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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2004[  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
 For the transition period from            to             . Commission file number 0-27116    PYRAMID BREWERIES INC.  Washington
(State or other jurisdiction of
incorporation or organization)
    
    91-1258355
(I.R.S. Employer
Identification No.)
 91 South Royal Brougham Way,
Seattle, WA 98134
(Address of principal executive offices) (Zip Code) Registrants telephone number, including area code: (206) 682-8322    Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes
[  ]  No [X] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes
[  ]  No [X] Common stock, par value of $.01 per share: 8,765,845 shares of Common
Stock outstanding as of September 30, 2004 1




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PYRAMID BREWERIES INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 TABLE OF CONTENTS PagePART IFINANCIAL INFORMATIONItem 1. Financial StatementsUnaudited Condensed Consolidated Balance Sheets September 30, 2004 and December 31, 2003
    
    
    3Unaudited Condensed Consolidated Statements of Operations Three Month and Nine Month Periods Ended September 30, 2004 and 2003
    
    
    4Unaudited Condensed Consolidated Statements of Cash Flows Nine Month Periods Ended September 30, 2004 and 2003
    
    
    5Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    19Item 4. Controls and Procedures
    
    
    19PART IIOTHER INFORMATIONItem 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    19Item 6. Exhibits
    
    
    20SIGNATURE
    
    
    21EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 31.3EXHIBIT 32.1EXHIBIT 32.2EXHIBIT 32.3
  2




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PART I 
 Item 1  FINANCIAL STATEMENTS PYRAMID BREWERIES INC. 
 UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands) September 30,
    
    December 31,2004
    
    2003CURRENT ASSETS:Cash and cash equivalents
    
    $
    
    
    
    $
    1,558Short term investments
    
    
    300
    
    
    
    492Accounts receivable, net of $32 and $20 allowance
    
    
    2,836
    
    
    
    1,281Inventories
    
    
    2,629
    
    
    
    1,654Prepaid expenses and other
    
    
    529
    
    
    
    756Total current assets
    
    
    6,294
    
    
    
    5,741Note receivable related party
    
    
    
    
    
    
    81Fixed assets, net
    
    
    28,964
    
    
    
    21,406Goodwill
    
    
    415
    
    
    
    415Other assets
    
    
    456
    
    
    
    141Total assets
    
    $
    36,129
    
    
    $
    27,784CURRENT LIABILITIES:Accounts payable
    
    $
    3,163
    
    
    $
    1,349Accrued expenses
    
    
    2,567
    
    
    
    1,562Refundable deposits
    
    
    641
    
    
    
    487Line of credit
    
    
    231
    
    
    
    Short-term note payable to related party
    
    
    7,200
    
    
    
    Note payable-current
    
    
    20
    
    
    
    20Deferred rent  current
    
    
    75
    
    
    
    199Dividends payable
    
    
    193
    
    
    
    379Total current liabilities
    
    
    14,090
    
    
    
    3,996Note payable, net of current portion
    
    
    20
    
    
    
    16Deferred rent, net of current portion
    
    
    632
    
    
    
    1,569Total liabilities
    
    
    14,742
    
    
    
    5,581COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Preferred stock, 10,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, $.01 par value; 40,000,000 shares authorized,
8,766,000 and 8,620,000 shares issued and outstanding
    
    
    88
    
    
    
    86Additional paid-in capital
    
    
    36,793
    
    
    
    36,374Note receivable  related party
    
    
    
    
    
    
    (764
    )Deferred stock-based compensation
    
    
    
    
    
    
    (27
    )Accumulated deficit
    
    
    (15,494
    )
    
    
    (13,466
    )Total stockholders equity
    
    
    21,387
    
    
    
    22,203Total liabilities and stockholders equity
    
    $
    36,129
    
    
    $
    27,784
 The accompanying notes are an integral part of these unaudited condensed consolidated statements. 3




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PYRAMID BREWERIES INC. 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts) Three Month Period Ended September 30,
    
    Nine Month Period Ended September 30,2004
    
    2003
    
    2004
    
    2003Gross sales
    
    $
    11,745
    
    
    $
    10,765
    
    
    $
    30,971
    
    
    $
    27,624Less excise taxes
    
    
    532
    
    
    
    493
    
    
    
    1,475
    
    
    
    1,327Net sales
    
    
    11,213
    
    
    
    10,272
    
    
    
    29,496
    
    
    
    26,297Cost of sales
    
    
    8,898
    
    
    
    8,082
    
    
    
    23,221
    
    
    
    20,451Gross margin
    
    
    2,315
    
    
    
    2,190
    
    
    
    6,275
    
    
    
    5,846Selling,
general and administrative expenses
    
    
    2,738
    
    
    
    2,264
    
    
    
    7,641
    
    
    
    6,348Operating loss
    
    
    (423
    )
    
    
    (74
    )
    
    
    (1,366
    )
    
    
    (502
    )Other income, net
    
    
    3
    
    
    
    118
    
    
    
    99
    
    
    
    268(Loss) income before income taxes
    
    
    (420
    )
    
    
    44
    
    
    
    (1,267
    )
    
    
    (234
    )Provision for income taxes
    
    
    
    
    
    
    
    
    
    
    (3
    )
    
    
    (2
    )Net (loss) income
    
    $
    (420
    )
    
    $
    44
    
    
    $
    (1,270
    )
    
    $
    (236
    )Basic and
diluted net (loss) income per share
    
    $
    (0.05
    )
    
    $
    0.01
    
    
    $
    (0.15
    )
    
    $
    (0.03
    )Weighted average shares outstanding
    
    
    8,615
    
    
    
    8,456
    
    
    
    8,512
    
    
    
    8,439Weighted
average diluted shares outstanding
    
    
    8,615
    
    
    
    8,655
    
    
    
    8,512
    
    
    
    8,439Cash dividends declared per share
    
    $
    0.022
    
    
    $
    0.044
    
    
    $
    0.088
    
    
    $
    0.132
 The accompanying notes are an integral part of these unaudited condensed consolidated statements. 4




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PYRAMID BREWERIES INC. 
 UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) Nine Month Period Ended September 30,2004
    
    2003OPERATING ACTIVITIES:Net loss
    
    $
    (1,270
    )
    
    $
    (236
    )Adjustments to reconcile net loss to net cash provided by
operating activities:Depreciation and amortization
    
    
    1,973
    
    
    
    1,767Stock-based compensation expense
    
    
    3
    
    
    
    40Accretion of discount on long-term debt
    
    
    4
    
    
    
    3Loss on sales of fixed assets
    
    
    10
    
    
    
    1Deferred rent
    
    
    (116
    )
    
    
    689Changes in operating assets and liabilities, net of business acquired:Accounts receivable
    
    
    (597
    )
    
    
    17Inventories
    
    
    (417
    )
    
    
    (220
    )Prepaid expenses and other
    
    
    147
    
    
    
    (148
    )Accounts payable and accrued expenses
    
    
    1,575
    
    
    
    998Refundable deposits
    
    
    50
    
    
    
    15Net cash provided by operating activities
    
    
    1,362
    
    
    
    2,926INVESTING ACTIVITIES:Purchases of short-term investments
    
    
    
    
    
    
    (2,455
    )Proceeds from the sale and maturities of short-term
investments
    
    
    192
    
    
    
    4,355Proceeds from sales of fixed assets
    
    
    11
    
    
    
    Acquisition of Berkeley facility land and building
    
    
    (195
    )
    
    
    Acquisition of Portland Brewing Company assets
    
    
    (1,416
    )
    
    
    Acquisition of fixed assets
    
    
    (769
    )
    
    
    (3,082
    )Net cash used in investing activities
    
    
    (2,177
    )
    
    
    (1,182
    )FINANCING ACTIVITIES:Proceeds from the sale of common stock and option exercises
    
    
    203
    
    
    
    117Note receivable
    
    
    
    
    
    
    22Net borrowings on line of credit
    
    
    231
    
    
    
    Deferred financing fees
    
    
    (68
    )
    
