-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IzWKfG+huLLNvaoyxpwHn3zpkeePKRdFq4+8xmoruPRepI4n6mhzPoN5JxuSk8p0 QZz6izghbLxkKvWLMVR9GA== 0000891618-97-001527.txt : 19970401 0000891618-97-001527.hdr.sgml : 19970401 ACCESSION NUMBER: 0000891618-97-001527 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PETES BREWING CO CENTRAL INDEX KEY: 0000856873 STANDARD INDUSTRIAL CLASSIFICATION: MALT BEVERAGES [2082] IRS NUMBER: 770110743 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-26834 FILM NUMBER: 97570593 BUSINESS ADDRESS: STREET 1: 514 HIGH ST CITY: PALO ALTO STATE: CA ZIP: 94303 BUSINESS PHONE: 4153287383 MAIL ADDRESS: STREET 1: 514 HIGH STREET CITY: PALO ALTO STATE: CA ZIP: 94301 10-K405 1 FORM 10-K405 FOR FISCAL YEAR ENDED 12/31/96 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /X/ Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 1996 or / / Transition report pursuant to Section 13 of 15(d) of the Securities Exchange Act of 1934 for the transition period from ________________ to _______________. COMMISSION FILE NUMBER: 0-26834 PETE'S BREWING COMPANY (Exact name of registrant as specified in its charter) CALIFORNIA 77-0110743 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 514 HIGH STREET, PALO ALTO, CALIFORNIA 94301 (Address of principal executive office) (zip code) Registrant's telephone number, including area code: (415) 328-7383 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange Title of each class on which registered ------------------- --------------------- None None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, no par value Preferred Share Purchase Rights (Title of Class) 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 X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. /X/ The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on February 28, 1997 as reported on the Nasdaq National Market, was approximately $37,395,503. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of February 28, 1997, registrant had outstanding 10,715,769 shares of Common Stock. DOCUMENTS INCORPORATED BY REFERENCE The Registrant has incorporated by reference into Part III of this Form 10-K portions of its Proxy Statement for the Annual Meeting of Shareholders to be held May 12, 1997. Portions of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1996 are incorporated by reference into Parts II and IV of this Form 10-K. 2 PART I The information contained in this Report includes forward-looking statements, based on current expectations, that involve risks and uncertainties which could cause actual results to differ materially from those expressed in the forward-looking statements. Various important factors known to Pete's Brewing Company that could cause such material differences are identified below in Part I, Item 1 of this report and in the "Management's Discussion and Analysis of Results of Operations and Financial Condition" included in the Company's 1996 Annual Report to Shareholders, which is incorporated by reference into Part II, Item 7 of this Report. ITEM 1. BUSINESS Pete's Brewing Company ("Pete's" or the "Company") is the second largest major domestic craft brewer in the United States. The Company currently markets its 12 distinctive full-bodied beers in 49 states, the District of Columbia and the United Kingdom under the "Pete's Wicked" brand name. Pete's Wicked Ale, the Company's flagship beer has won 17 awards for excellence since it was introduced in 1986. In addition, Pete's currently markets Pete's Wicked Bohemian Pilsner, Pete's Wicked Honey Wheat, Pete's Wicked Amber Ale, Pete's Wicked Summer Brew and Pete's Wicked Winter Brew. In order to appeal to varying consumer preferences, in July 1996 the Company diversified its product line by introducing and marketing four new beers, Pete's Wicked Pale Ale, Pete's Wicked Maple Porter, Pete's Wicked Strawberry Blonde and Pete's Wicked Multi Grain. By year end, Pete's completed its calendar of seasonal offerings with the introduction of Pete's Wicked Oktoberfest and Pete's Wicked Mardi Gras to provide a seasonal bridge between the number-one selling craft beer in their respective seasons, Pete's Wicked Summer Brew and Pete's Wicked Winter Brew. INDUSTRY BACKGROUND The Company participates in the craft beer segment of the estimated $50 billion domestic beer market. The domestic craft beer segment, which includes brewpubs, microbreweries, regional breweries and custom brewers, represented approximately 4% of total domestic beer retail sales in 1996. Craft beers are generally brewed according to traditional German or English recipes and tend to be more full-bodied and more bitter in taste than mass produced domestic beers. As a result, these amber lagers and ales, stouts, porters, bocks, German recipe wheat beers and seasonal brews tend to be more flavorful and fresher tasting. The domestic craft beer segment grew at an annual rate of approximately 36% for the year ended December 31, 1996, while volume in the overall domestic beer market has remained relatively flat. The Company believes that this growth in the craft beer segment has resulted from several factors. Craft brewers produce high quality, full-bodied, distinctive styles of beer and convincingly promote the notion that beer "made in small batches" from "all natural ingredients" is better than mass produced domestic and imported products, particularly powerful in light of the trend among large brewers to minimize costs through the use of lower cost adjuncts. The increased consumer demand for craft beers allows for a price premium relative to mass produced beers. This price premium results in higher profit margins throughout the distribution channel motivating distributors and retailers to carry and promote products of the craft beer segment. Finally, consumers' interest in beer making and brewing history has flourished, as demonstrated by the growth of related industries such as homebrewing, beer festivals, consumer publications devoted to beer and the popularity of beer celebrities. In general, three types of brewers produce beers that compete with the Company's beers: the major domestic producers, the import beer companies and craft brewers. The major domestic producers, seeking to capitalize on the growth in the craft beer segment, have begun to produce and market fuller-bodied beers designed to appeal to consumers of craft beers. The brewers of imported beers from Holland, Germany, Canada and Mexico were the first to provide beers to address and to benefit from shifting consumer preferences toward fuller-bodied, better-tasting -2- 3 beers. There are approximately 1,200 craft brewers in the United States, falling into four main categories: brewpubs, microbrewers, regional brewers and custom brewers. Brewpubs, consisting of bars and restaurants, produce at least 50% of their product for on-site consumption. Microbrewers, generally defined within the industry as brewers of less than 15,000 barrels of beer annually, generally have very limited distribution. Regional brewers typically own and operate their own breweries to produce between 15,000 and 2,000,000 barrels of beer annually. While the regional craft brewers have strong presences in their geographic regions, they generally have less distribution and market share outside of their home region and transportation costs and less-than-ideal locations are barriers to achieving full scale national distribution. In addition, regional brewers typically invest substantially all of their resources in building and maintaining breweries, leaving little to invest in sales and marketing activities. Such brewers rely primarily on word of mouth and occasional media attention to promote their growth. Custom brewers utilize excess brewing capacity within the industry to produce their beers according to proprietary recipes. The custom brewers devote their resources toward advertising and promotion of their craft beers, rather than a capital-intensive brewing operation. Large national brewers have long dominated the overall beer industry in the United States, of which the craft beer segment forms only a small portion. As a result of extensive consolidation, the United States beer industry is highly concentrated, with five companies--Anheuser-Busch Companies, Inc., Miller Brewing Company, Inc., Stroh Brewery Co., Adolf Coors Co. and Pabst Brewing Co.--accounting for over 88% of domestic beer shipments in 1996. The large domestic beer producers generally offer an homogeneous selection of beers designed for mass appeal. These beers, principally light-bodied lagers and pilsners, are brewed using low-cost mass production techniques, lower cost adjuncts, such as rice and corn, and relatively less hops. In contrast to the substantial growth in the craft beer segment in recent years, over the last 10 years, overall growth in the domestic beer market has been relatively low, with volume growing at an annual rate of less than 1% since 1984. Adult per capita annual beer consumption in the United States has also declined slightly. The Company believes that this low growth rate and reduced beer consumption can be attributed to a variety of factors, including increased concerns about the health consequences of consuming alcoholic beverages; safety consciousness and concerns about drinking and driving; a trend toward a diet including lighter, lower calorie beverages such as diet soft drinks, juices and sparkling water products; the increased activity of anti-alcohol consumer protection groups; an increase in the minimum drinking age from 18 to 21 years in all states; the general aging of the population; and increased federal and state excise taxes. The growing consumer trend toward moderation in alcohol consumption has benefitted craft beers by resulting in beer drinkers' selective consumption of one or two better tasting beers per sitting. STRATEGY The Company's objective is to become the leading brewer of high quality craft beers in the United States. Key elements of the Company's business strategy to increase market share and profitability include the following: Brand Investment. The Company devotes significant financial resources to innovative selling, advertising and promotional activities designed to build brand awareness and a high level of consumer loyalty. Through participation in trade shows, other beer industry events and co-founder Pete Slosberg's beer education seminars, the Company seeks to educate distributors, retailers and consumers about the craft beer industry and the Company's beers. In 1996, 1995 and 1994, selling, advertising and promotional expenses represented 42.0%, 36.4% and 34.3%, respectively, of the Company's net sales. The Company markets all of its beers under the "Pete's Wicked" trademarks in order to concentrate its marketing efforts behind a single brand name. Research conducted by the Company indicates that consumers in the Company's target market are attracted to the "Pete's Wicked" brand name and associate both quality and fun with the brand. In addition, the "Pete's Wicked" brand is versatile, amenable to brand expansion and is not constrained by regional or provincial connotations. -3- 4 Through ongoing consumer research, the Company seeks to gain further understanding of the craft beer category as it exists today and changes over time, in particular with respect to the "Pete's Wicked" brand and advertising awareness, consumption patterns and craft beer consumer demographics. In June 1996, the Company initiated a radio advertising campaign in the United States. The Company's radio advertising campaign featuring the Company's co-founder, Pete Slosberg, concentrated on communicating the Company's variety of products. The Company intends to continue to expend significant resources on selling, advertising and promotion to increase its market share in key geographic regions in the United States. The Company's advertising and promotional activities which have promoted the Company's image as a small and innovative brewer, with a personal and inviting character behind the label, a unique brand name and high quality beers will be subject to review in the Company's consumer research in order to strengthen such advertising and promotional activities. Cost Efficient, High Quality Brewing. Since inception, the Company has taken advantage of the excess capacity in the domestic brewing industry by utilizing breweries of independent companies to custom brew the Company's beers under the Company's on-site supervision and pursuant to the Company's proprietary recipes. The Company assures the quality of its beers by selecting specialty malts and hops, controlling the custom brewing operations and by following advanced brewing industry guidelines for in-process and finished product testing. In general, the custom brewing strategy allows the Company to (i) devote significant financial resources to sales, promotion and advertising activities, (ii) maintain strong sales growth with a relatively lean infrastructure and (iii) secure access to the brewing capacity required to efficiently distribute its beers nationally, while maintaining high quality across its product offerings. The Company has a strategic alliance with The Stroh Brewery Company ("Stroh") pursuant to which the Company custom brews all of its beers at the breweries of Stroh. In August 1995, the Company began shipping products brewed at the St. Paul, Minnesota Stroh brewery. In March 1996, the Company began shipping products brewed at the Winston-Salem, North Carolina Stroh brewery. Under the Company's long-term brewing agreement with Stroh (the "Stroh Agreement"), the Company has reduced its production costs. The Company will have the ability to strategically utilize multiple brewing sites in different geographic regions of the United States to reduce transportation costs and delivery times to distributors. The Company believes that utilizing multiple breweries of a single brewer provides advantages over utilizing several different brewers, including ease of management of operations, uniformity of product quality and ability to use a single management information system. In connection with the Stroh Agreement, the Company issued a warrant to Stroh to purchase 1,140,284 shares of the Company's Common Stock and an executive officer of Stroh joined the Company's Board of Directors. National Distribution Network. The Company's strategy is to expand market share in key markets of the United States by leveraging its established national distribution network to increase retail account distribution. The Company has recently expanded its distribution network to include 49 states, the District of Columbia and the United Kingdom. The Company has invested significant resources to educate distributors and retailers about promoting and selling the Company's beers and the craft beer segment in general. The Company chooses distributors in each market that will devote significant attention and resources to the promotion and sale of the Company's beers. These distributors may be wine and spirits distributors or traditional beer wholesalers. Product Diversity and Quality. The Company intends to continue to expand its product line with additional beers designed to appeal to varying consumer preferences. The Company has successfully formulated and introduced six new beers in 1996. These new beers accounted for 22% of sales in 1996. The Company currently markets 12 distinctive full-bodied craft beers, consisting of eight year-round -4- 5 products and four seasonal brews. The Company's beers, ranging from brown to amber to gold colors, all bear the "Pete's Wicked" brand name and allow the Company to appeal to a broad range of consumers. The Company intends to establish a selection of year-round and seasonal beers that will attract consumers to craft beers and allow them to explore new tastes. The company brews its beers using only water, malt, hops, yeast and natural spices and flavors. The Company uses no additives, adjuncts or preservatives in the brewing process. PETE'S WICKED BREWS The Company produces 12 distinctive beers under the "Pete's Wicked" brand name. The Company introduced six new beers in 1996. The Company positions all of its products as full-bodied beers of the highest quality. The Company's products contain no artificial preservatives and are made only from high quality natural ingredients. The Company brews its beer using only water, malt, hops, yeast and natural spices and flavors and does not utilize additives or adjuncts to extend the natural ingredients. The Company's beers have won numerous awards for excellence. The Company's net sales and barrels of beer sold have grown rapidly from $2.5 million and 14,700 barrels, respectively, in 1991 to $70.6 million and 425,600 barrels, respectively, in 1996, representing a compound annual growth in net sales and in barrels of 95.1% and 96.0%, respectively. Brands The Company offers the following Pete's Wicked brews: Pete's Wicked Ale. Introduced in 1986, the Company's flagship beer, Pete's Wicked Ale, is a dark amber beer with a medium body, malt richness and strong hop flavor. Pale, chocolate and caramel malts provide the beer's distinctive roasted flavor and a complex blend of Cascade and rare Brewer's Gold hops create a floral aroma. Pete's Wicked Bohemian Pilsner. Introduced in 1992 as Pete's Wicked Lager, Pete's Wicked Bohemian Pilsner is a pilsner beer brewed with Saaz hops. A combination of pale and caramel malts enhances the full body and rich color of Pete's Wicked Bohemian Pilsner, resulting in a spicy, fruity pilsner with a hop bitterness. Pete's Wicked Amber Ale. Introduced in August 1994 as Pete's Wicked Red, Pete's Wicked Amber Ale is a full-bodied red amber ale. A blend of pale, caramel and Munich malts contribute to the beer's nutty malt character and rich red hue. Yakima Cluster and Cascade hops along with late-kettled Tettanger hops provide the floral aroma of Pete's Wicked Amber Ale. Pete's Wicked Honey Wheat. Introduced in July 1995, Pete's Wicked Honey Wheat is a richly colored, delicately malted wheat beer. The honey flavor naturally enhances the depth of the malt and hop flavors for a rich, smooth taste. Late-kettled hopping with a blend of Tettanger and Cascade hops adds a slightly fruity aroma. The beer is unfiltered to retain the distinctive honey-flavored finish. Pete's Wicked Winter Brew. Introduced in the winter of 1993, Pete's Wicked Winter Brew is a seasonal amber ale with a raspberry aroma and taste. This holiday offering is available annually from the Fall through the Winter. Pete's Wicked Summer Brew. Introduced in April 1995, Pete's Wicked Summer Brew is made with pale and wheat malt to create a golden color and all malt flavor. Tettanger hops deliver a crisp hop bite and -5- 6 light carbonation is added. A delicate hint of natural lemon flavor is added. This summer offering is available annually from April to August. The Company believes that Pete's Wicked Summer Brew was the number one selling craft summer seasonal beer in the United States in 1995 and 1996. Pete's Wicked Pale Ale. Introduced in July 1996, Pete's Wicked Pale Ale has a medium body and color and is initially sweet yet spicy with a lingering bitter finish. Cascade and Cluster hops blended with imported Czech Saaz hops deliver an intense bitter aroma and flavor. Pete's Wicked Maple Porter. Introduced in July 1996, Pete's Wicked Maple Porter has a sweet maple aroma and roasted malt character that dominate the tall bodied dark porter. This brew is a new twist on a favorite English beer style of the 1700s. Pete's Wicked Multi Grain. Introduced in July 1996, Pete's Wicked Multi Grain is an innovative blend of oats, rye, wheat and barley with a copper color and subtle sweetness. The rye adds a unique spicy note and the oats contribute to the smooth, balanced taste. Pete's Wicked Strawberry Blonde. Introduced in July 1996, Pete's Wicked Strawberry Blonde is a light bodied brew with a refreshingly sweet strawberry aroma. The color is golden, but with a reddish hue. Pete's Wicked Mardi Gras. Introduced in December 1996, Pete's Wicked Mardi Gras is a light-bodied brew enhanced with a hint of ginger. This limited release beer offers a taste of the celebration held annually in New Orleans, Louisiana. Pete's Wicked Oktoberfest. Introduced in August 1996, Pete's Wicked Oktoberfest is a traditional Bavarian celebration brew created in the classic Marzen (Oktoberfest) style. This copper colored, medium-bodied brew has a sweet, caramel nutty flavor with balancing bitterness. Awards for Excellence The Company's beers have won numerous awards for excellence. In 1996, the Company's beers won 12 different awards. The following table lists certain awards and distinctions achieved by the Company's beers: PETE'S WICKED ALE 1997 SILVER MEDAL: Ale Category World Beer Championship 1997 GOLD MEDAL: Brown Ale Category Cheers One World Festival, Florida 1996 GOLD MEDAL: Brown Ale Category World Beer Championships 1996 SILVER MEDAL: Brown Ale Category All American Beer Festival, Houston 1995 BRONZE MEDAL: American Brown Ale Great American Beer Festival(R), Denver 1995 SILVER MEDAL: Brown Ale Category World Beer Championships 1994 SILVER MEDAL: Brown Ale Category World Beer Championships 1992 GOLD MEDAL: American Brown Ale Great American Beer Festival(R), Denver 1992 BEST ALE Atlanta Tribune Tasting, Atlanta 1991 1ST PLACE BROWN ALES Twin Cities Reader Poll, Minneapolis 1991 2ND PLACE ALL STYLES Los Angeles Times Tasting, LA 1990 BEST BROWN ALE Great American Beer Tasting, New York 1990 2ND PLACE ALE Milwaukee Beer Festival, Milwaukee 1988 SILVER MEDAL KPBS International Beer Festival, San Diego
-6- 7 1988 SILVER MEDAL: Great American Beer Festival(R), Denver Brown Ale Category 1987 SILVER MEDAL: Great American Beer Festival(R), Denver Ale Category 1987 1ST PLACE ALL STYLES Bay Guardian Competition, San Francisco PETE'S WICKED AMBER ALE 1997 SILVER MEDAL: World Beer Championships Amber Ale Category 1996 SILVER MEDAL: World Beer Championships Amber Ale Category 1995 SILVER MEDAL: World Beer Championships Amber Ale Category PETE'S WICKED BOHEMIAN PILSNER 1997 SILVER: Cheers One World Festival, Florida Pilsner Category 1996 GOLD MEDAL: World Beer Championships Pilsner Category 1996 BRONZE MEDAL: All American Beer Festival, Houston Lager Category 1995 GOLD MEDAL: World Beer Championships Pilsner Category 1995 SILVER MEDAL: California Beer Festival Traditional Pilsen 1994 GOLD MEDAL: World Beer Championships Pilsner Category 1993 GOLD MEDAL Great International Beer Tasting, Denver PETE'S WICKED HONEY WHEAT 1997 GOLD MEDAL: Cheers One World Beer Festival, Florida Flavored Wheat Category 1996 SILVER MEDAL: World Beer Championships Flavored Wheat Category 1996 SILVER MEDAL: All American Beer Festival. Houston Wheat Category 1996 BEST HONEY BEER World Expo of Beer "People's Choice", MI 1995 SILVER MEDAL: World Beer Championships Herb & Spice Category PETE'S WICKED STRAWBERRY BLONDE 1996 SILVER MEDAL: World Beer Championship Fruit Beer Category PETE'S WICKED MAPLE PORTER 1996 SILVER MEDAL: World Beer Championship Herb-Spice Flavored Category PETE'S WICKED PALE ALE 1997 SILVER MEDAL: World Beer Championships Pale Ale Category PETE'S WICKED SUMMER BREW 1996 BEST PALE ALE World Expo of Beer "People's Choice", MI 1995 SILVER MEDAL: World Beer Championships Fruit Beer Category
