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Pyramid Breweries 10-Q 2005
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 JUNE 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
(State or other jurisdiction of
incorporation or organization)
  91-1258355
(I.R.S. Employer
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
     Common stock, par value of $.01 per share: 8,790,353 shares of Common Stock outstanding as of June 30, 2005
 
 

 


PYRAMID BREWERIES INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
TABLE OF CONTENTS
         
    Page
       
       
       
June 30, 2005 and December 31, 2004
    3  
       
Three Month and Six Month Periods Ended June 30, 2005 and 2004
    4  
       
Six Month Periods Ended June 30, 2005 and 2004
    5  
    6  
    12  
    19  
    19  
 
       
    20  
 
    21  
 EXHIBIT 10.26
 EXHIBIT 10.27
 EXHIBIT 10.28
 EXHIBIT 31.1
 EXHIBIT 31.2
 EXHIBIT 31.3
 EXHIBIT 32.1
 EXHIBIT 32.2
 EXHIBIT 32.3

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PART I
Item 1 — FINANCIAL STATEMENTS
PYRAMID BREWERIES INC.
BALANCE SHEETS
(Unaudited)
                 
    June 30,   December 31,
    (in thousands)
    2005   2004
     
CURRENT ASSETS:
               
Cash and cash equivalents
  $     $  
Accounts receivable, net of $20 allowance
    3,524       2,191  
Inventories
    2,037       2,129  
Prepaid expenses and other
    314       324  
     
Total current assets
    5,875       4,644  
     
Note receivable related party
           
Fixed assets, net
    27,997       28,859  
Goodwill
    415       415  
Intangibles
    186       209  
Other assets
    814       189  
     
Total assets
  $ 35,287     $ 34,316  
     
 
               
CURRENT LIABILITIES:
               
Accounts payable
  $ 3,790     $ 2,776  
Accrued expenses
    2,829       2,682  
Refundable deposits
    756       582  
Line of credit
    554       400  
Current portion of long-term financing
    96       83  
Note payable — current
    20       20  
Deferred rent — current
    75       75  
Dividends payable
          193  
     
Total current liabilities
    8,120       6,811  
Long-term financing, net of current
    7,721       7,117  
Deferred rent, net of current
    581       615  
     
Total liabilities
    16,422       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, 8,790,000 and 8,776,000 shares issued and outstanding
    88       88  
Additional paid-in capital
    37,237       37,214  
Deferred stock-based compensation
    (352 )     (384 )
Accumulated deficit
    (18,108 )     (17,145 )
     
Total stockholders’ equity
    18,865       19,773  
     
Total liabilities and stockholders’ equity
  $ 35,287     $ 34,316  
     
The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amount)
                                 
    Three Month Period Ended June 30,   Six Month Period Ended June 30,
    2005   2004   2005   2004
Gross sales
  $ 13,713     $ 10,936     $ 24,170     $ 19,225  
Less excise taxes
    693       534       1,250       942  
 
                               
Net sales
    13,020       10,402       22,920       18,283  
Cost of sales
    10,025       7,939       18,420       14,534  
 
                               
Gross margin
    2,995       2,463       4,500       3,749  
Selling, general and administrative expenses
    2,820       2,397       5,389       4,692  
 
                               
Operating income (loss)
    175       66       (889 )     (943 )
Other income, net
    (7 )     81       (71 )     95  
 
                               
Income (loss) before income taxes
    168       147       (960 )     (848 )
Provision for income taxes
          (2 )     (3 )     (3 )
 
                               
Net income (loss)
  $ 168     $ 145     $ (963 )   $ (851 )
 
                               
 
                               
Basic and diluted net income (loss) per share
  $ 0.02     $ 0.02     $ (0.11 )   $ (0.10 )
Weighted average basic shares outstanding
    8,790,000       8,391,000       8,786,000       8,495,000  
Weighted average diluted shares outstanding
    9,141,000       8,462,000       8,786,000       8,495,000  
Cash dividend declared per share
  $     $ 0.022     $     $ 0.066  
The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    Six Month Period Ended June 30,
    ( in thousands)
    2005   2004
OPERATING ACTIVITIES:
               
Net loss
  $ (963 )   $ (851 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    1,370       1,325  
Stock-based compensation expense
    32       (10 )
Interest expense
          2  
Loss on sales of fixed assets
          12  
Deferred rent
    (34 )     (99 )
Changes in operating assets and liabilities:
               
