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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-Q   (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED JUNE 30, 2004
 o
    
    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
    
    91-1258355(State or other jurisdiction of
incorporation or organization)
    
    (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 X No    . 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: 8,312,369 shares of Common
Stock outstanding as of June 30, 2004 1




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PYRAMID BREWERIES INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004 TABLE OF CONTENTS PagePART IFINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Balance SheetsJune 30, 2004 and December 31, 2003
    
    
    3Condensed Statements of OperationsThree Month and Six Month Periods Ended June 30, 2004 and 2003
    
    
    4Condensed Statements of Cash FlowsSix Month Periods Ended June 30, 2004 and 2003
    
    
    5Notes to Condensed 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
    
    
    16Item 4. Controls and Procedures
    
    
    17PART IIOTHER INFORMATIONItem 2. Changes in Securities and Use of Proceeds
    
    
    17Item 4. Submission of Matters to a vote of Security Holders
    
    
    18Item 6. Exhibits and Reports on Form 8-K
    
    
    18SIGNATURE
    
    
    19EXHIBIT 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. BALANCE SHEETS
(Unaudited) June 30,
    
    December 31,2004
    
    2003CURRENT ASSETS:Cash and cash equivalents
    
    $
    655,000
    
    
    $
    1,558,000Short term investments
    
    
    492,000
    
    
    
    492,000Accounts receivable, net
    
    
    2,573,000
    
    
    
    1,281,000Inventories
    
    
    1,850,000
    
    
    
    1,654,000Prepaid expenses and other
    
    
    428,000
    
    
    
    756,000Total current assets
    
    
    5,998,000
    
    
    
    5,741,000Note receivable related party
    
    
    
    
    
    
    81,000Fixed assets, net
    
    
    20,499,000
    
    
    
    21,406,000Goodwill
    
    
    415,000
    
    
    
    415,000Other assets
    
    
    279,000
    
    
    
    141,000Total assets
    
    $
    27,191,000
    
    
    $
    27,784,000CURRENT LIABILITIES:Accounts payable
    
    $
    2,153,000
    
    
    $
    1,349,000Accrued expenses
    
    
    2,115,000
    
    
    
    1,562,000Refundable deposits
    
    
    538,000
    
    
    
    487,000Note payable
 current
    
    
    20,000
    
    
    
    20,000Deferred rent  current
    
    
    199,000
    
    
    
    199,000Dividends payable
    
    
    183,000
    
    
    
    379,000Total current liabilities
    
    
    5,208,000
    
    
    
    3,996,000Note payable, net of current
    
    
    18,000
    
    
    
    16,000Deferred rent, net of current
    
    
    1,470,000
    
    
    
    1,569,000Total liabilities
    
    
    6,696,000
    
    
    
    5,581,000COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS EQUITY:Preferred stock, 10,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, $.01 par value; 40,000,000 shares authorized,
8,313,000 and 8,620,000 shares issued and outstanding
    
    
    83,000
    
    
    
    86,000Additional paid-in capital
    
    
    35,294,000
    
    
    
    36,374,000Note receivable  related party
    
    
    
    
    
    
    (764,000
    )Deferred stock-based compensation
    
    
    
    
    
    
    (27,000
    )Accumulated deficit
    
    
    (14,882,000
    )
    
    
    (13,466,000
    )Total stockholders equity
    
    
    20,495,000
    
    
    
    22,203,000Total liabilities and stockholders equity
    
    $
    27,191,000
    
    
    $
    27,784,000
 The accompanying notes are an integral part of these statements. 3




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PYRAMID BREWERIES INC. CONDENSED STATEMENTS OF OPERATIONS
(Unaudited) Three Month Period Ended June 30,
    
    Six Month Period Ended June 30,2004
    
    2003
    
    2004
    
    2003Gross sales
    
    $
    10,936,000
    
    
    $
    9,882,000
    
    
    $
    19,225,000
    
    
    $
    16,858,000Less excise taxes
    
    
    534,000
    
    
    
    481,000
    
    
    
    942,000
    
    
    
    833,000Net sales
    
    
    10,402,000
    
    
    
    9,401,000
    
    
    
    18,283,000
    
    
    
    16,025,000Cost of sales
    
    
    7,829,000
    
    
    
    6,901,000
    
    
    
    14,323,000
    
    
    
    12,369,000Gross margin
    
    
    2,573,000
    
    
    
    2,500,000
    
    
    
    3,960,000
    
    
    
    3,656,000Selling, general and administrative expenses
    
    
    2,507,000
    
    
    
    2,160,000
    
    
    
    4,903,000
    
    
    
    4,083,000Operating income (loss)
    
    
    66,000
    
    
    
    340,000
    
    
    
    (943,000
    )
    
    
    (427,000
    )Other income, net
    
    
    81,000
    
    
    
    106,000
    
    
    
    95,000
    
    
    
    150,000Income (loss) before income taxes
    
    
    147,000
    
    
    
    446,000
    
    
    
    (848,000
    )
    
    
    (277,000
    )Provision for income taxes
    
    
    (2,000
    )
    
    
    (1,000
    )
    
