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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q (MARK ONE) þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 for the transition period from  to COMMISSION FILE NUMBER 0-26542 _________________________ REDHOOK ALE BREWERY, INCORPORATED  Washington
(State or other jurisdiction of
incorporation or organization)
    
    91-1141254
(I.R.S. Employer
Identification No.)
 14300 NE 145thStreet, Suite 210
Woodinville, Washington
(Address of principal executive offices)
    
    98072-9045
(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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ The number of shares of the
registrants Common Stock outstanding as of May 13, 2005
was 8,188,859. Page 1 of 24 sequentially numbered pages




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REDHOOK ALE BREWERY, INCORPORATED FORM 10-Q For The Quarterly Period Ended March 31, 2005 TABLE OF CONTENTS PagePART I. Financial InformationITEM 1. Financial StatementsBalance Sheets as of March 31, 2005 and December 31, 2004
    
    
    3Statements of Operations for the Three Months Ended March
31, 2005 and 2004
    
    
    4Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004
    
    
    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
    
    
    23ITEM 4. Controls and Procedures
    
    
    23PART II. Other InformationITEM 6. Exhibits
    
    
    23EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
 2




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PART 1. 
 ITEM 1.Financial Statements REDHOOK ALE BREWERY, INCORPORATED 
 BALANCE SHEETS March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)ASSETSCurrent Assets:Cash and Cash Equivalents
    
    $
    5,070,425
    
    
    $
    5,589,621Accounts Receivable
    
    
    1,574,220
    
    
    
    1,123,475Trade Receivable from Craft Brands Alliance LLC
    
    
    865,793
    
    
    
    398,707Inventories
    
    
    3,224,872
    
    
    
    3,000,309Other
    
    
    508,830
    
    
    
    506,328Total Current Assets
    
    
    11,244,140
    
    
    
    10,618,440Fixed Assets, Net
    
    
    62,304,428
    
    
    
    63,018,806Receivable from Craft Brands Alliance LLC
    
    
    
    
    
    
    277,144Investment in Craft Brands Alliance LLC
    
    
    169,381
    
    
    
    192,857Other Assets
    
    
    19,258
    
    
    
    20,977Total Assets
    
    $
    73,737,207
    
    
    $
    74,128,224LIABILITIES AND COMMON STOCKHOLDERS EQUITYCurrent Liabilities:Accounts Payable
    
    $
    2,090,244
    
    
    $
    1,815,380Trade Payable to Craft Brands Alliance LLC
    
    
    730,295
    
    
    
    431,089Accrued Salaries, Wages and Payroll Taxes
    
    
    1,038,207
    
    
    
    1,220,248Refundable Deposits
    
    
    2,657,145
    
    
    
    2,526,088Other Accrued Expenses
    
    
    498,106
    
    
    
    515,123Current Portion of Long-Term Debt
    
    
    450,000
    
    
    
    450,000Total Current Liabilities
    
    
    7,463,997
    
    
    
    6,957,928Long-Term Debt, Net of Current Portion
    
    
    5,062,500
    
    
    
    5,175,000Deferred Income Taxes, Net
    
    
    398,798
    
    
    
    468,798Other Liabilities
    
    
    81,129
    
    
    
    64,903CommitmentsCommon Stockholders Equity:Common
Stock, Par Value $0.005 per Share, Authorized,
50,000,000 Shares; Issued and Outstanding, 8,188,859
Shares in 2005 and
8,188,199 Shares in 2004
    
    
    40,944
    
    
    
    40,941Additional Paid-In Capital
    
    
    68,763,039
    
    
    
    68,761,766Retained Earnings (Deficit)
    
    
    (8,073,200
    )
    
    
    (7,341,112
    )Total Common Stockholders Equity
    
    
    60,730,783
    
    
    
    61,461,595Total Liabilities and Common Stockholders Equity
    
    $
    73,737,207
    
    
    $
    74,128,224
 See Accompanying Notes to Financial Statements 3




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REDHOOK ALE BREWERY, INCORPORATED 
 STATEMENTS OF OPERATIONS
(Unaudited) Three Months Ended March 31,2005
    
    
    2004Sales
    
    $
    7,324,974
    
    
    $
    9,390,479Less Excise Taxes
    
    
    752,427
    
    
    
    770,645Net Sales
    
    
    6,572,547
    
    
    
    8,619,834Cost of Sales
    
    
    6,048,289
    
    
    
    6,574,213Gross Profit
    
    
    524,258
    
    
    
    2,045,621Selling, General and Administrative Expenses
    
    
    1,542,523
    
    
    
    2,528,568Income from Equity Investment in Craft Brands
    
    
    259,694
    
    
    
    Craft Brands Alliance Shared Formation Expenses
    
    
    
    
    
    
    406,767Operating Income (Loss)
    
    
    (758,571
    )
    
    
    (889,714
    )Interest Expense
    
    
    61,319
    
    
    
    43,607Other Income (Expense)  Net
    
    
    28,802
    
    
    
    12,783Income (Loss) before Income Taxes
    
    
    (791,088
    )
    
    
    (920,538
    )Income Tax Provision (Benefit)
    
    
    (59,000
    )
    
    
    Net Income (Loss)
    
    $
    (732,088
    )
    
    $
    (920,538
    )Basic Earnings (Loss) per Share
    
    $
    (0.09
    )
    
    $
    (0.15
    )Diluted Earnings (Loss) per Share
    
    $
    (0.09
    )
    
    $
    (0.15
    )
 See Accompanying Notes to Financial Statements 4




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REDHOOK ALE BREWERY, INCORPORATED 
 STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended March 31,2005
    
    
    2004Operating ActivitiesNet Income (Loss)
    
    $
    (732,088
    )
    
    $
    (920,538
    )Adjustments to Reconcile Net Income (Loss) to Net Cash
Used in Operating Activities:Depreciation and Amortization
    
    
    730,342
    
    
    
    738,576Income from Equity Investment in Craft Brands in
Excess of Cash Distribution
    
    
    (34,253
    )
    
    
    Deferred Income Taxes, Net
    
    
    (70,000
    )
    
    
    Net Change in Operating Assets and Liabilities
    
    
    (287,728
    )
    
    
    (797,932
    )Net Cash Used in Operating Activities
    
    
    (393,727
    )
    
    
    (979,894
    )Investing ActivitiesExpenditures for Fixed Assets
    
    
    (14,245
    )
    