Accounts receivable
    (1,223 )     (1,292 )
Inventories
    92       (196 )
Prepaid expenses and other
    39       125  
Accounts payable and accrued expenses
    1,161       1,384  
Refundable deposits
    174       51  
 
               
Net cash provided by operating activities
    648       451  
INVESTING ACTIVITIES:
               
Purchases of short-term investments
           
Proceeds from the sale and maturities of short-term investments
           
Acquisitions of fixed assets
    (633 )     (384 )
Proceeds from sales of fixed assets
    33        
 
               
Net cash used in investing activities
    (600 )     (384 )
FINANCING ACTIVITIES:
               
Proceeds from the sale of common stock and option exercises
    23       187  
Note Payable
    (32 )      
Cash dividends paid
    (193 )     (761 )
Cash paid on line of credit
    154       (31 )
Purchase and retirement of common stock
          (365 )
 
               
Net cash used in financing activities
    (48 )     (970 )
 
               
(Decrease) increase in cash and cash equivalents
          (903 )
Cash and cash equivalents at beginning of period
          1,558  
 
               
Cash and cash equivalents at end of period
  $     $ 655  
 
               
The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.
NOTES TO CONDENSED 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 and in operating restaurants. The Company’s products are produced at breweries in Seattle, Washington; Portland, Oregon; and in Berkeley, Walnut Creek and Sacramento, California. 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, Saxer, and Nor’Wester. The Company also manufactures a line of gourmet sodas under the Thomas Kemper Soda Company label. As of June 30, 2005, the Company’s products were distributed in approximately 38 states and Canada. As of June 30, 2005, the Company also operated five restaurants adjacent to its breweries under the Pyramid Alehouse and MacTarnahan’s Taproom brand names.
     The Company formed an entity, PBC Acquisition LLC, for the express purpose of acquiring certain assets from Portland Brewing Company. 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. The assets of these entities are consolidated into the Company’s unaudited condensed consolidated financial statements for financial reporting purposes.
     Effective July 23, 2004, the Company completed its purchase of the Berkeley Brewery and Alehouse facility located at 901 Gilman Street in Berkeley, California. Previously the Company had leased this facility. The Company’s lease obligations terminated with its purchase of the facility.
     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. 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.
Stock Based Compensation
     At June 30, 2005, the Company has stock-based compensation plans which are described more fully in Note 18 of the Consolidated Audited 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.” 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 $32,000 for the three and six months ended June 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. The pro forma amounts of the Company’s net income (loss) and net income (loss) per share for the quarters and six-month periods ended June 30, 2005 and 2004, are as follows:
                                 
    Three Month Period Ended June 30,   Six Month Period Ended June 30,
    (in thousands)
    2005   2004   2005   2004
         
Net income (loss) as reported
  $ 168     $ 145     $ (963 )   $ (851 )
Add: Stock-based compensation cost as reported
    16             32       (10 )
Less: Stock-based compensation cost determined under the fair value based method
    (26 )     (37 )     (60 )     (74 )
         
Net income (loss) pro forma
  $ 158     $ 108     $ (991 )   $ (935 )
 
                               
Basic and diluted net income (loss) per share as reported
  $ 0.02     $ 0.02     $ (0.11 )   $ (0.10 )
Basic and diluted net income (loss) per share pro forma
  $ 0.02     $ 0.01     $ (0.12 )   $ (0.11 )

