UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549




FORM
      10-K




(Mark
      One)




xANNUAL
      REPORT
      PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934




FOR
      THE
      FISCAL YEAR ENDED DECEMBER 31, 2006




or




oTRANSITION
      REPORT
      PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
      the
      transition period from __________  to
      __________




COMMISSION
      FILE NUMBER 1-13636




MENDOCINO
      BREWING COMPANY, INC.


(Exact
      name of Registrant as Specified in its Charter)




CALIFORNIA
            68-0318293(State
                or Other Jurisdiction of Incorporation or Organization)
            (IRS
                Employer
              Identification
                No.)





1601
      AIRPORT ROAD, UKIAH, CA 95482


(Address
      of principal executive offices)




(707)
      463-6610


(Registrant's
      Telephone Number, Including Area Code)




Securities
      registered pursuant to section 12(b) of the Act: none




Securities
      registered pursuant to section 12(g) of the Act:




Common
      stock, no par value




Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.


Yes o No x




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Exchange Act. Yes o No
x




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
o




Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulations S-K is not contained herein, and will not be contained, to the
      best
      of the registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K. x




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of
      the
      Exchange Act)




Large
      accelerated Filer o  Accelerated
      Filer o  Non-accelerated
      Filer x




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes o No
x




The
      aggregate market value of the Common Stock held by non-affiliates of the
      registrant (based on the average of the closing bid and asked prices for such
      stock, as reported by the NASDAQ OTC Bulletin Board on March 29, 2007 was
      $2,441,917.




The
      number of shares of the registrant's Common Stock outstanding as of March 29,
      2007 was 11,628,174.




DOCUMENTS
      INCORPORATED BY REFERENCE




(1)
      Portions of the registrant's Proxy Statement relating to its 2007 Annual
      Stockholders' Meeting, to be filed subsequently-Part III.





**TABLE
      OF CONTENTS**




PageITEM
                1.
            
            BUSINESS
            
            1ITEM
                1A.
            
            RISK
                FACTORS
            
            8ITEM
                1B.
            
            UNRESOLVED
                STAFF COMMENTS
            
            9ITEM
                2.
            
            PROPERTIES.
            
            9ITEM
                3.
            
            LEGAL
                PROCEEDINGS.
            
            10ITEM
                4.
            
            SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY HOLDERS.
            
            10PART
                II
            
            
            
            11ITEM
                5.
            
            MARKET
                FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
              MATTERS
            
            11ITEM
                6.
            
            SELECTED
                FINANCIAL DATA
            
            13ITEM
                7.
            
            MANAGEMENT'S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
              RESULTS
                OF OPERATIONS.
            
            14ITEM
                7A.
            
            QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            
            23ITEM
                8.
            
            FINANCIAL
                STATEMENTS AND SUPPLEMENTARY DATA
            
            23ITEM
                9.
            
            CHANGES
                IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE.
            
            24ITEM
                9A.
            
            CONTROLS
                AND PROCEDURES
            
            24ITEM
                9B.
            
            OTHER
                INFORMATION.
            
            25ITEM
                10.
            
            DIRECTORS,
                EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE
              COMPANY
            
            25ITEM
                11.
            
            EXECUTIVE
                COMPENSATION
            
            28ITEM
                12.
            
            SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTAND
                RELATEDSTOCKHOLDER
                MATTERS.
            
            28ITEM
                13.
            
            CERTAIN
                RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
              INDEPENDENCE
            
            29ITEM
                14.
            
            PRINCIPAL
                ACCOUNTING FEES AND SERVICES
            
            29ITEM
                15.
            
            EXHIBITS
                AND FINANCIAL STATEMENT SCHEDULES
            
            30




i


**FORWARD-LOOKING
      INFORMATION**




Various
      portions of this Annual Report on Form 10-K, (the "Annual Report") including
      but
      not limited to the sections captioned "Description of Business" and
      "Management's Discussion and Analysis of Financial Condition and Results of
      Operation," contain forward-looking information. Such information involves
      risks
      and uncertainties that are based on current expectations, estimates and
      projections about the Company's business, Management's beliefs, and assumptions
      made by Management. Words such as "expects," "anticipates," "intends," "plans,"
      "believes," "seeks," "estimates," and variations of those and similar words
      are
      intended to identify such forward-looking information. Actual outcomes and
      results may differ materially from what is expressed or forecasted in such
      forward-looking information due to numerous factors, including but not limited
      to availability of financing for operations, successful performance of internal
      operations, the impact of competition, changes in distributor relationships
      or
      performance, and other risks discussed elsewhere in this Annual Report on Form
      10-K and from time to time in the Company's filings and reports with the
      Securities and Exchange Commission (the "Commission"). In addition, such
      statements could be affected by general industry and market conditions and
      growth rates, and by general economic and political conditions in the markets
      in
      which the Company competes. Readers are cautioned not to place undue reliance
      on
      these forward-looking statements.




**PART
      I**




**ITEM
      1.**  **BUSINESS**




**OVERVIEW**




Mendocino
      Brewing Company, Inc., a California corporation, was founded in 1983. It was
      one
      of the first modern craft brewers, having opened the first new brewpub in
      California and the second in the United States following the repeal of
      Prohibition, and it has been recognized for its innovations in the brewpub
      concept, its craft brew style and its distinctive labels. (In this Annual
      Report, the term "the Company" and its variants and the terms "we," "us," and
      "our" and their variants are generally used to refer to Mendocino Brewing
      Company, Inc. together with its subsidiaries, while the term "MBC" is used
      to
      refer to Mendocino Brewing Company, Inc. as an individual entity.)




The
      Company operates in two geographic markets, domestic (the United States)
      (referred to in this Annual Report as the "Domestic Territory") and Europe
      (including Austria, Belgium, Denmark, Ireland, Italy, the Netherlands, France,
      Finland, Germany, Greece, Iceland, Liechtenstein, Luxembourg, Norway, Portugal,
      Spain, Sweden, Switzerland, and the United Kingdom) as well as Canada
      (collectively, referred to in this Annual Report as the "European
      Territory").




The
      Company's domestic operations consist primarily of brewing and marketing a
      variety of proprietary craft beers, including among others Red Tail Ale, Blue
      Heron Pale Ale, Black Hawk Stout, Eye of the Hawk Select Ale, White Hawk
      Original IPA, and Red Tail Lager, and a licensed international specialty beer,
      Kingfisher Premium Lager. For domestic distribution, the Company brews its
      brands in its own facilities, which are located in Ukiah, California and
      Saratoga Springs, New York, and these beers are distributed in 41 states and
      the
      District of Columbia.




The
      Company's European operations, which are conducted through its wholly-owned
      subsidiary United Breweries International (U.K.) Limited ("UBI") and UBI's
      wholly-owned subsidiary UBSN, Ltd. ("UBSN"), consist primarily of the marketing
      and distribution of Kingfisher Premium Lager throughout the European Territory
      through ethnic Indian restaurants, chain retail grocers, liquor stores, and
      other retail outlets (such as convenience stores). The Company holds an
      exclusive license to brew and distribute Kingfisher Premium Lager from United
      Breweries Limited ("UB Limited"), an Indian corporation. The Company's Chairman
      of the Board, Dr. Vijay Mallya, is also the Chairman of the Board of UB
      Limited.




All
      of
      the Company's beers sold in the European Territory are brewed in England under
      contract by Shepherd Neame, Ltd. ("Shepherd Neame"), a prominent English brewer.
      Although UBSN is the sole distributor of Kingfisher Premium Lager in the United
      Kingdom, Ireland, continental Europe, and Canada, it does not physically
      distribute its products to its ultimate trade customers, relying instead on
      specialist restaurant trade distributors in the United Kingdom and Shepherd
      Neame, acting as UBSN's agent, on a commission basis, for distribution to the
      supermarket and liquor and convenience store trade.






1




**COMPANY
      BACKGROUND**




MBC
      first
      bottled its flagship brand, Red Tail Ale, in December 1983, and made its initial
      public offering in February 1995. The Company completed construction of its
      brewery in Ukiah, California in May 1997. This facility, which has a current
      annual bottling capacity of 90,000 brewers' barrels ("bbl."), was designed
      to
      enable the Company's production to be expanded to 200,000 bbl. per year with
      the
      addition of necessary equipment.




The
      Company's New York subsidiary, Releta Brewing Company, LLC, d/b/a Ten Springs
      Brewery ("Releta"), which is located in Saratoga Springs, New York, commenced
      production in its leased facilities in February 1998, with an initial capacity
      of 60,000 bbl. per year expandable to 200,000 bbl. per year.




In
      July
      1998, the Company purchased certain of the assets of Carmel Brewing Company,
      Inc., a California corporation ("Carmel Brewing"), such as trademarks, trade
      names, and other brand related assets as well as certain point of sales and
      brewing ingredients inventory.




On
      August
      13, 2001, the Company acquired UBI together with UBI's wholly-owned subsidiary
      UBSN, from Inversiones Mirabel, S. A., a Panamanian corporation ("Inversiones"),
      in exchange for MBC stock then valued at approximately $5,500,000 (the "UBI
      Acquisition"). The UBI Acquisition was considered to be a related-party
      transaction because at the time of the acquisition Inversiones was owned by
      a
      trust in which the Company's Chairman, Dr. Mallya, may have been deemed to
      have
      been a beneficial owner at the time. UBI and UBSN primarily market, sell, and
      distribute Kingfisher Premium Lager in the Company's European Territory.
      Kingfisher Premium Lager, which is the flagship brand of UB Limited, an
      India-based brewing and distribution company, is a recognized international
      brand, with widespread distribution outside the Company's geographic markets.




The
      Company also acquired the United States brewing and distribution rights for
      Kingfisher Premium Lager as a result of the UBI Acquisition. The Company brews
      Kingfisher Premium Lager in both of its U.S. brewing facilities -- Saratoga
      Springs and Ukiah. The Company has engaged Shepherd Neame to brew Kingfisher
      Premium Lager for distribution in the European Territory.




During
      the last quarter of fiscal year 2005, United Breweries of America, BVI, a
      British Virgin Islands corporation ("UBA-BVI"), an indirect beneficial owner
      of
      a majority of the Company's outstanding shares, merged into United Breweries
      Holdings, Ltd., an Indian Corporation ("UBHL"). As a result of the merger of
      UBA-BVI into UBHL, UBHL acquired indirect control over approximately 73% of
      the
      Company's outstanding shares. Dr. Mallya is the Chairman of the board of
      directors of UBHL.




**INDUSTRY
      OVERVIEW**




**DOMESTIC
      MARKET**




The
      U.S.
      domestic beer market falls into a number of market categories, some of which
      include low-priced, premium, super premium, lite, import, and specialty/craft
      beers. In the Domestic Territory, the Company competes in the specialty/craft
      category, which is currently estimated to be in the range of 6.6 million barrels
      per year. Craft beers are typically all malt, characterized by their full
      flavor, and are usually produced using methods similar to those of traditional
      European brews.




**EUROPEAN
      MARKET**




The
      vast
      majority of the Company's sales in the European Territory are made in the United
      Kingdom. During fiscal years 2006, 2005 and 2004 the Company's sales in the
      United Kingdom constituted approximately 92%, 94% and 94%, respectively, of
      its
      total sales in the European Territory.




Within
      the European Territory, the Company primarily distributes its products through
      Indian restaurants using specialist restaurant trade distributors. In addition,
      the Company distributes its products through other licensed premises and through
      other retail outlets such as supermarkets, liquor stores, and licensed shops
      and
      convenience stores.




**BUSINESS
      OF THE COMPANY**




**SEGMENT
      INFORMATION**




Prior
      to
      2001, the Company's business operations were exclusively located in the United
      States, where it was divided into two segments, (i) manufacturing and
      distribution of beer, which accounted for the majority of the Company's gross
      sales, and (ii) retail sales (primarily at the Company's Hopland, California,
      tavern and merchandise store) which generally accounted for less than 5% of
      annual gross sales (by revenue). With the Company's acquisition of UBI and
      UBSN
      in August 2001, however, the Company added a new business segment, distribution
      of beer outside the United States, primarily in the European Territory. The
      European Territory accounted for approximately 61%, 63% and 63% of the Company's
      gross sales during fiscal years 2006, 2005 and 2004 respectively, with the
      Company's manufacturing and distribution in the Domestic Territory accounting
      for 38%, 36% **** and
      36%
      of the Company's gross sales during fiscal years 2006, 2005 and 2004,
      respectively. The Company's retail segment accounted for less than 1% of gross
      sales for fiscal years 2006, 2005 and 2004. With the closure of the restaurant
      at the Company's Hopland property, Management expects that the retail sales
      segment will represent an insignificant portion of the Company's overall gross
      sales in the future. (For information on the Company's gross sales, income
      or
      loss and total assets for each segment, see the Company's Audited Financial
      Statements for fiscal year 2006 included in this Annual Report.)




2




**THE
      HOPLAND TAVERN ALE HOUSE AND MERCHANDISE STORE**




The
      historic Hopland tavern ale house and merchandise store serves to market the
      Company's products in the Domestic Territory. Located on a tourist route in
      Hopland, California, 100 miles north of San Francisco, the Hopland Brewery
      opened in 1983 as the first new brewpub in California and the second in the
      United States following the repeal of Prohibition.




Beverages
      served at the Hopland tavern include Red Tail Ale, Blue Heron Pale Ale, Black
      Hawk Stout, Eye of the Hawk Select Ale, Peregrine Golden Ale, White Hawk IPA,
      and a seasonal brew on tap, along with local wines and soft drinks. The adjacent
      merchandise store sells the Company's brews and merchandise such as
      hand-screened label T-shirts, posters, engraved glasses and mugs, logo caps
      and
      other brewery-related gifts.




**PRODUCTS**




The
      Company brews five ales, one wheat beer, three lagers, one stout and a root
      beer
      on a year-round basis, and three seasonal ales, for distribution in the Domestic
      Territory. All of these products are brewed at the Company's production
      facilities in Ukiah, California, and Saratoga Springs, New York.




In
      the
      European Territory, the Company currently distributes Kingfisher Premium Lager.
      Prior to April 1, 2005, the Company also distributed Sun Lik Chinese Lager
      in
      the United Kingdom.




The
      Company's principal products are as follows.




**RED
      TAIL ALE** ,
      a full
      flavored amber ale, is the Company's flagship brand. It is available year-round
      in 12 oz. six-packs and twelve-packs, half-barrel kegs, and 5 gallon
      kegs.




**BLUE
      HERON PALE ALE** is a
      golden ale with a full body and a distinctive hop character. It is available
      year-round in 12 oz. six-packs and twelve-packs, half-barrel kegs, and 5 gallon
      kegs.




**BLACK
      HAWK STOUT** is a
      rich bodied stout with big traditional flavors. It is available year-round
      in 12
      oz. six-packs, half-barrel kegs, and 5 gallon kegs.




**EYE
      OF THE HAWK SELECT ALE** is a
      strong rich bodied amber ale. It is available year round in 12 oz. six-packs,
      half-barrel kegs, and 5 gallon kegs.




**WHITE
      HAWK ORIGINAL IPA** is a
      heavily hopped ale with distinctive hop character and bold malt flavor. It
      is
      available year round in 12 oz. six-packs and half-barrel kegs.




**KINGFISHER
      PREMIUM LAGER** is a
      conventionally fermented specialty lager with a smooth crisp taste. In the
      Domestic Territory, Kingfisher Premium Lager is currently available year-round
      in 12 oz. six-packs, 22 oz. bottles, and on-draft. In the European Territory,
      it
      is available year-round, in 330ml and 660ml bottles in multi-packs in the United
      Kingdom, Ireland, and continental Europe and in 330ml bottles in Canada, as
      well
      as in a variety of keg sizes. In the United Kingdom, it is also available on
      draft in Indian restaurants.




**RED
      TAIL LAGER** is a
      traditional lager, with a smooth light feel and a crisp sweet finish. It is
      currently available year-round only in northern California in 12-oz. six packs
      and half-barrel kegs.




**DISTRIBUTION
      METHODS**




In
      the
      Domestic Territory, the Company's bottled products are sold through wholesale
      distributors to consumers at supermarkets, warehouse stores, liquor stores,
      taverns and bars, restaurants, and convenience stores.






3




Most
      of
      the Company's brands are also available on draft. The Company's products are
      delivered to retail outlets by independent distributors whose principal business
      is the distribution of beer and in some cases other alcoholic beverages, and
      who
      typically also distribute one or more national beer brands. Together with its
      distributors, the Company markets its products to retail outlets and relies
      on
      its distributors to provide regular deliveries, to maintain retail shelf space,
      and to oversee timely rotation of inventory. The Company also offers a variety
      of ales and lagers directly to consumers at the tavern and merchandise store
      in
      Hopland, California.




In
      the
      European Territory, the Company's products are distributed primarily through
      Indian restaurants by specialist restaurant trade distributors. Such points
      of
      sale represent approximately 95% of the Company's total sales volume in the
      European Territory, with the remaining 5% of sales volume attributed to the
      combination of sales in other ethnic restaurants (primarily Chinese) and to
      sales by supermarkets, liquor stores, and licensed shops and convenience stores.
      The majority of the Company's restaurant sales are through its approximately
      3,500 on-tap draft installations. UBI also exports Kingfisher Premium Lager
      to
      16 European markets outside of the United Kingdom and to Canada, and its sales
      growth in those markets typically correlates with the establishment and
      proliferation of Indian restaurants in such locations.




**SEASONALITY**




**DOMESTIC
      OPERATIONS** :
      Sales
      of the Company's products are somewhat seasonal, with first and fourth quarters
      historically being slow. The volume of sales in any given year and region may
      also be affected by local weather conditions. It is not clear to what extent,
      if
      any, seasonality will affect the results of operation of the Company in the
      future.




**EUROPEAN
      OPERATIONS** :
      Beer
      consumption in the United Kingdom, Ireland, and continental Europe has
      historically increased during the winter months. However, during the past few
      years, the Company has not seen a significant increase in sales during the
      winter. It is not clear to what extent, if any, seasonality will affect the
      results of operations of the Company.




Results
      of operations of any of the Company's segments for any given fiscal quarter
      may
      not necessarily be indicative of results that may be achieved in the same
      segment in other fiscal quarters or during the full fiscal year.




**COMPETITION**




In
      the
      Domestic Territory, the Company competes against a variety of brewers in the
      craft beer segment, including brewpubs, microbrewers, regional craft brewers,
      and craft beer products of major national breweries. Additionally, the entire
      craft beer segment competes to some extent with other segments of the United
      States beer market, including major national brands like Budweiser and Miller
      and imported beers such as Heineken and Becks.




The
      lager
      market in the United Kingdom is dominated by major international brands such
      as
      Carling, Budweiser, Becks, and Holsten Pils, both in the restaurant and pub
      sectors and in sales through supermarkets and other retail outlets. The
      Company's products are marketed through Indian and other restaurants, major
      supermarket chains, smaller chains, and individual stores. In all these sectors,
      the Company faces competition from other ethnic and international brands
      produced by local and large international brewers. The Company vigorously
      promotes Kingfisher Premium Lager as the worldwide No. 1 selling premium Indian
      lager brand. The profile of this brand has been raised significantly through
      the
      Company's continued promotion of Kingfisher World Curry Week in support of
      the
      charity "Action Against Hunger" that provides aid in the Indian sub-continent
      and southeast Asia.




The
      Company faces tough competition in the Domestic Territory as well as in the
      European Territory. The Company competes with other beer and beverage companies
      not only for consumer acceptance and loyalty but also for shelf and tap space
      in
      retail establishments. The Company must also vie for marketing focus by the
      Company's distributors and their customers, all of which also distribute and
      sell other beer and alcoholic beverage products. Many of these competitors
      have
      substantially greater financial and marketing resources and distribution
      networks than the Company. Moreover, the introduction of new products by
      competitors that compete directly with the Company's products, or that diminish
      the importance of the Company's products to retailers or distributors may have
      a
      material adverse effect on the Company's results of operations, cash flows
      and
      financial position.




**SOURCES
      AND AVAILABILITY OF RAW MATERIALS**




Production
      of the Company's beverages requires quantities of various agricultural products,
      including barley, hops, malt, and malted wheat for beer. The Company fulfills
      its commodities requirements through purchases from various sources, some
      through contractual arrangements and others on the open market. In the European
      Territory, these purchases are made directly by or for Shepherd Neame, which
      brews the Company's products on a contract basis. Although the Company believes
      that adequate supplies of these agricultural products are available presently,
      it cannot predict future availability or prices of such products and materials.
      The commodity markets have experienced and will continue to experience price
      fluctuations. The price and supply of raw materials will be determined by,
      among
      other factors, the level of crop production, weather conditions, export demand,
      and government regulations and legislation affecting agriculture. The Company
      does not use any hedges or unconditional purchase obligations to purchase its
      raw materials.






4




The
      Company's major suppliers in the United States are Great Western Malting Co.,
      Yakima, Washington, and Canada Malting company, Montreal, Canada (malt); Hop
      Union LLC, Yakima, Washington and S S Steiner, Inc., New York, New York (hops);
      Gamer Packaging Inc., Minneapolis, Minnesota (bottles and crown corks); Alliance
      Packaging, Seattle, Washington, Inland Paper Board and Packaging, Inc., Antioch,
      California and Empire State Container, Inc., Syracuse, New York (cartons);
      Sierra Pacific Packaging, Oroville, California and Caraustar, Ashland, Ohio
      (carriers); and DWS Printing Associates, Bay Shore, NY (labels).




The
      Company's major supplier for the European Territory is Shepherd Neame, which
      brews on a contract basis all of the Company's products that are sold in the
      European Territory. The Company does not directly purchase any material amounts
      of agricultural commodities or other products for use in the European
      Territory.




**DEPENDENCE
      ON MAJOR CUSTOMERS**




Sales
      to
      the Company's top five customers in fiscal year 2006 totaled $8,032,600, or
      approximately 24%, of the Company's total net sales, as compared to $7,610,500
      or 24% of total net sales for fiscal year 2005 and $7,942,000 or 25% of total
      net sales for 2004.




In
      the
      Company's Domestic Territory, sales to Mesa distributing company totaled
      approximately 8.5% of the Company's domestic sales (or approximately 3.3% of
      its
      total sales) for fiscal year 2006. During the years 2005 and 2004, sales to
      Alta
      Marketing totaled approximately to 10.4% and 10.2% respectively of the Company’s
      domestic sales (or approximately 3.8% of total sales in both
      years).




Sales
      to
      the Company's principal European customer, Shepherd Neame have also remained
      relatively stable. During fiscal year 2006 they represented approximately 16.2%
      of the Company's European Territory sales (or approximately 9.9% of the
      Company's total sales), as compared to approximately 14.6% and 15.3% of European
      Territory sales (or approximately 9.2% and 9.6% of total net sales) in fiscal
      years 2005 and 2004, respectively. No other individual customer accounted for
      more than 5% of the Company's total net sales during fiscal years 2006, 2005
      or
      2004.




**TRADEMARKS** ****




The
      Company has U.S. federal trademark registrations on the principal register
      of
      the United States Patent and Trademark Office for the following marks: MENDOCINO
      BREWING COMPANY word mark (Reg. No. 2,441,141), RED TAIL ALE word mark (Reg.
      No.
      2,032,382), RED TAIL design mark (Reg. No. 2,011,817), BLUE HERON PALE ALE
      design mark (Reg. No. 2,011,816), EYE OF THE HAWK SELECT ALE word mark (Reg.
      No.
      1,673,594), EYE OF THE HAWK SPECIAL EDITION ANNIVERSARY ALE design mark (Reg.
      No. 2,011,815), YULETIDE PORTER word mark (Reg. No. 1,666,891), BREWSLETTER
      word
      mark (Reg. No. 1,768,639), PEREGRINE GOLDEN ALE word mark (Reg. No. 2,475,522),
      HOPLAND BREWERY word mark (Reg. No. 2,509,464), BLACK EYE ALE word mark (Reg.
      No. 2,667,078), SUN LAGER PREMIUM HANDCRAFTED BREW word and design mark (Reg.
      No. 2,583,446), WHITE HAWK ORIGINAL IPA word and design mark (Reg. No.
      2,956,999), RAPTOR RED LAGER word and design mark (Reg. No. 3,113,619), and
      BLACK HAWK STOUT word mark (Reg. No. 3,205,652).




The
      Company uses the BLUE HERON word mark under a concurrent use agreement with
      Bridgeport Brewing Company which gives the Company the exclusive right to use
      the BLUE HERON word mark throughout the United States with the exception of
      Oregon, Idaho, Washington, and Montana. Bridgeport Brewing Company, the other
      concurrent use party, has the exclusive right to use the BLUE HERON word mark
      in
      those states.




The
      Company's use of the BLACK HAWK STOUT word mark is, by agreement with Hiram
      Walker & Sons, Inc., subject to the restriction that it be used solely to
      identify and distinguish malt beverage products namely, beer, ale and stout,
      and
      only in conjunction with the words "Mendocino Brewing Company."






5




The
      Company's United States federal trademark registration for the BLUE HERON word
      mark (Cancelled Reg. No. 1,820,076) was cancelled as a result of an alleged
      technical deficiency in registration compliance filings. The Company continues
      to use the BLUE HERON word mark and claims common law trademark rights in and
      to
      that mark. The Company presently has a pending application on file with the
      United States Patent and Trademark Office for the re-registration of the BLUE
      HERON word mark.




The
      Company claims common law trademark rights in and to the TALON BARLEY WINE
      ALE
      word mark and TALON BARLEY WINE ALE word and design mark and intends to register
      the marks with the United States Patent and Trademark Office.




The
      Company has acquired the trademark CARMEL BREWING COMPANY and any other
      variation of the same as used by Carmel Brewing Company and claims common law
      trademark rights in and to all such marks. The Company has also acquired the
      rights to use the RAZOR EDGE word mark through a License Agreement with Beverage
      Mates, Ltd. However, the Company is currently not using the RAZOR EDGE mark,
      and
      it is unclear whether it will use the mark in the future. The RAZOR EDGE License
      Agreement expires in 2008, but will be automatically renewed unless specifically
      terminated. License fees are calculated based on sales of the product. The
      Company has not had any sales of this brand since 2001.




Releta
      has a federal trademark registration on the supplemental register of the United
      States Patent and Trademark Office for the SARATOGA CLASSIC PILSNER word mark
      (Reg. No. 2,396,601).




**LICENSE
      AGREEMENTS**




In
      August
      2001, the Company acquired UBI and its wholly-owned subsidiary UBSN, which
      hold
      the exclusive brewing and distribution rights for Kingfisher Premium Lager
      in
      the United Kingdom, Ireland, continental Europe, and Canada through a Licensing
      Agreement with UB Limited. They also held Sun Lik Chinese Lager distribution
      rights in the United Kingdom, which expired in March 2005.




In
      July
      2001, MBC entered into the Kingfisher Trademark and Trade Name License Agreement
      with Kingfisher America, Inc., pursuant to which MBC obtained a royalty-free,
      exclusive license to use the Kingfisher trademark and trade name in connection
      with the brewing and distribution of beer in the United States. Under its terms,
      this agreement is currently scheduled to remain in effect until October of
      2013.




Since
      1998, UBI and UBSN have licensed to Shepherd Neame the exclusive right to brew,
      keg, bottle, can, label, and package all beers and related products sold under
      the Kingfisher trademark in the United Kingdom, Ireland, and continental Europe.
      (For additional information see "Item 13. -- Certain Relationships and Related
      Transactions - Shepherd Neame - Brewing Agreement".)




In
      April
      2004, the Company entered into a licensing agreement with Frank's Famous Foods
      ("FFF") and granted a non exclusive license to FFF for the trademark and trade
      name Red Tail Ale to be used in the manufacture and sale of barbecue sauces
      and
      marinades. FFF pays to the Company licensing fees ranging from $1.50 to $3.00
      per case sold.