    
    (22,662
    )Other, Net
    
    
    
    
    
    
    (1,251
    )Net Cash Used in Investing Activities
    
    
    (14,245
    )
    
    
    (23,913
    )Financing ActivitiesPrincipal Payments on Debt
    
    
    (112,500
    )
    
    
    (112,500
    )Issuance of Common Stock
    
    
    1,276
    
    
    
    58,815Net Cash Used in Financing Activities
    
    
    (111,224
    )
    
    
    (53,685
    )Increase (Decrease) in Cash and Cash Equivalents
    
    
    (519,196
    )
    
    
    (1,057,492
    )Cash and Cash Equivalents:Beginning of Period
    
    
    5,589,621
    
    
    
    6,123,349End of Period
    
    $
    5,070,425
    
    
    $
    5,065,857
 See Accompanying Notes to Financial Statements 5




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REDHOOK ALE BREWERY, INCORPORATED 
 NOTES TO FINANCIAL STATEMENTS
(Unaudited) 1. Basis of Presentation The accompanying financial statements and related notes of Redhook Ale Brewery, Incorporated
(the Company) should be read in conjunction with the financial statements and notes thereto
included in the Companys Annual Report on Form 10-K for the year ended December 31, 2004. 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. Inventories Inventories consist of the following: March 31,
    
    
    December 31,2005
    
    
    2004Raw materials
    
    $
    1,296,606
    
    
    $
    1,122,290Work in process
    
    
    885,647
    
    
    
    833,846Finished goods
    
    
    418,314
    
    
    
    350,543Promotional merchandise
    
    
    442,721
    
    
    
    480,338Packaging materials
    
    
    181,584
    
    
    
    213,292$
    3,224,872
    
    
    $
    3,000,309
 Work in process is beer held in fermentation tanks prior to the filtration and packaging
process. 3. Craft Brands Alliance LLC On July 1, 2004, the Company entered into agreements with Widmer Brothers Brewing Company
(Widmer) with respect to the operation of a joint venture, Craft Brands Alliance LLC (Craft
Brands). Pursuant to these agreements, the Company manufactures and sells its product to Craft
Brands at prices below wholesale pricing levels; Craft Brands, in turn, purchases products from the
Company and advertises, markets, sells and distributes these products in the western United States
pursuant to a distribution agreement between Craft Brands and Anheuser-Busch, Incorporated (A-B).
The Company and Widmer also entered into a restated operating agreement with Craft Brands (the
Operating Agreement) that governs the operations of Craft Brands and the obligations of its
members. The Operating Agreement requires the Company to make certain capital contributions to support
the operations of Craft Brands. Contemporaneous with the execution of the Operating Agreement, the
Company was obligated to make a 2004 sales and marketing capital contribution in the amount of
$250,000. The agreement designated this sales and marketing capital contribution to be used by
Craft Brands for expenses related to the marketing, advertising, and promotion of the Companys
products (Special Marketing Expense). 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 Craft
Brands territory is less than 92% of the volume of sales of Redhook products in 2003 in the Craft
Brands territory. 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 with respect to the 2008 sales and marketing
capital contribution and sales of its product. The Operating Agreement also obligates the Company
and Widmer to make other additional capital contributions only upon the request and consent of the
Craft Brands board of directors. 6




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited) 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. The Operating Agreement additionally addresses the allocation of profits and losses of Craft
Brands. After giving effect to the allocation of the 2004 Special Marketing Expense, which is
allocated 100% to Redhook up to the $250,000 sales and marketing capital contribution, and after
giving effect to income attributable to the Kona brand, which is shared differently between the
Company and Widmer through 2006, the remaining profits and losses of Craft Brands are allocated
between the Company and Widmer based on the cash flow percentages of 42% and 58%, respectively. 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, with the
exception of 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 assessed its investment in Craft Brands pursuant to the provisions of
Financial Accounting Standards Board (FASB) Interpretation No. 46 Revised, Consolidation of
Variable Interest Entities  an Interpretation of ARB No. 51(FIN 46R). FIN 46R 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 46R are 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
46R also requires disclosure of significant variable interests in variable interest entities for
which a company is not the primary beneficiary. The Company has concluded that its investment in
Craft Brands meets the definition of a variable interest entity but that the Company is not the
primary beneficiary. In accordance with FIN 46R, the Company has not consolidated the financial
statements of Craft Brands with the financial statements of the Company, but instead accounted for
its investment in Craft Brands under the equity method, as outlined by Accounting Principle Board
Opinion (APB) No. 18, The Equity Method of Accounting for Investments in Common Stock. The equity
method requires that the Company recognize its share of the net earnings of Craft Brands by
increasing its investment in Craft Brands in the Companys balance sheet and recognizing income
from equity investment in the Companys statement of operations. A cash distribution or the
Companys share of a net loss reported by Craft Brands is
reflected as a decrease in its investment in
Craft Brands in the Companys balance sheet. The Company does not control the amount or timing of
cash distributions by Craft Brands. The Company will periodically review its investment in Craft
Brands to insure that it complies with the guidelines prescribed by FIN 46R. For the three months ended March 31, 2005, the Companys share of Craft Brands net income
totaled $260,000. This share of Craft Brands profit was net of $135,000 of the Special Marketing
Expense that had been incurred by Craft Brands during the same period and was fully allocated to
the Company. As of March 31, 2005, the entire $250,000 2004 sales and marketing capital
contribution made by the Company had been used by Craft Brands for designated Special Marketing
Expenses and netted against Craft Brands profits allocated to the Company. In the first quarter
of 2005, the Company received cash distributions of $560,000, of which $335,000 related to 2004
earnings, representing its share of the net cash flow of Craft Brands. In conjunction with the sale of Redhook product to Craft Brands, the Companys balance sheets
as of March 31, 2005 and December 31, 2004 reflect a trade payable due to Craft Brands of
approximately $730,000
and $431,000, respectively, and a trade receivable due from Craft Brands of approximately
$866,000 and $399,000, respectively. During the formation of Craft Brands in 2004, both the Company and Widmer incurred certain
start-up expenses, including severance expenses and legal fees. The Companys operating loss for
the quarter ended March 31, 2004 reflects $407,000 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 7




