-----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, HW4QtBPzI1YsTNhFlKq0J8q4V4KmnSTvk+nF6zXRtiVnNsihxxie8b2Y3FMWXwsw Sh6zhmDyJ2ywyoHIRCYSSA== 0000891618-98-001301.txt : 19980327 0000891618-98-001301.hdr.sgml : 19980327 ACCESSION NUMBER: 0000891618-98-001301 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980326 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: SEC FILE NUMBER: 000-26834 FILM NUMBER: 98573991 BUSINESS ADDRESS: STREET 1: 514 HIGH ST CITY: PALO ALTO STATE: CA ZIP: 94301 BUSINESS PHONE: 4153287383 MAIL ADDRESS: STREET 1: 514 HIGH STREET CITY: PALO ALTO STATE: CA ZIP: 94301 10-K405 1 FORM 10-K405 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 YEAR ENDED DECEMBER 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 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: (650) 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 [ ] Indicated 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 27, 1998 as reported on the Nasdaq National Market, was approximately $34,641,245. Shares of Common Stock held by each officer and director and by each person known to the Company 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 27, 1998, registrant had 10,815,273 outstanding shares of Common Stock. 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 June 8, 1998. ================================================================================ 2 PETE'S BREWING COMPANY FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1997 INDEX
PAGE ---- PART I. Item 1. Business.................................................... 1 Employees................................................... 13 Item 2. Properties.................................................. 13 Item 3. Legal Proceedings........................................... 13 Item 4. Submission of Matters to a Vote of Security Holders......... 13 Executive Officers of the Registrant........................ 14 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......................................... 15 Item 6. Selected Financial Data..................................... 16 Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations................................... 17 Item 8. Financial Statements and Supplementary Data................. 26 PART III. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 41 Item 10. Directors and Executive Officers of the Registrant.......... 41 Item 11. Executive Compensation...................................... 41 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 41 Item 13. Certain Relationships and Related Transactions.............. 41 PART IV. Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K......................................................... 41 Signatures.................................................. 43 Consent of Independent Accountants.......................... Report of Independent Accountants on Financial Statement Schedule.................................................... 44 Valuation and Qualifying Accounts........................... 45
i 3 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." 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 9 distinctive full-bodied beers in 49 states, the District of Columbia and the United Kingdom under the "Pete's" brand name. Pete's Wicked Ale, the Company's flagship beer, has won 22 awards for excellence since it was introduced in 1986. In addition, Pete's currently markets Pete's Signature Pilsner, Pete's Honey Wheat, and Pete's Strawberry Blonde and Pete's Oktoberfest. By year end 1997, Pete's completed its calendar of seasonal offerings with the introduction of Pete's Springfest to provide a seasonal bridge between the number-one selling craft beers in their respective seasons, Pete's Summer Brew and Pete's Winter Brew. In response to varying consumer preferences, the Company will diversify its product line by introducing and marketing a new beer, Pete's ESP Lager, in March 1998. INDUSTRY BACKGROUND The Company participates in the domestic craft beer segment of the estimated $50 billion domestic beer market. This segment represented approximately 4.5% of total domestic, retail beer sales in 1997. In general, three types of brewers produce beers that compete with the Company's beers: major domestic brewers, import beer companies and domestic craft brewers. There are approximately 1,300 brewers in the United States. The industry is both highly concentrated, with the top five domestic brewers, Anheuser-Busch Companies, Inc., Miller Brewing Company, Inc., Adolph Coors Co., Stroh Brewery Co., and Pabst Brewing Co., accounting for nearly 90% of U.S. beer volume shipments in 1997, and fragmented within the nearly 1,300 domestic craft brewers. The large domestic beer producers generally offer a homogenous selection of beer choices designed for broad mass appeal. These beers, principally light-bodied lagers and pilsners, are brewed for low flavor and aroma, using mass production techniques for low cost. The brewers of import beers from Holland, Germany, Canada and Mexico were the first, in recent decades, to provide beers to address and benefit from shifting consumer preferences toward more full-bodied, more flavorful beers. Imported beers often reflect the style preferences of their country of origin and frequently carry a premium image with U.S. consumers. As a result, imports are frequently priced at a premium to most domestic mainstream brands. Domestic craft brewers generally brew their beers 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, and German-style wheat beers and seasonal beers tend to be more flavorful and fresher tasting. Craft brewers have convincingly promoted the concept that beers made in smaller batch sizes than the mainstream brewers and from "all natural ingredients" produce a better beer. This has been particularly relevant, as consumers have shown an increasing interest in the process of beer making, alternative styles of beer, and the history surrounding beer. This increased demand for craft beers has allowed a price premium relative to mass produced domestic beers and higher margins throughout the distribution channel, motivating distributors and retailers to carry and promote these products. Despite the rapid growth of craft beers and imports in recent years, growth in the total domestic beer market has been less than 1% per annum since 1984. Adult per capita consumption of beer in the United States has also declined slightly. The Company believes that these trends can be attributed to a variety of factors, including increased concerns over the health consequences of consuming alcoholic beverages; safety 1 4 concerns about drinking and driving; a trend toward a diet of lighter, lower calorie beverages; 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 increases in federal and state excise taxes. After several years of dramatic growth, the domestic craft beer market grew at an annual rate of approximately 8% for the year ended December 31, 1997. This growth rate was significantly below the rates of the past five years, and the Company believes that deceleration of growth by the craft segment will continue in 1998. The Company estimates that the segment was flat to slightly down during the fourth quarter of 1997. The success of the craft segment has attracted significant numbers of entrants to the category, based on the relatively low barriers to entry. This has, in turn, led to significant over-proliferation of brewers and brands in the marketplace. Consumers, previously stimulated to experiment with an increasing array of choice, appear to be moving toward safer, more reliable brand choices among the premium, "better beer" alternatives to mainstream domestic beers. Consumer research conducted by the Company during 1997 suggests that there is significant interaction between craft brands and import brands when consumers are seeking a "better beer". Import brands have effectively marketed their premium image and heritage to attract consumers from the craft segment during the past year. The Company believes that future success of its brand will depend on providing adequate and relevant brand communication to consumers who are seeking "better beers". Domestic craft brewers fall 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, defined within the industry as brewers of less than 15,000 barrels of beer annually, generally have limited distribution and tend to serve a very local market. Regional brewers typically own and operate their own breweries to produce between 15,000 and 2,000,000 barrels of beer annually. While regional brewers generally have a strong presence in their geographic regions, they tend to have less distribution and market share outside of their home region. Such brewers typically invest their resources in constructing and maintaining breweries, leaving little to invest in selling infrastructure and marketing activities. Word of mouth and occasional media attention are relied upon to promote growth. Custom brewers utilize excess industry brewing capacity to produce their beers according to their own proprietary recipes. Custom brewers devote their resources toward advertising and promotion of their craft beers, rather than a capital intensive brewing operation. 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 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 1997, 1996 and 1995, selling, advertising and promotional expenses represented 51.7%, 42.0% and 36.4%, respectively, of the Company's net sales. Beginning in 1998, the Company will market all of its beers under the "Pete's" trademark. Research conducted by the Company during 1997 indicated that consumers in the Company's target market are attracted to the "Pete's" brand name and associate both quality and fun with the brand. In addition, the "Pete's" brand is versatile, amenable to brand expansion and is not constrained by regional or provincial connotations. 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" brand and advertising awareness, consumption patterns and craft beer consumer demographics. Current consumer research indicates that beer lovers are attracted to the "Pete's" brand in large part because Pete Slosberg is a real person, who is passionate about making better beer and his company -- Pete's Brewing Company -- makes great beer. This research also determined that the "Pete's Wicked" image was uniquely associated with 2 5 the flagship beer "Pete's Wicked Ale" and, therefore, brand positioning will be adjusted during 1998 on the Company's other products to maintain this distinction. The repositioning of the brand resulted in the removal of the "Wicked" name from all of the Company's products except for "Pete's Wicked Ale". The Company intends to continue to expend significant resources on selling, advertising and promoting these concepts to increase its market share in key geographic regions in the United States. The Company's advertising and promotional activities promote the Company's image as an innovative brewer, with a personal and inviting character behind the label, a unique brand name and high quality beers. 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 quality assurance. 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 brewing 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 and in late 1997 began to qualify products for brewing at the Seattle, Washington Stroh brewery when Stroh closed its St. Paul 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 facilities of 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 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 update its product line with beers designed to appeal to varying consumer preferences. The Company currently markets 9 distinctive full flavored craft beers, consisting of five year-round products and four seasonal brews. The Company's beers, ranging from brown to amber to gold colors, all bear the "Pete's" 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. PETE'S BREWS The Company positions all of its products as full-bodied beers of the highest quality. The Company's products are made only from high quality natural ingredients. The Company brews its beer using only water, malt, hops, yeast and natural spices and flavors. 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 $58.3 million and 361,100 barrels, respectively, in 1997, which are lower than 1996 levels of $70.6 million in net sales and 425,600 barrels. 3 6 Brands The Company offers or plans to offer in the near future the following Pete's brews: Pete's Wicked Ale. Introduced in 1986, the Company's flagship beer, Pete's Wicked Ale, is widely recognized as the original American brown ale, with a roasted malt sweetness, strong hop flavor and aroma, and medium body. Pale, chocolate and caramel malts and a complex blend of Cascade and rare Brewer's Gold hops have contributed to the numerous awards for brewing excellence that this beer has received since 1986. Pete's Signature Pilsner. Introduced in 1992 as Pete's Wicked Lager, and repositioned as Pete's Wicked Bohemian Pilsner in 1996, Pete's Signature Pilsner is an authentic Czech pilsner. A medium-bodied lager, it has a malty sweetness with assertive bitterness and strong hoppy aroma from the use of imported Saaz hops. Pete's Winter Brew. Introduced in the winter of 1993, Pete's Winter Brew, formerly Pete's Wicked Winter Brew, is a medium bodied amber ale with a raspberry aroma and taste. This holiday offering is available annually from the Fall through the Winter. Pete's Summer Brew. Introduced in April 1995, Pete's Summer Brew, formerly Pete's Wicked Summer Brew, is a light, refreshing golden pale ale made with pale and wheat malt, Tettanger hops, and a delicate hint of natural lemon flavor. 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 1997, 1996, and 1995. Pete's Honey Wheat. Introduced in July 1995, Pete's Honey Wheat, formerly Pete's Wicked Honey Wheat, is an ambered colored, delicately malted wheat beer that is distinguished by its use of caramel malt in addition to wheat malt. 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 Strawberry Blonde. Introduced in July 1996, Pete's Strawberry Blonde, formerly Pete's Wicked Strawberry Blonde, is a golden ale with a soft malty finish, and a distinct strawberry aroma. Pete's Oktoberfest. Introduced in August 1996, Pete's Oktoberfest, formerly Pete's Wicked Oktoberfest, is a traditional Bavarian amber lager brewed in the classic Marzen style. This copper colored, medium-bodied brew has a sweet, caramel nutty flavor arising from the use of caramel malts, with the balancing bitterness of a blend of Cascade, Yakima Cluster and Tettanger hops. This fall seasonal is available in September and October. Pete's Springfest. Introduced in December 1997, Pete's Springfest, formerly Pete's Wicked Springfest, is a hearty, full-bodied, amber brew designed in the tradition of spring celebration seasonal bock beers. Its rich malty flavor derives from the brewmaster's use of caramel, wheat, munich, and pale malts balanced by a variety of hops. This spring seasonal is available in February and March. Pete's ESP Lager. Created in late 1997 for early 1998 introduction, Pete's ESP Lager is made in the style of European export lagers. Its golden color, combined with a refreshing craft character and crisp finish, make it a relevant alternative to more full-bodied styles. Crafted with the use of pale and wheat malts and Yakima Cluster and Tettanger hops, this new style will be introduced in March 1998. In January 1998, the Company announced its plan to realign its portfolio of brands and discontinue Pete's Wicked Multigrain, Pete's Wicked Maple Porter, Pete's Wicked Amber Ale, and Pete's Wicked Pale Ale. 4 7 Awards for Excellence The Company's beers have won numerous awards for excellence. 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 1997 1ST PLACE Norwalk, CT Consumer Preference Poll 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 1994 GOLD AWARD Karnival of Beers, Fullerton 1994 4TH PLACE: Brown Ales Great International Beer Tasting, Denver 1993 4TH PLACE: Brown Ales Great International Beer Tasting, Denver 1992 GOLD MEDAL: American Brown Ale Great American Beer Festival(R), Denver 1992 1ST PLACE Great American Beer Festival(R) "People's Choice" 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 1988 SILVER MEDAL: Brown Ale Category Great American Beer Festival(R), Denver 1987 SILVER MEDAL: Ale Category Great American Beer Festival(R), Denver 1987 1ST PLACE ALL STYLES Bay Guardian Competition, San Francisco PETE'S SIGNATURE PILSNER 1997 SILVER: Lager Category World Beer Championships 1997 SILVER: Pilsner Category Cheers One World Festival, Florida 1996 GOLD MEDAL: Pilsner Category World Beer Championships 1996 BRONZE MEDAL: Lager Category All American Beer Festival, Houston 1995 GOLD MEDAL: Pilsner Category World Beer Championships 1995 SILVER MEDAL: Traditional Pilsen California Beer Festival 1994 GOLD MEDAL: Pilsner Category World Beer Championships 1994 GOLD AWARD: Karnival of Beers, Fullerton 1994 1ST PLACE: Great International Beer Tasting, Denver 1993 GOLD MEDAL Great International Beer Tasting, Denver PETE'S HONEY WHEAT 1997 BRONZE MEDAL: Wheat Category All American Beer Festival, Houston 1997 GOLD MEDAL: Flavored Wheat Category Cheers One World Beer Festival, Florida 1996 SILVER MEDAL: Flavored Wheat Category World Beer Championships 1996 SILVER MEDAL: Wheat Category All American Beer Festival. Houston 1996 BEST HONEY BEER World Expo of Beer "People's Choice", MI 1995 SILVER MEDAL: Herb & Spice Category World Beer Championships
5 8 PETE'S STRAWBERRY BLONDE 1997 SILVER MEDAL: Fruit Beer Category World Beer Championship 1997 1ST PLACE: Ale Category Chicago Beer Affair 1997 BRONZE MEDAL: Fruit Beer Category All American Beer Festival, Houston 1996 SILVER MEDAL: Fruit Beer Category World Beer Championship PETE'S SUMMER BREW 1996 BEST PALE ALE World Expo of Beer "People's Choice", MI 1995 SILVER MEDAL: Fruit Beer Category World Beer Championships PETE'S OKTOBERFEST 1997 1ST PLACE: Seasonal Category Chicago Beer Affair 1996 SILVER MEDAL: Oktoberfest Category World Beer Championship PETE'S 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 and continues to invest 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 October 1997, the Company initiated a uniform packaging re-design of the "Pete's" brand to focus on Pete Slosberg and the "Pete's" brand, allowing the "Pete's Wicked" image to represent the flagship beer "Pete's Wicked Ale" alone. In January 1998, the Company announced the planned April 1998 release of new packaging to support the new brand positioning and emphasis on Pete's founder, Pete Slosberg. The Company packages its beers in bottles, cans, 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 corrugated container. In 1997, the Company introduced cans in select retail markets such as commercial airlines. 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 16 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 and oversees all elements of the brewing of the Company's beers. 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, 6 9 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. ADVERTISING AND PROMOTION The Company's marketing programs emphasize the "Pete's" 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 passion and knowledge of its founder, Pete Slosberg 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 and Company Founder, the Company has the only national brand identified with an individual deemed to be a true "beer folk hero." Additional innovations, such as a (1-800) line, further differentiate the label from other brands and help to keep the Company close to the consumer. In addition, the Company will continue to use advertising of various mediums in key markets. In 1997, the Company updated its seasonal line of beers with the introduction of Pete's Springfest. Pete's Springfest is available between the Pete's Wicked Winter Brew and Pete's Wicked Summer Brew selling seasons. All of these marketing tools have succeeded in increasing the brand's visibility, with the Company's distributors, retailers and consumers since its initial introduction. 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 recent point of sale promotional activities included (i) a fall/winter promotion entitled "Seek the Peak" encouraging wholesaler execution objectives and (ii) a "Tarot Card" Halloween theme promoting the natural connection between the "Pete's Wicked Ale" brand name and Halloween. The Company's bottle labeling and package artwork also enhances the Company's visibility at the point of sale. Advertising. The Company's advertising activities feature Pete Slosberg, the Company's founder and spokesperson, as an everyday guy and the ultimate beer enthusiast. In 1994, the Company became the first national, domestic craft beer producer to utilize television advertising to promote its products. In May 1996, the Company initiated radio advertising in several markets across the United States. In 1997 the Company's radio campaign was focused on the #1 selling seasonal "Pete's Summer Brew". The Company will continue to advertise in various mediums and to monitor the effectiveness of its advertising among beer consumers and to 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. Recent articles in Modern Brewery Age and Impact magazine featured viewpoints from senior Pete's Brewing Company executives. 7 10 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 trade shows in 1997, 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" 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. 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, drug stores, 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 of "Pete's brews" (all of whom carry other beverage products that compete with the Company's beers) of "Pete's" 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 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 and in 1997, is expected to continue to impact the Company's 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 1997 and 1996, the Company's ten largest distributors accounted for approximately 34.1% and 39.2%, respectively, of the Company's sales. Sales to Premium Coastal, the Company's distributor covering the Commonwealth of Massachusetts, represented approximately 9.1%, 9.4% and 10.7%, of the Company's sales in 1997, 1996 and 1995, respectively. Sales to Southern Wine and Spirits, the Company's former California distributor, represented approximately 10.7% and 20.7% of the Company's sales in 1996 and 1995, 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 8 11 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 a 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. CUSTOM BREWING Since inception, the Company has followed a strategy of utilizing breweries with excess capacity to brew the Pete's 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 the Stroh brewery in St. Paul was completed in November 1995. The Company began shipping beer from the Stroh Brewery in Winston-Salem, North Carolina in March 1996. In November 1997, Stroh closed its St. Paul brewery and currently, all of the Company's beers are produced at the Stroh brewery in 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. The Company has chosen Stroh as its custom brewing partner because of Stroh's ability to support the brewing of the Company's craft beers according to traditional European brewing styles and methods and to ensure high quality throughout the brewing process. The Company will begin shipping beer from the Stroh brewery in Seattle, Washington in 1998. Additionally, the Company also has access to the Stroh brewery in Longview, Texas. The alliance with Stroh 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 that may not be available to the Company. The annual brewing capacity available to the Company at the three Stroh breweries is over three times greater than the total volume of beer sold by the Company in 1997. 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. The Company has agreed to pay Stroh a manufacturing services price equal to the aggregate of a contractually specified brewing fee for contract services performed, 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 9 12 assurance that the Company will achieve such minimum levels. The Company did achieve such minimum levels in 1996 however did not in 1997 and does not expect to in 1998. 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 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 1997. 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" 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. The Company's brewmaster works in Winston-Salem and oversees brewing in all locations. 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, for access to contracted facilities, and the performance of services under the manufacturing services agreement, 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 provide contracted access to capacity or fail to perform according to the provisions of its manufacturing services agreement. 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. 10 13 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 determined not to go forward with previously disclosed plans to construct and 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. 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 took a charge to earnings of $713,000 for the write-off of previously capitalized costs in connection with the brewery project. Such write-off adversely impacted 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" brews. "Pete's" 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" 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 monitored 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 the entire 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. Current consumer research indicates that the "Pete's Wicked" image is uniquely associated with the Company's flagship beer "Pete's Wicked Ale." The Company will adjust its brand positioning in 1998 to maintain this distinction. 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 to take action to protect against imitation 11 14 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. The Company also believes that increased sales volume from the Company's current levels offers some competitive edge and is seeking various ways to achieve a larger scale operation. 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 has historically been one of the fastest growing segments of the domestic beer market; however, 1997 saw a significant decline in the growth trend over the last 5 years and the Company expects a generally flat growth trend for the category in 1998. 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, generally 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 decline in the segment's growth rate, and 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. 12 15 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 as a whole, though it could in particular markets. The State of Missouri has recently enacted a law requiring inclusion on the label of the owner of the brewery assets. The Company has filed a lawsuit, in combination with several other brewers, to contest the constitutionality of the law. The Company believes that it will prevail, but an adverse determination could have a material impact on the Company's business in the State of Missouri, though would not have a material impact to the Company's overall business. Certain states, including California, Connecticut, Delaware, Iowa, Maine, Massachusetts, Michigan, New York, Oklahoma, 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. EMPLOYEES As of December 31, 1997 the Company had 115 employees, including 85 in sales and marketing and 30 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. 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 8,279 square feet, respectively, in Palo Alto, California pursuant to leases which expire March 2001 and February 2002. In addition, the Company leases sales offices in Boston, Philadelphia, Atlanta, St. Paul, Seattle, Dallas, Chicago, and New Rochelle. 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. 13 16 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
NAME AGE POSITION ---- --- -------- Jeffrey Atkins 49 Chief Executive Officer and Chief Financial Officer Scott Barnum 42 President and Chief Operating Officer Stephen Cooke 40 Vice President Finance and Administration Donald Quigley 43 Senior Vice President Sales Omer Malchin 35 Vice President Marketing Patrick Couteaux 39 Vice President Brewing and Brewmaster
Officers serve at the discretion of the Board of Directors. There are no family relationships among any executive officers of the Company. Jeffrey Atkins. Jeffrey Atkins joined the Company in December 1996 as Senior Vice President and Chief Financial Officer. In June 1997, Mr. Atkins also became 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). Scott Barnum. Scott Barnum joined Pete's Brewing Company as President and Chief Operating Officer on August 1, 1997. Mr. Barnum is responsible for the execution of the company's marketing, operations, and brewing strategies. In addition, Mr. Barnum also directs the administration of human resources. Mr. Barnum was formerly the general manager of the American Specialty & Craft Beer Co., an independent subsidiary of Miller Brewing Company from February 1995 until joining the Company in August 1997. While there he was responsible for the operational management of three regional breweries, representing 23 brands. Prior to this, Mr. Barnum directed Miller's low-calorie and premium brands in 1993 and 1994, respectively. Stephen Cooke. Stephen Cooke joined the Company in October 1992 as Controller, became Director of Financial Planning and Administration in January 1994 and Vice President, Planning and Administration in January 1995. Mr. Cooke left the Company in June 1996 and worked as an independent financial consultant for a variety of companies until July 1997 when he was contracted as a consultant for the Company. In January 1998, Mr. Cooke rejoined the Company as Vice President Finance and Administration. 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 marketing Manager -- Black Velvet and McMaster's Canadian Whiskies. 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 for 1986 to November 1993. 14 17 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 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 indicates high and low closing 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 Fiscal Year Ended December 31, 1997 First Quarter............................................ $ 7.75 $ 5.02 Second Quarter........................................... $ 6.88 $ 5.02 Third Quarter............................................ $ 6.88 $ 4.82 Fourth Quarter........................................... $ 5.88 $ 3.94
As of February 27, 1997, the Company's record date, there were 489 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. With respect to the requirements of Item 701(f) of Regulation S-K regarding the reporting of use of proceeds, pursuant to the information required to be reported by Item 701(f)(4)(vii), since its report on Form 10-Q for the period ended September 30, 1997, the Company used net proceeds in the amounts noted for the following purposes: Purchase and installation of machinery and equipment $280,000; working capital $706,000; and temporary investments in liquid instruments such as municipal bonds and notes and market rate preferreds $24,989,000. There were no direct or indirect payments to directors or officers of the Company or to any other person or entity. The Registration Statement on Form S-1 filed by the Company in connection with its initial public offering stated that the Company intended to use part of the net proceeds for the construction of a brewery in California. 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 determined not to go forward with the construction of the brewery in California. The Company now intends to use such net proceeds for general corporate purposes, including to meet working capital needs pending the analysis, currently underway, of the alternative uses available to the Company. In addition, a portion of those net proceeds may be used for the acquisition of businesses, products and technologies that are complimentary to those of the Company. 15 18 ITEM 6. SELECTED FINANCIAL DATA
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------------------------- 1997 1996 1995 1994 1993 ---------- --------- --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE, PER BARREL AND EMPLOYEE DATA) Net sales............................... $ 58,336 $70,634 $59,176 $30,837 $12,236 Gross profit............................ 27,653 35,873 29,517 13,939 5,733 Income (loss) from operations........... (11,016) 1,078 2,536 603 166 Net income (loss)....................... $ (6,094) $ 1,683 $ 1,538 $ 551 $ 131 Net income (loss) per share, basic...... $ (0.57) $ 0.16 $ 0.19 $ 0.15 $ 0.06 Net income (loss) per share diluted..... $ (0.57) $ 0.16 $ 0.18 $ 0.07 $ 0.02 Barrels sold............................ 361.1 425.6 347.8 180.2 69.3 Cash, cash equivalents, and available for sale securities................... $ 31,199 $39,234 $42,960 $ 1,090 $ 171 Working Capital (deficit)............... 35,993 42,914 44,425 (807) (211) Total Assets............................ 49,756 66,088 54,250 5,918 3,118 Total shareholders' equity.............. 45,472 51,311 49,023 1,040 414 Total number of employees............... 115 126 86 67 37
16 19 ITEM 7. 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 sixth paragraph of "Overview" concerning the period of time through which available brewery capacity will be sufficient to meet the Company's needs, 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. The Company intends to continue to devote substantial resources toward selling, advertising and promotional activities, particularly as it focuses on expanding retail distribution. 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, is the most cost-effective. 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 utilizes the St. Paul, Minnesota and Winston-Salem, North Carolina breweries of Stroh. Although Stroh owns the brewery, 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 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. On September 25, 1997, Stroh announced its intention to close its brewery in St. Paul Minnesota, where the Company produced a significant portion of its beer. The closure of this production facility was effective late November 1997. The Company's management along with the management of Stroh is implementing a plan to transition the production of the Company's beer to other Stroh breweries. In addition, the Company is currently working with Stroh to develop a long term, multi-plant sourcing plan to provide cost effective production of its beers. 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 determined not to go forward with previously disclosed plans to construct and equip a 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 17 20 analysis, currently underway, of the alternative uses available to the Company. See "Liquidity and Capital Resources." During 1997, the Company recorded a charge to earnings for the write-off of previously capitalized costs in connection with the brewery project. This write-off adversely impacted the Company's 1997 earnings. During 1997, the Company recognized the write-off of promotional inventories of $2.1 million. The value of these inventories was evaluated in light of the Company's revised strategic marketing plans. Those items determined to be either excess or obsolete were written off. As a result of competitive market factors, efforts to reduce wholesale inventories and other factors described under "Results of Operations," the Company realized a net loss during the three months ended December 31, 1997 of $1,415,000. RESULTS OF OPERATIONS The following table sets forth certain items from the Company's consolidated statements of operations as a percentage of net sales for the periods indicated:
YEARS ENDED DECEMBER 31, -------------------------- 1997 1996 1995 ------ ------ ------ Sales............................................... 111.1% 110.6% 110.1% Less excise taxes................................... 11.1 10.6 10.1 ----- ----- ----- Net sales......................................... 100.0 100.0 100.0 Cost of goods sold.................................. 52.6 49.2 50.1 ----- ----- ----- Gross profit...................................... 47.4 50.8 49.9 ----- ----- ----- Selling, advertising and promotional expenses....... 51.7 42.0 36.4 General and administrative expenses................. 13.4 7.2 7.2 Write-off of brewery start-up....................... 1.2 0.0 0.0 Brewery transition charges.......................... 0.0 0.0 2.0 ----- ----- ----- Total operational expenses........................ 66.3 49.2 45.6 ----- ----- ----- Income (loss) from operations..................... (18.9) 1.6 4.3 Interest income net................................. 1.9 1.9 0.1 ----- ----- ----- Income (loss) before income taxes................. (17.0) 3.5 4.4 Income tax benefit (provision)...................... 6.6 (1.1) (1.8) ----- ----- ----- Net income (loss)................................. (10.4)% 2.4% 2.6% ===== ===== =====
18 21 The following table sets forth certain items from the Company's consolidated statements of operations on a per barrel sold basis for the periods indicated:
YEARS ENDED DECEMBER 31, ----------------------------- 1997 1996 1995 ------- ------- ------- Sales......................................... $179.52 $183.48 $187.35 Less excise taxes............................. 17.97 17.52 17.21 ------- ------- ------- Net sales................................... 161.55 165.96 170.14 Cost of goods sold............................ 84.97 81.67 85.27 ------- ------- ------- Gross profit................................ 76.58 84.29 84.87 ------- ------- ------- Selling, advertising and promotional expenses.................................... 83.56 69.80 61.90 General and administrative expenses........... 21.55 11.96 12.24 Write-off of brewery start-up................. 1.98 -- -- Brewery Transition Changes.................... -- -- 3.44 ------- ------- ------- Total operational expenses.................. 107.09 81.76 77.58 ------- ------- ------- Income (loss) from operations............... (30.51) 2.53 7.29 Interest income............................... 3.02 3.20 0.14 ------- ------- ------- Income (loss) before income taxes........... (27.49) 5.73 7.43 Income tax benefit (provision)................ 10.61 (1.78) (3.01) ------- ------- ------- Net income (loss)........................... $(16.88) $ 3.95 $ 4.42 ======= ======= ======= Barrels sold (in thousands)................... 361.1 425.6 347.8 ======= ======= =======
