2,939       21.7       2,169       19.3  
Selling, general and administrative expenses
    2,910       21.5       2,592       23.1  
 
                       
Operating income (loss)
    29       0.2       (423 )     (3.8 )
Other income, net
    411       3.0       3        
 
                       
Income (loss) before income taxes
    440       3.2       (420 )     (3.8 )
Provision for income taxes
    (1 )                  
 
                       
Net income (loss)
  $ 439       3.2     $ (420 )     (3.8 )
 
                       
 
                               
Basic and diluted net income (loss) per share
  $ 0.05             $ (0.05 )        
 
                       
 
                               
Operating data (in barrels):
                               
Beer barrels shipped
    51,200               40,600          
Soda barrels shipped
    13,300               11,300          
 
                       
Total barrels shipped
    64,500               51,900          
 
                       
Annual production capacity
    250,000               335,000          
 
                       

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    Nine Month Period Ended September 30,  
    ( in thousands, except barrels & per share amounts)  
            % of             % of  
    2005     Net Sales     2004     Net Sales  
Gross sales
  $ 38,454             $ 30,971          
Less excise taxes
    2,007               1,475          
 
                       
Net sales
    36,447       100.0       29,496       100.0  
Cost of sales
    29,008       79.6       23,577       79.9  
 
                       
Gross margin
    7,439       20.4       5,919       20.1  
Selling, general and administrative expenses
    8,299       22.8       7,285       24.7  
 
                       
Operating loss
    (860 )     (2.4 )     (1,366 )     (4.6 )
Other income, net
    340       0.9       99       0.3  
 
                       
Loss before income taxes
    (520 )     (1.5 )     (1,267 )     (4.3 )
Provision for income taxes
    (4 )     (0.0 )     (3 )     (0.0 )
 
                       
Net loss
  $ (524 )     (1.5 )   $ (1,270 )     (4.3 )
 
                       
 
                               
Basic and diluted net loss per share
  $ (0.06 )           $ (0.15 )        
 
                       
 
                               
Operating data (in barrels):
                               
Beer barrels shipped
    138,400               101,700          
Soda barrels shipped
    36,700               33,100          
 
                       
Total barrels shipped
    175,100               134,800          
 
                           
Annual production capacity
    250,000               334,000          
 
                           
QUARTER ENDED SEPTEMBER 30, 2005 COMPARED TO QUARTER ENDED SEPTEMBER 30, 2004
     Gross Sales. Gross sales increased 21.6% to $14.3 million in the quarter ended September 30, 2005, from $11.7 million in the same quarter in 2004. Wholesale beverage segment sales increased 27.2% to $10.1 million in the quarter from $7.9 million in the same quarter in 2004 as a result of a 24.3% increase in total beverage shipments for the respective quarters. Of the total beverage shipments, beer shipments increased by 26.1% to 51,200 barrels in the quarter from 40,600 barrels in the same period in 2004 primarily due to Pyramid beer brand shipments which increased 23.7% to 37,800 barrels in the quarter driven by Pyramid Hefeweizen, the Company’s top selling product, which was up 22.3% in shipment volumes for the quarter. Shipments of Thomas Kemper Soda increased 2,000 barrels to 13,300 barrels for the quarter. All sales regions increased shipment volumes in the quarter ended September 30, 2005 over the third quarter in 2004, Alehouse sales increased 9.9%, to $4.2 million in the quarter from $3.8 million in the same quarter in 2004. Excluding the Portland Taproom, which was acquired in July 2004, the same store alehouse sales increased $209,000, or 6.0%, over the same period in 2004.
     Excise Taxes. Excise taxes totaled 7.5% and 6.7% respectively, of gross beverage sales for the quarters ended September 30, 2005 and 2004. Per beer barrel shipped excise taxes increased to $14.80 per beer barrel from $13.10 per beer barrel in the same period in 2004 primarily as a result of additional shipment volume taxed at a higher rate. Federal taxes paid on beer shipments is determined by the level of shipments. A 60,000 barrel threshold exists at the federal level, resulting in incremental volume being taxed at an $18 per beer barrel rate versus a $7 per beer barrel rate on production below 60,000 barrels. State taxes per barrel vary on a state by state basis. The Company calculates a weighted average cost per barrel for the year based on the tax rates in order to allocate excise tax costs throughout the year.
     Gross Margin. Gross margin increased $770,000 to $2.9 million, an increase of 35.5%, in the quarter ended September 30, 2005 compared to the same period in 2004. The gross margin dollars increased primarily as a result of higher sales volumes in the beverage segment in conjunction with a decrease in the per barrel costs for the quarter ended September 30, 2005 resulting primarily from the cost reduction initiatives related to consolidating production operations, offset by increased freight costs. Additionally, the gross margin as a percentage of sales increased to 28.2% in the quarter ended September 30, 2005 from 26.3% in the same period in 2004.
                                                 