-7- 8 PETE'S WICKED OKTOBERFEST 1996 SILVER MEDAL: Oktoberfest Category World Beer Championship PETE'S WICKED WINTER BREW 1997 SILVER MEDAL: Winter Ale Category World Beer Championships 1995 SILVER MEDAL: Fruit Flavored Category California Beer Festival 1993 NINKASI AWARD Based on one of the homebrew recipes by the 1993 National Homebrew Grand Champion
Packaging The label imagery on the Pete's bottle and the other graphics on the packaging containers are the primary communication with the consumer at the point of sale. For this reason the Company has invested significant resources to design, develop and protect the product package designs and artwork. All of the Company's bottles include visually appealing labels and a descriptive message from Pete. In 1990, the distinctive packaging for Pete's Wicked Ale won a Clio Award for the Best International Beer Packaging. In July 1996, the Company initiated a uniform packaging re-design of the "Pete's Wicked" brand. The Company packages its beers in bottles or kegs and sells to distributors in four packaging formats. Six packs contain six 12-ounce bottles in an open-top, logo emblazoned pressboard carrier. Twelve packs contain 12 12-ounce bottles in a sealed, logo emblazoned cardboard container. In March 1990, the Company introduced 22-ounce "big bottles" sold individually at the retail level. The oversized bottles have been popular trial packages with first-time purchasers that are experimenting with several types and brands of craft beers. For distribution to pubs, bars and restaurants, the Company packages draught beer in kegs. One keg holds one half barrel or 15.5 gallons. Research and Product Development Research and product development activities are on-going. Opportunities identified by the Company are formulated and developed by the Company's Brewmaster, Pat Couteaux. Mr. Couteaux has 15 years of experience in the brewing industry, most recently with G. Heileman Brewing Co., and holds a master's degree in Brewing Science from the Technical University of Munich at Weihenstephan, Germany. He is in charge of establishing quality control limits, developing new beers, managing raw material selection, optimizing efficiency and educating Company personnel regarding taste and other qualities. Since most beer types fall into major categories or subcategories, an extensive development process is not required to bring a new product to market. The sale of a limited number of beers has accounted for substantially all of the Company's sales since inception. The Company believes that the sale of its currently offered beers will continue to account for a significant portion of sales for the foreseeable future. Therefore, the Company's future operating results, particularly in the near term, are significantly dependent upon the continued market acceptance of these beers. There can be no assurance that the Company's beers will continue to achieve market acceptance. A decline in the demand for the Company's beers as a result of competition, changes in consumer tastes and preferences, government regulation or other factors would have a material adverse effect on the Company's business, operating results and financial condition. In addition, there can be no assurance that the Company will be successful in developing, introducing and marketing additional new beers that will sustain sales growth in the future. -8- 9 ADVERTISING AND PROMOTION The Company's marketing programs emphasize the "Pete's Wicked" brand name and are generally designed to promote brand recognition and trial of the Company's products. The Company targets its marketing efforts at adults, ages 21 to 39, which the Company believes form the most significant group contributing to the growth of the craft beer industry. The Company's advertising and promotion activities focus on the Company's microbrewing origins and the high quality of its beers. The Company has successfully maintained its microbrewery heritage while expanding distribution and sales. The Company uses a combination of educational and promotional programs aimed at distributors, retailers and consumers, radio and print advertising, public relations activities, attendance at trade shows and other craft beer industry events and consumer communications to market its products. The Company has undertaken a number of marketing initiatives that have strengthened its franchise and role as an industry innovator. By promoting Pete Slosberg as a beer enthusiast, the Company has the only national brand identified with an individual deemed to be a true "beer folk hero." Additional innovations, such as an (800) line and catalog of Wicked Ware clothing, further differentiate the label from other brands and help to keep the Company close to the consumer. In addition, the Company initiated a radio advertising campaign in the second half of 1996. In 1996, the Company completed its seasonal line of beers with the introduction of Pete's Wicked Mardi Gras and Pete's Wicked Oktoberfest which are available between the Pete's Wicked Summer Brew and Pete's Wicked Winter Brew selling seasons. Also in 1996, the Company introduced a direct mail and consumer membership program, VIPete's, which the Company believes to be the first national loyalty program introduced by a craft brewer. All of these marketing tools have succeeded in increasing the brand's visibility, with the Company's distributors, retailers and consumers. The Company believes that with the recent increased competition in the craft beer industry, it is necessary to increase advertising spending in order to increase brand loyalty among consumers. The Company intends to reduce promotional point-of-purchase spending and reallocate those resources to consumer advertising strategies. Educational and Promotional Programs. The Company's sales force actively educates and trains distributors and retailers about the brewing process, the craft beer segment in general and the Company's beers in particular. The Company's sales force provides a high level of support to distributors, assisting in regular planning of marketing and promotional programs and providing consumer and distributor training and education. Pete Slosberg's beer education seminars are additive to the Company's education activities. Through these efforts, the Company seeks to obtain a competitive advantage by encouraging more attention to its beers and a more effective resale effort from distributors and retailers. At the retail level, the Company provides creative point of sale display materials and theme promotions designed to encourage trial and repeat purchases of the Company's beers. The Company's point of sale promotional activities in 1996 included (i) a newly re-designed line of "Pete's Wicked" packaging (ii) a summer promotion entitled "Letus Gamus Beginus" encouraging mass displays at retail outlets (iii) a "Get Wicked Tonight" Halloween theme promoting the natural connection between the "Pete's Wicked" brand name and Halloween and (iv) a holiday theme promotion featuring Pete's Wicked Winter Brew in the fourth quarter. The Company's bottle labeling and package artwork also enhance the Company's visibility at the point of sale. Radio and Print Advertising. The Company's radio and print advertising activities feature Pete Slosberg, the Company's co-founder and spokesperson, as an everyday guy and the ultimate beer enthusiast. In 1994, the -9- 10 Company became the first national, domestic craft beer producer to utilize television advertising to promote its products. In June 1996, the Company initiated a radio advertising campaign in markets across the United States. The advertising campaign, which ran in two flights in the third and fourth quarters of 1996, consisted of three 60 second spots that aired on radio stations targeted to adults, ages 21 to 39. The radio ads featured Pete, the person behind the product, and concentrated on the Company's variety of products. The Company continues to monitor the effectiveness of its radio advertising among beer consumers and identify effective long-term communications strategies in order to build loyalty among the Company's target consumer group. The Company also utilizes print advertising to develop its image and create demand for its beers. The Company concentrates its print advertising efforts on prominent trade magazines, including Beer--The Magazine, All About Beer and American Brewer. The Company also seeks to identify and encourage editorial and third-party testimonial publicity to promote the Company and its products. Trade Shows and Other Events. The Company participates in trade shows, national and international beer-tasting events and other craft beer industry events. The Company participated in over 100 trade shows in 1996, including the Great American Beer Festival(R) and the National Beer Wholesalers Association Conference, as well as numerous regional restaurant and hotel expositions. Many of these events provide a forum for Pete to promote the Company's image and further strengthen the "Pete's Wicked" brand name. Consumer Communications. The Company encourages direct communication with consumers by maintaining a consumer hotline and printing the number (1-800-877-PETE) on each bottle of beer it sells. The hotline allows consumers to obtain additional information regarding the Company and its beers and allows craft beer enthusiasts to express their opinions to the Company. During business hours, a Company representative personally answers every phone call. To increase consumer involvement and further differentiate the brand, the Company also sells Wicked Ware, a line of T-Shirts, sweatshirts, jackets, hats and similar products emblazoned with "Pete's Wicked" graphics. The Company also utilizes direct mail, distributing full color merchandise catalogues and the Company's newsletter, The Wicked Word. In addition to promoting the Company's products, the newsletter includes information about the history of the Company, the craft beer industry and the different styles and types of beer. In 1996, the Company introduced VIPete's, a direct mail and consumer membership loyalty program. As of December 31, 1996, the Company's sales and marketing group consisted of 101 employees. During 1996, 1995 and 1994, selling, advertising and promotion expenses were $29.7 million, $21.5 million and $10.6 million, respectively, representing 42.0%, 36.4% and 34.3% of net sales, respectively. DISTRIBUTION AND SALES The Company sells its beers to independent beverage distributors for resale to retailers who sell the beers to the consumer. The Company currently has approximately 400 distributors and its beers are sold in 49 states, the District of Columbia and the United Kingdom in supermarkets, liquor stores, bars, pubs, restaurants, warehouse club stores and convenience stores. The Company chooses distributors in each market that will devote attention and resources to the promotion and sale of the Company's beers, which may be either wine and spirits distributors or beer wholesalers. Independent wholesale distributors (all of whom carry other beverage products that compete with the Company's beers) of "Pete's Wicked" brews are formally appointed in a variety of ways throughout the 49 states in which the Company does business. In most cases, variations in appointment procedures are directly attributable to state alcoholic beverage laws mandating territorial appointment (some exclusive and some non-exclusive), restricting in various ways the Company's ability to terminate or not renew the services of wholesale distributors and providing -10- 11 varying periods and methods of resolving contractual disputes. Generally, these state laws vary from a requirement that good cause be shown for the action taken to a requirement that compensation be paid to the terminated distributor for the fair market value of the lost business. In most states, the Company uses appointment letters accompanied by a standard terms and conditions agreement committing the wholesale distributor to an investment in the promotion of the Company's beers. The Company supports its distributor network with a sales force that is organized by region with the Senior Vice President Sales overseeing the various regions. The Company seeks to create and maintain a prominent position with its distributors through the strength of its brand name, product diversity, sophisticated selling support, customer service and attractive profit margins throughout the distribution channel. During the second half of 1996, the Company transitioned to a new wholesale distribution network in California, Colorado, and Washington, D.C. Previously, the Company had relied on a single or limited number of distributors in these key markets. The transition of the Company's distribution from a single or limited number of distributors to in excess of 30 new distributors adversely impacted the Company's level of revenues and profitability in the fourth quarter of 1996. The Company expects that the transition of the distribution network in these key markets will continue to impact the Company's business, financial condition and results of operations in the near term. The Company is dependent upon its distributors to sell the Company's products and to assist the Company in promoting market acceptance of, and creating demand for, the Company's products. There can be no assurance that the Company's distributors will devote the resources necessary to provide effective sales and promotion support to the Company. During 1996 and 1995, the Company's ten largest distributors accounted for approximately 39.2% and 49.6%, respectively, of the Company's sales. Sales to Southern Wine and Spirits, the Company's former California distributor, represented approximately 10.7%, 20.7% and 27.8% of the Company's sales in 1996, 1995, 1994, respectively. Sales to Premium Coastal, the Company's distributor covering the Commonwealth of Massachusetts, represented approximately 9.4%, 10.7% and 11.1%, of the Company's sales in 1996, 1995 and 1994, respectively. No other distributor accounted for 10% or more of the Company's sales during such periods. The Company expects sales to its ten largest distributors to continue to represent a significant portion of sales. The Company believes that its future growth and success will continue to depend in large part upon these significant distributors. If one or more of these significant distributors were to discontinue selling, or decrease the level of orders for the Company's products, the Company's business would be adversely affected in the areas serviced by such distributors until the Company retained replacements. There can be no assurance however that the Company would be able to replace a significant distributor in a timely manner or at all in the event it were to discontinue selling the Company's products. In addition, there is always a risk that the Company's distributors will give higher priority to the products of other beverage companies, including products directly competitive with the Company's beers, thus reducing their efforts to sell the Company's products. This risk is exacerbated by the fact that many of the Company's distributors are reliant on the beers of one of the major beer producers for a large percentage of their revenues and, therefore, may be influenced by such producer. The Company's strategy for increasing market share involves establishing a network of distributors in a market, educating the distributors and retailers and finally building sales volume through aggressive promotion and advertising campaigns. To date, the Company has applied significant selling, advertising and promotional resources to only a limited number of key markets. The Company intends to focus on those key markets where the increasing population base, historically high level of beer consumption and relative lack of competition from other craft beers provides the greatest opportunities for growth. -11- 12 CUSTOM BREWING Since inception, the Company has followed a strategy of utilizing breweries with excess capacity to brew the Pete's Wicked brews pursuant to the Company's proprietary recipes. The Company believes that there is high quality excess brewing capacity available in the domestic beer industry to meet its needs for the foreseeable future. The Company's custom brewing strategy allows it to forego the substantial investment of financial resources required to purchase, or build, and maintain a brewery and results in lower capital and overhead costs per barrel of beer sold. From June 1992 through May 1995, the Company produced and packaged all of its beers at the St. Paul, Minnesota brewery of Minnesota Brewing Company ("MBC"). In May 1995, the Company began transitioning production of its beers from MBC to the Stroh brewery, also in St. Paul, Minnesota. The transition to Stroh was completed in November 1995. Currently, all of the Company's beers are produced at the Stroh breweries in St. Paul, Minnesota and Winston-Salem, North Carolina. Custom Brewing Agreement with Stroh. The Company has a strategic alliance with Stroh pursuant to which the Company custom brews its beers at the breweries of Stroh. The Company believes that Stroh is one of the most knowledgeable, experienced and skilled brewers of beer in the United States. Stroh or its predecessors, have brewed beer at the St. Paul brewery for over 136 years. The Company has chosen Stroh as its custom brewing partner because of Stroh's ability to brew the Company's craft beers according to traditional European brewing styles and methods and to ensure high quality throughout the brewing process. The Company began shipping beer from the Stroh Brewery in Winston-Salem in March 1996. The Company also has access to additional Stroh breweries in Longview, Texas and Seattle, Washington, in addition to the St. Paul, Minnesota and Winston-Salem, North Carolina breweries. The alliance with Stroh therefore allows the Company to custom brew Pete's Wicked brews in multiple geographic locations, which offers the opportunity for more efficient national distribution and shortened delivery times. Production at multiple breweries also reduces or eliminates the risks associated with brewing all of the Company's beers at a single brewery. Under the Stroh alliance, Stroh purchases all of the ingredients used in producing the Company's beers in compliance with rigorous quality assurance requirements, guidelines and specifications established by the Company. The Company believes that Stroh is able to achieve volume purchase pricing discounts which may not be available to the Company. The annual brewing capacity available to the Company at the St. Paul brewery is nearly two times greater than the total volume of beer sold by the Company in 1996, and the combined brewing capacity available to the Company at the four Stroh breweries is almost four times greater than the total volume of beer sold by the Company in 1996. The Stroh Agreement expires May 31, 2004. Pursuant to the Stroh Agreement, the Company is obligated, with certain limited exceptions, to brew all of its beers at the Stroh breweries. One such exception to the agreement is that the Company may brew its beers at a brewery owned and operated by the Company in California. The Company has agreed to pay Stroh a manufacturing services price equal to the aggregate of a contractually specified brewing fee and the cost of materials for all beer shipped. In addition, the Company is eligible for certain volume discounts through 1998 if the shipments exceed certain minimum levels and do not exceed certain maximum levels, although there can be no assurance that the Company will achieve such minimum levels. The Company did achieve such minimum levels in 1996. Stroh may terminate the agreement only on the limited grounds of the Company's breach or insolvency. Pete's is responsible for all capital improvements or modifications required to produce the company's beers at the additional Stroh breweries in either Longview or Seattle. In the event that either party terminates the brewing agreement according to its terms, the Company must reimburse Stroh for the unamortized costs of any such improvements or modifications. Should Stroh elect to terminate brewing operations at any one of its breweries, Stroh -12- 13 will shift production of the Company's beers to another of the Stroh breweries and will pay all costs associated with such move, except for incremental freight costs incurred by the Company or its distributors as a result of the move. The Company is required to provide Stroh with annual and periodic barrel production forecasts. The Company is required to produce a certain minimum barrelage at the Stroh breweries each year, which amount is significantly less than the volume of beer sold by the Company in 1996. However, in the event that the minimum barrelage is not produced, the Company must make certain payments to Stroh. Stroh retains a security interest in all beer produced under the brewing agreement until the Company has paid the specified price or until such beer is shipped. Payment is due to Stroh upon shipment. Under the terms of the Stroh brewing agreement, delivery of all "Pete's Wicked" brews by Stroh to the Company or its distributors is at the dock of the subject Stroh brewery. The Company is responsible for securing and paying for carrier services for its beers from Stroh's breweries. The Company assures the quality of its beers by controlling the custom brewing operations and by following the most advanced brewing industry guidelines for in-process and finished product testing. A staff of five full-time Pete's employees, including the Company's brewmaster, works in St. Paul and oversees brewing in all locations. The Company's on-site staff assists in the brewing, purchasing, accounting, transportation, development and