YEARS ENDED DECEMBER 31, 1997 AND 1996 Sales. Sales decreased by 17.0% from $78.1 million in 1996 to $64.8 million in 1997. Sales volume decreased 15.2% from 425,600 barrels sold in 1996 to 361,100 barrels sold in 1997. The decrease in sales was primarily attributable to decreased sales volume in existing markets as a result of reduced wholesaler inventories, and a decline in depletions, which are wholesaler reported shipments from wholesale to retail. Sales per barrel decreased from $183.48 in 1996 to $179.52 in 1997. The decrease in sales per barrel was due to changes in the sales mix between keg and bottled beer and changes in the sales mix between states during 1997 when compared to 1996. Excise Taxes. Federal and state excise taxes decreased by 13.3% from $7.5 million in 1996 to $6.5 million in 1997. Excise taxes as a percentage of net sales increased from 10.6% to 11.1%. Excise taxes per barrel sold increased from $17.52 in 1996 to $17.97 in 1997. The overall decrease in excise taxes was attributable to the decrease in sales volume, since the excise tax is assessed on a per barrel basis. The increase in excise taxes on a per barrel basis and as a percentage of net sales was due to the change in mix between states during 1997 when compared to 1996. Excise taxes vary from state to state and as such will vary as the mix between states changes. Cost of Goods Sold. Cost of goods sold decreased 11.7% from $34.8 million in 1996 to $30.7 million in 1997 reflecting the decrease in volume of beer sold. Cost of goods sold as a percentage of net sales increased from 49.2% in 1996 to 52.6% in 1997. Cost of goods sold per barrel increased from $81.67 in 1996 to $84.97 in 1997. The increases in cost of goods sold as a percentage of net sales and per barrel sold were primarily attributable to increased costs of production and increased transportation expenses. The increased production costs were primarily due to a reduction in contractually agreed discounts during 1997, due to the reduced production volumes in 1997. Transportation expenses decreased 10.4% from $6.7 million in 1996 to $6.0 million in 1997. Transportation expenses as a percentage of net sales increased from 9.5% in 1996 to 10.3% in 1997. Transportation expenses per barrel sold increased from $15.74 per barrel in 1996 to $16.66 per barrel in 1997. The increase in transportation expenses as a percentage of net sales and on a per barrel basis were primarily due to the increased costs associated with the restructuring of the Company's distribution network in California. As a result of expanding its distributor network from a limited number of distributors to 19 22 in excess of 30, during the fourth quarter of 1996, the Company has continued to experience increased transportation costs in this key market. Selling, Advertising and Promotional Expenses. Selling, advertising and promotional expenses increased by 1.6% from $29.7 million in 1996 to $30.2 million in 1997. Selling, advertising and promotional expenses as a percentage of net sales increased from 42.0% in 1996 to 51.7% in 1997. Selling, advertising and promotional expenses per barrel sold increased from $69.80 in 1996 to $83.56 in 1997. The increase in selling advertising and promotional expenses are primarily due to the write-off of excess and obsolete point of sales advertising material inventories, increased product packing design costs, increased consumer research expenses, increased distributor incentives and increased personnel costs, offset by reduced advertising and promotional expenditures. General and Administrative Expenses. General and administrative expenses increased 52.9% from $5.1 million in 1996 to $7.8 million in 1997. General and administrative expenses as a percentage of net sales increased from 7.2% in 1996 to 13.4% in 1997. General and administrative expenses per barrel sold increased from $11.96 in 1996 to $21.55 in 1997. The increase in general and administrative expenses resulted primarily from increased personnel costs and professional fees. Write-off of Brewery Start-up Costs. During 1997, based on a decision made at its February 1997 Board Meeting to indefinitely delay construction of a California brewery, the Company recorded a charge to earnings of $713,000 for the write-off of previously capitalized costs in connection with the California brewery project. Interest Income (Expense), Net. Interest income (expense), net, decreased $0.3 million from $1.4 million in 1996 to $1.1 million in 1997. This decrease reflected decreased earnings from investments due to a reduction in the amount of cash and cash equivalents and available for sale securities when compared to 1996. Income Tax Benefit (Provision). The Company accounts for income taxes using the deferral method of accounting for tax assets and liabilities. The 1997 income tax benefit of $3.8 million takes into account the effects of state income taxes, non-deductible expenses and non-taxable income. The income tax benefit (provision) during 1997 was above the federal statutory rate (34%) as a result of non-taxable income offset by state taxes and non-deductible expenses in 1997. The 1996 income tax provision of $754,000 was below the federal statutory rate (34%) as a result of non-taxable income offset by state taxes and non-deductible expenses in 1996. 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. 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. 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 20 23 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 ease 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. 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. 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. 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 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 earning from investment of the net proceeds of the Company's November 1995 public offering. 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. FACTORS AFFECTING FUTURE 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 costs 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 21 24 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, 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. For example, in September 1997, the Company recorded a $1.4 million charge to earnings for the write-off of obsolete promotional materials. 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, for access to contracted facilities, and the performance of services under the manufacturing services agreement, 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. During November 1997, Stroh closed its brewery in St. Paul, Minnesota, where the Company produced a significant portion of its beer. The Company's management along with the management of Stroh is implementing a plan to transition the production of the Company's beer to other Stroh breweries. In addition, the Company is currently working with Stroh to develop a long term, multi-plant sourcing plan to provide cost effective production of its beers. 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 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 22 25 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 and in 1997. 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. 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 announced in January 1998 the discontinuation of four current products and the planned 1998 introduction of one new product. The Company believes that the sale of the remaining 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. 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 Regulations. 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 23 26 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 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 affect 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. The Company's future success will depend, in part, on the ability of its executive officers to operate effectively, both independently and as a group. Year 2000 Issues. The Company has conducted a comprehensive review of its computer systems to identify the systems that could be affected by the "Year 2000" issue and is developing an implementation plan to resolve the issue. The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. The Company presently believes that, with modifications to existing software and converting to new software, the Year 2000 problem will not pose significant operational problems for the Company's computer systems as so modified and converted. However, if such modifications and conversions are not completed timely, or if significant Year 2000 problems are not timely detected, the Year 2000 problem may have a material impact on the operations of the Company. 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, 1997, the Company had $36.0 million in working capital, including $18.8 million in cash and cash equivalents and $12.4 million in available for sale securities, as compared to working capital of $42.9 million as of December 31, 1996. The decrease was primarily due to cash used by operations. The Company's cash and cash equivalents decreased by $1.0 million in 1997 as compared to a decrease of $23.1 million in 1996 and an increase of $41.9 million in 1995. The Company used $6.9 million in cash from operations in 1997 as compared to $1.4 million provided by operations in 1996 and $0.5 million in 1995. The increase in the uses of cash from operations in 1997 resulted primarily from the $6.1 million net loss recognized during 1997 and the payment of unusually high accounts payable and accrued expenses outstanding at December 31, 1996, offset by the reduction in accounts receivable and prepaid expenses. The unusually high balances of accounts payable and accrued expenses at December 31, 1996 consisted primarily of accruals for 1996 income taxes and advertising expenses. The Company's principal investing activities consisted of the purchase and sale of available for sale securities in 1997 of $19.2 million and $26.3 million, respectively. During 1996, the principal investing activity was the purchase of available for sale securities of $28.9 million and the purchase of $4.1 million of capital equipment. The Company's principal investing activities during 1995 consisted of additions to property and equipment of $867,000. The only significant financing activities in both 1997 and 1996 was the issuance of Common Stock to employees of the Company under the Company's employee stock purchase plan and incentive stock option plans, which provided $252,000 of cash flow in 1996 and $378,000 in 1997. The Company's principal investing activity during 1995 was the sale of common stock in the Company's initial public offering providing $43.5 million of cash flow. 24 27 As described in "Overview," the Company determined during February 1997 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 and available for sale securities will be sufficient to meet its working capital and capital expenditure requirements for at least the next twelve months. 25 28 PETE'S BREWING COMPANY AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) ASSETS
DECEMBER 31, ------------------ 1997 1996 ------- ------- Current assets: Cash and cash equivalents................................. $18,841 $19,814 Available for sale securities............................. 12,358 19,420 Trade accounts receivable, net............................ 1,396 7,664 Inventories............................................... 2,617 4,431 Prepaid expenses and other current assets................. 1,189 4,046 Tax refund receivable..................................... 2,074 -- Deferred taxes............................................ 1,140 2,088 ------- ------- Total current assets.............................. 39,615 57,463 Property and equipment, net................................. 4,056 5,112 Deferred taxes.............................................. 3,125 -- ------- ------- Other assets................................................ 2,960 3,513 ------- ------- $49,756 $66,088 ======= ======= LIABILITIES Current liabilities: Trade accounts payable.................................... $ 1,433 $ 5,299 Accrued expenses.......................................... 2,189 9,250 ------- ------- Total current liabilities................................. 3,622 14,549 Deferred taxes............................................ 662 228 ------- ------- Total liabilities......................................... 4,284 14,777 ------- ------- Commitments and contingencies (Note 14) 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: 10,815 December 31, 1997 and 10,733 December 31, 1996......... 48,803 48,551 Unrealized gain on available for sale securities............ 14 11 Retained earnings (deficit)................................. (3,345) 2,749 ------- ------- Total shareholders' equity........................ 45,472 51,311 ------- ------- $49,756 $66,088 ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 26 29 PETE'S BREWING COMPANY AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 -------- -------- -------- Sales....................................................... $64,825 $78,089 $65,160 Less excise taxes........................................... 6,489 7,455 5,984 ------- ------- ------- Net sales................................................. 58,336 70,634 59,176 Cost of goods sold.......................................... 30,683 34,761 29,659 ------- ------- ------- Gross profit.............................................. 27,653 35,873 29,517 ------- ------- ------- Selling, advertising and promotional expenses............... 30,173 29,705 21,525 General and administrative expenses......................... 7,783 5,090 4,258 Write-off of brewery start-up costs......................... 713 -- -- Brewery transition charges.................................. -- -- 1,198 ------- ------- ------- Total operating expense................................... 38,669 34,795 26,981 ------- ------- ------- Income (loss) from operations............................. (11,016) 1,078 2,536 Interest expense............................................ -- (3) (198) Interest income............................................. 1,091 1,362 247 ------- ------- ------- Income (loss) before income taxes......................... (9,925) 2,437 2,585 Income tax benefit (provision).............................. 3,831 (754) (1,047) ------- ------- ------- Net income (loss)......................................... $(6,094) $ 1,683 $ 1,538 ======= ======= ======= Net income (loss) per share, basic.......................... $ (0.57) $ 0.16 $ 0.19 ======= ======= ======= Shares used in per share calculation, basic................. 10,778 10,682 8,157 ======= ======= ======= Net income (loss) per share, diluted........................ $ (0.57) $ 0.16 $ 0.18 ======= ======= ======= Shares used in per share calculation, diluted............... 10,778 10,819 8,463 ======= ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 27 30 PETE'S BREWING COMPANY AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
UNREALIZED SERIES A AND B GAIN PREFERRED SHARES COMMON SHARES ON AVAILABLE RETAINED ---------------- ---------------- NOTES FOR SALE EARNINGS SHARES AMOUNT SHARES AMOUNT RECEIVABLE SECURITIES (DEFICIT) TOTAL ------ ------- ------ ------- ---------- ------------ --------- ------- Balances, January 1, 1995................. 3,305 $ 1,221 3,691 $ 373 $(82) $-- $ (472) $ 1,040 Common share options exercised ($0.10-$1.25 per share)............... -- -- 925 106 -- -- -- 106 Issuance of common shares from IPO, net of issuance costs of $1,733........... -- -- 2,700 43,465 -- -- -- 43,465 Conversion of preferred shares to common shares at close of IPO................ (3,305) (1,221) 3,305 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............... -- -- 10,621 47,957 -- -- 1,066 49,023 Common share options exercised ($0.10-$2.50 per share)............... -- -- 76 34 -- -- -- 34 Issuance of shares from employee stock purchase plan......................... -- -- 36 344 -- -- -- 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............... -- -- 10,733 48,551 -- 11 2,749 51,311 Common share options exercised ($0.10 - $18.00 per share)..................... -- -- 46 39 -- -- -- 39 Issuance of shares from employee stock purchase plan......................... -- -- 36 162 -- -- -- 162 Options granted below fair market value................................. -- -- -- 51 -- -- -- 51 Unrealized gain on available for sale securities............................ -- -- -- -- -- 3 -- 3 Net loss................................ -- -- -- -- -- -- (6,094) (6,094) ------ ------- ------ ------- ---- --- ------- ------- Balances, December 31, 1997............... -- $ -- 10,815 $48,803 $ -- $14 $(3,345) $45,472 ====== ======= ====== ======= ==== === ======= =======
The accompanying notes are an integral part of these consolidated financial statements. 28 31 PETE'S BREWING COMPANY AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 1997 1996 1995 --------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)......................................... $ (6,094) $ 1,683 $ 1,538 Adjustments to reconcile net income (loss) to net cash (used) provided by operations: Depreciation and amortization.......................... 3,021 1,471 807 Deferred taxes......................................... (1,743) (1,745) 98 Loss on disposal of property and equipment............. -- -- 93 Changes in operating assets and liabilities: Trade accounts receivable.............................. 6,268 (4,480) (2,234) Inventories............................................ 1,814 (2,187) (663) Prepaid expenses and other current assets.............. 2,857 (2,914) (559) Tax refund receivable.................................. (2,074) -- -- Accounts payable and accrued expenses.................. (10,927) 9,538 1,461 -------- -------- ------- Net cash (used) provided by operations............ (6,878) 1,366 541 -------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment....................... (387) (4,112) (867) Purchases of available for sale securities................ (19,191) (28,885) -- Proceeds from sale of available for sale securities....... 26,256 9,476 -- Additions to other assets................................. (1,025) (1,369) (257) -------- -------- ------- Net cash provided by (used in) investing activities...................................... 5,653 (24,890) (1,124) -------- -------- ------- 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 Repayment of short term note payable to shareholder....... -- -- (1,300) Net borrowings from revolving credit agreement with bank................................................... -- -- (1,000) Proceeds from issuance of common shares pursuant to exercise of stock options and warrants................. 252 378 106 -------- -------- ------- Net cash provided by financing activities......... 252 378 42,453 -------- -------- ------- Net (decrease) increase in cash and cash equivalents..................................... (973) (23,146) 41,870 CASH AND CASH EQUIVALENTS: Beginning of period....................................... 19,814 42,960 1,090 -------- -------- ------- End of period............................................. $ 18,841 $ 19,814 $42,960 ======== ======== =======
The accompanying notes are an integral part of these consolidated financial statements. 29 32 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 12 distinctive full bodied beers in 49 states, the District of Columbia and the United Kingdom. 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 or remaining maturities of three months or less, at the date of purchase. Brewing Operations. In July 1992, the Company entered into a three-year agreement with Minnesota Brewing Company of St. Paul, Minnesota. This Agreement was terminated in 1995 upon the execution of the Alternating Premise 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, for access to contracted facilities, and the performance of services under the manufacturing services agreement, 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 provide contracted access to capacity or fail to perform according to the provisions of its manufacturing services agreement. 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 life of five to twenty 30 33 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. 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, 1997 and 1996, $786,000 and $657,000 of advertising was reported in prepaid expenses, respectively. Advertising expense was $2,588,000, $5,246,000 and $2,224,000 in 1997, 1996 and 1995, 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 bases 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. Net Income (Loss) Per Share. The Company has adopted Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings per Share;" which supersedes APB Opinion No. 15 (APB No. 15), "Earnings per Share," and which is effective for all periods ending after December 15, 1997. SFAS 128 requires dual presentation of basic and diluted earnings per share (EPS) for complex capital structures on the face of the Statements of Operations. Basic EPS is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution from the exercise or conversion of other securities into common stock. For the year ended December 31, 1997, the effects of the exercise or conversion of other securities were excluded from the calculation of diluted EPS because their effect was antidilutive. 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. In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income". This statement establishes requirements for disclosure of comprehensive income and becomes effective for the Company for fiscal years beginning after December 15, 1997, with reclassification of earlier financial statements for comparative purposes. Comprehensive income generally represents all changes in shareholders' equity except those resulting from investments or contributions by shareholders. The Company is evaluating alternative formats for presenting this information, but does not expect this pronouncement to materially impact the Company's result of operations. In June 1997, The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an Enterprise and Related Information". This statement establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about 31 34 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) products and services, geographic areas and major customers. This statement supersedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise." The new standard becomes effective for fiscal years beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures. 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. 2. AVAILABLE FOR SALE SECURITIES At December 31, 1997 and 1996, available for sale securities are stated at estimated fair value and consist of municipal bonds and notes, market auction preferreds, preferred stock, commercial paper, auction rate receipts and treasury notes. Available for sales securities are as follows (in thousands):
DECEMBER 31, 1997 DECEMBER 31, 1996 ------------------------------ ------------------------------ COST UNREALIZED COST UNREALIZED FAIR MARKET --------------- FAIR MARKET --------------- VALUE BASIS GAIN VALUE BASIS GAIN ----------- ------- ---- ----------- ------- ---- Municipal Bonds and Notes.................. $10,354 $10,340 $14 $11,969 $11,958 $11 Market Auction Preferreds............. 2,004 2,004 -- -- -- -- Preferred Stock.......... -- -- -- 3,109 3,109 -- Commercial Paper......... -- -- -- 1,936 1,936 -- Auction Rate Receipts.... -- -- -- 1,412 1,412 -- Treasury Notes........... -- -- -- 994 994 -- ------- ------- --- ------- ------- --- $12,358 $12,344 $14 $19,420 $19,409 $11 ======= ======= === ======= ======= ===
3. TRADE ACCOUNTS RECEIVABLE: Trade accounts receivable are as follows (in thousands):
DECEMBER 31, ---------------- 1997 1996 ------ ------ Trade accounts receivable.......................... $3,679 $9,918 Less allowance for credit notes.................... 2,099 2,115 Less allowance for doubtful accounts............... 184 139 ------ ------ $1,396 $7,664 ====== ======
4. INVENTORIES: Inventories are as follows (in thousands):
DECEMBER 31, ---------------- 1997 1996 ------ ------ Finished goods..................................... $ 651 $ 972 Beer in progress................................... 407 799 Promotional material............................... 1,559 2,660 ------ ------ $2,617 $4,431 ====== ======
32 35 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. PROPERTY AND EQUIPMENT: Property and equipment are as follows (in thousands):
DECEMBER 31, ---------------- 1997 1996 ------ ------ Kegs, machinery and equipment...................... $4,135 $4,353 Office furniture and equipment..................... 1,550 1,115 Leasehold improvements............................. 278 285 Construction in progress........................... -- 591 ------ ------ 5,963 6,344 Less accumulated depreciation and amortization..... 1,907 1,232 ------ ------ $4,056 $5,112 ====== ======
Depreciation and amortization of property and equipment charged to operations was $1,443,000, $568,000, and $391,000, for 1997, 1996, and 1995, respectively. 6. OTHER ASSETS: Other assets are as follows (in thousands):
DECEMBER 31, ----------------- 1997 1996 ------- ------ Intangible costs associated with warrant.......... $ 2,789 $2,789 Less accumulated amortization..................... (672) (362) ------- ------ 2,117 2,427 ------- ------ Package design costs.............................. 1,606 1,426 Less accumulated amortization..................... (1,598) (575) ------- ------ 8 851 ------- ------ Other assets...................................... 269 235 ------- ------ Long term notes receivable........................ 566 -- ------- ------ $ 2,960 $3,513 ======= ======
Amortization of intangible costs and package design costs were $1,578,000, $886,000, and $363,000 in 1997, 1996 and 1995, respectively. 33 36 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. ACCRUED EXPENSES:
DECEMBER 31, ---------------- 1997 1996 ------ ------ Accrued distribution liabilities................. $ -- $5,111 Accrued expenses................................. 730 934 Accrued freight.................................. 389 757 Accrued income and excise taxes.................. 22 1,881 Accrued bonuses.................................. 303 304 Accrued merchandise purchases.................... 745 263 ------ ------ $2,189 $9,250 ====== ======
Stroh currently manufactures the Company's products under the Company's supervision. The Company paid approximately $28.6 million in 1997 and 1996 and $7.6 million in 1995 to Stroh for charges under the Agreement and had a payable of approximately $1.2 million and $2.0 million at December 31, 1997 and 1996, respectively. 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 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. 9. WRITE-OFF OF BREWERY START UP COSTS 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 determined not to go forward with previously disclosed plans to construct and equip a brewery in California. As a result of this determination the Company recorded a charge to earnings of $713,000 in 1997. This was comprised primarily of pre-construction architectural, engineering and contractor fees. 10. INCOME TAXES The provision for (benefit from) income taxes is as follows for the years ended December 31, 1997, 1996, and 1995 (in thousands):
1997 1996 1995 ------- ------- ------ Current: Federal...................................... $(2,090) $ 2,005 $ 723 State........................................ 2 586 226 ------- ------- ------ (2,088) 2,591 949 Deferred: Federal...................................... (1,278) (1,475) 80 State........................................ (465) (362) 18 ------- ------- ------ (1,743) (1,837) 98 ------- ------- ------ $(3,831) $ 754 $1,047 ======= ======= ======
34 37 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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, 1997, 1996 and 1995:
1997 1996 1995 ----- ----- ----- United States statutory rate...................... (34.0%) 34.0% 34.0% States taxes (net of federal benefit)............. (3.1) 6.1 5.6 Nontaxable dividends and interest................. (3.7) (16.3) (3.0) Non-deductible expenses........................... 1.1 4.6 3.9 Other............................................. 1.1 2.5 -- ----- ----- ----- (38.6%) 30.9% 40.5 ===== ===== =====
The tax effect of temporary differences that give rise to significant portions of the deferred tax asset are as follows (in thousands):
DECEMBER 31, ---------------- 1997 1996 ------ ------ Deferred tax assets: Allowance for doubtful accounts.......................... $ 76 $ 59 Allowance for credit notes............................... 4 562 Accrued distribution liabilities......................... -- 1,171 Net operating loss carry forward......................... 2,939 -- Vacation and bonus....................................... 196 167 Reserves and other....................................... 1,330 185 ------ ------ Total............................................ 4,545 2,144 ------ ------ Deferred tax liabilities: Depreciation and amortization............................ 662 228 State income taxes....................................... 280 21 Other.................................................... -- 35 ------ ------ Total............................................ 942 284 ------ ------ Net deferred taxes......................................... $3,603 $1,860 ====== ======
11. 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. 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 an 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, is amortized to cost of goods sold over the nine year term of the amended manufacturing agreement. 35 38 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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 options vest 25% after the first year of service and 1/48 for each month thereafter. 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 option to each new director upon their appointment to the Board, at the closing price on the date of the grant, and annual grants of 5,000 options for each director upon their reappointment to the Board of Directors at the closing price on the date of the grant. The options vest 25% after the first year of service and 1/48 for each month thereafter. In July 1997, the Company granted 12,000 shares of the Company's common stock to the Chairman of the Board of Directors of the Company, at $1.25 per share, under a nonstatutory stock option. The excess of the fair market value of the option over the grant price was charged to operations over the vesting period. The option becomes fully vested in February 1998 and expires in July 2007. Information regarding these Plans follows (in thousands, except per share data):
OPTIONS WEIGHTED OUTSTANDING AVERAGE SHARES PRICE EXERCISE AVAILABLE SHARES PER SHARE TOTAL PRICE ---------- ------- -------------- ------- --------- Balances, January 1, 1995............ 18 1,099 $0.06 - $ 1.25 $ 189 $ 0.17 Authorized......................... 1,200 -- -- -- -- Granted............................ (452) 452 $2.50 - $18.00 7,734 $17.11 Canceled........................... 22 (22) $0.14 - $ 1.25 (10) $ 0.44 Exercised.......................... -- (925) $0.10 - $ 1.25 (106) $ 0.11 Additional shares of 1986 plan canceled........................ (14) -- -- -- -- ----- ----- -------------- ------- ------ Balances, December 31, 1995.......... 774 604 $0.10 - $18.00 7,807 $12.93 Granted............................ (430) 430 $6.50 - $18.75 3,438 $ 7.99 Canceled........................... 34 (34) $0.14 - $18.75 (568) $16.72 Exercised.......................... -- (76) $0.10 - $ 2.50 (34) $ 0.44 Additional shares of 1986 plan canceled........................ (3) -- -- -- -- ----- ----- -------------- ------- ------ Balances, December 31, 1996.......... 375 924 $0.10 - $18.00 10,643 $12.93 Authorized......................... 12 -- -- -- -- Granted............................ (327) 327 $1.25 - $ 6.25 1,854 $ 5.66 Canceled........................... 291 (291) $1.25 - $18.00 (4,794) $16.47 Exercised.......................... -- (46) $0.10 - $18.00 (39) $ 0.86 Additional shares of 1986 plan canceled........................ (4) -- -- -- ----- ----- -------------- ------- ------ Balances, December 31, 1997.......... 347 914 $0.14 - $18.75 $ 7,664 $ 8.39 ===== ===== =======
36 39 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The option outstanding and currently exercisable by exercise price at December 31, 1997 are as follows (in thousands, except per share data):
OPTIONS OUTSTANDING ----------------------------------- OPTIONS CURRENTLY EXERCISABLE WEIGHTED --------------------------------- NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE EXERCISE PRICE (IN THOUSANDS) CONTRACTUAL LIFE EXERCISE PRICE (IN THOUSANDS) EXERCISE PRICE - --------------- --------------- ----------------- ---------------- --------------- --------------- $ 0.14 19 0.97 years $ 0.14 19 $ 0.14 $ 1.25 - $ 2.50 41 3.96 years $ 1.59 38 $ 1.58 $ 4.94 - $ 5.91 127 9.68 years $ 5.35 $ 6.13 - $ 8.88 553 8.76 years $ 6.84 98 $ 7.27 $18.00 - $18.75 174 7.92 years $18.03 94 $18.02 --- --- $ 0.14 - $18.75 914 8.35 years $ 8.39 249 $ 9.92 === ===
The weighted average fair value of those options granted in 1997, 1996 and 1995 was $4.21, $5.33, and $11.38, respectively. Employee Stock Purchase Plan. In September 1995, the Company adopted the 1995 Employee Stock Purchase Plan (the "Purchase Plan"). The Purchase Plan has one year offering periods. The Employee Stock Purchase Plan permits eligible employees to purchase shares of the Company's common stock at 85% of the lesser of fair market value of the common stock on the first day of the offering period of the last day of the purchase period. The Company has reserved 400,000 shares of its common stock for issuance under the Purchase Plan. As of December 31, 1997, 72,000 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 1997, 1996 and 1995 consistent with the provisions of SFAS No. 123, the Company's net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts indicated below:
YEARS ENDED DECEMBER 31, --------------------------- 1997 1996 1995 ------- ------ ------ Net income (loss) as reported......................... $(6,094) $1,683 $1,538 Net income (loss) pro forma........................... $(7,497) $ 208 $1,308 Net income (loss) per share-basic..................... $ (0.57) $ 0.16 $ 0.19 Net income (loss) per share-basic pro forma........... $ (0.70) $ 0.02 $ 0.16 Net income (loss) per share diluted................... $ (0.57) $ 0.16 $ 0.18 Net income (loss) per share diluted pro forma......... $ (0.70) $ 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:
1997 1996 1995 ------ ------ ------ Risk-free interest rate.......................... 6.05% 6.20% 6.20% Expected life in years........................... 3.48 4.19 4.19 Expected dividends............................... None None None Expected volatility.............................. 0.9774 .8598 .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. 37 40 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. COMPUTATION OF NET (LOSS) INCOME PER SHARE Basic and diluted earnings per share are calculated as follows for the years ended December 31, 1997, 1996 and 1995 (in thousands except per share amounts):
YEARS ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 ------- ------- ------ Basic: Weighted average shares.............................. 10,778 10,682 8,157 ======= ======= ====== Net (loss) income.................................... $(6,094) $ 1,683 $1,538 ======= ======= ====== Net (loss) income per share.......................... $ (0.57) $ 0.16 $ 0.19 ======= ======= ====== Diluted: Weighted average shares.............................. 10,778 10,682 8,157 Common equivalent shares from stock options and warrants.......................................... -- 137 306 ------- ------- ------ Shares used in per share calculation................. 10,778 10,819 8,463 ======= ======= ====== Net (loss) income.................................... $(6,094) $ 1,683 $1,538 ======= ======= ====== Net (loss) income per share.......................... $ (0.57) $ 0.16 $ 0.18 ======= ======= ======
13. 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. 14. 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. The Company has commitments under operating leases for office space and equipment which expire through 2002. 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 non-cancelable lease terms in excess of one year at December 31, 1997 are $697,000 in 1998, $664,000 in 1999, $639,000 in 2000, $453,000 in 2001 and $65,000 in 2002. Rental expense was approximately $608,000, $489,000 and $286,000 for the years ended December 31, 1997, 1996 and 1995, respectively. 38 41 PETE'S BREWING COMPANY AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. SUPPLEMENTAL CASH FLOW INFORMATION Supplemental cash flow information for the years ended December 31, 1997, 1996 and 1995 is summarized as follows (in thousands):
1997 1996 1995 ------ ------ ------ Cash paid during the period for: Excise taxes......................................... $7,011 $7,449 $5,889 Interest............................................. -- 3 201 Income taxes......................................... 1,947 1,448 140 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....................... 14 11 --
16. SIGNIFICANT INFORMATION AND SIGNIFICANT CUSTOMERS The Company has no operations outside of the United States and operates in one industry segment. No one customer accounted for more than 10% of 1997 sales. One customer accounted for 14% of 1996 sales. Two customers accounted for 24% and 11% of sales in 1995. To date export sales have not been significant. 39 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, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. San Jose, California February 18, 1998 40 43 PART III ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 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 June 8, 1998, 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 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 STATEMENT SCHEDULES S-1 -- Report of Independent Accountants on Financial Statement Schedule S-2 -- Valuation and Qualifying Accounts Additional schedules are not required under the related schedule instructions or are inapplicable, and therefore have been omitted. 41 44 (a)(2) 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. 10.13 Lease between Registrant and Utah State Retirement Investment Fund dated July 15, 1997. 10.14 Lease between Registrant and 1300 Iroquois Venture dated September 29, 1997. 10.15 Lease between Registrant and Rotterdam Ventures, Inc., dated September 1997. 10.16(4) Nonstatutory Stock Option Agreement by and between the Company and Philip Marineau, Chairman of the Board of Directors dated July 22, 1997. 22.1(1) List of subsidiaries of the Registrant. 23.1 Consent of Independent Accountants. 24.1 Power of Attorney (See Page 42). 27.1 Financial Data Schedule.
