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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (MARK ONE) [X]
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
 OR [   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 for the transition period from _______________ to ______________ COMMISSION FILE NUMBER 0-26542  
 REDHOOK ALE BREWERY, INCORPORATED  Washington
    
    91-1141254(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)14300 NE 145th Street, Suite 210Woodinville, Washington
    
    98072-9045(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (425) 483-3232 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 Rule 12b-2 of the Exchange Act).
Yes  [   ]   No  [X] The number of shares of the registrants Common Stock outstanding as of
April 30, 2004 was 6,271,006. Page 1 of 21 sequentially numbered pages




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REDHOOK ALE BREWERY, INCORPORATED FORM 10-Q For The Quarterly Period Ended March 31, 2004 TABLE OF CONTENTS PagePART I.
    
    Financial InformationITEM 1.
    
    Financial StatementsBalance Sheets as of March 31, 2004 and December 31 2003
    
    
    3Statements of Operations for the Three Months Ended March
31, 2004 and 2003
    
    
    4Statements of Cash Flows for the Three Months Ended March
31, 2004 and 2003
    
    
    5Notes to Financial Statements
    
    
    6ITEM 2.
    
    Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    10ITEM 3.
    
    Quantitative and Qualitative Disclosures about Market
Risk
    
    
    20ITEM 4.
    
    Controls and Procedures
    
    
    20PART II.
    
    Other InformationITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    
    20EXHIBIT 3.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I 
 ITEM 1. FINANCIAL STATEMENTS REDHOOK ALE BREWERY, INCORPORATED 
 BALANCE SHEETS March 31,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    5,065,857
    
    
    $
    6,123,349Accounts Receivable
    
    
    2,513,668
    
    
    
    1,686,735Inventories
    
    
    3,358,753
    
    
    
    3,342,006Other
    
    
    744,232
    
    
    
    247,038Total Current Assets
    
    
    11,682,510
    
    
    
    11,399,128Fixed Assets, Net
    
    
    64,986,714
    
    
    
    65,699,658Other Assets
    
    
    30,537
    
    
    
    32,256Total Assets
    
    $
    76,699,761
    
    
    $
    77,131,042LIABILITIES, PREFERRED STOCK
AND COMMON STOCKHOLDERS EQUITYCurrent Liabilities:Accounts Payable
    
    $
    2,106,778
    
    
    $
    1,983,377Accrued Salaries, Wages and Payroll Taxes
    
    
    1,900,201
    
    
    
    1,561,526Refundable Deposits
    
    
    2,316,475
    
    
    
    2,272,328Other Accrued Expenses
    
    
    641,678
    
    
    
    621,185Current Portion of Long-Term Debt
    
    
    450,000
    
    
    
    450,000Total Current Liabilities
    
    
    7,415,132
    
    
    
    6,888,416Long-Term Debt, Net of Current Portion
    
    
    5,512,500
    
    
    
    5,625,000Deferred Income Taxes, Net
    
    
    468,798
    
    
    
    468,798Other Liabilities
    
    
    16,226
    
    
    
    CommitmentsConvertible Redeemable Preferred Stock
    
    
    16,243,755
    
    
    
    16,232,655Common Stockholders Equity:Common Stock, Par Value $0.005 per Share, Authorized, 50,000,000
Shares; Issued and Outstanding, 6,263,006 Shares in 2004 and
6,226,306 Shares in 2003
    
    
    31,316
    
    
    
    31,132Additional Paid-In Capital
    
    
    54,308,690
    
    
    
    54,250,059Retained Earnings (Deficit)
    
    
    (7,296,656
    )
    
    
    (6,365,018
    )Total Common Stockholders Equity
    
    
    47,043,350
    
    
    
    47,916,173Total Liabilities, Preferred Stock and
Common Stockholders Equity
    
    $
    76,699,761
    
    
    $
    77,131,042
 See Accompanying Notes to Financial Statements 3




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REDHOOK ALE BREWERY, INCORPORATED 
 STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended March 31,2004
    
    2003Sales
    
    $
    9,390,479
    
    
    $
    8,671,200Less Excise Taxes
    
    
    770,645
    
    
    
    733,014Net Sales
    
    
    8,619,834
    
    
    
    7,938,186Cost of Sales
    
    
    6,574,213
    
    
    
    6,266,742Gross Profit
    
    
    2,045,621
    
    
    
    1,671,444Selling, General and Administrative Expenses
    
    
    2,528,568
    
    
    
    2,833,274Craft Brands Alliance Shared Formation Expenses
    
    
    406,767
    
    
    
    Operating Income (Loss)
    
    
    (889,714
    )
    
    
    (1,161,830
    )Interest Expense
    
    
    43,607
    
    
    
    51,012Other Income (Expense)  Net
    
    
    12,783
    
    
    
    18,622Income (Loss) before Income Taxes
    
    
    (920,538
    )
    
    
    (1,194,220
    )Income Tax Provision (Benefit)
    
    
    
    
    
    
    Net Income (Loss)
    
    $
    (920,538
    )
    
    $
    (1,194,220
    )Basic Earnings (Loss) per Share
    
    $
    (0.15
    )
    
    $
    (0.19
    )Diluted Earnings (Loss) per Share
    
    $
    (0.15
    )
    
    $
    (0.19
    )
 See Accompanying Notes to Financial Statements 4




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REDHOOK ALE BREWERY, INCORPORATED 
 STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended March 31,2004
    
    2003Operating ActivitiesNet Income (Loss)
    
    $
    (920,538
    )
    
    $
    (1,194,220
    )Adjustments
to Reconcile Net Income (Loss) to Net CashProvided by (Used in) Operating Activities:Depreciation and Amortization
    
    
    738,576
    
    
    
    766,846Net Change in Operating Assets and Liabilities
    
    
    (797,932
    )
    
    
    (954,539
    )Net Cash Used in Operating Activities
    
    
    (979,894
    )
    
    
    (1,381,913
    )Investing ActivitiesExpenditures for Fixed Assets
    
    
    (22,662
    )
    
    
    (408,595
    )Other, Net
    
    
    (1,251
    )
    
    
    Net Cash Used in Investing Activities
    
    
    (23,913
    )
    
    
    (408,595
    )Financing ActivitiesPrincipal Payments on Debt
    
    
    (112,500
    )
    
    
    (112,500
    )Repurchase of Common Stock
    
    
    
    
    
    
    (183,814
    )Issuance of Common Stock
    
    
    58,815
    
    
    
    Net Cash Used in Financing Activities
    
    
    (53,685
    )
    
    
    (296,314
    )Increase (Decrease) in Cash and Cash Equivalents
    
    
    (1,057,492
    )
    
    
    (2,086,822
    )Cash and Cash Equivalents:Beginning of Period
    
    
    6,123,349
    
    
    