quality control of the Company's products on a routine basis. The Company has access to Stroh's technical breweries and pilot plant to conduct tests and developmental work with respect to existing flavors and proposed malt beverages. In connection with the Stroh Agreement, the Company issued a warrant to Stroh to purchase 1,140,284 shares of the Company's Common Stock at an exercise price of $14.00 per share. In addition, Christopher T. Sortwell, Senior Vice President and Chief Financial Officer of Stroh, joined the Company's Board of Directors in October 1995. The Company relies upon Stroh at all phases of the production of its beers, including sourcing and purchasing the ingredients used to make the Company's beers, scheduling production to meet delivery requirements, brewing and packaging the Company's beers, performing quality control and assurance, invoicing distributors upon shipment, and collecting and remitting payments to the Company. The Company's relationship with Stroh is therefore critical to the Company's business, operating results and financial condition. The Company's dependence on Stroh entails a number of significant risks. The Company's business, results of operations and financial condition would be materially adversely affected if Stroh were unable, for any reason, to meet the Company's delivery commitments or if beer brewed at the Stroh brewery failed to satisfy the Company's quality requirements. In the event that the Company were unable to continue to custom brew its beers in required volumes at the Stroh breweries, the Company would have to identify, qualify and transition production to an acceptable alternative brewery. This identification, qualification and transition process could take two years or longer, and no assurance can be given that an alternative brewery would be available to the Company or be in a position to satisfy the Company's production requirements on a timely and cost-effective basis. Accordingly, if the Company's ability to obtain product from the Stroh breweries were interrupted or impaired for any reason, the Company would not be able to establish an alternative production source, nor would the Company be able to develop its own production capabilities, without substantial disruption to the Company's operations. Any inability to obtain adequate production of the Company's beers on a timely basis or any other circumstances that would require the Company to seek alternative sources of supply would delay shipments of the Company's products, which could damage relationships with its current and prospective distributors and retailers, provide an advantage to the Company's competitors and have a material adverse effect on the Company's business, financial condition and operating results. Construction of Brewery. After a review of a brewery construction feasibility study prepared by the Company in conjunction with its architect, mechanical engineer and general contractor, and a review of available capacity under the Stroh Agreement and other factors, the Company has recently determined not to go forward with previously disclosed plans to construct and equip a new brewery in California. Although the Company believes that -13- 14 the brewing capacity available to the Company under the Stroh Agreement is adequate to meet its needs for the foreseeable future, the Company will continue to monitor long-term capacity availability in light of its business plan. The financial resources previously earmarked to finance capital expenditures in connection with the construction of the brewery will now be used for general corporate purposes, including to meet working capital needs, pending the analysis, currently underway, of the alternative uses available to the Company. During the first quarter of 1997, based on a decision made at its February 1997 Board of Directors meeting to indefinitely delay construction of a brewery, the Company will take a charge to earnings for the write-off of previously capitalized costs in connection with the brewery project. Such write-off will adversely impact the Company's earnings in the first quarter of 1997. Ingredients and Packaging Materials. The Company or Stroh has established relationships with the several suppliers of water, malt, hops and yeast used in the brewing of "Pete's Wicked" brews. "Pete's Wicked" brews do not contain fillers such as corn, rice or sugar which are typically found in mass produced beers and which tend to diminish a beer's true character. All ingredients purchased by Stroh under the brewing agreement must comply with the Company's established quality assurance requirements, procedures, guidelines and specifications. The Brewer's Gold hops used in the production of Pete's Wicked Ale are specially grown for the Company in the Willamette Valley in Oregon. In order to secure adequate amounts of these rare Brewer's Gold hops, the Company must make certain advance purchase commitments. These hops are not otherwise grown in quantities sufficient to satisfy the Company's requirements for the production of Pete's Wicked Ale. If the Company were unable to obtain sufficient quantities of the Brewer's Gold hops it would be required to use alternative hops which would change the character of Pete's Wicked Ale. Under the terms of the brewing agreement, the Company will, with certain exceptions, purchase packaging for the "Pete's Wicked" brews brewed through Stroh. All such packaging must comply with the Company's quality assurance specifications. The Company will reimburse Stroh for the purchase or modification of any equipment necessary to properly assemble the packaging. Quality Assurance Program. In order to control the quality of finished products, Pete's has established acceptable inventory shelf lives of 180 days for pasteurized bottled products and 60 days for refrigerated draft products. Each of the Company's beers has a code date that is managed by the Company's sales personnel, distributors and retailers to ensure product freshness. The Company conducts standard testing according to the specifications and methodology set forth by the American Society of Brewing Chemists and the European Brewing Convention. The Company's quality assurance program encompasses all of the final aged product to ensure that the Company's rigorous specifications have been met. TRADEMARKS, COPYRIGHTS AND BEER RECIPES The Company owns all of the "Pete's Wicked" product names and has registered or filed applications to register each in the United States Patent and Trademark Office. The Company utilizes a number of recipes in the production of its beers and protects these recipes as trade secrets. In addition, product package, advertising and promotion design and artwork are important to the Company's success, and such materials are protected by copyright. The Company considers the "Pete's Wicked" trademarks and its beer recipes to be of considerable value and critical to its business. The Company's rights to the "Pete's Wicked" trademarks in the United States will last indefinitely so long as the Company continues to use and police the trademarks and to renew filings with applicable governmental agencies. No challenges to the Company's rights to use the "Pete's Wicked" trademark in the United States are pending and the Company has no reason to believe that any such challenges will arise in the future. The Company has filed applications and has obtained registrations for certain of its trademarks in various foreign countries. The Company will continue to take appropriate measures, such as entering into confidentiality agreements with its custom brewing partners, to maintain the secrecy and proprietary nature of its beer recipes. In addition, the Company intends -14- 15 to take action to protect against imitation of its products and packages and to protect its trademarks and copyrights as necessary. Despite the Company's efforts to protect its proprietary rights, unauthorized parties may attempt to copy or obtain and use information that the Company regards as proprietary. There can be no assurance that the steps taken by the Company to protect its proprietary information will prevent misappropriation of such information and such protections may not preclude competitors from developing confusingly similar brand names or promotional materials or developing products with taste and other qualities similar to the Company's beers. COMPETITION The Company competes in the craft beer segment of the domestic beer market. The Company believes that its products compete with those domestic and imported beers that generally sell for retail prices in excess of $5.99 per six pack. The principal competitive factors affecting the market for the Company's products include product quality and taste, packaging, price, brand recognition and distribution capabilities. The Company believes that it currently competes favorably overall with respect to these factors. There can be no assurance however that the Company will be able to compete successfully against current and future competitors based on these and other factors. The domestic craft beer market is the fastest growing segment of the domestic beer market. The Company competes with a variety of domestic and international brewers, many of whom have significantly greater financial, production, distribution and marketing resources and a higher level of brand recognition than the Company. As a result of the increased demand for craft beers, the Company competes with and anticipates competition from several of the major national brewers, such as Anheuser-Busch, Miller Brewing Co. and Adolph Coors Co., each of which has introduced and is marketing fuller flavored beers designed to compete directly in the craft beer segment. For example, Anheuser-Busch, Miller Brewing Co. and Adolph Coors have introduced and marketed Elk Mountain Ale, Leinenkeugel and Killian's Red, respectively. In addition, the Company expects that certain of the major national brewers, with their superior financial resources and established distribution networks, may seek further participation in the continuing growth of the craft beer market through the investment in, or the formation of, distribution alliances with smaller craft brewers. The increased participation of the major national brewers will likely increase competition for market share and heighten price sensitivity within the craft beer market. The Company believes that significant competition comes from producers of imported beers such as Bass PLC, Cerveceria Modelo, S.A. (brewer of Corona Extra), Guinness PLC, Cerveceria Moctezuma, S.A. (brewer of Dos Equis) and Heineken N.V. which currently produce premium fully-flavored beers. Imported beer accounts for a greater share of the domestic beer market than craft beers. The Company expects continued competition from imported beer brewers, many of whom have greater financial and marketing resources, as well as greater brand name recognition, than the Company. The Company also anticipates increased competition in the craft beer market from existing craft brewers such as The Boston Beer Company, Inc., Redhook Ale Brewery, Inc., Sierra Nevada Brewing Co., Pyramid Brewing Co. and Anchor Brewing Co. and new market entrants. In particular, the Company believes that competition has intensified recently as a result of the proliferation of small local craft brewers that have introduced and are marketing significant numbers of products. The Company also competes with other beer and beverage companies not only for consumer acceptance and loyalty but also for shelf and tap space in retail establishments and for marketing focus by the Company's distributors and their customers, all of which also distribute and sell other beers and alcoholic beverage products. Increased competition could result in price reductions, reduced margins and loss of market share, all of which could have a material adverse effect on the Company. Although the demand for craft beers has increased dramatically over the past decade, there can be no assurance that this demand will continue, or, even if such demand continues to increase, that consumers will choose the Company's products. -15- 16 GOVERNMENT REGULATION The Company's business is highly regulated by federal, state and local laws and regulations. Federal and state laws and regulations govern licensing requirements, trade and pricing practices, permitted and required labeling, advertising, promotion and marketing practices, relationships with distributors and related matters. For example, federal and state regulators require warning labels and signage on the Company's products. The Company believes that it has obtained all regulatory permits and licenses necessary to operate its business in the states where the Company's products are currently being distributed. Failure on the part of the Company to comply with federal, state or local regulations could result in the loss or revocation or suspension of the Company's licenses, permits or approvals and accordingly could have a material adverse effect on the Company's business. Governmental entities also levy various taxes, license fees and other similar charges and may require bonds to ensure compliance with applicable laws and regulations. The Company must also comply with numerous federal, state and local environmental protection laws. The Company is operating within existing laws and regulations or is taking action aimed at assuring compliance therewith. The Company does not expect compliance with such laws and regulations to materially affect the Company's capital expenditures, earnings or competitive position. The federal government and each of the states levy excise taxes on alcoholic beverages, including beer. The federal excise tax is currently $18.00 per barrel ($1.31 per case of 24-12 oz. containers) and the state excise taxes range in rate from $1.86 per barrel to $6.30 per barrel. Federal excise taxes are typically included in the price charged to the Company's distributors whereas state excise taxes are typically included in the price charged to retailers by the distributors. All excise taxes are ultimately passed on to the consumer. It is possible that in the future the rate of excise taxation could be increased by both the federal government and a number of state governments. Further increases in excise taxes on beer, if enacted, could materially and adversely affect the Company's financial condition and results of operations. There is a small brewers federal excise tax credit that grants each brewing company with production under 2,000,000 barrels a year an $11.00 credit per barrel on its first 60,000 barrels produced annually. The Company is currently able to take advantage of a $660,000 annual credit pursuant to this exemption. Although the Company is not aware of any plans by the federal government to reduce or eliminate this small brewer's credit or by federal or state authorities to increase the excise tax rate, any such change could have a material adverse effect on the Company. Certain states, including California, Connecticut, Delaware, Iowa, Maine, Massachusetts, Michigan, New York, Oregon and Vermont, and a small number of local jurisdictions, have adopted restrictive beverage packaging laws and regulations that require deposits on beverage containers. Congress and a number of additional state or local jurisdictions may adopt similar legislation in the future, and in such event, the Company may be required to incur significant expenditures in order to comply with such legislation. Changes to federal and state excise taxes on beer production, federal and state environmental regulations, including laws relating to packaging and waste discharge, or any other federal and state laws or regulations which affect the Company's products could materially adversely affect the Company's results of operations. -16- 17 EMPLOYEES As of December 31, 1996, the Company had 126 employees, including 101 in sales and marketing and 25 in administration. The Company's future success will depend, in part, on its ability to continue to attract, retain and motivate highly qualified marketing and managerial personnel. None of the Company's employees are represented by a collective bargaining agreement, nor has the Company experienced work stoppages. The Company believes that its relations with its employees are good. In addition, the Company has recently hired several key executive officers to supplement its management team. Moreover, the Company is currently conducting a search to select a new Chief Executive Officer. The Company's future success will depend, in part, on the ability of its current and future executive officers to operate effectively, both independently and as a group. ITEM 2. PROPERTIES The Company's principal administrative, sales and marketing and product development facilities are located in two buildings of approximately 7,091 square feet and 7,056 square feet, respectively, in Palo Alto, California pursuant to leases which expire between February 1998 and June 2001. In addition, the Company leases sales offices in Boston, Philadelphia, Atlanta and St. Paul. The Company believes that its existing facilities are adequate to meet its current needs and that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed. ITEM 3. LEGAL PROCEEDINGS The Company is engaged in certain legal and administrative proceedings incidental to its normal business activities. While it is not possible to determine the ultimate outcome of these actions, at this time the Company believes that any liabilities resulting from such proceedings, or claims which are pending or known to be threatened, will not have a material adverse effect on the Company's consolidated financial position or results of operation. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. -17- 18 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
NAME AGE POSITION ---- --- -------- Jeffrey Atkins 48 Senior Vice President, Chief Financial Officer and Acting Chief Operating Officer Donald Quigley 42 Senior Vice President Sales Omer Malchin 34 Vice President Marketing James Collins 38 Vice President Operations Patrick Couteaux 38 Vice President Brewing and Brewmaster
Officers serve at the discretion of the Board of Directors. Jeffrey Atkins. Jeffrey Atkins joined the Company in December 1996 as Senior Vice President and Chief Financial Officer. In addition to all areas of finance, Mr. Atkins has responsibility for brewery management, operations and is the Corporate Secretary. In February 1997, Mr. Atkins also became Acting Chief Operating Officer, pending completion of the Company's search for a new Chief Executive Officer. Prior to joining the Company, from 1977 to December 1996, Mr. Atkins served in various senior financial and operating positions for The Quaker Oats Company, a diversified manufacturer of packaged foods and beverages, most recently as Vice President Corporate Planning. From 1972 to 1977, he was with The Union Oil Company (Unocal). Donald Quigley. Donald Quigley joined the Company in October 1996 as Senior Vice President Sales. Prior to joining the Company, Mr. Quigley was Vice President, Sales of Ernest & Julio Gallo Winery ("Gallo") from March 1996 to October 1996. From May 1993 to March 1996, he served as Vice President, National Chain Accounts at Gallo. Prior to that, Mr. Quigley served in various state, division, region and senior sales management positions with Gallo. Omer Malchin. Omer Malchin joined the Company in January 1997 as Vice President Marketing. Prior to joining the Company, Mr. Malchin was Group Product Director-Cordials with The Paddington Corporation, a distilled spirits importing and marketing company, and a subsidiary of Grand Metropolitan PLC, from November 1996 to December 1996. From December 1994 to November 1996, he served as Brand Manager - Baileys and Baileys Light at The Paddington Corporation. From August 1992 to November 1994, Mr. Malchin was with Heublein, Inc., most recently as as Marketing Manager-Black Velvet and McMaster's Canadian Whiskies. James Collins. James Collins rejoined the Company in March 1992 as the Chief Financial Officer and Secretary. In December 1996, Mr. Collins became Vice President Operations. From October 1990 to February 1992, he served as a manager in the Business Investigation Services group at Coopers & Lybrand, a public accounting firm. From 1989 until October 1990, Mr. Collins served as Chief Financial Officer and Secretary of the Company. Prior to joining the Company, he was with Coopers & Lybrand, from 1982, most recently as an Audit Manager. Mr. Collins is a Certified Public Accountant. Patrick Couteaux. Patrick Couteaux joined the Company in November 1993 as Brewmaster. In January 1997, Mr. Couteaux became Vice President, Brewing. Prior to joining the Company, he held various positions at G. Heileman Brewing Company including First Assistant Brewmaster at the Blitz-Weinhard plant in Portland, Oregon from 1986 to November 1993. -18- 19 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this item is incorporated by reference to page 43 (under the caption "Market and Stock Price Data") of the Company's 1996 Annual Report to Shareholders for the fiscal year ended December 31, 1996, portions of which are filed as Exhibit 13.1 hereto (the "Annual Report to Shareholders"). ITEM 6. SELECTED FINANCIAL DATA The information required by this item is incorporated by reference to page 19 of the Company's Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is incorporated by reference to pages 20 to 29 of the Company's Annual Report to Shareholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is incorporated by reference to pages 30 to 43 of the Company's Annual Report to Shareholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item concerning the Company's directors is incorporated by reference from the section captioned "Election of Directors" contained in the Company's Proxy Statement related to the Annual Meeting of Shareholders to be held May 12, 1997, to be filed by the Company with the Securities and Exchange Commission within 120 days of the end of the Company's fiscal year pursuant to General Instruction G(3) of Form 10-K (the "Proxy Statement"). The information required by this item concerning executive officers is set forth in Part I of this Report. The information required by this item concerning compliance with Section 16(a) of the Exchange -19- 20 Act is incorporated by reference from the section captioned "Compliance with Section 16(a) of the Exchange Act" contained in the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference from the section captioned "Executive Compensation and Other Matters" contained in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference from the section captioned "Record Date and Principal Share Ownership" contained in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference from the sections captioned "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions With Management" contained in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a)(1) Financial Statements The following financial statements are incorporated by reference in Item 8 of this Report: Report of Independent Accountants Consolidated Balance Sheets at December 31, 1996 and 1995 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements (a)(2) Financial Statement Schedules S-1 - Report of Independent Accountants on Financial Statement Schedules S-2 - Valuation and Qualifying Accounts Additional schedules are not required under the related schedule instructions or are inapplicable, and therefore have been omitted. -20- 21 (a)(3) Exhibits 3.1(2) Restated Articles of Incorporation of the Registrant. 