- --------------- (1) Incorporated by reference to exhibits filed with Registrant's Registration Statement of 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. (4) Incorporated by reference to Registrant's Form S-8 filed October 15, 1997. (b) REPORTS ON FORM 8-K The Company did not file any reports on Form 8-K during the quarter ended December 31, 1997. (c) EXHIBITS See Item 14(a)(2) above. (d) FINANCIAL STATEMENT SCHEDULES See Item 14(a)(1) above. 42 45 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, 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 Chief Executive Officer and Chief Financial Officer Date: March 27, 1998 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:
NAME TITLE DATE ---- ----- ---- /s/ JEFFREY ATKINS Chief Executive Officer and March 27, 1998 - ----------------------------------------------------- Chief Financial Officer Jeffrey Atkins /s/ HUNTER HASTINGS Director March 27, 1998 - ----------------------------------------------------- Hunter Hastings /s/ AUDREY MACLEAN Director March 27, 1998 - ----------------------------------------------------- Audrey Maclean /s/ KEVIN O'ROURKE Director March 27, 1998 - ----------------------------------------------------- Kevin O'Rourke /s/ PETE SLOSBERG Director March 27, 1998 - ----------------------------------------------------- Pete Slosberg /s/ CHRISTOPHER SORTWELL Director March 27, 1998 - ----------------------------------------------------- Christopher Sortwell /s/ PHILIP MARINEAU Director and Chairman of March 27, 1998 - ----------------------------------------------------- the Board of Directors Philip Marineau
43 46 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, 1997 and 1996 and for each of the three years in the period ended December 31, 1997, 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)(1) 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 18, 1998 44 47 PETE'S BREWING COMPANY AND SUBSIDIARY VALUATION AND QUALIFYING ACCOUNTS
BALANCES AT CHARGED TO BEGINNING OF COSTS AND WRITE-OFF BALANCE AT DESCRIPTION PERIOD EXPENSES OF ACCOUNTS END OF PERIOD ----------- ------------ ---------- ----------- ------------- (IN THOUSANDS) Year ended December 31, 1995 Allowance for doubtful accounts.............. $ 37 $ -- $ -- $ 37 Year ended December 31, 1996 Allowance for doubtful accounts.............. $ 37 $102 $ -- $139 Year ended December 31, 1997 Allowance for doubtful accounts.............. $139 $202 $157 $184
45 48 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1(2) Restated Articles of Incorporation of the Registrant 3.2(1) Bylaws of the Registrant 4.1(3) Preferred Shares Rights Plan 10.13 Lease between Registrant and Utah State Retirement Investment Fund dated July 15, 1997 10.14 Lease between Registrant and 1300 Iroquois Venture dated September 29, 1997 10.15 Lease between Registrant and Rotterdam Ventures, Inc., dated September 1997 10.16(4) Nonstatutory Stock Option Agreement by and between the Company and Philip Marineau, Chairman of the Board of Directors dated July 22, 1997 22.1(1) List of subsidiaries of the Registrant 23.1 Consent of Independent Accountants 24.1 Power of Attorney (See Page 42) 27.1 Financial Data Schedule
- --------------- (1) Incorporated by reference to exhibits filed with Registrant's Registration Statement of 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. (4) Incorporated by reference to Registrant's Form S-8 filed October 15, 1997. 46 EX-10.13 2 LEASE BETWEEN REGISTRANT AND UTAH STATE RETIREMENT 1 EXHIBIT 10.13 LEASE AGREEMENT BETWEEN UTAH STATE RETIREMENT INVESTMENT FUND, AS LANDLORD, AND PETE'S BREWING COMPANY, A CALIFORNIA CORPORATION, AS TENANT SUITE 1010 DATED JULY 15,1997 2 TABLE OF CONTENTS
Page 1. DEFINITIONS ...........................................................1 2. PREMISES ..............................................................1 3. TERM ..................................................................1 4. USE ...................................................................1 5. RENT ..................................................................1 5.1 Base Rent.....................................................1 5.2 Base Rent Adjustment..........................................1 5.3 Additional Rent...............................................1 5.4 Parking Charge................................................2 5.5 Payment of Rent...............................................2 5.6 Delinquent Payments and Handling Charge.......................2 5.7 Prepaid Rent and Security Deposit.............................2 6. CONSTRUCTION OF IMPROVEMENTS ..........................................2 6.1 General.......................................................2 6.2 Access by Tenant Prior to Commencement of Term................2 6.3 Commencement Date; Adjustments to Commencement Date...........2 7. SERVICES TO BE FURNISHED BY LANDLORD ..................................3 7.1 General.......................................................3 7.2 Keys..........................................................3 7.3 Tenant Identity...............................................3 7.4 Charges.......................................................3 7.5 Operating Hours...............................................4 8. REPAIR AND MAINTENANCE.................................................4 8.1 By Landlord...................................................4 8.2 By Tenant.....................................................4 9. TAXES ON TENANTS PROPERTY..............................................4 10. TRANSFER BY TENANT.....................................................4 10.1 General.......................................................4 10.2 Conditions....................................................4 10.3 Liens.........................................................5 11. ALTERATIONS............................................................5 12. SPECIFICALLY PROHIBITED USES...........................................5 13. ACCESS BY LANDLORD.....................................................5 14. CONDEMNATION...........................................................5 15. CASUALTY...............................................................6 15.1 General ......................................................6 15.2 Acts of Tenant ...............................................6 16. SUBORDINATION AND ATTORNMENT ..........................................6 16.1 General ......................................................6 16.2 Attornment ...................................................6 17. INSURANCE .............................................................6 17.1 General.......................................................6 17.2 Waiver of Subrogation.........................................7 18. TENANT'S INDEMNITY.....................................................7 19. THIRD PARTIES; ACTS OF FORCE MAJEURE...................................7
i 3 20. SECURITY INTEREST.......................................................7 21. CONTROL OF COMMON AREAS.................................................7 22. RIGHT TO RELOCATE.......................................................7 23. QUIET ENJOYMENT.........................................................8 24. DEFAULT BY TENANT.......................................................8 24.1 Events of Default.............................................8 24.2 Remedies of Landlord..........................................8 24.3 Payment by Tenant.............................................8 24.4 Reletting.....................................................9 24.5 Landlords Right to Pay or Perform.............................9 24.6 No Waiver; No Implied Surrender...............................9 25. DEFAULTS BY LANDLORD....................................................9 26. RIGHT OF REENTRY........................................................9 27. MISCELLANEOUS...........................................................9 27.1 Independent Obligations; No Offset.............................9 27.2 Time of Essence...............................................10 27.3 Applicable Law................................................10 27.4 Assignment by Landlord........................................10 27.5 Commencement Date and Estoppel Certificates...................10 27.6 Signs, Building Name and Building Address.....................10 27.7 Notices.......................................................10 27.8 Entire Agreement, Amendment and Binding Effect................10 27.9 Severability..................................................10 27.10 Number and Gender, Captions and References....................10 27.11 Attorneys' Fees...............................................11 27.12 Brokers.......................................................11 27.13 Interest on Tenant's Obligations..............................11 27.14 Authority.....................................................11 27.15 Recording.....................................................11 27.16 Exhibits......................................................11 27.17 Multiple Counterparts.........................................11 Signature Page ...............................................12
4 LEASE AGREEMENT THIS LEASE AGREEMENT (this "LEASE") is entered as of July 15, 1997 , between UTAH STATE RETIREMENT INVESTMENT FUND ("LANDLORD") and PETE'S BREWING COMPANY, A CALIFORNIA CORPORATION ("TENANT"). 1. DEFINITIONS. The definitions of certain of the capitalized terms used in this Lease are set forth in the Glossary of Defined Terms attached as EXHIBIT A. 2. PREMISES. Subject to the provisions of this Lease, Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, approximately 821 rentable square feet of space in the Building, which space is outlined on the floor plan attached hereto as Exhibit B (the "PREMISES"). In connection with such demise, Landlord hereby grants to Tenant the non-exclusive right to use during the Term all Common Areas designed for the use of all tenants in the Building, in common with all tenants in the Building and their invitees, for the purposes for which designed and in accordance with all Legal Requirements. By occupying the Premises, Tenant accepts the Premises as being suitable for Tenant's intended use of the Premises. 3. TERM. The Term of this Lease shall commence on the Commencement Date (which is scheduled to be August 15, 1997) and shall expire at 5:00 pm. August 31, 2000 unless earlier terminated as provided herein (the "TERM"). 4. USE. Tenant shall occupy and use the Premises solely for lawful, general business office purposes in strict compliance with the Building Rules and Regulations from time to time in effect and all other Legal Requirements. 5. RENT. 5.1 BASE RENT. In consideration of Landlord's leasing the Premises to Tenant, Tenant shall pay to Landlord as follows:
Monthly Term Amount ---- ------ September 1, 1997 - August 31, 1998 $1,461.38 September 1, 1998 - August 31, 1999 $1,529.79 September 1, 1999 - August 31, 2000 $1,598.21
The Base Rent set forth in this Section 5.1 is a negotiated figure and shall govern whether or not the actual gross rentable square footage of the Premises is the same as set forth in Section 2 hereof or changes pursuant to the standards set in the definition of Net Rentable Area. Tenant shall have no right to withhold, deduct or offset any amount of the monthly Base Rent or any other sum due hereunder even if the actual gross rentable square footage of the premises is less than that set forth in Section 2 hereof or changes pursuant to the standards set forth in the definition of Net Rentable Area. 5.3 Additional Rent. For purposes of this Lease, Tenant's "ADDITIONAL RENT" for any Fiscal Year (or portion thereof) shall mean the product of (a) Net Rentable Area of the Premises multiplied by (b) the difference between (i) the Operating Expenses divided by the Net Rentable Area of the Building minus (ii) the Expense Stop, all as applicable for the period in question. By the Commencement Date, Landlord shall estimate the Additional Rent to be due by Tenant for the balance of the Fiscal Year in which the Commencement Date occurs. Thereafter, unless Landlord delivers to Tenant a revision of the estimated Additional Rent, Tenant shall pay to Landlord, coincident with Tenant's payment of Base Rent, an amount equal to the estimated Additional Rent for the remainder of such year divided by the number of months remaining in such year. From time to time during any Fiscal Year, Landlord may estimate and re-estimate the Additional Rent to be due by Tenant for that Fiscal Year and deliver a copy of the estimate or re-estimate to Tenant. Thereafter, the monthly installments of Additional Rent payable by Tenant shall be appropriately adjusted in accordance with the estimation so that, by the end of the Fiscal Year, Tenant shall have paid all of the Additional Rent as estimated by Landlord. After the conclusion of each Fiscal Year during the Term, and after the termination or expiration of the Term, Landlord shall deliver to Tenant a statement of actual Additional Rent due by Tenant for the Fiscal Year (or, with respect to termination or expiration, the portion 1 5 of the Fiscal Year) just ended. Within 30 days thereafter, Tenant shall pay to Landlord or Landlord shall credit against the next installment of Additional Rent due by Tenant (or Landlord shall refund to Tenant, if the Term has expired and ail payments due by Tenant to Landlord have been paid in full) the difference between the actual Additional Rent due for such year and the estimated Additional Rent paid by Tenant during such year. Tenant may review, at Tenant's expense and after giving 20-days' prior written notice to Landlord, Landlord's records relating to Operating Expenses for any periods within two Fiscal Years prior to the review; provided, however, no review shall extend to periods of time preceding the Commencement Date. In lieu of allowing Tenant to review Landlord's records under this Section 5.3, Landlord may deliver to Tenant a report of the Operating Expenses prepared by a certified public accountant, which report shall be conclusive for purposes of this Lease. 5.4 PARKING CHARGES. Tenant shall at all times during the Term lease from Landlord three (3) unassigned automobile parking spaces in the Parking Facility at no extra charge. 5.5 PAYMENT OF RENT. Except as otherwise expressly provided in this Lease, all Rent shall be due in advance monthly installments on the first day of each calendar month during the Term. Rent shall be paid to Landlord at its address recited in Section 27.7 or to such other person or at such other address as Landlord may from time to time designate in writing. Rent shall be paid without notice, demand, abatement, deduction or offset in legal tender of the United States of America. If the Term commences or ends on other than the first or the last day of a calendar month, the Rent for the partial month shall be prorated on the basis of the number of days during the month for which the Term was in effect. If the Term commences or ends on other then the first or the last day of a Fiscal Year, the Additional Rent for the partial Fiscal Year shall be prorated on the basis of the number of days during the Fiscal Year for which the Term was in effect. 5.6 DELINQUENT PAYMENTS AND HANDLING CHARGE. All Rent and other payments required of Tenant hereunder shall bear interest from the date due until the date paid at the rate of interest specified in Section 27.13. Alternatively, Landlord may charge Tenant, as additional Rent hereunder, a fee equal to five percent of the delinquent payment to reimburse Landlord for its cost and inconvenience incurred as a consequence of Tenant's delinquency. In no event, however, shall the charges permitted under this Section 5.6 or elsewhere in this Lease, to the extent the same are considered to be interest under applicable law, exceed the maximum rate of interest allowable under applicable law. 5.7 PREPAID RENT AND SECURITY DEPOSIT. Landlord hereby acknowledges receipt of $ 2,368.85, representing (a) the first monthly installment of Base Rent paid in advance, to be applied to the Rent for the first PARTIAL month of the Term when due, and (b) the Security Deposit as security for the full and timely payment and performance by Tenant of its obligations under this Lease. Landlord may apply any or all of the Security Deposit toward the payment of any sum or the performance of any obligation which Tenant was obligated, but failed, to pay or perform hereunder. The Security Deposit shall not be considered an advance payment of Rent by Tenant or a measure of or a limit to Landlord's damages upon an Event of Default. TENANT SHALL PAY TO LANDLORD A DEPOSIT OF $15.00 FOR EACH ACCESS CARD REQUESTED TO GAIN ACCESS TO THE BUILDING, 6. CONSTRUCTION OF IMPROVEMENTS. 6.1 GENERAL. Subject to events of Force Majeure, Landlord shall install, furnish, perform and apply, at its expense, the Landlord's Work as specified in the Work Letter. Performance of the Landlord's Work shall constitute Landlord's sole construction obligation to Tenant under this Lease. 6.2 ACCESS BY TENANT PRIOR TO COMMENCEMENT OF TERM. Provided that Tenant obtains and delivers to Landlord the certificates or policies of insurance called for in Section 17.1, Landlord, in its sole discretion, may permit Tenant and its employees, agents, contractors and suppliers to enter the Premises before the Commencement Date (and such entry, alone, shall not constitute Tenant's taking possession of the Premises for the purpose of Section 6.3(c)) to prepare the Premises for Tenant's occupancy. Tenant and each other person or firm who or which enters the Premises before the Commencement Date shall conduct itself so as to not interfere with Landlord or other occupants of the Building. Landlord may withdraw any permission granted under this Section 6.2 upon 24-hours' notice to Tenant if Landlord, in its sole discretion, determines that any such interference has been or may be caused. Any prior entry shall be under all of the terms of this Lease (other than the obligation to pay Base Rent and Additional Rent) and at Tenant's sole risk. Landlord shall not be liable in any way for personal injury, death or property damage (including damage to any personal property which Tenant May bring into, or any work which Tenant may perform in, the Premises) which may occur in or about the Complex by Tenant or such other person or firm as a result of any prior entry. 6.3 COMMENCEMENT DATE: ADJUSTMENTS TO COMMENCEMENT DATE. For purposes of this Lease, the "COMMENCEMENT DATE" shall mean the earliest of: (a) the date on which Landlord substantially completes the Landlord's Work and tenders possession of the Premises to Tenant; (b) the date on which Landlord would have substantially completed the Landlords Work and tendered possession of the Premises to Tenant but for (i) the delay or failure of Tenant to furnish information or other matters required in the Work Letter, (ii) Tenants request for changes in the Plans or non-Building Standard Items or (iii) any other action or inaction of Tenant, or any person or firm employed or retained by Tenant or (1) the date on which Tenant takes possession of the Premises. If by the scheduled Commencement Date specified in Section 3 the Landlord's Work has not been substantially completed, and such failure to substantially complete renders the Premises untenable for their intended purpose, all as reasonably determined by Landlord, or Landlord is unable to tender possession of the Premises to Tenant, then the 2 6 Commencement Date (and the commencement of payment of Base Rent and Additional Rent) shall be postponed until the Landlord's Work is substantially completed as reasonably determined by Landlord or until possession of the Premises is tendered to Tenant, as the case may be. Such postponement shall extend the scheduled expiration of the Term for a number of days equal to the postponement. The postponement of the payment of Base Rent and Additional Rent under this Section 6.3 shall be Tenant's exclusive remedy for Landlord's delay in completing the Landlord's Work or tendering possession of the Premises to Tenant. 7. SERVICES TO BE FURNISHED BY LANDLORD. 7.1 GENERAL. Subject to applicable Legal Requirements and Tenant's performance of its obligations hereunder, Landlord shall use all reasonable efforts to furnish the following services: (a) Air-conditioning and heating to the Premises during Building Operating Hours, at such temperatures and in such amounts as are considered by Landlord to be suitable and standard (thus excluding air-conditioning or heating for electronic data processing or other specialized equipment); (b) Hot and cold water at those points of supply common to all floors for lavatory and drinking purposes only; (c) Janitor service and periodic window washing in and about the Building and the Premises; (d) Elevator service, if necessary, to provide access to and egress from the Premises; (e) Electric current during Building Operating Hours for normal office machines and other machines of low electrical consumption (which shall exclude electric current for electronic data processing equipment, lighting in excess of Building Standard or any other item of electrical equipment which singly consumes more than 0.5 kilowatts per hour at rated capacity or requires a voltage other than 120 volts single phase); and (f) Replacement of fluorescent lamps in Building Standard light fixtures installed by Landlord and of incandescent bulbs or fluorescent lamps in all public restrooms, stairwells and other common areas in the Building. if any of the services described above or elsewhere in this Lease are interrupted, Landlord shall use reasonable diligence to promptly restore same. However, neither the interruption or cessation of such services nor the failure of Landlord to restore same shall render Landlord liable for damages to person or property, or be construed as an eviction of Tenant, or work an abatement of Rent or relieve Tenant from fulfilling any of its other obligations hereunder. 7.2 KEYS. Landlord shall furnish Tenant, at Landlords expense, with three (3) keys, and at Tenant's expense with such additional keys as Tenant may request, to unlock each corridor door entering the Premises. Tenant shall not install, or permit to be installed, any additional lock on any door into or in the Premises or make, or permit to be made, any duplicates of keys to the Premises. Landlord shall be entitled at all times to possession of a duplicate of all keys to all doors to or inside of the Premises. All keys referred to in this Section 7.2 shall remain the property of Landlord. Upon the expiration or termination of the Term, Tenant shall surrender all such keys to Landlord and shall deliver to Landlord the combination to all locks on all safes, cabinets and vaults which will remain in the Premises. Landlord shall be entitled to install, operate and maintain security systems in or about the Premises and the Complex which monitor, by closed circuit television or otherwise, all persons leaving or entering the Complex, the Building and the Premises. 7.3 TENANT IDENTITY. Landlord shall provide and install, in Building Standard graphics, letters or numerals identifying Tenant's name and suite number on entrance doors to the Premises. Without Landlord's prior written consent, no other signs, numerals, letters, graphics, symbols or marks identifying Tenant shall be placed on the exterior, or on the interior if they are visible from the exterior, of the Premises. Landlord shall install up to one (1) directory strip(s) for each 821 net rentable square feet in the Premises, listing the names and suite numbers of Tenant on the Building directory board to be placed in the main lobby of the Building. 7.4 CHARGES. Tenant shall pay to Landlord, monthly as billed, as additional Rent, such charges as may be separately metered or as Landlord may compute for the following: (a) any utility services utilized by Tenant for computers, data processing equipment or other electrical equipment in excess of that agreed to be furnished by Landlord pursuant to Section 7.1(e), (b) lighting installed in the Premises in excess of Building Standard lighting, or provided at times other than Building Standard Hours; (c) air-conditioning, heating and other services in excess of that stated in Section 7.1(a) or provided at times other than Building Operating Hours; and 3 7 HVAC and lighting utilized at times other than Building Standard Hours will be furnished only upon the request of Tenant, provided that Tenant shall pay to the Landlord for the actual costs of such additional services monthly, upon receipt of a bill therefor, the sum equal to the amount charged to Landlord by the applicable utilities authority plus a $5.00 monthly service charge for such metering recording device. Tenant acknowledges that such service and temperature may be subject to change by local, county, state or federal regulation. Whenever machines or equipment that generate abnormal heat are used in the Leased Premises which affect the temperature otherwise maintained by the air conditioning system, Landlord shall have the right to install supplemental air conditioning in the Leased Premises, and the cost thereof, including the cost of installation, operating, use and maintenance, shall be paid by Tenant to Landlord as additional rental upon demand. With respect to any other Non-Building Standard services provided to Tenant, Landlord may elect to estimate the charges to be paid by Tenant under this Section 7.4 and bill such charges to Tenant monthly in advance, in which event Tenant shall promptly pay the estimated charges. When the actual charges are determined by Landlord an appropriate cash adjustment shall be made between Landlord and Tenant to account for any underpayment or overpayment by Tenant. 7.5 OPERATING HOURS. Subject to Building Rules and Regulations and such security standards as Landlord may from time to time adopt, the Building shall be open to the public during the Building Operating Hours and the Premises shall be open to Tenant during hours other then Building Operating Hours. 8. REPAIR AND MAINTENANCE. 8.1 BY LANDLORD. Landlord shall maintain the Building (excluding leasehold improvements which become fixtures thereto) in a good and operable condition, and shall make such repairs and replacements as may be required to maintain the Building in such condition. This Section 8.1 shall not apply to damage resulting from a Taking (as to which Section 14 shall apply), or damage resulting from a casualty (as to which Section 15.1 shall apply) or to damage for which Tenant is otherwise responsible under this Lease. 8.2 BY TENANT. Tenant shall maintain the Premises in a clean, safe, operable, attractive condition, and will not commit or allow to remain any waste or damage to any portion of the Premises. Tenant shall repair or replace, subject to Landlord's direction and supervision, any damage to the Complex caused by Tenant or Tenant's agents, contractors or invitees. If Tenant fails to make such repairs or replacements, Landlord may make same at Tenant's cost. Such cost shall be payable to Landlord by Tenant on demand as additional Rent. All contractors, workmen, artisans and other persons which or who Tenant proposes to retain to perform Work in the Premises (or the Complex, pursuant to the second sentence of this Section 8.2) pursuant to this Section 8.2 or Section 11 shall be approved by Landlord prior to the commencement of any such work. 9. TAXES ON TENANT'S PROPERTY. Tenant shall be liable for and shall pay, before their becoming delinquent, all taxes and assessments levied against any personal property placed by Tenant in the Premises (even if same becomes a fixture by operation of law or the property of Landlord by operation of this Lease), including any additional Impositions which may be assessed, levied, charged or imposed against Landlord or the Building by reason of Non-Building Standard Items in the Premises. Tenant may withhold payments of any taxes and assessments described in this Section 9 so long as Tenant contests its obligation to pay in accordance with applicable law and the non-payment thereof does not pose a threat of loss or seizure of the Building or any interest of Landlord therein. 10. TRANSFER BY TENANT. 10.1 GENERAL. Without the prior written consent of Landlord, Tenant shall not effect or suffer any Transfer. Any attempted Transfer without such consent shall be void. If Tenant desires to effect a Transfer, it shall deliver to Landlord written notice thereof in advance of the date on which Tenant proposes to make the Transfer, together with all of the terms of the proposed Transfer and the identity of the proposed Transferee. Landlord shall have 30 days following receipt of the notice and information within which to notify Tenant in writing whether Landlord elects (a) to refuse to consent to the Transfer and to terminate this Lease as to the space proposed to be Transferred as of the date so specified by Tenant, in which event Tenant will be relieved of all further obligations hereunder as to such space, (b) to refuse to consent to the Transfer and to continue this Lease in full force as to the entire Premises or (c) to permit Tenant to effect the proposed Transfer. If Landlord fails to notify Tenant of its election within said 30 day period, Landlord shall be deemed to have elected option (b). The consent by Landlord to a particular Transfer shall not be deemed a consent to any other Transfer. If a Transfer occurs without the prior written consent of Landlord as provided herein, Landlord may nevertheless collect rent from the Transferee and apply the net amount collected to the Rent payable hereunder, but such collection and application shall not constitute a waiver of the provisions hereof or a release of Tenant from the further performance of its obligations hereunder. 10.2 CONDITIONS. The following conditions shall automatically apply to each Transfer, without the necessity of same being stated in or referred to in Landlord's written consent: (a) Tenant shall execute, have acknowledged and deliver to Landlord, and cause the Transferee to execute, have acknowledged and deliver to Landlord, an instrument in form and substance acceptable to Landlord in which (i) the Transferee adopts this Lease and agrees to perform, jointly and severally with 4 8 Tenant, all of the obligations of Tenant hereunder, as to the space transferred to it, (ii) the Transferee grants Landlord an express first and prior security interest in its personal property brought into the transferred space to secure its obligations to Landlord hereunder, (iii) Tenant subordinates to Landlord's statutory lien and security interest any liens, security interests or other rights which Tenant may claim with respect to any property of the Transferee, (iv) Tenant agrees with Landlord that, if the rent or other consideration due by the Transferee exceeds the Rent for the transferred space, then Tenant shall pay Landlord as additional Rent hereunder all such excess rent and other consideration immediately upon Tenant's receipt thereof, (v) Tenant and the Transferee agree to provide to Landlord, at their expense, direct access from a public corridor in the Building to the transferred space, (vi) the Transferee agrees to use and occupy the transferred space solely for the purpose specified in Section 4 and otherwise in strict accordance with this Lease and (vii) Tenant acknowledges that, notwithstanding the Transfer, Tenant remains directly and primarily liable for the performance of all the obligations of Tenant hereunder (including, without limitation, the obligation to pay all Rent), and Landlord shall be permitted to enforce this Lease against Tenant or the Transferee, or both, without prior demand upon or proceeding in any way against any other persons, and (b) Tenant shall deliver to Landlord a counterpart of all instruments relative to the Transfer executed by all parties to such transaction (except Landlord). 10.3 LIENS. Without in any way limiting the generality of the foregoing, Tenant shall not grant, place or suffer, or permit to be granted, placed or suffered, against the Complex or any portion thereof, any lien, security interest, pledge, conditional sale contract, claim, charge or encumbrance (whether constitutional, contractual or otherwise) and if any of the aforesaid does arise or is asserted, Tenant will, promptly upon demand by Landlord and at Tenant's expense, cause same to be released. 11. ALTERATIONS. Tenant shall not make, or permit to be made, any alteration, improvement or addition to, or install, or permit to be installed, any fixture or equipment (other than desk top electrical equipment) in, the Premises without the prior written consent of Landlord. All such alterations, improvements and additions (including all articles attached to the floor, wall or ceiling of the Premises) shall become the property of Landlord and shall, at Landlord's election, be (a) surrendered with the Premises as part thereof at the termination or expiration of the Term, without any payment, reimbursement or compensation therefor, or (b) removed by Tenant, at Tenant's expense, with all damage caused by such removal repaired by Tenant. Tenant may remove Tenant's trade fixtures, office supplies, movable office furniture and equipment not attached to the Building provided such removal is made within five days after the expiration of the Term, no uncured Event of Default has occurred and Tenant promptly repairs all damage caused by such removal. 12. SPECIFICALLY PROHIBITED USES. Tenant will not (a) use, occupy or permit the use or occupancy of the Premises for any purpose or in any manner which is or may be, directly or indirectly, violative of any Legal Requirement, or dangerous to life or property, or a public or private nuisance or disruptive or obstructive of any other tenant of the Building, (b) keep, or permit to be kept, any substance in or conduct, or permit to be conducted, any operation from the Premises which might emit offensive odors or conditions into other portions of the Building, or make undue noise or create undue vibrations, (c) commit or permit to remain any waste to the Premises, (d) install or permit to remain any improvements to the Premises (other than window coverings which have first been approved by Landlord) which are visible from the outside of the Premises, or exceed the structural loads of floors or walls of the Building, or adversely affect the mechanical, plumbing or electrical systems of the Building or affect the structural integrity of the Building in any way, (e) install any food, soft drink or other vending machine (other than those for the exclusive, non-commercial use of Tenant and its business invitees) in the Premises or (f) commit, or permit to be committed, any action or circumstance in or about the Building which, directly or indirectly, would or might justify any insurance carrier in cancelling or increasing the premium on the fire and extended coverage insurance policy maintained by Landlord on the Building or contents, and if any increase results from any act of Tenant, then Tenant shall pay such increase promptly upon demand therefor by Landlord. 13. ACCESS BY LANDLORD. Landlord, its employees, contractors, agents and representatives, shall have the right (and Landlord, for itself and such persons and firms, hereby reserves the right) to enter the Premises at all hours (a) to inspect, clean, maintain, repair, replace or alter the Premises or the Building, (b) to show the Premises to prospective purchasers (or, during the last 12 months of the Term, to prospective tenants), (c) to determine whether Tenant is performing its obligations hereunder and, if it is not, to perform same at Landlord's option and Tenant's expense or (d) for any other purpose deemed reasonable by Landlord. In an emergency, Landlord (and such persons and firms) may use any means to open any door into or in the Premises without any liability therefor. Entry into the Premises by Landlord or any other person or firm named in the first sentence of this Section 13 for any purpose permitted herein shall not constitute a trespass or an eviction (constructive or otherwise), or entitle Tenant to any abatement or reduction of Rent, or constitute grounds for any claim (and Tenant hereby waives any claim) for damages for any injury to or interference with Tenant's business, for loss of occupancy or quiet enjoyment or for consequential damages. 14. CONDEMNATION. If all of the Complex is Taken, or if so much of the Complex is Taken that, in Landlord's opinion, the remainder cannot be restored to an economically viable, quality office building, or if the awards payable to Landlord as a result of any Taking are, in Landlords opinion, inadequate to restore the remainder to an economically viable, quality office building, Landlord may, at its election, exercisable by the giving of written notice to Tenant within 60 days after the date of the Taking, terminate this Lease as of the date of the Taking or the 5 9 date Tenant is deprived of possession of the Premises (whichever is later). If this Lease is not terminated as result of a Taking, Landlord shall restore the Premises remaining after the Taking to a Building Standard condition. During the period of restoration, Base Rent shall be abated to the extent the Premises are rendered untenantable and, after the period of restoration, Base Rent and Tenant's Share shall be reduced in the proportion that the area of the Premises Taken or otherwise rendered untenantable bears to the area of the Premises just prior to the Taking. If any portion of Base Rent is abated under this Section 14, Landlord may elect to extend the expiration date of the Term for the period of the abatement. All awards, proceeds, compensation or other payments from or with respect to any Taking of the Complex or any portion thereof shall belong to Landlord, Tenant hereby assigning to Landlord all of its right, title, interest and claim to same. Tenant may assert a claim for and recover from the condemning authority, but not from Landlord, such compensation as may be awarded on account of Tenant's moving and relocation expenses, and depreciation to and loss of Tenant's moveable personal property. 15. CASUALTY. 15.1 GENERAL. TENANT shall give prompt written notice to Landlord of any casualty to the Complex of which Tenant is aware and any casualty to the Premises. If the Complex or the Premises are totally destroyed, or if the Complex or the Premises are partially destroyed but in Landlord's opinion, they cannot be restored to an economically viable, quality office building, or if the insurance proceeds payable to Landlord as a result of any casualty are, in Landlord's opinion, inadequate to restore the portion remaining to an economically viable and quality office building, Landlord may, at its election exercisable by the giving of written notice to Tenant within 60 days after the casualty, terminate this Lease as of the date of the casualty or the date Tenant is deprived of possession of the Premises (whichever is later). If this Lease is not terminated as a result of a casualty, Landlord shall (subject to Section 15.2) restore the Premises to a Building Standard condition. During the period of restoration, Base Rent shall be abated to the extent the Premises are rendered untenantable and, after the period of restoration, Base Rent and Tenant's Share shall be reduced in the proportion that the area of the Premises remaining tenantable after the casualty bears to the area of the Premises just prior to the casualty. If any portion of Base Rent is abated under this Section 15. 1, Landlord may elect to extend the expiration date of the Term for the period of the abatement. 15.2 ACTS OF TENANT. Notwithstanding any provisions of this Lease to the contrary, if the Premises or the Complex are damaged or destroyed as a result of a casualty arising from the acts or omissions of Tenant, or any of Tenant's officers, directors, shareholders, partners, employees, contractors, agents, invitees or representatives, (a) Tenant's obligation to pay Rent and to perform its other obligations under this Lease shall not be abated, reduced or altered in any manner, (b) Landlord shall not be obligated to repair or restore the Premises or the Complex and (c) subject to Section 17.2, Tenant shall be obligated, at Tenant's cost, to repair and restore the Premises or the Complex to the condition they were in just prior to the damage or destruction under the direction and supervision of, and to the satisfaction of, Landlord and any Landlord Mortgagee. 16. SUBORDINATION AND ATTORNMENT. 16.1 GENERAL. This Lease, Tenant's leasehold estate created hereby and all of Tenant's rights, titles and interests hereunder and in and to the Premises are subject and subordinate to any Mortgage presently existing or hereafter placed upon all or any portion of the Complex. However, Landlord and Landlord's Mortgagee may, at any time upon the giving of written notice to Tenant and without any compensation or consideration being payable to Tenant, make this Lease, and the aforesaid leasehold estate and rights, titles and interests, superior to any Mortgage. Upon the written request by Landlord or by Landlord's Mortgagee to Tenant, and within five (5) days of the date of such request, and without any compensation or consideration being payable to Tenant, Tenant shall execute, have acknowledged and deliver a recordable instrument confirming that this Lease, Tenant's leasehold estate in the Premises and all of Tenant's rights, titles and interests hereunder are subject and subordinate (or, at the election of Landlord or Landlord's Mortgagee, superior) to the Mortgage benefiting Landlord's Mortgagee. 