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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 1934FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004OR[  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934for 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
July 31, 2004 was 8,181,309. Page 1 of 27 sequentially numbered pages




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REDHOOK ALE BREWERY, INCORPORATED FORM 10-Q For The Quarterly Period Ended June 30, 2004 TABLE OF CONTENTS  
 PagePART I.
    
    Financial InformationITEM 1.
    
    Financial StatementsBalance Sheets as of June 30, 2004 and December 31, 2003
    
    
    3Statements of Operations for the Three Months Ended June 30, 2004 and 2003 and the Six Months Ended June 30, 2004 and 2003
    
    
    4Statements of Cash Flows for the Six Months Ended June 30, 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
    
    
    25ITEM 4.
    
    Controls and Procedures
    
    
    25PART II.
    
    Other InformationITEM 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    25ITEM 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    25ITEM 6.
    
    Exhibits and Reports on Form 8-K
    
    
    26EXHIBIT 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 June 30,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    7,407,187
    
    
    $
    6,123,349Accounts Receivable
    
    
    1,931,564
    
    
    
    1,686,735Inventories
    
    
    3,005,965
    
    
    
    3,342,006Other
    
    
    629,513
    
    
    
    247,038Total Current Assets
    
    
    12,974,229
    
    
    
    11,399,128Fixed Assets, Net
    
    
    64,256,904
    
    
    
    65,699,658Other Assets
    
    
    28,817
    
    
    
    32,256Total Assets
    
    $
    77,259,950
    
    
    $
    77,131,042LIABILITIES, PREFERRED STOCK AND COMMON STOCKHOLDERS EQUITYCurrent Liabilities:Accounts Payable
    
    $
    2,581,179
    
    
    $
    1,983,377Accrued Salaries, Wages and Payroll Taxes
    
    
    1,287,591
    
    
    
    1,561,526Refundable Deposits
    
    
    2,609,488
    
    
    
    2,272,328Other Accrued Expenses
    
    
    674,956
    
    
    
    621,185Current Portion of Long-Term Debt
    
    
    450,000
    
    
    
    450,000Total Current Liabilities
    
    
    7,603,214
    
    
    
    6,888,416Long-Term Debt, Net of Current Portion
    
    
    5,400,000
    
    
    
    5,625,000Deferred Income Taxes, Net
    
    
    468,798
    
    
    
    468,798Other Liabilities
    
    
    32,452
    
    
    
    CommitmentsConvertible Redeemable Preferred Stock
    
    
    16,254,855
    
    
    
    16,232,655Common Stockholders Equity:Common Stock, Par Value $0.005 per Share, Authorized, 50,000,000
Shares; Issued and Outstanding, 6,361,806 Shares in 2004 and
6,226,306 Shares in 2003
    
    
    31,810
    
    
    
    31,132Additional Paid-In Capital
    
    
    54,483,375
    
    
    
    54,250,059Retained Earnings
(Deficit)
    
    
    (7,014,554
    )
    
    
    (6,365,018
    )Total Common Stockholders Equity
    
    
    47,500,631
    
    
    
    47,916,173Total Liabilities, Preferred Stock and
Common Stockholders Equity
    
    $
    77,259,950
    
    
    $
    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 June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Sales
    
    $
    11,443,406
    
    
    $
    12,331,580
    
    
    $
    20,833,885
    
    
    $
    21,002,780Less Excise Taxes
    
    
    952,566
    
    
    
    1,068,380
    
    
    
    1,723,211
    
    
    
    1,801,394Net Sales
    
    
    10,490,840
    
    
    
    11,263,200
    
    
    
    19,110,674
    
    
    
    19,201,386Cost of Sales
    
    
    7,479,198
    
    
    
    7,843,863
    
    
    
    14,053,411
    
    
    
    14,110,605Gross Profit
    
    
    3,011,642
    
    
    
    3,419,337
    
    
    
    5,057,263
    
    
    
    5,090,781Selling, General and Administrative Expenses
    
    
    2,545,796
    
    
    
    2,936,539
    
    
    
    5,074,364
    
    
    
    5,769,813Craft Brands Alliance Shared Formation Expenses
    
    
    130,808
    
    
    
    
    
    
    
    537,575
    
    
    
    Operating Income (Loss)
    
    
    335,038
    
    
    
    482,798
    
    
    
    (554,676
    )
    
    
    (679,032
    )Interest Expense
    
    
    42,793
    
    
    
    49,733
    
    
    
    86,400
    
    
    
    100,745Other Income (Expense)  Net
    
    
    10,957
    
    
    
    14,806
    
    
    
    23,740
    
    
    
    33,428Income (Loss) before Income Taxes
    
    
    303,202
    
    
    
    447,871
    
    
    
    (617,336
    )
    
    
    (746,349
    )Income Tax Provision (Benefit)
    
    
    10,000
    
    
    
    
    
    
    
    10,000Net Income (Loss)
    
    $
    293,202
    
    
    $
    447,871
    
    
    $
    (627,336
    )
    
    $
    (746,349
    )Basic Earnings (Loss) per Share
    
    $
    0.04
    
    
    $
    0.07
    
    
    $
    (0.10
    )
    
    $
    (0.12
    )Diluted Earnings (Loss) per Share
    
    $
    0.04
    
    
    $
    0.06
    
    
    $
    (0.10
    )
    
    $
    (0.12
    )
 See Accompanying Notes to Financial Statements 4




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REDHOOK ALE BREWERY, INCORPORATED 
 STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30,2004
    
    2003Operating ActivitiesNet Income (Loss)
    
    $
    (627,336
    )
    
    $
    (746,349
    )Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided by Operating Activities:Depreciation and Amortization
    
    
    1,477,591
    
    
    
    1,537,690Deferred Income Taxes, Net
    
    
    
    
    
    
    (14,001
    )Net Change in Operating Assets and Liabilities
    
    
    455,987
    
    
    
    (597,839
    )Net Cash Provided by Operating Activities
    
    
    1,306,242
    
    
    
    179,501Investing ActivitiesExpenditures for Fixed Assets
    
    
    (28,898
    )
    
    
    (671,062
    )Other, Net
    
    
    (2,500
    )
    
    
    Net Cash Used in Investing Activities
    
    
    (31,398
    )
    