    7,007,351End of Period
    
    $
    5,065,857
    
    
    $
    4,920,529
 See Accompanying Notes to Financial Statements 5




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REDHOOK ALE BREWERY, INCORPORATED 
 NOTES TO FINANCIAL STATEMENTS
(Unaudited) 1. Basis of Presentation The accompanying financial statements and related notes of Redhook Ale
Brewery, Incorporated (the Company) should be read in conjunction with the
financial statements and notes thereto included in the Companys Annual Report
on Form 10-K for the year ended December 31, 2003. These financial statements
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted pursuant to such rules and regulations. These financial
statements are unaudited but, in the opinion of management, reflect all
material adjustments necessary to present fairly the financial position,
results of operations and cash flows of the Company for the periods presented.
All such adjustments were of a normal, recurring nature. The results of
operations for such interim periods are not necessarily indicative of the
results of operations for the full year. 2. Liquidity The Companys sales consist predominantly of sales of beer to third-party
distributors and Anheuser-Busch, Incorporated (A-B) through the Companys
distribution alliance (the Distribution Alliance or the Alliance) with A-B.
The Alliance, executed in October 1994, consists of a national distribution
agreement (the A-B Distribution Agreement) and an investment by A-B in the
Company (the A-B Investment Agreement). The Alliance gives the Company access
to A-Bs national distribution network to distribute its products. Pursuant to
the A-B Investment Agreement, A-B invested approximately $30 million to
purchase 1,289,872 shares of the Companys convertible redeemable Series B
Preferred Stock (the Series B Preferred Stock) and 953,470 shares of the
Companys Common Stock (Common Stock), including 716,714 shares issued
concurrent with the Companys initial public offering. As of March 12, 2004,
A-B held 29.8% of the Companys outstanding shares of Common Stock, calculated
on a Fully Diluted Basis. The A-B Distribution Agreement has a stated term of 20 years, but is
subject to one-time early termination by either party without cause on December
31, 2004. The A-B Distribution Agreement is also terminable at any time by
either party for cause. In the event that the A-B Distribution Agreement is
terminated on or before December 31, 2004, the terms of the Series B Preferred
Stock held by A-B require the mandatory redemption of the Series B Preferred
Stock on December 31, 2004, at a redemption price equal to $12.61 per share
(approximately $16.3 million in the aggregate), plus an amount equal to
accumulated and unpaid dividends thereon, if any. The terms of the Series B
Preferred Stock further provide that, if at the time of the mandatory
redemption the Company has insufficient legally available funds to redeem all
shares of Series B Preferred Stock, then all funds that are legally available
must be used to redeem Series B Preferred Stock. At any time thereafter when
additional funds of the Company become legally available, such funds must be
immediately used to redeem additional shares of Series B Preferred Stock. The termination of the A-B Distribution Agreement for any reason or the
failure by the Company to perform any of its material obligations under the A-B
Investment Agreement would also constitute an event of default under the
Companys bank credit agreement. Upon default, the bank may declare the entire
outstanding term loan balance immediately due and payable. If the loan balance
became due and payable, such payment would have seniority over the redemption
of the Series B Preferred Stock. If this were to occur, it would be unlikely
that the Company could satisfy its obligations under the term loan. In all
events, unless additional capital were raised, the Company would not have
sufficient liquidity to satisfy both its obligation under the term loan and its
obligation to redeem the Series B Preferred Stock. The Company could seek to
refinance its term loan with one or more banks or obtain additional equity
capital, however, there can be no assurance the Company would be able to access
additional capital to meet its needs or that such additional capital would be
at commercially reasonable terms. These matters raise substantial doubt about
the Companys ability to continue as a going concern. The first quarter 2004
financials statements
and the fiscal year 2003 financial statements do not include any adjustments
that might result from the outcome of this uncertainty. 6




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS
(Unaudited) In addition, if the A-B Distribution Agreement were terminated, it would
be extremely difficult for the Company to rebuild its distribution network
without a severe negative impact on the Companys sales and results of
operations. There cannot be any guarantee that the Company would be successful
in rebuilding all, or part, of its distribution network. Management of the Company and A-B are having ongoing discussions. To date,
neither the Company nor Anheuser-Busch has given notice of its intention to
terminate the A-B Distribution Agreement. 3. Earnings (Loss) per Share The Company follows Financial Accounting Standards Board (FASB)
Statement of Financial Accounting Standard (SFAS) No. 128, Earnings per
Share. Basic earnings (loss) per share is calculated using the weighted average
number of shares of Common Stock outstanding. The calculation of adjusted
weighted average shares outstanding for purposes of computing diluted earnings
per share includes the dilutive effect of all outstanding convertible
redeemable preferred stock and outstanding stock options for periods when the
Company reports net income. The convertible preferred stock and outstanding
stock options have been excluded from the calculation of diluted loss per share
for all periods presented because their effect is antidilutive. The calculation
uses the treasury stock method and the as if converted method in determining
the resulting incremental average equivalent shares outstanding as applicable. The following table sets forth the computation of basic and diluted
earnings (loss) per common share: Three Months EndedMarch 31,2004
    
    2003Net income (loss)
    
    $
    (920,538
    )
    
    $
    (1,194,220
    )Preferred stock accretion
    
    
    (11,100
    )
    
    
    (11,100
    )Income (loss) available to common stockholders
    
    $
    (931,638
    )
    
    $
    (1,205,320
    )Weighted average common shares
    
    
    6,227,687
    
    
    
    6,291,916Basic and diluted earnings (loss) per share
    
    $
    (0.15
    )
    
    $
    (0.19
    )
 4. Inventories Inventories consist of the following: March 31,
    
    December 31,2004
    
    2003Raw materials
    
    $
    1,123,863
    
    
    $
    1,184,733Work in process
    
    
    925,388
    
    
    
    900,388Finished goods
    
    
    548,269
    
    
    
    408,561Promotional merchandise
    
    
    546,133
    
    
    
    631,147Packaging materials
    
    
    215,100
    
    
    
    217,177$
    3,358,753
    
    
    $
    3,342,006
 Work in process is beer held in fermentation tanks prior to the filtration
and packaging process. 7