    
    Borrowings on short-term note payable to related party
    
    
    200
    
    
    
    Cash dividends paid
    
    
    (944
    )
    
    
    (1,126
    )Purchases and retirement of common stock
    
    
    (365
    )
    
    
    Net cash used in financing activities
    
    
    (743
    )
    
    
    (987
    )(Decrease) increase in cash and cash equivalents
    
    
    (1,558
    )
    
    
    757Cash and cash equivalents at beginning of period
    
    
    1,558
    
    
    
    596Cash and cash equivalents at end of period
    
    $
    
    
    
    $
    1,353Supplemental DataInterest paid
    
    $
    91
    
    
    $
    Purchase of facility with debt
    
    $
    7,000
    
    
    $
    Stock issued for purchase of Portland Brewing Company assets
    
    $
    1,474
    
    
    $
    Note Receivable repaid through stock repurchase
    
    $
    843
    
    
    $
    
 The accompanying notes are an integral part of these unaudited condensed consolidated statements. 5




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PYRAMID BREWERIES INC. 
 NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION: Pyramid Breweries Inc. (the Company), a Washington corporation, is
engaged in the brewing, marketing and selling of craft beers and premium sodas
and in restaurant operations. The Company operates breweries in Seattle,
Washington, Portland, Oregon and in Berkeley, Walnut Creek and Sacramento,
California. Effective July 31, 2004, the Company completed its acquisition of
the brewing and restaurant assets of Portland Brewing Company located in
Portland Oregon. The Portland Brewing Company asset acquisition and related
results of operations, for the months of August and September, are included in
the presentation of the financial statements of the three and nine month
periods ended September 30, 2004 as the purchase occurred during the period
being reported. The Company sells its beer through a network of selected
independent distributors and alehouse locations primarily in Washington, Oregon
and California. The Companys core brands include Pyramid, MacTarnahan and
Thomas Kemper Soda, its other smaller product lines are reported under the
Allied Brand designation and include Thomas Kemper Beer, Saxer, and NorWester.
The Company also manufactures a line of gourmet sodas under the Thomas Kemper
Soda Company label. As of September 30, 2004, the Companys products were
distributed in approximately 35 states and Canada. As of September 30, 2004,
the Company also operated five restaurants adjacent to its breweries under the
Pyramid Alehouse and MacTarnahans Taproom brand names. The Company established a new entity, PBC Acquisition LLC, for the express
purpose of acquiring certain assets from Portland Brewing Company. The assets
of this entity are consolidated into the Companys unaudited condensed
consolidated financial statements for financial reporting purposes. Effective July 23, 2004, the Company completed its purchase of the
Berkeley Brewery and Alehouse facility located at 901 Gilman Street, Berkeley,
California 94710. Previously the Company had leased this facility. The
Companys lease obligations terminated with its purchase of the facility. The accompanying unaudited condensed consolidated financial statements
have been prepared by the Company, without audit, in accordance with accounting
principles generally accepted in the United States for interim financial
information and pursuant to the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the accompanying unaudited
condensed consolidated financial statements contain all material adjustments,
consisting only of those of a normal recurring nature, considered necessary for
a fair presentation of the Companys financial position, results of operations
and cash flows at the dates and for the periods presented. The operating
results for the interim periods presented are not necessarily indicative of the
results expected for the full year. For a presentation including all
disclosures required by generally accepted accounting principles, these
financial statements should be read in conjunction with the audited financial
statements for the year ended December 31, 2003, included in the Annual Report
on Form 10-K. Stock Based Compensation At September 30, 2004, the Company has stock-based compensation plans
which are described more fully in the 2003 Annual Report and in Appendix A of
the 2004 Proxy Statement for the 2004 Equity Compensation Plan. The Company
accounts for those plans under the recognition and measurement principles of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued
to Employees, and related interpretations. The Company has adopted the
disclosure-only provisions of Statement of Financial Accounting Standards
(SFAS) No. 123 Accounting for Stock-Based Compensation. Accordingly, no
compensation cost has been recognized for the fair value of options issued
under the Employee and Director Plans (the Plans) except as described in Note 5
and except that the Company is committed to granting 175,000 shares of
restricted stock, and an additional 175,000 shares if certain performance
criteria are met, to its CEO over a six year period as per the terms of his
employment agreement. The Company has recorded $13,000 in stock based
compensation costs in the three month period ended September 30, 2004 related
to these stock grants. Had compensation cost been recognized based on the fair
value at the date of grant for options awarded under the Plans, the pro forma
amounts of the Companys net income (loss) and net income (loss) per share for
the three and nine month periods ended September 30, 2004 and 2003, would have
been as follows: 6




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Three Month Period Ended September 30,
    
    Nine Month Period Ended September 30,2004
    
    2003
    
    2004
    
    2003(in thousands, except
per share amounts)Net income (loss) as reported
    
    $
    (420
    )
    
    $
    44
    
    
    $
    (1,270
    )
    
    $
    (236
    )Add: Stock-based compensation cost as reported
    
    
    13
    
    
    
    (24
    )
    
    
    3
    
    
    
    40Less: Stock-based compensation cost determined under the
fair value based method
    
    
    (32
    )
    
    
    (41
    )
    
    
    (124
    )
    
    
    (167
    )Net loss pro forma
    
    $
    (439
    )
    
    $
    (21
    )
    
    $
    (1,391
    )
    
    $
    (363
    )Basic and diluted net income (loss) per share as reported
    
    $
    (0.05
    )
    
    $
    0.01
    
    
    $
    (0.15
    )
    
    $
    (0.03
    )Basic and diluted net income (loss) per share pro forma
    
    $
    (0.05
    )
    
    $
    (0.00
    )
    
    $
    (0.16
    )
    
    $
    (0.04
    )
 7




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Revenue Recognition The Company recognizes revenue from the sale of wholesale beer and soda
products at the time of shipment, when the title of the Companys products
passes to the customer, in accordance with distributor sales agreements, and
collectibility is probable. The Companys revenue from its alehouses is
comprised of food, beverage and merchandise, and is recognized at the time of
sale. 2. PORTLAND BREWING COMPANY ASSET ACQUISITION On July 31, 2004, the Company completed its purchase of certain Portland
Brewing Company assets. Per the asset purchase agreement, Pyramid Breweries
Inc. acquired Portland Brewing Companys brewery and alehouse for total
consideration including transaction costs of approximately $4.01 million, consisting of a combination of
assumed liabilities, cash and Pyramid common stock. The terms of the
transaction also include a 5-year earn out which may result in additional
payments to Portland Brewing Company based on sales of Portland Brewing brands
during the earn-out period. In addition to the purchase price, the Company
incurred an estimated $300,000 in transaction costs, including consulting fees
and amounts relating to legal and accounting charges. The results of operations
of the acquired assets of Portland Brewing Company since July 31, 2004 to
September 30, 2004 are included in Pyramids statement of operations for the
three and nine month periods ended September 30, 2004. The assets acquired from Portland Brewing Company, including the alehouse
and brewery assets, were acquired because of their strategic fit within the
existing Pyramid operations. The Portland Taproom provides a venue for
Portland area residents to sample Company products, the Portland brewery
provides a production facility in the mature Oregon craft beer markets. The
acquisition is intended to bring together two pivotal players in the craft
brewing industry and position the Company for growth across all businesses,
including beer, soda and restaurants as well as strengthening its position in
the key West Coast markets. The acquisition was accounted for as a business combination under SFAS 141
Business Combinations. Accordingly, the purchase price has been allocated to
the assets acquired and liabilities assumed on the basis of their respective
fair values on the acquisition date. 445,434 shares were issued in conjunction
with the asset purchase. The allocation of the purchase price is preliminary
as the Company has not yet received all of the information it has arranged to
obtain. The following unaudited pro forma information represents the results of
operations for Pyramid Breweries Inc and Portland Brewing Company for the three
and nine month periods ended September 30, 2004 and 2003, as if the asset
purchase had been consummated as of January 1, 2004 and January 1, 2003,
respectively. This pro forma information does not purport to be indicative of
what may occur in the future: (Unaudited)
    
