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Pyramid Breweries 10-Q 2007 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007
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) (206) 682-8322 (Registrant’s telephone number, including area code) 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 a large accelerated filer, an accelerated
filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer”
in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated filer o Accelerated filer o Non-accelerated filer 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: 9,156,578 shares of Common Stock outstanding as of
May 7, 2007
Table of Contents
PYRAMID BREWERIES INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2007 TABLE OF CONTENTS
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PART I
Item 1 — FINANCIAL STATEMENTS
PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
The accompanying notes are an integral part of these statements.
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PYRAMID
BREWERIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except share data)
The accompanying notes are an integral part of these statements.
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PYRAMID BREWERIES INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
The accompanying notes are an integral part of these statements.
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PYRAMID BREWERIES INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Nature of Operations and Summary of Significant Accounting Policies
The Company
Pyramid Breweries Inc. (“Pyramid” or the “Company”), a Washington corporation, was
incorporated in 1984 and is engaged in the brewing, marketing and selling of craft beers and sodas.
Until the end of 2006, we also produced a line of premium sodas (Note 2). We own two alehouse
restaurants adjacent to our full production breweries under the Pyramid Alehouse and MacTarnahan’s
Taproom brand names in Berkeley, California and Portland, Oregon, respectively, and three alehouse
restaurants in Walnut Creek and Sacramento, California and Seattle, Washington. We sell our
products through a network of selected independent distributors and alehouses located primarily in
Washington, Oregon and California. As of March 31, 2007, our products were distributed in
approximately 37 states within the U.S. Our core Pyramid brand family includes Hefe Weizen and
Apricot Weizen beers and our non-core beer brands include MacTarnahan’s along with smaller product
lines reported under the Allied Brand designation.
Basis of Presentation
The accompanying condensed consolidated balance sheet as of December 31, 2006, which has been
derived from audited consolidated financial statements, and the unaudited interim condensed
consolidated financial statements as of March 31, 2007, have been prepared in accordance with
accounting principles generally accepted in the United States (GAAP) 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 our 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. These financial statements should be read in
conjunction with the audited financial statements and notes thereto included in the Company’s
Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
Basis of Consolidation
The accompanying condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries: PBC Acquisition, LLC and Pyramid Gilman Street Property,
LLC. Intercompany transactions and balances are eliminated in consolidation.
Impairment of Long-lived Assets
We review our long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of the assets may not be recoverable. Each impairment test is
based on a comparison of the undiscounted future cash flows to the recorded value of the asset. If
an impairment is indicated, the asset is written down to its estimated fair value based on quoted
fair market values.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined using standard cost,
which approximates actual cost, on a first-in, first-out basis and market represents the lower of
replacement cost or estimated net realizable value. We regularly review our inventories for the
presence of excess and obsolete inventory using criteria such as age, quality, seasonal demand
forecasts and branding changes, and write-off or adjust the inventory to carrying value.
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Revenue Recognition
We recognize revenue from the sale of wholesale beer and contract manufactured soda products
at the time of shipment, when the title to products passes to the customer in accordance with
distributor sales agreements and collectibility is probable. Our revenue from our alehouses is
comprised of food, beverage and merchandise, and is recognized at the time of sale.
We do not have standard terms that permit return of product. However, occasionally products
are destroyed by distributors or us for quality reasons such as expiration of product. The costs
for product returns are recorded in cost of sales in the Condensed Consolidated Statements of
Operation and revenue is reduced at the value of the original sales price in the period that the
product is returned.
We report revenues under the contract manufacturing arrangements with the Kemper Company (Note
2) on a net basis pursuant to the guidance prescribed in Emerging Issues Task Force (“EITF”) Issue
No. 99-19, Reporting Revenue as a Principal versus Net as an Agent, as we are an agent.
Excise Taxes
The federal government levies excise taxes on alcoholic beverages, including beer. For brewers
producing no more than 2.0 million barrels of beer per calendar year, the federal excise tax is
$7.00 per barrel on the first 60,000 barrels of beer removed for consumption or sale during a
calendar year, and $18.00 per barrel for each barrel in excess of 60,000. Individual states also
impose excise taxes on alcoholic beverages in varying amounts, which have also been subject to
change.