    
    (3,000
    )
    
    
    (3,000
    )Net income (loss)
    
    $
    145,000
    
    
    $
    445,000
    
    
    $
    (851,000
    )
    
    $
    (280,000
    )Basic and diluted net income (loss) per share
    
    $
    0.02
    
    
    $
    0.05
    
    
    $
    (0.10
    )
    
    $
    (0.03
    )Weighted average basic shares outstanding
    
    
    8,391,000
    
    
    
    8,443,000
    
    
    
    8,495,000
    
    
    
    8,430,000Weighted average diluted shares outstanding
    
    
    8,462,000
    
    
    
    8,665,000
    
    
    
    8,495,000
    
    
    
    8,430,000Cash dividend declared per share
    
    $
    0.022
    
    
    $
    0.044
    
    
    $
    0.066
    
    
    $
    0.088
 The accompanying notes are an integral part of these statements. 4




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PYRAMID BREWERIES INC. CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited) Six Month Period Ended June 30,OPERATING ACTIVITIES:
    
    2004
    
    2003Net loss
    
    $
    (851,000
    )
    
    $
    (280,000
    )Adjustments to reconcile net loss to net cash provided by
operating activities:Depreciation and amortization
    
    
    1,325,000
    
    
    
    1,111,000Stock-based compensation expense
    
    
    (10,000
    )
    
    
    63,000Interest expense
    
    
    2,000
    
    
    
    2,000Loss on sales of fixed assets
    
    
    12,000
    
    
    
    1,000Deferred rent
    
    
    (99,000
    )
    
    
    738,000Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,292,000
    )
    
    
    (620,000
    )Inventories
    
    
    (196,000
    )
    
    
    40,000Prepaid expenses and other
    
    
    125,000
    
    
    
    244,000Accounts payable and accrued expenses
    
    
    1,384,000
    
    
    
    372,000Refundable deposits
    
    
    51,000
    
    
    
    6,000Net cash provided by operating activities
    
    
    451,000
    
    
    
    1,677,000INVESTING ACTIVITIES:Purchases of short-term investments
    
    
    
    
    
    
    (2,455,000
    )Proceeds from the sale and maturities of short-term
investments
    
    
    
    
    
    
    4,355,000Acquisitions of fixed assets
    
    
    (384,000
    )
    
    
    (2,407,000
    )Net cash used in investing activities
    
    
    (384,000
    )
    
    
    (507,000
    )FINANCING ACTIVITIES:Proceeds from the sale of common stock and option exercises
    
    
    187,000
    
    
    
    103,000Note receivable
    
    
    
    
    
    
    16,000Cash dividends paid
    
    
    (761,000
    )
    
    
    (750,000
    )Cash paid on line of credit
    
    
    (31,000
    )
    
    
    Purchase and retirement of common stock
    
    
    (365,000
    )
    
    
    Net cash used in financing activities
    
    
    (993,000
    )
    
    
    (631,000
    )(Decrease) increase in cash and cash equivalents
    
    
    (901,000
    )
    
    
    539,000Cash and cash equivalents at beginning of period
    
    
    1,558,000
    
    
    
    596,000Cash and cash equivalents at end of period
    
    $
    655,000
    
    
    $
    1,135,000
 The accompanying notes are an integral part of these statements. 5




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PYRAMID BREWERIES INC. NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited) 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 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
(please refer to Subsequent Events Note 8 to the Financial Statements below for further
discussion of this transaction). The Portland Brewing Company asset
acquisition, and related results of operations, are not reflected in the
presentation of the financial statements of the three and six month periods
ended June 30, 2004 as the purchase occurred on July 31, subsequent to the
second quarter reporting period. The Company sells its beer through a network
of selected independent distributors and alehouse locations primarily in
Washington, Oregon and California under the Pyramid brand and, to a lesser
extent, the Thomas Kemper brand. The Company also manufactures a line of
gourmet sodas under the Thomas Kemper Soda Company label. As of June 30, 2004,
the Companys products were distributed in 32 states and Canada. As of June
30, 2004, the Company also operated four restaurants adjacent to its breweries
under the Pyramid Alehouse brand name. The accompanying condensed 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 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 June 30, 2004, the Company has stock-based compensation plans which are
described more fully in Note 15 of the 2003 Annual Report and as Appendix A of
the 2004 Proxy Statement for the recently approved 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 4. 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 six month periods ended June 30, 2004 and 2003, would have been
as follows: Three Month Period Ended June 30,
    
    Six Month Period Ended June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) as reported
    
    $
    145,000
    
    
    $
    445,000
    
    
    $
    (851,000
    )
    
    $
    (280,000
    )Add: Stock-based compensation cost as reported
    
    
    
    
    
    
    59,000
    
    
    
    (10,000
    )
    
    
    63,000Less: Stock-based compensation cost determined
under the
fair value based method
    
    
    (37,000
    )
    
    
    (73,000
    )
    
    
    (74,000
    )
    
    
    (125,000
    )Net income (loss) pro forma
    
    $
    108,000
    
    
    $
    431,000
    
    
    $
    (935,000
    )
    