16.2 ATTORNMENT. Upon the written request of any person or party succeeding to the interest of Landlord under this Lease, Tenant shall automatically become the tenant of and attorn to such successor in interest without any change in any of the terms of this Lease. No successor in interest shall be (a) bound by any payment of Rent for more than one month in advance, except payments of security for the performance by Tenant of Tenant's obligations under this Lease, (b) subject to any offset, defense or damages arising out of a default or any obligations of any preceding Landlord or (c) bound by any amendment of this Lease entered into after Tenant has been given written notice of the name and address of Landlord's Mortgagee and without the written consent of Landlord's Mortgagee or such successor in interest. The subordination, attornment and mortgage protection clauses of this Section 16 shall be self-operative and no further instruments of subordination, attornment or mortgagee protection need be required by any Mortgagee or successor in interest thereto. Nevertheless upon the written request therefor and without any compensation or consideration being payable to Tenant, Tenant agrees to execute, have acknowledged and deliver such instruments as may be requested to confirm the same. 17. INSURANCE. 17.1 GENERAL. Tenant shall obtain and maintain throughout the Term the following policies of insurance: (a) fire and all risk insurance, with vandalism, malicious mischief and sprinkler leakage endorsements, on all of Tenant's personal property located in, and on all Non-Building Standard Items to, the Premises in an amount not less than eighty percent of the replacement cost thereof; 6 10 (b) comprehensive general and contractual liability insurance against claims for personal injury, bodily injury, death and property damage occurring in or about the Premises, such insurance to afford protection to the limits of (i) not less than $1,000,000 per occurrence; (c) insurance required hereunder shall be written by companies licensed to do business in the State of Texas and shall have a minimum rating of A:X by Best's Key Rating Guide. (d) such other policy or policies of insurance as Landlord may reasonably require or as Landlord is then requiring from one or more other tenants in the Building. Tenant shall deliver to Landlord, prior to the Commencement Date, certificates of such insurance and shall, at all times during the Term, deliver to Landlord upon request true copies of such insurance policies. The policy described in clause (b) shall (i) name Landlord as an addition insured, (ii) provide that it will not be cancelled, reduced or nonrenewed without 30-days' prior written notice to Landlord, (iii) insure performance of the indemnities of Tenant contained in Section 18 and elsewhere in this Lease and (iv) be primary coverage, so that any insurance coverage obtained by Landlord shall be in excess thereto. Tenant shall deliver to Landlord certificates of renewal at least 30 days before the expiration date of each such policy and copies of new policies at least 30 days before terminating any such policies. All policies of insurance required to be obtained and maintained by Tenant shall be subject to the approval of Landlord as to terms, coverage, deductibles and issuer. 17.2 WAIVER OF SUBROGATION. Landlord and Tenant hereby waive all claims, rights of recovery and causes of action that either party or any party claiming by, through or under such party may now or hereafter have by subrogation or otherwise against the other party or against any of the other party's officers, directors, shareholders, partners or employees for any loss or damage that may occur to the Complex, the Premises, Tenant's improvements or any of the contents of any of the foregoing by reason of fire or other casualty, or by reason of any other cause except gross negligence or willful misconduct (thus including simple negligence of the parties hereto or their officers, directors, shareholders, partners or employees), that could have been insured against under the terms of (a) in the case of Landlord, the standard fire and extended coverage insurance policies available in the state where the Complex is located at the time of the casualty and (b) in the cue of Tenant, the fire and extended coverage insurance policy required to be obtained and maintained under Section 17.1; provided, however, that the waiver set forth in this Section 17.2 shall not apply to any deductibles on insurance policies carried by Landlord or to any coinsurance penalty which Landlord might sustain. Landlord and Tenant shall cause an endorsement to be issued to their respective insurance policies recognizing this waiver of subrogation. 18. TENANT'S INDEMNITY. Subject to Section 17.2, Tenant shall defend, indemnify and hold harmless Landlord and Landlord's officers, directors, shareholders, partners and employees from and against, all liabilities, obligations, losses, damages, penalties, claims, actions, suits, costs, expenses and disbursements (including court costs and reasonable attorneys' fees) resulting from any injuries to or death of any person or damage to any property occurring during the Term in or about the Premises. 19. THIRD PARTIES: ACTS OF FORCE MAJEURE. Landlord shall have no liability to Tenant, or to Tenant's officers, directors, shareholders, partners, employees, agents, contractors or invitees, for bodily injury, death, property damage, business interruption, loss of profits, loss of trade secrets or other direct or consequential damages occasioned by (a) the acts or omissions of any other tenant or such other tenant's officers, directors, shareholders, partners, employees, agents, contractors or other invitees within the Complex, (b) Force Majeure, (c) vandalism, theft, burglary and other criminal acts (other than those committed by Landlord and its employees), (d) water leakage or (e) the repair, replacement, maintenance, damage, destruction or relocation of the Premises. 20. SECURITY INTEREST. As security for Tenant's payment of Rent and performance of all of its other obligations under this Lease, Tenant hereby grants to Landlord a security interest in all property of Tenant now or hereafter placed in the Premises. Landlord, as secured party, shall be entitled to all of the rights, remedies and recourses afforded to a secured party under the Texas Uniform Commercial Code, which rights, remedies and recourses shall be cumulative of all other rights, remedies, recourses, liens and security interests afforded Landlord by law, equity or this Lease. Contemporaneously with the execution of this Lease, Tenant shall execute and deliver, as debtor, promptly upon request and without any compensation or consideration being payable to Tenant, such additional financing statement or statements as Landlord may request. However, Landlord may at any time file a copy of this Lease as a financing statement. 21. CONTROL OF COMMON AREAS. Landlord shall have the exclusive control over the Common Areas. Landlord may, from time to time, create different Common Areas, close or otherwise modify the Common Areas, and modify and the Building Rules and Regulations with respect thereto. 22. RIGHT TO RELOCATE. Landlord retains the right and power, to be exercised reasonably and at Landlord's expense, to relocate Tenant within the Building in space which is comparable in size to the Premises and is suited to Tenant's use. Instances when the exercise of Landlord's right and power to relocate Tenant shall be deemed reasonable include, but shall not be limited to, instances where Landlord desires to consolidate the rentable area in the Building to provide Landlord's services more efficiently, or to provide contiguous vacant space for a prospective tenant. Landlord shall not be liable to Tenant for any claims arising in connection with a relocation permitted under this Section 22. 7 11 23. QUIET ENJOYMENT. Provided Tenant has performed all its obligations under this Lease, Tenant shall and may peaceably and quietly have, hold, occupy, use and enjoy the Premises during the Term subject to the provisions of this Lease. Landlord shall warrant and forever defend Tenant's right to occupancy of the Premises against the claims of any and all persons whomsoever lawfully claiming the same or any part thereof, by, through or under Landlord, but not otherwise, subject to the provisions of this Lease. 24. DEFAULT BY TENANT. 24.1 EVENTS OF DEFAULT. Each of the following occurrences shall constitute an Event of Default (herein so called): (a) The failure of Tenant to pay Rent as and when due hereunder and the continuance of such failure for a period of three days after written notice from Landlord to Tenant specifying the failure; provided, however, after Landlord has given Tenant written notice pursuant to this clause (a) on two separate occasions Landlord shall not be required to give Tenant any further notice under this clause (a); (b) The failure of Tenant to perform, comply with or observe any other agreement, obligation or undertaking of Tenant, or any other term, condition or provision, in this Lease, and the continuance of such failure for a period of ten days after written notice from Landlord to Tenant specifying the failure; (c) The abandonment of the Premises by Tenant or the failure of Tenant to occupy the Premises or any significant portion thereof, (d) The filing of a petition by or against Tenant (the term "Tenant" also meaning, for the purpose of this clause (d), any guarantor of the named Tenants obligations hereunder) (i) in any bankruptcy or other insolvency proceeding, (ii) seeking any relief under the Bankruptcy Code or any similar debtor relief law, (iii) for the appointment of a liquidator or receiver for all or substantially all of Tenant's property or for Tenant's interest in this Lease or (iv) to reorganize or modify Tenant's capital structure; and (e) The admission by Tenant in writing that it cannot meet its obligations as they become due or the making by Tenant of an assignment for the benefit of its creditors. 24.2 REMEDIES OF LANDLORD. Upon any Event of Default, Landlord may, at Landlord's option and in addition to all other rights, remedies and recourses afforded Landlord hereunder or by law or equity, do any one or more of the following: (a) Terminate this Lease by the giving of written notice to Tenant, in which event Tenant shall pay to Landlord the sum of (i) all Rent and other amounts accrued hereunder to the date of termination, (ii) all amounts due under Section 24.3 and (iii) liquidated damages in an amount equal to (A) the total Rent that Tenant would have been required to pay for the reminder of the Term discounted to present value at the prime lending rate (or equivalent rate, however denominated) in effect on the date of termination at the largest national bank in the state where the Complex is located minus (B) the then present fair rental value of the Premises for such period, similarly discounted. (b) Terminate Tenant's right to possession of the Premises without terminating this Lease by the giving of written notice to Tenant, in which event Tenant shall pay to Landlord (i) all Rent and other amounts accrued hereunder to the date of termination of possession, (ii) all amounts due from time to time under Section 24.3 and (iii) all Rent and other sums required hereunder to be paid by Tenant during the remainder of the Term, diminished by any net sums thereafter received by Landlord through reletting the Premises during said period. Reentry by Landlord in the Premises will not affect the obligations of Tenant hereunder for the unexpired Term. Landlord may bring action against Tenant to collect amounts due by Tenant on one or more occasions, without the necessity of Landlords waiting until expiration of the Term. If Landlord elects to proceed under this Section 24.2(b), it may at any time elect to terminate this Lease pursuant to Section 24.2(a). (c) Without notice, alter any and all locks and other security devices at the Premises without being obligated to deliver new keys to the Premises, unless Tenant has cured all Events of Default before Landlord has terminated this Lease under Section 24.2(a) or has entered into a lease to relet all or a portion of the Premises. (d) If an Event of Default specified in Section 24.1(c) occurs, Landlord may remove and store any property that remains on the Premises, and, if Tenant does not claim such property within ten days after Landlord has delivered to Tenant notice of such storage, Landlord may appropriate, sell, destroy, or otherwise dispose of the property in question without notice to Tenant or any other person and without any obligation to account for such Property. 24.3 PAYMENT BY TENANT. Upon any Event of Default, Tenant shall also pay to Landlord all costs and expenses incurred by Landlord, including court costs and reasonable attorneys' fees, in (a) retaking or otherwise obtaining possession of the Premises, (b) removing and storing Tenant's or any other occupant's property, (c) 8 12 repairing, restoring, altering, remodeling or otherwise putting the Premises into condition acceptable to a new tenant or tenants, (d) reletting all or any part of the Premises, (e) paying or performing the underlying obligation which Tenant failed to pay or perform and (f) enforcing any of Landlord's rights, remedies or recourses arising as a consequence of the Event of Default. 24.4 RELETTING. Upon termination of this Lease or upon termination of Tenant's right to possession of the Premises, Landlord shall use reasonable efforts to relet the Premises on such terms and conditions as Landlord in its sole discretion may determine (including a term different then the Term, rental concessions, and alterations to, and improvements of, the Premises); however, Landlord shall not be obligated to relet the Premises before leasing other portions of the Building. Landlord shall not be liable, nor shall Tenant's obligations hereunder be diminished because of, Landlord's failure to relet the Premises or collect rent due in respect of such reletting. Tenant shall not be entitled to the excess of any rent obtained by reletting over the Rent herein reserved. 24.5 LANDLORD'S RIGHT TO PAY OR PERFORM. Upon an Event of Default, Landlord may, but without obligation to do so and without thereby waiving or curing such Event of Default, pay or perform the underlying obligation for the account of Tenant, and enter the Premises and expend the Security Deposit for such purpose. 24.6 NO WAIVER, NO IMPLIED SURRENDER, Provisions of this Lease may only be waived by the party entitled to the benefit of the provision evidencing the waiver in writing. Thus, neither the acceptance of Rent by Landlord following an Event of Default (whether known to Landlord or not), nor any other custom or practice followed in connection with this Lease, shall constitute a waiver by Landlord of such Event of Default or any other Event of Default. Further, the failure by Landlord to complain of any action or inaction by Tenant, or to assert that any action or inaction by Tenant constitutes (or would constitute, with the giving of notice and the passage of time) an Event of Default, regardless of how long such failure continues, shall not extinguish, waive or in any way diminish the rights, remedies and recourses of Landlord with respect to such action or inaction. No waiver by Landlord of any provision of this Lease or of any breach by Tenant of any obligation of Tenant hereunder shall be deemed to be a waiver of any other provision hereof, or of any subsequent breach by Tenant of the same or any other provision hereof. Landlord's consent to any act by Tenant requiring Landlord's consent shall not be deemed to render unnecessary the obtaining of Landlord's consent to any subsequent act of Tenant. No act or omission by Landlord (other than Landlord's execution of a document acknowledging such surrender) or Landlord's agents, including the delivery of the keys to the Premises, shall constitute an acceptance of a surrender of the Premises. 25. DEFAULTS BY LANDLORD. Landlord shall not be in default under this Lease, and Tenant shall not be entitled to exercise any right, remedy or recourse against Landlord or otherwise as a consequence of any alleged default by Landlord under this Lease, unless Landlord fails to perform any of its obligations hereunder and said failure continues for a period of 30 days after Tenant gives Landlord and (provided that Tenant shall have been given the name and address of Landlord's Mortgagee) Landlord's Mortgagee written notice thereof specifying, with reasonable particularity, the nature of Landlord's failure. If, however, the failure cannot reasonably be cured within the 30-day period, Landlord shall not be in default hereunder if Landlord or Landlord's Mortgagee commences to cure the failure within the 30 days and thereafter pursues the curing of same diligently to completion. If Tenant recovers a money judgment against Landlord for Landlord's default of its obligations hereunder or otherwise, the judgment shall be limited to Tenant's actual direct, but not consequential, damages therefor and shall be satisfied only out of the interest of Landlord in the Complex as the same may then be encumbered, and Landlord shall not otherwise be liable for any deficiency. In no event shall Tenant have the right to levy execution against any property of Landlord other than its interest in the Complex. The foregoing shall not limit any right that Tenant might have to obtain specific performance of Landlord's obligations hereunder. 26. RIGHT OF REENTRY. Upon the expiration or termination of the Term for whatever cause, or upon the exercise by Landlord of its right to re-enter the Premises without terminating this Lease, Tenant shall immediately, quietly and peaceably surrender to Landlord possession of the Premises in "broom clean" and good order, condition and repair, except only for ordinary wear and tear, damage by casualty not covered by Section 15.2 and repairs to be made by Landlord pursuant to Section 15.1. If Tenant fails to surrender possession as herein required, Landlord may, without giving Tenant prior notice to vacate the Premises or any other notice, initiate any and all legal action as Landlord may elect to dispossess Tenant and all of its property, and all persons or firms claiming by, through or under Tenant and all of their property, from the Premises, and may remove from the Premises and store (without any liability for loss, theft, damage or destruction thereto) any such property at Tenant's cost. While Tenant remains in possession of the Premises after such expiration, termination or exercise by Landlord of its re-entry right, Tenant shall be deemed to be occupying the Premises as a tenant-at-sufferance, subject to all of the obligations of Tenant under this Lease, except that the daily Rent shall be twice the per day Rent in effect immediately before such expiration, termination or exercise by Landlord. No such holding over shall extend the Term. If Tenant fails to surrender possession of the Premises in the condition herein required, Landlord may, at Tenants expense, restore the Premises to such condition. 27. MISCELLANEOUS. 27.1 INDEPENDENT OBLIGATIONS; NO OFFSET. The obligations of Tenant to pay Rent and to perform the other undertakings of Tenant hereunder constitute independent unconditional obligations to be performed at the times specified hereunder, regardless of any breach or default by Landlord hereunder. Tenant shall have no right, and Tenant hereby waives and relinquishes all rights which Tenant might otherwise have, to claim any nature of lien 9 13 specified hereunder, regardless of any breach or default by Landlord hereunder. Tenant shall have no right, and Tenant hereby waives and relinquishes all rights which Tenant might otherwise have, to claim any nature of lien against the Complex or to withhold, deduct from or offset against any Rent or other sums to be paid to Landlord by Tenant. 27.2 TIME OF ESSENCE. Time is of the essence with respect to each date or time specified in this Lease by which an event is to occur. 27.3 APPLICABLE-LAW. This Lease shall be governed by, and construed in accordance with, the laws of the State of Texas. All monetary and other obligations of Landlord and Tenant are performable in the county where the Complex is located. 27.4 ASSIGNMENT BY LANDLORD. Landlord shall have the right to assign, in whole or in part, any or all of its rights, titles or interests in and to the Complex or this Lease and, upon any such assignment, Landlord shall be relieved of all unaccrued liabilities and obligations hereunder to the extent of the interest so assigned. 27.5 COMMENCEMENT DATE AND ESTOPPEL CERTIFICATES. From time to time at the request of Landlord or Landlord's Mortgagee, Tenant will promptly and without compensation or consideration execute, have acknowledged and deliver a certificate stating (a) the Commencement Date and the date of expiration of the Term, (b) the rights (if any) of Tenant to extend the Term or to expand the Premises, (c) the Rent (or any components of the Rent) currently payable hereunder, (d) whether this Lease has been amended in any respect and, if so, submitting copies of or otherwise identifying the amendments, (e) whether, within the knowledge of Tenant, there are any existing breaches or defaults by Landlord hereunder and, if so, swing the defaults with reasonable particularity and (f) such other information pertaining to this Lease as Landlord or Landlord's Mortgagee may reasonably request. 27.6 SIGNS, BUILDING NAME AND BUILDING ADDRESS. Landlord may, from time to time at its discretion, maintain any and all signs anywhere in the Complex, and to change the name and street address of the Complex. Tenant shall not use the name of the Building for any purpose other than as the address of the business to be conducted by Tenant from the Premises. 27.7 NOTICES. All notices and other communications given pursuant to this Lease shall be in writing and shall either be mailed by first class United States mail, postage prepaid, registered or certified with return receipt requested, and addressed as set forth in this Section 27.7, or delivered in person to the intended addressee, or sent by prepaid telegram, cable or telex followed by a confirmatory letter. Notice mailed in the aforesaid manner shall become effective three business days after deposit; notice given in any other manner, and any notice given to Landlord, shall be effective only upon receipt by the intended addressee. Each party shall have the continuing right to change its address for notice hereunder by the giving of 15 days' prior written notice to the other party in accordance with this Section 27.7. ALL PAYMENTS SHOULD BE MADE PAYABLE TO "THE MADISON OFFICE BUILDING" AND DELIVERED TO THE PROPERTY MANAGER'S OFFICE. Landlord: Tenant: State of Utah Retirement Investment Fund Pete's Brewing Company c/o Cottonwood Partners 15851 Dallas Parkway, Suite 1010 7557 Rambler Rd., Suite 932 Dallas, TX 75248 Dallas, Texas 75231 cc: Attn: Property Manager cc: Attn: Jennifer Torrance Funk Cottonwood Management Services Pete's Brewing Company 15851 Dallas Parkway, Suite 950 514 High Street Dallas, TX 75248 Palo Alto, CA 94301 27.8 ENTIRE AGREEMENT, AMENDMENT AND BINDING EFFECT. This Lease constitutes the entire agreement between Landlord and Tenant relating to the subject matter hereof and all prior agreements relative hereto which are not contained herein are terminated. This Lease may be amended only by a written document duly executed by Landlord and Tenant (and, if a Mortgage is then in effect, by the Landlord's Mortgagee entitled to the benefits thereof), and any alleged amendment which is not so documented shall not be effective as to either party. The provisions of this Lease shall be binding upon and inure to the benefit of the parties hereto and their heirs, executors, administrators, successors and assigns; provided, however, that this Section 27.8 shall not negate, diminish or alter the restrictions on Transfers applicable to Tenant set forth elsewhere in this Lease. 27.9 SEVERABILITY. This Lease is intended to be performed in accordance with and only to the extent permitted by all Legal Requirements. If any provision of this Lease or the application thereof to any person or circumstance shall, for any reason and to any extent, be invalid or unenforceable, but the extent of the invalidity or unenforceability does not destroy the basis of the bargain between the parties as contained herein, the remainder of this Lease and the application of such provision to other persons or circumstances shall not be affected thereby, but rather shall be enforced to the greatest extent permitted by law. 27.10 NUMBER AND GENDER, CAPTIONS AND REFERENCES. As the context of this Lease may require, pronouns shall include natural persons and legal entities of every kind and character, the singular number shall 10 14 section hereof. Whenever the terms "hereof," "hereby," "herein", "hereunder" or words of similar import are used in this Lease, they shall be construed as referring to this Lease in its entirety rather than to a particular section or provision, unless the context specifically indicates to the contrary. Any reference to a particular "Section" shall be construed as referring to the indicated section of this Lease. 27.11 ATTORNEYS' FEES. If either party hereto initiates any litigation against the other party relating to this Lease, the prevailing party shall be entitled to recover, in addition to all damages allowed by law and other relief, all court costs and reasonable attorneys' fees incurred in connection with such litigation. 27.12 BROKERS. Tenant and Landlord hereby wan-ant and represent unto the other that it has not incurred or authorized any brokerage commission, finder's, fees or similar payments in connection with this Lease, other than that which is due to Fults Associates and Cottonwood Partners, which payment(s) shall be paid by Landlord. Each party shall defend, indemnify and hold the other harmless from and against any claim for brokerage commission, finder's fees or similar payment arising by virtue of authorization of such party, or any Affiliate of such party, in connection with this Lease. 27.13 INTEREST ON TENANT'S OBLIGATIONS. Any amount due from Tenant to Landlord which is not paid when due shall bear interest at the maximum rate allowed by law from the date such payment is due until paid, but the payment of such interest shall not excuse or cure the default in payment. 27.14 AUTHORITY. The person executing this Lease on behalf of Tenant personally warrants and represents to Landlord that (a) Tenant is a duly organized and existing legal entity, in good standing in the State of Texas; (b) Tenant has full right and authority to execute, deliver and perform this Lease; (c) the person executing this Lease on behalf of Tenant was authorized to do so; and (d) upon request of Landlord, such person will deliver to Landlord satisfactory evidence of his or her authority to execute this Lease on behalf of Tenant. 27.15 RECORDING. Neither this Lease (including any Exhibit hereto) nor any memorandum hereof shall be recorded without the prior written consent of Landlord. 27.16 EXHIBITS. All Exhibits and written addenda hereto are incorporated herein for any and all purposes. 27.17 MULTIPLE COUNTERPARTS. This Lease may be executed in two or more counterparts, each of which shall be an original, but all of which shall constitute but one instrument. [INTENTIONALLY LEFT BLANK] 11 15 EXECUTED as of the date and year above first written. TENANT ACKNOWLEDGES THAT LANDLORD HAS MADE NO WARRANTIES TO TENANT AS TO THE CONDITION OF THE PREMISES, EITHER EXPRESS OR IMPLIED, AND LANDLORD AND TENANT EXPRESSLY DISCLAIM ANY IMPLIED WARRANTY THAT THE PREMISES ARE SUITABLE FOR TENANT'S INTENDED COMMERCIAL PURPOSE, AND TENANT'S OBLIGATION TO PAY RENT HEREUNDER IS NOT DEPENDENT UPON THE CONDITION OF THE PREMISES OR THE PERFORMANCE BY LANDLORD OF ITS OBLIGATIONS HEREUNDER, AND TENANT SHALL CONTINUE TO PAY THE RENT, WITHOUT ABATEMENT (EXCEPT AS OTHERWISE EXPRESSLY PROVIDED HEREIN), SET OFF, DEDUCTION, NOTWITHSTANDING ANY BREACH BY LANDLORD OF ITS DUTIES OR OBLIGATIONS HEREUNDER, WHETHER EXPRESS OR IMPLIED. TENANT: PETE'S BREWING COMPANY, a California corporation By: /s/ JEFFREY A. ATKINS ------------------------------- Name: Jeffrey A. Atkins ------------------------------- Title: CEO ------------------------------- Date:8/14/97 ------------------------------- LANDLORD: UTAH STATE RETIREMENT INVESTMENT FUND, an independent agency of the State of Utah BY: Wallace Realty Advisors, Ltd., A Texas limited partnership BY: Wallace Realty Advisors I, Inc., A Texas corporation, its general partner By: ROBERT J. AXLEY ------------------------------- Name: Robert J. Axley ------------------------------ Title: Chairman ----------------------------- By: JOHN L. WEST ------------------------------- Name: John L. West ------------------------------ Title: President ----------------------------- 12 16 EXHIBIT INDEX EXHIBIT A: Glossary EXHIBIT B: Description of Premises EXHIBIT C: Rules and Regulations EXHIBIT D: Work Letter EXHIBIT E: Property Legal Description 17 EXHIBIT A GLOSSARY OF DEFINED TERMS 1. "ADDENDUM" shall mean the Addendum, if any, attached to this Lease. 2. "AFFILIATE" shall mean a person or party who or which controls, is controlled by or is under common control with another person or party. 3. "BUILDING" shall mean that certain 12 floor office building and garage structure constructed on the Land, the street address of which is 15851 Dallas Parkway, Addison, Texas, and is more particularly described in the deed recorded in Volume 85021, Page 1686 of the Deed Records of Dallas County, Texas. The term "Building" shall include all fixtures and appurtenances in and to the aforesaid structure, including specifically but without limitation all above grade walkways and all electrical, mechanical, plumbing, security, elevator, boiler, HVAC, telephone, water, gas, storm sewer, sanitary sewer and all other utility system and connections, all life support systems, sprinklers, smoke detection and other fire protection systems, and all equipment, machinery, shafts, flues, piping, wiring, ducts, duct work, panels, instrumentation and other appurtenances relating thereto. 4. "BUILDING OPERATING HOURS" shall mean 7:00 a.m. to 7:00 p.m. Monday through Friday and Saturday 8:00 a.m. to 1:00 p.m., exclusive of Sundays and Holidays. 5. "BUILDING RULES AND REGULATIONS" shall mean the rules and regulations governing the Complex promulgated by Landlord from time to time. The current Building Rules and Regulations maintained by Landlord are attached as Exhibit C hereto. 6. "BUILDING STANDARD", when applied to an item, shall mean such item as has been designated by Landlord (orally or in writing) as generally applicable throughout the leased portions of the Building. 7. "COMMENCEMENT DATE" shall mean the date of the commencement of the Term as determined pursuant to Section 6.3. 8. "COMMON AREAS" shall mean all areas and facilities within the Complex which have been constructed and are being maintained by Landlord for the common, general, non-exclusive use of all tenants in the Building, and shall include restrooms, lobbies, corridors, service areas, elevators, stairs and stairwells, the Parking Facility, driveways, loading areas, ramps, walkways and landscaped areas. 9. "COMPLEX" shall mean the Land and all improvements thereon, including the Building and the Parking Facility. 10. "EXPENSE STOP" shall mean that portion of the Operating Expenses, expressed in terms of dollars per square foot of Net Rentable Area per Fiscal Year, which will be excluded from the computation of Additional Rent. Unless changed by mutual agreement of the parties, the "Expense Stop" shall equal the actual operating expenses for calendar year 1997. 11. "FISCAL YEAR" shall mean the fiscal year (or portion thereof) of Landlord as elapses during the Term. The Fiscal Year currently commences on January 1; however, Landlord may change the Fiscal Year at any time or times. 12. "FORCE MAJEURE" shall mean the occurrence of any event which hinders, prevents or delays the performance by Landlord of any of its obligations hereunder and which is beyond the reasonable control of Landlord. 13. "HOLIDAYS" shall mean (a) Now Year's Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day, (b) other days on which national or state banks located in the state where the Complex is located must or may close for ordinary operations and (c) other days which are commonly observed as holidays by the majority of tenants of the Building. If the Holiday occurs on a Saturday or Sunday, the Friday preceding or the Monday following may, at Landlords discretion, be observed as a Holiday. 14. "HVAC" shall mean the heating, ventilation and air conditioning systems in the Building. 15. "IMPOSITIONS" shall mean (a) all real estate, personal property, rental, water, sewer, transit, use, occupancy and other taxes, assessments, charges, excises and levies (including any interest, costs or penalties with respect thereto), general and special, ordinary and extraordinary, foreseen and unforeseen of any kind and nature whatsoever which are assessed, levied, charged or imposed upon or with respect to the Complex, or any portion thereof, or the sidewalks, streets or alley ways adjacent thereto, or the ownership, use, occupancy or enjoyment thereof (including but not limited to mortgage taxes and other taxes and assessments passed on to Landlord by Landlord's Mortgagee) and (b) all charges for any easement, license, permit or agreement maintained for the benefit of the Complex. "Impositions" shall not include income taxes, estate and inheritance taxes, excess profit taxes, franchise taxes, taxes imposed on or measured by the income of Landlord from the operation of the Complex, and taxes imposed on account of the transfer of ownership of the Complex or the Land. If any or all of the Impositions A-1 18 be discontinued and, in substitution therefor, taxes, assessments, charges, excises or impositions be assessed, levied, charged or imposed wholly or partially on the Rents received or payable hereunder (a "SUBSTITUTE IMPOSITION"), then the Substitute Imposition shall be deemed to be included within the term "Impositions". 17. "LAND" shall mean the real property on which the Building is constructed and which is further described in Exhibit E hereto. 18. "LANDLORD'S MORTGAGEE" shall mean the mortagee of any mortgage, the beneficiary of any deed of trust, the pledgee of any pledge, the secured party of any security interest. the assignee of any assignment and the transfer of any other instrument of transfer (including the ground lessor of any ground lease on the Land) now or hereafter in existence on all of any portion of the Complex, and their successors, assigns and purchasers. "MORTGAGE" shall mean any such mortgage, deed of trust, pledge, security agreement, assignment or transfer instrument, including all renewals, extensions and rearrangements thereof and of all debts secured thereby. 19. "LANDLORD'S WORK" shall mean all improvements, components, assemblies, installations, finish, labor, materials and services that Landlord is required to furnish, install, perform, provide or apply to the Premises as specified in the Work Letter. 20. "PREMISES" shall mean the area leased by Tenant pursuant to this Lease as outlined on the floor plan drawing attached as Exhibit B hereto and all other space added to the Premises pursuant to the terms of this Lease. The Premises includes the space between the top surface of the floor slab of the outlined area and the finished surface of the coiling immediately above. 21. "LEGAL REQUIREMENTS" shall mean any and all (a) judicial decisions, orders, injunctions, writs, statutes, rulings, rules, regulations, promulgations, directives, permits, certificates or ordinances of any governmental authority in any way applicable to Tenant or the Complex, including but not limited to the Building Rules and Regulations, zoning, environmental and utility conservation matters, (b) requirements imposed on Landlord by any Landlord's Mortgagee, (c) insurance requirements and (d) other documents, instruments or agreements (written or oral) relating to the Complex or to which the Complex may be bound or encumbered. 22. "NET RENTABLE AREA" whether of the Premises or the Complex shall mean the area determined pursuant to the American National Standard Method for measuring floor space in office buildings, as set forth in American National Standard's Institute publication Z65.1-1980 and as, from time to time, revised. Landlord and Tenant hereby stipulate that, unless and until revised by virtue of the application of the standards set forth in said publication or in a revised publication, the Net Rentable Area of the Premises shall be 821. square feet and the Net Rentable Area of the Building shall be 278,367 square feet. 23. "OPERATING EXPENSES" shall mean all costs and expenses which Landlord pays or accrues by virtue of the ownership, use, management, leasing, maintenance, service, operation, insurance or condition of the Complex during a particular Fiscal Year or portion thereof as determined by Landlord or its certified public accountants in accordance with generally accepted accounting principles plus (in instances where the Building was not fully occupied for the entire period in question) all additional costs and expenses which Landlord or such accountant reasonably determines Landlord would have paid or accrued during such period if the Building has been fully occupied (defined as 95% occupied). "Operating Expenses" shall include, but shall not be limited to, the following to the extent they relate to the Complex: (a) all Impositions and other governmental charges; (b) all insurance premiums charged for policies obtained by Landlord, which may include without limitation, at Landlord's election, (i) fire and extended coverage insurance including earthquake, windstorm, hail, explosion, riot, strike, civil commotion, aircraft, vehicle and smoke insurance, (ii) public liability and property damage insurance, (iii) elevator insurance, (iv) workmen's compensation insurance for the employees covered by clause (h), (v) boiler, machinery, sprinkler, water damage, legal liability, burglary, hold-up, fidelity and pilferage insurance, (vi) rental loss insurance and (vii) such other insurance as Landlord may elect to obtain; (c) all deductible amounts incurred in any Fiscal Year relating to an insurable loss; (d) all maintenance, repair, replacement and painting costs; A-2 19 (e) all janitorial, custodial, cleaning, washing, landscaping, landscape maintenance, trash removal and pest control costs; (f) all security costs; (g) all electrical, energy monitoring, water, water treatment, gas, sewer, telephone and other utility and utility related charges; (h) all wages, salaries, salary burdens, employee benefits, payroll taxes, social security and insurance for all persons engaged by Landlord or an Affiliate of Landlord; (i) all costs of leasing or purchasing supplies, tools, equipment and materials; (j) all management fees and other charges for management services (including, without limitation, travel and related expenses), whether provided by an independent management company, by Landlord or by an Affiliate of Landlord; (k) all few and other charges paid under all maintenance and service agreements, including but not limited to window cleaning, elevator and HVAC maintenance; (l) all legal, accounting and auditing fees and expense; and (m) amortization of the cost of acquiring, financing and installing capital items which are intended to reduce (or avoid increases in) operating expenses or which are required by a governmental authority. Such costs shall be amortized over the reasonable life of the items in accordance with generally accepted accounting principles, but not beyond the reasonable life the Building. "Operating Expenses" shall not include (i) expenditures classified as capital expenditures for federal income tax purposes except as set forth in clause (m), (ii) costs for which Landlord is entitled to specific reimbursement by Tenant, by any other tenant of the Building or by any other third party, (iii) allowances specified in the Work Letter for expenses incurred by Landlord for improvements to the Premises, (iv) leasing commissions, and all non-cash expenses (including depreciation), except for the amortized costs specified in clause (m), (v) land or ground rent, if applicable, and (vi) debt service on any indebtedness secured by the Complex (except debt service on indebtedness to purchase or pay for items specified as permissible "Operating Expenses" under clause (a) through (m). 24. "PARKING FACILITY" shall mean (a) any parking garage and any other parking lot or facility adjacent to or in the Complex servicing the Building and (b) any parking area, open or covered, leased by Landlord to service the Building. 25. "RENT" shall mean Base Rent, Additional Rent, the parking charge called for in Section 5.4 and all other amounts provided for under this Lease to be paid by Tenant, whether as additional rent or otherwise. "BASE RATE" shall mean the base rent specified in Section 5.1 as adjusted in accordance with Section 5.2. "BASE RENT ADJUSTMENT" shall mean the increase in the annual Base Rent as set forth in Section 5.2. "ADDITIONAL RENT" shall mean the additional rent specified in Section 5.3. 