**GOVERNMENTAL
      REGULATION**




The
      Company's Domestic Territory operations are subject to licensing by local,
      state
      and federal governments, as well as to regulation by a variety of state and
      local agencies. The Company is licensed to manufacture and sell beer by the
      Departments of Alcoholic Beverage Control in California and New York. A federal
      permit from the United States Treasury Department, Alcohol and Tobacco Tax
      and
      Trade Bureau (the "TTB") (formerly the Bureau of Alcohol, Tobacco, and Firearms)
      allows the Company to manufacture fermented malt beverages. To keep these
      licenses and permits in force the Company must pay annual fees and submit timely
      production reports and excise tax returns. Prompt notice of any changes in
      the
      operations, ownership, or company structure must also be made to these
      regulatory agencies. The TTB must also approve all product labels, which must
      include an alcohol use warning. These agencies require that individuals owning
      equity securities in aggregate of 10% or more in the Company be investigated
      as
      to their suitability of character. The Company's production operations must
      also
      comply with the Occupational Safety and Health Administration's workplace safety
      and worker health regulations and comparable state laws. Management believes
      that the Company is presently in compliance with the aforementioned laws and
      regulations. In addition, the Company has implemented its own voluntary safety
      program. The Hopland tavern is regulated by the Mendocino County Health
      Department, which requires an annual permit and conducts spot inspections to
      monitor compliance with applicable health codes.




6




In
      the
      United States, the federal excise tax rate is $7.00 per bbl. for up to 60,000
      bbl. per year and $18.00 per bbl. for over 60,000 bbl. for brewers producing
      less than 2,000,000 barrels per year. The California excise tax rate is $6.20
      per bbl. The State of New York presently imposes on brewers an excise tax of
      $3.88 per bbl. for production in excess of 100,000 bbl. per year.




The
      Company's operations in the European Territory are subject to regulation by
      United Kingdom and European laws, as well as by the laws of various individual
      countries in which UBI distributes its products. Because Shepherd Neame is
      contracted to perform the brewing operations for the European Territory,
      Shepherd Neame is subject to the various laws of the European countries
      regarding production, bottling, packaging, and labeling in lieu of the Company.
      Trade with Canada is subject to, and in compliance with, regulation by the
      provincial Liquor Boards.




**COMPLIANCE
      WITH ENVIRONMENTAL LAWS**




The
      Company is subject to various federal, state, and local environmental laws
      which
      regulate the use, storage, handling, and disposal of various
      substances.




The
      Company's waste products consist of water, spent grains, hops, glass and
      cardboard. The Company has instituted a recycling program for its office paper,
      newspapers, magazines, glass, and cardboard at minimal cost to the Company.
      The
      Company sells or gives away its spent grain to local cattle ranchers. The
      Company has not purchased any special equipment and does not incur any
      identifiable fees in connection with environmental compliance at its Hopland
      site.




Ukiah.
      The Company has built its own wastewater treatment plant for the Ukiah facility.
      As a consequence, the Company is not currently required to incur sewer hook-up
      fees at that location. If the Company's discharge exceeds 55,000 gallons per
      day, which Management does not expect to occur until annual capacity exceeds
      100,000 bbl., the Company may be required to pay additional fees. The wastewater
      treatment facility cost approximately $900,000, and the estimated cost of
      operating the plant is between $6,000 and $10,000 per month. The operating costs
      of the facility may increase with increased production. The Company has
      contracted to have the liquid sediment that remains from the treated wastewater
      trucked to a local composting facility for essentially the cost of
      transportation. The Company obtained a Mendocino County Air Quality Control
      Permit to operate the natural gas fired boiler in Ukiah; this permit is valid
      until August 30, 2007. Management expects this permit to be
      renewed.




Saratoga
      Springs. The Saratoga Springs facility is subject to various federal, state,
      and
      local environmental laws which regulate use, storage and disposal of various
      materials. The Company's solid waste materials consist of spent grain,
      cardboard, glass, and liquid waste. The Company has instituted a recycling
      program for cardboard, office paper and glass at a minimal cost to the Company.
      Spent grain is sold to local cattle dairy farms. The Company pays approximately
      $2,400 per month in sewer fees for liquid waste. The sewer discharge from the
      brewery is monitored and is within the standards set by the Saratoga County
      Sewer Department. The Company follows and operates under the rules and
      regulations of the New York Department of Environmental Conservation for Air
      Pollution Control.




Various
      states in which the Company sells its products in the Domestic Territory,
      including California and New York, have adopted certain restrictive packaging
      laws and regulations for beverages that require deposits on packages. Such
      laws
      have not had a significant effect on the Company's sales. The adoption of
      similar legislation by Congress or a substantial number of states or additional
      local jurisdictions might require the Company to incur significant capital
      expenditures to comply.




In
      general, European packaging regulations are covered by specifications provided
      by the European Union; the Company believes it is in compliance with such
      specifications.




The
      Company has not received any notice from any governmental agency relating to
      the
      violation by the Company of any applicable environmental law.




**EMPLOYEES**




As
      of
      December 31, 2006, MBC employed 54 full-time and 17 part-time individuals in
      the
      United States, including 13 in management and administration, 47 in brewing
      and
      production operations, 3 in retail and tavern operations and 8 in sales and
      marketing positions. In England, UBI and UBSN together employed 10 people in
      sales and marketing and 6 in managerial and administrative positions. Management
      believes that the Company's relations with its employees are generally
      good.






7




On
      February 28, 2003, approximately 21 employees engaged in brewing, bottling,
      warehousing, and shipping at the Ukiah brewery elected Teamsters Local No.
      896,
      International Brotherhood of Teamsters, AFL-CIO (the "Union") to represent
      them
      as a collective bargaining agent. The Company and the Union executed a
      collective bargaining agreement effective November 17, 2003. Such collective
      bargaining agreement will expire on July 31, 2008. All of such 21 employees'
      positions henceforth must be held and filled by members of the
      union.




**RESEARCH
      AND DEVELOPMENT**




The
      Company has not spent a material amount during the last three fiscal years
      on
      research and development activities nor on customer-sponsored research
      activities relating to the development of new products, services or techniques
      or the improvement of existing products, services or techniques.




**BACKLOG**




Management
      of the Company does not believe that backlog as of any particular date is
      meaningful to its operations and results.




**FINANCIAL
      INFORMATION ABOUT GEOGRAPHIC AREAS**




See
      "Item
      8. —
      Financial Statements and Supplementary Data" for a discussion of sales,
      operating income and identifiable assets attributable to the Company's
      operations.




**AVAILABLE
      INFORMATION**




The
      Company is subject to the informational reporting requirements of the Securities
      Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
      therewith periodically files reports, proxy statements, and other information
      with the Securities and Exchange Commission (the "Commission"). Such reports,
      proxy statements and other information can be inspected and copies can be made
      or obtained at or by writing to the SEC's Public Reference Room at 450 Fifth
      Street, N.W., Washington, D.C. 20549. The public may obtain information on
      the
      operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
      Such material may also be accessed electronically through the Edgar filings
      by
      the Company, by means of the Commission's Internet Web site
      (http://www.sec.gov).




**ITEM
      1A.**  **RISK
      FACTORS**




In
      addition to the other information in this Annual Report on Form 10-K, described
      below are risks and uncertainties that we believe are most likely to be material
      to our business and results of operations. Our business operations and results
      may also be adversely affected by additional risks and uncertainties not
      presently known, or which we currently deem immaterial, or which are applicable
      in general to the industries in which we compete or to the economy. If any
      of
      the following risks or uncertainties actually occurs, our business, financial
      condition, results of operations or cash flows would likely suffer.




LACK
      OF
      PROFITABLE OPERATIONS: We incurred a net loss for fiscal year 2006.
      Historically, the Domestic Territory has operated at a net loss. Since the
      year
      2005, the European territory has also been operating at a loss. We believe
      such
      losses are attributable to low sales volumes and low production capacity
      utilization rates at our domestic brewing facilities and higher operating
      expenses in the European territory. Our business is also subject to certain
      fixed and semi-variable operating costs, and when combined with the impact
      of
      the correlation between current levels of production and maximum production
      capacity, our gross margins may be sensitive to small increases or decreases
      in
      sales volume in the Domestic Territory. In addition, higher cost of materials
      and energy costs in 2006 resulted in increased materials and freight costs.
      We
      may not be able to offset such increased expenses with comparable price
      increases in our products, which could also impact our gross margins. We may
      not
      be successful in our efforts to increase sales volume and utilization rates.
      Moreover, it is uncertain when, if at all, our operations will become profitable
      once again. Future operating losses may have a material adverse effect on our
      cash flows and financial position.




LIQUIDITY:
      Low utilization of the production capacity at our Ukiah and Saratoga Springs
      facilities and losses from our European operations continued to place demands
      on
      our working capital. We have loans, lines of credit, other credit facilities,
      and lease obligations with various creditors. Any breach of a loan by us which
      leads to our default, or to an attempt by one of our creditors to exercise
      its
      rights to certain of our tangible or intangible assets which have been used
      as
      collateral or which have been pledged as security for our obligations, could
      potentially make it difficult, at least in the short term, for us to continue
      our operations.






8




COMPETITION:
      We face intense competition in both our Domestic Territory as well as in our
      European Territory from both competitors in the beer market as well as from
      producers of wine and spirits. Certain of our competitors have substantially
      greater financial and marketing resources and more extensive distribution
      networks than we do. In addition, the introduction of new products by existing
      competitors or new entrants into the market may impact our market share.
      Moreover, consumer preference and consumer trends may result in a decrease
      in
      demand for our products which could also have an impact on our results of
      operations.




RAW
      MATERIALS: We are dependant on a limited number of suppliers, and in some
      instances on a sole supplier, for the majority of the raw materials and
      packaging materials used in our operations. As a result, an interruption in
      the
      supply chain may have an adverse effect on our operations if we were unable
      to
      find an alternative supplier at a comparable price. Our cost of materials
      including energy costs continued to increase during the year 2006 as well as
      in
      the first quarter of the year 2007. While we have increased our selling prices
      marginally, we may not be in a position to pass the entire cost increase to
      our
      customers which may have an adverse effect on our operations.




DEPENDENCY
      ON CONTRACT BREWING ARRANGEMENTS: We have entered into short term non-binding
      arrangements with several brewers to brew and package their brands at our
      brewing facilities, predominantly at our Releta facility. Approximately 17%
      of
      our sales volume in the Domestic Territory for fiscal year 2006 includes sales
      made under such contract brewing arrangements. There is no certainty that such
      existing arrangements will be extended in the future or that we will be able
      to
      enter into new arrangements. Any significant variation in these arrangements
      could have a material adverse effect on the Company's results of operations,
      cash flows and financial position.




ARRANGEMENT
      WITH SHEPHERD NEAME: UBI and UBSN entered into a brewing agreement that grants
      Shepherd Neame the exclusive right to brew and package all beers sold under
      the
      Kingfisher trademark in the United Kingdom, and to distribute such products
      elsewhere in the European Territory. Any interruption of the brewing, packaging
      or distribution of our products by Shepherd Neame for any reason is likely
      to
      have a material adverse effect on our results of operations, cash flows and
      financial position.




MATERIAL
      CONTRACT FOR THE SUPPLY OF KEGS: We have entered into an exclusive Keg
      Management Agreement with MicroStar Keg Management LLC ("MicroStar") which
      expires in September 2009. Under the terms of the agreement with MicroStar,
      we
      receive our entire supply of kegs exclusively from MicroStar. Moreover, pursuant
      to the terms of the agreement, if the agreement is terminated, we are required
      to purchase three times the average monthly keg usage for the preceding
      six-month period from MicroStar at purchase prices ranging from $54 to $84
      per
      keg. If we are required in the future to purchase such kegs we may need to
      incur
      additional debt financing to fund such purchases. An interruption in the supply
      of kegs by MicroStar to us or in case of termination of the agreement, our
      failure to obtain the necessary funding to facilitate such purchases could
      have
      a material adverse effect on our business, results of operations, cash flow
      or
      financial position.




CHANGE
      IN
      PUBLIC ATTITUDE AND DRINKING PREFERENCES: There
      is
      an increasing public concern over alcohol-related social problems, including
      drunk driving, underage drinking and health consequences from the misuse of
      alcohol, including alcoholism. This may adversely affect consumption of
      alcoholic beverages. Consumers drinking preferences may also change due to
      availability of a variety of products in the craft brew segment. Hence any
      change in government regulation and shift in consumer preference may have an
      adverse impact on our operations.




**I** **TEM
      1B.**  **UNRESOLVED
      STAFF COMMENTS**




Not
      applicable.






**ITEM
      2.**  **PROPERTIES.**




**BREWING
      FACILITIES**




The
      Company owns nine acres of land in Ukiah, California on which its Ukiah brewery
      is located. Management believes that this facility is adequate for the Company's
      current capacity and also provides space for future expansion. Grand Pacific
      Financing Corporation currently holds a first deed of trust on this property
      in
      connection with a loan advanced to the Company. (See "Item 7. — Management's
      Discussion and Analysis of Financial Condition and Results of Operations -
      Liquidity and Capital Resources - Long-Term Debt".) The principal amount
      outstanding on the loan as of December 31, 2006 was $2,989,400.






9




The
      Company has estimated the life of the building at 40 years and depreciates
      the
      cost of the building on a straight-line method over its anticipated life. The
      Company does not depreciate the cost of the land. The Company's tax basis on
      the
      Ukiah facility is $10,826,200. Various other assets incorporated in this
      facility are being depreciated, on a straight-line basis, at rates of between
      10
      and 20 years. Property taxes are currently assessed on the Ukiah property at
      a
      rate of 1.11%, for an annual tax of $120,200.




The
      Company also leases 3.66 acres in Saratoga Springs, New York, on which the
      Ten
      Springs Brewery facilities are located. In November 2004, the Company leased
      additional warehouse space and extended the term of the lease until November
      2019.




The
      Company's Ukiah and Releta facilities have both been operating at low production
      capacity utilization rates. The brewery in Ukiah, California has a current
      annual bottling capacity of approximately 90,000 bbl. on a single shift basis,
      whereas the annual sales volume from this facility was approximately 39,700
      bbl.
      or 44% of maximum production capacity, in 2006, as compared with 41,600 bbl.
      or
      46% of maximum production capacity, in 2005, and 43,400 bbl. or 48% of maximum
      production capacity, in 2004. The brewery at Saratoga Springs, New York has
      an
      annual bottling capacity of approximately 60,000 bbl. per year a on single
      shift
      basis, although its annual sales volume from this facility was approximately
      26,300 bbl. or 44% of its maximum capacity, in 2006, as compared with 17,400
      bbl. or 29% of its maximum capacity, in 2005, and 16,300 bbl. or 27% of maximum
      production capacity in 2004. Despite their low production capacity utilization
      rates, both of these breweries incur costs for maintenance, property taxes,
      and
      other costs on a level consistent with their maximum production capacity rather
      than with the current utilization levels of these facilities. The inability
      of
      the Company to align costs and utilization rates affects the Company's capital,
      liquidity, and resources of management. Failure to adequately align such costs
      and utilization rates may have a material adverse affect on the Company's
      business, financial condition, and results of operations.




**TAVERN**




The
      Company has leased a 2,275 square foot building in Hopland on which the Hopland
      tavern ale house and merchandise store are located. The lease on this property
      expires in August 2010.




**MACHINERY
      AND EQUIPMENT**




The
      Company leases certain equipment and vehicles under capital and operating leases
      which expire at varying times through April 2008. Additionally, the Company
      leases equipment and vehicles under various other leases. As these leases
      expire, it is anticipated that, in accordance with the Company's current
      practices, the equipment will be acquired pursuant to the terms of the leases
      and the vehicles will be surrendered.




UBSN
      has
      leased a 1,365 square foot office located at Faversham, Kent, in England for
      a
      period of 10 years beginning in July 2005. The Company does not own or lease
      any
      other material properties in Europe.




The
      Company considers its land, buildings, improvements, and equipment to be well
      maintained, in good condition, and adequate to meet the operating demands placed
      upon them. In the opinion of Management, all of these properties are adequately
      covered by insurance.




**ITEM
      3.**  **LEGAL
      PROCEEDINGS.**




None.




**ITEM
      4.**  **SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS.**




MBC
      held
      its 2006 Annual Meeting of Shareholders on November 27, 2006. At that meeting,
      MBC's shareholders voted to elect all seven of the Board's nominees for
      Director. The votes cast for each of the nominees were as follows. There were
      no
      broker non-votes; ballots for a total of 1,883,898 shares were not cast with
      respect to any candidate.




Director's
                Name
            
            Votes
                for
            
            WithheldVijay
                Mallya
            
            9,704,395
            
            39,881H.
                Michael Laybourn
            
            9,731,931
            
            12,345Jerome
                G. Merchant
            
            9,716,077
            
            28,199Sury
                Rao Palamand
            
            9,695,578
            
            48,698Kent
                D. Price
            
            9,729,281
            
            14,995Yashpal
                Singh
            
            9,695,878
            
            48,398Scott
                R. Heldfond
            
            9,730,031
            
            14,245






10





In
      addition, the Shareholders voted to ratify the selection of PMB Helin Donovan
      (successor firm of Pohl, McNabola, Berg & Company, LLP) as the Company's
      independent accountants. 9,708,548 votes were cast for such action, 31,003
      votes
      were cast against such action and there were 4,725 broker
      non-votes.




**PART
      II**




**ITEM
      5.**  **MARKET
      FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
      MATTERS.**




**MARKET
      INFORMATION**




Since
      May
      2002, the Company's Common Stock has been quoted on the NASDAQ OTC Bulletin
      Board, under the symbol "MENB". The table below sets forth, for the fiscal
      quarters indicated, the reported high and low bid prices for the Company's
      Common Stock, as reported on the OTC Bulletin Board. The information listed
      below reflects inter-dealer bids, without retail mark-up, mark-down, or
      commission, and may not represent actual transactions.




2006
            
            High
            
            LowFirst
                Quarter
            
            $
            0.22
            
            $
            0.10Second
                Quarter
            
            $
            0.30
            
            $
            0.13Third
                Quarter
            
            $
            0.34
            
            $
            0.15Fourth
                Quarter
            
            $
            0.25
            
            $
            0.17





2005
            
            High
            
            LowFirst
                Quarter
            
            $
            0.25
            
            $
            0.18Second
                Quarter
            
            $
            0.25
            
            $
            0.16Third
                Quarter
            
            $
            0.20
            
            $
            0.17Fourth
                Quarter
            
            $
            0.28
            
            $
            0.11




The
      Company had approximately 2,308 holders of its common stock of record as of
      March 15, 2007. The Company has never paid a cash dividend on its Common Stock
      and Management does not expect the Company to pay cash dividends in the
      foreseeable future. The Company's credit agreements provide that the Company
      may
      not declare or pay any dividend or other distribution on its Common Stock (other
      than a stock dividend), or purchase or redeem any Common Stock, without the
      lender's prior written consent. Management anticipates that similar restrictions
      will remain in effect for as long as the Company has significant bank
      financing.




The
      holders of the Company's 227,600 outstanding shares of Series A Preferred Stock
      (which are not listed for trading on any market or to the Company's knowledge
      quoted on any bulletin board or other public quotation system) are entitled
      to
      aggregate cash dividends and liquidation proceeds of $1.00 per share before
      any
      dividend may be paid with respect to the Common Stock. The Series A Preferred
      Shares must be canceled after the holders of these shares have received their
      $1.00 per share aggregate dividend. Management does not have any present
      intention to declare or pay a dividend on the Series A Preferred
      Stock.






11




**SECURITIES
      AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS**




As
      of
      December 31, 2006, the Company had authorized and issued equity compensation
      in
      the following amounts.




Plan
                Category
            
            Number
                of securities to be issued upon exercise of outstanding options,
                warrants
                and rights
              (a)
            
            Weighted-average
                exercise price of outstanding options, warrants and rights
              (b)
            
            Number
                of securities remaining available for future issuance under equity
                compensation plans (excluding securities reflected in column
              (a))
                (c)Equity
                compensation plans approved by security holders
            
            
            240,385
                #
            
            $
            0.52
            
            
            --
                **Equity
                compensation plans not approved by security holders
            
            
            *
            
            
            *
            
            
            --Total
            
            
            240,385
                #
            
            $
            0.52
            
            
            --





#  All
      the
      options expired on January 3, 2007.




*  See
      "
      Recent Sales of Unregistered Securities; Use of Proceeds from Registered
      Securities" for a description of the Company's Director's Compensation
      Plan.




**  The
      Company's 1994 Stock Option Plan expired in 2004 and has not been
      extended.




**RECENT
      SALES OF UNREGISTERED SECURITIES**




The
      Company's policy with respect to the compensation of outside directors of MBC
      for their services as directors is as follows: each outside director receives
      $3,000 per Board meeting attended and $1,000 per committee meeting
      attended.




Prior
      to
      2003, the Company had a policy of granting shares of Common Stock in lieu of
      cash to non-employee directors at their option, as compensation for their
      attendance at meetings of the Board of Directors and of Committees of the Board
      on which they served, based on a standard schedule of $3,000 per Board meeting
      attended and $1,000 per committee meeting attended. However, because the market
      value of the Company's Common Stock fell below $0.50 per share during the latter
      half of 2003, and has since remained consistently below $1.00 per share (at
      times falling below twenty cents per share) - which would have increased quite
      significantly the number of shares otherwise issuable to these directors --
      the
      Board of Directors adopted a Directors' Stock Grant Plan under which
      non-employee directors would receive, as compensation for Board and Committee
      meetings attended, shares of the Company's Common Stock valued at the higher
      of
      the book or market value calculated as of the last day of each year in respect
      of which such compensation was due. On October 3, 2006 the Company issued 22,221
      shares to Scott Heldfond, 27,924 shares to Michael Layborne, 53,576 shares
      to
      Sury Rao Palamand and 50,539 shares to Kent Price, totaling 154,260 shares
      as
      remuneration to directors for the years 2004 and 2005. Management believes
      that
      the issuance of the shares was exempt from registration pursuant to Section
      4(2)
      of the Act because of the limited number of recipients, and the fact that the
      recipient had significant business experience, financial sophistication, and
      intimate knowledge of and familiarity with the Company's business.




The
      Company's policy for compensation of its non-employee directors has in the
      past
      included the annual issuance of options, pursuant to the Company's 1994 Stock
      Option Plan (the "Plan"), to purchase a number of shares of the Company's Common
      Stock having a fair market value of $25,000. The Plan expired in 2004, however,
      and to date no new option or similar plan has been adopted by the board. The
      Board may adopt new plans and guidelines for compensation in the
      future.




The
      Company issued thirteen (13) promissory notes pursuant to a Master Line of
      Credit Agreement between the Company and United Breweries of America, Inc.
      ("UBA") and one note on substantially similar terms to UBA between September
      1999, and March 2005 (the "UBA Notes"). The outstanding principal amount of
      the
      UBA Notes, and the unpaid interest thereon may be converted, at UBA's
      discretion, into shares of the Company's unregistered Common Stock at a
      conversion rate of $1.50 per share. As of December 31, 2006, the outstanding
      principal and interest on the UBA Notes totaled approximately $2,733,392, and
      the UBA Notes were convertible into 1,822,261 shares of the Company's Common
      Stock. If the UBA Notes were deemed to be securities, the Company's Management
      believes that the issuance of all such notes is exempt from registration
      pursuant to Section 4(2) of the Securities Act of 1983, as amended (the "Act"),
      because UBA, the sole offeree and recipient thereof, has significant business
      experience, financial sophistication, and knowledge of and familiarity with
      the
      business of the Company. Management believes that if these notes were eventually
      to be converted into shares of the Company's Common Stock, the issuance of
      such
      shares would also be exempt from registration pursuant to Section 4(2) of the
      Act.






12




**ISSUER
      PURCHASE OF EQUITY SECURITIES**




None.




**ITEM
      6.**  **SELECTED
      FINANCIAL DATA.**




In
      August
      of 2001, the Company acquired all the outstanding stock of UBI, in exchange
      for
      5,000,000 shares of MBC Common Stock. Since it was considered a related party
      transaction, this acquisition was required to be reported on an "as-if pooled"
      basis. The Company's consolidated financial statements have been presented
      as if
      the acquisition of UBI had occurred on January 1, 2000.




**STATEMENT
      OF OPERATIONS DATA**




**YEARS
                ENDED****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Sales
            
            $
            32,948,900
            
            $
            31,927,300
            
            $
            32,157,900
            
            $
            28,864,300
            
            $
            26,085,100Less
                Excise Taxes
            
            
            673,500
            
            
            635,500
            
            
            652,400
            
            
            673,900
            
            
            651,600Net
                Sales
            
            
            32,275,400
            
            
            31,291,800
            
            
            31,505,500
            
            
            28,190,300
            
            
            25,433,500Cost
                of goods sold
            
            
            23,063,300
            
            
            21,754,200
            
            
            21,045,500
            
            
            19,145,500
            
            
            16,892,800Gross
                Profit
            
            
            9,212,100
            
            
            9,537,600
            
            
            10,460,000
            
            
            9,044,800
            
            
            8,540,700Operating
                Expenses
            
            
            9,657,400
            
            
            10,054,000
            
            
            10,006,200
            
            
            8,067,300
            
            
            7,312,000Depreciation
                & Amortization
            
            
            1,017,800
            
            
            903,700
            
            
            1,031,300
            
            
            1,127,100
            
            
            1,049,000Net
                income (Loss)
            
            
            (1,430,600
            )
            
            (1,314,700
            )
            
            (468,900
            )
            
            46,900
            
            
            (1,729,800
            )Net
                income (Loss) per common share
            
            
            (0.12
            )
            
            (0.11
            )
            
            (0.04
            )
            
            0.00
            
            
            (0.15
            )Average
                common shares outstanding
            
            
            11,512,479
            
            
            11,472,213
            
            
            11,266,874
            
            
            11,266,874
            
            
            11,266,874




**BALANCE
      SHEET DATA**




**December
                31,****2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Cash
                and Cash equivalent
            
            $
            345,900
            
            $
            247,700
            
            $
            526,600
            
            $
            554,300
            
            $
            146,800Working
                capital
            
            
            (2,683,400
            )
            
            (3,076,800
            )
            
            (2,215,100
            )
            
            (1,795,600
            )
            
            (2,673,000
            )Property
                and equipment
            
            
            13,446,000
            
            
            13,185,600
            
            
            13,533,900
            
            
            13,874,800
            
            
            14,159,400Deposit
                and other assets
            
            
            356,200
            
            
            372,700
            
            
            205,100
            
            
            188,600
            
            
            73,600Total
                assets
            
            
            24,052,100
            
            
            22,557,400
            
            
            24,363,100
            
            
            23,471,700
            
            
            22,289,600Long
                term debt
            
            
            7,613,300
            
            
            5,607,400
            
            
            5,457,500
            
            
            5,855,900
            
            
            5,320,300Capital
                lease
            
            
            65,600
            
            
            121,500
            
            
            62,600
            
            
            204,100
            
            
            193,900Total
                liabilities
            
            
            20,546,600
            
            
            17,683,300
            
            
            18,209,100
            
            
            16,965,100
            
            
            15,943,200Accumulated
                deficit
            
            
            (11,661,800
            )
            
            (10,231,200
            )
            
            (8,916,500
            )
            
            (8,447,600
            )
            
            (8,494,500
            )Shareholders
                equity
            
            
            3,505,500
            
            
            4,874,100
            
            
            6,154,000
            
            
            6,506,600
            
            
            6,346,400Cash
                Dividend Declared Per Common Share
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —




13




**ITEM
      7.**  **MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF**


**OPERATIONS.**




The
      following discussion and analysis should be read in conjunction with the
      Financial Statements and the Notes thereto and other financial information
      included elsewhere in this Report. The discussion of results and trends does
      not
      necessarily imply that these results and trends will continue. With respect
      to
      certain forward-looking statements contained in the following discussion, please
      refer to the paragraph captioned "Forward Looking Statements" set forth
      immediately prior to Part I of this Annual Report, above.




**CRITICAL
      ACCOUNTING POLICIES**




**Changes
      in 2006**




On
      January 1, 2006, we adopted Statement of Financial Accounting Standards No.
      123
      (revised 2004), "Share-Based Payment," which requires the measurement and
      recognition of compensation expense for all share-based awards made to employees
      and directors, including employee stock options and employee stock purchases,
      based on estimated fair values. Prior to the adoption of SFAS 123(R), we
      accounted for stock-based awards to employees and directors using the intrinsic
      value method in accordance with Accounting Principles Board Opinion No. 25,
      "Accounting for Stock Issued to Employees." Under the intrinsic value method,
      which had been allowed under the original provisions of Statement 123, no stock
      compensation expense had been recognized in our statement of operations as
      the
      exercise price of our stock options granted to employees and directors equaled
      the fair market value of the underlying stock at the date of grant.