    $
    (342,000
    )Basic and diluted net income (loss) per share
as reported
    
    $
    0.02
    
    
    $
    0.05
    
    
    $
    (0.10
    )
    
    $
    (0.03
    )Basic and diluted net income (loss) per share
pro forma
    
    $
    0.01
    
    
    $
    0.05
    
    
    $
    (0.11
    )
    
    $
    (0.04
    )
 There were no options granted in the second quarter of 2004. The fair
value of options granted in the second quarter ended June 30, 2003 was
estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions: risk-free interest rate of 3.98%; expected option
lives of seven years; expected volatility of 51%; and expected future dividends
of 5.5%. There were no options granted in the six month period ended June 30, 2004.
The fair value of options granted in the six month period ended June 30, 2003
was estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions: risk- 6




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free interest rates ranging from 3.98% to
5.13%; expected option lives of seven years; expected volatility of 51% to 52%;
and expected future dividends of 5.5%. 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. INVENTORIES Inventories consist of the following: June 30,
    
    December 31,2004
    
    2003Raw materials
    
    $
    861,000
    
    
    $
    664,000Work in process
    
    
    162,000
    
    
    
    155,000Finished goods
    
    
    827,000
    
    
    
    835,000$
    1,850,000
    
    
    $
    1,654,000
 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. 3. FIXED ASSETS Fixed assets consist of the following: June 30,
    
    December 31,2004
    
    2003Brewery and retail equipment
    
    $
    16,642,000
    
    
    $
    16,402,000Furniture and fixtures
    
    
    923,000
    
    
    
    952,000Leasehold improvements
    
    
    17,604,000
    
    
    
    17,587,000Construction in progress
    
    
    224,000
    
    
    
    101,00035,393,000
    
    
    
    35,042,000Less: accumulated depreciation
and amortization
    
    
    (14,894,000
    )
    
    
    (13,636,000
    )$
    20,499,000
    
    
    $
    21,406,000
 4. 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 bear 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 arrangement. 8




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5. ACCRUED EXPENSES Accrued expenses consist of the following: June 30,
    
    December 31,2004
    
    2003Salaries, wages and related accruals
    
    $
    757,000
    
    
    $
    529,000Barrel taxes
    
    
    326,000
    
    
    
    100,000Other accruals
    
    
    1,032,000
    
    
    
    933,000$
    2,115,000
    
    
    $
    1,562,000
 6. OTHER INCOME, NET Other income, net consists of interest income and parking fee income, and
other non-operating income and expenses as follows:. Three Month Period Ended June 30,
    
    Six Month Period Ended June 30,2004
    
    2003
    
    2004
    
    2003Interest income
    
    $
    7,000
    
    
    $
    13,000
    
    
    $
    14,000
    
    
    $
    37,000Interest expense
    
    
    (1,000
    )
    
    
    (1,000
    )
    
    
    (2,000
    )
    
    
    (2,000
    )Parking income
    
    
    78,000
    
    
    
    83,000
    
    
    
    84,000
    
    
    
    92,000Loss on sale of assets
    
    
    (2,000
    )
    
    
    (1,000
    )
    
    
    (12,000
    )
    
    
    (1,000
    )Loan fee amortization
    
    
    (3,000
    )
    
    
    
    
    
    
    (3,000
    )
    
    
    Other income
    
    
    2,000
    
    
    
    12,000
    
    
    
    14,000
    
    
    
    24,000Other income, net
    
    $
    81,000
    
    
    $
    106,000
    
    
    $
    95,000
    
    
    $
    150,000
 7. INCOME (LOSS) PER SHARE Basic income (loss) per share was computed by dividing net income (loss)
by the weighted average number of shares of common stock outstanding during the
period, excluding shares subject to repurchase. Diluted income (loss) per share
was computed by dividing net income (loss) 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. Options to purchase approximately 197,000 and 183,000 shares of
common stock were outstanding as of June 30, 2004 and 2003, respectively, but
were not included in the six month periods computation of EPS
because their effects are antidilutive. Three Month Period Ended June 30,
    
    Six Month Period Ended June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    145,000
    
    
    $
    445,000
    
    
    $
    (851,000
    )
    
    $
    (280,000
    )Shares:Weighted average shares outstanding
    
    
    8,391,000
    
    
    
    8,543,000
    
    
    
    8,495,000
    
    
    
    8,530,000Shares subject to repurchase
    
    
    
    
    
    
    (100,000
    )
    
    
    
    
    
    
    (100,000
    )Weighted average basic shares outstanding
    
    
    8,391,000
    
    
    
    8,443,000
    
    
    
    8,495,000
    
    
    
    8,430,000Basic income (loss) per share
    
    $
    0.02
    
    
    $
    0.05
    
    
    $
    (0.10
    )
    
    $
    (0.03
    )Stock option dilution
    
    
    71,000
    
    
    
    222,000
    
    
    
    
    
    
    
    Weighted average diluted shares outstanding
    
    
    8,462,000
    
    
    
    8,665,000
    
    
    
    8,495,000
    
    
    
    8,430,000Diluted income (loss) per share
    
    $
    0.02
    
    
    $
    0.05
    
    
    $
    (0.10
    )
    
