SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                   FORM 10-KSB
(Mark One)
    [x]     ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES  EXCHANGE
            ACT OF 1934

For the fiscal year ended December 31, 1996

    [ ]     TRANSITION  REPORT  UNDER  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.
                 (Name of small business issuer in its charter)


          California                                    68-0318293
(State or other jurisdiction of            (I.R.S. Employee Identification No.)
  incorporation or organization)


13351 South Highway 101, Hopland, CA                      95449
 (Address of principal executive offices)              (Zip code)

Issuer's telephone number:  (707) 744-1015

Securities registered under Section 12(b) of the Act:

     Title of each class               Name of each exchange on which registered
 Common Stock, without par value             The Pacific Stock Exchange

Securities registered under Section 12(g) of the Act:

                                 Not applicable
                                (Title of class)

     Check  whether  the issuer (1) filed all  reports  required  to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 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
                                                                       -    -

     Check if there is no disclosure  of  delinquent  filers in response to Item
405 of  Regulation  S-B not contained in this form,  and no  disclosure  will be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]

     State issuer's revenues for its most recent fiscal year: $4,004,700

     The  aggregate  market  value of the voting  stock  held by  non-affiliates
computed by reference to the last  reported sale price of such stock as of April
2, 1997 was $10,416,000.

     The number of shares the issuer's common stock  outstanding as of March 31,
1997  is  2,322,222.   (Does  not  include  300,000  shares  issued  subject  to
substantial  restrictions  as security for a forbearance.  Also does not include
approximately  16,000 shares,  subscriptions  for which the Company had received
but not accepted as of March 31, 1997.)

     Transitional Small Business Disclosure Format Yes   No X
                                                       -    -


<PAGE>


                                     PART I

Item 1.  Business.

Overview

         Mendocino  Brewing  Company,  Inc.  brews Red Tail Ale, Blue Heron Pale
Ale, Black Hawk Stout,  and three other ales, one stout,  and one porter for the
domestic craft beer market. A "craft beer" is a full-flavored beer brewed in the
traditional  style.  Mendocino  Brewing is one of the first of the modern  craft
brewers, having opened the first new brewpub in California and the second in the
United States since the repeal of  Prohibition,  and has been recognized for its
innovations  in the  brewpub  concept,  its craft brew  style,  its  distinctive
labels, and its role in industry associations.  Mendocino Brewing's objective is
to transform  itself from the country's  leading  microbrewery  (based on annual
sales from 1990  through 1995 among  brewers  with annual  capacity of less than
15,000 bbl.) to a major national craft brewer offering among the highest quality
craft beers available anywhere in America.

         Mendocino  Brewing is building a new brewery in Ukiah,  California (110
miles north of San Francisco).  Management  presently expects to begin producing
test brews at the new  facility  in April  1997.  The new  brewery  will have an
initial annual capacity of  approximately  60,000 bbl.,  which is more than four
times the Company's  annual  capacity from 1993 through the first nine months of
1995 of 13,600 bbl.  Ultimately,  the  facility  can expand to 200,000  bbl. per
year.

Company Background

         Mendocino  Brewing  Company  was  originally  formed in March 1983 as a
California  limited  partnership  (the  "Partnership").  On January 1, 1994, the
business was  incorporated  by  transferring  all of the  Partnership's  assets,
including its name, to a newly formed California corporation in exchange for all
of  the  Common  and  Preferred  Stock  of  the  corporation.   The  Partnership
distributed  these shares to its partners on January 3, 1994. As used hereafter,
references  to the  "Company"  and  "Mendocino  Brewing"  include  the  business
operations of the Partnership before its incorporation.

         Mendocino  Brewing first bottled its flagship  brand,  Red Tail Ale, in
December  1983. In February  1995,  Mendocino  Brewing  completed a $3.6 million
direct public offering at $6 per share. The Company purchased nine acres of land
in Ukiah,  California  in 1995 and broke  ground on the new brewery in September
1995.  Seeking to maximize the capacity of the Hopland  facility in the interim,
the  Company  added an  additional  bottling  tank in the  Fall of  1995,  which
permitted the Company to begin 24 hour brewing  operations.  This  increased the
annual capacity of the Hopland facility to 18,000 bbl.,  technically  taking the
Company out of the  microbrewery  category.  The Company's  products are sold in
over 1,500  retail  outlets in Northern  California  and in  selected  locations
throughout the United States. See "Product Distribution."

         Mendocino  Brewing is  recognized  for its  contributions  to the craft
brewing  industry  and  enjoys a  national  and  international  reputation.  The
Company's  distinctive  and  award  winning  Red  Tail Ale  label is  frequently
featured  in  calendars,  posters,  and  literature  concerning  the craft  beer
industry.  Although  introduced only this summer,  the equally  distinctive Blue
Heron  Pale Ale  label  has also won  awards  and is  featured  in the 1997 Brew
Art(TM) calendar  published by Ronnie Sellers  Productions of Kennebunk,  Maine.
The  Company  enjoys good  visibility  within the  industry,  due in part to the
leadership its officers have provided within various industry trade groups.  See
"Management."

                                      -1-

<PAGE>

Industry Overview

         Domestic   Beer  Market.   According  to  Modern   Brewery  Age's  1996
Statistical Report, overall domestic beer sales in 1996 was 178 million bbl. (up
0.6% from 1995). A barrel equals  approximately  13.78 cases or 331 twelve ounce
bottles;  178 million  bbl. is  therefore  the  approximate  equivalent  of 59.0
billion 12 oz. bottles of beer.
<TABLE>
         The U.S. beer market may be divided into five segments:
<CAPTION>
                       1995 Est.                                                           Representative Suggested
Segment              Market Share               Top Brands                                  Retail Price/6-pack
--------------------------------------------------------------------------------------------------------------------
<S>                    <C>       <C>                                                           <C>  
Low-Priced             60.0%     Busch, Milwaukee's Best, Old Milwaukee                             $2.80
Premium                31.4%     Budweiser, Miller Lite, Bud Light, Coors Light                     $4.05
Super-Premium           1.2%     Michelob, Lowenbrau                                                $4.67
Import                  5.5%     Heineken, Guinness, Bass                                           $7.90
Domestic Craft          1.9%     Samuel Adams, Pete's, Sierra Nevada, Red Tail Ale             $5.99 to $6.99
</TABLE>

         Domestic  Craft  Beer  Segment.  While  overall  beer  sales  have been
basically flat for several years,  domestic craft beer sales have increased at a
rate of  approximately  40% per year for several  years,  slowing a bit in 1996.
Many industry  analysts  predict that craft beer sales will continue to increase
until they achieve a market share of 5%-6% by the year 2000.

         Craft  beers are  characterized  by their  full-flavor  and are usually
produced along traditional  European brewing styles. The majority of craft beers
are ales, although some are malt lagers. Wheat beers and fruit flavored ales and
lagers have enjoyed recent popularity among craft beer consumers.

Competition

         The craft beer category consists of:

   o     Contract  brews -- any style brew produced by one brewer for sale under
         the label of someone else who does not have a brewery or whose  brewery
         does not have sufficient capacity.

   o     Regional craft brews --  "hand-crafted"  brews,  primarily  ales,  sold
         under the label of the brewery that produced it.

   o     Microbrews --  "hand-crafted"  brews,  primarily  ales,  sold under the
         label of the brewery  that  produced it, if the capacity of the brewery
         does not exceed 15,000 bbl. per year.

   o     Large brewer  craft-style  brews -- a brand brewed by a national brewer
         which may only  imitate  the style of a craft beer.  These  craft-style
         brews are often sold  under the label of a brewery  that does not exist
         or the label of a brewpub with no bottling capacity.  The term "phantom
         brewery" is sometimes used to describe such brands.

   o     Brewpub brews -- "hand-crafted" brews produced for sale and consumption
         at the brewery,  which is normally connected with a  restaurant/saloon.
         Brewpub  brews  are not  normally  sold  for  off-site  consumption  in
         significant quantities.

         Mendocino  Brewing competes against all of the above brewers  primarily
on the basis of product quality and image.

         Of the approximately 3.7 million bbl. of craft beer produced in America
in 1995 (detailed  1996  statistical  information  is not currently  available),
contract  brews (led by Samuel Adams Boston Lager,  Pete's Wicked Ale, and their
respective  related brands) accounted for approximately 1.5 million bbl., or 41%
of the total;  regional  craft brands (led by Sierra  Nevada,  Redhook,  Pyramid
(Hart Brewing,  Inc.),  Anchor,  and Full Sail) represented  approximately  1.25
million  bbl.,  or 34% of the  total;  and  microbrews  (led  by Red  Tail  Ale)
represented  approximately  910,000 bbl., or 25% of the total. Because Mendocino
Brewing's annual production  exceeded 15,000 bbl. by less than 150 bbl. in 1995,
some  industry  publications  have  classified  the Company as a regional  craft
brewer for that year.

                                      -2-

<PAGE>
<TABLE>

----------------------------------------------------------------------------------------------------------------
                                           1995 & 1996 Domestic Craft Beer Market
<CAPTION>
                                                                    1995                       1996
           Largest Craft Brewers in Mendocino              Total Sales      Annual      Total Sales     Annual
           Brewing's Primary & Target Markets             (x 1,000 bbl.)    Growth    (x 1,000 bbl.)    Growth
---------------------------------------------------       --------------   --------  ---------------  ----------
<S>                                                           <C>             <C>          <C>           <C>
     1   Boston Beer Co. (Boston, MA)                          960            37%          1210           26%
     2   Pete's Brewing Co. (Palo Alto, CA)                    348            91            426           22
     3   Sierra Nevada Brewing Co. (Chico, CA)                 201            31            267           33
     4   Redhook Ale Brewery (Seattle, WA)                     158            69            225           42
     5   Hart Brewing Co. (Kalma, WA)                          123            71            128            4
     6   Widmer Brewing Co. (Portland, OR)                      70            40            122           75
     7   Anchor Brewing Co. (S.F., CA)                         105             1            108            3
     8   Full Sail Brewing Co. (Hood River, OR)                 70            36             79           12
     9   Portland Brewing Co. (Portland, OR)                    63            82             67            6
    10   Bridgeport Brewing Co. (Portland, OR)                  19             6             20            6
    11   Mendocino Brewing Co. (Hopland, CA)                    14             8             17           13
         Remaining Domestic Craft Brewers (approx. 1200)     1,663            44            N/A          N/A
                                                             -----
     Total Domestic Specialty Segment Production             3,780            44%           N/A          N/A
-----------------------------------------------------------------------------------------------------------------
</TABLE>
         Source:  Modern Brewery Age

Products

         Mendocino  Brewing  brews  three  ales  and a stout  year-round,  three
seasonal ales, and a seasonal porter:

   o     RED TAIL ALE, a full  flavored  amber  ale,  is the  flagship  brand of
         Mendocino Brewing.

   o     BLUE HERON PALE ALE is a golden ale with a full body and a  distinctive
         hop character.

   o     BLACK  HAWK STOUT is the  fullest  in flavor and body of the  Company's
         brews.

   o     EYE OF THE HAWK SELECT ALE is a high gravity deep amber summer ale.

   o     YULETIDE PORTER is a deep brown Holiday brew with a traditionally rich,
         creamy flavor.

   o     PEREGRINE PALE ALE is brewed year-round with a more delicate flavor and
         character.

   o     SPRINGTIDE  ALE is brewed  around St.  Patrick's  Day and  appears as a
         fresh, flowery, spicy golden ale.

   o     FROLIC SHIPWRECK ALE 1850, a Scottish-style ale brewed around July, was
         introduced in 1994 as a fund-raiser for the Mendocino  County Museum to
         commemorate  the wreck of the clipper  ship  Frolic,  with its cargo of
         Scottish  ale, on the  Mendocino  coast in 1850.  Salvage  efforts were
         abandoned  when workers,  upon sighting the  previously  unreported big
         trees of  Mendocino  County,  launched  the timber  industry  which has
         characterized the area ever since.

         Mendocino Brewing uses an ale yeast strain that was first introduced at
New Albion Brewing Co. in the late 1970s.  Management  knows of no other brewery
that  ferments  its beer with this  particular  strain  of  yeast.  The  Company
maintains  the  yeast  strain  under  laboratory   conditions  at  two  separate
locations.  Mendocino  Brewing is among a minority  of brewers who use whole hop
flowers  instead of  processed  hop  pellets in their  brewing  processes.  This
technique  contributes  to the  distinctive  characteristics  of the brews.  The
Company adds active  fermenting beer (Krausen) after the beer is bottled,  which
produces a pleasant  amount of natural  carbonation.  The thin layer of brewer's
yeast  in the  bottom  of the  bottle  is a  natural  characteristic  of  bottle
conditioned ale.

         Mendocino  Brewing's  distinctive brews have been very well received in
the market and within the industry.  Eye of the Hawk Select Ale won a gold medal
at the 1991 Great  American  Beer Festival  after winning a silver in 1990,  and
also won a bronze in 1992.  Blue Heron Pale Ale was  awarded a Gold Medal with a
Special Award of Excellence from the  Underground  Wine Journal in February 1997
in a  competition  among 183 ales from across the United States and won a bronze
medal at the 1991 Great American Beer Festival.

The Hopland Brewery Brewpub and Merchandise Store

         To date,  Mendocino Brewing's major marketing tool has been the Hopland
Brewery  brewpub and  merchandise  store.  Located on a major  tourist  route in
Hopland,  California,  100 miles north of San  Francisco,  the

                                      -3-

<PAGE>

Hopland  Brewery,  which  opened  in  1983,  was the  first  brewpub  to open in
California and the second in the United States since the repeal of Prohibition.

         The brewpub is housed in a 100 year-old  brick  building  that was once
known as the Hop Vine  Saloon.  The inside  walls are trimmed  with the original
turn-of-the-century  ornamental stamped tin. Works of local artists are featured
on a rotating basis. The bar is  hand-crafted,  early California style blond oak
and brass that  complements the tradition of the tavern and the Company's brews.
The pub includes a dart room and a stage.  Patrons can view the brewing  process
through  windows in the adjoining  brewhouse.  An outdoor Beer Garden includes a
shaded grape arbor, flowers,  trellised hops in the summer, picnic tables, and a
sandbox for the kids.

         Beverages  served include Red Tail Ale, Blue Heron Pale Ale, Black Hawk
Stout,  Peregrine  Pale Ale, and a seasonal brew on tap, along with local wines,
Hopland  Seltzer  Water,  local apple juice,  and soft drinks.  The brewpub also
features  hand  pumped  cask  conditioned  ales.  The menu  features  home-style
cooking,  spicy beer  sausages,  legendary  hamburgers,  Red Tail  chili,  fresh
salads,  snacks,  vegetarian entrees, and daily specials at moderate prices. The
brewpub operates days and evenings, with live music on Saturdays and for special
events,  such as the  Company's  annual  Anniversary  Party  in  August  and its
Oktoberfest in October.