3.2(1) Bylaws of the Registrant. 4.1(3) Preferred Shares Rights Plan. 10.1(1) 1986 Stock Option Plan, and form of agreements thereto. 10.2(1) 1995 Employee Stock Option Plan, and form of agreements thereto. 10.3(1) 1995 Employee Stock Purchase Plan, and form of agreement thereto. 10.4(1) 1995 Director Stock Option Plan, and form of agreement thereto. 10.5(1) Form of Indemnification Agreement between the Registrant and its officers and directors. 10.6(1)* Distribution Agreement between the Registrant and Southern Wine and Spirits of America, Inc., dated as of January 1, 1994. 10.7(1)* Second Amendment and Restatement of Manufacturing Services Agreement dated as of the 1st day of October 1995, between The Stroh Brewery Company and the Registrant. 10.7.1(1) Form of Warrant to Purchase Stock between Registrant and The Stroh Brewery Company. 10.8.1(1) Leases between Registrant and Herbert P. McLaughlin dated May 13, 1994, November 4, 1994 and January 24, 1995. 10.8.2(2) Lease between Registrant and High Street Project Limited Partnership dated January 12, 1996. 10.9(1) Amended and Restated Loan and Security Agreement between the Registrant and Silicon Valley Bank dated September 25, 1995. 10.10(1) Form of Registration Rights Agreement. 10.11 Nonstatutory Stock Option Agreement by and between the Company and Jeffrey Atkins, the Company's Senior Vice President, Chief Financial Officer and Acting Chief Operating Officer dated December 13, 1996. 10.12 Incentive Stock Option Agreement by and between the Company and Jeffrey Atkins, the Company's Senior Vice President, Chief Financial Officer and Acting Chief Operating Officer dated December 13, 1996. 11.1 Computation of net income per share. 13.1 Portions of Registrant's Annual Report to Shareholders for the year ended December 31, 1996. 22.1(1) List of subsidiaries of the Registrant. 23.1 Consent of Independent Accountants. 24.1 Power of Attorney (See Page 22). 27.1 Financial Data Schedule. - ------------------ * Confidential treatment has been granted with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. (1) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-1 (Reg. No. 33-97264) as declared effective by the Commission on November 6, 1996. (2) Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1995. (3) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form 8-A as filed with the Securities and Exchange Commission on November 27, 1996. (b) Reports on Form 8-K. The Company did not file any reports on Form 8-K during the quarter ended December 31, 1996. (c) Exhibits. See Item 14(a)(3) above. (d) Financial Statement Schedules. See Item 14(a)(2) above. -21- 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. PETE'S BREWING COMPANY By: /s/ JEFFREY ATKINS Jeffrey Atkins Senior Vice President, Chief Financial Officer and Acting Chief Operating Officer Date: March 31, 1997 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jeffrey Atkins, as his or her true and lawful attorney-in-fact and agent,with full power of substitution and resubstitution, to sign any and all amendments (including post-effective amendments) to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute or substitutes, or any of them, shall do or cause to be done by virtue hereof. PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:
SIGNATURE TITLE DATE - ------------------------- ---------------------------------- -------------- /s/ JEFFREY ATKINS Senior Vice President, March 31, 1997 - ------------------------- Chief Financial Officer and Jeffrey Atkins Acting Chief Operating Officer /s/ MARK BRONDER Director March 31, 1997 - ------------------------- Mark Bronder
-22- 23
SIGNATURE TITLE DATE - ------------------------- ---------------------------------- -------------- /s/ AUDREY MACLEAN Director March 31, 1997 - ------------------------- Audrey MacLean /s/ KEVIN O'ROURKE Director March 31, 1997 - ------------------------- Kevin O'Rourke /s/ PETE SLOSBERG Director March 31, 1997 - ------------------------- Pete Slosberg /s/ CHRISTOPHER SORTWELL Director March 31, 1997 - ------------------------- Christopher Sortwell /s/ PHILIP MARINEAU Director March 31, 1997 - ------------------------- Philip Marineau
-23- 24 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE In connection with our audits of the consolidated financial statements of Pete's Brewing Company and Subsidiary as of December 31, 1996 and 1995, and for each of the three years in the period ended December 31, 1996, which financial statements are included in the Annual Report on Form 10-K, we have also audited the financial statement schedule listed in Item 14(a)(2) herein. In our opinion, the financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. San Jose, California February 14, 1997 S-1 25 PETE'S BREWING COMPANY AND SUBSIDIARY VALUATION AND QUALIFYING ACCOUNTS (in thousands)
BALANCES AT CHARGED TO BEGINNING OF COSTS AND WRITE-OFF BALANCE AT DESCRIPTION PERIOD EXPENSES OF ACCOUNTS END OF PERIOD - ----------- ------ -------- ----------- ------------- Year ended December 31, 1994 Allowance for doubtful accounts -- 50 13 37 Year ended December 31, 1995 Allowance for doubtful accounts 37 -- -- 37 Year Ended December 31, 1996 Allowance for doubtful accounts 37 102 -- 139
S-2 26 EXHIBIT INDEX 3.1(2) Restated Articles of Incorporation of the Registrant. 3.2(1) Bylaws of the Registrant. 4.1(3) Preferred Shares Rights Plan. 10.1(1) 1986 Stock Option Plan, and form of agreements thereto. 10.2(1) 1995 Employee Stock Option Plan, and form of agreements thereto. 10.3(1) 1995 Employee Stock Purchase Plan, and form of agreement thereto. 10.4(1) 1995 Director Stock Option Plan, and form of agreement thereto. 10.5(1) Form of Indemnification Agreement between the Registrant and its officers and directors. 10.6(1)* Distribution Agreement between the Registrant and Southern Wine and Spirits of America, Inc., dated as of January 1, 1994. 10.7(1)* Second Amendment and Restatement of Manufacturing Services Agreement dated as of the 1st day of October 1995, between The Stroh Brewery Company and the Registrant. 10.7.1(1) Form of Warrant to Purchase Stock between Registrant and The Stroh Brewery Company. 10.8.1(1) Leases between Registrant and Herbert P. McLaughlin dated May 13, 1994, November 4, 1994 and January 24, 1995. 10.8.2(2) Lease between Registrant and High Street Project Limited Partnership dated January 12, 1996. 10.9(1) Amended and Restated Loan and Security Agreement between the Registrant and Silicon Valley Bank dated September 25, 1995. 10.10(1) Form of Registration Rights Agreement. 10.11 Nonstatutory Stock Option Agreement by and between the Company and Jeffrey Atkins, the Company's Senior Vice President, Chief Financial Officer and Acting Chief Operating Officer dated December 13, 1996. 10.12 Incentive Stock Option Agreement by and between the Company and Jeffrey Atkins, the Company's Senior Vice President, Chief Financial Officer and Acting Chief Operating Officer dated December 13, 1996. 11.1 Computation of net income per share. 13.1 Portions of Registrant's Annual Report to Shareholders for the year ended December 31, 1996. 22.1(1) List of subsidiaries of the Registrant. 23.1 Consent of Independent Accountants. 24.1 Power of Attorney (See Page 22). 27.1 Financial Data Schedule. - ------------------ * Confidential treatment has been granted with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. (1) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form S-1 (Reg. No. 33-97264) as declared effective by the Commission on November 6, 1996. (2) Incorporated by reference to Registrant's Annual Report on Form 10-K for the year ended December 31, 1995. (3) Incorporated by reference to exhibits filed with Registrant's Registration Statement on Form 8-A as filed with the Securities and Exchange Commission on November 27, 1996. EX-10.11 2 OPTION AGREEMENT WITH JEFFREY ATKINS 1 Exhibit 10.11 PETE'S BREWING COMPANY STOCK OPTION AGREEMENT Unless otherwise defined herein, the terms defined in the 1995 Stock Option Plan (the "Plan") shall have the same defined meanings in this Option Agreement. I. NOTICE OF STOCK OPTION GRANT JEFFREY A. ATKINS You have been granted an option to purchase Common Stock of the Company, subject to the terms and conditions of the Plan and this Option Agreement, as follows: Grant Number 150 Date of Grant December 13, 1996 Vesting Commencement Date December 13, 1996 Exercise Price per Share $6.50 Total Number of Shares Granted 89,000 Total Exercise Price $578,500 Type of Option: Incentive Stock Option --- X Nonstatutory Stock Option --- Term/Expiration Date: December 13, 2006
Vesting Schedule: This Option may be exercised, in whole or in part, in accordance with the following schedule: 25% of the Shares subject to the Option shall vest twelve months after the Vesting Commencement Date, and 1/48th of the Shares subject to the Option shall vest each month thereafter. Dissolution, Merger, or Assets Sale Notwithstanding the foregoing Vesting Schedule, in the event of a Change in Control of the Company, the Optionee shall have the right to exercise this Option as to all of the Shares, including Shares as to which it would not otherwise be exercisable. "Change in Control" shall mean the occurrence of any of the following events: 2 (i) Any "person" or "group" (as such term is used in Section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 50% or more of the total voting power represented by the Company's then outstanding voting securities; or (ii) A change in the composition of the Board of the Company occurring within a two-year period, as a result of which fewer than a majority of the directors are Incumbent Directors. "Incumbent Directors" shall mean directors who either (A) are directors of the Company as of the date hereof, or (B) are elected, or nominated for election, to the Board of the Company with the affirmative votes of at least a majority of the Incumbent Directors at the time of such election with an actual or threatened proxy contest relating to the election of directors to the Company); or (iii) The shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets (other than to a subsidiary or subsidiaries). Termination Period: This Option may be exercised for three (3) months after termination of the Optionee's employment or consulting relationship with the Company. Upon the death or disability of the Optionee, this Option may be exercised for such longer period as provided in the Plan. In the event of the Optionee's change in status from Employee to Consultant or Consultant to Employee, this Option Agreement shall remain in effect. In no event shall this Option be exercised later than the Term/Expiration Date as provided above. II. AGREEMENT 1. Grant of Option. The Plan Administrator of the Company hereby grants to the Optionee named in the Notice of Grant attached as Part I of this Agreement (the "Optionee") an option (the "Option") to purchase the number of Shares, as set forth in the Notice of Grant, at the exercise price per share set forth in the Notice of Grant (the "Exercise Price"), subject to the terms and conditions of the Plan, which is incorporated herein by reference. Subject to Section 14(c) of the Plan, in the event of a conflict between the terms and conditions of the Plan and the terms and conditions of this Option Agreement, the terms and conditions of the Plan shall prevail. 2 3 If designated in the Notice of Grant as an Incentive Stock Option ("ISO"), this Option is intended to qualify as an Incentive Stock Option under Section 422 of the Code. However, if this Option is intended to be an Incentive Stock Option, to the extent that it exceeds the $100,000 rule of Code Section 422(d) it shall be treated as a Nonstatutory Stock Option ("NSO"). 2. Exercise of Option. (a) Right to Exercise. This Option is exercisable during its term in accordance with the Vesting Schedule set out in the Notice of Grant and the applicable provisions of the Plan and this Option Agreement. In the event of Optionee's death, Disability or other termination of Optionee's employment or consulting relationship, the exercisability of the Option is governed by the applicable provisions of the Plan and this Option Agreement. (b) Method of Exercise. This Option is exercisable by delivery of an exercise notice, in the form attached as Exhibit A (the "Exercise Notice"), which shall state the election to exercise the Option, the number of Shares in respect of which the Option is being exercised (the "Exercised Shares"), and such other representations and agreements as may be required by the Company pursuant to the provisions of the Plan. The Exercise Notice shall be signed by the Optionee and shall be delivered in person or by U.S. mail to the Stock Plan Administrator. The Exercise Notice shall be accompanied by payment of the aggregate Exercise Price as to all Exercised Shares. This Option shall be deemed to be exercised upon receipt by the Company of such fully executed Exercise Notice accompanied by such aggregate Exercise Price. No Shares shall be issued pursuant to the exercise of this Option unless such issuance and exercise complies with all relevant provisions of law and the requirements of any stock exchange or quotation service upon which the Shares are then listed. Assuming such compliance, for income tax purposes the Exercised Shares shall be considered transferred to the Optionee on the date the Option is exercised with respect to such Exercised Shares. 3. Method of Payment. Payment of the aggregate Exercise Price shall be by any of the following, or a combination thereof, at the election of the Optionee: (a) check; or (b) delivery of a properly executed exercise notice together with such other documentation as the Administrator and the broker, if applicable, shall require to effect an exercise of the Option and delivery to the Company of the sale or loan proceeds required to pay the exercise price; or (c) surrender of other Shares which (i) in the case of Shares acquired upon exercise of an option, have been owned by the Optionee for more than six (6) months on the date of surrender, and (ii) have a Fair Market Value on the date of surrender equal to the aggregate Exercise Price of the Exercised Shares. 3 4 4. Non-Transferability of Option. This Option may not be transferred in any manner otherwise than by will or by the laws of descent or distribution and may be exercised during the lifetime of Optionee only by the Optionee. The terms of the Plan and this Option Agreement shall be binding upon the executors, administrators, heirs, successors and assigns of the Optionee. 5. Term of Option. This Option may be exercised only within the term set out in the Notice of Grant, and may be exercised during such term only in accordance with the Plan and the terms of this Option Agreement. 6. Tax Consequences. Some of the federal and California tax consequences relating to this Option, as of the date of this Option, are set forth below. THIS SUMMARY IS NECESSARILY INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. THE OPTIONEE SHOULD CONSULT A TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES. (a) Exercising the Option. (i) Nonstatutory Stock Option. The Optionee may incur regular federal income tax and California income tax liability upon exercise of a NSO. The Optionee will be treated as having received compensation income (taxable at ordinary income tax rates) equal to the excess, if any, of the Fair Market Value of the Exercised Shares on the date of exercise over their aggregate Exercise Price. If the Optionee is an Employee or a former Employee, the Company will be required to withhold from his or her compensation or collect from Optionee and pay to the applicable taxing authorities an amount in cash equal to a percentage of this compensation income at the time of exercise, and may refuse to honor the exercise and refuse to deliver Shares if such withholding amounts are not delivered at the time of exercise. (ii) Incentive Stock Option. If this Option qualifies as an ISO, the Optionee will have no regular federal income tax or California income tax liability upon its exercise, although the excess, if any, of the Fair Market Value of the Exercised Shares on the date of exercise over their aggregate Exercise Price will be treated as an adjustment to alternative minimum taxable income for federal tax purposes and may subject the Optionee to alternative minimum tax in the year of exercise. In the event that the Optionee undergoes a change of status from Employee to Consultant, any Incentive Stock Option of the Optionee that remains unexercised shall cease to qualify as an Incentive Stock Option and will be treated for tax purposes as a Nonstatutory Stock Option on the ninety-first (91st) day following such change of status. (b) Disposition of Shares. (i) NSO. If the Optionee holds NSO Shares for at least one year, any gain realized on disposition of the Shares will be treated as long-term capital gain for federal income tax purposes. (ii) ISO. If the Optionee holds ISO Shares for at least one year after exercise AND two years after the grant date, any gain realized on disposition of the Shares will be treated as 4 5 long-term capital gain for federal income tax purposes. If the Optionee disposes of ISO Shares within one year after exercise or two years after the grant date, any gain realized on such disposition will be treated as compensation income (taxable at ordinary income rates) to the extent of the excess, if any, of the lesser of (A) the difference between the Fair Market Value of the Shares acquired on the date of exercise and the aggregate Exercise Price, or (B) the difference between the sale price of such Shares and the aggregate Exercise Price. (c) Notice of Disqualifying Disposition of ISO Shares. If the Optionee sells or otherwise disposes of any of the Shares acquired pursuant to an ISO on or before the later of (i) two years after the grant date, or (ii) one year after the exercise date, the Optionee shall immediately notify the Company in writing of such disposition. The Optionee agrees that he or she may be subject to income tax withholding by the Company on the compensation income recognized from such early disposition of ISO Shares by payment in cash or out of the current earnings paid to the Optionee. 7. Entire Agreement; Governing Law. The Plan is incorporated herein by reference. The Plan and this Option Agreement constitute the entire agreement of the parties with respect to the subject matter hereof and supersede in their entirety all prior undertakings and agreements of the Company and Optionee with respect to the subject matter hereof, and may not be modified adversely to the Optionee's interest except by means of a writing signed by the Company and Optionee. This agreement is governed by California law except for that body of law pertaining to conflict of laws. By your signature and the signature of the Company's representative below, you and the Company agree that this Option is granted under and governed by the terms and conditions of the Plan and this Option Agreement. Optionee has reviewed the Plan and this Option Agreement in their entirety, has had an opportunity to obtain the advice of counsel prior to executing this Option Agreement and fully understands all provisions of the Plan and Option Agreement. Optionee hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the 5 6 Administrator upon any questions relating to the Plan and Option Agreement. Optionee further agrees to notify the Company upon any change in the residence address indicated below. OPTIONEE: PETE'S BREWING COMPANY By:_______________________________ By: _________________________ Jeffrey A. Atkins Kevin O'Rourke Director Title:____________________________ __________________________________ Residence Address __________________________________ CONSENT OF SPOUSE The undersigned spouse of Optionee has read and hereby approves the terms and conditions of the Plan and this Option Agreement. In consideration of the Company's granting his or her spouse the right to purchase Shares as set forth in the Plan and this Option Agreement, the undersigned hereby agrees to be irrevocably bound by the terms and conditions of the Plan and this Option Agreement and further agrees that any community property interest shall be similarly bound. The undersigned hereby appoints the undersigned's spouse as attorney-in-fact for the undersigned with respect to any amendment or exercise of rights under the Plan or this Option Agreement. __________________________________ Spouse of Optionee 6 7 EXHIBIT A PETE'S BREWING COMPANY EXERCISE NOTICE Pete's Brewing Company 514 High Street Palo Alto, CA 94301 Attention: Secretary 1. Exercise of Option. Effective as of today, _______, 199__, the undersigned ("Purchaser") hereby elects to purchase ______________ shares (the "Shares") of the Common Stock of Pete's Brewing Company (the "Company") under and pursuant to the 1995 Stock Option Plan (the "Plan") and the Stock Option Agreement dated December 13, 1996 (the "Option Agreement"). The purchase price for the Shares shall be $6.50, as required by the Option Agreement. 2. Delivery of Payment. Purchaser herewith delivers to the Company the full purchase price for the Shares. 3. Representations of Purchaser. Purchaser acknowledges that Purchaser has received, read and understood the Plan and the Option Agreement and agrees to abide by and be bound by their terms and conditions. 4. Rights as Shareholder. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a shareholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. A share certificate for the number of Shares so acquired shall be issued to the Optionee as soon as practicable after exercise of the Option. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 12 of the Plan. 5. Tax Consultation. Purchaser understands that Purchaser may suffer adverse tax consequences as a result of Purchaser's purchase or disposition of the Shares. Purchaser represents that Purchaser has consulted with any tax consultants Purchaser deems advisable in connection with the purchase or disposition of the Shares and that Purchaser is not relying on the Company for any tax advice. 6. Entire Agreement; Governing Law. The Plan and Option Agreement are incorporated herein by reference. This Agreement, the Plan and the Option Agreement constitute the entire agreement of the parties with respect to the subject matter hereof and supersede in their entirety all prior undertakings and agreements of the Company and Purchaser with respect to the subject matter hereof, and may not be modified adversely to the Purchaser's interest except by means of a writing signed by the Company and Purchaser. 8 This agreement is governed by California law except for that body of law pertaining to conflict of laws. Submitted by: Accepted by: PURCHASER: PETE'S BREWING COMPANY __________________________________ By: _________________________ Signature Jeffrey A. Atkins Chief Financial Officer __________________________________ Print Name Address: Address: __________________________ 514 High Street __________________________ Palo Alto, CA 94301 2 EX-10.12 3 PETE'S BREWING COMPANY STOCK OPTION AGREEMENT 1 EXHIBIT 10.12 PETE'S BREWING COMPANY STOCK OPTION AGREEMENT Unless otherwise defined herein, the terms defined in the 1995 Stock Option Plan (the "Plan") shall have the same defined meanings in this Option Agreement. I. NOTICE OF STOCK OPTION GRANT JEFFREY A. ATKINS You have been granted an option to purchase Common Stock of the Company, subject to the terms and conditions of the Plan and this Option Agreement, as follows: Grant Number 149 Date of Grant December 13, 1996 Vesting Commencement Date December 13, 1996 Exercise Price per Share $6.50 Total Number of Shares Granted 61,000 Total Exercise Price $396,500 Type of Option: X Incentive Stock Option --- Nonstatutory Stock Option --- Term/Expiration Date: December 13, 2006 Vesting Schedule: This Option may be exercised, in whole or in part, in accordance with the following schedule: 25% of the Shares subject to the Option shall vest twelve months after the Vesting Commencement Date, and 1/48th of the Shares subject to the Option shall vest each month thereafter. Dissolution, Merger, or Assets Sale Notwithstanding the foregoing Vesting Schedule, in the event of a Change of Control of the Company, the Optionee shall have the right to exercise this Option as to all of the Shares, including Shares as to which it would not otherwise be exercisable. "Change of Control" shall mean the occurrence of any of the following events: 2 (i) Any "person" or "group" (as such term is used in Section 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended) is or becomes the "beneficial owner" (as defined in Rule 13d-3 under said Act), directly or indirectly, of securities of the Company representing 50% or more of the total voting power represented by the Company's then outstanding voting securities; or (ii) A change in the composition of the Board of the Company occurring within a two-year period, as a result of which fewer than a majority of the directors are Incumbent Directors. "Incumbent Directors" shall mean directors who either (A) are directors of the Company as of the date hereof, or (B) are elected, or nominated for election, to the Board of the Company with the affirmative votes of at least a majority of the Incumbent Directors at the time of such election or nomination (but shall not include an individual whose election or nomination is in connection with an actual or threatened proxy contest relating to the election of directors to the Company); or (iii) The shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) more than fifty percent (50%) of the total voting power represented by the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all of the Company's assets (other than to a subsidiary or subsidiaries). Termination Period: This Option may be exercised for three (3) months after termination of the Optionee's employment or consulting relationship with the Company. Upon the death or disability of the Optionee, this Option may be exercised for such longer period as provided in the Plan. In the event of the Optionee's change in status from Employee to Consultant or Consultant to Employee, this Option Agreement shall remain in effect. In no event shall this Option be exercised later than the Term/Expiration Date as provided above. II. AGREEMENT 1. Grant of Option. The Plan Administrator of the Company hereby grants to the Optionee named in the Notice of Grant attached as Part I of this Agreement (the "Optionee") an option (the "Option") to purchase the number of Shares, as set forth in the Notice of Grant, at the exercise price per share set forth in the Notice of Grant (the "Exercise Price"), subject to the terms and conditions of the Plan, which is incorporated herein by reference. Subject to Section 14(c) of the Plan, in the event of a conflict between the terms and conditions of the Plan and the terms and conditions of this Option Agreement, the terms and conditions of the 2 3 Plan shall prevail. If designated in the Notice of Grant as an Incentive Stock Option ("ISO"), this Option is intended to qualify as an Incentive Stock Option under Section 422 of the Code. However, if this Option is intended to be an Incentive Stock Option, to the extent that it exceeds the $100,000 rule of Code Section 422(d) it shall be treated as a Nonstatutory Stock Option ("NSO"). 2. Exercise of Option. (a) Right to Exercise. This Option is exercisable during its term in accordance with the Vesting Schedule set out in the Notice of Grant and the applicable provisions of the Plan and this Option Agreement. In the event of Optionee's death, Disability or other termination of Optionee's employment or consulting relationship, the exercisability of the Option is governed by the applicable provisions of the Plan and this Option Agreement. (b) Method of Exercise. This Option is exercisable by delivery of an exercise notice, in the form attached as Exhibit A (the "Exercise Notice"), which shall state the election to exercise the Option, the number of Shares in respect of which the Option is being exercised (the "Exercised Shares"), and such other representations and agreements as may be required by the Company pursuant to the provisions of the Plan. The Exercise Notice shall be signed by the Optionee and shall be delivered in person or by U.S. mail to the Stock Plan Administrator. The Exercise Notice shall be accompanied by payment of the aggregate Exercise Price as to all Exercised Shares. This Option shall be deemed to be exercised upon receipt by the Company of such fully executed Exercise Notice accompanied by such aggregate Exercise Price. No Shares shall be issued pursuant to the exercise of this Option unless such issuance and exercise complies with all relevant provisions of law and the requirements of any stock exchange or quotation service upon which the Shares are then listed. Assuming such compliance, for income tax purposes the Exercised Shares shall be considered transferred to the Optionee on the date the Option is exercised with respect to such Exercised Shares. 3. Method of Payment. Payment of the aggregate Exercise Price shall be by any of the following, or a combination thereof, at the election of the Optionee: (a) check; or (b) delivery of a properly executed exercise notice together with such other documentation as the Administrator and the broker, if applicable, shall require to effect an exercise of the Option and delivery to the Company of the sale or loan proceeds required to pay the exercise price; or (c) surrender of other Shares which (i) in the case of Shares acquired upon exercise of an option, have been owned by the Optionee for more than six (6) months on the date of surrender, and (ii) have a Fair Market Value on the date of surrender equal to the aggregate Exercise Price of the Exercised Shares. 3 4 4. Non-Transferability of Option. This Option may not be transferred in any manner otherwise than by will or by the laws of descent or distribution and may be exercised during the lifetime of Optionee only by the Optionee. The terms of the Plan and this Option Agreement shall be binding upon the executors, administrators, heirs, successors and assigns of the Optionee. 5. Term of Option. This Option may be exercised only with the term set out in the Notice of Grant, and may be exercised during such term only in accordance with the Plan and the terms of this Option Agreement. 6. Tax Consequences. Some of the federal and California tax consequences relating to this Option, as of the date of this Option, are set forth below. THIS SUMMARY IS NECESSARILY INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. THE OPTIONEE SHOULD CONSULT A TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES. (a) Exercising the Option. (i) Nonstatutory Stock Option. The Optionee may incur regular federal income tax and California income tax liability upon exercise of a NSO. The Optionee will be treated as having received compensation income (taxable at ordinary income tax rates) equal to the excess, if any, of the Fair Market Value of the Exercised Shares on the date of exercise over their aggregate Exercise Price. If the Optionee is an Employee or a former Employee, the Company will be required to withhold from his or her compensation or collect from Optionee and pay to the applicable taxing authorities an amount in cash equal to a percentage of this compensation income at the time of exercise, and may refuse to honor the exercise and refuse to deliver Shares if such withholding amounts are not delivered at the time of exercise. (ii) Incentive Stock Option. If this Option qualifies as an ISO, the Optionee will have no regular federal income tax or California income tax liability upon its exercise, although the excess, if any, of the Fair Market Value of the Exercised Shares on the date of exercise over their aggregate Exercise Price will be treated as an adjustment to alternative minimum taxable income for federal tax purposes and may subject the Optionee to alternative minimum tax in the year of exercise. In the event that the Optionee undergoes a change of status from Employee to Consultant, any Incentive Stock Option of the Optionee that remains unexercised shall cease to qualify as an Incentive Stock Option and will be treated for tax purposes as a Nonstatutory Stock Option on the ninety-first (91st) day following such change of status. (b) Disposition of Shares. (i) NSO. If the Optionee holds NSO Shares for at least one year, any gain realized on disposition of the Shares will be treated as long-term capital gain for federal income tax purposes. 4 5 (ii) ISO. If the Optionee holds ISO Shares for at least one year after exercise and two years after the grant date, any gain realized on disposition of the Shares will be treated as long-term capital gain for federal income tax purposes. If the Optionee disposes of ISO Shares within one year after exercise or two years after the grant date, any gain realized on such disposition will be treated as compensation income (taxable at ordinary income rates) to the extent of the excess, if any, of the lesser of (A) the difference between the Fair Market Value of the Shares acquired on the date of exercise and the aggregate Exercise Price, or (B) the difference between the sale price of such Shares and the aggregate Exercise Price. (c) Notice of Disqualifying Disposition of ISO Shares. If the Optionee sells or otherwise disposes of any of the Shares acquired pursuant to an ISO on or before the later of (i) two years after the grant date, or (ii) one year after the exercise date, the Optionee shall immediately notify the Company in writing of such disposition. The Optionee agrees that he or she may be subject to income tax withholding by the Company on the compensation income recognized from such early disposition of ISO Shares by payment in cash or out of the current earnings paid to the Optionee. 7. Entire Agreement; Governing Law. The Plan is incorporated herein by reference. The Plan and this Option Agreement constitute the entire agreement of the parties with respect to the subject matter hereof and supersede in their entirety all prior undertakings and agreements of the Company and Optionee with respect to the subject matter hereof, and may not be modified adversely to the Optionee's interest except by means of a writing signed by the Company and Optionee. This agreement is governed by California law except for that body of law pertaining to conflict of laws. 5 6 By your signature and the signature of the Company's representative below, you and the By Company agree that this Option is granted under and governed by the terms and conditions of the Plan and this Option Agreement. Optionee has reviewed the Plan and this Option Agreement in their entirety, has had an opportunity to obtain the advice of counsel prior to executing this Option Agreement and fully understands all provisions of the Plan and Option Agreement. Optionee hereby agrees to accept as binding, conclusive and final all decisions or interpretations of the Administrator upon any questions relating to the Plan and Option Agreement. Optionee further agrees to notify the Company upon any change in the residence address indicated below. OPTIONEE: PETE'S BREWING COMPANY By: By: ------------------------------ --------------------------- Jeffrey A. Atkins Kevin O'Rourke Director Title: --------------------------- - --------------------------------- Residence Address - --------------------------------- CONSENT OF SPOUSE The undersigned spouse of Optionee has read and hereby approves the terms and conditions of the Plan and this Option Agreement. In consideration of the Company's granting his or her spouse the right to purchase Shares as set forth in the Plan and this Option Agreement, the undersigned hereby agrees to be irrevocably bound by the terms and conditions of the Plan and this Option Agreement and further agrees that any community property interest shall be similarly bound. The undersigned hereby appoints the undersigned's spouse as attorney-in-fact for the undersigned with respect to any amendment or exercise of rights under the Plan or this Option Agreement. - --------------------------------- Spouse of Optionee 6 7 EXHIBIT A PETE'S BREWING COMPANY EXERCISE NOTICE Pete's Brewing Company 514 High Street Palo Alto, CA 94301 Attention: Secretary 1. Exercise of Option. Effective as of today___________, 199__, the undersigned ("Purchaser") hereby elects to purchase ______________ shares (the "Shares") of the Common Stock of Pete's Brewing Company (the "Company") under and pursuant to the 1995 Stock Option Plan (the "Plan") and the Stock Option Agreement dated December 13, 1996 (the "Option Agreement"). The purchase price for the Shares shall be $6.50, as required by the Option Agreement. 2. Delivery of Payment. Purchaser herewith delivers to the Company the full purchase price for the Shares. 3. Representations of Purchaser. Purchaser acknowledges that Purchaser has received, read and understood the Plan and the Option Agreement and agrees to abide by and be bound by their terms and conditions. 4. Rights as Shareholder. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a shareholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. A share certificate for the number of Shares so acquired shall be issued to the Optionee as soon as practicable after exercise of the Option. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 12 of the Plan. 5. Tax Consultation. Purchaser understands that Purchaser may suffer adverse tax consequences as a result of Purchaser's purchase or disposition of the Shares. Purchaser represents that Purchaser has consulted with any tax consultants Purchaser deems advisable in connection with the purchase or disposition of the Shares and that Purchaser is not relying on the Company for any tax advice. 6. Entire Agreement: Governing Law. The Plan and Option Agreement are incorporated herein by reference. This Agreement, the Plan and the Option Agreement constitute the entire agreement of the parties with respect to the subject matter hereof and supersede in their entirety all prior undertakings and agreements of the Company and Purchaser with respect to the subject matter hereof, and may not be modified adversely to the Purchaser's interest except by means of a writing signed by the Company and Purchaser. 8 This agreement is governed by California law except for that body of law pertaining to conflict of laws. Submitted by: Accepted by: PUCHASER: PETE'S BREWING COMPANY By: - ------------------------------------ ---------------------------------- Signature Jeffrey A. Atkins Chief Financial Officer - ------------------------------------ Print Name Address: Address: - ------------------------------------ 514 High Street - ------------------------------------ Palo Alto, CA 94301 EX-11.1 4 COMPUTATION OF NET INCOME PER SHARE 1 Exhibit 11.1 PETE'S BREWING COMPANY AND SUBSIDIARY COMPUTATION OF NET INCOME PER SHARE (1) (in thousands, except per share data)
Year Ended December 31, --------------------------- 1996 1995 1994 ---- ---- ---- Weighted average common shares outstanding for the period ....... 10,682 8,157 3,611 Common equivalent shares assuming conversion of convertible Series A and Series B preferred stock .......................... -- -- 3,305 Common equivalent shares assuming conversion of stock options and warrants under the treasury stock method .................. 137 306 948 ------- ------ ------ Shares used in per share calculation ............................ 10,819 8,463 7,864 ======= ====== ====== Net income ...................................................... $ 1,683 $1,538 $ 551 ======= ====== ====== Net income per share ............................................ $ 0.16 $ 0.18 $ 0.07 ======= ====== ======
- ------------------------------- (1) There is no difference between primary and fully diluted net income per share for all periods presented. EX-13.1 5 PORTIONS OF THE ANNUAL REPORT DATED 12/31/96 1 Exhibit 13.1 SELECTED FINANCIAL DATA
For the years ended December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (amounts in thousands except per share and employee data) 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------------------------ Net sales $70,634 $59,176 $ 30,837 $ 12,236 $ 5,519 Gross profit 35,873 29,517 13,939 5,733 2,164 Income from operations 1,078 2,536 603 166 46 Net income 1,683 1,538 551 131 21 Net income per share $ 0.16 $ 0.18 $ 0.07 $ 0.02 $ 0.00 Barrels sold 425.6 347.8 180.2 69.3 29.4 Cash, cash equivalents, and available for sale securities $39,234 $42,960 $ 1,090 171 53 Working capital (deficit) 42,914 44,425 (807) (211) (151) Total assets 66,088 54,250 5,918 3,118 1,178 Total shareholders' equity 51,311 49,023 1,040 414 223 Total number of employees(1) 126 86 67 37 17