In
      the
      ordinary course of business, we have made a number of estimates and assumptions
      relating to the reporting of our results of operations and financial conditions
      in the preparation of our financial statements in conformity with generally
      accepted accounting principles in the United States.




Actual
      results could differ significantly from those estimates under different
      assumptions and conditions. We believe that the following discussion addresses
      our most critical accounting policies, which are those that are most important
      to the portrayal of our financial condition and results. We constantly
      re-evaluate these significant factors and makes adjustments where facts and
      circumstances dictate. Historically, actual results have not significantly
      deviated from those determined using the necessary estimates inherent in the
      preparation of financial statements. Estimates and assumptions include, but
      are
      not limited to, customer receivables, inventories, assets held for sale, fixed
      asset lives, contingencies and litigation. We have also chosen certain
      accounting policies when options were available, including:




·
            The
                average-cost method to value a majority of our
                inventories;




·
            Effective
                January 1, 2006, we adopted SFAS 123(R) to account for all stock-based
                compensation;




·
            A
                full valuation allowance of deferred tax assets for NOLs that are
                expected
                to expire prior to utilization;




·
            The
                carrying value of certain plants and equipment are not impaired under
                FASB
                144 based on expected future cash flows from
                operations;






14




These
      accounting policies are applied consistently for all years presented. Our
      operating results would be affected if alternative methods were used.
      Information about the impact on our operating results is included in the
      footnotes to our consolidated financial statements.




**Revenue
      Recognition**




We
      recognize revenues once the following criteria are met:




·
            Persuasive
                evidence of an arrangement exists;




·
            Delivery
                of our obligation to our customer has
                occurred;




·
            The
                price to be charged to the buyer is fixed or determinable;
                and




·
            Collectibility
                of the fees to be charged is reasonably
                assured;




We
      determine that collectibility is reasonably assured through a standardized
      credit review to determine each customer's credit worthiness.




**OVERVIEW**




We
      reported a net loss for fiscal year 2006, primarily as a result of higher costs
      of goods sold and higher operational expenses incurred in connection with our
      operations in the European Territory.




In
      the
      Domestic Territory, brewing operations sales (based on volume) were 65,969
      bbl.
      during fiscal year 2006, as compared to 59,046 bbl. and 59,616 bbl. in fiscal
      years 2005 and 2004, respectively. Sales from the Ukiah facility totaled 39,693
      bbl., 41,620 bbl. and 43,358 bbl., for the fiscal years 2006, 2005 and 2004,
      respectively. Sales from the Saratoga Springs facility totaled 26,276 bbl.,
      17,426 bbl., and 16,258 bbl. for the fiscal years 2006, 2005 and 2004,
      respectively. We bottled 3,577 bbl., 2,919 bbl., and 1157 bbl. in fiscal years
      2006, 2005 and 2004, respectively, of cider products for California Cider
      Company.




We
      sold
      67,797 bbl. of beer in our European Territory during fiscal year 2006 as
      compared to 67,633 bbl. and 67,496 bbl. during fiscal years 2005 and 2004,
      respectively. Sales in the United Kingdom accounted for 60,187 bbl., 61,077
      bbl.
      and 61,564 bbl. during 2006, 2005 and 2004, respectively. Sales in continental
      Europe and Canada totaled 7,610 bbl., 6,556 bbl. and 5,929 bbl. during fiscal
      years 2006, 2005 and 2004, respectively. Although the sales of certain brands
      have fluctuated over the past few years, overall sales levels have remained
      consistent. The Company does not predict any material changes in sales’ levels
      during the upcoming year.




**RESULTS
      OF OPERATIONS**




**FISCAL
      YEAR 200** **6
      COMPARED TO FISCAL YEAR 2005**




**NET
      SALES**




As
      used
      herein, the term "net sales" refers to gross sales less excise taxes. Overall
      net sales for fiscal year 2006 were $32,275,400, an increase of $983,600 or
      3.14%, as compared to $31,291,800 in fiscal year 2005 mainly due to higher
      sales
      volume in the Domestic Territory.




DOMESTIC
      OPERATIONS: Net sales in the Domestic Territory totaled $12,149,400 in fiscal
      year 2006, compared to $11,125,500 for fiscal year 2005, representing an
      increase of $1,023,900 or 9.2%. Sales of beer for fiscal year 2006 increased
      by
      6,923 barrels, to 65,969 barrels an increase of 11.72% as compared to 59,046
      barrels in fiscal year 2005. The increase was due to increases in the sale
      of
      contract brands by 5,632 bbl., Company brands by 405 bbl. and Kingfisher Premium
      Lager by 886 bbl. During fiscal year 2006, we bottled 3,577 bbl. of cider
      products for California Cider Company on a contract basis compared to 2,919
      bbl.
      in fiscal year 2005. We anticipate continuing to solicit opportunities to enter
      into non-binding contract brewing arrangements to address the low production
      capacity utilization rates in our Ukiah and Releta brewing facilities and
      anticipate that such contract brewing arrangements will continue to impact
      our
      net sales in the Domestic Territory.




EUROPEAN
      TERRITORY: Net sales in the Company's European Territory totaled $20,126,000
      (£10,917,900) in fiscal year 2006, compared to $20,166,300 (£11,078,000) during
      fiscal year 2005. The decrease is attributed to exchange rate fluctuations.
      Net
      sales presented in U.S. dollars resulted in a decrease of 0.20%, as compared
      to
      fiscal year 2005, alternatively, when presented in pounds sterling, net sales
      decreased by 1.45% compared to fiscal year 2005. We sold 67,797 bbl. of beer
      in
      our European Territory during fiscal year 2006 as compared to 67,633 bbl. in
      fiscal year 2005, an increase of 164 bbl. or 0.24%.




15




**COST
      OF GOODS SOLD:**




Overall
      cost of goods sold during fiscal year 2006 was $23,063,300, as compared to
      $21,754,200 during fiscal year 2005, an increase of $1,309,100, or 6.02%. As
      a
      percentage of net sales, costs of goods sold was 71.5% in fiscal year 2006,
      as
      compared to 69.5% during fiscal year 2005. Such amounts are calculated in U.S.
      dollars, and do not take into account the effect of exchange rate fluctuations
      on the actual costs of goods sold in the Company's European
      Territory.




DOMESTIC
      OPERATIONS: Cost of goods sold as a percentage of net sales in the Domestic
      Territory during fiscal year 2006 was 70.6%, as compared to 69.5% during the
      fiscal year 2005. The increase was due mainly to increased costs of raw
      materials and packaging materials and utilities due to increases in energy
      costs. We rely heavily on natural gas to operate brewing operations, and
      electricity to operate our bottling and refrigeration units. Any significant
      increase in our usage of natural gas or electricity or increases in price rates
      for these utilities could significantly impact our future
      operations.




EUROPEAN
      TERRITORY: As a percentage of net sales, cost of goods sold in the United
      Kingdom during fiscal year 2006 was 72.5%, as compared to 70% during fiscal
      year
      2005 (in each case as calculated in U.S. dollars, after taking into account
      the
      effects of exchange rate fluctuations). The percentage increase was mainly
      due
      to increased costs and fees we owed Shepherd Neame pursuant to the standard
      annual cost adjustment provisions under our production and distribution
      agreements with them and product mix. Such increases were not fully offset
      by
      comparable price increases in our products. When the market allows us to pass
      on
      price increases to the purchaser, we do so, but in uncertain markets, we absorb
      a portion of the costs.




**GROSS
      PROFIT**




As
      a
      result of increased costs of goods sold, gross profit for fiscal year 2006
      (expressed in U.S. dollars) was approximately $9,212,100, a decrease of
      $325,500, or 3.4%, as compared to gross profit of $9,537,600 in fiscal year
      2005. As a percentage of net sales, our overall gross profit during fiscal
      year
      2006 decreased to 28.5%, as compared to 30.5% for fiscal year 2005.




**OPERATING
      EXPENSES**




Operating
      expenses for fiscal year 2006 totaled $9,657,400, a decrease of $396,600, or
      3.94%, as compared to $10,054,000 for fiscal year 2005. Operating expenses
      consist of marketing and distribution expenses, general and administrative
      expenses, and retail operating expenses. As a percentage of net sales, such
      expenses decreased to 29.9% in fiscal year 2006, as compared to 32.1% in fiscal
      year 2005.




MARKETING
      AND DISTRIBUTION EXPENSES: Our marketing and distribution expenses consist
      of
      salaries and commissions, advertising costs, product and sales promotion costs,
      travel expenses, and related costs. For fiscal year 2006, such expenses equaled
      $5,011,500, a decrease of $1,204,700 or 19.38%, as compared to $6,216,200 in
      fiscal year 2005. As a percentage of net sales, our marketing and distribution
      expenses decreased to 15.5% in fiscal year 2006, as compared to 19.9% in fiscal
      year 2005.




DOMESTIC
      OPERATIONS: Marketing and distribution expenses for the Domestic Territory
      in
      fiscal year 2006 equaled $1,117,900, a decrease of $249,500, or 18.2%, as
      compared to $1,367,400 in marketing and distribution expenses incurred during
      fiscal year 2005. Marketing and distribution expenses equaled 9.2% of Domestic
      Territory net sales during fiscal year 2006, as compared to 12.3% during fiscal
      year 2005. The decrease was mainly attributed to reduced salary and travel
      costs
      resulting from a reduction in headcount.




EUROPEAN
      TERRITORY: Marketing and distribution expenses in the European Territory during
      fiscal year 2006 equaled $3,893,600, a decrease of $955,200, or 19.7%, as
      compared to $4,848,800 during fiscal year 2005. As a percentage of net sales
      in
      the United Kingdom, such expenses increased to 19.4% during 2006, as compared
      to
      34.4% during 2005 (in each case as calculated in U.S. dollars, after taking
      into
      account the effects of exchange rate calculations). We ran a special advertising
      campaign in London in June and July of 2005 which was not repeated in the year
      2006, resulting in a significant reduction in marketing costs. The decrease
      was
      also due to a decrease in headcount in the United Kingdom and associated reduced
      salary and travel costs and reduction in freight expenses due to lower sales
      volumes in the United Kingdom.






16






GENERAL
      AND ADMINISTRATIVE EXPENSES: Our general and
      administrative expenses totaled $4,548,700 for fiscal year 2006, representing
      an
      increase of $813,300, or 21.8%, as compared to $3,735,400 for fiscal year 2005.
      General and administrative expenses equaled 14% and 12% respectively of net
      sales for fiscal years 2006 and 2005 respectively.




DOMESTIC
      OPERATIONS. General and administrative expenses for our Domestic Territory
      equaled $1,661,200 for fiscal year 2006, representing a decrease of $149,400,
      or
      8.25%, as compared to $1,810,600 for fiscal year 2005. The decrease was
      primarily due to a portion of common corporate overheads being transferred
      to
      UBSN and a reduction in legal expenses partly offset by increases in salaries
      and loan fees.




EUROPEAN
      TERRITORY. General and administrative expenses for our European Territory
      equaled $2,887,500 in fiscal year 2006, representing an increase of $962,700,
      or
      50%, as compared to $1,924,800 for fiscal year 2005. The increase was mainly
      due
      to an increase in the provision against bad debts on account of a customer
      having filed for liquidation of their operations, an increase in legal fees
      and
      common corporate overheads being transferred from MBC.




RETAIL
      OPERATING EXPENSES: Retail operating expenses for fiscal year 2006 totaled
      $97,200, representing a decrease of $5,200, or 5.1%, from $102,400 in fiscal
      year 2005. As a percentage of net sales, retail operating expenses decreased
      to
      0.3% as compared to 0.33% for fiscal year 2005.




**OTHER
      EXPENSES**




Other
      expenses totaled $982,800 in fiscal year 2006, representing an increase of
      $58,900, or 6.4%, as compared to $923,900 in fiscal year 2005. The increase
      in
      other expenses was mainly due to higher interest expenses associated with the
      increased amount of borrowings as well as due to increases in the prime lending
      rates in the United States.




**INCOME
      TAXES**




We
      incurred an income tax expense of $2,500 for fiscal year 2006, as compared
      to an
      income tax benefit of $125,600 for fiscal year 2005. The income tax benefit
      for
      fiscal year 2005 related to the estimated refunds due to us, relating to excess
      payments by us of taxes for operations in the United Kingdom.




As
      a
      result of the accumulated losses in our U.S. operations we have determined
      that
      the deferred tax assets associated with our net operating loss carryforwards
      and
      investment tax credits may expire prior to utilization. We recorded a valuation
      allowance of $4,100,500 for deferred tax assets. We also have $68,433 of
      California Manufacturers' Investment Tax Credits that can be carried forward
      to
      reduce future taxes. These credits begin expiring in 2011.




**NET
      LOSS**




Our
      net
      loss for fiscal year 2006 was $1,430,600, an increase of $115,900 as compared
      to
      a net loss of $1,314,700 for fiscal year 2005. After taking into account a
      foreign currency translation adjustment of $6,000 for fiscal year 2006 ($63,900
      for fiscal year 2005), our comprehensive fiscal year 2006 net loss was
      $1,436,600, as compared to a net loss of $1,378,600 in fiscal year
      2005.




**RETAIL
      SEGMENT**




We
      operate brew pubs at Hopland and Saratoga Springs. Although sales revenues
      at
      the brew pubs, are not significant, $221,300 in 2006 and $203,100 in 2005,
      we
      view the pubs as a marketing opportunity for our products. The pubs serve our
      brews on tap and also sell logo merchandise.




**FISCAL
      YEAR 200** **5
      COMPARED TO FISCAL YEAR 2004**




**NET
      SALES**




As
      used
      herein, the term "net sales" refers to gross sales less excise taxes. Overall
      net sales for fiscal year 2005 were $31,291,800, a decrease of $213,700, or
      0.68%, as compared to $31,505,500 in fiscal year 2004. Lower sales volume in
      both the Domestic Territory and in the European Territory contributed to the
      decrease in net sales.






17




DOMESTIC
      OPERATIONS: Net sales in the Domestic Territory totaled $11,125,500 in fiscal
      year 2005, compared to $11,245,600 for fiscal year 2004, representing a decrease
      of $120,100 or 1.1%. Sales of beer for fiscal year 2005 decreased by 570
      barrels, to 59,046 barrels a decrease of 2.1% as compared to 59,616 barrels
      in
      fiscal year 2004. The decrease was mainly due to decreases in the sale of our
      brands (other than Kingfisher Premium Lager) by 751 bbl., offset partially
      by
      increases in sales of Kingfisher Premium Lager by 98 bbl. and contract brands
      by
      83 bbl. During fiscal year 2005, we bottled 2,919 bbl. of cider products for
      California Cider Company on a contract basis compared to 1,157 bbl. in fiscal
      year 2004. The decrease in our overall net sales during fiscal year 2005 was
      mainly due to a decrease of $112,000 associated with the wholesale shipment
      of
      beer. The Northern California market was soft in 2005 and increased competition
      may also have been a factor in the decrease.




EUROPEAN
      TERRITORY: Net sales in the Company's European Territory totaled $20,166,300
      (£11,078,000) in fiscal year 2005, compared to $20,259,900 (£11,052,900) during
      fiscal year 2004. The decrease is attributed to exchange rate fluctuations.
      Net
      sales presented in U.S. dollars resulted in a decrease of 0.46%, as compared
      to
      fiscal year 2004, alternatively, when presented in pounds sterling, net sales
      increased by 0.23% compared to fiscal year 2004. We sold 67,633 bbl. of beer
      in
      our European Territory during fiscal year 2005 as compared to 67,493 bbl. in
      fiscal year 2004, an increase of 140 bbl. or 0.2%.




**COST
      OF GOODS SOLD:**




Overall
      cost of goods sold during fiscal year 2005 was $21,754,200, as compared to
      $21,045,500 during fiscal year 2004, an increase of $708,700, or 3.4%. As a
      percentage of net sales, costs of goods sold was 69.5% in fiscal year 2005,
      as
      compared to 66.8% during fiscal year 2004. Such amounts are calculated in U.S.
      dollars, and do not take into account the effect of exchange rate fluctuations
      on the actual costs of goods sold in the Company's European
      Territory.




DOMESTIC
      OPERATIONS: Cost of goods sold as a percentage of net sales in the Domestic
      Territory during fiscal year 2005 was 69.5%, as compared to 66.4% during the
      fiscal year 2004, representing an increase of 3.1%. The increase was due mainly
      to increased costs of packaging materials and utilities due to increases in
      energy costs.




EUROPEAN
      TERRITORY: As a percentage of net sales, cost of goods sold in the United
      Kingdom during fiscal year 2005 was 70%, as compared to 67.5% during fiscal
      year
      2004 (in each case as calculated in U.S. dollars, after taking into account
      the
      effects of exchange rate fluctuations). The percentage increase was mainly
      due
      to increased costs and fees we owed Shepherd Neame pursuant to the standard
      annual cost adjustment provisions under our production and distribution
      agreements with them. Such increases were not fully offset by comparable price
      increases in our products.




**GROSS
      PROFIT**




As
      a
      result of lower sales volumes and increased costs of goods sold, gross profit
      for fiscal year 2005 (expressed in U.S. dollars) was approximately $9,537,600,
      a
      decrease of approximately $922,400, or 8.8%, as compared to gross profit of
      $10,460,000 in fiscal year 2004. As a percentage of net sales, our overall
      gross
      profit during fiscal year 2005 decreased to 30.5%, as compared to 33.2% for
      fiscal year 2004, largely as a result of increases in cost of goods
      sold.




**OPERATING
      EXPENSES**




Operating
      expenses for fiscal year 2005 totaled $10,054,000, an increase of $47,800,
      or
      0.5%, as compared to $10,006,200 for fiscal year 2004. Operating expenses
      consist of marketing and distribution expenses, general and administrative
      expenses, and retail operating expenses.




MARKETING
      AND DISTRIBUTION EXPENSES: Our marketing and distribution expenses consist
      of
      salaries and commissions, advertising costs, product and sales promotion costs,
      travel expenses, and related costs. For fiscal year 2005, such expenses equaled
      $6,216,200, an increase of $375,000 or 6.4%, as compared to $5,841,200 in fiscal
      year 2004. As a percentage of net sales, our marketing and distribution expenses
      increased to 19.9% in fiscal year 2005, as compared to 18.5% in fiscal year
      2004.




DOMESTIC
      OPERATIONS: Marketing and distribution expenses for the Domestic Territory
      in
      fiscal year 2005 equaled $1,367,400, a decrease of $194,500, or 12.5%, as
      compared to $1,561,900 in marketing and distribution expenses incurred during
      fiscal year 2004. Marketing and distribution expenses equaled 12.3% of Domestic
      Territory net sales during fiscal year 2005, as compared to 13.9% during fiscal
      year 2004. The decrease was mainly attributed to reduced salary and travel
      costs
      resulting from a reduction in the number of our personnel. The increase in
      overall marketing expenses was caused by a one-time promotion in the European
      Territory discussed below.






18




EUROPEAN
      TERRITORY: Marketing and distribution expenses in the European Territory during
      fiscal year 2004 equaled $4,848,800, an increase of $569,500, or 13.3%, as
      compared to $4,279,300 during fiscal year 2004. As a percentage of net sales
      in
      the United Kingdom, such expenses increased to 34.4% during 2005, as compared
      to
      21.1% during 2004 (in each case as calculated in U.S. dollars, after taking
      into
      account the effects of exchange rate calculations). The increase resulted mainly
      from a special advertising campaign that we ran in London in June and July
      of
      2005. The increase was also due to an increase in the number of our personnel
      in
      the United Kingdom and associated increased salary and travel costs.




GENERAL
      AND ADMINISTRATIVE EXPENSES: Our general and administrative expenses totaled
      $3,735,400 for fiscal year 2005, representing a decrease of $39,500, or 1%,
      as
      compared to $3,774,900 for fiscal year 2004. General and administrative expenses
      equaled 12% of net sales for fiscal year 2005 and fiscal year 2004.




DOMESTIC
      OPERATIONS. General and administrative expenses for our Domestic Territory
      equaled $1,810,600 for fiscal year 2005, representing a decrease of $144,600,
      or
      7.4%, as compared to $1,955,200 for fiscal year 2004. The decrease in general
      and administrative expenses was primarily due to a decrease in legal expenses,
      incurred in 2005 vis a vis 2004 as a material legal dispute with one of our
      former distributors was settled in 2004.




EUROPEAN
      TERRITORY. General and administrative expenses for our European Territory
      equaled $1,924,800 in fiscal year 2005, representing an increase of $105,100,
      or
      5.8%, as compared to $1,819,700 for fiscal year 2004. The increase in general
      and administrative expenses was mainly due to higher personnel
      costs.




RETAIL
      OPERATING EXPENSES: Retail operating expenses for fiscal year 2005 totaled
      $102,400, representing a decrease of $37,100, or 26.6%, from $139,500 in fiscal
      year 2004. As a percentage of net sales, retail operating expenses decreased
      to
      0.3% as compared to 0.4% for fiscal year 2004. The decrease in retail operating
      expenses consisted mainly of decreases in labor expenses as a result of a
      reduction in the hours of operation of the Hopland tavern.




LEGAL
      DISPUTE SETTLEMENT: We settled a legal dispute with one of our former
      distributors in fiscal year 2004. The amount of the settlement represented
      a
      non-recurring expense.




**OTHER
      EXPENSES**




Other
      expenses totaled $923,900 in fiscal year 2005, representing an increase of
      $123,000, or 15.4%, as compared to $800,900 in fiscal year 2004. The increase
      in
      other expenses was mainly due to higher interest expenses associated with an
      increase in the amount of our outstanding credit facilities as well as due
      to
      increased prime lending rates in the United States.




**INCOME
      TAXES**




We
      received an income tax benefit of $125,600 for fiscal year 2005, which
      represented a decrease in liability of $247,400, as compared to an income tax
      expense of $121,800 for fiscal year 2004. The income tax benefit for fiscal
      year
      2005 relates to the estimated refunds due to us on account of excess payments
      of
      taxes by us relating to our operations in the United Kingdom.




As
      a
      result of the continuing losses in our U.S. operations we have determined that
      the deferred tax assets associated with net operating loss carryforwards and
      investment tax credits may expire prior to utilization. We recorded a valuation
      allowance of $3,717,200 for deferred tax assets. We also have $68,433 of
      California Manufacturers' Investment Tax Credits that can be carried forward
      to
      reduce future taxes. These credits begin expiring in 2011.




**NET
      LOSS**




Our
      net
      loss for fiscal year 2005 was $1,314,700, an increase of $845,800 as compared
      to
      a net loss of $468,900 for fiscal year 2004. After taking into account a foreign
      currency translation adjustment of $63,900 for fiscal year 2005 ($116,300 for
      fiscal year 2004), our comprehensive fiscal year 2005 net loss was $1,378,600,
      as compared to a net loss of $352,600 in fiscal year 2004.






19




**RETAIL
      SEGMENT**




The
      Company operates brew pubs at Hopland and Saratoga Springs. Although sales
      revenues at the brew pubs, are not significant, $203,100 in 2005 and $211,200
      in
      2004, we view the pubs as a marketing opportunity for our products. The pubs
      serve our brews on tap and also sell logo merchandise.




**LIQUIDITY
      AND CAPITAL RESOURCES**




Low
      production capacity utilization rates at our Ukiah and Saratoga Springs
      facilities and losses from European operations continue to place demands on
      our
      working capital. Beginning approximately in the second quarter of 1997, the
      time
      at which the Ukiah brewery commenced operations, proceeds from operations have
      not been able to provide sufficient working capital. As a result we have entered
      into a substantial number of loans, lines of credit, other credit facilities,
      and lease agreements over the last several years. In order to continue our
      operations, we will have to make timely payments of our debt and lease
      commitments as they become due. Any breach of a loan or lease covenant which
      actually leads to default, or to an attempt by a creditor to exercise its rights
      against our tangible or intangible assets, could potentially make it difficult,
      at least in the short term, for us to continue our operations.




**BFI
      LOAN AND LINE OF CREDIT**




On
      May 5,
      2005, we entered into a receivables and inventory-based line of credit
      transaction with BFI Business Finance ("BFI"), pursuant to which BFI provided
      us
      with a $2,000,000 maximum revolving line of credit with an advance rate based
      on
      80% of MBC's qualified accounts receivable, 70% of Releta's qualified accounts
      receivable, and 50% of MBC and Releta’s eligible inventory (the "BFI Line of
      Credit").




The
      minimum monthly interest payment under the BFI Line of Credit was approximately
      $6,000, and because it was outstanding for an initial six month period, there
      was no prepayment fee. The BFI Facility carried an interest rate equal to the
      greater of 9.5%, or the prime rate announced in the Western edition of the
      Wall
      Street Journal plus 3.75 %, payable monthly. The facility was also subject
      to a
      monthly administrative fee of 0.40%.




We
      issued
      a $200,000 promissory note to BFI in connection with the BFI Line of Credit
      on
      December 27, 2005. This note was repaid in full on July 28, 2006.




We
      also
      issued an additional promissory note to BFI on April 5, 2006 in the amount
      of
      $289,937.70.




On
      November 21, 2006, we used the immediately available amount drawable under
      the
      Marquette Business Credit Inc. facility (the “MBCI Facility”) discussed below to
      pay off the entire outstanding balance due to BFI.




MASTER
      LINE OF CREDIT. On August 31, 1999, MBC and UBA, one of our principal
      shareholders, entered into a Master Line of Credit Agreement, which was
      subsequently amended in April 2000 and February 2001 (the "Credit Agreement").
      The terms of the Credit Agreement provide us with a line of credit in the
      principal amount of up to $1,600,000. We have executed an Extension of Term
      of
      Notes under Master Line of Credit Agreement (the "Extension Agreement") with
      UBA. The Extension Agreement confirms UBA's and our extension of the terms
      of
      the UBA Notes for a period ending on December 31, 2006. On December 28, 2001,
      we
      entered into a Confirmation of Waiver with UBA which confirms that as of August
      13, 2001, UBA waived its rights with regard to all conversion rate protection
      as
      set forth in the UBA Notes.




As
      of the
      date of this filing, UBA has made thirteen (13) separate advances to us under
      the Credit Agreement and one additional advance on substantially the same terms
      as those under the Credit Agreement, pursuant to a series of individual
      eighteen-month promissory notes issued by us to UBA (the "UBA Notes"). The
      aggregate outstanding principal amount of the UBA Notes as of December 31,
      2006
      was $1,915,400, and the accrued but unpaid interest thereon was equal to
      approximately $818,000, for a total amount due of $2,733,400.




The
      outstanding principal amount of the notes and the unpaid interest thereon may
      be
      converted, at UBA's discretion, into shares of our unregistered Common Stock
      at
      a conversion rate of $1.50 per share. As of December 31, 2006, the outstanding
      principal and interest on the UBA Notes was convertible into 1,822,261 shares
      of
      our Common Stock.




The
      UBA
      Notes require us to make quarterly interest payments to UBA on the first day
      of
      April, July , October , and January. To date, UBA has permitted us to capitalize
      all accrued interest; therefore, we have borrowed the maximum amount available
      under the facility. Upon maturity of any UBA Note, unless UBA has given us
      prior
      instructions to commence repayment of the outstanding principal balance, the
      outstanding principal and accrued but unpaid interest on such Note may be
      converted, at the option of UBA, into shares of our common stock. If UBA does
      not elect to so convert any UBA Note upon maturity, it has the option to extend
      the term of such notes for any period of time mutually agreed upon by UBA and
      us. During the extended term of any note, UBA has the right to require us to
      repay the outstanding principal balance, along with the accrued and unpaid
      interest thereon, to UBA within sixty (60) days.