    
    (671,062
    )Financing ActivitiesPrincipal Payments on Debt
    
    
    (225,000
    )
    
    
    (225,000
    )Repurchase of Common Stock
    
    
    
    
    
    
    (230,667
    )Issuance of Common Stock
    
    
    233,994
    
    
    
    Net Cash Provided by (Used in) Financing Activities
    
    
    8,994
    
    
    
    (455,667
    )Increase (Decrease) in Cash and Cash Equivalents
    
    
    1,283,838
    
    
    
    (947,228
    )Cash and Cash Equivalents:Beginning of Period
    
    
    6,123,349
    
    
    
    7,007,351End of Period
    
    $
    7,407,187
    
    
    $
    6,060,123
 See Accompanying Notes to Financial Statements 5




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REDHOOK ALE BREWERY, INCORPORATED 
 NOTES TO FINANCIAL STATEMENTS  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. 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 the Companys common stock (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. 6




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited) The following table sets forth the computation of basic and diluted
earnings (loss) per common share: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Basic earnings (loss) per share computation:Numerator:Net income (loss)
    
    $
    293,202
    
    
    $
    447,871
    
    
    $
    (627,336
    )
    
    $
    (746,349
    )Preferred stock accretion
    
    
    (11,100
    )
    
    
    (11,100
    )
    
    
    (22,200
    )
    
    
    (22,200
    )Numerator  income (loss) available
to common stockholders
    
    $
    282,102
    
    
    $
    436,771
    
    
    $
    (649,536
    )
    
    $
    (768,549
    )Denominator:Weighted average common shares
    
    
    6,296,769
    
    
    
    6,232,429
    
    
    
    6,262,228
    
    
    
    6,262,008Basic earnings (loss) per share
    
    $
    0.04
    
    
    $
    0.07
    
    
    $
    (0.10
    )
    
    $
    (0.12
    )Diluted earnings (loss) per share computation:Numerator:Net income (loss)
    
    $
    293,202
    
    
    $
    447,871
    
    
    $
    (627,336
    )
    
    $
    (746,349
    )Preferred stock accretion
    
    
    
    
    
    
    
    
    
    
    (22,200
    )
    
    
    (22,200
    )Numerator  income (loss) available
to common stockholders
    
    $
    293,202
    
    
    $
    447,871
    
    
    $
    (649,536
    )
    
    $
    (768,549
    )Denominator:Weighted average common shares
    
    
    6,296,769
    
    
    
    6,232,429
    
    
    
    6,262,228
    
    
    
    6,262,008Effect of dilutive securities:Series B convertible preferred stock
    
    
    1,289,872
    
    
    
    1,289,872
    
    
    
    
    
    
    
    Stock options, net
    
    
    125,901
    
    
    
    86,815
    
    
    
    
    
    
    
    Denominator for diluted earnings (loss)
per share
    
    
    7,712,541
    
    
    
    7,609,116
    
    
    
    6,262,228
    
    
    
    6,262,008Diluted earnings (loss) per share
    
    $
    0.04
    
    
    $
    0.06
    
    
    $
    (0.10
    )
    
    $
    (0.12
    )
 3. Inventories Inventories consist of the following: June 30,
    
    December 31,2004
    
    2003Raw materials
    
    $
    988,023
    
    
    $
    1,184,733Work in process
    
    
    875,475
    
    
    
    900,388Finished goods
    
    
    460,164
    
    
    
    408,561Promotional merchandise.
    
    
    519,441
    
    
    
    631,147Packaging materials
    
    
    162,862
    
    
    
    217,177$
    3,005,965
    
    
    $
    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 (Continued)
(Unaudited) 4. Common Stock Activity In conjunction with the exercise of stock options granted under the
Companys stock option plans, the Company issued 135,500 shares of Common Stock
totaling $234,000 during the six months ended June 30, 2004, including 98,800
shares of Common Stock totaling $175,000 issued during the three months ended
June 30, 2004. No Common Stock was issued during the six months ended June 30,
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 six-month period ended June 30, 2003, 101,400
shares of Common Stock were purchased for $231,000. 5. 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 three and six months ended June 30, 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 Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss), as reported
    
    $
    293,202
    
    
    $
    447,871
    
    
    $
    (627,336
    )
    
    $
    (746,349
    )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
    
    
    (45,473
    )
    
    
    (65,008
    )
    
    
    (99,022
    )
    
    
    (132,624
    )Pro forma net income (loss)
    
    $
    247,729
    
    
    $
    382,863
    
    
    $
    (726,358
    )
    
    $
    (878,973
    )Earnings (loss) per share:Basic  as reported
    
    $
    0.04
    
    
    $
    0.07
    
    
    $
    (0.10
    )
    
    $
    (0.12
    )Basic  pro forma
    
    $
    0.04
    
    
    $
    0.06
    
    
    $
    (0.12
    )
    
    $
    (0.14
    )Diluted  as reported
    
    $
    0.04
    
    
    $
    0.06
    
    
    $
    (0.10
    )
    
    $
    (0.12
    )Diluted  pro forma
    
    $
    0.04
    
    
    $
    0.05
    
    
    $
    (0.12
    )
    