26. "SECURITY DEPOSIT" shall mean $1,519.53 paid by Tenant as security for the full and faithful performance of the obligations of Tenant under this Lease. 27. "TAKING" or "TAKEN" shall mean the actual or constructive condemnation, or the actual or constructive acquisition by or under threat of condensation, eminent domain or similar proceeding, by or at the direction of any governmental authority or agency. 28. "TENANT'S SHARE" shall mean the proportion by which the Net Rentable Area of the Premises beats to the Net Rentable Area of the Building. "Tenant's Share" shall be adjusted by Landlord from time to time to reflect adjustments to the then current Net Rentable Area of the Building or the Premises. "Tenant's Share" shall initially mean 821 rentable square fed + 278,367 rentable square feet = 0.2949 %. 29. "TRANSFER" shall mean (a) an assignment (direct or indirect, absolute or conditional, by operation of law or otherwise) by Tenant of all or any portion of Tenant's interest in this Lease or the leasehold estate created hereby, (b) a sublease of all or any portion of the Promises or (c) the grant or conveyance by Tenant of any concession or license within the Premises. If Tenant is a corporation then any transfer of this Least by merger, consolidation or dissolution, or by any change in ownership or power to vote a majority of the voting stock (being the shares of stock regularly entitled to vote for the election of directors) in Tenant outstanding at the time of execution of this Lease shall constitute a Transfer. If Tenant is a partnership having one or more corporations as general partners, the preceding sentence shall apply to each corporation as if the corporation alone had been the Tenant hereunder. If Tenant is a general or limited partnership, joint venture or other form of association, the transfer of a majority of the ownership interests therein shall constitute a Transfer. "TRANSFEREE" shall mean the assignee, sublessee, pledgee, concessionee, licensee or other transferee of all or any portion of Tenant's interest in this Lease, the leasehold estate created hereby or the Premises. A-3 20 30. "WORK LETTER" shall mew the agreement, if any, attached as Exhibit D hereto between Landlord and Tenant for the construction of improvements in the Premises. A-4 21 EXHIBIT B PREMISES Suite 1010 (Approximately 821 Rentable Square Feet) [FLOOR PLAN] THE MADISON 10TH FLOOR 22 EXHIBIT C RULES AND REGULATIONS 1. Landlord may from time to time adopt appropriate system and procedures for the security or safety of the Building, any persons occupying, using, or entering the Building, or any equipment, finishings, or contents of the Building, and each tenant shall comply with such systems and procedures. 2. Tenant's employees, visitors, and licensees shall not loiter in or interfere with the use of the Parking Facility or the Complex's driveway or parking areas nor consume alcohol in the common areas of the Complex or the Parking Facility. The sidewalks, halls, passages, exits, entrances, elevators, escalators, and stairways of the Building will not be obstructed by any tenants or used by any of them for any purpose other than for ingress to and egress from their respective premises. The halls, passages, exits, entrances, elevators, escalators, and stairways am not for the general public, and Landlord may control and prevent access to them by all persons whose presence, in the reasonable judgment of Landlord, would be prejudicial to the safety, character, reputation and interests of the Building and its tenants; in determining whether access will be denied, Landlord may consider attire worn by a person and its appropriateness for an office building, whether shoes are being worn, use of profanity, either verbally or on clothing, actions of a person (including, without limitation, spitting, verbal abusiveness, and the like), and such other matters as Landlord may reasonably consider appropriate. 3 . No sign, placard, picture, name, advertisement, or notice visible from the exterior of any tenant's premises shall be inscribed, painted, affixed, or otherwise displayed by any tenant on any part of the Building without the prior written consent of Landlord. All approved signs or lettering on doors will be printed, painted, affixed, or inscribed at the expense of the tenant desiring such by a person approved by Landlord. Material visible from outside the Building will not be permitted. Landlord may remove such material without any liability, and my charge the expense incurred by such removal to the tenant in question. 4. No curtains, draperies, blinds, shutters, shades, screens, or other coverings, hangings, or decorations will be attached to, hung, or placed in, or used in connection with any window of the Building or the Premises. 5. The sashes, sash doors, skylights, windows, heating, ventilating, and air conditioning vents and doors that reflect or admit light and air into the halls, passageways, or other public places in the Building shall not be covered or obstructed by any tenant, nor will any bottles, parcels, or other articles be placed on any window sills. 6. No showcases or other articles will be put in front of or affixed to any part of the exterior of the Building, nor placed in the public halls, corridors, or vestibules without the prior written consent of Landlord. 7. No tenant will permit its Premises to be used for lodging or sleeping. No cooking will be done or permitted by any tenant on its premises, except in areas of the premises which are specially constructed for cooking, so long as such use is in accordance with all applicable federal, state, and city laws, codes, ordinances, rules, and regulations. 8. No tenant will employ any person or persons other than the cleaning service of Landlord for the purpose of cleaning the premises, unless otherwise agreed by Landlord in writing. If any tenant's actions result in any increased expense for any required cleaning, Landlord may assess such tenant for such expenses. Janitorial service will not be furnished on nights to offices which are occupied after business hours on those nights unless, by prior written agreement of Landlord, service is extended to a later hour for specifically designated offices. 9. The toilets, urinals, wash bowls, and other plumbing fixtures will not be used for any purposes other than those for which they were constructed, and no sweepings, rubbish, rags, or other foreign substances will be thrown in them. All damages resulting from any misuse of the fixtures will be borne by the tenant who, or whose servants, employees, agents, visitors, or licensees, have caused the damage. 10. No tenant will deface any part of the premises or the Building. Without the prior written consent of Landlord, no tenant will lay linoleum, or other similar floor covering, so that it comes in direct contact with the floor of such tenant's premises. If linoleum or other similar floor covering is to be used, an interlining of builder's deadening felt will be first affixed to the floor, by a paste or other material, soluble in water. The use of cement or other similar adhesive material is expressly prohibited. 11. No tenant will alter, change, replace, or rekey any lock or install a new lock or a knocker on any door of the premises. Landlord, its agent or employee, will retain a master key to all door locks on the premises. Any new door locks required by a tenant or any change in keying of existing locks will be installed or changed by Landlord following such tenant's written request to Landlord and will be at such tenant's expense. All new locks and rekeyed locks will remain operable by Landlord's master key. Landlord will furnish to each tenant, free of charge, two (2) keys to each door lock on its premises. Landlord will have the right to collect a reasonable charge for additional keys and cards requested by any tenant. Each tenant, upon termination of its tenancy, will deliver to Landlord all keys and access cards for the premises and Building which have been furnished to such tenant. 12. The elevator designated for freight by Landlord will be available for use by all tenants in the Building during the hours and pursuant to such procedures as Landlord may determine from time to time. The persons employed to move tenant's equipment, Material, furniture, or other property in or out of the Building must be acceptable to Landlord; such C-1 23 persons must be a locally recognized professional mover, whose primary business is the performing of relocation services, and must be bonded and fully insured. A certificate or other verification of such insurance must be received and approved by Landlord prior to the start of any moving operations. Insurance must be sufficient, in Landlord's sole opinion, to cover all personal liability, theft, or damage to the Building, including without limitation floor coverings, doors, walls, elevators, stairs, foliage, and landscaping. All moving operations will be conducted at such times and in such a manner as Landlord may direct, and all moving will take place during nonbusiness hours unless Landlord otherwise agrees in writing. The moving tenant shall be responsible for the provision of Building security during all moving operations, and shall be liable for all losses and damages sustained by any party as a result of the failure to supply adequate security. Landlord may prescribe the weight, size, and position of all equipment, materials, furniture, or other property brought into the Buildings. Heavy objects will, if considered necessary by Landlord, stand on wood strips of such thickness as is necessary to distribute the weight properly. Landlord will not be responsible for loss of or damage to any such property from any cause, and all damage done to the Building by moving or maintaining such property will be repaired at the expense of the moving tenant. Landlord may inspect all such property to be brought into the Building and to exclude from the Building all such property which violates any of these rules and regulations or the lease of which these rules and regulations are a part. Supplies, goods, materials, packages, furniture, and all other items of every kind delivered to or taken from the premises will be delivered or removed through the entrance and route designated by Landlord. 13. No tenant will use or keep in the premises or the Building any kerosene, gasoline, or inflammable or combustible or explosive fluid or material or chemical substance other then limited quantities of them reasonably necessary for the operation or maintenance of office equipment or limited quantities of cleaning fluids and solvents required in normal operation of the premises. Without Landlord's prior written approval, no tenant will use any method of heating or air conditioning other than that supplied by Landlord. No tenant will keep any firearms within the Premises. No tenant will use or keep or permit to be used or kept any foul or noxious gas or substance in the premises, or permit of suffer the premises to be occupied or used in an manner offensive or objectionable to Landlord or other occupants of the Building by reason of noise, odors, or vibrations, or interfere in any way with other tenants or those having business in the Building. 14. Landlord may without notice and without liability to any tenant, change the name and street address of the Building. 15. Landlord will have the right to prohibit any advertising by tenant, mentioning the Building, which, in Landlord's reasonable opinion, tends to impair the reputation of the Building or its desirability as a Building for offices, and upon written notice from Landlord, tenant will discontinue such advertising. 16. Tenant will not bring any animals or birds into the Building, and will not permit bicycles or other vehicles inside or on the sidewalks outside the Building except in areas designated from time to time by Landlord for such purposes. 17. All persons entering or leaving the Building at any time other than the Building's business hours shall comply with such off-hour regulations as Landlord may establish and modify from time to time. Landlord may limit or restrict access to the Building during such periods. 18. Each tenant will store all its trash and garbage within its premise. No material will be placed in the trash boxes or receptacles if such material is of such nature that it may not be disposed of in the ordinary and customary manner of removing and disposing of trash and garbage without being in violation of any law or ordinance governing such disposal. All garbage and refuse disposal will be made only through entryways and elevators provided for such purposes and at such times as Landlord may designate. No furniture, appliances, equipment, or flammable products of any type may be disposed of in the Building trash receptacles. 19. Canvassing, peddling, soliciting, and distribution of handbills or any other written materials in the Building are prohibited, and each tenant will cooperate to prevent same. 20. Each tenant shall keep the doors of the premises closed and locked and shall shut off all water faucets, water apparatus, and utilities before tenant or tenants employees leave the premises, so as to prevent waste or damage, and for any default or carelessness in this regard tenant shall be liable for all injuries sustained by other tenants or occupants of the Building or Landlord. On multiple-tenancy floors, all tenants will keep the doors to the Building corridors closed at all times except for ingress and egress. C-2 24 EXHIBIT D WORKLETTER Landlord agrees, at its sole expense (not to exceed $4,708.00), to make the following leasehold improvements: - Repair base in breakroom. - Clean carpet throughout. - Clean damaged drape in breakroom. - Repaint existing adjustable shelves and breakroom walls. - Install 4' base cabinet with sink, and "insta-hot". - Install 4' of upper cabinets in breakroom. - Install duplex wall outlet above cabinet in breakroom capable of handling both microwave and coffee machine. In all other respects, Tenant accepts the Premises "As-built". D-1 25 EXHIBIT E LEGAL DESCRIPTION OF PROPERTY BEING a tract or parcel of land out of the D.W. FISHER SURVEY, Abstract No. 482, Dallas County, Texas, said tract being all of that tract recorded as the 15851 DALLAS NORTH PARKWAY ADDITION, an Addition to the City of Addison, as recorded in Volume 85021, Page 1686, Map Records, Dallas County, Texas, except that portion thereof conveyed by The Young Companies IV to the Texas Turnpike Authority for right of way for the Dallas North Tollway as recorded in Volume 86134, Page 435, Deed Records, Dallas County, Texas, said 4.022 acre tract of land being more particularly described as follows: BEGINNING at a 1/2 inch iron rod with cap set in the south right of way line of Airport Parkway (55 feet wide) said point being at the intersection of said line of Airport Parkway with the west right of way line of the Dallas North Tollway as defined by said conveyance by The Young Companies IV to the Texas Turnpike Authority, said point being North 89 degrees 37 minutes 15 seconds West, a distance of 92.70 feet along said line of Airport Parkway from the northeast comer of said 15851 Dallas North Parkway Addition; THENCE South 40 degrees 26 minutes 12 seconds East, with said west right of way line of the Dallas North Tollway (a Variable width right of way), a distance of 23.50 feet to a 1/2 inch iron rod with cap set at an angle point; THENCE South 08 degrees 41 minutes 31 seconds West, continuing with said line of the Dallas North Tollway, a distance of 53.20 feet to a 1/2 inch iron rod with cap set at the beginning of a curve to the left, the center of which bears South 81 degrees 18 minutes 29 seconds East, a distance of 1283.24 feet from said point; THENCE in a southerly direction continuing with said line of said Dallas North Tollway, through a central angle of 07 degrees 42 minutes 30 seconds, an arc distance of 172.64 feet to a 1/2 inch iron rod with cap set at the end of said curve; THENCE South 00 degrees 59 minutes 01 seconds West, continuing with said line of the Dallas North Tollway a distance of II 7.56 feet to a 1/2 inch iron rod with cap set in the south line of said 15851 Dallas North Parkway Addition; THENCE North 89 degrees 37 minutes 15 seconds West, with the south line of said 15851 Dallas North Parkway Addition and with the north line of a tract of land conveyed to Opubco Resources, Inc. by deed recorded in Volume 78070, Page 3638, Deed Records, Dallas County, Texas, a distance of 477.99 feet to a 1/2 inch iron rod with cap found for comer, said point being the southeast comer of a tract of land conveyed to Chaney and Hope, Inc., by deed recorded in Volume 78194, Page 1741, Deed Records, Dallas County, Texas; THENCE North 00 degrees 19 minutes 15 seconds West, with the west line of said 15851 Dallas North Parkway Addition, and with the east line of said Chaney and Hope, Inc. tract, a distance of 360.00 feet to a 1/2 inch iron rod with cap found for comer in the south line of Airport Parkway; THENCE South 89 degrees 37 minutes 15 seconds East, with said line of Airport Parkway a distance of 489.38 feet to the POINT OF BEGINNING and CONTAINING 175,196 square feet or 4.022 acres of land, more or less. E-1 26 ADDENDUM TO LEASE THIS FIRST ADDENDUM TO LEASE (this "Addendum") is made between UTAH STATE RETIREMENT INVESTMENT FUND ("Landlord"), and PETE'S BREWING COMPANY ("Tenant"), to be a part of that certain Lease Agreement between Landlord and Tenant of even date herewith (the "Lease"). Landlord and Tenant agree that, notwithstanding anything to the contrary in the Lease, the Lease is hereby modified and supplemented as follows: 1. Assignment and Subletting. A. Landlord shall not unreasonably withhold its consent to a proposed Transfer. B. With prior written notice to Landlord. Tenant may, without Landlord's prior written consent and without being subject to Landlord's right to terminate the Lease or otherwise recapture the Premises, Transfer the Premises to: (i) a subsidiary, affiliate, division or corporation, controlling, controlled by or under common control with Tenant; (ii) a successor corporation related to Tenant by merger or consolidation, or (iii) a purchaser of all or substantially all of Tenant's assets. For the purpose of this Lease, the sale or transfer of Tenant's capital stock, including without limitation, a transfer in connection with the merger or consolidation of Tenant and any sale through any public exchange, shall not be deemed a Transfer. 2. Alterations. Landlord's consent to any alterations proposed by Tenant shall not be unreasonably withheld. 3. Access by Landlord: Except in the case of an emergency, Landlord shall give Tenant reasonable notice prior to entering the Premises for the purposes stated in Sections 13(b) through 13(d) of the Lease. Landlord shall only have the right to show the Premises to prospective tenants during the last six (6) months of the Term. 4. Casualty. A. The last sentence of Section 15.1 is deleted. B. Section 15.2 is modified as follows: (i) by adding the following at the end of clause (a): "; provided however, that Tenant shall be entitled to rental statement in the amount provided in Section 15.1 hereof, but not to exceed the amount of rental abatement proceeds which Landlord receives under insurance policies carried by Landlord"; and (ii) clause (b) is deleted. 5. Insurance. The last sentence of Section 17.1 is modified by adding the following at the end thereof: "which approval shall not be unreasonably withheld". 6. Indemnity. Section 18 is modified by deleting "about the Premises" and replacing it with the following: "on the Premises or from any injuries to or death of any person or damage to any property arising from the act or omission of Tenant, or its employees, agents, contractors, and/or invitees." 1 27 8. Right to Relocate. The following is added to Section 22. If Landlord elects to relocate Tenant the new space shall be comparable in size and configuration to the Premises and with comparable leasehold improvements. Tenant shall not be required to pay any increase in Base Rent or Additional Rent as a result of the relocation, unless Tenant requests larger space. 9. Default by Tenant. The following is added at the end of Subsection 24.1(b): "or such longer time as may reasonably be required to cure the default so long as Tenant commences to cure such failure within such ten (10)-day period and diligently prosecutes such cure to completion provided however, that in no event shall such additional time exceed sixty (60) days." 10. Condition of Premises. Landlord represents that as of the Commencement Date the Premises will be in good condition and repair and free of defects and the electrical, mechanical, HVAC, plumbing, elevator (if any), fire safety, security and other systems serving the Premises and the Building will be in good condition and repair consistent with similar grade buildings in the far North Dallas submarket. 11. Operating Expenses. Operating Expenses shall not include costs related to the remediation and cleanup of groundwater and/or soils contamination from hazardous substances in, on, or under the Premises or the Complex except to the extent resulting from (i) the release, disposal, emission or discharge of hazardous substances by Tenant, or (ii) minor occurrences resulting from the daily operation of the Building. 12. Effect of Addendum: All terms with initial capital letters used herein as defined terms shall have the meanings ascribed to them in the Lease unless specifically defined herein. In the event of any inconsistency between the Lease and this the terms of this Addendum shall prevail.
LANDLORD: TENANT: UTAH STATE RETIREMENT INC. INVESTMENT FUND PETE'S BREWING COMPANY By: WALLACE REALTY ADVISORS, LTD. By: /s/ JEFFREY A. ATKINS ---------------------------- --------------------- Wallace Realty Advisors I, Inc. Its: CEO ------------------------------- -------------------- /s/ ROBERT J. AXLEY -------------------------------- Date: 8/22/97 Robert J. Axley -------------------- Chairman By: /s/ JOHN L. WEST -------------------------------- John L. West President
2 EX-10.14 3 LEASE BETWEEN REGISTRANT AND 1300 IROQUOIS VENTURE 1 EXHIBIT 10.14 Building: IROQUOIS COMMONS OFFICE PARK Address: 1300 Iroquois Drive, Naperville, Illinois LEASE LANDLORD: 1300 Iroquois Venture, an Illinois Limited Partnership TENANT: Pete's Brewing Company PREMISES: Suite 245 DATE OF LEASE: September 29, 1997 2 TABLE OF CONTENTS Page LANDLORD-TENANT ......................................... 1 DEMISED PREMISES ........................................ 1 RENT .................................................... 1 SERVICE ................................................. 1 COMMENCEMENT DATE ....................................... 2 CONDITION OF PREMISES ................................... 3 FAILURE TO GIVE POSSESSION .............................. 3 USE OF PREMISES ......................................... 4 CARE AND MAINTENANCE .................................... 6 ALTERATIONS ............................................. 6 ACCESS TO PREMISES ...................................... 7 UNTENANTABILITY ......................................... 8 SUBROGATION ............................................. 8 EMINENT DOMAIN .......................................... 8 ASSIGNMENT - SUBLETTING ................................. 9 WAIVER OF CLAIMS AND INDEMNITY .......................... 10 MORTGAGE - GROUND LEASE ................................. 10 CERTAIN RIGHTS RESERVED TO THE LANDLORD ................. 11 HOLDING OVER ............................................ 12 LANDLORD'S REMEDIES ..................................... 12 DEFAULT UNDER OTHER LEASE ............................... 14 SURRENDER OF POSSESSION ................................. 14 NOTICES ................................................. 15 SECURITY DEPOSIT ........................................ 15 MISCELLANEOUS ........................................... 16 3 THIS LEASE, made as of this 29th day of September, 1997 between 1300 Iroquois Venture, an Illinois Limited Partnership (hereinafter known as "Landlord"), and Pete's Brewing Company (hereinafter known as "Tenant"); WITNESSETH: THAT Landlord hereby leases to Tenant, and Tenant accepts the demised premises hereinafter known as "demised premises" or "Premises"), described in the plan attached hereto as Exhibit "A" in the building (hereinafter known as "Building"), known as 1300 Iroquois Drive, Naperville, IL 60563, for the term of 48 months unless sooner terminated as provided herein, commencing on the Commencement Date (as hereinafter defined) and ending forty-eight (48) months thereafter, to be occupied and used by the Tenant for general offices, sales, marketing and other legally related uses and no other purpose, subject to the agreements herein contained. IN CONSIDERATION THEREOF, THE PARTIES COVENANT AND AGREE: 1. RENT. The Tenant shall pay as Rent to Landlord or to such other person or at such other place as Landlord may direct in writing in accordance with the following schedule, in advance on or before the first day of each month of the term, except that the Tenant shall pay the first such monthly installment on the execution hereof: MONTHS GROSS RENT* ------ ----------- 1 through 12 $1,894.67/mo. 13 through 24 $1,970.46/mo 25 through 36 $2,049.28/mo. 37 through 48 $2,131.25/mo. All such Rent shall be paid without any set-off or deduction whatsoever. Unpaid Rent shall bear interest at the rate of nine percent (9%) per annum from the date due until paid. Time is of the essence of this Lease. Tenant agrees to do and perform each and every covenant, agreement and obligation to be performed by Tenant hereunder. (*Gross rent includes all common area maintenance and real estate taxes. Tenant to pay individual utilities as provided in Section 3, TENANT, paragraph a.) 2. INTENTIONALLY DELETED. 3. SERVICE. The Landlord, shall furnish: (a) Window washing of all windows in the demised premises, both inside and out, at such times as shall be required in the Landlord's sole judgement; 1 4 (b) A parking area as shown on the site plan of the Building to be used by Tenant, in common with Landlord and other Tenants in the Building, for passenger vehicles. The parking area will be maintained and repaired by the Landlord. (c) Maintenance of exterior landscaping. (d) Scavenger and garbage removal service. (e) Snow removal from sidewalks and parking lot. (f) Maintenance and repair of sidewalks. (g) Maintenance and repair of exterior walls and roof of Building, and structural portions not repaired and maintained by Tenant pursuant to Section 8 of this Lease. (h) Janitorial services for the Building and demised premises. TENANT shall have the responsibility for paying for the following services at it's expense: (a) Electricity shall be paid by Tenant from billings received directly from the utility company. (b) Tenant agrees to purchase from Landlord or its agents all lamps, bulbs, ballast and starters used in the Demised Premises after the installation thereof (c) Tenant shall be responsible for the maintenance and repair of the demised premises as provided in Section 8 herein. The Landlord does not warrant that any of the services referred to in this Section 3 will be free from interruptions caused by war, insurrection, civil commotion, riots, acts of God or the enemy, governmental action, repairs, renewals, improvements, alterations, strikes, lockouts, picketing, whether legal or illegal, accidents, inability of the Landlord to obtain fuel or supplies or any other cause or causes beyond the reasonable control of the Landlord. Any such interruption of service shall never be deemed an eviction or disturbance of the Tenant's use and possession of the premises or any part thereof, or render the Landlord liable to the Tenant for damages, or relieve the Tenant from performance of the Tenant's obligations under this Lease. 4. COMMENCEMENT DATE. The Tenant acknowledges that Landlord is undertaking extensive reconstruction of the Building necessary to create Tenant's Premises in accordance with attached Exhibit A. As soon as Landlord shall deliver the Premises to Tenant and, upon such delivery, the lease term will commence hereunder (herein referred to as "Commencement Date") and Tenant is free to take possession of the Premises depicted on Exhibit A. Both Landlord and Tenant agree to execute a letter to memorialize said Commencement Date. In the event Landlord is unsuccessful in obtaining a building permit from the City of Napervil 2 5 ("building permit") on or before December 31, 1997, this Lease will terminate without further action of the parties unless the parties hereto agree, in writing, to an extension. Landlord agrees to deliver said Premises to Tenant within sixty (60) days of the issuance of the building permit and it shall be Landlord's sole obligation to build out the Premises in accordance with the attached Exhibit A. 5. CONDITIONS OF PREMISES. The Tenant's taking possession shall be conclusive evidence as against the Tenant that the demised premises were in good order and satisfactory condition when the Tenant took possession. No promise of the Landlord to alter, remodel, decorate, clean or improve the demised premises or the Building and no representation respecting the condition of the demised premises or the Building have been made by the Landlord to the Tenant, unless the same is contained herein, or made a part hereof, or in a written document signed by Landlord or its Agent. The Premises shall be improved according to the attached Exhibit "A". Said improvements shall include professionally painting all walls within the Premises and new building standard carpeting throughout the Premises. This Lease does not grant any rights to air over property. 6. FAILURE TO GIVE POSSESSION. If the Landlord shall be unable to give possession of the demised premises on the date of the commencement of the term hereof by reason of any of the following: (i) the Building has not been sufficiently completed to make the demised premises ready for occupancy, (ii) the Landlord has not completed its preparation of the demised premises, (iii) the Landlord is unable to give possession of the demised premises by reason of the holding over to retention of possession by any tenant, tenants, or occupants, or; (iv) for any other reason, Landlord shall not be subject to any liability for the failure to give possession on said date. Under such circumstances the Rent reserved and covenanted to be paid herein shall not commence until the demised premises are available for occupancy by Tenant, and no such failure to give possession on the date of commencement of the term hereof shall affect the validity of this Lease or the obligations of the Tenant hereunder, nor shall the same be construed to extend the term of this Lease. If the demised premises are ready for occupancy prior to the date of commencement of the term hereof and Tenant occupies the premises prior to said date, Tenant shall pay rental for the period of occupancy prior to the date of commencement of the term hereof at the proportionate rental to the rent reserved herein. The said demised premises shall not be deemed to be unready for Tenant's occupancy or incomplete if only minor or insubstantial details of construction, decoration or mechanical adjustments remain to be done in the demised premises or any part thereof, or if the delay in the availability of the demised premises for occupancy shall be due to special work, changes, alterations or additions required or made by Tenant in the layout or finish of the demised premises or any part thereof or shall be caused in whole or in part by Tenant through the delay of Tenant in submitting plans, supplying information, approving plans specifications or estimates, giving authorizations or otherwise or shall be caused in whole or in part by delay and/or default on 3 6 the part of Tenant and/or its subtenant or subtenants. In the event of any dispute as to whether the premises are ready for Tenant's occupancy, the decision of Landlord's architect shall be final and binding on the parties. 7. USE OF PREMISES. The Tenant shall occupy and use the demised premises during the full term for the purpose above specified and none other; (a) the Tenant will not make or permit to be made any use of the demised premises which, directly or indirectly is forbidden by public law, ordinance or governmental regulation or which may be dangerous to persons or property, or which may invalidate or increase the premium cost of any policy of insurance carried on the Building or covering its operations; the Tenant shall not do, or permit to be done, any act or thing upon the demised premises which will be in conflict with fire insurance policies governing the Building of which the demised premises form a part. The Tenant, at its sole expense shall comply with all rules, regulations or requirements of the local Inspection and Rating Bureau, or any other similar body, and shall not do, or permit anything to be done upon said premises, or bring or keep anything thereon in violation of rules, regulations or requirements of the Fire Department, local inspection and Rating Bureau, Fire Insurance Rating Organization or other authority having jurisdiction and then only in such quantity and manner of storage as not to increase the rate of fire insurance applicable to the Building; (b) any sign installed in the demised premises shall be installed by Landlord at Tenant's cost and in such manner, character and style as Landlord may approve in writing; (c) the Tenant shall not advertise the business, profession or activities of the Tenant conducted in the Building in any manner which violates the letter or spirit of any code of ethics adopted by any recognized association or organization pertaining to such business, profession or activities, and shall not use the name of the Building for any purpose other than that of business address of the Tenant, and shall never use any picture or likeness of the Building in any circulars, notices, advertisements, or correspondence without the Landlord's express consent in writing; (d) the Tenant shall not obstruct, or use for storage, or for any purpose other than ingress and egress, the sidewalks, entrances, passages, courts, corridors, vestibules, halls, elevators, and stairways of the Building; (e) no bicycles or other vehicle and no dog or other animal or bird shall be brought or permitted to be in the Building or any part thereof; (f) the Tenant shall not make or permit any noise or odor that is objectionable to the other occupants of the Building to emanate from the demised premises, and shall not create or maintain a nuisance thereon, and shall not disturb, solicit or canvass any occupant of the Building, and shall not do any act tending to injure the reputation of the Building; (g) the Tenant shall not install any musical instrument or equipment in the Building, or any antennas, aerial wires or other equipment inside or outside the Building, without, in each and every instance, prior approval in writing by the Landlord. The use thereof, if permitted, shall be 4 7 subject to control by the Landlord to the end that others shall not be disturbed or annoyed; (h) the Tenant shall not waste water by tying, wedging or otherwise fastening open any faucet; (i) no additional locks or similar devices shall be attached to any door. No keys for any door other than those provided by the Landlord shall be made. If more than two keys for one lock are desired by the Tenant, the Landlord may provide the same upon payment by the Tenant. Upon termination of this Lease or of Tenant's possession, the Tenant shall surrender all keys of the demised premises and shall make known to the Landlord the explanation of all combination locks on safes, cabinets and vaults; (j) the Tenant shall be responsible for the locking of doors in and to the demised premises. Any damage resulting from neglect of this clause shall be paid for by the Tenant; (k) if the Tenant desires telegraphic, telephonic, burglar alarm or signal service, the Landlord will, upon request, direct where and how connections and all wiring for such service shall be introduced and run. Without such directions, no boring, cutting or installation of wires or cables is permitted; (1) shades, draperies or other forms of inside window covering must be of such shape, color and material as approved by the Landlord; (m) the Tenant shall not overload any floor. Safes, furniture and all large articles shall be brought through the Building and into the demised premises at such times and in such manner as the Landlord shall direct and at the Tenant's sole risk and responsibility. The Tenant shall list all furniture, equipment and similar articles to be removed from the Building, and the list must be approved at the Office of the Building or by a designated person before building employees will permit any article to be removed; (n) unless the Landlord gives advance written consent in each and every instance, the Tenant shall not install or operate any steam or internal combustion engine, boiler, machinery, refrigerating or heating device or air-conditioning apparatus in or about the demised premises, or carry on any mechanical business therein, or use the demised premises for housing accommodations or lodging or sleeping purposes, or do any cooking therein or install or permit the installation of any vending machines, or use any illumination other than electric light, or use or permit to be brought into the Building and inflammable oils or fluids such as gasoline, kerosene, naphtha and benzene, or any explosive or other articles hazardous to persons or property; (o) the Tenant shall not place or allow anything to be against or near the glass of partitions, doors or windows of the demised premises which may diminish the light in, or be unsightly from the exterior of the Building, public halls or corridors; (p) the Tenant shall not install in the demised premises any equipment which uses a substantial amount of electricity without the advance written consent of the Landlord. The Tenant shall ascertain from the Landlord the maximum amount of electrical current which can safely be 5 8 used in the demised premises, taking into account the capacity of the electrical wiring in the Building and the demised premises and the needs of other tenants in the Building and shall not use more than such safe capacity. The Landlord's consent to the installation of electric equipment shall not relieve the Tenant from the obligation not to use more electricity than such safe capacity; (q) the Tenant may not install carpet padding or carpet by means of a mastic, glue or cement. Such installation shall be by tackless strip or double-face tape only; (r) in addition to all other liabilities for breach of any covenant of this Section 6, the Tenants shall pay to the Landlord all damages caused by such breach and shall also pay to the Landlord as additional rent an amount equal to any increase in insurance premium or insurance premiums caused by such breach. Any violation of this Section 6 may be restrained by injunction. The Tenant shall be liable to the Landlord for all damages resulting from violation of any of the provisions of this Section 6. The Landlord shall have the right to make such reasonable rules and regulations as the Landlord or its agent may from time to time adopt on such reasonable notice to be given as the Landlord may elect. Nothing in this Lease shall be construed to impose upon the Landlord any duty or obligation to enforce provisions of this Section 6 or any rules and regulations hereafter adopted, or the terms, covenants or conditions of any other lease as against any other tenant, and the Landlord shall not be liable to the Tenant for violation of the same by any other tenant, its servants, employees, agents, visitors, or licensees. 8. CARE AND MAINTENANCE BY TENANT. Subject to the provisions of section 10, Tenant shall at Tenant's own expense keep the demised premises, including the walls, floors, ceiling, plumbing and electric fixtures and outlets, in good order, condition and repair during the term. If Tenant does not make repairs promptly and adequately, the Landlord may, but need not, make repairs, and the Tenant shall promptly pay the cost thereof. Landlord shall furnish and pay for a heating, ventilating and air conditioning maintenance contract. 