20




These
      UBA
      Notes are subordinated to credit facilities extended to us by Grand Pacific
      Financing Corporation (“Grand Pacific”) and MBCI under subordination agreements
      executed by UBA. As per the terms of the subordination agreements, UBA is
      precluded from demanding repayment of the notes due unless the Grand Pacific
      and
      MBCI facilities are settled in full. Hence, we do not expect to make payments
      on
      any of these UBA Notes within the next year.




(For
      additional information on the Credit Agreement see "Item 13. Certain
      Relationships and Related Transactions -Master Line of Credit
      Agreement".)




LONG
      TERM
      DEBT: MBC obtained a $2.7 million loan from Savings Bank of Mendocino County
      ("SBMC"), secured by a first priority deed of trust on the Ukiah land, fixtures,
      and improvements. The loan was payable in partially amortizing monthly
      installments of $24,443 including interest at the rate of 7.24%, maturing
      December 2012 with a balloon payment in the amount of $932,600. The interest
      rate was adjustable on every five year anniversary of the agreement to the
      Treasury Constant Maturity Rate plus 4.17%. The amount of the balloon payment
      varied depending on the change in interest rates over the term of the loan.
      In
      addition to the Ukiah land and facility, this loan was secured by certain other
      assets of the Company (other than the Releta facility), including, without
      limitation, most of the Company's equipment. This loan was fully settled on
      July
      3, 2006 out of the proceeds from the loan which we received from Grand Pacific.




GRAND
      PACIFIC FINANCING CORPORATION LOAN : On July 3, 2006, MBC obtained a $3.0
      million loan from Grand Pacific, secured by a first priority deed of trust
      on
      the Ukiah land, fixtures attached to the land, and improvements. The loan is
      payable in partially amortizing monthly installments of $27,261 **** including
      interest at the rate of 1.75% over the prime rate published by The Wall Street
      Journal, maturing June 28, 2011 with a balloon payment. The amount of the
      balloon payment will vary depending on the change in interest rates over the
      term of the loan. MBC used the proceeds of the loan to repay in full all the
      then outstanding loans owed to SBMC. Grand Pacific also collects on a monthly
      basis an amount of approximately $10,554 towards property taxes payable on
      the
      Ukiah property and pays such taxes when they become due.




MARQUETTE
      BUSINESS CREDIT INC. FACILITY: On November 21, 2006, Marquette Business Credit
      Inc. (“MBCI”) extended a total facility of $4,925,000 for a period up to June
      27, 2011 consisting of a $2,750,000 revolving facility, a $1,525,000 term loan
      and a $650,000 capital expenditure loan. The rate of interest on the term loan
      and capital expenditure loan is the one-month LIBOR rate published in the Wall
      Street Journal plus a margin of $5.25% and on the revolving facility is
      one-month LIBOR rate published in the Wall Street Journal plus a margin of
      $4.25%. The facility is subject to certain financial covenants including
      prescribed minimum fixed charges coverage, maintaining prescribed minimum
      tangible net worth and minimum earning before interest, depreciation and taxes.
      The facility also has a prepayment penalty if settled prior to the maturity
      date. The facility is secured by substantially all of our assets located in
      the
      United States excluding real property and fixtures located at our property
      in
      Ukiah, California.




**OTHER
      LOANS AND CREDIT FACILITIES**




SAVINGS
      BANK OF MENDOCINO TEMPORARY LOAN: On December 31, 2003, SBMC extended a
      temporary loan in the principal amount of approximately $576,200 to MBC in
      order
      to finance a buy-out of equipment leased through Finova Capital Corporation.
      This loan was fully settled on July 3, 2006 out of the proceeds from the loan
      which the Company received from Grand Pacific.




On
      July
      3, 2006, SBMC provided short term financing in the principal amount of $350,000
      for a period of six months, at a variable rate of interest of the higher of
      10%
      or prime plus 1.5%. This loan is secured against the equipment at the Ukiah
      brewery. This loan was fully paid off on November 21, 2006 out of the proceeds
      from the loan which the Company received from MBCI.




ROYAL
      BANK OF SCOTLAND FACILITY: Royal Bank of Scotland Commercial Services Limited
      (“RBS”) provided UBSN with a £1,750,000 maximum revolving line of credit with an
      advance rate based on 80% of UBSN's qualified accounts receivable. This facility
      has a minimum maturity of twelve months, but will be automatically extended
      unless terminated by either party upon six months' written notice.






21




SHEPHERD
      NEAME LOAN: Shepherd Neame has a contract with UBSN to brew Kingfisher Premium
      Lager for the Company's European Territory. As consideration for extending
      the
      brewing contract, Shepherd Neame advanced a loan of £600,000 to UBSN, repayable
      in annual installments of £60,000 per year, commencing in June 2003. The loan
      carries a fixed interest rate of 5% per year. (For more information about this
      loan see "Item 13. - Certain Relationships and Related Transactions -- Loan
      Agreement Between UBSN and Shepherd Neame".)




WEIGHTED
      AVERAGE INTEREST: The weighted average interest rates paid on our debts incurred
      in connection with the Domestic Territory was 11.16% for fiscal year 2006
      compared to 9.13% and 7.85% for fiscal year 2005 and (including the long term
      capital lease of equipment with Finova Capital Corporation Inc.) for the fiscal
      year 2004, respectively. For loans primarily associated with our European
      territory, the weighted average interest rates paid were 6.15%, 6.15% and 5.9%
      in fiscal years 2006, 2005 and 2004, respectively.




KEG
      MANAGEMENT ARRANGEMENT: We entered into a keg management agreement (the "Keg
      Agreement") with MicroStar Keg Management LLC ("Microstar") for a five year
      term
      on September 1, 2004. Under this arrangement, MicroStar provides us with
      half-barrel kegs for which we pay a filling and use fee. Distributors return
      the
      kegs to MicroStar instead of to us. MicroStar then supplies us with additional
      kegs. Under the terms of the Keg Agreement, if, on any given month, the
      agreement is not extended and terminates, we would be required to purchase
      a
      certain number of kegs from MicroStar. We anticipate financing the purchase
      of
      such kegs through debt or lease financing, if available. However, there can
      be
      no assurance that we will be able to finance the purchase of such kegs. Failure
      to purchase the necessary kegs from MicroStar upon the termination of the Keg
      Agreement is likely to have a material adverse effect on both our business
      (if
      we are unable to find a comparable supplier) as well as on our working capital
      (if we are required to purchase the kegs upon early termination and are unable
      to obtain adequate financing).




CURRENT
      RATIO: Our ratio of current assets to current liabilities on December 31, 2006
      was 0.79 to 1.0 and our ratio of total assets to total liabilities was 1.17
      to
      1.0. On December 31, 2005 our ratio of current assets to current liabilities
      was
      0.75 to 1.0 and our ratio of total assets to total liabilities was 1.28 to
      1.0.
      On December 31, 2004, our ratio of current assets to current liabilities was
      0.83 to 1.0 and our ratio of total assets to total liabilities was 1.3 to
      1.0.




OVERDUE
      PROPERTY TAXES: We owed overdue property taxes on our property in Ukiah for
      the
      period from April 1999 to June 2003. As of June 30, 2003, the delinquent
      property taxes due on the Ukiah property, including penalties and interest,
      totaled $710,600. On July 31, 2003, we entered into an installment payment
      plan
      to settle the deficiency. The entire balance outstanding as of June 30, 2006
      was
      paid out of the proceeds of the Grand Pacific loan on July 3, 2006.




RESTRICTED
      NET ASSETS. Our wholly-owned subsidiary, UBI, had retained losses of
      approximately GBP 61,600 as of December 31, 2006. Under UBSN's line of credit
      agreement with Royal Bank of Scotland, distributions and other payments from
      our
      subsidiaries to us are not permitted if the retained earnings drop below
      approximately GBP1,000,000.




RELATED
      PARTY TRANSACTIONS: Over the last several years, MBC and its subsidiaries have
      entered into or amended several agreements with affiliated and related entities.
      Among such agreements have been a Brewing Agreement and a Loan Agreement between
      UBSN and Shepherd Neame; a Market Development Agreement, a Distribution
      Agreement, and a Brewing License Agreement between MBC and UBSN; a Distribution
      Agreement between UBI and UBSN; a Trademark Licensing Agreement between MBC
      and
      Kingfisher of America, Inc.; and a License Agreement between UBI and UB Limited.
      (For more information on these agreements please see "Item 13. -- Certain
      Relationships and Related Transactions".)




OFF-BALANCE
      SHEET TRANSACTIONS. We are not a party to nor do we engage in any off-balance
      sheet transactions.




**CONTRACTUAL
      OBLIGATIONS**




The
      following chart sets forth our contractual obligations as of December 31,
      2006.




Contractual
                Obligations
            
            Payments
                due by periodTotal
            
            Less
                than 1 year
            
            1
                -3 years
            
            3
                -5 years
            
            More
                than 5 yearsLong
                Term Debt Obligations
            
            $
            4,463,200
            
            $
            236,500
            
            $
            506,500
            
            $
            3,720,200
            
            $
            -Capital
                Lease Obligations
            
            
            148,700
            
            
            83,100
            
            
            65,600
            
            
            -
            
            
            -Operating
                Lease Obligations
            
            
            1,189,700
            
            
            229,900
            
            
            411,400
            
            
            343,000
            
            
            205,400Purchase
                Obligations
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -Other
                Long Term Liabilities
            
            
            3,438,500
            
            
            117,500
            
            
            235,000
            
            
            2,968,500
            
            
            117,500Total
            
            $
            9,240,100
            
            $
            667,000
            
            $
            1,218,500
            
            $
            7,031,700
            
            $
            322,900






22




**ITEM
      7A.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**




As
      of
      December 31, 2006, the Company did not hold derivative instruments, or engage
      in
      hedging activities, of any material value or in any material amount, whether
      for
      trading or for hedging purposes. The Company's direct exposure to risks arises
      out of changes in interest rates, foreign currency exchange rate fluctuations
      and commodity prices.




**INTEREST
      RATE RISK**




The
      Company had total debt as of December 31, 2006 of $11,051,100, of which
      $10,346,000 was subject to variable rates of interest (either prime or LIBOR
      plus 1.5% or prime plus 1.75% or LIBOR plus 4.25% or LIBOR plus 5.25%). Its
      long-term debt (including current portion) as of December 31, 2006 totaled
      $7,116,800 of which $705,100 had fixed rates of interest and the remaining
      $6,411,700 was subject to variable rates. Short term debts amounted to
      $3,934,300, all of which were subject to variable rates. At current borrowing
      levels, an increase in prime and LIBOR rates of 1% would result in an annual
      increase of $103,500 in interest expense on the Company's variable rate
      loans.




**FOREIGN
      CURRENCY RATE FLUCTUATIONS**




The
      Company's principal reporting currency is the U.S. dollar. However, the
      Company's primary operating subsidiary, UBSN, operates in the European
      Territory, and primarily in the United Kingdom. As a result, its income and
      its
      expenses are denominated in pounds sterling. The Company's net income in the
      European Territory may be impacted either positively or negatively depending
      on
      the exchange rate of the pound sterling vis a vis the U.S. dollar. Therefore,
      a
      percentage of the Company's consolidated cash flows and earnings which are
      derived from UBSN are subject to fluctuations due to changes in the value of
      the
      pound sterling as compared with the U.S. dollar.




UBSN
      and
      its parent, UBI, contributed approximately 61% of the Company's total sales
      in
      2006, as compared to approximately 63% in 2005 as well as 2004. The Company
      had
      a net operating loss in 2006 and 2005, but in 2004 UBSN and UBI contributed
      about 69.7% of the Company's total operating income. All of the percentages
      in
      this paragraph account for exchange rate fluctuations.




The
      Company utilizes the rates published by the Board of Governors of the Federal
      Reserve System to convert operational results and cash flow for the European
      Territory into U.S. dollars. On that basis, the average annual rates of exchange
      for converting pounds sterling into dollars during the years 2006, 2005, and
      2004 were $1.843, $1.820 and $1.833 respectively, representing an increase
      in
      the value of the pound sterling (as compared to the dollar) of 1.26% for 2006
      as
      compared to 2005 and a decrease of 0.7% for 2005 as compared to
      2004.




Similarly,
      the exchange rates used to convert the value of the assets and liabilities
      of
      UBI and UBSN from pound sterling to U.S. dollars at December 31, 2006, 2005,
      and
      2004 were $1.959, $1.719, and $1.916, respectively. These year-end valuations
      represent an increase in the value of the pound sterling, vis a vis the U.S.
      dollar, of 13.96% as of December 31, 2006 as compared to December 31, 2005,
      and
      a decrease in the value of the pound sterling, as against the U.S. dollar,
      of
      10.3% as of December 31, 2005 as compared to December 31, 2004.




**ITEM
      8.**  **FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA.**




With
      the
      exception of the chart set forth below, the information required by this item
      is
      set forth at Pages F-1 through F-17 to this Annual Report.






23




The
      following chart sets forth, on a quarterly basis, certain financial information
      about the Company's results of operations for the 2006 and 2005 fiscal
      years.




2006
            
            2005Q1
            
            Q2
            
            Q3
            
            Q4
            
            Q1
            
            Q2
            
            Q3
            
            Q4Net
                Sales
            
            $
            7,272,100
            
            $
            8,328,600
            
            $
            8,221,700
            
            $
            8,453,000
            
            $
            7,256,900
            
            $
            8,240,600
            
            $
            7,919,300
            
            $
            7,875,000Gross
                profit
            
            $
            2,258,800
            
            $
            2,481,700
            
            $
            2,485,000
            
            $
            1,986,600
            
            $
            2,270,500
            
            $
            2,702,200
            
            $
            2,483,100
            
            $
            2,081,800Net
                income before extra-
              ordinary
                items
            
            $
            (228,900
            )
            $
            (456,500
            )
            $
            (50,000
            )
            $
            (695,200
            )
            $
            (198,400
            )
            $
            212,100
            
            $
            (564,600
            )
            $
            (763,800
            )Net
                income (loss)
            
            $
            (228,900
            )
            $
            (456,500
            )
            $
            (50,000
            )
            $
            (695,200
            )
            $
            (198,400
            )
            $
            212,100
            
            $
            (564,600
            )
            $
            (763,800
            )Basic
                Earnings (Loss) per
              share
            
            $
            (0.02
            )
            $
            (0.04
            )
            $
            (0.00
            )
            $
            (0.06
            )
            $
            (0.02
            )
            $
            0.02
            
            $
            (0.05
            )
            $
            (0.07
            )




**ITEM
      9.**  **CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.**




None.




**ITEM
      9A.**  **CONTROLS
      AND PROCEDURES.**




The
      Company's management, including the Chief Executive Officer ("CEO") and Chief
      Financial Officer ("CFO") has evaluated the effectiveness of the design,
      maintenance, and operation of the Company's "disclosure controls and procedures"
      as of December 31, 2006, the end of the period covered by this report.
      Disclosure controls and procedures are controls and other procedures that are
      designed to ensure that information required to be disclosed by the Company
      in
      its reports under the Securities Exchange Act of 1934, as amended (the "Exchange
      Act"), is recorded, processed, summarized, and reported within the time periods
      specified in the Commission's rules and forms. Disclosure controls and
      procedures are also designed to ensure that information that the Company is
      required to disclose in its reports under the Exchange Act is accumulated and
      communicated to the Company's management, including its CEO and CFO, as
      appropriate to allow timely decisions regarding the required
      disclosure.




Certain
      aspects of the Company's internal control over financial reporting are included
      in the Company's disclosure controls and procedures, and are therefore included
      in management's evaluation. Management evaluates internal control over financial
      reporting on a quarterly basis to determine whether any changes have occurred.
      Internal control over financial reporting is also evaluated on an annual basis
      in connection with the preparation of the Company's Annual Report on Form
      10-K.




Management's
      review of the disclosure controls and procedures includes a review of their
      objectives, design, implementation, and results. Based on this evaluation,
      the
      CEO and CFO believe that, as of the end of the period covered by this report,
      subject to the limitations set forth below, the Company's disclosure controls
      and procedures were effective in providing reasonable assurance that the
      information required to be disclosed in the Company's reports under the Exchange
      Act is recorded, processed, summarized, and reported within the time specified
      by the Commission, and that material information pertaining to the Company
      is
      timely communicated to the Company's management (including the CEO and CFO).
      Management is not aware of any changes in the Company's internal or other
      controls over financial reporting identified in connection with that evaluation
      that occurred during the most recent fiscal quarter that have materially
      affected, or are reasonably likely to materially affect, the Company's internal
      control over financial reporting.




**LIMITATIONS
      ON CONTROLS**




Disclosure
      controls and procedures, no matter how well designed and implemented, can
      provide only reasonable assurance of achieving the Company's disclosure
      objectives. The likelihood of achieving such objectives is affected by
      limitations inherent in such controls and procedures, including the fact that
      human judgment in decision making can be faulty and that breakdowns in internal
      controls can occur because of human failures such as simple errors or mistakes
      or intentional circumvention of the established process.






24




**ITEM
      9B.**  **OTHER
      INFORMATION.**




On
      November 21, 2006, Marquette Business Credit, Inc. extended a total facility
      of
      $4,925,000 with a maturity date of June 27, 2011 consisting of (i) a $2,750,000
      revolving facility, (ii) a $1,525,000 term loan, and (iii) a $650,000 capital
      expenditure loan. The rate of interest on the term loan and the capital
      expenditure loan is the one-month LIBOR rate published in the Wall Street
      Journal plus a margin of 5.25% and on the revolving facility is the one-month
      LIBOR rate published in the Wall Street Journal plus a margin of 4.25%. The
      facility is secured by substantially all of the assets of the Company located
      in
      the United States excluding real property and fixtures located at the Company's
      property in Ukiah, California. The Loan and Security Agreement, Revolving Note,
      Term Note and CAPEX Note are filed as exhibits to this Annual Report on Form
      10-K. For additional information on this facility see "Item 7- Management's
      Discussion and Analysis of Financial Condition and Results of
      Operation-Liquidity and Capital Resources-Marquette Business Credit Inc.
      Facility."




**PART
      III**




**ITEM
      10.**  **DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE COMPANY**




The
      following table sets forth the names, ages as of February 28, 2007, and certain
      information regarding each of the Company's current directors and executive
      officers:




Name
            
            Age
            
            Position(s)
            
            Director
                Since**Scott
                R. Heldfond
            
            62
            
            Director
            
            2005Michael
                Laybourn
            
            68
            
            Director
            
            1993Vijay
                Mallya, Ph.D.
            
            51
            
            Director
                and Chairman of the Board
            
            1997Jerome
                G. Merchant*+
            
            45
            
            Director
            
            1997Mahadevan
                Narayanan
            
            49
            
            Chief
                Financial Officer and SecretarySury
                Rao Palamand, Ph.D.*+
            
            75
            
            Director
            
            1998Kent
                D. Price*+
            
            63
            
            Director
            
            1998Yashpal
                Singh
            
            61
            
            Director,
                President, and Chief Executive Officer
            
            1997





**
            All
                directors are elected by the Shareholders at the Annual Meeting to
                serve
                until the following Annual Meeting. The term of employment for the
                Company's Chief Executive Officer has been extended until March 31,
                2011.
                The Company's Chief Financial Officer and Chairman do not have any
                set
                date for the expiration of their respective terms of
                office.




*
            Member
                of the Audit/Finance Committee.




+
            Member
                of the Compensation Committee.




Mr.
      Scott
      Heldfond joined the Board in January 2005. He is a Director of NASDAQ Insurance
      Group, LLC, a national insurance brokerage and consulting firm owned by the
      NASDAQ Stock Market. Mr. Heldfond has also served as the Managing Partner of
      eSEED Capital, LLC, a technology-focused merchant banking firm since 1999.
      He
      also served as President and Chief Executive Officer of Frank Crystal & Co.
      of California, a New York-based insurance brokerage from 1995 to 1999, Chairman
      of Hales Capital LLC, an investment banking firm from 1994 to February 1997
      and
      firm President of AON Real Estate & Investments. Mr. Heldfond also served as
      a Director of HomeGain, Inc (recently sold to Classified Ventures), a private
      venture backed company and UBICS, a NASDAQ traded firm that provides information
      technology staffing and solutions for domestic and international businesses.
      Mr.
      Heldfond has also served as a Director of Galoob Toys, which was the third
      largest toy manufacture before its sale to Hasbro. Mr. Heldfond holds an
      undergraduate degree from the University of California, Berkeley and a J.D.
      from
      the University of San Francisco Law School. He is a Commissioner and the
      President of the Health Services Commission of the City and County of San
      Francisco, in addition he serves as an advisor to or on the Board of Directors
      of a number of local, statewide, and national charitable and community service
      organizations. Mr. Heldfond is the Honorary Consul General to the U.S. for
      the
      Republic of Rwanda.




25




H.
      Michael Laybourn, co-founder of the Company, served as the Company's President
      from its inception in 1982 through December 1999, and as its Chief Executive
      Officer from inception through October 1997. Mr. Laybourn was elected a Director
      in November 1993 when the Company began the process of converting from a limited
      partnership to a corporation and served as Chairman of the Board from June
      1994
      through October 1997. Mr. Laybourn is a former Vice President of the California
      Small Brewers Association and a former Chairman of the Board of Directors of
      the
      Brewers Association of America. Mr. Laybourn holds a Bachelor of Fine Arts
      degree from Arizona State University.




Vijay
      Mallya, Ph.D., became Chairman of the Board in October 1997 and was its Chief
      Executive Officer until January 2005. Dr. Mallya is Chairman of UBICS, Inc.,
      United Breweries Limited, UB Engineering Limited, Mangalore Chemicals and
      Fertilizers Ltd., Herbertsons Limited, McDowell & Co. Ltd., and other
      affiliated companies (collectively the "UB Group"). United Breweries Limited
      and
      McDowell & Co., Ltd. are two of Asia's leading beer and spirits companies.
      The UB Group has annual sales in excess of U.S. dollars $1 billion. He also
      sits
      on the boards of several foreign companies and organizations including companies
      comprising the UB Group, The Institute of Economic Studies (India), and the
      Federation of the Indian Chamber of Commerce and Industries. Dr. Mallya was
      recently elected to serve as a member of the Upper House of the Indian
      Parliament. Dr. Mallya holds a Bachelor of Commerce degree from the University
      of Calcutta in India and an honorary Doctorate in Business Administration from
      the University of California, Irvine.




Jerome
      G.
      Merchant became a director in October 1997 and was Chief Financial Officer
      of
      the Company from November 1997 to October 1998. Mr. Merchant currently serves
      as
      the Strategic Planning Consultant to the Chairman's Office of the Company and
      has served in such capacity since July 1996. Mr. Merchant is currently a
      Managing Director with RSM EquiCo Capital Markets, LLC a mid market investment
      bank. He has over 20 years experience in investment banking and capital raising.
      Previously, he held executive positions at Citigroup and MetLife Investors.
      Mr.
      Merchant has advised the investment division and clients of Citibank, Smith
      Barney, Bank of America, Wells Fargo and U.S. Bank amongst others. In executive
      and strategic planning capacities, he has advised public and private companies
      and both institutional and high-net worth investors. Between April 1993 and
      December 2003, Mr. Merchant served in various senior capacities for Cal Fed
      Investments, a wholly owned subsidiary of Cal Fed Bank. Previously, Mr. Merchant
      directed the West Coast capital raising for a private equity group making equity
      oriented management buyouts and strategic acquisitions. He received his B.S.
      degree in Managerial Economics-Finance from the University of California, at
      Davis.




Mahadevan
      Narayanan joined the company in early 2001 as Secretary, Corporate Controller
      and Chief Financial Officer. Before joining the Company, he served the United
      Breweries Group in India for 17 years in various financial and accounting
      capacities. Mahadevan Narayanan was most recently employed as Senior Manager
      of
      Accounting Services of Herbertsons Ltd. for the past six years. He holds a
      Bachelor of Science degree in Mathematics from Madurai Kamaraj University in
      India and is an associate member of the Institute of Chartered Accountants
      of
      India.




Sury
      Rao
      Palamand became a director of the Company in January 1998. Dr. Palamand is
      a
      director and partner of Summit Products, Inc, a beverage development and
      consulting company serving the food and beverage industry. He is also a director
      and partner in the Historic Lemp Brewery involved in the development of
      microbreweries and brewpubs in addition to his real estate activities in the
      restoration of historic buildings. Dr. Palamand has over 40 years of experience
      in the brewing industry and has published numerous scientific and technical
      papers on beer and other fermented beverages in various Technical Journals
      in
      the USA and abroad. He is an associate member of the Institute of Brewing,
      London and is a member of several brewing organizations in the United States.
      In
      addition, Dr. Palamand possesses technical and technological expertise in Wine
      making as well as in the development of soft drinks. Prior to joining the
      Company as a director, Dr. Palamand served as director of Beer and New Beverage
      development at Anheuser-Busch Companies, Inc. Dr. Palamand holds a Bachelor
      of
      Science degree from the University of Mysore, India, a Master of Science degree
      in Applied Chemistry from the University of Bombay, India and a Masters degree
      in Food Microbiology and a Ph.D. degree in Food and Flavor technology from
      the
      Ohio State University, Columbus, Ohio. Dr. Palamand is listed in the MARQUIS
      WHO
      is WHO in America and in the WHO is WHO in the Midwest.




Kent
      D.
      Price became a director in January 1998. Kent Price is a founder and President
      of Parker Price Venture Capital. Mr. Price was a Rhodes Scholar at Oxford
      University, attended the University of Montana, UCLA and Harvard Business
      School. Mr. Price is a member of the board of directors of the University of
      Montana and a member of the Investment Committee. Mr. Price has extensive
      operational experience, including his role as CEO of The Chloride Group, a
      global battery company, CEO of the Bank of San Francisco, General Manager of
      Banking, Finance and Securities Group at IBM, Chief Financial Office at the
      Bank
      of New England, Executive Vice President of the Bank of America and a senior
      officer at Citibank. He has lived and worked in England, Germany, Ireland,
      Nigeria, Ivory Coast, Taiwan, Hong Kong, Japan, Singapore as well as the United
      States. He has served on boards in the UK, India, South Africa, Hong Kong,
      Taiwan, China and the United States. Mr. Price served as a Captain in the United
      States Air Force.






26




Yashpal
      Singh, President of the Company since January 2000, became a director in October
      1997 and has served as its Executive Vice President and Chief Operating Officer
      since May 1998. Mr. Singh became the Chief Executive Officer in January 2005.
      From May 1997 to March 1998, Mr. Singh served as Executive Vice-President-
      Operations for UBA. In that capacity, he was responsible for UBA's United States
      brewing operations. Between 1992 and 1997, Mr. Singh also served as Senior
      Vice
      President-Operations for United Breweries Ltd., an Indian Corporation, where
      he
      was responsible for the operations of 12 breweries, instituting new projects,
      and technical and operational evaluations of potential acquisition opportunities
      worldwide. Mr. Singh has over 38 years of experience in the brewing industry.
      Mr. Singh holds a Bachelors degree in Science from Punjab University in India,
      and has graduate training in the fields of Brewing, Malting, and Mineral Water
      Technology. Mr. Singh is an associate member of the Institute of Brewing,
      London, a member of the Master Brewers Association of America, and was a former
      executive member of the Managing Committee of the All India Brewer's
      Association.




FAMILY
      RELATIONSHIPS




There
      are
      no family relationships between any of the directors and executive
      officers.




INVOLVEMENT
      IN CERTAIN LEGAL PROCEEDINGS




None.




SECTION
      16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE




Based
      solely on its review of the Forms 3, 4 and 5 furnished to the Company during
      and
      with respect to the year 2006, the Company is not aware of any person that
      was a
      Director, officer, or greater than 10% beneficial owner of the Company that
      failed to file on a timely basis reports required by Section 16(a) of the
      Exchange Act during the Company's most recent fiscal year.




AUDIT
      COMMITTEE




The
      Company has a separately-designated standing Audit/ Finance Committee
      established in accordance with Section 3(a)(58)(A) of the Exchange Act. Jerome
      G. Merchant, Sury Rao Palamand and Kent D. Price serve as the committee members
      of the Audit/Finance Committee.