    $
    (0.03
    )
 8. SUBSEQUENT EVENTS 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 was financed with a short-term
$7,200,000 secured loan from Sugar Mountain Capital, LLC, a party related to
Pyramid Breweries Inc. The terms of the short-term financing, approved by the
Companys board of directors and audit committee, include interest only monthly
payments at a stated interest rate of 6.26% which is due six months
from the date of the note. The Company anticipates that as a
part of recording the transaction in the third quarter of 2003, it will
reclassify leasehold improvements to the building asset account. The
accounting effects of this transaction are not reflected in the fixed asset
table above. The Company intends to convert this short-term financing to permanent
financing with Sugar Mountain Capital, LLC within the next six months at market
based terms. In the event that the Company is unable to complete its planned
permanent financing with Sugar Mountain Capital, LLC within the next six
months, it will seek unrelated third party financing. There is no guarantee
that such financing will be available on commercially acceptable terms. In the
event that Pyramid is unable to permanently refinance the debt with an
unrelated third party, the short-term loan with Sugar Mountain Capital, LLC
will be converted to a long-term note and the Company will be required to make monthly
principal repayments on the loan as well as pay a higher rate of interest. Effective at the close of business 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 of approximately $4.2 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. The final purchase
allocation of payment made among assumed liabilities, cash payment of
$1,160,000 and stock
was not known as of the date of this form filing as the Portland
Brewing Company is subject to a total assets purchased review prior to finalizing the
allocation. As a result of the pending financial revenue the final
purchase price allocation has not been finalized and will be
disclosed in a subsequent reporting period. 9. 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. 9




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During
the quarter ended June 30, 2004, the Company entered into a
$2,000,000 line of credit (the Line of Credit) with a third party bank for
short-term operating needs. The Line of Credit extends 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 250 basis
points. Management expects a portion of the line of credit will be used to meet the
additional operating cash needs of the Portland Brewing Company asset
acquisition, as well as for covering the purchase and transaction costs.
As of June 30, 2004, the Company had not borrowed on the line of credit.

10



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##### Table of Contents



10. CASH DIVIDEND The Board of Directors announced on April 27, 2004, the declaration of a
$0.022 per common share dividend payable on July 16, 2004 to shareholders of
record on June 30, 2004. The cash dividends declared totaled approximately
$183,000 for all common stock outstanding as of the record date. Cash dividends declared per common share: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    $
    0.022
    
    
    $
    0.0662003
    
    $
    0.044
    
    
    $
    0.088
 Although the Company has declared and paid a dividend every quarter since
the fourth quarter of 1999, continued future declaration of dividends will
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 Board of Directors may in its discretion consider relevant and in the
best long term interest of the shareholders. 11. 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 Pyramid ales
and lagers, Thomas Kemper beers and Thomas Kemper Soda Company products. The
alehouse segment consists of four 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 current 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. 11




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##### Table of Contents



Segment profit and segment assets are as follows: Beverage
    
    
    
    
    
    Corporate andOperations
    
    Alehouse
    
    Other
    
    TotalQuarter ended June 30, 2004
    
    (Dollars in thousands)Gross revenues from external customers
    
    $
    7,399
    
    
    $
    3,537
    
    
    $
    
    
    
    $
    10,936Net revenues from external customers
    
    
    6,865
    
    
    
    3,537
    
    
    
    
    
    
    
    10,402Intersegment revenues
    
    
    142
    
    
    
    
    
    
    
    (142
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    7
    
    
    
    7Depreciation and amortization
    
    
    404
    
    
    
    213
    
    
    
    45
    
    
    
    662Operating income (loss)
    
    
    959
    
    
    
    280
    
    
    
    (1,173
    )
    
    
    66Capital expenditures
    
    
    123
    
    
    
    31
    
    
    
    38
    
    
    
    192Total assets
    
    
    18,348
    
    
    
    6,458
    
    
    
    2,385
    
    
    
    27,191Quarter ended June 30, 2003Gross revenues from external customers
    
    $
    6,981
    
    
    $
    2,901
    
    
    $
    
    
    
    $
    9,882Net revenues from external customers
    
    
    6,500
    
    
    
    2,901
    
    
    
    
    
    
    
    9,401Intersegment revenues
    
    
    107
    
    
    
    
    
    
    
    (107
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    13
    
    
    
    13Depreciation and amortization
    
    
    386
    
    
    
    122
    
    
    
    49
    
    
    
    557Operating income (loss)
    
    
    1,171
    
    
    
    291
    
    
    
    (1,122
    )
    
    
    340Capital expenditures
    
    
    141
    
    
    
    1,440
    
    
    
    60
    
    
    
    1,641Total assets
    
    
    19,251
    
    
    
    6,596
    
    
    
    3,702
    
    
    
    29,549Six months ended June 30, 2004Gross revenues from external customers
    
    $
    12,659
    
    
    $
    6,566
    
    
    $
    
    
    
    $
    19,225Net revenues from external customers
    
    
    11,717
    
    
    
    6,566
    
    
    
    
    
    
    
    18,283Intersegment revenues
    
    
    236
    
    
    