As presented in the Condensed Consolidated Statement of Operations, gross sales represent
billed to customer activities. Excise taxes are taxes paid by us to state and federal government
agencies. Net sales represent revenues to us net of applicable state and federal excise taxes.
Net Earnings (Loss) Per Share
Basic net earnings (loss) per share is computed by dividing net income (loss) by the
weighted average number of common shares outstanding during the period. Diluted net earnings (loss)
per share is computed by dividing net income (loss) by the weighted average number of common shares
of stock outstanding and assumes the vesting of other dilutive securities including employee stock
options and awards.
The following represents the reconciliation of basic net earnings (loss) per share and diluted
net earnings (loss) per share (in thousands, except per share amounts):
The following shares attributable to outstanding stock options were excluded from the calculation
of dilutive earnings (loss) per share because their inclusion would have been anti-dilutive.
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Liquidity
As of March 31, 2007, cash and cash equivalents and accounts receivable were $3.8 million.
Although our working capital was positive at $424,000, working capital was negatively impacted by
amounts accrued in 2006 including, executive transition costs, the excise tax settlement, as well
as an increase in short term financing related to our capital lease keg financing agreement (Note
6).
Net cash used in operating activities increased to approximately $2.2 million for the three
months ended March 31, 2007, compared to approximately $99,000 in the first quarter a year ago.
Excluding the effects of the non-cash gain related to the sale of the Thomas Kemper brand and
related net assets and liabilities (“TK Soda Assets”), the increase in net cash used in operating
activities is primarily attributed to the reduction in accounts payable and accrued expenses during
the first quarter of 2007. Additionally, decreases in our gross margins primarily due to product
mix sold in the first quarter, and increases in selling and marketing expenses due to brand
building and expansion efforts contributed to the increase in net cash used in operating
activities.
The beverage segment operates with relatively short accounts receivable terms and the alehouse
segment operates essentially as a cash business, as such we typically tend to collect within 30
days of a sale or immediately upon sale. Therefore, we generally do not require significant cash on
hand to meet operating needs.
In January 2007, we completed the sale of the TK Soda Assets to The Kemper Company, a new
company formed by Adventure Funds, a Portland-based equity investment fund. Under the terms of the
transaction, we received $3.1 million in cash, $310,000 of which is held in escrow, for TK Soda
Assets including the brand and intellectual property, soda kegs, vehicles and point of sale
materials. The transaction includes a five-year supply agreement under which we will continue to
manufacture Thomas Kemper Soda products for The Kemper Company at our breweries in Portland, Oregon
and Berkeley, California. Through this transaction, we are further increasing our strategic focus
on our beer business and are making a number of investments in our brewing infrastructure in the
coming year. This includes investments in new kegs and fermentation tanks to handle additional
growth, and improvements to our packaging processes to enhance production efficiencies.
We believe that our cash flow from operating activities, tighter management of capital
spending and cash management in combination with various financing options, including the line of
credit and capital asset leasing, should provide adequate working capital to meet our needs.
Additionally, we believe that the cash provided from the sale of the TK Soda Assets will improve
our liquidity while allowing us to make these capital investments. However, it is possible that
this cash infusion may be insufficient to meet our capital investment requirements, which would
require us to seek additional capital from other sources, which may not be available to us on
attractive terms or at all.
We also plan to focus on initiatives to further improve operating results which include
driving sales volume growth of our core brand family to deliver revenue growth and judicious use of
marketing investment in programs which deliver positive returns.
Recently Issued Accounting Pronouncements
In June 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF No. 06-3,
How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in
the Income Statement (That Is, Gross versus Net Presentation), which states that a company may
adopt a policy for presenting taxes on a gross or net basis. If taxes are significant, the
accounting policy should be disclosed, and if taxes are presented gross, the amounts included in
revenue should be disclosed. The consensus reached on this Issue is effective for periods beginning
after December 15, 2006 with early application permitted. As our accounting policy is to present
excise taxes on a “gross basis” as described in the EITF 06-3, our policy and disclosure
presentation are already in accordance with EITF No. 06-3.