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS
(Unaudited) 5. Common Stock Activity In conjunction with the exercise of stock options granted under the
Companys stock option plans, the Company issued 36,700 shares of Common Stock
totaling $59,000 during the three months ended March 31, 2004. No Common Stock
was issued during the quarter ended March 31, 2003. From May 2000 through May 2003, the Company repurchased its Common Stock
in conjunction with a repurchase plan authorized by the Board of Directors. The
plan allowed for the repurchase of 1.5 million outstanding shares of Common
Stock for a total maximum repurchase of $2,750,000. In May 2003, at which time
a total of 1,463,100 shares of Common Stock had been purchased in the open
market for an aggregate expenditure of $2,750,000, the Company ended the
repurchase plan. During the three-month period ended March 31, 2003, 80,600
shares of Common Stock were purchased for $184,000. 6. Stock-Based Compensation The Company accounts for its employee stock-based compensation plans using
the intrinsic value method, as prescribed by Accounting Principle Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employees. Under APB 25, because
the Companys employee stock options are granted at an exercise price equal to
the fair market value of the underlying Common Stock on the date of the grant,
no compensation expense is recognized. As permitted, the Company has elected to
adopt the disclosure only provisions of SFAS No. 148, Accounting for
Stock-Based Compensation. The following table illustrates the effect on net income (loss) and
earnings (loss) per share for the quarters ended March 31, 2004 and 2003 had
compensation cost for the Companys stock options been recognized based upon
the estimated fair value on the grant date under the fair value methodology. Three Months EndedMarch 31,2004
    
    2003Net income (loss), as reported
    
    $
    (920,538
    )
    
    $
    (1,194,220
    )Add: Stock-based employee compensation expense
as reported under APB 25
    
    
    
    
    
    
    Less: Stock-based employee compensation
expense determined under fair value based
method for all options, net of related tax
effects
    
    
    (32,155
    )
    
    
    (67,616
    )Pro forma net income (loss)
    
    $
    (952,693
    )
    
    $
    (1,261,836
    )Earnings (loss) per share:Basic and Diluted  as reported
    
    $
    (0.15
    )
    
    $
    (0.19
    )Basic and diluted  pro forma
    
    $
    (0.15
    )
    
    $
    (0.20
    )
 7. Craft Brands Alliance LLC On February 3, 2004, the Company announced that it had reached an
agreement in principle with Widmer Brothers Brewing Company to form a joint
sales and marketing organization that will serve both companies operations in
the Western United States. The joint organization, named Craft Brands Alliance
LLC, was formed in March 2004 and is seeking required regulatory approvals. The
Company and Widmer have both incurred certain formation expenses, including
severance expenses and legal fees, in conjunction with the formation of Craft
Brands Alliance. The Companys first quarter 2004 operating loss includes
$407,000 attributable to the 8




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS
(Unaudited) Companys share of expenses incurred in the
formation of Craft Brands Alliance. Additionally, until Craft Brands Alliance
is fully operational, the Company and Widmer have agreed to share certain
sales-related costs, primarily salaries and overhead. The Companys share of
those costs totaled $54,000 for the quarter ended March 31, 2004 and are
reflected in the Companys statement of operations as selling, general and
administrative expenses. Reflected in the Companys balance sheet as of
March 31, 2004 are a receivable due from Craft Brands Alliance for
approximately $339,000 and a liability due to Widmer Brothers Brewing of
approximately $37,000. 9




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ITEM 2.Managements Discussion and Analysis of Financial Condition and
Results of Operations The following discussion and analysis should be read in conjunction with
the Companys Financial Statements and Notes thereto included herein. The
discussion and analysis includes period-to-period comparisons of the Companys
financial results. Although period-to-period comparisons may be helpful in
understanding the Companys financial results, the Company believes that they
should not be relied upon as an accurate indicator of future performance. Overview Since its formation, the Company has focused its business activities on
the brewing, marketing and selling of craft beers in the United States. The
Company produces its specialty bottled and draft products in two
technologically advanced, Company-owned breweries, one in the Seattle suburb of
Woodinville, Washington (the Washington Brewery) and the other in Portsmouth,
New Hampshire (the New Hampshire Brewery). For the three months ended March
31, 2004, the Company had gross sales of $9,390,000, an increase of 8.3% over
gross sales of $8,671,000 for the three months ended March 31, 2003. The
Companys sales consist predominantly of sales of beer to third-party
distributors and Anheuser-Busch, Inc. (A-B) through the Companys
distribution alliance with A-B (the Distribution Alliance). In addition, the
Company derives other revenues from sources including the sale of beer, food,
apparel and other retail items in its two brewery pubs. The Companys sales volume (shipments) increased 5.2% to 50,200 barrels
for the three months ended March 31, 2004 as compared to 47,700 barrels in the
same 2003 period. Sales in the craft beer industry generally reflect a degree
of seasonality, with the first and fourth quarters historically being the
slowest and the rest of the year typically demonstrating stronger sales. The
Company has historically operated with little or no backlog and, therefore, its
ability to predict sales for future periods is limited. The Companys sales are affected by several factors, including consumer
demand, price discounting and competitive considerations. The Company competes
in the highly competitive craft brewing market as well as in the much larger
specialty beer market, which encompasses producers of import beers, major
national brewers that have introduced fuller-flavored products, and large
spirit companies and national brewers that produce flavored alcohol beverages.
Beyond the beer market, craft brewers have also faced competition from
producers of wines and spirits. The craft beer segment is highly competitive
due to the proliferation of small craft brewers, including contract brewers,
and the large number of products offered by such brewers. Imported products
from foreign brewers have enjoyed resurgence in demand since the mid-1990s.
Certain national domestic brewers have also sought to appeal to this growing
demand for craft beers by producing their own fuller-flavored products. In 2001
and 2002, the specialty segment saw the introduction of flavored alcohol
beverages, the consumers of which, industry sources generally believe,
correlate closely with the consumers of the import and craft beer products.
While sales of flavored alcohol beverages were initially very strong, these
growth rates slowed in 2003. The wine and spirits market has experienced a
surge in the past several years, attributable to competitive pricing, increased
merchandising, and increased consumer interest in spirits. Because the number
of participants and number of different products offered in this segment have
increased significantly in the past ten years, the competition for bottled
product placements and especially for draft beer placements has intensified. In January 2003, the Company entered into a licensing agreement with
Widmer Brothers Brewing Company (Widmer) to produce and sell the Widmer
Hefeweizenbrand in states east of the Mississippi River. Brewing of this
product, which began in February 2003, is conducted at the Companys New
Hampshire Brewery under the supervision and assistance of Widmers brewing
staff to insure their brands quality and matching taste profile. The term of
this agreement is for five years, with an additional one-year automatic renewal
unless either party elects to terminate the arrangement. The agreement may be
terminated by either party at any time without cause pursuant to 150 days
notice. The agreement may be terminated for cause by either party under certain
conditions. During the term of this agreement, Redhook
will not brew, advertise, market, or distribute any product that is
labeled or advertised as a Hefeweizen or any similar product in the agreed
upon eastern territory. Brewing and selling of Redhooks Hefe-weizen was
discontinued in conjunction with this agreement. This agreement, for the
Eastern United States only, is expected to increase capacity utilization and
strengthen the Companys product portfolio. 10




