REDHOOK ALE BREWERY INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000

COMMISSION FILE NUMBER 0-26542

REDHOOK ALE BREWERY, INCORPORATED
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

WASHINGTON 91-1141254
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)

3400 PHINNEY AVENUE NORTH
SEATTLE, WASHINGTON 98103
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(206) 548-8000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.005 PER SHARE

RIGHTS TO PURCHASE COMMON STOCK
(TITLE OF CLASS)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]

The aggregate market value of the Common Stock held by non-affiliates of
the registrant, based on the closing price on March 17, 2001, as reported on
Nasdaq, was $8,635,793.(1)

The number of shares of the registrant's Common Stock outstanding as of
March 17, 2001, was 7,141,586.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's Proxy Statement relating to the registrant's
2001 Annual Meeting of Stockholders to be held on May 22, 2001, are incorporated
by reference into Part III of this Report.
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(1) Excludes shares held of record on that date by directors and executive
officers and greater than 10% shareholders of the registrant. Exclusion of
such shares should not be construed to indicate that any such person
directly or indirectly possesses the power to direct or cause the direction
of the management of the policies of the registrant.

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REDHOOK ALE BREWERY, INCORPORATED

FORM 10-K

TABLE OF CONTENTS

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PART I.
ITEM 1. Business.................................................... 1
ITEM 2. Properties.................................................. 14
ITEM 3. Legal Proceedings........................................... 15
ITEM 4. Submission of Matters to a Vote of Security Holders......... 15
ITEM 4A. Executive Officers of the Company........................... 15

PART II.
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters....................................... 16
ITEM 6. Selected Financial Data..................................... 17
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 18
ITEM 7A. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 24
ITEM 8. Financial Statements and Supplementary Data................. 25
ITEM 9. Changes In and Disagreements With Accountants on Accounting
and Financial Disclosures................................. 43

PART III.
ITEM 10. Directors and Executive Officers of the Registrant.......... 43
ITEM 11. Executive Compensation...................................... 43
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 43
ITEM 13. Certain Relationships and Related Transactions.............. 43

PART IV.
ITEM 14. Exhibits, Financial Statements and Reports on Form 8-K...... 43

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PART I.

ITEM 1. BUSINESS

Redhook Ale Brewery, Incorporated ("Redhook" or the "Company") is one of
the leading brewers of craft beers in the United States and has been at the
forefront of the domestic craft brewing segment since the Company's formation in
1981. Redhook produces its specialty bottled and draft products in two
technologically-advanced, company-owned breweries, one in the Seattle suburb of
Woodinville, Washington and the other in Portsmouth, New Hampshire. By operating
its own small-batch breweries, the Company believes it is better able to control
the quantities, types and flavors of beer produced, while optimizing the quality
and consistency of its products. Management believes that the Company's
significant production capacity is of the highest quality compared to that of
any domestic craft brewer and that Redhook is the only domestic craft brewer
that owns and operates substantial production facilities in both a western
region and eastern region of the United States.

The Company currently produces eight styles of beer, marketed under
distinct brand names. The Company's flagship brand is Redhook E.S.B., and its
other principal products include Redhook India Pale Ale, Redhook Hefe-Weizen,
Blackhook Porter, Double Black Stout, and its seasonal offerings Redhook Blonde
Ale, Winterhook, and Redhook Nut Brown Ale. In addition to its principal
products, the Company periodically develops and markets new products to test and
measure consumer response to varying styles and flavors. The Company distributed
its products through a network of third-party wholesale distributors and a
long-term distribution alliance with Anheuser-Busch, Incorporated ("A-B") (the
"Distribution Alliance" or the "Alliance") in 48 states as of December 31, 2000.

INDUSTRY BACKGROUND

The Company is a leader in the relatively small craft brewing segment of
the U.S. brewing industry, which includes regional specialty brewers such as the
Company, contract brewers, microbreweries and brewpubs. Craft beers are
distinguishable from other domestically-produced beers by their fuller flavor
and adherence to traditional European brewing styles. According to industry
sources, the market share of the craft beer segment remained flat at
approximately 2.9% of total beer sold in the U.S. in 1999 as compared to 1998.
The craft beer segment shipped approximately 5.7 million barrels and 5.6 million
barrels in 1999 and 1998, respectively, while total beer sold in the US,
including imported beer, was approximately 195 million and 192 million during
the same years. Although industry information for 2000 is not yet available, the
Company believes that the craft beer segment's market share has increased
slightly. In contrast, the number of craft brewers in the U.S. has grown
dramatically, from 627 at the end of 1994 to approximately 1,490 as of June
2000. As of December 2000, the Company believes that the number of craft brewers
is substantially unchanged.

In the early 1900's, the U.S. brewing industry was comprised of nearly
2,000 breweries, most of which were small operations that produced distinctive
beers for local markets. Fewer than 1,000 of these breweries reopened following
Prohibition. During the ensuing decades, competition in the beer industry came
to focus on a narrowing of product offerings to less distinctive beer styles
(principally pale lagers and pilsners): to please the broadest possible segment
of the population; for economies of scale; to facilitate mass production
techniques; to lower costs and lighten flavor profiles through the use of less
barley and more corn, rice and other adjuncts; use of pasteurization processes
to prolong shelf-life; and marketing a few major brand names on a national
basis, principally through mass-media advertising. As a result of these
competitive factors, extensive industry consolidation occurred. Currently,
according to industry sources, the four largest domestic brewers account for
approximately 85% of domestic beer shipments.

By the early 1980s, annual domestic consumption of beer produced by U.S.
brewers had plateaued at approximately 180 million barrels. Over the past
decade, per capita annual domestic beer consumption has declined slightly, due
to increasing health and safety consciousness and the changing tastes, affluence
and consumption attitudes of the maturing generation of beer drinkers born after
World War II. A growing number of consumers began to migrate away from less
flavorful mass-marketed beers toward greater taste and

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broader variety in their malt beverages, mirroring similar trends in other
beverage and cuisine categories. Initially, foreign brewers were the principal
beneficiaries of these evolving consumption patterns. Even though the principal
European, Canadian and Mexican imported beers are also mass-produced, many
represent a fuller-flavored alternative to the national brands produced in the
United States.

By the latter half of the 1980s, a substantial new domestic industry
segment had developed in response to the increasing consumer demand for
fuller-flavored beers. Across the country, a proliferation of regional specialty
brewers (annually selling more than 15,000 barrels of craft beer brewed at their
own facilities), contract brewers (selling craft beer brewed by a third party to
the contract brewer's specifications), microbreweries (selling less than 15,000
barrels per year), and brewpubs (combination restaurant-breweries) emerged to
form the craft beer industry. The strength of consumer demand has enabled
certain craft brewers, such as the Company, to evolve from microbreweries into
regional specialty brewers by constructing larger breweries, while still
adhering to the traditional European brewing methods that characterize the craft
brewing segment. Other craft brewers have sought to take advantage of growing
consumer demand by hiring certain brewers of typical American-style lagers to
perform contract brewing at their otherwise underutilized brewing facilities.
Certain national brewers of mass-produced beers have also sought to appeal to
this growing demand for craft beers by introducing their own fuller-flavored
products. Also, in recent years imported products from foreign brewers have
enjoyed a resurgence in demand and that has contributed to the reduced volume
growth in the craft beer segment.

BUSINESS STRATEGY

The Company's principal business objective is to be the leading brewer of
craft beers in the United States. Redhook seeks to achieve this objective by
expanding penetration in existing markets. The central elements of the Company's
business strategy include:

- Production of High-Quality Craft Beers. The Company is committed to the
production of a variety of distinctive, flavorful craft beers. The
Company brews its craft beers according to traditional European brewing
styles and methods, using only high-quality ingredients and
technologically-advanced brewing equipment. The Company does not intend
to compete directly in terms of production style, pricing or extensive
mass-media advertising with the mass-marketed national brands.

- Control of Production in Company-Owned Breweries. The Company builds,
owns and operates its own brewing facilities to optimize the quality and
consistency of its products and to achieve the greatest control over its
production costs. Management believes that its ability to engage in
constant product innovation and its control over product quality are
critical competitive advantages. Accordingly, the Company does not hire
third parties to perform contract brewing of any of its products.

- Production Economies through Technologically-Advanced Equipment. The
Company's technologically-advanced, highly automated breweries are
designed to produce beer in small batches, while attaining production
economies through automation rather than scale. The Company believes that
its investment in technological leadership enables it to optimize
employee productivity, to contain operating costs, to produce innovative
beer styles and tastes, and to achieve the production flexibility
afforded by small-batch brewing, with minimal loss of efficiency and
process reliability.

- Strategic Distribution Alliance with Industry Leader. In October 1994,
the Company entered into a long-term distribution agreement with A-B,
pursuant to which Redhook distributes its products in substantially all
of its markets through A-B's wholesale distribution network. A-B's
network consists of over 700 wholesale distributors, who are for the most
part geographically contiguous and independently owned and operated. The
Alliance with A-B enabled the Company to expand its distribution to new
markets more quickly and without the delays, costs and potential gaps or
overlaps in coverage associated with developing a network of distributors
on a piecemeal basis. With the proliferation of craft beer companies,
combined with the consolidation trend in the beer distribution business,
it is no longer as easy for many brewers to gain access to quality
distributors because of limitations on distributors' ability to
effectively manage a greater number of brands, as well as the desire of
many

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distributors for higher product quality and consistency, and marketing
support. As an independent company, Redhook maintains complete control
over the production and marketing of its product.

- Operation of Regional Brewing Facilities. Management believes that by
locating its production facilities in proximity to the key regional
markets it serves, the Company is able to enjoy distinct competitive
advantages, including shortened delivery times to maximize product
freshness, reduced shipping costs, established consumer identification
with the Company's brands, and enhanced familiarity with local consumer
tastes. If additional capacity is required Redhook may construct
additional brewing facilities, in select locations in the United States,
with the capability to produce Redhook's principal products, as well as
to offer select products to respond to local taste preferences. By
pursuing this strategy, Redhook believes that it will be able to preserve
its reputation and prestige as a regional craft brewer.

- Promotion of Products. Prior to June 1999, the Company had done very
limited advertising. Based upon market and competitive considerations,
the Company determined that a significant increase in such spending was
appropriate. Accordingly, in June 1999, the Company began a brand
investment program that significantly increased advertising and related
costs. The increased advertising investment continued in 2000 and is
expected to continue for the foreseeable future with the objective of
establishing or maintaining momentum towards capturing a larger share of
the fragmented craft beer market. In addition, market and competitive
considerations could require an increase in other promotional costs
associated with developing existing and new markets. Expenditures for
this program totaled $2.4 million and $2.5 million for the years ended
December 31, 2000 and 1999, respectively. In addition to the brand
investment program, the Company markets its products to distributors,
retailers and consumers through a variety of specialized training and
promotional methods. The Company actively trains its distributors and
retailers in understanding the brewing process, the craft beer segment
and Redhook products. Promotional methods include introducing Redhook
products on draft in pubs and restaurants, using promotional items
including tap handles, glassware and coasters, and participating in local
festivals and sports venues to increase brand name recognition. In
addition, the Company's prominently located breweries feature pubs and
retail outlets and offer guided tours to further increase consumer
awareness of Redhook. The Company has historically believed that its
training and promotional methods are effective in communicating and
educating consumers and are important support to the brand investment
program.