    (Unaudited)
    
    (Unaudited)
    
    (Unaudited)Three Month Period Ended September 30,
    
    Nine Month Period Ended September 30,(in thousands except
per share amounts)2004
    
    2003
    
    2004
    
    2003Net sales
    
    
    12,328
    
    
    
    13,393
    
    
    
    35,245
    
    
    
    33,885Net (loss) income
    
    $
    (879
    )
    
    $
    270
    
    
    $
    (2,295
    )
    
    $
    (929
    )Basic and diluted net (loss) income per share
    
    $
    (0.10
    )
    
    $
    0.03
    
    
    $
    (0.26
    )
    
    $
    (0.10
    )Weighted average basic and diluted shares
outstanding
    
    
    8,765
    
    
    
    8,902
    
    
    
    8,858
    
    
    
    8,847
 The following represents the preliminary allocation of the purchase price
to the acquired assets and assumed liabilities of Portland Brewing Company and
is for illustrative purposes only. This allocation is preliminary and based on
Portland Brewing Companys assets and liabilities as of July 31, 2004. (in thousands)Net tangible assets acquired:Cash
    
    $
    3Accounts receivable
    
    
    958Inventories
    
    
    573Property, plant and equipment
    
    
    2,452Other long-term assets
    
    
    24Total purchase price
    
    $
    4,010
 Net tangible assets consists of cash, accounts receivable, inventories,
property plant and equipment and other assets. Portland Brewing Company`s
current assets, property, plant and equipment assets and liabilities assumed
were adjusted based on the fair value of those 8




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assets acquired and liabilities assumed. Based on a preliminary assessment,
Pyramid management believes there is not significant value associated with the
intangible assets acquired as part of the asset purchase agreement. 3. INVENTORIES Inventories consist of the following: September 30,
    
    December 31,2004
    
    2003(in thousands)Raw materials
    
    $
    1,226
    
    
    $
    664Work in process
    
    
    72
    
    
    
    155Finished goods
    
    
    1,331
    
    
    
    835$
    2,629
    
    
    $
    1,654
 Raw materials primarily include ingredients, flavorings and packaging.
Work in process includes beer held in fermentation prior to the filtration and
packaging process. Finished goods primarily include product ready for
shipment, as well as promotional merchandise held for sale. Inventory levels
experience fluctuations in carrying levels and values based on seasonality. 4. FIXED ASSETS Fixed assets consist of the following: September 30,
    
    December 31,2004
    
    2003(in thousands)Land
    
    $
    6,188
    
    
    $
    Building
    
    
    11,901
    
    
    
    Brewery and retail equipment
    
    
    19,194
    
    
    
    16,402Furniture and fixtures
    
    
    1,024
    
    
    
    952Leasehold improvements
    
    
    5,853
    
    
    
    17,587Construction in progress
    
    
    251
    
    
    
    10144,411
    
    
    
    35,042Less: accumulated depreciation
and amortization
    
    
    (15,447
    )
    
    
    (13,636
    )$
    28,964
    
    
    $
    21,406
 In conjunction with the acquisition of the Berkeley alehouse and brewing
facility, the Company reclassified the Berkeley facility leasehold improvements
of $11,847,000 from the leasehold improvement category to buildings as well as
extended the depreciable lives of the building assets from the lease term to 40
years for depreciation calculation purposes. 5. NOTE RECEIVABLE FROM RELATED PARTY In June 2001, the Company issued a $787,000 full recourse note to Martin
Kelly, the Companys Chief Executive Officer (CEO) in connection with the
exercise of options for 387,400 shares of the Companys common stock. In
addition, the Company issued a $115,000 full recourse note to Mr. Kelly to fund
his payment of taxes on the exercise of the options. The notes were due on the
earlier of June 30, 2011 or upon the sale of the stock and had an annual
interest rate of 5.6%. A total of 135,100 of those shares were unrestricted,
except for being pledged as collateral for the notes, and the remaining 252,300
shares were due to become unrestricted by December 2004. On February 26, 2004 the Company announced that Mr. Kelly was stepping
down as CEO. Mr. Kellys last official day was March 10th, 2004. Per the full
recourse note agreement dated June 2001 with Mr. Kelly, upon termination he had
the right to require the Company to buy-back the 387,400 shares collateralizing
the promissory notes and pay any balances owed under the notes, with any net
cash balance made payable to Mr. Kelly. On April 9, 2004, Mr. Kelly exercised
his right and the Company repurchased the 387,400 shares at a five day average
market price of $3.18 per share. The total sales value of $1,233,000 was
applied to the notes payable in the amount of $843,000, to interest balances in
the amount of $25,000 and the balance of $365,000 was paid to Mr. Kelly. This
arrangement was accounted for as a variable equity-based compensation
arrangement. 6. ACCRUED EXPENSES Accrued expenses consist of the following: 9




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September 30,
    
    December 31,2004
    
    2003(in thousands)Salaries, wages and related accruals
    
    $
    1,144
    
    
    $
    529Barrel taxes
    
    
    165
    
    
    
    100Other accruals
    
    
    1,258
    
    
    
    933$
    2,567
    
    
    $
    1,562
 7. OTHER INCOME, NET Other income, net consists of interest, lease and parking fee income,
interest expense and other non-operating income and expenses as follows:. Three Month Period
    
    Nine Month PeriodEnded September 30,
    
    Ended September 30,2004
    
    2003
    
    2004
    
    2003(in thousands)Interest income
    
    $
    5
    
    
    $
    16
    
    
    $
    18
    
    
    $
    54Lease income
    
    
    36
    
    
    
    
    
    
    
    36
    
    
    
    Interest expense
    
    
    (94
    )
    
    
    (1
    )
    
    
    (96
    )
    
    
    (4
    )Loan fee amortization
    
    
    (22
    )
    
    
    
    
    
    
    (24
    )
    
    
    Parking income
    
    
    77
    
    
    
    91
    
    
    
    161
    
    
    
    183Loss on sale of assets
    
    
    1
    
    
    
    
    
    
    
    (10
    )
    
    
    (1
    )Other income
    
    
    
    
    
    
    12
    
    
    
    14
    
    
    
    36Other income, net
    
    $
    3
    
    
    $
    118
    
    
    $
    99
    
    
    $
    268
 8. INCOME (LOSS) PER SHARE Basic (loss) income per share was computed by dividing net (loss) income
by the weighted average number of shares of common stock outstanding during the
period, excluding shares subject to repurchase. Diluted income per share was
computed by dividing net income by the weighted average number of common shares
of common stock outstanding plus additional common shares that would be
outstanding from in-the-money stock options. The net effect of stock options
has not been included in the calculation of diluted net loss per share as the
effect is antidilutive. Options to purchase approximately 174,000 shares of
common stock were outstanding during the three month period ended September 30,
2004, but were not included in the computation of loss per share because their
effects are antidulutive. Options to purchase approximately 197,000 and 188,000 shares of common
stock were outstanding during the nine month period ended September 30, 2004
and 2003, respectively, but were not included in the computations of loss per
share because their effects are antidilutive. Three Month Period Ended September 30,
    
    Nine Month Period Ended September 30,2004
    
    2003
    
    2004
    
    2003(in thousands except
per share amounts)Net (loss) income
    
    $
    (420
    )
    
    $
    44
    
    
    $
    (1,270
    )
    
    $
    (236
    )Shares:Weighted average shares outstanding
    
    
    8,615
    
    
    
    8,556
    
    
    
    8,512
    
    
    
    8,539Shares subject to repurchase
    
    
    
    
    
    
    (100
    )
    
    
    
    
    
    
    (100
    )Weighted average basic shares outstanding
    
    
    8,615
    
    
    
    8,456
    
    
    
    8,512
    
    
    
    8,439Basic (loss) income per share
    
    $
    (0.05
    )
    
    $
    0.01
    
    
    $
    (0.15
    )
    
    $
    (0.03
    )Stock option dilution
    
    
    
    
    