In July 2006, the FASB issued Interpretation (“FIN”) No. 48, Accounting for Uncertainty
in Income Taxes—an Interpretation of FASB Statement No. 109, which clarifies the accounting for
uncertainty in tax positions including whether to file or not to file a return in a particular
jurisdiction. This Interpretation prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected
to be taken in income tax returns. The provisions of FIN No. 48 are effective as of the beginning
of our 2007 fiscal year, with any cumulative effect of the change in accounting principle recorded
as an adjustment to opening retained earnings. The impact of adopting FIN No. 48 did not have a
material impact on our financial position, results of operations and cash flows.
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In September 2006, SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements
when Quantifying Current Year Misstatements. SAB No. 108 requires analysis of misstatements using
both an income statement (rollover) approach and a balance sheet (iron curtain) approach in
assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB No.
108 is effective for our fiscal year 2007 annual financial statements. We adopted SAB 108 effective
January 1, 2006. During the fourth quarter of 2006, we decreased beginning retained earnings by
$258,000, and increased deferred rent by $174,000.
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair
Value Measurements, which defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair value measurements.
SFAS No. 157 does not require any new fair value measurements, but provides guidance on how to
measure fair value by providing a fair value hierarchy used to classify the source of the
information. This statement is effective for us as of the beginning of our 2008 fiscal year. We are
currently assessing the potential impact that the adoption of SFAS No. 157 will have on our
financial position, results of operations and cash flows.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities—Including an Amendment of FASB Statement No. 115. The Statement permits
entities to choose, at specified election dates, to measure many financial instruments and certain
other items at fair value that are not currently measured at fair value. Unrealized gains and
losses on items for which the fair value option has been elected would be reported in earnings at
each subsequent reporting date. SFAS No. 159 also establishes presentation and disclosure
requirements in order to facilitate comparisons between entities choosing different measurement
attributes for similar types of assets and liabilities. SFAS No. 159 does not affect existing
accounting requirements for certain assets and liabilities to be carried at fair value. This
statement is effective for us as of the beginning of our 2008 fiscal year. We are currently
evaluating the requirements of SFAS No. 159 and have not yet determined the impact on the financial
statements.
Reclassification
Certain reclassifications have been made to the prior year balances to conform to the current
year presentation.
2. Thomas Kemper Soda Transaction
On January 2, 2007, we entered into an Asset Purchase Agreement (“Purchase Agreement”) with
The Kemper Company (“Kemper”), a new company formed by Adventure Funds, a Portland-based equity
investment fund, pursuant to which we agreed to sell the TK Soda Assets to Kemper (the “Sale”).
Pursuant to the Purchase Agreement, Kemper paid $3.1 million, $310,000 of which is held in escrow
in exchange for the TK Soda Assets, including the brand and other intellectual property, kegs,
vehicles and point of sale materials. We recorded a gain of $2.4 million, which represented the
difference between the proceeds from the sale of the net assets and liabilities held for sale, net
of transaction costs and adjustments of $224,000.
In connection with the Sale, the Company and Kemper also entered into an Exclusive Soda
Production and Supply Agreement (“Supply Agreement”), on January 2, 2007, pursuant to which we will
manufacture Thomas Kemper Soda products for Kemper to specifications mutually agreed upon by both
parties. The Supply Agreement appoints us as the exclusive manufacturer of existing Thomas Kemper
Soda products in a territory comprised of 14 states in the West and Southwest, including
Washington, Oregon, California and Texas. To the extent the parties so agree, our appointment may
be expanded to cover additional territories and/or new soda products. The Supply Agreement has an
initial term of five years, which may be terminated earlier by either party as a result of the
other party’s material breach or bankruptcy, or by Kemper beginning in 2009 provided that Kemper
makes certain early termination payments to us. Unless earlier terminated, the Supply Agreement
will automatically extend beyond the initial five year term and then may be terminated by either
party with six months written notification. Under the Supply Agreement, Kemper will pay us a
tolling fee for all products manufactured by us under the Supply Agreement, comprised of
manufacturing costs plus a profit component, and reimburse us for shipping costs. The tolling fee
may be adjusted annually to reflect any increases or decreases in our costs of manufacturing the
products.