PRODUCTS

The Company produces a variety of styles of full-flavored craft beers using
traditional European brewing methods. The Company brews its beers using only
high-quality hops, malted barley, wheat, rye and other natural ingredients, and
does not use any rice, corn, sugar, syrups or other adjuncts. The Company's
beers are marketed on the basis of freshness and distinctive flavor profiles. To
help maintain full flavor, the Company's products are not pasteurized. As a
result, it is appropriate that they be kept cool so that oxidation and heat-
induced aging will not adversely affect the original taste, and that they be
distributed and served as soon as possible, generally within approximately three
months after packaging to maximize freshness and flavor. The Company distributes
its products only in glass bottles and kegs, and its products are freshness
dated for the benefit of consumers.

The Company presently produces eight principal brands, each with its own
distinctive combination of flavor, color and clarity:

Redhook E.S.B. The Company's flagship brand, Redhook E.S.B., which
accounted for approximately 64% of the Company's sales in 2000, is a full, rich,
well-rounded, amber-colored ale with a sweet toasted malt flavor balanced by a
pleasant floral/herbal liveliness derived from Tettnang hops.

Redhook India Pale Ale. A premium English pub-style bitter ale, Redhook IPA
is pale and aggressively hopped, has a brassy color imparted by caramelized
malt, an herbal aroma characteristic of Northwest Cascade hops, and a crisp
finish.

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Redhook Hefe-Weizen. This wheat beer is unfiltered and named hefe-weizen,
which means "wheat beer with yeast." Leaving the yeast in, instead of filtering
it out, accentuates the wheat flavor and adds visual appeal.

Blackhook Porter. A London-style Porter, Blackhook has an ebony tone, a
pleasant "toasted" character produced by highly roasted black barley, and a dark
malt flavor suggesting coffee and chocolate, balanced by lively hopping.

Double Black Stout. A rich, imperial stout using a variety of dark malts
creating a big roasty flavor that is rounded out with a touch of honey.

Redhook Blonde Ale. A delicious, thirst-quenching golden ale. The
combination of lightly roasted barley, subtle hops, and a touch of wheat create
perfectly balanced and distinctively drinkable ale. Blonde Ale is generally
available during the spring and summer months.

Winterhook. A rich seasonal holiday ale formulated specially each year for
cold-weather enjoyment, Winterhook typically is deep in color and rich in
flavor, with complex flavors and a warm finish. Winterhook is available during
the fall and winter months.

Redhook Nut Brown Ale. A malty ale with a hint of sweetness in the finish.
The combination of six barley malts and two hop varieties result in a
surprisingly smooth, well-balanced dark beer. Nut Brown Ale is available during
the late winter and early spring.

In an effort to be responsive to varying consumer style and flavor
preferences, the Company also periodically engages in the development and
testing of new products. The Company believes that the continued success of
craft brewers will be affected by their ability to be innovative and attentive
to consumer desires for new and distinctive taste experiences while maintaining
consistently high product quality. The Company may also consider producing
low-alcohol beer or other low-alcohol or nonalcoholic beverages (such as root
beer, fruit beers, craft sodas and ciders). The Company's
technologically-advanced breweries allow it to produce small-batch experimental
ales within three weeks. These experimental products are periodically developed
and typically produced in draft form only for on-premise test marketing at the
Company's pubs and selected retail sites. If the initial consumer reception of
an experimental brew is sufficiently positive, then its taste and formula are
refined, as necessary, and a new Redhook brand may be created. Redhook India
Pale Ale, Redhook Nut Brown Ale, and Double Black Stout are examples of products
that were developed in this manner. Other such products have included ales such
as Barley Wine, Honey Stout, Oatmeal Stout, Scotch Ale and Wit, and lagers such
as Marzen and Pilsner.

BREWING OPERATIONS

The Brewing Process. Beer is made primarily from four natural ingredients:
malted grain, hops, yeast and water. The grain most commonly used in brewing is
barley, owing to its distinctive germination characteristics, which make it easy
to ferment. The Company uses the finest barley malt, typically using strains of
barley having two rows of grain in each ear. A wide variety of hops may be used
to add seasoning to the brew; some varieties best confer bitterness, while
others are chosen for their ability to impart distinctive aromas to the beer.
Nearly all the yeasts used to induce or augment fermentation of beer are of the
species Saccharomyces cerevisiae, which includes both the top-fermenting yeasts
used in ale production and the bottom-fermenting yeasts associated with lagers.

The brewing process begins when the malt supplier soaks the barley grain in
water, thereby initiating germination, and then dries and cures the grain
through kilning. This process, known as "malting," breaks down complex
carbohydrates and proteins so that they can be easily extracted. The malting
process also imparts color and flavor characteristics to the grain. The cured
grain, referred to as "malt," is then sold to the brewery. At the brewery,
various malts are cracked by milling, and mixed with warm water. This mixture,
or "mash," is heated and stirred in the mash tun, allowing the simple
carbohydrates and proteins to be converted into fermentable sugars. Naturally
occurring enzymes help facilitate this process. The mash is then strained and
rinsed in the lauter tun to produce a residual liquid, high in fermentable
sugars, called "wort," which then flows into a brew kettle to be boiled,
concentrated and clarified. Hops are added during the boil to impart
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bitterness, balance and aroma. The specific mixture of hops and the brewing time
and temperature further affect the flavor of the beer. After the boil, the wort
is strained and cooled before it is moved to a fermentation cellar, where
specially cultured yeast is added to induce fermentation. During fermentation,
the wort's sugars are metabolized by the yeast cells, producing carbon dioxide
and alcohol. Some of the carbon dioxide is recaptured and absorbed back into the
beer, providing a natural source of carbonation. After fermentation, the beer is
cooled for several days while the beer is clarified and full flavor develops.
Filtration, the final step for a filtered beer, removes unwanted yeast. At this
point, the beer is in its peak condition and ready for bottling or keg racking.
The entire brewing process of ales, from mashing through filtration, is
typically completed in 14 to 21 days, depending on the formulation and style of
the product being brewed.

[Redhook Ale Brew Process Graphic]

Brewing Equipment. The Company uses only technologically advanced and
highly automated small-batch brewing equipment. The Woodinville Brewery employs
a 100-barrel mash tun; lauter tun; wort receiver; wort kettle; whirlpool kettle;
five 70,000-pound, one 35,000-pound and two 25,000-pound grain silos; two
100-barrel, fifty-four 200-barrel, and ten 600-barrel fermenters; and two
300-barrel and four 400-barrel bright tanks. The Portsmouth Brewery employs a
100-barrel mash tun; lauter tun; wort receiver; wort kettle; whirlpool kettle;
three 70,000-pound and two 35,000-pound grain silos; three 100-barrel and
sixteen 400-barrel fermenters; two 200-barrel and two 400-barrel bright tanks;
and an anaerobic waste-water treatment facility which completes the process
cycle. Both breweries use advanced microfiltration technology, including a
diatomaceous earth pad filter to eliminate unwanted yeast and to extend shelf
life.

In early 1998, operations at the Fremont Brewery were terminated, the
Fremont production assets were written down to an estimate of their net
realizable value. During 1999, the Company completed the sale of the equipment
for an amount approximately equal to its estimated net realizable value. See
discussion in Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

Bottling and Kegging. The Company packages its craft beers in both bottles
and kegs. Both of the Company's breweries have fully automated,
technologically-advanced bottling and keg lines. The bottle filler at each
brewery utilizes a carbon dioxide environment during bottling designed to ensure
that minimal oxygen is dissolved in the beer, thereby extending shelf life.
Redhook uses the latest keg technology, which is

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preferred by many draft beer retailers because the kegs are designed to be
easier to handle and lift, to consume less floor space, to have more consistent
flow and to reduce waste.

Quality Control. The Woodinville Brewery was designed to be the center of
the quality control and analysis function. The Company monitors production and
quality control at both of its breweries with central coordination at the
Woodinville Brewery. Both the Woodinville and Portsmouth breweries have an
on-site laboratory where microbiologists and lab technicians supervise on-site
yeast propagation, monitor product quality, test products, measure color and
bitterness, and test for oxidation and unwanted bacteria. The Company also
regularly utilizes independent laboratories for product analysis.

Ingredients and Raw Materials. The Company currently obtains all of its
malted barley from multiple suppliers and its premium-quality select hops, grown
in the Pacific Northwest, from competitive sources. The Company periodically
purchases small lots of European hops, which it uses to achieve a special hop
character in certain of its beers. Redhook believes that alternate sources of
malted barley and hops are available at competitive prices. In order to ensure
the supply of the hop varieties used in its products, the Company enters into
supply contracts for its hop requirements. The Company currently cultivates its
own Saccharomyces cerevisiae yeast supply. The Company has available to it
multiple competitive sources for packing materials, such as bottles, labels,
six-pack carriers, crowns and shipping cases.

PRODUCT DISTRIBUTION

Redhook's products are available for sale directly to consumers in draft
and bottles at restaurants, bars and liquor stores, as well as in bottles at
supermarkets, warehouse clubs and convenience stores. Like substantially all
craft brewers, the Company's products are delivered to these retail outlets
through a network of local distributors, whose principal business is the
distribution of beer and in some cases other alcoholic beverages, and who
traditionally have local distribution relationships with one or more national
beer brands. The Company, together with its distributors, markets its products
to retail outlets and relies on its distributors to provide regular delivery to
retailers, to maintain retail shelf space and to oversee timely rotation of
inventory to ensure the freshness of its products. The Company also offers its
products directly to consumers at the Company's three on-premise retail
establishments, the Trolleyman pub in Fremont, the Forecasters Public House in
Woodinville, and the Cataqua Public House in Portsmouth, New Hampshire.

In October 1994, the Company entered into the Distribution Alliance with
A-B pursuant to which Redhook distributes its products in new markets
exclusively through A-B's wholesale distribution network. If an A-B distributor
does not agree to carry the Company's products, the Company may select a non-A-B
distributor for that territory. The exclusivity provisions of the A-B
Distribution Agreement do not apply to territories currently subject to
distribution arrangements with non-Alliance distributors until such arrangements
expire. During 1996, Redhook changed the distribution in substantially all of
the significant markets previously served by non-A-B wholesalers to distribution
through the Alliance.

Prior to establishing the Alliance with A-B, the Company distributed its
products regionally through distributors, many of which were A-B affiliated, in
eight western states: Washington, California (northern), Oregon, Idaho, Montana,
Wyoming, Colorado and Alaska. The Company's most significant non-Alliance
wholesaler, K&L Distributors, Inc., an independent A-B distributor responsible
for distribution in most of King County, Washington, which includes Seattle,
accounted for approximately 16%, 17% and 17% of total sales in 2000, 1999 and
1998, respectively. As of December 31, 2000, the Company had 20 non-Alliance
distributors. The Company expects the percentage of sales represented by
non-Alliance distributors to continue to decline as the Company expands its
sales through the Alliance.

A-B, whose products accounted for approximately 48% of total domestic beer
sales by volume in 2000, distributes its products throughout the United States
through a network of over 700 wholesale distributors, which are for the most
part geographically contiguous and independently owned and operated. The Company
believes that the typical A-B distributor is financially stable and has both a
long-standing presence and a substantial market share of beer sales in its
territory.