    
    199
    
    
    
    
    
    
    
    Weighted average diluted shares outstanding
    
    
    8,615
    
    
    
    8,655
    
    
    
    8,512
    
    
    
    8,439Diluted (loss) income per share
    
    $
    (0.05
    )
    
    $
    0.01
    
    
    $
    (0.15
    )
    
    $
    (0.03
    )
 9. BANK LINE OF CREDIT AND SHORT-TERM DEBT The Company entered into a $2,000,000 line of credit (the Line of Credit)
for short-term operating needs on May 14, 2004. The Line of Credit revolves
through May 14, 2006. At that date, any outstanding balance will be due in
full. Borrowings under the Line of Credit will accrue interest at the banks
prime rate plus 25 basis points. A portion of the Line of Credit was used to
meet the additional operating cash needs of the Portland Brewing Company asset
acquisition, as well as covering the purchase and transaction costs. As of
September 30, 2004, the Company had borrowed $231,000 on the line of credit.
The Line of Credit is secured by the Companys accounts receivable. 10




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##### Table of Contents



Effective July 23, 2004, the Company completed its purchase of the
Berkeley Brewery and Alehouse facility located at 901 Gilman Street, Berkeley,
California 94710. The $7,000,000 purchase price and related costs were
financed with a short-term $7,200,000 secured
loan from Sugar Mountain Capital, LLC, a party related to Pyramid
Breweries Inc. The short-term note has been secured by a Deed of Trust against
the property. Sugar Mountain Capital, LLC is controlled by Mr. Kurt Dammeier,
who is a Director of Pyramid Breweries Inc. and is Pyramids largest
shareholder. The terms of the short-term financing, approved by the Companys
Board and Audit Committee, include interest only monthly payments through
maturity on January 23, 2005, at a stated interest rate of 6.26%. 10. COMMITMENTS AND CONTINGENCIES The Company is involved from time to time in claims, proceedings and
litigation arising in the ordinary course of business. The Company does not
believe that any such claim, proceeding or litigation, either alone or in the
aggregate, will have a material adverse effect on the Companys financial
position or results of operations. 11. CASH DIVIDEND The Board of Directors announced on September 17, 2004, the declaration of
a $0.022 per common share dividend payable on October 15, 2004 to shareholders
of record on September 30, 2004. The cash dividends declared totaled
approximately $193,000 for all common stock outstanding as of the record date. Cash dividends declared per common share: Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2004
    
    $
    0.022
    
    
    $
    0.0882003
    
    $
    0.044
    
    
    $
    0.132
 The Board of Directors announced on November 3, 2004, the declaration of a
$0.022 per common share dividend payable on January 15, 2004 to shareholders of
record on December 31, 2004. The cash dividends declared totaled approximately
$193,000 for all common stock outstanding as of the record date. Although the Company has declared and paid a dividend every quarter since
the fourth quarter of 1999, continued future declaration of dividends will
depend on, among other things, the Companys liquidity and ability to pay
obligations as they come due, which will depend on results of operations,
capital requirements and financial condition, and on such other factors as the
Companys Board of Directors may in its discretion consider relevant and in the
best long term interest of the shareholders. 12. SEGMENT INFORMATION The Company follows the provisions of SFAS No. 131 Disclosures about
Segments of an Enterprise and Related Information, and reports segment
information in the same format as reviewed by the Companys management (the
Management Approach), which is organized around differences in products and
services. Products and Services The Companys reportable segments include beverage operations and
alehouses. Beverage operations include the production and sale of Company
beverage products including both beer and soda. The alehouse segment consists
of five full-service alehouses, which market and sell the full line of the
Companys beer and soda products as well as food and certain merchandise. Factors used to identify reportable segments The Companys reportable segments are strategic business units that offer
different products and services. These segments are managed separately because
each business requires different production, management and marketing
strategies. Measurement of segment profit and segment assets The accounting policies of the segments are the same as those described in
the summary of critical accounting policies included in the notes to the
financial statements included in the Companys most recent Form 10-K. The
Company evaluates performance based on profit or loss from operations before
income taxes not including nonrecurring gains and losses. The Company records
intersegment sales at cost. Segment profit and segment assets are as follows: 11




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##### Table of Contents



Beverage
    
    
    
    
    
    Corporate andOperations
    
    Alehouse
    
    Other
    
    Total(in thousands)Quarter ended September 30, 2004Gross revenues from external customers
    
    $
    7,941
    
    
    $
    3,804
    
    
    $
    
    
    
    $
    11,745Net revenues from external customers
    
    
    7,409
    
    
    
    3,804
    
    
    
    
    
    
    
    11,213Intersegment revenues
    
    
    161
    
    
    
    
    
    
    
    (161
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    5Depreciation and amortization
    
    
    382
    
    
    
    203
    
    
    
    46
    
    
    
    631Operating income (loss)
    
    
    687
    
    
    
    218
    
    
    
    (1,328
    )
    
    
    (423
    )Capital expenditures operating
    
    
    209
    
    
    
    108
    
    
    
    68
    
    
    
    385Capital expenditures acquisition
    
    
    8,750
    
    
    
    1,140
    
    
    
    195
    
    
    
    10,085Total assets
    
    
    21,341
    
    
    
    6,691
    
    
    
    8,097
    
    
    
    36,129Quarter ended September 30, 2003Gross revenues from external customers
    
    $
    6,777
    
    
    $
    3,988
    
    
    $
    
    
    
    $
    10,765Net revenues from external customers
    
    
    6,284
    
    
    
    3,988
    
    
    
    
    
    
    
    10,272Intersegment revenues
    
    
    143
    
    
    
    
    
    
    
    (143
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    16Depreciation and amortization
    
    
    393
    
    
    
    210
    
    
    
    53
    
    
    
    656Operating income (loss)
    
    
    703
    
    
    
    297
    
    
    
    (1,074
    )
    
    
    (74
    )Capital expenditures
    
    
    75
    
    
    
    564
    
    
    
    36
    
    
    
    675Total assets
    
    
    18,659
    
    
    
    6,929
    
    
    
    4,209
    
    
    
    29,797Nine months ended September 30, 2004Gross revenues from external customers
    
    $
    20,601
    
    
    $
    10,370
    
    
    $
    
    
    
    $
    30,971Net revenues from external customers
    
    
    19,126
    
    
    
    10,370
    
    
    
    
    
    
    
    29,496Intersegment revenues
    
    
    397
    
    
    
    
    
    
    
    (397
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    18
    
    
    
    18Depreciation and amortization
    
    
    1,186
    
    
    
    634
    
    
    
    153
    
    
    
    1,973Operating income (loss)
    
    
    1,994
    
    
    
    487
    
    
    
    (3,847
    )
    
    
    (1,366
    )Capital expenditures operating
    
    
    415
    
    
    
    200
    
    
    
    154
    
    
    
    769Capital expenditures acquisition
    
    
    8,750
    
    
    
    1,140
    
    
    
    195
    
    
    
    10,085Total assets
    
    
    21,341
    
    
    
    6,691
    
    
    
    8,097
    
    
    
    36,129Nine months ended September 30, 2003Gross revenues from external customers
    
    $
    18,382
    
    
    $
    9,242
    
    
    $
    
    
    
    $
    27,624Net revenues from external customers
    
    
    17,055
    
    
    
    9,242
    
    
    
    
    
    
    
    26,297Intersegment revenues
    
    
    323
    
    
    
    
    
    
    
    (323
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    54
    
    
    
    54Depreciation and amortization
    
    
    1,166
    
    
    
    446
    
    
    
    155
    
    
    
    1,767Operating income (loss)
    
    
    1,816
    
    
    
    704
    
    
    
    (3,022
    )
    
    
    (502
    )Capital expenditures
    
    
    464
    
    
    
    2,493
    
    
    
    125
    
    
    
    3,082Total assets
    
    
    18,659
    
    
    
    6,929
    
    
    
    4,209
    
    
    