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     There were no options granted in the second quarter of 2005 and 2004. Fair value of options granted in the six months ended June 30, 2005 was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: risk-free interest rate of 3.9%; expected option lives of five years; expected volatility of 51%.There were no options granted in the six months ended June 30, 2005.
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.
Reclassification
     Beginning with the quarter ended June 30, 2005, the Company changed the accounting method for alehouse administrative costs, which were previously reflected as selling, general and administrative expenses, to reflect these costs as a cost of sales on the Company’s statement of operations. This change has been accounted for as a prior period adjustment in accordance with Accounting Principals Board Opinion No. 20 “Accounting Changes.” Results from prior periods have been similarly adjusted to reflect this change.
2. Liquidity
     During the six months ended June 30, 2005 the Company’s working capital decreased $78,000 to a negative $2,245,000. This decrease in working capital is the result of normal seasonality in its operating divisions, as the first quarter of the year is historically the slowest for the Company resulting in an operating cash use. With the warmer weather of the spring and summer seasons the second and third quarters of the Company are historically the best and help to mitigate the negative working capital of the first quarter. Seasonality, the impact of the integration costs of the Portland Brewing Company assets and underutilized brewing capabilities negatively impacted the working capital during the first half of the year. The Company’s operating activities for the six months ended June 30, 2005 provided $649,000, comprised of cash used of $644,000 in the first quarter of the year and $1,293,000 in cash provided by operating activities in the second quarter of the year. This cash provided by operating activities was the result of the reported net income and improved operating results driven through consolidating production facilities. The Company’s investment activities of $600,000 for the six months ended June 30, 2005 were primarily directed toward adding additional kegs for the increased demand for draught and facility operational improvement projects. The net cash used in financing activities of $49,000 for the six months ended June 30, 2005 were principally from the cash dividends paid in the first quarter funded by $154,000 drawn under the operating line of credit. As of June 30, 2005 the Company had drawn $554,000 of the $2,000,000 available under its line of credit balance.
     Management initiatives designed to improve operating results, increase working capital, and enhance production efficiencies in the Company’s operations are underway. These initiatives include 1) the consolidation of the majority of the Company’s Seattle brewery production into the recently acquired Portland brewery in order to meet rising demand for its Pyramid branded products and to reduce production costs; 2) reductions in non-critical and redundant overhead costs throughout the Company; 3) elimination of unprofitable and low volume products to help streamline production and 4) alternative uses for the Seattle brewery. Management believes that these initiatives are beginning to show meaningful and positive impact on the Company’s performance. The Company expects to implement these initiatives throughout 2005. The impact of these changes are expected to improve the Company’s performance and to improve the Company’s cash position in the second half of the 2005.
     As of June 30, 2005, the Company had no cash and a working capital deficit of $2,245,000. However, 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. and Management believes that the Company has adequate financing to conduct its operations.
     The Company expects that the initiatives to improve operating results, the cash provided by operating activities and the funds available through the Company’s line of credit will provide adequate cash to meet the Company operating needs. However, 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.
3. Inventories
     Inventories consist of the following:

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    June 30,   December 31,
    (in thousands)
    2005   2004
Raw materials
  $ 834     $ 905  
Work in process
    243       191  
Finished goods
    960       1,033  
 
               
 
  $ 2,037     $ 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.
4. Fixed Assets
     Fixed assets consist of the following:
                 
    June 30,   December 31,
    (in thousands)
    2005   2004
Land
  $ 6,181     $ 6,181  
Buildings
    11,895       11,895  
Brewery and retail equipment
    19,611       19,328  
Furniture and fixtures
    1,116       1,106  
Leasehold improvements
    6,053       5,899  
Construction in progress
    204       208  
 
               
 
    45,060       44,617  
 
               
Less: accumulated depreciation and amortization
    (17,063 )     (15,758 )
 
               
 
  $ 27,997     $ 28,859  
 
               
5. Accrued Expenses
     Accrued expenses consist of the following:
                 
    June 30,   December 31,
    (in thousands)
    2005   2004
Salaries, wages and related accruals
  $ 1,007     $ 978  
Barrel taxes
    581       157  
Other accruals
    1,241       1,547  
 
               
 
  $ 2,829     $ 2,682  
 
               
6. Other (Expense) Income, net
     Other (Expense) Income, net consists of interest income and parking fee income, and other non-operating income and expenses as follows:

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    Three Months Ended June 30,   Six Months Ended June 30,
    (in thousands)   (in thousands)
    2005   2004   2005   2004
Interest income
  $ 4     $ 7     $ 4     $ 14  
Sublease income
    57             111        
Interest expense
    (143 )     (1 )     (275 )     (2 )
Parking income
    82       78       103       84  
(Loss) gain on sale of assets
          (2 )           (12 )
Loan fee amortization
    (7 )     (3 )     (14 )     (3 )
Other income (expense)
          2             14  
 
                               
Other income, net
  $ (7 )   $ 81     $ (71 )   $ 95  
 
                               
7. Income (Loss) Per Share
     Basic income (loss) per share was computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted income (loss) per share was computed by dividing net income (loss) by the weighted average number of common shares of common stock outstanding plus additional common shares that would be outstanding from in-the-money stock options.
     Options to purchase approximately 430,000 and 197,000 shares of common stock were outstanding as of June 30, 2005 and 2004, respectively, but were not included in the six months’ computation of EPS because their effects are antidilutive.
                                 
