<PAGE>   1
 
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                                 UNITED STATES
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
   
                                 FORM 10-KSB/A
    
   
                               (AMENDMENT NO. 1)
    
 
[X]           ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
                      FOR THE YEAR ENDED DECEMBER 31, 1997
 
                       COMMISSION FILE NUMBER: 000-27800
 
                             FREDERICK BREWING CO.
       (EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                                      <C>
                        MARYLAND                                                52-1769647
     (STATE OR OTHER JURISDICTION OF INCORPORATION                           (I.R.S. EMPLOYER
                    OR ORGANIZATION)                                       IDENTIFICATION NO.)
                4607 WEDGEWOOD BOULEVARD
                  FREDERICK, MARYLAND                                             21703
        (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                                (ZIP CODE)
</TABLE>
 
                                 (301) 694-7899
                (ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
              103 SOUTH CARROLL STREET, FREDERICK, MARYLAND, 21701
                        (FORMER NAME, FORMER ADDRESS AND
               FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)
 
     Indicate by check mark whether the issuer (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.  [X] Yes  [ ] No
 
     Check if there is no disclosure of delinquent filers in response to Item
405 of the Regulation S-B is not contained in this Form, and no disclosure will
be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.  [ ]
 
     Issuer's revenues for the recent fiscal year: $3,286,776
 
     The aggregate market value of voting shares held by non-affiliates as of
March 27, 1997: $6,361,127
 
<TABLE>
<S>                                                      <C>
            COMMON STOCK, $0.00004 PAR VALUE                                    4,540,356
                 (TITLE OF EACH CLASS)                                (NUMBER OF SHARES OUTSTANDING
                                                                         AS OF DECEMBER 31, 1997)
</TABLE>
 
Transitional Small Business Disclosure Format (Check one):
 
Yes [ ]     No [X]
 
   
Explanation Note: This amended filing is being submitted due to modifications to
the Selected Financial Data table of Item 6, the table indicating the Security
Ownership of Certain Beneficial Owners and Management of Item 11, the Balance
Sheets, the Statements of Changes in Stockholders' Equity and the Statements of
Cash Flows of the Financial Statements of Frederick Brewing Co. and Note 8
thereto, the Signature page and Exhibit 23.
    
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<PAGE>   2
 
                             FREDERICK BREWING CO.
                         ------------------------------
   
                             INDEX TO FORM 10-KSB/A
    
                         ------------------------------
 
   
<TABLE>
<S>         <C>                                                           <C>
                                PART II.
Item 6.     Management's Discussion and Analysis of Financial Condition
            and Results of Operations...................................    1
Item 7.     Financial Statements........................................    6
 
                               PART III.
Item 11.    Security Ownership of Certain Beneficial Owners and
            Management..................................................    7
Item 13.    Exhibits, List and Reports on Form 8-K......................    7
 
                               SIGNATURES
</TABLE>
    
<PAGE>   3
 
                                    PART II.
 
   
                                    * * * *
    
 
ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS
 
   
     The following selected financial data and Management's Discussion and
Analysis of Financial Conditions and Results of Operations should be read in
conjunction with the Company's 1997 financial statements and the notes thereto,
included elsewhere in this Form 10-KSB/A. (See Item 7).
    
 
                            SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                                                       FOR THE YEAR ENDED DECEMBER 31,
                                           -------------------------------------------------------
                                             1997        1996        1995        1994       1993
                                           ---------   ---------   ---------   ---------   -------
                                               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S>                                        <C>         <C>         <C>         <C>         <C>
Sales....................................  $   3,287   $   1,872   $   1,832   $   1,186   $   106
Less excise taxes, returns, allowances...        209         152          87          59         4
                                           ---------   ---------   ---------   ---------   -------
     Net sales...........................      3,078       1,720       1,745       1,127       102
Cost of sales............................      2,838       1,743       1,253         847        89
                                           ---------   ---------   ---------   ---------   -------
Gross Profit.............................        240         (23)        492         280        13
Selling, general, and administrative
  expenses...............................      4,622       1,990         831         485       259
Loss on assets to be disposed............          0         641           0           0         0
                                           ---------   ---------   ---------   ---------   -------
Loss from operations.....................     (4,382)     (2,654)       (339)       (205)     (246)
Interest (income) expense, net...........        140         (29)         79          52        11
Other (income) expense...................       (159)         --         (42)         (5)        1
                                           ---------   ---------   ---------   ---------   -------
Loss before income taxes.................     (4,363)     (2,625)       (376)       (252)     (258)
(Benefit) provision for income taxes.....         --          --         (17)         17        --
                                           ---------   ---------   ---------   ---------   -------
Basic net loss...........................     (4,363)     (2,625)       (359)       (269)     (258)
Preferred stock deemed dividend
  requirements...........................     (3,612)         --          --          --        --
                                           ---------   ---------   ---------   ---------   -------
Net loss attributable to common
  shareholders...........................  $  (7,975)  $  (2,625)  $    (359)  $    (269)  $  (258)
                                           =========   =========   =========   =========   =======
Net loss per common share................      (1.59)      (1.45)      (0.30)      (0.24)    (0.29)
                                               =====       =====       =====       =====     =====
Weighted average common shares...........  2,741,583   1,804,503   1,204,719   1,122,437   886,908
                                           =========   =========   =========   =========   =======
</TABLE>
 
                OVERVIEW OF SIGNIFICANT ACTIVITIES AND EXPENSES
 
     The Company was incorporated in Maryland on March 4, 1992, began selling
draft beer brewed under contract in April of 1993 and began selling bottled and
draft beer produced at its original brewery in downtown Frederick, Maryland in
November of 1993. More than 95% of the Company's sales are derived from the sale
of beer it produces under its own brands to independent wholesale distributors.
The Company also produces and sells small amounts of beer (approximately 400
barrels in 1997) under contract for the owners of other brands, who then sell
the beer through their own distributor network. The Company also derives small
amounts of revenue from the retail sale of apparel, glassware and other
promotional items bearing the Company's designs and trademarks to the public and
sales of such items at, or below, cost to its wholesale distributors. Sales
volumes for the Company's beers are affected by numerous factors, including
changing levels of consumer demand in current markets, new product introductions
by the Company and by competitors, geographic expansion of the Company's market
territory, the relative effort exerted on behalf of the Company's brands by its
third-party wholesale distributors and competitive factors such as changes in
the number of other domestic specialty beers available in the Company's markets
as well as the promotional efforts, spending and pricing of brewers, marketers
and importers of competitive products. Seasonality also appears to affect
consumer demand for the Company's products, with higher demand during the second
and
 
                                        1
<PAGE>   4
 
fourth quarters and lower demand in the first and third quarters. From 1993
through May of 1997, when the new brewery became fully operational, the
Company's sales were periodically depressed by its lack of brewing capacity.
Between November, 1993 and December of 1995, the Company expanded its original
brewery in three phases to increase annual capacity from approximately 2,500
barrels to 12,000 barrels. The new brewery was opened with an annual capacity of
approximately 40,000 barrels. In August and September of 1997, additional
fermentation tanks were installed to increase capacity to approximately 80,000
barrels per year. Since June of 1997 the Company has been fully able to meet
demand for its products. The new brewery is designed to allow rapid expansion,
by the addition of fermentation tanks, to an annual capacity of approximately
160,000.
 
     The Company had a large negative operating margin in 1997. Management
believes the Company's operating margin will improve in the future for several
reasons, including: (1) gross profit should improve as previously underutilized
brewing capacity is put to productive use, reducing per barrel fixed costs (such
as depreciation, plant maintenance, production management compensation and
general utilities), particularly after the first quarter of 1998 when the
production and sale of the Wild Goose and Brimstone brands begins; (2)
extraordinary administrative costs (including brokerage and finders fees;
investor relations expenses; legal, accounting and filing fees) associated with
raising necessary equity capital to complete and expand the new brewery, finance
the acquisition of Wild Goose Brewery, Inc. and to provide working capital
should be reduced or eliminated; and (3) the reduction of expenditures on
relatively costly mass-market advertising in favor of less costly trade
advertising, on-premise promotion and point of sale merchandising. These factors
could, however, be off-set, in whole or in part, by other developments, such as:
(1) competitive reductions in selling prices; (2) declining consumer demand for
some or all of the Company's brands; (3) increased salary and amortization
expenses for the goodwill acquired in connection with the Wild Goose and
Brimstone brands; (4) increases in the costs of packaging materials and raw
ingredients; and (5) changes in the Company's sales mix.
 
     The Company sells its beers packaged in both bottles and kegs. Bottled beer
sales produce higher per barrel revenues and contribution margins (revenues net
of direct labor, materials and ingredients costs) than do keg sales but keg
sales produce higher gross margin percentages. In 1996 and 1997 keg sales made
up approximately 18% and 14% of beer sales revenues, respectively. Management
believes the percentage of volume shipped in kegs may increase during 1998
because both the Wild Goose Brewery, Inc. and Brimstone Brewing Company, Inc.
historically sold a larger percentage of their beer in kegs than did the Company
before acquiring those brands.
 
     In 1997, the Company privately placed five series of convertible preferred
stock, raising a total of $9,103,000, net of finder's fees and other offering
expenses, which were approximately $1,406,000 in the aggregate. In order to
provide liquidity to these private investors and all Company shareholders, the
Company retained Corporate Relations Group, Inc., Orlando, Florida ("CRG"), as
its investor relations advisor pursuant to a pre-paid five-year contract at a
total fee of $650,000. The Company also issued CRG warrants to purchase 500,000
shares of Common Stock. These warrants had an estimated aggregate fair value of
$670,000 on the date of grant. These amounts are being amortized over the five
year term of the contract. In addition, the Company paid CRG and its affiliates
$1,304,560 over the course of the year for producing and distributing printed
materials to investment professionals, stockbrokers, investment advisors and
individual investors which were expensed as incurred. Management expects that
expenditures for investor relations services will be greatly reduced in future
periods.
 