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Redhook chose to align itself with A-B through the Alliance as an integral
part of its growth strategy, and to provide access to quality distribution
throughout the nation. Redhook was the first and is the largest independent
craft brewer to have a formal distribution agreement with a major U.S. brewer.
The Company believes that access to A-B's distribution network enabled it to
enter targeted new markets more rapidly and with more thorough penetration of
the available customer base in the territory. The Distribution Alliance allowed
the Company to retain control over the selection and timing of new market
introductions. The Company believes that the existence of the Alliance,
presentations by Redhook's management at A-B's distributor conventions, A-B
communications about Redhook in printed distributor materials, and A-B-supported
opportunities for Redhook to educate A-B distributors about its specialty
products result in increased awareness of and demand for Redhook products among
A-B's distributors.

The Company believes that local beer distribution territories have tended
to become dominated by a smaller number of distributors, generally those
carrying beers marketed by the larger national breweries, and that this
consolidation has had the effect of making it more difficult for relatively
small craft brewers to establish effective distribution networks with reliable
distributors. That belief is based upon distribution limitations on the number
of brands they can effectively manage and higher expectations for product
quality and consistency, and marketing support. Management believes that the
Company's competitors in the craft beer segment generally negotiate distribution
relationships separately with distributors in each locality and, as a result,
typically distribute through a variety of wholesalers representing differing
national beer brands with uncoordinated territorial boundaries. Because A-B's
distributors are assigned territories that generally are contiguous, the
Alliance enables the Company to reduce the gaps and overlaps in distribution
coverage often experienced by the Company's competitors. As a result, the
Company believes the Alliance provides the Company with significant advantages
over competitors in the craft beer industry, who generally are unable to achieve
the distribution efficiencies afforded by the Alliance network.

The Company's products were distributed in 48 states at the end of 2000. As
of December 31, 2000, the Company had 727 Alliance distributors, accounting for
approximately 68% of the Company's sales volume in 2000. In addition, sales to
non-Alliance A-B affiliated distributors accounted for 27% of the Company's
sales volume in 2000.

Under the Alliance, the Company is responsible for marketing its products
to A-B's distributors, as well as to retailers and consumers. The A-B
distributors then place orders with the Company, through A-B, for Redhook
products. The Company separately packages and ships the orders in refrigerated
trucks to the A-B distribution center nearest to the distributor or, under
certain circumstances, directly to the distributor. Generally, the Company sells
its products to A-B at the same list prices paid by non-Alliance distributors in
the respective markets, net of the Alliance fee. The Company pays an Alliance
fee to A-B, determined by a formula, that effectively reduces the total gross
profit margin earned on sales to A-B. However, management believes that the
benefits of the Alliance, particularly the potential for increased sales volume,
and efficiencies in delivery, state reporting and licensing, billing and
collections created by the Alliance are significant to the Company's business.

Under the Alliance, the Company has granted A-B the first right to
distribute Redhook products in the United States and Mexico, except in those
territories already subject to distribution agreements with non-Alliance
distributors, in which case such right does not commence until the existing
arrangements expire. A-B additionally has a first right to distribute new
Redhook products in non-Alliance territories. In exchange, prior to October
1997, A-B could not acquire an interest between 10% and 50% of the common stock
of, or distribute the products of, any other U.S.-based small brewer (producing
or distributing less than 1,000,000 barrels annually) that distributes beer in
those areas where the Company distributes its products, without the Company's
approval. After October 1997, if A-B were to agree to distribute the products of
any U.S.-based small brewer in areas where the Company's products are
distributed, without the Company's approval, the Alliance fee would be
substantially reduced on sales of Redhook products in such areas.

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SALES AND MARKETING

Based upon market and competitive considerations, in 1999 the Company
determined that a significant increase in media advertising was appropriate.
Accordingly, in June 1999 the Company began a brand investment program that
significantly increased advertising and related costs. The increased advertising
investment continued in 2000 and is expected to continue for the foreseeable
future with the objective of establishing or maintaining momentum towards
capturing a larger share of the fragmented craft beer market. This increased
media advertising has significantly increased the Company's selling, general and
administrative expenses in 1999 and 2000, leading to increased losses and a
reduction in stockholders' equity. In addition, market and competitive
considerations could require an increase in other promotional costs associated
with developing existing and new markets.

Prior to 1999, the Company had engaged in very limited media advertising to
market its products, choosing instead to stimulate consumer demand by educating
consumers and wholesalers as to the distinctive qualities of its products, and
by sponsoring localized promotions designed to enhance Redhook's word-of-mouth
reputation. The Company maintains a sales and marketing staff whose efforts are
focused principally on local promotions, programs for on-premise consumer and
retailer education, and distributor training and assistance. The Company seeks
to identify its products with local markets by participating in or sponsoring
cultural and community events, local music and other entertainment venues, local
craft beer festivals and cuisine events, and local professional sporting events,
as well as the limited use of print and billboard advertising.

The Company's sales and marketing staff also offers education, training and
other support to wholesale distributors of the Company's products. Because the
Company's wholesalers generally also distribute much higher-volume national beer
brands and commonly distribute other specialty brands, a critical function of
the sales and marketing staff is to elevate each distributor's awareness of the
Company's products and to retain the distributor's interest in promoting
increased sales of these products. This is accomplished primarily through
personal contact with each distributor, including on-site sales training,
educational tours of the Company's breweries and promotional activities and
expenditures shared with the distributors. The Company's sales representatives
also provide other forms of support to wholesale distributors, such as direct
contact with restaurant and grocery chain buyers, direct involvement in the
design of grocery store displays, stacking and merchandising of beer inventory
and supply of point-of-sale materials.

The Company's sales representatives devote considerable effort to the
promotion of on-premise consumption at participating pubs and restaurants. The
Company believes that educating retailers about the freshness and quality of the
Company's products will in turn allow retailers to assist in educating
consumers. The Company considers on-premise product sampling and education to be
among its most effective tools for building brand identity with consumers and
establishing word-of-mouth reputation. On-premise marketing is also accomplished
through a variety of other point-of-sale tools, such as neon signs, tap handles,
coasters, table tents, banners, posters, glassware and menu guidance. The
periodic distribution of the Company's experimental products in limited
quantities to selected pubs and restaurants is another example of on-premise
marketing designed to increase consumer awareness.

The Company's breweries also play a significant role in increasing consumer
awareness of the Company's products and enhancing Redhook's image as a regional
brewer. More than 24,000 visitors participated in tours at the Company's
breweries in 2000. Each of the Company's breweries has a retail pub on-site
where the Company's products are served. In addition, the breweries have meeting
rooms that the public can rent for business meetings, parties and holiday
events, and that the Company uses to entertain and educate distributors,
retailers and the media about the Company's products. See Item 2. "Properties."
The Company also sells various items of apparel and memorabilia bearing the
Company's trademarks at its pubs, which the Company believes create further
awareness of the Company's beers and reinforce the Company's quality image.

To further promote retail bottled product sales and in response to local
competitive conditions, the Company regularly offers "post-offs," or price
discounts, to distributors in most of its markets in response to local
competitive conditions. Distributors and retailers usually participate in the
cost of these price discounts.
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COMPETITION

The domestic market in which the Company's craft beers are sold is highly
competitive due to the proliferation of small craft brewers, including contract
brewers, the increase in the number of products offered by such brewers and the
introduction of fuller-flavored products by major national brewers. The Company
competes primarily with other participants in the craft beer segment, producers
of imported beers and mass-market national brewers. See "Industry Background."
The number of participants and number of different products offered in this
segment have increased significantly in recent years, thereby intensifying
competition for the bottled product placements and especially for draft beer
placements. Competition within the domestic craft beer segment is based on
product quality, taste, consistency and freshness; ability to differentiate
products; promotional methods and product support; transportation costs;
distribution coverage, local appeal and price. A significant portion of the
Company's past sales growth has been achieved through increasing sales in the
Pacific Northwest region, which the Company believes is one of the most
competitive craft beer markets in the United States in terms of number of market
participants and consumer awareness. Craft beers represented approximately 9% of
total beer sales in Washington during 2000 and the Company believes the market
share in Oregon to be comparable. Because of the strong demand for the Company's
products in this region, the Company has not historically encountered
significant pricing pressures relative to those found in other regions, although
regular "post-offs" are offered. In 1999, 1998 and 1997, the sales for the
Company, and many of its competitors, declined in Washington State compared to
1996. This trend was reversed as the Company's Washington State 2000 sales
volumes increased 7.6% compared to 1999.

As the Company expanded its distribution network outside the Pacific
Northwest region, and as other craft brewers expanded their distribution to the
Pacific Northwest, Redhook has encountered increasing competition from
microbreweries, other regional specialty brewers such as Sierra Nevada Brewing
Company and Anchor Brewing Company, as well as from contract brewers such as
Pete's Brewing Company and Boston Beer Company. Although certain of these
competitors distribute their products nationally and may have greater financial
and other resources than the Company, management believes that the Company
possesses certain competitive advantages, including its
technologically-advanced, company-owned production facilities and distribution
through the Alliance.

The Company also competes against producers of imported beers, such as
Becks, Heineken, Labatts, Modelo (Corona) and Molson. Most of these foreign
brewers have significantly more financial and other resources than the Company.
Although imported beers currently account for a much greater share of the U.S.
beer market than craft beers, the Company believes that regional craft brewers
possess certain competitive advantages over some importers, including lower
transportation and no importation costs, proximity to and familiarity with local
consumers, a higher degree of product freshness, eligibility for lower federal
excise taxes and absence of currency fluctuations.

In response to the growth of the craft beer segment, most of the major
domestic brewers have introduced fuller-flavored beers. Although these product
offerings are intended to compete with craft beers, many of them are brewed
according to methods used by the major national brewers. The Company believes
that certain of the major national brewers, with their superior financial
resources, access to raw materials and established distribution networks, may
seek further participation in the craft beer segment through the acquisition of
equity positions in, or the formation of distribution alliances with, existing
craft brewers. Although increased participation of the major national brewers
will likely increase competition for market share and heighten price sensitivity
within the craft beer segment, the Company believes that their participation
will tend to increase advertising, distribution and consumer education and
awareness of craft beers, and thus may contribute to further growth of this
industry segment.

REGULATION

The Company's business is highly regulated at federal, state and local
levels. Various permits, licenses and approvals necessary to the Company's
brewery and pub operations and the sale of alcoholic beverages are required from
various agencies, including the U.S. Treasury Department, Bureau of Alcohol,
Tobacco and Firearms (the "BATF"); the United States Department of Agriculture;
the United States Food and Drug

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Administration; state alcohol regulatory agencies in the states in which the
Company sells its products; and state and local health, sanitation, safety, fire
and environmental agencies. In addition, the beer industry is subject to
substantial federal excise taxes, although the Company benefits from favorable
treatment granted to brewers producing less than 2 million barrels per year.

Management believes that the Company currently has all licenses, permits
and approvals necessary for its current operations. However, existing permits or
licenses could be revoked if the Company were to fail to comply with the terms
of such permits or licenses, and additional permits or licenses could in the
future be required for the Company's existing or expanded operations. If
licenses, permits or approvals necessary for the Company's brewery or pub
operations were unavailable or unduly delayed, or if any such permits or
licenses were revoked, the Company's ability to conduct its business could be
substantially and adversely affected.

Alcoholic Beverage Regulation and Taxation

Each of the Company's breweries and pubs is subject to licensing and
regulation by a number of governmental authorities. The Company operates its
breweries under federal licensing requirements imposed by the BATF. The BATF
requires the filing of a "Brewer's Notice" upon the establishment of a
commercial brewery. In addition, commercial brewers are required to file an
amended Brewer's Notice every time there is a material change in the brewing
process or brewing equipment, change in the brewery's location, change in the
brewery's management or a material change in the brewery's ownership. The
Company's operations are subject to audit and inspection by the BATF at any
time.