    
    
    
    
    (236
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    14
    
    
    
    14Depreciation and amortization
    
    
    804
    
    
    
    431
    
    
    
    90
    
    
    
    1,325Operating income (loss)
    
    
    1,307
    
    
    
    269
    
    
    
    (2,519
    )
    
    
    (943
    )Capital expenditures
    
    
    206
    
    
    
    93
    
    
    
    85
    
    
    
    384Total assets
    
    
    18,348
    
    
    
    6,458
    
    
    
    2,385
    
    
    
    27,191Six months ended June 30, 2003Gross revenues from external customers
    
    $
    11,604
    
    
    $
    5,254
    
    
    $
    
    
    
    $
    16,858Net revenues from external customers
    
    
    10,771
    
    
    
    5,254
    
    
    
    
    
    
    
    16,025Intersegment revenues
    
    
    180
    
    
    
    
    
    
    
    (180
    )
    
    
    Interest income
    
    
    
    
    
    
    
    
    
    
    37
    
    
    
    37Depreciation and amortization
    
    
    774
    
    
    
    236
    
    
    
    101
    
    
    
    1,111Operating income (loss)
    
    
    1,113
    
    
    
    407
    
    
    
    (1,947
    )
    
    
    (427
    )Capital expenditures
    
    
    389
    
    
    
    1,939
    
    
    
    79
    
    
    
    2,407Total assets
    
    
    19,251
    
    
    
    6,596
    
    
    
    3,702
    
    
    
    29,549
 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. 12




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##### Table of Contents



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 Three Month Period Ended June 30,% of
    
    
    
    
    
    % of2004
    
    Net Sales
    
    2003
    
    Net SalesGross sales
    
    $
    10,936,000
    
    
    
    
    
    
    $
    9,882,000Less excise taxes
    
    
    534,000
    
    
    
    
    
    
    
    481,000Net sales
    
    
    10,402,000
    
    
    
    100.0
    
    
    
    9,401,000
    
    
    
    100.0Cost of sales
    
    
    7,829,000
    
    
    
    75.3
    
    
    
    6,901,000
    
    
    
    73.4Gross margin
    
    
    2,573,000
    
    
    
    24.7
    
    
    
    2,500,000
    
    
    
    26.6Selling, general and administrative expenses
    
    
    2,507,000
    
    
    
    24.1
    
    
    
    2,160,000
    
    
    
    23.0Operating income
    
    
    66,000
    
    
    
    0.6
    
    
    
    340,000
    
    
    
    3.6Other income, net
    
    
    81,000
    
    
    
    0.8
    
    
    
    106,000
    
    
    
    1.1Income before income taxes
    
    
    147,000
    
    
    
    1.4
    
    
    
    446,000
    
    
    
    4.7Provision for income taxes
    
    
    (2,000
    )
    
    
    (0.0
    )
    
    
    (1,000
    )
    
    
    (0.0
    )Net income
    
    $
    145,000
    
    
    
    1.4
    
    
    $
    445,000
    
    
    
    4.7Basic and diluted net income per share
    
    $
    0.02
    
    
    
    
    
    
    $
    0.05Operating data (in barrels):Beer barrels shipped
    
    
    34,540
    
    
    
    
    
    
    
    32,223Soda barrels shipped
    
    
    13,716
    
    
    
    
    
    
    
    13,511Total barrels shipped
    
    
    48,256
    
    
    
    
    
    
    
    45,734Annual production capacity
    
    
    204,000
    
    
    
    
    
    
    
    203,000
 Six Month Period Ended June 30,% of
    
    
    
    
    
    % of2004
    
    Net Sales
    
    2003
    
    Net SalesGross sales
    
    $
    19,225,000
    
    
    
    
    
    
    $
    16,858,000Less excise taxes
    
    
    942,000
    
    
    
    
    
    
    
    833,000Net sales
    
    
    18,283,000
    
    
    
    100.0
    
    
    
    16,025,000
    
    
    
    100.0Cost of sales
    
    
    14,323,000
    
    
    
    78.3
    
    
    
    12,369,000
    
    
    
    77.2Gross margin
    
    
    3,960,000
    
    
    
    21.7
    
    
    
    3,656,000
    
    
    
    22.8Selling, general and administrative expenses
    
    
    4,903,000
    
    
    
    26.8
    
    
    
    4,083,000
    
    
    
    25.5Operating loss
    
    
    (943,000
    )
    
    
    (5.1
    )
    
    
    (427,000
    )
    
    
    (2.7
    )Other income, net
    
    
    95,000
    
    
    
    0.5
    
    
    
    150,000
    
    
    
    0.9Loss before income taxes
    
    
    (848,000
    )
    
    
    (4.6
    )
    
    
    (277,000
    )
    
    
    (1.8
    )Provision for income taxes
    
    
    (3,000
    )
    
    
    (0.0
    )
    
    
    (3,000
    )
    
    
    (0.0
    )Net loss
    
    $
    (851,000
    )
    
    
    (4.6
    )
    
    $
    (280,000
    )
    
    
    (1.8
    )Basic and diluted net loss per share
    
    $
    (0.10
    )
    