     As of March 24, 1998, the Company had approximately 9,000,000 shares of
Common Stock outstanding or reserved for later issuance, an increase of
7,045,124 over the 1,954,876 shares outstanding as of December 31, 1996. The
Company has issued virtually all of the 9,000,000 shares of Common Stock it is
currently authorized to issue. The increase in shares of Common Stock
outstanding or reserved is the result of 2754 shares issued upon the conversion
of Series A Preferred Stock, 2,474,286 shares issued upon the conversion of
Series B Preferred Stock and 2,671,089 shares issued upon the conversion of
Series C and D Preferred Stock, and 1,180,000 shares reserved for issuance to
the former shareholders of Wild Goose Brewery Inc. and Brimstone Brewing
Company, Inc. in consideration of the acquisition of their equity securities and
brands, respectively. In addition, there are approximately 829 shares of Series
C and 218 shares of Series D
                                        2
<PAGE>   5
 
Convertible Preferred Stock outstanding. The holders of 657 shares have given
notice of their intent to convert these preferred shares into approximately
1,138,412 common shares as soon as the Company is legally authorized to issue
more common shares. Also outstanding are 1828 shares of Series A Convertible
Preferred Stock which are immediately convertible into 245,461 shares of common
stock and 3000 shares of Series E Convertible Preferred Stock ("Series E"). The
Series E shares are convertible into Common Stock at a 25% discount to the
average closing bid price as of the date of conversion. The Series E shares can
be redeemed by the Company at a 33% premium to purchase price and management is
seeking the financing necessary to carry out the redemptions but no assurance
can be given that the redemptions will be carried out. If not redeemed, the
Series E shares will likely be converted in the near term, causing substantial
additional dilution of current shareholder interests.
 
     The Company is not in compliance with one of the covenants contained in its
loan agreements with its senior debt holders. This covenant requires that the
ratio of the Company's quarterly cash flows over the four most recent quarters
to 12 months' debt service payments exceed 1.5:1. See Note 6 to financial
statements.
 
SALES
 
     Sales are affected by market distribution, seasonal product introductions,
advertising and promotional campaigns and competition. For 1997 and 1996 gross
sales were $3,286,776 and $1,871,593 respectively, an increase of $1,415,183, or
75.6%. Production volumes in 1997 and 1996 were 17,300 barrels and 10,910
barrels, respectively, an increase of 6,390 barrels, or 58.6%. The increases in
production and sales were due to several factors, including: the completion of
the new brewery in the second quarter which removed capacity constraints that
had effectively put a cap on sales; the successful introduction of Hempen Ale in
May, 1997 and Hempen Gold in September, 1997; and the opening of new markets in
the Company's distribution territory, primarily for the Hempen product line.
Revenues per barrel for the year of 1997 and 1996 were $190 and $172 per barrel,
respectively, an increase of $18 per barrel, or 10.5% This increase in revenue
per barrel reflects the sales during 1996 of distressed product at a lower
overall selling price, the introduction of the Hempen Ale and Hempen Gold brands
at higher pricing during 1997 and an increase in case sales from 82% of beer
revenues in 1996 to 86% in 1997.
 
EXCISE TAXES
 
     Federal and state excise taxes were $169,236 and $100,697 during 1997 and
1996, respectively, representing 5.5% and 5.9% of net sales, respectively. The
decrease in excise taxes in 1997, as a percentage of net sales, is due primarily
to the increase in the Company's gross revenue per barrel. The Federal
government and all state governments impose excise taxes on all beer sold. These
taxes are levied on volume, regardless of the price or revenue generated from
those sales. Each state in which the Company distributes its product has
different excise tax rates and regulations. Some states require the distributor
to pay such taxes instead of the producer. In states where the producer pays the
excise tax, the Company attempts to mark up the sales prices to its distributors
to at least partially cover the tax, while maintaining competitive pricing at
the retail level.
 
RETURNS AND ALLOWANCES
 
     Returns and allowances of $39,859 and $50,463 for 1997 and 1996 represents
1.3% and 2.7% of net sales respectively. This year to year decrease reflects the
sales during 1996 of distressed products.
 
COST OF GOODS SOLD
 
     Cost of goods sold for 1997 and 1996 was $2,837,229 and $1,743,896
respectively, an increase of $1,093,332 or 62.6%. As a percentage of gross
sales, the cost of goods sold declined from 93.2% to 86.3%. The Company's cost
of goods sold in 1997 included the following increases in production overhead
expenses over 1996: (1) an increase in depreciation of $251,764, reflecting that
the new brewery was put into service in March of 1997; (2) an increase in
production management, quality assurance, transportation and plant maintenance
compensation expenses of $90,645, reflecting the additional personnel, effort
and expertise
 
                                        3
<PAGE>   6
 
necessary to operate and maintain the much larger and more complex new brewery
and an increase in utilities expense of $212,714, reflecting the additional cost
of heating, cooling and lighting of the larger facility.
 
     In addition, production costs were inflated during the first six months of
1997 due, in part, to approximately $42,088 in temporary labor expenses and
overtime pay made necessary by the fact that several critical components of the
Company's automated bottling line initially did not function as expected and
were not made fully operational until August of 1997. During the last two
quarters of the year, direct labor, material and ingredient costs fell to $96
per barrel and 48.6% of gross sales from $99 per barrel and 56.3% of gross sales
during the first two quarters of 1997.
 
     For the full year 1997, however, direct labor, materials and ingredients
costs fell from $124 per barrel and 72.4% of gross sales in 1996 to $97 per
barrel and 51.2% of gross sales in 1997. This was the result of cost savings
resulting from the new brewery's capability of handling bulk-packed and
bulk-delivered malted grains, glass bottles, six packs and case cartons, as well
as the labor efficiencies provided with larger batch sizes in brewing and
fermentation and high speed bottling equipment, relative to the old brewery's
much more labor intensive equipment. Management anticipates that the cost of
goods sold per barrel and as a percentage of gross sales will diminish further
in 1998 compared to 1997 because the labor efficiencies realized during the
second half of 1997 should be reflected for the entire year and the higher
levels of production expected due to the Wild Goose and Brimstone brand
acquisitions should substantially reduce per unit production overhead costs.
 
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES
 
     Selling, general, and administrative ("S,G&A") expenses were $4,622,029 and
$1,990,323 in 1997 and 1996, respectively. S,G&A expense increases from 1996 to
1997 resulted primarily from the following: $1,304,560 in investor relations
fees; an increase of $370,048 in compensation and other expenses for the
Company's sales force, which grew from 9 members to 14 members during 1997; an
increase of $366,346 in expenditures for advertising and promotions; an increase
of $164,769 in legal and accounting fees, largely in connection with negotiating
a forebearance agreement with the Company's senior lender during the first
quarter and litigating the Company's claim against a packaging machinery vendor,
an increase of $48,997 in additional salaries and expenses to new personnel in
the marketing, finance and accounting areas. Management believes that it can
significantly reduce its reliance and spending on outside legal, accounting,
advertising, financial and investor relations professionals in future periods
without substantially increasing the Company's employee base above current
levels. No increase in the sales force is currently planned, even with the
substantial increase in the Company's historic sales base due to the Wild Goose
and Brimstone brand acquisitions because management believes the current sales
force is adequate to cover the brands' common sales territories.
 
OTHER INCOME
 
     During 1997, the Company recorded a gain of $158,167 on the sale of
equipment which had previously been used at the old brewery. The equipment had
been written down in 1996 to reflect management's initial estimate of its fair
market value. The gain represents the amount by which the actual sale proceeds
exceeded that estimate.
 
INTEREST (INCOME) EXPENSE, NET
 
     Interest (income) expense, net during 1997 was $140,030 compared to
$(29,427) in 1996. The Company had net interest income in 1996 because it paid
off nearly all of its prior debt with the proceeds of its initial public
offering in March of 1996 and had interest income from the short-term investment
of some of the balance of those proceeds. The net interest expense primarily
reflects interest paid on increasing long term collaterated loan balances from
January through June of 1997 as the long term collaterated loan proceeds were
disbursed on a schedule tied to the completion of the new brewery building and
equipment installation and commissioning.
 
                                        4
<PAGE>   7
 
INCOME TAX PROVISION
 
     The Company has incurred net operating losses for years ending from 1996
through 1997 and, accordingly, no provisions for income taxes have been provided
in the Statements of Operations.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     Due to losses experienced during the start-up and expansion of the Company,
operations to date have been funded primarily from private and public placements
of common and preferred stock, and loans from stockholders and financial
institutions. As of December 31, 1997 the Company had working capital of
approximately $2,373,000. This balance was principally the result of the receipt
in December of 1997 of $2,400,000 in net cash proceeds from the private
placement of 3,000 shares of Series E Preferred stock at $1,000 per share and
$190,000 cash received in settlement of the Company's lawsuit against a vendor
of automated packaging equipment. Net cash used in operating activities was
approximately $4,900,000 in 1997.
 
     Net cash used in investing activities during 1997 was approximately
$2,498,000, which primarily represented payments to the general contractor for
construction of the new brewery building and payments made to vendors for the
fabrication and installation of new brewery equipment and other purchases of
capital assets. In addition, various expenses incurred for trademarks and
copyrights were capitalized as intangible assets. The Company generated proceeds
of approximately $300,000 from the sale of certain brewing equipment that had
been housed in the old facility.
 