    Three Month Period Ended June 30,   Six Month Period Ended June 30,
    2005   2004   2005   2004
         
Net income (loss)
  $ 168     $ 145     $ (963 )   $ (851 )
 
                               
Shares:
                               
Weighted average basic shares outstanding
    8,790,000       8,391,000       8,786,000       8,495,000  
         
Basic income (loss) per share
  $ 0.02     $ 0.02     $ (0.11 )   $ (0.10 )
         
Stock option dilution
    351,143       71,000              
         
Weighted average diluted shares outstanding
    9,141,143       8,462,000       8,786,000       8,495,000  
         
Diluted income (loss) per share
  $ 0.02     $ 0.02     $ (0.11 )   $ (0.10 )
         
8. Line of Credit
     The Company has a $2 million line of credit agreement with its bank. 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 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 June 30, 2005. The line of credit expires December 31, 2005.
9. Debt
     On January 27, 2005, the Company announced that it has entered into a long-term $7,850,000 securitized financing arrangement with Morgan Stanley Mortgage Capital Inc., for the purpose of refinancing the Company’s existing $7,200,000 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 5.77%, 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 $1,729 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.

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At June 30, 2005, future minimum payments are as follows:
         
2005
  $ 50,000  
2006
    99,000  
2007
    105,000  
2008
    110,000  
2009
    118,000  
Thereafter
    7,335,000  
 
       
 
  $ 7,817,000  
 
       
10. 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.
11. Cash Dividend
     On February 9, 2005, the Company announced that its Board of Directors has determined to cease paying dividends at this time 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.
12. Subsequent Event
     On August 4, 2005, the Company accepted an offer from a third party to purchase substantially all equipment currently located in the Seattle, Washington brewing facility at a purchase price of $725,000. The transaction is expected to be completed in August 2005. The assets consist of brewing and production equipment with an original cost of approximately $1,604,000 and a net book value of approximately $305,000. The Company expects to report a gain of approximately $300,000 net of sales commissions and fees in the three months ending September 30, 2005.
13. 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.
     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, 2005, 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:

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    Beverage            
    Operations   Alehouse   Other   Total
            (Dollars in thousands)        
Quarter ended June 30, 2005
                               
Gross revenues from external customers
  $ 9,589     $ 4,124     $     $ 13,713  
Net revenues from external customers
    8,896       4,124             13,020  
Intersegment revenues
    172             (172 )      
Interest income
                4       4  
Depreciation and amortization
    435       215       63       713  
Operating income (loss)
    1,444       294       (1,563 )     175  
Capital expenditures
    271       33       8       312  
Total assets
    20,807       6,463       8,017       35,287  
 
                               
Quarter ended June 30, 2004
                               
Gross revenues from external customers
  $ 7,399     $ 3,537     $     $ 10,936  
Net revenues from external customers
    6,865       3,537             10,402  
Intersegment revenues
    142             (142 )      
Interest income
                7       7  
Depreciation and amortization
    404       213       45       662  
Operating income (loss)
    959       280       (1,173 )     66  
Capital expenditures
    123       31       38       192  
Total assets
    18,348       6,458       2,385       27,191  
 
                               
Six months ended June 30, 2005
                               
Gross revenues from external customers
  $ 16,692     $ 7,478     $     $ 24,170  
Net revenues from external customers
    15,442       7,478             22,920  
Intersegment revenues
    303             (303 )      
Interest income
                4       4  
Depreciation and amortization
    849       427       126       1,402  
Operating income (loss)
    1,689       235       (2,813 )     (889 )
Capital expenditures
    410       138       30       578  
Total assets
    20,807       6,463       8,017       35,287  
 
                               
Six months ended June 30, 2004
                               
Gross revenues from external customers
  $ 12,659     $ 6,566     $     $ 19,225  
Net revenues from external customers
    11,717       6,566             18,283  
Intersegment revenues
    236             (236 )      
Interest income
                14       14  
Depreciation and amortization
    804       431       90       1,325  
Operating income (loss)
    1,307       269       (2,519 )     (943 )
Capital expenditures
    206       93       85       384  
Total assets
    18,348       6,458       2,385       27,191  

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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 June 30,        
    (in thousands, except barrel & shares)
            % of           % of
    2005   Net Sales   2004   Net Sales
Gross sales
  $ 13,713             $ 10,936          
Less excise taxes
    693               534          
 