    Three Month Period Ended September 30,
    (in thousands)
            % of           % of        
            Division           Division        
Gross Margin   2005   Net Sales   2004   Net Sales   $ Change   % Change
     
Beverage Division
  $ 2,632       28.2 %   $ 1,951       26.3 %   $ 681       34.9 %
Alehouse Division
    307       7.3 %     218       5.7 %     89       40.8 %
     
Total
  $ 2,939       21.7 %   $ 2,169       19.3 %   $ 770       35.5 %
     

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     Selling, General and Administrative Expenses. Selling, general and administrative expenses for the quarter increased $318,000 to $2.9 million over the same period in 2004. The additional expense was attributed to a $274,000 increase in selling and marketing expense for package redesign work released in the third quarter and an increased sales force in order to raise selling efforts related to growing the Pyramid brands and the brands acquired from the Portland Acquisition. Selling expenses for the quarter ended September 30, 2005 totaled $1.4 million, or 15.0% of net beverage segment sales, compared to $1.2 million, or 16.5% of net beverage segment sales in the same period in 2004, while marketing expenses for the quarters ended September 30, 2005 and 2004 totaled $635,000 and $540,000, respectively. General and administrative expenses for the quarter were $871,000 compared to $827,000 in the same period in 2004.
     Other Income, net. Other income, net increased to $411,000 in the third quarter of 2005 from $3,000 in the third quarter of 2004. This change is primarily attributable to the sale of excess production equipment resulting in a $415,000 gain in the third quarter.
     Income Taxes. The Company recorded $1,000 income tax expense in the third quarter of 2005 compared to no income tax expense for the third quarter of 2004. For the most part, however, the Company recorded no income tax, other than minimal state filing fees, for the quarters ended September 30, 2005 and 2004. A valuation allowance was recorded against the deferred tax asset for the benefits of tax losses, which allowance may not be realized. Realization of the deferred tax assets is dependent on the Company’s ability to generate future U.S. taxable income. The Company does not believe that its net deferred assets meet the “more likely than not” realization criteria of SFAS No. 109. Accordingly, a full valuation allowance has been established. The Company will continue to evaluate the realizability of the deferred tax assets quarterly by assessing the need for and amount of a valuation allowance.
     Net Income (loss). The Company reported net income of $439,000 for the quarter ended September 30, 2005 compared to a net loss of $420,000 in the same quarter of 2004. The increase of $859,000 is primarily attributable to the $415,000 gain realized on the sale of excess production equipment as well as beverage sales volume increases, the cost reduction initiatives related to consolidating production operations offset by increased freight costs and additional sales and marketing activities.
NINE MONTH PERIOD ENDED SEPTEMBER 30, 2005 COMPARED TO NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004
     Gross Sales. Gross sales increased 24.2% to $38.4 million for the nine months ended September 30, 2005 from $31.0 million in the same period in 2004. Wholesale beverage sales increased 30.1% to $26.8 for the nine months ended September 30, 2005, from $20.6 million in the same period in 2004 as a result of a 29.9% increase in total beverage shipments. Of the total beverage shipments, beer shipments increased by 36.1% to 138,400 barrels in the quarter from 101,700 barrels in the same period in 2004 primarily due to Pyramid beer brand shipments which increased 13.5% to 102,000 barrels, compared to 89,900 barrels for the same period in 2004. Shipments of Thomas Kemper Soda increased by 10.8% to 36,700 barrels from 33,100 barrels in the same period of the prior year. Alehouse sales increased 12.4% to $11.7 million, in the nine month period from $10.3 million in the same period in 2004. The increase in alehouse sales was driven by the Portland Taproom, which was acquired in August 2004 and contributed $1.5 million in sales for the nine months ended September 30, 2005. Excluding the Portland Taproom, the same store alehouse sales increased $139,000, or 1.4%, largely due to higher traffic in the Seattle and Walnut Creek, California Alehouse locations offset by lower traffic at the Sacramento, California Alehouse location.
     Excise Taxes. Excise taxes totaled 7.5% and 7.2% respectively of gross beverage sales for each of the nine month periods ended September 30, 2005 and 2004. Per beer barrel shipped excise taxes remained flat at $14.50 per beer barrel. Although there was an increase in beer barrels shipped at the higher federal tax rate of $18.00 per barrel during the nine month period ended September 30, 2005 over the same period in 2004, this increase was offset by a decrease as a result of a greater portion of beverage sales to states with lower excise taxes and in which distributors pay the excise tax as well as contract brewing arrangements in which the Company allocates the payment of excise taxes to third parties.
     Gross Margin. Gross margin increased $1.5 million to $7.4 million, or 25.7%, for the nine months ended September 30, 2005 compared to the same period in 2004 due to higher beverage volumes. Gross margin as a percentage of sales increased to 20.4% from 20.1% in the same period in 2004.
                                                 