         The adjacent Merchandise Store sells off-sale packages of the Company's
brews  (including  gift  packs)  and  merchandise  such as  hand-screened  label
T-shirts,  posters,  engraved  glasses and mugs, logo caps, books about brewing,
gift packs, and other brewery-related gifts.

         Management had planned to continue  bottling  operations at the Hopland
facility  until  the  Company  could no  longer  keep up with  demand,  and then
transfer bottling operations to the Ukiah facility.  Until that time, production
at the Ukiah facility was to consist solely of draft beer.  Based on preliminary
sales data for January and March, 1997, it appears that bottling operations will
need to move to Ukiah as quickly as  practical.  The  Company  will  continue to
operate the Hopland  facility to provide  special  occasion  draft beers for the
brewpub; to research, develop, and test-market new craft brews; and as a brewing
education and training site.

Strategy

         Mendocino Brewing's objective is to transform itself from the country's
leading  microbrewery  (based  on annual  sales  from  1990  through  1995) to a
nationally  known and  respected  craft  brewer  that  offers  among the highest
quality craft beers available anywhere in America. Management perceives that the
continued  growth in the domestic craft beer segment (see "-Industry  Overview")
has given rise to a qualitative shift in the public's  awareness of craft beers,
and that this shift now gives the Company an opportunity to enter new markets at
a time when many  consumers  are  discovering  craft  brews for the first  time.
Management  believes that an important step is to position  Mendocino  Brewing's
products  as  offering  superior  quality  with  very high  perceived  value and
distinctive brand images, even when compared with other craft brews.  Management
plans to accomplish  this  objective by making the Company's  most popular brews
available  in 12 oz.  six  packs  and  draft,  increasing  the  Company's  brand
development  efforts,  and entering new  geographic  markets.  In completing the
plans for the new brewery,  Management  also  concluded  that it could  position
itself better in the market and realize  certain cost  efficiencies  and overall
cost reductions by designing a plant with an initial capacity of 60,000 bbl. per
year (20% greater than originally  planned) and an ultimate  capacity of 200,000
bbl. per year (54% greater than originally planned).

New Product Offerings

         Until recently,  Mendocino Brewing's capacity limitations and marketing
considerations  dictated that the bulk of the  Company's  production be Red Tail
Ale in 12 oz. six packs.  Draft beer has been limited to production  for sale at
the Hopland  Brewery,  and other brews,  such as Blue Heron Pale Ale, Black Hawk
Stout,  Eye of the Hawk Select Ale,  Yuletide  Porter,  and Frolic Shipwreck Ale
1850,  have  been  available  only  in  limited  quantities  of 750 ml or 22 oz.
bottles. A key element of the Company's strategy is to make more of its products
available in 12 oz. six-packs and draft. The new products are:

   o     Blue  Heron  Pale  Ale 12 oz.  Six-Packs.  Blue  Heron  Pale Ale is now
         available at selected  retail outlets in 12 oz. six packs.  The bottles
         and carrier pack  feature a colorful  new label  depicting a Great Blue
         Heron  preparing  for flight  against a soft,  misty  background of the
         Russian River (which flows through Hopland) and surrounding  hills. The
         design has already won the  prestigious  1996 Northern  California Addy
         award and the silver medal in the 1996  International  Brand  Packaging
         Award competition sponsored by Graphic

                                      -4-

<PAGE>

         Design:  USA  magazine.  The  label is also  featured  in the 1997 Brew
         Art(TM) calendar published by Ronnie Sellers  Productions of Kennebunk,
         Maine.

   o     Black Hawk Stout 12 oz. Six-Packs.  Management plans to introduce Black
         Hawk Stout in 12 oz.  six-packs  following  completion of its new label
         development,  which  Management  expects to occur in 1997. This forward
         looking  statement is subject to risks and  uncertainties.  Among other
         things,   tasks  such  as   completing   the  new  brewery  may  divert
         Management's  attention  from  matters such as label  development.  The
         speed with which new Black Hawk Stout  labels are  developed  will also
         depend,  in part,  on the amount of  proceeds  raised in the  Company's
         current direct public  offering.  The Black Hawk Stout label  presently
         consists of the basic  Mendocino  Brewing  Company  logo with the words
         BLACK  HAWK  STOUT and is  distributed  in 22 oz.  bottles  in  limited
         quantities.

   o     Draft brews in half barrel kegs.  Management  presently intends to make
         draft  production  of Red Tail Ale, Blue Heron Pale Ale, and Black Hawk
         Stout in half barrel kegs the first  priority of the new  brewery.  The
         Company is designing special tap handles and other marketing  materials
         for its draft products.  Historically in the beer industry, introducing
         draft products into  restaurants  and other  establishments  has driven
         bottle sales which in turn has increased  demand for draft  products in
         locations not served.  These forward looking  statements are subject to
         risks and uncertainty.  Among other things,  there is no assurance that
         sale of the Company's brews will help it achieve the critical mass that
         Management seeks.

Brand Development

         Management  believes that consumers of the Company's brews are like the
typical  craft beer  consumer  described in the H.C.  Wainwright & Co.  industry
report of October 12, 1995.  According to this  report,  the typical  craft beer
consumer is interested in "upscale and diversified" products with a "distinctive
brand image" and "full  flavored  taste." Craft beer  consumers  also tend to be
consumers  of gourmet  coffees,  fine  wines,  all-natural  products,  and other
"affordable  luxuries." A survey  conducted  by ICR of Media,  PA found that the
following percentages of people had tried a craft beer:

      o   25% of all U.S. beer drinkers
      o   23% of women beer drinkers
      o   26% of male beer drinkers

      o   51% of  people  with  annual  incomes  of  $75,000+
      o   Greater than 50% of  college educated  people 
      o   38% of adults  25-34 years old 
      o   10% of adults 45 years and older

      o   32% of beer drinkers in the Northeast 
      o   28% of beer drinkers in the West 
      o   26% of beer drinkers in the Midwest 
      o   17% of beer drinkers in the South

         One of the ways  Mendocino  Brewing  projects its quality and corporate
values to consumers is through its Red Tail Ale, Blue Heron Pale Ale, and Eye of
the Hawk Select Ale  labels.  The  Company  has used  nationally-known  wildlife
artists  including Randy Johnson and Lee Jayred for its label designs.  In 1990,
Mendocino Brewing received the Paperboard  Packaging  Council's Silver Award for
Excellence  in  Packaging  and Award for  Excellence  in  Graphic  Design  and a
Northern  California  Addy Award for its Red Tail Ale  packaging.  In 1996,  the
Company  received a  Northern  California  Addy Award and a silver  medal in the
International Band Packaging Award competition  sponsored by Graphic Design: USA
magazine for its Blue Heron Pale Ale packaging.  It is  Management's  experience
that  distributors  and retailers  realize the importance of superior  packaging
graphics and appreciate the Company's offerings for that reason.

         Management   believes   that  the  Red  Tail  Ale  label   successfully
communicates  the  value  of  Mendocino  Brewing's  products  with  the  label's
respectful depiction of a red tail hawk flaring its wings as it prepares to land
with  clusters of hops and barley in its  talons.  The  illustrations  Mendocino
Brewing  uses with its Blue Heron Pale Ale and Eye of the Hawk Select Ale labels
are intended to evoke similar  responses,  as will be the illustration for Black
Hawk Stout when introduced.

         The popularity of Mendocino Brewing's logos and trademarks is evidenced
by  the  sale  of  merchandise  bearing  these  marks  at  the  Hopland  Brewery
merchandise store and through the merchandise  catalogue the Company

                                      -5-

<PAGE>

introduced  in 1994. As part of its marketing  efforts,  therefore,  the Company
intends to implement a brand marketing development program that will emphasize:

   o     Point-of-sale promotional materials including brochures, signage, table
         tents, coasters, tap handles, and glassware.

   o     Clothing (caps, T-shirts, polo shirts, sweatshirts, etc.).

   o     Signage for distributor trucks to create "moving billboards." Mendocino
         Brewing's  emphasis  on  separate,  distinctive  illustrations  for its
         various  brands  enables  it to  produce a variety  of images to create
         consumer interest.

   o     World  Wide  Web  Page.  Mendocino  Brewing's  web page is  located  at
         http://mendobrew.com and features information about the Company and the
         Hopland Brewery brewpub and merchandise  store,  the Company's  brewing
         process,  the Company's brands, the Hopland area, Company  merchandise,
         and  shareholder   information.   The  web  page  address  is  featured
         prominently on Company marketing  materials and can be accessed through
         the Real Beer web site.

   o     Continued  use of the  Brewsletter  beyond its current  mailing list of
         12,000. The Brewsletter is a newsletter Mendocino Brewing publishes and
         distributes to educate  subscribers  about the brewing industry and the
         Company's  products and to promote the  Company's  image and  corporate
         values.

   o     Strong  visual  presence  at  beer  shows  and  tasting   competitions,
         including  the Great  America  Beer  Festival in Denver,  the  Portland
         Brewers Festival, and the KQED Beer Festival in San Francisco.

Regional Expansion

         The Company's  products are  distributed  widely in  California  and in
limited  quantities at selected accounts in the metropolitan areas of Washington
D.C., Boston, Seattle, Phoenix,  Chicago,  Milwaukee, New York, and Atlanta, and
throughout North Carolina,  Texas,  Oregon,  Nevada,  and Colorado.  The Company
plans  to  add  distributors  in  New  Jersey,   Maryland,   Virginia,  and  the
metropolitan areas of Minneapolis/St.  Paul and Philadelphia in the near future.
Northern  California is the Company's  most  important  market,  and  Management
anticipates  that it will remain so for the  foreseeable  future.  The Company's
three  largest   distributors,   Golden  Gate  Distributing  (Sonoma  and  Marin
Counties),  Bay Area  Distributing  (the East San Francisco  Bay Area),  and A&D
Distributing  (South  San  Francisco  area)  accounted  for 18%,  14%,  and 10%,
respectively, of the Company's wholesale distribution in 1996. The percentage of
the Company's sales for which these  distributors  have accounted has decreased,
and will continue to decrease, as the Company adds new distributors and supplies
them with more product.  These  forward-looking  statements are subject to risks
and  uncertainties.  There is no assurance  that the Company will be able to add
additional  distributors or that its products will be  well-received in targeted
markets. Management believes that regional identification assists the Company in
Northern  California  and may assist the Company's  local  competitors  in other
regional markets.

Pricing Strategy

         Mendocino  Brewing's  products  are  priced  at or near  the top of the
market and have been for several years. Recently, the Company decided to pass on
to consumers some of the economies resulting from increased capacity and reduced
the  suggested  retail price for a six-pack of Red Tail Ale from $7.43 to $6.99.
The suggested  retail price for a six-pack of Blue Heron Pale Ale is also $6.99.
The Company has noticed  that the price range of 12 oz.  six-packs  of the major
craft  brew  brands  has  narrowed  in the  last two  years  and  appears  to be
converging  on $6.50 per six pack,  with no major  craft brew brand at less than
$6.45 per six pack.  There is no assurance  that craft beer prices will continue
at these levels.  Nevertheless,  Management believes that the Company's products
will continue to command  prices that will be on at least a par with other major
regional craft brewers.  These forward  looking  statements are subject to risks
and  uncertainties.  Retail prices are subject to many factors most of which are
beyond the  control of the  Company.  These  factors  include  general  economic
conditions, competition and consolidation, and ability to anticipate and respond
to  evolving   consumer   preferences  and  attitudes  toward  adult  beverages.
Management  anticipates that the Company will  periodically give temporary price
reductions through special promotions in response to market conditions. Frequent
price reductions can condition  consumers to expect such  reductions,  which may
increase or reduce overall unit sales depending on the circumstances.

                                      -6-

<PAGE>

Social Responsibility

         Part of  Mendocino  Brewing's  mission is to be viewed as a  community,
regional,  and national asset and as a positive example of how a business should
be operated.  Management  believes that the Company's customers require products
with high intrinsic  value;  that product quality alone is not  sufficient;  and
that a product must  distinguish  itself from the competition with the values it
communicates.   These  values   include   commitment  to  employees,   community
involvement,  and environmental  responsibility.  Management attempts to instill
these values in Company personnel and operations and to communicate to customers
the  commitment  of the  Company  to act  responsibly.  The  Company  encourages
employees and  distributors  to share  ownership and mission with  Management as
well as a  sense  of  pride  in the  Company's  products.  Although  part of the
Company's  strategy is to grow through  expanded sales, it promotes its brews as
beverages  of  moderation  whose  distinctive  taste and high  quality  give the
consumer satisfaction.

New Brewery

         Mendocino  Brewing  is  completing  a 62,000 sq.  ft.  custom  designed
facility  on nine  acres of land in Ukiah,  California,  approximately  10 miles
north of the original brewery. The facility was approximately 89% complete as of
March 31,  1997,  and is expected to begin  producing  test brews in April.  The
facility is planned to feature new  fermenting  tanks,  kegs,  and packaging and
other  miscellaneous  equipment  to be  installed  with the  Company's  existing
bottling line.  Certain features of the new brewery have been specially designed
for the Company's  brewing  methods,  such as equipment for using whole hops and
designated space for bottle conditioning.  The facility will initially open with
an annual capacity of 60,000 bbl. per year. The Company had originally planned a
50,000 bbl.  facility,  but was able to take  advantage of certain  economies by
revising  its plans to a capacity  of 60,000  bbl.  per year (20%  greater  than
originally  planned).  The facility has been  designed to allow for expansion in
stages up to a maximum  capacity  of 200,000  bbl.  per year (54%  greater  than
originally  planned).  The Company also elected to construct an extensive  water
treatment  facility as part of its commitment to the  environment  and to reduce
the over-all cost of disposing of its waste water.

Product Distribution

         Mendocino Brewing's beers are sold through distributors to consumers in
bottles at  supermarkets,  warehouse  stores,  liquor stores,  taverns and bars,
restaurants,  and convenience  stores. The Company intends to make Red Tail Ale,
Blue Heron Pale Ale,  and Black Hawk Stout  available in draft form and may sell
to additional kinds of outlets,  such as sporting events. 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.
The  Company,  together  with its  distributors,  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 its products  directly to consumers at the Hopland  Brewery
brewpub and  merchandise  store. Of the Company's total beer sales for 1996, 89%
(77% of total sales)  constituted sales to independent  distributors and 11% (9%
of total sales) constituted sales at the Hopland Brewery brewpub and merchandise
store.  Beer  sales  (wholesale  and  retail  combined)  constituted  86% of the
Company's total sales in 1996,  with food and  merchandise  retail and catalogue
sales  constituting  the balance.  As the Company's sales  increase,  Management
expects sales to independent distributors to increase materially as a percentage
of total sales.