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited) 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 $54,000 for the three months ended March 31, 2004, and
are reflected in the Companys statement of operations as selling, general and administrative
expenses. 4. Common Stockholders Equity In conjunction with the exercise of stock options granted under the Companys stock option
plans, the Company issued 660 shares of the Companys common stock (Common Stock) totaling $1,300
during the three months ended March 31, 2005 and 36,700 shares of common stock totaling $59,000
during the three months ended March 31, 2004. 5. Earnings (Loss) per Share The Company follows FASB Statement of Financial Accounting Standard (SFAS) No. 128, Earnings
per Share. Basic earnings (loss) per share is calculated using the weighted average number of
shares of Common Stock outstanding. The calculation of adjusted weighted average shares outstanding
for purposes of computing diluted earnings (loss) 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. Outstanding stock options have been excluded from the calculation
of diluted loss per share for the three months ended March 31, 2005 because their effect is
antidilutive. The outstanding convertible preferred stock and outstanding stock options have been
excluded from the calculation of diluted loss per share for the three months ended March 31, 2004
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. On July 1, 2004, 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 and the
related accretion of offering costs were cancelled. The following table sets forth the computation of basic and diluted earnings (loss) per common
share: Three Months EndedMarch 31,2005
    
    
    2004Net income (loss)
    
    $
    (732,088
    )
    
    $
    (920,538
    )Preferred stock accretion
    
    
    
    
    
    
    (11,100
    )Income (loss) available to common stockholders
    
    $
    (732,088
    )
    
    $
    (931,638
    )Weighted average common shares
    
    
    8,188,691
    
    
    
    6,227,687Basic and diluted earnings (loss) per share
    
    $
    (0.09
    )
    
    $
    (0.15
    )
 6. Stock-Based Compensation The Company accounts for its employee stock-based compensation plans using the intrinsic value
method, as prescribed by 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. 123, Accounting for Stock-Based Compensationas amended by SFAS No. 148. 8




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REDHOOK ALE BREWERY, INCORPORATED NOTES TO FINANCIAL STATEMENTS (Continued)
(Unaudited) The following table illustrates the effect on net income (loss) and earnings (loss) per share
for the quarters ended March 31, 2005 and 2004 had compensation cost for the Companys stock
options been recognized based upon the estimated fair value on the grant date under the fair value
methodology. Three Months EndedMarch 31,2005
    
    
    2004Net income (loss), as reported
    
    $
    (732,088
    )
    
    $
    (920,538
    )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
    
    
    (11,308
    )
    
    
    (32,155
    )Pro forma net income (loss)
    
    $
    (743,396
    )
    
    $
    (952,693
    )Earnings (loss) per share:Basic  as reported
    
    $
    (0.09
    )
    
    $
    (0.15
    )Basic  pro forma
    
    $
    (0.09
    )
    
    $
    (0.15
    )Diluted  as reported
    
    $
    (0.09
    )
    
    $
    (0.15
    )Diluted  pro forma
    
    $
    (0.09
    )
    
    $
    (0.15
    )
 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 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). 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). Since July 1, 2004, the
Companys sales have consisted of sales of product to Craft Brands Alliance LLC (Craft Brands)
and A-B. Craft Brands is a joint venture between the Company and Widmer Brothers Brewing Company
(Widmer).The Company manufactures and sells its product to Craft Brands at a price substantially
below wholesale pricing levels; Craft Brands, in turn, advertises, markets, sells and distributes
the product to wholesale outlets in the western United States through a distribution agreement
between Craft Brands and A-B. Profits and losses of Craft Brands are generally shared between the
Company and Widmer based on the cash flow percentages of 42% and 58%, respectively. The Company
continues to sell its product in the midwest and eastern United States through sales to A-B
pursuant to a new distribution agreement dated July 1, 2004
(A-B Distribution Agreement). For additional information regarding Craft
Brands and the A-B Distribution Agreement, see Part 1, Item 1, Business  Production
Distribution, Relationship with Anheuser-Busch, Incorporated and Relationship with Craft Brands
Alliance LLC of the Companys Annual Report on Form 10K for the fiscal year ended December 31,
2004, and Craft Brands Alliance LLC below. In addition to sales of beer, the Company derives
other revenues from sources including the sale of retail beer, food, apparel and other retail items
in its two brewery pubs. The Companys gross sales and net loss for the three months ended March 31, 2005 totaled
$7,325,000 and $732,000, respectively, compared to gross sales and a net loss of $9,390,000 and
$921,000, respectively, for the same period in 2004. However, comparability of the Companys first
quarter 2005 operating results relative to the results for the first quarter of 2004 is
significantly impacted by the July 1, 2004 formation of Craft Brands and the July 1, 2004 A-B
Distribution Agreement, as sales for the first quarter of 2005 in the western United States were
made to Craft Brands at discounted rates. The Companys sales volume (shipments) decreased 2.0% to 49,200 barrels for the three months
ended March 31, 2005 as compared to 50,200 barrels for the same 2004 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 produce fuller-flavored products, and large spirit
companies and national brewers that produce flavored alcohol beverages. Beyond the beer market,
craft brewers also face 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-1990s. Certain national domestic brewers have also
sought to appeal to this growing demand for craft beers by producing their own fuller-flavored
products. In the last few years, the specialty segment has seen 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 10




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2003 and 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. 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 process, 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. 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 if actual production increases. In addition to capacity utilization, other factors that could affect cost of sales and gross
margin include sales to Craft Brands at a fixed transfer price substantially below wholesale
pricing levels, 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 Agreement with A-B. See Managements Discussion and Analysis of Financial Condition and Results of Operations
 Certain Considerations: Issues and Uncertainties. Critical Accounting Policies and Estimates The Companys financial statements are based upon the selection and application of significant
accounting policies that require management to make significant estimates and assumptions.
Management believes that the following are some of the more critical judgment areas in the
application of the Companys accounting policies that currently affect its financial condition and
results of operations. Judgments and uncertainties affecting the application of these policies may
result in materially different amounts being reported under different conditions or using different
assumptions. Income Taxes.The Company records federal and state income taxes in accordance with Financial
Accounting Standards Board (FASB) Statement of Financial Accounting Standard (SFAS) No. 109,
Accounting for Income Taxes. Deferred income taxes or tax benefits reflect the tax effect of
temporary differences between the amounts of assets and liabilities for financial reporting
purposes and amounts as 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 11