AUDIT
      COMMITTEE FINANCIAL EXPERT




The
      Company's Board of Directors believes that at least one member of the Company's
      Audit Committee - Mr. Kent D. Price - is both an independent Director and
      qualifies as an "audit committee financial expert" as that term is defined
      in
      the Securities Exchange Act of 1934, as amended, and pursuant to the rules
      and
      regulations promulgated by the Securities and Exchange Commission.




CODE
      OF
      ETHICS




The
      Company has adopted a Code of Ethics that applies to its Chief Executive
      Officer, Chief Financial Officer, and principal accounting officer. The Code
      of
      Ethics is posted on the Company's website at www.mendobrew.com. The Company
      intends to disclose future amendments to certain provisions of its Code of
      Ethics, or waivers of such provisions granted to executive officers and
      directors on this website within four (4) business days following the date
      of
      such amendment or waiver. Any person desiring a free copy of the Code of Ethics
      should send a written request to the Company's Secretary, N. Mahadevan at the
      Company's principal executive offices located at 1601 Airport Road, Ukiah,
      CA
      95482.




DIRECTORS'
      NOMINATIONS




There
      have been no material changes to the procedures by which shareholders may
      recommend nominees to the Company's board of directors.




27




**ITEM
      11.**  **EXECUTIVE
      COMPENSATION**




The
      information appearing under the headings "Director Compensation," "Report of
      the
      Compensation Committee," "Compensation Discussion and Analysis," and "Executive
      Compensation" of our 2007 Proxy Statement is incorporated by reference in this
      section.




**ITEM
      12.**  **SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**


**AND** **RELATED
      STOCKHOLDER MATTERS.**




The
      following table sets forth certain information known to the Company regarding
      the beneficial ownership of the Company's Common Stock and Series A Preferred
      Stock as of March 30, 2007, for (a) each shareholder known by the Company to
      own
      beneficially 5% or more of the outstanding shares of its Common Stock or Series
      A Preferred Stock; (b) each director; and (c) all directors and executive
      officers of the Company as a group. Except as otherwise noted, the Company
      believes that the beneficial owners of the Common Stock and Series A Preferred
      Stock listed below, based on information furnished by such owners, have sole
      investment and voting power with respect to such shares, subject to community
      property laws where applicable.




Name
                and Address
            
            Shares
                Beneficially Owned (1)
            
            Approximate
                Percentage**COMMON
                STOCK**United
                Breweries of America, Inc.
              1050,
                Bridge way,
              Sausalito,
                CA 94965
            
            
            3,087,818
            (2)
            
            26.6
            %Inversiones
                Mirabel S.A.
              Hong
                Kong Bank Building
              6th
                Floor, Samuel Lewis Avenue
              P
                O
                Box 6-4298, El Dorado
              Panama
                City, Panama
            
            
            5,500,000
            (2)
            
            47.3
            %United
                Breweries (Holdings) Limited.
              100/1,
                Richmond Road,
              Bangalore
                - 560 025, India
            
            
            8,587,818
            (3)
            
            73.9
            %H.
                Michael Laybourn +
            
            
            345,664
            (4)
            
            2.9
            %Vijay
                Mallya
            
            
            8,587,818
            (5)
            
            73.9
            %Kent
                D Price
              c/o
                Parker Price Venture Capital, Inc.
              101,
                California Street
              Suite
                2830
              San
                Francisco, CA 94111
            
            
            189,435
            (4)
            
            1.6
            %Sury
                Rao Palamand, Ph.D. +
            
            
            154,593
            (4)
            
            1.3
            %Jerome
                G. Merchant+
            
            
            105,665
            (4)
            
            —Yashpal
                Singh+
            
            
            —
            
            
            —Scott
                R. Heldfond +
            
            
            22,221
            
            
            —N.
                Mahadevan
            
            
            —
            
            
            —All
                Directors and executive officers as a group (8 persons)
            
            
            9,405,396
            (6)
            
            81
            %




**SERIES
                A PREFERRED STOCK**H.
                Michael Laybourn +
            
            
            6,100
            
            
            2.7
            %All
                Directors and executive officers as a group (8 persons)
            
            
            6,100
            
            
            2.7
            %





+  1601
      Airport Road, Ukiah, CA 95402




28




(1)  Applicable
      percentages of ownership are based on 11,628,174 shares of Common Stock
      outstanding. Shares of Common Stock subject to a contract of purchase or options
      currently exercisable or exercisable within 60 days after the date of this
      Annual Report on Form 10-K are deemed outstanding for purposes of computing
      the
      percentage ownership of the person obligated to purchase the shares or holding
      the options, but are not deemed outstanding for computing the percentage of
      any
      other person.




(2)  Does
      not
      include 1, 852,960 shares
      issuable to UBA upon conversion of certain convertible notes issued by MBC
      to
      UBA under a Master Line of Credit Agreement (For additional information, see
      "Item 13. Certain Relationships and Related Transactions"). UBHL is the ultimate
      beneficiary of substantially all of the shares owned by both UBA and
      Inversiones.




(3)  Includes
      all shares held by the Company's two largest shareholders, UBA and Inversiones.
      UBHL is the beneficial owner of UBA and Inversiones because they are both
      controlled by Rigby International Corp., a company registered in the British
      Virgin Island with its primary offices at Vanterpool Plaza, 2nd Floor, Wickhams
      Cay I, Road Town, Tortola, British Virgin Island 2 and its mailing address
      c/o
      CAS SA, 12-14 Avenue, Riverdil, CH-1260, Lyon, Switzerland, which in turn is
      a
      wholly-owned subsidiary of UBHL. Such amount does not include 1,852,960 shares
      issuable to UBA upon conversion of certain convertible notes issued by MBC
      to
      UBA under a Master Line of Credit Agreement.




(4)  [Intentionally
      omitted]




(5)  Includes
      all shares indirectly held by UBHL. Does not include 1,852,960 shares issuable
      to UBA upon conversion of certain convertible notes issued by MBC to UBA
      described in footnotes (2) and (3) above. Dr. Mallya disclaims beneficial
      ownership of the reported securities except to the extent of his pecuniary
      interest therein.




(6)  Does
      not
      include shares which may be obtained upon the conversion of the Notes described
      in footnotes (2) and (3), above.




CHANGES
      IN CONTROL




There
      are
      no arrangements currently known to the Company which may result in a change
      in
      control of the Company at a future date.




**ITEM
      13.**  **CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE.**




The
      information appearing in our 2007 Proxy Statement under the heading "Certain
      Relationships and Related Transactions" and "Corporate Governance" is
      incorporated by reference in this section.




**ITEM
      14.**  **PRINCIPAL
      ACCOUNTING FEES AND SERVICES.**




The
      Company has appointed PMB Helin Donovan, L.L.P. ("PMB"), formerly Pohl,
      McNabola, Berg & Company, LLP, as its independent auditors to perform the
      audit of the Company's financial statements for the year 2006. The estimated
      audit fees for the audit of the 2006 financial statements are
      $85,000.




Moss
      Adams, L.L.P. ("Moss Adams"), performed the audit of the Company's financial
      statements for the year 2004. All audit and other services performed by PMB
      or
      Moss Adams on behalf of the Company are or were approved in advance by the
      Audit
      Committee, on a case-by-case basis.




AUDIT
      FEES. The aggregate fees billed by PMB for the audit of the Company's annual
      consolidated financial statements for the year ended December 31, 2005 was
      $90,000; fees of an additional $45,685 were billed to the Company during 2006
      in
      connection with PMB’s review of interim financial statements in connection with
      the Company's Quarterly Reports on Form 10-Q for this year. Such fees
      represented 90% of the total fees for services rendered to the Company by PMB
      during 2006.




The
      aggregate fees billed by Moss Adams for the audit of the Company's annual
      consolidated financial statements for the year ended December 31, 2004 was
      $117,885; fees of an additional $35,690 were billed to the Company during 2005
      in connection with Moss Adams' review of financial statements in connection
      with
      the Company's Quarterly Reports on Form 10-Q for this year. Such fees
      represented 87% of the total fees for services rendered to the Company by Moss
      Adams during 2005.




29




AUDIT
      RELATED FEES. Neither PMB nor Moss Adams billed any amount in fees for assurance
      or related services to the Company in 2006, 2005 or 2004,
      respectively.




TAX
      FEES.
      The aggregate fees billed during 2006 for tax products and services related
      to
      the preparation of the Company's tax returned provided by PMB, other than those
      described in the foregoing paragraphs, was $15,000. Such fees represented 10%
      of
      the total fees for services rendered to the Company by PMB during
      2006.




The
      aggregate fees billed during 2005 for tax products and services related to
      the
      preparation of the Company's tax returns provided by Moss Adams, other than
      those described in the foregoing paragraphs, was $19,611. Such fees represented
      11% of the total fees for services rendered to the Company by Moss Adams during
      2005.




ALL
      OTHER
      FEES. During the year 2006, PMB did not bill the Company for any amount other
      than those mentioned above.




The
      aggregate fees billed to the Company for all other services related to
      correspondence with the SEC and the reissuing of an audit certificates to be
      included in the Company's restated annual report on Form 10K/A rendered by
      Moss
      Adams for the year ended December 31, 2005 was $4,341. Such fees represented
      2%
      of the total fees for services rendered to the Company by Moss Adams during
      2005.




The
      Company is not aware that any significant amount of the work done during the
      course of the audits of the Company's 2005 and 2004 Financial Statements was
      performed by persons other than full-time, permanent, employees of PMB and
      Moss
      Adams, respectively.




**ITEM
      15.**  **EXHIBITS** **AND FINANCIAL STATEMENT SCHEDULES.**




(a)  DOCUMENTS
      FILED AS PART OF THIS REPORT. The following documents are filed as part of
      this
      Report:




(1)
            Audited
                financial statements and financial statement
                schedules




Report
      of
      PMB Helin Donovan., LLP, Independent Registered Auditors




Report
      of
      Moss Adams, LLP, Independent Registered Auditors




Consolidated
      Balance Sheets as of December 31, 2006 and 2005




Consolidated
      Statements of Operations and Comprehensive Income for the Years Ended December
      31, 2006, 2005, and 2004




Consolidated
      Statements of Stockholders' Equity for the Years Ended December 31, 2006, 2005,
      and 2004




Consolidated
      Statements of Cash Flow for the Years Ended December 31, 2006, 2005, and
      2004




Notes
      to
      Financial Statements




(2)
            FINANCIAL
                STATEMENT SCHEDULES. The financial statement schedules required to
                be
                filed by Item 8 of this Annual Report on Form 10-K are listed above.
                All
                other financial statement schedules are omitted because they were
                not
                required or the required information is included in the Financial
                Statements or Notes thereto.




(3)
            LIST
                OF EXHIBITS.




Exhibit
                Number
            
            
            
            Description
                of Document3.1
            
            (T)
            
            Articles
                of Incorporation of the Company, as amended.3.2
            
            (T)
            
            Bylaws
                of the Company, as amended.10.1
            
            
            
            [Intentionally
                omitted]10.2
            
            
            
            [Intentionally
                omitted]




30




Exhibit
                Number
            
            
            
            Description
                of Document10.3
            
            (A)
            
            Wholesale
                Distribution Agreement between the Company and Bay Area
                Distributing.10.4
            
            
            
            [Intentionally
                omitted]10.5
            
            (B)
            
            Liquid
                Sediment Removal Services Agreement with Cold Creek Compost,
                Inc.10.6
            
            
            
            [Intentionally
                omitted]10.7
            
            (C)
            
            Commercial
                Real Estate Purchase Contract and Receipt for Deposit (previously
                filed as
                Exhibit 19.2).10.8
            
            (D)
            
            Commercial
                Lease between Stewart's Ice Cream Company, Inc. and Releta Brewing
                Company
                LLC.10.9
            
            
            
            [Intentionally
                omitted]10.10
            
            (F)
            
            Keg
                Management Agreement with MicroStar Keg Management LLC.10.11
            
            (G)
            
            Agreement
                to Implement Condition of Approval No. 37 of the Site Development
                Permit
                95-19 with the City of Ukiah, California (previously filed as Exhibit
                19.6).10.12
            
            
            
            [Intentionally
                omitted]10.13
            
            
            
            [Intentionally
                omitted]10.14
            
            
            
            [Intentionally
                omitted]10.15
            
            (I)
            
            Hazardous
                Substances Certificate and Indemnity with the Savings Bank of Mendocino
                County.10.16
            
            
            
            [Intentionally
                omitted]10.17
            
            
            
            [Intentionally
                omitted]10.18
            
            
            
            [Intentionally
                omitted]10.19
            
            (K)
            
            Investment
                Agreement with United Breweries of America, Inc.10.20
            
            
            
            [Intentionally
                omitted]10.21
            
            (K)
            
            Registration
                Rights Agreement Among the Company, United Breweries of America,
                Inc., H.
                Michael Laybourn, Norman Franks, Michael Lovett, John Scahill, and
                Don
                Barkley.10.22
            
            (L)
            
            Indemnification
                Agreement with Vijay Mallya.10.23
            
            (L)
            
            Indemnification
                Agreement with Michael Laybourn.10.24
            
            (L)
            
            Indemnification
                Agreement with Jerome Merchant.10.25
            
            (L)
            
            Indemnification
                Agreement with Yashpal Singh.10.27
            
            (L)
            
            Indemnification
                Agreement with Robert Neame.10.28
            
            (L)
            
            Indemnification
                Agreement with Sury Rao Palamand.10.29
            
            (L)
            
            Indemnification
                Agreement with Kent Price.10.30
            
            
            
            [Intentionally
                omitted]10.31
            
            
            
            [Intentionally
                omitted]10.32
            
            
            
            [Intentionally
                omitted]10.33
            
            (N)
            
            Employment
                Agreement with Yashpal Singh.10.35
            
            (O)
            
            Master
                Line of Credit Agreement between the Company and United Breweries
                of
                America Inc. dated August 31, 1999.





31





Exhibit
                Number
            
            
            
            Description
                of Document10.36
            
            (O)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated Sept. 7,
                1999.10.37
            
            (P)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated October 21,
                1999.10.38
            
            (P)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated November
                12,
                1999.10.39
            
            (P)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated December
                17,
                1999.10.40
            
            (P)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated December
                31,
                1999.10.41
            
            (P)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated February
                16,
                2000.10.42
            
            (P)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated February
                17,
                2000.10.43
            
            (P)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated April 28,
                2000.10.44
            
            (P)
            
            First
                Amendment to Master Line of Credit Agreement between the Company
                and
                United Breweries of America, Inc., dated April 28,
                2000.10.45
            
            (Q)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated September
                11,
                2000.10.46
            
            (Q)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated September
                30,
                2000.10.47
            
            (Q)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated December
                31,
                2000.10.48
            
            (Q)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated February
                12,
                2001.10.49
            
            (R)
            
            Convertible
                Note in favor of United Breweries of America Inc. dated July 1,
                2001.10.50
            
            (S)
            
            Confirmation
                of Waiver Between Mendocino Brewing Company, Inc. and United Breweries
                of
                America, Inc., dated as of December 28, 2001.10.51
            
            (S)
            
            Extension
                of Term of Notes Under Master Line of Credit Agreement between Mendocino
                Brewing Company, Inc. and United Breweries of America, Inc., dated
                February 14, 2002.10.52
            
            (T)
            
            License
                Agreement between United Breweries Limited and United Breweries
                International (U.K.), Limited.10.53
            
            (T)
            
            Supplemental
                Agreement to License Agreement between United Breweries Limited and
                United
                Breweries International (U.K.), Limited.10.54
            
            (T)
            
            Distribution
                Agreement between United Breweries International (U.K.), Limited.
                and
                UBSN, Ltd.10.55
            
            (T)
            
            Supplemental
                Agreement to Distribution Agreement between United Breweries International
                (U.K.), Limited. and UBSN, Ltd.10.56
            
            (T)
            
            Market
                Development, General and Administrative Services Agreement between
                Mendocino Brewing Company, Inc. and UBSN,
                Ltd.




32
  Exhibit
                  Number
              
              
              
              Description
                  of Document


10.57
            
            (T)
            
            Contract
                to Brew and Supply Kingfisher Products among Shepherd Neame, Limited,
                United Breweries International (U.K.), Limited. and UBSN,
                Ltd.10.58
            
            (T)
            
            Supplemental
                Agreement to Contract to Brew and Supply Kingfisher Products among
                Shepherd Neame, Limited, United Breweries International (U.K.), Limited.
                and UBSN, Ltd.10.59
            
            (T)
            
            Loan
                Agreement between Shepherd Neame, Limited and UBSN,
                Ltd.10.60
            
            (T)
            
            Brewing
                License Agreement between UBSN, Ltd. and Mendocino Brewing Company,
                Inc.10.61
            
            (T)
            
            Kingfisher
                Trade Mark and Trade Name License Agreement between Kingfisher of
                America,
                Inc. and Mendocino Brewing Company, Inc.10.62
            
            (U)
            
            First
                Amendment to Extension of Term of Notes Under Master Line of Credit
                Agreement between Mendocino Brewing Company, Inc. and United Breweries
                of
                America, Inc., dated November 13, 2002.10.63
            
            (U)
            
            Second
                Amendment to Extension of Term of Notes Under Master Line of Credit
                Agreement between Mendocino Brewing Company, Inc. and United Breweries
                of
                America, Inc., dated March 31, 2003.10.64
            
            
            
            [Intentionally
                omitted]10.65
            
            
            
            [Intentionally
                omitted]10.66
            
            (W)
            
            Third
                Amendment to Extension of Term of Notes under Master Line of Credit
                Agreement, dated August 14, 2003.10.67
            
            
            
            [Intentionally
                omitted]10.68
            
            (X)
            
            Fourth
                Amendment to Extension of Term of Notes Under Master Line of Credit
                Agreement between Mendocino Brewing Company, Inc. and United Breweries
                of
                America, Inc., dated as of August 14, 2004.10.69
            
            
            
            [Intentionally
                omitted]10.70
            
            (Z)
            
            Second
                Agreement dated October 9, 1998 between UBSN, Ltd. and Shepherd Neame,
                Ltd.10.71
            
            
            
            [Intentionally
                omitted]10.72
            
            
            
            [Intentionally
                omitted]10.73
            
            
            
            [Intentionally
                omitted]10.74
            
            (BB)
            
            Convertible
                Promissory Note of Mendocino Brewing Company, Inc. in favor of United
                Breweries of America, Inc., dated March 2, 2005.10.75
            
            
            
            [Intentionally
                omitted]10.76
            
            (DD)
            
            Invoice
                Discounting Agreement between The Royal Bank of Scotland Commercial
                Services Limited and UBSN Limited, dated April 26,
                2005.10.77
            
            
            
            [Intentionally
                omitted]10.78
            
            
            
            [Intentionally
                omitted]10.79
            
            (EE)
            
            Loan
                Agreement by and between Mendocino Brewing Company, Inc. and grand
                Pacific
                Financing Corporation dated June 28, 2006.10.80
            
            (EE)
            
            Promissory
                Note of Mendocino Brewing Company, Inc. in favor of Grand Pacific
                Financing Corporation, dated June 28,
                2006.




33


Exhibit
                  Number
              
              
              
              Description
                  of Document


10.81
            
            
            
            [Intentionally
                omitted]10.82
            
            *
            
            Loan
                and Security Agreement by and among Marquette Business Credit Inc.
                and
                Mendocino Brewing Company, Inc. and Releta Brewing Company, LLC,
                dated
                November 16, 2006.10.83
            
            *
            
            Revolving
                Note of Mendocino Brewing Company, Inc. and Releta Brewing Company,
                LLC in
                favor of Marquette Business Credit Inc., dated November 16,
                2006.10.84
            
            *
            
            Term
                Note of Mendocino Brewing Company, Inc. and Releta Brewing Company,
                LLC in
                favor of Marquette Business Credit Inc., dated November 16,
                2006.10.85
            
            *
            
            CAPEX
                Note of Mendocino Brewing Company, Inc. and Releta Brewing Company,
                LLC in
                favor of Marquette Business Credit Inc., dated November 16,
                2006.10.86
            
            *
            
            Fifth
                Amendment to Extension of Term of Notes Under Master Line of Credit
                Agreement, effective August 31, 2005.10.87
            
            *
            
            Sixth
                Amendment to Extension of Term of Notes under Master Line of Credit
                Agreement, effective December 31, 2006.10.88
            
            *
            
            Second
                Amendment to Convertible Promissory Note, effective December 31,
                2006.14.1
            
            (V)
            
            Code
                of Ethics





*
      Filed
      herewith.




**NOTES** :
      Each
      Exhibit listed above that is annotated with one or more of the following letters
      is incorporated by reference from the following sources:




(A)
            The
                Company's Registration Statement dated June 15, 1994, as amended,
                previously filed with the Commission, Registration No.
                33-78390-LA.




(B)
            The
                Company's Annual Report on Form 10-KSB for the period ended December
                31,
                1995.




(C)
            The
                Company's Quarterly Report on Form 10-QSB for the period ended March
                31,
                1995.




(D)
            The
                Company's Quarterly Report on Form 10-QSB/A No. 1 for the period
                ended
                September 30, 1997.




(F)
            The
                Company's Annual Report on Form 10-KSB for the period ended December
                31,
                1996.




(G)
            The
                Company's Quarterly Report on Form 10-QSB for the period ended September
                30, 1995.




(I)
            The
                Company's Annual Report on Form 10-KSB for the period ended December
                31,
                1997.




(K)
            Schedule
                13D filed November 3, 1997, by United Breweries of America, Inc.
                and Vijay
                Mallya.




(L)
            The
                Company's Quarterly Report on Form 10-QSB for the period ended June
                30,
                1998.




(N)
            The
                Company's Quarterly Report on Form 10-QSB for the period ended June
                30,
                1999.




(O)
            Amendment
                No. 5 to Schedule 13D filed September 15, 1999, by United Breweries
                of
                America, Inc. and Vijay Mallya.




(P)
            Amendment
                No. 6 to Schedule 13D filed May 12, 2000, by United Breweries of
                America,
                Inc. and Vijay Mallya.




(Q)
            Amendment
                No. 7 to Schedule 13D filed February 22, 2001, by United Breweries
                of
                America, Inc. and Vijay Mallya.




(R)
            Amendment
                No. 8 to Schedule 13D filed August 22, 2001, by United Breweries
                of
                America, Inc and Vijay Mallya.




34




(S)
            The
                Company's Current Report on Form 8-K filed as of February 19,
                2002.




(T)
            The
                Company's Annual Report on Form 10-KSB for the period ended December
                31,
                2001.




(U)
            Amendment
                No. 9 to Schedule 13D filed March 31, 2003, by United Breweries of
                America, Inc. and Vijay Mallya.




(V)
            The
                Company's Annual Report on Form 10-KSB for the year ended December
                31,
                2003.




(W)
            Amendment
                No. 10 to Schedule 13D filed August 18, 2003 by United Breweries of
                America, Inc. and Dr. Vijay Mallya.




(X)
            Amendment
                No. 11 to Schedule 13D, jointly filed by United Breweries of America,
                Inc.
                and Dr. Vijay Mallya on August 16,
                2004.




(Z)
            The
                Company's Quarterly Report on Form 10-Q for the period ended September
                30,
                2004.




(BB)
            The
                Company's Current Report on Form 8-K filed as of March 8,
                2005.




(DD)
            The
                Company's Quarterly Report on Form 10-Q for the period ended June
                30,
                2005.




(EE)
            The
                Company's Quarterly Report on Form 10-Q for the period ended June 30,
                2006.




(b)
            Exhibits
                AttachedThe following Exhibits are attached to this Annual Report on Form
                10-K:




10.82
            Loan
                and Security Agreement by and among Marquette Business Credit Inc.
                and
                Mendocino Brewing Company, Inc. and Releta Brewing Company, LLC,
                dated
                November 16, 2006.




10.83
            Revolving
                Note of Mendocino Brewing Company, Inc. and Releta Brewing Company,
                LLC in
                favor of Marquette Business Credit Inc., dated November 16,
                2006.




10.84
            Term
                Note of Mendocino Brewing Company, Inc. and Releta Brewing Company,
                LLC in
                favor of Marquette Business Credit Inc., dated November 16,
                2006.




10.85
            CAPEX
                Note of Mendocino Brewing Company, Inc. and Releta Brewing Company,
                LLC in
                favor of Marquette Business Credit Inc., dated November 16,
                2006.




10.86
            Fifth
                Amendment to Extension of Term of Notes Under Master Line of Credit
                Agreement, effective August 31,
                2005.




10.87
            Sixth
                Amendment to Extension of Term of Notes Under Master Line of Credit
                Agreement, effective August 31,
                2006.




10.88
            Second
                Amendment to Convertible Promissory Note, effective December 31,
                2006.




31.1
            Certification
                of Chief Executive Officer pursuant to Rule
                13a-14(a)/15d-14(a).




31.2
            Certification
                of Chief Financial Officer pursuant to Rule
                13a-14(a)/15d-14(a).




32.1
            Certification
                of Chief Executive Officer Pursuant to U.S.C.
                1350.




32.2
            Certification
                of Chief Financial Officer Pursuant to U.S.C.
                1350.




(c)
            Excluded
                Financial Statements.
                None.




**SIGNATURES**




Pursuant
      to the requirements of Section 13 or 15(d) f 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.




MENDOCINO
                BREWING COMPANY, INC.
              (Registrant)By:
            /s/ Yashpal
              SinghYashpal
              SinghIts
              President, Director and Chief Executive OfficerDate: March 31,
              2007




35


Pursuant
        to the requirements of the Securities Exchange Act of 1934, this report has
        been
        signed below by the following persons on behalf of the registrant and in
        the
        capacity and on the dates indicated.


MENDOCINO
                  BREWING
                  COMPANY, INC.
                (Registrant)By:Dr.
                Vijay MallyaDirector
                  and Chairman of the BoardDate:
                  March 31, 2007


By:
                /s/  Yashpal SinghYashpal
                  SinghIts
                      President, Director and Chief Executive OfficerDate:
                    March 31, 2007


By:
                    /s/ Scott R. HeldfondScott
                      R. Heldfond, DirectorDate:
                        March 31, 2007
 By:
                              /s/ Jerome G. MerchantJerome
                                G. Merchant, DirectorDate:
                                  March 31, 2007
 By:
                                          /s/ N. MahadevanN. Mahadevan
                                            Its Secretary and
                                              Chief Financial
                                              OfficerDate:
                                              March 31, 2007
 By:
                                                      /s/ H.
                                                        Michael LaybournH.
                                                          Michael Laybourn, DirectorDate:
                                                          March 31, 2007
 By:
                                                                  /s/
                                                                    Kent PriceKent
                                                                      Price, DirectorDate:
                                                                      March 31, 2007
  By:
                                                                              /s/
                                                                                Sury
                                                                                Rao
                                                                                PalamandSury
                                                                                  Rao
                                                                                  Palamand,
                                                                                  DirectorDate:
                                                                                  March 31,
                                                                                  2007
 36








**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**





**C** **ONSOLIDATED** **F** **INANCIA** **L
      S** **TATEMENTS**


**F** **OR
      THE** **Y** **EARS** **E** **NDED**


**D** **ECEMBER** **31, 2006** **AND** **2005**











**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 
 **C** **ONSOLIDATED** **F** **INANCIA** **L
        S** **TATEMENTS**
 **F** **OR
        THE** **Y** **EARS** **E** **NDED**
 **D** **ECEMBER** **31, 2006** **AND** **2005**





**CONTENTS**







Reports
                of Independent Registered Public Accounting Firms
            
            F-1 
                – F-2Consolidated
                Balance Sheets
            
            F-3Consolidated
                Statements of Operations and Comprehensive Income
            
            F-4Consolidated
                Statements of Stockholders' Equity
            
            F-5Consolidated
                Statements of Cash Flows
            
            F-6Notes
                to Financial Statements
            
            F-7 
                –  F-33









**R** **EPORT** **** **OF** **I** **NDEPENDENT** **R** **EGISTERED** **P** **UBLIC** **A** **CCOUNTING** **F** **IRM**


To
      the
      Board of Directors and Stockholders


Mendocino
      Brewing Company, Inc.