Suppliers

         The Company's major  suppliers are Great Western  Malting Co.,  Yakima,
Washington (malt);  John I. Haas, Co., New York, New York (hops); and California
Glass Company,  Oakland,  California and Vitro Packaging,  Inc.,  Dallas,  Texas
(bottles). The City of Ukiah will supply power and water to the new brewery.

Employees

         As of December  31,  1996,  the Company  employed 43  full-time  and 39
part-time  individuals  including 10 in  management  and  administration,  24 in
brewing operations, and 48 in retail and brewpub operations. Upon the completion
of its expansion,  Management expects the Company to have increased four current
employees to full-time  status and to have hired five additional  management and
administrative  employees,  three  marketing  employees  and five  employees  in
operations.  Management believes that the Company's relations with its employees
is

                                      -7-

<PAGE>

excellent.  None of its work force is unionized. The Company has agreed with the
City of Ukiah  that for two  years it will  give  preference  in its  hiring  to
residents of Mendocino County.

Patents and Trademarks

         The  Company  has  federal  trademark  registrations  of the  MENDOCINO
BREWING COMPANY word mark (Reg. No. 1,785,745), RED TAIL ALE word mark (Reg. No.
2,032,382), RED TAIL DESIGN (Reg. No. 2,011,817), BLUE HERON word mark (Reg. No.
1,820,076), BLUE HERON PALE ALE DESIGN (Reg. No. 2,011,816),  PEREGRINE PALE ALE
word mark (Reg. No.  1,667,796),  EYE OF THE HAWK SELECT ALE word mark (Reg. No.
1,673,594),  EYE OF THE HAWK SELECT ALE DESIGN (Reg. No. 2,011,818),  EYE OF THE
HAWK SPECIAL EDITION ANNIVERSARY ALE AND DESIGN (Reg. No. 2,011,815), BLACK HAWK
STOUT  word mark (Reg.  No.  1,791,807),  YULETIDE  PORTER  word mark (Reg.  No.
1,666,891), and BREWSLETTER word mark (Reg. No. 1,768,639).

         The  registration  of the word  mark  BLUE  HERON is a  concurrent  use
registration  which gives the Company the  exclusive  right to use the word mark
BLUE HERON  throughout  the United States with the  exception of Oregon,  Idaho,
Washington, and Montana. BridgePort Brewing Company, the other concurrent owner,
has the  exclusive  right to use the word mark BLUE HERON in those  states.  The
BridgePort Pale Ale label used outside of Oregon, Idaho, Washington, and Montana
depicts a blue  heron  wading in a marsh  although  the words  BLUE HERON do not
appear.

         Mendocino  Brewing's  use of the word  mark  BLACK  HAWK  STOUT  is, by
agreement with Hiram Walker & Sons, Inc.,  subject to the restriction that it be
used only in conjunction with the words "Mendocino Brewing Company".

         Mendocino Brewing does not consider its recipes, techniques, processes,
yeast strain, or equipment to be proprietary or necessary to protect.

Government Regulation

         Mendocino  Brewing  is  licensed  to  manufacture  and sell beer by the
California  Department  of Alcoholic  Beverage  Control  ("ABC").  A "Small Beer
Manufacturer's  License"  allows the Company to brew up to  1,000,000  bbl.  per
year, to conduct wholesale sales, and to sell beer and wine for consumption both
on and off the premises.  A federal permit from the Bureau of Alcohol,  Tobacco,
and  Firearms  ("BATF")  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.  BATF 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.

         Taxation  of  alcohol  has  increased  significantly  in recent  years.
Currently, the Federal 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. The  California  tax rate is $6.20 per
bbl.

         The Hopland  Brewery's  brewpub is  regulated by the  Mendocino  County
Health Department, which requires an annual permit and conducts spot inspections
to monitor compliance with applicable health codes.

         The  Company's   production   operations  must  also  comply  with  the
Occupational  Safety and  Health  Administration's  workplace  safety and worker
health  regulations and applicable  state laws thereunder.  Management  believes
that the Company  presently is in compliance  with the  aforementioned  laws and
regulations and has implemented its own voluntary safety program.

Environmental Regulation

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

                                      -8-

<PAGE>

         The Company's waste products  consist of water,  spent grains and hops,
and 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 pays approximately $1,000 per month in sewage fees relating
to waste water from its Hopland  facility.  The Company gives its spent grain to
local cattle ranchers, who pick up the spent grain at their expense. The Company
has not purchased any special equipment and does not incur any identifiable fees
in connection with its environmental compliance at its Hopland site.

         Management   anticipates  that  Mendocino  Brewing  will  continue  its
recycling  program  at the new  brewery.  Because  of the  increased  quantities
involved,  Management expects the Company to sell the spent grain from the Ukiah
location to ranchers  and/or dairy farmers rather than give it away. The Company
has built its own  wastewater  treatment  plant  for the  Ukiah  facility.  As a
consequence,  the Company  will not be 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 will be required to pay  additional  fees. The estimated cost of the
wastewater treatment facility is approximately  $900,000, and the estimated cost
of  operating  the plant is between  $6,000 and $10,000 per month.  The cost may
increase with increased production.  The Company is exploring various methods of
recycling  treated  wastewater and could realize some revenue from doing so. The
Company has contracted to have the liquid sediment that remains from the treated
wastewater to be trucked to a local composting facility for essentially the cost
of  transportation.  A  Mendocino  County Air  Quality  Control  Permit  will be
required to operate the natural gas fired boiler at the new facility.

         The Company has not  received any notice from any  governmental  agency
that it is a potentially responsible person under any environmental law.

Research and Development

         In 1995 the  Company  performed  some  research  into  low-alcohol  and
non-alcoholic  ale.  Research and  development  activity  1996 was minimal.  The
Company intends to use its original  brewing  facility at the Hopland Brewery to
develop and test market new brews after completion of the new facility.

Qualified Small Business Issuer

         Federal and  California  tax laws  provide a 50%  exclusion of any gain
from the sale of "qualified small business stock." For shares to qualify for the
exclusion, several tests must be met. For instance, the shares must be purchased
directly from the Company,  not in any later trading market, and the shares must
be held for at least five years.

         A  "qualified  small  business"  must not have more than $50 million in
assets,  at  least  80% of  which  are used in a  qualified  trade  or  business
throughout the holding period.  A "qualified trade or business" does not include
"operating a hotel,  motel,  restaurant,  or similar  business." It is uncertain
whether  the  Company's  operation  of the  Hopland  Brewery  brewpub  currently
prevents it from meeting the definition of "qualified  small  business",  as the
brewing  equipment in Hopland is  presently  used in both  wholesale  and retail
operations and no applicable regulations have been published to assist in making
such determination.  Management believes, after consulting with its accountants,
that  completing  the new brewery  will reduce the assets of the Company used in
the operation of the brewpub to well below 20%, but  Management  does not intend
to request any opinions or rulings on this issue at the present time.

         The  Company  intends  to submit  reports  if and to the extent any are
required  under  federal  law to  make  the 50%  exclusion  from  capital  gains
available, and submitted such a report in California for 1995, the first year in
which  California  required  such a report.  Given  the  absence  of  applicable
regulations, there is no assurance that California taxing authorities will agree
with the  information  contained  in the report.  There are  limitations  on the
persons who may use any exclusion.  Prospective  investors  should consult their
own tax advisors concerning the possible applicability of these exclusions.

                                      -9-
<PAGE>

Item 2.  Description of Property.

         The Company  currently leases a 15,500 square foot building in Hopland.
The lease expires on September 1, 2004. Additionally, the Company leases a 4,000
sq. ft. portion of a warehouse, located approximately two miles from the Hopland
facility. The Company owns nine acres of land in Ukiah,  California on which the
Company is completing its new brewery.


Item 3.  Legal Proceedings.

         The Company is not  currently  involved in any material  litigation  or
proceeding. The Company has received a written claim by a terminated distributor
that its  termination was improper  notwithstanding  the language of the written
distribution  agreement  permitting  either party to terminate by giving 30 days
written  notice.  No legal action has been instituted with respect to this claim
as of the date of this  Report.  Management  does not believe  that there is any
merit to the claim.


Item 4.  Submission of Matters to a Vote of Security Holders.

         There  were no  matters  submitted  to a vote of the  security  holders
during the fourth quarter of 1996.

                                     PART II

Item 5.  Market for Common Equity and Related Stockholder Matters.
<TABLE>

         Mendocino  Brewing's  Common  Stock  was  listed on the  Pacific  Stock
Exchange  (symbol  MBR) on February  21,  1995.  The high and low closing  sales
prices for the Common  Stock on the Pacific  Stock  Exchange are set forth below
for the quarters indicated:
<CAPTION>

                             1995                                                1996
      --------------------------------------------------   ---------------------------------------------------
      1st Quarter   2nd Quarter  3rd Quarter  4th Quarter  1st Quarter  2nd Quarter  3rd Quarter   4th Quarter
<S>     <C>            <C>          <C>          <C>          <C>         <C>          <C>            <C>  
High    $13.50         $9.25        $8.75        $8.12        $7.38       $10.82       $10.00         $8.38
Low      $7.62         $7.12        $7.75        $7.00        $5.50        $5.82        $7.38         $5.75
</TABLE>

         There were approximately  2,435 shareholders of record as of January 6,
1997.  Management intends to retain Mendocino  Brewing's earnings for use in the
business  and  does  not  expect  the  Company  to  pay  cash  dividends  in the
foreseeable  future.  The Company's credit  agreements  provide that the Company
shall 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  such
restrictions  will remain in effect for as long as the  Company has  significant
bank  financing,  including  the  long-term  debt on the Ukiah real estate.  The
holders of the Company's 227,600  outstanding shares of Series A Preferred Stock
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 are canceled after they 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.

Item 6.  Management's Discussion and Analysis.

         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.

                                      -10-

<PAGE>

Overview

         Mendocino  Brewing's   financial   performance  during  1996  was  been
characterized  by increased sales and gross profits from brewing  operations and
decreased  cost of goods sold as a percentage of net sales,  offset by increased
marketing  expenses,  administrative  expenses  attributable  to  the  Company's
expansion  plan and the cost of being a public  company,  and the  aggregate net
effect of certain  one-time  gains,  certain  one-time  losses,  and  decreasing
interest  earnings  from  the  net  proceeds  of the  Company's  initial  public
offering.  Management  attributes the increase in sales to the implementation of
new marketing  strategies,  including new point of sale materials and additional
field  sales   representatives,   beginning  in  the  second  quarter  of  1996.
Improvements to brewing  operations in September 1995 increased  capacity by 32%
and significantly reduced cost of goods as a percentage of sales.

         Comparing  1996 to 1995,  net sales were up 7.7%,  gross  profit was up
12.2%,  and. cost of goods sold was down 2.0% as a percentage  of net sales.  In
1996, the bankruptcy of a distributor,  increased promotional and labor expenses
associated  with the operation of the Hopland  Brewery  brewpub and  merchandise
store,  and  increased  marketing  expenses  resulted  in a  36.8%  increase  in
operating  expenses.  While Management plans to continue marketing expenses at a
high level and plans to continue  promotional  expenses  at the Hopland  Brewery
brewpub at current  levels,  the Company  will not incur any  additional  losses
(approximately  $33,000) attributable to the bankrupt distributor.  Management's
decision  to write off $47,600 in  expenses  incurred  in  exploring a long-term
alliance  with  a  mid-western   distribution   company  (classified  as  "other
expense"),  when combined with a $117,500  decrease in net interest  earnings as
the Company spent the cash  proceeds from the public  offering for equipment and
building  construction,  resulted in a $123,800 loss for 1996 compared to income
of $173,700 for the same period in 1995.

Results of Operations

         The following  tables set forth, as a percentage of net sales,  certain
items  included in  Mendocino  Brewing's  Statements  of Income.  See  Financial
Statements  and  Notes  thereto.

                                                  Year Ended December 31,
                                                  -----------------------
                                                     1996           1995
                                                    ------         ------
Statements of Income Data:
  Sales .........................................   104.30%        104.73%
  Less excise taxes .............................     4.30           4.73
                                                    ------         ------
  Net sales .....................................   100.00         100.00
  Costs of goods sold ...........................    49.74          51.77
                                                    ------         ------
  Gross profit ..................................    50.26          48.23
  Operating expenses ............................    54.75          43.10
                                                    ------         ------
  Income (loss) from operations .................    (4.49)          5.13
  Other income (expense) ........................    (0.77)          4.03
                                                    ------         ------
  Income (loss) before income taxes .............    (5.26)          9.16
  Provision for (benefit from) income taxes .....    (2.04)          4.29
                                                    ------         ------
  Net income (loss) .............................    (3.22)%         4.87%
                                                    ======         ======

                                                         At December 31,
                                                 -------------------------------
                                                       1996              1995
                                                 ---------------    ------------
Balance Sheet Data:
     Cash and cash equivalents ..............      $   494,800       $1,696,100
     Working capital ........................       (3,616,800)         959,100
     Property and equipment .................        9,270,300        3,954,100
     Deposits and other assets ..............          304,100           71,000
     Total assets ...........................       11,144,600        6,514,000
     Long-term debt .........................             --            554,900
     Obligation under capital lease .........        1,863,000             --
     Total liabilities ......................        6,844,200        2,089,800
     Shareholder's equity ...................        4,300,400        4,424,200

                                      -11-

<PAGE>

         Sales.  Net sales  increased 7.7% from $3,566,500 in 1995 to $3,839,700
in 1996.  Management attributes the growth in sales to the implementation of new
marketing strategies, including new point of sale materials and additional field
sales  representatives,  beginning in the second  quarter of 1996. A decrease in
sales in the first and fourth quarters of 1996 compared to 1995 was offset by an
increase  in sales in the second and third  quarters  of 1996  compared to 1995.
Management  attributes  the  decrease in the first  quarter of 1996 to delays in
implementing  the new  marketing  plan,  the  increases  in the second and third
quarters  of 1996 to the new  marketing  plan,  and the  decrease  in the fourth
quarter to a  wholesale  price  reduction  in  September  1996 (see  "Business -
Pricing  Strategy")  plus a  decrease  in case  shipments  of  1.7%.  Management
attributes  approximately  half of the sales  increases  in the second and third
quarters  to  increased  sales to  existing  distributors  and the other half to
geographic   expansion.   Retail  sales  at  the  Hopland  Brewery  brewpub  and
merchandise  store  were  down  2.4%  for  1996  compared  to  1995.  Management
attributes the decline in sales at the Hopland  Brewery  brewpub and merchandise
store to slower off-premise bottled beer sales (due to increased availability of
MBC products outside of Hopland) offset by increased food sales.