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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, 2004, the Company had approximately $11.9 million of
deferred tax assets, comprised principally of federal net operating loss carryforwards (NOLs)
that expire from 2012 through 2024 and state NOLs that expire through 2019. 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, 2004, the Company also had a valuation allowance
of $1,154,000, reflected as a reduction of the Companys deferred tax assets on its balance sheet.
The Company established the valuation allowance in 2002 and increased the balance in 2003 and 2004.
The Company reduced the valuation allowance by $70,000 in the first three months of 2005. 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 2004, 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. Investment in Craft Brands Alliance LLC.The Company has assessed its investment in Craft
Brands pursuant to the provisions of FASB Interpretation No. 46 Revised, Consolidation of Variable
Interest Entities  an Interpretation of ARB No. 51(FIN 46R). FIN 46R 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 46R are 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
46R also requires disclosure of significant variable interests in variable interest entities for
which a company is not the primary beneficiary. The Company has concluded that its investment in
Craft Brands meets the definition of a variable interest entity but that the Company is not the
primary beneficiary. In accordance with FIN 46R, the Company has not consolidated the financial
statements of Craft Brands with the financial statements of the Company, but instead accounted for
its investment in Craft Brands under the equity method, as outlined by Accounting Principle Board
Opinion (APB) No. 18, The Equity Method of Accounting for Investments in Common Stock.The equity
method requires that the Company recognize its share of the net earnings of Craft Brands by
increasing its investment in Craft Brands in the Companys balance sheet and recognizing income
from equity investment in the Companys statement of operations. A cash distribution or the
Companys share of a net loss reported by Craft Brands is
reflected as a decrease in its investment in
Craft Brands in the Companys balance sheet. The Company does not control the amount or timing of
cash distributions by Craft Brands. In the first quarter of 2005, the Company recognized $260,000 of
undistributed earnings related to its investment in Craft Brands. In
the first quarter of 2005, the
Company received cash distributions of $560,000, of which $335,000 related to 2004 earnings,
representing its share of the net cash flow of Craft Brands. The Companys share of the earnings of
Craft Brands contributed a significant portion of income to the Companys results of operations.
The Company will periodically review its investment in Craft Brands to insure that it complies with
the guidelines prescribed by FIN 46R. 12




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Revenue Recognition.The Company recognizes revenue from product sales, net of excise taxes,
discounts and certain fees the Company must pay in connection with sales to A-B, when the products
are shipped to customers. Although title and risk of loss do not transfer until delivery of the
Companys products to A-B or the A-B distributor, the Company recognizes revenue upon shipment
rather than when title passes because the time lag between shipment and delivery is short and
product damage claims and returns are immaterial. The Company recognizes revenue on retail sales at
the time of sale. The Company recognizes revenue from events at the time of the event. Results of Operations Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 The
following table sets forth, for the periods indicated, a comparison
of certain items from the Companys
Statements of Operations expressed as a percentage of net sales: Three Months EndedMarch 31,2005
    
    
    2004Sales
    
    
    111.4
    %
    
    
    108.9
    %Less Excise Taxes
    
    
    11.4
    
    
    
    8.9Net Sales
    
    
    100.0
    
    
    
    100.0Cost of Sales
    
    
    92.0
    
    
    
    76.3Gross Profit
    
    
    8.0
    
    
    
    23.7Selling, General and Administrative Expenses
    
    
    23.5
    
    
    
    29.3Income from Equity Investment in Craft Brands
    
    
    4.0
    
    
    
    Craft Brands Alliance Shared Formation Expenses
    
    
    
    
    
    
    4.7Operating Income (Loss)
    
    
    (11.5
    )
    
    
    (10.3
    )Interest Expense
    
    
    0.9
    
    
    
    0.5Other Income (Expense)  Net
    
    
    0.4
    
    
    
    0.1Income (Loss) before Income Taxes
    
    
    (12.0
    )
    
    
    (10.7
    )Provision (Benefit) for Income Taxes
    
    
    (0.9
    )
    
    
    Net Income (Loss)
    
    
    (11.1
    )%
    
    
    (10.7
    )%
 The following table sets forth, for the periods indicated, a comparison of certain items
from the Companys Statements of Operations: Three Months EndedMarch 31,
    
    
    Increase/
    
    
    %2005
    
    
    2004
    
    
    (Decrease)
    
    
    ChangeSales
    
    $
    7,324,974
    
    
    $
    9,390,479
    
    
    $
    (2,065,505
    )
    
    
    (22.0
    )%Less Excise Taxes
    
    
    752,427
    
    
    
    770,645
    
    
    
    (18,218
    )
    
    
    (2.4
    )Net Sales
    
    
    6,572,547
    
    
    
    8,619,834
    
    
    
    (2,047,287
    )
    
    
    (23.8
    )Cost of Sales
    
    
    6,048,289
    
    
    
    6,574,213
    
    
    
    (525,924
    )
    
    
    (8.0
    )Gross Profit
    
    
    524,258
    
    
    
    2,045,621
    
    
    
    (1,521,363
    )
    
    
    (74.4
    )Selling, General and Administrative Expenses
    
    
    1,542,523
    
    
    
    2,528,568
    
    
    
    (986,045
    )
    
    
    (39.0
    )Income from Equity Investment in Craft Brands
    
    
    259,694
    
    
    
    
    
    
    
    259,694
    
    
    
    100.0Craft Brands Alliance Shared Formation Expenses
    
    
    
    
    
    
    406,767
    
    
    
    (406,767
    )
    
    
    (100.0
    )Operating Income (Loss)
    
    
    (758,571
    )
    
    
    (889,714
    )
    
    
    131,143
    
    
    
    14.7Interest Expense
    
    
    61,319
    
    
    
    43,607
    
    
    
    17,712
    
    
    
    40.6Other Income (Expense)  Net
    
    
    28,802
    
    
    
    12,783
    
    
    
    16,019
    
    
    
    125.3Income (Loss) before Income Taxes
    
    
    (791,088
    )
    
    
    (920,538
    )
    
    
    129,450
    
    
    
    14.1Provision (Benefit) for Income Taxes
    
    
    (59,000
    )
    
    
    
    
    
    
    (59,000
    )
    
    
    (100.0
    )Net Income (Loss)
    
    $
    (732,088
    )
    
    $
    (920,538
    )
    
    $
    188,450
    
    
    
    20.5
    %Beer Shipped (in barrels)
    
    
    49,200
    
    
    
    50,200
    
    
    
    (1,000
    )
    