    29,797
 12




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##### Table of Contents



Corporate and Other Corporate and other consists of interest income, general, administrative
and marketing expense, corporate office assets and other reconciling items that
are not allocated to segments for internal management reporting purposes.
Total assets included in corporate and other include all assets except for
accounts receivable, inventory, goodwill and fixed assets, which are presented
by segment. 
 Item 2  Managements Discussion and Analysis of Financial Condition and
Results of Operations RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain
selected unaudited operating data, expressed as a percentage of net sales. SELECTED UNAUDITED OPERATING DATA (dollars in thousands) Three Month Period Ended September 30,% of
    
    
    
    
    
    % of2004
    
    Net Sales
    
    2003
    
    Net SalesGross sales
    
    $
    11,745
    
    
    
    
    
    
    $
    10,765Less excise taxes
    
    
    532
    
    
    
    
    
    
    
    493Net sales
    
    
    11,213
    
    
    
    100.0
    
    
    
    10,272
    
    
    
    100.0Cost of sales
    
    
    8,898
    
    
    
    79.4
    
    
    
    8,082
    
    
    
    78.7Gross margin
    
    
    2,315
    
    
    
    20.6
    
    
    
    2,190
    
    
    
    21.3Selling, general and administrative expenses
    
    
    2,738
    
    
    
    24.4
    
    
    
    2,264
    
    
    
    22.0Operating income
    
    
    (423
    )
    
    
    (3.8
    )
    
    
    (74
    )
    
    
    (0.7
    )Other income, net
    
    
    3
    
    
    
    0.0
    
    
    
    118
    
    
    
    1.1Income before income taxes
    
    
    (420
    )
    
    
    (3.7
    )
    
    
    44
    
    
    
    0.4Provision for income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income(loss)
    
    $
    (420
    )
    
    
    (3.7
    )
    
    $
    44
    
    
    
    0.4Basic and diluted net income(loss) per share
    
    $
    (0.05
    )
    
    
    
    
    
    $
    0.01Operating data (in barrels):Beer barrels shipped
    
    
    40,645
    
    
    
    
    
    
    
    31,720Soda barrels shipped
    
    
    11,273
    
    
    
    
    
    
    
    13,925Total barrels shipped
    
    
    51,918
    
    
    
    
    
    
    
    45,645Annual production capacity
    
    
    335,000
    
    
    
    
    
    
    
    204,000
 13




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##### Table of Contents



Nine Month Period Ended September 30,% of
    
    
    
    
    
    % of2004
    
    Net Sales
    
    2003
    
    Net Sales(in thousands except
per share amounts)Gross sales
    
    $
    30,971
    
    
    
    
    
    
    $
    27,624Less excise taxes
    
    
    1,475
    
    
    
    
    
    
    
    1,327Net sales
    
    
    29,496
    
    
    
    100.0
    
    
    
    26,297
    
    
    
    100.0Cost of sales
    
    
    23,221
    
    
    
    78.7
    
    
    
    20,451
    
    
    
    77.8Gross margin
    
    
    6,275
    
    
    
    21.3
    
    
    
    5,846
    
    
    
    22.2Selling, general and administrative expenses
    
    
    7,641
    
    
    
    25.9
    
    
    
    6,348
    
    
    
    24.1Operating loss
    
    
    (1,366
    )
    
    
    (4.6
    )
    
    
    (502
    )
    
    
    (1.9
    )Other income, net
    
    
    99
    
    
    
    0.3
    
    
    
    268
    
    
    
    1.0Loss before income taxes
    
    
    (1,267
    )
    
    
    (4.3
    )
    
    
    (234
    )
    
    
    (0.9
    )Provision for income taxes
    
    
    (3
    )
    
    
    (0.0
    )
    
    
    (2
    )
    
    
    (0.0
    )Net loss
    
    $
    (1,270
    )
    
    
    (4.3
    )
    
    $
    (236
    )
    
    
    (0.9
    )Basic and diluted net loss per share
    
    $
    (0.15
    )
    
    
    
    
    
    $
    (0.03
    )Operating data (in barrels):Beer barrels shipped
    
    
    101,714
    
    
    
    
    
    
    
    86,920Soda barrels shipped
    
    
    33,069
    
    
    
    
    
    
    
    34,702Total barrels shipped
    
    
    134,783
    
    
    
    
    
    
    
    121,622
 QUARTER ENDED SEPTEMBER 30, 2004 COMPARED TO QUARTER ENDED SEPTEMBER 30, 2003 Gross Sales.Gross sales increased 9.1% to $11,745,000 in the third
quarter ended September 30, 2004 from $10,765,000 in the same quarter of 2003.
Wholesale beverage segment sales increased 17.2% to $7,941,000 in the third
quarter ended September 30, 2004 from $6,777,000 in the same quarter of 2003.
Total beer shipments increased 28.1%, to 40,645 barrels principally as a result
of the addition of the Portland Brewing Company barrelage. The additional
barrelage added to the Pyramid family include MacTarnahans, Saxer, NorWester
and the licensed Buffalo Bills products. These products added 8,069 barrels to
the 30,553 barrels of Pyramid, 634 of Thomas Kemper beer and 1,389 of contract
brewing products. Shipments of Thomas Kemper Soda totaled 11,273 barrels, down
19% from a year ago. Total beverage shipments amounted to 51,918 barrels in
the quarter, increasing 13.7% from the prior year period. Total beverage
shipments increased in all of the Companys major sales regions over the same
period in 2003. Pyramid Hefeweizen, the Companys top selling product, was up
6.0% in shipment volumes for the quarter. Alehouse sales decreased 4.6%, to
$3,804,000 in the third quarter ended September 30, 2004, from $3,988,000 in
the same quarter of 2003. Excluding the Sacramento Alehouse, which opened in
July 2003, and the Portland Taproom acquired in July 2004, the same store
alehouse sales decreased $145,000 or 4.8% due to lower traffic at the Seattle,
Washington alehouse location. Excise Taxes.Excise taxes totaled 6.7% and 7.3% of gross beverage sales
for the quarters ended September 30, 2004 and 2003, respectively. The decrease
in excise taxes as a percentage of gross sales was due mainly to the excise tax
on the products produced at the Portland, OR Brewing facility which are paid at
the lower tax rate as the Portland Brewing Company has not exceeded the 60,000
barrels threshold, thereby lowering the average per barrel tax paid in total as
Pyramid has exceeded the limit and is paying the higher $18 per barrel tax. Per
beer barrel shipped excise taxes decreased to $13.09 per beer barrel from
$15.54 per beer barrel. Federal taxes paid on beer shipments is determined by
the level of shipments. A 60,000 barrel threshold exists at the federal level,
resulting in incremental volume being taxed at an $18 per beer barrel rate
versus a $7 per beer barrel rate on production below 60,000 barrels. State
taxes per barrel vary on a state by state basis. The Company calculates a
weighted average cost per beer barrel for the year based on the tax rates in
order to allocate excise tax costs throughout the year. Gross Margin. Gross margin increased $125,000 to $2,315,000, an increase
of 5.7% in the quarter ended September 30, 2004. Although gross margin dollars
increased as a result of higher sales volumes on the beverage side of the
business and increased alehouse sales with the addition of the Portland
Taproom, the gross margin as a percentage of sales decreased. The decrease in
gross margin as a percentage of sales is primarily the result of increasing
labor, utility and freight costs as well as the integration costs related to
the Portland Brewing and restaurant operations. 14




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##### Table of Contents



Three Month Period Ended September 30,Gross
    
    
    
    
    
    GrossGross Margin
    
    2004
    
    Margin %
    
    2003
    
    Margin %
    
    $ Change
    
    % ChangeBeverage Division
    
    $
    1,951
    
    
    
    26.3
    %
    
    $
    1,808
    
    
    
    28.8
    %
    
    $
    143
    
    
    
    7.9
    %Alehouse Division
    
    
    364
    
    
    
    9.6
    %
    
    
    382
    
    
    
    9.6
    %
    
    
    (18
    )
    
    
    -4.7
    %Total
    
    $
    2,315
    
    
    