Ukiah,
      California





We
      have
      audited the accompanying consolidated balance sheets of Mendocino Brewing
      Company, Inc. (“MBC”) as of December 31, 2006 and 2005, and the related
      consolidated statements of operations and comprehensive income, stockholders’
equity and cash flows for the years ended December 31, 2006 and 2005. These
      consolidated financial statements are the responsibility of the Company’s
      management. Our responsibility is to express an opinion on these consolidated
      financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statement is free of material misstatement. The Company is not required to
      have,
      nor were we engaged to perform, an audit of its internal control over financial
      reporting. Our audit includes consideration of internal control over financial
      reporting as a basis for designing audit procedures that are appropriate in
      the
      circumstances, but not for expressing an opinion on the effectiveness of the
      Company’s internal control over financial reporting. Accordingly, we express no
      such opinion. An audit includes examining, on a test basis, evidence supporting
      the amounts and disclosures in the financial statement. An audit also includes
      assessing the accounting principles used and significant estimates made by
      management, as well as evaluating the overall financial statement presentation.
      We believe that our audits provide a reasonable basis for our
      opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of MBC, Inc.
      as of
      December 31, 2006 and 2005 and the consolidated results of their operations
      and
      their consolidated cash flows for the years ended December 31, 2006 and 2005,
      in
      conformity with accounting principles generally accepted in the United States
      of
      America.





As
      discussed in Note 1 to the consolidated financials statements, the Company
      changed its method of accounting for stock-based compensation upon adoption
      of
      Financial Accounting Standards No. 123(R), “Share-Based
      Payment.”








/s/
      PMB
      Helin Donovan, LLP





**PMB
      Helin Donovan, LLP**


San
      Francisco, California


March
      27,
      2006





F-1




REPORTOFINDEPENDENTREGISTEREDPUBLICACCOUNTINGFIRM
 To
          the
          Board of Directors and Stockholders
 Mendocino
          Brewing Company, Inc.
 
 We
          have
          audited Mendocino Brewing Company, Inc.’s, consolidated statements of operations
          and comprehensive income, stockholders’ equity, and cash flows for the year
          ended December 31, 2004. These financial statements are the responsibility
          of
          the Company’s management. Our responsibility is to express an opinion on these
          financial statements based on our audit.
 
 We
          conducted our audit in accordance with the standards of the Public Company
          Accounting Oversight Board (United States). Those standards require that
          we plan
          and perform the audit to obtain reasonable assurance about whether the
          financial
          statements are free of material misstatement. The Company is not required
          to
          have, nor were we engaged to perform, an audit of its internal control
          over
          financial reporting. Our audit included consideration of internal control
          over
          financial reporting as a basis for designing audit procedures that are
          appropriate in the circumstances, but not for the purpose of expressing
          an
          opinion on the effectiveness of the Company's internal control over financial
          reporting. Accordingly, we express no such opinion. An audit includes examining,
          on a test basis, evidence supporting the amounts and disclosures in the
          financial statements. An audit also includes assessing the accounting principles
          used and significant estimates made by management, as well as evaluating
          the
          overall financial statement presentation. We believe our audit provide
          a
          reasonable basis for our opinion.
 
 In
          our
          opinion, the consolidated financial statements referred to above present
          fairly,
          in all material respects, Mendocino Brewing Company, Inc.’s, results of its
          operations and cash flows for the year ended December 31, 2004, in conformity
          with accounting principles generally accepted in the United States of
          America.
 
 /s/
          Moss
          Adams LLP
 
 Santa
          Rosa, California
 February
          4, 2005
 F-2
  **M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
              I** **NC** **.**
 **C**ONSOLIDATED****B****ALANCE****S****HEETS****
 **A** **S
            OF** **D** **ECEMBER** **31, 2006** **AND** **2005**




2006
            
            2005ASSETSCurrent
                AssetsCash
            
            $
            345,900
            
            $
            247,700Accounts
                receivable, net of allowance fordoubtful
                accounts of $60,500 and $54,900, respectively
            
            
            7,903,100
            
            
            7,051,500Inventories
            
            
            1,329,500
            
            
            1,151,400Prepaid
                expenses
            
            
            671,400
            
            
            548,500Total
                Current Assets
            
            
            10,249,900
            
            
            8,999,100Property
                and Equipment(net
                of accumulated depreciation)
            
            
            13,446,000
            
            
            13,185,600Other
                AssetsIncome
                tax receivable
            
            
            -
            
            
            116,000Deposits
                and other assets
            
            
            302,300
            
            
            179,200Intangibles,
                (net of amortization)
            
            
            53,900
            
            
            77,500Total
                Other Assets
            
            
            356,200
            
            
            372,700Total
                Assets
            
            $
            24,052,100
            
            $
            22,557,400LIABILITIES
                AND STOCKHOLDERS' EQUITYCurrent
                LiabilitiesSecured
                lines of credit
            
            $
            3,934,300
            
            $
            3,774,000Note
                payable
            
            
            -
            
            
            576,200Accounts
                payable
            
            
            7,164,300
            
            
            5,491,800Accrued
                liabilities
            
            
            1,397,600
            
            
            1,714,800Current
                maturities of notes to related parties
            
            
            117,500
            
            
            103,100Current
                maturities of obligation under long-term debt
            
            
            236,500
            
            
            284,400Current
                maturities of obligation under capital lease
            
            
            83,100
            
            
            131,600Total
                Current Liabilities
            
            
            12,933,300
            
            
            12,075,900Long-Term
                LiabilitiesNotes
                to related parties including accruedinterest
                of $818,000 and $636,800, respectively
            
            
            3,321,000
            
            
            3,171,000Long
                term debt, less current maturities
            
            
            4,226,700
            
            
            2,314,900Obligations
                under capital leases, less current maturities
            
            
            65,600
            
            
            121,500Total
                Long-Term Liabilities
            
            
            7,613,300
            
            
            5,607,400Total
                Liabilities
            
            
            20,546,600
            
            
            17,683,300Stockholders'
                EquityPreferred
                stock, Series A, no par value, withliquidation
                preference of $1 per share; 10,000,000shares
                authorized, 227,600 shares issued and outstanding
            
            
            227,600
            
            
            227,600Common
                stock, no par value 30,000,000 shares authorized,11,628,174
                and 11,473,914 shares issued and outstanding
            
            
            14,815,300
            
            
            14,747,300Accumulated
                comprehensive income
            
            
            124,400
            
            
            130,400Accumulated
                deficit
            
            
            (11,661,800
            )
            
            (10,231,200
            )Total
                Stockholders' Equity
            
            
            3,505,500
            
            
            4,874,100Total
                Liabilities and Stockholders' Equity
            
            $
            24,052,100
            
            $
            22,557,400


The
        accompanying notes are an integral part of these financial
        statements.
  F-3





**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**C** **ONSOLIDATED** **S** **TATEMENTS** **** **OF** **O** **PERATIONS** **** **AND** **C** **OMPREHENSIVE** **I** **NCOME** **(L** **OSS** **)**


**F** **OR** **** **THE** **Y** **EARS** **E** **NDING** **D** **ECEMBER** **31, 2006, 2005** **AND** **2004**




2006
            
            2005
            
            2004Sales
            
            $
            32,948,900
            
            $
            31,927,300
            
            $
            32,157,900Less
                excise tax
            
            
            673,500
            
            
            635,500
            
            
            652,400Net
                Sales
            
            
            32,275,400
            
            
            31,291,800
            
            
            31,505,500Cost
                of Goods Sold
            
            
            23,063,300
            
            
            21,754,200
            
            
            21,045,500Gross
                Profit
            
            
            9,212,100
            
            
            9,537,600
            
            
            10,460,000Operating
                ExpensesRetail
                operating
            
            
            97,200
            
            
            102,400
            
            
            139,500Marketing
            
            
            5,011,500
            
            
            6,216,200
            
            
            5,841,200General
                and administrative
            
            
            4,548,700
            
            
            3,735,400
            
            
            3,774,900Legal
                dispute settlement
            
            
            -
            
            
            -
            
            
            250,600Total
                Operating Expenses
            
            
            9,657,400
            
            
            10,054,000
            
            
            10,006,200Income
                (Loss) from Operations
            
            
            (445,300
            )
            
            (516,400
            )
            
            453,800Other
                Income (Expense)Miscellaneous
                income
            
            
            89,900
            
            
            60,600
            
            
            36,800Profit
                (loss) on sale of equipment, net
            
            
            5,000
            
            
            (6,000
            )
            
            15,600Interest
                expense
            
            
            (1,077,700
            )
            
            (978,500
            )
            
            (853,300
            )Total
                Other Income (Expense)
            
            
            (982,800
            )
            
            (923,900
            )
            
            (800,900
            )Income
                (Loss) before Income Taxes
            
            
            (1,428,100
            )
            
            (1,440,300
            )
            
            (347,100
            )Provision
                for (Benefit from) Income Taxes
            
            
            2,500
            
            
            (125,600
            )
            
            121,800Net
                Income (Loss)
            
            
            (1,430,600
            )
            
            (1,314,700
            )
            
            (468,900
            )Other
                Comprehensive Income (Loss)Foreign
                currency translation adjustment
            
            
            (6,000
            )
            
            (63,900
            )
            
            116,300Comprehensive
                Income (Loss)
            
            $
            (1,436,600
            )
            $
            (1,378,600
            )
            $
            (352,600
            )Net
                Income (Loss) percommon
                share (basic and diluted)
            
            $
            (0.12
            )
            $
            (0.11
            )
            $
            (0.04
            )Weighted
                average common shares outstandingoutstanding
                (basic and diluted)
            
            $
            11,512,479
            
            $
            11,472,213
            
            $
            11,266,874




The
        accompanying notes are an integral part of these financial
        statements.
  F-4





**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**C** **ONSOLIDATED** **S** **TATEMENTS** **** **OF** **S** **TOCKHOLDERS** **’
      E** **QUITY**


**F** **OR
      THE** **Y** **EARS** **E** **NDING** **D** **ECEMBER** **31, 2006, 2005** **AND** **2004**





Series
                A
            
            
            
            
            
            
            
            OtherPreferred
            
            
            
            Common
            
            
            
            Comprehensive
            
            Accumulated
            
            TotalShares
            
            Amount
            
            Shares
            
            Amount
            
            Income/(Loss)
            
            Deficit
            
            EquityBalance
                December 31, 2003
            
            
            227,600
            
            $
            227,600
            
            
            11,266,874
            
            $
            14,648,600
            
            $
            78,000
            
            $
            (8,447,600
            )
            $
            6,506,600Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (468,900
            )
            
            (468,900
            )Currency
                translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            116,300
            
            
            -
            
            
            116,300Balance
                December 31, 2004
            
            
            227,600
            
            
            227,600
            
            
            11,266,874
            
            
            14,648,600
            
            
            194,300
            
            
            (8,916,500
            )
            
            6,154,000Stock
                issued for accrued compensation
            
            
            -
            
            
            -
            
            
            207,040
            
            
            98,700
            
            
            -
            
            
            -
            
            
            98,700Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (1,314,700
            )
            
            (1,314,700
            )Currency
                translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (63,900
            )
            
            -
            
            
            (63,900
            )Balance
                December 31, 2005
            
            
            227,600
            
            
            227,600
            
            
            11,473,914
            
            
            14,747,300
            
            
            130,400
            
            
            (10,231,200
            )
            
            4,874,100Stock
                issued for accrued compensation
            
            
            -
            
            
            -
            
            
            154,260
            
            
            68,000
            
            
            -
            
            
            -
            
            
            68,000Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (1,430,600
            )
            
            (1,430,600
            )Currency
                translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (6,000
            )
            
            -
            
            
            (6,000
            )Balance
                December 31, 2006
            
            
            227,600
            
            $
            227,600
            
            
            11,628,174
            
            $
            14,815,300
            
            $
            124,400
            
            $
            (11,661,800
            )
            $
            3,505,500




The
        accompanying notes are an integral part of these financial
        statements.
  F-5





**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**C** **ONSOLIDATED** **S** **TATEMENTS** **** **OF** **C** **ASH** **F** **LOWS**


**F** **OR
      THE** **Y** **EARS** **E** **NDING** **D** **ECEMBER** **31, 2006, 2005** **AND** **2004**




2006
            
            2005
            
            2004CASH
                FLOWS FROM OPERATING ACTIVITIESNet
                income (loss)
            
            $
            (1,430,600
            )
            $
            (1,314,700
            )
            $
            (468,900
            )Adjustments
                to reconcile net income(loss)
                to net cash from operating activities:Depreciation
                and amortization
            
            
            1,017,800
            
            
            903,700
            
            
            1,031,300Allowance
                for doubtful accounts
            
            
            -
            
            
            10,200
            
            
            8,000Loss
                (gain) on sale of assets
            
            
            (5,000
            )
            
            6,000
            
            
            (15,600
            )Interest
                accrued on related party notes
            
            
            181,200
            
            
            142,100
            
            
            88,600Deferred
                income tax
            
            
            -
            
            
            (122,900
            )
            
            -Changes
                in operating assets and liabilities:(Increase)
                decrease in accounts receivable
            
            
            (11,300
            )
            
            702,600
            
            
            (1,004,900
            )(Increase)
                decrease in inventories
            
            
            (178,100
            )
            
            34,000
            
            
            700(Increase)
                decrease in prepaid expenses
            
            
            (71,400
            )
            
            (229,800
            )
            
            224,200(Increase)
                decrease in deposits and other assets
            
            
            273,700
            
            
            59,400
            
            
            (27,800
            )Increase
                in accounts payable
            
            
            1,039,300
            
            
            47,400
            
            
            125,700Increase
                (decrease) in accrued liabilities
            
            
            (424,900
            )
            
            (420,200
            )
            
            338,200Decrease
                in income taxes payable
            
            
            -
            
            
            (127,400
            )
            
            (192,500
            )Net
                cash provided by (used in) operating activities
            
            
            390,700
            
            
            (309,600
            )
            
            107,000CASH
                FLOWS FROM INVESTING ACTIVITIESPurchases
                of property, equipment and leasehold improvements
            
            
            (988,200
            )
            
            (600,900
            )
            
            (597,800
            )Proceeds
                from sale of fixed assets
            
            
            41,400
            
            
            77,000
            
            
            24,300Net
                cash used in investing activities:
            
            
            (946,800
            )
            
            (523,900
            )
            
            (573,500
            )CASH
                FLOWS FROM FINANCING ACTIVITIESNet
                borrowing (repayment) on line of credit
            
            
            (148,200
            )
            
            706,400
            
            
            1,211,500Borrowings
                on long term debt
            
            
            4,180,900
            
            
            -
            
            
            -Repayment
                on long-term debt
            
            
            (2,628,300
            )
            
            (285,300
            )
            
            (575,900
            )Borrowings
                on related party debt
            
            
            -
            
            
            400,000
            
            
            -Repayment
                on related party debt
            
            
            (110,600
            )
            
            (91,000
            )
            
            (128,300
            )Proceeds
                from notes payable
            
            
            350,000
            
            
            -
            
            
            -Repayment
                of notes payable
            
            
            (926,200
            )
            
            -
            
            
            -Payments
                on obligations under long term leases
            
            
            (168,800
            )
            
            (142,900
            )
            
            (124,000
            )Net
                cash provided by financing activities:
            
            
            548,800
            
            
            587,200
            
            
            383,300EFFECT
                OF EXCHANGE RATE CHANGES ON CASH
            
            
            105,500
            
            
            (32,600
            )
            
            55,500Net
                Change in Cash
            
            
            98,200
            
            
            (278,900
            )
            
            (27,700
            )Cash
                at beginning of period
            
            
            247,700
            
            
            526,600
            
            
            554,300Cash
                at end of period
            
            $
            345,900
            
            $
            247,700
            
            $
            526,600SUPPLEMENTAL
                CASH FLOW INFORMATIONCash
                paid during the period for:Interest
            
            $
            896,500
            
            $
            836,400
            
            $
            764,700Income
                taxes
            
            $
            2,500
            
            $
            -
            
            $
            314,200Non-cash
                investing and financing activities:Common
                stock issued for accrued compensation
            
            $
            68,000
            
            $
            98,700
            
            $
            -Seller
                financed equipment
            
            $
            44,600
            
            $
            216,400
            
            $
            15,400





The
        accompanying notes are an integral part of these financial
        statements.
  F-6





**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**N** **OTES
      TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**


DECEMBER31,
      2006





**1.**  **Description
      of Operations and Summary of Significant Accounting
      Policies**





Description
      of Operations





Mendocino
      Brewing Company, Inc., ("the Company" or "MBC"), has operating subsidiaries,
      Releta Brewing Company, ("Releta"), and United Breweries International, Limited
      (UK), ("UBIUK"). In the United States, MBC and its subsidiary, Releta, operate
      two breweries that produce beer and malt beverages for the specialty "craft"
      segment of the beer market. The breweries are located in Ukiah, California
      and
      Saratoga Springs, New York. The Company also owns and operates a brewpub and
      gift store located in Hopland, California. The majority of US sales for
      Mendocino Brewing Company are in California. The Company brews several brands,
      of which Red Tail Ale is the flagship brand. In addition, the Company performs
      contract brewing for several other brands, and MBC holds the license to
      distribute Kingfisher Lager in the US.





The
      Company's UK subsidiary, UBIUK, is a holding company for UBSN Limited. UBSN
      is a
      distributor of alcoholic beverages, mainly Kingfisher Lager, in the United
      Kingdom and Europe. The distributorship is located in Faversham, Kent in the
      United Kingdom.





Principles
      of Consolidation





The
      consolidated financial statements present the accounts of Mendocino Brewing
      Company, Inc., and its wholly-owned subsidiaries, Releta Brewing Company, LLC,
      and UBIUK. All material inter-company balances, profits and transactions have
      been eliminated.





Basis
      of Presentation and Organization





The
      financial statements for the fiscal years ended December 31, 2006, 2005 and
      2004, have been prepared in accordance with accounting principles generally
      accepted in the United States. The financial statements and notes are
      representations of the management and the Board of Directors, who are
      responsible for their integrity and objectivity.





Cash
      and Cash Equivalents, Short- and Long-Term Investments





For
      purposes of cash flows, the Company considers all highly liquid investments
      purchased with a maturity of three months or less to be cash equivalents, those
      with original maturities not greater than three months and current maturities
      less than twelve months from the balance sheet date are considered short-term
      investments, and those with maturities greater than twelve months from the
      balance sheet date are considered long-term investments.





Financial
      instruments that potentially subject the Company to significant concentration
      of
      credit risk consist primarily of cash and cash equivalents. Substantially all
      of
      the Company's cash and cash equivalents are deposited with large commercial
      banks in the US and the UK.




F-7




**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**N** **OTES
      TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**


DECEMBER31,
      2006




**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Trade
      Accounts Receivable and Allowance for Doubtful Accounts





Trade
      accounts receivable are stated at the invoiced amount and are the amount the
      Company expects to collect. The allowance for doubtful accounts is the Company’s
      best estimate of the amount of probable credit losses in the Company’s existing
      accounts receivable; however, changes in circumstances relating to accounts
      receivable may result in a requirement for additional allowances in the future.
      Management considers the following factors when determining the collectibility
      of specific customer accounts: customer credit-worthiness, past transaction
      history with the customer, current economic industry trends and changes in
      customer payment terms. Past due balances over 90 days and other higher risk
      amounts are reviewed individually for collectibility. If the financial condition
      of the Company's customers were to deteriorate, adversely affecting their
      ability to make payments, additional allowances would be required. Based on
      management's assessment, the Company provides for estimated uncollectible
      amounts through a charge to earnings and a credit to a valuation allowance.
      Balances that remain outstanding after the Company has used reasonable
      collection efforts are written off through a charge to the valuation allowance
      and a credit to accounts receivable.





*Allowance
      for Doubtful Accounts*





The
      Company maintains allowances for doubtful accounts for estimated losses
      resulting from the inability of its customers to make required payments. A
      considerable amount of judgment is required in assessing the ultimate
      realization of accounts receivable including the current credit-worthiness
      of
      each customer. If the financial condition of the Company’s customers were to
      deteriorate, resulting in an impairment of their ability to make payments,
      additional allowances may be required. As of December 31, 2006, the Company
      maintained a reserve of $60,500 of potentially doubtful accounts receivable.
      Bad
      debt expenses totaled $679,300, $49,100, and $60,900 for the years ended
      December 31, 2006, 2005, and 2004 respectively.





Inventories





Inventories
      are stated at the lower of average cost or market (net realizable
      value).





Property
      and Equipment





Property
      and equipment are stated at cost and depreciated or amortized using
      straight-line method over the assets' estimated useful lives. Leasehold
      improvements are amortized over the shorter of the life of the related asset
      or
      the life of the lease. The Company uses other depreciation methods (generally,
      accelerated depreciation methods) for tax purposes where appropriate. Costs
      of
      maintenance and repairs are charged to expense as incurred; significant renewals
      and betterments are capitalized. Long-lived assets are assessed for impairment
      whenever events or changes in circumstances indicate their carrying amounts
      may
      not be recoverable. When property and equipment are retired, sold, or otherwise
      disposed of, the asset’s carrying amount and related accumulated depreciation
      are removed from the accounts and any gain or loss is included in
      operations.




F-8




**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**N** **OTES
      TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**


DECEMBER31,
      2006




**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Property
      and Equipment (continued)





*Assets
      Held under Capital Leases* **





Assets
      held under capital leases are recorded at the lower of the net present value
      of
      the minimum lease payments or the fair value of the leased asset at the
      inception of the lease. Amortization expense is computed using the straight-line
      method over the shorter of the estimated useful lives of the assets or the
      period of the related lease.





Estimated
      useful lives of property and equipment are as follows:





Building
            
            
            40
                yearsMachinery
                and equipment
            
            
            3
                - 40 yearsEquipment
                under capital lease
            
            
            3
                - 20 yearsLeasehold
                improvements
            
            
            7
                - 20 yearsVehicles
            
            
            2
                - 5 yearsFurniture
                and fixtures
            
            
            5
                - 10 years




*Impairment
      of Long-Lived Assets*





The
      Company assesses the impairment of its long-lived assets periodically in
      accordance with the provisions of Statement of Financial Accounting Standards
      ("SFAS") 144, "Accounting for the Impairment and Disposal of Long-Lived Assets".
      The Company reviews the carrying value of property and equipment for impairment
      whenever events and circumstances indicate that the carrying value of an asset
      may not be recoverable from the estimated future cash flows expected to result
      from its use and eventual disposition. In cases where undiscounted expected
      future cash flows are less than the carrying value, an impairment loss is
      recognized equal to an amount by which the carrying value exceeds the fair
      value
      of assets. The factors considered by management in performing this assessment
      include current operating results, trends, and prospects, as well as the effects
      of obsolescence, demand, competition, and other economic factors. Long-lived
      assets that management commits to sell or abandon are reported at the lower
      of
      carrying amount or fair value less cost to sell.





Intangibles





Intangibles
      consist of, trade names, trademarks, and other intangibles. Purchased trademarks
      are initially measured based on their fair values. Trademarks
      include purchased trademarks, brand names, logos or other recognizable symbols
      associated with the Company's products. Trademarks are not amortized because
      they have indefinite lives. Intangibles
      that are amortized are deferred financing costs. Assets determined to have
      indefinite lives are no longer amortized in accordance with SFAS No. 142,
      GOODWILL AND OTHER INTANGIBLES, but are tested for impairment on an annual
      basis. The carrying amount of intangibles not subject to amortization is $47,600
      for December 31, 2006 and 2005.




F-9




**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**N** **OTES
      TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**


DECEMBER31,
      2006




**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Deferred
      Financing Costs





Costs
      relating to obtaining financing are capitalized and amortized over the term
      of
      the related debt using the straight-line method. Deferred financing costs were
      $311,300, and the related accumulated amortization at December 31, 2006 and
      2005
      was $32,700 and $21,600, respectively. Amortization of deferred financing costs
      charged to operations was $54,300 for the year ended December 31, 2006 and
      $2,700 for each of the years ended 2005 and 2004. The Company will continue
      to
      amortize these fees until 2011. When a loan is paid in full, any unamortized
      financing costs are removed from the related accounts and charged to
      operations.





Impairment
      of Intangible Assets





The
      Company evaluates the recoverability of identifiable intangible assets whenever
      events or changes in circumstances indicate that an intangible asset's carrying
      amount may not be recoverable. Such circumstances could include, but are not
      limited to: (1) a significant decrease in the market value of an asset, (2)
      a
      significant adverse change in the extent or manner in which an asset is used,
      or
      (3) an accumulation of costs significantly in excess of the amount originally
      expected for the acquisition of an asset. The Company measures the carrying
      amount of the asset against the estimated undiscounted future cash flows
      associated with it. Should the sum of the expected future net cash flows are
      less than the carrying value of the asset being evaluated, an impairment loss
      would be recognized. The impairment loss would be calculated as the amount
      by
      which the carrying value of the asset exceeds its fair value. The fair value
      is
      measured based on quoted market prices, if available. If quoted market prices
      are not available, the estimate of fair value is based on various valuation
      techniques, including the discounted value of estimated future cash flows.
      The
      evaluation of asset impairment requires the Company to make assumptions about
      future cash flows over the life of the asset being evaluated. These assumptions
      require significant judgment and actual results may differ from assumed and
      estimated amounts. During the year ended December 31, 2006, 2005 and 2004,
      the
      Company recorded no impairment losses related to an intangible
      asset.





Concentration
      of Credit Risks





Financial
      instruments that potentially subject the Company to credit risk consist
      principally of trade receivables, cash deposits in excess of FDIC limits, and
      assets located in the United Kingdom. The Company's cash deposits are placed
      with major financial institutions in the US and UK.





Wholesale
      distributors account for substantially all accounts receivable; therefore,
      this
      risk concentration is limited due to the number of distributors and the laws
      regulating the financial affairs of distributors of alcoholic beverages. The
      Company has approximately $290,200 in cash deposits and $6,090,800 of accounts
      receivable due from customers located in the United Kingdom as of December
      31,
      2006.




F-10




**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**N** **OTES
      TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**


DECEMBER31,
      2006




**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Income
      Taxes





The
      Company accounts for its income taxes using the Financial Accounting Standards
      Board Statements of Financial Accounting Standards No. 109, "Accounting for
      Income Taxes," which requires the establishment of a deferred tax asset or
      liability for the recognition of future deductible or taxable amounts and
      operating loss and tax credit carryforwards. Deferred tax expense or benefit
      is
      recognized as a result of timing differences between the recognition of assets
      and liabilities for book and tax purposes during the year.





Deferred
      tax assets and liabilities are measured using enacted tax rates expected to
      apply to taxable income in the years in which those temporary differences are
      expected to be recovered or settled. Deferred tax assets are recognized for
      deductible temporary differences and operating loss, and tax credit
      carryforwards. A valuation allowance is established to reduce the deferred
      tax
      asset if it is "more likely than not" that the related tax benefits will not
      be
      realized.





In
      July
      2006, the Financial Accounting Standards Board issued FASB Interpretation No.
      48, "Accounting for Uncertainty in Income Taxes.” The Interpretation requires
      that realization of an uncertain income tax position must be estimated as "more
      likely than not" (i.e., greater than 50% likelihood of receiving a benefit)
      before it can be recognized in the financial statements. Further, the
      Interpretation requires the recognition of tax benefits recorded in the
      financial statements to be based on the amount most likely to be realized
      assuming a review by tax authorities having all relevant information. The
      Interpretation also clarifies the financial statement classification of
      tax-related penalties and interest and sets forth new disclosures regarding
      unrecognized tax benefits. MBC will adopt the Interpretation when required
      in
      the first quarter 2007. The company expects minimal impact from adoption of
      this
      Interpretation.





Revenue
      Recognition





The
      Company recognizes revenue from the brewing and distribution operations when
      the
      product is shipped. Revenues from the brewpub and gift store are recognized
      when
      sales have been completed.





The
      Company recognizes revenue only when all of the following criteria have been
      met:





·
            Persuasive
                evidence of an arrangement exists;


·
            Delivery
                has occurred or services have been
                rendered;


·
            The
                fee for the arrangement is fixed or determinable;
                and


·
            Collectibility
                is reasonably assured.





*"Persuasive
      Evidence of an Arrangement" -* The
      Company documents all terms of an arrangement in a written contract or purchase
      order signed by the customer prior to recognizing revenue.