    
    (2.0
    )%
 13




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Sales.The following factors played a role in the $2,066,000 decline in total sales in
the first three months of 2005 as compared to the first three months of 2004: Sales to Craft Brands. Significantly impacting the comparability of 2005 to 2004
are sales of Redhook product to Craft Brands in the first quarter of 2005. Approximately 60% of
the 2005 total shipments were sold to Craft Brands at a price substantially below wholesale
pricing levels. Shipments. Total Company shipments declined 2.0%. Total sales volume for the three
months ended March 31, 2005 decreased to 49,200 barrels from 50,200 barrels for the same period
in 2004, the result of a 6.6% decrease in shipments of its packaged products and a 6.2% increase
in shipments of the Companys draft products. Excluding 1,450 barrels of draft beer shipped in
the first quarter of 2005 under a contract brewing arrangement, shipments of the Companys draft
products decreased 1.8%. Since the mid 1990s, package beer sales have steadily increased as a
percentage of total beer sales. The migration toward increasing package sales reversed slightly,
though, in the three months of 2005 with 60.8% of total shipments being package shipments versus
63.8% in the same three months of 2004. At March 31, 2005 and 2004, the Companys products were
distributed in 48 states. Although shipments in the midwest and eastern United States were nearly flat, an 8.0%
decline in West Coast volume, including an 6.2% decrease in shipments in Washington state,
contributed to the majority of the overall sales volume decrease. A significant portion of the
Companys sales continue to be in the Pacific
Northwest region, which the Company believes is one of the most competitive craft beer
markets in the United States, both in terms of number of market participants and consumer
awareness. The Company faces extreme competitive pressure in Washington state, which is not only
the Companys largest market but is also its oldest market. Since 1997, the Company has
experienced a decline in sales volume in Washington state of approximately 17%. Management
believes that the decline can be partially attributable to the relative maturity of the brand in
this region and, more recently, the formation of Craft Brands. The Company believes that the beer
industry is influenced by individual relationships. The transition to Craft Brands impacted its
established wholesaler and retailer relationships which, prior to Craft Brands, had existed for
many years. Because the transition to Craft Brands took longer than anticipated, and because
nearly all the Companys sales staff responsible for Washington state left the Company, the
Company and Craft Brands have had to re-establish many of these relationships with wholesalers
and retailers. Sales have also been impacted by a reduction in the pricing promotions
historically offered in this region. Pricing and Fees. Total Company average revenue per barrel for 2005 was
significantly impacted by sales of Redhook product to Craft Brands during the first quarter 2005.
The Company sells its product to Craft Brands at a price substantially below historical wholesale
pricing levels; Craft Brands, in turn, advertises, markets, sells and distributes the product to
wholesale outlets in the western United States through a distribution agreement between Craft
Brands and A-B. For the first quarter 2005, sales to Craft Brands represented approximately 60.0%
of total shipments, or 29,400 barrels. Redhook continues to sell its product at wholesale pricing levels in the midwest and eastern
United States through sales to A-B. Average wholesale revenue per barrel on sales of draft
product in the midwest and eastern United States showed modest improvement while average
wholesale revenue per barrel on sales of bottled product in the same regions declined slightly.
Overall improvement in average wholesale revenue per barrel was driven by strength in pricing in
many of the Companys markets, although the 2005 average revenue per barrel did experience some
downward pressure as a result of the contract brewing arrangement, sold at a significantly lower
revenue per barrel. Negatively impacting average wholesale revenue per barrel were fees that the
Company paid to A-B on sales in these same regions increased pursuant to the July 1, 2004
Distribution Agreement with A-B. Average wholesale revenue per barrel for draft products,
excluding contract sales and net of discounts, increased approximately 7.3% in the first quarter
of 2005 as compared to the same quarter in 2004. This increase in pricing accounted for
approximately $155,000 of the change in total sales. Average wholesale revenue per barrel for
bottle products, net of discounts, decreased approximately 0.7% in the first three months of 2005
as compared to the same period in 2004. This decrease in pricing accounted for approximately
$45,000 of the change in total sales. Seldom, if ever, are pricing changes driven by an
inflationary period. Instead, pricing changes implemented by the Company generally follow pricing
changes initiated by large domestic or import brewing companies. While the 14




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Company has
implemented modest pricing increases during the past few years, some of the benefit has been
offset by competitive promotions and discounting. Additionally, the Company may experience a
decline in sales in certain regions following a price increase. In connection with all sales through the Distribution Alliance prior to July 1, 2004, the
Company paid a Margin fee to A-B. The July 1, 2004 A-B Distribution Agreement modified the Margin
fee structure such that the Margin per barrel shipped increased and is paid on all sales through
the new A-B Distribution Agreement. The Margin does not apply to sales to the Companys retail
operations or to dock sales. The Margin also does not apply to the Companys sales to Craft
Brands because Craft Brands pays a comparable fee to A-B on its resale of the product. The A-B
Distribution Agreement also provides that the Company shall pay an additional fee on shipments
that exceed shipments for the same territory during fiscal 2003. For the three month period ended
March 31, 2005, the Margin was paid to A-B on shipments totaling 17,000 barrels to 341
distribution points. For the three months ended March 31, 2004, the Margin was paid to A-B on
shipments totaling 38,000 barrels to 477 Alliance distribution points. The Margin paid is
reflected as a reduction of sales in the Companys statement of operations. Retail Operations. Sales in the Companys retail operations increased $86,000 to
$1,023,000 from $937,000 for the three months ended March 31, 2005 and 2004. Excise Taxes. Excise taxes decreased $18,000 to $752,000 for the first three months of 2005
compared to $771,000 for the same 2004 period. The Company continues to be responsible for federal
and state excise taxes for all shipments, including those to Craft Brands. The comparability of
excise taxes as a percentage of net sales is impacted most significantly by the sale of Redhook
product to Craft Brands at a price substantially below wholesale pricing levels, but also by
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 first quarter of 2005 to the first quarter of 2004, cost of
sales decreased 8.0%, or $526,000, and decreased on a per barrel basis. Freight costs declined by
approximately 63% as the cost of shipping Redhook product in the western United States is now borne
by Craft Brands, and the Companys effort at streamlining its shipping relationships in the midwest
and eastern United States has yielded additional freight savings. Based upon the breweries
combined current production capacity of 93,750 barrels for the three months ended March 31, 2005
and 2004, the utilization rates were 52.5% and 53.5%, respectively. In January 2003, the Company entered into a licensing agreement with Widmer Brothers Brewing
Company to produce and sell the Widmer Hefeweizen brand in states east of the Mississippi River.
Brewing of this product is conducted at the New Hampshire Brewery under the supervision and
assistance of Widmers brewing staff to insure their brands quality and matching taste profile.
The term of this agreement is for five years, with an additional one-year automatic renewal unless
either party elects to terminate the arrangement. The agreement may be terminated by either party
at any time without cause pursuant to 150 days notice. The agreement may be terminated for cause by
either party under certain conditions. During the term of this agreement, Redhook will not brew,
advertise, market, or distribute any product that is labeled or advertised as a Hefeweizen or any
similar product in the agreed upon eastern territory. Brewing and selling of Redhooks Hefe-weizen
was discontinued in conjunction with this agreement. This agreement, for the eastern United States
only, is expected to increase capacity utilization and has strengthened the Companys product
portfolio. The Company shipped 4,300 and 3,400 barrels of Widmer
Hefeweizen during the quarters
ended March 31, 2005 and 2004, respectively. A licensing fee of $58,000 and $47,000 due to Widmer
is reflected in the Companys statement of operations for the quarters ended March 31, 2005 and
2004, respectively. Selling, General and Administrative Expenses. Selling, general and administrative expenses
decreased $986,000 to $1,543,000 from expenses of $2,529,000 for the first quarter of 2004,
significantly impacted by the formation of Craft Brands. All advertising, marketing and selling
costs in the western United States became the responsibility of Craft Brands on July 1, 2004. While
the Company and Widmer sought the regulatory approval required for Craft Brands to become fully
operational, they agreed to share certain sales-related costs, primarily salaries and overhead. The
Companys share of those costs totaled $54,000 for the three months ended March 31, 2004 and is
reflected in the Companys statement of operations as selling, general and administrative expenses. 15