In addition to the regulations imposed by the BATF, the Company's breweries
are subject to various regulations concerning retail sales, pub operations,
deliveries and selling practices in states in which the Company sells its
products. Failure by the Company to comply with applicable federal or state
regulations could result in limitations on the Company's ability to conduct its
business. The BATF's permits can be revoked for failure to pay taxes, to keep
proper accounts, to pay fees, to bond premises, and to abide by federal
alcoholic beverage production and distribution regulations, or if holders of 10%
or more of the Company's equity securities are found to be of questionable
character. Permits from state regulatory agencies can be revoked for many of the
same reasons.

The U.S. federal government currently imposes an excise tax of $18 per
barrel on beer sold for consumption in the United States. However, any brewer
with production under 2 million barrels per year instead pays federal excise tax
in the amount of $7 per barrel on the first 60,000 barrels it sells annually.
While the Company is not aware of any plans by the federal government to reduce
or eliminate this benefit to small brewers, any such reduction in a material
amount could have an adverse effect on the Company. In addition, the Company
would lose the benefit of this rate structure if it exceeds the 2 million barrel
production threshold. Individual states also impose excise taxes on alcoholic
beverages in varying amounts, which have also been subject to change. It is
possible that excise taxes will be increased in the future by both the federal
government and several states. In addition, increased excise taxes on alcoholic
beverages have in the past been considered in connection with various
governmental budget-balancing or funding proposals. Any such increases in excise
taxes, if enacted, could adversely affect the Company.

State and Federal Environmental Regulation

The Company's brewery operations are subject to environmental regulations
and local permitting requirements and agreements regarding, among other things,
air emissions, water discharges and the handling and disposal of wastes. While
the Company has no reason to believe the operations of its facilities violate
any such regulation or requirement, if such a violation were to occur, the
Company's business may be adversely affected. In addition, if environmental
regulations were to become more stringent in the future, the Company could be
adversely affected.

Dram Shop Laws

The serving of alcoholic beverages to a person known to be intoxicated may,
under certain circumstances, result in the server's being held liable to third
parties for injuries caused by the intoxicated customer. The
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Company's pubs have addressed this concern by establishing early closing hours
and employee training and designated-driver programs. Large uninsured damage
awards against the Company could adversely affect the Company's financial
condition.

RELATIONSHIP WITH ANHEUSER-BUSCH, INCORPORATED

In October 1994, the Company entered into the Alliance with A-B. The
Alliance consists of a long-term national distribution agreement (the "A-B
Distribution Agreement") and an investment by A-B in the Company (the "A-B
Investment Agreement"). The Alliance gives the Company access to A-B's domestic
network of over 700 wholesale distributors, while the Company maintains control
over the production and marketing of its products. Pursuant to the A-B
Investment Agreement, A-B invested approximately $30 million to purchase the
Company's Series B Preferred Stock (the "Series B Preferred Stock") and common
stock of the Company ("Common Stock"), including newly-issued shares concurrent
with the Company's initial public offering.

A-B Distribution Agreement

The A-B Distribution Agreement has a stated term of 20 years, but is
subject to earlier termination (i) by either party without cause on December 31,
2004, (ii) by either party upon an uncured material breach by the other party of
certain provisions of the Series B Preferred Stock, the A-B Investment
Agreement, the A-B Distribution Agreement and certain related A-B investment
documents, or upon the insolvency of the other party, (iii) by A-B upon (a)
acquisition by another large alcoholic beverage competitor of 10% or greater
equity ownership of the Company and a seat on the Company's Board of Directors
or (b) a deterioration of the Company's financial condition that results from a
change in ownership of the Company and materially adversely affects its ability
to perform under the A-B Distribution Agreement, or (iv) by A-B following (a)
any action by the Company that in A-B's sole determination damages the
reputation or image of A-B or the brewing industry (for example, production of a
high-alcohol beer, defamation of A-B or its products or contamination of the
Company's products, but not poor operating results, an unsuccessful product
introduction or competition with A-B's products), (b) any acquisition of,
agreement to acquire, or institution of a tender or exchange offer to acquire a
percentage of the Company's equity securities equal to or greater than that held
by A-B, (c) certain agreements pursuant to which the Company would merge into or
consolidate with another corporation or sell substantially all of its assets or
certain of its trademarks, or (d) the failure to appoint a successor acceptable
to A-B in the event Paul S. Shipman ceases to function as the Company's Chief
Executive Officer. The term "Extraordinary Termination" refers to the
termination by A-B of the A-B Distribution Agreement for any of the reasons
described under clause (iv) above.

In the event that the A-B Distribution Agreement is terminated on or before
December 31, 2004, under the circumstances described in (i), (iii) or (iv)
above, or by A-B under the circumstances described in (ii) above, the terms of
the Series B Preferred Stock purchased by A-B pursuant to the A-B Investment
Agreement (see A-B Investment Agreement below) require the mandatory redemption
of the Series B Preferred Stock on December 31, 2004, at a redemption price
equal to $12.61 per share (approximately $16.3 million in the aggregate), plus
an amount equal to accumulated and unpaid dividends thereon, from legally
available funds.

A-B Investment Agreement

Pursuant to the A-B Investment Agreement, A-B purchased 236,756 shares of
Common Stock for $7.00 per share in October 1994 and 1,289,872 shares of Series
B Preferred Stock for $12.61 per share in November 1994.

A-B Preemptive Rights. Pursuant to the A-B Investment Agreement, A-B
exercised its right in connection with the Company's public offering in August
1995 to purchase 716,714 shares of Common Stock at $17.00 per share in order to
maintain its 25% ownership percentage of the Common Stock on a Fully Diluted
Basis (as defined below). A-B has no further preemptive rights.

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A-B Standstill and Transfer Restrictions. Pursuant to the A-B Investment
Agreement, A-B has agreed that neither it nor its affiliates will acquire any
Common Stock, or any option, right or warrant to acquire, or security
convertible or exchangeable into Common Stock, if such purchase or acquisition
would result in A-B and its affiliates holding in the aggregate in excess of 30%
(prior to November 16, 2001) of the outstanding shares of Common Stock,
calculated on a Fully Diluted Basis (the "A-B Standstill"). Certain increases in
A-B's beneficial ownership resulting from involuntary acquisitions or decreases
in the number of outstanding shares are excluded from the A-B Standstill.

The A-B Standstill terminates prior to November 16, 2001 if (i) any person
unaffiliated with A-B directly or indirectly: (a) becomes a beneficial owner of,
or enters into an agreement to acquire, commences a tender offer or exchange
offer to acquire, or announces the intention to acquire and, in A-B's reasonable
judgment, has a reasonable likelihood of acquiring as a result thereof, 30% or
more of the outstanding shares of Common Stock, calculated on a Fully Diluted
Basis; (b) enters into an agreement to consolidate with the Company, to have the
Company merged into or with it or to enter into a share exchange with the
Company (other than any merger, consolidation or share exchange in which the
holders of the Company's outstanding voting securities immediately preceding
such transaction will, immediately after such transaction, own capital stock
possessing more than 50% of the aggregate voting power and economic rights of
the outstanding capital stock of the entities surviving such transaction); or
(c) enters into an agreement to acquire all or substantially all of the
Company's assets or certain trademarks or trade names; (ii) the Company
announces its intention to enter into any agreement described above; or (iii) at
any time continuing directors (defined as directors as of the date of the
Company's initial public offering, directors subsequently elected whose
nomination was approved by a majority of the continuing directors, and directors
designated by A-B) cease to constitute at least a majority of the Company's
Board of Directors. If the A-B Standstill is terminated but the underlying
transaction giving rise to termination of the A-B Standstill does not in fact
transpire, the A-B Standstill will be reinstated as if such event had not
occurred if A-B has not increased its ownership above the standstill limitation
in the interim.

The A-B Investment Agreement further provides that, to the extent A-B's
ownership exceeds the limits permitted under the A-B Standstill as the result of
a rights offering while such obligations are still in effect, A-B will, in
certain circumstances, take steps to divest itself of such shares no later than
the later of (i) one year from the date of such purchase or acquisition and (ii)
the earliest period in which such shares may be sold pursuant to Rule 144 under
the Securities Act of 1933, as amended.

The A-B Investment Agreement imposes further restrictions on A-B's ability
to transfer Series B Preferred Stock and Common Stock, including, subject to
certain exceptions (including sales of less than 3% of the outstanding Common
Stock, or sales pursuant to the exercise of registration rights), a limited
right of first refusal in favor of the Company on proposed sales of Common Stock
by A-B, an outright prohibition of sales by A-B of more than 12.5% of the Common
Stock on a Fully Diluted Basis to any single person or group, or of any Common
Stock to brewers of malt beverages, and a prohibition on any sale of Series B
Preferred Stock prior to an Extraordinary Termination of the A-B Distribution
Agreement.

A-B Board Representation. Under the A-B Investment Agreement, A-B has the
right to designate a number of nominees based on its percentage ownership, but
not less than two, so long as A-B holds at least 20% of the Common Stock on a
Fully Diluted Basis (which number will be rounded up to the next highest whole
number if not a whole number). A-B's percentage ownership on a "Fully Diluted
Basis," as defined in the A-B Investment Agreement is calculated based on the
assumption that all outstanding shares of Series B Preferred Stock and other
convertible securities are converted into Common Stock, that all outstanding
warrants and stock options (other than stock options granted to officers,
directors and employees under the Company's option plans) have been exercised in
full, and that all holdings of A-B and its affiliated companies are aggregated.
Currently, there are no outstanding options or warrants that would be included
in the calculation of outstanding shares on a Fully Diluted Basis. The Company
is obligated to use reasonable efforts to cause the election of the nominees
designated by A-B. If the designees are not elected, the Company is obligated to
take certain remedial measures, and A-B is entitled to elect the same number of
directors by class voting under the terms of the Series B Preferred Stock. A-B
also has a contractual right to have one of its Board designees sit on each
committee of the Company's Board of Directors.
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Covenants Binding the Company. The Company has agreed, pursuant to the A-B
Investment Agreement, that it will not, without A-B's consent, (i) enter into
any acquisition or investment transaction involving an aggregate purchase price
exceeding 50% of the book value of the Company's assets prior to such
transaction; (ii) enter into any transaction involving the transfer of specified
trademarks or trade names or of assets representing more than 50% of the book
value of the Company's assets prior to such transaction; (iii) issue or sell to
any person (including A-B), or amend its capital structure to authorize the
issuance of, equity securities except within certain permitted categories,
including pursuant to (a) the conversion of the Series B Preferred Stock, (b) a
stock split or the exercise of any outstanding option, (c) the issuance of
Common Stock in an initial public offering not exceeding 25% of the Common Stock
outstanding (assuming conversion of all Preferred Stock) as of the closing date
for the sale of the Series B Preferred Stock to A-B, (d) other issuances not
exceeding in the aggregate 20% of the shares of Common Stock and Series B
Preferred Stock (as if converted) outstanding at the beginning of each two-year
period commencing on January 1, 1995 and on January 1 of every second year
thereafter, and (e) issuances under certain antitakeover plans; (iv) authorize
or issue any shares of capital stock ranking equal or prior to the Series B
Preferred Stock as to dividend or liquidation rights, or entitled to more than
one vote per share or to class voting on any matter (except as required by
Washington corporation law) or to ordinary voting power in the election of
directors (other than Common Stock), or authorize or issue any new class or
series of common shares; (v) issue or sell any equity securities to persons
having revenues of $100 million or more from the production or distribution of
alcoholic beverages in North and South America; (vi) afford to any other person
or group the right to designate a number of the Company's directors equal to or
greater than the largest number A-B is contractually entitled to designate;
(vii) enter into any transaction with any affiliate of the Company except under
certain circumstances; (viii) engage in any material respect in any business
other than producing and distributing beverages; (ix) enter into a merger,
consolidation or share exchange with another corporation, except for
transactions meeting multiple criteria (including, among others, survival of the
Company and no change in control); or (x) amend its Articles or Bylaws in
certain respects.