(1) As of December 31, 2 page 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements in the Management's Discussion and Analysis of Financial Condition and Results of Operations are forward-looking statements. These forward-looking statements are based on current expectations and entail various risks and uncertainties that could cause actual results to differ materially from those expressed in such forward-looking statements. Such risks and uncertainties are set forth below under "Factors Affecting Future Operating Results." These forward-looking statements include, but are not limited to, the statement in the fifth paragraph of "Overview" concerning the period of time through which available brewery capacity will be sufficient to meet the Company's needs, the statements in the sixth and seventh paragraphs of "Overview," the statements in the analysis of the years ended December 31, 1996 and 1995, under "Sales" regarding expectations for barrel shipments and sales per barrel, under "Cost of Goods Sold" regarding the expectation of cost of sales per barrel, under "Selling, Advertising and Promotional Expenses" regarding the Company's expectations for selling, advertising and promotional expenses, under "General and Administrative Expenses" regarding expectations, under "Interest Income (Expense), Net" regarding expectations for interest earnings, the statements under "Factors Affecting Future Operating Results," and the statement in the last paragraph under "Liquidity and Capital Resources" regarding the sufficiency of the Company's available resources to meet working capital and capital expenditure requirements. OVERVIEW. Pete's Brewing Company ("the Company") was incorporated in California in 1986. The Company markets its beers in 49 states, the District of Columbia and the United Kingdom, through independent beverage distributors that sell to retail establishments that sell to consumers. The Company has historically devoted substantial resources toward selling, advertising and promotional activities to build consumer awareness and brand loyalty and support expansion of sales and distribution efforts. The Company believes that this brand investment has resulted in better recognition of the Company and its products, better placement on store shelves and increased distribution of the Company's beers. The Company intends to continue to devote substantial resources toward selling, advertising and promotional activities, particularly as it focuses on expanding retail distribution and introduces new products. The Company's profitability is significantly impacted by the timing and level of expenditures related to selling, advertising and promotion. Since its inception, the Company has made an ongoing analysis of the most cost-effective method to produce its beers. Given the geographic dispersion of sales throughout the United States, the Company has determined that a strategy of utilizing excess capacity of strategically located independent breweries to custom brew its beers, under the Company's on-site supervision and pursuant to the Company's proprietary recipes, would be the most cost effective. In 1995, the Company entered into a nine-year Manufacturing Services Agreement (the "Stroh Agreement") with The Stroh Brewery Company ("Stroh") of Detroit, Michigan. Under the Stroh Agreement, the Company uses the St. Paul, Minnesota and Winston-Salem, North Carolina Stroh breweries. Although Stroh owns the breweries, the Company supervises the brewing, testing, bottling and kegging of its beers in accordance with the Company's written specifications and proprietary recipes. All costs relating to the Stroh Agreement are charged to cost of goods sold. As an alternating brewer, the Company is liable for the payment of excise taxes to various federal and state agencies upon shipment of beer from the breweries. The Company takes title to all beer in process and finished goods, and pays Stroh a manufacturing services fee, equal to the aggregate of a specific brewing fee and the cost of packaging and raw materials, upon shipment to distributors. The Company may also, upon agreement with Stroh and the investment of necessary funds, have access to additional locations within the Stroh system. After review of a brewery construction feasibility study prepared by the Company in conjunction with its architect, mechanical engineer and general contractor, and a review of available capacity under the Stroh Agreement and other factors, the Company has recently determined not to go forward with previously disclosed plans to construct and 3 page 21 equip a new brewery in California. Although the Company believes that the brewing capacity available to the Company under the Stroh Agreement is adequate to meet its needs for the foreseeable future, the Company will continue to monitor long term capacity availability in light of its business plan. The financial resources previously earmarked to finance capital expenditures in connection with the construction of the brewery will now be used for general corporate purposes, including to meet working capital needs pending the analysis, currently underway, of the alternative uses available to the Company. See "Liquidity and Capital Resources." During the first quarter of 1997, based on a decision made at its February 1997 Board meeting to indefinitely delay construction of a brewery, the Company will take a charge to earnings for the write-off of previously capitalized costs in connection with the brewery project. Such write-off will adversely impact the Company's earnings in the first quarter of 1997. During the second half of 1996, the Company transitioned to a new wholesale distribution network in California, Colorado, and Washington, D.C. Previously, the Company had relied on a single or limited number of distributors in these key markets. The transition of the Company's distribution from a single or limited number of distributors to in excess of 30 new distributors adversely impacted the Company's level of revenues and profitability in the fourth quarter of 1996. The Company expects that the transition of the distribution network in these key markets will continue to impact the Company's business, financial condition and results of operations in the near term. As a result of competitive market factors, the transition of the distribution network in key markets and other factors described below under "Results of Operations," the Company realized net income during the fourth quarter of 1996 of approximately $6,000. In addition, the Company expects that net sales in the first quarter of 1997 will decline when compared to the first quarter of 1996. The Company also expects to record a net loss for the first quarter of 1997, as a result of competitive market factors, the continuing transition of the distribution network and other factors, together with the write-off of brewery project costs and other write-offs to be incurred during the quarter. RESULTS OF OPERATIONS. The following table sets forth certain items from the Company's consolidated statements of operations as a percentage of sales for the periods indicated:
Years ended December 31, - ----------------------------------------------------------------------------------- 1996 1995 1994 - ----------------------------------------------------------------------------------- Sales 110.6% 110.1% 109.0% Less excise taxes 10.6 10.1 9.0 ------------------------------ Net sales 100.0 100.0 100.0 Cost of goods sold 49.2 50.1 54.8 ------------------------------ Gross profit 50.8 49.9 45.2 ------------------------------ Selling, advertising and promotional expenses 42.0 36.4 34.3 General and administrative expenses 7.2 7.2 8.9 Brewery transition charges -- 2.0 -- ------------------------------ Total operating expenses 49.2 45.6 43.2 ------------------------------ Income from operations 1.6 4.3 2.0 Interest income (expense), net 1.9 0.1 (0.3) ------------------------------ Income before income taxes 3.5 4.4 1.7 Income tax (provision) benefit (1.1) (1.8) 0.1 ------------------------------ Net income 2.4% 2.6% 1.8% ------------------------------
4 page 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following table sets forth the number of barrels sold together with certain items from the Company's consolidated statements of operations on a per barrel sold basis for the periods indicated:
Years ended December 31, -------------------------------------------------------------------------------------------------------------------- 1996 1995 1994 -------------------------------------------------------------------------------------------------------------------- Sales $183.48 $187.35 $186.55 Less excise taxes 17.52 17.21 15.42 -------------------------------------------------------- Net sales 165.96 170.14 171.13 Cost of goods sold 81.67 85.27 93.77 -------------------------------------------------------- Gross profit 84.29 84.87 77.36 -------------------------------------------------------- Selling, advertising and promotional expenses 69.80 61.90 58.71 General and administrative expenses 11.96 12.24 15.30 Brewery transition charges -- 3.44 -- -------------------------------------------------------- Total operating expenses 81.76 77.58 74.01 -------------------------------------------------------- Income from operations 2.53 7.29 3.35 Interest income (expense), net 3.20 0.14 (0.49) -------------------------------------------------------- Income before income taxes 5.73 7.43 2.86 Income tax (provision) benefit (1.78) (3.01) 0.20 -------------------------------------------------------- Net income $ 3.95 $ 4.42 $ 3.06 -------------------------------------------------------- Barrels sold (in thousands) 425.6 347.8 180.2 --------------------------------------------------------
YEARS ENDED DECEMBER 31, 1996 AND 1995. SALES. Sales increased by 19.8% from $65.2 million in 1995 to $78.1 million in 1996. Sales volume increased 22.4% from 347,800 barrels sold in 1995 to 425,600 barrels sold in 1996. The increase in sales was primarily attributable to growth in sales volume in existing markets and, to a lesser extent, increased sales volume resulting from expansion into new geographic markets. The increased sales volume reflected increased sales of the Company's new products; Pete's Wicked Pale Ale, Pete's Wicked Strawberry Blonde, Pete's Wicked Multi Grain and Pete's Wicked Maple Porter, which were introduced in late June of 1996, partially offset by reduced sales of the Company's other year-round products. Sales per barrel decreased from $187.35 in 1995 to $183.48 in 1996 primarily as a result of price reductions in select markets. Sales per barrel is expected to range between $181.00 and $183.00 for 1997, assuming there is no significant change in the sales mix between keg and bottled beer from 1996. EXCISE TAXES. Federal and state excise taxes increased by 24.6% from $6.0 million in 1995 to $7.5 million in 1996. Excise taxes as a percentage of net sales increased from 10.1% in 1995 to 10.6% in 1996. Excise taxes per barrel sold increased from $17.21 in 1995 to $17.52 in 1996. The increase in excise taxes was attributable to the increase in sales volume, since the excise tax is assessed on a per barrel basis, and to the increased per barrel excise tax burden as the Company's sales volume for the year surpassed 60,000 barrels. If the Company successfully increases sales volume in future periods, excise taxes will continue to increase as a percentage of net sales and per barrel sold, due to the diminished impact of the small brewers excise tax credit. 5 page 23 COST OF GOODS SOLD. Cost of goods sold increased 17.2% from $29.7 million in 1995 to $34.8 million in 1996 reflecting the increase in volume of beer sold. Cost of goods sold as a percentage of net sales decreased from 50.1% in 1995 to 49.2% in 1996. Cost of goods sold per barrel decreased from $85.27 in 1995 to $81.67 in 1996. The decreases in cost of goods sold as a percentage of net sales and per barrel sold were primarily attributable to reduced packaging material costs due to purchasing economies of scale and reduced brewing processing fees resulting from contractually agreed discounts with Stroh. Transportation expenses are a significant component of cost of goods sold. Transportation expenses increased 28.8% from $5.2 million in 1995 to $6.7 million in 1996. Transportation expenses as a percentage of net sales increased from 8.9% in 1995 to 9.5% in 1996. Transportation expenses per barrel sold increased from $14.95 per barrel in 1995 to $15.74 per barrel in 1996. The increase in transportation expenses as a percentage of net sales and per barrel sold were primarily due to increased warehousing and transportation costs associated with the restructuring of the Company's distribution network in California during the three months ended December 31, 1996, and increased freight costs attributable to backhauling of empty kegs from wholesalers' warehouses to the brewery. These increases were partially offset by the cost savings realized by shipping beer to east coast distributors from the Winston-Salem brewery during 1996. Cost of goods sold in the fourth quarter of 1996 was adversely impacted by the Company's transition to a new distribution network, as the Company incurred incremental costs to establish and support the new distributors, and by the reduced sales volume in the fourth quarter. The Company expects that cost of goods sold per barrel for 1997 will be between $79.00 and $81.00 per barrel, due to anticipated lower raw material costs associated with the purchase of malt ingredients and improved freight costs. SELLING, ADVERTISING AND PROMOTIONAL EXPENSES. Selling, advertising and promotional expenses increased by 38.1% from $21.5 million in 1995 to $29.7 million in 1996. Selling, advertising and promotional expenses as a percentage of net sales increased from 36.4% in 1995 to 42.0% in 1996. Selling, advertising and promotional expenses per barrel sold increased from $61.90 in 1995 to $69.80 in 1996. The percentage and per barrel increases from 1995 were attributable to higher advertising costs associated with the Company's radio campaign initiated in June 1996 and increased payroll costs associated with the increased headcount in the sales force during 1996. The Company expects selling, advertising and promotional expenses to be between $64.00 and $67.00 per barrel during 1997 as the Company's business plan for 1997 includes increased headcount in the sales force in 1997 and anticipated increases in advertising, partially funded from a reduction of consumer point of sale expenses. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 18.6% from $4.3 million in 1995 to $5.1 million in 1996. General and administrative expenses as a percentage of net sales remained consistent with 1995 at 7.2%. General and administrative expenses per barrel sold decreased from $12.24 in 1995 to $11.96 in 1996. The absolute increase in general and administrative expenses resulted primarily from increased legal fees associated with distributor transitions, professional fees associated with being a publicly traded entity and increased rental and office expenses due to expansion of the Company's office space during 1996. The Company expects general and administrative expenses to be between $13.00 and $15.00 per barrel during 1997 as the result of continued efforts to build the management infrastructure through key headcount additions. 6 page 24 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BREWERY TRANSITION CHARGES. In 1995, the Company transitioned all of the production of its beers to Stroh and incurred $1.2 million of brewery transition charges, including payments to Minnesota Brewing Company ("MBC") in connection with the termination of the Company's brewery agreement with MBC, and abandonment of assets. There were no brewery transition charges incurred during 1996 and none are expected in 1997. INTEREST INCOME (EXPENSE), NET. Interest income (expense), net, increased $1,310,000 from $49,000 in 1995 to $1,359,000 in 1996. The increase reflected earnings from investment of the net proceeds of the Company's November 1995 public offering. The Company anticipates interest earnings in 1997 approximately equal to 1996. INCOME TAX PROVISION. The Company accounts for income taxes using the deferral method of accounting for tax assets and liabilities. The income tax provision for 1996 was below the federal statutory rate (34%) as a result of non-taxable income earned during 1996 offset by state taxes and non-deductible expenses in the third quarters of 1996 and 1995. The income tax provision for 1995 was above the federal statutory rate (34%) as a result of state taxes and non-deductible expenses partially offset by non-taxable income during 1995. The Company anticipates an effective tax rate between 32% and 33% during 1997. YEARS ENDED DECEMBER 31, 1995 AND 1994. SALES. Sales increased by 93.8% from $33.6 million in 1994 to $65.2 million in 1995. Sales volume increased 93.0% from 180,200 barrels sold in 1994 to 347,800 barrels sold in 1995. The increase in sales was primarily attributable to growth in sales volume in existing markets and, to a lesser extent, increased sales volume resulting from expansion into new geographic markets. The increased sales volume reflected increased sales of Pete's Wicked Ale, Pete's Wicked Winter Brew and Pete's Wicked Red. Pete's Wicked Summer Brew and Pete's Wicked Honey Wheat were introduced in 1995 and accounted for slightly less than half of the Company's 1995 sales growth. Sales per barrel increased from $186.55 in 1994 to $187.35 in 1995. EXCISE TAXES. Federal and state excise taxes increased by 115.3% from $2.8 million in 1994 to $6.0 million in 1995. Excise taxes as a percentage of net sales increased from 9.0% in 1994 to 10.1% in 1995. Excise taxes per barrel sold increased from $15.42 in 1994 to $17.21 in 1995. The increase in excise taxes was attributable to the increase in sales volume, since the excise tax is assessed on a per barrel basis, and to the increased per barrel excise tax burden as the Company's sales volume for the year surpassed 60,000 barrels. COST OF GOODS SOLD. Cost of goods sold increased 75.5% from $16.9 million in 1994 to $29.7 million in 1995 reflecting the increase in volume of beer sold. Cost of goods sold as a percentage of net sales decreased from 54.8% in 1994 to 50.1% in 1995. Cost of goods sold per barrel decreased from $93.77 in 1994 to $85.28 in 1995. The decreases in cost of goods sold as a percentage of net sales and per barrel sold were primarily attributable to a decrease in packaging material costs due to purchasing economies of scale and the production fees charged under the Company's brewing agreements with MBC and Stroh. Transportation is a significant component of cost of goods sold. Transportation increased 87.0% from $2.8 million in 1994 to $5.2 million in 1995. Transportation as a percentage of net sales decreased from 9.1% in 1994 to 8.9% in 1995. Transportation per barrel sold decreased from $15.54 per barrel in 1994 to $15.06 per barrel in 1995. 7 page 25 SELLING, ADVERTISING AND PROMOTIONAL EXPENSES. Selling, advertising and promotional expenses increased by 103.5% from $10.6 million in 1994 to $21.5 million in 1995. Selling, advertising and promotional expenses as a percentage of net sales increased from 34.3% in 1994 to 36.4% in 1995. Selling, advertising and promotional expenses per barrel sold increased from $58.71 in 1994 to $61.89 in 1995. The increases were primarily attributable to: (i) increased investment in point of sale costs and advertising to support the growth in sales volume, expansion into new markets and the introduction of Pete's Wicked Summer Brew and Pete's Wicked Honey Wheat; (ii) increased distributor sales discounts and incentives associated with increased sales; and (iii) increased employee compensation associated with increased sales. GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased 54.4% from $2.8 million in 1994 to $4.3 million in 1995. General and administrative expenses as a percentage of net sales decreased from 8.9% in 1994 to 7.2% in 1995. General and administrative expenses per barrel sold decreased from $15.30 in 1994 to $12.24 in 1995. The increase in general and administrative expenses resulted primarily from increased staffing and associated expenses necessary to support the Company's growth. BREWERY TRANSITION CHARGES. In 1995 the Company transitioned all of the production of its beers to Stroh and incurred $1.2 million of Brewery Transition Charges, including payments to MBC, in connection with the termination of the Company's brewery agreement with MBC, moving expenses and abandonment of assets. INTEREST INCOME (EXPENSES) NET. Interest income (expense), net increased $140,000 from a net interest expense of $90,000 in 1994 to a net interest income of $49,000 in 1995. The increase reflected earnings from the net proceeds from the Company's November 1995 public offering in excess of borrowings prior to the November offering. INCOME TAX (PROVISION) BENEFIT. The Company accounts for income taxes using the deferral method of accounting for tax assets and liabilities. The income tax (provision) benefit takes into account the effects of state income taxes. Income tax provisions in 1994 and 1995 were above the federal statutory rate (34%) as a result of state taxes, partially offset by the utilization of net operating loss carryforwards and nondeductible expenses. FACTORS AFFECTING FUTURE OPERATING RESULTS. QUARTERLY OPERATING RESULTS FLUCTUATE. The Company's quarterly operating results have varied significantly in the past, and may do so in the future, depending on factors such as increased competition, the transition to new distributors in key markets, fluctuations in sales volume which result in variations in cost of goods sold, the timing of new product announcements by the Company or its competitors, the timing of significant advertising and promotional campaigns by the Company, changes in mix between kegs and bottles, the impact of an increasing average federal excise tax rate as sales volume changes, fluctuations in the price of packaging and raw materials, seasonality of sales of the Company's beers, general economic factors, trends in consumer preferences, regulatory developments including changes in excise tax and other tax rates, changes in average selling prices or market acceptance of the Company's beers, increases in production costs associated with initial production of new products and fluctuations in volume of sales and variations in shipping and transportation costs. The Company's expense levels are based, in part, on its expectations of future sales levels. If sales levels are below expectations, operating results are likely to be materially adversely affected. In particular, 8 page 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS net income, if any, may be disproportionately affected by a reduction in sales because certain of the Company's operating expenses are fixed in the short-term. The Company's profitability has been significantly impacted by the timing and level of expenditures related to selling, advertising and promotional expenses. In addition, the Company's decision to undertake a significant media advertising campaign could substantially increase the Company's expenses in a particular quarter, while any increase in sales from such advertising may be realized in subsequent periods. The Company believes that quarterly sales and operating results are likely to vary significantly in the future and that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. In addition, historical growth rates should not be considered indicative of future sales growth, if any, or of future operating results. There can be no assurance that the Company's sales will grow or be sustained in future periods or that the Company will remain profitable in any future period. DEPENDENCE ON STROH. The Company relies upon Stroh at all phases of the production of its beers, including sourcing and purchasing the ingredients used to make the Company's beer, scheduling production to meet delivery requirements, brewing and packaging the Company's beers, performing quality control and assurance, invoicing distributors upon shipment, collecting and remitting payments to the Company and performing regulatory compliance. The Company's business, results of operations and financial condition would be materially adversely affected if Stroh were unable, for any reason, to meet the Company's delivery commitments or if beer brewed at Stroh breweries failed to satisfy the Company's quality requirements. If the Company's ability to obtain product from the Stroh breweries were interrupted or impaired for any reason, the Company would not be able to establish an alternative production source, nor would the Company be able to develop its own production capabilities, without substantial disruption to the Company's operations. Any inability to obtain adequate production of the Company's beers on a timely basis or any other circumstance that would require the Company to seek alternative sources of supply would delay shipments of the Company's product, which could damage relationships with the Company's current and prospective distributors and retailers, provide an advantage to the Company's competitors and have a material adverse effect on the Company's business, financial condition and operating results. COMPETITION. The Company competes with a variety of domestic and international brewers, many of whom have significantly greater financial, production, distribution and marketing resources and a higher level of brand recognition than the Company. The Company competes with and anticipates competition from