    $
    (0.14
    )
 8




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited) 6. Craft Brands Alliance LLC On July 1, 2004, the Company announced that it had entered into definitive
agreements with Widmer Brothers Brewing Company with respect to the operation
of Craft Brands Alliance LLC (Craft Brands). Craft Brands will advertise,
market, sell and distribute the Companys and Widmers products in the western
United States. In conjunction with the formation of Craft Brands, both the
Company and Widmer incurred certain start-up expenses, including severance
expenses and legal fees. The Companys operating income (loss) for the three
months and six months ended June 30, 2004 reflects $131,000 and $538,000,
respectively, attributable to the Companys share of these start-up expenses.
Additionally, during the period March 15, 2004 through June 30, 2004, while the
companies sought the regulatory approval required for Craft Brands to become
fully operational, the Company and Widmer agreed to share certain sales-related
costs, primarily salaries and overhead. The Companys share of those costs
totaled $500,000 for the quarter ended June 30, 2004 and $554,000 for the six
months ended June 30, 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 June 30, 2004 are a liability due to Craft Brands
Alliance for approximately $7,000 and a liability due to Widmer Brothers
Brewing of approximately $381,000. The Company is currently reviewing
relevant accounting pronouncements in order to determine the
appropriate accounting treatment with respect to Craft Brands and the
Company's interest in the entity. This determination will be
completed and implemented in the third quarter of 2004. 7. Relationship with Anheuser-Busch On July 1, 2004, the Company completed the restructuring of its ongoing
relationship with Anheuser-Busch, Inc. (A-B). The terms of the agreement,
which closed on July 1, 2004, provided that the Company issue 1,808,243 shares
of Common Stock to A-B in exchange for 1,289,872 shares of Series B Preferred
Stock held by A-B. The Series B Preferred Stock, reflected in the Companys
June 30, 2004 balance sheet at approximately $16.3 million, was cancelled. In
connection with the exchange, the Company agreed to pay $2.0 million to A-B
prior to December 1, 2004. Following the July 1, 2004 exchange of stock, A-Bs
ownership of the Company increased to approximately 33.8% of the Companys
Common Stock. A-B was also granted certain contractual registration rights with
respect to the shares of Common Stock held by A-B. On July 1, 2004, the Company
also entered into a new distribution agreement with Anheuser-Busch which will
expire on December 31, 2024, subject to the one-time right of Anheuser-Busch to
terminate the distribution agreement on December 31, 2014. The new
distribution agreement provides for the distribution of the Companys products
in the Midwest and eastern United States and includes an increase in certain
fees Redhook pays to A-B in connection with sales through the distribution
alliance. The Company is currently reviewing
relevant accounting pronouncements in order to determine the
appropriate accounting treatment with respect to the transactions.
This determination will be completed and the impact recorded in the
financial statements in the third quarter of 2004. 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 Financial Statements and Notes thereto of Redhook Ale Brewery, Incorporated
(the Company or Redhook) 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 six months ended June 30,
2004, the Company had gross sales of $20,834,000, a decrease of 0.8% over gross
sales of $21,003,000 for the six months ended June 30, 2003. Prior to July 1, 2004, the Companys sales consisted 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 Alliance or the
Distribution Alliance). On July 1, 2004, the Company entered into definitive
agreements with Widmer Brothers Brewing Company (Widmer) with respect to the
operation of a joint venture, Craft Brands Alliance LLC (Craft Brands).
Craft Brands will advertise, market, sell and distribute the Company and
Widmers products in the western United States. The Company will continue to
sell its products in the midwest and eastern United States through sales to A-B
pursuant to a new distribution agreement with A-B (the A-B Distribution
Agreement). For additional information regarding Craft Brands and the A-B
Distribution Agreement, see Managements Discussion and Analysis of Financial
Condition and Results of Operations  Formation of Craft Brands Alliance and
Restructuring of Relationship with Anheuser-Busch, Incorporated. In addition to sales of beer, 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) decreased 2.9% to 112,200 barrels
for the six months ended June 30, 2004 as compared to 115,600 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 and early 2004. 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. 10




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In January 2003, the Company entered into a licensing agreement with
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, the Company 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. 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. 11




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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 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 six months ended June 30, 2004, the Company increased its
valuation allowance by $209,000 thereby reducing the estimated deferred 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. 12




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##### Table of Contents



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 Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Sales
    
    
    109.1
    %
    
    
    109.5
    %
    
    
    109.0
    %
    
    
    109.4
    %Less Excise Taxes
    
    
    9.1
    
    
    
    9.5
    
    
    
    9.0
    
    
    
    9.4Net Sales
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Cost of Sales
    
    
    71.3
    
    
    
    69.6
    
    
    
    73.5
    
    
    
    73.5Gross Profit
    
    
    28.7
    
    
    
    30.4
    
    
    
    26.5
    
    
    
    26.5Selling, General and Administrative Expenses
    
    
    24.3
    
    
    
    26.1
    
    
    
    26.6
    
    
    
    30.0Craft Brands Alliance Shared Formation Expenses
    
    
    1.2
    
    
    
    
    
    
    
    2.8
    
    
    
    Operating Income (Loss)
    
    
    3.2
    
    
    
    4.3
    
    
    
    (2.9
    )
    
    
    (3.5
    )Interest Expense
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.5Other Income (Expense)  Net
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.1Income (Loss) before Income Taxes
    
    
    2.9
    
    
    
    4.0
    
    
    
    (3.2
    )
    
    
    (3.9
    )Income Tax Provision (Benefit)
    
    
    0.1
    
    
    
    
    
    
    
    0.1
    
    
    
    Net Income (Loss)
    
    
    2.8
    %
    
    
    4.0
    %
    
    
    (3.3
    )%
    
    
    (3.9
    )%
 Three Months Ended June 30, 2004 Compared to Three Months Ended June 30,
2003 The following table sets, for the periods indicated, a comparison of
certain items from the Companys Statements of Operations: Three Months EndedJune 30,
    
    Increase/
    
    %2004
    
    2003
    
    (Decrease)
    
    ChangeSales
    
    $
    11,443,406
    
    
    $
    12,331,580
    
    
    $
    (888,174
    )
    
    
    (7.2
    )%Less Excise Taxes
    
    
    952,566
    
    
    
    1,068,380
    
    
    
    (115,814
    )
    
    
    (10.8
    )Net Sales
    
    
    10,490,840
    
    
    
    11,263,200
    
    
    
    (772,360
    )
    
    
    (6.9
    )Cost of Sales
    
    
    7,479,198
    
    
    
    7,843,863
    
    
    
    (364,665
    )
    
    
    (4.6
    )Gross Profit
    
    
    3,011,642
    
    
    
    3,419,337
    
    
    
    (407,695
    )
    
    
    (11.9
    )Selling, General and Administrative Expenses
    
    
    2,545,796
    
    
    
    2,936,539
    
    
    
    (390,743
    )
    
    
    (13.3
    )Craft Brands Alliance Shared Formation Expenses.
    