    Nine Month Period Ended September 30,
    (in thousands)
            % of Div.           % of Div.        
Gross Margin   2005   Net Sales   2004   Net Sales   $ Change   % Change
     
Beverage Operations
  $ 6,899       27.8 %   $ 5,431       28.4 %   $ 1,468       27.0 %
Alehouse Operations
    540       4.6 %     488       4.7 %     52       10.7 %
     
Total Operations
  $ 7,439       20.4 %   $ 5,919       20.1 %   $ 1,520       25.7 %
     

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     Selling, General and Administrative Expenses. Selling, general and administrative expenses for the nine months ended September 30, 2005 increased $1.0 million to $8.3 million over the same period in 2004. The additional expense was attributed to a $1.2 million increase in selling and marketing expenses for marketing of the MacTarnahan family of brands acquired in July 2004, as well as increased selling efforts related to Pyramid and acquired brands. Selling and marketing expenses for the nine months ended September 30, 2005 totaled $3.9 million and $1.9 million respectively, or 15.6% and 7.7% of net beverage segment sales, compared to $3.3 million and $1.3 million respectively, or 17.0% 6.9% of net beverage segment sales for the same period in 2004. General and administrative expenses for the nine months ended September 30, 2005 were $2.5 million, compared to $2.7 million in the same period in 2004. General and administrative expenses in 2004 included $434,000 in non-recurring charges related to severance and related expenses due to the change of the Company’s CEO in the first quarter of 2004.
     Other Income, net. Other income, net increased to $340,000 for the nine months ended September 30, 2005 from $99,000 for the same period in 2004. This change is primarily attributable to the sale of excess production equipment resulting in a $415,000 gain in the third quarter of 2005. For the nine months ended September 30, 2005, interest expense increased to $403,000, compared to $96,000 in the third quarter of 2004, primarily due to interest associated with the Berkeley facility mortgage and the line of credit interest, partially offset by sublease income of $172,000 recorded for the Berkeley facility during the third quarter of 2005.
     Income Taxes. The Company recorded approximately $4,000 and $3,000 of income tax expense in the nine months ended September 30, 2005 and 2004, respectively, related to certain state tax expense. For the most part, however, the Company recorded no income tax for the periods ended September 30, 2005 and 2004 because it has recorded a full valuation allowance against its net operating loss carryforwards.
     Net Loss. The Company reported a net loss of $524,000 for the nine months ended September 30, 2005 compared to a net loss of $1.3 million in the same period in 2004. The increase of $746,000 is primarily attributable to the $415,000 gain realized on the sale of excess production equipment as well as beverage sales volume increases, the cost reduction initiatives related to consolidating production operations offset by increased freight costs and additional sales and marketing activities.
LIQUIDITY AND CAPITAL RESOURCES
     The Company had a zero balance of cash, cash equivalents and short-term investments at September 30, 2005 and December 31, 2004 respectively. At September 30, 2005, the Company’s working capital was a negative $1.1 million compared to a negative $2.2 million at December 31, 2004 and was impacted by Portland Acquisition integration cost and underutilized brewing capabilities.
     Net cash provided in operating activities for the nine months ended September 30, 2005 decreased to $643,000 from $1.4 million for the nine months ended September 30, 2004. The decrease in cash provided in operating activities was primarily due to the $524,000 in net loss for the year, which included a $415,000 gain on the sale of excess brewery equipment compared to $1.3 million net loss in the same period last year, offset by an increase in accounts receivable of $571,000 for the comparative periods.
     Net cash used in investing activities totaled approximately $32,000 for the nine months ended September 30, 2005 compared to $2.2 million for the same period of the prior year. The net cash used in investing activities for the nine months ended September 30, 2005, was due to capital purchases primarily related to the consolidation of brewing activities to the Portland site and other brewery projects which approximated $325,000 and the purchases of approximately $272,000 of new kegs offset by proceeds from the sale of excess brewery equipment. The net cash used in investing activities for the nine months ended September 30, 2004, was primarily due to the $1.4 million acquisition of certain Portland Brewing Company assets, and purchases of fixed assets approximating $769,000 which included purchases of brewery equipment and improvements totaling approximately $415,000.
     Net cash used in financing activities totaled approximately $611,000 during the nine months ended September 30, 2005, compared to approximately $743,000 for the same period during 2004. The net cash used in financing activities during the nine months ended September 30, 2005, as compared to the same period in 2004, was primarily due to a $751,000 decrease in cash dividends paid, offset by an increase in cash paid on the line of credit. Additionally, the Company incurred a financing cash requirement of $365,000 related to the buyback of Company stock from the former CEO in the nine months ended September 30, 2004.
     Although the Company has no cash and a working capital deficit as of September 30, 2005, because the beverage segment operates with relatively short accounts receivable terms and the alehouse segment operates as a cash business, the Company typically tends to collect within 30 days of a sale or immediately upon sale. Therefore, the Company generally does not require significant cash on hand to meet operating needs.
     Management believes that the August 2005 consolidation of the majority of the Company’s Seattle brewery production into the recently acquired Portland brewery will reduce production costs and help to meet rising demand for Pyramid branded products. The Company plans to continue its focus on initiatives to further improve operating results which include driving growth of its core brand

