Pyramid Breweries 10-Q 2005
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FOR THE QUARTER ENDED SEPTEMBER 30, 2005
For the transition period from to .
Commission file number 0-27116
PYRAMID BREWERIES INC.
(Exact name of registrant as specified in its charter)
91 South Royal Brougham Way,
Seattle, WA 98134
(Address of principal executive offices) (Zip Code)
Registrants 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.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
TABLE OF CONTENTS
Item 1 FINANCIAL STATEMENTS
PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these statements.
PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amount)
The accompanying notes are an integral part of these statements.
PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these statements.
PYRAMID BREWERIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 MacTarnahans Taproom brand names. The Companys 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 Companys 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 Companys core beer brands include Pyramid and MacTarnahans, 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 Companys 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 Companys 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.
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 Companys 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):
The fair value of options granted was estimated using the Black-Scholes option-pricing model, assuming no dividends and the following other assumptions:
The Company recognizes revenue from the sale of wholesale beer and soda products at the time of shipment, when the title of the Companys products passes to the customer in accordance with distributor sales agreements and collectibility is probable. The Companys 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.
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 Companys financial position, results of operations or cash flows.
During the nine months ended September 30, 2005, the Companys 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 Companys 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 Companys 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 Companys line of credit during the seasonally slow winter months, and it is possible that some or all of the Companys 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.
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.
Inventories consist of the following (in thousands):
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.
4. Fixed Assets
Fixed assets consist of the following (in thousands):
5. Accrued Expenses
Accrued expenses consist of the following (in thousands):
6. Other Income, net
Other income, net consists of the following (in thousands):
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 Banks prior approval. The Company was in compliance with these covenants as of September 30, 2005.
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 Companys 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 Companys 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 Companys 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):
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 Companys 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 Companys management (the Management Approach), which is organized around differences in products and services.
Products and Services
The Companys 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 Companys beer and soda products as well as food and certain merchandise.
Factors used to identify reportable segments
The Companys 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.
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 Companys 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:
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 Managements 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
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 Companys 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.
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 Companys 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.
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 Companys 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 Companys 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 Companys 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 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 Companys line of credit during the seasonally slow winter months, and it is possible that some or all of the Companys 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 Companys positive cash flow back into the business. Any future declaration of dividends will depend, among other things, on the Companys results of operations, capital requirements and financial condition, and on such other factors as the Companys 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 Companys 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:
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 Companys 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 Companys long-lived assets change, the Companys 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 Companys 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 Companys ability to generate future U.S. taxable income change, the Companys evaluation of its ability to realize its deferred tax assets could materially change.
Promotional Activities Accrual. Throughout the year, the Companys sales force engages in promotional activities with the Companys 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 managements estimates and assumptions. If managements 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 Companys 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 Companys 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 Companys 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 Companys restaurant operations. Multi-unit foodservice operations such as the Companys 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 Companys 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 Companys 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 Companys 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
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 Companys 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 Companys 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 Companys promotions may increase during 2005. Increased costs associated with these promotions may adversely affect the Companys 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 Companys 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 Companys 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 managements 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 Companys 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 Companys common stock. In future quarters, the Companys 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 Companys 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
Evaluation of disclosure controls and procedure
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 Commissions rules and forms. The Companys Chief Executive Officer and Chief Financial Officer have evaluated the Companys 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 Companys 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 Companys 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:
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
Items 1, 2, 3 and 5 of PART II are not applicable and have been omitted
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.
DATE: November 14, 2005