    
    130,808
    
    
    
    
    
    
    
    130,808
    
    
    
    100.0Operating Income (Loss)
    
    
    335,038
    
    
    
    482,798
    
    
    
    (147,760
    )
    
    
    (30.6
    )Interest Expense
    
    
    42,793
    
    
    
    49,733
    
    
    
    (6,940
    )
    
    
    (14.0
    )Other Income (Expense)  Net
    
    
    10,957
    
    
    
    14,806
    
    
    
    (3,849
    )
    
    
    (26.0
    )Income (Loss) before Income Taxes
    
    
    303,202
    
    
    
    447,871
    
    
    
    (144,669
    )
    
    
    (32.3
    )Provision for Income Taxes
    
    
    10,000
    
    
    
    
    
    
    
    10,000
    
    
    
    100.0Net Income (Loss)
    
    $
    293,202
    
    
    $
    447,871
    
    
    $
    (154,669
    )
    
    
    (34.5
    )%Beer Shipped (in barrels)
    
    
    62,000
    
    
    
    67,900
    
    
    
    (5,900
    )
    
    
    (8.7
    )%
 13




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##### Table of Contents



Sales.The $888,000 decline in sales in the second quarter of 2004 was
largely driven by a 5,900 barrel decline in shipments, partially offset by a
modest improvement in average wholesale revenue per barrel and sales increases
at both of the Companys retail operations. Total sales volume for the second
quarter of 2004 decreased to 62,000 barrels from 67,900 barrels for the same
period in 2003, the result of a 13.9% decrease in shipments of its packaged
products and a 0.6% 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 60.5% of total shipments in the second quarter 2004 being
package shipments versus 64.2% in the same 2003 quarter. Sales volume for the
12-pack package, which is more costly to produce, increased in the second
quarter of 2004 to 37.9% of package sales from 32.3% in the second quarter of
2003. A 10.5% decline in West Coast sales volume, including a 15.7% decrease in
shipments in Washington State, the Companys largest market, contributed to the
overall quarterly sales volume decrease. Improvement in average wholesale
revenue per barrel was driven by strength in pricing in many of the Companys
markets, although the quarters average revenue per barrel did experience some
downward pressure as a result of a contract brewing arrangement, sold at a
significantly lower revenue per barrel, with Widmer Brothers Brewing Company.
Sales in the Companys retail operations increased $123,000, or 10.3%. At June
30, 2004 and 2003, the Companys products were distributed in 48 states. Excise Taxes. Excise taxes decreased to $953,000, or 9.1% of net sales,
in the 2004 second quarter compared to $1,068,000, or 9.5% 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.Comparing the 2004 second quarter to the 2003 second
quarter, cost of sales decreased 4.6%, or $365,000, but increased as a
percentage of net sales and on a per barrel basis. 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 was offset by larger
increases in some indirect costs, including utilities, freight, as well as
depreciation and production wages, following the 2003 expansion of brewing
capacity in the Companys New Hampshire brewery. As a percentage of net sales,
cost of sales increased to 71.3% in the 2004 second quarter from 69.6% in the
comparable 2003 quarter. Based upon the breweries combined current production
capacity of 93,750 barrels for the quarters ended June 30, 2004 and 2003, the
utilization rates were 66.1% and 72.42%, respectively. Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $391,000 to $2,546,000 from 2003 second
quarter expenses of $2,937,000, positively impacted by the formation of Craft
Brands as well as Company efforts to re-focus its sales and marketing spending
in its primary markets. While the companies sought the regulatory approval
required for Craft Brands to become fully operational, the Company and Widmer
agreed to share certain sales-related costs, primarily salaries and overhead.
The Companys share of those costs totaled $500,000 for the quarter ended June
30, 2004 and are reflected in the Companys statement of operations as selling,
general and administrative expenses. Craft Brands Alliance Shared Formation Expenses.In conjunction with the
formation of Craft Brands, both the Company and Widmer incurred certain
start-up expenses, including severance expenses and legal fees. The Companys
operating income for the three months ended June 30, 2004 reflects $131,000
attributable to the Companys share of these expenses. Interest Expense.Interest expense was $43,000 for the second quarter of
2004, down from $50,000 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 $11,000 in the 2004 second quarter compared to income of $15,000 in
the 2003 second quarter. Interest income declined $4,000 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 3.3% current
state tax provision for the second quarter of 2004 and 0.0% for the second
quarter of 2003. In the first three months of
2004 and 2003, 14




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##### Table of Contents



the Company increased the valuation allowance to fully cover net
tax operating loss carryforwards and other net deferred tax assets
that were generated during the quarter. 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. Six Months Ended June 30, 2004 Compared to Six Months Ended June 30, 2003 The following table sets, for the periods indicated, a comparison of
certain items from the Companys Statements of Operations: Six Months EndedJune 30,
    
    Increase/
    
    %2004
    
    2003
    
    (Decrease)
    
    ChangeSales
    
    $
    20,833,885
    
    
    $
    21,002,780
    
    
    $
    (168,895
    )
    
    
    (0.8
    )%Less Excise Taxes
    
    
    1,723,211
    
    
    
    1,801,394
    
    
    
    (78,183
    )
    
    
    (4.3
    )Net Sales
    
    
    19,110,674
    
    
    
    19,201,386
    
    
    
    (90,712
    )
    
    
    (0.5
    )Cost of Sales
    
    
    14,053,411
    
    
    
    14,110,605
    
    
    
    (57,194
    )
    
    
    (0.4
    )Gross Profit
    
    
    5,057,263
    
    
    
    5,090,781
    
    
    
    (33,518
    )
    
    
    (0.7
    )Selling, General and Administrative Expenses
    
    
    5,074,364
    
    
    
    5,769,813
    
    
    
    (695,449
    )
    
    
    (12.1
    )Craft Brands Alliance Shared Formation Expenses.
    