9. ALTERATIONS. The Tenant shall not do any painting or decorating, or erect any partitions, make any alterations in or additions to the demised premises or do any nailing, boring or screwing into the ceilings, walls or floors, without the Landlord's prior written consent in each and every instance. Unless otherwise agreed by Landlord and Tenant in writing, all such work shall be performed either by or under the direction of Landlord, but at the cost of Tenant. The Landlord's decision to refuse such consent shall be conclusive. If the Landlord consents to such alterations or additions, before commencement of the work or delivery of any materials onto the demised premises or into the Building, the Tenant shall furnish the Landlord for approval: (a) plans and specifications; (b) names and addresses of contractors; (c) copies of contracts; (d) necessary permits; 6 9 (e) indemnification in form and amount satisfactory to Landlord and certificates of insurance from all contractors performing labor or furnishing materials, insuring against any and all claims, costs, damages, liabilities and expenses which may arise in connection with the alterations or additions. Whether the Tenant furnishes the Landlord with the foregoing or not, the Tenant hereby agrees to hold the Landlord, its beneficiaries, Owner and Owner's partners and their respective agents and employees harmless from any and all liabilities of every kind and description which may arise out of or be connected in any way with said alterations or additions. Any mechanic's lien filed against the demised premises, or the Building of which the same form a part, for work claimed to have been furnished to the Tenant shall be discharged of record by the Tenant within ten (10) days thereafter, at the Tenant's expense. Upon completing any alterations or additions, the Tenant shall furnish the Landlord with contractors' affidavits and full and final waivers of lien and receipted bills covering all labor and materials expended and used. All alterations and additions shall comply with all insurance requirements and with all ordinances and regulations of any pertinent governmental authority. All alterations and additions shall be constructed in a good and workmanlike manner and good grades of materials shall be used. All additions, decorations, fixtures, hardware, non-trade fixtures and all improvements, temporary or permanent, in or upon the demised premises, whether placed there by the Tenant or by the Landlord, shall, unless the Landlord requests their removal, become the Landlord's property and shall remain upon the demised premises at the termination of the Lease by lapse of time or otherwise without compensation or allowance or credit to the Tenant. If, upon the Landlord's request, the Tenant does not remove said additions, decorations, fixtures, hardware, non-trade fixtures and improvements, the Landlord may remove the same and the Tenant shall pay the cost of such removal to the Landlord upon demand. 10. ACCESS TO PREMISES. The Tenant shall permit the Landlord to erect, use and maintain pipes, ducts, wiring and conduits in and through the demised premises. The Landlord or Landlord's agents shall have the right to enter upon the premises, to inspect the same, to perform janitorial and cleaning services and to make such decorations, repairs, alterations, improvements or additions to the premises or the Building as the Landlord may deem necessary or desirable, and the Landlord shall be allowed to take all material into and upon said demised premises that may be required therefore without the same constituting an eviction of the Tenant in whole or in part and the rent reserved shall in no wise abate (except as provided in Section 10) while said decorations, repairs, alterations, improvements, or additions are being made, by reason of loss or interruption of business of the Tenant, or otherwise. If the Tenant shall not be personally present to open and permit an entry into said demised premises, at any time, when for any reason an entry therein shall be necessary and permissible, the Landlord or Landlord's agents may enter the same by a master key, or may forcibly enter the same, without rendering the Landlord or such agents liable therefor (if during such entry Landlord or Landlord's agents shall accord reasonable care to Tenant's property), and without in any manner affecting the obligations and covenants of this Lease. Nothing herein contained, however, shall be deemed or construed to impose upon the Landlord any obligations, responsibility or liability whatsoever, for the care, supervision or repair of the Building 7 10 or any part thereof, other than as herein provided. The Landlord shall also have the right, at any time, without the same constituting an actual or constructive eviction and without incurring any liability to the Tenant therefor, to change the arrangement and/or location of entrances or passageways, doors and doorways, and corridors, elevators, stairs, toilets or public parts of the Building, and to close entrances, doors, corridors, elevators or other facilities. The landlord shall not be liable to the Tenant for any expense, injury, loss or damage resulting from work done in or upon, or the use of, any adjacent or nearby building, land, street or alley. 11. UNTENANTABILITY. If the demised premises or the Building are made untenantable by fire or other casualty, Landlord may elect: (a) to terminate this Lease as of the date of the fire or casualty by notice to the Tenant within sixty (60) days after that date, or (b) to proceed with all due diligence to repair, restore or rehabilitate the Building or the demised premises at Landlord's expense, in which latter event this Lease shall not terminate. In the event the Lease is not terminated pursuant to this provision, rent shall abate on a per diem basis during the period of untenantability. In the event of termination of this Lease pursuant to this section, rent shall be apportioned on a per diem basis and paid to the date of the fire or casualty. In the event that the demised premises are partially damaged by fire or other casualty but are not made wholly untenantable, then Landlord shall, except during the last year of the term hereof, proceed with all due diligence to repair and restore the demised premises and the rent shall abate in proportion to the non-usability of the demised premises during the period of untenantability. If a portion of the demised premises are made untenantable as aforesaid during the last year of the term hereof, Landlord shall have the right to terminate this Lease as of the date of the fire or other casualty by giving written notice thereof to Tenant within thirty (30) days after the date of fire or other casualty, in which event the rent shall be apportioned on a per diem basis and paid to the date of such fire or other casualty. 12. SUBROGATION. Landlord and Tenant agree to use good faith efforts to have any and all fire, extended coverage, or any and all material damage insurance which may be carried endorsed with the following subrogation clause: "This insurance shall not be invalidated should the insured waive in writing, prior to a loss, any or all right of recovery against any party for loss occurring to the property described herein". Both Landlord and Tenant hereto hereby waive all claims for recovery against the other for damage, injury to, or loss of any of the property of either Landlord or Tenant, insured under valid and collectible insurance policies to the extent of any recovery collectible under that insurance. This waiver is subject to the limitation that it shall apply only when it is permitted or, by the use of such good faith efforts could have been so permitted by the applicable policies of insurance, of both Landlord and Tenant. 13. EMINENT DOMAIN. If the Building, or a substantial part of the demised premises shall be lawfully taken or condemned for any public or quasi-public use or purpose, or 8 11 conveyed under threat of such condemnation, the term of this Lease shall end upon, and not before, the date of the taking of possession by the condemning authority, and without apportionment of the award. Tenant hereby assigns to the Landlord Tenant's interest in such award, if any. Current rent shall be apportioned as of the date of such termination. If any part of the Building, other than the demised premises or any part of the building not constituting a substantial part of the demised premises, shall be so taken or condemned, or if the grade of any street or alley adjacent to the Building is changed by any competent authority and such taking or change of grade makes it necessary or desirable to substantially remodel or restore the Building, the Landlord shall have the right to cancel this lease upon not less than ninety (90) days prior notice to the date of cancellation designated in the notice. No money or other consideration shall be payable by the Landlord to the Tenant for the right of cancellation, and the Tenant shall have no right to share in the condemnation award or in any judgement for damages caused by the change of grade. 14. ASSIGNMENT - SUBLETTING. Tenant shall not, without Landlord's prior written consent: (a) Assign, hypothecate, mortgage, encumber, or convey this Lease or any interest under it; (b) Allow any transfer thereof or any lien upon Tenant's interest by operation of law. Tenant covenants not to sublet to demised premises in whole or in part without the prior written consent of Landlord. Landlord hereby grants its consent to subletting of the whole of the demised premises under the following conditions, and each of them, and no other subletting, in whole or in part shall be made without Landlord's prior written consent, as aforesaid, namely: (a) Prior to making any sublease, Tenant shall first notify Landlord in writing of its election in that regard and submit to Landlord a fully executed copy of said Sublease. Any time within sixty (60) days after service of said notice and copy of said sublease, Landlord may notify Tenant that it elects to cancel and terminate this lease and enter into a new lease with the proposed subtenant. If said notice is served by Landlord, then this Lease shall terminate and come to an end on a day thirty (30) days following the date of service of said Landlord's notice as if said date were herein originally set forth as the expiration date of the term providing that said new lease is executed by and between the proposed subtenant and Landlord. If Landlord shall not serve said notice, then Tenant may sublet the demised premises at any time after the expiration of said initial sixty (60) day period; (b) The use for which the Premises may be sublet shall be only for lawful office use in keeping with the general character of the Building and which is not extra-hazardous on account of fire; (c) Unless new lease is executed by and between the proposed subtenant and Landlord, the granting of such right and any assignment or subletting shall not release Tenant of liability under this lease or permit any subsequent prohibited act, unless specifically provided in such consent; 9 12 Any document purporting to sublet the demised premises shall not have any force or effect unless the same shall bear the consent of Landlord. 15. WAIVER OF CLAIMS AND INDEMNITY. To the extent permitted by law, the Tenant releases the Landlord, its beneficiaries, Owner and Owner's partners and their respective agents and servants from, and waives all claims for, damage to person or property sustained by the Tenant or any occupant of the Building or premises resulting from the Building or premises or any part of either or any equipment or appurtenant becoming out of repair, or resulting from any accident in or about the Building, or resulting directly or indirectly from any act or neglect of any tenant or occupant of the Building or of any other person, including Landlord's agents and servants. This Section 14 shall apply especially, but not exclusively, to the flooding of basements or other subsurface areas, and to damage caused by refrigerators, sprinkling devices, air-conditioning apparatus, water, snow, frost, steam, excessive heat or cold, falling plaster, broken glass, sewage, gas, odors or noise, or the bursting or leaking of pipes or plumbing fixtures, and shall apply equally whether any damage results from the act or neglect of the Landlord or of other tenants, occupants or servants in the Building or of any other person, and whether such damage be caused or result from any thing or circumstance above mentioned or referred to, or any other thing or circumstance whether of a like nature or of a wholly different nature. If any such damage, whether to the demised premises or to the Building or any part thereof, or whether to the Landlord or to other tenants in the Building, results from any act or neglect of the Tenant, its employees, agents, invitees and customers, the Tenant shall be liable therefor and the Landlord may, at the Landlord's option, repair such damage and the Tenant shall, upon demand by the Landlord, reimburse the Landlord forthwith for the total cost of such repairs. The Tenant shall not be liable for any damage caused by its act or neglect if the Landlord or a tenant has recovered the full amount of damage from insurance and the insurance company has waived its right of subrogation against the Tenant. All property belonging to the Tenant or any occupant of the premise that is in the Building or the premises shall be there at the risk of the Tenant or other person only, and the Landlord shall not be liable for damage thereto or theft or misappropriation thereof Tenant agrees to indemnify and save the Landlord, its beneficiaries, Owner and Owner's partners and their respective agents and employees harmless against any and all claims, demands, costs and expenses, including reasonable attorney's fees for the defense thereof, arising from Tenant's occupation of the demised premises or from any breach or default on the part of Tenant in the performance of any covenant or agreement on the part of Tenant to be performed pursuant to the terms of this Lease, or from any act or negligence of Tenant, its agents, servants, employees or invitees, in or about the demised premises. In case of any action or proceeding brought against Landlord, its beneficiaries, Owner and Owner's partners or their respective agents or employees by reason of any such claim, upon notice from Landlord, Tenant covenants to defend such action or proceeding by counsel reasonably satisfactory to Landlord. 16. MORTGAGE - GROUND LEASE. Landlord may execute and deliver a mortgage or trust deed in the nature of a mortgage, both sometimes hereinafter referred to as "Mortgage" against the Building, the Real Property or any interest thereon, and may sell and lease back the underlying land on which the Building is situated. This lease and the rights of Tenant 10 13 hereunder shall be and are hereby made expressly subject and subordinate at all times to any such Mortgage and/or ground lease, now or hereafter, existing and all amendments, modifications and renewals thereof and extensions, consolidations or replacements thereof, and to all advance made or hereafter to be made upon the security thereof. Tenant agrees to execute and deliver such further instruments subordinating this Lease to said Mortgage or ground lease as may be requested in writing by Landlord from time to time. Tenant hereby appoints Landlord as attorney-in-fact for Tenant with full power and authority to execute and deliver in the name of the Tenant any such instrument in the event Tenant fails to do so. Should any Mortgage affecting the Building or the Real Property be foreclosed or if any ground or underlying lease be terminated: (a) The liability of the mortgage, trustee or purchaser at such foreclosure sale or the liability of a subsequent owner designated as Landlord under this Lease shall exist only so long as such trustee, mortgagee, purchaser or owner is the owner of the Building or Real Property and such liability shall not continue or survive after further transfer of ownership. (b) Upon request of the mortgagee or trustee, Tenant will attorn, as Tenant under this Lease, to the purchaser at any foreclosure sale thereunder, or if any ground or underlying lease be terminated for any reason, Tenant will attorn as tenant under this Lease to the ground Lessor under the ground lease and will execute such instruments as may be necessary or appropriate to evidence such attornment. 17. CERTAIN RIGHTS RESERVED TO THE LANDLORD. The Landlord reserves and may exercise the following rights without affecting Tenant's obligations hereunder: (a) to change the name or street address of the Building; (b) to install and maintain a sign or signs on the interior or exterior of the Building; (c) to have access for the Landlord and the other tenants of the Building to any mail chutes located on the demised premises according to the rules of the United States Post Office; (d) to designate all sources furnishing sign painting and lettering, ice, drinking water, towels, coffee cart service and toilet supplies, lamps and bulbs used on the demised premises; (e) to decorate, remodel, repair, alter or otherwise prepare the demised premises for reoccupancy if Tenant vacates the demised premises prior to the expiration of the term; (f) to retain at all times pass keys to the demised premises; (g) to grant to anyone the exclusive right to conduct any particular business or undertaking in the Building; 11 14 (h) to exhibit the demised premises to others and to display "For Rent" signs on the demised premises; (i) to approve the weight, size and location of safes and other heavy equipment or articles, which articles may be moved in, about, or out of the Building or premises only at such times and in such manner as Landlord shall direct and in all events, however, at Tenant's sole risk and responsibility; (j) to take any and all measures, including inspections, repairs, alterations, decorations, additions and improvements to the premises or to the Building, as may be necessary or desirable for the safety, protection or preservation of the premises or the Building or the Landlord's interests, or as may be necessary or desirable in the operation of the Building. The Landlord may enter upon the demised premises and may exercise any or all of the foregoing rights hereby reserved without being deemed guilty of an eviction or disturbance of the Tenant's use or possession and without being liable in any manner to the Tenant and without abatement of rent or affecting any of the Tenant's obligations hereunder. 18. HOLDING OVER. If the Tenant retains possession of the demised premises or any part thereof after the termination of the term or any extension thereof, by lapse of time or otherwise, the Tenant shall pay the Landlord the monthly rent, at double the rate payable for the month immediately preceding said holding over (including increases for Expenses and Taxes which Landlord may reasonably estimate), computed on a per-month basis, for each month or part thereof (without reduction for any such partial month) that the Tenant thus remains in possession, and in addition thereto, Tenant shall pay the Landlord all damages, consequential as well as direct, sustained by reason for the Tenant's retention of possession. Alternatively, at the election of Landlord expressed in a written notice to the Tenant and not otherwise, such retention of possession shall constitute a renewal of this Lease for one (1) year. The provisions of this paragraph do not exclude the Landlord's right of re-entry or any other right hereunder. 19. LANDLORD'S REMEDIES. All rights and remedies of the Landlord herein enumerated shall be cumulative, and none shall exclude any other right or remedy allowed by law. (a) If any involuntary action or proceeding under any section or sections of any bankruptcy act in any court or tribunal shall adjudge or declare Tenant insolvent or unable to pay Tenant's debts, or if any voluntary petition or similar proceeding under any section or sections of any bankruptcy act shall be filed by Tenant in any court or tribunal to declare Tenant insolvent or unable to pay Tenant's debts, then and in any such event Landlord may, if Landlord so elects but not otherwise, and with or without notice of such election, and with or without entry or other action by Landlord, forthwith terminate this Lease, and notwithstanding any other provision of this Lease, Landlord shall forthwith upon such termination be entitled to cover damages in an amount equal to the then present value of the rent specified in Section I of this Lease, as adjusted, pursuant to paragraph 2, for the residue of the stated term hereof, less the fair rental value of the premises for the residue of the stated term. 12 15 (b) If the Tenant defaults in the payment of Rent, and the Tenant does not correct the default within five (5) days after demand for payment of such rent or if the Tenant defaults in the prompt and full performance of any other provisions of this Lease; and the Tenant does not cure the default within twenty (20) days after written demand by the Landlord that the default be cured (unless the default involves a hazardous condition, which shall be cured forthwith) or if the leasehold interest of the Tenant be levied upon under execution or be attached by process of law, or if the Tenant makes an assignment for the benefit of creditors or admits its inability to pay its debts, or if a receiver be appointed for any property of the Tenant, or if the Tenant abandons the premises, then and in any such event the Landlord may, if the Landlord so elects but not otherwise, and with or without notice of such election, and with or without any demand whatsoever, either forthwith terminate this Lease and the Tenant's right to possession of the premises, or, without terminating this Lease, forthwith terminate the Tenant's right to possession of the premises. (c) Upon any termination of this Lease, whether by lapse of time or otherwise, or upon any termination of the Tenant's right to possession without termination of the Lease, the Tenant shall surrender possession and vacate the premises immediately, and deliver possession thereof to the Landlord, and hereby grants to the Landlord full and free license to enter into and upon the premises in such event with or without process of law and to repossess the Landlord of the premises as of the Landlord's former estate and to expel or remove the Tenant and any others who may be occupying or be within the premises and to remove any and all property therefrom, using such force as may be necessary, without being deemed in any manner guilty of trespass, eviction or forcible entry or detainer, and without relinquishing the Landlord's rights to rent or any other right given to the Landlord hereunder or by operation of law. (d) If the Tenant vacates or abandons the premises or otherwise entitles the Landlord so to elect, and the Landlord elects to terminate the Tenant's right to possession only, without terminating the Lease, the Landlord may at the Landlord's option, enter into the premises, remove the Tenant's sign and other evidences of tenancy, and take and hold possession thereof as in Paragraph (c) of this Section 18 provided, without such entry and possession terminating the Lease or releasing the Tenant, in whole or in part, from the Tenant's obligation to pay the Rent hereunder for the full term, and in any such case the Tenant shall pay forthwith to the Landlord, if the Landlord so elects, a sum equal to the entire amount of the rent specified in Section 1 of this Lease for the residue of the stated term plus any other sums then due hereunder. Upon and after entry into possession without termination of the lease, the Landlord may, but need not, relet the premises or any part thereof for the account of the Tenant to any person, firm or corporation other than the Tenant for such rent, for such time and upon such terms as the Landlord in the Landlord's sole discretion shall determine, and the Landlord shall not be required to accept any tenant offered by the Tenant or to observe any instructions given by the Tenant about such reletting. In any such case, the Landlord may make repairs, alterations and additions in or to the premises, and redecorate the same to the extent deemed by the Landlord necessary or desirable, and the Tenant shall, upon demand, pay the costs thereof, together with the Landlord's expenses of the reletting. If the consideration collected by the Landlord upon any such reletting for the Tenant's account is not sufficient to pay monthly the full amount of the rent reserved in this Lease, together with the costs of repairs, alterations, additions, redecorating and the Landlord's expenses, the Tenant shall pay to the Landlord the amount of each monthly deficiency upon demand. 13 16 (e) Any and all property which may be removed from the premises by the Landlord pursuant to the authority of the Lease or of law, to which the Tenant is or may be entitled, may be handled, removed or stored by the Landlord at the risk, cost and expense of the Tenant, and the Landlord shall in no event be responsible for the value, preservation or safekeeping thereof. The Tenant shall pay to the Landlord, upon demand, any and all expenses incurred in such removal and all storage charges against such property so long as the same shall be in the Landlord's possession or under the Landlord's control. Any such property of the Tenant not retaken from storage by the Tenant within thirty (30) days after the end of the term, however terminated, shall be conclusively presumed to have been conveyed by the Tenant to the Landlord under this Lease as a bill of sale without further payment or credit by the Landlord to the Tenant. (f) Tenant hereby grants to Landlord a first lien upon the interest of Tenant under this Lease to secure the payment of moneys due under this Lease, which lien may be enforced in equity; and Landlord shall be entitled as a matter of right to have a receiver appointed to take possession of the demised premises and relet the same under order of court. (g) The Tenant shall pay upon demand all the Landlord's costs, charges and expenses, including fees of counsel, agents and others retained by the Landlord, incurred in enforcing the Tenant's obligations hereunder or incurred by the Landlord in any litigation, negotiation or transaction in which the Tenant causes the Landlord, without the Landlord's fault, to become involved or concerned. 20. DEFAULT UNDER OTHER LEASE. If the term of any lease, other than this lease, made by the Tenant for any demised premises in the Building shall be terminated or terminable after the making of this Lease because of any default by the Tenant under such other lease, such fact shall empower the Landlord, at the Landlord's sole option, to terminate this Lease by notice to the Tenant. 21. SURRENDER OF POSSESSION. Upon the expiration or other termination of the term of this Lease, Tenant shall quit and surrender to Landlord the Premises, broom clean, in good order and condition, ordinary wear, casualty and condemnation and hazardous substances not caused by Tenant excepted, and Tenant shall remove all of its property including all wires and cables installed in premises by Tenant, with the exception of wires and cables installed for telephone service. If the Tenant does not remove its property of every kind and description from demised premises prior to the end of the term, however ended, the Tenant shall be conclusively presumed to have conveyed the same to the Landlord under this Lease as a bill of sale without further payment or credit by the Landlord to the Tenant and the Landlord may remove the same and the Tenant shall pay the cost of such removal to the Landlord upon demand. Tenant's obligation to observe or perform this covenant shall survive the expiration or other termination of the term of this lease. 14 17 22. NOTICES. Notices shall be in writing. (a) Notices shall be effectively served by Landlord upon Tenant in any one of the following manners. (i) By delivery to Tenant, or representative of Tenant; or (ii) By forwarding through Certified or Registered Mail, postage prepaid, to Tenant at the premises, in which case the time of mailing shall be the time of notice; or (iii) By leaving a copy at the premises; or (iv) By affixing a copy to any door leading into the demised premises. (b) Notices shall be effectively served by Tenant upon Landlord when addressed to Landlord and served either: (i) Upon an officer of Landlord; or (ii) Upon an authorized person in the office of the Building; or (iii) By forwarding through Certified Mail or Registered Mail, postage prepaid, to Landlord at Building or if notified of another address by Landlord, at such latter address. 23. SECURITY DEPOSIT. Tenant agrees to deposit with Landlord, upon the execution of this Lease, the sum of $3,800.00 as security for the full and faithful performance by Tenant of each and every term, provision, covenant, and condition of this Lease. If Tenant defaults in respect to any of the terms, provisions, covenants and conditions of this Lease including, but not limited to, payment of the Rent and additional rent, Landlord may use, apply, or retain the whole or any part of the security so deposited for the payment of any such rent in default, or for any other sum which the Landlord may expend or be required to expend by reason of Tenant's default including, without limitation, any damages or deficiency in the reletting of the demised premises, whether such damages or deficiency shall have accrued before or after any re-entry by Landlord. If any of the security shall be so used, applied or retained by Landlord at any time or from time to time, Tenant shall promptly, in each such instance, on written demand therefor by Landlord, pay to the Landlord such additional sum as may be necessary to restore the security to the original amount set forth in the first sentence of this paragraph. If Tenant shall fully and faithfully comply with all the terms, provisions, covenants, and conditions of this Lease, the security deposit, or any balance thereof, shall be returned to Tenant after the following: (a) the time fixed as the expiration of the term of this Lease; (b) the removal of tenant from the demised premises; 15 18 (c) the surrender of the demised premises by Tenant to Landlord in accordance with this Lease; and (d) the time required for the escalation charges due pursuant to the Lease to have been computed by Landlord and paid by Tenant. Except as otherwise required by law, Tenant shall not be entitled to any interest on the aforesaid security. In the absence of evidence satisfactory to Landlord of an assignment of the right to receive the security or the remaining balance thereof, Landlord may return the security to the original Tenant, regardless of one or more assignments of this Lease. 24. MISCELLANEOUS. (a) No receipt of money by the Landlord from the Tenant after the termination of this Lease or after the service of any notice or after the commencement of any suit, or after final judgement for possession of the demised premises shall reinstate, continue or extend the term of this Lease or affect any such notice, demand or suit. (b) No waiver or any default of the Tenant hereunder shall be implied from any omission by the Landlord to take any action on account of such default if such default persists or be repeated, and no express waiver shall affect any default other than the default specified in the express waiver and that only for the time and to the extent therein stated. (c) The words "Landlord" and "Tenant" wherever used in this Lease shall be construed to mean plural where necessary, and the necessary grammatical changes required to make the provisions hereof apply either to corporations or individuals, men or women, shall in all cases be assumed as though in each case fully expressed. (d) Each provision hereof shall extend to and shall, as the case may require, bind and inure to the benefit of the Landlord and the Tenant and their respective heirs, legal representatives, successors and assigns in the event this Lease has been assigned with the express written consent of the Landlord. (e) Submission of this instrument for examination does not constitute a reservation of or option for the premises. The instrument does not become effective as a lease or otherwise until executed and delivered by both Landlord and Tenant. (f) All amounts (unless otherwise provided herein, and other than the Rent, which shall be due as hereinbefore provided) owed by the Tenant to the Landlord hereunder shall be deemed additional rent and be paid within five (5) days after the date the Landlord renders statements of account therefor. In regard to Rent, Tenant agrees to pay a late charge of 5.0% of the amount of Rent then due if Rent is not paid within five days of the date due hereunder. Such late charges shall be in addition to Landlord's other rights upon default by Tenant. Whenever rent is referred to in this Lease, it shall include Rent. 16 19 (g) All riders attached to this Lease and initialed by the Landlord and the Tenant are hereby made a part of this Lease as though inserted in this Lease. (h) The headings of sections are for convenience only and do not limit or construe the contents of the sections. (i) If the Tenant shall occupy the premises prior to the beginning of the term of this Lease with the Landlord's consent, all the provisions of this Lease shall be in full force and effect as soon as the Tenant occupies the premises. (j) Should any mortgage, leasehold or otherwise, require a modification or modifications of this Lease, which modification or modifications will not bring about any increased cost or expense to Tenant or in any other way substantially change the rights and obligations of Tenant hereunder, then and in such event, Tenant agrees that this Lease may be modified. (k) The Tenant represents at the Tenant has dealt directly with and only with McWilliams & Associates, Inc. and Cornish and Cary Commerical as broker in connection with this Lease and that insofar as the Tenant knows no other broker negotiated this Lease or is entitled to any commission in connection therewith. Tenant indemnifies and holds Landlord, its beneficiaries, Owner and Owner's partners and their respective agents and employees harmless from all claims of any broker or any other brokers in connection with this Lease. (1) The Tenant agrees that from time to time upon not less than ten (1O) days prior to request by the Landlord, the Tenant will deliver to the Landlord a statement in writing certifying (a) that this Lease is unmodified and in full force and effect (or if there have been modifications that the same is in full force and effect as modified and identifying the modifications), (b) the dates to which the rent and other charges have been paid, and (c) that so far as the person making the certificate knows, the Landlord is not in default under any provision of this Lease. (m) The Landlord's or Owner's title is and always shall be paramount to the title of the Tenant, and nothing herein contained shall empower the Tenant to do any act which can, shall or may encumber such title. (n) The laws of the State in which the demised premises are located shall govern the validity, performance and enforcement of this Lease. (o) If any term, covenant or condition of this Lease or the application thereof to any person or circumstance shall, to any extent, be invalid or unenforceable, the remainder of this Lease, or the application of such term, covenant or condition to persons or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby and each term, covenant or condition of this Lease shall be valid and be enforced to the fullest extent permitted by law. (p) The term "Owner," as used in this Lease, means the Partnership, if any, which owns title to the Real Property and any liability or obligation of said partnership under this Lease shall be 17 20 limited to its partnership assets and no partner of said partnership shall be individually or personally liable for any claim arising out of this Lease. A deficit capital account of any such partner shall not be deemed an asset or property of said partnership. (q) If Landlord is a bank as trustee, this Lease is executed by the undersigned trustee, not personally but solely as trustee and it is expressly understood and agreed by the parties hereto, anything contained herein to the contrary notwithstanding, that each and all of the covenants, undertakings, representations and agreements herein made are intended, not as personal covenants, undertakings, representations and agreements of the trustee, individually or for the purpose of binding it personally, but this Lease is executed and delivered by the trustee, solely in the exercise of powers conferred upon it as such trustee under said trust agreement and no personal liability or personal responsibility is assumed by, nor shall at any time be asserted or enforced against said bank on account hereof, or on account of any covenant, undertaking, representation, warranty or agreement herein contained, either expressed or implied, all such personal liability, if any, being hereby expressly waived and released by the parties hereto or holder hereof, and by all persons claiming by or under said parties or holder hereof. Such trustee, hereby confirms that its beneficiary has the authority to manage the Building and has designated McWilliams & Associates, Inc. as Agent for the Beneficiary in connection with the management of the Building. IN WITNESS WHEREOF, the parties hereto have executed this Lease the date first above written. LANDLORD: 1300 Iroquois Venture, an Illinois Limited Partnership By O'Brien Development Company Its General Partner By: /s/ WALTER J. O'BRIEN ---------------------------------------- Walter J. O'Brien II Its President TENANT: Pete's Brewing Company By: /s/ [SIG] ---------------------------------------- Its CEO ---------------------------------------- 18 21 FIRST ADDENDUM TO LEASE THIS FIRST ADDENDUM TO LEASE (this "Addendum") is made by and between 1300 Iroquois Venture, an Illinois Limited Partnership Company ("Landlord"), and Pete's Brewing Company, a California corporation ("Tenant"), to be a part of that certain Lease of even date herewith between Landlord and Tenant (the "Lease") concerning approximately 1421 rentable square feet of space, located at 1300 Iroquois Drive (the "Building"), Suite 245, Naperville, Illinois (the "Premises"). Landlord and Tenant agree that, notwithstanding anything to the contrary in the Lease, the Lease is hereby modified and supplemented as set forth below. 1. FAILURE TO GIVE POSSESSION. If Landlord shall be unable to give possession of the Premises for any reason whatsoever on or before sixty days after the issuance of the building permit, then, Tenant may terminate the Lease by written notice to Landlord, whereupon any monies previously paid by Tenant to Landlord shall be reimbursed to Tenant. 2. TENANT IMPROVEMENTS. The improvements set forth in Section 4 of the Lease and Exhibit A shall be constructed in accordance with all applicable laws, in a good and workmanlike manner, free of defects and using new materials and equipment of good quality. Tenant shall have the right to submit a written "punch list" to Landlord, setting forth any defective item of construction, and Landlord shall promptly cause such items to be corrected. Tenant's acceptance of the Premises or submission of a "punch list" shall not be deemed a waiver of Tenant's right to have defects in the improvements or the Premises repaired at no cost to Tenant. 3. ORDINANCES AND STATUTES. Tenant shall not be required to comply with or cause the Premises to comply with any laws, rules or regulations requiring alterations or improvements to the Premises unless the compliance with any of the foregoing is necessitated solely due to Tenant's particular use of the Premises. 4. WAIVER OF CLAIMS AND INDEMNITY. Landlord shall not be released or indemnified from any losses, damages, liabilities, judgments, actions, claims, attorneys' fees, consultants' fees, payments, costs and expenses arising from the negligence or willful misconduct of Landlord or its agents, contractors, licensees or invitees, Landlord's violation of any law, order or regulation, or a breach of Landlord's obligations or representations under the Lease. 5. WAIVER OF SUBROGATION. Notwithstanding anything to the contrary in the Lease or this Addendum, the parties hereto release each other and their respective agents, employees, successors, assignees and subtenants from all liability for damage to any property that is caused by or results from a risk which is actually insured against, which is required to be insured against under this Lease, or which would normally be covered by all risk property insurance, without regard to the negligence or willful misconduct of the entity so released. Each party shall use its best efforts to cause each insurance policy it obtains to provide that the insurer thereunder waives all right of recovery by way of subrogation as required herein in connection with any injury or damage covered by the policy. If such insurance policy cannot be obtained with such waiver of subrogation, or if such waiver of subrogation is only available at additional cost and the party for 22 whose benefit the waiver is not obtained does not pay such additional cost, then the party obtaining such insurance shall immediately notify the other party of that fact. 6. REPAIRS AND MAINTENANCE. Subject to the provisions of Section 8 of the Lease, Landlord shall perform and construct, and Tenant shall have no responsibility to perform or construct, any repair, maintenance or improvements (a) required as a consequence of any violation of any laws or construction defects in the Premises or the Building as of the Commencement Date, (b) for which Landlord has a right of reimbursement from others, (c) which could be treated as a "capital expenditure" related to the Building as a whole under generally accepted accounting principles, and (f) to any portion of the Building outside of the demising walls of the Premises. 7. UNTENANTABILITY. If the Premises are condemned or damaged by any peril and Landlord does not elect to terminate the Lease or is not entitled to terminate the Lease pursuant to its terms, then Tenant shall have the option to terminate the Lease if the Premises cannot be, or are not in fact, fully restored by Landlord to their prior condition within ninety (90) days after the condemnation or damage. Landlord shall not have the right to terminate the Lease if the damage to the Building is relatively minor (e.g., repair or restoration would cost less than ten percent (10%) of the replacement cost of the Building). 8. ASSIGNMENT AND SUBLETTING. Tenant may, without Landlord's prior written consent, sublet the Premises or assign the Lease to (a) a subsidiary, affiliate, division or corporation controlling, controlled by or under common control with Tenant, (b) a successor corporation related to Tenant by merger, consolidation, nonbankruptcy reorganization, or government action, or (c) a purchaser of substantially all of Tenant's assets located in the Premises. A sale or transfer of Tenant's capital stock shall not be deemed an assignment, subletting or any other transfer of the Lease or the Premises. 9. EFFECT OF ADDENDUM. All terms with initial capital letters used herein as defined terms shall have the meanings ascribed to them in the Lease unless specifically defined herein. In the event of any inconsistency between this Addendum and the Lease, the terms of this Addendum shall prevail. In Witness Whereof, said parties hereunto subscribe their names. LANDLORD: TENANT: 1300 IROQUOIS VENTURE, PETE'S BREWING COMPANY, an Illinois Limited Partnership a California Corporation By O'Brien Development Company, Its General Partner By /s/ WALTER J. O'BRIEN II By: /s/ JEFFREY A. ATKINS ----------------------------- -------------------------------- Walter J, O'Brien II Name: Jeffrey A. Atkins Its President -------------------------- Its: CEO --------------------------- 2 23 EXHIBIT "A" TO LEASE BETWEEN 1300 IROQUOIS VENTURE (LANDLORD) AND PETE'S BREWING COMPANY (TENANT) DATED SEPT. 29, 1997 [FLOORPLAN DIAGRAM] EX-10.15 4 LEASE BETWEEN REGISTRANT AND ROTTERDAM VENTURES 1 EXHIBIT 10.15 LEASE dated as of September __, 1997 between ROTTERDAM VENTURES, INC. D/B/A GALESI ENTERPRISES as Lessor and PETE'S BREWING COMPANY as Lessee Affecting a portion of the premises commonly known 145 Huguenot Street New Rochelle, New York 2 TABLE OF CONTENTS