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families in order to deliver revenue growth, increasing capacity utilization while decreasing fixed production costs, judicious use of marketing investment in programs which deliver positive returns, and achieving further operating efficiencies in our breweries to reduce costs and improve margin delivery. The Company will continue to evaluate opportunities for continued improvements and financial performance. However, management anticipates utilizing the funds under the Company’s line of credit during the seasonally slow winter months, and it is possible that some or all of the Company’s cash requirements may not be met by these activities, which would require the Company to seek additional capital from other sources. Alternative sources of capital may not be available to the Company on attractive terms or at all.
     Other measures taken to manage cash flows include the decision announced by the Company in February 2005, that its Board of Directors had determined to cease paying dividends in order to reinvest the Company’s positive cash flow back into the business. Any future declaration of dividends will depend, among other things, on the Company’s results of operations, capital requirements and financial condition, and on such other factors as the Company’s Board of Directors may in its discretion consider relevant.
     Future capital requirements may vary depending on such factors as the cost of acquisition of businesses, brands and real estate costs in the markets selected for future expansion, whether such real estate is leased or purchased and the extent of improvements necessary. While there can be no assurance that current expectations will be realized and plans are subject to change upon further review, the Company believes that its cash from operations and, to the extent required and available, bank borrowings, will be sufficient for the Company’s working capital needs.
Critical Accounting Policies
     To prepare financial statements that conform with accounting principles generally accepted in the United States, management must select and apply accounting policies and make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our accounting estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
     There are certain critical accounting estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We consider an accounting estimate to be critical if:
    it requires us to make assumptions because information was not available at the time or it included matters that were highly uncertain at the time we were making the estimate, and
 
