UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the transition period from            to .

Commission file number 0-27116

PYRAMID BREWERIES INC.

91 South Royal Brougham Way,
Seattle, WA 98134
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (206) 682-8322

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No    .

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]

     Common stock, par value of $.01 per share: 8,312,369 shares of Common Stock outstanding as of June 30, 2004

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PYRAMID BREWERIES INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

TABLE OF CONTENTS

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PART I

Item 1 — FINANCIAL STATEMENTS

PYRAMID BREWERIES INC.

BALANCE SHEETS
(Unaudited)

     The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.

CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)

The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.

CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)

The accompanying notes are an integral part of these statements.

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PYRAMID BREWERIES INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

1. BASIS OF PRESENTATION:

     Pyramid Breweries Inc. (the “Company”), a Washington corporation, is engaged in the brewing, marketing and selling of craft beers and premium sodas and in restaurant operations. The Company operates breweries in Seattle, Washington and in Berkeley, Walnut Creek and Sacramento, California. Effective July 31, 2004, the Company completed its acquisition of the brewing and restaurant assets of Portland Brewing Company located in Portland Oregon (please refer to Subsequent Events Note 8 to the Financial Statements below for further discussion of this transaction). The Portland Brewing Company asset acquisition, and related results of operations, are not reflected in the presentation of the financial statements of the three and six month periods ended June 30, 2004 as the purchase occurred on July 31, subsequent to the second quarter reporting period. The Company sells its beer through a network of selected independent distributors and alehouse locations primarily in Washington, Oregon and California under the Pyramid brand and, to a lesser extent, the Thomas Kemper brand. The Company also manufactures a line of gourmet sodas under the Thomas Kemper Soda Company label. As of June 30, 2004, the Company’s products were distributed in 32 states and Canada. As of June 30, 2004, the Company also operated four restaurants adjacent to its breweries under the Pyramid Alehouse brand name.

     The accompanying condensed financial statements have been prepared by the Company, without audit, in accordance with accounting principles generally accepted in the United States for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the accompanying unaudited financial statements contain all material adjustments, consisting only of those of a normal recurring nature, considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows at the dates and for the periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year. For a presentation including all disclosures required by generally accepted accounting principles, these financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2003, included in the Annual Report on Form 10-K.

Stock Based Compensation

     At June 30, 2004, the Company has stock-based compensation plans which are described more fully in Note 15 of the 2003 Annual Report and as Appendix A of the 2004 Proxy Statement for the recently approved 2004 Equity Compensation Plan. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123 “Accounting for Stock-Based Compensation.” Accordingly, no compensation cost has been recognized for the fair value of options issued under the Employee and Director Plans (the Plans) except as described in Note 4. Had compensation cost been recognized based on the fair value at the date of grant for options awarded under the Plans, the pro forma amounts of the Company’s net income (loss) and net income (loss) per share for the three and six month periods ended June 30, 2004 and 2003, would have been as follows:

     There were no options granted in the second quarter of 2004. The fair value of options granted in the second quarter ended June 30, 2003 was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: risk-free interest rate of 3.98%; expected option lives of seven years; expected volatility of 51%; and expected future dividends of 5.5%.

     There were no options granted in the six month period ended June 30, 2004. The fair value of options granted in the six month period ended June 30, 2003 was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: risk-

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free interest rates ranging from 3.98% to 5.13%; expected option lives of seven years; expected volatility of 51% to 52%; and expected future dividends of 5.5%.

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Revenue Recognition

     The Company recognizes revenue from the sale of wholesale beer and soda products at the time of shipment, when the title of the Company’s products passes to the customer, in accordance with distributor sales agreements and collectibility is probable. The Company’s revenue from its alehouses is comprised of food, beverage and merchandise, and is recognized at the time of sale.

2. INVENTORIES

     Inventories consist of the following:

     Raw materials primarily include ingredients, flavorings and packaging. Work in process includes beer held in fermentation prior to the filtration and packaging process. Finished goods primarily include product ready for shipment, as well as promotional merchandise held for sale. Inventory levels experience fluctuations in carrying levels and values based on seasonality.

3. FIXED ASSETS

     Fixed assets consist of the following:

4. NOTE RECEIVABLE FROM RELATED PARTY

     In June 2001, the Company issued a $787,000 full recourse note to Martin Kelly, the Company’s Chief Executive Officer (CEO) in connection with the exercise of options for 387,400 shares of the Company’s common stock. In addition, the Company issued a $115,000 full recourse note to Mr. Kelly to fund his payment of taxes on the exercise of the options. The notes were due on the earlier of June 30, 2011 or upon the sale of the stock and bear an annual interest rate of 5.6%. A total of 135,100 of those shares were unrestricted, except for being pledged as collateral for the notes, and the remaining 252,300 shares were due to become unrestricted by December 2004.