several of the major national brewers, such as Anheuser-Busch, Miller Brewing Co., and Adolph Coors Co., each of whom has introduced and is marketing fuller flavored beers designed to compete directly in the craft beer segment of the domestic beer market in which the Company competes. In addition, the Company expects that certain of the major national brewers, with their superior financial resources and established distribution networks, may seek further participation in the growth of the craft beer market through investment in, or the formation of, distribution alliances with smaller craft brewers. The increased participation of the major national brewers will likely increase competition for market share and heighten price sensitivity within the craft beer market. In addition, the Company expects continued competition from imported beer brewers, many of whom 9 page 27 have greater financial and marketing resources, as well as greater brand name recognition, than the Company. The Company also anticipates increased competition in the craft beer market from existing craft brewers such as The Boston Beer Company, Inc., Redhook Ale Brewery, Inc., Sierra Nevada Brewing Co., Pyramid Brewing Co., Anchor Brewing Co. and new market entrants. In particular, the Company believes that competition has intensified recently as a result of the proliferation of small local craft brewers that have introduced and are marketing significant numbers of products. The Company also competes with other beer and beverage companies not only for consumer acceptance and loyalty but also for shelf and tap space in retail establishments and for marketing focus by the Company's distributors and their customers, all of which also distribute and sell other beers and alcoholic beverage products. Increased competition has in the past and could in the future result in price reductions, reduced margins and loss of market share, all of which could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON DISTRIBUTORS. The Company is dependent upon its distributors to sell the Company's products and to assist the Company in promoting market acceptance of, and creating demand for, the Company's products. During the second half of 1996, the Company transitioned to a new wholesale distribution network in California, Colorado, and Washington, D.C. Previously, the Company had relied on a single or limited number of distributors in these key markets. The transition of the Company's distribution from a single or limited number of distributors to in excess of 30 new distributors adversely impacted the Company's level of revenues and profitability in the fourth quarter of 1996. The Company expects that the transition of the distribution network in these key markets will continue to impact the Company's business, financial condition and results of operation in the near term. In addition, there is always a risk that the Company's distributors will give higher priority to the products of other beverage companies, including products directly competitive with the Company's beers, thus reducing their efforts to sell the Company's products. In addition, there can be no assurance that the Company's distributors will devote the resources necessary to provide effective sales and promotion support to the Company. If one or more of the Company's significant distributors were to discontinue selling, or decrease the level of orders for the Company's products, the Company's business would be adversely affected in the areas serviced by such distributors until the Company retained replacements. There can be no assurance that the Company would be able to replace a significant distributor in a timely manner or at all in the event a distributor were to discontinue selling the Company's products. PRODUCT CONCENTRATION. The sale of a limited number of beers has accounted for substantially all of the Company's sales since inception. The Company believes that the sale of its currently offered beers will continue to account for a significant portion of sales for the foreseeable future. Therefore, the Company's future operating results, particularly in the near term, are significantly dependent upon the continued market acceptance of these beers. There can be no assurance that the Company's beers will continue to achieve market acceptance. A decline in the demand for any of the Company's beers as a result of competition, changes in consumer tastes and preferences, government regulation or other factors would have a material adverse effect on the Company's business, operating results and financial condition. 10 page 28 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS DEVELOPMENT OF NEW PRODUCTS. The craft beer market is highly competitive and characterized by changing consumer preferences and continuous introduction of new products. The Company believes that its future growth will depend, in part, on its ability to anticipate changes in consumer preferences and develop and introduce, in a timely manner, new beers that adequately address such changes. There can be no assurance that the Company will be successful in developing, introducing and marketing new products on a timely and regular basis. If the Company is unable to introduce new products or if the Company's new products are not successful, the Company's sales may be adversely affected as customers seek competitive products. GOVERNMENT REGULATION. The Company's business is highly regulated by federal, state and local laws and regulations. Such laws and regulations govern licensing requirements, trade and pricing practices, permitted and required labeling, advertising, promotion and marketing practices, relationships with distributors and related matters. Failure on the part of the Company to comply with federal, state and local regulations could result in the loss or revocation or suspension of the Company's licenses, permits or approvals and accordingly could have a material adverse effect on the Company's business. The federal government and each of the states levy excise taxes on alcoholic beverages, including beer. Increases in excise taxes on beer, if enacted, could materially and adversely affect the Company's financial condition and results of operations. Certain states and local jurisdictions, have adopted restrictive beverage packaging laws and regulations that require deposits on beverage containers. Congress and a number of additional state and local jurisdictions may adopt similar legislation in the future, and in such event, the Company may be required to incur significant expenditures in order to comply with such legislation. Changes to federal and state excise taxes on beer production, or any other federal and state laws or regulations which affect the Company's products could materially adversely affect the Company's business, financial condition and results of operations. DEPENDENCE ON KEY PERSONNEL. The Company's success depends to a significant degree upon the continuing contributions of, and on its ability to attract and retain, qualified management, sales, production and marketing personnel. The competition for qualified personnel is intense and the loss of any of such persons as well as the failure to recruit additional key personnel in a timely manner, could adversely affect the Company. There can be no assurance that the Company will be able to continue to attract and retain qualified management and sales personnel for the development of its business. Failure to attract and retain key personnel could have a material adverse effect on the Company's business, operating results and financial condition. In addition, the Company has recently hired several key executive officers to supplement its management team. In addition, the Company is currently conducting a search to select a new Chief Executive Officer. The Company's future success will depend, in part, on the ability of its current and future executive officers to operate effectively, both independently and as a group. 11 page 29 LIQUIDITY AND CAPITAL RESOURCES. Since its inception, the Company has funded its operations primarily through cash generated from operations, private sales of preferred stock, bank and other debt, and capital equipment leases. In addition, the Company received net proceeds of approximately $43.5 million from its initial public offering completed in November 1995. As of December 31, 1996, the Company had $42.9 million in working capital, including $19.8 million in cash and cash equivalents and $19.4 million in available for sale securities, as compared to working capital of $44.4 million as of December 31, 1995. The decrease was primarily due to the Company's investment in property and equipment offset by the cash provided from operations. The Company's cash and cash equivalents decreased by $23.1 million in 1996 and increased by $41.9 million and $920,000 in 1995 and 1994, respectively. The Company generated $1.4 million, $541,000 and $1.0 million in cash from operating activities during those same periods. Cash from operations in 1996 was generated primarily from net income and an increase to accounts payable and accrued expenses which was offset by an increase in accounts receivable, inventories and prepaid expenses. The Company's principal investing activities during 1996 consisted of purchases of available for sale securities of $19.4 million and purchases of new Sankey kegs approximating $3.0 million. The Company's principal investing activities in 1995 and 1994 were additions to property and equipment of $867,000 and $752,000, respectively. The only financing activity during 1996 was the issuance of common stock to employees of the Company under the Company's employee stock purchase and stock option plans, which provided $378,000 of cash flow. The Company's primary investing activities in 1995 and 1994 were the sale of common stock in the Company's initial public offering in 1995 and borrowing under the line of credit in 1994 of $43.5 million and $700,000, respectively. As described under "Overview," the Company has recently determined not to go forward with previously disclosed plans to construct and equip a new brewery in California. The financial resources previously earmarked to finance capital expenditures in connection with the construction of the brewery will be used for general corporate purposes, including to meet working capital needs, pending the Company's analysis, currently underway, of the alternative uses available to the Company. The Company anticipates that its current cash available for sale securities and cash flow from operations will be sufficient to meet its working capital and capital expenditure requirements for the near term. 12 page 30 CONSOLIDATED BALANCE SHEETS
December 31, - --------------------------------------------------------------------------------------------------------------------- (in thousands) 1996 1995 - --------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $19,814 $42,960 Available for sale securities 19,420 -- Trade accounts receivable, net 7,664 3,184 Inventories 4,431 2,244 Prepaid expenses and other current assets 4,046 1,149 Deferred taxes 2,088 115 ------- ------- Total current assets 57,463 49,652 Property and equipment, net 5,112 1,568 Other assets 3,513 3,030 ------- ------- $66,088 $54,250 ======= ======= LIABILITIES Current liabilities: Trade accounts payable $ 5,299 $ 1,474 Accrued expenses 9,250 3,753 ------- ------- Total current liabilities 14,549 5,227 Deferred taxes 228 -- ------- ------- Total liabilities 14,777 5,227 Commitments and Contingencies (Note 12) SHAREHOLDERS' EQUITY Preferred shares, no par value: Authorized: 5,000 shares; issued and outstanding: none -- -- Common shares, no par value: Authorized: 50,000 shares; issued and outstanding: 10,733 in 1996 and 10,621 in 1995 48,551 47,957 Unrealized gain on available for sale securities 11 -- Retained earnings 2,749 1,066 ------- ------- Total shareholders' equity 51,311 49,023 ------- ------- $66,088 $54,250 ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 13 page 31 CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31, - ------------------------------------------------------------------------------------------------------------------------------ (in thousands, except per share data) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------ Sales $ 78,089 $ 65,160 $ 33,616 Less excise taxes 7,455 5,984 2,779 -------------------------------------------------------- Net sales 70,634 59,176 30,837 Cost of goods sold 34,761 29,659 16,898 -------------------------------------------------------- Gross profit 35,873 29,517 13,939 -------------------------------------------------------- Selling, advertising and promotional expenses 29,705 21,525 10,579 General and administrative expenses 5,090 4,258 2,757 Brewery transition charges -- 1,198 -- -------------------------------------------------------- Total operating expense 34,795 26,981 13,336 -------------------------------------------------------- Income from operations 1,078 2,536 603 Interest expense (3) (198) (89) Interest income 1,362 247 -- -------------------------------------------------------- Income before income taxes 2,437 2,585 514 Income tax (provision) benefit (754) (1,047) 37 -------------------------------------------------------- Net income $ 1,683 $ 1,538 $ 551 ======================================================== Net income per share $ 0.16 $ 0.18 $ 0.07 ======================================================== Shares used in per share calculation 10,819 8,463 7,867 ========================================================
The accompanying notes are an integral part of these consolidated financial statements. 14 page 32 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Series A and B Preferred Shares Common Shares -------------------------------- ------------- (in thousands) Shares Amount Shares - ------------------------------------------------------------------------------------------------------------------------ Balances, January 1, 1994 3,305 $ 1,221 3,147 Common share options exercised ($0.063-$0.138 per share) -- -- 354 Common share warrants exercised, net of issuance costs -- -- 190 Net income -- -- -- -------------------------------------------------- Balances, December 31, 1994 3,305 1,221 3,691 Common share options exercised ($0.10-$1.25 per share) -- -- 925 Issuance of common shares from IPO, net of issuance costs of $1,733 -- -- 2,700 Conversion of preferred shares to common shares at close of IPO (3,305) (1,221) 3,305 Repayment of notes receivable -- -- -- Issuance of warrant -- -- -- Tax benefit associated with exercise of options -- -- -- Net income -- -- -- -------------------------------------------------- Balances, December 31, 1995 -- -- 10,621 Common share options exercised ($0.10-$2.50 per share) -- -- 76 Issuance of shares from employee stock purchase plan -- -- 36 Tax benefit associated with exercise of options -- -- -- Unrealized gain on available for sale securities -- -- -- Net income -- -- -- -------------------------------------------------- BALANCES, DECEMBER 31, 1996 -- $ -- 10,733 --------------------------------------------------
Unrealized Gain Retained Common Shares Notes on Available for Earnings (in thousands) Amount Receivable Sale Securities (Deficit) Total - ------------------------------------------------------------------------------------------------------------------------------------ Balances, January 1, 1994 $ 298 $(82) $-- $(1,023) $ 414 Common share options exercised ($0.063-$0.138 per share 28 -- -- -- 28 Common share warrants exercised, net of issuance costs 47 -- -- -- 47 Net income -- -- -- 551 551 ------------------------------------------------------------------ Balances, December 31, 1994 373 (82) -- (472) 1,040 Common share options exercised ($0.10-$1.25 per share) 106 -- -- -- 106 Issuance of common shares from IPO, net of issuance costs of $1,733 43,465 -- -- -- 43,465 Conversion of preferred shares to common shares at close of IPO 1,221 -- -- -- -- Repayment of notes receivable -- 82 -- -- 82 Issuance of warrant 2,790 -- -- -- 2,790 Tax benefit associated with exercise of options 2 -- -- -- 2 Net income -- -- -- 1,538 1,538 ------------------------------------------------------------------ Balances, December 31, 1995 47,957 -- -- 1,066 49,023 Common share options exercised ($0.10-$2.50 per share) 34 -- -- -- 34 Issuance of shares from employee stock purchase plan 344 -- -- -- 344 Tax benefit associated with exercise of options 216 -- -- -- 216 Unrealized gain on available for sale securities -- -- 11 -- 11 Net income -- -- -- 1,683 1,683 ------------------------------------------------------------------ BALANCES, DECEMBER 31, 1996 $48,551 $ -- $11 $ 2,749 $51,311 ------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 15 page 33 CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, - --------------------------------------------------------------------------------------------------------------------------- (in thousands) 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ 1,683 $ 1,538 $ 551 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 1,471 807 415 Deferred income tax (1,745) 98 (123) Loss on disposal of property and equipment -- 93 -- Changes in operating assets and liabilities: Trade accounts receivable (4,480) (2,234) (550) Inventories (2,187) (663) (278) Prepaid expenses and other current assets (2,914) (559) (428) Trade accounts payable and accrued liabilities 9,538 1,461 1,430 ---------------------------------------- Net cash provided by operations 1,366 541 1,017 ---------------------------------------- Cash flows from investing activities: Additions to property and equipment (4,112) (867) (752) Purchases of available for sale securities (28,885) -- -- Proceeds from available for sale securities 9,476 -- -- Additions to other assets (1,369) (257) (120) ---------------------------------------- Net cash used in investing activities (24,890) (1,124) (872) ---------------------------------------- Cash flows from financing activities: Proceeds from sale of common shares, net -- 43,465 -- Collection of notes receivable -- 82 -- Proceeds from short term note payable to shareholder -- 1,100 400 Repayment of notes payable to shareholders -- (1,300) (400) Net borrowings from revolving credit agreement with bank -- (1,000) 700 Proceeds from issuance of common shares pursuant to exercise of stock options and warrants 378 106 75 ---------------------------------------- Net cash provided by financing activities 378 42,453 775 ---------------------------------------- Net increase (decrease) in cash and cash equivalents (23,146) 41,870 920 Cash and cash equivalents: Beginning of year 42,960 1,090 170 ---------------------------------------- End of year $ 19,814 $ 42,960 $ 1,090 ----------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 16 page 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. Pete's Brewing Company (the Company) was incorporated in April 1986 under the laws of the State of California. The Company is a major domestic craft brewer. The Company currently markets its 12 distinctive full bodied beers in 49 states. The following is a summary of the Company's significant accounting policies: PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of Pete's Brewing Company and its sole subsidiary Wicked Ware, Inc. (collectively referred to as the Company). All significant intercompany accounts and transactions have been eliminated. CASH EQUIVALENTS. Cash equivalents include all highly liquid investments with original maturities of three months or less. BREWING OPERATIONS. In July 1992, the Company entered into an agreement with Minnesota Brewing Company of St. Paul, Minnesota. This Agreement was terminated in 1995 upon the execution of the Alternating Premises Transition Agreement as discussed in Note 8. In 1995, the Company entered into a nine year Manufacturing Services Agreement ("Agreement") with the Stroh Brewery Company ("Stroh") of Detroit, Michigan. Under the Agreement the Company will alternate the use of the brewery with Stroh and will supervise the brewing, testing, bottling and kegging done on the Company's behalf. Stroh is responsible for purchasing all packaging and raw material necessary for the Company to produce its beers. All costs relating to the Agreement are charged to cost of goods sold. The Company is liable for the payment of excise taxes to various federal and state agencies upon shipment of malt beverages from the breweries. The Company takes title to all beer in process and finished goods and pays Stroh upon shipment to distributors. CERTAIN RISKS. Financial instruments which potentially expose the Company to concentrations of credit risk consist primarily of trade accounts receivable and cash and cash equivalents. The Company's customer base includes primarily beer, wine and spirits distributors throughout the United States. The Company does not generally require collateral for its trade accounts receivable and maintains an allowance for doubtful accounts. The Company maintains cash-equivalent investments with a brokerage firm and its cash in bank deposit accounts with a bank. At times, the balances in these accounts may exceed federally insured limits. The Company has not experienced any losses on such accounts. The Company relies upon Stroh at all phases of the production of its beers. If the Agreement with Stroh was terminated, the Company believes that alternative suppliers could be found, but that significant delays and costs would be incurred which would materially effect the Company. ALLOWANCE FOR CREDIT NOTES. The Company records a provision for the estimated costs related to promotional programs for its distributors. Such costs primarily include incentive discounts and allowances. INVENTORIES. Inventories consist of beer in progress, finished goods and promotional materials and are stated at the lower of first-in, first-out cost or market. DEPRECIATION AND AMORTIZATION. Kegs, machinery and equipment, and office furniture and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of five to twenty years. Leasehold improvements are recorded at cost and amortized using the straight-line method over the shorter of the useful life of the improvements or the related lease term. Capital leases are recorded at the lower of fair market value or the present value of future minimum lease payments. Assets under capital leases are amortized using the straight-line method over the shorter of the related lease term or the useful life of the assets. Package design costs are amortized over a twelve month term. 17 page 35 REVENUE RECOGNITION. The Company recognizes revenue upon shipment of product and passage of title to the customer. ADVERTISING. The Company expenses the production costs of advertising the first time the advertising takes place, except for promotional agency fees which are capitalized and amortized over their expected periods of future benefit. Promotional agency fees consists of creative development costs associated with future promotional campaigns. The capitalized costs are amortized over a six month period. At December 31, 1996 and 1995, $657,000 and $742,000 of advertising was included in prepaid expenses, respectively. Advertising expense was $5,246,000, $2,224,000 and $1,468,000 in 1996, 1995 and 1994, respectively. INCOME TAXES. The Company accounts for income taxes under the liability method which requires that deferred taxes be computed annually on an asset and liability method and adjusted when new tax laws or rates are enacted. Deferred tax assets and liabilities are determined based on the differences between the financial report and tax basis of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. COMPUTATION OF NET INCOME PER SHARE. Net income per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of stock options and warrants (using the treasury stock method for all periods presented) and convertible Series A and Series B preferred shares. USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECENT ACCOUNTING PRONOUNCEMENTS. During February 1997, the Financial Accounting Standards Board issued Statement No. 128(SFAS 128), "Earnings per Share", which specifies the computation, presentation and disclosure requirements for Earnings per Share. SFAS 128 will become effective for the Company's 1997 fiscal year. The Company's management is currently studying the implications of SFAS 128. The impact of adopting SFAS 128 on the Company's financial statements has not yet been determined. RECLASSIFICATIONS. Certain amounts in the consolidated financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no impact on previously reported income from operations or net income. NOTE 2. AVAILABLE FOR SALE SECURITIES. At December 31, 1996, available for sale securities are stated at estimated fair value and consist of bonds, preferred stock, commercial paper, auction rate receipts and treasury notes. Available for sale securities at December 31, 1996 are summarized below:
