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 [  ]  No [X]

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

     Common stock, par value of $.01 per share: 8,765,845 shares of Common Stock outstanding as of September 30, 2004

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

TABLE OF CONTENTS

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PART I

Item 1 — FINANCIAL STATEMENTS

PYRAMID BREWERIES INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

The accompanying notes are an integral part of these unaudited condensed consolidated statements.

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PYRAMID BREWERIES INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

The accompanying notes are an integral part of these unaudited condensed consolidated statements.

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PYRAMID BREWERIES INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

The accompanying notes are an integral part of these unaudited condensed consolidated statements.

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PYRAMID BREWERIES INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION:

     Pyramid Breweries Inc. (the “Company”), a Washington corporation, is engaged in the brewing, marketing and selling of craft beers and premium sodas and in restaurant operations. The Company operates breweries in Seattle, Washington, Portland, Oregon and in Berkeley, Walnut Creek and Sacramento, California. Effective July 31, 2004, the Company completed its acquisition of the brewing and restaurant assets of Portland Brewing Company located in Portland Oregon. The Portland Brewing Company asset acquisition and related results of operations, for the months of August and September, are included in the presentation of the financial statements of the three and nine month periods ended September 30, 2004 as the purchase occurred during the period being reported. The Company sells its beer through a network of selected independent distributors and alehouse locations primarily in Washington, Oregon and California. The Company’s core brands include Pyramid, MacTarnahan and Thomas Kemper Soda, its other smaller product lines are reported under the Allied Brand designation and include Thomas Kemper Beer, Saxer, and Nor’Wester. The Company also manufactures a line of gourmet sodas under the Thomas Kemper Soda Company label. As of September 30, 2004, the Company’s products were distributed in approximately 35 states and Canada. As of September 30, 2004, the Company also operated five restaurants adjacent to its breweries under the Pyramid Alehouse and MacTarnahans Taproom brand names.

     The Company established a new entity, PBC Acquisition LLC, for the express purpose of acquiring certain assets from Portland Brewing Company. The assets of this entity are consolidated into the Company’s unaudited condensed consolidated financial statements for financial reporting purposes.

     Effective July 23, 2004, the Company completed its purchase of the Berkeley Brewery and Alehouse facility located at 901 Gilman Street, Berkeley, California 94710. Previously the Company had leased this facility. The Company’s lease obligations terminated with its purchase of the facility.

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

Stock Based Compensation

     At September 30, 2004, the Company has stock-based compensation plans which are described more fully in the 2003 Annual Report and in Appendix A of the 2004 Proxy Statement for the 2004 Equity Compensation Plan. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (SFAS) No. 123 “Accounting for Stock-Based Compensation.” Accordingly, no compensation cost has been recognized for the fair value of options issued under the Employee and Director Plans (the Plans) except as described in Note 5 and except that the Company is committed to granting 175,000 shares of restricted stock, and an additional 175,000 shares if certain performance criteria are met, to its CEO over a six year period as per the terms of his employment agreement. The Company has recorded $13,000 in stock based compensation costs in the three month period ended September 30, 2004 related to these stock grants. Had compensation cost been recognized based on the fair value at the date of grant for options awarded under the Plans, the pro forma amounts of the Company’s net income (loss) and net income (loss) per share for the three and nine month periods ended September 30, 2004 and 2003, would have been as follows:

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Revenue Recognition

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

2. PORTLAND BREWING COMPANY ASSET ACQUISITION

     On July 31, 2004, the Company completed its purchase of certain Portland Brewing Company assets. Per the asset purchase agreement, Pyramid Breweries Inc. acquired Portland Brewing Company’s brewery and alehouse for total consideration including transaction costs of approximately $4.01 million, consisting of a combination of assumed liabilities, cash and Pyramid common stock. The terms of the transaction also include a 5-year earn out which may result in additional payments to Portland Brewing Company based on sales of Portland Brewing brands during the earn-out period. In addition to the purchase price, the Company incurred an estimated $300,000 in transaction costs, including consulting fees and amounts relating to legal and accounting charges. The results of operations of the acquired assets of Portland Brewing Company since July 31, 2004 to September 30, 2004 are included in Pyramid’s statement of operations for the three and nine month periods ended September 30, 2004.

     The assets acquired from Portland Brewing Company, including the alehouse and brewery assets, were acquired because of their strategic fit within the existing Pyramid operations. The Portland Taproom provides a venue for Portland area residents to sample Company products, the Portland brewery provides a production facility in the mature Oregon craft beer markets. The acquisition is intended to bring together two pivotal players in the craft brewing industry and position the Company for growth across all businesses, including beer, soda and restaurants as well as strengthening its position in the key West Coast markets.

     The acquisition was accounted for as a business combination under SFAS 141 “Business Combinations.” Accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed on the basis of their respective fair values on the acquisition date. 445,434 shares were issued in conjunction with the asset purchase. The allocation of the purchase price is preliminary as the Company has not yet received all of the information it has arranged to obtain.