*"Delivery
      Has Occurred or Services Have Been Performed" -* The
      Company delivers the products prior to recognizing revenue or performs services
      as per contractual terms. Product is considered delivered upon delivery to
      a
      customer's designated location and services considered performed upon completion
      of Company's contractual obligations.




F-11




**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**N** **OTES
      TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**


DECEMBER31,
      2006




**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Revenue
      Recognition (continued)





*"The
      Fee for the Arrangement is Fixed or Determinable" -* Prior to
      recognizing revenue, an amount is either fixed or determinable under the terms
      of the written contract. The price is negotiated at the outset of the
      arrangement and is not subject to refund or adjustment during the initial term
      of the arrangement.





*"Collectibility
      is Reasonably Assured" -* The
      Company determines that collectibility is reasonably assured prior to
      recognizing revenue. Collectibility is assessed on a customer-by-customer basis
      based on criteria outlined by management. The Company does not enter into
      arrangements unless collectibility is reasonably assured at the outset. Existing
      customers are subject to ongoing credit evaluations based on payment history
      and
      other factors. If it is determined during the arrangement that collectibility
      is
      not reasonably assured, revenue is recognized on a cash basis.





The
      Company has adopted EITF - 01-09 “Accounting for Consideration Given by a Vendor
      to a Customer (including a Reseller of the Vendor’s Products)”. This EITF
      requires that certain cash consideration paid to customers for services or
      placement fees are to be reported as a reduction in revenue rather than as
      an
      expense. The Company has reclassified these items on the income statement as
      a
      reduction in revenue and as a corresponding reduction in marketing and selling
      expenses. This reclassification has no impact on net income.





Taxes
      Collected From Customers





Taxes
      collected from customers and remitted to tax authorities are state and federal
      excise taxes on beer shipments. Excise taxes are shown in a separate line item
      in the consolidated statement of operations as reduction of gross sales. Sales
      taxes collected from customers are recognized as a liability, with the liability
      subsequently reduced when the taxes are remitted to the tax authority. Total
      sales taxes collected from customers and remitted to tax authorities were not
      material in 2006, 2005 and 2004.





Delivery
      Costs





In
      accordance with EITF 00-10, "Accounting for Shipping and Handling Fees and
      Costs," the company reports pass-through freight costs on beer shipped to
      independent beer wholesalers in cost of sales. Reimbursements of these costs
      by
      wholesalers are reported in sales.




Costs
      incurred by the Company to deliver beer to customers are included in marketing,
      distribution and administrative expenses. These costs are considered marketing
      related because in addition to product delivery, drivers provide marketing
      and
      other customer service functions to customers including product display, shelf
      space management, distribution of promotional materials, and product rotation. Shipping
      costs included in marketing expense totaled $879,100, $929,100, and $978,600
      for
      the years ended December 31, 2006, 2005, and 2004, respectively.




F-12




**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
      I** **NC** **.**


**N** **OTES
      TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**


DECEMBER31,
      2006




**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Stock-Based
      Compensation





Prior
      to
      the adoption of Statement of Financial Accounting Standards No. 123 (revised
      2004), “Share-Based Payment,” (“SFAS 123(R)”), the Company accounted for
      stock-based awards to employees and directors using the intrinsic value method
      in accordance with Accounting Principles Board Opinion No. 25, “Accounting
      for Stock Issued to Employees” (“APB 25”). Under the intrinsic value method that
      was used to account for stock-based awards prior to January 1, 2006, which
      had
      been allowed under the original provisions of Statement 123, no stock
      compensation expense had been recognized in the Company’s statement of
      operations as the exercise price of the Company’s stock options granted to
      employees and directors equaled the fair market value of the underlying stock
      at
      the date of grant.





On
      January 1, 2006, the Company adopted SFAS 123(R) which requires the measurement
      and recognition of compensation expense for all share-based awards made to
      employees and directors, including employee stock options and employee stock
      purchases, based on estimated fair values. SFAS 123(R) supersedes the Company’s
      previous accounting for share-based awards under APB 25 for periods beginning
      in
      2006. In March 2005, the Securities and Exchange Commission issued Staff
      Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has
      applied the provisions of SAB 107 in its adoption of SFAS 123(R). The Company
      adopted SFAS 123(R) using the modified prospective transition method, which
      requires the application of the accounting standard as of the beginning of
      the
      Company’s current year. The Company’s financial statements as of and for the
      year ended December 31, 2006 reflect the impact of SFAS 123(R). In accordance
      with the modified prospective transition method, the Company’s financial
      statements for prior periods have not been restated to reflect, and do not
      include, the impact of SFAS 123(R).





Stock
      compensation expense recognized during the period is based on the value of
      share-based awards that are expected to vest during the period. Stock
      compensation expense recognized in the Company’s statement of operations for
      2006 includes compensation expense related to share-based awards granted prior
      to January 1, 2006 that vested during the current period based on the grant
      date
      fair value estimated in accordance with the pro forma provisions of SFAS 123.
      Stock compensation expense during the current period also includes compensation
      expense for the share-based awards granted subsequent to January 1, 2006 based
      on the grant date fair value estimated in accordance with the provisions of
      SFAS
      123(R). As stock compensation expense recognized in the statement of operations
      is based on awards ultimately expected to vest, it has been reduced for
      estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at
      the
      time of grant and revised, if necessary, in subsequent periods if actual
      forfeitures differ from those estimates. In the Company’s pro forma information
      required under SFAS 123 for the periods prior to 2006, forfeitures were
      estimated and factored into the expected term of the options.





The
      Company’s determination of estimated fair value of share-based awards utilizes
      the Black-Scholes option-pricing model. The Black-Scholes model is affected
      by
      the Company’s stock price as well as assumptions regarding a number of highly
      complex and subjective variables. These variables include, but are not limited
      to; the Company’s expected stock price volatility over the term of the awards,
      and actual and projected employee stock option exercise behaviors.




F-13


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Stock-Based
      Compensation (continued)





SFAS
      123(R) requires the calculation of the beginning balance of the pool of excess
      tax benefits (additional paid in capital pool or “APIC pool”) available to
      absorb tax deficiencies recognized subsequent to its adoption. SFAS 123(R)
      states that this beginning APIC pool shall include the net excess tax benefits
      that would have arisen had the company adopted the original Statement 123.
      FASB
      Staff Position (“FSP”) 123(R)-3 provides a simplified method for determining
      this APIC pool, which the Company may elect to adopt up to one year from its
      initial adoption of SFAS 123(R). The Company has not yet determined whether
      to
      elect the simplified method for determining its APIC pool as provided in FSP
      No.
      123(R)-3.





In
      2006,
      2005 and 2004, the Company did not grant any options or warrants, and all
      options outstanding were vested.





*Stock-based
      Compensation - Non-employees*





The
      company accounts for equity instruments issued to non-employees in accordance
      with the provisions of SFAS No 123(R) and Emerging Issues Task Force (“EITF”) No
      96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees
      for Acquiring, or in Conjunction with Selling Goods or
      Services.





Basic
      and Diluted Earnings (Loss) per Share





In
      accordance with SFAS No. 128, "Earnings Per Share," the basic earnings (loss)
      per share is computed by dividing the loss attributable to common stockholders
      by the weighted average number of common shares outstanding during the period.
      Basic net loss per share excludes the dilutive effect of stock options or
      warrants and convertible notes. Diluted net loss per share was the same as
      basic
      net loss per share for 2006, 2005 and 2004, since the effect of any potentially
      dilutive securities is excluded, as they are anti-dilutive due to the Company's
      net losses. The following table sets forth the computation of basic and diluted
      net loss per common share:




Year
                Ended December 31,2006
            
            2005
            
            2004Net
                income (loss) - available to common shareholders
            
            $
            (1,430,600
            )
            $
            (1,314,700
            )
            $
            (468,900
            )Weighted
                average common shares outstanding: Basic and diluted
            
            
            11,512,479
            
            
            11,472,213
            
            
            11,266,874Total
                shares outstanding at end of period
            
            
            11,628,174
            
            
            11,473,914
            
            
            11,266,874Net
                income (loss) per common share: Basic and diluted
            
            $
            (0.12
            )
            $
            (0.11
            )
            $
            (0.04
            )








The
      potential shares, which are excluded from the determination of basic and diluted
      net loss per share as their effect is anti-dilutive, are as
      follows:





Year
                Ended December 31,2006
            
            2005
            
            2004Options
                to purchase common stock
            
            
            240,385
            
            
            240,385
            
            
            340,385Potential
                equivalent shares excluded
            
            
            240,385
            
            
            240,385
            
            
            340,385




F-14


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Foreign
      Currency Translation





Financial
      statements of foreign subsidiaries, located in the United Kingdom, where the
      local currency, UK Pound Sterling, is the functional currency are translated
      into U.S. dollars using period-end exchange rates for assets and liabilities
      and
      average exchange rates during the period for revenues and expenses. Cumulative
      translation adjustments associated with net assets or liabilities are reported
      in non-owner changes in equity.  Any exchange rate gains or losses related
      to foreign currency transactions are recognized in the income statement as
      incurred, in the same financial statement caption as the underlying transaction,
      and are not material for any year shown.





Cash
      at
      UBIUK was translated at exchange rates in effect at December 31, 2006, 2005
      and
      2004, and its cash flows were translated at the average exchange rates for
      the
      years then ended. Changes in cash resulting from the translations are presented
      as a separate item in the statements of cash flows.





Use
      of
      Estimates





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America includes having the Company
      make estimates and assumptions affecting the reported amounts of assets,
      liabilities, revenues and expenses, and disclosure of contingent assets and
      liabilities. The amounts estimated could differ from actual results. Significant
      estimates include, allowance for bad debts, depreciation and amortization
      periods, and the future utilization of deferred tax assets. The Company has
      determined that deferred tax assets associated with net operating loss
      carryforwards in the US may expire prior to utilization. The Company has placed
      a valuation allowance on these assets in the US.





Advertising





Advertising
      costs are expensed as incurred and were $1,094,100, $2,239,700 and $1,674,000
      for the years ended December 31, 2006, 2005, and 2004.





Fair
      Value of Financial Instruments





The
      carrying value of certain of the financial instruments, including accounts
      receivable, other current assets, accounts payable and accrued expenses,
      approximate fair value due to their short maturities. Based on borrowing rates
      currently available to the Company for loans with similar terms, the carrying
      value of short and long term notes payable approximate fair
      value.





Comprehensive
      Income (Loss)





Comprehensive
      income (loss) is composed of the Company's net income (loss) and changes in
      equity from non-stockholder sources. The accumulated balances of these
      non-stockholder sources are reflected as a separate item in the equity section
      of the balance sheet.




F-15


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Reportable
      Segments





The
      Company manages its operations through three business segments: brewing
      operations, tavern and tasting room operations (domestic) and distributor
      operations (international). The international business segment sells the
      Company's products outside the U.S. The Company evaluates performance based
      on
      net operating profit. Where applicable, portions of the administrative function
      expenses are allocated between the operating segments. The operating segments
      do
      not share manufacturing or distribution facilities. In the event any materials
      and/or services are provided to one operating segment by the other, the
      transaction is valued according to the company's transfer policy, which
      approximates market price. The costs of operating the manufacturing plants
      are
      captured discretely within each segment. The Company's property, plant and
      equipment, inventory, and accounts receivable are captured and reported
      discretely within each operating segment.





Reclassifications





Certain
      amounts in the prior periods presented have been reclassified to conform to
      the
      current period financial statement presentation. These reclassifications have
      no
      effect on previously reported net loss.





Recent
      Accounting Pronouncements





SFAS 154
      replaces APB Opinion No. 20 and SFAS 3 and became effective in the first
      quarter of 2006. The standard introduces a new requirement to retrospectively
      apply accounting principle changes to prior years’ comparative financial
      statements as if the Company had always applied the newly adopted accounting
      principle. Changes in depreciation, amortization and depletion methods
      previously considered a change in accounting principle are now considered a
      change in estimate under SFAS 154, requiring prospective adoption. New
      pronouncements may contain specific implementation guidance which would
      supersede the requirements of SFAS 154. The adoption of SFAS 154 did not
      have an impact on the consolidated financial statements included
      herein.





In
      February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid
      Financial Instruments”. SFAS No. 155 amends SFAS No 133, “Accounting for
      Derivative Instruments and Hedging Activities”, and SFAF No. 140, “Accounting
      for Transfers and Servicing of Financial Assets and Extinguishments of
      Liabilities”. SFAS No. 155, permits fair value remeasurement for any hybrid
      financial instrument that contains an embedded derivative that otherwise would
      require bifurcation, clarifies which interest-only strips and principal-only
      strips are not subject to the requirements of SFAS No. 133, establishes a
      requirement to evaluate interest in securitized financial assets to identify
      interests that are freestanding derivatives or that are hybrid financial
      instruments that contain an embedded derivative requiring bifurcation, clarifies
      that concentrations of credit risk in the form of subordination are not embedded
      derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
      qualifying special-purpose entity from holding a derivative financial instrument
      that pertains to a beneficial interest other than another derivative financial
      instrument. This statement is effective for all financial instruments acquired
      or issued after the beginning of the Company’s first fiscal year that begins
      after September 15, 2006. The Company adoption of SFAS No. 155 will not have
      any
      material effect on its consolidated financial position, results of operations
      or
      cash flows.




F-16


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Recent
      Accounting Pronouncements (continued)





In
      March
      2006, the FASB issued SFAS No. 156, *Accounting
      for Servicing of Financial Assets—an amendment of FASB Statement No.
      140.* Companies are required to apply SFAS No. 156 as of the first annual reporting
      period that begins after September 15, 2006. The Company does not believe
      adoption of SFAS No. 156 will have a material effect on its unaudited condensed
      consolidated financial position, results of operations or cash
      flows.





In
      June
      2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty
      in
      Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48). FIN 48
      provides guidance for the recognition, derecognition and measurement in
      financial statements of tax positions taken in previously filed tax returns
      or
      tax positions expected to be taken in tax returns. FIN 48 requires an entity
      to
      recognize the financial statement impact of a tax position when it is more
      likely than not that the position will be sustained upon examination. If the
      tax
      position meets the more-likely-than-not recognition threshold, the tax effect
      is
      recognized at the largest amount of the benefit that is greater than fifty
      percent likely of being realized upon ultimate settlement. The Company will
      be
      required to adopt FIN 48 as of January 1, 2007, with any cumulative effect
      of
      the change in accounting principle recorded as an adjustment to opening retained
      earnings. The Company is currently evaluating the impact of FIN 48 and does
      not
      expect a significant impact on its earnings or financial position.





In
      June
      2006, the FASB ratified the consensus on Emerging Issues Task Force
      (“EITF”) Issue No. 06-3, “How Taxes Collected from Customers and
      Remitted to Governmental Authorities Should Be Presented in the Income
      Statement” (“EITF No. 06-3”). The scope of EITF No. 06-3 includes any
      tax assessed by a governmental authority that is directly imposed on a
      revenue-producing transaction between a seller and a customer and may include,
      but is not limited to, sales, use, value added, Universal Service Fund
      (“USF”) contributions and some excise taxes.  The Task Force affirmed
      its conclusion that entities should present these taxes in the income statement
      on either a gross or a net basis, based on their accounting policy, which should
      be disclosed pursuant to APB Opinion No. 22, “Disclosure of Accounting
      Policies.”  If such taxes are significant and are presented on a gross
      basis, the amounts of those taxes should be disclosed.  The consensus on
      EITF No. 06-3 will be effective for interim and annual reporting periods
      beginning after December 15, 2006.  The Company currently does not
      show sales tax billed to its customers on the income statement but records
      the
      same as a liability.





In
      September 2006, the Securities and Exchange Commission issued Staff Accounting
      Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year
      Misstatements when Quantifying Current Year Misstatements.” SAB No. 108
      requires analysis of misstatements using both an income statement (rollover)
      approach and a balance sheet (iron curtain) approach in assessing materiality
      and provides for a one-time cumulative effect transition adjustment. SAB
      No. 108 is effective for the Company’s fiscal year 2007 annual financial
      statements. The Company is currently assessing the potential impact that the
      adoption of SAB No. 108 will have on its financial statements; however, the
      impact is not expected to be material.





F-17


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**1.**  **Description
      of Operations and Summary of Significant Accounting Policies
      (continued)**





Recent
      Accounting Pronouncements (continued)





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,”
which defines fair value, establishes a framework for measuring fair value
      in
      generally accepted accounting principles, and expands disclosures about fair
      value measurements. SFAS No. 157 does not require any new fair value
      measurements, but provides guidance on how to measure fair value by providing
      a
      fair value hierarchy used to classify the source of the information. This
      statement is effective on the Company beginning July 1, 2008. The Company
      is currently assessing the potential impact that the adoption of SFAS
      No. 157 will have on its financial statements. In
      September 2006, the FASB issued SFAS No. 158, Employer’s Accounting
      for Defined Benefit Pension and Other Postretirement Plans, an Amendment of
      FASB
      Statements No. 87, 88, 106 and 132(R), which applies to all plan sponsors
      who offer defined benefit postretirement plans. SFAS No. 158 requires
      recognition of the funded status of a defined benefit postretirement plan in
      the
      statement of financial position and expanded disclosures in the notes to
      financial statements. The Company adopted this provision for the year ended
      December 31, 2006 and the adoption did not have a material impact on its
      consolidated financial position. In addition, SFAS No. 158 requires
      measurement of plan assets and benefit obligations as of the date of the plan
      sponsor’s fiscal year end. The Company is required to adopt the measurement
      provision of SFAS No. 158 for its fiscal year ending December 31,
      2008. The Company is in the process of evaluating the impact of the measurement
      provision of SFAS No. 158 on its 2008 consolidated financial position,
      operations and cash flows. The
      Company is currently assessing the potential impact that the adoption of SFAS
      158 will have on its financial statements; however, the impact is not expected
      to be material.





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
      for Financial Assets and Financial Liabilities—Including an amendment of FASB
      Statement No. 115” (“SFAS 159”). SFAS 159 expands the use of fair value
      accounting but does not affect existing standards which require assets or
      liabilities to be carried at fair value. Under SFAS 159, a company may elect
      to
      use fair value to measure accounts and loans receivable, available-for-sale
      and
      held-to-maturity securities, equity method investments, accounts payable,
      guarantees and issued debt. Other eligible items include firm commitments for
      financial instruments that otherwise would not be recognized at inception and
      non-cash warranty obligations where a warrantor is permitted to pay a third
      party to provide the warranty goods or services. If the use of fair value is
      elected, any upfront costs and fees related to the item must be recognized
      in
      earnings and cannot be deferred, e.g., debt issue costs. The fair value election
      is irrevocable and generally made on an instrument-by-instrument basis, even
      if
      a company has similar instruments that it elects not to measure based on fair
      value. At the adoption date, unrealized gains and losses on existing items
      for
      which fair value has been elected are reported as a cumulative adjustment to
      beginning retained earnings. Subsequent to the adoption of SFAS 159, changes
      in
      fair value are recognized in earnings. SFAS 159 is effective for fiscal years
      beginning after November 15, 2007 and is required to be adopted by the
      Company in the first quarter of fiscal 2009. MBC is currently is determining
      whether fair value accounting is appropriate for any of its eligible items
      and
      cannot estimate the impact, if any, which SFAS 159 will have on its consolidated
      results of operations and financial condition.




F-18


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**2.**  **Liquidity
      and Management Plans**





At
      December 31, 2006, the Company had cash and cash equivalents of $345,900, a
      working capital deficit of $2,683,400 and an accumulated deficit of $11,661,800.
      Additionally, the Company has a history of past losses as infrastructure costs
      were incurred in advance of obtaining customers.





Management
      has taken several actions to ensure that the Company will have sufficient cash
      for its working capital needs through December 31, 2007, including obtaining
      a
      secured line of credit, reductions in discretionary expenditures, and additional
      debt financing. In 2006, the Company successfully obtained additional financing
      and repaid several debts and raised additional working capital. Management
      believes that these actions will enable the Company to meet its working capital
      needs through December 31, 2007.





**3.**  **Inventories**





Inventories,
      consisting of materials, materials overhead, labor, and manufacturing overhead,
      are stated at the lower of average cost or market (net realizable value) and
      consist of the following at December 31:




2006
            
            2005Raw
                materials
            
            $
            481,900
            
            $
            447,900Work-in-progress
            
            
            199,600
            
            
            143,900Finished
                goods
            
            
            630,000
            
            
            539,800Merchandise
            
            
            18,000
            
            
            19,800$
            1,329,500
            
            $
            1,151,400




**4.**  **Property
      and Equipment**





The
      following is a summary of property and equipment, at cost less accumulated
      depreciation, at December 31:




2006
            
            2005Machinery
                and equipment
            
            $
            12,956,600
            
            $
            11,094,500Buildings
            
            
            7,202,300
            
            
            7,202,300Equipment
                under capital lease
            
            
            6,300
            
            
            580,800Land
            
            
            810,900
            
            
            810,900Leasehold
                improvements
            
            
            1,432,400
            
            
            1,432,400Vehicles
            
            
            424,600
            
            
            429,500Furniture
                and fixtures
            
            
            176,900
            
            
            165,500Equipment
                in progress
            
            
            5,900
            
            
            27,50023,015,900
            
            
            21,743,400Less:
                Accumulated depreciation and amortization
            
            
            (9,569,900
            )
            
            (8,557,800
            )$
            13,446,000
            
            $$
            13,185,600





The
      Company has property and equipment located in the United Kingdom with a net
      book
      value of approximately $1,919,200 as of December 31, 2006. Amortization of
      assets under capital leases is included in depreciation and amortization
      expense.




F-19


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006




**5.**  **Line
      of Credit and Note Payable**





Effective
      May 5, 2005, the Company obtained a secured lending facility from BFI Business
      Finance (BFI). The Company's borrowings were secured by the underlying trade
      receivables and inventory. The borrowings were collateralized, with recourse,
      by
      certain eligible trade receivables up to a maximum percentage of 80% of the
      qualified net amounts of such receivables of MBC and 70% of the qualified net
      amounts of such receivables of Releta, and 50% of MBC’s and Releta’s eligible
      inventory located in the US. On December 31, 2005 BFI advanced the Company
      $200,000 under a promissory note repayable in 30 weekly installments. On April
      5, 2006 BFI advanced the Company approximately $289,900 under another promissory
      note repayable in 39 weekly installments. The entire outstanding amount due
      to
      BFI was repaid by the Company in November 2006 out of proceeds of a new loan
      from Marquette Business Credit, Inc.





On
      December 31, 2003, Savings Bank of Mendocino County ("SBMC") extended the
      Company a temporary note of approximately $576,200 to finance the end of term
      buy-out of certain equipment previously leased from Finova Capital Corporation.
      This note was repaid by the Company in full in July 2006 out of the proceeds
      of
      a borrowing with Grand Pacific Financing Corporation.





In
      November 2006, Marquette Business Credit, Inc. provided a line of credit
      drawable up to 85% of eligible receivable and 60% of eligible inventory for
      a
      period up to June 2011. The borrowings were collateralized, with recourse,
      by
      certain eligible trade receivables up to a maximum percentage of 85% of the
      qualified net amounts of such receivables of each of MBC and Releta and 60%
      of
      MBC’s and Relata’s eligible inventory located in the US. This facility carries
      interest at a rate of one-month LIBOR plus 4.25% and secured by substantially
      all assets, excluding real property of the Releta and MBC.





The
      Company retains the right to recall any of the collateralized receivables under
      the line of credit, and the receivables are subject to recourse. Therefore,
      the
      transaction does not qualify as a sale under the terms of Financial Accounting
      Standards Board Statement No. 125 (Accounting for Transfers and Servicing of
      Financial Assets and Extinguishments of Liabilities). Included in the Balance
      Sheets as receivable at December 31, 2006, are account balances totaling
      $1,812,300 of uncollected receivables collateralized to the financial
      institution under this facility.





On
      April
      26, 2005, Royal Bank of Scotland Commercial Services Limited ("RBS") provided
      an
      invoice discounting facility to UBSN Limited for a maximum amount of GBP
      1,750,000 based on 80% prepayment against qualified accounts receivable related
      to UBSN's United Kingdom customers. The initial term of the facility is for
      a
      period of one year after which the facility can be terminated by either party
      by
      providing the other party a notice of six months. The facility carries an
      interest rate of 1.38% above RBS base rate and a service charge of 0.10% of
      each
      invoice discounted. The amount outstanding on this line of credit as of December
      31, 2006 was approximately $2,570,700.





F-20


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**6.**  **Long-Term
      Debt**





Maturities
      of long-term debt for succeeding years are as follows:




2006
            
            2005Note
                to a financial institution, payable in monthly installment of $18,200,
                plus interest at one month LIBOR plus 5.25% with a balloon payment
                of
                $544,600 in June 2011; secured by substantially all assets of the
                Releta
                Brewing Company and Mendocino Brewing Company excluding real property
                at
                Ukiah
            
            $
            1,506,900
            
            $
            -Note
                to a financial institution, payable in monthly installment of $27,300
                including interest at prime plus 1.75% with a balloon payment of
                approximately $2,867,900 in June 2011. (net of discount of
                $33,100)
            
            
            2,956,300
            
            
            -Note
                to a bank; payable in monthly installments of $24,400, including
                interest
                at the Treasury Constant Maturity Index, plus 4.17% paid in full
                in July
                2006
            
            
            -
            
            
            2,168,400Payable
                to Mendocino County in four annual installments of $143,600, plus
                interest
                at 18%, paid in full in July 2006
            
            
            -
            
            
            430,9004,463,200
            
            
            2,599,300Less
                current maturities
            
            
            236,500
            
            
            284,400$
            4,226,700
            
            $
            2,314,900





Payments
                due during Year Ending December 31,2007
            
            $
            236,5002008
            
            
            249,9002009
            
            
            256,6002010
            
            
            260,5002011
            
            
            3,492,800Thereafter
            
            
            -$
            4,496,300





On
      July
      3, 2006, MBC obtained a $3.0 million loan from Grand Pacific Financing
      Corporation("GP"), secured by a first priority deed of trust on the Ukiah land,
      fixtures, and improvements. The loan is payable in partially amortizing monthly
      installments of $27,261 including interest at the rate of 1.75% over the prime
      rate published by The Wall Street Journal, maturing July 2, 2011 with a balloon
      payment. The amount of the balloon payment will vary depending on the change
      in
      interest rates over the term of the loan. MBC used the proceeds of the loan
      to
      repay in full all the then outstanding loans owed to SBMC.





F-21


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**7.**  **Capital
      Lease Obligations**





The
      Company leases certain brewing equipment, vehicles and office equipment under
      agreements that are classified as capital leases. The future minimum lease
      payments required under the capital leases and the present value of the net
      minimum lease payments as of December 31, 2006, are as follows:





Year
                Ending December 31,2007
            
            $
            91,6002008
            
            
            74,2002009
            
            
            1,5002010
            
            
            -2011
            
            
            -167,300Less
                amounts representing interest
            
            
            (18,600
            )Present
                value of minimum lease payments
            
            
            148,700Less
                current maturities
            
            
            (83,100
            )Non-current
                leases payable
            
            $
            65,600




**8.**  **Notes
      to Related Party - Subordinated**





Notes
      payable to a related party consist of unsecured convertible notes to United
      Breweries of America (UBA), with interest at the prime rate plus 1.5%, but
      not
      to exceed 10% per year. The notes are convertible into common stock at $1.50
      per
      share. The notes have been extended until June 2007. UBA may demand payment
      within 60 days of the end of the extension period but is precluded from doing
      so
      because the notes are subordinated to long-term debt agreements with Grand
      Pacific Financing Corporation and Marquette Business Credit, Inc., both maturing
      in June 2011. Therefore, the Company will not require the use of working capital
      to repay any of the UBA notes until the above facilities are repaid.
      Accordingly, the entire amount due of $2,733,400 and $2,552,200 as of December
      31, 2006 and 2005 under the notes is classified as a long term liability. The
      notes include $818,000 and $636,800 of accrued interest at December 31, 2006
      and
      2005.