    
    
    
    
    $
    (0.03
    )Operating data (in barrels):Beer barrels shipped
    
    
    61,071
    
    
    
    
    
    
    
    55,200Soda barrels shipped
    
    
    21,795
    
    
    
    
    
    
    
    20,776Total barrels shipped
    
    
    82,866
    
    
    
    
    
    
    
    75,976Annual production capacity
    
    
    204,000
    
    
    
    
    
    
    
    203,000
 13




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##### Table of Contents



QUARTER ENDED JUNE 30, 2004 COMPARED TO QUARTER ENDED JUNE 30, 2003 Gross Sales.Gross sales increased 10.7% to $10,936,000 in the second
quarter ended June 30, 2004 from $9,882,000 in the same quarter of 2003.
Wholesale beverage segment sales increased 6.0% to $7,399,000 in the second
quarter ended June 30, 2004 from $6,981,000 in the same quarter of 2003. Total
beverage barrel shipments increased 5.5% compared to the same period in the
prior year. Pyramid beer brand shipments increased 7.8% to 33,842 barrels,
while Thomas Kemper beer shipments declined 30.6% to 698 barrels compared to
the same quarter a year ago. Total beer shipments, including Thomas Kemper
beer, increased by 7.2% to 34,540 barrels. Shipments of Thomas Kemper Soda
remained relatively consistent at 13,716 barrels for the quarter. The Northwest
and Southwest sales regions, the Companys two largest, increased shipment
volumes over the second quarter of 2003 with 1.9% and 8.5% volume increases
respectively. The Companys Western region represented the Companys largest
regional increase with a 15.2% increase over the same quarter of 2003. Pyramid
Hefeweizen, the Companys top selling product, was up 14.9% in shipment volumes
for the quarter. Alehouse sales increased 21.9%, to $3,537,000 in the second
quarter ended June 30, 2004, from $2,901,000 in the same quarter of 2003.
Excluding the Sacramento Alehouse, which opened in July 2003, the same store
alehouse sales decreased $33,000 or 1.1% due to lower traffic at the Walnut
Creek, California alehouse location. Excise Taxes.Excise taxes totaled 7.2% and 6.9% of gross beverage sales
for the quarters ended June 30, 2004 and 2003, respectively. The increase in
excise taxes as a percentage of gross sales was due mainly to a greater portion
of beer sales versus soda sales. Per beer barrel shipped excise taxes increased
slightly to $15.46 per beer barrel from $14.93 per beer barrel. This slight
increase is the result of the Company attaining increased shipment volumes over
the 60,000 barrel threshold for the year resulting in incremental beer volume
being taxed at an $18 per beer barrel rate 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 $73,000 to $2,573,000, an increase
of 2.9% in the quarter ended June 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 Sacramento, 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 freight costs in
the form of fuel surcharges amounting to $107,000 during the quarter and the
sales growth of higher cost variety packaged products, or mixed packs. Three Month Period Ended June 30,% of Div.
    
    
    
    
    
    % of Div.Gross Margin
    
    2004
    
    Net Sales
    
    2003
    
    Net Sales
    
    $ Change
    
    % ChangeBeverage Division
    
    $
    2,183,000
    
    
    
    31.8
    %
    
    $
    2,167,000
    
    
    
    33.3
    %
    
    $
    16,000
    
    
    
    0.7
    %Alehouse Division
    
    
    390,000
    
    
    
    11.0
    %
    
    
    333,000
    
    
    
    11.5
    %
    
    
    57,000
    
    
    
    17.1
    %Total
    
    $
    2,573,000
    
    
    
    24.7
    %
    
    $
    2,500,000
    
    
    
    26.6
    %
    
    $
    73,000
    
    
    
    2.9
    %
 Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased 16.1% to $2,507,000, or 24.1% of net sales
for the second quarter ended June 30, 2004. The $347,000 increase was primarily
attributed to $258,000 of planned increases
in selling expenses and personnel related payroll costs which are intended
to sustain long-term sales growth, and  $49,000 related to
the hire of the Companys new CEO, John Lennon. Other Income, net. Other income, net was approximately $81,000, or 0.8% of
net sales for the quarter ended June 30, 2004 as compared to $106,000, or 1.1%
of net sales in the same quarter of 2003. Both lower investment balances and
lower rates of interest earned on cash equivalents and short-term investments
caused the decline in interest income. Interest income was $7,000 and $13,000
for the quarters ended June 30, 2004 and 2003, respectively. Other income,
recorded in connection with the related party loans, decreased to $2,000 from
$12,000 for the quarters ended June, 2004 and 2003, respectively, as the loan
balances were paid off as part of the stock buy-back arrangement with the former
Company CEO. Income Taxes. The Company recorded approximately $2,000 of income tax
expense in the second quarter related to certain state tax expense. For the
most part, however, the Company recorded no income tax for the quarters ended
June 30, 2004 and 2003 because it has recorded a full valuation allowance
against its net operating loss carryforwards. Net Income. The Company reported net income of $145,000 for the quarter
ended June 30, 2004 compared to a net income of $445,000 in the same quarter of
2003. Other.In January 2004, the Company announced an agreement to purchase
substantially all the assets of Portland Brewery Company in exchange for cash,
the assumption of certain liabilities, and at Pyramids sole option, common
stock. The transaction was finalized and closed on July 31, 2004. 14