                               
Net sales
    13,020       100.0       10,402       100.0  
Cost of sales
    10,025       77.0       7,939       76.3  
 
                               
Gross margin
    2,995       23.0       2,463       23.7  
Selling, general and administrative expenses
    2,820       21.7       2,397       23.0  
 
                               
Operating income
    175       1.3       66       0.6  
Other (expense) income, net
    (7 )     (0.1 )     81       0.8  
 
                               
Income before income taxes
    168       1.3       147       1.4  
Benefit for income taxes
                (2 )     (0.0 )
 
                               
Net income
  $ 168       1.3     $ 145       1.4  
 
                               
 
                               
Basic and diluted net income per share
  $ 0.02             $ 0.02          
 
                               
 
                               
Operating data (in barrels):
                               
Beer barrels shipped
    50,100               34,500          
Soda barrels shipped
    13,700               13,700          
 
                               
Total barrels shipped
    63,800               48,200          
 
                               
Annual production capacity
    334,000               204,000          
 
                               

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    Six Month Period Ended June 30,
    ( in thousands, except barrels)
            % of           % of
    2005   Net Sales   2004   Net Sales
Gross sales
  $ 24,170             $ 19,225          
Less excise taxes
    1,250               942          
 
                               
Net sales
    22,920       100.0       18,283       100.0  
Cost of sales
    18,420       80.4       14,534       79.5  
 
                               
Gross margin
    4,500       19.6       3,749       20.5  
Selling, general and administrative expenses
    5,389       23.5       4,692       25.7  
 
                               
Operating loss
    (889 )     (3.9 )     (943 )     (5.2 )
Other income, net
    (71 )     (0.3 )     95       0.5  
 
                               
Loss before income taxes
    (960 )     (4.2 )     (848 )     (1.8 )
Provision for income taxes
    (3 )     (0.0 )     (3 )     (0.0 )
 
                               
Net loss
  $ (963 )     (4.2 )   $ (851 )     (1.8 )
 
                               
 
                               
Basic and diluted net loss per share
  $ (0.11 )           $ (0.10 )        
 
                               
 
                               
Operating data (in barrels):
                               
Beer barrels shipped
    87,100               61,100          
Soda barrels shipped
    23,400               21,800          
 
                               
Total barrels shipped
    110,500               82,900          
 
                               
Annual production capacity
    334,000               204,000          
 
                               
QUARTER ENDED JUNE 30, 2005 COMPARED TO QUARTER ENDED JUNE 30, 2004
     Gross Sales. Gross sales increased 25.4% to $13,713,000 in the quarter ended June 30, 2005, from $10,936,000 in the same quarter in 2004. Wholesale beverage segment sales increased 29.6% to $9,589,000 in the quarter from $7,399,000 in the same quarter in 2004. Total beverage barrel shipments increased 32.4% in the quarter compared to the same period in the prior year. Total beer shipments increased by 45.2% to 50,100 barrels in the quarter from 34,500 barrels in the same period in 2004. Pyramid beer brand shipments increased 10.7% to 37,300 barrels in the quarter, while MacTarnahan’s beer shipments increased to 4,600 barrels in the quarter, contract brewing increased 5,300 barrels to 5,500 beer barrel shipments in the quarter and Allied beer shipments increased 292.1% to 2,700 barrels in the quarter from 700 barrels in the same period in 2004. Shipments of Thomas Kemper Soda remained consistent at 13,700 barrels for the quarter. All sales regions increased shipment volumes in the quarter ended June 30, 2005 over the second quarter in 2004, with the core states of Washington, Oregon and California all recording double digit growth. Pyramid Hefeweizen, the Company’s top selling product, was up 18.4% in shipment volumes for the quarter. Alehouse sales increased 16.6%, to $4,124,000 in the quarter from $3,537,000 in the same quarter in 2004. Excluding the Portland Taproom, which was acquired in July 2004, the same store alehouse sales increased $65,000, or 1.8%, over the same period in 2004.
     Excise Taxes. Excise taxes totaled 7.2% of gross beverage sales for the quarters ended June 30, 2005 and 2004. Per beer barrel shipped excise taxes decreased to $13.83 per beer barrel from $15.48 per beer barrel in the same period in 2004. This decrease is the 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. 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 $532,000 to $2,995,000, an increase of 21.6%, in the quarter ended June 30, 2005 compared to the same period in 2004. Although gross margin dollars increased as a result of higher sales volumes in the beverage segment and increased alehouse sales with the addition of the Portland Taproom, the gross margin as a percentage of sales decreased to 23.0% in the quarter ended June 30, 2005 from 23.7% in the same period in 2004. The decrease in gross margin as a percentage of sales is primarily the result of increasing freight costs in the form of higher fuel surcharges of 43% per barrel, and the sales growth of higher cost variety packaged products, or mixed packs.