    
    537,575
    
    
    
    
    
    
    
    537,575
    
    
    
    100.0Operating Income (Loss)
    
    
    (554,676
    )
    
    
    (679,032
    )
    
    
    124,356
    
    
    
    18.3Interest Expense
    
    
    86,400
    
    
    
    100,745
    
    
    
    (14,345
    )
    
    
    (14.2
    )Other Income (Expense)  Net
    
    
    23,740
    
    
    
    33,428
    
    
    
    (9,688
    )
    
    
    (29.0
    )Income (Loss) before Income Taxes
    
    
    (617,336
    )
    
    
    (746,349
    )
    
    
    129,013
    
    
    
    17.3Provision for Income Taxes
    
    
    10,000
    
    
    
    
    
    
    
    10,000
    
    
    
    100.0Net Income (Loss)
    
    $
    (627,336
    )
    
    $
    (746,349
    )
    
    $
    119,013
    
    
    
    15.9
    %Beer Shipped (in barrels)
    
    
    112,200
    
    
    
    115,600
    
    
    
    (3,400
    
    
    
    (2.9
    )%
 Sales.The $169,000 decline in sales in the first six months of 2004 was
largely driven by a 3,400 barrel decline in shipments, partially offset by a
modest improvement in average wholesale revenue per barrel and sales increases
at both of the Companys retail operations. Total sales volume for the six
months ended June 30, 2004 decreased to 112,200 barrels from 115,600 barrels
for the same period in 2003, the result of a 6.9% decrease in shipments of its
packaged products, offset by a 4.1% 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 62.0% of total shipments in the first six
months of 2004 being package shipments versus 64.6% in the same 2003 period.
Sales volume for the 12-pack package, which is more costly to produce,
increased in the first six months of 2004 to 37.3% of package sales from 33.0%
in the same 2003 period. A 4.7% decline in West Coast sales volume, including a
12.3% decrease in shipments in Washington State, the Companys largest market,
contributed to the overall year-to-date sales volume decrease. Improvement in
average wholesale revenue per barrel was driven by strength in pricing in many
of the Companys markets, although the six-month periods average revenue per
barrel did experience some downward pressure as a result of a contract brewing
arrangement, sold at a significantly lower revenue per barrel, with Widmer
Brothers Brewing Company. Sales in the Companys retail operations increased
$216,000, or 10.7%. At June 30, 2004 and 2003, the Companys products were
distributed in 48 states. Excise Taxes. Excise taxes decreased to $1,723,000, or 9.0% of net sales,
in the six months ended June 30, 2004 compared to $1,801,000, or 9.4% 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. 15




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##### Table of Contents



Cost of Sales.Cost of sales decreased 0.4%, or $57,000, remained flat as
a percentage of net sales, but increased on a per barrel basis. 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 was offset by larger
increases in some indirect costs, including freight, as well as depreciation
and production wages, following the 2003 expansion of brewing capacity in the
Companys New Hampshire brewery. As a percentage of net sales, cost of sales
was 73.5% in the six months ended June 30, 2004 and 2003. Based upon the
breweries combined current production capacity of 187,500 barrels for the six
months ended June 30, 2004 and 183,750 barrels for the same 2003 period,
the utilization rates were 59.8% and 62.9%, respectively. Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $695,000 to $5,074,000 from the 2003
year-to-date expenses of $5,770,000, positively impacted by the formation of
Craft Brands as well as Company efforts to re-focus its sales and marketing
spending in its primary markets. While the companies sought the regulatory
approval required for Craft Brands to become fully operational, the Company and
Widmer agreed to share certain sales-related costs, primarily salaries and
overhead. The Companys share of those costs totaled $554,000 for the six
months ended June 30, 2004 and are reflected in the Companys statement of
operations as selling, general and administrative expenses. Craft Brands Alliance Shared Formation Expenses.In conjunction with the
formation of Craft Brands, both the Company and Widmer incurred certain
start-up expenses, including severance expenses and legal fees. The Companys
operating income (loss) for the six months ended June 30, 2004 reflects
$538,000 attributable to the Companys share of these expenses. Interest Expense.Interest expense was $86,000 for the first six months
of 2004, down from $101,000 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 $24,000 in the first six months of 2004 compared to income of $33,000
in the first six months of 2003. Interest income declined $11,000 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 1.6% current
state tax provision for the first six months of 2004 and 0.0% for the
comparable 2003 period. In the first six
months of 2004 and 2003, the Company increased the valuation allowance to fully
cover net tax operating loss carryforwards and other net deferred tax assets that were generated during
the quarter. 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 $7,407,000 and $6,123,000 of cash and cash equivalents at
June 30, 2004 and December 31, 2003, respectively. At June 30, 2004, the
Company had working capital of $5,371,000. The Companys long-term debt as a
percentage of total capitalization (long-term debt, convertible redeemable
preferred stock and common stockholders equity) was 8.4% at June 30, 2004
compared to 8.7% at December 31, 2003. Cash provided by operating activities
totaled $1,306,000 for the six months ended June 30, 2004, an improvement over
cash provided by operating activities of $180,000 for the comparable 2003
period. The 16




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##### Table of Contents



improvement was primarily attributable to timing related to
collections of accounts receivable as of December 31, 2002,. During the six months ended June 30, 2004, the Companys capital
expenditures totaled $29,000. 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) is provided. The Term Loan, which originated in June 1997
upon the conversion of a $9 million secured credit facility, matures on June 5,
2007 and has a 20 year amortization schedule. The credit agreement also
provided for a $2 million revolving credit facility; however, the Company did
not renew the revolving facility upon the July 1, 2004 expiration of the
commitment period. There were no borrowings outstanding under the expired
revolving facility. The Term Loan is 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 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 June 30,
2004, there was $5.850 million outstanding on the Term Loan, and the Companys
one-month LIBOR-based borrowing rate was 3.13%. The termination of the A-B
Distribution Agreement for any reason 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, 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 June 30, 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 six months of 2003, 101,400 shares of Common
Stock were purchased for $231,000. No shares of Common Stock were repurchased
in 2004. Formation of Craft Brands Alliance and Restructuring of Relationship with
Anheuser-Busch, Incorporated Overview of Product Distribution The Companys products are available for sale directly to consumers in
draft and bottles at restaurants, bars and liquor stores, as well as in bottles
at supermarkets, warehouse clubs and convenience stores. Like substantially all
craft brewers, the Companys products are delivered to these retail outlets
through a network of local distributors whose principal business is the
distribution of beer and, in some cases, other alcoholic 17