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The Company is required to pay federal excise taxes on sales of its beer.
The excise tax burden on beer sales increases from $7 to $18 per barrel on
annual sales over 60,000 barrels and thus, if sales volume increases, federal
excise taxes would increase as a percentage of sales. Most states also collect
an excise tax on the sale of beer. Under normal circumstances, the Company operates its brewing facilities up
to six days per week with multiple shifts per day. Under ideal brewing
conditions (which would include, among other factors, production of a single
brand in a single package), the current production capacity is approximately
250,000 barrels per year at the Washington Brewery and 125,000 barrels per year
at the New Hampshire Brewery. Because of various factors, including the
following two, the Company does not believe that it is likely that actual
production volume will approximate current production capacity: (1) the
Companys brewing process, which management believes is similar to its
competitors brewing processes, inherently results in some level of beer loss
attributable to filtering, bottling, and keg filling; and (2) the Company
routinely brews and packages various brands and package sizes during the year. During the peak sales volume periods of 2002, production capacity at the
New Hampshire Brewery was nearly fully utilized. In order to accommodate volume
growth in the markets served by the New Hampshire Brewery, including
anticipated growth resulting from sales of Widmer Hefeweizen, the Company
expanded fermentation capacity during the first half of 2003. This expansion
brought the production capacity from approximately 110,000 barrels per year at
the end of December 2002 to the current capacity of approximately 125,000
barrels per year. Production capacity at the New Hampshire Brewery can be added
in phases until the facility reaches its maximum designed production capacity
of approximately 250,000 barrels per year, under ideal brewing conditions. Such
an increase would require additional capital expenditures, primarily for
fermentation equipment, and production personnel. The decision to add capacity
is affected by the availability of capital, construction constraints and
anticipated sales in new and existing markets. The Companys capacity utilization has a significant impact on gross
profit. Generally, when facilities are operating at their maximum designed
production capacities, profitability is favorably affected because fixed and
semi-variable operating costs, such as depreciation and production salaries,
are spread over a larger sales base. Because current period production levels
have been below the Companys current production capacity, gross margins have
been negatively impacted. This negative impact could be reduced as actual
production increases. In addition to capacity utilization, other factors that could affect cost
of sales and gross margin include changes in freight charges, the availability
and price of raw materials and packaging materials, the mix between draft and
bottled product sales, the sales mix of various bottled product packages, and
fees related to the Distribution Alliance with A-B. See Managements Discussion and Analysis of Financial Condition and
Results of Operations  Certain Considerations: Issues and Uncertainties. Critical Accounting Policies and Estimates The Companys financial statements are based upon the selection and
application of significant accounting policies that require management to make
significant estimates and assumptions. Management believes that the following
are some of the more critical judgment areas in the application of the
Companys accounting policies that currently affect its financial condition and
results of operations.
Judgments and uncertainties affecting the application of these policies
may result in materially different amounts being reported under different
conditions or using different assumptions. Income Taxes.The Company records federal and state income taxes in
accordance with Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standard (SFAS) No. 109, Accounting for Income Taxes.
Deferred income taxes or tax benefits reflect the tax effect of temporary
differences between the amounts of assets and liabilities for financial
reporting purposes and amounts as 11




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measured for tax purposes. The Company will
establish a valuation allowance if it is more likely than not that these items
will either expire before the Company is able to realize their benefits or that
future deductibility is uncertain. The valuation allowance is reviewed and
adjusted on a quarterly basis based on managements assessment of the
realizability of the deferred tax assets. As of December 31, 2003, the Company
had approximately $11.8 million of deferred tax assets, comprised principally
of federal net operating loss carryforwards (NOLs) that expire from 2012
through 2023 and state NOLs that expire through 2018. The recognition of these
assets is dependent upon estimates of future taxable income resulting from
future reversals of existing taxable temporary differences, which have been
recorded as deferred tax liabilities and exceed the deferred tax assets. As of
December 31, 2003, the Company also had a valuation allowance of $738,000,
reflected as a reduction of the Companys deferred tax assets on its balance
sheet. During the three months ended March 31, 2004, the Company increased its
valuation allowance by $303,000 thereby reducing the estimated income tax
benefit recorded in its statement of operations to $0. The valuation allowance
covers a portion of the Companys deferred tax assets, specifically certain
federal and state NOL carryforwards, that may expire before the Company is able
to utilize the tax benefit. Realization of the benefit is dependent on the
Companys ability to generate future U.S. taxable income. To the extent that
the Company is unable to generate adequate taxable income in the future, the
Company may not be able to recognize additional tax benefits and may be
required to record a greater valuation allowance covering expiring NOLs. Long-Lived Assets.The Company evaluates potential impairment of
long-lived assets in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 establishes
procedures for review of recoverability and measurement of impairment, if
necessary, of long-lived assets, goodwill and certain identifiable intangibles.
When facts and circumstances indicate that the carrying values of long-lived
assets may be impaired, an evaluation of recoverability is performed by
comparing the carrying value of the assets to projected future undiscounted
cash flows in addition to other quantitative and qualitative analyses. Upon
indication that the carrying value of such assets may not be recoverable, the
Company recognizes an impairment loss by a charge against current operations.
Fixed assets are grouped at the lowest level for which there are identifiable
cash flows when assessing impairment. During 2003, the Company performed an
analysis of its brewery assets to determine if an impairment might exist. The
Companys estimate of future undiscounted cash flows indicated that such
carrying values were expected to be recovered. Nonetheless, it is possible that
the estimate of future undiscounted cash flows may change in the future,
resulting in the need to write down those assets to their fair value. Results of Operations The following table sets forth, for the periods indicated, certain items
from the Companys Statements of Operations expressed as a percentage of net
sales. Three Months EndedMarch 31,2004
    
    2003Sales
    
    
    108.9
    %
    
    
    109.2
    %Less Excise Taxes
    
    
    8.9
    
    
    
    9.2Net Sales
    
    
    100.0
    
    
    
    100.0Cost of Sales
    
    
    76.3
    
    
    
    78.9Gross Profit
    
    
    23.7
    
    
    
    21.1Selling, General and Administrative Expenses
    
    
    29.3
    
    
    
    35.7Craft Brands Alliance Shared Formation Expenses
    
    
    4.7
    
    
    
    Operating Income (Loss)
    
    
    (10.3
    )
    
    
    (14.6
    )Interest Expense
    
    
    0.5
    
    
    
    0.6Other Income (Expense)  Net
    
    
    0.1
    
    
    
    (0.2
    )Income (Loss) before Income Taxes
    
    
    (10.7
    )
    
    
    (15.0
    )Provision for Income Taxes
    
    
    
    
    
    
    Net Income (Loss)
    
    
    (10.7
    )%
    
    
    (15.0
    )%
 12




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Three Months Ended March 31, 2004 Compared to Three Months Ended March 31,
2003 The following table sets, for the periods indicated, a comparison of
certain items from the Companys Statements of Operations: Three Months EndedMarch 31,
    
    Increase/
    
    %2004
    
    2003
    
    (Decrease)
    