    20.6
    %
    
    $
    2,190
    
    
    
    21.3
    %
    
    $
    125
    
    
    
    5.7
    %
 Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the third quarter increased $474,000 over the same
period in 2003. The additional expense was primarily attributed to $190,000
of increases in selling expenses expected to drive future beverage division
sales, $73,000 in additional marketing expenses for advertising, special events
and promotions, $80,000 increase in legal, accounting and other costs
associated with filings required as a public company, additional internal
travel and administrative expenses related to the integration of the Portland
Brewing Company business and other personnel related payroll expenses. Other Income, net. Other income, net was approximately $3,000 for the
quarter ended September 30, 2004 as compared to $118,000 in the same quarter of
2003. Lower investment balances on cash equivalents and short-term investments
caused the decline in interest income to $5,000 from $16,000 for the quarters
ended September 30, 2004 and 2003, respectively. Interest expense was $94,000
and $1,000 for quarters ended September 30, 2004 and 2003. The increase in
interest expense was due primarily to the Berkeley facility purchase and
associated debt to finance the purchase. Loan fee amortization in the amount of
$22,000 was recorded in connection with the financing of the Berkeley facility
and the opening of a line of credit. Lease income of $36,000 for quarter ended
September 30, 2004 was related to subleasing a portion of the Berkeley facility
to a third party tenant. Income Taxes. The Company recorded no income tax expense in the third
quarter. For the most part, however, the Company recorded no income tax for the
quarters ended September 30, 2004 and 2003 because it has recorded a full
valuation allowance against its net operating loss carryforwards. Net Income(Loss). The Company reported a net loss of $420,000 for the
quarter ended September 30, 2004 compared to net income of $44,000 in the same
quarter of 2003. NINE MONTH PERIOD ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTH PERIOD ENDED
SEPTEMBER 30, 2003 Gross Sales.Gross sales increased 12.1% to $30,971,000 for the nine
month period ended September 30, 2004 from $27,624,000 in the same period of
2003. Wholesale beverage sales increased 12.1% to $20,601,000 for the nine
month period ended September 30, 2004 from $18,382,000 in the same period of
2003. Total beverage barrel shipments increased 10.8% compared to the same
period in the prior year. Pyramid beer brand shipments increased 6.8% to
89,862 barrels, while MacTarnahan brand shipments were 1,581, Allied Brand
shipments increased to 7,784. Shipments of Thomas Kemper Soda decreased by 4.7%
to 33,069 barrels from 34,702 barrels in the same nine month period of the
prior year. Alehouse sales increased 12.2%, to $10,369,000 in the nine month
period ended September 30, 2004, from $9,242,000 in the same period of 2003.
The increase was driven by the Sacramento Alehouse, which opened in July 2003,
contributing $1,977,000 in sales for the nine months ended September 30, 2004.
Excluding the Sacramento Alehouse sales increase of $1,003,000 and the Portland
Taproom sales increase of $350,000 the same store alehouse sales decreased
$226,000 or 2.7% largely due to lower traffic at the Seattle, Washington and
Walnut Creek, California Alehouse locations. Excise Taxes.Excise taxes totaled 7.2% of gross beverage sales for each
of the nine month periods ended September 30, 2004 and 2003. Per beer barrel
shipped excise taxes decreased to $14.50 per beer barrel from $15.27 per beer
barrel. This per barrel decrease is the result of the lower excise tax
requirements on the products produced by the Portland brewery facility. A
60,000 barrel threshold exists for beer shipments with volume being taxed at an
$18 per beer barrel rate once 60,000 barrels is attained versus a $7 per beer
barrel rate on production below 60,000 barrels. The Company calculates a
weighted average cost per beer barrel for the year based on the tax rates in
order to allocate excise tax costs throughout the year. Gross Margin. Gross margin increased $429,000 to $6,275,000, or 7.3% for
the nine month period ended September 30, 2004 due to higher beverage volumes,
the addition of the Sacramento Alehouse and Portand Brewery and the absence of
$89,000 of pre-opening expenses incurred in preparation of the opening for the
Sacramento Alehouse in 2003. 15




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##### Table of Contents



Nine Month Period Ended September 30,Gross
    
    
    
    
    
    GrossGross Margin
    
    2004
    
    Margin %
    
    2003
    
    Margin %
    
    $ Change
    
    % ChangeBeverage Operations
    
    $
    5,430
    
    
    
    28.4
    %
    
    $
    4,962
    
    
    
    29.1
    %
    
    $
    468
    
    
    
    9.4
    %Alehouse Operations
    
    
    845
    
    
    
    8.1
    %
    
    
    884
    
    
    
    9.6
    %
    
    
    (39
    )
    
    
    (4.4
    %)Total Operations
    
    $
    6,275
    
    
    
    21.3
    %
    
    $
    5,846
    
    
    
    22.2
    %
    
    $
    429
    
    
    
    7.3
    %
 Selling, General and Administrative Expenses.Selling, general and
administrative expenses for the first nine months of 2004 increased to
$7,641,000, compared to $6,348,000 incurred during the first nine months of
2003. The $1,293,000 additional expense was attributed to an increase in
administrative expenses, including $434,000 of non-recurring costs related to
changing the Companys CEO, $139,000 of additional legal, accounting and
compliance costs associated with being a public company, as well as a
non-recurring $99,000 state and local tax refund recorded in 2003 as an expense
reduction. The additional $621,000 increase is the result of costs related to
the integration of Portland Brewing Company operations, increases in selling
and personnel related expenses which are expected to drive future beverage
division sales and improve alehouse sales, quality and consistency as well as
additional marketing activities. Other Income, net. Other income, net was approximately $99,000, or 0.3% of
net sales for the nine month period ended September 30, 2004 compared to
$268,000, or 1.0% of net sales in the same period of 2003. Lower investment
balances on cash equivalents and short-term investments caused the decline in
interest income. Interest income was $18,000 and $54,000 for each of the nine
month periods ended September 30, 2004 and 2003, respectively. Interest expense
was $96,000 and $4,000 for the nine month period ended September 30, 2004 and
2003, respectively. The increase was due primarily to the Berkeley facility
purchase. Lease income of $36,000 for the nine month ended September 30, 2004
was related to leasing part of the Berkeley facility. Loan fee amortization in
the amount of $24,000 was recorded in connection with the financing of the
Berkeley facility and the opening of a line of credit. Other income, recorded
in connection with the related party loans, decreased to $14,000 from $36,000
as the loan balance was paid off as part of the stock buy-back arrangement with
the former Company CEO. A loss on the disposal of fixed assets in the amount of
$10,000 was recorded during the nine month period ended September 30, 2004,
primarily related to the upgrade and replacement of brewery production
equipment, which also added to the decline of other income, net. Income Taxes. The Company recorded approximately $3,000 of income tax
expense in the nine month period ended September 30, 2004 related to certain
state tax expenses. For the most part, however, the Company recorded no income
tax for the periods ended September 30, 2004 and 2003. A valuation allowance
was recorded against the deferred tax asset for the benefits of tax losses
which may not be realized. Realization of the deferred tax assets is dependent
on the Companys ability to generate future U.S. taxable income. The Company
does not believe that its net deferred assets meet the more likely than not
realization criteria of SFAS No. 109. Accordingly, a full valuation allowance
has been established. The Company will continue to evaluate the realizability
of the deferred tax assets quarterly by assessing the need for and amount of
the valuation allowance. Net Loss. The Company reported a net loss of $1,270,000 for the nine
month period ended September 30, 2004 compared to a net loss of $236,000 in the
same period of 2003. LIQUIDITY AND CAPITAL RESOURCES The Company had approximately $300,000 of short-term investments at
September 30, 2004 compared to $2,050,000 of cash, cash equivalents and
short-term investments at December 2003. At September 30, 2004, the Company had
working capital of negative $7,796,000 compared to positive $1,745,000 at
December 31, 2003. The negative working capital as of September 30, 2004 is a
result of $7,200,000 of short term financing related to the Berkeley facility
purchase, a line of credit of $231,000 to finance the Portland Brewing Company
asset acquisition and capital spending related to various brewery and alehouse
projects, $365,000 for the purchase and retirement of stock related to the
former CEO arrangement and $944,000 paid out in cash dividends, offset by
$1,362,000 of cash provided by operating activities which included a $1,575,000
increase in accounts payable and other various current asset and liability
changes. Net cash provided by operating activities during the nine month period
ended September 30, 2004 was approximately $1,362,000 compared to $2,926,000
for the same period of the prior year. The decrease in net cash provided by
operating activities was due primarily to an increased net loss and a
nonrecurring tenant improvement credit of $800,000 paid to Pyramid Breweries
Inc. by the landlord of the Sacramento Alehouse received in 2003. Net cash used in investing activities for the nine month period ended
September 30, 2004 was $2,177,000 compared to net cash used in investing
activities of $1,182,000 for the same period of the prior year. The cash used
in investing activities in 2004 included $195,000 for the costs associated with
the acquisition of the Berkeley facility land and building purchase, $1,416,000
for the acquisition of certain Portland Brewing Company assets, approximately
$415,000 for brewery equipment and improvements, $200,000 for alehouse
equipment and upgrades and $154,000 for information systems and computer system
upgrades and replacements. 16