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##### Table of Contents



SIX MONTH PERIOD ENDED JUNE 30, 2004 COMPARED TO SIX MONTH PERIOD ENDED JUNE 30, 2003 Gross Sales.Gross sales increased 14.0% to $19,225,000 for the six month
period ended June 30, 2004 from $16,858,000 in the same period of 2003.
Wholesale beverage sales increased 9.1% to $12,659,000 for the six month period
ended June 30, 2004 from $11,604,000 in the same period of 2003. Total
beverage barrel shipments increased 9.1% compared to the same period in the
prior year. Pyramid beer brand shipments increased 10.9% to 59,501 barrels,
while Thomas Kemper beer declined 8.5% to 1,570 barrels. Shipments of Thomas
Kemper Soda increased by 4.9% to 21,795 barrels from 20,776 barrels in the same
six month period of the prior year. Alehouse sales increased 25.0%, to
$6,566,000 in the six month period ended June 30, 2004, from $5,254,000 in the
same period of 2003. The increase was driven by the Sacramento Alehouse, which
opened in July 2003, contributing $1,393,000 in sales for the six months ended
June 30, 2004. Excluding the Sacramento Alehouse, the same store alehouse sales
decreased $81,000 or 1.5% largely due to lower traffic at the Seattle,
Washington and Walnut Creek, California Alehouse locations. Excise
Taxes.Excise taxes totaled 7.4% of gross beverage sales for each
of the six month periods ended June 30, 2004 and 2003. Per beer barrel shipped
excise taxes increased slightly to $15.42 per beer barrel from $15.10 per beer
barrel. This slight increase is the result of the Company attaining increased
shipment volumes over the 60,000 barrel threshold for the year resulting in
incremental beer volume being taxed at an $18 per beer barrel rate 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 $304,000 to $3,960,000, or 8.3% for
the six month period ended June 30, 2004 due to higher beverage volumes, the
addition of the Sacramento Alehouse and the absence of $89,000 of pre-opening
expenses incurred in preparation of the opening for the Sacramento Alehouse in
2003. The decrease in gross margin is primarily the result of increasing
freight costs in the form of fuel surcharges, an increased proportion of higher
cost variety packaged products, or mixed packs, and an increase in alehouse
controllable costs such as menu, dishes, utensils and promotional costs. Six Month Period Ended June 30,% of Div.
    
    
    
    
    
    % of Div.Gross Margin
    
    2004
    
    Net Sales
    
    2003
    
    Net Sales
    
    $ Change
    
    % ChangeBeverage Operations
    
    $
    3,480,000
    
    
    
    29.7
    %
    
    $
    3,154,000
    
    
    
    29.3
    %
    
    $
    326,000
    
    
    
    10.3
    %Alehouse Operations
    
    
    480,000
    
    
    
    7.3
    %
    
    
    502,000
    
    
    
    9.6
    %
    
    
    (22,000
    )
    
    
    (4.4
    %)Total Operations
    
    $
    3,960,000
    
    
    
    21.7
    %
    
    $
    3,656,000
    
    
    
    22.8
    %
    
    $
    304,000
    
    
    
    8.3
    %
 Selling, General and Administrative Expenses. Selling, general and
administrative expenses for the first six months of 2004 increased to
$4,903,000, compared to $4,083,000 incurred during the first six months of
2003. The $820,000 additional expense was attributed to an increase in
administrative expenses, including $368,000 related to the
termination and replacement of the Companys CEO as well as a non-recurring
$99,000 state and local tax refund recorded in 2003 as an expense reduction.
The remaining $353,000 increase is primarily the result of planned increases in
selling and personnel related expenses which are expected to drive future
beverage division sales and improve alehouse sales, quality and consistency. Other Income, net. Other income, net was approximately $95,000 and 0.5% of
net sales for the six month period ended June 30, 2004 compared to $150,000 and
0.9% of net sales in the same period of 2003. Both lower investment balances
and lower rates of interest earned on cash equivalents and short-term
investments caused the decline in interest income. Interest income was $14,000
and $37,000 for each of the six month periods ended June 30, 2004 and 2003,
respectively. Other income, recorded in connection with the related party
loans, decreased to $14,000 from $24,000 as the loan balance were 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 $12,000 was recorded during the
six month period ended June 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 six month period ended June 30, 2004 related to certain state
tax expense. For the most part, however, the Company recorded no income tax for
the periods ended June 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 a
valuation allowance. Net Loss. The Company reported a net loss of $851,000 for the six month
period ended June 30, 2004 compared to a net loss of $280,000 in the same
period of 2003. 15