Fair Market Cost Unrealized (in thousands) Value Basis Gain - --------------------------------------------------------------------------------------------- Bonds $11,969 $11,958 $11 Preferred stock 3,109 3,109 0 Commercial paper 1,936 1,936 0 Auction rate receipts 1,412 1,412 0 Treasury notes 994 994 0 ----------------------------------------------- $19,420 $19,409 $11 -----------------------------------------------
18 page 36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3. TRADE ACCOUNTS RECEIVABLE. Trade accounts receivable are as follows:
December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Trade accounts receivable $ 9,918 $ 4,988 Less allowance for credit notes 2,115 1,767 Less allowance for doubtful accounts 139 37 ------------------------------ $ 7,664 $ 3,184 ============================== NOTE 4. INVENTORIES. Inventories are as follows: December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Finished goods $ 972 $ 184 Beer in progress 799 430 Promotional material 2,660 1,630 ------------------------------ $ 4,431 $ 2,244 ============================== NOTE 5. PROPERTY AND EQUIPMENT. Property and equipment are as follows: December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Kegs, machinery and equipment $ 4,353 $ 1,339 Office furniture and equipment 1,115 750 Leasehold improvements 285 136 Construction in progress 591 -- ------------------------------ 6,344 2,225 Less accumulated depreciation and amortization 1,232 657 ------------------------------ $ 5,112 $ 1,568 ============================== Depreciation and amortization of property and equipment charged to operations was $568,000, $391,00, and $242,000, for fiscal years 1996, 1995 and 1994, respectively. NOTE 6. OTHER ASSETS. Other assets are as follows: December 31, - ------------------------------------------------------------------------------------------------------------------------------------ (in thousands) 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------------ Intangible costs associated with warrant $ 2,789 $ 2,789 Less accumulated amortization (362) (51) ------------------------------ 2,427 2,738 Package design costs 1,426 347 Less accumulated amortization (575) (99) ------------------------------ 851 248 Other assets 235 44 ------------------------------ $ 3,513 $ 3,030 ==============================
Amortization of intangible costs and package design costs were $886,000, $363,000, and $151,000 in 1996, 1995 and 1994, respectively. 19 page 37 NOTE 7. ACCRUED EXPENSES. Accrued expenses are as follows:
December 31, - ------------------------------------------------------------------------------------ (in thousands) 1996 1995 - ------------------------------------------------------------------------------------ Accrued distribution liabilities $5,111 $ -- Accrued brewery charges -- 449 Accrued expenses 934 847 Accrued freight 757 343 Accrued income and excise taxes 1,881 1,093 Accrued bonuses 304 543 Accrued merchandise purchases 263 478 --------------------------- $9,250 $3,753 ===========================
Stroh currently manufactures the Company's products under the Company's supervision. The Company paid approximately $28.6 million in 1996 and $7.6 million in 1995 to Stroh for charges under the Agreement and had a payable of approximately $2.0 million and $1.5 million at December 31, 1996 and 1995, respectively. NOTE 8. BREWERY TRANSITION CHARGES. In September 1995, the Company entered into an Alternating Premises Transition Agreement with Minnesota Brewing Company of St. Paul, Minnesota, terminating the existing Brewing Agreement. As a result of this transition, the Company recorded a charge of $1,198,000 in 1995. The charge is comprised of $890,000 of payments required to be made to Minnesota Brewing Company under the agreement, $93,000 loss on abandoned property and equipment, and $215,000 of scrapped materials and other transition costs. NOTE 9. INCOME TAXES. The provision for (benefit from) income taxes is as follows for the years ended December 31, 1996, 1995, and 1994:
December 31, - -------------------------------------------------------------------------------------------- (in thousands) 1996 1995 1994 - -------------------------------------------------------------------------------------------- Current: Federal $ 2,005 $ 723 $ -- State 586 226 86 ---------------------------------------------------- 2,591 949 86 Deferred: Federal (1,475) 80 (116) State (362) 18 (7) ---------------------------------------------------- (1,837) 98 (123) ---------------------------------------------------- $ 754 $1,047 $ (37) ====================================================
20 page 38 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The principal items accounting for the difference between income taxes computed at the United States statutory rate and the provision for income taxes reflected in the statements of operations are as follows, for the years ended December 31, 1996, 1995 and 1994:
- ---------------------------------------------------------------------------------------------------------------------------- 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------- United States statutory rate 34.0% 34.0% 34.0% State taxes (net of federal benefit) 6.1 5.6 7.1 Utilization of net operating loss carryforwards -- -- (49.2) Nontaxable dividends and interest (16.3) (3.0) -- Change in valuation allowance -- -- 0.8 Non-deductible expenses 4.6 3.9 -- Other 2.5 -- -- -------------------------------------------------- 30.9% 40.5% (7.3)% --------------------------------------------------
The tax effect of temporary differences that rise to significant portions of the deferred tax asset are as follows:
December 31, - ------------------------------------------------------------------------------------------- (in thousands) 1996 1995 - ------------------------------------------------------------------------------------------- Deferred tax assets: Allowance for doubtful accounts $ 59 $ 15 Allowance for credit notes 562 -- Accrued distribution liabilities 1,171 -- Vacation and bonus 167 42 State income taxes -- 32 Reserves and other 185 26 ------------------------- Total 2,144 115 ------------------------- Deferred tax liabilities: Depreciation and amortization 228 90 State income taxes 21 -- Other 35 -- ------------------------- Total 284 90 ------------------------- Net deferred taxes $1,860 $ 25 -------------------------
NOTE 10. SHAREHOLDERS' EQUITY. CAPITAL STOCK. In August 1995, the Company's Board of Directors approved a 4 for 1 split and increased the authorized common shares to 50,000,000. The consolidated financial statements have been retroactively adjusted to reflect this change. In November 1995, the Company completed the initial public offering of its common stock. The Company sold approximately 2,700,000 shares for net proceeds of $43,465,000. Concurrent with the closing of the initial public offering, the Company's Board of Directors authorized 5,000,000 preferred shares. In addition, the holders of Series A and Series B convertible preferred shares received common shares pursuant to an automatic, share-for-share conversion, resulting in the issuance of 3,305,000 common shares. WARRANT. In October 1995, the Company issued a warrant, expiring in five years, to Stroh to purchase 1,140,284 of the Company's common shares at the exercise price of $14.00 per share in exchange for Stroh granting the Company certain cost reductions and other benefits in an amended manufacturing agreement. The $2,790,000 intangible cost, as determined by an independent appraisal, will be amortized to cost of goods sold over the nine year term of the amended manufacturing agreement. 21 page 39 STOCK OPTION PLANS. In 1986, the Company adopted a combined nonstatutory and incentive stock option plan scheduled to expire in 1996 (the 1986 Plan). Under the Plan, a total of 1,932,000 of the Company's common shares have been reserved for issuance to officers, directors, and employees of and consultants to the Company. This plan was canceled by the Board of Directors during 1995. In September 1995, the Company adopted the 1995 Employee Stock Option Plan (the "1995 Plan"). Under the plan, a total of 1,000,000 of the Company's common shares have been reserved for issuance to officers, employees and consultants of the Company. Options to purchase the Company's common shares may be granted at the closing price on the date of grant. The term of the options granted under the 1995 Plan is ten years from the date of grant. In September 1995, the Company adopted the 1995 Director Option Plan (the "Director Plan") and has reserved 200,000 common shares for issuance under this plan. The Director Plan provides for an initial grant of 15,000 options to each director upon the effective date of the initial public offering at a per share price equal to the initial public offering price, an initial grant of 15,000 options to each new director upon their appointment to the Board, and annual grants of 5,000 options for each director upon their reappointment to the Board of Directors. Information regarding these Plans follows:
Options Outstanding - ------------------------------------------------------------------------------------------------------------- Shares Price (in thousands, except per share data) Available Shares Per Share - ------------------------------------------------------------------------------------------------------------- Balances, January 1, 1996 774 604 $0.100 - $ 18.00 Granted (430) 430 $6.500 - $ 18.75 Canceled 34 (34) $0.140 - $ 18.75 Exercised -- (76) $0.100 - $ 2.50 Additional shares of 1986 plan canceled (3) ------------------------------------------- Balances, December 31, 1996 375 924 $0.100 - $ 18.00 -------------------------------------------
At December 31, 1996, 184,000 shares were exercisable at an average price of $10.89 per share under the Plan. The options outstanding and currently exercisable by exercise price at December 31, 1996 are as follows:
Options Outstanding --------------------------------------------------------------------------------------- Exercise Number Outstanding Weighted Average Weighted Average Price (in thousands) Remaining Contractual Life Exercise Price --------------------------------------------------------------------------------------- $ 0.10 10 .09 $ 0.10 $ 0.14 31 1.97 $ 0.14 $ 1.25 38 2.58 $ 1.25 $ 2.50 18 3.31 $ 2.50 $ 6.50 246 9.95 $ 6.50 $ 8.00 100 9.81 $ 8.00 $ 8.75 15 9.56 $ 8.75 $ 8.88 38 9.63 $ 8.88 $ 18.00 422 8.88 $18.00 $ 18.75 6 9.08 $18.75
Options Currently Exercisable - ------------------------------------------------------- Number Exercisable Weighted Average (in thousands) Exercise Price - ------------------------------------------------------- 10 $ 0.10 31 $ 0.14 27 $ 1.25 8 $ 2.50 0 -- 0 -- 0 -- 0 -- 108 $18.00 0 --
22 page 40 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS EMPLOYEE STOCK PURCHASE PLAN. In September 1995, the Company adopted the 1995 Employee Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan allows qualified employees to purchase shares of the Company's common stock at 85% of the lower of the fair market value on the enrollment date or exercise date. The Purchase Plan has one year offering periods. The Company has reserved 400,000 shares of its common stock for issuance under the Purchase Plan. As of December 31, 1996 36,000 shares have been issued under the plan. PRO FORMA COMPENSATION EXPENSE. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the Plans (including the Employee Stock Purchase Plan). Had compensation cost for the Plans been determined based on the fair value at the grant date for awards in 1996 and 1995 consistent with the provisions of SFAS No. 123, the Company's net income and net income per share would have been reduced to the pro forma amounts indicated below:
December 31, - ------------------------------------------------------------------------------------------- (in thousands) 1996 1995 - ------------------------------------------------------------------------------------------- Net income- as reported $ 1,683 $ 1,538 Net income- pro forma $ 208 $ 1,308 Net income per share- as reported $ 0.16 $ 0.18 Net income per share- pro forma $ 0.02 $ 0.15
The fair value of each option grant is estimated on the date of grant using the Black-Scholes method with the following weighted average assumptions: Risk-free interest rate 6.20% Expected life in years 4.19 Expected dividends None Expected volatility 0.8598
The weighted average expected life was calculated based on the vesting period and exercise behavior. The risk-free interest rate was calculated in accordance with the grant date and expected life calculated for each subgroup. NOTE 11. BENEFIT PLAN. In April 1995, the Company adopted the Pete's Brewing Company 401(k) Savings Plan (the "401(k) Plan"), which is intended to qualify under Section 401 of the Internal Revenue Code. All employees meeting minimum age requirements are eligible to participate in the 401(k) Plan. Employee contributions are limited to 15% of compensation. The Company may make contributions to fund the 401(k) Plan. The Company has not made any contributions to the 401(k) Plan. NOTE 12. COMMITMENTS AND CONTINGENCIES. The Company is engaged in certain legal and administrative proceedings incidental to its normal business activities. While it is not possible to determine the ultimate outcome of these actions, at this time management believes that any liabilities resulting from such proceedings, or claims which are pending or known to be threatened, will not have a material adverse effect on the Company's consolidated financial position or results of operations. 23 page 41 The Company has commitments under operating leases for office space and equipment which expire through 2001. Under the terms of the leases for office space, the Company is responsible for certain utilities and maintenance expenses, including taxes, insurance and other operating expenses. The Company has the option to renew certain of these operating leases. Future minimum rental payments required under the operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 1996 are $545,000 in 1997, $372,000 in 1998, $267,787 in 1999, $216,785 in 2000 and $53,433 in 2001. Rental expense was approximately $489,000, $286,000 and $152,000 for the years ended December 31, 1996, 1995, and 1994, respectively. NOTE 13. SUPPLEMENTAL CASH FLOW INFORMATION. Supplemental cash flow information is summarized as follows:
December 31, - --------------------------------------------------------------------------------------------------------------------- (in thousands) 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------- Cash paid during the period for: Excise taxes $7,449 $5,889 $2,779 Interest 3 201 97 Income taxes 1,448 140 26 Noncash investing and financing activities: Intangible costs associated with issuance of warrants -- 2,790 -- Tax benefit associated with exercise of options 216 -- -- Unrealized gain on investments 11 -- --
NOTE 14. SIGNIFICANT INFORMATION AND SIGNIFICANT CUSTOMERS. The Company has no operations outside of the United States and operates in one industry segment. One customer accounted for 14% of 1996 sales. Two customers accounted for 24% and 11% and 31% and 11% of 1995 and 1994 sales, respectively. To date export sales have not been significant. 24 page 42 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Pete's Brewing Company and Subsidiary We have audited the accompanying consolidated balance sheets of Pete's Brewing Company and Subsidiary as of December 31, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Pete's Brewing Company and Subsidiary as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand LLP - --------------------------- San Jose, California February 14, 1997 25 page 43 CORPORATE DIRECTORY AND INFORMATION DIRECTORS AND OFFICERS Jeffrey A. Atkins Senior Vice President, Chief Financial Officer and Acting Chief Operating Officer; Secretary James E. Collins Vice President Operations Patrick Couteaux Vice President Brewing and Brewmaster Omer D. Malchin Vice President Marketing Don W. Quigley Senior Vice President Sales Pete S. Slosberg Co-Founder; Director Mark J. Bronder(1) Private Investor; Co-Founder and Director Audrey MacLean(2) Private Investor; Director Philip A. Marineau President and Chief Operating Officer of Dean Foods Company, a food pro- cessing company; Chairman of the Board Kevin O'Rourke(1)(2) Chief Financial Officer and Director of O'Rourke Investment Corporation, a Venture Capital Investment Firm; Director Christopher T. Sortwell(1) Executive Vice President and Chief Financial Officer of The Stroh Brewery Company, a Brewery; Director (1)Member of Audit Committee (2)Member of Compensation Committee ANNUAL MEETING The Annual Meeting of Shareholders will be held on May 12, 1997 at 1:00pm (PDT) at the Airport Hilton, San Francisco International Airport, CA REGISTRAR AND TRANSFER AGENT American Stock Transfer and Trust Company 40 Wall Street New York, NY 10005 (800) 937-5449 INDEPENDENT ACCOUNTANTS Coopers & Lybrand L.L.P. Ten Almaden Boulevard San Jose, CA 95113 PUBLICATIONS Copies of the Company's Form 10-K or Form 10-Q reports filed with the Securities and Exchange Commission are available without charge. To request a copy, please call our Investor Relations line at 1-800-955-WIKD or write our Investor Relations department at the Corporate Headquarters. CORPORATE HEADQUARTERS PETE'S BREWING COMPANY 514 High Street Palo Alto, CA 94301 Telephone: (415) 328-PETE Customer Info: (800) 877- PETE VIPete's: (888)VIP-1058 Investor Relations: (800) 955-WIKD Fax on Demand: (800) 955-WIKD Investor Website: www.peteswicked.com MARKET AND STOCK PRICE DATA Price Range of Common Stock: The Common Stock of the Company has been traded on the Nasdaq National Market under the symbol WIKD since the Company's initial public offering on November 7, 1995. Prior to that time, there was no public market for the Company's Common Stock. The following table sets forth for the periods indicating high and low sale prices of the Common Stock.
- -------------------------------------------------------------------------------------- High Low - -------------------------------------------------------------------------------------- Fiscal Year Ended December 31, 1995 Fourth Quarter (from November 7, 1995) $26.50 $13.50 Fiscal Year Ended December 31, 1996 First Quarter $20.00 $15.50 Second Quarter $21.00 $14.50 Third Quarter $15.25 $ 7.00 Fourth Quarter $ 9.00 $ 6.13
As of March 21, 1997, the Company's record date, there were 474 shareholders of record of Common Stock. The Company has never paid cash dividends on its capital stock. The Company currently expects that it will retain its future earnings for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future. TRADEMARKS Pete's Wicked Ale, Wicked Ale, Pete's & Design, Pete's Wicked Lager & Design, and Wicked Ware are registered U.S. trademarks of Pete's Brewing Company. U.S. Trademarks pending registration include Wicked Red, Wicked Winter Brew, Get Wicked Tonight, Gettin' Wicked, Team Wicked, Time Files/Get Wicked, wick-id, Wicked and peteswicked.com. Pete's Brewing Company also has exclusive use of the Strawberry Blonde(R) and Mardi Gras(R) marks. EX-23.1 6 CONSENT OF INDEPENDENT ACCOUNTANTS 1 Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the Registration Statement on Form S-8 (File No. 333-1308) of our report dated February 14, 1997, on our audits of the financial statements and financial statement schedule of Pete's Brewing Company as of December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994 which report is included in this Annual Report on Form 10-K. COOPERS & LYBRAND L.L.P. San Jose, California March 26, 1997 EX-27.1 7 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PETE'S BREWING COMPANY'S FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1996 AS SHOWN IN THE 10-K FILING. 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 19,814 19,420 7,664 139 4,431 57,463 5,112 0 66,088 14,549 0 0 0 48,551 2,760 66,088 70,634 70,634 34,761 0 34,795 0 3 2,437 754 1,683 0 0 0 1,683 .16 .16
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