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    Three Month Period Ended June 30,
    (in thousands)
            % of Div.           % of Div.        
Gross Margin   2005   Net Sales   2004   Net Sales   $ Change   % Change
     
Beverage Division
  $ 2,701       30.4 %   $ 2,183       31.8 %   $ 518       23.7 %
Alehouse Division
    294       7.1 %     280       7.9 %     14       5.0 %
     
Total
  $ 2,995       23.0 %   $ 2,463       23.7 %   $ 532       21.6 %
     
     Selling, General and Administrative Expenses. Selling, general and administrative expenses for the quarter increased $423,000 to $2,820,000 over the same period in 2004. The additional expense was attributed to a $388,000 increase in selling and marketing expenses, for marketing of the MacTarnahan’s family of brands acquired in July 2004, as well as increased selling efforts related to all the acquired brands and the Pyramid brands. Selling expenses for the quarter ended June 30, 2005 totaled $1,257,000, or 14.1% of net beverage segment sales, compared to $1,112,000, or 16.2% of net beverage segment sales in the same period in 2004. General and administrative expenses for the quarter were $855,000 compared to $820,000 in the same period in 2004.
     Other Income (Expense), net. Other income (expense), net decreased to ($7,000) in the second quarter of 2005 from $82,000 in the second quarter of 2004. This change is primarily attributable to the interest expense associated with the Berkeley facility mortgage and the line of credit interest expense. For the second quarter of 2005, interest expense increased to $143,000, compared to $1,000 in the second quarter of 2004, partially offset by sublease income of $57,000 recorded for the Berkeley facility during the second quarter of 2005.
     Income Taxes. The Company recorded no income tax expense in the second quarter of 2005 compared to $2,000 of income tax expense for the second quarter of 2004. For the most part, however, the Company recorded no income tax, other than minimal state filing fees, for the quarters ended June 30, 2005 and 2004 because it has recorded a full valuation allowance against its net operating loss carryforwards.
     Net Income. The Company reported net income of $168,000 for the quarter ended June 30, 2005 compared to a net income of $145,000 in the same quarter of 2004.
SIX MONTH PERIOD ENDED JUNE 30, 2005 COMPARED TO SIX MONTH PERIOD ENDED JUNE 30, 2004
     Gross Sales. Gross sales increased 25.7% to $24,170,000 for the six months ended June 30, 2005 from $19,225,000 in the same period in 2004. Wholesale beverage sales increased 31.9% to $16,692,000 for the six months ended June 30, 2005, from $12,659,000 in the same period in 2004. Total beverage barrel shipments increased 33.4% compared to the same period in the prior year. Pyramid beer brand shipments increased 8.0% to 64,000 barrels, compared to 59,300 barrels for the same period in 2004, while MacTarnahan’s beer shipments increased to 9,200 barrels in the six months ended June 30, 2005, contract brewing increased to 9,000 beer barrel shipments and Allied beer increased 214.3% to 4,900 barrels. Shipments of Thomas Kemper Soda increased by 7.9% to 23,400 barrels from 21,800 barrels in the same period of the prior year. Alehouse sales increased 13.9%, to $7,478,000, in the six month period from $6,566,000 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 $983,000 in sales for the six months ended June 30, 2005. Excluding the Portland Taproom, the same store alehouse sales decreased $70,000, or 1.1%, largely due to lower traffic at the Sacramento and Walnut Creek, California Alehouse locations.
     Excise Taxes. Excise taxes totaled 7.4% of gross beverage sales for each of the six month periods ended June 30, 2005 and 2004. Per beer barrel shipped excise taxes decreased to $15.05 per beer barrel, from $16.31 per beer barrel in the same period in 2004. This decrease is the 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 . 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 $751,000 to $4,500,000, or 13.6%, for the six months ended June 30, 2005 compared to the same period in 2004 due to higher beverage volumes. Gross margin as a percentage of sales decreased to 19.6% from 20.5% in the same period in 2004. The decrease in gross margin as a percentage of net sales is primarily the result of increasing freight costs in the form of higher fuel surcharges and an increased proportion of higher cost variety packaged products.

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    Six Month Period Ended June 30,
    (in thousands)
            % of Div.           % of Div.        
Gross Margin   2005   Net Sales   2004   Net Sales   $ Change   % Change
     
Beverage Operations
  $ 4,266       27.6 %   $ 3,480       29.7 %   $ 786       22.6 %
Alehouse Operations
    234       5.9 %     269       4.1 %     (35 )     (13.0 %)
     
Total Operations
  $ 4,500       19.6 %   $ 3,749       20.5 %   $ 751       20.0 %
     
     Selling, General and Administrative Expenses. Selling, general and administrative expenses for the six month ended June 30, 2005 increased $486,000 over the same period in 2004. The additional expense was attributed to a $922,000 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 acquired brands and the Pyramid brands. Selling expenses for the six months ended June 30, 2005 totaled $2,468,000, or 16.0%, of net beverage segment sales, compared to $2,031,000, or 17.3%, of net beverage segment sales for the same period in 2004. General and administrative expenses for the six months ended June 30, 2005 were $1,647,000, compared to $1,872,000 in the same period in 2004. General and administrative expenses in 2004 included $260,000 related to the change of the Company’s CEO in the first quarter of 2004. The Company incurred no similar costs during the six months ended June 30, 2005.
     Other Income, net. Other income (expense), net decreased to ($71,000) for the six–months ended June 2005 from $96,000 for the same period in 2004. This change is primarily attributable to interest expense associated with the Berkeley facility mortgage and the line of credit interest expense. For the six–months ended June 2005, interest expense increased to $275,000, compared to $3,000 for the same period in 2004, partially offset by sublease income of $111,000 recorded for the Berkeley facility during the six months ended June 30, 2005.
     Income Taxes. The Company recorded approximately $2,000 of income tax expense in the six months ended June 30, 2005 related to certain state tax expense. For the most part, however, the Company recorded no income tax for the periods ended June 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 Loss. The Company reported a net loss of $963,000 for the six months ended June 30, 2005 compared to a net loss of $851,000 in the same period in 2004.
LIQUIDITY AND CAPITAL RESOURCES
     The Company had a zero balance of cash, cash equivalents and short-term investments at June 30, 2005 and at December 31, 2004. At June 30, 2005, the Company’s working capital was a negative $2,245,000 compared to a negative $2,167,000 at December 31, 2004. Net cash provided in operating activities for the six-months ended June 30, 2005 increased to $649,000 from $451,000 for the six-months ended June 30, 2004. The increase in cash provided in operating activities was primarily due to the $963,000 in net loss for the year offset by an increase in accounts payable in the six months of 2005 compared to the same period in 2004.
     Net cash used in investing activities for the six months ended June 30, 2005 was $600,000 compared to net cash used in investing activities of $384,000 for the same period of the prior year. The cash used in investing activities in the six months ended June 30, 2005 included approximately $215,000 for new kegs, approximately $198,000 in brewery projects, including consolidating brewing activities in Portland, and approximately $127,000 in various Alehouse projects, with the balance made up of various marketing and general and administrative capital spending projects.
     The elimination of the quarterly dividend resulted in a $193,000 decrease in accrued dividends payable as of June 30, 2005 and provided for a significant improvement to the financing activities cash requirements. During the first six months of 2004, the Company incurred a financing cash requirement of $365,000 related to the buyback of Company stock from the former CEO.
     At June 30, 2005, the Company’s commitments to make future payments under contractual obligations were as follows:

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            Less Than 1                   More Than
    Total   Year (2005)   1 -3 years   3 - 5 years   5 years
     
Operating leases
  $ 8,718,000     $ 888,000     $ 2,140,000     $ 2,220,000     $ 3,470,000  
Note payable (1)
    20,000       20,000                    
Note payable (2)
    7,817,000       50,000       204,000       228,000       7,335,000  
 
(1)   - The amounts are payments as stated in the non-interest bearing note. The note payable was recorded using a 10% discount rate on the balance sheet.
 