PARAGRAPH & TITLE PAGE ---- 1. TERM .................................................................... 4 1A. OPTION TO RENEW ......................................................... 4 2. RENTAL SCHEDULE ......................................................... 5 3. USE OF PREMISES ......................................................... 5 4. TAXES & ASSESSMENTS-UTILITY CHARGES & OPERATING SERVICES................. 6 5. ELECTRICAL SYSTEM & SERVICE ............................................. 9 6. HEATING, VENTILATING & AIR CONDITIONING SYSTEM & SERVICE................ 10 7. INSURANCE - INDEMNITY ...................................................11 8. PREPARATION OF THE LEASED PREMISES ......................................13 9. OTHER LEASEHOLD IMPROVEMENTS BY LESSEE ..................................13 10. OCCUPANCY/COMMENCEMENT DATE .............................................15 11. MAINTENANCE AND REPAIRS .................................................15 12. CLEANING/JANITORIAL SERVICES ............................................17 13. DAMAGE TO OR DESTRUCTION OF LEASED PREMISES .............................17 14. ACTION OF PUBLIC AUTHORITIES ............................................17 15. DEFAULT .................................................................18 16. ACCELERATION OF RENT UPON DEFAULT .......................................18 17. SUBORDINATION ...........................................................19 18. SUBLETTING AND ASSIGNMENT ...............................................19 19. RECORDATION .............................................................20 20. SURRENDERS AND WAIVERS ..................................................20 21. NOTICE ..................................................................21 22. BROKERAGE ...............................................................22 23. ENTIRE AGGEEMENT ........................................................22
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PARAGRAPH & TITLE PAGE ---- 24. CHANGES, MODIFICATIONS OR AMENDMENTS ................................... 22 25. SEVERABILITY ........................................................... 22 26. COVENANTS TO BIND RESPECTIVE PARTIES ................................... 22 27. BUILDING NAME .......................................................... 22 28. CERTIFICATE ............................................................ 22 29. LESSEE'S REPRESENTATIONS ............................................... 22 30. LESSEE'S REMEDIES ...................................................... 23 31. SECURITY ............................................................... 23 32. GOVERNING LAW .......................................................... 23 EXHIBIT A - RENTAL SCHEDULE ............................................ 26 EXHIBIT B - DRAWING .................................................... 27 EXHIBIT C - WORK LETTER ................................................ 28 EXHIBIT D - RULES AND REGULATIONS ...................................... 29 EXHIBIT E - CLEANING/JANITORIAL SPECIFICATIONS ......................... 31
3 4 LEASE AGREEMENT THIS LEASE AGREEMENT, made this day of September, 1997 between ROTTERDAM VENTURES, INC. D/B/A/ GALESI ENTERPRISES, having a place of business at 145 Huguenot Street, New Rochelle, New York 10801 (Lessor) and PETE'S BREWING COMPANY, a California corporation having its principal office at 514 High Street, Palo Alto, California 94301 (Lessee). W I T N E S S E T H WHEREAS, Lessor is the owner of that certain tract of land with building and improvements thereon erected commonly known as 145 Huguenot Street (hereinafter referred to as the "Premises") New Rochelle, New York; and WHEREAS, Lessee desires to rent a portion of the Premises for the conduct-of its business; NOW THEREFORE, in consideration of the payment by Lessee of the rent hereinafter reserved and the mutual performance of the covenants and conditions hereinafter set forth, Lessor does hereby let and demise unto Lessee and Lessee does hereby take and hire from Lessor, a certain portion of the Lessor's premises (hereinafter referred to as the "Leased Premises"), located on the first floor of the Premises, Suite 101, comprising approximately 1,320 square feet of rentable space as more particularly described on Exhibit B attached hereto and made a part hereof. Lessor shall perform the construction required for the Leased Premises as set forth in Exhibit C. 1. TERM: This Lease Agreement is for a term of three (3) years, commencing on the later of September 1, 1997 or the date by which the Leased Premises are outfitted and ready for occupancy by Lessee (as defined in Paragraph 10 thereof) (the "Commencement Date") and expiring on August 31, 2000 unless renewed or shall end on such earlier date or be canceled or terminated pursuant to the provisions of this Lease Agreement or pursuant to law (the "Lease Term"). If the Commencement Date has not occurred for any reason whatsoever not related to the acts or omissions of Lessee, or any of its employees, contractors, agents or representatives, on or before December 1, 1997, then, in addition to Lessee's other rights or remedies, Lessee may terminate this Lease Agreement by written notice to Lessor given on or before December 10, 1997, whereupon any monies previously paid by Lessee to Lessor shall be reimbursed to Lessee. 1A. OPTION TO RENEW Lessee shall have the option to renew this Lease Agreement for three (3) years upon one hundred twenty (120) days prior written notice to Lessor provided that Lessee is not in default (beyond any applicable cure periods), under this Lease Agreement. During the renewal period all terms and conditions of this Lease Agreement shall remain in full force and effect except that the fixed rent shall be $23,760.00 per annum payable in equal monthly installments of $1,980.00. 4 5 2. RENTAL SCHEDULE: A) The fixed rental for the Leased Premises is $21,120.00 per annum, payable in monthly installments, on the first day of each calendar month in increments of $1,760.00, for years one, two and three ; (the "Fixed Rent") all based on there being 1,320 square feet in the Leased Premises and subject to correction if there are fewer or greater square feet in the Leased Premises. These rates do not include electric, or air conditioning. The Lessee shall pay a late charge of two (2%) percent per month in the event any rental payment is made more than five (5) days after the first day of each month, of any installment of rental (Fixed minimum, or other as may be construed as rent) if said rental payment is made after its due date (the "Late Charge"). B) The rentable area set forth above has been determined from the plans of the Leased Premises, If Lessee should expand its area of actual occupancy such that there should be any variance between said plans and the actual rentable area occupied by Lessee, then promptly upon notice by Lessor to Lessee of such variance, the parties shall enter into a recordable agreement to reflect such change and the Fixed Rent shall be adjusted in accordance therewith. C) The Lessor reserves the sole right upon ninety (90) days notice, to relocate the Lessee to other space in the Premises, which space shall be comparable in size, location and configuration to the presently Leased Premises and the decor of the "New" Premises shall be at least equal to or superior to the presently Leased Premises under this Lease Agreement. This request shall be in writing and does not require Lessee's written approval. All relocation costs, moving costs, remodeling, etc., shall be borne by the Lessor and all terms and covenants of this Lease Agreement shall remain unchanged and in full effect except as noted below. Lessor agrees to relocate Lessee after 5:00 p.m. on Friday and have Lessee open for business by 9:00 a.m. on Monday. Depending upon the term of the Lease Agreement, the parties reserve the right with mutual assent to enter renegotiation discussions regarding the Lease Term of the Lease Agreement. D) The monthly fixed rental payments shall be paid in advance, without notice, on or before the first day of each calendar month following the Commencement Date and each month thereafter during the term of this Lease Agreement or any renewal thereof Lessee covenants that the Fixed Rent shall be paid promptly to Lessor, at Lessee's option by mail or in person either at the offices of Lessor at 145 Huguenot Street, New Rochelle, New York or to such other person or at such other place as Lessor may designate, in lawful money of the United States, without notice, demand or abatement (except an abatement expressly provided for in this Lease Agreement) and without any setoff or deduction whatsoever. Lessee further covenants that any Additional Rent (as hereinafter defined) hereinafter provided for shall be paid to Lessor in the same manner and subject to the same conditions, covenants and requirements as provided for the payment of the Fixed Rent, on or before the first day of the first calendar month or within ten (10) day grace period following demand therefor (unless otherwise specifically provided in this Lease Agreement). 3 USE OF PREMISES: Lessee will use and occupy the Leased Premises as executive, office, conference center and general office activities for its lawful business purposes. Lessee will comply with any and all laws, ordinances rules, orders and regulations of any governmental authority which are applicable to the conduct of Lessee's business on the Leased Premises. 5 6 The parties agree not to hinder the operational activities of either party within such common areas as the Plaza entrance and Lobby, elevators, fire access lanes, driveways, turn-around areas, parking, loading, unloading and shall mutually observe the restricted areas of either party or other tenants on the Premises. Notwithstanding the foregoing, Lessee shall not be required to comply with or cause the Leased Premises to comply with any laws, rules or regulations requiring alterations or improvements to the Leased Premises unless the compliance with any of the foregoing is necessitated solely due to Lessee's particular use of the Leased Premises. 4. TAXES & ASSESSMENT - UTILITY CHARGES & OPERATING SERVICES: A) During the term of this Lease Agreement Lessee shall pay as Additional Rent (as hereinafter defined) its pro rata share of any real estate tax ("Tax") which is in excess of the real estate tax imposed or assessed on the same for the base tax year ("Additional Rent"). The base tax year shall be calendar year 1998. 1) Lessee's share of any increased Tax shall be due and payable thirty (30) days after presentation of appropriate Tax statements showing that such Tax is due and substantiating Tax receipts by Lessor. 2) The Lessee's proportionate share of any Tax increase shall be .48%. In the event that the amount of space rented by Lessee shall increase or decrease, the share of Tax paid by Lessee shall be proportionately increased or decreased. 3) The terms "Tax" or "Taxes" shall mean the total of all real estate taxes and special assessments levied or imposed against the Premises, together with any franchise, income, profit or other tax, however designated, which is, due to a future change in the method of taxation, substituted in full or in part for or in lieu of such real estate tax but not including interest or penalties, including but not limited to any new tax of a nature not presently in effect but which may be hereinafter levied, assessed or imposed on the Lessor, or the Premises, if such Tax shall be based or arise out of the ownership, use or operation of the premises. Under no circumstances, however, shall "Tax" or "Taxes" include income tax or franchise tax due in respect of Lessor's business. 4) Notwithstanding anything herein to the contrary, if any act of the Lessee results in the increase of real estate taxes payable by the Lessor, the full amount of such increase shall be charged to the Lessee and paid as Additional Rent hereunder. B) During the term of this Lease Agreement or any renewal or extension thereof, Lessee shall pay for the following utilities required for its operations: 1) All telephone equipment, installation and usage to be billed direct to the account of the Lessee by the utility. 2) Lessor shall cause hot and cold water for ordinary lavatory, cleaning, drinking and toilet facility purposes to be furnished at no expense to Lessee. 3) Lessor shall provide Lessee with electric energy. Lessor shall install (at Lessor's own expense) an electric submeter coveting the Leased Premises and Lessee shall pay 6 7 Lessor for Lessee's actual electrical usage based on the electric utility's actual charges to Lessor therefor. If a sub-meter is not possible, then the parties will enter into an agreement amending this Lease Agreement which will provide for Lessee to pay for electric energy on a rent inclusion basis with the Additional Rent inclusion factor being two ($2.00) dollars per square foot per annum and with electric energy charges to be adjusted by means of electrical survey and also to accommodate changes in utility charges. C) Lessee agrees to pay as Additional Rent .48% cost of any increases to the "Operating Costs" that may be incurred during every calendar year or part thereof during the term of this Lease Agreement which shall be in excess of the operating costs for the calendar year 1998 based on full occupancy of the Premises (hereinafter referred to as the "Operating Base Year"). In the event that the amount of space rented by Lessee shall increase or decrease, the share of maintenance costs paid by Lessee shall be proportionately increased or decreased. "Operating Costs" shall include Lessor's reasonable costs or contribution to costs incurred in good faith for: 1) Wages and salaries paid by or contributed to by Lessor, and contract costs paid to independent contractors utilized by Lessor for the normal operation, maintenance and repair of the Premises, including Social Security taxes, Unemployment Insurance taxes, worker's compensation payments, payments required by any union rule or regulation, and other provisions imposed by law, together with any employee "fringe benefits" incurred by Lessor; 2) Management charges provided same are not in excess of such charges customarily charged in similar buildings in Westchester County; 3) Uniforms of employees specified in subparagraph (1) above and the cleaning and pressing thereof; 4) Repairs to, replacement of and physical maintenance of the Premises and its equipment and appurtenances; and additions and improvements required by law; and the cost of supplies and equipment used in connection therewith; and the cost of painting in public and common areas; 5) Premiums and other charges by Lessor with respect to insurance of all kinds for the Premises which are customarily maintained by lessors of similar buildings in the Westchester County which Lessor determines to be reasonably necessary at its sole discretion and which Lessor in good faith pays and incurs; 6) Costs incurred for fuel or other energy for heating the premises and operating the air conditioning system, for electricity, steam, or other power required in connection with the operation of the Premises; it being understood that this shall not include costs for which Lessor is reimbursed by other tenants (including electric energy paid for by rent inclusion); 7) Costs incurred in connection with inspection and servicing of the Premises, its appurtenances and equipment; 8) Water and sewer charges, except as specified in Paragraph 4(B, 2) above; 7 8 9) Any other tax or expense, direct or indirect, incurred by Lessor in connection with the operation, maintenance and repair of the Premises, its appurtenances and equipment. 10) Attorneys' and auditing fees necessarily incurred in connection with the maintenance and operation of the Premises, and accounting fees incurred in connection with the preparation of Expense Control Statements (as hereinafter defined), as well as expenses incurred (including attorneys' fees) with respect to efforts to obtain a reduction in the annual assessed valuation of the Premises, but with attorneys' fees therefor not in excess of the amount of the resulting decrease in Taxes; 11) Operating costs shall be "net" only, and for that purpose shall be deemed reduced by the amounts of any insurance reimbursement, other reimbursement, recoupment payment, discount, credit, reduction, allowance, or the like, received by Lessor in connection with such operating costs. 12) Notwithstanding anything contained herein and without limiting the generality of the foregoing, the following costs shall not be including in operating costs: a) The cost of painting, repainting, decorating or redecorating for any Lessee of the Premises or of providing for any such Lessee special cleaning services; b) Any renting commissions or collection expense; c) The cost of making any installations, changes or alterations for existing or incoming leases; d) Expenditures for improvements and replacements which under generally accepted accounting principles and practice should be classified as capital expenditure except that there shall be included: i) any capital expenditure for improvements the purpose of which is to realize savings of costs in the maintenance and operation of the Premises; such expenses shall be included in the operation costs, amortized on a straight line basis over the period of time reasonably anticipated to result in a saving in operating costs, equal to the amount of such expenditure; and ii) periodic capital expenditures which under generally accepted accounting principles and practice are regarded as normal building operating expenses in major office buildings; iii) if, by reason of installation of labor saving devices or otherwise, any items which are included in Lessor's Operating Base year shall be eliminated in any later year, then for the purpose of computing Operating Costs for such later year such items shall be deemed to be eliminated during the Operating Base Year. (e) costs occasioned by casualty or by the exercise of the power of eminent domain. 8 9 13) The Lessor's "Expense Control Statement" shall set forth the amount of the above items of operating costs for the Operating Base Year and for each year of increased costs and shall be in sufficient detail to substantiate the amount of the increase and the amount to be paid by Lessee. The Lessor or its Certified Public Accountants shall attest to the applicable increased costs and the increase to be paid by the Lessee. If Lessor shall not have delivered to Lessee the statement mentioned herein for any year, Lessee shall continue to pay Lessor the sums payable for the immediately preceding calendar year until the statement for the then current calendar year shall have been delivered, at which time the monthly payments by Lessee shall be adjusted retroactively. Lessor shall permit Lessee to audit and verify the same on reasonable request by Lessee, allow Lessee's representatives to examine the records and receipts pertaining to the costs referred to in the Expense Control Statement and shall confer with Lessee in an effort to in good faith resolve any disputes. Notwithstanding any other provision in this Lease Agreement, only one Expense Control Statement shall be issued in respect of any one year and it shall be issued within six (6) months after the end of the year to which it pertains. 14) All such increased payments shall be prorated for any partial calendar years during the term of this Lease Agreement. D) The amounts due under Section 4, Paragraphs (A), (B), and (C) hereof shall be paid by Lessee and collectible as Additional Rent without setoff or deduction and shall be paid within thirty (30) days after written demand by Lessor accompanied by the documentation required by this Lease Agreement except that at Lessor's option, Lessee shall pay the Lessor, on demand, in advance, a sum equal to one-twelfth (1/12) of any amounts due by reason hereof multiplied by the number of months of the calendar year then elapsed, and one-twelfth (1/12) of such in respect of the then current month, and thereafter one-twelfth (1/1 2) in respect of each succeeding month in the applicable year on each monthly rent day, and Lessee shall be entitled to a credit for the amount so paid in advance against the escalation shown due at the end of each such year. E) Lessor's failure during the Lease Term to prepare and deliver any of the foregoing tax bills, statements or bills, or Lessor's failure to make a demand, shall not in any way result in or cause Lessor to forfeit or surrender its rights to collect any of the foregoing items of Additional Rent which may have become due during the term of this Lease Agreement. F) Lessee's liability for the amounts due under this Paragraph shall survive the expiration of the Lease Term. In no event shall any rent adjustment hereunder result in a decrease in the Fixed Annual Rent. 5. ELECTRICAL SYSTEM & SERVICE: A) The Lessor shall provide to the Lessee the installed or connected electrical system and related equipment for the Leased Premises. Any relocation, addition or alteration of the system beyond the building standard, done at the request of Lessee after the Leased Premises are outfitted as provided by this Lease Agreement, shall be at the Lessee's expense. B) Lessor shall not be liable to Lessee at any time for any loss, damage, or expense resulting from any change in the quantity or character of the electrical service furnished to the Premises by the electric utility; by the cessation or interruption of the supply of current by the electric; 9 10 nor shall any such loss, damage or expense, or non-suitability, non-availability, cessation or interruption in the supply of electric service or current by the electric utility in any way affect the tenancy or in any way relieve Lessee of any obligation arising under the terms of the Lease Agreement. C) In order that the personal safety and property of the occupants and owner of the Premises may not be imperiled by the over-taxing of the capacity of the existing electrical distribution system, Lessee agrees not to make any alterations or additions to the electrical equipment, appliances, fixtures or other machinery utilizing electric power (other than lamps, lighting, typewriters, word processing equipment, document reproduction equipment, telephone, facsimile and communications equipment, refrigerator, microwave, television and VCR, personal computers, IBM or similar computer equipment, and other normal or small office machines) without obtaining the prior written consent of Lessor in each instance. Lessor shall provide feeders and wiring necessary for Lessee's equipment as provided by this lease and Lessee covenants and agrees that at all times its use of electric current shall never exceed the capacity of such existing feeders or any wiring installation in the Leased Premises. D) Replacement lamps/starters for all lighting fixtures shall be for the Lessor's account. 6. HEATING, VENTILATING & AIR CONDITIONING SYSTEM & SERVICE: A) Lessor shall provide heating, air conditioning, and year round ventilating System into the interior areas, temperature conditions of 68 degrees F. dry bulb when the outside is 0 degrees F., and 75 degrees F. dry bulb when the outside temperature is 95 degrees F. Any change in location of diffusers or peripheral system units, control valves, thermostats and openings in the demising wall to the slave to allow for the transfer of return air within the plenum, done at the request of Lessee after the Leased Premises are outfitted as provided by this Lease Agreement, shall be for the account of the Lessee. B) Lessor shall provide the above levels of HVAC throughout the year, in accordance with the Regular Business Hours of the premises (which shall be Monday through Friday, 7: 00 a.m. to 6:00 p.m.). For any usage beyond the above time for HVAC equipment not included in Lessee's submeter, the Lessee shall compensate the Lessor for the actual cost of Lessee's actual usage at the Lessor's then current hourly rate; such charges to be billed by the Lessor and paid by Lessee monthly as Additional Rent. Lessee shall give notice prior to 4:00 p.m. in the case of service oil working days and prior to 4:00 p.m. on Fridays (or the preceding working day, in the case of holidays) in the case of such service on days other than working days. C) Lessee agrees to keep and cause to be kept closed all windows in the Leased Premises and to close the blinds when necessary because of the sun's position, and Lessee agrees at all times to cooperate fully with the Lessor's energy conservation measures and to abide by all reasonable regulations and requirements which lessor may prescribe for the proper functioning and protection of the HVAC system. D) Lessee agrees that in the event its occupancy level or electrical load or both shall exceed the design capacity, the cost to Lessor of providing the necessary additional HVAC capacity, including but not limited to any necessary equipment, duct work or the like together with the cost of operation thereof, shall be for the account of Lessee and shall be payable by Lessee 10 11 to Lessor, based upon the capacity of such additional equipment or the cost of otherwise providing such additional capacity. Lessor shall furnish Lessee in writing with an estimate of the cost of any such additional HVAC equipment together with the additional monthly amount for operating any additional capacity, and shall receive Lessee's written approval thereof prior to providing such additional HVAC capacity. E) Lessor, through the term of this Lease Agreement, shall have free and unrestricted access to any and all HVAC equipment in the Leased Premises upon reasonable notice. Lessor reserves the right to interrupt, curtail, stop or suspend such HVAC equipment when necessary by reason of accident, or repairs, alterations or improvements that are in the judgment of Lessor to be desirable or necessary to be made. No diminution or abatement of rent or other compensation shall or will be claimed by Lessee, nor shall the Lease Agreement or any of the obligations of Lessee be affected or reduced by reason of interruption or curtailment of such HVAC, when such interruption or curtailment or stoppage or suspension shall be due to failure of electric power or accident, or to repairs, alterations or improvements that are in the reasonable judgment of Lessor desirable or necessary to be made, or to difficulty or inability in securing supplies or labor, or to strikes, or to any other cause beyond the reasonable control of Lessor, whether such other cause be similar or dissimilar to those herein before specifically mentioned. F) Lessor shall not be required to furnish, and Lessee shall not be entitled to receive, any HVAC service after regular business hours during any period wherein Lessee shall be in default beyond the applicable notice period in the payment of rent as specified in the Lease Agreement. 7. INSURANCE - INDEMNITY: (A) Lessor shall procure and maintain property insurance covering the full insurable value of the Premises and all other insurance which it deems necessary for its protection against loss or damage to the Leased Premises or any other property of Lessor situated thereon. B) Nothing contained in this Lease Agreement shall be construed to require either party to repair, replace, reconstruct, or pay for any property of the other party which may be damaged or destroyed by fire, flood, windstorm, earthquake, strikes, riots, civil commotions, acts of public enemy, act of God, or other casualty, and each party hereby waives all claims against the other for all loss or damage arising out of perils normally insured against by standard fire and extended coverage insurance. Notwithstanding anything to the contrary in this Lease Agreement, the parties hereto release each other and their respective agents, employees, successors, assignees and subtenants from all liability for damage to any property that is caused by or results from a risk which is actually insured against, which is required to be insured against under this Lease Agreement, or which would normally be covered by all risk property insurance, without regard to the negligence or willful misconduct of the entity so released. Each party shall use its reasonable good faith efforts to cause each insurance policy it obtains to provide that the insurer thereunder waives all right of recovery by way of subrogation as required herein in connection with any injury or damage covered by the policy. If such insurance policy cannot be obtained with such waiver of subrogation, or if such waiver of subrogation is only available at additional cost and the party for whose benefit the waiver is not obtained does not pay such additional cost, then the party obtaining such insurance shall immediately notify the other party of that fact. C) Neither party nor any agent or employee of either party shall be liable for: 11 12 1) Loss of or damage to any property of the other party, or of any entity within the other party's control, or injury to any entity (if a person) within the other party's control, from any cause whatsoever, unless caused by or due to the party's gross negligence or willful misconduct; 2) Any damage referred to in (1) above caused by other occupants or persons in the premises or by construction of any private, public or quasi-public work; or 3)Any latent defect in the Leased Premises or the Premises and Lessee shall not be entitled to any compensation therefor or for abatement of Rent or to any release of any of Lessee's obligations under this Lease Agreement so long as such defect remains latent; nor shall the same constitute an eviction. D) Lessee and Lessor shall indemnify each other, defend and hold the other party harmless against and from all liability referred to in (a) above arising out of any action brought by any entity within the party's control, which, for purposes of this Paragraph, shall include the party's agents, employees, contractors and invitees. E) Lessee shall reimburse and compensate Lessor as Additional Rent, within five (5) days after rendition of a statement for all expenditures (except attorneys' fees) made by, or damages or fines sustained or incurred due to non-performance of or non-compliance with or breach by or failure to observe any term, covenant or condition of this Lease upon such party's part to be kept, observed, performed or complied with. F) Except to the extent of Lessor's gross negligence or willful misconduct, Lessee shall save Lessor harmless and indemnify it from and against all injury, loss, claims or damage (except attorneys' fees) to any person or property while on the Premises arising out of use or occupancy of the Leased Premises by the party or its employees, suppliers, contractors or agents and from and against all injury, loss, claim or damage to any person or property anywhere occasioned by any act, neglect or default of the party or its employees, suppliers, contractors or agents. Lessee covenants and agrees that during the term of this Lease Agreement it will provide and keep in force general public liability insurance protecting and indemnifying persons and property in or about the Leased Premises and in the Premises throughout and the connecting corridors thereof to the limit of not less than one million ($1,000,000.00) dollars in respect of any one occurrence and three million ($3,000,000.00) dollars for bodily injury or death to any number of persons in any one occurrence and to the limit of not less than one million ($1,000,000.00) dollars for property damage. Lessee shall provide, or cause to be provided, Worker's Compensation Insurance covering all persons employed in connection with the performance of work upon, in or about the Leased Premises and the Premises throughout and the connecting corridors thereof (exclusive of work being done by Lessee as provided by this Lease Agreement). All such insurance shall be effected in standard form under valid, enforceable policies issued by insurers of recognized responsibility and licensed to do business in the State of New York and shall, except in the case of Worker's Compensation Insurance, name Lessee as insured and include Lessor as additional insured. Certificates of such insurance shall be delivered to Lessor from time to time during the term of this Lease Agreement at least ten (10) days prior to the expiration date of the previous policy together with certificates evidencing the renewal of such policy with satisfactory evidence of payment of the premium on such policy. To the extent obtainable, all such policies shall contain agreements by the insurers that (i) such polices shall 12 13 not be canceled except upon ten (10) days prior written notice to each named insured and (ii) the coverage afforded thereby shall not be affected by the performance of any work upon, in or about the Leased Premises. G) If by reason of the negligence or willful misconduct of Lessee there shall be an increase in the insurance premiums applicable to the Premises. Lessee shall pay such increase or expense to the Lessor on the first day of the month immediately following the submission of a bill or statement by Lessor to the Lessee for the same. 8. PREPARATION OF THE LEASED PREMISES: A) The Lessor shall provide and install in the Leased Premises those items as specified in Exhibit C (Work Letter) (the "Tenant Improvements"). B) The Lessor's agreement to do the work in the Leased Premises as set forth in the "Work Letter" shall not require it to incur overtime costs and expenses and shall be subject to unavoidable delays due to acts of God, governmental restrictions, strikes, labor disturbances, shortages of materials and supplies and for any other causes or events beyond Lessor's reasonable control. Lessor has made, and makes, no representation as to the date when the Leased Premises will be ready for Lessee's occupancy. C) The Tenant Improvements shall be constructed in accordance with applicable laws, in a good and workmanlike manner, free of defects and using new materials and equipment of good quality. Lessee shall have the right to submit a written "punch list" to Lessor, setting forth any defective items of construction, and Lessor shall promptly cause such items to be corrected. Lessee's acceptance of the Leased Premises or submission of a "punch list" shall not be deemed a waiver of Lessee's right to have defects in the Tenant Improvements or the Leased Premises repaired at no cost to Lessee. Lessee shall give notice to Lessor whenever any such defect becomes reasonably apparent, and Lessor shall repair such defect as soon as practicable. 9. OTHER LEASEHOLD IMPROVEMENTS BY LESSEE: A) Lessee shall have the right, with the prior written consent of Lessor (except that decorative improvements including painting, wall coverings, carpeting and non-structural work shall require only prior notice to Lessor), and at Lessee's sole expense, to make alterations or improvements in or to the Leased Premises as it shall consider necessary or desirable for the conduct of its business, provided that all such work shall be done in a good and workmanlike manner, that the structural integrity of the Premises shall not be impaired, and no liens shall attach to the Leased Premises by reason thereof and provided also that all requirements of governmental authorities be complied with. B) With respect to other improvements by the Lessee requiring Lessor's written consent, Lessee shall prepare at its expense the outline drawings and specifications indicating the alterations, modifications or any other improvements to be made to the Leased Premises by the Lessee. All such plans shall conform to the conditions outlined herein and as may be reasonably established by Lessor. 13 14 C) The Lessee shall submit the plans and specifications to the Lessor for review and approval prior to the start of any work. The Lessor's approval or conditioned acceptance of the improvements shall be within ten (10) days after receipt. D) With respect to other improvements by the Lessee requiring Lessor's written consent, the Lessee, at the expense of the Lessee, shall file the appropriate plan with the appropriate municipal building department and obtain approval and an occupancy or other permits for the Lessee. No work shall commence until the above approvals have been received. E) With respect to other improvements by the Lessee requiring Lessor's written consent, Lessee shall furnish a copy to Lessor of any construction contracts with contractors who will perform the Lessee's improvements to the Leased Premises. The Lessor shall have the right to inspect and to insure: 1) That the work will be done in accordance with the approved plans and specifications and the consents, authorizations and licenses obtained: 2) That the contractor or other persons performing the work and furnishing materials will look solely to Lessee for payment and will hold Lessor and the Leased Premises and the Premises containing the Leased Premises free from all liens and claims of all persons furnishing labor or materials therefor, or both; 3) That qualified and skilled tradesmen only shall be used in the performance of Lessee's leasehold improvement. 4) Any mechanic's lien filed against the Leased Premises or the Premises for work claimed to have been done or materials furnished to Lessee shall be discharged by Lessee, at its expense, within fifteen (15) days after notice from Lessor to such effect. For the purposes hereof, the bonding of such lien by a reputable casualty insurance company shall be deemed the equivalent of a discharge of such mechanic's lien. Should Lessee fail to comply with the provisions of this Paragraph, Lessor will procure the discharge of such mechanic's lien and charge the expense thereof (including attorneys' fees) to Lessee as Additional Rent. 5) Contractors doing Lessee's work shall employ only such labor as will not result in jurisdictional disputes or strikes or otherwise cause labor discord with respect to the Premises. F) Lessee or its employees, suppliers, contractors or agents agree to indemnify and save Lessor harmless against any and all bills for labor performed and equipment, fixtures and materials installed on the Premises containing the same and from and against all losses, damages, costs, expenses, suits and claims whatsoever in connection with the access to the Premises and to the Lessee's leasehold improvements in the Leased Premises. The cost of Lessee's leasehold improvements shall be paid for in cash or its equivalent, so that the leased premises and the Premises containing the same shall at all times be free of liens for labor and materials supplied or claimed to have been supplied. G) Except as hereinafter provided, upon the termination of this Lease Agreement, the improvements and any other alterations, additions or improvements (other than trade fixtures) shall, become the property of Lessor and shall be surrendered with the Leased Premises, and 14 15 Lessee shall have no obligation to remove such alterations, additions or improvements. Notwithstanding the foregoing, Lessor, by written notice to Lessee within ten (10) days after the date on which Lessee provides Lessor notice of any alterations, additions, or improvements to be performed by Lessee, shall have the right to require Lessee to remove any such alterations, additions or improvements upon the termination of this Lease Agreement, and, any part of the Leased Premises affected by such removal shall be restored to its original condition, reasonable wear and tear, casualty, and hazardous substances not caused by Lessee excepted. 