    Change(in thousands except barrels)Sales
    
    $
    9,390
    
    
    $
    8,671
    
    
    $
    719
    
    
    
    8.3
    %Less Excise Taxes
    
    
    770
    
    
    
    733
    
    
    
    37
    
    
    
    5.1Net Sales
    
    
    8,620
    
    
    
    7,938
    
    
    
    682
    
    
    
    8.6Cost of Sales
    
    
    6,574
    
    
    
    6,267
    
    
    
    307
    
    
    
    4.9Gross Profit
    
    
    2,046
    
    
    
    1,671
    
    
    
    375
    
    
    
    22.4Selling, General and Administrative Expenses
    
    
    2,529
    
    
    
    2,833
    
    
    
    (304
    )
    
    
    (10.7
    )Craft Brands Alliance Shared Formation
Expenses
    
    
    407
    
    
    
    
    
    
    
    407
    
    
    
    100.0Operating Income (Loss)
    
    
    (890
    )
    
    
    (1,162
    )
    
    
    272
    
    
    
    23.3Interest Expense
    
    
    44
    
    
    
    51
    
    
    
    (7
    )
    
    
    (13.7
    )Other Income (Expense)  Net
    
    
    13
    
    
    
    19
    
    
    
    (6
    )
    
    
    (31.6
    )Net Income (Loss)
    
    $
    (921
    )
    
    $
    (1,194
    )
    
    $
    273
    
    
    
    22.9
    %Beer Shipped (in barrels)
    
    
    50,200
    
    
    
    47,700
    
    
    
    2,500
    
    
    
    5.2
    %
 Sales.Total sales increased 8.3% to $9,390,000 for the three months
ended March 31, 2004 compared to $8,671,000 for the three months ended March
31, 2003, attributable to a 5.2% increase in barrels sold, some strength in
pricing and an increase in sales in the pubs located in the Companys two
breweries. Total sales volume for the first quarter of 2004 increased to 50,200
barrels from 47,700 barrels for the same period in 2003, the result of a 3.0%
increase in shipments of its packaged products and a 9.2% increase in shipments
of the Companys draft products. The mix of package sales to draft sales
generally affects overall revenue per barrel, with package product generating a
higher revenue per barrel but also an increased cost of sales per barrel. The
migration toward increasing package sales slowed, with 63.8% of total shipments
in the first quarter 2004 being package shipments versus 65.1% in the same 2003
quarter. Sales volume for the 12-pack package, which is more costly to produce,
increased in the first quarter of 2004 to 36.5% of package sales from 34.0% in
the first quarter of 2003. West Coast sales increased 3.1% in the first quarter
of 2004 as compared to the same period in 2003, despite a 7.6% decrease in
shipments in Washington State, the Companys largest market. Sales other than
wholesale beer sales, primarily retail pub revenues, increased to $937,000 in
the first quarter of 2004 from $843,000 in the first quarter of 2003. At March
31, 2004 and 2003, the Companys products were distributed in 48 states. Excise Taxes. Excise taxes increased to $771,000, or 8.9% of net sales,
in the 2004 first quarter compared to $733,000, or 9.2% of net sales, in the
same 2003 period. The comparability of excise taxes as a percentage of net
sales is impacted by many factors, including average revenue per barrel, the
proportion of pub sales to total sales, and the estimated annual average
federal and state excise tax rates. Cost of Sales.Cost of sales increased 4.9% to $6,574,000 in the three
months ended March 31, 2004 compared to $6,267,000 in the same 2003 period, but
remained nearly flat on a per barrel basis and decreased as a percentage of net
sales. As a percentage of net sales, cost of sales decreased to 76.3% in the
2004 first quarter from 78.9% in the comparable 2003 quarter. Based upon the
breweries combined current production capacity of 90,000 barrels for the
quarters ended March 31, 2004 and 2003, the utilization rates were 55.8% and
53.0%, respectively. The cost of the Companys most significant ingredient,
malted barley, declined somewhat in 2004 following a significant cost increase
in 2003 (driven by a poor 2002 worldwide barley harvest). Improvement in the
Companys direct costs were offset slightly by an increase in 13




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some indirect
costs, primarily depreciation and production wages, following the 2003
expansion of brewing capacity in the Companys New Hampshire brewery. Craft Brands Alliance Shared Formation Expenses.On February 3, 2004, the
Company announced that it had reached an agreement in principle with Widmer
Brothers Brewing Company to form a joint sales and marketing organization that
will serve both companies operations in the Western United States. The joint
organization, named Craft Brands Alliance LLC, was formed in March 2004 and is
seeking required regulatory approvals. The Company and Widmer have both
incurred certain formation expenses, including severance expenses and legal
fees, in conjunction with the formation of Craft Brands Alliance. The Companys
first quarter 2004 operating loss includes $407,000 attributable to the
Companys share of expenses incurred in the formation of Craft Brands Alliance. Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $2,529,000 in the 2004 first quarter
compared to $2,833,000 in the 2003 first quarter, also declining to 29.3% from
35.7% as a percentage of net sales, respectively. While significant components
continued to be expenditures for the Companys promotion programs as well as
salaries for the national sales force, the Company did review its advertising
and marketing programs and reduce spending where the anticipated value was not
expected to meet expectations. In addition, until Craft Brands Alliance is
fully operational, which is now anticipated to be early in the third quarter of
2004, the Company and Widmer have agreed to share certain sales-related costs,
primarily salaries and overhead. The Companys share of those costs totaled
$54,000 for the quarter ended March 31, 2004 and are reflected as selling,
general and administrative expenses. Interest Expense.Interest expense was $44,000 for the first quarter of
2004, down from $51,000 for the comparable 2003 period, reflecting the effect
of lower outstanding debt and lower average interest rates. Other Income (Expense) Net. Other income (expense)  net decreased to
income of $13,000 in the 2004 first quarter compared to income of $19,000 in
the 2003 first quarter. Interest income declined $8,000 in the same period as a
result of a lower average balance of interest-bearing deposits and lower
average interest rates. Income Taxes. The Companys effective income tax rate was a 0.0% for the
first quarter of 2004 and 2003. Both years income taxes reflect a deferred
income tax benefit offset by the recording of a valuation allowance. In the
first three months of 2004 and 2003, the Company increased the valuation
allowance to fully cover net tax operating loss carryforwards that were
generated by the quarters deferred income tax benefit. The valuation allowance
covers a portion of the Companys deferred tax assets, specifically certain
federal and state NOLs that may expire before the Company is able to utilize
the tax benefit. Realization of the benefit is dependent on the Companys
ability to generate future U.S. taxable income. To the extent that the Company
continues to be unable to generate adequate taxable income in future periods,
the Company will not be able to recognize additional tax benefits and may be
required to record a greater valuation allowance covering potentially expiring
NOLs. Liquidity and Capital Resources The Company has required capital principally for the construction and
development of its production facilities. To date, the Company has financed its
capital requirements through cash flow from operations, bank borrowings and the
sale of common and preferred stock. The Company expects to meet its future
financing needs and working capital and capital expenditure requirements
through cash on hand, operating cash flow and, to the extent required and
available, bank borrowings and offerings of debt or equity securities. The Company had $5,066,000 and $6,123,000 of cash and cash equivalents at
March 31, 2004 and December 31, 2003, respectively. At March 31, 2004, the
Company had working capital of $4,267,000. The Companys long-term debt as a
percentage of total capitalization (long-term debt, convertible redeemable
preferred stock and common stockholders equity) was 8.6% at March 31, 2004
compared to 8.7% at December 31, 2003. Cash used in operating activities
totaled $980,000 for the quarter ended March 31, 2004, an improvement over cash
used in operating activities of $1,382,000 for the comparable 2003 quarter. The 14