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During the quarter two events occurred requiring a change in the
contractual obligation table presented in the Companys Form 10-K as of the
year ended December 31, 2003, as follows:.  
    
    A financing arrangement was entered into related to the purchase of
the Berkeley Alehouse and Brewery facility located in Berkley,
California. The purchase of the Berkeley facility occurred on July 23,
2004. The $7,000,000 purchase price and related costs were financed
with a short-term $7,200,000 secured loan from Sugar Mountain Capital,
LLC, a party related to Pyramid Breweries Inc. The note is due in
January 2005. Pyramid previously leased this facility. Concurrent with
purchase of the facility, Pyramids lease obligations for the facility
ended.  
    
    With the purchase of the Portland Brewing Company assets the Company
entered into three operating leases for the restaurant and brewing
facilities located in Portland Oregon. The Company entered into two
separate ten year leases for the building located at 2730 NW
31st for
$5,833 per month for the brewery space and $7,500 per month for the
restaurant space. The Company also entered into a third operating lease
for the building located at 2750 NW 31st for the brewery facilities
expiring in 2008 for $12,576 per month, with one three year option and
two five year options to renew. On December 15, 1999, the Company announced its first regular quarterly
cash dividend and has declared and paid a quarterly cash dividend each
consecutive quarter since the initial declaration. During the quarter ended
September 30, 2004 the Company declared per share dividends of $0.022 and paid
out $183,000 in cash dividends. During the second quarter of 2004, the Board of
Directors made the decision to reduce the dividend by 50% due to the strategic
shift of the Company with an increased focus on growth. Although the Company
has declared and paid a dividend every quarter since the fourth quarter of
1999, continued future declaration of dividends will depend on, among other
things, the Companys results of operations, capital requirements and financial
condition, and on such other factors as the Companys Board of Directors may in
its discretion consider relevant and in the best long term interest of the
shareholders. On December 15, 1999, the Company also announced a stock buyback plan to
repurchase up to $2,000,000 of the Companys common stock from time to time on
the open market. Stock purchases are at the discretion of management and
depend, among other things, on the Companys results of operations, capital
requirements and financial condition, and on such other factors as the
Companys management may consider relevant. As of September 30, 2004, the
Company has purchased and retired a total of 457,724 shares at an average price
of $1.94 per share for a total of $892,000 since the inception of the program.
The Company has not repurchased any shares under the stock buyback plan since
November 2001. On February 26, 2004, the Company announced that Martin Kelly was stepping
down as Chairman and Chief Executive Officer. In connection with Mr. Kellys
termination, there were amounts due to him related to salary continuation
payments under his employment agreement. Additionally, Mr. Kelly had the right
to sell his shares of Company stock back to the Company, which resulted in
acceleration of repayment of the notes due to the Company related to his
original purchase of those shares. The net cash impact of Mr. Kelly selling
his shares to the Company was a function of the then current market price of
the Companys stock, reduced by the balance of the notes outstanding at that
time. On April 9, 2004 Mr. Kelly exercised his right requiring the Company to
repurchase his shares at the average market price of $3.18 per share. The
proceeds from the purchase were used to reduce Mr. Kellys notes payable to the
Company in the amount of $843,000, payoff interest balances owed on the notes
in the amount of $25,000 with net proceeds of $365,000 paid in cash to Mr.
Kelly. Effective July 23, 2004, the Company completed its purchase of the Berkeley
Brewery and Alehouse facility located at 901 Gilman Street, Berkeley,
California 94710. The $7,000,000 purchase price and related costs were
financed with a short-term $7,200,000 secured loan from Sugar Mountain Capital,
LLC, a party related to Pyramid Breweries Inc. The short-term loan has been
secured by a Deed of Trust against the property. The Company chose to obtain
financing from Sugar Mountain Capital, LLC because it offered the most
competitive financing proposal among several provided by lenders to the
Company. Sugar Mountain Capital, LLC is controlled by Mr. Kurt Dammeier, who
is a Director of Pyramid Breweries Inc. and is Pyramids largest shareholder.
The terms of the short-term financing, approved by the Companys Board and
Audit Committee, include interest only monthly payments through maturity in
January, 2005 at a stated interest rate of 6.26%. The Company intends to
replace this short-term financing with permanent financing within the next four
months at market based terms. There is no guarantee that such financing will
be available on commercially acceptable terms. . The Company has a $2,000,000 line of credit (the Line of Credit) for
short-term operating needs. The Line of Credit revolves through May 14, 2006.
At that date, any outstanding balance will be due in full. Borrowings under the
Line of Credit will accrue interest at the banks prime rate plus 25 basis
points. A portion of the Line of Credit was used to meet the additional
operating cash needs of the Portland Brewing Company asset acquisition, as well
as covering the purchase and transaction costs. As of September 30, 2004, the
Company had borrowed $231,000 on the Line of Credit. Effective at the close of business on July 31, 2004, the Company completed
its purchase of certain Portland Brewing Company assets. The Company acquired
Portland Brewing Companys brewery and alehouse assets for total consideration
of approximately $4.01 million, consisting of a combination of assumed
liabilities, cash and unregistered Pyramid common stock. The terms of the
transaction also include a 5-year earn-out which may result in additional
payments to Portland Brewing Company based on sales of Portland Brewing 17