     The following unaudited pro forma information represents the results of operations for Pyramid Breweries Inc and Portland Brewing Company for the three and nine month periods ended September 30, 2004 and 2003, as if the asset purchase had been consummated as of January 1, 2004 and January 1, 2003, respectively. This pro forma information does not purport to be indicative of what may occur in the future:

     The following represents the preliminary allocation of the purchase price to the acquired assets and assumed liabilities of Portland Brewing Company and is for illustrative purposes only. This allocation is preliminary and based on Portland Brewing Company’s assets and liabilities as of July 31, 2004.

Net tangible assets consists of cash, accounts receivable, inventories, property plant and equipment and other assets. Portland Brewing Company`’s current assets, property, plant and equipment assets and liabilities assumed were adjusted based on the fair value of those

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assets acquired and liabilities assumed. Based on a preliminary assessment, Pyramid management believes there is not significant value associated with the intangible assets acquired as part of the asset purchase agreement.

3. INVENTORIES

     Inventories consist of the following:

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

4. FIXED ASSETS

     Fixed assets consist of the following:

     In conjunction with the acquisition of the Berkeley alehouse and brewing facility, the Company reclassified the Berkeley facility leasehold improvements of $11,847,000 from the leasehold improvement category to buildings as well as extended the depreciable lives of the building assets from the lease term to 40 years for depreciation calculation purposes.

5. NOTE RECEIVABLE FROM RELATED PARTY

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

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

6. ACCRUED EXPENSES

     Accrued expenses consist of the following:

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7. OTHER INCOME, NET

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

8. INCOME (LOSS) PER SHARE

     Basic (loss) income per share was computed by dividing net (loss) income by the weighted average number of shares of common stock outstanding during the period, excluding shares subject to repurchase. Diluted income per share was computed by dividing net income by the weighted average number of common shares of common stock outstanding plus additional common shares that would be outstanding from in-the-money stock options. The net effect of stock options has not been included in the calculation of diluted net loss per share as the effect is antidilutive. Options to purchase approximately 174,000 shares of common stock were outstanding during the three month period ended September 30, 2004, but were not included in the computation of loss per share because their effects are antidulutive.

     Options to purchase approximately 197,000 and 188,000 shares of common stock were outstanding during the nine month period ended September 30, 2004 and 2003, respectively, but were not included in the computation’s of loss per share because their effects are antidilutive.

9. BANK LINE OF CREDIT AND SHORT-TERM DEBT

     The Company entered into a $2,000,000 line of credit (the Line of Credit) for short-term operating needs on May 14, 2004. The Line of Credit revolves through May 14, 2006. At that date, any outstanding balance will be due in full. Borrowings under the Line of Credit will accrue interest at the bank’s prime rate plus 25 basis points. A portion of the Line of Credit was used to meet the additional operating cash needs of the Portland Brewing Company asset acquisition, as well as covering the purchase and transaction costs. As of September 30, 2004, the Company had borrowed $231,000 on the line of credit. The Line of Credit is secured by the Company’s accounts receivable.

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     Effective July 23, 2004, the Company completed its purchase of the Berkeley Brewery and Alehouse facility located at 901 Gilman Street, Berkeley, California 94710. The $7,000,000 purchase price and related costs were financed with a short-term $7,200,000 secured loan from Sugar Mountain Capital, LLC, a party related to Pyramid Breweries Inc. The short-term note has been secured by a Deed of Trust against the property. Sugar Mountain Capital, LLC is controlled by Mr. Kurt Dammeier, who is a Director of Pyramid Breweries Inc. and is Pyramid’s largest shareholder. The terms of the short-term financing, approved by the Company’s Board and Audit Committee, include interest only monthly payments through maturity on January 23, 2005, at a stated interest rate of 6.26%.

10. COMMITMENTS AND CONTINGENCIES

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

11. CASH DIVIDEND

     The Board of Directors announced on September 17, 2004, the declaration of a $0.022 per common share dividend payable on October 15, 2004 to shareholders of record on September 30, 2004. The cash dividends declared totaled approximately $193,000 for all common stock outstanding as of the record date.

     Cash dividends declared per common share:

     The Board of Directors announced on November 3, 2004, the declaration of a $0.022 per common share dividend payable on January 15, 2004 to shareholders of record on December 31, 2004. The cash dividends declared totaled approximately $193,000 for all common stock outstanding as of the record date.

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

12. SEGMENT INFORMATION

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

     Products and Services

     The Company’s reportable segments include beverage operations and alehouses. Beverage operations include the production and sale of Company beverage products including both beer and soda. The alehouse segment consists of five full-service alehouses, which market and sell the full line of the Company’s beer and soda products as well as food and certain merchandise.

     Factors used to identify reportable segments

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

     Measurement of segment profit and segment assets

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

     Segment profit and segment assets are as follows:

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