As a result of our significant continuing involvement in manufacturing of Thomas Kemper Soda
under the Supply Agreement, the Sale does not qualify for presentation as a discontinued operation.
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3. Stock-Based Compensation
Effective January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payment, using the modified
prospective transition method which requires the application of the accounting standard as of
January 1, 2006. Under the modified prospective transition method, compensation cost associated
with the stock option plans recognized for the three months ended March 31, 2007 and 2006 includes:
(a) compensation cost for stock options granted prior to, but not yet vested as of January 1, 2007,
based on the grant date fair value estimated in accordance with the original provision of SFAS No.
123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for
Stock-Based Compensation — Transition and Disclosure, and (b) compensation cost for stock options
granted subsequent to January 1, 2006, based on the grant date fair value under SFAS 123(R). SFAS
123(R) also requires us to estimate future forfeitures in calculating the expense relating to
stock-based compensation as opposed to only recognizing these forfeitures and the corresponding
reduction in expense as they occur. We use the Black-Scholes valuation model for estimating the
grant-date fair value of awards.
Restricted Stock Awards
Effective January 1, 2007, restricted stock awards for 187,000 shares were granted to certain
executive officers and employees, as approved by the Committee, with a weighted average grant date
fair value of $3.07. Of these restricted stock award grants, 164,000 shares are time-based and
vest in even increments over five years beginning one year from the grant date. Compensation cost
associated with the time-based awards is recognized on a straight-line basis over the requisite
service period which is approximately six years.
The performance-based awards are contingent on corporate performance and were granted
effective January 1, 2007 after the 2006 annual performance goal had been met and vest one year
from the grant date. Compensation cost associated with these performance grants is recognized when
it is probable that the performance targets will be met and accordingly, all expense associated
with these awards was recorded in 2006.
Under an Employment Separation Agreement, 4,000 shares of time-based and 4,000 shares of
performance-based restricted stock awards vested immediately.
Employee Stock Purchase Plan
In May 2003, we adopted and our shareholders approved, an Employee Stock Purchase Plan (the
“Purchase Plan”) which allowed eligible employees to acquire shares of common stock of the Company
at a discount. A total of 500,000 shares of common stock were available under the Purchase Plan. We
terminated the Purchase Plan after the fourth quarter purchase in January 2007.
There were 3,155 and 4,076 shares issued to employees under the Purchase Plan for the three
months ended March 31, 2007 and 2006, respectively to satisfy obligations under this plan for
fourth quarter purchases in each respective previous year.
The weighted average estimated fair value of these purchase rights was $2.13 and $1.88 for the
three months ended March 31, 2007 and 2006, respectively.
Stock-based Compensation Expense and Proceeds
In the three months ended March 31, 2007 and 2006, we recognized $37,000 and $30,000 in
stock-based compensation expense for stock options, restricted stock awards, and employee stock
plan purchases. As of March 31, 2007 the total estimated unrecognized compensation cost related to
stock options was approximately $3,000 expected to recognize over a weighted average remaining
period of 1.5 years. As of March 31, 2007, the total estimated unrecognized compensation cost
related to restricted stock awards was approximately $434,000 expected to recognize over a weighted
average remaining period of 4.8 years.
In the three months ended March 31, 2007, we received $39,000 in cash proceeds from stock
option exercises, and there were no stock options exercised for the three months ended March 31,
2006.
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4. Inventories
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.
5. Line of Credit
We have a $2.5 million line of credit agreement with our bank, which we modified in March 2007
to extend the maturity date to March 31, 2008 from the previous maturity of June 30, 2007. A
portion of the line of credit, $345,000, has been reserved to support the standby letter of credit
for the keg lease agreement (Note 6). Based on the terms of the agreement, the availability to
borrow on the line is 75% of eligible accounts receivable. The interest rate charged on the amounts
outstanding is prime plus 0.5%, fully floating, with a 0.8% commitment fee. We granted the bank
security interest in our property and assets as well as the proceeds and the products of the
collateral, namely cash, accounts receivable, inventory and fixed assets. We have also agreed to
adhere to certain financial performance covenants with a bank consent restriction on the payment of
future dividends and must limit capital expenditures to $3.25 million. We were in compliance with
these covenants as of March 31, 2007.
6. Capital Lease
In February 2006, we entered into a non-cancelable lease agreement for the lease of up to
14,500 new kegs and we purchased the maximum amount of kegs allowed under the lease agreement for
$1.2 million in debt payable over a 30-month period. We are required by the terms of the lease
agreement to furnish a standby letter of credit in the amount of $345,000 which reduces the amount
available on our $2.5 million line of credit.
7. Litigation and Contingencies
In June 2005, Sound Beverages, a former distributor of ours, filed a suit in King County
Superior Court against us. The suit alleged that we had violated Washington’s Wholesale
Distributor/Supplier Equity Act, RCW 19.126, by unreasonably withholding consent to the transfer of
distribution rights to Columbia Distribution. We contend that we were within our rights to
reasonably withhold consent, and are contesting this matter including the $450,000 in damages
claimed by Sound Beverages. This matter is in the early stages of arbitration. Management
believes that the ultimate outcome to us will not have a material adverse impact on our financial
condition or results of operations.
In addition to the matter discussed above, we are involved from time to time in claims,
proceedings and litigation arising in the ordinary course of business. We do not believe that any
such claim, proceeding or litigation, either alone or in the aggregate, will have a material
adverse effect on our financial position or results of operations.
8. Segment Information
Our management has identified two primary operating segments, beverage operations and
alehouses, which are organized around differences in products and services and are managed
separately because each business requires different production, management and marketing
strategies. Beverage operations include the production and sale of our beverage products including
both beer and soda, which effective in 2007, is contract manufactured for Kemper. The alehouse
segment consists of five alehouses, which market and sell the full line of our beer products as
well as food and certain merchandise.
The accounting policies of the segments are the same as those described in the summary of
significant accounting policies (Note 1). We evaluate performance based on profit or loss from
operations before income taxes not including nonrecurring gains and losses.
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We record intersegment sales at cost. The “Other” category consists of interest income,
general and administrative expenses, corporate office assets and other reconciling items that are
not allocated to segments for internal management reporting purposes. Total assets include accounts
receivable, inventory, goodwill and fixed assets specific to a segment.
Segment information for the periods ended March 31, 2007 and 2006 is as follows (in
thousands):
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Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This report contains forward-looking statements within the meaning of the federal securities
laws. All statements that do not concern historical facts are forward-looking statements concerning
future performance, developments or events, concerning potential sales, restaurant expansion,
production capacity, pending agreements with third parties and any other guidance on future
periods, constitute forward-looking statements. These statements may be identified by the use of
forward-looking terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,”
“expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should,” or “will,” or the
negative thereof, or comparable terminology. While we believe these expectations, assumptions,
estimates and projections are reasonable, such forward-looking statements are only predictions and
involve known and unknown risks and uncertainties, many of which are beyond our control and which
could cause actual results or outcomes to differ materially from our stated expectations. Some
factors, which could cause or contribute to such differences include, but are not limited to, those
discussed in Item 1A of Part I, “Risk Factors,” included in our Annual Report on Form 10-K for the
year ended December 31, 2006 as filed with the Securities and Exchange Commission (SEC). Any
forward-looking statements are made only as of the date hereof. We do not intend to update any such
statements or to publicly announce the results of any revisions to any such statements to reflect
future events or developments, except as may be required by law. Our actual future results could
differ materially from those projected in the forward-looking statements. We assume no obligation
to update the forward-looking statements for such factors.
Overview
We are engaged in the brewing, marketing and selling of craft beers under the Pyramid and
MacTarnahan’s labels. Until the end of 2006, we also produced a line of gourmet sodas under the
Thomas Kemper Soda Company label, which we sold in January 2007 as more fully discussed below.
We operate two alehouse restaurants adjacent to our full production breweries under the
Pyramid Alehouse and MacTarnahan Taproom brand names in Berkeley, California and Portland, Oregon,
respectively, and three alehouse restaurants located in Walnut Creek and Sacramento, California and
Seattle, Washington. As of March 31, 2007, our products were distributed in approximately 37 states
within the U.S. through a network of selected independent distributors and brokers.
On January 2, 2007, we completed the sale of the Thomas Kemper Soda brand and related net
assets and liabilities (“TK Soda Assets”) to The Kemper Company, a new company formed by Adventure
Funds, a Portland-based equity investment fund. Under the terms of the transactions, we received
$3.1 million for Thomas Kemper Soda assets including the brand and intellectual property, soda
kegs, vehicles and point of sale materials. The transaction includes a five-year supply agreement
(“Supply Agreement”) under which we will continue to manufacture Thomas Kemper Soda products for
Kemper at our breweries in Portland, Oregon and Berkeley, California. Through this transaction, we
are further increasing our strategic focus on our beer business and are making a number of
investments in our brewing infrastructure in the coming year. This includes investments in new kegs
and fermentation tanks to handle additional growth, and improvements to our packaging processes to
enhance production efficiencies.
Results of Operations
The following table sets forth, for the periods indicated, certain selected unaudited
operating data, expressed as a percentage of net sales.
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SELECTED UNAUDITED OPERATING DATA
QUARTER ENDED MARCH 31, 2007 COMPARED TO QUARTER ENDED MARCH 31, 2006
Gross Sales. Gross sales decreased 3.1%, or $352,000, to $11.2 million in the quarter ended
March 31, 2007, from $11.5 million in the same quarter in 2006 driven primarily by wholesale
beverage segment sales which decreased 4.4%, or $360,000, to $7.8 million in the first quarter. The
decrease was primarily attributable to the fact that beginning in 2007, we now contract to
manufacture Thomas Kemper Soda as an agent, and as such, we record the revenues and cost of sales
as a net amount, in gross sales. Additionally, under the new Supply Agreement, we realize lower
revenues as a contact manufacturer. Total beverage shipments increased 5.7% to 53,500 barrels and
of the total beverage shipments, beer shipments increased by 4.7% to 44,700 barrels in the quarter
from 42,700 barrels in the same period in 2006, primarily due to increased Pyramid brand shipments.
Pyramid brand shipments increased 8.5% to 38,400 barrels for the quarter, driven by Pyramid Hefe
Weizen, our top selling product, which was up 10.5% in shipment volumes for the quarter. Alehouse
sales of $3.4 million remained flat in the first quarter of 2007 and were comprised of single digit
sales growth increases in our Sacramento and Walnut Creek locations offset by declines in sales in
our other locations.
Excise Taxes. Excise taxes were 10.2% and 8.0% of gross beverage sales for the quarters ended
March 31, 2007 and 2006, respectively. Per beer barrel shipped, excise taxes in the first quarter
of 2007 increased to $18.45 per beer barrel as compared to $15.96 in the same period in 2006.
Federal taxes paid on beer shipments are determined by the level of shipments. For the first 60,000
barrels of production the federal excise tax rate for “small brewers” like Pyramid is $7 per barrel
resulting in incremental volume being taxed at an $18 per beer barrel rate. State taxes per barrel
vary on a state by state basis. The increase in excise taxes on a per beer barrel basis is related
primarily to the agreement reached with the federal Alcohol and Tobacco Tax and Trade Bureau
(“TTB”) during the third quarter of 2006, thereby recognizing us as the brewer of record at the
Portland brewery facility.
Gross Margin. Gross margin for the quarter ended March 31, 2007 decreased 8.6% to $2.3 million
from $2.5 million as compared to the same period in 2006 primarily as a result of product mix in
the beverage division and lower revenue on Thomas Kemper Soda products under the new supply
agreement. Additionally, gross margin as a percentage of net sales decreased to 21.9% in the
quarter ended March 31, 2007, as compared to 22.8% in the same period in 2006.
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Selling, General and Administrative Expenses. Selling, general and administrative expenses
increased 16.0%, or $469,000, to $3.4 million for the quarter ended March 31, 2007, from $2.9
million in the same period in 2006. The additional expense was primarily attributed to an increase
in selling and marketing expenses of $363,000 comprised of a $183,000 increase in marketing
expenses to $570,000 primarily due to brand building efforts for our Pyramid and MacTarnahan’s
brands and other advertising and sponsorship costs and a $180,000 increase in selling expenses
to $1.5 million, or 21.1% of net beverage segment sales,
compared to $1.3 million, or 17.3% of net beverage segment sales
in the same period in 2006 primarily due to expansion efforts.
