| As of December 31, 2005, the Company had a cash balance of dlra416cmam000, accounts receivable of dlra2dtta8 million and negative working capital |
| In March 2006, the Company renegotiated its line of credit which makes available through March 2007, a dlra2dtta5 million line of credit |
| At December 31, 2005, there were no borrowings on the line of credit |
| Although the Company expects the initiatives discussed in “Liquidity and Capital Resources” to drive additional sales and eliminate redundant costs, there is no guarantee that the savings will be sufficient to meet the cash operating and investing needs of the Company |
| Beverage Competition |
| The domestic market in which the Company’s craft beers compete is highly competitive for many reasons, including the continuing proliferation of new beers and brew-pubs, efforts by regional craft brewers to expand their distribution, the introduction of fuller-flavored products by certain major national brewers, and underutilized craft brewing capacity |
| Additionally, a recent change in the Washington State law will make it easier for out-of-state brewers to ship directly to retailers rather than shipping through distributors, which could increase competition and create pricing pressure for companies such as ours that use 8 _________________________________________________________________ [74]Table of Contents traditional distribution channels |
| The Company anticipates that intensifying competition from craft beer and imported beer producers and excess capacity in the craft beer segment may adversely impact the Company’s operating margins |
| In addition, the larger national brewers have developed brands to compete directly with craft beers |
| These national competitors have advantages such as lower production costs, larger marketing budgets, greater financial and other resources and more developed and extensive distribution networks than the Company |
| There can be no assurance that the Company will be able to grow its volumes or be able to maintain its selling prices in existing markets or as it enters new markets |
| Alehouse Competition |
| The restaurant industry is highly competitive |
| There are a substantial number of restaurant operations that compete directly and indirectly with the Company, many of which have significantly greater financial resources, higher revenues and greater economies of scale |
| The restaurant business is often affected by changes in consumer tastes and discretionary spending patterns, national and regional economic, demographic trends, the cost and availability of raw materials, labor and energy, purchasing power, governmental regulations and local competitive factors |
| Any change in these or other related factors could adversely affect the Company’s restaurant operations |
| Access to Markets |
| Most of the Company’s independent distributors are also distributors of national brewers, some of whom have used their greater influence and marketing resources to persuade those distributors to exclude the products of other breweries from their portfolios |
| Such actions by national brewers have the effect of reducing distribution options for the Company’s products |
| In addition, many independent distributors are moving towards consolidation to improve profit margins |
| Although the Company has not yet been negatively impacted by such events, it is possible that the Company could effectively be denied access to a market or markets by the tactics of the national brewers and further consolidation of independent distributors |
| In the states that comprise the majority of its sales, the Company has the option to distribute its products directly to retailers |
| However, there is no assurance that self-distribution can be done in an economic manner over large territories |
| Government Regulations, Policies and Audits |
| We could be adversely affected by changes in and compliance with governmental policies and regulations with respect to our products, including the adoption by the TTB of more restrictive application of the excise tax rules, which it recently announced would take effect beginning September 2006 |
| The Company’s business is highly regulated at the federal, state and local levels, and its brewery and restaurant operations require various licenses, permits and approvals |
| The loss or revocation of any existing licenses, permits or approvals, or the failure to obtain any additional licenses, permits or approvals in new jurisdictions where the Company intends to do business could have a material adverse effect on the ability of the Company to conduct its business |
| Further, federal regulations prohibit, among other things, the payment of slotting allowances to retailers for beer products |
| These regulations have the effect of preventing competitors with greater financial resources from excluding smaller brewers from retailers |
| If these regulations were repealed or substantially modified, there would likely be a material adverse effect on the Company’s business and operating results |
| The TTB is currently auditing the Company’s federal excise tax returns and related operations for the period of May 1, 2003 to November 30, 2005 |
| Among other operational and compliance matters that are being audited, the TTB is reviewing the Company’s contract brewing arrangement with Portland Brewing |
| Because the TTB audit is still underway, the Company is unable at this time to predict the outcome of the TTB’s review of this arrangement |
| The Company believes the outcome of the TTB’s audit is uncertain because of possible differences between the Company’s and the TTB’s interpretive positions on federal excise tax laws that relate to contract brewing arrangements due to the recently announced more restrictive application of the excise tax rules with respect to alternating proprietorships |
| Although the contract brewing arrangement between the Company and Portland Brewing is materially different from an alternating proprietorship arrangement, both may result in tax reductions relative to production by a single proprietor, and the TTB’s announcement regarding alternating proprietorships may indicate an intent to apply a restrictive interpretation of the excise tax rules that apply to contract brewing relationships |