         Cost of goods sold. Cost of goods sold decreased as a percentage of net
sales by 2.0 percentage points from 1995 to 1996. The  implementation of 24-hour
brewing  in  September  1995  significantly  improved  production  efficiencies.
Management  negotiated a reduction in the cost of bottles  starting in the third
quarter of 1995.

         Gross profit.  Gross profit  increased 12.2% from $1,720,000 in 1995 to
$1,930,000 in 1996.

         Operating expenses.  Operating expenses increased 36.8% from $1,537,300
in 1995 to $2,102,400 in 1996.  Several  factors  contributed  to the increases.
Marketing  expenses  increased  by  $404,500  from  1995  to  1996.   Management
attributes  the  increases  to  $120,400  in  increased  point of sale and other
promotional  and  advertising  costs,  $77,400 in increased  marketing and sales
labor,  $54,000 to additional periodic price discounts to distributors,  $48,700
in increased travel and lodging  expenses  incurred in developing new geographic
markets,  $47,200 to increased distribution expense, $32,900 to the write-off of
a bad  debt  from a  bankrupt  distributor,  and  $23,900  in net  miscellaneous
expenses.  Most of the foregoing  expenses were incurred in connection  with the
Company's  expansion plan.  Management  expects the Company to further  increase
marketing expenses through 1997.  General and  administrative  expense increased
from 1995 to 1996 by $71,600  consisting  of $47,200 in  increased  labor costs,
$27,800 in increased legal fees, $18,400 in un-reimbursed  glass recycling fees,
and  $14,100  in costs  associated  with  being a public  company,  offset  by a
decrease in  profit-sharing  retirement  plan  contribution of $30,000 and a net
decrease of $5,900 in other costs.  Finally,  operating  expenses at the Hopland
Brewery  brewpub and  merchandise  store  increased  from 1995 to the comparable
period in 1996 by $89,000 due  primarily to $55,500 in  additional  labor costs,
$17,900 in  increased  promotional  expenses,  and $15,600 in net  miscellaneous
expenses.

         Impact of  Inventory  Aging  Policies.  During the time that  Mendocino
Brewing's  distributors  were on  allocation,  the  Company  shipped  all of its
product  promptly  upon  production.   Product   freshness  was  not  an  issue.
Inventories of packaged beer increased when the Company initially  increased its
capacity in late 1995 and early 1996 before implementing its new marketing plan.
The Company does not use  preservatives  in its products,  and  accordingly  the
packaged beer has a shelf life of approximately  120 days from the release date.
The  Company's  policy  is to  sell  product  to  distributors  with  sufficient
remaining  shelf  life to ensure  that the beer  will be fresh  when sold to the
consumer.  Product that remains unsold after 120 days is returned to the Company
for destruction or other disposition.  In accordance with these policies, in the
third  quarter  of 1996,  the  Company  wrote-down  its  inventories  by $51,000
representing  approximately  6,000 cases of product  remaining  from its initial
overproduction.  The  write-down  was  reflected as an increase in cost of goods
sold.

         Other income (expense). Other income (expense) decreased by $173,600 in
1996 compared to the same period for 1995 primarily as a result of a decrease of
$117,500  in net  interest  earnings  as cash  from the  initial  direct  public
offering  was  used  for the  expansion  project,  a  write-off  of  $38,300  in
professional  expenses  and  $9,300 in product  development  costs  incurred  in
exploring a long-term alliance with a mid-western  distribution company, and the
non-recurrence of $15,300 in one-time refunds of workers' compensation premiums.
These  expenses  were  offset by $3,600 in income from  disposition  of unneeded
assets and $3,200 additional miscellaneous income.

                                      -12-

<PAGE>

         Provision  for (benefit  from) income taxes.  The Company  recognized a
benefit  from income  taxes in 1996 of $78,200  compared to a tax  provision  of
$173,700 for the same period in 1995. See "Notes to Financial Statements, Note 1
- Description of Operations and Summary of Significant  Accounting  Policies and
Note 12 - Income Taxes."

         Net income  (loss).  For 1996 compared to the same period for 1995, net
income was down  $297,500  for a net loss of $123,800  compared to net income of
$173,700 due to a $565,000 increase in operating expense and a $173,600 decrease
in other income  (expense)  which more than offset a $210,000  increase in gross
profit and a $231,100 reduction in the provision for income taxes.

Segment Information

         Mendocino  Brewing's business  presently consists of two segments.  The
first is brewing for wholesale to distributors and other retailers. This segment
accounted  for 76.6% of the  Company's  1996 annual  sales.  The second  segment
consists  of  brewing  beer for sale  along  with  food and  merchandise  at the
Company's  brewpub  and retail  merchandise  store,  the Hopland  Brewery.  This
segment  accounted for 23.4% of the Company's  1996 annual sales,  9.3% of which
consisted  of the sale of draft and bottled  beer,  and the  remaining  14.1% of
which  consisted  of sales of food and  merchandise.  Wholesale  and retail beer
sales in both segments combined comprised 85.9% of the Company's annual sales in
1996. See "Notes to Financial Statements, Note 13 - Segment Information."

         Mendocino  Brewing is now in the  process  of  increasing  its  brewing
capacity by more than three times  (18,000 bbl. to 60,000  bbl.).  Proceeds from
the sale of all of the stock  offered in the  Company's  current  direct  public
stock offering would permit the Company to expand its operations to up to 75,000
bbl. per year,  an aggregate  increase from the  Company's  current  capacity of
18,000  bbl. of more than four  times.  (See  "Business:  New  Brewery")  As the
Company  does not intend to expand its brewpub  operations,  Management  expects
that retail sales, as a percentage of total sales, will decrease  proportionally
to the expected increase in the Company's wholesale sales.

Seasonality

         Beer consumption nationwide has historically increased by approximately
20% during the summer months. Mendocino Brewing's wholesale distributors were on
allocation  while the  Company's  annual  capacity was capped at 13,600 bbl., so
seasonality  had little  effect on wholesale  sales through late 1995. It is not
clear to what  extent  seasonality  will  affect the  Company as it expands  its
capacity and its  geographic  markets.  The Company brews four  seasonal  beers:
Springtide Ale in March,  Eye of the Hawk Select Ale from July through  October,
Frolic Shipwreck Ale 1850 in July, and Yuletide Porter in November and December.
These  seasonal beers tend to augment sales during the periods in which they are
available.   Retail  operations,   which  depend  largely  on  tourist  traffic,
historically have been higher in the third and fourth quarters.

Financing the New Brewery.

         New Brewery Cost.  The presently  estimated  cost of the new brewery at
its initial annual capacity of 60,000 bbl. is $11.4 million.  This includes $0.8
million for the land,  $7.1 million for  improvements  to the real estate,  $3.1
million for  equipment,  and $0.4 million for financing  costs.  Increasing  the
initial  annual  capacity  of the new  brewery to 75,000  bbl.  will  require an
additional  expenditure  for equipment of  approximately  $0.5 million.  Of this
amount,  approximately  $9.84  million has been paid or  provided  for from cash
raised in the Company's  initial direct public offering and the proceeds of debt
described below and cash from operations.  The balance of approximately  $1.56 -
$2.06 million will have to be funded from the proceeds of the Company's  current
direct public offering, cash from operations,  and/or other sources as described
below.

         Construction  Financing.  Mendocino Brewing has obtained a $2.7 million
construction  loan secured by a first  priority  deed of trust on the Ukiah land
and improvements and the proceeds of the current direct public offering from the
Savings Bank of Mendocino County along with a written  commitment to convert the
construction  loan to a 15 year term loan upon successful  completion of the new
brewery, subject to certain conditions.  As of March 31, 1997, approximately 89%
of the construction  loan had been funded.  The construction loan bears interest
at the lender's prime plus 2% (initially  10.25%),  payable monthly.  The lender
has  agreed  to  extend  the  due  date  to July  1,  1997,  and  the  necessary
documentation  is  pending.  Assuming  that the loan is  extended,  the  current
commitment provides that upon

                                      -13-

<PAGE>

conversion,  the loan will bear interest at the then  prevailing 5 Year Treasury
Constant  Maturity  Index (but not less than 10%),  with a maximum for the first
five years at 2% above the initial fully indexed rate,  and a maximum during the
remaining  term of the loan at 3% above the initial  fully  indexed  rate at the
beginning of the remaining  term.  The minimum  annual  interest rate is 8%. The
loan will be over 25 years with a balloon  payment upon  maturity.  The lender's
commitment  letter  states that the lender will convert the unpaid  principal at
maturity to a fully amortized 10-year loan subject to terms and conditions to be
agreed upon at that time. The commitment  letter proposes to require the Company
to pledge all proceeds of the Company's current direct public offering in excess
of $2.5 million as collateral for the 15-year term loan, with the provision that
the  lender  will  release  the funds  from the  pledge to  purchase  additional
equipment if the Company is meeting its sales and revenue objectives.

         Equipment  Lease.  FINOVA Capital  Corporation has also agreed to lease
new  brewing  equipment  with a total  cost of  approximately  $2.07  million to
Mendocino  Brewing  for a term  of 7  years  with  monthly  rental  payments  of
approximately  $29,000 each.  The lease  commenced in December 1996. As of March
31, 1997,  approximately  81% of the lease had been  funded.  The balance of the
funds are deemed to have been advanced but are held by FINOVA as cash collateral
pending  acquisition of certain additional  equipment.  Before that time, FINOVA
advanced $750,000 to the Company with interest at the Citibank prime plus 3%. At
expiration  of the  initial  term of the lease,  the Company  may  purchase  the
equipment  at its then  current fair market value but not less than 25% nor more
than 30% of the original cost of the equipment,  or at the Company's option, may
extend the term of the lease for an additional year at approximately $45,600 per
month with an option to purchase  the  equipment  at the end of the year at then
current fair market value. The lease is not pre-payable.

         Seller Financing of Ukiah Real Estate. The seller of the Ukiah land has
a note,  secured by a third priority deed of trust on the land, with a remaining
principal balance as of December 31, 1996 of approximately $262,600 at 9% annual
interest  payable in monthly  installments  of principal  and interest of $2,380
with the balance due at maturity on June 27, 1997.

         WestAmerica Loan. WestAmerica Bank of Santa Rosa, California has loaned
Mendocino Brewing $600,000 secured by Mendocino  Brewing's  accounts  receivable
and  inventory.  The loan is fully  funded  and  bears  interest  at a  variable
interest rate of prime plus 1.5% payable  monthly and matures on April 27, 1997.
WestAmerica Bank has not indicated to the Company whether it will renew the loan
or on  what  terms.  The  Company  has an  outstanding  commitment  letter  from
WestAmerica Bank to convert the $600,000 term loan to a revolving line of credit
with  an  advance  rate  of 80% of  qualified  accounts  receivable  and  25% of
inventory.  Conversion of the loan by WestAmerica Bank will likely depend, among
other things,  on whether  WestAmerica Bank renews the loan at maturity.  As the
Company's  sales  continue to expand,  the amount of inventory  and  receivables
financing available should increase proportionately, assuming an otherwise sound
financial  condition.  These forward looking statements are subject to risks and
uncertainties.  Even if the Company's accounts receivable and inventory grows in
quantity,  credit may be unavailable for other reasons relating to the Company's
business,  financial  condition,  and  results  of  operations,  the craft  brew
industry, the lending industry, or economic conditions in general. To the extent
that the loan is not  extended or  refinanced,  the Company  will be required to
repay the loan out of cash from  operations,  the net proceeds of the  Company's
current  direct  public  offering,  or the  proceeds  of another  debt or equity
financing, a strategic alliance, or a joint venture.

         Vendor  Financing.  The general  contractor  for the new  brewery,  BDM
Construction  Co.,  Inc.  ("BDM"),  has agreed to defer up to  $900,000  in fees
otherwise owed or to become payable on December 31, 1996, subject to performance
by BDM of its obligations  under the  construction  contract,  until January 31,
1997 with interest at 12% per annum. As of December 31, 1996,  $300,000 had been
deferred under this arrangement. Additional amounts payable to BDM after January
31, 1997 are  outstanding  and no  modifications  have been made to the deferral
arrangement to address the current  circumstances.  The deferral  arrangement is
secured by a second  priority deed of trust on the Ukiah land and  improvements,
and by 300,000  shares of  Mendocino  Brewing's  Common  Stock.  In the event of
default,  BDM is required to proceed against the Common Stock before  initiating
any proceeding  against the real estate.  The Common Stock collateral was issued
to BDM by the Company  pursuant to Section  4(2) of the  Securities  Act of 1933
subject to the restrictions (a) that the shares shall be canceled if the amounts
owed BDM are paid in full,  (b) that if full  amount  owed BDM is not paid,  the
shares must be sold in a  commercially  reasonable  manner as  specified  in the
California Commercial Code, and (c) that any shares not needed to be sold to

                                      -14-

<PAGE>

satisfy the obligation to BDM shall be canceled.  Under  California law, BDM may
not retain the shares in  satisfaction  of the  obligation  without  the written
consent of the Company given after an event of default.  Management  had planned
to pay the  Company's  obligation  to BDM out of the  proceeds of the  Company's
current direct public offering,  but the Company has not yet raised net proceeds
sufficient  to do so. See "New  Brewery  Cost." BDM has the right to require the
Company to register the shares issued for its account for sale to the public. As
of April 9,  1997,  BDM has not  taken  any  action  to  enforce  the  Company's
obligations  to it. To the extent  that the  proceeds of the  Company's  current
direct public offering are insufficient, the Company will be required to pay the
obligation  out of cash from  operations,  proceeds  from the sale of the shares
held as  collateral,  or the  proceeds  of  another  debt or  equity  financing,
strategic alliance, or a joint venture.

         Other  Financing.  Mendocino  Brewing has entered into a keg management
agreement with MicroStar Keg Management LLC. Under this  arrangement,  MicroStar
provides the Company with  half-barrel kegs for which the Company pays a filling
fee. Distributors return the kegs to MicroStar instead of the Company. MicroStar
then supplies the Company with additional kegs. If the agreement terminates, the
Company is  required to purchase a certain  number of kegs from  MicroStar.  The
Company would probably finance the purchase through debt or lease financing,  if
available.