These covenants, as well as A-B's contractual Board and committee
representation rights, terminate upon the earliest of (i) a reduction in the
ownership of A-B and its affiliates to less than the greater of (a) 610,000
shares of Common Stock (assuming conversion and exercise of all convertible
securities, options and warrants and ignoring any stock split or other
recapitalization) and (b) 7.5% of the Common Stock calculated on a Fully Diluted
Basis, (ii) an increase in the ownership of A-B and its affiliates to more than
30% of the Common Stock calculated on a Fully Diluted Basis, (iii) an
Extraordinary Termination of the A-B Distribution Agreement, (iv) termination of
the A-B Distribution Agreement by Redhook on the basis of an uncured breach by,
or insolvency of, A-B, and (v) termination of the A-B Distribution Agreement by
either party at the end of 2004 or the expiration thereof at the end of 2014.

TRADEMARKS

The Company has obtained U.S. trademark registrations for the marks and
corresponding logo designs for: Ballard Bitter, Blackhook, Redhook, Redhook ESB,
Wheathook, Winterhook, Double Black Stout and Blueline. The Company has also
obtained U.S. trademark registrations for Forecasters, Trolleyman, and Cataqua.
The Redhook mark and certain other Company marks are also registered or pending
in various foreign countries. The Company regards its Redhook and other
trademarks as having substantial value and as being an important factor in the
marketing of its products. The Company is not aware of any infringing uses that
could materially affect its current business or any prior claim to the
trademarks that would prevent the Company from using such trademarks in its
business. The Company's policy is to pursue registration of its marks in its
markets whenever possible and to oppose vigorously any infringement of its
marks.

EMPLOYEES

At December 31, 2000, the Company had 192 employees, including 56 in
production, 78 in the pubs, 45 in sales and marketing, and 13 in administration.
Of these, 1 in production, 44 in the pubs and 8 in sales and marketing are
part-time employees. The Company believes its relations with its employees to be
good.

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ITEM 2. PROPERTIES

The Company currently operates two technologically-advanced, highly
automated small-batch breweries, one in the Seattle suburb of Woodinville,
Washington and the other in Portsmouth, New Hampshire. See Notes 3, 4 and 10 of
the Notes to Financial Statements included elsewhere herein.

The Fremont Brewery. In June 1987, the Company leased the historic Fremont
brewery building and hired German brewery engineers to design and install a
brewery to meet its special requirements. Production began in 1989 with an
annual capacity of approximately 30,000 barrels. As the result of further
expansion that included construction of a kegging and warehousing facility,
capacity increased in stages to approximately 75,000 barrels per year by 1993.
In January 1998, production at the Fremont Brewery was significantly reduced and
the brewery served as a backup facility to the Woodinville Brewery. During the
quarter ended June 30, 1998, the Company analyzed its current and future
production capacity requirements and its plans for the Fremont Brewery
production assets. Based upon that analysis, the Company decided to permanently
curtail the Fremont Brewery operations and sell substantially all of those
production assets. In compliance with Financial Accounting Standards Board
("FASB") Statement No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of ("Statement 121"), the Fremont
production assets were written down to an estimate of their net realizable value
in the quarter ended June 30, 1998. The write-down was recorded through a
non-cash valuation provision totaling $5.2 million. The special valuation
provision, net of the related income tax benefit, totaled $3.4 million. The
Company leases the brewery building, which covers approximately 26,000 square
feet. The brewery building is currently occupied by the Trolleyman pub and the
Company's corporate offices. The lease expires in October 2002, unless the
five-year extension option is exercised. The Company previously leased
approximately 7,600 square feet of adjacent office space under a lease that
originally expired in 2001. During 1998, the Company exercised its option to
terminate that lease and moved its corporate offices into the Fremont Brewery
building. Adjacent to the Fremont Brewery, the Company owned a warehousing
facility and land, which was used as the keg filling, storage and shipping
facility prior to curtailing the Fremont Brewery operations. In July 2000, the
Company sold the real estate parcel for approximately $1.7 million in cash and
recorded a gain of approximately $1.0 million for the quarter ended September
30, 2000.

The Woodinville Brewery. In 1993, the Company acquired approximately 22
acres (17 of which are developable) in Woodinville, Washington, a suburb of
Seattle, to build a second brewery and packaging facility. The site is across
the street from the Chateau Ste. Michelle Winery, next to the Corus Brands
Winery and visible from a popular bicycle path. The Woodinville Brewery is
housed in an approximately 88,000 square-foot building that currently includes a
100-barrel brewhouse, fermentation cellars, filter rooms, grain storage silos, a
bottling line, dry storage, a cooler, a water pre-treatment system and loading
docks. This building also includes a retail merchandise outlet and the
Forecasters Public House, a 4,000 square-foot family-oriented pub that seats 200
and features an outdoor beer garden that seats an additional 200. This brewery
also has a 4,000 square-foot special events room accommodating up to 250 people.
The Woodinville Brewery began limited operations in September 1994 with an
annual capacity of approximately 60,000 barrels. Completion of an outdoor tank
farm during 1996 brought the Woodinville Brewery to its maximum designed
production capacity of approximately 250,000 barrels per year. During 1997, the
Company completed construction of a 40,000 square-foot keg filling, cold
storage, distribution and office facility adjacent to the brewery building.

The Portsmouth Brewery. In May 1995, the Company subleased approximately 23
acres in Portsmouth, New Hampshire to build a brewery and a bottling and kegging
facility to supply eastern U.S. markets. The sublease expires in 2047, and
contains two seven-year extension options. The Portsmouth Brewery is modeled
after the Woodinville Brewery and is similarly equipped, but is larger in
design, covering 125,000 square feet to accommodate all phases of the Company's
brewing operations under one roof. Included is a retail merchandise outlet, the
Cataqua Public House, a 4,000 square-foot family-oriented pub with an outdoor
beer garden, and a special events room accommodating up to 250 people.
Production began in late October 1996, with an initial capacity of approximately
100,000 barrels per year. The Company plans to phase in additional capacity as
needed, up to the maximum designed production capacity of approximately 250,000
barrels per year.

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ITEM 3. LEGAL PROCEEDINGS

The Company is involved from time to time in claims, proceedings and
litigation arising in the normal course of business. The Company believes that
any pending or threatened litigation involving the Company or its properties
will not likely have a material adverse effect on the Company's financial
condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY

Paul S. Shipman (48) -- President, Chief Executive Officer and Chairman of the
Board

Mr. Shipman is one of the Company's founders and has served as its
President since September 1981, Chairman of the Board since November 1992, and
Chief Executive Officer since June 1993. Prior to founding the Company, Mr.
Shipman was a marketing analyst for the Chateau Ste. Michelle Winery from 1978
to 1981. Mr. Shipman received his Bachelor's degree in English from Bucknell
University in 1975 and his Master's degree in Business Administration from the
Darden Business School, University of Virginia, in 1978.

David J. Mickelson (41) -- Executive Vice President, Chief Financial Officer
and Chief Operating Officer

Mr. Mickelson was named Chief Financial Officer in August 2000 in addition
to his position of Executive Vice President and Chief Operating Officer, which
he has held since March 1995. From April 1994 to March 1995 he was the Company's
Vice President and General Manager. From July 1992 to December 1994, he served
as its Chief Financial Officer, and was also named General Manager in January
1994. He served as the Company's Controller from 1987 to July 1992, and
additionally was elected Treasurer in 1989. From 1985 to 1987 he was the
Controller for Certified Foods, Inc. and from 1981 to 1985 served as a loan
officer with Barclays Bank PLC. Mr. Mickelson received his Bachelor's degree in
Business Administration from the University of Washington in 1981.

Gregory J. Marquina (46) -- Vice President, Sales

Mr. Marquina joined the Company in August 2000 as Vice President, Sales.
From 1993 to 2000, he was a principal of Coast Distributing Company, an A-B
distributor in San Diego, California. From March 1979 to May 1993, Mr. Marquina
held several management positions for A-B, including Division Manager So.
California (1989 - 1993), Division Manager Northwest (1986 - 1989), Region
Marketing Coordinator (1983 - 1986), Region Administrator (1981 - 1983), and
District Manager (1979 - 1981). Mr. Marquina served as Product Manager from 1977
to 1979, and Regional Account Manager from 1976 to 1977, both with Armour Food
Co. He received his Bachelor's degree in Business Administration from the
University of Oregon in 1976.

Pamela J. Hinckley (47) -- Vice President, Marketing

Ms. Hinckley has served as Vice President, Marketing since August 2000, and
from March 1995 to May 1996. From June 1996 to July 2000, Ms. Hinckley served as
the Company's Vice President, Sales and Marketing. She served as the Company's
Marketing Director from August 1992 to March 1995 and its Retail Tourism Manager
from August 1988 to August 1992. From 1984 to 1988, she was the wine buyer for a
Seattle-area specialty food and wine retailer and from 1982 to 1984 she was the
retail and tourism manager for Stevenot Winery. Ms. Hinckley received her
Bachelor's degree in Psychology from Suffolk University in 1974.

Allen L. Triplett (42) -- Vice President, Brewing

Mr. Triplett has served as Vice President, Brewing since March 1995. From
1987 to March 1995 he was the Company's Production Manager. He has worked in
virtually every facet of production since joining the Company in 1985. Mr.
Triplett has taken extensive coursework at the Siebel Institute of Brewing and
the University of California at Davis. He received his Bachelor's degree in
Petroleum Engineering from the University of Wyoming in 1985.

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18

PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company effected its initial public offering of Common Stock on August
16, 1995, and since that date the Company's Common Stock has traded on the
Nasdaq National Market. The table below sets forth, for the fiscal quarters,
indicated the reported high and low sale prices of the Company's Common Stock,
as reported on the Nasdaq National Market.

HIGH LOW
------ ------

2000
First quarter............................................ $3.750 $1.750
Second quarter........................................... $2.000 $1.156
Third quarter............................................ $1.938 $1.438
Fourth quarter........................................... $1.875 $1.375

1999
First quarter............................................ $6.563 $4.500
Second quarter........................................... $4.625 $3.625
Third quarter............................................ $4.094 $2.750
Fourth quarter........................................... $3.375 $1.875

As of March 17, 2001, there were 826 recordholders of Common Stock,
although the Company believes that the number of beneficial owners of its Common
Stock is substantially greater.

The Company has not paid any dividends, other than a one-time extraordinary
dividend in 1994 from the proceeds of the sale of Series B Preferred Stock to
A-B. That dividend totaled $9,071,354 ($2.00 per share) and was paid on all
Series A Preferred Stock and common shares outstanding (except those owned by
A-B). The Company anticipates that for the foreseeable future, all earnings, if
any, will be retained for the operation and expansion of its business and that
it will not pay cash dividends. The payment of dividends, if any, in the future
will be at the discretion of the Board of Directors and will depend upon, among
other things, future earnings, capital requirements, restrictions in future
financing agreements, the general financial condition of the Company and general
business conditions. Payment of dividends is also restricted by terms of the
Series B Preferred Stock.