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Income from Equity Investment in Craft Brands Alliance.In accordance with the Craft Brands
operating agreement, the Company made a $250,000 sales and marketing capital contribution to Craft
Brands, which was to be used by Craft Brands for expenses related to the marketing, advertising
and promotion of Redhook products (Special Marketing Expense). After giving effect to the
allocation of the Special Marketing Expense, which is allocated 100% to Redhook, and giving effect
to income attributable to the Kona brand, which is shared differently between the Company and
Widmer through 2006, the operating agreement dictates that remaining profits and losses of Craft
Brands are allocated between the Company and Widmer based on the Cash Flow Percentages of 42% and
58%, respectively. For the quarter ended March 31, 2005, the Companys share of Craft Brands net
income totaled $260,000. This share of Craft Brands profit was net of $135,000 of the Special
Marketing Expense that had been incurred by Craft Brands during the same period and was fully
allocated to the Company. As of March 31, 2005, the entire $250,000 2004 sales and marketing
capital contribution made by the Company had been used by Craft Brands for designated Special
Marketing Expenses and netted against Craft Brands profits allocated to the Company. Net cash flow of Craft Brands, if any, is generally distributed monthly to the Company based
on the Companys cash flow percentage of 42%. In the first quarter 2005, the Company received cash
distributions of $560,000, of which $335,000 related to 2004 earnings, representing its share of
the net cash flow of Craft Brands. 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 quarter ended March 31, 2004
reflects $407,000 attributable to the Companys share of these expenses. Interest Expense.Interest expense was $61,000 for the first three months of 2005, up from
$44,000 for the comparable 2004 period. Higher average interest rates in the first three months of
2005, offset by a declining term loan balance, resulted in an increase in interest expense. Other Income (Expense) Net. Other income (expense)  net increased by
$16,000 to income of $29,000 for the first three months of 2005 compared to income of $13,000 for
the first three months of 2004, due primarily to higher average interest rates earned on
interest-bearing deposits. Income
Taxes.The Companys effective income tax rate was a 7.5% benefit for the quarter ended
March 31, 2005 and 0% for the comparable 2004 period. The $59,000 benefit recorded in the first
quarter of 2005 reflects a $70,000 reduction in the Companys valuation allowance offset by a
provision for current state taxes. In the first quarter of 2004, 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 period. 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. Craft Brands Alliance LLC The Company has accounted for its investment in Craft Brands under the equity method, as
outlined by APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock.
Pursuant to APB No. 18, the Company has recorded its share of Craft Brands net income in the
Companys statement of operations as income from equity investment in Craft Brands. The following
discussion should be read in conjunction with the financial statements and notes thereto of Craft
Brands Alliance LLC, filed with the Companys Form 10-K for the year ended December 31, 2004, in
Item 15. Exhibits and Financial Statement Schedulesin accordance with Rule 3-09 of Regulation S-X. The following summarizes certain items included in Craft Brands statement of operations for
the quarter ended March 31, 2005. 16