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improvement was primarily attributable to returning inventory levels to more
normal levels as of March 31, 2003, following unusually low inventory levels at
December 31, 2002. During the quarter ended March 31, 2004, the Companys capital
expenditures totaled $23,000. Capital expenditures for fiscal year 2004 are
expected to total approximately $450,000. The Company has a credit agreement with a bank under which a term loan
(the Term Loan) and a $2 million revolving credit facility (the Revolving
Facility) are provided. The Term Loan, which originated in June 1997 upon the
conversion of a $9 million secured credit facility, had a five-year term with a
20-year amortization schedule. In June 2001, the credit agreement was amended
to extend the maturity date on the Term Loan to June 5, 2007. In June 2002, the
credit agreement was amended to extend the commitment period for the Revolving
Facility to July 1, 2004. In October 2003, the credit agreement was amended to
reduce the $10 million revolving credit facility to a $2 million revolving
credit facility. The Term Loan and the Revolving Facility are secured by
substantially all of the Companys assets. Through June 4, 2002, interest on
the Term Loan accrued at a variable rate based on the London Inter Bank Offered
Rate (LIBOR) plus 1.25%. Since June 5, 2002, interest on the Term Loan
accrued at LIBOR plus 1.75%. The interest rate on the Revolving Facility is the
applicable LIBOR plus 1.00% to 2.00%, depending on the Companys funded debt
ratio. The Company has the option to fix the applicable interest rate for up to
twelve months by selecting LIBOR for one- to twelve- month periods as a base.
As of March 31, 2004, there was $5.963 million outstanding on the Term Loan,
and the Companys one-month LIBOR-based borrowing rate was 2.9%. As of March
31, 2004, there were no borrowings outstanding on the Revolving Facility. The
termination of the A-B Distribution Agreement for any reason or the failure by
the Company to perform any of its material obligations under the A-B Investment
Agreement would constitute an event of default under the credit agreement and
the bank may declare the entire outstanding loan balance immediately due and
payable. See  Certain Considerations: Issues and Uncertainties below. If
this were to occur, it would be unlikely that the Company could satisfy its
obligations under the Term Loan. In all events, unless additional capital was
raised, the Company would not have sufficient liquidity to satisfy both its
obligation under the Term Loan and its obligation to redeem the Series B
Preferred Stock under the A-B Investment Agreement. The Company could seek to
refinance its Term Loan with one or more banks or obtain additional equity
capital; however, there can be no assurance the Company would be able to access
additional capital to meet its needs or that such additional capital would be
at commercially reasonable terms. The terms of the credit agreement require the Company to meet certain
financial covenants. In December 2001, March 2003 and February 2004, the
credit agreement was amended to modify several financial covenants. These
revisions have reduced the likelihood that a violation of the covenants by the
Company will occur; however, if the Company were to report a significant net
loss for one or more quarters within a time period covered by the financial
covenants, one or more of the covenants would be negatively impacted and could
cause a violation. Failure to meet the covenants required by the credit
agreement is an
event of default and, at its option, the Bank could deny a request for a
waiver and declare the entire outstanding loan balance immediately due and
payable. In such a case, the Company would seek to refinance the loan with one
or more banks, potentially at less desirable terms. However, there can be no
guarantee that additional financing would be available at commercially
reasonable terms, if at all. The Company was in compliance with all covenants
for the quarter ended March 31, 2004. From May 2000 through May 2003, the Company repurchased its Common Stock
in conjunction with a repurchase plan authorized by the Board of Directors. The
plan allowed for the repurchase of 1.5 million outstanding shares of Common
Stock for a total maximum repurchase of $2,750,000. In May 2003, at which time
a total of 1,463,100 shares of Common Stock had been purchased in the open
market for an aggregate expenditure of $2,750,000, the Company ended the
repurchase plan. During the first quarter of 2003, 80,600 shares of Common
Stock were purchased for $184,000. No shares of Common Stock were repurchased
in 2004. Certain Considerations: Issues and Uncertainties 15