(2)   - The amounts are principal only payments as stated in the securitized financing arrangement for the Berkeley facility purchase.
     On February 9, 2005, the Company announced 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.
     On December 15, 1999, the Company also announced a stock buyback plan to repurchase up to $2,000,000 of the Company’s common stock from time to time on the open market. Stock purchases are at the discretion of management and 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 management may consider relevant. As of June 30, 2005, the Company has purchased and retired a total of 457,724 shares at an average price of $1.94 per share for a total of $892,000 since the inception of the program. The Company has not repurchased any shares since November 2001.
     Management initiatives designed to improve operating results, increase working capital, and enhance production efficiencies in the Company’s operations are underway. These initiatives include 1) consolidating the majority of the Company’s Seattle brewery production into the recently acquired Portland brewery in order to meet rising demand for its Pyramid branded products and to reduce production costs; 2) reductions in non-critical and redundant overhead costs throughout the Company; 3) elimination of unprofitable and low volume products to help streamline production; and 4) looking for alternative uses for the Seattle brewery. Management believes that these initiatives are beginning to show meaningful and positive impact on the Company’s performance. The Company expects to implement these initiatives throughout 2005. The impacts of these changes are expected to improve the Company’s performance and to improve the Company’s cash position in the second half of 2005.
     As of June 30, 2005 the Company had no cash and a working capital deficit. However, because the beverage segment operates with 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 and management believes that the Company has adequate liquidity to conduct its operations.
     The first quarter of the calendar year tends to be the slowest season for the Company, followed by a strong season during the second and third quarter. As a result of seasonality, cash during the first quarter is needed to build inventory levels in preparation for future sales activities. The Company expects that the initiatives to improve operating results, the cash provided by operating activities and the funds available through the Company’s line of credit will provide adequate cash to meet the Company operating needs. However, it is possible that some or all of the Company’s cash requirements may not be met by these activities which may require the Company to seek additional capital from other sources, which may or may not be available to the Company.
     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, we 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.

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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:
     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.
     Stock-Based Compensation. The Company follows Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees”, in accounting for its employee stock options and employee stock purchase plan using the fair value based method. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in the Company’s Statements of Operations. The Company is required under SFAS No. 123, “Accounting for Stock-Based Compensation”, to disclose pro forma information regarding option grants made to its employees based on specific valuation techniques that produce estimated compensation charges. The Black-Scholes option pricing model is used by the Company in estimating the fair value of options. If the Company changes the accounting for stock-based compensation, the Company’s results of operations could materially change.
     In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”. This Statement is a revision of SFAS No. 123, and supersedes APB 25 and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). SFAS No. 123R is effective at the beginning of the reporting period of the next fiscal year. The Company intends to implement the provisions of SFAS No. 123R in the first quarter 2006.
     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 June 30, 2005, the allowance for keg deposits liability was approximately $756,000.

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Subsequent Event
     On August 4, 2005, the Company accepted an offer from a third party to purchase substantially all equipment currently located in the Seattle, Washington brewing facility at a purchase price of $725,000. The transaction is expected to be completed in August 2005. The assets consist of brewing and production equipment with an original cost of approximately $1,604,000 and a net book value of approximately $305,000. The Company expects to report a gain of approximately $300,000 net of sales commissions and fees in the three months ending September 30, 2005.
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 June 30, 2005. In addition, the Company’s line of credit expires on December 31, 2005 and therefore must be paid in full at that time unless we agree with the bank to extend the line. At June 30, 2005, the total borrowing on the line of credit was $554,000. 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 as the company as well as pay off the line of credit.
     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 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

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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
     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

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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 6. EXHIBITS
     
10.26
  Employment Offer Letter between Registrant and Jim Hilger*
     
10.27
  Employment Offer Letter between Registrant and Patrick Coll*
     
10.28
  Pyramid Breweries Inc. Directors Compensation Plan*
     
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, 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: James K. Hilger, Vice-President and Chief Financial Officer
     
31.3
  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, Controller 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, 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: James K. Hilger, Vice-President and Chief Financial Officer
     
32.3
  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, Controller and Chief Accounting Officer
 
*   Indicates management contract or compensatory plan or arrangement
Items 1, 2, 3, 4 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/ JAMES K. HILGER
 
       
 
      James K. Hilger, Vice-President and Chief Financial Officer
 
       
 
  By:   /s/ JASON W. REES
 
       
 
      Jason W. Rees, Controller and Chief Accounting Officer
DATE: August 15, 2005

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