Additionally, general and administrative expenses for the quarter ended March 31, 2007 increased by
$106,000, to $1.4 million, due primarily to an increase in public company costs of $80,000
associated primarily with our compliance efforts with the Sarbanes-Oxley Act of 2002 and increases
in salary and benefits due to an increase in personnel offset by a decrease in professional fees
attributed to higher legal costs in the prior year due to the TTB audit and the related contract
manufacturing arrangements with Portland Brewing Company.
Gain on sale. We recognized a gain on sale of $2.4 million in the first quarter of 2007 as
the result of the sale of the TK Soda Assets.
Other (Expense) Income, Net. Other (expense) income, net, decreased to expense of $30,000 in
the first quarter of 2007 from expense of $51,000 in the first quarter of 2006, primarily
attributable to an increase in interest expense associated with our capital lease offset by other
miscellaneous income.
Income Taxes. As of March 31, 2007, we had deferred tax assets arising from deductible
temporary differences and tax loss carryforwards offset against certain deferred tax liabilities.
Realization of the deferred tax assets is dependent on our ability to generate future U.S. taxable
income. We do not believe that our net deferred assets meet the “more likely than not” realization
criteria and accordingly, a full valuation allowance has been established. We will continue to
evaluate the ability to realize the deferred tax assets quarterly by assessing the need for and
amount of the valuation allowance.
Net Income (Loss). We reported net income of $1.3 million for the quarter ended March 31, 2007
compared to a net loss of $505,000 in the same quarter of 2006. The net income for the quarter
ended March 31, 2007 is primarily due to the gain recognized on the sale of the TK Soda Assets.
Liquidity and Capital Resources and Commitments
We
had a $595,000 and $227,000 balance of cash and cash equivalents and a $3.2 million and $3.1
million accounts receivable balance at March 31, 2007 and December 31, 2006, respectively. At March
31, 2007, our working capital was positive at $424,000 compared to a negative $1.4 million at
December 31, 2006. Although our working capital was impacted positively by the proceeds received in
connection with the sale of the TK Soda Assets, working capital was negatively impacted by amounts
accrued in 2006 including, executive transition costs, the excise tax settlement, as well as an
increase in short term financing related to our capital lease keg financing agreement.
Net cash used in operating activities for the three months ended March 31, 2007 increased to
$2.2 million from $99,000 for the three months ended March 31, 2006. Excluding the effects of the
non-cash gain related to the sale of the TK Soda Assets, the increase in net cash used in operating
activities is primarily attributed to the reduction in accounts payable and accrued expenses during
the first quarter of 2007. Additionally, decreases in our gross margins primarily due to product
mix sold in the first quarter, and increases in selling and marketing expenses due to brand
building and expansion efforts contributed to the increase in net cash used in operating
activities.
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Net cash provided by investing activities totaled approximately $2.7 million for the three
months ended March 31, 2007 compared to net cash used of $175,000 for the same period of the prior
year. The increase in cash provided by investing activities primarily reflects the cash we received
in conjunction with the sale of TK Assets offset by capital asset purchases in the first quarter of
2007, as compared to the first quarter of 2006.
Net cash used in financing activities totaled approximately $132,000 during the three months
ended March 31, 2007, compared to net cash used of approximately $18,000 for the same period during
2006. The increase from the three months ended March 31, 2007 was primarily due to payments made on
our capital lease obligation and our TTB excise tax obligation during the first quarter of 2007.
In March 2007, we renegotiated our line of credit agreement with the bank which makes
available through March 31, 2008, a $2.5 million line of credit. A portion of the line of credit,
$345,000, has been reserved to support the standby letter of credit for the keg lease agreement
(Note 6 to the condensed consolidated financial statements). Any borrowings are subject to an
interest rate of prime plus 0.5%, fully floating, with a 0.8% commitment fee. Under the terms of
the agreement, we must limit capital expenditures to $3.25 million and adhere to certain financial
performance covenants with a restriction on the payment of future dividends.