         Remaining  Costs.  To finance the  anticipated  cost of the new brewery
(approximately  $1.56 million for a 60,000 bbl.  brewery and $2.06 million for a
75,000 bbl.  brewery)  management  initiated the direct public offering which is
currently  under way. If the proceeds from such offering are not  sufficient and
timely, financing will need to be provided by vendors, future operations,  other
debt or equity financing,  or a strategic alliance or joint venture or expansion
plans and operations will need to be deferred or curtailed. As of April 9, 1997,
the Company did not have any enforceable commitment for the necessary additional
financing.

Liquidity and Capital Resources

         Generally. The expansion now underway has had and will continue to have
a material impact on Mendocino  Brewing's assets,  liabilities,  commitments for
capital  expenditures,  and liquidity.  Capital resources for the expansion plan
have been  supplied by the net proceeds of Mendocino  Brewing's  initial  public
offering and debt and equipment  financing as described  above.  Working capital
for day to day business  operations  has  historically  been provided  primarily
through  operations.  Proceeds  from  operations  are not  expected  to  provide
sufficient working capital for day to day operations as the Company expands.

         New Brewery.  See "-- Financing the New Brewery" above.

         Debt to Equity Ratio.  Upon  completion  of the new brewery,  Mendocino
Brewing will have long-term debt and equipment financing commitments  (including
current portions) of at least $5.0 million. The exact amount to be financed will
depend on the results of the  Company's  current  direct  public  offering,  the
amount and type of any additional equipment  purchased,  and the extent to which
the Company obtains debt or lease financing for additional  equipment.  On a pro
forma basis,  as of December 31, 1996 assuming  that the Company's  $2.7 million
short-term  construction  loan had instead been a long term loan,  the Company's
ratio of long-term debt to shareholder's  equity,  which was actually 0.47 to 1,
would have been 1.11 to 1.

         Impact of  Expansion on Cash Flow.  Mendocino  Brewing must make timely
payment of its debt and lease  commitment  to continue in  operation.  Increased
capacity will also place additional  demands on the Company's working capital to
pay the cost of additional sales and marketing activities and staff,  production
personnel, and administrative staff and to fund increased purchases of supplies.
There will be a lag between the time the Company must incur some or all of these
costs and the time the Company realizes  revenue from increased  sales.  Working
capital to fund these  expenses  will have to be provided by trade terms offered
by suppliers and vendors,  the proceeds of the Company's  current  direct public
offering,  additional  debt or equity  from other  sources,  and/or  deferral of
certain expenses.  As of April 9, 1997, the Company did not have any enforceable
commitment for the necessary additional financing.

         Direct Public Offering. In February 1997 the Company commenced a direct
public offering of 600,000 shares of common stock at an offering price of $8.50.
As of March 31, 1997, the Company had received  subscriptions  for approximately
16,000 shares ($136,000).

                                      -15-

<PAGE>

         Strategic  Alliances and Joint Ventures.  The rapid growth of the craft
beer  industry has been  characterized  in part by a variety of  consolidations,
strategic  alliances,  and joint ventures.  Mendocino Brewing and its President,
Michael Laybourn,  are very visible within the craft brew segment because of the
Company's place in the history of modern craft brewing,  the  distinctiveness of
its Red Tail Ale and Blue Heron Pale Ale labels,  and Mr. Laybourn's  leadership
positions  in  industry  trade  groups.  See  "Management."  From  time  to time
Mendocino  Brewing has received  indications  of interest in forming a strategic
alliance, joint venture, or other relationship.  To date, only one such proposal
evolved beyond a term sheet before the Company withdrew from  negotiations.  The
Company is,  however,  carrying on discussions  with certain  parties that could
result in a strategic  alliance or joint venture.  The Company's primary goal in
any such  arrangement  would be to  obtain  additional  capital  to  expand  the
capacity  of the new  brewery  to  200,000  bbl.  per  year  and  enter  into an
arrangement  for  sharing  the  expanded  brewery  capacity  to provide  optimal
utilization of overhead and thereby  reduce unit costs and/or access  additional
channels of domestic  and/or  international  distribution.  Creating  additional
value for  shareholders is an important  objective of these goals, but providing
liquidity by way of a sale or merger is not.  Nevertheless,  a sale or merger of
the Company is among the possible consequences of such discussions.  The Company
offers no  assurances  or estimates of the  possibility  that the Company  might
enter  into  such a  strategic  alliance  or  joint  venture  at any time in the
foreseeable future.


Item 7.  Financial Statements.

     The  information  required  by this item is set forth at Pages F-1  through
F-15 to this Report.


Item  8.  Changes  In and  Disagreements  With  Accountants  on  Accounting  and
Financial Disclosure.

     None.


                                    PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
With Section 16(a) of the Exchange Act.

Executive Officers, Directors, and Significant Employees

         The executive  officers,  directors,  and significant  employees of the
Company, and their ages as of March 31, 1997, are as follows:

     Name               Age  Position
-------------------    ----- ---------------------------------------------------
H. Michael Laybourn     58   Chief Executive Officer, President, and Chairman of
                             the Board

Norman H. Franks        50   Chief Financial Officer, Vice President, Treasurer,
                             and Director

Michael F. Lovett       50   Marketing Director, Secretary, and Director

Eric G. Bradley*        59   Director

Daniel R. Moldenhauer*  63   Director

Thomas I. Palmtag       53   National Sales Manager

John Scahill            57   Facilities Manager

Donald Barkley          43   Master Brewer
----------
*Member of the Compensation and Audit Committees

         H. Michael  Laybourn,  co-founder,  has served as the  Company's  Chief
Executive  Officer and President  since its inception in 1982. 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 Chairman of the Board
in June 1994. Before co-founding  Mendocino  Brewing,  Mr. Laybourn co-owned and
operated Thunder Road Design and Construction.  Mr. Laybourn is a Vice President
of the  California  Small  Brewers  Association  and  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.

                                      -16-

<PAGE>

         Norman  H.  Franks,  co-founder,  has  served  as the  Company's  Chief
Financial Officer and Vice President since its inception in 1982. Mr. Franks was
elected a  director  in  November  1993 when the  Company  began the  process of
converting  from a limited  partnership  to a  corporation.  Before  co-founding
Mendocino  Brewing,  Mr.  Franks  co-owned and operated  Thunder Road Design and
Construction.  Mr.  Franks  holds a  Bachelor  of Science  degree in  mechanical
engineering from the University of California, Berkeley.

         Michael F. Lovett joined the Company in 1983 as Assistant Master Brewer
and became  Marketing  Director in 1987,  serving  since that time under that or
other  titles.  Mr.  Lovett was  elected a director  in  November  1993 when the
Company  began  the  process  of  converting  from a  limited  partnership  to a
corporation and was appointed Secretary in June 1994. Between 1980 and 1983, Mr.
Lovett was Vice President Quality Control of New Albion Brewing Co. From 1976 to
1980, Mr. Lovett was Production  Superintendent  at Farm Foods in San Francisco.
He is the immediate past  Membership  Chairman and a past Technical  Chairman of
the Master Brewers  Association of the Americas.  Mr. Lovett holds a B.A. degree
in Psychology from San Francisco State College.

         Eric G. Bradley  became a director in June 1994. Mr. Bradley has been a
business and financial consultant since 1988. For the preceding 20 years, he was
employed by Kaiser Aluminum & Chemical Corp., in positions  rising from Division
Controller  to Business  Manager.  Mr.  Bradley is a Fellow of the  Institute of
Chartered Accountants (UK) and a Certified Personal Financial Planner.

         Daniel R. Moldenhauer  became a director in June 1994. Mr.  Moldenhauer
is a management  consultant.  He was president of Conex Products Inc. of Dublin,
California  from 1988 to 1990, a company  formed from assets  divested by Kaiser
Aluminum  &  Chemical  Corp.  and  later  sold to  Coleman  Cable  Systems.  Mr.
Moldenhauer  served in several  capacities with Kaiser Aluminum & Chemical Corp.
from 1971 to 1988, most recently as general manager of a subsidiary.

         Thomas I. Palmtag  joined the Company in January 1997 as National Sales
Manager.  Immediately before joining the Company,  he served as President of two
regional beer distributors, Colorado Beverage Distributing Co., Inc. of Colorado
Springs (1994 - 1995) and Mesa Distributing  Company,  Inc. of San Diego (1993 -
1994), both Miller distributors owned by Liquid Investments,  Inc. in San Diego.
From  1980  to  1993,  Mr.  Palmtag  served  in  various  capacities  for  Coast
Distributing Company in San Diego, an Anheuser-Busch distributor,  most recently
as Vice President and General Manager (1984 - 1993).  From 1977 through 1980 Mr.
Palmtag was employed as a Marketing Manager and Sales Manager for Anheuser-Busch
in Riverside and Sylmar,  California.  From 1967 through 1977 he was employed in
various capacities for beer distributors in Illinois and California. Mr. Palmtag
holds a B.S. degree from the University of Wisconsin.

         John  Scahill,  co-founder,  has  served  as the  Company's  Facilities
Manager since its inception.  Before  co-founding  the Company Mr. Scahill was a
self-employed  rancher.  Mr.  Scahill  has  a  background  in  construction  and
counseling  and  holds  a B.S.  degree  in  sociology  from  the  University  of
California, Berkeley.

         Donald Barkley joined the Company in 1983 as Master Brewer. Immediately
before joining the Company, Mr. Barkley was the Head Brewer and Plant Manager at
New Albion  Brewing Co. from 1981 to 1983. Mr. Barkley joined New Albion Brewing
Co. in 1978 and held several  positions.  In 1993 Mr.  Barkley was the President
and  representative  to the national  board of  governors of the Master  Brewers
Association of the Americas,  Northern California District.  Mr. Barkley holds a
B.S. degree in fermentation science from the University of California, Davis.

Director Term of Office

         Directors are elected at each annual meeting of  shareholders  to serve
until their  successors  are elected and qualified at the next annual meeting of
shareholders.

Item 10.  Executive Compensation.

         The following table sets forth, for the fiscal years ended December 31,
1995 and December 31, 1996, annual compensation,  including salary, bonuses, and
certain other compensation, paid by the Company to the Company's Chief Executive
Officer, Chief Financial Officer, and to all executive officers as a group. None
of the Company's other executive officers' total compensation  exceeded $100,000
for fiscal 1996.

                                      -17-

<PAGE>

<TABLE>
<CAPTION>
                                                                 Annual Compensation
                                                   Fiscal        -------------------       All Other
Name and Principal Position                         Year        Salary         Bonus     Compensation*
---------------------------                        ------     ----------     ---------   -------------
<S>                                                 <C>       <C>          <C>            <C>        
H. Michael Laybourn............................     1995      $    89,016  $    22,255    $     9,804
     Chief Executive Officer                        1996           89,016            0          7,053

Norman H. Franks...............................     1995           79,008       23,702          5,835
     Chief Financial Officer                        1996           79,008            0          3,567

All executive officers as a group..............     1995          233,464       55,758         20,701
     (3 persons)                                    1996          233,464       10,792         13,662
----------
<FN>
*    Includes an allowance  for health  insurance,  life  insurance,  disability
     insurance,  and  participation in the Company's  profit sharing  retirement
     plan  (annual  discretionary  contributions  by the Company of up to 15% of
     gross compensation).
</FN>
</TABLE>

Director Compensation

         The Company's inside directors do not receive any cash compensation for
their  service on the Board of  Directors.  Outside  directors  receive $600 per
meeting.  No  additional  fees  are  paid for  attending  Compensation  or Audit
Committee  meetings.  Directors  may be  compensated  for  certain  expenses  in
connection with their  attendance at Board meetings.  Since July 1996,  Director
Daniel  R.  Moldenhauer  has acted as a project  management  consultant  for the
Company with respect to its ongoing construction project.

Employment Agreements and Change in Control Arrangements

         The Company has entered into employment  agreements with its President,
Chief Financial Officer, and Marketing Director. The agreements call for minimum
annual base salary of $89,000, $79,000, and $55,000 respectively. The agreements
provide for bonus awards of a percentage of their  respective base salaries upon
the  satisfaction  of performance  objectives  established  by the  Compensation
Committee  (subject to the inherent  oversight powers of the Board) and approved
by the employee.  The agreements specify that the performance objectives must be
reasonably  attainable,  must not be probable of attainment without  significant
effort,  and must  reflect  or  indicate  that  value has been  created  for the
shareholders. The Compensation Committee may award a bonus regardless of whether
previously  specified  objectives  are realized if, as a result of an employee's
efforts or  leadership,  the Company has  achieved  other goals that  reflect or
indicate that value has been created for the shareholders.

         The agreements also require the Company to grant options to purchase up
to 20,000,  20,000,  and 10,000  shares,  respectively,  of Company Common Stock
pursuant to the Company's 1994 Stock Option Plan at exercise  prices of $9.2125,
$9.2125, and $8.375 per share,  respectively.  The options vest in equal monthly
increments  over five  years.  The option  agreements  have terms of 5 years,  5
years, and 10 years, respectively. The options were granted in January 1997.

         The  agreements  do  not  provide  for  any  benefits  as a  result  of
resignation or retirement.  The Board of Directors has discussed the subject of,
and might in the  future  grant,  retirement  benefits  to  Mendocino  Brewing's
founders in addition to their  participation  in the  Company's  profit  sharing
plan.

         The  agreements  provide for severance  benefits in the form of 36, 36,
and 18 months,  respectively,  of salary continuation if the Company actually or
constructively  terminates the employee's employment without cause as defined in
the agreement. If the actual or constructive  termination occurs within one year
after a change in control as defined in the agreement,  the  agreements  provide
for an  additional  lump sum benefit of up to $500,000,  $500,000,  and $250,000
respectively.  Any amount payable pursuant to these severance provisions will be
deferred  indefinitely  and  without  interest  to the extent  the amount  would
otherwise  constitute an excess parachute  payment as defined in Section 280G of
the Internal  Revenue Code.  Amounts so deferred may be paid at such time in the
future,  if any,  that no portion of the payment  will be  considered  an excess
parachute payment.

                                      -18-

<PAGE>

Item 11.  Security Ownership of Certain Beneficial Owners and Management.

         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 31, 1997, and as adjusted to reflect the sale of the
shares  offered in the Company's  current direct public  offering,  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, Management 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.
<TABLE>

COMMON STOCK:
<CAPTION>
                                                       Shares           Percentage of Shares Outstanding(1)
     Directors, Executive Officers,                 Beneficially         March 31, 1997      Pro Forma(2)
           and 5% Shareholders                          Owned           2,322,222 shares  2,922,222 shares
     -------------------------------               -------------        ----------------  ----------------
<S>                                                    <C>                    <C>               <C>  
     H. Michael Laybourn*................              272,367                11.73%             9.32%

     Norman H. Franks*(3)................              244,512                10.53%             8.36%

     Michael F. Lovett*(4)...............               93,034                 4.01%             3.18%

     Eric G. Bradley.....................                1,000                 0.04%             0.03%
       1056 Park Lane, Piedmont, CA  94610

     Daniel R. Moldenhauer...............                  500                 0.02%             0.02%
       662 St. Ives Court
       Walnut Creek, CA  94598

     John Scahill*.......................              248,809                10.71%             8.51%

     All directors and executive
       officers as a group (5 persons) ..              611,413                26.33%            20.92%

SERIES A PREFERRED STOCK:
                                                       Shares
     Directors, Executive Officers,                  Beneficially                  Percentage of
          and 5% Shareholders                           Owned                   Shares Outstanding
     ------------------------------                 ------------                -------------------
     H. Michael Laybourn..................               6,100                          2.68%
     All directors and executive
       officers as a group (five persons)                6,100                          2.68%

     * c/o Mendocino Brewing Company, Inc.
       13351 Hwy. 101 South
       Hopland, CA  95449-0400
<FN>
----------

1   Does not include 300,000 shares issued to BDM Construction Co., Inc. ("BDM")
    as security for the payment of up to $900,000  owed or to be owed to BDM for
    general  contractor  services  in  connection  with  the  new  brewery.  BDM
    presently has the power to vote the 300,000 shares.  Does not include 16,000
    shares,  subscripitions  for which the Company had received but not accepted
    as of March 31, 1997.

2   Assumes sale of all 600,000 shares offered pursuant to the Company's currant
    direct public offering.

3   Does not include 145 shares owned by Mr. Franks wife.  Mr. Franks  discliams
    any beneficial ownership of shares held in the name of his wife.

4   Mr.  Lovett's  shares are pledged to a  commercial  bank as  security  for a
    personal loan.
</FN>
</TABLE>

                                      -19-

<PAGE>

Item 12.  Certain Relationships and Related Transactions.

         There have been no  transactions  during the last two years,  and there
are now no  proposed  transactions,  involving  more than  $60,000  between  the
Company and any executive officer, director, nominee, 5% beneficial owner of any
class of the Company's  securities,  or member of the immediate family of any of
the foregoing persons, in which one or the foregoing individuals or entities had
a material interest, except as follows:

         On October 11, 1996, in recognition of Mr. Laybourn's personal guaranty
of  the  equipment   lease  with  FINOVA   Capital   Corporation   described  in
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations - Financing the New Brewery - Equipment Lease," the Company agreed to
grant  President  Michael  Laybourn a 5-year option to purchase 12,500 shares of
Common Stock of the Company at an exercise price of $8.80 per share.  The option
was granted in January 1997. Mr. Laybourn's  guaranty  automatically  terminated
when FINOVA made the final  payment for the purchase  price of the  equipment to
the manufacturer.

         The Company has entered into  written  employment  agreements  with its
President,  Chief  Financial  Officer,  and  Marketing  Director as described in
"Management -- Employment Agreements and Change in Control  Arrangements."

         It is  the  Company's  policy  that  all  transactions  with  officers,
directors,  nominees,  5%  beneficial  owners  of any  class  of  the  Company's
securities,  and  members  of the  immediate  families  of any of the  foregoing
persons be on terms no less favorable to the Company than could be obtained from
unaffiliated  third  parties.  The  Company's  bylaws  provide that the Board of
Directors  may approve  loans of money or  property  to, and  guaranties  of the
obligations  of,  officers of the  corporation,  and may adopt employee  benefit
plans  authorizing such loans and guaranties to officers of the corporation,  if
the vote of any  interested  director or  directors is not counted and the Board
determines  that such loan,  guaranty,  or plan may  reasonably  be  expected to
benefit the corporation.

Item 13.  Exhibits and Reports on Form 8-K.

Exhibit
Number         Description of Document
-------        -------------------------------

  3.1          (A) Articles of Incorporation, as amended, of the Company

  3.2          (B) Bylaws of the Company  (Incorporated  by referenced  from the
                   Company's  Report on Form 10-KSB for the annual  period ended
                   December 31, 1994 previously filed with the Commission.)

  4.1              Articles  5  and  6 of  the  Articles  of  Incorporation,  as
                   amended, of the Company (Reference is made to Exhibit 3.1.)

  4.2              Article 10 of the  Restated  Articles  of  Incorporation,  as
                   amended, of the Company (Reference is made to Exhibit 3.2.)

  4.3          (A) Form of Common Stock  Certificate  (Incorporated by reference
                   from the  Company's  Registration  Statement  dated  June 15,
                   1994,  as  amended,  previously  filed  with the  Commission,
                   Registration No. 33-78390-LA.)

 10.1          (A) Mendocino Brewing Company Profit Sharing Plan.

 10.2          (A) Wholesale  Distribution Agreement between the Company and Bay
                   Area Distributing.

 10.3          (A)  Wholesale  Distribution  Agreement  between  the Company and
                    Golden Gate Distributing.

 10.4          (F) Letter of Intent with Vitro Packaging, Inc.

 10.5          (A) Sales Contract between the Company and John I. Hass, Inc.

 10.6          (A) Lease Agreement between the Company and Kohn Properties.

 10.7          (A) Lease  Agreement  between the Company and Associated  Vintage
                   Group, Inc.

 10.8          (F)  Commitment  letter from  Savings  Bank of  Mendocino  County
                    (previously filed as Exhibit 19.9).

 10.9          (A)  Letter  of  intent  from  California   Statewide   Certified
                    Development Corporation.

                                      -20-

<PAGE>


Exhibit
Number         Description of Document
-------        -------------------------------

 10.10         (A) 1994 Stock Option Plan (previously filed as Exhibit 99.6).

 10.11         (C) Commercial  Real Estate  Purchase  Contract  and  Receipt for
                   Deposit (previously filed as Exhibit 19.2).

 10.12         (B) Proposal from Warren Capital Corporation.

 10.13         (C) Brewery Fixtures  Construction  Agreement with Enerfab,  Inc.
                   (previously filed as Exhibit 19.3).

 10.14         (D) Installment  Note  between  Ukiah  Redevelopment  Agency  and
                   Langley et al. (previously filed as Exhibit 19.5).

 10.15         (E) 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).

 10.16         (F) Standard  Form of Agreement  Between  Owner and Architect for
                   Designated Services between the Company and Victor Lopes.

 10.17         (F) Liquid Sediment  Removal  Services  Agreement with Cold Creek
                   Compost, Inc.

 10.18         (F) Promissory Note for $76,230 in favor of Langley et al.

 10.19         (G) Construction agreement with BDM Construction Company, Inc.

 10.20         (G) $60,000 Note payable to BDM Construction Company, Inc.

 10.21         (G) Agreement to modify note and deed of trust dated June 6, 1995
                   with Langley, et al.

 10.22         (G) Agreement to modify note dated June 6, 1995 with Langley,  et
                   al.

 10.23         (G) Amendment to installment note payable to Langley, et al.

 10.24         (G) Manufacturing  Business  Expansion  and Relocation  Agreement
                   with the City of Ukiah.

 10.25         (G) Manufacturing  Business  Expansion  and Relocation  Agreement
                   with the Ukiah Redevelopment Agency.

 10.26         (G) Consulting Agreement with Daniel R. Moldenhauer.

 10.27         (H) Business Loan Agreement with WestAmerica Bank.

 10.28         (J) Change in Terms Agreement with WestAmerica Bank.

 10.29         (J) Letter Agreement  Concerning Use of Proceeds with WestAmerica
                   Bank.

 10.30         (J) Commitment Letter from WestAmerica Bank.

 10.31         (J) Business  Loan  Agreement  with the Savings Bank of Mendocino
                   County.

 10.32         (J) Construction   Loan  Agreement  with  the  Savings   Bank  of
                   Mendocino County.

 10.33         (J) $2,700,000  Note  in favor of the Savings  Bank of  Mendocino
                   County.

 10.34         (J) Assignment of Deposit Account in favor of the Savings Bank of
                   Mendocino County.

 10.35         (J) Commitment Letter from the Savings Bank of Mendocino County.

 10.36         (J) Equipment Lease with FINOVA Capital Corporation.

 10.37         (J) Tri-Election  Rider to Equipment  Lease with  FINOVA  Capital
                   Corporation.

 10.38         (J) Master Lease Schedule with FINOVA Capital Corporation.

 10.39         (J) Advance and Subordination Agreement among the Company, FINOVA
                   Capital Corporation, and Enerfab, Inc.

 10.40         (J) $900,000 Note in favor of BDM Construction Co., Inc.

 10.41         (J) Letter  Agreement   Concerning  Use   of  Proceeds  with  BDM
                   Construction Co., Inc.

 10.42         (J) Employment Agreement with H. Michael Laybourn.


                                      -21-

<PAGE>

Exhibit
Number               Description of Document
-------              -------------------------------

 10.43         (J) Employment Agreement with Norman H. Franks.

 10.44         (J) Employment Agreement with Michael F. Lovett.

 10.45         (J) Employment Agreement with John Scahill.

 10.46         (A) 1994 Stock Option Plan (previously filed as Exhibit 99.6)

 19.1              Keg Management Agreement with MicroStar Keg Management LLC.

 19.2              Form of Change in Terms  Agreement  with the Savings  Bank of
                   Mendocino County

 27                Financial Data Schedule

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

               (B) Incorporated by referenced from the Company's  Report on Form
                   10-KSB  for  the  annual  period  ended   December  31,  1994
                   previously filed with the Commission.

               (C) Incorporated by referenced from the Company's  Report on Form
                   10-QSB for the quarter period ended March 31, 1995 previously
                   filed with the Commission.

               (D) Incorporated by referenced from the Company's  Report on Form
                   10-QSB for the quarter period ended June 30, 1995  previously
                   filed with the Commission.

               (E) Incorporated by referenced from the Company's  Report on Form
                   10-QSB  for the  quarter  period  ended  September  30,  1995
                   previously filed with the Commission.

               (F) Incorporated by referenced from the Company's  Report on Form
                   10-KSB  for  the  annual  period  ended   December  31,  1995
                   previously filed with the Commission.

               (G) Incorporated by referenced from the Company's  Report on Form
                   10-QSB for the quarter period ended June 30, 1996  previously
                   filed with the Commission.

               (H) Incorporated by referenced from the Company's  Report on Form
                   10-QSB/A  No. 1 for the  quarter  period  ended June 30, 1996
                   previously filed with the Commission.

               (J) Incorporated  by reference  from the  Company's  Registration
                   Statement  dated  February 6, 1997,  as  amended,  previously
                   filed with the Commission, Registration No. 333-15673.

The  registrant  did not file any Reports on Form 8-K during the last quarter of
the period covered by this report.

                                      -22-

<PAGE>

                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 of the  Exchange  Act,  the
registrant  caused  this  report to be signed on its behalf by the  undersigned,
thereto duly authorized.

                               (Registrant)   Mendocino Brewing Company, Inc.




                                              By: /s/ H. Michael Laybourn
                                                 -------------------------------
                                                 H.  Michael Laybourn,  Chairman
                                                     of  the  Board   and  Chief
                                                     Executive Officer

                                              Date:  April  15, 1997

     Pursuant to the requirements of Section 13 of the Exchange Act, this report
has been signed by the following  persons on behalf of the registrant and in the
capacities and on the dates indicated.




                                              By: /s/ Norman H. Franks
                                                 -------------------------------
                                                 Norman H. Franks, Director  and
                                                     Chief Financial Officer

                                              Date: April 14, 1997




                                              By: /s/ Michael F. Lovett
                                                 -------------------------------
                                                 Michael F. Lovett, Director

                                              Date: April 14, 1997




                                              By:
                                                 -------------------------------
                                                 Eric G. Bradley, Director

                                              Date: April  _________ , 1997




                                              By:
                                                 -------------------------------
                                                 Daniel R. Moldenhauer, Director

                                              Date: April  _________ , 1997


                                      -23-

<PAGE>


--------------------------------------------------------------------------------
                         MENDOCINO BREWING COMPANY, INC.

                          INDEPENDENT AUDITOR'S REPORT
                                       AND
                              FINANCIAL STATEMENTS

                           DECEMBER 31, 1996 AND 1995
--------------------------------------------------------------------------------

<PAGE>

--------------------------------------------------------------------------------


                                    CONTENTS


                                                                           PAGE

INDEPENDENT AUDITOR'S REPORT...............................................F - 1


FINANCIAL STATEMENTS

     Balance sheets........................................................F - 2

     Statements of operations..............................................F - 4

     Statements of stockholders' equity....................................F - 5

     Statements of cash flows..............................................F - 6

     Notes to financial statements.........................................F - 7


--------------------------------------------------------------------------------


<PAGE>

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors
Mendocino Brewing Company, Inc.


We have audited the  accompanying  balance sheets of Mendocino  Brewing Company,
Inc.,  as of  December  31,  1996  and  1995,  and  the  related  statements  of
operations,  stockholders' equity and cash flows for each of the two years ended
December 31, 1996.  These  financial  statements are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial  position of Mendocino  Brewing  Company,
Inc., as of December 31, 1996 and 1995,  and the results of its  operations  and
its cash flows for each of the two years ended  December 31, 1996, in conformity
with generally accepted accounting principles.

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a  going  concern.  As  discussed  in  Note 2 to the
financial  statements,  the Company has  significant  costs  associated with the
construction  of its new  brewery  and other debt that will  become due in 1997.
While the Company is presently pursuing various strategies, it does not have any
current  commitments  for  additional  capital or  financing to meet the payment
demands,  if made.  These  matters raise  substantial  doubt about the Company's
ability to continue as a going concern.  Management's  plans in regards to these
matters are also  described in Note 2. The  financial  statements do not include
any adjustments that might result from the outcome of this uncertainty.


                                                               /s/Moss Adams LLP

Santa Rosa, California
January 31, 1997, except for Note 2 as to which the date is March 31, 1997

                                                                      Page F - 1

<PAGE>

                                                 MENDOCINO BREWING COMPANY, INC.
                                                                  BALANCE SHEETS
--------------------------------------------------------------------------------

December 31,                                                1996         1995
--------------------------------------------------------------------------------

                                     ASSETS

CURRENT ASSETS
     Cash and cash equivalents                         $   494,800   $ 1,696,100
     Accounts receivable                                   317,400       458,900
     Inventories                                           380,500       256,200
     Prepaid expenses                                       58,600        47,100
     Refundable income taxes                                71,900          --
     Deferred income taxes                                  23,100        15,500
                                                       -----------   -----------

         Total current assets                            1,346,300     2,473,800
                                                       -----------   -----------

PROPERTY AND EQUIPMENT                                   9,270,300     3,954,100
                                                       -----------   -----------

OTHER ASSETS
     Label development costs, net of amortization           17,400        15,100
     Deferred stock offering costs                         202,000        11,400
     Deposits and other assets                             304,100        59,600
     Deferred income taxes                                   4,500          --
                                                       -----------   -----------

                                                           528,000        86,100
                                                       -----------   -----------

         Total assets                                  $11,144,600   $ 6,514,000
                                                       ===========   ===========


The accompanying notes are an integral part of these financial statements.
--------------------------------------------------------------------------------
                                                                      Page F - 2

<PAGE>

<TABLE>
                                                                             MENDOCINO BREWING COMPANY, INC.
                                                                                  BALANCE SHEETS (Continued)
-------------------------------------------------------------------------------------------------------------
<CAPTION>
December 31,                                                                          1996              1995
-------------------------------------------------------------------------------------------------------------

                                           LIABILITIES AND STOCKHOLDERS' EQUITY

<S>                                                                                    <C>         <C>      
CURRENT LIABILITIES
     Line of credit                                                                $   600,000   $      --
     Accounts payable                                                                  567,600       105,700
     Accrued wages and related expense                                                 118,200       129,800
     Accrued construction costs                                                        744,500     1,182,300
     Accrued liabilities                                                                16,100        22,300
     Accrued profit sharing                                                               --          30,000
     Income taxes payable                                                                 --          34,200
     Current maturities of long-term debt                                            2,765,400        10,400
     Current maturities of obligation under capital lease                              151,300          --
                                                                                   -----------   -----------

             Total current liabilities                                               4,963,100     1,514,700

LONG-TERM DEBT, less current maturities                                                   --         554,900

OBLIGATION UNDER CAPITAL LEASE, less
     current maturities                                                              1,863,000          --

DEFERRED INCOME TAXES                                                                   18,100        20,200
                                                                                   -----------   -----------

             Total liabilities                                                       6,844,200     2,089,800
                                                                                   -----------   -----------

STOCKHOLDERS' EQUITY
     Preferred  stock,  Series  A,  no par  value,
         with  aggregate  liquidation preference
         of $227,600; 227,600 shares authorized,
         issued and outstanding                                                       227,600       227,600
     Common stock, no par value; 20,000,000 shares
         authorized, 2,322,222 shares issued and
         outstanding                                                                 3,869,600     3,869,600
     Retained earnings                                                                 203,200       327,000
                                                                                   -----------   -----------

             Total stockholders' equity                                              4,300,400     4,424,200
                                                                                   -----------   -----------

             Total liabilities and stockholders' equity                            $11,144,600   $ 6,514,000
                                                                                   ===========   ===========


<FN>
The accompanying notes are an integral part of these financial statements.
-------------------------------------------------------------------------------------------------------------
</FN>
                                                                                                   Page F - 3
</TABLE>

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                                        STATEMENTS OF OPERATIONS

--------------------------------------------------------------------------------

Years Ended December 31,                                1996            1995
--------------------------------------------------------------------------------

SALES                                               $ 4,004,700     $ 3,735,100

LESS EXCISE TAXES                                       165,000         168,600
                                                    -----------     -----------

NET SALES                                             3,839,700       3,566,500

COST OF GOODS SOLD                                    1,909,700       1,846,500
                                                    -----------     -----------

GROSS PROFIT                                          1,930,000       1,720,000
                                                    -----------     -----------

OPERATING EXPENSES
     Retail Operating                                   738,200         649,200
     Marketing                                          682,300         277,800
     General and administrative                         681,900         610,300
                                                    -----------     -----------

                                                      2,102,400       1,537,300
                                                    -----------     -----------

INCOME (LOSS) FROM OPERATIONS                          (172,400)        182,700
                                                    -----------     -----------

OTHER INCOME (EXPENSE)
     Interest income                                     11,600         132,800
     Other income (expense)                             (41,200)         14,800
     Interest expense                                      --            (3,700)
                                                    -----------     -----------

                                                        (29,600)        143,900
                                                    -----------     -----------

INCOME (LOSS) BEFORE INCOME TAXES                      (202,000)        326,600

PROVISION FOR(BENEFIT FROM)  INCOME TAXES               (78,200)        152,900
                                                    -----------     -----------

NET INCOME (LOSS)                                   $  (123,800)    $   173,700
                                                    ===========     ===========

EARNINGS (LOSS) PER SHARE                           $     (0.05)    $      0.08
                                                    ===========     ===========

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING            2,322,222       2,307,074
                                                    ===========     ===========



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


<PAGE>


<TABLE>
                                                                                            MENDOCINO BREWING COMPANY, INC.
                                                                                         STATEMENTS OF STOCKHOLDERS' EQUITY
                                                                                     Years Ended December 31, 1996 and 1995
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------
                                           Series A
                                        Preferred Stock                Common Stock                                     
                                   --------------------------    --------------------------      Retained          Total
                                     Shares          Amount        Shares         Amount         Earnings         Equity
                                   -----------    -----------    -----------    -----------     -----------     -----------

<S>                                    <C>        <C>              <C>          <C>             <C>             <C>        
Balance, December 31, 1994             227,600    $   227,600      2,220,445    $ 3,342,400     $   153,300     $ 3,723,300

Issuance of common stock                  --             --          101,777        527,200            --           527,200

Net income                                --             --             --             --           173,700         173,700
                                   -----------    -----------    -----------    -----------     -----------     -----------

Balance, December 31, 1995             227,600        227,600      2,322,222      3,869,600         327,000       4,424,200

Net loss                                  --             --             --             --          (123,800)       (123,800)
                                   -----------    -----------    -----------    -----------     -----------     -----------

Balance, December 31, 1996             227,600    $   227,600      2,322,222    $ 3,869,600     $   203,200     $ 4,300,400
                                   ===========    ===========    ===========    ===========     ===========     ===========



<FN>
The accompanying notes are an integral part of these financial statements.
---------------------------------------------------------------------------------------------------------------------------
</FN>
                                                                                                                Page F - 5
</TABLE>

<PAGE>


<TABLE>
                                                                                        MENDOCINO BREWING COMPANY, INC.
                                                                                               STATEMENTS OF CASH FLOWS

-----------------------------------------------------------------------------------------------------------------------
<CAPTION>

Years Ended December 31,                                                              1996                    1995
-----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
<S>                                                                               <C>                      <C>        
     Net income (loss)                                                            $  (123,800)             $   173,700
     Adjustments to reconcile net income (loss) to net
         cash provided by operating activities:
             Depreciation and amortization                                             51,900                   49,300
             Loss (gain) on sale of assets                                             (3,600)                     500
             Deferred income taxes                                                    (14,200)                  20,600
         Changes in:
             Accounts receivable                                                      141,500                 (165,000)
             Inventories                                                             (124,300)                 (54,200)
             Prepaid expenses                                                         (11,500)                 (33,600)
             Refundable income taxes                                                  (71,900)                    --
             Accounts payable                                                         461,900                  (39,000)
             Accrued wages and related expense                                        (11,600)                  45,600
             Accrued liabilities                                                       (6,200)                   1,700
             Accrued profit sharing                                                   (30,000)                 (15,000)
             Income taxes payable                                                     (34,200)                  21,800
                                                                                  -----------              -----------

                Net cash provided by operating activities                             224,000                    6,400
                                                                                  -----------              -----------

CASH FLOWS FROM INVESTING ACTIVITIES
     Purchases of property, equipment and leasehold
         improvements                                                              (4,817,500)              (2,923,300)
     Other assets                                                                    (255,600)                 (16,400)
     Proceeds from sale of fixed assets                                                10,300                      500
                                                                                  -----------              -----------

                Net cash used by investing activities                              (5,062,800)              (2,939,200)
                                                                                  -----------              -----------

CASH FLOWS FROM FINANCING ACTIVITIES
     Net borrowings on line of credit                                                 600,000                     --
     Borrowings on long term debt                                                   2,502,800                     --
     Principal payments on long-term debt                                            (302,800)                 (11,700)
     Reimbursement from obligation under capital lease                              1,523,800                     --
     Payments on obligation under capital lease                                       (57,900)                    --
     Accrued construction costs                                                      (437,800)               1,182,300
     Proceeds from sale of common stock                                                  --                    568,900
     Deferred stock offering costs                                                   (190,600)                 (11,400)
                                                                                  -----------              -----------

                Net cash provided by financing activities                           3,637,500                1,728,100
                                                                                  -----------              -----------

DECREASE IN CASH AND CASH EQUIVALENTS                                              (1,201,300)              (1,204,700)

CASH AND CASH EQUIVALENTS, beginning of year                                        1,696,100                2,900,800
                                                                                  -----------              -----------

CASH AND CASH EQUIVALENTS, end of year                                            $   494,800              $ 1,696,100
                                                                                  ===========              ===========

<FN>
The accompanying notes are an integral part of these financial statements.
-----------------------------------------------------------------------------------------------------------------------
</FN>
                                                                                                             Page F - 6
</TABLE>

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                                   NOTES TO FINANCIAL STATEMENTS
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE  1   -   DESCRIPTION OF  OPERATIONS  AND  SUMMARY OF SIGNIFICANT ACCOUNTING
              POLICIES

Description  of  operations  - Mendocino  Brewing  Company,  located in Hopland,
California,  operates a  microbrewery  producing beer and malt beverages for the
specialty beer market,  and a brew pub and gift store. The majority of sales are
in California.

Inventories - Inventories are stated at the lower-of-average cost or market.

Property  and  equipment  -  Property  and  equipment  are  stated  at cost  and
depreciated or amortized using  straight-line  and accelerated  methods over the
assets' estimated useful lives. Capitalized interest was $214,900 and $15,200 in
1996 and 1995,  respectively.  Costs of  maintenance  and repairs are charged to
expense as incurred;  significant  renewals  and  betterments  are  capitalized.
Estimated useful lives are as follows:

         Machinery and equipment   5 -  7 years

         Furniture and fixtures    5 -  7 years

         Leasehold improvements    7 - 30 years

Amortization - Label development costs are amortized on the straight-line method
over a one-year period.

Deferred  stock  offering costs - Deferred stock offering costs consist of legal
and other costs  incurred  as part of the  Company's  public  offering of common
stock.

Deposits  and other  assets - Deposits  and other  assets  consist  primarily of
refundable deposits on the planned acquisition of brewing equipment during 1997.

Concentration of credit risks - Financial  instruments that potentially  subject
the  Company  to  credit  risk  consist  principally  of trade  receivables  and
interest-bearing   deposits   in   excess   of  FDIC   limits.   The   Company's
interest-bearing   deposits  are  placed  with  major  financial   institutions.
Wholesale  distributors  account  for  substantially  all  accounts  receivable;
therefore,  this concentration risk is limited due to the number of distributors
and state laws  regulating the financial  affairs of  distributors  of alcoholic
beverages.

Income  taxes - The  Company  accounts  for  income  taxes  under  Statement  of
Financial  Accounting  Standards No. 109,  "Accounting For Income Taxes",  which
requires  recognition  of deferred tax  liabilities  and assets for the expected
future tax  consequences  of events  that have been  included  in the  financial
statements  or tax  returns.  Under FAS 109, the Company is allowed to currently
recognize  future tax deductions of expenses  previously  recorded for financial
reporting purposes.

Cash  equivalents - The Company  considers all highly liquid  investments with a
current maturity of three months or less to be cash equivalents.

Earnings per share - Earnings per share were  computed by dividing net income by
the weighted average number of common shares  outstanding.  There were no common
stock equivalents.


--------------------------------------------------------------------------------
                                                                      Page F - 7

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE  1 -     DESCRIPTION OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING
              POLICIES (Continued)

Use of estimates - The  preparation of financial  statements in conformity  with
generally accepted accounting principles requires 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.

Advertising - Advertising costs are expensed as incurred.  Advertising  expenses
for the years ended  December  31,  1996 and 1995,  were  $93,900  and  $42,000,
respectively.

Fair value of financial instruments - The following methods and assumptions were
used by the  Company in  estimating  its fair value  disclosures  for  financial
instruments:

Cash and cash equivalents: The carrying amount reported in the balance sheet for
cash and cash equivalents approximates fair value.

Long-term debt: Based on the borrowing rates currently  available to the Company
for loans with similar terms and average maturities, the fair value of long-term
debt approximates cost.

Accrued  construction  costs - Accrued  construction  costs  consist of expenses
incurred for the construction of the new brewery including equipment.

Reclassifications  -  Certain  reclassifications  have  been  made  to the  1995
financial statements to conform to the 1996 presentation.


NOTE  2 -     GOING CONCERN AND MANAGEMENT'S PLANS

In September  1995,  the Company began  construction  of its new brewery with an
expected  completion  date  of  mid-1996.  The  brewery  was  to  be  paid  by a
combination  of financing  and the proceeds from the  Company's  initial  public
stock offering.  At the outset of construction,  the projected total cost of the
project,  including land,  building,  equipment and other costs, was $9,200,000.
The project is nearing  completion,  with the expectation  that the Company will
begin  brewing  and  selling  beer  in  April  1997.  However,  due to a  change
increasing the size and capacity of the brewery, cost overruns, and time delays,
the cost rose to an expected total of $11,400,000. The project is being paid for
and financed as follows:

o  $3,300,000 proceeds from the initial stock offering

o  $2,700,000  construction  loan to bank.  The bank has  provided a  commitment
   letter to convert the debt to permanent financing.

o  $2,100,000 in equipment financing as a capital lease

o  $800,000 to an individual for the acquisition of land. The current balance of
   $262,600 is due in September 1997.

o  $600,000 bank line of credit  secured by accounts  receivable  and inventory,
   maturing April 1997.

o  $900,000  to the  general  contractor

--------------------------------------------------------------------------------
                                                                      Page F - 8

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE  2 -     GOING CONCERN AND MANAGEMENT'S PLANS (Continued)

o  $550,000 of estimated  remaining  costs are  associated  with Phase II of the
   project and are expected to be deferred  until funds are available to pay for
   this work

o  $136,000 from funds  collected from the current stock offering  through March
   31, 1997

o  $314,000  balance is due to the general  contractor and other vendors with no
   current source of funding other than future operations

While the Company is pursuing various strategies, as outlined below, it does not
have any current  commitments  for  additional  capital or financing to meet the
payment demands of the obligations due in 1997, if those demands are made.