Notes
      payable also includes an unsecured loan from Shepherd Neame Limited to UBSN
      Limited payable in annual installment of $117,500 with interest at 5% per year
      beginning June 2003 and maturing June 2012. The amounts outstanding, under
      this
      loan as of December 31, 2006 and 2005 were $705,100 and $721,900
      respectively.





Payments
                due during Year Ending December 31,2007
            
            $
            117,5002008
            
            
            117,5002009
            
            
            117,5002010
            
            
            117,5002011
            
            
            2,851,000Thereafter
            
            
            117,500$
            3,438,500





F-22


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**9.**  **Profit-Sharing
      Plan**





Subsequent
      to December 31, 2004, the Company terminated its profit sharing plan.
      Contributions to the Plan were made at the discretion of the Board of Directors,
      and any contributions vested over a six year period. The plan covered
      substantially all full-time employees that met certain minimum age and service
      requirements. No contributions were made to the Plan for the years ended
      December 31, 2006, 2005, and 2004.





**10.**  **Commitments
      and Contingencies**





Legal





The
      Company is periodically involved in legal actions and claims that arise as
      a
      result of events that occur in the normal course of operations. The Company’s
      management and its legal counsel assess such contingent liabilities, and such
      assessment inherently involves an exercise of judgment. In assessing loss
      contingencies related to legal proceedings that are pending against the Company
      or unasserted claims that may result in such proceedings, the Company’s legal
      counsel evaluates the perceived merits of any legal proceedings or unasserted
      claims as well as the perceived merits of the amount of relief sought or
      expected to be sought therein.





If
      the
      assessment of a contingency indicates that it is probable that a material loss
      has been incurred and the amount of the liability can be estimated, then the
      estimated liability would be accrued in the Company’s financial statements. If
      the assessment indicates that a potentially material loss contingency is not
      probable, but is reasonably possible, or is probable but cannot be estimated,
      then the nature of the contingent liability, together with an estimate of the
      range of possible loss if determinable and material, would be
      disclosed.





Loss
      contingencies considered remote are generally not disclosed unless they involve
      guarantees, in which case the nature of the guarantee would be disclosed. The
      Company is not currently aware of any legal proceedings or claims that the
      Company believes will have, individually or in the aggregate, a material adverse
      effect on the Company's financial position or results of
      operations





Operating
      Leases





The
      Company leases many of its operating and office facilities for various terms
      under long-term, non-cancelable operating lease agreements. The leases expire
      at
      various dates through 2009 and provide for renewal options ranging from
      month-to-month to five years. In the normal course of business, it is expected
      that these leases will be renewed or replaced by leases on other properties.
      The
      leases provide for increases in future minimum annual rental payments based
      on
      defined increases which are generally meant to correlate with the Consumer
      Price
      Index, subject to certain minimum increases. Also, the agreements generally
      require the Company to pay certain costs (real estate taxes, insurance and
      repairs).





The
      Company and its subsidiaries have various lease agreements for the brewpub
      and
      gift store in Hopland, California; land at its Saratoga Springs, New York,
      facility; a building in the United Kingdom; and certain personal property.
      The
      land lease includes a renewal option for two additional five-year periods,
      which
      the Company intends to exercise, and some leases are adjusted annually for
      changes in the consumer price index. The leases begin expiring in 2007. Rent
      expense charged to operations was $212,800, $206,600, and $202,700 for the
      years
      ended December 31, 2006, 2005, and 2004.




F-23


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006




**10.**  **Commitments
      and Contingencies (continued)**





Operating
      Leases (continued)





Future
      minimum lease payments under these agreements are as follows:





Year
                Ending December 31,2007
            
            $
            229,9002008
            
            
            216,4002009
            
            
            195,0002010
            
            
            178,9002011
            
            
            164,100Thereafter
            
            
            205,400$
            1,189,700





Keg
      Management Agreement





In
      September 2004, the Company renewed the keg management agreement with MicroStar
      Keg Management LLC. Under this arrangement, MicroStar provides all kegs for
      which the Company pays a service fee between $5 and $15, depending on the
      applicable territory. The agreement is effective for five years ending in
      September 2009. If the agreement is terminated, the Company is required to
      purchase three times the average monthly keg usage for the preceding six-month
      period from MicroStar at purchase prices ranging from $54 to $84 per keg. The
      Company expects to continue this relationship. Rental expense associated with
      this agreement was $62,300, $65,500, and $91,400 for the years ended December
      31, 2006, 2005, and 2004.




**11.**  **Related-Party
      Transactions**





The
      Company conducts business with United Breweries of America (UBA), which owns
      approximately 74% of the Company's common stock through common ownership.
      Additionally, UBSN Limited has significant transactions with Shepherd Neame,
      Ltd., which is a related party to a former Board member. The Company also had
      transactions with AUBI, a company affiliated with one of the Board members.
      The
      following table reflects balances outstanding and the value of the transactions
      with these related parties for the years ended December 31, 2006, 2005, and
      2004:




2006
            
            2005
            
            2004TRANSACTIONSSales
                to Shepherd Neame Ltd.
            
            $
            3,255,300
            
            $
            2,871,100
            
            $
            3,099,500Purchases
                from Shepherd Neame Ltd.
            
            
            14,589,300
            
            
            14,108,500
            
            
            14,541,100Expenses
                reimbursement to Shepherd Neame Ltd.
            
            
            1,105,300
            
            
            1,143,300
            
            
            1,239,300Interest
                expenses associated with UBA notes (see note 8)
            
            
            181,200
            
            
            142,100
            
            
            88,500Interest
                paid to Shepherd Neame Ltd. (see note 6)
            
            
            35,900
            
            
            40,500
            
            
            46,300ACCOUNT
                BALANCESAccounts
                payable and accrued liabilities to Shepherd Neame Ltd.
            
            
            5,575,000
            
            
            4,080,400
            
            
            4,160,300Accounts
                receivable and prepayments to Shepherd Neame Ltd.
            
            
            781,900
            
            
            629,700
            
            
            841,700Amounts
                payable to AUBI
            
            
            20,000
            
            
            20,000
            
            
            20,000





F-24


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**12.**  **Major
      Customers**





Sales
      to
      the top five customers totaled $8,032,600, $7,610,500, and $7,942,000 for the
      years ended December 31, 2006, 2005, and 2004, which represents 24%, 24%, and
      25% of sales for the years ended December 31, 2006, 2005, and 2004.





**13.**  **Stockholders'
      Equity**





Independent
      outside members of the Board of Directors are compensated for attending Board
      of
      Directors and committee meetings through the issuance of common stock. Expenses
      related to this compensation totaled $32,000, $44,000, and $24,000 for the
      years
      ended December 31, 2006, 2005, and 2004. Common Stock has been issued for
      accrued compensation from the years 2004 and 2005 in the year 2006.




In
      October 2006, the Company issued 154,260 shares of its unregistered common
      stock
      to independent outside directors totaling $68,000 in accrued
      compensation.




Preferred
      Stock





Ten
      million shares of preferred stock have been authorized, of which 227,600 are
      designated as Series A. Series A shareholders are entitled to receive cash
      dividends and/or liquidation proceeds equal, in the aggregate, to $1.00 per
      share before any cash dividends are paid on the common stock or any other series
      of preferred stock. When the entire Series A dividend/liquidation proceeds
      have
      been paid, the Series A shares are automatically canceled and will cease to
      be
      outstanding. Only a complete corporate dissolution will cause a liquidation
      preference to be paid.





**14.**  **Stock
      Option Plan**





Under
      the
      1994 Stock Option Plan, which expired in 2004, the Company could issue options
      to purchase up to 1,000,000 shares of common stock. The Plan provided for both
      incentive stock options, as defined in Section 422 of the Internal Revenue
      Code,
      and options that did not qualify as incentive stock options.





The
      exercise price of incentive options was no less than the fair-market value
      of
      the Company's stock at the date the option was granted, while the exercise
      price
      of non-statutory options was no less than 85% of the fair-market value per
      share
      on the date of grant. Options granted to a person possessing more than 10%
      of
      the combined voting power of all classes of the Company's stock had an exercise
      price of no less than 110% of the fair-market value of the Company's stock
      at
      the date of grant. During 2002, 240,385 non-statutory stock options with a
      five-year term were issued to the independent members of the Board of Directors
      at the market price on the date of grant. All stock options outstanding are
      non-statutory, and were issued with a five year term and were fully vested
      on
      date of grant. The exercise price of the options outstanding as of December
      31,
      2006 was $0.52 per share. The 240,835 options expired in January 2007.




F-25


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**14.**  **Stock
      Option Plan (continued)**





The
      following table summarizes the number of options granted and exercisable and
      the
      weighted average exercise prices:




Shares
                under
              option
            
            Weighted-average
              exercise
                priceBalance
                at December 31, 2003
            
            
            429,273
            
            $
            $
                0.82Options
                granted
            
            
            -
            
            $
            -Options
                expired
            
            
            (88,888
            )
            $
            $
                1.13Balance
                at December 31, 2004
            
            
            340,385
            
            $
            $
                0.73Options
                granted
            
            
            -
            
            $
            -Options
                expired
            
            
            (100,000
            )
            $
            $
                1.25Balance
                at December 31, 2005
            
            
            240,385
            
            $
            $
                0.52Options
                granted
            
            
            -
            
            $
            -Options
                expired
            
            
            -
            
            $
            -Balance
                at December 31, 2006
            
            
            240,385
            
            $
            $
                0.52




*Current
      year ended December 31, 2006*





In
      conjunction with the adoption of SFAS 123(R), the Company elected to attribute
      the value of share-based compensation to expense using the straight-line method,
      which was previously used for its pro forma information required under SFAS
      123.
      Share-based compensation expense related to stock options was nil for the year
      ended December 31, 2006.





Share-based
      compensation expense (related to common stock granted to members of the Board
      of
      Directors) reduced the Company’s results of operations for the year ended
      December 31, 2006 as follows:




Twelve
                Months Ended
              December
                31, 2006Loss
                from continuing operations before income taxes
            
            $
            1,428,100Loss
                from continuing operations after income taxes
            
            $
            1,430,600Cash
                flows from operations
            
            $
            390,700Cash
                flows from financing activities
            
            $
            548,800Basic
                and Diluted EPS
            
            $
            (0.12
            )





During
      the year ended December 31, 2006, the Company granted no performance based
      options to executives and senior management.





As
      of
      December 31, 2006, there is no compensation cost related to non-vested awards
      not yet recognized. SFAS 123(R) requires the cash flows resulting from the
      tax
      benefits resulting from tax deductions in excess of the compensation cost
      recognized for those options to be classified as financing cash flows. Due
      to
      the Company’s loss position and not having any such compensation expense, there
      were no such tax benefits for the years ended December 31, 2004, 2005 and 2006.
      Prior to the adoption of SFAS 123(R), those benefits would have been reported
      as
      operating cash flows had the Company received any tax benefits related to stock
      option exercises.




F-26


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**14.**  **Stock
      Option Plan (continued)**





*Current
      year ended December 31, 2006 (continued)*





The
      fair
      value of stock-based awards to officers, directors and employees is calculated
      using the Black-Scholes option pricing model, even though this model was
      developed to estimate the fair value of freely tradable, fully transferable
      options without vesting restrictions, which differ significantly from the
      Company’s stock options. The Black-Scholes model also requires subjective
      assumptions, including future stock price volatility and expected time to
      exercise, which greatly affect the calculated values. The expected term of
      options granted is derived from historical data on employee exercises and
      post-vesting employment termination behavior. The risk-free rate selected to
      value any particular grant is based on the bond equivalent yields that
      corresponds to the pricing term of the grant effective as of the date of the
      grant. The expected volatility is based on the historical volatility of the
      Company’s stock price. These factors could change in the future, affecting the
      determination of stock-based compensation expense in future periods.





The
      following is a summary of changes to outstanding stock options during the fiscal
      year ended December 31, 2006:




Weighted
            
            Weighted
                AverageNumber
                of
            
            Average
            
            Remaining
            
            AggregateShare
            
            Exercise
            
            Contractual
            
            IntrinsicOptions
            
            Price
            
            Term
            
            ValueOutstanding
                at December 31, 2005
            
            
            240,385
            
            $
            0.52
            
            
            1.1
            
            $
            -Granted
            
            
            -
            
            
            -
            
            
            -
            
            
            -Exercised
            
            
            -
            
            
            -
            
            
            -
            
            
            -Forfeited
                or expired
            
            
            -
            
            
            -
            
            
            -
            
            
            -Outstanding
                at December 31, 2006
            
            
            240,385
            
            
            0.52
            
            
            0.1
            
            
            -Vested
                and expected to vest at December 31, 2006
            
            
            240,385
            
            
            
            
            
            0.1
            
            
            -Options
                exercisable at December 31, 2006
            
            
            240,385
            
            $
            0.52
            
            
            0.1
            
            $
            -




The
      table
      below presents information related to stock option activity for the fiscal
      ended
      December 31, 2006 and 2005 (in thousands):




Fiscal
                year ended December 31,2006
            
            2005Total
                intrinsic value of stock options exercised
            
            $
            -
            
            $
            -Cash
                received from stock option exercises
            
            $
            -
            
            $
            -Gross
                income tax benefit from the exercise of stock options
            
            $
            -
            
            $
            -




The
      aggregate intrinsic value of $0 as of December 31, 2006 is based on MBC's
      closing stock price of $0.21 on that date and represents the total pretax
      intrinsic value, which would have been received by the option holders had all
      option holders exercised their options as of that date. The total intrinsic
      value of options exercised during the twelve months ended December 31, 2006
      was
      nil as no options were exercised. The total number of in-the-money options
      exercisable as of December 31, 2006 was $0.




F-27


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006


**14.**  **Stock
      Option Plan (continued)**





*Valuation
      and Expense Information under SFAS 123*





Prior
      to
      the adoption of Statement of Financial Accounting Standards No. 123(R)
“Accounting for Stock-Based Compensation-Revised “(SFAS 123(R)), at
      March 31, 2006, the Company would not have recognized compensation expense
      for employee share-based awards, when the price of such awards equaled the
      market price of the underlying stock on the date of the grant. The Company
      previously had adopted the provisions of Statement of SFAS 123 as amended by
      SFAS 148, “Accounting for Stock Based Compensation, Transition and Disclosure”
(SFAS 148) through disclosure only.





There
      were no stock options granted during the fiscal year ended December 31, 2005
      and
      2004 .





The
      following table illustrates the effect on net loss and loss per share if the
      Company had applied the fair value recognition provisions of FASB Statement
      No.
      123, Accounting for Stock-Based Compensation, to stock-based employee
      compensation.




2005
            
            2004Net
                income (loss) - as reported
            
            $
            (1,314,700
            )
            $
            (468,900
            )Compensation
                expense - APB 25
            
            
            -
            
            
            -Compensation
                expense - SFAS 123
            
            
            -
            
            
            -Net
                income (loss) - pro forma
            
            $
            (1,314,700
            )
            $
            (468,900
            )Income
                (loss) per share - pro forma
            
            $
            (0.11
            )
            $
            (0.04
            )




Total
                options under the Plan at December 31, 2005, comprised the following:




Number
            
            Weighted
            
            NumberOutstanding
            
            Average
            
            ExercisableOption
            
            as
                of
            
            Remaining
            
            as
                ofExercise
            
            December
                31,
            
            Contractual
                life
            
            December
                31,Price
            
            2005
            
            (Years)
            
            2005$0.52
            
            
            240,385
            
            
            1.1
            
            
            240,385Total
                options under the Plan at December 31, 2006, comprised the following:Number
            
            
            Weighted
            
            
            NumberOutstanding
            
            
            Average
            
            
            ExercisableOption
            
            
            as
                of
            
            
            Remaining
            
            
            as
                ofExercise
            
            
            December
                31,
            
            
            Contractual
                life
            
            
            December
                31,Price
            
            
            2006
            
            
            (Years)
            
            
            2006$0.52
            
            
            240,385
            
            
            0.1
            
            
            240,385





F-28


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**15.**  **Income
      Taxes**





The
      accumulated losses in the U.S. operations has resulted in the Company
      determining that the deferred tax assets associated with net operating loss
      carryforwards and investment tax credits may expire prior to utilization. The
      Company recorded a valuation allowance of $4,100,500 for deferred tax assets.
      The Company also has $68,433 of California Manufacturers' Investment Tax Credits
      that can be carried forward to reduce future taxes. These credits begin expiring
      in 2011.






2006
            
            2005
            
            2004Provision
                for income taxesUS
                Federal
            
            $
            -
            
            $
            -
            
            $
            -US
                States
            
            
            2,500
            
            
            1,800
            
            
            3,800United
                Kingdom
            
            
            -
            
            
            (127,400
            )
            
            118,000Current
                provision
            
            
            2,500
            
            
            (125,600
            )
            
            121,800Change
                in deferred income taxes
            
            
            -
            
            
            -
            
            
            -Total
                provision for income taxes
            
            $
            2,500
            
            $
            (125,600
            )
            $
            121,800





The
      difference between the actual income tax provision and the tax provision
      computed by applying the statutory US Federal and United Kingdom income tax
      rates to earnings before taxes is attributable to the following:




2006
            
            2005
            
            2004US
                Federal income tax expense (benefit) at 34%
            
            $
            24,800
            
            $
            (110,700
            )
            $
            (232,400
            )US
                State income tax expense (benefit)
            
            
            6,500
            
            
            (28,800
            )
            
            (15,000
            )United
                Kingdom income tax expense (benefit)
            
            
            (450,300
            )
            
            (296,800
            )
            
            118,000Other
            
            
            38,200
            
            
            (31,500
            )
            
            (6,500
            )Change
                in valuation allowance
            
            
            383,300
            
            
            342,200
            
            
            257,700Total
            
            $
            2,500
            
            $
            (125,600
            )
            $
            121,800




Temporary
      differences and carryforwards that give rise to deferred tax assets and
      liabilities are as follows:




2006
            
            2005
            
            2004Benefit
                of net operating loss carryforwards
            
            $
            4,956,200
            
            $
            4,295,700
            
            $
            4,190,000Undistributed
                earnings of UBIUK
            
            
            (448,900
            )
            
            (393,900
            )
            
            (800,300
            )Investment
                in UBIUK
            
            
            349,900
            
            
            358,100
            
            
            321,600Depreciation
                and amortization
            
            
            (871,900
            )
            
            (670,000
            )
            
            (490,000
            )Other
            
            
            115,200
            
            
            127,300
            
            
            153,700Subtotal
            
            
            4,100,500
            
            
            3,717,200
            
            
            3,375,000Less
                valuation allowance
            
            
            (4,100,500
            )
            
            (3,717,200
            )
            
            (3,375,000
            )Total
            
            $
            -
            
            $
            -
            
            $
            -Change
                in valuation allowance
            
            $
            383,300
            
            $
            342,200
            
            $
            257,700




F-29


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006




**15.**  **Income
      Taxes (continued)**





The
      Company has net operating losses available for carry forward. The US Federal
      net
      operating losses total approximately $11,826,000 and expire beginning 2013
      and
      ending in 2026. The US state operating losses total approximately $3,770,000
      and
      expire beginning 2012 and ending 2026. The Company’s United Kingdom operating
      losses total approximately $2,065,000 and they do not expire.





**16.**  **Segment
      Information**





The
      Company's business presently consists of three segments. The first is brewing
      for wholesale to distributors and other retailers. This segment accounted for
      38%, 36%, and 36% of the Company's gross sales during 2006, 2005 and 2004.
      The
      second consists of distributing alcoholic beverages to retail establishments
      and
      restaurants in the United Kingdom and Europe. This segment accounted for
      approximately 61%, 63%, and 63% of the Company's gross sales during 2006, 2005,
      and 2004. The third segment consists of beer for sale along with merchandise
      at
      the Company's brewpub and retail merchandise store located at the Hopland
      Brewery and at Saratoga Springs brewery. This segment accounted for less than
      one percent of the Company's gross sales during 2006, 2005 and 2004. A summary
      of each segment is as follows:




Year
                Ended December 31,2006Brewing
                Operations
            
            Tavern
                & Tasting
              Room
            
            Distributor
              Operations
            
            Corporate
                and Other
            
            TotalSales
            
            $
            12,601,600
            
            $
            221,300
            
            $
            20,126,000
            
            $
            -
            
            $
            32,948,900Operating
                income (Loss)
            
            
            753,400
            
            
            45,700
            
            
            (1,244,400
            )
            
            -
            
            
            (445,300
            )Identifiable
                assets
            
            
            12,784,200
            
            
            61,600
            
            
            8,768,800
            
            
            2,437,500
            
            
            24,052,100Depreciation
                and amortization
            
            
            505,600
            
            
            4,600
            
            
            480,300
            
            
            27,300
            
            
            1,017,800Capital
                expenditures
            
            
            327,200
            
            
            -
            
            
            705,600
            
            
            -
            
            
            1,032,800




F-30


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**16.**  **Segment
      Information (continued)**




Year
                Ended December 31,2005Brewing
                Operations
            
            Tavern
                & Tasting
              Room
            
            Distributor
              Operations
            
            Corporate
                and Other
            
            TotalSales
            
            $
            11,557,900
            
            $
            203,100
            
            $
            20,166,300
            
            $
            -
            
            $
            31,927,300Operating
                income (Loss)
            
            
            168,200
            
            
            32,300
            
            
            (716,900
            )
            
            -
            
            
            (516,400
            )Identifiable
                assets
            
            
            12,670,400
            
            
            63,400
            
            
            7,864,800
            
            
            1,868,800
            
            
            22,557,400Depreciation
                and amortization
            
            
            465,200
            
            
            4,900
            
            
            401,600
            
            
            32,000
            
            
            903,700Capital
                expenditures
            
            
            34,200
            
            
            -
            
            
            753,600
            
            
            -
            
            
            787,800




Year
                Ended December 31,2004Brewing
                Operations
            
            Tavern
                & Tasting
              Room
            
            Distributor
              Operations
            
            Corporate
                and Other
            
            TotalSales
            
            $
            11,686,800
            
            $
            211,200
            
            $
            20,259,900
            
            $
            -
            
            $
            32,157,900Operating
                income (Loss)
            
            
            (49,900
            )
            
            12,800
            
            
            490,900
            
            
            -
            
            
            453,800Identifiable
                assets
            
            
            13,166,900
            
            
            99,400
            
            
            8,729,400
            
            
            2,367,400
            
            
            24,363,100Depreciation
                and amortization
            
            
            535,800
            
            
            5,000
            
            
            459,300
            
            
            31,200
            
            
            1,031,300Capital
                expenditures
            
            
            38,700
            
            
            -
            
            
            559,100
            
            
            -
            
            
            597,800





F-31


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006





**17.**  **Unrestricted
      Net Assets**





The
      Company's wholly-owned subsidiary, UBI, has retained losses of approximately
      $26,900 as of December 31, 2006. Under UBSN's line of credit agreement with
      RBS,
      distributions and other payments to the Company from its subsidiary are not
      permitted if the retained earnings drop below approximately $1,958,600.
      Condensed financial information of the parent company, Mendocino Brewing
      Company, Inc., is as follows:




Balance
                Sheets
            
            2006
            
            2005AssetsCash
            
            $
            55,700
            
            $
            11,500Accounts
                receivable
            
            
            1,812,300
            
            
            1,388,500Inventories
            
            
            1,329,500
            
            
            1,151,400Other
                current assets
            
            
            209,100
            
            
            212,600Total
                current assets
            
            
            3,406,600
            
            
            2,764,000Investment
                in subsidiary
            
            
            1,225,000
            
            
            1,225,000Property
                and equipment
            
            
            11,526,800
            
            
            11,682,900Other
                assets
            
            
            349,900
            
            
            245,700Total
                assets
            
            $
            16,508,300
            
            $
            15,917,600LiabilitiesLine
                of credit and note payable
            
            $
            1,363,600
            
            $
            2,181,000Accounts
                payable
            
            
            1,333,000
            
            
            1,486,000Accrued
                liabilities
            
            
            579,700
            
            
            892,900Current
                maturities of debt and leases
            
            
            246,200
            
            
            352,800Total
                current liabilities
            
            
            3,522,500
            
            
            4,912,700Intercompany
                payable
            
            
            1,079,800
            
            
            1,319,500Long-term
                debt and capital leases
            
            
            4,233,700
            
            
            2,332,700Notes
                payable to related party
            
            
            2,733,400
            
            
            2,552,300Total
                liabilities
            
            
            11,569,400
            
            
            11,117,200Stockholders'
                equityCommon
                stock
            
            
            14,815,300
            
            
            14,747,300Preferred
                stock
            
            
            227,600
            
            
            227,600Accumulated
                deficit
            
            
            (10,104,000
            )
            
            (10,174,500
            )Total
                stockholders' equity
            
            
            4,938,900
            
            
            4,800,400Total
                Liabilities and stockholders' equity
            
            $
            16,508,300
            
            $
            15,917,600




F-32


**M** **ENDOCINO** **B** **REWING** **C** **OMPANY** **,
        I** **NC** **.**
 **N** **OTES
        TO** **C** **ONSOLIDATED** **F** **INANCIAL** **S** **TATEMENTS**
 DECEMBER31,
        2006




**17.**  **Unrestricted
      Net Assets (continued)**




Statement
                of Operations
            
            2006
            
            2005
            
            2004Net
                sales
            
            $
            12,149,400
            
            $
            11,125,500
            
            $
            11,245,600Cost
                of goods sold
            
            
            8,576,200
            
            
            7,737,000
            
            
            7,467,000Selling,
                marketing, and retail expenses
            
            
            1,215,100
            
            
            1,469,800
            
            
            1,701,400General
                and administrative expenses
            
            
            1,661,200
            
            
            1,810,600
            
            
            1,955,200Legal
                dispute settlement
            
            
            -
            
            
            -
            
            
            250,600Income
                (loss) from operations
            
            
            696,900
            
            
            108,100
            
            
            (128,600
            )Other
                income and (expense)Interest
                expenses
            
            
            (832,000
            )
            
            (760,800
            )
            
            (725,900
            )Other
                income
            
            
            208,100
            
            
            329,100
            
            
            356,800Provision
                for taxes
            
            
            (2,500
            )
            
            (1,800
            )
            
            (3,800
            )(626,400
            )
            
            (433,500
            )
            
            (372,900
            )Net
                income (loss)
            
            $
            70,500
            
            $
            (325,400
            )
            $
            (501,500
            )




Statements
                of Cash Flows
            
            2006
            
            2005
            
            2004Cash
                flows from operating activities
            
            $
            (65,500
            )
            $
            (426,300
            )
            $
            462,800Cash
                flow from investing activitiesPurchase
                of property and equipment
            
            
            (327,200
            )
            
            (34,200
            )
            
            (38,700
            )Proceeds
                from sale of assets
            
            
            11,000
            
            
            -
            
            
            16,700Net
                cash from investment activities
            
            
            (316,200
            )
            
            (34,200
            )
            
            (22,000
            )Cash
                flow from financing activitiesNet
                borrowing (repayment) on line of credit
            
            
            (241,200
            )
            
            52,100
            
            
            343,400Borrowing
                on long-term debt
            
            
            4,180,900
            
            
            -
            
            
            -Repayment
                of long-term debt
            
            
            (2,628,300
            )
            
            (285,300
            )
            
            (575,900
            )Proceeds
                from note payable
            
            
            350,000Repayment
                of notes payable
            
            
            (926,200
            )
            
            -
            
            
            -Payment
                on obligation under capital lease
            
            
            (69,500
            )
            
            (122,900
            )
            
            (124,000
            )Net
                change in inter company payable
            
            
            (239,800
            )
            
            142,100
            
            
            (99,800
            )Proceeds
                from related party
            
            
            -
            
            
            400,000
            
            
            -Net
                cash flow from financing activities
            
            
            425,900
            
            
            186,000
            
            
            (456,300
            )Cash,
                beginning of year
            
            
            11,500
            
            
            286,000
            
            
            301,500Cash,
                end of year
            
            $
            55,700
            
            $
            11,500
            
            $
            286,000Cash
                dividend received from subsidiary
            
            $
            -
            
            $
            149,900
            
            $
            215,100




**18.**  **Subsequent
      Events**





During
      January 2007, the 240,385 non-statutory stock options issued in January 2002
      to
      the independent members of the Board of Directors expired prior being
      exercised.





F-33