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##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES The Company had approximately $1,147,000 of cash, cash equivalents and
short-term investments at June 30, 2004 compared to $2,050,000 at December
2003. At June 30, 2004, the Company had working capital of $790,000 compared to
$1,745,000 at December 31, 2003. The $955,000 decrease in working capital for
the six month period ended June 30, 2004 is a result of $384,000 of 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
$761,000 paid out in cash dividends, offset by $451,000 of cash provided by
operating activities and other various current asset and liability changes. Net cash provided by operating activities during the six month period
ended June 30, 2004 was approximately $451,000 compared to $1,677,000 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. The $800,000 cash receipt was
recorded as a deferred rent liability and is being amortized over the life of
the lease. Net cash used in investing activities for the six month period ended June
30, 2004 was $384,000 compared to net cash used in investing activities of
$507,000 for the same period of the prior year. The cash used in investing
activities in 2004 included approximately $206,000 for brewery equipment
improvements, $93,000 for alehouse equipment and upgrades, $70,000 for
information systems and computer system upgrades and replacements, and $15,000
for other various projects. The only material change in the contractual obligation table presented in
the Companys Form 10-K as of the year ended December 31, 2003 is the financing
arrangement 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 was financed
with a short-term $7,200,000 secured loan from Sugar Mountain Capital, LLC, a
party related to Pyramid Breweries Inc. 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
June 30, 2004 the Company declared per share dividends of $0.022 and paid out
$382,000 in cash dividends relating to dividends of $0.044 per share
declared during the quarter ended March 31, 2004. During the second quarter 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, among other things, on
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 June 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 was 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 lease has been secured with 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 audit committee, include
interest only monthly payments for six months at a stated interest rate of 6.26%. The Company intends to convert this short-term financing to permanent
financing with Sugar Mountain Capital, LLC within the next six months at market
based terms. In the event that the Company is unable to complete its planned
permanent financing with Sugar Mountain Capital, LLC within the next six
months, it will seek unrelated third party financing. There is no guarantee
that such financing 16




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will be available on commercially acceptable terms. In the
event that Pyramid is unable to permanently refinance the debt with an
unrelated third party, the short-term loan with Sugar Mountain Capital, LLC
will be converted to a long-term note and the Company will be required to make monthly
principal repayments on the loan as well as pay a higher rate of interest. 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 250 basis
points. A portion of the line of credit will likely be 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 June
30, 2004, the Company had not borrowed on the line of credit, although loan
fees were charged to the line and immediately paid by the Company. Effective at the close of business 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 of approximately $4.2 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 brands during the earn-out period. 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 costs 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: discussions of a
number of matters and subject areas that are not historical or current facts
but that address potential future circumstances, 17




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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 and 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. 
 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 currency.
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 there was no
borrowing against the line of credit at June 30, 2004 the Company believes that
the risk associated with interest rate fluctuations does not pose a material
risk 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 a set of 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 the June 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. Changes in internal controls There were no changes during the quarter ended June 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. Changes in Securities and Use of Proceeds The
following table provides information about purchases by the Company
during the quarter ended June 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
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Shares Purchased (1)
    
    Paid per Share
    
    Programs
    
    Plans or ProgramsApr. 1, 2004 - Apr. 30, 2004
    
    
    387,400
    
    
    $
    3.18
    
    
    
    0
    
    
    
    0May 1, 2004 - May 30, 2004
    
    
    0
    
    
    $
    0.00
    
    
    
    0
    
    
    
    0June 1, 2004 - June 30, 2004
    
    
    0
    
    
    $
    0.00
    
    
    
    0
    
    
    
    0Total
    
    
    387,400
    
    
    $
    3.18
    
    
    
    0
    
    
    $
    1,108,000
 (1)
Shares purchased
in connection to the full recourse note agreement dated June 2001
between the company and Mr. Kelly. See footnote 4 for more
details.
 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
June 30, 2004, $1,108,000 has not yet been repurchased. This
program does not have an expiration date. 
 ITEM 4. Submission of Matters to a Vote of Security Holders The annual shareholder meeting was held on May 12, 2004. 18




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Proposal 1: In an uncontested
election, Kurt Dammeier was elected for a three-year term expiring on
the date of the annual meeting in 2007. The following directors
continued after the annual meeting. George Hancock, Scott S.
Barnum, Scott Svenson and Nancy Mootz. Proposal 2: A management
proposal to approve the Companys 2004 Equity Incentive Plan Proposal 3: An advisory vote
on the appointment of KPMG LLP as the Companys auditor for the
fiscal year ending December 31, 2004. VotesFor
    
    Against
    
    AbstainProposal 1
    
    
    7,767,252
    
    
    
    
    
    
    
    758,890Proposal 2
    
    
    4,309,358
    
    
    
    627,488
    
    
    
    18,965Proposal 3
    
    
    8,453,808
    
    
    
    56,005
    
    
    
    16,329 
 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:R. George Hancock, Interim 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:George Hancock, Interim 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 During
the quarter ended June 30, 2004 a report on Form 8-K dated
April 27, 2004 was furnished on April 29, 2004. Items 1, 2, 3 and 5 of PART II are not applicable and have been omitted 19




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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 August 16, 2004. PYRAMID BREWERIES INC.By:
    
    /s/ JAMES K. HILGERJames K. Hilger, Vice-President and Chief Financial Officer
 DATE: August 16, 2004 20