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##### Table of Contents



brands during the earn-out period. The earn-out payments are calculated
annually based on shipments of the Portland Brewing Company brands. A per
barrel payment is due on all barrels in excess of 45,000 barrels per calendar
year. The expected effect of the transaction is to solidify core Portland
Brewing and Pyramid brands and open new markets. Portland Brewings Northwest
Portland brewery and Taproom restaurant will continue to operate and will join
Pyramids family of breweries and restaurants. Future capital requirements may vary depending on such factors as the cost
of acquiring businesses, brands and real estate in the markets selected for
future expansion, whether such real estate is leased or purchased, and the
extent of improvements necessary. Planned projects include the permanent
financing of the Berkley Brewery and Alehouse facility, upgrading of the
brewing equipment and alehouse facilities purchased from the Portland Brewing
Company and the continued upgrading of equipment and alehouse facilities in the
Seattle, Berkeley and Walnut Creek locations. While there can be no assurance
that current expectations will be realized and plans are subject to change upon
further review, the Company believes that its cash balances, together with cash
from operations and, to the extent required and available, bank borrowings,
will be sufficient for the Companys working capital needs. Critical Accounting Policies and Estimates The Company believes that its critical accounting policies and estimates
include the following: Long-Lived Assets Impairment.The Company reviews its long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset group may not be recoverable. The Companys
evaluation is based on an estimate of the future undiscounted net cash flows of
the related asset or asset group over the remaining life in measuring whether
the assets are recoverable. Long-lived assets to be disposed of are evaluated
in relation to the estimated fair value of such assets less the estimated costs
to sell. Long-lived assets are written down to their estimated net fair value
calculated using a discounted future cash flow analysis in the event of an
impairment. Beginning in the fiscal year 2002, the Company accounts for
long-lived assets in accordance with Statement of Financial Accounting
Standards (SFAS) No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. If circumstances related to the Companys long-lived
assets change, the Companys valuation of long-lived assets could materially
change. Realization of Deferred Tax Assets.The Company evaluates the
realizability of its deferred tax assets quarterly by assessing the need for
and amount of the valuation allowance. The evaluation of the realizability of
the deferred tax assets is based on expected reversals of existing deferred tax
liabilities and an assessment of the Companys ability to generate future U.S.
taxable income. Results of operations in recent years are considered in the
assessment. The Company records a valuation allowance for the portion of its
deferred tax assets that do not meet the more likely than not recognition
criteria of SFAS No. 109, Accounting for Income Taxes. If circumstances
related to the Companys ability to generate future U.S. taxable income change,
the Companys evaluation of the realizability of its deferred tax assets could
materially change. Stock-Based Compensation.The Company follows Accounting Principles Board
Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, in
accounting for its employee stock options and employee stock purchase plan
using the fair value based method. Under APB 25, because the exercise price of
the Companys employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense is recognized in the
Companys statements of operations, except for variable plans. The Company is
required under SFAS No. 123, Accounting for Stock-Based Compensation, to
disclose pro forma information regarding option grants made to its employees
based on specific valuation techniques that produce fair value based
compensation charges. The Black-Scholes option pricing model is used by the
Company in estimating the fair value of options. If the Company changes the
accounting for stock-based compensation, the Companys results of operations
could materially change. RISK FACTORS AND FORWARD LOOKING STATEMENTS The Company does not provide forecasts of future financial performance.
However, this report contains forward looking statements, including:
discussions of a number of matters and subject areas that are not historical or
current facts but that address potential future circumstances, operations, and
prospects. These forward-looking statements are subject to the safe harbor
created by Section 21E of the Securities Exchange Act of 1934, are qualified by
the inherent risks and uncertainties surrounding future expectations generally
and may differ materially from the Companys actual future experience as a
result of such factors as: the effects of increased competition from regional
craft brewers and major breweries, the Companys ability to gain and continue
access to the markets through independent distributors and chain stores, the
effects of governmental regulation and the Companys ability to obtain and
maintain necessary permits, licenses and approvals, the Companys ability to
maintain or increase the price of its products without decreasing demand and
the Companys ability to maintain or increase operating margins which may
decline as a result of lower sales volumes or selling prices or increased
production, transportation and promotions costs. Investors are cautioned that
all forward-looking statements involve a high degree of risk and uncertainty.
Additional information concerning those and other factors is contained in the
Companys Securities and Exchange Commission filings including its Form 10-K
for the year ended December 31, 2003. 18




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##### Table of Contents



ITEM 3. Quantitative and Qualitative Disclosures about Market Risk The Company has not and does not currently have any intention to hold any
derivative instruments or engage in hedging activities. Also, the Company does
not enter into significant transactions denominated in foreign currencies.
Therefore, the Companys direct exposure to risks arising from changes in
foreign currency exchange rates, commodity prices, equity prices, and other
market changes that affect market risk sensitive instruments is not material.
The Company has assessed its vulnerability to certain market risks, including
interest rate risk associated with the line of credit. As the borrowing against
the line of credit at September 30, 2004 was $231,000, the Company believes
that the risk associated with interest rate fluctuations does not pose a
material risk. The Company currently owes $7,200,000 against a secured loan from Sugar
Mountain Capital, LLC, a party related to Pyramid Breweries Inc. The Company
intends to replace this short-term financing with permanent financing within
the next four months at market based terms. There is no guarantee that such
financing will be available on commercially acceptable terms. The Company may
not be able to refinance this debt at comparable interest rates. The Company maintains an investment portfolio of various holdings, types
and maturities. These securities are generally classified as available for
sale and, consequently, are recorded on the balance sheets at fair value. At
any time, a rise or decrease in interest rates could have an impact on interest
earnings of the investment portfolio. The Company currently does not hedge
interest rate exposures. 
 ITEM 4. Controls and Procedures Procedures Evaluation of disclosure controls and procedure The Company maintains disclosure controls and procedures and internal
controls designed to ensure that information required to be disclosed in its
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commissions rules and forms. Based on their evaluation as of
September 30, 2004, the Companys Chief Executive Officer and Chief Financial
Officer have concluded that the Companys disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act
of 1934 (the Exchange Act)) are effective to ensure that information required
to be disclosed by the Company in reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms. Subsequent to September 30, 2004, the Company filed Form 8-KA several days
past its due date of October 16, 2004, The Company regrets the delay in
filing this form, but does believe that this late filing is not a systemic
problem within the Company. Changes in internal controls There were no changes during the quarter ended September 30, 2004 in the
Companys internal control over financial reporting in connection with this
evaluation that has materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. 
 PART II  OTHER INFORMATION 
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds In conjunction with the July 31, 2004 purchase of certain Portland Brewing
Company assets, Pyramid Breweries Inc. issued 445,434 shares of common stock on
August 2, 2004 to Portland Brewing Company in accordance with the asset
purchase agreement to finance the asset acquisition. The securities as well as
cash and assumed liabilities were provided in exchange for certain brewery and
restaurant assets. The following table provides information about purchases by the Company
during the quarter ended September 30, 2004 of equity securities that are
registered by the Company pursuant to Section 12 of the Exchange Act: Total Number of
    
    Approximate DollarShares Purchased as
    
    Value of SharesPart of Publicly
    
    that May Yet BeTotal Number of
    
    Average Price Paid
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Shares Purchased
    
    per Share
    
    Programs
    
    Plans or ProgramsJul. 1, 2004  Jul. 31, 2004
    
    
    0
    
    
    $
    0.00
    
    
    
    0
    
    
    
    0Aug. 1, 2004  Aug. 31, 2004
    
    
    0
    
    
    $
    0.00
    
    
    
    0
    
    
    
    0Sep. 1, 2004  Sep 30, 2004
    
    
    0
    
    
    $
    0.00
    
    
    
    0
    
    
    
    0Total
    
    
    0
    
    
    $
    0.00
    
    
    
    0
    
    
    $
    1,108,000
 19




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In December 1999, the Board of Directors authorized the Company to
repurchase up to $2,000,000 of its stock on the open market, of which
approximately $892,000 (457,724 shares) has been repurchased to date. This
program was announced in the Companys 1999 Form 10-K, which was filed on March
22, 2000. As of September 30, 2004, $1,108,000 has not yet been repurchased.
This program does not have an expiration date. 
 ITEM 6. Exhibits and Reports on Form 8-K (A) EXHIBITS The following exhibits are filed as part of this report.  3.1*
    
    Amended and Restated Articles of Incorporation3.2*
    
    Amended and Restated Bylaws31.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002:John J. Lennon, Chief Executive Officer31.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002:James K. Hilger, Vice-President and Chief Financial Officer31.3
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002:Jason W. Rees, Controller and Chief Accounting Officer32.1
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002:John J. Lennon, Chief Executive Officer32.2
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002:James K. Hilger, Vice-President and Chief Financial Officer32.3
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002:Jason W. Rees, Controller and Chief Accounting Officer * Incorporated by reference to the exhibits filed as part of the
Companys Registration Statement on Form S-1 (File No. 33-97834). (B) REPORTS ON FORM 8-K Reports on Form 8-K during the quarter ended September 30, 2004 were
filed on August 3, and July 20, 2004, and furnished on August 16, 2004. Items 1, 2, 3 and 5 of PART II are not applicable and have been omitted 20




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SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned; thereunto duly authorized, in the City of
Seattle, State of Washington, on November 15, 2004. PYRAMID BREWERIES INC.By:
    /s/ JAMES K. HILGERJames K. Hilger, Vice-President and Chief Financial Officer DATE: November 15, 2004 21