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beverages, and who
traditionally have local distribution relationships with one or more national
beer brands. The Company also offers its products directly to consumers at the
Companys two on-premise retail establishments, the Forecasters Public House in
Woodinville, Washington and the Cataqua Public House in Portsmouth, New
Hampshire. In October 1994, the Company entered into a distribution agreement with
A-B pursuant to which the Company began distributing its products, for any new
markets entered, exclusively through the Distribution Alliance. During 2003,
the Companys products were distributed in 48 states through 527 Alliance
distribution points, accounting for approximately 72% of the Companys sales
volume. In addition, sales through wholesalers that are part of the A-B
distribution network but that are not part of the Distribution Alliance
accounted for an additional 23% of the Companys sales volume in 2003. Craft Brands Alliance On July 1, 2004, the Company entered into definitive agreements with
Widmer with respect to the operation of Craft Brands. Craft Brands will
purchase products from the Company and Widmer and market, advertise, sell and
distribute these products in the Western Territory pursuant to a distribution
agreement with A-B (the CBA Distribution Agreement). The Western Territory
includes the following western states: Alaska, Arizona, California, Colorado,
Hawaii, Idaho, Montana, New Mexico, Nevada, Oregon, Washington and Wyoming. The
Company and Widmer are each a 50% member of Craft Brands and each has the right
to designate two directors to its six member board. A-B is entitled to
designate the remaining two directors. The Company and Widmer have entered into a restated operating agreement
with Craft Brands (the Operating Agreement) that will govern the operations
of Craft Brands and the obligations of its members. The Operating Agreement
requires the Company to make certain capital contributions and loans to Craft
Brands to assist Craft Brands in conducting its operations and meeting its
obligations. In July 2004, the Company made a 2004 sales and marketing capital
contribution to Craft Brands in an amount equal to $250,000 and a member loan
of $150,000. The sales and marketing contribution will be used by Craft Brands
for expenses related to the marketing, advertising, and promotion of Redhook
products. The Operating Agreement also requires an additional sales and
marketing contribution in 2008 if the volume of sales of Redhook products in
2007 in the Western Territory is less than 92% of the volume of sales of
Redhook products in 2003 in the Western Territory (other than sales made by the
Company at its on-premise retail establishments and from dock sales). The 2008 contribution, if one is
required, cannot exceed $750,000 and will be required to be paid by the Company
in no more than three equal installments made on or before February 1, 2008,
April 1, 2008, and July 1, 2008. Widmer has an identical obligation under the
Operating Agreement. Other additional capital contributions will be made only
upon the request and consent of the Craft Brands board. Additionally, to the extent cash flow from operations and borrowings from
financial institutions is not sufficient for Craft Brands to meet its
obligations, the Company and Widmer are obligated to lend to Craft Brands the
funds the president of Craft Brands deems necessary to meet such obligations. Under the Operating Agreement, profits and losses will generally be
allocated between the Company and Widmer based on the cash flow percentages of
42% and 58%, respectively (the Cash Flow Percentages). Net cash flow, if any,
will generally be distributed monthly to the Company and Widmer based upon the
Cash Flow Percentages. No distribution will be made to the Company or Widmer
unless, after the distribution is made, the assets of Craft Brands will be in
excess of its liabilities, except liabilities to members, and Craft Brands will
be able to pay its debts as they become due in the ordinary course of business. The Company has also entered into a supply, distribution and licensing
agreement with Craft Brands (the Supply and Distribution Agreement). Under
the Supply and Distribution Agreement, Craft Brands will sell, market, and
distribute the Companys products in the Western Territory. The Company will
manufacture and sell its product directly to Craft Brands (except in states
where laws require sales to be made directly from Redhook to wholesalers) and
Craft Brands will advertise, market and distribute the products to retail
outlets in the Western Territory through a distribution agreement between Craft
Brands and A-B (the CBA Distribution Agreement). The Company has granted
Craft Brands a license to use Redhook intellectual property in connection with
these efforts to advertise, market, sell and distribute the Companys products
in the Western Territory. The Supply and Distribution Agreement also gives the
Company the right to manufacture certain 18




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products of Widmer for sale to Craft
Brands if Widmer is unable to manufacture the quantity ordered by Craft Brands.
In addition, if sales of the Companys products decrease as compared to
previous year sales, the Company will have an option to manufacture Widmer
products in an amount equal to the lower of (i) the Companys product decrease
or (ii) the Widmer product increase. Widmer has also entered into a supply,
distribution and licensing agreement with Craft Brands upon substantially
similar terms. The Supply and Distribution Agreement has an indefinite term, subject to
early termination upon the occurrence of certain events. The Supply and
Distribution Agreement may be terminated immediately, by either party, upon the
occurrence of any one or more of the following events:  (a)
    
    the other party fails to timely make any payment required under the
Supply and Distribution Agreement for a period of 60 days following
written notice thereof by the nonbreaching party;(b)
    
    the other party fails to perform any other material obligation under
the Supply and Distribution Agreement and such failure remains uncured
for a period of 60 days following written notice thereof by the
nonbreaching party;(c)
    
    the other party becomes the subject of insolvency or bankruptcy
proceedings, ceases doing business, makes an assignment of assets for
the benefit of creditors, dissolves, or has a trustee appointed for all
or a substantial portion of such partys assets;(d)
    
    any government authority makes a final decision invalidating a
substantial portion of the Supply and Distribution Agreement;(e)
    
    either party finds that complying with any law or regulation relating
to fulfilling its obligations under the Supply and Distribution
Agreement would be commercially unreasonable and failure to comply with
the law or regulation would subject such party or any of its personnel
to a monetary or criminal penalty; or(f)
    
    the CBA Distribution Agreement with A-B terminates for any reason; or(g)
    