Management's plans to meet these obligations include the following strategies:

o  Sales are expected to increase  substantially with the opening of the brewery
   resulting in positive cash flow from operations

o  Increase efforts to attract investors to its current public stock offering

o  Negotiate extensions of due dates for debt due in 1997

o  Actively  pursue  other  sources  of equity  or debt  financing  through  the
   identification of a strategic alliance or joint venture partner

If  management  is  unsuccessful  in fully  realizing  its  plans,  there may be
uncertainty  about the Company's  ability to continue as a going concern.  These
financial  statements do not include any adjustments  that might result from the
outcome of this uncertainty.


NOTE  3 -     INVENTORIES

                                                      1996                 1995
                                                    --------            --------

Raw Materials                                       $121,800            $ 91,400
Work-in-process                                       81,700              89,500
Finished goods                                       139,800              37,200
Merchandise                                           37,200              38,100
                                                    --------            --------

                                                    $380,500            $256,200
                                                    ========            ========


--------------------------------------------------------------------------------
                                                                      Page F - 9

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE  4 -     PROPERTY AND EQUIPMENT

                                                           1996          1995
                                                        ----------    ----------

Construction in progress                                $5,719,600    $  921,700
Equipment in progress                                    2,573,600     2,031,800
Land                                                       810,900       810,900
Machinery and equipment                                    557,500       537,900
Leasehold improvements                                     129,000       129,000
Furniture and fixtures                                      19,800        19,800
                                                        ----------    ----------

                                                         9,810,400     4,451,100
Less accumulated depreciation and amortization             540,100       497,000
                                                        ----------    ----------

                                                        $9,270,300    $3,954,100
                                                        ==========    ==========

NOTE 5 -      LINE OF CREDIT

The Company has  available a $600,000 line of credit with interest at the bank's
index rate plus 1.5%.  The bank's  commitment  under the line of credit  matures
April 1997.  The  agreement  is secured by accounts receivable and inventory.

<TABLE>

NOTE  6 -     LONG-TERM DEBT
<CAPTION>

                                                                         1996           1995
                                                                       ----------     ---------
<S>                                                                       <C>          <C>    
Note payable  (construction  loan) to bank,  with interest at the 
     banks interest rate plus 2%; maturing June 1997; secured by 
     substantially all of the Company's assets                         $2,202,800     $   -

Note payable to  contractor,  with interest at 12%; due the later 
     of January 31, 1997 or 30 days after  completion  of the brewery; 
     secured by common stock and a second deed of trust
     on the brewery and subordinated to bank debt                         300,000         -

Note payable to an individual, due in monthly payments of $2,380, 
     including interest at 9%; maturing June 1997, with a balloon 
     payment of $260,500; secured by real property and
     subordinated to bank debt                                            262,600      489,100


-----------------------------------------------------------------------------------------------
                                                                                    Page F - 10
</TABLE>

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE  6 -     LONG-TERM DEBT (Continued)

                                                        1996             1995
                                                      ----------      ----------

Note payable to an individual, due in
     full December 1998, including
     accrued interest at 9%, secured
     by real property                                       --            76,200
                                                      ----------      ----------

                                                       2,765,400         565,300
Less current maturities                                2,765,400          10,400
                                                      ----------      ----------

                                                      $     --        $  554,900
                                                      ==========      ==========

NOTE  7 -     OBLIGATION UNDER CAPITAL LEASE

During  the year the  Company  entered  into a capital  lease  agreement  with a
financial  institution  for the  assets  related  to the  brewing  equipment  in
progress. The total assets under the capital lease are $2,073,000. The agreement
is  secured by the new  brewery  equipment.
<TABLE>

Future minimum lease payments for equipment  under this capital lease  agreement
are as follows:
<CAPTION>

                                   Year Ending December 31,

<S>                                          <C>                                  <C>             
                                             1997                                 $        346,600
                                             1998                                          378,100
                                             1999                                          378,100
                                             2000                                          378,100
                                             2001                                          378,100
                                          Thereafter                                     1,280,400
                                                                               --------------------

                                                                                         3,139,400
Less amounts representing interest                                                       1,125,100
                                                                               --------------------

Present value of minimum lease payments                                                  2,014,300
Less current maturities                                                                    151,300
                                                                               --------------------

                                                                                   $     1,863,000
                                                                               ====================


---------------------------------------------------------------------------------------------------
                                                                                        Page F - 11
</TABLE>

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE  8 -     PROFIT-SHARING PLAN

The  Company  has a  profit-sharing  retirement  plan  under  which  it may make
employer contributions at the discretion of the Board of Directors,  although no
such  contributions are required.  Employer  contributions vest over a period of
six years. The plan covers substantially all full-time employees meeting certain
minimum age and service requirements.  Contributions were $0 and $30,000 for the
years ended December 31, 1996 and 1995, respectively.


NOTE  9 -  COMMITMENTS

The  Company  leases  its  facilities  under a  noncancellable  operating  lease
expiring  August  2004.  The  monthly  lease  payment is $2,068,  to be adjusted
annually by  increases  in the  Consumer  Price  Index,  as defined in the lease
agreement.   Additionally,   the  Company  leases  certain   equipment  under  a
noncancellable  operating  lease which  expires in 1997.  Total rent expense was
$50,700  and  $34,000  for  the  years  ended   December   31,  1996  and  1995,
respectively. Future minimum lease payments are as follows:

           Year Ending December 31,

                     1997                              $  26,800
                     1998                                 24,800
                     1999                                 24,800
                     2000                                 24,800
                     2001                                 24,800
                  Thereafter                              66,100
                                                       ----------

                                                        $192,100
                                                       ==========

Employment  agreements - Five key  employees  have  employment  agreements  that
provide, in part, a minimum annual base salary; stock options (see Note 12); and
severance  benefits that include 18 to 36 months of salary  continuance  and, if
severance occurs within one year of a change in control,  as defined, a lump sum
benefit of from $250,000 to $500,000.

The  aggregate  annual base salary for the five key  employees is $317,100.  The
total lump sum benefit the Company is obligated to pay in the event of a defined
change in control is $1,750,000.

Keg  management  agreement - In January  1997,  the Company  entered  into a keg
management  agreement with MicroStar Keg Management LLC. Under this arrangement,
MicroStar  provides  half-barrel  kegs for which the Company pays a filling fee.
The  agreement is  effective  April 1, 1997,  for a five year period.  Mendocino
Brewing  Company has the option to terminate the agreement  with 30 days notice.
If terminated, the Company is required to purchase a certain number of kegs from
MicroStar.



--------------------------------------------------------------------------------
                                                                     Page F - 12

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE 10 -     BREWERY CONSTRUCTION

In late  1995,  the  Company  began  construction  of its new  brewery in Ukiah,
California. At this time, the total cost of the brewery including land, building
and equipment is estimated to be $11.4 million.  Funding for the brewery is from
a combination of proceeds from the stock sale,  private party  financing for the
land,  bank  financing for the building and a capital  lease for the  equipment.
Test brewing is expected to begin in April 1997.


NOTE 11 -     STOCKHOLDERS' EQUITY

Common Stock

Before January 1, 1994, the Company conducted  business in the form of a limited
partnership.  On January 1, 1994, the Company issued  1,722,222  share of no-par
value  common  stock  to the  partnership  in  exchange  for the  assets  of the
partnership. The partnership distributed the stock to its partners on January 3,
1994. As of December 31, 1995,  600,000 additional shares of stock had been sold
at $6 per share for total gross  proceeds of  $3,600,000.  These  proceeds  were
reduced by $286,700 of offering costs. All shares of stock authorized to sell in
the first public offering have been issued.

Subsequent  to December  31,  1996,  the Company  began  offering an  additional
600,000 shares of stock for sale in a second offering.

Preferred Stock

The Company has authorized 2,000,000 shares of preferred stock, of which 227,600
have  been  designated  as  Series  A. At the time of the  incorporation  of the
partnership,  the Company  issued  227,600  shares of  non-voting,  no-par value
Series A Preferred  Stock in exchange for  partnership  assets.  The partnership
distributed  the Series A  Preferred  Stock to its  partners on January 3, 1994.
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  Shares or any other  series of  Preferred  Shares.  When the
entire  Series A  dividend/liquidation  proceeds  have been  paid,  the Series A
Shares shall automatically be canceled and cease to be outstanding.


NOTE 12 -     STOCK OPTION PLAN

Under the 1994 Stock Option Plan,  the Company may issue  options to purchase up
to 200,000  shares of the  Company's  Common  Stock.  The plan provides for both
incentive stock options, as defined in Section 422 of the Internal Revenue Code,
and  options  that do not qualify as  incentive  stock  options.  The Plan shall
terminate  upon the earlier of (a) the tenth  anniversary of its adoption by the
Board or (b) the date on which all shares are available  for issuance  under the
Plan have been issued.

The  exercise  price of incentive  options must be no less then the  fair-market
value of such stock at the date the option is granted,  while the exercise price
of nonstatutory  options will be no less than 85% of the  fair-market  value per
share  on the  date of  grant.  With  respect  to  options  granted  to a person
possessing  more than 10% of the  combined  voting  power of all  classes of the
Company's stock, the exercise price will be no less than 110% of the fair-market
value of such share at the grant date.  As of December 31, 1996,  no options had
been granted, exercised, or canceled under the Plan.



--------------------------------------------------------------------------------
                                                                     Page F - 13

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

--------------------------------------------------------------------------------

NOTE 12 -     STOCK OPTION PLAN

In January  1997,  the  Company  granted  70,000  options to five key  employees
ranging in price from $8.38 to $9.21 per share.  The options become  exercisable
at 20% a year and expire between five and ten years. The Company also granted an
option to the Company's president to purchase 12,500 shares at $8.80. The option
expires in 2002.


NOTE 13 -     INCOME TAXES

                                                         1996           1995
                                                       ---------      ---------

Current
     Federal                                           $    --        $ 103,700
     State                                                   800         28,600
     Benefit of net operating loss carryback             (64,800)          --
                                                       ---------      ---------

                                                         (64,000)       132,300
                                                       ---------      ---------
Deferred
     Current                                              (7,600)        (3,700)
     Non-current                                          (6,600)        24,300
                                                       ---------      ---------

                                                         (14,200)        20,600
                                                       ---------      ---------

                                                       $ (78,200)     $ 152,900
                                                       =========      =========

The  difference  between the actual  income tax  provision and the tax provision
computed by applying the statutory  federal  income tax rate to earnings  before
taxes is attributable to the following:

                                                         1996           1995
                                                       ---------      ---------

Income tax provision (benefit) at 34%                 $ (68,700)      $ 105,300
State taxes                                                 800          28,100
Adjustment due to lower federal rates                     5,000          (1,100)
Recognition of future tax (deductions)                  (15,300)         20,600
                                                      ---------       ---------

                                                      $ (78,200)      $ 152,900
                                                      =========       =========


--------------------------------------------------------------------------------
                                                                     Page F - 14

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                       NOTES TO FINANCIAL STATEMENTS (Continued)
                                                      December 31, 1996 and 1995

 -------------------------------------------------------------------------------

NOTE 13 -     INCOME TAXES (Continued)

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

Inventories                                              $  3,200      $  3,000
Accruals                                                   21,700        13,700
Other                                                      (1,800)       (1,200)
                                                         --------      --------

Current deferred tax asset                               $ 23,100      $ 15,500
                                                         ========      ========

Depreciation and amortization                            $ (2,900)     $   --
Benefit of net operating loss carryforward                  7,400          --
                                                         --------      --------

Non-current deferred tax asset                           $  4,500          --
                                                         ========      ========

Depreciation and amortization                            $ 25,300      $ 21,000
Other                                                      (7,200)         (800)
                                                         --------      --------

Non-current deferred tax liability                       $ 18,100      $ 20,200
                                                         ========      ========

At December 31, 1996, the Company has available for  carryforward  approximately
$85,000 of California net operating losses that expire in 2011. The benefit from
this loss  carryforward has been recorded,  resulting in a deferred tax asset. A
valuation allowance is not provided since the Company believes it is more likely
than not that the loss carryforwards will be utilized.


NOTE 14 -     SEGMENT INFORMATION
<TABLE>

The  Company's   business   segments  are  brewing   operations   and  a  retail
establishment  known as the  Hopland  Brewery.  A summary of each  segment is as
follows:
<CAPTION>

                                                        Year Ending December 31, 1996
                                    ------------------------------------------------------------------------
                                         Brewing          Hopland             Corporate
                                        Operations        Brewery             and other              Total
                                    --------------   -----------------   ------------------   --------------
<S>                                   <C>             <C>                   <C>                  <C>        
Sales                                 $ 3,067,300     $   937,400           $      --            $ 4,004,700
Operating profits                         591,100         (81,600)                 --                509,500
Identifiable assets                     9,873,600          97,900             1,173,100           11,144,600
Depreciation and amortization              26,200           7,800                17,900               51,900
Capital expenditures                    5,339,800            --                  19,500            5,359,300


-------------------------------------------------------------------------------------------------------------
                                                                                                   Page F - 15
</TABLE>

<PAGE>


                                                 MENDOCINO BREWING COMPANY, INC.
                                      NOTES TO FINANCIAL STATEMENTS (Continued)
                                                     December 31, 1996 and 1995

-------------------------------------------------------------------------------
                                                     
NOTE 14 -     SEGMENT INFORMATION (Continued)

                                              Year Ending December 31, 1995
                                 -----------------------------------------------
                                   Brewing     Hopland    Corporate
                                 Operations    Brewery    and other      Total
                                 ----------   --------   ----------   ----------
Sales                            $2,775,500   $959,600   $    -       $3,735,100
Operating profits                   758,400     34,600        -          793,000
Identifiable assets               4,633,900    109,500    1,770,600    6,514,000
Depreciation and amortization        30,700      8,300       10,300       49,300
Capital expenditures              3,655,900     25,500        3,900    3,685,300


NOTE 15 -     STATEMENT OF CASH FLOWS

Supplemental cash flow information includes the following:

                                                        1996             1995
                                                      ----------      ----------

Cash paid during the year for:
     Interest                                          $180,400         $ 18,900
     Income taxes                                      $ 60,700         $113,500

Non-cash  investing and  financing  activities  for the year ended  December 31,
1996,  consisted of a note  payable that was  refinanced,  and  acquiring  fixed
assets of $548,500 through a capital lease.


NOTE 16 -     MAJOR CUSTOMERS

Sales to the top five customers totaled  $1,788,900 and $1,914,000 for the years
ended  December  31,  1996 and 1995,  respectively  representing  58% and 70% of
brewing operation sales.

--------------------------------------------------------------------------------
                                                                     Page F - 16