| If the TTB were to conclude that the contract brewing arrangement with Portland Brewing did not, for some period, qualify under the applicable legal requirements for such arrangements, the Company believes that the TTB would impute to the Company the production and/or removals from bond of beer produced at the Brewery |
| In that case, the TTB 9 _________________________________________________________________ [75]Table of Contents could assert a claim against the Company for underpayment of federal excise taxes for prior periods, the aggregate exposure of which could amount to approximately dlra1dtta5 million, including penalties which could have a material adverse effect on the Company’s business and operating results |
| Retention of Management Personnel |
| Our success is dependent in large part on the continued employment and performance of key executive and managerial personnel and our ability to attract and retain additional highly qualified personnel |
| We compete for key personnel with other companies |
| Our ability to maintain and expand our business may be impaired if we are unable to retain our current key personnel, hire or retain other qualified personnel in the future, or if our key personnel decided to join a competitor or otherwise competed with us |
| Stock Price Volatility |
| The trading price of our common stock may be highly volatile |
| Our common stock price could be subject to fluctuations in response to a number of factors, including: • actual or anticipated variations in quarterly operating results; • changes in financial estimates or recommendations by securities analysts; • conditions or trends in the craft beer, specialty beer or specialty restaurant markets; • announcements by us or our competitors of significant gains or losses of distributors, or new products, or other developments; • announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments; • additions or departures of key personnel; • sales of a large number of shares of our common stock; • adverse litigation; • unfavorable legislative or regulatory decisions; and • general market conditions |
| In the past, companies that have experienced volatility in the market price of their stock have been the target of securities class action litigation |
| We may become the target of this type of litigation in the future |
| Securities litigation against us could result in substantial costs and divert management attention, which could seriously harm our business |
| Selling Prices |
| The future selling prices the Company charges for its craft beer and other specialty beverages may decrease from historical levels due to increasing competitive pressures, which may adversely affect the Company’s revenues |
| The Company has and will continue to participate in price promotions with its wholesalers to their retail customers |
| Management believes that the number and frequency of the Company’s promotions may increase during 2006 |
| Increased costs associated with these promotions may adversely affect the Company’s operating results |
| Variability of Margins and Operating Results |
| The Company anticipates that its operating margins will fluctuate and may decline as a result of many factors, including (i) lower sales volumes and selling prices, (ii) increased depreciation and other fixed and semi-fixed operating costs as a percent of sales during periods when the Company’s breweries are producing below designed capacity, (iii) increased raw material and packaging costs, (iv) changes in product mix and packaging, (v) increased transportation costs, (vi) increased sales from retail operations which may have a lower gross margin (as a percentage of net sales) than beer sales, and (vii) increased selling and promotional costs incurred as the Company protects its business in existing markets |
| The Company pays federal excise taxes on all beer sales and pays state excise taxes on beer sales occurring in various states at various tax rates |
| Increases in federal or state excise taxes and the impact of an increasing average federal excise tax rate as production increases may also cause a decline in the Company’s gross margins |
| Our business is subject to seasonal fluctuations |
| Historically, sales have been higher during the summer months |
| As a result, our quarterly and annual operating results and comparable sales may fluctuate significantly as a result of seasonality and other factors |
| Accordingly, results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for any year and comparable sales for any particular future period may decrease |
| Public Safety and Health |
| The Company’s breweries and alehouses are subject to the Federal Food, Drug and Cosmetic Act, as well as other state laws and other regulations |
| The Company is also subject to “dram shop” laws in most states where it currently operates |
| These laws generally provide a person injured by an intoxicated person the right to recover damages from an establishment which wrongfully served alcoholic beverages to such person |
| The Company carries liquor liability coverage as part of its existing comprehensive general liability insurance, which it believes is consistent with coverage carried by other entities in the restaurant industry |
| However, a judgment against the Company under a “dram shop” statute in excess of the Company’s liability coverage could have a material adverse effect on the Company |
| Additionally, multi-unit foodservice operations such as the Company’s can also be substantially affected by adverse publicity resulting from food quality, illness, injury, health concerns or operating issues stemming from a single restaurant |
| The Company attempts to manage these factors, but the occurrence of any one of these factors could cause the entire Company, beverage and alehouse operations, to be adversely affected |
| Inclement Weather |
| Inclement weather conditions can impact customer traffic at our alehouses and cause the temporary underutilization of our seating capacity and adversely affect the Company’s operating results |