    the Operating Agreement terminates for any reason. Additionally, Craft Brands may, upon notice to Redhook, terminate the
Supply and Distribution Agreement if Redhook causes Craft Brands to be in
default in its obligations under the CBA Distribution Agreement and Redhook
either (a) fails to take all actions necessary to cause Craft Brands to cure
such default or (b) fails to pay on demand certain direct or indirect costs
arising out of or related to such default. Craft Brands may also terminate the
Supply and Distribution Agreement and cease advertising, marketing, or
distributing one or more of the Companys products if an event of default
occurs under the CBA Distribution Agreement that gives A-B the right to
terminate that agreement and Redhook caused such event of default. Relationship with Anheuser-Busch, Incorporated On July 1, 2004, the Company completed the restructuring of its ongoing
relationship with A-B. Pursuant to an exchange and recapitalization agreement
(the Exchange and Recapitalization Agreement), the Company issued 1,808,243
shares of common stock to A-B in exchange for 1,289,872 shares of Series B
Preferred Stock held by A-B. The Series B Preferred Stock, reflected in the
Companys June 30, 2004 balance sheet at approximately $16.3 million, was
cancelled. In connection with the exchange, the Company also agreed to pay
$2.0 million to A-B prior to December 1, 2004. After the exchange, A-B owned
approximately 33.8% of the Companys common stock. A-B was also granted certain
contractual registration rights with respect to its shares of the Companys
common stock. Additionally, pursuant to the Exchange and Recapitalization Agreement, A-B
is entitled to designate two members of the board of directors of the Company.
A-B also generally has the contractual right to have one of its designees sit
on each committee of the board of directors of the Company. The Exchange and
Recapitalization Agreement contains limitations on, among other matters, the
Companys ability to issue equity securities or acquire or sell assets or
stock, amend its Articles of Incorporation or bylaws and adopt plans that may
have the effect of deterring a change in control of the Company and requires
the Company to refrain from voluntarily terminating its listing on the Nasdaq
Stock Market, without the prior consent of A-B. Further, if the 19




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new A-B
Distribution Agreement described below or the CBA Distribution Agreement is
terminated, or the distribution of Redhook products is terminated by Craft
Brands under the CBA Distribution Agreement, A-B has the right to solicit and
negotiate offers from third parties to purchase all or substantially all of the
assets or securities of the Company or to enter into a merger or consolidation
transaction with the Company and cause the board of directors of the Company to
consider any such offer. On July 1, 2004 the Company also entered into a new A-B Distribution
Agreement. The A-B Distribution Agreement provides for the distribution of the
Companys products in the Midwest and eastern United States (the Eastern
Territory), which represents those states not covered by the Supply and
Distribution Agreement. The structure of the new A-B Distribution Agreement is
substantially similar to the Companys prior arrangement with A-B. Under the
A-B Distribution Agreement, the Company is responsible for marketing its
products to A-Bs distributors in the Eastern Territory, as well as to
retailers and consumers. The A-B distributors then place orders with the
Company, through A-B, for Redhook products. The Company separately packages and
ships the orders in refrigerated trucks to the A-B distribution center nearest
to the distributor or, under certain circumstances, directly to the
distributor. Generally, the Company sells its products to A-B at the same list
prices the Company charges non-Alliance distributors in the respective markets,
but it must pay A-B certain fees in connection with sales to A-B. Such fees are
determined by a formula that effectively reduces the total gross profit margin
earned on sales to A-B. However, management believes that the benefits of the
distribution arrangement with A-B, particularly the potential for increased
sales volume and efficiencies in delivery, state reporting and licensing,
billing and collections, are significant to the Companys business. Under the A-B Distribution Agreement, the Company has granted A-B the
first right to distribute Redhook products, including future new products, in
the Eastern Territory. In those areas already subject to distribution
agreements with distributors that are not part of the A-B Distribution
Alliance, such right does not commence until the existing arrangements expire
or are terminated. The new A-B Distribution Agreement has a term that expires on December 31,
2014, subject to automatic renewal for an additional ten-year period unless A-B
provides written notice of non-renewal to the Company on or prior to June 30,
2014. The A-B Distribution Agreement is also subject to early termination upon
the occurrence of certain events. The A-B Distribution Agreement may be terminated
immediately, by either party, upon the occurrence of any one or more of the
following events:  (a)
    
    a material default by the other party in the performance of any of
the provisions of the A-B Distribution Agreement or any other agreement
between the parties, which default is either:  (i)
    
    curable within 30 days, but is not cured within 30 days
following written notice of default; or(ii)
    
    not curable within 30 days and either:  (A)
    
    the defaulting party fails to take
reasonable steps to cure as soon as reasonably possible
following written notice of such default; or(B)
    
    such default is not cured within 90 days
following written notice of such default;  (b)
    
    default by the other party in the performance of any of the
provisions of the A-B Distribution Agreement or any other agreement
between the parties, which default is not described in (a) above and
which is not cured within 180 days following written notice of such
default;(c)
    
    the making by the other party of an assignment for the benefit of
creditors; or the commencement by the other party of a voluntary case or
proceeding or the other partys consent to or acquiescence in the entry
of an order for relief against such other party in an involuntary case
or proceeding under any bankruptcy, reorganization, insolvency or
similar law;(d)
    
    the appointment of a trustee or receiver or similar officer of any
court for the other party or for a substantial part of the property of
the other party, whether with or without the consent of the other party,
which is not terminated within 60 days from the date of appointment
thereof;(e)
    
    the institution of bankruptcy, reorganization, insolvency or
liquidation proceedings by or against the other party without such
proceedings being dismissed within 90 days from the date of the
institution thereof; 20




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(f)
    
    any representation or warranty made by the other party under or in
the course of performance of the A-B Distribution Agreement is false in
material respects; or(g)
    
    the CBA Distribution Agreement is terminated or the distribution
thereunder of the products of Redhook is terminated pursuant to its
terms. Additionally, the A-B Distribution Agreement may be terminated by A-B,
upon six months prior written notice to the Company, in the event:  (a)
    
    the Company engages in certain Incompatible Conduct (as defined in
the A-B Distribution Agreement) which is not curable or is not cured to
A-Bs satisfaction (in A-Bs sole opinion) within 30 days following
written notice;(b)
    
    any A-B competitor or affiliate thereof acquires 10% or more of the
outstanding equity securities in Redhook, and one or more officers,
designees or agents of such person become a member of the board of
directors of Redhook;(c)
    
    the current chief executive officer of Redhook ceases to function as
chief executive officer and within six months of such cessation a
successor satisfactory in the sole, good faith discretion of A-B is not
appointed;(d)
    
    the Company is merged or consolidated into or with any other person
or any other person merges or consolidates into or with the Company; or(e)
    