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ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data should be read in conjunction with
the Company's Financial Statements and the Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Form 10-K. The selected statement of operations and
balance sheet data for, and as of the end of, each of the five years in the
period ended December 31, 2000, are derived from the financial statements of the
Company. The operating data are derived from unaudited information maintained by
the Company.

YEAR ENDED DECEMBER 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)

STATEMENT OF OPERATIONS DATA:
Sales............................................ $37,837 $35,459 $35,962 $37,894 $39,410
Less Excise Taxes................................ 3,425 3,265 3,321 3,608 3,732
------- ------- ------- ------- -------
Net Sales........................................ 34,412 32,194 32,641 34,286 35,678
Cost of Sales.................................... 24,581 22,613 23,917 25,963 23,581
------- ------- ------- ------- -------
Gross Profit..................................... 9,831 9,581 8,724 8,323 12,097
Special Valuation Provision(1)................... -- -- 5,173 -- --
Selling, General and Administrative Expenses..... 11,747 11,290 9,086 9,981 7,853
------- ------- ------- ------- -------
Operating Income (Loss).......................... (1,916) (1,709) (5,535) (1,658) 4,244
Interest Expense................................. 593 533 679 378 --
Other Income (Expense), Net...................... 1,453 (49) 127 93 615
------- ------- ------- ------- -------
Income (Loss) Before Income Taxes................ (1,056) (2,291) (6,087) (1,943) 4,859
Income Tax Provision (Benefit)................... (328) (768) (2,076) (544) 1,773
------- ------- ------- ------- -------
Net Income (Loss)................................ $ (728) $(1,523) $(4,011) $(1,399) $ 3,086
======= ======= ======= ======= =======
Basic Earnings (Loss) per Share.................. $ (0.10) $ (0.20) $ (0.52) $ (0.18) $ 0.40
Diluted Earnings (Loss) per Share................ $ (0.10) $ (0.20) $ (0.52) $ (0.18) $ 0.34
OPERATING DATA (IN BARRELS):
Beer Shipped..................................... 212,600 197,600 202,300 214,600 224,700
Production Capacity, End of Period(2)............ 350,000 350,000 350,000 425,000 425,000

DECEMBER 31,
-----------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------- ------- -------

BALANCE SHEET DATA (IN THOUSANDS):
Cash and Cash Equivalents........................ $ 7,487 $ 5,463 $ 3,010 $ 892 $ 1,162
Working Capital.................................. 4,817 2,635 1,666 1,338 850
Total Assets..................................... 85,621 87,707 89,528 96,769 95,124
Long-term Debt, Net of Current Portion........... 6,975 7,425 7,875 9,874 6,191
Convertible Redeemable Preferred Stock........... 16,099 16,055 16,011 15,966 15,922
Common Stockholders' Equity...................... 54,502 55,859 57,326 61,298 62,630

- ---------------
(1) Represents a non-cash valuation provision to write-down Fremont production
assets. See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

(2) Based on the Company's estimate of normal production capacity of equipment
installed as of the end of such period. Amounts do not reflect maximum
designed production capacity. See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations."

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20

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis should be read in conjunction with
the Company's Financial Statements and Notes thereto included herein.

OVERVIEW

Since its formation, the Company has focused its business activities on the
brewing, marketing and selling of craft beers. For the year ended December 31,
2000, the Company had gross sales of $37,837,000, an increase of 6.7% from 1999.
The Company believes that period-to-period comparisons of its financial results
should not be relied upon as an accurate indicator of future performance. The
Company's sales consist predominantly of sales of beer to third-party
distributors and A-B through the Distribution Alliance. In addition, the Company
derives other revenues from sources including the sale of beer, food, apparel
and other retail items in its brewery pubs. The Company is required to pay
federal excise taxes on sales of its beer. The excise tax burden on beer sales
increases from $7 to $18 per barrel on annual sales over 60,000 barrels and
thus, if sales volume increases, federal excise taxes would increase as a
percentage of sales.

The Company's sales volume (shipments) increased 7.6% in 2000, compared to
1999. In addition to the level of consumer demand in existing markets, the
Company's sales are also affected by other factors such as competitive
considerations, including the significant number of craft brewers and their
promotional pricing and new product introductions as well as increased
competition from imported beers. Sales in the craft beer industry generally
reflect a degree of seasonality, with the first and fourth quarters historically
being the slowest and the rest of the year typically demonstrating stronger
sales. The Company has historically operated with little or no backlog, and its
ability to predict sales for future periods is limited.

Under normal circumstances, the Company generally operates its brewing
facilities up to five days per week, multiple shifts per day. The Company
increased its company-wide annual production capacity from approximately 3,000
barrels in 1982 to approximately 350,000 barrels as of December 31, 2000.
Production capacity of each facility can be added in phases until the facility
reaches its maximum designed production capacity. The decision to add capacity
is affected by the availability of capital, construction constraints and
anticipated sales in new and existing markets. While the maximum designed
capacity for each of the Woodinville and Portsmouth breweries is 250,000 barrels
per year, the current production capacity is 250,000 and 100,000 barrels per
year, respectively. Additional capital expenditures and production personnel
would be required to bring the Portsmouth Brewery to its maximum designed
capacity.

The Company's capacity utilization has a significant impact on gross
profit. When facilities are operating at their maximum designed production
capacities, profitability is favorably affected by spreading fixed and
semivariable operating costs, such as depreciation and production salaries, over
a larger sales base. Most capital costs associated with building a new brewery,
and fixed and semivariable costs related to operating a new brewery, are
incurred prior to, or upon commencement of, production at a facility. Because
the actual production level is currently substantially below the facility's
maximum designed production capacity, gross margins are negatively impacted.
This impact is reduced when actual production increases.

In January 1998, production at the Fremont Brewery was significantly
reduced, and the brewery served as a backup facility to the Woodinville Brewery.
During the quarter ended June 30, 1998, the Company analyzed its current and
future production capacity requirements and its plans for the Fremont Brewery
production assets. Based upon that analysis, the Company decided to permanently
curtail the Fremont Brewery operations and sell substantially all of those
production assets. In compliance with FASB Statement No. 121, the Fremont
production assets were written down to an estimate of their net realizable value
in the quarter ended June 30, 1998. During 1999, the Company completed the sale
of the equipment for an amount approximately equal to its estimated net
realizable value. During July 2000, the Company sold a real estate parcel which
was previously used as the Fremont Brewery keg filling, storage and shipping
facility. The parcel was sold for approximately $1.7 million in cash and the
resulting gain of approximately $1.0 million is reflected in Other Income
(Expense) -- Net in the statements of operations for the year ended December 31,
2000.

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21

In addition to capacity utilization, the Company expects other factors to
influence profit margins, including higher costs associated with the development
of newer distribution territories, such as increased shipping, marketing and
sales personnel costs; fees related to the distribution agreement with A-B;
changes in packaging and other material costs; and changes in product sales mix.

See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Certain Considerations: Issues and Uncertainties."

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain items
from the Company's Statements of Operations expressed as a percentage of net
sales.

YEAR ENDED DECEMBER 31,
-----------------------
2000 1999 1998
----- ----- -----

Sales............................................... 110.0% 110.1% 110.2%
Less Excise Taxes................................... 10.0 10.1 10.2
----- ----- -----
Net Sales........................................... 100.0 100.0 100.0
Cost of Sales....................................... 71.4 70.2 73.3
----- ----- -----
Gross Profit........................................ 28.6 29.8 26.7
Special Valuation Provision......................... -- -- 15.8
Selling, General and Administrative Expenses........ 34.2 35.1 27.8
----- ----- -----
Operating Income (Loss)............................. (5.6) (5.3) (16.9)
Interest Expense.................................... 1.7 1.7 2.1
Other Income (Expense) -- Net....................... 4.2 (0.1) 0.4
----- ----- -----
Income (Loss) before Income Taxes................... (3.1) (7.1) (18.6)
Income Tax Provision (Benefit)...................... (1.0) (2.4) (6.3)
----- ----- -----
Net Income (Loss)................................... (2.1)% (4.7)% (12.3)%
===== ===== =====

YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999

Sales. Total sales increased 6.7% to $37,837,000 in 2000, compared to
$35,459,000 in 1999, attributable to a 7.6% increase in barrels sold and an
increase in other sales offset by a slight decrease in average beer prices.
Total sales volume in 2000 increased to 212,600 barrels from 197,600 barrels in
1999. West Coast sales increased 4.5% in 2000, including a 7.6% increase in
Washington State, the Company's largest market. The competitive landscape has
been affected by the number of craft beer companies, their promotional pricing
and new product introductions, as well as increased competition from imported
beers. Sales other than wholesale beer sales, primarily retail pub revenues,
totaled $4,144,000 in 2000, compared to $3,743,000 in 1999. At December 31, 2000
and 1999, the Company's products were distributed in 48 states.

Excise Taxes. Excise taxes increased to $3,425,000, or 10.0% of net sales
in 2000, compared to $3,264,000, or 10.1% of net sales in 1999. In September
2000, Washington State regulations were modified to require beer taxes
previously paid by Washington State brewers now be paid by Washington State
distributors, the effect of which was to decrease sales prices charged
distributors and decrease excise taxes in 2000, resulting in a slight decrease
in both sales and excise taxes as a percentage of net sales.

Cost of Sales. Cost of sales increased 8.7% to $24,581,000 in 2000,
compared to $22,613,000 in 1999, primarily due to higher sales volume, increased
raw material costs and freight charges, and a shift in the product mix towards
increasing proportion of 12-pack sales. Cost of sales, as a percentage of net
sales, increased to 71.4% in 2000, compared to 70.2% in 1999. The combined
utilization rate of maximum designed capacity for the operating breweries was
42.5% and 39.5% for years ended December 31, 2000 and 1999, respectively.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $11,747,000 in 2000, compared to
$11,290,000 in 1999 due to the decision to add several new sales positions in

19
22

important geographic markets. Expenditures for the brand investment advertising
program, which began in mid-1999 and continued in 2000, totaled $2.4 million and
$2.5 million for the years ended December 31, 2000 and 1999, respectively. As a
percentage of net sales, selling, general and administrative expenses were 34.2%
and 35.1% for years ended December 31, 2000 and 1999, respectively.

Interest Expense. Interest expense increased to $594,000 in 2000, compared
to $533,000 in 1999, reflecting higher average interest rates partially offset
by the effect of lower outstanding debt.

Other Income (Expense) -- Net. Other income increased to $1,453,000 in 2000
compared to a net expense of $(48,000) in 1999. The 2000 period includes a gain
of approximately $1.0 million resulting from the sale of a real estate parcel
which was previously used as the Fremont Brewery keg filling, storage and
shipping facility. The 1999 period includes a non-cash loss of $260,000 related
to the exchange of some one-half barrel kegs for new one-sixth barrel kegs.
Excluding the 2000 gain and 1999 loss, other income increased due to a higher
average balance of interest-bearing deposits

Income Taxes. The Company's effective income tax rate was a 31.1% benefit
in 2000, compared to a 33.5% benefit in 1999. The difference between the 2000
and 1999 effective rates is primarily the result of a significantly lower
pre-tax loss in 2000, relative to other components of the tax provision
calculation, such as the exclusion of a portion of meals and entertainment
expenses from tax return deductions.

YEAR ENDED DECEMBER 31, 1999 COMPARED TO YEAR ENDED DECEMBER 31, 1998

Sales. Total sales decreased 1.4% to $35,459,000 in 1999, compared to
$35,962,000 in 1998, as a 2.3% decrease in total sales volume was partially
offset by a slight increase in other sales and a small increase in average beer
prices. Total sales volume in 1999 decreased 2.3% to 197,600 barrels from
202,300 barrels in 1998. West Coast sales decreased 4.2% in 1999, including a
3.9% decline in Washington State, the Company's largest market. The competitive
landscape has been affected by the increase in the number of craft beer
companies and the number of different products they offer, as well as increased
competition from imported beers. Sales other than wholesale beer sales,
primarily retail pub revenues, totaled $3,743,000 in 1999, compared to
$3,673,000 in 1998. At December 31, 1999 and 1998, the Company's products were
distributed in 48 states.

Excise Taxes. Excise taxes decreased to $3,264,000, or 10.1% of net sales
in 1999, compared to $3,321,000, or 10.2% of net sales in 1998.

Cost of Sales. Cost of sales decreased 5.5% to $22,613,000 in 1999,
compared to $23,917,000 in 1998, primarily due to the lower sales volume,
decreased packaging and other material costs, increased efficiencies and the
positive effect of curtailing production at the Fremont Brewery. Cost of sales,
as a percentage of net sales, decreased to 70.2% in 1999, compared to 73.3% in
1998. The combined utilization rate of maximum designed capacity for the
operating breweries was 39.5% and 39.0% for years ended December 31, 1999 and
1998, respectively.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased to $11,290,000 in 1999, compared to $9,086,000
in 1998 due to the advertising and promotional program which began in mid-1999.
As a percentage of net sales, these expenses were 35.1% and 27.8% for years
ended December 31, 1999 and 1998, respectively. The increase is due primarily to
the June 1999 launch of an advertising campaign in three key markets, which
totaled approximately $2.5 million, and was partially offset by cost savings
such as office rent and compensation.

Interest Expense. Interest expense decreased to $533,000 in 1999, compared
to $679,000 in 1998, reflecting lower outstanding debt and lower average
interest rates.

Other Income (Expense) -- Net. The 1999 period includes a non-cash loss of
$260,000 related to the exchange of some one-half barrel kegs for new one-sixth
barrel kegs. Excluding the loss, other income increased to $212,000 in 1999
compared to $127,000 in 1998 due to a higher average balance of interest-
bearing deposits.

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23

Income Taxes. The Company's effective income tax rate was a 33.5% benefit
in 1999, compared to a 34.1% benefit in 1998. The difference between the 1999
and 1998 effective rates is primarily the result of a significantly lower
pre-tax loss in 1999, relative to other components of the tax provision
calculation, such as the exclusion of a portion of meals and entertainment
expenses from tax return deductions.

LIQUIDITY AND CAPITAL RESOURCES

The Company had $7,487,000 and $5,463,000 of cash and cash equivalents at
December 31, 2000 and 1999, respectively. At December 31, 2000, the Company had
working capital of $4,817,000. The Company's long-term debt as a percentage of
total capitalization (long-term debt, preferred stock and common stockholders'
equity) was 9.5% and 9.9% as of December 31, 2000 and 1999, respectively. Cash
provided by operating activities totaled $1,671,000 and $2,857,000 in 2000 and
1999, respectively. The decrease in operating cash flow for the year ended
December 31, 2000, was due to the timing of the collection of accounts
receivable and payment of accounts payable in December 1999. The 1999 cash flow
amount includes the collection of an income tax receivable of approximately
$469,000.

On June 5, 1997, the Company converted the $9 million outstanding balance
of its secured bank facility (the "Secured Facility") to a five-year term loan
with a 20-year amortization schedule. As of December 31, 2000, there was $7.4
million outstanding on the Secured Facility, and the Company's one-month
LIBOR-based borrowing rate was approximately 7.8%. In addition, the Company has
a $10 million revolving credit facility (the "Revolving Facility") with the same
bank through July 1, 2002, and as of December 31, 2000, there were no borrowings
outstanding on the Revolving Facility. The Secured Facility and the Revolving
Facility are secured by substantially all of the Company's assets. Interest
accrues at a variable rate based on the London Inter Bank Offered Rate
("LIBOR"), plus 1.25% to 2.00% for the Secured Facility depending on the
Company's debt-to-tangible net worth ratio. The interest rate for the Revolving
Facility is the applicable LIBOR plus 1.00% to 2.00%, depending on the Company's
debt service-to-cash flow ratio. The Company has the option to fix the
applicable interest rate for up to twelve months by selecting LIBOR for one-to
twelve-month periods as a base.

The Company has required capital principally for the construction and
development of its technologically-advanced production facilities. To date, the
Company has financed its capital requirements through cash flow from operations,
bank borrowings and the sale of common and preferred stock. The Company expects
to meet its future financing needs, including the advertising expenditures
associated with the brand investment advertising program, and working capital
and capital expenditure requirements, through cash on hand, operating cash flow
and, to the extent required and available, bank borrowings and offerings of debt
or equity securities.

Capital expenditures for 2000 totaled $425,000. Capital expenditures for
2001 are expected to total approximately $500,000.

In May 2000, the Board of Directors authorized the repurchase of up to
500,000 shares of the Company's outstanding shares of common stock. In January
2001, the Board of Directors authorized the repurchase of an additional 250,000
shares of its outstanding common stock. As of December 31, 2000, 375,000
outstanding shares of common stock had been purchased in the open market for
$584,000. As of March 17, 2001, 546,200 outstanding shares of common stock had
been purchased in the open market for $864,000.

The Company has certain commitments, contingencies and uncertainties
relating to its normal operations. Management believes that any such
commitments, contingencies or uncertainties, including any environmental
uncertainties, will not have a material adverse effect on the Company's
financial position or results of operations.

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24

CERTAIN CONSIDERATIONS: ISSUES AND UNCERTAINTIES

The Company does not provide forecasts of future financial performance or
sales volumes, although this Annual Report contains certain other types of
forward-looking statements that involve risks and uncertainties. The Company
may, in discussions of its future plans, objectives and expected performance in
periodic reports filed by the Company with the Securities and Exchange
Commission (or documents incorporated by reference therein) and in written and
oral presentations made by the Company, include forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, or
Section 21E of the Securities Exchange Act of 1934, as amended. Such
forward-looking statements are based on assumptions that the Company believes
are reasonable, but are by their nature inherently uncertain. In all cases,
there can be no assurance that such assumptions will prove correct or that
projected events will occur. Actual results could differ materially from those
projected depending on a variety of factors, including, but not limited to, the
issues discussed below, the successful execution of market development and other
plans and the availability of financing. While Company management is optimistic
about the Company's long-term prospects, the following issues and uncertainties,
among others, should be considered in evaluating its business prospects and any
forward-looking statements.

Effect of Competition on Future Sales. The domestic market in which the
Company's craft beers are sold is highly competitive due to the proliferation of
small craft brewers, including contract brewers, the increase in the number of
products offered by such brewers, increased competition from imported beers and
the introduction of fuller-flavored products by major national brewers. The
Company's revenue growth rate began to slow in late 1996, and sales volume
declined between 2.3% and 5.7% during the years 1997, 1998 and 1999, due to the
highly competitive draft beer market. Sales volumes for the year ended December
31, 2000 increased 7.6% as compared to the corresponding prior year, and sales
volumes for all quarters from September 30, 1999 through December 31, 2000
increased from 2.0% to 14.2% as compared to corresponding prior year quarters.
If the Company were to experience negative sales trends, the Company's future
sales and results of operations would be adversely affected. The Company has
historically operated with little or no backlog and, therefore, its ability to
predict sales for future periods is limited.

Sales Prices. Future prices the Company charges for its products may
decrease from historical levels, depending on competitive factors in the
Company's various markets. The Company has participated in price promotions with
its wholesalers and their retail customers in most of its markets. The number of
markets in which the Company participates in price promotions and the frequency
of such promotions may increase in the future.

Variability of Gross Margin and Cost of Sales. The Company anticipates that
its future gross margins will fluctuate and may decline as a result of many
factors, including disproportionate depreciation and other fixed and
semivariable operating costs, depending on the level of production at the
Company's breweries in relation to maximum designed production capacity. The
Company's high level of fixed and semivariable operating costs causes gross
margin to be very sensitive to relatively small increases or decreases in sales
volume. In addition, other factors that could affect cost of sales include
changes in: freight charges, availability and prices of raw materials and
packaging materials, mix between draft and bottled product sales, the sales mix
of various bottled product packages and Federal or state excise taxes. Also, as
sales volumes through the Distribution Alliance increase, the alliance fee, and
other staging and administrative costs, would increase.

Advertising and Promotional Costs. Prior to June 1999 the Company had done
very limited advertising. Based upon market and competitive considerations, the
Company determined that a significant increase in such spending was appropriate.
Accordingly, in June 1999 the Company began a brand investment program that
significantly increased advertising and related costs. The increased advertising
investment continued in 2000 and is expected to continue for the foreseeable
future with the objective of establishing or maintaining momentum towards
capturing a larger share of the fragmented craft beer market. This increased
spending has significantly increased the Company's selling, general and
administrative expenses in 1999 and 2000, leading to increased losses and a
reduction in stockholders' equity. In addition, market and competitive
considerations could require an increase in other promotional costs associated
with developing existing and new markets.

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25

Relationship with Anheuser-Busch, Incorporated. Most of the Company's
future sales are expected to be through the Distribution Alliance with A-B. See
"Part 1, Item 1 -- Business -- Product Distribution, and Relationship With
Anheuser-Busch, Incorporated" for a further description of the relationship with
A-B. If the Distribution Alliance were to be terminated, or if the relationship
between A-B and the Company were to deteriorate, the Company's sales and results
of operations could be materially adversely affected. In the event that the A-B
Distribution Agreement is terminated on or before December 31, 2004, under
circumstances described in Item 1. (see Business -- Relationship with
Anheuser-Busch, Incorporated -- A-B Distribution Agreement), the terms of the
Series B Preferred Stock purchased by A-B pursuant to the A-B Investment
Agreement require the mandatory redemption of the Series B Preferred Stock on
December 31, 2004, at a redemption price equal to $12.61 per share
(approximately $16.3 million in the aggregate), plus an amount equal to
accumulated and unpaid dividends thereon, from legally available funds. Such a
mandatory redemption could have a material adverse effect on the financial
position and cash flows of the Company. While the Company believes that the
benefits of the Distribution Alliance, in particular distribution and material
cost efficiencies, offset costs associated with the Alliance, there can be no
assurance that these costs will not have a negative impact on the Company's
profit margins in the future.

Dependence on Third-Party Distributors. The Company relies heavily on
third-party distributors for the sale of its products to retailers. The
Company's most significant non-Alliance wholesaler, K&L Distributors, Inc., an
A-B affiliated wholesaler in the Seattle area, accounted for approximately 16%
of the Company's sales in 2000. Substantially all of the remaining sales volumes
are now through the Distribution Alliance to A-B affiliated distributors, most
of whom are independent wholesalers. A disruption of wholesalers' or A-B's
ability to distribute products efficiently due to any significant operational
problems, such as wide-spread labor union strikes, the loss of K&L Distributors
as a customer, or the termination of the Distribution Alliance could have a
material adverse impact on the Company's sales and results of operations.