     Net cash provided by financing activities during 1997 was approximately $10
million, consisting primarily of private placement proceeds of $10.5 million and
$1.6 million in proceeds from debt incurred to finance the equipment, building
and other capital improvements for the new facility (see Note 6 of the financial
statements), offset by repayments on short-term and long-term debt of $2.1
million. As of April 24, 1997, the Company's senior secured lender has advanced
the Company $969,000 under a bridge loan facility that was retired on that date
with the proceeds of a $1,000,000 Small Business Administration direct loan made
through and administered by Mid-Atlantic Business Finance Company of Baltimore,
Maryland. That loan is secured by a second position security interest in the
Company's brewing and packaging equipment and the personal guarantees of the
Company's President and Chief Executive Officer.
 
     The Company does not currently have a working capital line of credit or any
other revolving credit facility. Management does not anticipate obtaining this
or any other additional credit facility unless and until the Company's operating
cash flows improve substantially.
 
     The Company and its senior secured creditor have negotiated a modification
of the terms of the long term loan collateralized by most of the Company's
brewing and packaging equipment and current assets, as well as the commercial
mortgage on the land and building comprising the new brewery, which is owned by
Blue II, LLC and occupied by the Company under a capital lease. See Note 6 to
financial statements.
 
     The Company is currently negotiating with two alternate lenders with a view
toward refinancing all of the senior secured debt during the second quarter of
1998. Management believes this can be accomplished with an increase in the
interest rate payable and additional personal guarantees of the Company's Chief
Executive Officer and President, as well as other terms and conditions
acceptable to the Company's board of directors. No assurances can be given as to
the likelihood of such refinancing.
 
     The Company had cash balances of approximately $2,625,000 at December 31,
1997. In addition, at December 31, 1997, approximately $12,475 of cash
equivalents (short-term securities with original maturities of less than 90
days), were pledged as collateral to guarantee the Company's letter of credit in
favor of Frederick County to secure the company's performance of certain site
improvement work required by the County government as a condition of the
Company's building permits and was recorded as restricted cash.
 
     In connection with the acquisition and merger with Wild Goose Brewery, Inc.
the Company agreed to pay off Wild Goose's secured debt and revolving credit
line in full and to assume all of its payment obligations under its trade
accounts payable. Management currently estimates that approximately $1,100,000
in cash will be required to discharge these payment obligations during the first
and second quarters of 1998. The cash outlay will be partially off-set as the
Company collects Wild Goose's trade accounts receivable, which management
estimates will result in cash collections of approximately $246,000 during the
first two quarters of
 
                                        5
<PAGE>   8
 
1998 and by the net proceeds of the scheduled auction sale of most of Wild
Goose's brewing and packaging equipment, which management believes will result
in approximately $225,000 in cash collections during the second quarter of 1998.
 
     Management believes that this level of liquidity will be sufficient to fund
the Company's operations and until such time as the Company can generate
positive cash flows from operations, assuming that revenues increase and costs
are controlled as management intends. No assurance can be given that positive
cash flows will occur at such time.
 
IMPACT OF INFLATION
 
     Although the Company has not attempted to calculate the effect of
inflation, management does not believe inflation has had a material effect on
its results of operations. Material increases in costs and expenses,
particularly packaging, raw material and labor costs, in the future, could have
a significant impact on the Company's operating results to the extent that the
effect of such increases cannot be transferred to its customers.
 
IMPACT OF YEAR 2000 ISSUE
 
     The Company is in the process of assessing its computer applications to
insure their functionality with respect to the "Year 2000" millennium change. At
present, the Company does not anticipate that material incremental costs will be
incurred in any single future year.
 
NEW ACCOUNTING PRONOUNCEMENTS
 
     In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 130 "Comprehensive Income." SFAS No.
130 requires the reporting and display of comprehensive income and its
components in the financial statements. Comprehensive income is the change in
equity during the period from transactions with non-owner sources. Comprehensive
income includes net income and other comprehensive income including foreign
currency translation adjustments and gains and losses on certain marketable
securities. SFAS No. 130 does not require a specific format for the financial
statement in which comprehensive income is reported, but does require that an
amount representing total comprehensive income be reported in the statement. The
Company will implement SFAS No. 130 during the first quarter of 1998.
 
     In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 will change the way public companies report information about segments of
their business in annual financial statements and requires them to report
selected segment information in their quarterly reports issued to stockholders.
It also requires entity-wide disclosures about the products and services an
entity provides, the countries in which the entity holds material assets and
reports material revenues, and major customers. The Company will implement SFAS
No. 131 during the fourth quarter of 1998.
 
FORWARD-LOOKING INFORMATION
 
     The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for certain forward-looking statements made by the Company in its
disclosures to the public. There is certain information contained herein, in the
Company's press releases and in oral statements made by authorized officers of
the Company which are forward-looking statements, as defined by such Act. When
used herein, in the Company's press releases and in such oral statements, the
words "estimate," "project," "anticipate," "expect," "intend," "believe,"
"plans," and similar expressions are intended to identify forward-looking
statements. See Exhibit 99 for a discussion of the risks and uncertainties which
could cause actual results to differ materially from the forward-looking
information.
 
ITEM 7.  FINANCIAL STATEMENTS
 
     See page F-1 for Index to Financial Statements
                                        6
<PAGE>   9
 
                                   PART III.
 
   
ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
    
 
     The following table sets forth certain information regarding beneficial
ownership of the Company's Common Stock as of March 27, 1998, by: (i) each
person known by the Company to be the beneficial owner of more than 5.0% of the
Company's Common Stock, (ii) each of the Company's directors, (iii) each of the
Company's Executive Officers named in the Summary Compensation Table (See Item
10 hereof), and (iv) all executive officers and directors as a group. Except as
otherwise noted, the named beneficial owner has sole voting and investment
power.
 
   
<TABLE>
<CAPTION>
                                                              SHARES BENEFICIALLY OWNED
                                                               AS OF MARCH 27, 1998(1)
                 DIRECTORS, NAMED EXECUTIVE                   --------------------------
                OFFICERS AND 5% STOCKHOLDERS                    NUMBER         PERCENT
                ----------------------------                    ------         -------
<S>                                                           <C>             <C>
Kevin E. Brannon(2).........................................   147,131            1.99
Marjorie A. McGinnis(2).....................................   147,131            1.99
Nicholas P. Foris, M.D.(3)..................................   118,194            1.59
Carl R. Hildebrand(4).......................................     5,000             .07
Jerome M. Pool(5)...........................................    24,344             .33
Maribeth Visco(6)...........................................    28,680             .39
James W. Lutz(7)............................................    99,450            1.34
Steven T. Nordahl(8)(10)....................................    56,073             .75
Leslie P. Harper(9)(10).....................................     3,334             .04
Patrick N. Helsel(10).......................................       522             .01
Cameron E. Barry............................................         0               0
All directors and executive(10) officers as a group (11
  persons)..................................................   629,859            8.50
</TABLE>
    
 
---------------
 (1) Based upon information furnished by respective individuals. The information
     is not necessarily indicative of beneficial ownership for any other
     purpose. Under regulations promulgated pursuant to the Exchange Act, shares
     are deemed to be beneficially owned by a person if he or she directly or
     indirectly has or shares; (i) voting power, which includes the power to
     vote or to direct voting of the shares, or (ii) investment power, which
     includes the power to dispose or to direct the disposition of the shares.
 
 (2) The number of shares shown in the table excludes the number of shares
     beneficially owned by the other. The business address for such persons is
     4607 Wedgewood Boulevard, Frederick, Maryland 21703.
 
 (3) Includes immediately exercisable options to purchase 6,000 shares of Common
     Stock. Does not include 210 shares of Series A Convertible Preferred Stock,
     which are immediately convertible into common stock at the price of $3.8388
     per share.
 
 (4) Includes immediately exercisable options to purchase 5,000 shares of Common
     Stock.
 
 (5) Includes immediately exercisable options to purchase 7,000 shares of Common
     Stock.
 
 (6) With respect to Ms. Visco's shares, see Item 12, and Certain Relationships
     and Related Transactions, below, includes immediately exercisable options
     to purchase 7,000 shares of Common Stock.
 
   
 (7) Reflects shares reserved for issuance upon completion of the reconciliation
     of the shares of Common Stock to be distributed to the former shareholders
     of Wild Goose Brewery, Inc.
    
 
   
 (8) Includes immediately exercisable options to purchase 16,779 shares of
     Common Stock.
    
 
   
 (9) Includes immediately exercisable options to purchase 3,334 shares of Common
     Stock.
    
 
   
(10) Under the Exchange Act, a person is deemed to have beneficial ownership of
     any shares of Common Stock which may be acquired within 60 days of March
     27, 1998 pursuant to the exercise of outstanding stock options. Shares of
     Common Stock which are subject to stock options are deemed to be
     outstanding for the purpose of computing the percentage of outstanding
     Common Stock owned by such person or group but not deemed outstanding for
     the purpose of computing the percentage of Common Stock owed by any other
     person or group. The amounts set forth in the table include 16,779 shares
     which may be received upon the exercise of stock options by Mr. Nordahl,
     522 shares which may be received upon the exercise of options by Mr.
     Helsel, 3,334 shares which may be received upon exercise of options by Mr.
     Harper and 25,000 shares which may be received upon the exercise of stock
     options by the non-employee directors. For all the directors and executive
     officers as a group, the number of shares includes 45,665 shares of Common
     Stock subject to outstanding stock options.
    
 
                                        7
<PAGE>   10
 
   
ITEM 13.  EXHIBITS, LIST AND REPORTS ON FORM 8-K
    
 
   
     (3)(a) The following exhibits are filed as part of the Form 10-KSB/A, and
this list includes the Exhibit Index.
    
 
   
<TABLE>
<CAPTION>
NO.                           DESCRIPTION
---                           -----------
<C>   <S>
23    Consent of Independent Accountants
</TABLE>
    
 
                                        8
<PAGE>   11
 
                         INDEX TO FINANCIAL STATEMENTS
 
<TABLE>
<S>                                                           <C>
Report of Independent Accountants...........................  F-2
Financial Statements:
     Balance Sheets.........................................  F-3
     Statements of Operations...............................  F-4
     Statements of Changes in Stockholders' Equity..........  F-5
     Statements of Cash Flows...............................  F-6
     Notes to Financial Statements..........................  F-7
</TABLE>
 
                                       F-1
<PAGE>   12
 
   
                       REPORT OF INDEPENDENT ACCOUNTANTS
    
 
Board of Directors
Frederick Brewing Co.
Frederick, Maryland
 
     We have audited the accompanying balance sheets of Frederick Brewing Co. as
of December 31, 1997 and 1996, and the related statements of operations, changes
in stockholders' equity and cash flows for the years then ended. 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 Frederick Brewing Co. as of
December 31, 1997 and 1996, and the results of its operations and its cash flows
for the years then ended, in conformity with generally accepted accounting
principles.
 
                                          Coopers & Lybrand L.L.P.
 
McLean, Virginia
March 30, 1998
 
                                       F-2
<PAGE>   13
 
                             FREDERICK BREWING CO.
 
                                 BALANCE SHEETS
 
                           DECEMBER 31, 1997 AND 1996
 
   
<TABLE>
<CAPTION>
                                                                  1997          1996
                                                              ------------   -----------
<S>                                                           <C>            <C>
                           ASSETS
Current assets:
     Cash and cash equivalents..............................  $  2,612,880   $    48,990
     Cash -- restricted.....................................        12,475       640,000
     Trade receivables, net of allowance for doubtful
      accounts of $35,544 and $25,000, respectively.........       333,437       239,413
     Inventories, net.......................................       354,224       210,563
     Prepaid expenses and other current assets..............       103,476        82,412
                                                              ------------   -----------
          Total current assets..............................     3,416,492     1,221,378
Property and equipment, net.................................     8,375,645     3,287,696
Intangibles, net............................................       258,225       186,251
Deferred public relations costs, net........................     1,131,500            --
Other assets................................................       219,557        71,000
                                                              ------------   -----------
          Total assets......................................  $ 13,401,419   $ 4,766,325
                                                              ============   ===========
            LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
     Current maturities of long-term debt...................  $    272,814   $   437,690
     Capital lease obligations, current portion.............        88,976        27,506
     Accounts payable.......................................       274,966       629,216
     Accrued liabilities....................................       406,943       165,538
                                                              ------------   -----------
          Total current liabilities.........................     1,043,699     1,259,950
Long-term debt..............................................     2,208,736     1,631,411
Capital lease obligations...................................     2,880,536        51,577
                                                              ------------   -----------
          Total liabilities.................................     6,132,971     2,942,938
                                                              ------------   -----------
Stockholders' equity:
     Preferred stock -- $.01 par value, 1,000,000 shares
      authorized:
       Cumulative, convertible Series A, 1,828 shares issued
        and outstanding, liquidation preference of
        $914,000............................................       655,213            --
       Convertible Series B, 0 shares issued and
        outstanding.........................................            --            --
       Convertible Series C, 2,100 shares issued and
        outstanding, liquidation preference of $2,100,000...     1,762,500            --
       Convertible Series D, 1,045 shares issued and
        outstanding, liquidation preference of $1,045,000...       810,000            --
       Convertible Series E, 2,700 shares issued and
        outstanding, liquidation preference of $2,700,000...     2,325,000            --
          Common stock -- $0.00004 par value, 9,000,000
             shares authorized, 4,540,356 and 1,954,876
             shares issued and outstanding..................           167            72
     Additional paid-in capital.............................    12,778,758     4,911,424
     Accumulated deficit....................................   (11,063,190)   (3,088,109)
                                                              ------------   -----------
          Total stockholders' equity........................     7,268,448     1,823,387
                                                              ------------   -----------
          Total liabilities and stockholders' equity........  $ 13,401,419   $ 4,766,325
                                                              ============   ===========
</TABLE>
    
 
   The accompanying notes are an integral part of these financial statements.
 
                                       F-3
<PAGE>   14
 
                             FREDERICK BREWING CO.
 
                            STATEMENTS OF OPERATIONS
                 FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                                 1997          1996
                                                              -----------   -----------
<S>                                                           <C>           <C>
Gross sales.................................................  $ 3,286,776   $ 1,871,593
Less: Returns and allowances................................       39,859        50,463
Less: Excise taxes..........................................      169,236       100,697
                                                              -----------   -----------
     Net sales..............................................    3,077,681     1,720,433
     Cost of sales..........................................    2,837,229     1,743,896
                                                              -----------   -----------
     Gross profit (loss)....................................      240,452       (23,463)
Selling, general and administrative expenses................    4,622,029     1,990,323
Loss on assets to be disposed...............................           --       640,815
                                                              -----------   -----------
     Operating loss.........................................   (4,381,577)   (2,654,601)
Gain on sale of equipment...................................     (158,167)           --
Interest (income) expense...................................      140,030       (29,427)
                                                              -----------   -----------
     Loss before income taxes...............................   (4,363,440)   (2,625,174)
Provision for income taxes..................................           --            --
                                                              -----------   -----------
     Net loss...............................................   (4,363,440)   (2,625,174)
Preferred stock deemed dividend requirements................   (3,611,641)            0
                                                              -----------   -----------
Net loss attributable to common shareholders................  $(7,975,081)  $(2,625,174)
                                                              ===========   ===========
Basic and diluted earnings per common share:
     Net loss before preferred stock dividend
      requirements..........................................  $     (1.59)  $     (1.45)
     Preferred stock dividend requirements..................        (1.32)           --
                                                              -----------   -----------
     Net loss per common share..............................  $     (2.91)  $     (1.45)
                                                              ===========   ===========
Weighted average common shares (basic and diluted)..........    2,741,583     1,804,503
                                                              ===========   ===========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                       F-4
<PAGE>   15
 
                             FREDERICK BREWING CO.
 
                 STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
                 FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
   
<TABLE>
<CAPTION>
                                      CUMULATIVE,
                                      CONVERTIBLE           CONVERTIBLE            CONVERTIBLE           CONVERTIBLE
                                   SERIES A PREFERRED    SERIES B PREFERRED    SERIES C PREFERRED    SERIES D PREFERRED
                                         STOCK                 STOCK                  STOCK                 STOCK
                                   ------------------   --------------------   -------------------   -------------------
                                   SHARES    AMOUNT     SHARES     AMOUNT      SHARES     AMOUNT     SHARES     AMOUNT
                                   ------   ---------   ------   -----------   ------   ----------   -------   ---------
 <S>                               <C>      <C>         <C>      <C>           <C>      <C>          <C>       <C>
 Balance, December 31, 1995......     --    $      --       --   $        --      --    $       --       --    $     --
 Issuance of common stock for
  cash, net of issuance costs....     --           --       --            --      --            --       --          --
 Exercise of options.............  .....           --       --            --      --            --       --          --
 Fair value of warrants issued to
  non-employees for services.....     --           --       --            --      --            --       --          --
 Net loss........................     --           --       --            --      --            --       --          --
                                   -----    ---------   ------   -----------   -----    ----------    -----    --------
 Balance, December 31, 1996......     --           --       --            --      --            --       --          --
 Issuance of preferred stock for
  cash, net of issuance costs....  1,828      833,840    3,750     3,181,161   2,100     1,837,500    1,045     835,500
 Fair value of warrants issued in
  connection with issuance of
  preferred stock................     --     (150,000)      --      (460,000)     --            --       --          --
 Fair value of common stock in
  connection with issuance of
  preferred stock................     --           --       --      (232,031)     --       (75,000)      --     (25,500)
 Beneficial conversion feature in
  connection with Series A
  preferred stock................     --     (114,505)      --            --      --            --       --          --
 Deemed dividend in connection
  with beneficial conversion
  feature on preferred stock.....     --       85,878       --            --      --            --       --          --
 Pledge of common stock to
  management in lieu of salary...     --           --       --            --      --            --       --          --
 Conversion of Series B preferred
  stock to common stock..........     --           --   (3,750)   (2,489,130)     --            --       --          --
 Fair value of warrants issued
  for deferred public relations
  costs..........................     --           --       --            --      --            --       --          --
 Fair value of warrants issued to
  bank for services..............     --           --       --            --      --            --       --          --
 Net loss........................     --           --       --            --      --            --       --          --
                                   -----    ---------   ------   -----------   -----    ----------    -----    --------
 Balance, December 31, 1997......  1,828    $ 655,213       --   $        --   2,100    $1,762,500    1,045    $810,000
                                   =====    =========   ======   ===========   =====    ==========    =====    ========
 
<CAPTION>
 
                                       CONVERTIBLE
                                   SERIES E PREFERRED
                                          STOCK             COMMON STOCK                                           TOTAL
                                   -------------------   ------------------     ADDITIONAL      ACCUMULATED    STOCKHOLDERS'
                                   SHARES     AMOUNT      SHARES     AMOUNT   PAID-IN CAPITAL     DEFICIT         EQUITY
                                   ------   ----------   ---------   ------   ---------------   ------------   -------------
 <S>                               <C>      <C>          <C>         <C>      <C>               <C>            <C>
 Balance, December 31, 1995......     --    $       --   1,128,444    $ 42      $ 1,043,775     $   (462,935)   $   580,882
 Issuance of common stock for
  cash, net of issuance costs....     --            --     771,154      28        3,847,701               --      3,847,729
 Exercise of options.............     --            --      55,278       2            9,948               --          9,950
 Fair value of warrants issued to
  non-employees for services.....     --            --          --      --           10,000               --         10,000
 Net loss........................     --            --          --      --               --       (2,625,174)    (2,625,174)
                                   -----    ----------   ---------    ----      -----------     ------------    -----------
 Balance, December 31, 1996......     --            --   1,954,876      72        4,911,424       (3,088,109)     1,823,387
 Issuance of preferred stock for
  cash, net of issuance costs....  2,700     2,415,000          --      --               --               --      9,103,001
 Fair value of warrants issued in
  connection with issuance of
  preferred stock................     --            --          --      --          610,000               --             --
 Fair value of common stock in
  connection with issuance of
  preferred stock................     --       (90,000)    106,500       4          422,527               --             --
 Beneficial conversion feature in
  connection with Series A
  preferred stock................     --            --          --      --          114,505               --             --
 Deemed dividend in connection
  with beneficial conversion
  feature on preferred stock.....     --            --          --      --        3,525,763       (3,611,641)            --
 Pledge of common stock to
  management in lieu of salary...     --            --          --      --           17,500               --         17,500
 Conversion of Series B preferred
  stock to common stock..........     --            --   2,478,980      91        2,489,039               --             --
 Fair value of warrants issued
  for deferred public relations
  costs..........................     --            --          --      --          670,000               --        670,000
 Fair value of warrants issued to
  bank for services..............     --            --          --      --           18,000               --         18,000
 Net loss........................     --            --          --      --               --       (4,363,440)    (4,363,440)
                                   -----    ----------   ---------    ----      -----------     ------------    -----------
 Balance, December 31, 1997......  2,700    $2,325,000   4,540,356    $167      $12,778,758     $(11,063,190)   $ 7,268,448
                                   =====    ==========   =========    ====      ===========     ============    ===========
</TABLE>
    
 
   The accompanying notes are an integral part of these financial statements.
 
                                       F-5
<PAGE>   16
 
                             FREDERICK BREWING CO.
 
                            STATEMENTS OF CASH FLOWS
                 FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
 
   
<TABLE>
<CAPTION>
                                                                 1997          1996
                                                              -----------   -----------
<S>                                                           <C>           <C>
Cash flows from operating activities:
     Net loss...............................................  $(4,363,440)  $(2,625,174)
     Adjustments to reconcile net loss to net cash used for
      operating activities:
          Depreciation and amortization.....................      560,671       161,772
          Amortization of deferred public relations costs...      188,500            --
          (Gain) loss on sale or disposal of equipment......     (158,167)      640,815
          Bad debt expense..................................       37,090       109,484
          Provision for inventory write-down................           --        48,060
          Fair value of stock pledged to management in lieu
            of salary.......................................       17,500            --
          Fair value of warrants issued to bank for
            services........................................       18,000            --
          Changes in operating assets and liabilities:
               Trade receivables............................     (131,114)     (123,430)
               Inventories..................................     (143,661)      (48,108)
               Prepaid expenses and other current assets....      (21,064)      (39,779)
               Other assets.................................     (148,557)      (71,000)
               Deferred public relations costs..............     (650,000)           --
               Accounts payable.............................     (354,250)      254,642
               Accrued liabilities..........................      241,405        71,463
                                                              -----------   -----------
          Net cash used for operating activities............   (4,907,087)   (1,621,255)
                                                              -----------   -----------
Cash flows from investing activities
     Purchase of property and equipment.....................   (2,748,745)   (2,833,176)
     Purchase of intangibles................................      (52,900)     (107,093)
     Proceeds from sale of equipment........................      303,239            --
                                                              -----------   -----------
          Net cash used for investing activities............   (2,498,406)   (2,940,269)
                                                              -----------   -----------
Cash flows from financing activities
     Proceeds from issuance of Series A preferred stock.....      914,000            --
     Proceeds from issuance of Series B preferred stock.....    3,750,000            --
     Proceeds from issuance of Series C preferred stock.....    2,100,000            --
     Proceeds from issuance of Series D preferred stock.....    1,045,000            --
     Proceeds from issuance of Series E preferred stock.....    2,700,000            --
     Offering costs associated with issuance of preferred
      stock.................................................   (1,405,999)           --
     Proceeds from debt borrowings..........................    1,605,485     1,965,114
     Payments on debt obligations...........................   (1,193,036)     (498,895)
     Payments on capital leases.............................     (109,571)      (12,874)
     Proceeds from common stock issuance....................           --     4,636,924
     Costs of common stock issuance.........................           --      (769,245)
     Decrease in restricted cash............................      627,525      (640,000)
     Payment of loan origination fees.......................      (64,021)      (70,510)
                                                              -----------   -----------
          Net cash provided by financing activities.........    9,969,383     4,610,514
                                                              -----------   -----------
Net increase in cash and cash equivalents...................    2,563,890        48,990
Cash and cash equivalents, beginning of period..............       48,990            --
                                                              -----------   -----------
Cash and cash equivalents, ending of period.................  $ 2,612,880   $    48,990
                                                              ===========   ===========
</TABLE>
    
 
   The accompanying notes are an integral part of these financial statements.
 
                                       F-6
<PAGE>   17
 
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
1.  BUSINESS AND FINANCING
 
BUSINESS
 
     Frederick Brewing Co. ("the Company") engages in the manufacture, bottling,
distribution and sale of beer primarily in the Mid-Atlantic region.
 
2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
CASH AND CASH EQUIVALENTS
 
     Cash and cash equivalents, stated at cost which approximates fair value,
consist of amounts on hand in operating bank account and a highly liquid
short-term investment account with a major bank. All cash equivalents have
original maturities of three months or less. The short-term investment, of
$12,475 which is presented as restricted cash, was pledged as collateral to
guarantee the Company's letter of credit to ensure the Company's performance of
site improvement work required by the Frederick County government.
 
CONCENTRATION OF CREDIT RISK
 
     The Company's financial instruments that are exposed to concentrations of
credit risk consist primarily of its cash and cash equivalents and accounts
receivable. The Company maintains cash and cash equivalents in separate accounts
at a major bank. The Company has not experienced any losses on these
investments.
 
     The Company's accounts receivable result primarily from beer sales to
wholesale distributors (see Note 10). The Company periodically assesses the
financial strength of its customers and provides allowances for anticipated
losses when necessary.
 
INVENTORIES
 
     Inventories, consisting of raw materials, work in process, finished goods,
and packaging and marketing supplies, are valued at lower of cost or market,
with cost based on a moving average method.
 
PROPERTY AND EQUIPMENT
 
     Property and equipment are recorded at cost and are depreciated using
straight-line and accelerated methods over the estimated useful lives of the
assets as follows:
 
<TABLE>
<S>                                                           <C>
Brewing equipment...........................................    7-20 years
Automobiles and trucks......................................       5 years
Furniture and fixtures......................................     3-7 years
</TABLE>
 
     Leasehold improvements are recorded at cost and are depreciated over the
terms of the related lease or the estimated useful life of the related
improvement, whichever is shorter. Upon retirement or disposition of property
and equipment, the cost and accumulated depreciation are removed from the
accounts and any resulting gain or loss is reflected in operations. Repairs and
maintenance are charged to expense as incurred.
 
     The Company leases its production facility under a long-term capital lease.
The lease is included in property and equipment at its estimated fair value. The
production facility is being amortized over the twenty-year lease term.
Depreciation expense includes the amortization of the production facility under
the capital lease.
 
     The Company evaluates the recoverability of the carrying value of
long-lived assets, including property and equipment and intangible assets, in
accordance with the provisions of Statement of Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets to be Disposed Of". The
Company considers historical performance and anticipated future results in its
evaluation of potential impairment. Accordingly,
 
                                       F-7
<PAGE>   18
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
when indicators of impairment are present, the Company evaluates the carrying
value of these assets in relation to the operating performance of the business
and future and undiscounted cash flows without interest expected to result from
the use of these assets. Impairment losses are recognized when the fair value of
the asset or the present value of expected future cash flows are less than the
assets' carrying value. There were no impairment losses in 1997. The Company
recorded a $640,815 impairment loss in 1996 (see note 5).
 
INTANGIBLE ASSETS
 
     Intangible assets consist primarily of trademarks, copyrights and loan
origination costs related to existing debt obligations. Trademarks and
copyrights are being amortized over a five-year period on a straight-line basis.
Loan origination costs are amortized over the term of the related loan.
Amortization expense was $44,947 and $17,453 for the years ended December 1997
and 1996, respectively.
 
DEFERRED PUBLIC RELATIONS COSTS
 
     Deferred public relations costs consist of $650,000 cash paid in advance
and $670,000, representing the estimated fair value of 500,000 warrants issued
to a third party for public and investor relations services to be rendered over
a five-year service period (see Note 8). These amounts are being amortized on a
straight-line basis over the five-year term of the service contract.
Amortization expense was $188,500 for the year ended December 31, 1997. In
addition, the Company paid $1,300,000 to this entity for public and investor
relations services rendered during 1997. The related cash payments were expensed
as incurred.
 
REVENUE RECOGNITION
 
     Revenue is recognized upon shipment of product to distributors. The Company
has established 180 days as the acceptable inventory shelf life for its
products. The Company will reimburse distributors for 50% of all out-of-date
product destroyed in the first year of each new distribution agreement. Amounts
reimbursed for out-of-date products have historically been minimal.
 
INCOME TAXES
 
     Deferred income taxes are recognized for the tax consequences in future
years for differences between the tax bases of assets and liabilities and their
financial reporting amounts at each year-end, based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established, when
necessary, to reduce deferred tax assets to the amount expected to be realized.
Income tax expense represents the current tax provision for the period plus the
change during the period in deferred tax assets and liabilities.
 
NET LOSS PER COMMON SHARE
 
     Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards No. 128, "Earnings Per Share," which requires the
presentation of basic earnings per share and diluted earnings per share for all
years presented. Basic earnings per share is based on the weighted average
number of outstanding common shares for the period. Diluted earnings per share
adjusts the weighted average for the potential dilution that could occur if
stock options, warrants or other convertible securities were exercised or
converted into common stock. Diluted earnings per share equals basic earnings
per share for 1997 and 1996 because the effects of such items were
anti-dilutive. Differences between historical quarterly earnings per share
amounts, reported on a primary earnings per share basis and amounts now reported
as basic earnings per share are not material.
 
                                       F-8
<PAGE>   19
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
NEW ACCOUNTING STANDARDS
 
     The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income," and Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information," in June 1997, which are both effective for
the year ending December 31, 1998. SFAS No. 130 establishes standards for
reporting comprehensive income in a full set of general purpose financial
statements either in the income statement or in a separate statement. SFAS No.
131 establishes standards for reporting information about operating segments,
including related disclosures about products and services, geographic areas and
major customers. These standards are not expected to have a material impact on
the Company's disclosures.
 
USE OF ACCOUNTING ESTIMATES
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual amounts could differ from these estimates.
 
FAIR VALUE INFORMATION
 
     The carrying amounts of current assets and current liabilities approximate
fair value because of their short term maturity. The carrying amount of the
Company's debt approximates its fair value as the debt bears interest at rates
approximating current market rates.
 
3.  ACQUISITIONS
 
     Subsequent to year-end, the Company acquired 100% of the outstanding common
stock of Wild Goose Brewery, Inc. (Wild Goose) and the brands, formulas,
copyrights, trademarks and related intangible assets of Brimstone Brewing
Company, Inc. (Brimstone). The consideration for Wild Goose consisted of the
issuance of approximately 1,100,000 shares of the Company's common stock with an
aggregate value of $2,206,000 and the assumption of approximately $580,000 in
outstanding Wild Goose notes payable. The actual number of shares to be issued
in connection with the Wild Goose acquisition is subject to adjustment based on
a final accounting of its 1997 operating results. The consideration for
Brimstone was 80,000 shares of the Company's common stock with an aggregate
value of approximately $162,000. These acquisitions will be accounted for under
the purchase method of accounting.
 
     The purchase price for each acquisition will be allocated to the assets
acquired and liabilities assumed based on their estimated fair values. Results
of operations for Wild Goose and Brimstone will be included with those of the
Company for periods subsequent to the date of acquisition. The excess of the
purchase price over the net assets acquired will be recorded as goodwill and
amortized over 10 years. The purchase price allocation will be determined during
1998. The final allocation may have a material effect on the unaudited pro forma
information presented below.
 
     The following unaudited pro forma summary presents the consolidated results
of operations as if the acquisitions had been completed at the beginning of the
periods presented and does not purport to be
 
                                       F-9
<PAGE>   20
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
indicative of what would have occurred had the acquisitions actually been made
as of such date or of results which may occur in the future.
 
<TABLE>
<CAPTION>
                                                        1997          1996
                                                     -----------   -----------
                                                            (UNAUDITED)
<S>                                                  <C>           <C>
Net sales..........................................  $ 5,769,000   $ 4,347,000
Net loss...........................................  $(4,564,000)  $(2,869,000)
Net loss per common share..........................  $     (1.16)  $     (0.96)
</TABLE>
 
4.  INVENTORIES
 
     Inventories at December 31, consist of the following:
 
<TABLE>
<CAPTION>
                                                                1997       1996
                                                              --------   --------
<S>                                                           <C>        <C>
Raw materials...............................................  $ 64,194   $ 35,957
Work in process.............................................    51,677     17,153
Finished goods..............................................   100,469     15,749
Packaging and marketing supplies............................   137,884    189,764
Inventory allowances........................................        --    (48,060)
                                                              --------   --------
     Total..................................................  $354,224   $210,563
                                                              ========   ========
</TABLE>
 
5.  PROPERTY AND EQUIPMENT
 
     Property and equipment at December 31, consists of the following:
 
<TABLE>
<CAPTION>
                                                                 1997         1996
                                                              ----------   ----------
<S>                                                           <C>          <C>
Brewing equipment...........................................  $4,117,219   $  491,660
Building....................................................   3,000,000           --
Leasehold improvements......................................   1,348,254           --
Automobiles and trucks......................................     201,499      201,499
Furniture and fixtures......................................     110,806       68,821
Construction in progress....................................          --    2,830,834
                                                              ----------   ----------
     Total..................................................   8,777,778    3,592,814
Less accumulated depreciation...............................    (402,133)    (305,118)
                                                              ----------   ----------
Property and equipment, net.................................  $8,375,645   $3,287,696
                                                              ==========   ==========
</TABLE>
 
     Construction in progress represented costs incurred in connection with the
preparation of purchased brewing equipment for their intended use. As a result
of the Company's move into its new brewery in early 1997, there was a
significant amount of brewing equipment housed in the old facility which was
sold in 1997. A loss of $640,815 was included in the statement of operations for
the year ended December 31, 1996 associated with the write-down of the brewing
equipment to its estimated fair value and the write-off of leasehold
improvements in the old facility. The company sold the related brewing equipment
in 1997 for cash proceeds of $303,329 resulting in a gain of $158,167.
 
     Included in property and equipment as of December 31, 1997 and 1996 was
$3,022,497 and $101,869, respectively in assets held under capital lease.
Accumulated amortization as of December 31, 1997 and 1996 related to these
assets was $118,672 and $29,275, respectively.
 
                                      F-10
<PAGE>   21
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
6.  DEBT OBLIGATIONS
 
  Long-term debt
 
     The long-term debt at December 31 consists of the following:
 
   
<TABLE>
<CAPTION>
                                                                      DECEMBER 31,   DECEMBER 31,
                     DESCRIPTION                          MATURITY        1997           1996
                     -----------                        ------------  ------------   ------------
<S>                                                     <C>           <C>            <C>
Note payable to bank, interest at LIBOR + 150 basis
  points, 108 monthly payments at $13,889, commencing
  Aug. 1997, collateralized by brewing equipment (see
  below). ............................................  July 2006      $1,366,756     $1,500,000
Note payable to bank, interest at LIBOR + 150 basis
  points, interest only payments, collateralized by
  brewing equipment (see below). .....................  July 1997              --        363,515
Note payable to United States Small Business
  Administration, interest at 7.368%, monthly
  principal and interest payments of $7,967,
  collateralized by secondary lien on all
  equipment. .........................................  May 2017          984,002             --
Notes payable to bank, monthly payments ranging from
  $268 to $808, including interest ranging from 7.9%    May 1999 to
  to 9.1%, collateralized by vehicles. ...............  October 2000       93,676        143,920
Stockholder loans payable, monthly payments ranging
  from $425 to $655 including interest ranging from
  10% to 11%..........................................  To July 1999       37,116         61,666
                                                                       ----------     ----------
     Total..........................................................    2,481,550      2,069,101
     Less current maturities........................................     (272,814)      (437,690)
                                                                       ----------     ----------
     Total long-term debt...........................................   $2,208,736     $1,631,411
                                                                       ==========     ==========
</TABLE>
    
 
     During 1996, the Company entered into agreements to have a new brewery
built by Blue II, LLC, a limited liability company affiliated with certain
directors of the Company ("Blue II"). Blue II constructed the new brewery
building to the Company's specifications and is leasing the building to the
Company. On July 19, 1996, in connection with the purchase of the equipment to
be housed in the new brewery, the Company obtained a $1,500,000 revenue bond
from the Maryland Economic Development Corporation ("MEDCO") and a $969,000
bridge loan from a bank which has been repaid. The $1,500,000 revenue bond was
immediately assigned by MEDCO to a bank. In connection with the $1,500,000
revenue bond, the bank issued a note to the Company from the proceeds of the
revenue bond. There are certain restrictive covenants existing on the $1,500,000
note payable to the bank. Among those covenants is a cash flow to debt service
ratio for which the Company was not in compliance as of December 31, 1997. This
covenant violation represents an event of default on the note and also a cross
default on a $3,000,000 loan obtained by Blue II for the construction of the
brewery for which the Company is a guarantor of the Blue II loan. The Company
and Blue II has obtained a waiver of this covenant violation as of December 31,
1997. Subsequent to year end, for both the $1,500,000 loan and $3,000,000 Blue
II loan the bank has waived compliance with the cash flow to debt service
covenant for the calendar quarters ending March 31, 1998, June 30, 1998 and
September 30, 1998. The bank has also modified this covenant for the calendar
quarter ending December 31, 1998 and for each quarter thereafter whereby the
Company must maintain a cash flow to debt service ratio of 1.0 to 1. In
addition, the bank modified the current ratio covenant whereby the Company must
maintain a ratio of current assets to current liabilities of 1.0 to 1 as of
calendar quarter March 31, 1998 and each calendar quarter thereafter. The
Company anticipates it will be able to comply with these modified covenants. In
exchange for these covenant modifications, the maturity date on the loans was
revised to April 1, 1999, the interest rate increased to the prime rate plus
1.25% for the Company's loan and the prime rate plus 1.5% for the Blue II loan,
was required to pay a loan modification fee of $25,000 payable in two
installments of $10,000 and $15,000 on June 30, 1998 and September 30, 1998,
respectively, be responsible for all fees and expenses
 
                                      F-11
<PAGE>   22
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
incurred by the bank in connection with preparation of the modification and use
its best efforts to obtain replacement financing.
 
     In February 1997, the bank declared that a material adverse change,
primarily caused by a $340,000 overrun in equipment purchases as compared to the
original budget, had occurred in the Company's business and declared the
Company's notes payable in default. The bank agreed, under a forbearance
agreement, dated February 27, 1997, to waive its rights under the events of
default and to fund the Company with additional advances of $250,000 under the
bridge loan. In connection with this forbearance agreement, the Company
committed to the issuance of certain shares of Series A Preferred Stock (See
Note 7), to maintain specified levels of accounts receivable at specified
measurement dates, and to pay to the bank the proceeds obtained from the sale of
the equipment at the old brewery. Further, in connection with the forbearance
agreement, the bridge loan was personally guaranteed by both the Chief Executive
Officer and the President of the Company. Additionally, the Company issued
warrants to the bank to purchase 5,750 shares of the Company's common stock for
no consideration as a fee for the forbearance agreement. The fair value of these
warrants on the date of grant was estimated to be $18,000 based on the
Black-Scholes valuation model with the following weighted-average assumptions:
dividend yield of 0%, expected volatility of 58%, risk free interest rate of
6.93% and expected term of 10 years. This amount has been reflected in the
Statement of Operations and has been recorded as an increase to additional paid
in capital.
 
     On April 24, 1997, the Company obtained a $1,000,000 term loan with the
United States Small Business Administration (SBA). The proceeds from this loan
were used to repay the outstanding principal balance of the bridge loan. Each of
the existing loans contain restrictive covenants, including certain financial
ratios relating to the Company's liquidity and financial position at certain
dates set forth in the agreements and restrictions on the occurrence of adverse
changes deemed material by the bank with respect to the business, assets,
operations or financial condition of the Company. The note payable to the SBA
has been personally guaranteed by both the Chief Executive Officer and the
President of the Company.
 
     Principal repayments required on all notes payable are due as follows:
 
<TABLE>
<S>                                                           <C>
1998........................................................  $  272,814
1999........................................................     239,940
2000........................................................     197,250
2001........................................................     196,456
2002........................................................     198,140
Thereafter..................................................   1,376,950
                                                              ----------
     Total..................................................  $2,481,550
                                                              ==========
</TABLE>
 
     During 1996 and in connection with the $3 million revenue bond obtained by
Blue II, the bank claimed that this loan was in default. Blue II obtained a
similar forbearance agreement which ensured the continued funding for the
construction. In connection with the Blue II forbearance agreement, the Company
sold certain shares of its Series A Preferred Stock (See Note 7) to the general
contractor of the brewery in an amount equal to the final net funding
deficiency. The proceeds from such sale were used to satisfy the funding
deficiency.
 
  Capital leases
 
     The Company has entered into leases for the land and building housing the
brewery as well as certain computer equipment which qualify as capital leases.
The Company has the option to purchase the building housing the brewery at any
time after March 1, 2023 at a price of $3,000,000.
 
                                      F-12
<PAGE>   23
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
     Future minimum payments under all capital leases are as follows as of
December 31, 1997:
 
<TABLE>
<S>                                                           <C>
1998........................................................  $   464,234
1999........................................................      444,702
2000........................................................      428,803
2001........................................................      412,174
2002........................................................      369,049
Thereafter..................................................    4,033,177
                                                              -----------
Total minimum lease payments................................    6,152,139
Less amount representing interest...........................   (3,182,627)
                                                              -----------
Present value of future minimum lease payments..............    2,969,512
Less current maturities.....................................      (88,976)
                                                              -----------
Long-term capital lease obligations.........................  $ 2,880,536
                                                              ===========
</TABLE>
 
7.  STOCKHOLDERS' EQUITY
 
PREFERRED STOCK
 
     The Company's Articles of Incorporation authorize the issuance of 1,000,000
shares of preferred stock, $.01 par value, of which 1,828 shares of non-voting
Cumulative, Convertible Series A Preferred Stock (Series A), 2,100 shares of
Convertible Series C Preferred Stock (Series C), 1,045 shares of Convertible
Series D Preferred Stock (Series D) and 2,700 shares of Convertible Series E
Preferred Stock (Series E) were issued during 1997 and are outstanding as of
December 31, 1997. The Company also issued 3,750 shares of Convertible Series B
Preferred Stock (Series B), which were all converted to Common Stock during
1997.
 
   
     The Series A shares are convertible at any time after one year from the
date of issuance, based on a conversion price of $3.67 per share, which was a
discount at the date of issuance. The Series B, Series C and Series D shares are
convertible immediately upon issuance at 70% of the average market price of the
common stock for the five trading days immediately prior to the conversion date.
The Series E shares are convertible immediately upon issuance at 75% of the
average market price of the common stock for the five trading days immediately
prior to the conversion date. The Company has recorded a deemed dividend of
$3,611,641 to reflect the beneficial conversion feature related to each of the
preferred stock issuance. The discount amount is recognized over the period from
the date of issuance to the earliest point the shares are convertible. The
beneficial conversion feature of $114,505 related to the Series A shares is
being recognized as a deemed dividend over the one year period from the date of
issuance of March 31, 1997, and the deemed dividends related to the Series B,
Series C, Series D and Series E shares was recognized immediately upon issuance.
    
 
     The holders of Series A shares are senior to the Common Stock with respect
to dividend rights and are entitled to a liquidation preference of $500 per
share. The annual dividend rate for the Series A Shares is $40 per share per
annum, with cumulative dividends in arrears of $73,120, and the annual dividend
rate for the Series C, Series D and Series E shares is $80 per share, when and
if declared by the Company's Board of Directors. Full dividends must be paid or
set aside on the Series A, Series C, Series D and Series E shares before
dividends may be paid or set aside on the common stock. All dividend payments
will be subordinated to the Company's debt obligations, and will be subject to
the prior approval of the Company's bank. No dividends were declared during
1997. The holders of Series B, Series C, Series D and Series E shares have a
liquidation preference of $1,000 per share over the Common Stock and the Series
A shares. The Company does not expect to declare or pay such dividends in the
foreseeable future.
 
     In connection with the issuance of the Series A shares, the Company issued
69,306 warrants with exercise prices ranging from $3.66 per share to $5 per
share as consideration to the entities responsible for attracting
 
                                      F-13
<PAGE>   24
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
the investors in the Series A shares. The Company determined the aggregate value
of these warrants on the date of grant to approximate $150,000, based on the
Black-Scholes valuation model, with the following weighted average assumptions:
dividend yield of 0%, expected volatility of 58%, risk free interest rate of
6.38% and expected term of 3 years. This value was recorded as a direct issuance
cost of the Series A offering and deducted from the proceeds. In connection with
the issuance of the Series B shares, the Company issued 200,000 warrants with
exercise prices ranging from $4.38 per share to $4.88 per share to the entity
responsible for attracting the investors. The Company determined the aggregate
value of these warrants on the date of grant to be approximately $460,000, based
on the Black-Scholes valuation model, with the following weighted average
assumptions: dividend yield of 0%, expected volatility of 58%, risk free
interest rate of 6.36% and expected term of 5 years. This value was recorded as
a cost of the Series B offering and deducted from the proceeds.
 
     In connection with the issuance of Series B, Series C and Series D shares,
the Company also issued 56,250, 37,500 and 12,750 shares of common stock,
respectively, to the entity responsible for attracting the investors. In
connection with the issuance of Series E shares, the Company pledged 45,000
shares of common stock to the entity responsible for attracting the investors.
The shares were issued subsequent to December 31, 1997. Based on the market
value of the common stock on the date of issuance, the Company has reflected an
aggregate of $422,531 as a cost of the related preferred stock issuance.
 
     During 1997, the Company pledged an aggregate of 10,000 shares of common
stock to certain members of management in lieu of their salary for past
services. The value of the common stock on the date pledged of $17,500 was
recorded as compensation expense and additional paid in capital.
 
     Subsequent to December 31, 1997, certain holders of Series C preferred
shares converted their shares into 402,663 shares of common stock.
 
8.  STOCK-BASED COMPENSATION
 
STOCK OPTIONS
 
     The Company has chosen to continue to account for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations for issuance of stock options to employees. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price at the date of the grant over the amount an employee must
pay to acquire the stock.
 
   
     Effective November 20, 1995, the Company adopted the 1995 Stock Option Plan
("the Plan") in order to attract and retain qualified personnel in key positions
as well as to compensate members of the Board of Directors. The Company has
reserved approximately 152,000 shares of common stock for issuance under the
Plan. The exercise price of all options under the Plan must be equal to at least
the fair value of the related common stock on the date of grant. Vesting
provisions for the options are to be determined by the Board of Directors. All
options are exercisable for ten years after the vesting date.
    
 
                                      F-14
<PAGE>   25
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
     A summary of the status of the Company's stock options is presented.
 
   
<TABLE>
<CAPTION>
                                                          YEAR ENDED                    YEAR ENDED
                                                       DECEMBER 31, 1997             DECEMBER 31, 1996
                                                       WEIGHTED-AVERAGE              WEIGHTED-AVERAGE
                                              SHARES    EXERCISE PRICE     SHARES     EXERCISE PRICE
                                              ------   -----------------   -------   -----------------
<S>                                           <C>      <C>                 <C>       <C>
Options outstanding at beginning of
  period....................................  59,987          1.60          85,489          0.18
Options exercised...........................      --            --         (55,278)        (0.18)
Options canceled............................    (355)        (5.79)         (3,334)        (5.00)
Options granted.............................  10,000          1.90          33,110          5.45
                                              ------                       -------
Options outstanding at end of period........  69,632          1.63          59,987          1.60
                                              ======                       =======
Options exercisable at end of period........  69,632          1.63          59,987          1.60
                                              ======                       =======
</TABLE>
    
 
     The weighted average fair value of options granted during the years ended
December 31, 1997 and 1996 was $1.32 per share and $2.38 per share respectively.
 
     As of December 31, 1997, the weighted average remaining contractual life of
the options, which have exercise prices ranging from $0.18 to $6.00, is
approximately 8 years.
 
     As of December 31, 1997 and 1996, the pro forma tax effects under SFAS 109
would not have a material impact to either the deferred tax asset or the
valuation allowance.
 
     Had compensation expense been determined based on fair value at the grant
dates for option awards consistent with the method of SFAS 123, the Company's
net loss attributable to common shareholders and net loss per common share would
have been increased to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                                1997          1996
                                                             -----------   -----------
<S>                                                          <C>           <C>
Net loss attributable to common shareholders
     As reported...........................................  $(7,957,081)  $(2,625,174)
     Pro forma.............................................   (7,961,471)   (2,703,915)
Net loss per common share (basic and diluted)
     As reported...........................................  $     (2.91)  $     (1.45)
     Pro forma.............................................        (2.91)        (1.50)
</TABLE>
 
     The fair value of each option is estimated on the date of grant using a
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants during the year ended December 31, 1997 and 1996.
 
<TABLE>
<CAPTION>
                                                               1997      1996
                                                              -------   -------
<S>                                                           <C>       <C>
Annual dividend yield.......................................       0%        0%
Estimated volatility........................................      58%       33%
Risk free interest rate.....................................     6.8%      6.3%
Expected term...............................................  8 years   8 years
</TABLE>
 
   
     Subsequent to December 31, 1997, the Board of Directors authorized the
modification of the terms of all stock options previously issued to
non-executive employees of the Company by changing the exercise price to $0.875
per share, representing the market value of the underlying common stock on March
28, 1998. There was no compensation charge associated with this modification,
since the revised exercise price is equal to the market value of the underlying
common stock on the date of re-measurement.
    
 
                                      F-15
<PAGE>   26
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
WARRANTS
 
     In April 1997, the Company entered into an agreement with a third party for
public and investor relations services to be rendered over a five-year period.
In consideration for these services, the Company paid $650,000 in cash and
issued the public relations firm 500,000 warrants to purchase common stock of
the Company. These warrants have various exercise prices and terms of
exercisability, and expire at varying dates through March 13, 2002. The Company
determined the estimated aggregate fair value of these warrants on the date of
grant to be approximately $670,000, based on the Black-Scholes valuation model
with the following weighted average assumptions: dividend yield of 0%, expected
volatility of 58%, risk free interest rate of approximately 6.15% and expected
term of approximately 3 years. The Company recorded the total consideration of
$1,320,000 as deferred public relation costs. The component of the total
consideration related to the estimated value of the warrants was recorded as an
increase to additional paid in capital at the value on the date on which a
performance commitment existed. The total consideration is being amortized over
the five-year term of the agreement.
 
     In connection with the initial public offering in 1996, the underwriter was
granted a warrant to purchase up to 38,558 shares of common stock at an exercise
price of $ 7.20 per share. In addition, during 1996, the Company entered into an
agreement with a financial consulting firm, and granted this firm warrants to
purchase $120,000 worth of the Company's common stock at an exercise price equal
to 125% of the average closing price of the shares for the twenty days prior to
the execution of the agreement between the Company and the consulting firm. The
Company recorded an expense of $10,000 and a corresponding increase to paid-
in-capital related to this grant based on the estimated fair value of the
warrants on their date of grant, determined using the Black-Scholes valuation
model.
 
9.  COMMITMENTS AND CONTINGENCIES
 
LEASES
 
     In February 1997, the Company moved into its new facility which it is
leasing under a twenty-year capital lease expiring March 2017. The monthly
capital lease payments, which began in March 1997, is equal to $20,857. The
Company also leases certain of its equipment under an operating lease with net
aggregate future lease payment as follows (see note 6).
 
<TABLE>
<S>                                                           <C>
1998........................................................  $137,653
1999........................................................   137,653
2000........................................................    45,884
                                                              --------
Total minimum rental payments...............................  $321,190
                                                              ========
</TABLE>
 
     Rent expense for the year-ended December 31, 1997 and 1996 was
approximately $92,000 and $53,000, respectively.
 
CONTINGENCIES
 
     In the normal course of business, the Company is involved in various claims
and litigation. Management is of the opinion that any liability or loss
resulting from such claims or litigation will not have a material adverse effect
on the Company's financial condition, results of operations or cash flows.
 
EMPLOYMENT AGREEMENTS
 
     In December 1995, the Company entered into employment agreements with four
key members of management. Under the terms of the agreements, aggregate base
salaries for 1998 of all the individuals are
 
                                      F-16
<PAGE>   27
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
$375,000. The employment agreements also include a provision for annual cash
bonuses not to exceed 25% of base salaries. In 1997 and 1996, no such bonuses
were paid or accrued based on a management decision.
 
10.  WHOLESALE DISTRIBUTORS
 
     The Company distributes its products only through independent wholesale
distributors for resale to retailers such as liquor and wine and beer stores,
restaurants, taverns, pubs, bars, and sporting arenas. Accordingly, the Company
is dependent upon these wholesale distributors to sell the Company's beers and
to assist the Company in creating demand for, and promoting market acceptance of
the Company's products and providing adequate service to all retail customers.
If a significant wholesale distributor were to discontinue selling, or decrease
the level of orders for, the Company's products, the Company's business would be
adversely affected in areas serviced by such wholesale distributors until the
Company retained replacements.
 
     Sales to wholesale distributors representing greater than 10% of total
sales were as follows for the years ended December 31:
 
<TABLE>
<CAPTION>
                                                          1997         1996
                                                       ----------   ----------
<S>                                                    <C>          <C>
Distributor A........................................  $1,236,400   $  961,000
Distributor B........................................          --       40,000
Distributor C........................................     271,600      241,000
                                                       ----------   ----------
                                                       $1,508,000   $1,242,000
                                                       ==========   ==========
</TABLE>
 
11.  INCOME TAXES
 
     The tax effects of the primary temporary differences giving rise to the
Company's deferred tax asset (liability) at December 31, 1997 and 1996 are
summarized as follows:
 
<TABLE>
<CAPTION>
                                                                 1997          1996
                                                              -----------   ----------
<S>                                                           <C>           <C>
Net operating loss carry forward............................  $ 2,710,000   $1,028,000
Other.......................................................       21,000        8,000
Depreciation................................................     (130,000)    (100,000)
                                                              -----------   ----------
     Subtotal...............................................    2,601,000      936,000
Valuation allowance.........................................   (2,601,000)    (936,000)
                                                              -----------   ----------
     Net deferred taxes.....................................  $        --   $       --
                                                              ===========   ==========
</TABLE>
 
     Realization of the net deferred tax asset at the balance sheet date is
dependent on future earnings which are uncertain. Accordingly, a full valuation
allowance was recorded against the asset. During the year ended December 31,
1997 the valuation allowance was increased primarily related to the increase in
the net operating loss carryforwards.
 
     As of December 31, 1997, the Company had net operating loss carry forwards
of approximately $6,800,000 expiring between 2009 and 2012 available to offset
future taxable income for federal income tax purposes, subject to Section 382
limitations.
 
                                      F-17
<PAGE>   28
                             FREDERICK BREWING CO.
 
                         NOTES TO FINANCIAL STATEMENTS
 
12.  SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
 
   
<TABLE>
<CAPTION>
                                                                 1997        1996
                                                              ----------   --------
<S>                                                           <C>          <C>
Cash paid for interest......................................  $  140,030   $53,088
Supplemental disclosure of non cash investing and financing
  activities:
Capital lease obligations...................................  $3,000,000   $ 5,076
Fair value of warrants issued to non-employees for
  services..................................................  $  670,000   $10,000
Fair value of stock pledge to management in lieu of
  salary....................................................  $   17,500   $    --
Fair value of warrants issued to bank for services..........  $   18,000   $    --
Fair value of warrants issued in connection with preferred
  stock issuance............................................  $  610,000   $    --
Common stock issued in connection with preferred stock
  issuance..................................................  $  422,531   $    --
Deemed dividend in connection with beneficial conversion
  feature on preferred stock................................  $3,611,641   $    --
Beneficial conversion feature in connection with Series A
  preferred stock...........................................  $  114,505   $    --
</TABLE>
    
 
                                      F-18
<PAGE>   29
 
                                   SIGNATURES
 
In accordance with the requirements of the Exchange Act, the Registrant has
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
 
                                          FREDERICK BREWING CO.
 
Date March, 27, 1998
     --------------------------------    /s/ Kevin E. Brannon
                                          --------------------------------------
                                          Kevin E. Brannon
                                          Chairman of the Board and
                                          Chief Executive Officer
 
Date March 27, 1998
     --------------------------------    /s/ Leslie P. Harper
                                          --------------------------------------
                                          Leslie P. Harper
                                          Chief Financial Officer
 
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
 
<TABLE>
<S>                                                     <C>
/s/ Kevin E. Brannon                                    Date: March 27, 1998
----------------------------------------
Kevin E. Brannon
Chairman
 
/s/ Marjorie A. McGinnis                                Date: March 27, 1998
----------------------------------------
Marjorie A. McGinnis
 
/s/ Nicholas P. Foris, M.D.                             Date: March 27, 1998
----------------------------------------
Nicholas P. Foris, M.D.
 
/s/ Carl R. Hildebrand                                  Date: March 27, 1998
----------------------------------------
Carl R. Hildebrand
 
/s/ James W. Lutz                                       Date: March 27, 1998
----------------------------------------
James W. Lutz
 
/s/ Jerome M. Pool                                      Date: March 27, 1998
----------------------------------------
Jerome M. Pool
 
/s/ Maribeth Visco                                      Date: March 27, 1998
----------------------------------------
Maribeth Visco
</TABLE>
<PAGE>   30
 
   
                                   SIGNATURES
    
 
   
In accordance with the requirements of the Exchange Act, the Registrant has
caused this Amendment No. 1 to the Form 10-KSB/A to be signed on its behalf by
the undersigned thereunto duly authorized.
    
 
   
                                          FREDERICK BREWING CO.
    
 
   
Date April 24, 1998                       /s/ Leslie P. Harper
    
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                                          Leslie P. Harper
                                          Chief Financial Officer