    A-B or its corporate affiliates incur any liability or expense as a
result of any claim asserted against them by or in the name of Redhook
or any shareholder of Redhook as a result of the equity ownership of A-B
or its affiliates in Redhook, or any equity transaction or exchange
between A-B or its affiliates and Redhook, and Redhook does not
reimburse and indemnify A-B and its corporate affiliates on demand for
the entire amount of such liability and expense. If the A-B Distribution Agreement and/or the Supply and Distribution
Agreement were terminated early, as described above, 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. It is likely
that the Company would need to raise additional funds to fund the development
of a new distribution network. There cannot be any guarantee that the Company
would be able to successfully rebuild all, or part, of its distribution network
or that any additional financing would be available when needed, or that any
such financing would be on commercially reasonable terms. The termination of the A-B Distribution Agreement for any reason 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. 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 on commercially reasonable
terms. Certain Considerations: Issues and Uncertainties 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 21




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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 made through the Distribution Alliance with A-B
and through sales to Craft Brands. Craft Brands will distribute the Companys
products through a separate distribution arrangement 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 description of the Companys relationship with A-B for
the period ended June 30, 2004, and Formation of Craft Brands Alliance and
Restructuring of Relationship with Anheuser-Busch, Incorporated above for a
description of the Companys restructured relationship with A-B and with Craft
Brands. If the relationship between A-B and the Company, between the Company
and Craft Brands or between A-B and Craft Brands 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. While the Company believes that the
benefits of the Distribution Alliance and its relationship with A-B and Craft
Brands, in particular distribution and material cost efficiencies, offset the
costs associated with the relationship, there can be no assurance that these
costs will not have a negative impact on the Companys profit margins in the
future. Craft Brands Alliance.On July 1, 2004, the Company entered into
definitive agreements with Widmer with respect to the operation of Craft
Brands. As discussed above, Craft Brands will advertise, market, sell and
distribute the Company and Widmers products in the western United States. 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, there can be no
assurance that the Company will see any anticipated benefits from the joint
venture. In conjunction with the formation of Craft Brands, both the Company and
Widmer have incurred certain start-up expenses, including severance expenses
and legal fees. The Companys operating income (loss) for the three months and
six months ended June 30, 2004 reflects $131,000 and $538,000, respectively,
attributable to the Companys share of these expenses. Additionally, during the
period March 15, 2004 through June 30, 2004, while the companies sought the
regulatory approval required for Craft Brands to become fully operational, the
Company and Widmer agreed to share certain sales-related costs, primarily
salaries and overhead. The Companys share of those costs totaled $500,000 for
the quarter ended June 30, 2004 and $554,000 for the six months ended June 30,
2004, and are reflected in the Companys statement of operations as selling,
general and administrative expenses. 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. 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. 22




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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
$574,000 for the six months ended June 30, 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. Upon the
formation of Craft Brands, the program in the Western United States markets was
suspended. Market and competitive considerations could require an increase in
other promotional costs associated with developing existing and new markets. 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 Distribution Alliance is a
distributor in the A-B distribution network, accounted for approximately 13% of
the Companys sales in the first six months of 2004. Substantially all of the
remaining sales volume was 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, Craft Brands, 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 or
the Supply and Distribution Agreement 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 23




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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 first six
months of 2004, the Company increased its valuation allowance by $209,000
thereby reducing the estimated deferred 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. 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. The Company is
currently reviewing the organizational documents regarding Craft Brands
Alliance LLC and the Companys interest in the entity. Until this review is
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. 24




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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 June
30, 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 2.Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities (c) On July 1,
2004, the Company closed an exchange and recapitalization
agreement with A-B, pursuant to which the Company issued 1,808,243 shares of
Common Stock to A-B in exchange for 1,289,872 shares of Series B Preferred
Stock held by A-B. The Series B Preferred Stock, which was reflected in the
Companys June 30, 2004 balance sheet at approximately $16.3 million, was
cancelled. Additionally, in connection with the transaction, the
Company agreed to pay $2.0 million to A-B prior to December 1, 2004. The securities were issued
to A-B pursuant to the exemption from registration contained in Section 4(2) of
the Securities Act of 1933. Following this exchange, A-Bs ownership of the
Company increased from 29.3% to approximately 33.8%. 
 ITEM 4.Submission of Matters to a Vote of Security Holders The Companys Annual Meeting of Shareholders was held on May 18, 2004. The
following matters were voted upon by the shareholders with the results as
follows: (1) The following directors were duly elected to serve until the next Annual
Meeting of Shareholders or until his earlier retirement, resignation or
removal: Director
    
    Votes For
    
    Votes WithheldFrank H. Clement
    
    
    6,926,271
    
    
    
    271,534Jerry D. Jones
    
    
    6,739,592
    
    
    
    458,213David R. Lord
    
    
    6,777,513
    
    
    
    420,292Patrick J. McGauley
    
    
    6,791,042
    
    
    
    406,763John D. Rogers, Jr.
    
    
    6,931,441
    
    
    
    266,364Paul S. Shipman
    
    
    6,739,549
    
    
    
    458,256Anthony J. Short
    
    
    6,811,573
    
    
    
    386,232
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(2) The ratification of the appointment of Ernst & Young as independent
auditors for the Companys fiscal year ending December 31, 2004 was approved as
follows: Votes For: 7,032,955Votes Against: 118,080Abstain: 46,770There were no broker non-votes for this item.
 
 ITEM 6.Exhibits and Reports on Form 8-K  (a)
    
    Exhibits The following exhibits are filed as part of this report. 3.1
    
    Restated Articles of Incorporation of Registrant, dated July 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 June 30, 2004, and between such date and the
filing of this Form 10-Q, the Company filed the following reports on
Form 8-K:  Current report dated May 18, 2004 containing Regulation FD disclosure
regarding the restructuring of the Registrants business relationship with
Anheuser-Busch.Current report dated May 19, 2004 containing Regulation FD disclosure
regarding the expiration date of the new distribution agreement with
Anheuser-Busch.Current report dated July 29, 2004 containing disclosure regarding a
change in Registrants certifying accountants.Current report dated August 3, 2004 furnishing a press release announcing
certain financial results for the quarter ended June 30, 2004. 26




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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, INCORPORATEDAugust 13, 2004
    
    
    
    BY:
    /s/ David J. MickelsonDavid J. MickelsonExecutive Vice President,Chief Financial Officer and Chief Operating OfficerAugust 13, 2004
    
    
    
    BY:
    /s/ Anne M. MuellerAnne M. MuellerTreasurer,Principal Accounting Officer
 27