The beverage segment operates with relatively short accounts receivable terms and the alehouse
segment operates essentially as a cash business, as such we typically tend to collect within 30
days of a sale or immediately upon sale. Therefore, we generally do not require significant cash on
hand to meet operating needs.
In January 2007, we completed the sale of the TK Soda Assets to The Kemper Company. Through
this transaction, we are further increasing our strategic focus on our beer business and are making
a number of investments in our brewing infrastructure in the coming year. This includes investments
in new kegs and fermentation tanks to handle additional growth, and improvements to our packaging
processes to enhance production efficiencies in our breweries to reduce costs and improve margins.
We believe that our cash flow from operating activities, tighter management of capital
spending and cash management in combination with various financing options, including the line of
credit and capital asset leasing, would provide adequate working capital to meet our needs.
Additionally, we believe that the cash provided from the sale of the TK Soda Assets will improve
our liquidity by reducing our reliance on our line of credit during the seasonally slow first
quarter of 2007, while allowing us to make capital investments. However, it is possible that this
cash infusion may be insufficient to meet our capital investment requirements, which would require
us to seek additional capital from other sources, which may not be available to us on attractive
terms or at all.
Contractual Obligations
At March 31, 2007, our commitment to make future payments under contractual obligations were
as follows (in thousands):
In conjunction with the Portland Brewing Company (“Portland Brewing”) asset purchase, we
entered into a 5-year earn-out agreement with Portland Brewing which may result in additional
payments to Portland Brewing based on sales of Portland Brewing brands during the earn-out period.
For the quarter ended March 31, 2007 and 2006, there were no amounts owed under the earn-out.
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Contingencies
In June 2005, Sound Beverages, a former distributor of ours, filed a suit in King County
Superior Court against us. The suit alleged that we had violated Washington’s Wholesale
Distributor/Supplier Equity Act, RCW 19.126, by unreasonably withholding consent to the transfer of
distribution rights to Columbia Distribution. We contend that we were within our rights to
reasonably withhold consent, and are contesting this matter including the $450,000 in damages
claimed by Sound Beverages which we believe is substantially less. This matter is in the early
stages of arbitration. Management believes that the ultimate outcome to us will not have a
material adverse impact on our financial condition or results of operations.
In addition to the matter discussed above, we are involved from time to time in claims,
proceedings and litigation arising in the ordinary course of business. We do not believe that any
such claim, proceeding or litigation, either alone or in the aggregate, will have a material
adverse effect on our financial position or results of operations.
Critical Accounting Policies
See the information concerning our critical accounting policies included under Item 7,
Management’s Discussion and Analysis of Financial Condition and Results of Operation—Critical
Accounting Policies in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006
as filed with the SEC. There have been no significant changes in our critical accounting policies
during the three months ended March 31, 2007.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
We currently do not hold derivative instruments or engage in hedging activities, nor have we
engaged in such activities in the past. Also, we did not have any outstanding variable rate debt as
of March 31, 2007 due to the fact that we did not have an outstanding balance on the line credit.
Further, we do not enter into significant transactions denominated in foreign currency.
Accordingly, our 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.
ITEM 4. Controls and Procedures
Procedures
Procedures
(a) Evaluation of disclosure controls and procedure
We maintain a set of disclosure controls and procedures and internal controls designed to
ensure that information required to be disclosed in our 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. Based on their evaluation as of the end of
the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief
Financial Officer and Vice President of Finance, have concluded that as of the end of the period
covered by this Quarterly Report on Form 10-Q, our 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 us in reports that we file or
submit under the Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in internal controls
There were no significant changes in the Company’s internal control over financial reporting
during the three months ended March 31, 2007 in connection with this evaluation that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting.
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PART II — OTHER INFORMATION
ITEM 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider
the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the
year ended December 31, 2006 as filed with the Securities and Exchange Commission which could
materially affect our business, financial condition or future results. The risks described in our
Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and
uncertainties not currently known to us or that we currently deem to be immaterial also may
materially adversely affect our business, financial condition and/or operating results.
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ITEM 6. EXHIBITS
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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.
DATE: May 14, 2007
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