10. OCCUPANCY/COMMENCEMENT DATE: A) In the event this Lease Agreement pertains to the initial occupancy by any Lessee of the Leased Premises, the Leased Premises shall be deemed ready for occupancy on the earliest date on which both of the following conditions have been met. 1) The improvements described herein to be performed by Lessor have been substantially completed, including the erection and painting or covering (as required) of the walls, the installation of the doors and hardware and locks therefore, the installation of lighting, electrical outlets and switches such that they are operational, the installation of telephone outlets (but not of telephone equipment, provided reasonable notice has been given to Lessee such that the telephone equipment vendor could reasonably have installed such equipment) and the issuance of such governmental approvals as may be required for occupancy. 2) Adequate means of access have been provided, and the use without material interference of the facilities necessary to Lessee's occupancy of the Leased Premises, including corridors, elevators, stairways, heating, ventilating, air conditioning, sanitary, water and electrical lighting and power facilities, are available to Lessee in accordance with Lessor's obligations under the Lease Agreement. B) Lessor shall give written notice to Lessee designating the Commencement Date for the term of the Lease Agreement in respect of the Leased Premises, which shall be not fewer than ten (10) business days notice. 11. MAINTENANCE AND REPAIRS: A) Lessee shall keep the Leased Premises in good condition, reasonable wear and tear excepted, and shall, in the use and occupancy of the Leased Premises, conform to all laws, orders and regulations of the Federal, State and municipal governments, or any of their departments, and regulations of the New York Board of Fire Underwriters, applicable to the Premises. Notwithstanding the foregoing, Lessee shall not be required to comply with or cause the Leased Premises to comply with any laws, rules or regulations requiring alterations or improvements to the Leased Premises unless the compliance with any of the foregoing is necessitated solely due to Lessee's particular use of the Leased Premises. Lessee shall not be required to perform any maintenance, repairs or replacements necessitated by the negligence of Lessor, its servants, agents, or employees, or structural defects or deficiencies in any building, or by fire, or other casualty. Notwithstanding the foregoing, Lessor shall perform and construct, and Lessee shall have no responsibility to perform or construct, any repair, maintenance or improvements (i) for which Lessor has a right of reimbursement from others, (ii) to the heating, ventilating, air conditioning, electrical, water, sewer, and plumbing systems serving the Leased Premises and the Premises and (iii) to any portion of the Premises 15 16 outside of the demising walls of the Leased Premises. Notwithstanding the foregoing, Lessee shall pay for its share of the repairs described in subsections (ii)-(iii) to the extent such costs are properly included in Operating Costs. B) Except for such maintenance, repairs, and replacements as are required by (A) above to be made by Lessee, Lessor shall perform any and all structural alterations, maintenance, repairs and equipment replacements which may be necessary to maintain the Premises in good, safe and tenantable condition. C) Lessee shall permit the Lessor to erect, use and maintain pipes and conduits in and through the Leased Premises, provided the same are installed and concealed behind walls and ceiling of the Leased Premises and it does not result in any noticeable loss of Lessee's space. All work necessary in connection with the foregoing shall to the extent possible, be done outside of Lessee's regular business hours. The Lessor or its agents shall have the right to enter the Leased Premises to make such repairs or alterations as the Lessor reasonably deems desirable for the proper operation of the Premises and shall have the right to enter the Leased Premises at any time on reasonable advance notice to Lessee to examine them or when necessary for the protection of the Leased Premises or the Premises. The Lessor, provided it proceeds with due diligence, shall be allowed to take all material into and upon the Leased Premises that may be required for such repairs or in part and without any abatement or diminution of rent. In the making of such repairs or alterations, the Lessor, to the extent practicable and consistent with efficiency and economy, shall exercise reasonable diligence so as to minimize the disturbance of or interference with the business of Lessee. Nothing herein contained, however, shall be deemed or construed to impose upon the Lessor any obligation, responsibility or liability whatsoever for the care, supervision, or repair of the Premises or any part thereof, other than as herein provided. The Lessor shall also have the right at any time, without the same constituting an actual or constructive eviction and without incurring any liability to Lessee, therefore, to change the arrangement or location of entrances or passageways, doors and doorways and corridors, stairs, toilets, or other public parts of the Premises, provided that no changes shall be made without Lessee's consent where such changes would adversely affect Lessee's ingress and egress to and from the Leased Premises from the street floor or from the lobby of the Premises or from the hallway or lobby of the Premises. D) Lessee shall at all times during the term of this Lease Agreement, and any extensions thereof, permit inspection of the Leased Premises during business hours, by the Lessor and its agents or representatives, or by or on behalf of prospective lessees. Except in the case of emergency, any such inspection will be done on at least twenty-four (24) hours' notice. Such inspection will be done in a manner so as not to unreasonably interfere with Lessee in the conduct of its business. E) Damages resulting from the negligence or willful misconduct of the Lessee or its employees, contractors, agents, licensees or invitee shall be repaired by the Lessee, if repaired by the Lessor, all costs shall be charged to the account of the Lessee. F) All repairs or replacements by Lessee or Lessor shall be of first quality and done in good and workmanlike manner. If Lessee is charged with making such repairs, restorations and replacements, the contractor chosen by Lessee to do such repairs, restorations or replacements shall be subject to Lessor's approval and further, if Lessee shall fail within fifteen (15) days' written request from Lessor to commence the making of such repairs, restorations and 16 17 replacements and complete the work with reasonable diligence, they may be made and completed by Lessor but at the expense of Lessee. 12. CLEANING/JANITORIAL SEVICES: Lessor shall provide cleaning/janitorial services at its own expense, as outlined in Exhibit F. 13. DAMAGE TO OR DESTRUCTION OF LEASED PREMISES: If during the term of the lease, the Leased Premises are damaged by fire, flood, windstorm, strikes, riots, civil commotions, acts of God, or other casualty so that the same are rendered wholly unfit for occupancy, and if said Leased Premises cannot be repaired within one hundred twenty (120) days from the time of such damage, then this Lease Agreement, at the option of the Lessor or Lessee, may be terminated as of the date of such damage. In the event that the Lessor elects to terminate this Lease Agreement, the Lessee shall pay the rent apportioned to the time of damage and shall immediately as practicable surrender the Leased Premises to the Lessor who may enter upon and repossess the same and Lessee shall be relieved from any further liability hereunder. If the parties elect not to terminate the Lease Agreement or if any damage by any of the above casualties, rendering the Leased Premises wholly unfit, can be repaired within one hundred twenty (120) days thereafter, Lessor agrees to repair such damage promptly within such period and this Lease Agreement shall not be affected in any manner except that the Rent shall be suspended and shall not accrue from the date of such damage until such repairs have been completed. If said Leased Premises shall be so slightly damaged by any of the above casualties as not to be rendered wholly unfit for occupancy, Lessor shall repair the Leased Premises promptly and to Lessee's satisfaction and during the period from the date of such damage until the repairs are completed the Rent shall be apportioned so that the Lessee shall pay as rent an amount which bears the same ratio to the entire monthly rent as the portion of the Leased Premises which Lessee is able to occupy without disturbance during such period bears to the entire Leased Premises. If the damage by any of the above casualties is so slight that Lessee is not disturbed in its possession and enjoyment of the Leased Premises, then Lessor shall repair the same promptly and in that case the rent accrued or accruing shall not abate. Notwithstanding, anything herein contained to the contrary, if the cost of repair or restoration exceeds thirty (30%) percent of the replacement value, less foundation, of the Premises, then Lessor shall have the option, exercisable on written notice to Lessee within sixty (60) days of such damage, not to repair and restore the Premises in which event this Lease Agreement shall terminate as of the date of the damage. Lessee hereby expressly waives the provisions of Section 227 of the Real Property Law or any other law or statute hereafter enacted of similar import and agrees that the foregoing provisions of this Paragraph shall govern and control in lieu thereof. 14. ACTION OF PUBLIC AUTHORITIES: In the event that any exercise of the power of eminent domain by any governmental authority, Federal, State, County, or municipal, or by any other party vested by law with such power shall at any time materially affect Lessee's use and enjoyment of the Leased Premises by Lessee for the purposes set forth in Paragraph 3, Lessor and Lessee shall each have the right thereupon to terminate this Lease Agreement. In the event of the termination of this Lease Agreement in accordance with the provisions of this Paragraph 14, the Fixed Rent and the Additional Rent shall be apportioned and prorated accordingly. Lessee shall not be entitled to claim or receive any part of any award in any condemnation proceeding or as result of such condemnation or taking, or to any damages against Lessor whether the same be for the value of the unexpired term of this Lease Agreement or otherwise. Nothing herein contained, however, shall be deemed to 17 18 preclude Lessee from making any claim against the condemnor for the value of any of Lessee's fixtures or improvements or for Lessee's moving expenses provided the award for such claim or claims is not in diminution of the award made to the Lessor (who shall not claim such items as his own). 15. DEFAULT: If Lessee shall fail to pay any Fixed or Additional Rent to Lessor when the same is due and payable under the terms of this Lease Agreement and such default shall continue for a period of ten (10) days after written notice thereof has been given to Lessee By Lessor, or if the Lessee shall materially fail to perform any of the covenants or conditions hereof or any other duty or obligation imposed upon it by this Lease Agreement and such default shall continue for a period of thirty (30) days after written notice thereof has been given to Lessee by Lessor, or if the Lessee shall be adjudged bankrupt, either voluntarily or involuntarily, or shall make a general assignment for the benefit of its creditors, or a receiver of any property of Lessee in or upon the Leased Premises be appointed in any action, suit, or proceeding by or against Lessee and such appointment shall not be vacated or annulled within sixty (60) days, or if Lessee enters into any type of reorganization under the United States Bankruptcy Act, as the same may from time to time be amended, or if the interest of Lessee in the Leased Premises shall be sold under execution of other legal process, then and in any such events Lessor, in its sole discretion, may at any time thereafter terminate this lease and the term thereof upon giving to the Lessee five (5) days notice in writing of its intention to do so and upon the giving of such notice, this Lease Agreement and the term thereof shall terminate, and Lessor shall again have, repossess and enjoy the same as if this Lease Agreement had not been made, and thereupon this Lease Agreement shall terminate without prejudice, however, to the right of Lessor to recover from Lessee all rent due and unpaid up to the time of such re-entry together with all damages and expenses, including attorneys' fees, incurred by Lessor due to Lessee's default. In the event of any such default and re-entry, Lessor shall have the right, but not the obligation to relet the Leased Premises for the remainder of the then existing term whether such term be the initial term of this Lease Agreement or any renewed or extended term, for the highest rent then obtainable, and to recover from Lessee, as damages, the difference between the rent reserved by this Lease Agreement and the amount obtained through such reletting, less the costs and expenses reasonably incurred by Lessor in such reletting (including reasonable attorneys' fees). In the event that the amount obtained through such reletting, less the reasonable costs and expenses thereof, including reasonable attorney's fees, shall exceed the rent herein reserved, Lessee shall have no right to such excess. Any such notice shall specifically refer to this Paragraph 15 and shall specify the default claimed. Lessor's remedies as specified in this Lease Agreement are cumulative and are not intended to preclude any other remedies or means of redress to which Lessor may lawfully be entitled at any time, and Lessor may invoke any remedy allowed at law or in equity as if specified remedies were not provided for in this Lease Agreement. 16. ACCELERATIQN OF RENT UPON DEFAULT: It is hereby mutually agreed, that not withstanding anything to the contrary herein contained, the said Leased Premises are demised for rental of $63,360.00 for the entire said term of three (3) years payable at the time of the making of this Lease Agreement, and that the provisions therein contained for the payment of said Rent in installments are for the convenience of Lessee only, and that, upon default in payment of the rent in installments, as herein allowed for more than thirty (30) days, then the whole of the Rent hereby reserved for the whole of the said Lease Term and then remaining unpaid shall at once become due and payable, without notice or demand. 18 19 17. SUBORDINATION: A) This Lease Agreement is subject and subordinate to any mortgages now or hereafter affecting or covering the Leased Premises and all or any part of the Premises, and to any and all renewals, modifications, consolidations, replacements and extensions of such leases and mortgages. This clause shall be self-operative and no further instrument of subordination shall be required. In confirmation of such subordination, Lessee agrees to execute any instrument which may be deemed necessary or desirable by Lessor and reasonably acceptable to Lessee to effectuate the subordination of this Lease Agreement to any such mortgage. B) Lessee shall attorn to and recognize a successor Lessor, whether through possession or foreclosure action or sale, as Lessee's landlord under this Lease Agreement and shall promptly execute and deliver any instrument, reasonably acceptable to Lessee, that such successor Lessor may reasonably request to evidence such "non-disturbance agreement" under which Lessee's use and occupancy of the Leased Premises and Lessee's rights under this Lease Agreement will not be disturbed so long as Lessee observes and performs the terms and conditions on Lessee's part to be performed under this Lease Agreement. 18. SUBLETTING AND ASSIGNMENT: A) Lessee shall not have the right to sublet or assign the Leased Premises except on the following terms and conditions: 1) Such subletting or assignment shall not relieve the Lessee from its duty to perform fully all of the agreements, covenants and conditions set forth in this Lease Agreement or any Guarantor from the obligations of any Guaranty executed and delivered in connection with this Lease Agreement. 2) The Lessee shall first obtain the Lessor's written consent to the subletting or assignment in each instance. 3) The Lessee shall provide the name of the proposed sublessee or assignee, the terms and conditions of the proposed subletting or assignment, the nature and character of the businness of the proposed sublessee or assignee, and the banking, financial and other credit information relating to the proposed sublessee reasonably sufficient to enable Lessor to determine the financial responsibility of said proposed sublessee or assignee. 4) Upon the receipt of such request from Lessee, Lessor shall have an option, to be exercised in writing within forty-five (45) days thereafter, to terminate this Lease Agreement effective on a date set forth in Lessor's notice of termination, which shall not be less than thirty (30) days nor more than one hundred twenty (120) days following the service upon Lessee of Lessor's notice of termination (the "Termination Date"). 5) In the event Lessor shall exercise such option to terminate this Lease Agreement, this Lease Agreement shall expire on the Termination Date as if that date had been originally fixed as the expiration date of the term herein granted and Lessee shall surrender possession of the entire Leased Premises on the Termination Date in accordance with the provisions of this Lease Agreement. 19 20 B) If Lessor shall not exercise its option within the period aforesaid, then Lessor's consent to such request shall not be unreasonably withheld but will be given only in the following conditions acknowledged by Lessee to be reasonable and proper: 1) That the subletting or assignment is for part of or the entire Leased Premises only; 2) That the subletting or assignment shall be to a sublessee whose occupancy will be in keeping with the dignity and character of the then use and occupancy of the Premises by other lessees and whose occupancy will not be more objectionable or more hazardous than that of Lessee herein. In no event shall any subletting or assignment be permitted to a school of any kind or an employment or placement agency; or governmental or quasi-governmental agency; 3) That the subletting or assignment shall not be to any lessee, sublessee or assignee of any leased space in the Premises of which the Leased Premises form a part; 4) That the subletting or assignment shall not be advertised at a lower rental rate than that being charged by Lessor at the time for similar space in the Premises; 5) That the sublease or assignment will expressly prohibit assignment of the Lease Agreement or further subletting by the sublessee without Lessor's written consent. 6) If this Lease Agreement shall be assigned, or if the Leased Premises or any part thereof, be sublet or occupied by any person or persons other than Lessee, Lessor may, after default by Lessee, collect Rent from the assignee, subtenant or occupant, and apply the net amount collected to the rent herein reserved, but no such assignment, subletting, occupancy or collection of Rent shall be deemed a waiver of the covenants contained in this Lease Agreement, nor shall it be deemed acceptance of the assignee, subtenant or occupant as a tenant or a release of Lessee from the full performance by Lessee of all of the terms, conditions and covenants of this Lease Agreement. C) Notwithstanding the foregoing, Lessee may, without Lessor's prior written consent, but with at least ten (10) days prior written notice and without being subject to Lessor's termination rights under subsections 18(A)(4) and 18(A)(5) of this Lease Agreement, sublet the Leased Premises or assign this Lease Agreement to (i) a subsidiary, affiliate, division or corporation controlling, controlled by or under common control with Lessee, (ii) a successor corporation related to Lessee by merger, consolidation, nonbankruptcy reorganization, or governmental action, or (iii) a purchaser of substantially all of Lessee's assets. A sale or transfer of Lessee's capital stock shall not be deemed an assignment, subletting or any other transfer of the Lease Agreement or the Leased Premises. 19. RECORDATION: Lessee and Lessor agree that they will not record this Lease Agreement nor any memorandum thereof 20. SURRENDERS AND WAIVERS: When this Lease Agreement shall terminate in accordance with the terms thereof, Lessee shall quietly and peaceably deliver up possession to Lessor without notice from Lessor other than as may be specifically required by any provision of this Lease Agreement. Lessee expressly waives the benefit of all laws now or hereafter in force requiring notice 20 21 from Lessor with respect to termination. Lessee shall deliver up possession of the Leased Premises in as good order, repair, and condition as the same are in at the beginning of the term of this lease Agreement except for reasonable wear and tear, casualty, condemnation and hazardous substances not caused by Lessee. The cost of repairing any damage to the Leased Premises arising from the removal of Lessee's property, shall be paid by Lessee. Lessee's obligation to observe or perform this provision shall survive the expiration or other termination of the term of this Lease Agreement. All property of Lessee not removed by it shall be deemed abandoned. The Lessee, for itself and on behalf of any person claiming through or under it, including creditors of all kinds, does hereby waive and surrender all rights and privileges which it might have under or by reason of any present or future law to redeem the Leased Premises or to have a continuance of this Lease Agreement for the Lease Term thereof after being dispossessed or ejected therefrom by process of law or under the provisions of this Lease Agreement or after any termination of this lease as herein provided. Lessee also waives the provisions of any law relating to notice or delay in levy of execution in case of an eviction or dispossession of Lessee for non-payment of rental or of any other law of like import now or hereafter in effect. Lessee shall not interpose any counterclaim or claim of set-off of any nature or description whatsoever, except for any mandatory counterclaims in any action or summary proceeding for the non-payment of the Fixed Rent or Additional Rent. Except for an action, proceeding or counterclaim brought by either Lessor or Lessee against the other for personal injury or property damage, Lessor and Lessee hereby waive trial by jury in any action or proceeding or counterclaim brought by either against the other on any matter whatsoever arising out of or in any way connected with this lease, the relationship of Lessor and Lessee, or Lessee's use or occupancy of the Leased Premises, including any emergency or other statutory remedy with respect thereto. 21. NOTICE: All notices of any nature referred to in this Lease Agreement shall be in writing and shall be deemed to have been given (i) when presented personally, (ii) three (3) business days after being deposited in a regularly maintained receptacle for the United States Postal Services, postage prepaid, registered or certified, return receipt requested or (iii) the next business day after delivery by any reputable overnight delivery service (ie., Federal Express, Airborne, etc.) to the respective addresses set forth below or to such other address as the respective parties hereto may designate in writing: To the Lessor: Rotterdam Ventures, Inc. d/b/a Galesi Enterprises c/o Galesi Management Corporation 100 State Street Albany, New York, 12207 With a copy to: Rotterdam Ventures, Inc. Rotterdam Industrial Park, Building 6 Schenectady, New York 12306 Attn: General Counsel or to such other address as Lessor may hereafter designate by notice to Lessee. 21 22 To the Lessee: Pete's Brewing Company 514 High Street Palo Alto, California 94301 Attn: Human Resources or to such other address as Lessee may hereafter designate by notice to Lessor. 22. BROKERAGE: Lessee hereby warrants and represents that Quadrelle Realty and Newmark Real Estate Company are the sole brokers concerned with this Lease Agreement. Lessor agrees that it will pay the commission of said brokers in accordance with separate agreements. Lessee shall indemnify and hold Lessor harmless against and from any and all claims for any brokerage commissions or other loss, damages, costs, expenses and liabilities, including, without limitation, attorneys' fees arising out of any misrepresentation or alleged misrepresentation of the foregoing representation. 23. ENTIRE AGREEMENT: The whole and entire agreement of the parties is set forth in this Lease Agreement and the parties are not bound by any agreements, understandings or conditions otherwise than as expressly set forth and stipulated hereunder. 24. CHANGES, MODIFICATIONS OR AMENDMENTS: This Lease Agreement may not be changed, modified, discharged or terminated orally or in any other manner than by an agreement signed by the parties hereto or their respective successors and assigns. 25. SEVERABILITY. If any provision of this Lease Agreement or its application to any situation, shall be invalid or unenforceable to any extent, the remainder of this Lease Agreement, or the application thereof to situations other than that as to which it is invalid or unenforceable, shall not be affected thereby, and every provision of this Lease Agreement shall be valid and enforceable to the fullest extent permitted by law. 26. COVENANTS TO BIND RESPECTIVE PARTIES: The covenants, agreements, conditions and provisions of this Lease Agreement shall be binding upon and inure to the benefit of Lessor and Lessee and their respective heirs, distributors, executors, administrators, successors and permitted assigns, except that no assignment or subletting in violation of the provisions of Paragraph 18 shall operate to vest any rights in any successor assignee or subtenant. 27. BUILDING NAME: The Lessor, for itself and its successors and assigns reserves the right to change the name of the Premises, now generally known as 145 Huguenot Street, or the address of the Premises or to designate additional addresses therefore, on Notice to Lessee. Lessee shall not use such name, or any similar name, on its letterhead or any advertising material. 28. CERTIFICATE: Lessee and Lessor agree, at any time and from time to time, upon not less than ten (10) days prior request by one party to the other, to execute, acknowledge and deliver a statement in writing certifying that this Lease Agreement is unmodified and is in full force and effect (or if there have been modifications, that the same is in full force and effect as modified and stating the modifications), the commencement date of this Lease Agreement, of any other existing status of the Lease Agreement, and the dates to which the rent and other charges have been paid in advance, if any, it being intended that any such statement delivered pursuant to this Paragraph may be relied upon by a prospective purchaser or mortgagee of the Leased Premises. 22 23 29. LESSEES REPRESENTATIONS: Lessee represents to Lessor that it has made a thorough examination and inspection of the Leased Premises and is familiar with the condition of every part thereof. Lessee agrees that it enters into this Lease Agreement without any representations or warranties by Lessor or any of its agents, representatives, employees or servants or by any other person as to the condition of the Leased Premises, and Lessee agrees to accept the Leased Premises on the commencement date "as is" in its then condition, without any alterations, improvements, repairs or decorations to be made by Lessor, except as hereinabove otherwise provided. 30. LESSE'S REMEDIES: Lessee shall look only to Lessor's estate and property in the Premises of which the Leased Premises are a part (or the proceeds thereof) for the satisfaction of Lessee's remedies for the collection of a judgment (or other judicial process) requiring the payment of money by Lessor in the event of any default by Lessor hereunder, and no other property or assets of Lessor or its partners or principals, disclosed or undisclosed, shall be subject to levy, execution, or other enforcement procedure for the satisfaction of Lessee's remedies under or with respect to this Lease Agreement, the relationship of Lessor and Lessee hereunder or Lessee's use and occupancy of the Leased Premises. 31. SECURITY: Lessee has deposited with Lessor the sum of $3,520.00 as security for the full and faithful performance and observance by Lessee of Lessee's obligations under this Lease Agreement upon execution of said Lease Agreement, beyond any applicable notice and cure periods. If Lessee defaults in the full and prompt payment and performance of any of Lessee's obligations under this Lease Agreement including, without limitation, the payment of Fixed Rent and Additional Rent, Lessor may use or apply the whole or any part of the security so deposited to the extent required for the payment of any Fixed Rent and Additional Rent or any other sum as to which Lessee is in default, beyond any applicable notice and cure periods or for any sum which Lessor may expend or may be required to expend by reason of Lessee's defaults, beyond any applicable notice and cure periods. If Lessor shall so use or apply the whole or any part of the security, Lessee shall, upon demand, immediately deposit with Lessor a sum equal to the amount so used, or applied as security aforesaid. If Lessee shall fully and faithfully comply with all of Lessee's obligations under this lease, the security or any balance thereof shall be returned to Lessee upon the termination of the lease and after delivery to the Lessor of entire possession of the Leased Premises. In the event of any sale of Lessor's interest in the Premises, Lessor shall have the right to transfer the security to the vendee and Lessor shall thereupon be released by Lessee from all liability for the return of such security. The security deposit shall be deposited by Lessor in an interest bearing account and interest earned by the security deposit is for the account of the Lessee. 32. GOVERNING LAW: The terms and conditions of this lease shall be construed and interpreted under the laws of the State of New York. 23 24 IN WITNESS WHEREOF, the undersigned have executed this Lease Agreement as of the date first above written. ROTTERDAM VENTURES, INC. d/b/a GALESI ENTERPRISES LESSOR BY:___________________________ Name:_________________________ Title:________________________ PETE'S BREWING COMPANY LESSEE BY:/s/ JEFFREY A. ATKINS --------------------------- Name:Jeffrey A. Atkins --------------------------- Title:CEO --------------------------- 24 25 ACKNOWLEDGEMENTS STATE OF NEW YORK ) ) SS.: COUNTY OF ) On this _____ day of ________, 1997, before me personally came _____________________, to me known, and known to me to be the ______________________ of Rotterdam Ventures, Inc., the corporation described in and which executed the within instrument, who being by me duly sworn did depose and say that the said ______________________ resides at __________________, and the he/she signed his/her name thereto by order of the Board of Directors of said corporation. ------------------------------- Notary Public STATE OF NEW YORK ) ) SS.: COUNTY OF ) On this ____ day of ________________, 1997, before me personally came _________________________, to me known, and known to me to be the _____________________ of _______________________, the ___________________ described in and which executed the within instrument, who being by me duly sworn did depose and say that the said ___________________ resides at ______________________, and the he/she signed his/her name thereto by order of the _________________________ of said _______________________. ------------------------------- Notary Public 25 26 EXHIBIT A - RENTAL SCHEDULE 1320 square feet - 145 Huguenot Street Tenant: Pete's Brewing Company Contact: Bill Brennen Lease Term: Three (3) Years Lease Rates: Year 1-3 $16.00 per square foot $2.00 per square foot per year electrical for Parking: One (1) permanent on-site space and One (1) temporary on-site space. Lessor may terminate the temporary on-site space upon sixty (60) days notice to Lessee. PREPARED July 25,1997 26 27 EXHIBIT B - DRAWING [FLOOR PLAN] 27 28 EXHIBIT C - WORK LETTER WORK LETTER 145 Huguenot Street New Rochelle, New York, 10801 1 Lessor will install interior wall partitions (5/8 inch sheetrock) as per drawing. 2. Lessor will paint entire Leased Premises two (2) coats, eggshell finish. Color to be chosen by Lessee. 3 Lessor will carpet entire Leased Premises with 20 oz. level loop carpeting. Color to be chosen by Lessee. 4. Lessor will replace any discolored or broken ceiling tiles. 5. Lessor will replace all burnt out bulbs. 6. Lessor will change all locks. 28 29 EXHIBIT D RULES AND REGULATIONS 1. The sidewalks, entrances, passages, courts or halls shall not be obstructed by Lessee or used for any purpose other than ingress and egress to and from the demised premises. Nothing shall be thrown out of windows or doors or down passages of Premises. 2. Movement of goods in or out of the Premises shall only be effected through the rear entrance. No hand trucks, carts, etc., shall be used in the Premises unless equipped with rubber tires and side guards. 3. The skylights, windows, and doors that reflect or admit light and air into the halls, or other public places in the Premises shall not be covered or obstructed by Lessee, nor shall anything be placed on the window sills. 4. The water and wash closets and other plumbing fixtures shall not be used for any purposes other than those for which they were constructed, and no rubbish, rags or other substances shall be thrown therein. All damages resulting from any misuse of the fixtures shall be borne by the Lessee who, or whose employees, agents, visitors or licensees, shall have caused the same. 5. No Lessee shall make, paint, drill into, or in any way deface any part of the demised premises or the Premises of which they form a part. No boring, cutting or stringing of wires shall be permitted, except with the prior written consent of the Lessor, and as the Lessor may direct. 6. No Lessee shall make, or permit to be made, any unseemly or disturbing noises or disturb or interfere with occupants of this or neighboring premises or buildings. 7. No Lessee or any of Lessee's employees, agents or visitors or licensees, shall bring or keep upon the demised premises any inflammable, combustible or explosive fluid, chemical or substance, other than those used in the normal course of business, or allow any unusual or objectionable odors to be produced upon the demised premises, or permit animals or birds to be brought or kept on the premises. 8. No machine may be operated on the premises without the written consent of the Lessor, except for normal business machines. Machinery shall be placed in approved settings to absorb or prevent any noise or annoyance. 9. No Lessee shall place a load upon any floor of the Premises exceeding the floor load per square foot area which such floor was designed to carry, and all floor loads shall be evenly distributed. All removals or deliveries of any safes, freight, furniture or bulky matter of any description must take place during the hours which the Lessor or Lessor's agent may determine from time to time, The Lessor reserves the right to prescribe the weight and position of all safes, which must be placed so as to distribute the weight. The Lessor reserves the right to inspect all freight to be brought into the Premises and to exclude from the Premises all freight which violates any of the Rules and Regulations. l0. Canvassing, soliciting and peddling in the Premises are prohibited and each Lessee shall cooperate to prevent the same. 11. No air conditioning unit or system, portable electric heater or similar apparatus shall be installed or used by any Lessee without the written consent of the Lessor. 12. Unless specifically designated within the Premises by the Lessor, the Premises , Leased Premises and common areas have been designated by Lessor as non-smoking areas. No smoking will be permitted in the Premises , unless Lessor has designated a specific smoking area. 13. Lessee shall not permit its employees, agents, visitors or licensees to loiter within the Premises or on the adjoining sidewalks. 14. Lessor reserves the right to change, amend or otherwise revise the Premises Standard rules and regulations as Lessor deems reasonable and necessary. 29 30 15. SORTING AND SEPARATION OF REFUSE AND TRASH (a) Compliance by Lessee. Lessee covenants and agrees, at its sole cost and expense, to comply with all applicable present and future laws, orders, and regulations of all state, federal, municipal, and local governments, departments, commissions, and boards regarding the collection, sorting, separation, and recycling of waste products, garbage, refuse, and trash. Lessee shall sort and separate such waste products, garbage, refuse, and trash into such categories as provided by law. Each separately sorted category of waste products, garbage, refuse, and trash shall be placed in separate receptacles reasonably approved by Lessor. Such separate receptacles may, at Lessor's option, be removed from the Leased Premises in accordance with a collection schedule prescribed by law. (b) Lessor's Rights in Event of Noncompliance. Lessor reserves the right to refuse to collect or accept from Lessee any waste products, garbage, refuse, or trash that is not separated and sorted as required by law, and to require Lessee to arrange for such collection at Lessee's sole cost and expense, utilizing a contractor satisfactory to Lessor. Lessee shall pay all costs, expenses, fines, penalties, or damages that may be imposed on Lessor or Lessee by reason of Lessee's failure to comply with the provisions of this Paragraph, and, at Lessee's sole cost and expense, shall indemnify, defend, and hold Lessor harmless (including legal fees and expenses) from and against any actions, claims, and suits arising from such noncompliance, utilizing counsel reasonably satisfactory to Lessor. 30 31 EXHIBIT E CLEANING/JANITORIAL SPECIFICATIONS 145 Huguenot Street New Rochelle, New York A. GENERAL - DAILY (MONDAY THROUGH FRIDAY EXCEPT HOLIDAYS) 1. Common Area: a. Wash all entrance door and all adjacent glass (interior/exterior). b. Vacuum mats, sweep/mop floors, maintain walls, cigarette urns, interior surfaces of lobby, elevators, and corridors (including entry from parking lot). c. Clean and wipe all water coolers. d. Lavatory floors swept and mopped; all basins, bowls, urinals, and toilet seats to be cleaned with disinfectant; all mirrors to be washed; and wash all tile walls, dividing partitions and doors. e. Empty and clean all waste receptacles; fill all dispensers with supplies (to be furnished by Lessor). f. Maintain all storage/janitor rooms in clean or orderly condition. g. Collect all rubbish and place in designated area for disposal. 2. Leased Premises: a. Tile floors swept and dust mopped. b. Dust all office furniture and furnishings. c. Clean ashtrays and waste receptacles. d. Clean entrance doors, doorways and wall areas adjoining switches/outlets. e. Vacuum all carpet as required. f. Collect all rubbish and place in designated area for disposal. B. SPECIAL - FREQUENCY AS NOTED 1. Common Area: a. Tile floors swept and dust-mopped. b. Weekly, high dust all walls, partitions, doorways, moldings, HVAC louvres, and wall fixtures. c. Weekly, low dust window sills and baseboards. 2. Leased Premises: a. Weekly, high dust all walls, partitions, doorways, moldings, HVAC louvers, wall hangings, and light fixtures. b. Weekly, low dust all window sills and baseboards. c. Bi-annually, wash all perimeter windows, inside and outside. d. Annually, machine scrub all tile floors and apply high- gloss, no-skid, water- resistant polish. e. Annually, hot water extract all carpeting. 31 EX-23.1 5 CONSENT OF INDEPENDENT ACCOUNTANTS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statement of Pete's Brewing Company and Subsidiary on Form S-8 (File No. 333-1308) of our report dated February 18, 1998, on our audits of the financial statements and financial statement schedule of Pete's Brewing Company and Subsidiary as of December 31, 1997 and 1996 and for the years ended December 31, 1997, 1996 and 1995 which reports are included in this Annual Report on Form 10-K. COOPERS & LYBRAND L.L.P. San Jose, California March 27, 1998 EX-27.1 6 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, 1997, AS SHOWN IN THE 10-K FILING. 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 18,841 12,358 1,396 184 2,617 39,615 4,056 0 49,094 3,622 0 0 0 48,803 14 49,094 58,336 58,336 30,683 0 38,669 0 0 (9,925) 3,831 (6,094) 0 0 0 (6,094) (.57) (.57)
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