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The Company does not provide forecasts of future financial performance or
sales volume, although this Quarterly Report contains certain other types of
forward-looking statements that involve risks and uncertainties. The Company
may, in discussions of its future plans, objectives and expected performance in
periodic reports filed by the Company with the Securities and Exchange
Commission (or documents incorporated by reference therein) and in written and
oral presentations made by the Company, include forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, or
Section 21E of the Securities Exchange Act of 1934, as amended. Such
forward-looking statements are based on assumptions that the Company believes
are reasonable, but are by their nature inherently uncertain. In all cases,
there can be no assurance that such assumptions will prove correct or that
projected events will occur. Actual results could differ materially from those
projected depending on a variety of factors, including, but not limited to, the
successful execution of market development and other plans, the availability of
financing and the issues discussed below. While Company management is
optimistic about the Companys long-term prospects, the following issues and
uncertainties, among others, should be considered in evaluating its business
prospects and any forward-looking statements. Relationship with Anheuser-Busch, Incorporated.Most of the Companys
future sales are expected to be through the Distribution Alliance with A-B. See
Part 1, Item 1  Business  Product Distribution, and Relationship with
Anheuser-Busch, Incorporated of the Companys Annual Report on Form 10-K for
the year ended December 31, 2003 for a further description of the Companys
relationship with A-B. If the Distribution Alliance were to be terminated, or
if the relationship between A-B and the Company were to deteriorate,
distribution of the Companys products would suffer significant disruption and
such event would have a long-term severe negative impact on the Companys sales
and results of operations, as it would be extremely difficult for the Company
to rebuild its own distribution network. Further, in the event that the A-B
Distribution Agreement is terminated on or before December 31, 2004, under
circumstances described in Item 1 (see Business  Relationship with
Anheuser-Busch, Incorporated  A-B Distribution Agreement), the terms of the
Series B Preferred Stock held by A-B pursuant to the A-B Investment Agreement
require the Company to redeem the Series B Preferred Stock on December 31,
2004, at a redemption price equal to $12.61 per share (approximately $16.3
million in the aggregate), plus an amount equal to accumulated and unpaid
dividends thereon, if any. The terms of the Series B Preferred Stock further
provide that, if at the time of the mandatory redemption the Company has
insufficient legally available funds to redeem all shares of Series B Preferred
Stock, then all funds that are legally available must be used to redeem Series
B Preferred Stock. At any time thereafter when additional funds of the Company
become legally available, such funds must be immediately used to redeem
additional shares of Series B Preferred Stock. The Company would not be legally
able to redeem shares of Series B Preferred Stock if, after giving effect to
such redemption, the Company would not be able to pay its debts when due in the
usual course of business or the Companys total assets would be less than the
sum of its total liabilities. Such a mandatory redemption could have a material
adverse effect on the financial position and cash flows of the Company. While
the Company believes that the benefits of the Distribution Alliance, in
particular distribution and material cost efficiencies, offset costs associated
with the Alliance, there can be
no assurance that these costs will not have a negative impact on the
Companys profit margins in the future. Notice of intention to terminate the
Distribution Agreement must be made by the party electing to do so no less than
six months prior to the termination date. To date, neither Redhook nor A-B has
given notice of its intention to terminate the Distribution Agreement. Failure
to come to an agreement with A-B or the termination of the Distribution
Agreement would have a material adverse effect on the Companys ability to
continue as a going concern. Effect of Competition on Future Sales.The Company competes in the highly
competitive craft brewing market as well as in the much larger specialty beer
market, which encompasses producers of import beers, major national brewers
that have introduced fuller-flavored products, and large spirit companies and
national brewers that produce flavored alcohol beverages. Beyond the beer
market, craft brewers have also faced competition from producers of wines and
spirits. Primarily as a result of increased competition, the Company
experienced declining sales volumes ranging from 2.3% to 5.7% for the years
1997 through 1999. And while the Companys sales volumes since 1999 have
increased when compared to the corresponding prior years volumes, competition
within the segment has, at times, negatively impacted pricing of the Companys
products. A further increase in competition could cause the Companys future
sales and results of operations to be adversely affected. The Company has
historically operated with little or no backlog and, therefore, its ability to
predict sales for future periods is limited. 16




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##### Table of Contents



Sales Prices.Future prices the Company charges for its products may
decrease from historical levels, depending on competitive factors in the
Companys various markets. The Company has participated in price promotions
with its wholesalers and their retail customers in most of its markets. The
number of markets in which the Company participates in price promotions and the
frequency of such promotions may increase in the future. Variability of Gross Margin and Cost of Sales.The Company anticipates
that its future gross margins will fluctuate and may decline as a result of
many factors, including disproportionate depreciation and other fixed and
semi-variable operating costs, depending on the level of production at the
Companys breweries in relation to current production capacity. The Companys
high level of fixed and semi-variable operating costs causes gross margin to be
very sensitive to relatively small increases or decreases in sales volume. In
addition, other factors that could affect cost of sales include changes in
freight charges, the availability and prices of raw materials and packaging
materials, the mix between draft and bottled product sales, the sales mix of
various bottled product packages and federal or state excise taxes. Also, as
sales volume through the Distribution Alliance increases, the related fees
would increase. Advertising and Promotional Costs.The Company has participated in
advertising programs to varying degrees over the past five years. Prior to
1999, the Company engaged in very limited advertising to market its products.
In order to increase brand awareness and capture a larger share of the
fragmented craft beer market, the Company determined that a significant
increase in spending on advertising and promotion was necessary. During 1999
and 2000, the Company primarily utilized radio, billboard and print advertising
in key markets, while also participating to a small degree in a co-operative
program with its distributors. In 2001, the Company allocated a larger share of
its advertising spending to this co-operative program whereby the Companys
spending is matched dollar for dollar by the distributor. In 2002 and 2003, the
Company continued its co-operative advertising and promotion program while
reducing even further those advertising expenditures where the Company funded
the entire program. The Company believes that the financial commitment as well
as the distributors knowledge of the local market result in an advertising and
promotion program that is targeted in a manner that will best promote Redhook.
Expenditures for the co-op program and media advertising program totaled
$255,000 for the three months ended March 31, 2004, and
$1.6 million and $1.9 million for the years ended December 31, 2003 and 2002, respectively.
This increased advertising spending has significantly increased the Companys
selling, general and administrative expense since 1998, leading to increased
losses and a reduction in stockholders equity. The Company expects to continue
to participate in the co-op advertising and promotion program and limited media
advertising in select Eastern United States markets throughout 2004 and in
Western United States markets until Craft Brands Alliance is fully operational.
Market and competitive considerations could require an increase in other
promotional costs associated with developing existing and new markets. Joint Organization with Widmer Brothers Brewing Company.On February 3,
2004, the Company announced that it had reached an agreement in principle with
Widmer Brothers Brewing Company to form a joint sales and marketing
organization that will serve both companies operations in the Western United
States. The joint organization, named Craft Brands Alliance LLC, was formed in
March 2004 and is seeking required regulatory approvals. The Company and Widmer
have both incurred certain formation expenses, including severance expenses and
legal fees, in conjunction with the formation of Craft Brands Alliance. The
Companys first quarter 2004 operating loss includes $407,000 attributable to
the Companys share of expenses incurred in the formation of Craft Brands
Alliance. Additionally, until Craft Brands Alliance is fully operational, which
is now anticipated to be early in the third quarter of 2004, the Company and
Widmer have agreed to share certain sales-related costs, primarily salaries and
overhead. The Companys share of those costs totaled $54,000 for the quarter
ended March 31, 2004 and are reflected in the Companys statement of operations
as selling, general and administrative expenses. The Company believes that the combined sales and marketing organization
will create synergies and capitalize on both companies sales and marketing
experience and complementary product portfolios. The Company anticipates that
the joint organization will positively impact revenues and decrease the
Companys selling, general and administrative expenses. However, negotiations
between the Company and Widmer are not complete, and there can be no assurance
that (i) the necessary regulatory approvals will be obtained, (ii) the parties
will agree upon the final structure of the joint venture or (iii) the Company
will see any anticipated 17