    changes in the estimate or different estimates that we reasonably could have selected would have had a material impact on our financial condition or results of operations.
     Our critical accounting policies are those that involve the most complex or subjective decisions or assessments. The Company believes that its critical accounting policies and estimates include the following:
     Inventory. Inventories are stated at the lower of cost or market. Cost is computed using standard costs, which approximates actual cost, on a first-in, first-out basis and market represents the lower of replacement cost or estimated net realizable value. The Company adjusts inventory carrying values downward to market values based on the existence of excess and obsolete inventories determined primarily by season demand forecasts and branding changes.
     Long-Lived Assets Impairment. The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company’s evaluation is based on an estimate of the future undiscounted net cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. Long-lived assets to be disposed of are evaluated in relation to the estimated fair value of such assets less the estimated costs to sell. Long-lived assets are written down to their estimated net fair value calculated using a discounted future cash flow analysis in the event of an impairment. Beginning in the fiscal year 2002, the Company accounts for long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” If circumstances related to the Company’s long-lived assets change, the Company’s valuation of the long-lived assets could materially change.
     Realization of Deferred Tax Assets. The Company evaluates its ability to realize its deferred tax assets quarterly by assessing the need for and amount of the valuation allowance. The evaluation of the realizability of the deferred tax assets is based on existing deferred tax liabilities and an assessment of the Company’s ability to generate future U.S. taxable income. Results of operations in recent years are considered in the assessment. The Company records a valuation allowance for the portion of its deferred tax assets that do not meet the recognition criteria of SFAS No. 109, “Accounting for Income Taxes.” If circumstances related to the Company’s ability to generate future U.S. taxable income change, the Company’s evaluation of its ability to realize its deferred tax assets could materially change.

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     Promotional Activities Accrual. Throughout the year, the Company’s sales force engages in promotional activities with the Company’s distributor and retail customers. In connection with financial statement preparation and other financial reporting, management is required to make certain estimates and assumptions regarding the amount and timing of expenditures resulting from these activities. Actual expenditures incurred could differ from management’s estimates and assumptions. If management’s estimates and assumptions differ from the actual promotional activities incurred a timing difference could result either understating or overstating the actual promotional activity expense in a subsequent period. Because of the nature of promotional activities and the historical trends used in management analysis, management does not consider the potential timing differences to be a significant risk in the financial statement presentation.
     Allowance for Keg Deposits. The Company purchases kegs from vendors and records these assets in property, plant and equipment. When the kegs are shipped to the distributors, a keg deposit is collected. The deposit amount is based on, among other things, the size of the keg and the destination point. This deposit is refunded to the distributors upon return of the kegs to the Company. The keg deposit liability is recorded as a current liability. On a periodic basis, typically annually, management is required to make certain estimates regarding the physical count of kegs in the marketplace, estimated loss of kegs, expectations regarding keg returns and assumptions that affect the reported amounts of keg deposit liabilities and keg assets in property, plant and equipment at the date of the financial statements. Actual keg deposit liability could differ from the estimates. For the quarter ended September 30, 2005, the allowance for keg deposits liability was approximately $756,000.
RISK FACTORS AND FORWARD LOOKING STATEMENTS
     The Company does not provide forecasts of future financial performance. However this report does contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which are subject to the “safe harbor” created by that section. There are numerous important factors that could cause results to differ materially from those anticipated by some of the statements made by the Company. Investors are cautioned that all forward-looking statements involve a high degree of risk and uncertainty.
     Liquidity. The Company has no cash, a negative working capital and negative net cash used in investing activities for the quarter ended September 30, 2005. In addition, the Company’s line of credit expires on March 31, 2006 and therefore must be paid in full at that time unless we agree with the bank to extend the line. At September 30, 2005, there were no borrowing on the line of credit. Although the Company expects the initiatives discussed above in “Liquidity and Capital Resources” to drive additional sales and eliminate redundant costs, there is no guarantee that the savings will be sufficient to meet the cash operating and investing needs of the company.
     Beverage Competition. The domestic market in which the Company’s craft beers compete is highly competitive for many reasons, including the continuing proliferation of new beers and brew pubs, efforts by regional craft brewers to expand their distribution, the introduction of fuller-flavored products by certain major national brewers, and underutilized craft brewing capacity. The Company anticipates that intensifying competition from craft beer and imported beer producers and excess capacity in the craft beer segment may adversely impact the Company’s operating margins. In addition, the larger national brewers have developed brands to compete directly with craft beers. These national competitors have advantages such as lower production costs, larger marketing budgets, greater financial and other resources and more developed and extensive distribution networks than the Company. There can be no assurance that the Company will be able to grow its volumes or be able to maintain its selling prices in existing markets or as it enters new markets.
     Alehouse Competition. The restaurant industry is highly competitive. There are a substantial number of restaurant operations that compete directly and indirectly with the Company, many of which have significantly greater financial resources, higher revenues and greater economies of scale. The restaurant business is often affected by changes in consumer tastes and discretionary spending patterns; national and regional economic and public safety conditions; demographic trends; the cost and availability of raw materials, labor and energy; purchasing power; governmental regulations and local competitive factors. Any change in these or other related factors could adversely affect the Company’s restaurant operations. Multi-unit foodservice operations such as the Company’s can also be substantially affected by adverse publicity resulting from food quality, illness, injury, health concerns or operating issues stemming from a single restaurant.
     Access to Markets. Most of the Company’s independent distributors are also distributors of national brewers, some of whom have used their greater influence and marketing resources to persuade those distributors to exclude the products of other breweries from their portfolios. Such actions by national brewers have the effect of reducing distribution options for the Company’s products. In addition, many independent distributors are moving towards consolidation to improve profit margins. Although the Company has not yet been negatively impacted by such events, it is possible that the Company could effectively be denied access to a market or markets by the tactics of the national brewers and further consolidation of independent distributors. In the states that comprise the majority of its sales, the Company has the option to distribute its products directly to retailers and the Company has previous experience in doing so. However, there is no assurance that self-distribution can be done in an economic manner over large territories.
     Government Regulations. The Company’s business is highly regulated at the federal, state and local levels, and its brewery and restaurant operations require various licenses, permits and approvals. The loss or revocation of any existing licenses, permits or approvals, or the failure to obtain any additional licenses, permits or approvals in new jurisdictions where the Company intends to do business could

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have a material adverse effect on the ability of the Company to conduct its business. Further, federal regulations prohibit, among other things, the payment of slotting allowances to retailers for beer products. These regulations have the effect of preventing competitors with greater financial resources from excluding smaller brewers from retailers. If these regulations were repealed or substantially modified, there would likely be a material adverse effect on the Company’s business and operating results.
     Selling Prices. The future selling prices the Company charges for its craft beer and other specialty beverages may decrease from historical levels due to increasing competitive pressures, which may adversely affect the Company’s revenues. The Company has and will continue to participate in price promotions with its wholesalers and their retail customers. Management believes that the number and frequency of the Company’s promotions may increase during 2005. Increased costs associated with these promotions may adversely affect the Company’s operating results.
     Variability of Margins and Operating Results. The Company anticipates that its operating margins will fluctuate and may decline as a result of many factors, including (i) lower sales volumes and selling prices, (ii) increased depreciation and other fixed and semi-fixed operating costs as a percent of sales during periods when the Company’s breweries are producing below designed capacity, (iii) increased raw material and packaging costs, (iv) changes in product mix and packaging, (v) increased transportation costs, (vi) increased sales from retail operations which may have a lower gross margin (as a percentage of net sales) than beer sales, and (vii) increased selling and promotional costs incurred as the Company protects its business in existing markets. Increases in federal or state excise taxes and the impact of an increasing average federal excise tax rate as production increases may also cause a decline in the Company’s gross margins. The Company pays federal excise taxes on all beer sales and pays state excise taxes on beer sales occurring in various states at various tax rates. The federal excise tax is $7.00 per barrel on the first 60,000 barrels and $18.00 per barrel exceeding 60,000 annually, as long as total annual sales are less than two million barrels. The Washington state excise tax is $4.78 per barrel annually, Oregon state excise tax is $2.60 per barrel annually and the California state excise tax is $6.20 per barrel annually.
     Seasonality. Our business is subject to seasonal fluctuations. Historically, sales have been higher during the summer months. As a result, our quarterly and annual operating results and comparable sales may fluctuate significantly as a result of seasonality and other factors. Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable sales for any particular future period may decrease.
     Acquisitions. The acquisition of existing brewery and or restaurant facilities may have unanticipated consequences that could harm our business and financial condition. The Company may seek to selectively acquire existing facilities which requires identification of suitable acquisition candidates, negotiating acceptable acquisition terms and obtaining appropriate financing. Any acquisition pursued may involve risks including material adverse effects on operating results, costs of integrating the acquired business into the Company operations, risks associated with entering into new markets, conducting operations where the Company has limited experience or the diversion of management’s attention from other business concerns. Future acquisitions, which may be accomplished through a cash purchase transaction or the issuance of equity securities, or a combination could result in potentially dilutive issuances of securities, the incurrence of debt and contingent liabilities and impairment charges related to goodwill and other intangible assets, any of which could harm the Company’s business and financial condition.
     Results of operations in any period should not be considered indicative of the results to be expected for future periods. Fluctuations in operating results may also result in fluctuations in the price of the Company’s common stock. In future quarters, the Company’s operating results may not meet the expectations of public market analysts or investors. In such an event, the market price of the common stock could be materially adversely affected.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
     The Company has not and does not currently have any intention to hold any derivative instruments or engage in hedging activities. Also, the Company does not have any outstanding variable rate debt, other than the bank line of credit which is tied to the prime rate, and the Company does not enter into significant transactions denominated in foreign currency. Therefore, the Company’s direct exposure to risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, and other market changes that affect market risk sensitive instruments is not material.
     The Company does, at times, maintain an investment portfolio of various holdings, types and maturities. These securities are generally classified as available for sale and, consequently, are recorded on the balance sheets at fair value. At any time, a rise or decrease in interest rates could have a material impact on interest earnings of the investment portfolio. The Company currently does not hedge interest rate exposures.
ITEM 4. Controls and Procedures
Procedures
     Evaluation of disclosure controls and procedure

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     The Company maintains a set of disclosure controls and procedures and internal controls designed to ensure that information required to be disclosed in its filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this report and have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
Changes in internal controls
     There were no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II — OTHER INFORMATION
ITEM 4. Submission of Matters to a Vote of Security Holders
     On September 22, 2005, we held our 2005 Annual Meeting of Shareholders (the “Annual Meeting”).
     At the Annual Meeting, the following directors were elected to serve until the Annual Meeting of Shareholders indicated below and until their respective successors are elected and qualified:
                         
Director Nominated   Term Expires   Votes For   Withheld
George Hancock
    2008       8,420,102       137,333  
                         
Scott S. Barnum
    2008       8,482,242       75,193  
                         
Lee Andrews
    2006       8,474,904       82,531  
                         
John Lennon
    2007       8,457,722       99,713  
     Other directors whose terms of office continued after the meeting included Scott Svenson and Kurt Dammeier.
     Our shareholders also ratified the appointment of Moss Adams LLP as the independent auditors for the Company for the fiscal year ending December 31, 2005. With respect to this proposal, there were 8,488,037 votes cast for the proposal, 57,465 votes cast against the proposal, 11,933 abstentions and no broker non-votes.
ITEM 6. EXHIBITS
         
   
10.26
  Offer Letter from Pyramid Breweries Inc. to Jason Rees, dated September 2, 2005*(1)
 
 
   
   
31.1
  Certification Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002: John J. Lennon, President and Chief Executive Officer
 
 
   
   
31.2
  Certification Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002: Jason W. Rees, Vice President of Finance and Chief Accounting Officer
   
 
   
   
32.1
  Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002: John J. Lennon, President and Chief Executive Officer
 
 
   
   
32.2
  Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002: Jason W. Rees, Vice President of Finance and Chief Accounting Officer
 
*   Indicates management contract or compensatory plan or arrangement
(1)   Incorporated by reference to the Registrant’s Current Report on Form 8-K filed September 6, 2005.
Items 1, 2, 3 and 5 of PART II are not applicable and have been omitted

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SIGNATURE
     Pursuant to the requirements of Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
             
    PYRAMID BREWERIES INC.    
 
           
 
  By:                       /s/ JOHN LENNON    
 
           
 
      John Lennon    
 
      President and Chief Executive Officer    
 
           
 
  By:                       /s/ JASON W. REES    
 
           
 
      Jason W. Rees    
 
      Vice President of Finance and Chief Accounting Officer    
 
      (Principal Financial Officer)    
DATE: November 14, 2005
      

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