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##### Table of Contents



Sales.Craft Brands sales totaled $12,595,000 for the quarter ended March 31, 2005. In
addition to selling 29,400 barrels of the Companys product sold to wholesalers in the western
United States, Craft Brands also sold products brewed by Widmer and Kona Brewery LLC. For the quarter
ended March 31, 2005, average wholesale revenue per barrel for all products sold by Craft Brands
was approximately 1% lower than average wholesale revenue per barrel
on sales to wholesalers in the midwest and eastern United States by the
Company during the same period. Craft Brands sales efforts during the first three months of 2005
included a reduction in discounting on the Companys products. Craft Brands also pays a fee to A-B
in connection with sales to A-B that are comparable to fees paid by the Company. Cost of Sales.Cost of sales of Craft Brands totaled $8,938,000 for the quarter ended March
31, 2005. Craft Brands purchases product from the Company and Widmer at prices substantially below
wholesale pricing levels pursuant to a Supply, Distribution, and Licensing Agreement between Craft
Brands and each of the Company and Widmer. Craft Brands has realized improvement in its average
freight cost per barrel over the Companys historical costs,
largely as a result of synergies created
by negotiating its shipping relationships as a single larger entity. Selling, General and Administrative expenses. Craft Brands selling, general and
administrative expenses totaled $2,675,000 for the quarter ended March 31, 2005, reflecting all
advertising, marketing and promotion efforts for the Companys, Widmers and Kona brands. During
the three-month period ended March 31, 2005, Craft Brands focused significant effort on advertising
and promotion resources to be utilized in conjunction with the planned 2005 second quarter
introduction of new packaging for the Companys bottled product. Although the Company anticipates
that advertising and promotion efforts will increase in 2005 as compared to expenditures in the
second half of 2004, predicting future expenditures is difficult. In accordance with the Craft
Brands operating agreement, the Company made a $250,000 sales and marketing capital contribution on
July 1, 2004, which was to be used by Craft Brands for expenses related to the marketing,
advertising and promotion of Redhook products (Special Marketing Expense). Selling, general and
administrative expenses of Craft Brands for the quarter ended March 31, 2005 includes approximately
$135,000 designated as Special Marketing Expense. As of March 31, 2005, the entire $250,000 2004
sales and marketing capital contribution made by the Company had been used by Craft Brands for
designated Special Marketing Expenses and netted against Craft Brands profits allocated to the
Company. Net Income. Craft Brands net income totaled $946,000 for the quarter ended March 31, 2005.
The Companys share of Craft Brands net income totaled $260,000. After giving effect to the
allocation of the Special Marketing Expense, which is allocated 100% to Redhook, and giving effect
to income attributable to the Kona brand, which is shared differently between the Company and
Widmer through 2006, the Operating Agreement dictates that remaining profits and losses of Craft
Brands are allocated between the Company and Widmer based on the cash flow percentages of 42% and
58%, respectively. Liquidity and Capital Resources The Company has required capital principally for the construction and development of its
production facilities. To date, the Company has financed its capital requirements through cash flow
from operations, bank borrowings and the sale of common and preferred stock. The Company expects to
meet its future financing needs and working capital and capital expenditure requirements through
cash on hand, operating cash flow and, to the extent required and available, bank borrowings and
offerings of debt or equity securities. The Company had $5,070,000 and $5,590,000 of cash and cash equivalents at March 31, 2005 and
December 31, 2004, respectively. At March 31, 2005, the Company had working capital of $3,780,000.
The Companys long-term debt as a percentage of total capitalization (long-term debt and common
stockholders equity) was 8.3% at March 31, 2005 compared to 8.4% at December 31, 2004. Cash used
in operating activities totaled $394,000 for the three months ended March 31, 2005, an improvement
over cash used in operating activities of $980,000 for the comparable 2004 period. The change was
primarily a result of normal fluctuations in operating assets and liabilities. 17




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##### Table of Contents



During the three months ended March 31, 2005, the Companys capital expenditures totaled
$14,000. Capital expenditures for fiscal year 2005 are expected to total approximately $368,000,
primarily for brewing equipment. In conjunction with the shipment of its products to wholesalers, the Company collects
refundable deposits on its pallets. In certain circumstances when the pallets are returned to the
Company, A-B may return the deposit to the wholesaler. The Companys balance
sheet as of March 31, 2005 reflects a refundable pallet deposit liability owed to A-B in the amount
of $881,000. This amount was paid to A-B in May 2005. 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 revolving facility at the time of its expiration. The Term Loan is secured by substantially all of the Companys assets. Since June 5, 2002,
interest on the Term Loan has accrued at London Inter Bank Offered
Rate (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 March 31, 2005, there was $5.513 million
outstanding on the Term Loan, and the Companys one-month LIBOR-based borrowing rate was 4.7%. 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. 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. The
Company was in compliance with all covenants for the quarter ended March 31, 2005 and expects that
it will remain in compliance with its debt covenants for the next twelve months. In December 2001,
March 2003, February 2004 and October 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 in the future; 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 following table summarizes the financial covenants required by the Term Loan and the
Companys current level of compliance with these covenants: Required by
    
    Quarter EndedTerm Loan
    
    March 31, 2005Tangible Net Worth
    
    Greater than $60,000,000
    
    $60,711,524Capital Ratio
    
    Less than: 1.25:1
    
    0.21:1Working Capital
    
    Greater than $1,900,000
    
    $ 3,780,143Fixed Charge Coverage Ratio
    
    Greater than 1.15:1
    
    3.388:1
 18




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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 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 and Craft Brands Alliance LLC.All of the
Companys future sales are expected to be made through the A-B Distribution Agreement 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. 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 Agreement 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 LLC.As discussed above, Craft Brands advertises, markets, sells and
distributes the Companys 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. The Company has already begun to see a significant
decrease in its selling, general and administrative expenses, and recognized income totaling
$260,000 in the first quarter of 2005 and $1.1 million in the last six months of 2004 from its
investment in Craft Brands. However, Craft Brands has been operational for less than a year, and
predicting future benefits from Crafts Brands is difficult. There can be no assurance that the
Company will see any further or anticipated benefits from the joint venture. 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
loss for the three months ended March 31, 2004 reflects $407,000 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 $54,000 for the three months ended March
31, 2004 and are reflected in the Companys statement of operations as selling, general and
administrative expenses. Dependence on Distributors.While all of the Companys future sales are expected to be made
through the A-B Distribution Agreement and through sales to Craft Brands, the Company relies
heavily on distributors, most of
which are independent wholesalers, for the sale of its products to retailers. The Companys
most significant wholesaler, K&L Distributors, Inc., accounted for approximately 11% of the
Companys shipments in the first three months of 2005. 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 A-B Distribution Agreement 19




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or the supply and
distribution agreement with Craft Brands could have a material adverse impact on the Companys
sales and results of operations. 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 produced fuller-flavored products, and large spirit
companies and national brewers that produce flavored alcohol beverages. Beyond the beer market,
craft brewers also face competition from producers of wines and spirits. Primarily as a result of
increased competition, the Company has experienced periods in which its sales volume has declined
and pricing of the Companys products has been negatively impacted. The Company experienced
declining sales volumes during the period from 1997 through 1999 when the Companys shipments
declined from 2.3% to 5.7% when compared to the prior year. And although the Company saw
improvements in shipments year over year from 2000 through 2003, the Company again experienced a
decline in shipments in 2004 and in the first quarter of 2005. Increasing 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. Dependence on Sales in Washington State. A significant portion of the Companys shipments
continue to be in the Pacific Northwest region, which the Company believes is one of the most
competitive craft beer markets in the United States, both in terms of number of market participants
and consumer awareness. The Company faces extreme competitive pressure in Washington state, which
is not only the Companys largest market but is also its oldest market. Since 1997, the Company has
experienced a decline in sales volume in Washington State of approximately 17%, significantly
impacted by a 12% decline in 2004 volume over 2003 volume. The Company believes that the Pacific
Northwest, and Washington state in particular, offers significant competition to its products, not
only from other craft brewers but also from the growing wine market and from flavored alcohol
beverages. This intense competition is magnified because the Companys brand is viewed as being
relatively mature. Recent focus studies have indicated that, while the Companys brand does possess
brand awareness among target consumers, it also appears to not attract key consumers who seem to be
more interested in experimenting with new products. These recent focus studies have resulted in
Craft Brands focusing its 2005 marketing efforts on the Pacific Northwest market in an effort to
stimulate demand. In addition, shipments in Washington state in late 2003, all of 2004 and early
2005 appear to have been significantly impacted by the formation of Craft Brands. Management
believes that the beer industry is influenced, both positively and negatively, by individual
relationships. In Washington State, where some of those relationships have existed for many years,
the formation of Craft Brands appears to have had some short-term negative impact on those
relationships. Some of the Companys relationships with wholesalers and retailers suffered as a
result of the transition to Craft Brands. The transition took longer than anticipated and nearly
all Company sales staff responsible for the Washington State market left the Company. While the
Company believes that the Craft Brands sales staff is reestablishing those relationships and that
sales of the Companys products will stabilize, the process is expected to take some time. However,
there can be no assurance that the Company will see any anticipated benefits from these efforts. 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 shipments to Craft
Brands at a fixed transfer price substantially below wholesale pricing levels, 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, if sales volume
through the A-B Distribution Agreement increases, the related fees would increase. 20




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Advertising and Promotional Costs. The Company directly manages its co-op advertising and
promotion program and limited media advertising in the midwest and eastern United States, and the
Craft Brands joint sales and marketing organization serves the operations of Redhook and Widmer in
the western United States by advertising, marketing, selling and distributing both companies products
to wholesale outlets. Similar to the Company, Craft Brands promotes its products through a variety
of advertising programs with its wholesalers; through training and education of wholesalers and
retailers; through promotions at local festivals, venues, and pubs; by utilizing the pubs located
at the Companys two breweries; and through price discounting. Management believes that, in
addition to achieving certain synergies, Craft Brands capitalizes on both companies sales and
marketing skills and complementary product portfolios. The Company believes that the combination of
the two brewers complementary brand portfolios, led by one focused sales and marketing
organization, will not only deliver financial benefits, but will also deliver greater impact at the
point of sale. However, Craft Brands has been operational for less than a year, and predicting
future benefits from Crafts Brands is difficult. There can be no assurance that the Company will
see any further or anticipated benefits from the joint venture. In the midwest and eastern United
States, the Company expects to continue to participate in co-op advertising and promotion programs
and limited media, but market and competitive considerations could require an increase in spending
in these programs. Customer Acceptance, Consumer Trends and Public Attitudes.If consumers were unwilling to
accept the Companys products or if general consumer trends caused a decrease in the demand for
beer, including craft beer, it could adversely impact the Companys sales and results of
operations. If the flavored alcohol beverage market, the wine market, or the spirits market
continue to grow, they could draw consumers away from the Companys products and have an adverse
effect on the Companys sales and results of operations. Further, the alcoholic beverage industry
has become the subject of considerable societal and political attention in recent years due to
increasing public concern over alcohol-related social problems, including drunk driving, underage
drinking and health consequences from the misuse of alcohol. If beer consumption in general were to
come into disfavor among domestic consumers, or if the domestic beer industry were subjected to
significant additional governmental regulation, the Companys sales and results of operations could
be adversely affected. Effect of Sales Trends on Brewery Efficiency and Operations. The Companys breweries have
been operating at production levels substantially below their current and maximum designed
capacities. Operating breweries at low capacity utilization rates negatively impacts gross margins
and operating cash flows generated by the production facilities. The Company periodically evaluates
whether it expects to recover the costs of its two 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, 2004, the Company had approximately $11.9 million of
deferred tax assets, comprised principally of federal net operating loss carryforwards that expire
from 2012 through 2024 and state NOLs that expire through 2019. Federal NOLs, generally permitted
to be carried forward no more than 20 years, and state NOLs, generally permitted to be carried
forward 5 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, 2004, the Company also had a
valuation allowance of $1,154,000, reflected as a reduction of the Companys deferred tax assets on
its balance sheet. The Company established the valuation allowance in 2002 and increased the
balance in 2003 and 2004. The Company reduced the valuation allowance by $70,000 in the first three
months of 2005. 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. 21




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Recent Accounting Pronouncements In November 2004, the FASB issued SFAS No. 151, Inventory Costs  an Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 requires idle facility expenses, abnormal freight, handling costs, and
wasted material (spoilage) to be recognized as current-period charges. In addition, SFAS No. 151
requires that allocation of fixed production overheads to the costs of conversion be based on the
normal capacity of the production facilities. SFAS No. 151 will be effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. The adoption of this Statement will not
have a material effect on the Companys financial condition or results of operation. In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which revises SFAS No.
123 and supercedes APB No. 25. SFAS No. 123R requires all share-based payments to employees to be
recognized as expenses in the statement of operations based on their fair values and vesting
periods. The effective date of SFAS 123R was extended and will now be effective for the Company as
of January 1, 2006. The cumulative effect of initially applying SFAS No. 123R is recognized as of
the required effective date. The Company is currently in the process of determining the impact this
statement will have on its financial condition and results of operations. 22




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ITEM 3.Quantitative and Qualitative Disclosures about Market Risk The Company has assessed its vulnerability to certain market risks, including interest rate
risk associated with financial instruments included in cash and cash equivalents and long-term
debt. Due to the nature of these investments and the Companys investment policies, the Company
believes that the risk associated with interest rate fluctuations related to these financial
instruments does not pose a material risk. The Company did not have any derivative financial instruments as of March 31, 2005. 
 ITEM 4.Controls and Procedures The Company has carried out an evaluation of the effectiveness of the design and operation of
the Companys disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) or
15d-15(e)) as of the end of the period covered by this quarterly report on Form 10-Q. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the
Companys disclosure controls and procedures are effective. No changes in the Companys internal control over financial reporting were identified in
connection with the evaluation that has materially affected, or is reasonably likely to materially
affect, the Companys internal control over financial reporting. 
 PART II. 
 ITEM 6.Exhibits (a) Exhibits The following exhibits are filed as part of this report.  31.1
    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 23




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. REDHOOK ALE BREWERY, INCORPORATED May 16, 2005
    
    BY: /s/ David J. MickelsonDavid J. MickelsonExecutive Vice President,Chief Financial Officer andChief Operating OfficerMay 16, 2005
    
    BY: /s/ Lorri L. JonesLorri L. JonesTreasurer,Principal Accounting Officer
 24