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##### Table of Contents



benefits from the joint venture. Until the joint
venture is fully deployed, the Company expects to continue to participate in
the co-op advertising and promotion program and limited media advertising in
the markets impacted by the organization. Dependence on Third-Party Distributors.The Company also relies heavily
on non-Alliance third-party distributors for the sale of its products to
retailers. The Companys most significant non-Alliance wholesaler, K&L
Distributors, Inc., that although not part of the Alliance is a distributor in
the A-B distribution network, accounted for approximately 12% of the Companys
sales in the first three months of 2004. Substantially all of the remaining
sales volume is through the Distribution Alliance to wholesalers that are part
of the A-B distribution network, most of which are independent wholesalers. A
disruption of the Companys, the wholesalers or A-Bs ability to distribute
products efficiently due to any significant operational problems, such as
wide-spread labor union strikes, the loss of K&L Distributors as a customer, or
the termination of the Distribution Alliance could have a material adverse
impact on the Companys sales and results of operations. Customer Acceptance, Consumer Trends and Public Attitudes.If consumers
were unwilling to accept the Companys products or if general consumer trends
caused a decrease in the demand for beer, including craft beer, it could
adversely impact the Companys sales and results of operations. If the flavored
alcohol beverage market, the wine market, or the spirits market continue to
grow, they could draw consumers away from the Companys products and have an
adverse effect on the Companys sales and results of operations. Further, the
alcoholic beverage industry has become the subject of considerable societal and
political attention in recent years due to increasing public concern over
alcohol-related social problems, including drunk driving, underage drinking and
health consequences from the misuse of alcohol. If beer consumption in general
were to come into disfavor among domestic consumers, or if the domestic beer
industry were subjected to significant additional governmental regulation, the
Companys sales and results of operations could be adversely affected. Effect of Sales Trends on Brewery Efficiency and Operations. The
Companys breweries have been operating at production levels substantially
below their current and maximum designed capacities. Operating breweries at low
capacity utilization rates negatively impacts gross margins and operating cash
flows generated by the production facilities. In 1998, after performing an
analysis of the Companys current and future production capacity requirements,
production at the Fremont Brewery was permanently curtailed and the assets were
written down to an estimate of their net realizable value. The Company will
continue to evaluate whether it expects to recover the costs of its two
remaining production facilities over the course of their useful lives. If facts
and circumstances indicate that the carrying value of these long-lived assets
may be impaired, an evaluation of recoverability will be performed in
accordance with FASB Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, by comparing the carrying value of
the assets to projected future undiscounted cash flows in addition to
other quantitative and qualitative analyses. If management believes that the
carrying value of such assets may not be recoverable, the Company will
recognize an impairment loss by a charge against current operations. Income Tax Benefits.As of December 31, 2003, the Company had
approximately $11.8 million of deferred tax assets, comprised principally of
federal net operating loss carryforwards that expire from 2012 through 2023 and
state NOLs that expire through 2018. Federal NOLs, generally permitted to be
carried forward no more than 20 years, and state NOLs, generally permitted to
be carried forward five to 15 years, can be used to offset regular tax
liabilities in future years. The recognition of these assets is dependent upon
estimates of future taxable income resulting from future reversals of existing
taxable temporary differences, which have been recorded as deferred tax
liabilities and exceed the deferred tax assets. As of December 31, 2003, the
Company also had a valuation allowance of $738,000, reflected as a reduction of
the Companys deferred tax assets on its balance sheet. During the three months
of 2004, the Company increased its valuation allowance by $303,000 thereby
reducing the estimated income tax benefit recorded in its statement of
operations to $0. The valuation allowance covers a portion of the Companys
deferred tax assets, specifically certain federal and state NOL carryforwards,
that may expire before the Company is able to utilize the tax benefit.
Realization of the benefit is dependent on the Companys ability to generate
future U.S. taxable income. To the extent that the Company is unable to
generate adequate taxable income in the future, the Company may not be able to
recognize additional tax benefits and may be required to record a greater
valuation allowance covering expiring NOLs. 18




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##### Table of Contents



Recent Accounting Pronouncements In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies the application
of consolidation accounting for certain entities that do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties or in which equity investors
do not have the characteristics of a controlling financial interest; these
entities are referred to as variable interest entities. Variable interest
entities within the scope of FIN 46 will be required to be consolidated by
their primary beneficiary. The primary beneficiary of a variable interest
entity is determined to be the party that absorbs a majority of the entitys
expected losses, receives a majority of its expected returns, or both. FIN 46
also requires disclosure of significant variable interests in variable interest
entities for which a company is not the primary beneficiary. Until the
organizational documents regarding Craft Brands Alliance LLC are complete, the
Company is unable to determine whether that entity is a variable interest
entity, and if it is, whether the Company will be the primary beneficiary. 19




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ITEM 3.Quantitative and Qualitative Disclosures about Market Risk The Company has assessed its vulnerability to certain market risks,
including interest rate risk associated with financial instruments included in
cash and cash equivalents and long-term debt. Due to the nature of these
investments and the Companys investment policies, the Company believes that
the risk associated with interest rate fluctuations related to these financial
instruments does not pose a material risk. The Company did not have any derivative financial instruments as of March
31, 2004. 
 ITEM 4.Controls and Procedures The Company has carried out an evaluation of the effectiveness of the
design and operation of the Companys disclosure controls and procedures (as
defined in Exchange Act Rule 13a-15(e) or 15d-15(e)) as of the end of the
period covered by this quarterly report on Form 10-Q. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Companys disclosure controls and procedures are effective. No changes in the Companys internal control over financial reporting were
identified in connection with the evaluation that has materially affected, or
is reasonably likely to materially affect, the Companys internal control over
financial reporting. 
 PART II. 
 ITEM 6.Exhibits and Reports on Form 8-K (a) Exhibits The following exhibits are filed as part of this report.  3.1
    
    Amended and Restated Bylaws of Registrant, dated
April 7, 200431.1
    
    Certification of
Chief Executive
Officer of Redhook
Ale Brewery,
Incorporated
pursuant to
Exchange Act Rule
13a-14(a)31.2
    
    Certification of
Chief Financial
Officer of Redhook
Ale Brewery,
Incorporated
pursuant to Exchange
Act Rule 13a-14(a)32.1
    
    Certification of
Chief Executive
Officer of Redhook
Ale Brewery,
Incorporated
pursuant to Exchange
Act 13a-14(b) and 18
U.S.C. Section 135032.2
    
    Certification of
Chief Financial
Officer of Redhook
Ale Brewery,
Incorporated
pursuant to Exchange
Act 13a-14(b) and 18
U.S.C. Section 1350 (b) Reports on Form 8-K During the quarter ended March 31, 2004, and between such date and the
filing of this Form 10-Q, the Company furnished the following report
on Form 8-K: Current reported dated March 29, 2004 containing Regulation FD disclosure
regarding Report of Ernst & Young LLP, Independent Auditors, included in
the Companys 2003 Form 10-K. Current report dated May 4, 2004 furnishing a press release announcing
certain financial results for the quarter ended March 31, 2004. 20




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. REDHOOK ALE BREWERY, INCORPORATED May 14, 2004
    
    BY: /s/ David J. MickelsonDavid J. Mickelson   Executive
Vice President,   Chief
Financial Officer   and
Chief Operating OfficerMay 14, 2004
    
    BY: /s/ Anne M. MuellerAnne M. Mueller   Controller
and Treasurer,   Principal
Accounting Officer
 21