     On February 26, 2004 the Company announced that Mr. Kelly was stepping down as CEO. Mr. Kelly’s last official day was March 10th, 2004. Per the full recourse note agreement dated June 2001 with Mr. Kelly, upon termination he had the right to require the Company to buy-back the 387,400 shares collateralizing the promissory notes and pay any balances owed under the notes, with any net cash balance made payable to Mr. Kelly. On April 9, 2004, Mr. Kelly exercised his right and the Company repurchased the 387,400 shares at a five day average market price of $3.18 per share. The total sales value of $1,233,000 was applied to the notes payable in the amount of $843,000, to interest balances in the amount of $25,000 and the balance of $365,000 was paid to Mr. Kelly. This arrangement was accounted for as a variable equity arrangement.

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5. ACCRUED EXPENSES

     Accrued expenses consist of the following:

6. OTHER INCOME, NET

     Other income, net consists of interest income and parking fee income, and other non-operating income and expenses as follows:.

7. INCOME (LOSS) PER SHARE

     Basic income (loss) per share was computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period, excluding shares subject to repurchase. Diluted income (loss) per share was computed by dividing net income (loss) by the weighted average number of common shares of common stock outstanding plus additional common shares that would be outstanding from in-the-money stock options.

     Options to purchase approximately 197,000 and 183,000 shares of common stock were outstanding as of June 30, 2004 and 2003, respectively, but were not included in the six month periods’ computation of EPS because their effects are antidilutive.

8. SUBSEQUENT EVENTS

     Effective July 23, 2004, the Company completed its purchase of the Berkeley Brewery and Alehouse facility located at 901 Gilman Street, Berkeley, California 94710. The $7,000,000 purchase price was financed with a short-term $7,200,000 secured loan from Sugar Mountain Capital, LLC, a party related to Pyramid Breweries Inc. The terms of the short-term financing, approved by the Company’s board of directors and audit committee, include interest only monthly payments at a stated interest rate of 6.26% which is due six months from the date of the note. The Company anticipates that as a part of recording the transaction in the third quarter of 2003, it will reclassify leasehold improvements to the building asset account. The accounting effects of this transaction are not reflected in the fixed asset table above.

     The Company intends to convert this short-term financing to permanent financing with Sugar Mountain Capital, LLC within the next six months at market based terms. In the event that the Company is unable to complete its planned permanent financing with Sugar Mountain Capital, LLC within the next six months, it will seek unrelated third party financing. There is no guarantee that such financing will be available on commercially acceptable terms. In the event that Pyramid is unable to permanently refinance the debt with an unrelated third party, the short-term loan with Sugar Mountain Capital, LLC will be converted to a long-term note and the Company will be required to make monthly principal repayments on the loan as well as pay a higher rate of interest.

     Effective at the close of business on July 31, 2004, the Company completed its purchase of certain Portland Brewing Company assets. Per the asset purchase agreement, Pyramid Breweries Inc. acquired Portland Brewing Company’s brewery and alehouse for total consideration of approximately $4.2 million, consisting of a combination of assumed liabilities, cash and Pyramid common stock. The terms of the transaction also include a 5-year earn out which may result in additional payments to Portland Brewing Company based on sales of Portland Brewing brands during the earn-out period. The final purchase allocation of payment made among assumed liabilities, cash payment of $1,160,000 and stock was not known as of the date of this form filing as the Portland Brewing Company is subject to a total assets purchased review prior to finalizing the allocation. As a result of the pending financial revenue the final purchase price allocation has not been finalized and will be disclosed in a subsequent reporting period.

9. COMMITMENTS AND CONTINGENCIES

     The Company is involved from time to time in claims, proceedings and litigation arising in the ordinary course of business. The Company does not believe that any such claim, proceeding or litigation, either alone or in the aggregate, will have a material adverse effect on the Company’s financial position or results of operations.

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10. CASH DIVIDEND

     The Board of Directors announced on April 27, 2004, the declaration of a $0.022 per common share dividend payable on July 16, 2004 to shareholders of record on June 30, 2004. The cash dividends declared totaled approximately $183,000 for all common stock outstanding as of the record date.

     Cash dividends declared per common share:

     Although the Company has declared and paid a dividend every quarter since the fourth quarter of 1999, continued future declaration of dividends will depend, among other things, on the Company’s results of operations, capital requirements and financial condition, and on such other factors as the Company’s Board of Directors may in its discretion consider relevant and in the best long term interest of the shareholders.

11. SEGMENT INFORMATION

     The Company follows the provisions of SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information,” and reports segment information in the same format as reviewed by the Company’s management (the Management Approach), which is organized around differences in products and services.

     Products and Services

     The Company’s reportable segments include beverage operations and alehouses. Beverage operations include the production and sale of Pyramid ales and lagers, Thomas Kemper beers and Thomas Kemper Soda Company products. The alehouse segment consists of four full-service alehouses, which market and sell the full line of the Company’s beer and soda products as well as food and certain merchandise.

     Factors used to identify reportable segments

     The Company’s reportable segments are strategic business units that offer different products and services. These segments are managed separately because each business requires different production, management and marketing strategies.

     Measurement of segment profit and segment assets

     The accounting policies of the segments are the same as those described in the summary of critical accounting policies included in the notes to the financial statements included in the Company’s current Form 10-K. The Company evaluates performance based on profit or loss from operations before income taxes not including nonrecurring gains and losses. The Company records intersegment sales at cost.

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Segment profit and segment assets are as follows: