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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                            ------------------------
 
                                   FORM 10-K
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
 
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996       COMMISSION FILE NUMBER 0-26542
 
                       REDHOOK ALE BREWERY, INCORPORATED
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
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                  WASHINGTON                                    91-1141254
           (STATE OF INCORPORATION)              (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
 
          3400 PHINNEY AVENUE NORTH                               98103
             SEATTLE, WASHINGTON                                (ZIP CODE)
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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                                 (206) 548-8000
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
          Securities registered pursuant to Section 12(b) of the Act:
                                      None
 
          Securities registered pursuant to Section 12(g) of the Act:
                    Common Stock, Par Value $0.005 Per Share
 
                        Rights to Purchase Common Stock
                                (TITLE OF CLASS)
 
     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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
 
     The aggregate market value of the Common Stock held by non-affiliates of
the registrant, based on the closing price on February 28, 1997, as reported on
NASDAQ, was $60,079,679.(1)
 
     The number of shares of the registrant's Common Stock outstanding as of
February 28, 1997, was 7,685,486.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Portions of the registrant's Proxy Statement relating to the registrant's
1997 Annual Meeting of Stockholders to be held on May 21, 1997, are incorporated
by reference into Part III of this Report.
---------------
(1) Excludes shares held of record on that date by directors and officers and
greater than 10% shareholders of the registrant. Exclusion of such shares should
not be construed to indicate that any such person directly or indirectly
possesses the power to direct or cause the direction of the management of the
policies of the registrant.
 
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                       REDHOOK ALE BREWERY, INCORPORATED
 
                                   FORM 10-K
 
                               TABLE OF CONTENTS
 
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                                          PART I.
ITEM 1.     Business..................................................................    1
ITEM 2.     Properties................................................................   14
ITEM 3.     Legal Proceedings.........................................................   14
ITEM 4.     Submission of Matters to a Vote of Security Holders.......................   15
ITEM 4A.    Executive Officers of the Company.........................................   15
                                          PART II.
ITEM 5.     Market for Registrant's Common Equity and Related Stockholder Matters.....   16
ITEM 6.     Selected Financial Data...................................................   17
ITEM 7.     Management's Discussion and Analysis of Financial Condition and Results of
            Operations................................................................   18
ITEM 8.     Financial Statements and Supplementary Data...............................   23
ITEM 9.     Changes In and Disagreements With Accountants on Accounting and Financial
            Disclosures...............................................................   40
                                         PART III.
ITEM 10.    Directors and Executive Officers of the Registrant........................   40
ITEM 11.    Executive Compensation....................................................   40
ITEM 12.    Security Ownership of Certain Beneficial Owners and Management............   40
ITEM 13.    Certain Relationships and Related Transactions............................   40
                                          PART IV.
ITEM 14.    Exhibits, Financial Statements and Reports on Form 8-K....................   40
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                                    PART I.
 
ITEM 1. BUSINESS
 
     Redhook Ale Brewery, Incorporated ("Redhook" or the "Company") is one of
the leading brewers of craft beers in the United States and has been at the
forefront of the domestic craft brewing segment since the Company's formation in
1981. Redhook produces its specialty bottled and draft products in three
technologically advanced, company-owned breweries, two in the Seattle,
Washington area and a third in Portsmouth, New Hampshire. By operating its own
small-batch breweries, the Company believes it is better able to control the
quantities, types and flavors of beer produced, while optimizing the quality and
consistency of its products. Management believes that the Company has the
largest company-owned production capacity of any domestic craft brewer and is
the only domestic craft brewer that owns and operates substantial production
facilities in both a western region and eastern region of the United States.
 
     The Company currently produces eight styles of beer, marketed under
distinct brand names. The Company's flagship brand is Redhook E.S.B., and its
other principal products include Ballard Bitter I.P.A., Redhook Rye, Redhook
Hefe-Weizen, Blackhook, Wheathook, Double Black Stout brewed with Starbucks(R)
coffee, and its Winterhook seasonal ale. In addition to its principal products,
the Company continually develops and markets new products under its Blueline
label to test and measure consumer response to varying styles and flavors. The
Company currently distributes its products through a network of third-party
wholesale distributors and a long-term distribution alliance with
Anheuser-Busch, Incorporated ("A-B") (the "Distribution Alliance" or the
"Alliance") in 47 states.
 
INDUSTRY BACKGROUND
 
     The Company is a leader in the relatively small but growing craft brewing
segment of the U.S. brewing industry, which includes regional specialty brewers
such as the Company, contract brewers, microbreweries and brewpubs. Craft beers
are distinguishable from other domestically produced beers by their fuller
flavor and adherence to traditional European brewing styles. According to
industry sources, shipments in the craft beer segment increased by 50% to 3.8
million barrels in 1995, yet represented only 2% of the 189 million barrels
shipped by domestic producers within the United States. For the years 1991
through 1995, shipments in the U.S. craft beer segment increased at a compound
annual growth rate of approximately 45%, while total U.S. beer industry
shipments experienced no meaningful growth.
 
     At the turn of this century, the U.S. brewing industry comprised nearly
2,000 breweries, most of which were small operations that produced distinctive
beers for local markets. Fewer than 1,000 of these breweries reopened following
Prohibition. During the ensuing decades, competition in the beer industry came
to focus on a narrowing of product offerings to less distinctive beer styles
(principally pale lagers and pilsners) to please the broadest possible segment
of the population; economies of scale; mass production techniques; lower costs
and lighter flavor profiles through the use of less barley and more corn, rice
and other adjuncts; use of pasteurization processes to prolong shelf-life; and
marketing a few major brand names on a national basis, principally through
mass-media advertising. As a result of these competitive factors, extensive
industry consolidation occurred. Currently, according to industry sources, the
five largest domestic brewers account for approximately 90% of domestic beer
shipments.
 
     By the early 1980s, annual domestic consumption of beer produced by U.S.
brewers had plateaued at approximately 180 million barrels. Over the past
decade, per capita annual domestic beer consumption has declined slightly, due
to increasing health and safety consciousness and the changing tastes, affluence
and consumption attitudes of the maturing generation of beer drinkers born after
World War II. A growing number of consumers began to migrate away from less
flavorful mass-marketed beers toward greater taste and broader variety in their
malt beverages, mirroring similar trends in other beverage and cuisine
categories. Initially, foreign brewers were the principal beneficiaries of these
evolving consumption patterns. Even though the principal European, Canadian and
Mexican imported beers are also mass-produced, many represent a fuller-flavored
alternative to the national brands produced in the United States.
 
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     By the latter half of the 1980s, a substantial new domestic industry
segment had developed in response to the increasing consumer demand for
fuller-flavored beers. Across the country, a proliferation of regional specialty
brewers (annually selling more than 15,000 barrels of craft beer brewed at their
own facilities), contract brewers (selling craft beer brewed by a third party to
the contract brewer's specifications), microbreweries (selling less than 15,000
barrels per year), and brewpubs (combination restaurant-breweries) emerged to
form the craft beer industry. The strength of consumer demand has enabled
certain craft brewers, such as the Company, to evolve from microbreweries into
regional specialty brewers by constructing larger breweries, while still
adhering to the traditional European brewing methods that characterize the craft
brewing segment. Other craft brewers have sought to take advantage of growing
consumer demand by hiring certain brewers of typical American-style lagers to
perform contract brewing at their otherwise underutilized brewing facilities.
Certain national brewers of mass-produced beers have also sought to appeal to
this growing demand for craft beers by introducing their own fuller-flavored
products.
 
BUSINESS STRATEGY
 
     The Company's principal business objective is to be the leading brewer of
craft beers in the United States. Redhook seeks to achieve this objective by
increasing sales in existing markets, while simultaneously entering new regional
markets. The central elements of the Company's business strategy include:
 
     - Production of High-Quality Craft Beers. Redhook is committed to the
       production of a variety of distinctive, flavorful craft beers designed to
       appeal to a growing number of consumers. The Company brews its craft
       beers according to traditional European brewing styles and methods, using
       only high-quality ingredients and technologically advanced brewing
       equipment. The Company does not intend to compete directly in terms of
       production style, pricing or mass-media advertising with the mass-
       marketed national brands.
 
     - Control of Production in Company-Owned Breweries. The Company builds,
       owns and operates its own brewing facilities to optimize the quality and
       consistency of its products and to achieve the greatest control over its
       production costs. Management believes that its ability to engage in
       constant product innovation and its control over product quality are
       critical competitive advantages. Accordingly, the Company does not hire
       third parties to perform contract brewing of any of its products.
 
     - Production Economies Through Technologically Advanced Equipment. The
       Company's technologically advanced, highly automated breweries are
       designed to produce beer in small batches, while attaining production
       economies through automation rather than scale. The Company believes that
       its investment in technological leadership enables it to optimize
       employee productivity, to contain operating costs, to produce innovative
       beer styles and tastes, and to achieve the production flexibility
       afforded by small-batch brewing, with minimal loss of speed and process
       reliability.
 
     - Strategic Distribution Alliance With Industry Leader. In October 1994,
       the Company entered into a long-term distribution agreement with A-B,
       pursuant to which Redhook distributes its products in new markets through
       A-B's wholesale distribution network. A-B's network consists of over 700
       wholesale distributors, which are for the most part geographically
       contiguous and independently owned and operated. The Alliance with A-B is
       intended to enable the Company to expand its distribution to selected new
       markets more quickly and without the delays, costs and potential gaps or
       overlaps in coverage associated with developing a network of distributors
       on a piecemeal basis. As an independent company, Redhook maintains
       complete control over the production and marketing of its product.
 
     - Operation of Regional Brewing Facilities. Management believes that by
       locating its production facilities in proximity to the regional markets
       it serves, the Company is able to enjoy distinct competitive advantages,
       including shortened delivery times to maximize product freshness, reduced
       shipping costs, established consumer identification with the Company's
       brands, and enhanced familiarity with local consumer tastes. Redhook may
       construct additional brewing facilities, if additional capacity is
       required, in select locations in the United States, with the capability
       to produce Redhook's principal products, as well as to offer select
       products to respond to local taste preferences. By pursuing
 
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       this strategy, Redhook believes that it will be able to preserve its
       reputation and prestige as a regional craft brewer, while selectively
       introducing its products into new regional markets.
 
     - Promotion of Products Within Local Markets. The Company markets its
       products to distributors, retailers and consumers through a variety of
       specialized training and promotional methods. The Company actively trains
       its distributors and retailers in understanding the brewing process, the
       craft beer segment and Redhook products. Promotional methods include
       introducing Redhook products on draft in pubs and restaurants, using
       promotional items including tap handles, glassware and coasters, and
       participating in local festivals to increase brand name recognition. In
       addition, the Company's prominently located breweries feature pubs and
       retail outlets and offer guided tours to further increase consumer
       awareness of Redhook. The Company believes that its training and
       promotional methods are more effective in communicating and educating
       consumers than broad-based, less flexible mass-media beer advertising
       campaigns, although the Company does limited print advertising and may
       consider other types of advertising in the future.
 
PRODUCTS
 
     The Company produces a variety of styles of full-flavored craft beers using
traditional European brewing methods. The Company brews its beers using only
high-quality hops, malted barley, wheat, rye and other natural ingredients, and
does not use any rice, corn, sugar, syrups or other adjuncts. The Company's
beers are marketed on the basis of freshness and distinctive flavor profiles. To
help maintain full flavor, the Company's products are not pasteurized. As a
result, it is appropriate that they be kept cool so that oxidation and heat-
induced aging will not adversely affect the original taste, and that they be
distributed and served as soon as possible, generally within approximately three
months after packaging to maximize freshness and flavor. The Company distributes
its products only in glass bottles and kegs, and its products are freshness
dated for the benefit of consumers.
 
     The Company presently produces eight principal brands, each with its own
distinctive combination of flavor, color and clarity:
 
     Redhook E.S.B. (Extra Special Bitter). The Company's flagship brand,
Redhook E.S.B., which accounted for approximately 69% of the Company's sales in
1996, is a full, rich, well-rounded, copper-colored ale with a sweet toasted
malt flavor balanced by a pleasant floral/herbal liveliness derived from
Tettnang hops.
 
     Ballard Bitter I.P.A. (India Pale Ale). A premium English pub-style bitter
ale, Ballard Bitter I.P.A. is pale and aggressively hopped, has a brassy color
imparted by caramelized malt, an herbal aroma characteristic of Northwest
Cascade hops, and a crisp, dry finish.
 
     Redhook Rye. A pleasing, sweet, light and easy-to-drink ale, Redhook Rye
has a flavor that is enhanced by the addition of flaked rye grain, which adds a
spicy character, and by the live yeast content that remains after it is racked
into kegs or bottled.
 
     Redhook Hefe-Weizen. This wheat beer is unfiltered and named hefe-weizen
which means "wheat beer with yeast." Leaving the yeast in instead of filtering
it out accentuates the wheat flavor and adds visual appeal.
 
     Blackhook. A London-style Porter, Blackhook has an ebony tone, a pleasant
"burnt" character produced by highly roasted black barley, and a dark malt
flavor suggesting coffee and chocolate, balanced by lively hopping.
 
     Wheathook. A delicate, lightly filtered ale brewed for refreshment and a
thirst-quenching character, Wheathook is made with equal parts of American wheat
and barley for a subtle apple-like flavor, and has delicate, mild hopping, very
little bitterness and a distinct wheat finish.
 
     Double Black Stout. A rich, imperial stout enhanced by the addition of an
extract of Starbucks(R) coffee. Dark malts and the coffee create a big roasty
flavor that is rounded out with a touch of honey.
 
     Winterhook. A rich seasonal holiday ale formulated specially each year for
cold-weather enjoyment, Winterhook typically is deep in color and rich in
flavor, with complex flavors and a warm finish.
 
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     In an effort to be responsive to varying consumer style and flavor
preferences, the Company is also continually engaged in the development and
testing of new products. The Company believes that the continued success of
craft brewers will increasingly depend on their ability to be innovative and
attentive to consumer desires for new and distinctive taste experiences. The
Company may also consider producing low-alcohol beer or other low-alcohol or
nonalcoholic beverages (such as root beer, fruit beers, craft sodas and ciders).
The Company's technologically advanced breweries allow it to develop and produce
small-batch experimental ales within two to three weeks. These experimental
products are developed throughout the year and typically produced in draft form
only for on-premise test marketing at the Company's pubs and selected retail
sites under the Company's Blueline label. If the initial consumer reception of a
Blueline experimental brew is sufficiently positive, then its taste and formula
are refined, as necessary, and a new Redhook brand may be created. Redhook Rye,
Ballard Bitter I.P.A., and Double Black Stout are examples of products that were
originally marketed under the Blueline label. Other Blueline products have
included ales such as Barley Wine, Honey Stout, Nut Brown, Oatmeal Stout, Scotch
Ale and Wit, and lagers such as Marzen and Pilsner.
 
BREWING OPERATIONS
 
     The Brewing Process. Beer is made primarily from four natural ingredients:
malted grain, hops, yeast and water. The grain most commonly used in brewing is
barley, owing to its distinctive germination characteristics, which make it easy
to ferment. The Company uses the finest barley malt, typically using strains of
barley having two rows of grain in each ear. A wide variety of hops may be used
to add seasoning to the brew; some varieties best confer bitterness, while
others are chosen for their ability to impart distinctive aromas to the beer.
Nearly all the yeasts used to induce or augment fermentation of beer are of the
species Saccharomyces cerevisiae, which includes both the top-fermenting yeasts
used in ale production and the bottom-fermenting yeasts associated with lagers.
 
     The brewing process begins when the malt supplier soaks the barley grain in
water, thereby initiating germination, and then dries and cures the grain
through kilning. This process, known as "malting," breaks down complex
carbohydrates and proteins so that they can be easily extracted. The malting
process also imparts color and flavor characteristics to the grain. The cured
grain, referred to as "malt," is then sold to the brewery. At the brewery,
various malts are cracked by milling, and mixed with warm water. This mixture,
or "mash," is heated and stirred in the mash tun, allowing the simple
carbohydrates and proteins to be converted into fermentable sugars. Naturally
occurring enzymes help facilitate this process. The mash is then strained and
rinsed in the lauter tun to produce a residual liquid, high in fermentable
sugars, called "wort," which then flows into a brew kettle to be boiled,
concentrated and clarified. Hops are added during the boil to impart bitterness,
balance and aroma. The specific mixture of hops and the brewing time and
temperature further affect the flavor of the beer. After the boil, the wort is
strained and cooled before it is moved to a fermentation cellar, where specially
cultured yeast is added to induce fermentation. During fermentation, the wort's
sugars are metabolized by the yeast cells, producing carbon dioxide and alcohol.
Some of the carbon dioxide is recaptured and absorbed back into the beer,
providing a natural source of carbonation. After fermentation, the beer is
cooled for several days while the beer is clarified and full flavor develops.
Filtration, the final step for a filtered beer, removes unwanted yeast. At this
point, the beer is in its peak condition and ready for bottling or keg racking.
The entire brewing process of ales, from mashing through filtration, is
typically completed in 10 to 14 days, depending on the formulation and style of
the product being brewed.
 
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                                 [ADD DIAGRAM]
 
     Brewing Equipment. The Company uses only technologically advanced and
highly automated small batch brewing equipment. The Fremont Brewery employs a
55-barrel mash tun; lauter tun; two brew kettles; four 35,000-pound grain silos;
and, thirty-eight 110-barrel, one 55-barrel and two 40-barrel fermenters. The
Woodinville Brewery employs a 100-barrel mash tun; lauter tun; wort receiver;
wort kettle; whirlpool kettle; five 70,000-pound, one 35,000-pound and two
25,000-pound grain silos; three 100-barrel, fifty-four 200-barrel, and ten
600-barrel fermenters; and, two 300-barrel and four 400-barrel bright tanks. The
Portsmouth Brewery employs a 100-barrel mash tun; lauter tun; wort receiver;
wort kettle; whirlpool kettle; three 70,000-pound and two 35,000-pound grain
silos; three 100-barrel and sixteen 400-barrel fermenters; two 200-barrel and
two 400-barrel bright tanks; and an anaerobic waste treatment facility which
completes the process cycle. Each brewery uses advanced microfiltration
technology, including a diatomaceous earth pad filter to eliminate unwanted
yeast and to extend shelf life.
 
     Bottling and Kegging. The Company packages its craft beers in both bottles
and kegs. Each of the Company's breweries has a fully automated, technologically
advanced bottling line. The bottle filler at each brewery utilizes a carbon
dioxide environment during bottling designed to ensure that minimal oxygen is
dissolved in the beer, thereby extending shelf life. Currently, the Company
fills kegs at the Fremont Brewery and the Portsmouth Brewery. Redhook uses the
latest keg technology, which is preferred by many draft beer retailers because
the kegs are designed to be easier to handle and lift, to consume less floor
space, to have more consistent flow and to reduce waste. The Company is
constructing kegging and additional warehouse facilities at its Woodinville
Brewery. Those new facilities are expected to be substantially complete by mid-
1997.
 
     Quality Control. The Woodinville Brewery was designed to be the center of a
quality control and analysis network. The Company monitors production and
quality control of each of its breweries with central coordination at the
Woodinville Brewery. Each brewery has an on-site laboratory where
microbiologists and lab technicians supervise on-site yeast propagation, monitor
product quality, test products, measure color and bitterness, and test for
oxidation and unwanted bacteria. The Company also regularly utilizes independent
laboratories for product analysis.
 
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     Ingredients and Raw Materials. The Company currently purchases all of its
malted barley from two suppliers and its premium-quality select hops, grown in
the Pacific Northwest, from three competitive sources. The Company periodically
purchases small lots of European hops, which it uses to achieve a special hop
character in certain of its beers. Redhook believes that alternate sources of
malted barley and hops are available at competitive prices. The Company
currently cultivates its own Saccharomyces cerevisiae yeast supply. The Company
has available to it multiple competitive sources of supply of packing materials,
such as bottles, labels, six-pack carriers, crowns and shipping cases.
 
PRODUCT DISTRIBUTION
 
     Redhook'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 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 beverages, and who traditionally have local
distribution relationships with one or more national beer brands. The Company,
together with its distributors, markets its products to retail outlets and
relies on its distributors to provide regular delivery to retailers, to maintain
retail shelf space and to oversee timely rotation of inventory to ensure the
freshness of its products. The Company also offers its products directly to
consumers at the Company's three on-premise retail establishments, the
Trolleyman pub in Fremont, the Forecasters pub in Woodinville, and the Cataqua
pub in Portsmouth, New Hampshire.
 
     Prior to establishing the Alliance with A-B, the Company distributed its
products regionally through distributors in eight western states: Washington,
California (northern), Oregon, Idaho, Montana, Wyoming, Colorado and Alaska. The
Company's most significant non-Alliance wholesaler, K&L Distributors, Inc., an
independent A-B distributor responsible for distribution in most of King County,
Washington, which includes Seattle, accounted for approximately 18%, 24% and 32%
of total sales in 1996, 1995 and 1994, respectively. The Company's second most
significant non-Alliance distributor, Golden Brands, which was responsible for
distribution in San Francisco, California, accounted for approximately 4%, 8%
and 11% of the Company's sales during the same three years, respectively. The
Company changed the San Francisco, California distribution to the A-B
Distribution Alliance in July 1996. As of December 31, 1996, the Company had 40
non-Alliance distributors. The Company expects the percentage of sales
represented by non-Alliance distributors to continue to decline as the Company
expands its distribution to additional wholesalers through the Alliance.
 
     In October 1994, the Company entered into the Distribution Alliance with
A-B pursuant to which Redhook distributes its products in new markets
exclusively through A-B's wholesale distribution network. If an A-B distributor
does not agree to carry the Company's products, the Company may select a non-A-B
distributor for that territory. The exclusivity provisions of the A-B
Distribution Agreement do not apply to territories currently subject to
distribution arrangements with non-Alliance distributors until such arrangements
expire. During 1996, Redhook changed the distribution in substantially all of
the significant markets previously served by non-A-B wholesalers to distribution
through the Alliance.
 
     A-B, whose products accounted for approximately 45% of total domestic beer
sales by volume in 1996, distributes its products throughout the United States
through a network of over 700 wholesale distributors, which are for the most
part geographically contiguous and independently owned and operated. The Company
believes that the typical A-B distributor is financially stable and has both a
long-standing presence and a substantial market share of beer sales in its
territory.
 
     Redhook chose to align itself with A-B through the Alliance as an integral
part of its growth strategy, and in order to develop a competitive advantage for
Redhook products. Redhook is the only independent craft brewer to have a formal
distribution agreement with a major U.S. brewer. The Company believes that
access to A-B's distribution network has enabled it to enter targeted new
markets more rapidly and with more thorough penetration of the available
customer base in the territory. The Distribution Alliance allows the Company to
retain control over the selection and timing of new market introductions, as
long as the Company is able to satisfy demand in its existing territories. The
Company believes that the existence of the Alliance, presentations by Redhook's
management at A-B's distributor conventions, A-B communications about
 
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Redhook in printed distributor materials, and A-B-supported opportunities for
Redhook to educate A-B distributors about its specialty products result in
increased awareness of and demand for Redhook products among A-B's distributors.
 
     The Company believes that local beer distribution territories have tended
to become dominated by smaller numbers of distributors, generally those carrying
beers marketed by the larger national breweries, and that this consolidation has
had the effect of making it more difficult for relatively small craft brewers to
establish effective distribution networks with reliable distributors. Management
believes that the Company's competitors in the craft beer segment generally
negotiate distribution relationships separately with distributors in each
locality and, as a result, typically distribute through a variety of wholesalers
representing differing national beer brands with uncoordinated territorial
boundaries. Because A-B's distributors are assigned territories that generally
are contiguous, the Company expects that the Alliance will enable the Company to
reduce the gaps and overlaps in distribution coverage often experienced by the
Company's competitors. As a result, the Company believes the Alliance provides
the Company with significant advantages over competitors in the craft beer
industry, who generally are unable to achieve the distribution efficiencies
afforded by the Alliance network.
 
     The Distribution Alliance has enabled the Company to accelerate the
distribution of its products into new markets. The Company expanded distribution
into 47 states by the end of 1996, although in many of those states the account
penetration is initially very low. As of December 31, 1996, the Company had 605
Alliance distributors, accounting for approximately 64% of the Company's sales
volume in 1996. The Company expects that the opening of the Portsmouth Brewery
will allow it to significantly increase its market penetration in the eastern
half of the United States. The Company plans to add new markets on a selective
basis, as the Company acquires knowledge about the market and educates local
distributors, retailers and consumers about Redhook's products. The key criteria
applied by the Company in selecting new markets include market size, distributor
interest, consumer tastes and demographics, retail opportunities, potential for
local competition, transportation and local taxation.
 
     Under the Alliance, the Company is responsible for marketing its products
to A-B's distributors, as well as to retailers and consumers. The A-B
distributors then place orders with A-B for the Company's products, which the
Company separately packages and delivers to the A-B distribution center nearest
to the distributor or, under certain circumstances, directly to the distributor.
The Company sells its products to A-B at the same list prices paid by
non-Alliance distributors, net of the Alliance fee. The Company pays an Alliance
fee to A-B, 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 Alliance, particularly increased sales volume and efficiencies
in delivery, state reporting and licensing, billing and collections created by
the Alliance are significant to the Company's growth.
 
     Under the Alliance, the Company has granted A-B the first right to
distribute Redhook products in the United States and Mexico, except in those
territories already subject to distribution agreements with non-Alliance
distributors, in which case such right does not commence until the existing
arrangements expire. A-B additionally has a first right to distribute new
Redhook products in non-Alliance territories. In exchange, prior to October
1997, A-B may not acquire an interest between 10% and 50% of the common stock
of, or distribute the products of, any other U.S.-based small brewer (producing
or distributing less than 1,000,000 barrels annually) that distributes beer in
those areas where the Company distributes its products. After October 1997, if
A-B were to distribute the products of any U.S.-based small brewer in areas
where the Company's products are distributed, the Alliance fee will be
substantially reduced on sales of Redhook products in such areas.
 
SALES AND MARKETING
 
     The Company has historically engaged in very limited media advertising to
market its products, choosing instead to stimulate consumer demand by educating
consumers and wholesalers as to the distinctive qualities of its products, and
by sponsoring localized promotions designed to enhance Redhook's word-of-mouth
reputation. At December 31, 1996, the Company maintained a sales and marketing
staff of approximately 50 employees, whose efforts are focused principally on
local promotions, programs for on-premise consumer
 
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<PAGE>   10
 
and retailer education, and distributor training and assistance. To maximize
product awareness within new markets, the Company generally hires a local sales
representative up to four weeks prior to beginning distribution of its products.
The Company seeks to identify its products with local markets by participating
in or sponsoring cultural and community events, local music and other
entertainment venues, local craft beer festivals and cuisine events, and local
professional sporting events.
 
     The Company's sales and marketing staff also offers education, training and
other support to wholesale distributors of the Company's products. Because the
Company's wholesalers generally also distribute much higher-volume national beer
brands and often distribute other specialty brands, a critical function of the
sales and marketing staff is to elevate each distributor's awareness of the
Company's products and to retain the distributor's interest in promoting
increased sales of these products. This is accomplished primarily through
personal contact with each distributor, including on-site sales training and
educational tours of the Company's breweries. The Company's sales
representatives also provide other forms of support to wholesale distributors,
such as direct contact with restaurant and grocery chain buyers, direct
involvement in the design of grocery store displays, stacking and merchandising
of beer inventory and supply of point-of-sale materials.
 
     The Company's sales representatives devote considerable effort to the
promotion of on-premise consumption at participating pubs and restaurants. The
Company believes that educating retailers about the freshness and quality of the
Company's products will in turn allow retailers to assist in educating
consumers. The Company considers on-premise product sampling and education to be
among its most effective tools for building brand identity with consumers and
establishing word-of-mouth reputation. On-premise marketing is also accomplished
through a variety of other point-of-sale tools, such as tap handles, coasters,
table tents, neon signs, banners, posters, glassware and menu guidance. The
distribution of the Company's Blueline products in limited quantities to
selected pubs and restaurants is another example of on-premise marketing
designed to increase consumer awareness.
 
     The Company's breweries also play a significant role in increasing consumer
awareness of the Company's products and enhancing Redhook's image as a regional
brewer. More than 60,000 visitors participated in brewery tours at the Company's
facilities in 1996. Each of the Company's breweries has a retail pub on-site
where the Company's products are served. In addition, each brewery has meeting
rooms that the public can rent for business meetings, parties and holiday
events, and that the Company uses to entertain and educate distributors,
retailers and the media about the Company's products. See Item 2. "Properties."
The Company also sells various items of apparel and memorabilia bearing the
Company's trademarks at its breweries, which the Company believes create further
awareness of the Company's beers and reinforce the Company's quality image.
 
     To further promote retail bottled product sales, the Company periodically
offers "post-offs," or price discounts to distributors in certain markets,
primarily in Washington state. Distributors and retailers participate in these
price discounts. In addition, the Company anticipates that it will offer such
promotions in additional markets in response to local competitive conditions.
 
COMPETITION
 
     The highly fragmented craft beer category is the fastest growing segment of
the domestic beer industry. The Company competes primarily with other
participants in the craft beer segment, producers of imported beers and
mass-market national brewers. See "Industry Background." The number of
participants and number of different products offered in this segment have
increased significantly, thereby intensifying competition. Competition within
the domestic craft beer segment is based on product quality, taste, consistency
and freshness; ability to differentiate products; promotional methods and
product support; transportation costs; distribution coverage and, to a lesser
degree, price. A significant portion of the Company's past sales growth has been
achieved through increasing sales in the Pacific Northwest region, which the
Company believes is one of the most competitive craft beer markets in the United
States in terms of number of market participants and consumer awareness. Craft
beers represented approximately 10% of total beer sales in Washington and Oregon
during 1996. Because of the strong demand for the Company's products in this
region, the Company has not historically encountered significant pricing
pressures relative to those found in other regions. In fourth
 
                                        8
<PAGE>   11
 
quarter of 1996, the sales for the Company, and many of its competitors,
declined in Washington State compared to the fourth quarter of 1995.
 
     As the Company expanded its distribution network outside the Pacific
Northwest region, and as other craft brewers expand their distribution to the
Pacific Northwest, Redhook expects to encounter increasing competition from
other regional specialty brewers such as Sierra Nevada Brewing Company and
Anchor Brewing Company, as well as from contract brewers such as Pete's Brewing
Company and Boston Beer Company. Although certain of these competitors
distribute their products nationally and may have greater financial and other
resources than the Company, management believes that the Company possesses
certain competitive advantages, including its technologically advanced,
company-owned production facilities and the availability of distribution through
the Alliance.
 
     The Company also competes against producers of imported beers, such as
Heineken, Molson, Modelo (Corona), Becks and Labatts. Although imported beers
currently account for a much greater share of the U.S. beer market than craft
beers, the Company believes that regional craft brewers possess significant
competitive advantages over certain importers, including lower transportation
and no importation costs, proximity to and familiarity with local consumers, a
higher degree of product freshness, eligibility for lower federal excise taxes
and absence of currency fluctuations.
 
     In response to the rapid growth of the craft beer segment, most of the
major domestic brewers have introduced fuller-flavored beers, and others may be
expected to do so in the future. Although these product offerings are intended
to compete with craft beers, they are brewed according to methods used by the
major national brewers. The Company expects that certain of the major national
brewers, with their superior financial resources, access to raw materials and
established distribution networks, will seek further participation in the
continuing growth of the craft beer segment through the acquisition of equity
positions in, or the formation of distribution alliances with, smaller craft
brewers. Although the increasing participation of the major national brewers
will likely increase competition for market share and heighten price sensitivity
within the craft beer segment, the Company believes that their participation
will tend to increase advertising, distribution and consumer education and
awareness of craft beers, and thus contribute to further growth of this industry
segment.
 
REGULATION
 
     The Company's business is highly regulated at federal, state and local
levels. Various permits, licenses and approvals necessary to the Company's
brewery and pub operations and the sale of alcoholic beverages are required from
various agencies, including the U.S. Treasury Department, Bureau of Alcohol,
Tobacco and Firearms (the "BATF"); the United States Department of Agriculture;
the United States Food and Drug Administration; state alcohol regulatory
agencies in the states in which the Company sells its products; and state and
local health, sanitation, safety, fire and environmental agencies. In addition,
the beer industry is subject to substantial federal excise taxes, although the
Company benefits from favorable treatment granted to brewers producing less than
2 million barrels per year.
 
     Management believes that the Company currently has all licenses, permits
and approvals necessary for its current operations. However, existing permits or
licenses could be revoked if the Company were to fail to comply with the terms
of such permits or licenses, and additional permits or licenses could in the
future be required for the Company's existing or expanded operations. If
licenses, permits or approvals necessary for the Company's brewery or pub
operations were unavailable or unduly delayed, or if any such permits or
licenses were revoked, the Company's ability to conduct its business could be
substantially and adversely affected.
 
  Alcoholic Beverage Regulation and Taxation
 
     Each of the Company's breweries and pubs is subject to licensing and
regulation by a number of governmental authorities. The Company operates its
breweries under federal licensing requirements imposed by the BATF. The BATF
requires the filing of a "Brewer's Notice" upon the establishment of a new
commercial brewery, such as at the Portsmouth Brewery and any other breweries
opened by the Company in the future. In addition, commercial brewers are
required to file an amended Brewer's Notice every time there
 
                                        9
<PAGE>   12
 
is a material change in the brewing process or brewing equipment, change in the
brewery's location, change in the brewery's management or a material change in
the brewery's ownership. The Company's operations are subject to audit and
inspection by the BATF at any time.
 
     In addition to the regulations imposed by the BATF, the Company's breweries
are subject to various regulations concerning retail sales, pub operations,
deliveries and selling practices in states in which the Company sells its
products. Failure by the Company to comply with applicable federal or state
regulations could result in limitations on the Company's ability to conduct its
business. The BATF's permits can be revoked for failure to pay taxes, to keep
proper accounts, to pay fees, to bond premises, and to abide by federal
alcoholic beverage production and distribution regulations, or if holders of 10%
or more of the Company's equity securities are found to be of questionable
character. Permits from state regulatory agencies can be revoked for many of the
same reasons.
 
     The U.S. federal government currently imposes an excise tax of $18 per
barrel on beer produced for consumption in the United States. However, any
brewer with production under 2 million barrels per year instead pays federal
excise tax in the amount of $7 per barrel on the first 60,000 barrels it
produces annually. While the Company is not aware of any plans by the federal
government to reduce or eliminate this benefit to small brewers, any such
reduction in a material amount could have an adverse effect on the Company. In
addition, the Company will lose the benefit of this rate structure if it exceeds
the 2 million barrel production threshold. Individual states also impose excise
taxes on alcoholic beverages in varying amounts, which have also been subject to
change. It is possible that excise taxes will be increased in the future by both
the federal government and several states. In addition, increased excise taxes
on alcoholic beverages have in the past been considered in connection with
various governmental budget-balancing or funding proposals. Any such increases
in excise taxes, if enacted, could adversely affect the Company.
 
  State and Federal Environmental Regulation
 
     The Company's brewery operations are subject to environmental regulations
and local permitting requirements and agreements regarding, among other things,
air emissions, water discharges and the handling and disposal of wastes. While
the Company has no reason to believe the operations of its facilities violate
any such regulation or requirement, if such a violation were to occur, the
Company's business may be adversely affected. In addition, if environmental
regulations were to become more stringent in the future, the Company could be
adversely affected.
 
  Dram Shop Laws
 
     The serving of alcoholic beverages to a person known to be intoxicated may,
under certain circumstances, result in the server's being held liable to third
parties for injuries caused by the intoxicated customer. The Company's pubs have
addressed this concern by establishing early closing hours and employee training
and designated-driver programs. Large uninsured damage awards against the
Company could adversely affect the Company's financial condition.
 
RELATIONSHIP WITH ANHEUSER-BUSCH, INCORPORATED
 
     In October 1994, the Company entered into the Alliance with A-B. The
Alliance consists of a long term national distribution agreement (the "A-B
Distribution Agreement") and an investment by A-B in the Company (the "A-B
Investment Agreement"). The Alliance gives the Company access to A-B's domestic
network of over 700 wholesale distributors, while the Company maintains control
over the production and marketing of its products. Pursuant to the A-B
Investment Agreement, A-B invested approximately $30 million to purchase common
stock of the Company ("Common Stock"), including newly-issued shares concurrent
with the Company's initial public offering, and the Company's Series B Preferred
Stock (the "Series B Preferred Stock").
 
                                       10
<PAGE>   13
 
  A-B Distribution Agreement
 
     The A-B Distribution Agreement has a stated term of 20 years, but is
subject to earlier termination (i) by either party after 10 years, (ii) by
either party upon an uncured material breach by the other party of certain
provisions of the Series B Preferred Stock, the A-B Investment Agreement, the
A-B Distribution Agreement and certain related A-B investment documents, or upon
the insolvency of the other party, (iii) by A-B upon (a) acquisition by another
large alcoholic beverage competitor of 10% or greater equity ownership of the
Company and a seat on the Company's Board of Directors or (b) a deterioration of
the Company's financial condition that results from a change in ownership of the
Company and materially adversely affects its ability to perform under the A-B
Distribution Agreement, or (iv) by A-B following (a) any action by the Company
that in A-B's sole determination damages the reputation or image of A-B or the
brewing industry (for example, production of a high-alcohol beer, defamation of
A-B or its products or contamination of the Company's products, but not poor
operating results, an unsuccessful product introduction or competition with
A-B's products), (b) any acquisition of, agreement to acquire, or institution of
a tender or exchange offer to acquire a percentage of the Company's equity
securities equal to or greater than that held by A-B, (c) certain agreements
pursuant to which the Company would merge into or consolidate with another
corporation or sell substantially all of its assets or certain of its
trademarks, or (d) the failure to appoint a successor acceptable to A-B in the
event Paul S. Shipman ceases to function as the Company's Chief Executive
Officer. The term "Extraordinary Termination" refers to the termination by A-B
of the A-B Distribution Agreement for any of the reasons described under clause
(iv) above.
 
  A-B Investment Agreement
 
     Pursuant to the A-B Investment Agreement, A-B purchased 236,756 shares of
Common Stock for $7.00 per share in October 1994 and 1,289,872 shares of Series
B Preferred Stock for $12.61 per share in November 1994.
 
     A-B Preemptive Rights. Pursuant to the A-B Investment Agreement, A-B
exercised its right in connection with the Company's public offering in August
1995 to purchase 716,714 shares of Common Stock at $17.00 per share in order to
maintain its 25% ownership percentage of the Common Stock on a Fully Diluted
Basis (as defined below). A-B has no further preemptive rights.
 
     A-B Standstill and Transfer Restrictions. Pursuant to the A-B Investment
Agreement, A-B has agreed that neither it nor its affiliates will acquire any
Common Stock, or any option, right or warrant to acquire, or security
convertible or exchangeable into Common Stock, if such purchase or acquisition
would result in A-B and its affiliates holding in the aggregate in excess of 25%
(prior to November 16, 1999) or 30% (prior to November 16, 2001) of the
outstanding shares of Common Stock, calculated on a Fully Diluted Basis (the
"A-B Standstill"). Certain increases in A-B's beneficial ownership resulting
from involuntary acquisitions or decreases in the number of outstanding shares
are excluded from the A-B Standstill.
 
     The A-B Standstill terminates prior to November 16, 2001 if (i) any person
unaffiliated with A-B directly or indirectly: (a) becomes a beneficial owner of,
or enters into an agreement to acquire, commences a tender offer or exchange
offer to acquire, or announces the intention to acquire and, in A-B's reasonable
judgment, has a reasonable likelihood of acquiring as a result thereof, 25% or
more (prior to November 16, 1999) or 30% or more of the outstanding shares of
Common Stock, calculated on a Fully Diluted Basis; (b) enters into an agreement
to consolidate with the Company, to have the Company merged into or with it or
to enter into a share exchange with the Company (other than any merger,
consolidation or share exchange in which the holders of the Company's
outstanding voting securities immediately preceding such transaction will,
immediately after such transaction, own capital stock possessing more than 50%
of the aggregate voting power and economic rights of the outstanding capital
stock of the entities surviving such transaction); or (c) enters into an
agreement to acquire all or substantially all of the Company's assets or certain
trademarks or trade names; (ii) the Company announces its intention to enter
into any agreement described above; or (iii) at any time continuing directors
(defined as directors as of the date of the Company's initial public offering,
directors subsequently elected whose nomination was approved by a majority of
the continuing directors, and directors designated by A-B) cease to constitute
at least a majority of the Company's Board of Directors. If the
 
                                       11
<PAGE>   14
 
A-B Standstill is terminated but the underlying transaction giving rise to
termination of the A-B Standstill does not in fact transpire, the A-B Standstill
will be reinstated as if such event had not occurred if A-B has not increased
its ownership above the standstill limitation in the interim.
 
     The A-B Investment Agreement further provides that, to the extent A-B's
ownership exceeds the limits permitted under the A-B Standstill as the result of
a rights offering while such obligations are still in effect, A-B will, in
certain circumstances, take steps to divest itself of such shares no later than
the later of (i) one year from the date of such purchase or acquisition and (ii)
the earliest period in which such shares may be sold pursuant to Rule 144 under
the Securities Act of 1933, as amended.
 
     The A-B Investment Agreement imposes further restrictions on A-B's ability
to transfer Series B Preferred Stock and Common Stock, including, subject to
certain exceptions (including sales of less than 3% of the outstanding Common
Stock, or sales pursuant to the exercise of registration rights), a limited
right of first refusal in favor of the Company on proposed sales of Common Stock
by A-B, an outright prohibition of sales by A-B of more than 12.5% of the Common
Stock on a Fully Diluted Basis to any single person or group, or of any Common
Stock to brewers of malt beverages, and a prohibition on any sale of Series B
Preferred Stock prior to an Extraordinary Termination of the A-B Distribution
Agreement.
 
     A-B Board Representation. Under the A-B Investment Agreement, A-B has the
right, until November 16, 1999, to designate two nominees for election to the
Company's Board of Directors (or, if the Board of Directors has other than nine
members, that number of nominees based on A-B's percentage ownership of the
Common Stock as calculated on a Fully Diluted Basis, but not less than two).
After November 16, 1999, A-B is entitled to designate that number of nominees
based on its percentage ownership, but not less than two, so long as A-B holds
at least 20% of the Common Stock on a Fully Diluted Basis. A-B's percentage
ownership on a "Fully Diluted Basis," as defined in the A-B Investment Agreement
is calculated based on the assumption that all outstanding shares of Series B
Preferred Stock and other convertible securities are converted into Common
Stock, that all outstanding warrants and stock options (other than stock options
granted to officers, directors and employees under the Company's option plans)
have been exercised in full, and that all holdings of A-B and its affiliated
companies are aggregated. Currently, there are no outstanding options or
warrants that would be included in the calculation of outstanding shares on a
Fully Diluted Basis.
 
     Pursuant to an agreement between A-B and the Company dated July 31, 1995,
if GE Capital Redhook Investment Corp. no longer has the right to designate any
nominees for election to the Company's Board of Directors, A-B is entitled to
designate for nomination to the Company's Board of Directors the number of Board
members which, as a percentage of the total Board, is no less than A-B's
percentage ownership of the Common Stock, calculated on a Fully-Diluted Basis
(which number will be rounded up to the next highest whole number if not a whole
number). The Company is obligated to use reasonable efforts to cause the
election of the nominees designated by A-B. If the designees are not elected,
the Company is obligated to take certain remedial measures, and A-B is entitled
to elect the same number of directors by class voting under the terms of the
Series B Preferred Stock. A-B also has a contractual right to have one of its
Board designees sit on each committee of the Company's Board of Directors.
 
     Covenants Binding the Company. The Company has agreed, pursuant to the A-B
Investment Agreement, that it will not, without A-B's consent, (i) enter into
any acquisition or investment transaction involving an aggregate purchase price
exceeding 50% of the book value of the Company's assets prior to such
transaction; (ii) enter into any transaction involving the transfer of specified
trademarks or trade names or of assets representing more than 50% of the book
value of the Company's assets prior to such transaction; (iii) issue or sell to
any person (including A-B), or amend its capital structure to authorize the
issuance of, equity securities except within certain permitted categories,
including pursuant to (a) the conversion of the Series B Preferred Stock, (b) a
stock split or the exercise of any outstanding option, (c) the issuance of
Common Stock in an initial public offering not exceeding 25% of the Common Stock
outstanding (assuming conversion of all Preferred Stock) as of the closing date
for the sale of the Series B Preferred Stock to A-B, (d) other issuances not
exceeding in the aggregate 20% of the shares of Common Stock and Series B
Preferred Stock (as if converted) outstanding at the beginning of each two-year
period commencing on January 1, 1995 and on January 1 of every second year
thereafter, and (e) issuances under certain antitakeover plans; (iv) authorize
 
                                       12
<PAGE>   15
 
or issue any shares of capital stock ranking equal or prior to the Series B
Preferred Stock as to dividend or liquidation rights, or entitled to more than
one vote per share or to class voting on any matter (except as required by
Washington corporation law) or to ordinary voting power in the election of
directors (other than Common Stock), or authorize or issue any new class or
series of common shares; (v) issue or sell any equity securities to persons
having revenues of $100 million or more from the production or distribution of
alcoholic beverages in North and South America; (vi) afford to any other person
or group the right to designate a number of the Company's directors equal to or
greater than the largest number A-B is contractually entitled to designate;
(vii) enter into any transaction with any affiliate of the Company except under
certain circumstances; (viii) engage in any material respect in any business
other than producing and distributing beverages; (ix) enter into a merger,
consolidation or share exchange with another corporation, except for
transactions meeting multiple criteria (including, among others, survival of the
Company and no change in control); or (x) amend its Articles or Bylaws in
certain respects. The number of shares of Common Stock sold by the Company in
the August 1995 initial public offering of the Company's Common Stock and
concurrent placement of shares of Common Stock with A-B was approximately 29% of
the Common Stock outstanding (assuming conversion of the Series A Preferred
Stock and Series B Preferred Stock) as of the closing date for the sale of
Series B Preferred Stock. As a result, without A-B's consent, the number of
shares the Company would otherwise be entitled to issue in reliance upon the
exception described in clause (iii)(d) above during the two-year period ending
January 1, 1999 will be reduced by 254,753 shares.
 
     These covenants, as well as A-B's contractual Board and committee
representation rights, terminate upon the earliest of (i) a reduction in the
ownership of A-B and its affiliates to less than the greater of (a) 610,000
shares of Common Stock (assuming conversion and exercise of all convertible
securities, options and warrants and ignoring any stock split or other
recapitalization) and (b) 7.5% of the Common Stock calculated on a Fully Diluted
Basis, (ii) an increase in the ownership of A-B and its affiliates to more than
30% of the Common Stock calculated on a Fully Diluted Basis, (iii) an
Extraordinary Termination of the A-B Distribution Agreement, (iv) termination of
the A-B Distribution Agreement by Redhook on the basis of an uncured breach by,
or insolvency of, A-B, and (v) termination of the A-B Distribution Agreement by
either party at the end of 2004 or the expiration thereof at the end of 2014.
 
TRADEMARKS
 
     The Company has obtained U.S. trademark registrations for the marks and
corresponding logo designs for: Ballard Bitter, Blackhook, Redhook, Redhook ESB,
Wheathook, Winterhook, Double Black Stout and Blueline. The Company has also
obtained U.S. trademark registrations for Forecasters, Trolleyman, and Cataqua.
The Redhook mark and certain other Company marks are also registered or pending
in various foreign countries. The Company regards its Redhook and other
trademarks as having substantial value and as being an important factor in the
marketing of its products. The Company is not aware of any infringing uses that
could materially affect its current business or any prior claim to the
trademarks that would prevent the Company from using such trademarks in its
business. The Company's policy is to pursue registration of its marks in its
markets whenever possible and to oppose vigorously any infringement of its
marks.
 
EMPLOYEES
 
     At December 31, 1996, the Company had 244 employees, including 69 in
production, 102 in the pubs, 51 in sales and marketing, and 22 in
administration. Of these, 6 in production, 62 in the pubs, 4 in sales and
marketing, and 2 in administration are part-time employees. The Company believes
its relations with its employees to be very good.
 
                                       13
<PAGE>   16
 
ITEM 2. PROPERTIES
 
     The Company currently operates three technologically advanced, highly
automated small-batch breweries, two in the Seattle, Washington area and a third
in Portsmouth, New Hampshire. See Note 9 of the Notes to Financial Statements
included elsewhere herein.
 
     The Fremont Brewery. In June 1987, the Company leased the historic Fremont
brewery building and hired German brewery engineers to design and install a
brewery to meet its special requirements. Production began in 1989 with an
annual capacity of approximately 30,000 barrels. As the result of further
expansion that included construction of a kegging and warehousing facility,
capacity increased in stages to approximately 75,000 barrels per year by 1993.
The Company leases the brewery building, which covers approximately 26,000
square feet, 1,500 square feet of which are occupied by the Trolleyman pub,
under a lease that expires in October 1997, with two five-year extension options
and an option to purchase in 1997 and at the end of each option period. The
Company owns the adjacent kegging and warehousing facilities, which cover
approximately 23,000 square feet, and leases approximately 5,600 square feet,
with an option to lease an additional 2,000 square feet of adjacent office
premises under a lease that expires in 2001. The Company also leases 2,400
square feet of storage space under a month-to-month lease.
 
     The Woodinville Brewery. In 1993, the Company acquired approximately 22
acres (17 of which are developable) in Woodinville, Washington, a suburb of
Seattle, to build a second brewery and bottling facility. The site is across the
street from the Chateau Ste. Michelle Winery, next to the Columbia Winery, and
visible from a popular bicycle path. The Woodinville Brewery is housed in an
approximately 88,000-square-foot building that currently includes a 100-barrel
brewhouse, fermentation cellars, a filter room, grain storage silos, a bottling
line, dry storage, a cooler, loading docks, a retail outlet and Forecasters, a
4,000-square-foot family-oriented pub that seats 175 and features an outdoor
beer garden that seats an additional 200. The Woodinville Brewery began limited
operations in September 1994 with an annual capacity of approximately 60,000
barrels. Completion of an outdoor tank farm during 1996 brought the Woodinville
Brewery to its maximum designed production capacity of approximately 250,000
barrels per year. The Company is in the process of constructing a 19,000
square-foot kegging and warehousing facility adjacent to the current building.
This facility is expected to be substantially completed by mid-1997.
 
     The Portsmouth Brewery. In May 1995, the Company subleased approximately 23
acres in Portsmouth, New Hampshire to build a third brewery and a bottling and
kegging facility to supply eastern U.S. markets. The sublease expires in 2047,
but contains two seven-year extension options. The Portsmouth Brewery is modeled
after the Woodinville Brewery, but the building is designed to be larger,
covering 125,000 square feet, to accommodate a keg racking line and a larger
cooler. Production began in late October 1996, with an initial capacity of
approximately 100,000 barrels per year. The Company plans to phase in additional
capacity, with maximum designed production capacity of approximately 250,000
barrels per year.
 
ITEM 3. LEGAL PROCEEDINGS
 
     The Company believes that neither it nor its properties are currently
involved in, or subject to, any pending legal proceedings which, if determined
adversely to the Company, would have a material adverse effect on the Company's
financial condition or results of operations.
 
                                       14
<PAGE>   17
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     None.
 
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
 
Paul S. Shipman (44) -- President, Chief Executive Officer and Chairman of the
Board
 
     Mr. Shipman is one of the Company's founders and has served as its
President since September 1981, Chairman of the Board since November 1992, and
Chief Executive Officer since June 1993. Prior to founding the Company, Mr.
Shipman was a marketing analyst for the Chateau Ste. Michelle Winery from 1978
to 1981. Mr. Shipman received his Bachelor's degree in English from Bucknell
University in 1975 and his Master's degree in Business Administration from the
Darden Business School, University of Virginia, in 1978.
 
Bradley A. Berg (39) -- Executive Vice President and Chief Financial Officer
 
     Mr. Berg has served as the Company's Chief Financial Officer since December
1994. He was the Vice President and Chief Financial Officer of Holly Residential
Properties, Inc., a NYSE-listed company engaged in the ownership and operation
of multi-family residential properties, from February 1994 to December 1994. Mr.
Berg served as Vice President and Controller of Burlington Resources Inc., a
NYSE-listed natural resources holding company, from November 1989 to February
1994. Prior to joining Burlington Resources Inc., he was a General Practice
Partner with the certified public accounting firm of Coopers & Lybrand. Mr. Berg
received his Bachelor's degree in Accounting from the University of Northern
Iowa in 1979.
 
David J. Mickelson (37) -- Executive Vice President and Chief Operating Officer
 
     Mr. Mickelson has served in his current position since March 1995, and from
April 1994 to March 1995 he was the Company's Vice President and General
Manager. From July 1992 to December 1994, he served as its Chief Financial
Officer, and was also named General Manager in January 1994. He served as the
Company's Controller from 1987 to July 1992, and additionally was elected
Treasurer in 1989. From 1985 to 1987 he was the Controller for Certified Foods,
Inc. and from 1981 to 1985 served as a loan officer with Barclays Bank PLC. Mr.
Mickelson received his Bachelor's degree in Business Administration from the
University of Washington in 1981.
 
Pamela J. Hinckley (43) -- Vice President, Sales and Marketing
 
     Ms. Hinckley has served in her current position since June 1996, and from
March 1995 to May 1996 she served as the Company's Vice President, Marketing.
She served as the Company's Marketing Director from August 1992 to March 1995
and its Retail Tourism Manager from August 1988 to August 1992. From 1984 to
1988, she was the wine buyer for a Seattle-area specialty food and wine retailer
and from 1982 to 1984 she was the retail and tourism manager for Stevenot
Winery. Ms. Hinckley received her Bachelor's degree in Psychology from Suffolk
University in 1974.
 
Allen L. Triplett (38) -- Vice President, Brewing
 
     Mr. Triplett has served in his current position since March 1995, and from
1987 to March 1995 he was the Company's Production Manager. He has worked in
every facet of production since joining the Company in 1985. Mr. Triplett has
taken extensive coursework at the Siebel Institute of Brewing and the University
of California at Davis. He received his Bachelor's degree in Petroleum
Engineering from the University of Wyoming in 1985.
 
                                       15
<PAGE>   18
 
                                    PART II.
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     The Company effected its initial public offering of Common Stock on August
16, 1995, at a price to the public of $17.00 per share. Since that date the
Company's Common Stock has traded on the NASDAQ National Market. The table below
sets forth for the fiscal quarters indicated the reported high and low last sale
prices of the Company's Common Stock, as reported on the NASDAQ National Market.
 
<TABLE>
<CAPTION>
                                                                            HIGH         LOW
                                                                           -------     -------
<S>                                                                        <C>         <C>
1995
  Third quarter (from August 16, 1995)...................................  $35.000     $24.750
  Fourth quarter.........................................................  $30.500     $24.750
 
1996
  First quarter..........................................................  $27.375     $21.000
  Second quarter.........................................................  $25.500     $20.500
  Third quarter..........................................................  $23.750     $17.750
  Fourth quarter.........................................................  $22.250     $ 9.125
</TABLE>
 
     As of March 6, 1997, there were 722 record holders of Common Stock,
although the Company believes that the number of beneficial owners of its Common
Stock is substantially greater.
 
     The Company has not paid any dividends other than a one-time extraordinary
dividend in 1994 from the proceeds of the sale of Series B Preferred Stock to
A-B. That dividend totaled $9,071,354 ($2.00 per share) and was paid on all
Series A Preferred Stock and common shares outstanding (except those owned by
A-B). The Company anticipates that for the foreseeable future, all earnings, if
any, will be retained for the operation and expansion of its business and that
it will not pay cash dividends. The payment of dividends, if any, in the future
will be at the discretion of the Board of Directors and will depend upon, among
other things, future earnings, capital requirements, restrictions in future
financing agreements, the general financial condition of the Company and general
business conditions. Payment of dividends is also restricted by terms of the
Series B Preferred Stock.
 
                                       16
<PAGE>   19
 
ITEM 6. SELECTED FINANCIAL DATA
 
     The following selected financial data should be read in conjunction with
the Company's Financial Statements and the Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Form 10-K. The selected income and balance sheet data
for, and as of the end of, each of the five years in the period ended December
31, 1996, are derived from the financial statements of the Company, which were
audited by Ernst & Young LLP, independent auditors. The operating data are
derived from unaudited information maintained by the Company.
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER 31,
                                           -------------------------------------------------------
                                            1996        1995        1994        1993        1992
                                           -------     -------     -------     -------     -------
                                             (IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<S>                                        <C>         <C>         <C>         <C>         <C>
STATEMENT OF INCOME DATA:
Sales....................................  $39,410     $28,426     $16,209     $12,331     $ 8,593
Less Excise Taxes........................    3,732       2,532       1,280         847         507
                                           -------     -------     -------     -------     -------
Net Sales................................   35,678      25,894      14,929      11,484       8,086
Cost of Sales............................   23,581      16,970       8,686       6,162       4,469
                                           -------     -------     -------     -------     -------
Gross Profit.............................   12,097       8,924       6,243       5,322       3,617
Selling, General and Administrative
  Expenses...............................    7,853       4,606       2,801       2,001       1,608
                                           -------     -------     -------     -------     -------
Operating Income.........................    4,244       4,318       3,442       3,321       2,009
Interest Expense.........................       --          24         130         158         236
Other Income, Net........................      615         678           9          40          40
                                           -------     -------     -------     -------     -------
Income Before Income Taxes...............    4,859       4,972       3,321       3,203       1,813
Provision for Income Taxes...............    1,773       1,790       1,196       1,099         553
                                           -------     -------     -------     -------     -------
Income Before Accounting Change..........    3,086       3,182       2,125       2,104       1,260
Change in Accounting for Taxes...........       --          --          --          99          --
                                           -------     -------     -------     -------     -------
Net Income...............................  $ 3,086     $ 3,182     $ 2,125     $ 2,005     $ 1,260
                                           =======     =======     =======     =======     =======
Per Share:
  Income Before Accounting Change........  $  0.34     $  0.44     $  0.40     $  0.49     $  0.37
  Net Income.............................  $  0.34     $  0.44     $  0.40     $  0.47     $  0.37
Dividends per Share(1)...................       --          --     $  2.00          --          --
Average Number of Common and Equivalent
  Shares Outstanding.....................    9,138       7,299       5,280       4,293       3,417
OPERATING DATA (IN BARRELS):
Beer Shipped.............................  224,700     158,700      93,700      73,900      49,500
Production Capacity, End of Period(2)....  425,000     245,000     135,000      75,000      60,000
</TABLE>
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                           -------------------------------------------------------
                                            1996        1995        1994        1993        1992
                                           -------     -------     -------     -------     -------
                                                               (IN THOUSANDS)
<S>                                        <C>         <C>         <C>         <C>         <C>
BALANCE SHEET DATA (END OF PERIOD):
Working Capital (Deficit)................  $   850     $21,385     $  (842)    $ 1,735     $  (566)
Total Assets.............................   95,124      86,638      34,689      20,044       9,949
Long-term Debt, Net of Current Portion...    6,191       1,825       3,793       2,066       3,014
Series A Preferred Stock.................       --          --       8,956       8,335          --
Series B Preferred Stock.................   15,922      15,877      15,834          --          --
Common Stockholders' Equity..............   62,630      59,579       1,269       6,683       4,952
</TABLE>
 
---------------
 
(1) Consists entirely of a one-time extraordinary dividend paid to shareholders
    other than A-B from the proceeds of the sale of Series B Preferred Stock to
    A-B.
 
(2) Based on the Company's estimate of production capacity of equipment
    installed as of the end of such period, assuming, among other things,
    production five days per week, two shifts per day. At times, production may
    exceed the Company's estimate. Production capacity (end of period) does not
    reflect maximum designed production capacity. See Item 7. "Management's
    Discussion and Analysis of Financial Condition and Results of Operations."
 
                                       17
<PAGE>   20
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 
     The following discussion and analysis should be read in conjunction with
the Company's Financial Statements and Notes thereto included herein.
 
OVERVIEW
 
     Since its formation, the Company has focused its business activities on the
brewing, marketing and selling of craft beers. For the year ended December 31,
1996, the Company had gross sales of $39,410,000, an increase of 39% over 1995.
The Company believes that period-to-period comparisons of its financial results
should not be relied upon as an accurate indicator of future performance. The
Company's sales consist predominantly of sales of beer to third-party
distributors and A-B through the Distribution Alliance. In addition, the Company
derives other revenues from the sale of beer, food, apparel and other retail
items in its brewery pubs. 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 production over 60,000 barrels and thus, as the Company
increases its sales volume, federal excise taxes will increase as a percentage
of sales.
 
     In addition to the level of consumer demand in existing markets, the
Company's sales are also affected by other factors such as the opening of new
distribution territories, new product introductions and competitive
considerations, including the increasing number of craft brewers and promotional
pricing. Sales in the craft beer industry generally reflect a degree of
seasonality, with the second half of the year typically demonstrating stronger
sales in connection with summer activities and fall and early winter holidays.
The Company has historically operated with little or no backlog, and its ability
to predict sales for future periods is limited.
 
     Under normal circumstances, the Company generally operates its brewing
facilities five days per week, two shifts per day. To meet the increasing demand
for its products, the Company has periodically increased its annual production
capacity, from approximately 3,000 barrels at its first brewery in the Ballard
neighborhood of Seattle in 1982 to approximately 425,000 barrels as of December
31, 1996. Production capacity of each facility is added in phases until the
facility reaches its maximum designed production capacity. The timing of each
phase is affected by the availability of capital, construction constraints and
the Company's plans for an orderly entry into selected new markets and growth in
existing markets. The Portsmouth, New Hampshire brewery began commercial
production during October 1996. The Portsmouth brewery's initial production
capacity is approximately 100,000 barrels per year and its maximum designed
production capacity is approximately 250,000 barrels per year. Additional
capital expenditures and production personnel will be required to bring the
Portsmouth Brewery to its maximum designed capacity.
 
     The Company's capacity utilization has a significant impact on gross
profits. When facilities are operating at their maximum designed production
capacity, profitability is favorably affected by spreading fixed and
semivariable operating costs, such as depreciation and production salaries, over
a larger sales base. Most capital costs associated with building a new brewery
and fixed and semivariable costs related to operating a new brewery are incurred
prior to, or upon commencement of, production at a facility. Because the initial
production level is substantially below the facility's maximum designed
production capacity, gross margins are negatively impacted. This impact is
reduced as the facility's actual production increases. In addition, as the
Company's total production capacity increases, the impact on gross margins of
each additional facility will be reduced.
 
     In addition to capacity utilization, the Company expects other factors to
influence profit margins, including higher costs associated with the opening of
new distribution territories, such as increased shipping, marketing and sales
personnel costs; fees related to the distribution agreement with Anheuser-Busch,
Inc. ("A-B"); changes in packaging and other material costs; and changes in
product sales mix. The incremental cost of shipping beer from the Company's
breweries will continue to increase as the volume of beer supplied to more
distant markets increases. The Company believes that full-scale production at
the Portsmouth Brewery will reduce shipping expenses to eastern U.S. markets.
Also, the Company's ability to connect directly to the City of Portsmouth water
line is subject to approval of design plans and weather conditions. There is no
assurance as to the timing of such direct connection, although the Company
anticipates completing the connection in the second quarter of 1997. Until the
direct connection is complete, the cost of tankering water
 
                                       18
<PAGE>   21
 
from the City of Portsmouth's system, or other sources, for production purposes
at the Portsmouth Brewery will negatively impact gross profit.
 
     See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Certain Considerations: Issues and Uncertainties."
 
RESULTS OF OPERATIONS
 
     The following table sets forth, for the periods indicated, certain items
from the Company's Statements of Income expressed as a percentage of net sales.
 
<TABLE>
<CAPTION>
                                                                       YEAR ENDED DECEMBER 31,
                                                                      -------------------------
                                                                      1996      1995      1994
                                                                      -----     -----     -----
<S>                                                                   <C>       <C>       <C>
Sales...............................................................  110.5%    109.8%    108.6%
Less Excise Taxes...................................................   10.5       9.8       8.6
                                                                      -----     -----     -----
Net Sales...........................................................  100.0     100.0     100.0
Cost of Sales.......................................................   66.1      65.5      58.2
                                                                      -----     -----     -----
Gross Profit........................................................   33.9      34.5      41.8
Selling, General and Administrative Expenses........................   22.0      17.8      18.8
                                                                      -----     -----     -----
Operating Income....................................................   11.9      16.7      23.0
Interest Expense....................................................     --       0.1       0.9
Other Income, Net...................................................    1.7       2.6       0.1
                                                                      -----     -----     -----
Income Before Income Taxes..........................................   13.6      19.2      22.2
Provision for Income Taxes..........................................    5.0       6.9       8.0
                                                                      -----     -----     -----
Net Income..........................................................    8.6%     12.3%     14.2%
                                                                      =====     =====     =====
</TABLE>
 
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
 
     Sales. Sales increased by 38.6% to $39,410,000 in 1996 from $28,426,000 in
1995, primarily due to expansion into new markets and growth in existing
markets. At December 31, 1996, the Company was selling beer in 47 states
compared to 29 states at December 31, 1995. This sales increase reflects a 41.6%
increase in sales volume to 224,700 barrels in 1996 from 158,700 barrels in
1995, and relatively stable sales prices in the Company's various markets. The
Company's other sales totaled $3,372,000 in 1996, compared to $3,347,000 in
1995. The Company's sales growth slowed in late 1996 due in large part to lower
than expected fourth quarter sales on the West Coast. Total fourth quarter sales
volumes increased 17% compared to last year's fourth quarter. West Coast sales
increased over 25% for the full year but decreased approximately 5% in the
fourth quarter compared to the 1995 fourth quarter, including an 11% decline in
Washington State volumes compared to the 1995 fourth quarter. Washington State
is the Company's largest market. The competitive landscape has been affected by
the continued increase in the number of craft beer companies and the number of
different products they offer.
 
     Excise Taxes. Excise taxes increased to $3,732,000, or 10.5% of net sales
in 1996, from $2,532,000, or 9.8% of net sales in 1995, reflecting increased
sales volumes and the increased excise tax rate applicable to annual production
in excess of 60,000 barrels.
 
     Cost of Sales. Cost of sales increased to $23,581,000 in 1996 from
$16,970,000 in 1995, primarily due to the increase in sales volume. Cost of
sales, as a percentage of net sales, increased to 66.1% in 1996 compared to
65.5% in 1995, primarily due to higher freight costs, substantially offset by
increased capacity utilization and the resulting effect of spreading fixed and
semivariable operating costs over a larger production base. The utilization rate
of the breweries' maximum designed capacity was 61% and 49% in 1996 and 1995,
respectively. The utilization rate dropped to 47% in the fourth quarter of 1996
due to the commissioning of the Portsmouth Brewery in late October. Shipping
expense significantly increased in 1996 compared to 1995, reflecting increased
shipments of beer to new, more distant markets. Cost of sales, as a percentage
of sales, was negatively impacted in the quarter ended December 31, 1996 due to
commencing production at the
 
                                       19
<PAGE>   22
 
Portsmouth Brewery and the resulting decrease in the Company's capacity
utilization rate. That impact will be partially offset by lower freight costs on
shipments to eastern markets beginning in 1997.
 
     Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $7,853,000 in 1996 from $4,606,000 in 1995.
The increase is primarily related to the Company's expansion into new markets.
These expenses increased as a percentage of net sales to 22.0% in 1996 from
17.8% in 1995, primarily attributable to additional sales personnel in the new
markets and related expenses, including promotional and marketing support.
 
     Other Income, Net. Other income, net, decreased to $615,000 in 1996
compared to $678,000 in the 1995 period. The decrease is due primarily to a
decline in income from short-term investments as available funds were invested
in the Portsmouth and Woodinville breweries.
 
     Income Taxes. The Company's effective income tax rate increased to 36.5% in
1996 from 36.0% in 1995. That increase is the result of the Company's expansion
into new states and the corresponding increase in state income taxes.
 
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
 
     Sales. Sales increased by 75.4% to $28,426,000 in 1995 from $16,209,000 in
1994, primarily due to growth in existing markets and expansion into new
markets. At December 31, 1995, the Company was selling beer in 29 states
compared to 8 states at December 31, 1994. The sales increase reflects a 69.4%
increase in sales volume to 158,700 barrels in 1995 from 93,700 barrels in 1994,
and relatively stable sales prices in the Company's various markets. The
Company's sales growth during most of 1994 was limited by the approximately
75,000-barrel annual production capacity of the Fremont Brewery, while the
Company's sales in 1995 benefited from the added capacity of the Woodinville
Brewery, which commenced production in September 1994. The Company's other sales
totaled $3,347,000 in 1995, compared to $1,739,000 in 1994, substantially as a
result of the opening of the Woodinville Brewery pub in September 1994. The rate
of growth in 1995 was unusually high as compared to prior periods, and is not
necessarily indicative of future results.
 
     Excise Taxes. Excise taxes increased to $2,532,000, or 9.8% of net sales in
1995, from $1,280,000, or 8.6% of net sales in 1994, reflecting increased sales
volumes and the increased excise tax rate applicable to annual production in
excess of 60,000 barrels.
 
     Cost of Sales. Cost of sales increased to $16,970,000 in 1995 from
$8,868,000 in 1994, primarily due to the increase in sales volume. Cost of
sales, as a percentage of net sales, increased to 65.5% in 1995 compared to
58.2% in 1994, primarily due to the additional fixed and semivariable operating
costs relating to the Woodinville Brewery, including depreciation, increases in
shipping expense, and costs relating to the Company's increase in other sales.
The utilization rate of the breweries' maximum designed capacity was 49% and 59%
in 1995 and 1994, respectively. Shipping expense increased significantly in
1995, reflecting increased shipments of beer to new, more distant markets. In
addition, costs relating to the Company's other sales increased in 1995,
primarily due to the costs associated with serving a relatively higher volume of
food at the Woodinville Brewery pub that opened in the third quarter of 1994.
 
     Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $4,606,000 in 1995 from $2,801,000 in 1994.
The increase is primarily due to the Company's growth in existing and new
markets, in addition to costs associated with managing and administering that
growth. These expenses decreased as a percentage of net sales to 17.8% in 1995
from 18.8% in 1994, primarily attributable to additional sales personnel in the
new markets and related expenses, including promotional and marketing support.
 
     Other Income, Net. Other income, net, increased to $678,000 in 1995
compared to $9,000 in the 1994 period. The net increase is due primarily to the
income earned on the short-term investment of cash from the August 1995 sale of
common stock.
 
                                       20
<PAGE>   23
 
LIQUIDITY AND CAPITAL RESOURCES
 
     The Company had $1,162,000 and $24,676,600 of cash and cash equivalents at
December 31, 1996 and December 31, 1995, respectively. At December 31, 1996, the
Company had working capital of $850,000. The Company's long-term debt as a
percentage of total capitalization (long-term debt, preferred stock and common
stockholders' equity) was 7.5% and 2.5% as of December 31, 1996 and 1995,
respectively.
 
     The Company requires capital principally for the construction and
development of its technologically advanced 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.
 
     Capital expenditures for 1996 totaled $33,094,000. The capital expenditures
related primarily to additional fermentation equipment and the kegging and cold
storage facility at the Woodinville Brewery, and costs associated with the
construction of the new brewery in Portsmouth, New Hampshire. The construction
of the Portsmouth Brewery began in late May 1995 and the facility commenced
commercial operations in October 1996. The Portsmouth brewery's initial
production capacity is 100,000 barrels on an annual basis, and its maximum
designed production capacity is approximately 250,000 barrels per year. The
Company is currently constructing a keg racking and cold storage facility at the
Woodinville Brewery. This facility is expected to cost approximately $6 million
and will be used to supplement the supply of Redhook draft beer in western
states. Capital expenditures for 1997 are expected to total approximately $5
million.
 
     The Company has $10 million available under a secured bank facility (the
"Secured Facility") through June 5, 1997 that may be converted to a five-year
term loan with a 20-year amortization schedule. In addition, the Company has $10
million available under an unsecured revolving credit facility with the same
bank through June 5, 1998. Interest accrues at a variable rate based on the
Inter Bank Offered Rate ("IBOR"), plus 1.00% to 2.50%, depending on the
Company's debt-to-tangible net worth ratio. The Company can fix the rate by
selecting IBOR for one- to twelve-month periods as a base. As of December 31,
1996, there were $4,500,000 in borrowings outstanding under these bank
facilities and the Company's one-month IBOR-based borrowing rate was
approximately 6.625%.
 
     The Company expects to meet its future financing needs, including 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, convertible securities or equity securities.
 
     The Company has certain commitments, contingencies and uncertainties
relating to its normal operations. Management believes that any such
commitments, contingencies or uncertainties, including any environmental
uncertainties, will not have a material adverse effect on the Company's
financial position or results of operations.
 
CERTAIN CONSIDERATIONS: ISSUES AND UNCERTAINTIES
 
     The Company does not provide forecasts of future financial performance or
sales volumes, although this Annual Report contains certain other
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 or Section 21E
of the Securities Exchange Act of 1934, as amended. Such forward-looking
statements are based on assumptions which 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 issues discussed below,
the successful execution of expansion and other plans and the availability of
financing. 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 growth outlook and any forward-looking statements.
 
                                       21
<PAGE>   24
 
     Effect of Competition on Future Growth. The domestic market in which the
Company's craft beers compete is highly competitive due to the continuing
proliferation of small craft brewers, including contract brewers, the increase
in the number of products offered by such brewers and the introduction of
fuller-flavored products by major national brewers. The Company's revenue growth
rate began to slow in late 1996, due primarily to slower than expected sales in
our competitive West Coast markets. If the West Coast sales trends were to
continue or growth in other markets were to slow, the Company's future growth
rate could be materially 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. In certain markets, the Company has participated in
price promotions with its wholesalers and their retail customers. The number of
markets in which the Company participates in price promotions and the frequency
of such promotions is expected to increase in the future.
 
     Variability of Gross Margin and Cost of Sales. The Company anticipates that
its future gross margins will fluctuate and may decline as a result of many
factors, including disproportionate depreciation and other fixed and
semivariable operating costs, during periods when the Company's breweries are
producing below maximum designed production capacity. The Company's high level
of fixed and semivariable operating costs causes gross profit 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:
shipping costs, availability and prices of raw materials and packaging
materials, mix between draft and bottled product sales, and Federal or state
excise taxes. Also, as sales volumes through the Distribution Alliance increase,
the alliance fee, and other staging and administrative costs, will increase.
 
     Advertising and Promotional Costs. While the Company has historically done
very limited advertising, market and competitive considerations could make an
increase in such spending appropriate. In addition, market and competitive
considerations could require an increase in other promotional costs associated
with developing existing and new markets.
 
     Relationship with Anheuser-Busch, Incorporated. Most of the Company's
future sales are expected to be through the Distribution Alliance with A-B. See
"Part 1, Item 1 -- Business -- Product Distribution, and Relationship With
Anheuser-Busch, Incorporated" for a further description of the relationship with
A-B. If the Distribution Alliance were to be terminated, or if the relationship
between A-B and the Company were to deteriorate, the Company's sales growth and
profitability could be materially adversely affected. While the Company believes
that the benefits of the Distribution Alliance, in particular increased sales
volume, access to distributors and distribution efficiencies, offset related
costs associated with the Alliance, there can be no assurance that these costs
will not have a negative impact on the Company's profit margins in the future.
 
     Dependence on Third-Party Distributors. The Company relies heavily on
third-party distributors for the sale of its products to retailers. The
Company's most significant non-Alliance wholesaler, K&L Distributors, Inc., an
A-B affiliated wholesaler in the Seattle area, accounted for approximately 18%
of the Company's sales during 1996. Substantially all of the remaining sales
volumes are now through the Distribution Alliance to A-B affiliated
distributors, most of whom are independent wholesalers. The loss of K&L or the
termination of the Distribution Alliance could have a material adverse impact on
the Company's sales growth and profitability.
 
     Customer Acceptance, Consumer Trends and Public Attitudes. If consumers
were unwilling to accept the Company's products or if the recent trends toward
drinking craft beers were to change, it could adversely impact the Company's
sales growth and profitability. 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 growth and profitability
could be adversely affected.
 
                                       22
<PAGE>   25
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                                        PAGE
                                                                                        ----
<S>                                                                                     <C>
AUDITED FINANCIAL STATEMENTS:
 
Report of Ernst & Young LLP, Independent Auditors.....................................    24
 
Balance Sheets as of December 31, 1996 and 1995.......................................    25
 
Statements of Income for the Years Ended December 31, 1996,
  1995 and 1994.......................................................................    26
 
Statements of Common Stockholders' Equity for the Years Ended December 31, 1996, 1995
  and 1994............................................................................    27
 
Statements of Cash Flows for the Years Ended December 31, 1996, 1995 and 1994.........    28
 
Notes to Financial Statements.........................................................    29
</TABLE>
 
                                       23
<PAGE>   26
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors
Redhook Ale Brewery, Incorporated
 
     We have audited the accompanying balance sheets of Redhook Ale Brewery,
Incorporated as of December 31, 1996 and 1995, and the related statements of
income, common stockholders' equity, and cash flows for each of the three years
in the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Redhook Ale Brewery,
Incorporated as of December 31, 1996 and 1995, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1996, in conformity with generally accepted accounting principles.
 
                                          ERNST & YOUNG LLP
Seattle, Washington
February 4, 1997
 
                                       24
<PAGE>   27
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                                 BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,     DECEMBER 31,
                                                                        1996             1995
                                                                    ------------     ------------
<S>                                                                 <C>              <C>
                                           ASSETS
Current Assets:
  Cash and Cash Equivalents.......................................  $  1,162,352     $ 24,676,600
  Accounts Receivable.............................................     2,051,591        2,027,454
  Inventories.....................................................     2,229,376        1,340,444
  Income Taxes Receivable.........................................       427,075               --
  Other...........................................................     1,725,942          272,849
                                                                    ------------     ------------
     Total Current Assets.........................................     7,596,336       28,317,347
Fixed Assets, Net.................................................    86,357,559       57,799,694
Other Assets......................................................     1,170,144          521,395
                                                                    ------------     ------------
          Total Assets............................................  $ 95,124,039     $ 86,638,436
                                                                      ==========       ==========
 
                             LIABILITIES, REDEEMABLE PREFERRED STOCK
                                 AND COMMON STOCKHOLDERS' EQUITY
Current Liabilities:
  Accounts Payable................................................  $  4,075,699     $  4,828,902
  Accrued Salaries, Wages and Payroll Taxes.......................     1,220,212          695,645
  Refundable Deposits.............................................       950,926          972,957
  Other Accrued Expenses..........................................       367,025          312,948
  Current Portion of Long-Term Debt...............................       132,554          121,659
                                                                    ------------     ------------
     Total Current Liabilities....................................     6,746,416        6,932,111
                                                                    ------------     ------------
Long-Term Debt, Net of Current Portion............................     6,190,764        1,825,339
                                                                    ------------     ------------
Deferred Income Taxes.............................................     3,582,692        2,389,588
                                                                    ------------     ------------
Other Liabilities.................................................        52,461           35,348
                                                                    ------------     ------------
Convertible Redeemable Preferred Stock............................    15,921,855       15,877,455
                                                                    ------------     ------------
Common Stockholders' Equity:
  Common Stock, Par Value $0.005 per Share, Authorized, 20,000,000
     Shares; Issued and Outstanding, 7,685,486 Shares in 1996 and
     7,683,596 Shares in 1995.....................................        38,428           38,417
  Additional Paid-In Capital......................................    56,652,764       56,642,663
  Retained Earnings...............................................     5,938,659        2,897,515
                                                                    ------------     ------------
     Total Common Stockholders' Equity............................    62,629,851       59,578,595
                                                                    ------------     ------------
          Total Liabilities, Redeemable Preferred Stock and Common
             Stockholders' Equity.................................  $ 95,124,039     $ 86,638,436
                                                                      ==========       ==========
</TABLE>
 
                             See Accompanying Notes
 
                                       25
<PAGE>   28
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                              STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                                YEAR ENDED DECEMBER 31,
                                                      -------------------------------------------
                                                         1996            1995            1994
                                                      -----------     -----------     -----------
<S>                                                   <C>             <C>             <C>
 
Sales...............................................  $39,410,119     $28,425,729     $16,209,072
Less Excise Taxes...................................    3,732,034       2,531,378       1,279,976
                                                      -----------     -----------     -----------
Net Sales...........................................   35,678,085      25,894,351      14,929,096
Cost of Sales.......................................   23,580,745      16,969,859       8,685,653
                                                      -----------     -----------     -----------
Gross Profit........................................   12,097,340       8,924,492       6,243,443
Selling, General and Administrative Expenses........    7,853,360       4,606,375       2,801,465
                                                      -----------     -----------     -----------
Operating Income....................................    4,243,980       4,318,117       3,441,978
Interest Expense....................................           --          23,814         130,105
Other Income, Net...................................      615,145         678,280           8,647
                                                      -----------     -----------     -----------
Income before Income Taxes..........................    4,859,125       4,972,583       3,320,520
Provision for Income Taxes..........................    1,773,581       1,790,130       1,195,606
                                                      -----------     -----------     -----------
Net Income..........................................  $ 3,085,544     $ 3,182,453     $ 2,124,914
                                                      ===========     ===========     ===========
 
Net Income per Share................................  $      0.34     $      0.44     $      0.40
                                                      ===========     ===========     ===========
Average Number of Common and Equivalent Shares
  Outstanding.......................................    9,137,943       7,298,612       5,279,752
                                                      ===========     ===========     ===========
</TABLE>
 
                             See Accompanying Notes
 
                                       26
<PAGE>   29
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                                           COMMON STOCK                                              TOTAL
                                       ---------------------     ADDITIONAL                         COMMON
                                                       PAR         PAID-IN        RETAINED       STOCKHOLDERS'
                                        SHARES        VALUE        CAPITAL        EARNINGS          EQUITY
                                       ---------     -------     -----------     -----------     -------------
<S>                                    <C>           <C>         <C>             <C>             <C>
 
Balance, December 31, 1993...........  3,068,320     $15,342     $ 2,302,822     $ 4,364,790      $ 6,682,954
  Sale of Common Stock...............    236,756       1,184       1,656,144              --        1,657,328
  Stock Options Exercised............    224,500       1,123         575,803              --          576,926
  Income Tax Benefit from Exercise of
     Stock Options...................         --          --         263,486              --          263,486
  Note Receivable for Stock
     Purchase........................         --          --        (333,000)             --         (333,000)
  Preferred Stock Accretion..........         --          --              --        (632,284)        (632,284)
  Dividend...........................         --          --      (3,352,716)     (5,718,638)      (9,071,354)
  Net Income.........................         --          --              --       2,124,914        2,124,914
                                       ---------      ------      ----------      ----------      -----------
Balance, December 31, 1994...........  3,529,576      17,649       1,112,539         138,782        1,268,970
  Sale of Common Stock, net..........  2,910,206      14,549      46,187,364              --       46,201,913
  Stock Options Exercised and Other,
     net.............................        957           5          12,780              --           12,785
  Preferred Stock Accretion..........         --          --              --        (423,720)        (423,720)
  Conversion of Series A Preferred to
     Common Stock....................  1,242,857       6,214       9,329,980              --        9,336,194
  Net Income.........................         --          --              --       3,182,453        3,182,453
                                       ---------      ------      ----------      ----------      -----------
Balance, December 31, 1995...........  7,683,596      38,417      56,642,663       2,897,515       59,578,595
  Stock Options Exercised and Other,
     net.............................      1,890          11          10,101              --           10,112
  Preferred Stock Accretion..........         --          --              --         (44,400)         (44,400)
  Net Income.........................         --          --              --       3,085,544        3,085,544
                                       ---------      ------      ----------      ----------      -----------
Balance, December 31, 1996...........  7,685,486     $38,428     $56,652,764     $ 5,938,659      $62,629,851
                                       =========      ======      ==========      ==========      ===========
</TABLE>
 
                             See Accompanying Notes
 
                                       27
<PAGE>   30
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                            STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31,
                                                 ------------------------------------------------
                                                     1996              1995              1994
                                                 ------------      ------------      ------------
<S>                                              <C>               <C>               <C>
OPERATING ACTIVITIES
Net Income...................................... $  3,085,544      $  3,182,453      $  2,124,914
Adjustments to Reconcile Net Income to Net Cash
  Provided by Operating Activities:
     Depreciation and Amortization..............    2,042,780         1,324,239           762,455
     Deferred Income Tax Provision..............    1,193,104         1,027,771           521,768
     Changes in Operating Assets and
       Liabilities:
       Accounts Receivable......................      (24,137)         (881,236)         (215,637)
       Inventories..............................     (888,932)         (762,014)         (317,504)
       Income Taxes.............................     (427,075)          326,361          (200,687)
       Other Current Assets.....................     (295,765)         (202,641)         (108,232)
       Other Assets.............................     (586,053)         (345,111)           (6,243)
       Accounts Payable and Other Accrued
          Expenses..............................      655,633          (391,421)          947,247
       Accrued Salaries, Wages and Payroll
          Taxes.................................      524,567           240,980           223,375
       Refundable Deposits......................      (22,031)          457,251           183,273
                                                 ------------      ------------      ------------
Net Cash Provided by Operating Activities.......    5,257,635         3,976,632         3,914,729
                                                 ------------      ------------      ------------
INVESTING ACTIVITIES
Expenditures for Fixed Assets...................  (33,094,235)      (24,023,006)      (16,434,132)
Other...........................................      (70,365)            3,503           (11,873)
                                                 ------------      ------------      ------------
Net Cash Used in Investing Activities...........  (33,164,600)      (24,019,503)      (16,446,005)
                                                 ------------      ------------      ------------
FINANCING ACTIVITIES
Proceeds from Debt..............................   23,600,000        16,789,249        12,645,747
Repayments on Debt..............................  (19,223,680)      (18,751,683)      (10,911,365)
Proceeds from Sale of Preferred Stock...........           --                --        15,822,375
Proceeds from Sale of Common Stock..............           --        46,201,913         1,657,328
Dividend Paid...................................           --                --        (9,071,354)
Other...........................................       16,397             7,505           404,913
                                                 ------------      ------------      ------------
Net Cash Provided by Financing Activities.......    4,392,717        44,246,984        10,547,644
                                                 ------------      ------------      ------------
Increase (Decrease) in Cash and Cash
  Equivalents...................................  (23,514,248)       24,204,113        (1,983,632)
Cash and Cash Equivalents:
  Beginning of Year.............................   24,676,600           472,487         2,456,119
                                                 ------------      ------------      ------------
  End of Year................................... $  1,162,352      $ 24,676,600      $    472,487
                                                 ============      ============      ============
</TABLE>
 
                             See Accompanying Notes
 
                                       28
<PAGE>   31
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                         NOTES TO FINANCIAL STATEMENTS
 
1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
 
     Redhook Ale Brewery, Incorporated (the "Company") was incorporated on May
4, 1981 for the purpose of brewing, marketing and selling craft beers. Its
operations consist of a brewery and distribution facility in the Fremont area of
Seattle, Washington; a brewery in the Seattle suburb of Woodinville, Washington;
and, a brewery in Portsmouth, New Hampshire. As of December 31, 1996, the
Company's products were distributed in 47 states.
 
     In 1994, the Company signed an agreement (the "Distribution Alliance" or
the "Alliance") with Anheuser-Busch, Incorporated ("A-B"), pursuant to which the
Company utilizes A-B's national distribution network as the Company expands the
markets in which it sells Redhook products. In addition, A-B purchased 1,289,872
shares of Series B convertible redeemable preferred stock (the "Series B
Preferred Stock") and 236,756 newly issued shares of common stock in connection
with the Distribution Alliance. As of December 31, 1996, A-B owned 25% of the
Company's voting stock, which is the maximum percentage currently allowed under
the agreements with the Company.
 
     Cash and Cash Equivalents
 
     The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. The carrying amount
of cash equivalents approximates fair value because of the short-term maturity
of these instruments.
 
     Inventories
 
     Inventories are stated at the lower of cost or market. Cost is determined
by the first-in, first-out method.
 
     Fixed Assets
 
     Fixed assets are stated at cost. Significant additions and improvements are
capitalized. Maintenance and repairs are expensed as incurred. Upon disposition
of fixed assets, any gains or losses are reflected in the statement of income.
The Company provides for depreciation and amortization using the straight-line
method to recognize the costs over the following estimated useful lives:
 
<TABLE>
            <S>                                          <C>
            Buildings..................................  31 - 40 years
            Brewery equipment..........................  20 - 25 years
            Leasehold improvements.....................  Lesser of lease term or useful life
            Furniture, fixtures and other equipment....  2 - 10 years
            Delivery vehicles..........................  5 years
</TABLE>
 
     Earnings per Share
 
     Earnings per share is based on the weighted average number of common and
common equivalent shares outstanding during the respective years. The
calculation of average common equivalent shares outstanding includes the effect
of all outstanding convertible redeemable preferred stock and outstanding stock
options. Because all of the Company's outstanding preferred shares are common
equivalent shares, for purposes of calculating earnings per share, the accretion
related to the preferred stock carrying value is not deducted from net income in
the calculation of earnings per share. Pursuant to the rules of the Securities
and Exchange Commission, common and common equivalent shares issued during the
twelve months immediately preceding the July 1995 filing of the Company's
registration statement on Form S-1 related to the initial public offering (the
"Offering") of its common stock have been included in the calculation of the
average common and common equivalent shares outstanding for all periods
presented that were prior to the Offering. The
 
                                       29
<PAGE>   32
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
calculation uses the treasury stock method in determining the resulting
incremental average equivalent shares outstanding.
 
     Income Taxes
 
     The Company accounts for income taxes under the liability method, whereby
deferred taxes are provided for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities. These
deferred tax assets and liabilities are measured under the provisions of the
currently enacted tax laws.
 
     Note Receivable for Stock Purchase
 
     The Company's President had an interest-bearing loan for $333,000
outstanding at December 31, 1996 and 1995 related to the exercise of stock
options. The loan is secured by Company stock held by the officer and is
included as a reduction in common stockholders' equity. The note, including
interest accruing at 6% per year, is due no later than September 30, 2001.
 
     Use of Estimates
 
     The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.
 
     Reclassifications
 
     Certain reclassifications have been made to the prior years' financial
statements to conform to the current-year presentation.
 
     Impact of Recently Issued Accounting Standards
 
     In October 1995, the Financial Accounting Standards Board issued Statement
No. 123, Accounting for Stock-Based Compensation ("Statement 123"). Statement
123, which is required for fiscal years beginning after December 15, 1995,
establishes accounting and reporting standards for stock-based employee
compensation plans, including: stock purchase plans, stock options, and stock
appreciation rights. Statement 123 defines a fair value-based method of
accounting for these equity instruments. This method measures compensation cost
based on the value of the award and recognizes that cost over the service
period. Upon adoption of Statement 123, companies may elect to continue
accounting for these types of equity instruments under APB Opinion No. 25,
Accounting for Stock Issued to Employees ("Opinion 25"). Companies which elect
to continue using the rules of Opinion 25 for accounting purposes must make pro
forma disclosures of net income and earnings per share as if Statement 123 had
been applied for accounting purposes. The Company has elected to continue
accounting for stock-based compensation in accordance with Opinion 25 and has
included the pro forma disclosures required by Statement 123 in Note 7 of these
Notes to Financial Statements.
 
                                       30
<PAGE>   33
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
2. INVENTORIES
 
   Inventories consist of the following:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1996           1995
                                                              ----------     ----------
        <S>                                                   <C>            <C>
        Finished goods......................................  $1,264,480     $  786,580
        Raw materials.......................................     282,603        121,651
        Promotional merchandise.............................     511,089        222,160
        Packaging materials.................................     171,204        210,053
                                                              ----------     ----------
                                                              $2,229,376     $1,340,444
                                                              ==========     ==========
</TABLE>
 
     Finished goods include beer held in fermentation prior to the filtration
and packaging process.
 
3. OTHER CURRENT ASSETS
 
   Other current assets consist of the following:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                               -----------------------
                                                                  1996          1995
                                                               ----------     --------
        <S>                                                    <C>            <C>
        Insurance receivable, construction claim.............  $1,157,328     $     --
        Prepaid expenses.....................................     374,478      166,913
        Other................................................     194,136      105,936
                                                               ----------     --------
                                                               $1,725,942     $272,849
                                                               ==========     ========
</TABLE>
 
4. FIXED ASSETS
 
   Fixed assets consist of the following:
 
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                            ---------------------------
                                                               1996            1995
                                                            -----------     -----------
        <S>                                                 <C>             <C>
        Land and improvements.............................  $ 5,163,835     $ 4,280,609
        Buildings.........................................   28,994,115      13,723,265
        Brewery equipment.................................   47,683,654      24,422,474
        Furniture, fixtures and other equipment...........    2,756,420       1,005,355
        Leasehold improvements............................      480,161         447,748
        Delivery vehicles.................................      136,478          84,835
        Construction in progress..........................    7,105,985      10,933,729
        Deposits on brewery equipment.....................           --       6,846,770
                                                            -----------     -----------
                                                             92,320,648      61,744,785
        Less accumulated depreciation and amortization....    5,963,089       3,945,091
                                                            -----------     -----------
                                                            $86,357,559     $57,799,694
                                                            ===========     ===========
</TABLE>
 
     Construction in progress at December 31, 1996 related primarily to the
kegging and cold storage facility at the Woodinville Brewery and certain
Portsmouth Brewery costs. Deposits on equipment at December 31, 1995 related
primarily to advances on brewing, bottling and kegging equipment for the
Portsmouth Brewery.
 
                                       31
<PAGE>   34
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 5. DEBT
 
     Long-term debt consists of the following:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1996           1995
                                                              ----------     ----------
        <S>                                                   <C>            <C>
        Note payable to bank, currently payable monthly at
          $20,880, including interest at 6.6%, maturing in
          2006..............................................  $1,823,318     $1,946,998
        Bank facility, interest at 6.625%...................   4,500,000             --
                                                              ----------     ----------
        Total long-term debt................................   6,323,318      1,946,998
        Current portion.....................................     132,554        121,659
                                                              ----------     ----------
                                                              $6,190,764     $1,825,339
                                                              ==========     ==========
</TABLE>
 
     Annual principal payments required on long-term debt during the next five
years are as follows:
 
<TABLE>
                <S>                                                <C>
                1997.............................................  $  132,554
                1998.............................................   4,641,759
                1999.............................................     151,541
                2000.............................................     161,734
                2001.............................................     173,159
                Thereafter.......................................   1,062,571
                                                                   ----------
                                                                   $6,323,318
                                                                   ==========
</TABLE>
 
     The Company has $10 million available under a secured bank facility (the
"Secured Facility") through June 5, 1997 that may be converted to a five-year
term loan with a 20-year amortization schedule. In addition, the Company has $10
million available under an unsecured revolving credit facility with the same
bank through June 5, 1998. Interest accrues at a variable rate based on the
Inter Bank Offered Rate ("IBOR") plus 1.00% to 2.50%, depending on the Company's
debt-to-tangible net worth ratio. The Company can fix the rate by selecting IBOR
for one- to twelve-month periods as a base. As of December 31, 1996, $4,500,000
in borrowings was outstanding under the unsecured bank facility and the
Company's one-month IBOR-based borrowing rate was approximately 6.625%.
 
     The note payable to the bank and the Secured Facility are secured by all of
the Company's Washington State brewing equipment, inventories and accounts
receivable.
 
     The Company made interest payments totaling $289,633, $444,464 and $335,954
for the years ended December 31, 1996, 1995 and 1994, respectively. Interest
capitalized as a part of construction costs for the years ended December 31,
1996, 1995 and 1994 totaled $291,105, $402,093 and $224,407, respectively.
Included in other assets are capitalized loan fees with a net unamortized
balance of $53,673 and $39,259 at December 31, 1996 and 1995, respectively.
 
                                       32
<PAGE>   35
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 6. CONVERTIBLE REDEEMABLE PREFERRED STOCK
 
     Convertible redeemable preferred stock outstanding is as follows:
 
<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                            ---------------------------
                                                               1996            1995
                                                            -----------     -----------
        <S>                                                 <C>             <C>
        Series B, par value $0.005 per share, issued and
          outstanding 1,289,872 shares; net of $445,713 in
          offering costs, plus accretion to redemption
          value...........................................  $15,921,855     $15,877,455
                                                            ===========     ===========
</TABLE>
 
     There are 5,000,000 shares of preferred stock authorized. During 1993, the
Board of Directors designated 1,242,857 preferred shares as Series A Preferred
Stock. In August 1993, the Company sold all such designated shares of Series A
Preferred Stock to existing common shareholders, institutional investors and
other qualified or accredited investors for approximately $8.7 million, or $7.00
per share. All shares of Series A Preferred Stock were automatically converted
to an equal number of common shares upon the closing of the Company's initial
public offering in August 1995.
 
     During 1994, the Board of Directors designated 1,289,872 preferred shares
as Series B Preferred Stock. In November 1994, the Company sold all shares of
Series B Preferred Stock to A-B for approximately $16.3 million, or $12.61 per
share. A-B's ownership percentage of the Company is limited to 25% of the
outstanding Common Stock, assuming the conversion of all outstanding Preferred
Stock. That percentage limitation increases to 30% for the period November 1999
through November 2001.
 
     Each share of Series B Preferred Stock is entitled to as many votes as the
number of shares of common stock into which it is convertible. The conversion
rate is one share of common stock for each share of preferred stock, subject to
antidilution adjustment under certain circumstances. The Series B Preferred
Stock is convertible to common stock at any time by its holder and is subject to
automatic conversion under certain circumstances on December 31, 2004 or
December 31, 2014.
 
     Under the terms of the Series B Preferred Stock purchase agreement, the
Company is required to meet various affirmative and negative covenants. These
covenants limit the Company's ability to declare dividends on, or purchase, any
of its capital stock without prior approval. The holders of Series B Preferred
Stock and converted Series A Preferred Stock also are entitled to certain
contractual registration rights.
 
     Holders of Series B Preferred Stock generally are entitled to receive
dividends at a rate equal to any dividends declared on common stock, when and if
dividends are declared by the Company's Board of Directors. In addition, under
certain circumstances relating to the termination of the Distribution Alliance
by A-B, the Series B Preferred Stock would prospectively accumulate preferential
dividends until stock redemption at a fixed annual rate based on the ten-year
U.S. Treasury rate, plus 2.75%. Holders of Series B Preferred Stock also have
mandatory redemption rights and liquidation preferences equal to $12.61 per
share, plus any accumulated and unpaid dividends. The Company is required to
redeem all shares of outstanding Series B Preferred Stock on December 31, 2004,
or on December 31, 2014, under certain other conditions relating to a
termination of the Distribution Alliance by A-B.
 
     The difference between the issuance price, net of offering costs, of the
convertible redeemable preferred stock and the redemption value is accreted
periodically through the redemption date by a charge to retained earnings.
 
                                       33
<PAGE>   36
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 7. COMMON STOCKHOLDERS' EQUITY
 
     Sale of Common Stock
 
     In August 1995, the Company completed the sale of 2,193,492 shares of
common stock through an initial public offering and 716,714 common shares in a
concurrent private placement to A-B (collectively, the "Offerings") at a price
of $17.00 per share. The net proceeds of the Offerings totaled approximately $46
million. All of the 1,242,857 shares of Series A convertible preferred stock
automatically converted to an equal number of common shares upon closing of the
Offerings.
 
     Stock Option Plans
 
     In 1993, the Company's shareholders approved the 1992 Stock Incentive Plan
(the "Plan") and the Directors Stock Option Plan (the "Directors Plan"). Under
the Plan, as amended in May 1996, the approval provides for 1,270,000 shares of
common stock for options. The approval, as amended in May 1996, also provided
for 170,000 shares of common stock for options under the Directors Plan.
Employee options generally vest over a five-year period and director options
vest over a six-month period. Vested options are generally exercisable for ten
years from the date of grant.
 
     In September 1990, the Company reserved 120,000 shares of common stock for
its 1990 Incentive Stock Option Plan. Options for 120,000 shares were granted at
that time with an exercise price equal to the estimated fair market value. The
exercise price increased from the original price by 5% per year until full
vesting occurred. These options generally vested over five years and are
exercisable for ten years from the date of grant.
 
     Under the terms of the Company's incentive stock option plans, employees
and directors may be granted options to purchase the Company's common stock at
no less than 100% of the market price on the date the option is granted. At
December 31, 1996, 1995 and 1994, a total of 1,279,504, 726,744 and 495,500
shares, respectively, were reserved for future issuance under the plans.
 
     The Company applies Opinion 25 in accounting for its stock option plans.
Accordingly, because the grant price equals the market price on the date of
grant, no compensation expense is recognized for stock options issued. Had
compensation cost for the Company's stock options been recognized based upon the
estimated fair value on the grant date under the methodology prescribed by
Statement 123, the Company's net income and earnings per share for the year
ended December 31, 1996 would have been impacted as indicated in the following
table. Pursuant to the provisions of Statement 123, the pro forma results shown
below only reflect the impact of options granted in 1995 and 1996. Since option
vesting occurs over five years, the pro forma impact is expected to increase for
the next 3 - 5 years and then remain relatively constant thereafter, absent
significant changes to valuation assumptions or option grant patterns.
 
<TABLE>
<CAPTION>
                                                               YEAR ENDED DECEMBER 31,
                                                              -------------------------
                                                                 1996           1995
                                                              ----------     ----------
        <S>                                                   <C>            <C>
        Reported net income.................................  $3,085,544     $3,182,453
        Pro forma net income................................   2,609,350      3,064,581
 
        Reported earnings per share.........................  $     0.34     $     0.44
        Pro forma earnings per share........................        0.29           0.42
</TABLE>
 
                                       34
<PAGE>   37
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
     The fair value of options granted (which is amortized to expense over the
option vesting period in determining the proforma impact) is estimated on the
date of grant using Black-Scholes option-pricing model with the following
weighted average assumptions:
 
<TABLE>
<CAPTION>
                                                               1996          1995
                                                               -----     -------------
        <S>                                                    <C>       <C>
        Expected life of option...........................    5 yrs.            5 yrs.
        Risk-free interest rate...........................     6.42%     5.63 to 6.88%
        Expected volatility of the Company's stock........     50.0%             50.0%
        Expected dividend yield on the Company's stock....      0.0%              0.0%
</TABLE>
 
     The weighted average estimated fair value of options granted during the
years ended December 31, 1996 and 1995 is as follows:
 
<TABLE>
<CAPTION>
                                                              1996              1995
                                                            --------         ----------
        <S>                                                 <C>              <C>
        Total number of options granted...................    68,000            227,700
        Estimated fair value of each option granted.......  $  10.72         $    10.26
        Total estimated fair value of all options
          granted.........................................  $728,960         $2,336,202
</TABLE>
 
     In accordance with Statement 123, the weighted average estimated fair value
of stock options granted is required to be based on a theoretical statistical
model using the preceding Black-Scholes assumptions. In actuality, because
Company stock options do not trade on a secondary exchange, employees can
receive no value nor derive any benefit from holding stock options under these
plans without an increase, above the grant price, in the market price of the
Company's stock. Such an increase in stock price would benefit all stockholders
commensurately.
 
     Presented below is a summary of stock option plans' activity for the years
shown:
 
<TABLE>
<CAPTION>
                                                SHARES
                                                  OF
                                                COMMON
                                                STOCK       WEIGHTED       OPTIONS       WEIGHTED
                                                UNDER       AVERAGE      EXERCISABLE     AVERAGE
                                                 THE        EXERCISE         AT          EXERCISE
                                                 PLAN        PRICE       END OF YEAR      PRICE
                                               --------     --------     -----------     --------
    <S>                                        <C>          <C>          <C>             <C>
    Balance at December 31, 1993.............   424,000
      Granted................................   124,500      $12.06
      Exercised..............................  (224,500)       2.57
      Canceled...............................    (3,900)       3.77
                                               --------                    -------
 
    Balance at December 31, 1994.............   320,100                     87,799        $ 6.53
      Granted................................   227,700       20.11
      Exercised..............................      (957)      12.02
      Canceled...............................    (2,721)      11.37
                                               --------                    -------
 
    Balance at December 31, 1995.............   544,122                    165,422          8.55
      Granted................................    68,000       22.75
      Exercised..............................    (1,890)       8.48
      Canceled...............................   (20,760)      20.13
                                               --------                    -------
 
    Balance at December 31, 1996.............   589,472                    291,312         11.84
                                               ========                    =======
</TABLE>
 
                                       35
<PAGE>   38
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
     The following table summarizes information for options currently
outstanding and exercisable at December 31, 1996:
 
<TABLE>
<CAPTION>
                               OPTIONS OUTSTANDING
                     ----------------------------------------       OPTIONS EXERCISABLE
                                      WEIGHTED                    ------------------------
                                       AVERAGE       WEIGHTED                     WEIGHTED
                                      REMAINING      AVERAGE                      AVERAGE
RANGE OF EXERCISE      NUMBER        CONTRACTUAL     EXERCISE       NUMBER        EXERCISE
     PRICES          OUTSTANDING     LIFE (YRS.)      PRICE       EXERCISABLE      PRICE
-----------------    -----------     -----------     --------     -----------     --------
<S>                  <C>             <C>             <C>          <C>             <C>
$ 1.65 to $ 3.33        72,800           5.04         $ 2.94         63,040        $ 2.87
  7.00 to  11.50       132,600           6.94           9.78         78,380          9.23
 12.61 to  17.00       199,192           7.65          13.15         99,952         13.37
 22.75 to  25.50       184,880           4.77          24.68         49,940         24.18
                       -------                                      -------
  1.65 to  25.50       589,472           6.27          14.75        291,312         11.84
                       =======                                      =======
</TABLE>
 
  Dividends
 
     The Company declared and paid an extraordinary dividend in December 1994 of
$2.00 per share on its Series A Preferred Stock and common stock, excluding the
236,756 shares of common stock held by A-B.
 
  Shareholder Rights Agreement
 
     In September 1995, the Company's Board of Directors adopted a shareholder
rights agreement (the "Rights Agreement"). Pursuant to the Rights Agreement,
holders of common stock have certain rights to purchase common stock that are
exercisable only in certain circumstances (the "Rights"). The Rights trade
together with the common stock until the Distribution Date. The "Distribution
Date" shall occur on the earlier of: (i) ten days following the date that the
Company learns that a person or group of affiliated or associated persons (an
"Acquiring Person") has acquired beneficial ownership of 20% or more of the
outstanding common stock and (ii) such date as may be designated by the
Company's Board following the commencement of, or announcement of an intention
to make, a tender or exchange offer, the consummation of which would result in
the beneficial ownership by a person or group of 20% or more of such outstanding
common stock. Each Right will not be exercisable until the Distribution Date. If
any person becomes an Acquiring Person, the Rights will entitle each holder of a
Right (other than those held by an Acquiring Person (or any affiliate or
associate of any Acquiring Person)) to purchase, for $120 per Right (the
"Purchase Price"), that number of shares of common stock which at the time of
the transaction would have a market value of twice the Purchase Price. The
Rights Agreement provides certain exceptions for beneficial ownership by A-B for
up to 30% of the Company's common stock. The Rights, which are not currently
exercisable, expire on September 22, 2005, but may be redeemed at any time by
the Company for $0.001 per Right.
 
                                       36
<PAGE>   39
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
 8. INCOME TAXES
 
     The components of income tax expense are as follows:
 
<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                 ----------------------------------------
                                                    1996           1995           1994
                                                 ----------     ----------     ----------
        <S>                                      <C>            <C>            <C>
        Current................................  $  580,477     $  762,359     $  673,838
        Deferred...............................   1,193,104      1,027,771        521,768
                                                 ----------     ----------     ----------
                                                 $1,773,581     $1,790,130     $1,195,606
                                                 ==========     ==========     ==========
</TABLE>
 
     The Company's effective income tax rate was 36.5%, 36.0% and 36.0% for the
years ended December 31, 1996, 1995 and 1994, respectively. The rate exceeded
the 34% federal statutory rate due primarily to the effect of state income
taxes.
 
     Deferred income taxes reflect the net tax effects of temporary differences
between the bases of assets and liabilities for financial reporting purposes and
the bases used for income tax return purposes. Significant components of the
Company's deferred tax liabilities and assets are as follows:
 
<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              -------------------------
                                                                 1996           1995
                                                              ----------     ----------
        <S>                                                   <C>            <C>
        Deferred tax liabilities:
          Tax-over-book depreciation........................  $4,166,502     $2,595,392
          Other.............................................     520,957        156,003
                                                              ----------     ----------
                                                               4,687,459      2,751,395
        Deferred tax assets.................................   1,104,767        361,807
                                                              ----------     ----------
        Net deferred tax liability..........................  $3,582,692     $2,389,588
                                                              ==========     ==========
</TABLE>
 
     The Company paid alternative minimum tax in 1996 and 1995, resulting in a
tax credit carryforward of $758,000 at December 31, 1996, which will be utilized
to offset regular tax liabilities in future years. The alternative minimum tax
credit carryforward has no expiration date and is the primary component of the
Company's deferred tax asset presented above.
 
     The Company made income tax payments (net of refunds) of $984,000, $392,000
and $621,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
 
 9. COMMITMENTS AND CONTINGENCIES
 
     The Company leases its Fremont brewery and office premises under operating
leases. Terms of the brewery premises lease include annual rental payment
adjustments to reflect changes in the Consumer Price Index. The initial lease
period runs through October 1997. The Company has an option to extend the lease
for two additional five-year periods and to purchase the building in accordance
with the purchase option at the end of the initial lease term and at the end of
each option period. The office premises lease runs through May 2001, and the
monthly rental rate escalates 8% in February 1999.
 
     In May 1995, the Company entered into an agreement to lease the land on
which the New Hampshire brewery was constructed. The initial lease period runs
through April 2047 and may be extended at the Company's option for two
additional seven-year terms. The sublease also provides the Company with the
first right of refusal to purchase the premises should the sublessor receive an
offer to sell the property to a third party. The monthly rent commenced upon the
completion of the facility, and can escalate up to 5% at the end of every
five-year period.
 
                                       37
<PAGE>   40
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
     Rent expense for the years ended December 31, 1996, 1995 and 1996 totaled
$532,000, $451,000 and $245,000, respectively.
 
     Minimum aggregate future lease payments under noncancelable operating
leases as of December 31, 1996 are as follows:
 
<TABLE>
                <S>                                               <C>
                1997............................................  $   669,960
                1998............................................      453,380
                1999............................................      464,020
                2000............................................      464,987
                2001............................................      379,284
                Thereafter......................................   14,432,341
                                                                  -----------
                                                                  $16,863,972
                                                                  ===========
</TABLE>
 
     The Company also periodically enters into commitments to purchase certain
raw materials in the normal course of business.
 
10. EMPLOYEE BENEFIT PLAN
 
     The Company maintains a 401(k) savings plan for employees age 21 years or
older with at least one year of service. The maximum employee contribution is
15% of the participant's compensation. The Company matches 100% of each dollar
contributed by a participant, with a maximum matching contribution of 4% of a
participant's compensation. The Company's contributions to the plan vest at
varying rates up to five years depending upon the employee's years of service
and totaled $142,147, $86,891 and $57,935 in 1996, 1995 and 1994, respectively.
 
11. FINANCIAL INSTRUMENTS, MAJOR CUSTOMERS AND RELATED-PARTY TRANSACTIONS
 
     Financial instruments that potentially subject the Company to credit risk
consist principally of trade receivables and interest-bearing deposits. The
Company's interest-bearing deposits are placed with major financial
institutions. Wholesale distributors account for substantially all accounts
receivable; therefore, this concentration risk is limited due to the number of
distributors, their geographic dispersion, and state laws regulating the
financial affairs of distributors of alcoholic beverages. The Company's two
largest non-Alliance distributors collectively represented 22%, 32% and 43% of
total sales in 1996, 1995 and 1994, respectively. The sales to A-B through the
Distribution Alliance represented 59% and 28% of total sales, or $23,417,000 and
$7,950,000 (net of an approximate 2% alliance fee), in 1996 and 1995,
respectively. Additional fees incurred by the Company for administrative and
handling charges totaled $146,000 and $92,000 in 1996 and 1995, respectively.
The Company purchased certain raw materials through A-B totaling $1,728,000 in
1996. Net amounts due from A-B were $502,000 and $312,000 as of December 31,
1996 and 1995, respectively.
 
                                       38
<PAGE>   41
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                   NOTES TO FINANCIAL STATEMENTS (CONTINUED)
 
12. INTERIM FINANCIAL DATA (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                  1996 QUARTER ENDED                           1995 QUARTER ENDED
                                       -----------------------------------------    -----------------------------------------
                                       DEC. 31    SEPT. 30    JUNE 30    MAR. 31    DEC. 31    SEPT. 30    JUNE 30    MAR. 31
                                       -------    --------    -------    -------    -------    --------    -------    -------
                                                              (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S>                                    <C>        <C>         <C>        <C>        <C>        <C>         <C>        <C>
Sales................................ $10,159     $10,394    $10,302     $8,555     $8,753      $7,389     $6,677     $5,607
Less Excise Taxes....................     943         963        992        834        788         633        594        517
                                       -------    -------     -------    ------     ------      ------     ------     ------
Net Sales............................   9,216       9,431      9,310      7,721      7,965       6,756      6,083      5,090
Cost of Sales........................   6,683       6,045      5,798      5,055      5,200       4,416      3,878      3,476
                                       -------    -------     -------    ------     ------      ------     ------     ------
Gross Profit.........................   2,533       3,386      3,512      2,666      2,765       2,340      2,205      1,614
Selling, General and
  Administrative Expenses............   2,342       2,117      1,862      1,532      1,452       1,180      1,082        892
                                       -------    -------     -------    ------     ------      ------     ------     ------
Operating Income.....................     191       1,269      1,650      1,134      1,313       1,160      1,123        722
Interest Expense and
  Other Income, Net..................      41         128        189        257        431         198         13         12
                                       -------    -------     -------    ------     ------      ------     ------     ------
Income Before Taxes..................     232       1,397      1,839      1,391      1,744       1,358      1,136        734
Provision for Income Taxes...........      85         510        671        507        627         489        409        265
                                       -------    -------     -------    ------     ------      ------     ------     ------
Net Income...........................  $  147     $   887     $1,168     $  884     $1,117      $  869     $  727     $  469
                                       =======    =======     =======    ======     ======      ======     ======     ======
Net Income per Share.................  $ 0.02     $  0.10     $ 0.13     $ 0.10     $ 0.12      $ 0.12     $ 0.12     $ 0.08
                                       =======    =======     =======    ======     ======      ======     ======     ======
Average Common and Equivalent
  Shares Outstanding.................   9,073       9,142      9,158      9,207      9,257       7,520      6,189      6,189
Barrels Shipped......................    58.1        57.6       59.3       49.7       49.5        40.3       37.1       31.8
</TABLE>
 
                                       39
<PAGE>   42
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
 
     None.
 
                                   PART III.
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
     Information regarding the Company's directors and executive officers is
incorporated by reference from the Company's definitive proxy statement for its
1997 Annual Meeting of Stockholders (the "1997 Proxy Statement") under the
captions "Board of Directors" or "Executive Compensation."
 
ITEM 11. EXECUTIVE COMPENSATION
 
     Information regarding executive compensation is incorporated by reference
from the 1997 Proxy Statement caption "Executive Compensation."
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
     Information regarding security ownership of certain beneficial owners and
management is incorporated by reference from the 1997 Proxy Statement under the
caption "Security Ownership of Certain Beneficial Owners and Management."
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
     Information regarding certain relationships and related transactions is
incorporated by reference from the 1997 Proxy Statement under the caption
"Certain Transactions."
 
                                    PART IV.
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
 
     The following documents are filed as part of this report:
 
<TABLE>
<C>  <S>
  1. Financial Statements and Financial Statement Schedules. See Index to
     Financial Statements at Item 8 on page 23 of this report. All other
     financial statement schedules are omitted because they were not required
     or the required information is included in the Financial Statements or
     Notes thereto.
  2. Exhibit Index is included in the Form 10-K filed with Securities and
     Exchange Commission.
</TABLE>
 
                                       40
<PAGE>   43
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) 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, in the City of
Seattle, State of Washington, on March 13, 1997.
 
                                          REDHOOK ALE BREWERY, INCORPORATED
 
                                          By  /s/ BRADLEY A. BERG
                                            ------------------------------------
                                            Bradley A. Berg
                                            Executive Vice President and
                                            Chief Financial Officer
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                   SIGNATURE                                TITLE                    DATE
-----------------------------------------------  ---------------------------    ---------------
 
<S>                                              <C>                            <C>
/s/ PAUL S. SHIPMAN                              President, Chief Executive     March 13, 1997
-----------------------------------------------  Officer and Chairman of the
Paul S. Shipman                                  Board (Principal Executive
                                                 Officer)
 
/s/ BRADLEY A. BERG                              Executive Vice President       March 13, 1997
-----------------------------------------------  and Chief Financial Officer
Bradley A. Berg                                  (Principal Financial
                                                 Officer)
/s/ DAVID H. KIRSKE                              Controller and Treasurer       March 13, 1997
-----------------------------------------------  (Principal Accounting
David H. Kirske                                  Officer
 
/s/ GORDON A. BOWKER                             Director                       March 13, 1997
-----------------------------------------------
Gordon A. Bowker
 
/s/ JOHN T. CARLETON                             Director                       March 13, 1997
-----------------------------------------------
John T. Carleton
 
/s/ FRANK H. CLEMENT                             Director                       March 13, 1997
-----------------------------------------------
Frank H. Clement
 
/s/ DAVID R. ENGLISH                             Director                       March 13, 1997
-----------------------------------------------
David R. English
 
/s/ JERRY D. JONES                               Director                       March 13, 1997
-----------------------------------------------
Jerry D. Jones
 
/s/ BRUCE M. SANDISON                            Director                       March 13, 1997
-----------------------------------------------
Bruce M. Sandison
 
/s/ WALTER F. WALKER                             Director                       March 13, 1997
-----------------------------------------------
Walter F. Walker
 
/s/ DENNIS P. WESTON                             Director                       March 13, 1997
-----------------------------------------------
Dennis P. Weston
</TABLE>
 
                                       41
<PAGE>   44
 
                       REDHOOK ALE BREWERY, INCORPORATED
 
                              REPORT OF MANAGEMENT
 
To the Stockholders and Directors of
Redhook Ale Brewery, Incorporated:
 
     The accompanying financial statements have been prepared by management in
conformity with generally accepted accounting principles. The fairness and
integrity of these financial statements, including any judgments, estimates and
selection of appropriate generally accepted accounting principles, are the
responsibility of management, as is all other information presented in this
Annual Report.
 
     In the opinion of management, the financial statements are fairly stated,
and, to that end, the Company maintains a system of internal control which:
provides reasonable assurance that transactions are recorded properly for the
preparation of financial statements; safeguards assets against loss or
unauthorized use; maintains accountability for assets; and requires proper
authorization and accounting for all transactions. Management is responsible for
the effectiveness of internal control. This is accomplished through established
accounting and other control systems, policies and procedures, employee
selection and training, appropriate delegation of authority and segregation of
responsibilities.
 
     Our independent auditors provide an objective independent review by their
audit of the Company's financial statements. Their audit is conducted in
accordance with generally accepted auditing standards and includes a review of
internal accounting control to the extent deemed necessary for the purposes of
their audit.
 
     The Audit Committee of the Board of Directors is composed entirely of
Directors who are not employees of the Company. They meet regularly with the
independent auditors and management to review the work of each and to ensure
that each is properly discharging its financial reporting and internal control
responsibilities. To ensure complete independence, the independent auditors have
full and free access to the Audit Committee to discuss the results of their
audits, the adequacy of internal auditing controls and the quality of financial
reporting.
 
March 13, 1997
 
                                               /s/ BRADLEY A. BERG
                                               Bradley A. Berg
                                               Executive Vice President and
                                               Chief Financial Officer
 
                                               /s/ DAVID H. KIRSKE
                                               David H. Kirske
 
                                               Controller and Treasurer
                                               Principal Accounting Officer
 
                                       42
<PAGE>   45
 
                                 EXHIBIT INDEX
 
<TABLE>
<C>    <C>     <S>
    (1)  3.1   Articles of Amendment to and Second Restatement of Articles of Incorporation of
               Registrant dated November 15, 1994; Articles of Amendment, dated November 15,
               1994; and Articles of Amendment, dated June 15, 1995
 
    (1)  3.2   Amended and Restated Bylaws of Registrant, dated April 2, 1991; Amendment to
               the Bylaws of Registrant, dated August 9, 1993; Amendments to Bylaws of
               Registrant, dated October 11, 1994
    (1) 10.1   Securities Purchase Agreement dated as of July 21, 1993, between the Registrant
               and GE Capital Redhook Investment Corp.
    (1) 10.2   Securities Purchase Agreement dated as of July 21, 1993, among Registrant and
               certain investors
    (1) 10.3   Amendment No. 2 dated as of October 18, 1994, to Securities Purchase Agreement
               dated as of July 21, 1993 (see Exhibits 10.1 and 10.2)
    (1) 10.4   Investment Agreement dated as of October 18, 1994, between the Registrant and
               Anheuser-Busch, Incorporated
    (1) 10.5   Registrant Rights Agreement dated as of August 9, 1993, between the Registrant
               and Purchasers (as defined therein)
    (1) 10.6   Amendment No. 1 dated as of October 18, 1994, to Registration Rights Agreement
               dated as of August 9, 1993
    (1) 10.7   Registration Rights Agreement dated as of October 18, 1994, between Registrant
               and Anheuser-Busch, Incorporated
    (1) 10.8   Employment Agreement between Registrant and Paul Shipman, dated October 18,
               1994
    (1) 10.9   Multi-tenant lease between the Quadrant Corporation and Registrant, dated June
               1, 1987, as amended, November 5, 1987, February 1, 1988, March 29, 1988, June
               27, 1988, October 27, 1988, June 18, 1991, October 1, 1991, December 22, 1992
               and March 31, 1993
    (1) 10.10  Lease Agreement between Lake Union Center Phase One Limited Partnership and
               Registrant, dated December 15, 1994
    (1) 10.11  Sublease between Pease Development Authority as Sublessor and Registrant as
               Sublessee, dated May 30, 1995
    (1) 10.12  Agreement between Owner (Registrant) and Construction Manager (Seattle
               Construction Services, Inc.) for Phase 1 of the New Brewery; Woodville,
               Washington, dated May 1, 1993
    (1) 10.13  Agreement Between Owner (Registrant) and Construction Manager (Seattle
               Construction Services, Inc.) for Redhook's New Hampshire Brewery Facility,
               dated September 14, 1994
    (1) 10.14  Amended and Restated Registrant's Directors Stock Option Plan
    (1) 10.15  Registrant's Incentive Stock Option Plan, dated September 12, 1990
    (1) 10.16  1992 Stock Incentive Plan, approved October 20, 1992, as amended, October 11,
               1994 and May 25, 1995
    (1) 10.17  New York Life Insurance Policy No. 44 939 338 for Paul Shipman, dated July 1,
               1993
    (1) 10.18  Amended and Restated Credit Agreement between U.S. Bank of Washington, National
               Association and Registrant, dated June 5, 1995
    (1) 10.19  Loan Agreement between the City of Seattle Industrial Development Corporation
               and Registrant, dated November 1, 1991
    (1) 10.20  Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture
               Filing, dated November 1, 1991, as amended, June 5, 1995
</TABLE>
<PAGE>   46
 
<TABLE>
<C>    <C>     <S>
 (1)(5) 10.21  Master Distributor Agreement between Registrant and Anheuser-Busch,
               Incorporated, dated October 18, 1994
    (1) 10.22  Amendment No. 3 dated as of July 27, 1995, to Securities Purchase Agreement
               dated as of July 21, 1993 (see Exhibits 10.1 and 10.2)
    (1) 10.23  Amendment dated as of July 25, 1995, between the Registrant and GE Capital
               Redhook Investment Corp.
    (1) 10.24  Assignment of Sublease and Assumption Agreement dated as of July 1, 1995,
               between Registrant and Redhook of New Hampshire, Inc. (see Exhibit 10.11)
    (1) 10.25  Letter Agreement dated as of July 31, 1995, between Registrant and
               Anheuser-Busch, Incorporated
    (2) 10.26  Employment Agreement between Registrant and Bradley A. Berg, dated January 8,
               1996
    (2) 10.27  Employment Agreement between Registrant and David J. Mickelson, dated January
               8, 1996
    (2) 10.28  Employment Agreement between Registrant and Allen L. Triplett, dated January 8,
               1996
    (2) 10.29  Employment Agreement between Registrant and Pamela J. Hinckley, dated January
               8, 1996
    (3) 10.30  Amendment No. 1 dated as of June 26, 1996, to Master Distribution Agreement
               between Registrant and Anheuser-Busch, Incorporated, dated October 18, 1994
    (3) 10.31  Amendment dated as of February 27, 1996, to Registrant's 1992 Stock Incentive
               Plan, as amended
    (3) 10.32  Amendment dated as of February 27, 1996 to Amended and Restated Registrant's
               Directors Stock Option Plan
    (3) 10.33  Amendment dated as of July 25, 1996, to Registrant's 1992 Stock Incentive Plan,
               as amended
    (4) 10.34  First Amendment dated as of July 25, 1996, to Amended and Restated Credit
               Agreement between U.S. Bank of Washington, National Association and Registrant,
               dated June 5, 1995
        11.1   Computation of Earnings Per Share
    (1) 21.1   Subsidiaries of the Registrant
        23.1   Consent of Independent Auditors
        27     Financial Data Schedule
</TABLE>
 
---------------
 
(1) Incorporated by reference to same exhibit number as in the Company's
    Registration Statement on Form S-1, Registration No. 33-94166.
 
(2) Incorporated by reference to same exhibit number as in the Company's Form
    10-K for the year ended December 31, 1995.
 
(3) Incorporated by reference to same exhibit number as in the Company's Form
    10-Q for the quarter ended June 30, 1996.
 
(4) Incorporated by reference to same exhibit number as in the Company's Form
    10-Q for the quarter ended September 30, 1996.
 
(5) Confidential treatment has been granted for portions of this document.