Customer Acceptance, Consumer Trends and Public Attitudes. If consumers
were unwilling to accept the Company's products or if general consumer trends
caused a decrease in the demand for beer, including craft beer, it could
adversely impact the Company's sales and results of operations. The alcoholic
beverage industry has become the subject of considerable societal and political
attention in recent years due to increasing public concern over alcohol-related
social problems, including drunk driving, underage drinking and health
consequences from the misuse of alcohol. If beer consumption in general were to
come into disfavor among domestic consumers, or if the domestic beer industry
were subjected to significant additional governmental regulation, the Company's
sales and results of operations could be adversely affected.

Effect of Sales Trends on Brewery Efficiency and Operations. Even though
sales volumes for 2000 increased 7.6% as compared to 1999, the Company's sales
volumes declined modestly in 1997, 1998 and the first half of 1999. Those
declines coincided with significantly slower sales growth in the highly
competitive craft beer segment. The Company's breweries have been operating at
production levels substantially below their actual and maximum designed
capacities. Operating breweries at low capacity utilization rates negatively
impacts gross margins and operating cash flows generated by the production
facilities. In 1998, the Company permanently curtailed production at its Fremont
Brewery and wrote the related assets down to their estimated net realizable
value. The Company will continue to evaluate whether it expects to recover the
costs of its two remaining production facilities over the course of their useful
lives.

Income Tax Benefits. As of December 31, 2000, the Company had federal
income tax net operating loss carryforwards ("NOL's") of $23.5 million,
substantially all of which expire from 2012 through 2020. NOL's can generally be
utilized to offset regular tax liabilities in future years, and carried back no
more than 2 years and forward no more than 20 years. Should the Company incur
significant operating losses in the future, thus generating additional NOL's,
the Company may be required to establish a valuation allowance if it is more
likely than not that all, or a portion, of an NOL would either expire before the
Company is able to realize its benefit, or that future utilization is uncertain.
Such a valuation allowance would reduce the income tax benefit recorded in the
statement of operations.

23
26

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." In June 2000, the FASB issued
SFAS No. 138, which amends certain provisions of SFAS 133 to clarify specific
areas presenting difficulties in implementation. The Company has adopted the
provisions of FAS 133/138 as of January 1, 2001. Adoption of SFAS 133/138 did
not have a material impact on the Company's results of operations, financial
position or cash flows.

In December 1999, the staff of the Securities and Exchange Commission
released Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition,"
to provide guidance on the recognition, presentation and disclosure of revenues
in financial statements. The Company believes that its revenue recognition
practices are in conformity with the guidelines in SAB 101, as revised, and that
this pronouncement did not have a material impact on its financial statements.

In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation: an interpretation of APB
Opinion No. 25." Interpretation No. 44 provides clarification of certain issues,
such as the determination of who is an employee, the criteria for determining
whether a plan qualifies as a non-compensatory plan, the accounting consequence
of various modifications to the terms of a previously fixed stock option or
award and the accounting for an exchange of stock compensation awards in a
business combination. The Company believes that its accounting for stock-based
compensation is in conformity with this guidance, and therefore Interpretation
No. 44 did not have an impact on the Company's financial condition or results of
operations.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has assessed its vulnerability to certain market risks,
including interest rate risk associated with financial instruments included in
cash and cash equivalents and long-term debt. Due to the nature of these
investments and the Company's investment policies, the Company believes that the
risk associated with interest rate fluctuations related to these financial
instruments does not pose a material risk.

The Company does not have any derivative financial instruments as of
December 31, 2000.

24
27

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REDHOOK ALE BREWERY, INCORPORATED

INDEX TO FINANCIAL STATEMENTS

PAGE
----

AUDITED FINANCIAL STATEMENTS:

Report of Ernst & Young LLP, Independent Auditors........... 26

Balance Sheets as of December 31, 2000 and 1999............. 27

Statements of Operations for the Years Ended December 31,
2000, 1999 and 1998....................................... 28

Statements of Common Stockholders' Equity for the Years
Ended December 31, 2000, 1999 and 1998.................... 29

Statements of Cash Flows for the Years Ended December 31,
2000, 1999 and 1998....................................... 30

Notes to Financial Statements............................... 31

25
28

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors
Redhook Ale Brewery, Incorporated

We have audited the accompanying balance sheets of Redhook Ale Brewery,
Incorporated as of December 31, 2000 and 1999, and the related statements of
operations, common stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Redhook Ale Brewery,
Incorporated as of December 31, 2000 and 1999, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States.

ERNST & YOUNG LLP

Seattle, Washington
January 26, 2001

26
29

REDHOOK ALE BREWERY, INCORPORATED

BALANCE SHEETS

DECEMBER 31, DECEMBER 31,
2000 1999
------------ ------------

ASSETS

Current Assets:
Cash and Cash Equivalents................................. $ 7,487,190 $ 5,462,779
Accounts Receivable....................................... 1,075,730 1,174,853
Inventories............................................... 2,726,071 2,406,797
Other..................................................... 296,082 331,481
----------- -----------

Total Current Assets................................... 11,585,073 9,375,910
Fixed Assets, Net........................................... 73,670,248 77,739,550
Other Assets................................................ 365,181 591,431
----------- -----------

Total Assets...................................... $85,620,502 $87,706,891
=========== ===========

LIABILITIES, PREFERRED STOCK
AND COMMON STOCKHOLDERS' EQUITY

Current Liabilities:
Accounts Payable.......................................... $ 2,664,165 $ 2,743,971
Accrued Salaries, Wages and Payroll Taxes................. 1,528,739 1,408,552
Refundable Deposits....................................... 1,791,267 1,571,028
Other Accrued Expenses.................................... 333,805 567,206
Current Portion of Long-Term Debt......................... 450,000 450,000
----------- -----------

Total Current Liabilities.............................. 6,767,976 6,740,757
----------- -----------

Long-Term Debt, Net of Current Portion...................... 6,975,000 7,425,000
----------- -----------

Deferred Income Taxes, Net.................................. 1,276,149 1,627,067
----------- -----------

Commitments

Convertible Redeemable Preferred Stock...................... 16,099,455 16,055,055
----------- -----------

Common Stockholders' Equity:
Common Stock, Par Value $0.005 per Share, Authorized,
50,000,000 Shares; Issued and Outstanding, 7,312,786
Shares in 2000 and 7,687,786 Shares in 1999............ 36,564 38,439
Additional Paid-In Capital................................ 56,407,023 56,989,631
Retained Earnings (Deficit)............................... (1,941,665) (1,169,058)
----------- -----------

Total Common Stockholders' Equity................. 54,501,922 55,859,012
----------- -----------
Total Liabilities, Preferred Stock and Common
Stockholders' Equity........................... $85,620,502 $87,706,891
=========== ===========

See Accompanying Notes
27
30

REDHOOK ALE BREWERY, INCORPORATED

STATEMENTS OF OPERATIONS

YEAR ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------

Sales............................................... $37,836,882 $35,458,710 $35,962,126
Less Excise Taxes................................... 3,425,046 3,264,311 3,320,824
----------- ----------- -----------

Net Sales........................................... 34,411,836 32,194,399 32,641,302
Cost of Sales....................................... 24,580,536 22,613,468 23,917,360
----------- ----------- -----------

Gross Profit........................................ 9,831,300 9,580,931 8,723,942
Special Valuation Provision......................... -- -- 5,172,650
Selling, General and Administrative Expenses........ 11,747,095 11,290,271 9,086,312
----------- ----------- -----------

Operating Income (Loss)............................. (1,915,795) (1,709,340) (5,535,020)
Interest Expense.................................... 593,628 533,360 678,516
Other Income (Expense) -- Net....................... 1,453,090 (48,192) 126,862
----------- ----------- -----------

Income (Loss) before Income Taxes................... (1,056,333) (2,290,892) (6,086,674)
Income Tax Provision (Benefit)...................... (328,126) (767,458) (2,075,494)
----------- ----------- -----------

Net Income (Loss)................................... $ (728,207) $(1,523,434) $(4,011,180)
=========== =========== ===========

Basic Earnings (Loss) per Share..................... $ (0.10) $ (0.20) $ (0.52)
=========== =========== ===========

Diluted Earnings (Loss) per Share................... $ (0.10) $ (0.20) $ (0.52)
=========== =========== ===========

See Accompanying Notes
28
31

REDHOOK ALE BREWERY, INCORPORATED

STATEMENTS OF COMMON STOCKHOLDERS' EQUITY

COMMON STOCK TOTAL
------------------- ADDITIONAL RETAINED COMMON
PAR PAID-IN EARNINGS STOCKHOLDERS'
SHARES VALUE CAPITAL (DEFICIT) EQUITY
--------- ------- ----------- ----------- -------------

Balance, January 1, 1998......... 7,687,486 $38,438 $56,805,633 $ 4,454,356 $61,298,427
Other, Net..................... -- -- 83,000 (44,400) 38,600
Net Loss....................... -- -- -- (4,011,180) (4,011,180)
--------- ------- ----------- ----------- -----------

Balance, December 31, 1998....... 7,687,486 38,438 56,888,633 398,776 57,325,847
Other, Net..................... 300 1 100,998 (44,400) 56,599
Net Loss....................... -- -- -- (1,523,434) (1,523,434)
--------- ------- ----------- ----------- -----------

Balance, December 31, 1999....... 7,687,786 38,439 56,989,631 (1,169,058) 55,859,012
Repurchase of Common Stock..... (375,000) (1,875) (582,608) -- (584,483)
Other.......................... -- -- -- (44,400) (44,400)
Net Loss....................... -- -- -- (728,207) (728,207)
--------- ------- ----------- ----------- -----------

Balance, December 31, 2000....... 7,312,786 $36,564 $56,407,023 $(1,941,665) $54,501,922
========= ======= =========== =========== ===========

See Accompanying Notes
29
32

REDHOOK ALE BREWERY, INCORPORATED

STATEMENTS OF CASH FLOWS

YEAR ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------

OPERATING ACTIVITIES

Net Income (Loss)................................... $ (728,207) $(1,523,434) $(4,011,180)
Adjustments to Reconcile Net Income (Loss) to Net
Cash Provided by Operating Activities:
Depreciation and Amortization..................... 3,240,484 3,271,381 3,343,377
Deferred Income Tax (Benefit) Provision........... (350,918) (778,822) (1,581,630)
Special Valuation Provision....................... -- -- 5,172,650
(Gain) Loss on Disposal of Fixed Assets........... (898,155) 265,415 --
Changes in Operating Assets and Liabilities:
Accounts Receivable............................ 99,123 350,855 62,660
Inventories.................................... (319,274) (139,387) 548,372
Income Taxes Receivable........................ -- 469,272 655,541
Other Current Assets........................... 35,399 (27,858) 215,892
Other Assets................................... 215,436 56,249 317,581
Accounts Payable and Other Accrued Expenses.... 36,518 696,054 38,380
Accrued Salaries, Wages and Payroll Taxes...... 120,187 (43,384) 128,970
Refundable Deposits............................ 220,239 260,662 144,296
----------- ----------- -----------

Net Cash Provided by Operating Activities........... 1,670,832 2,857,003 5,034,909
----------- ----------- -----------

INVESTING ACTIVITIES
Expenditures for Fixed Assets....................... (425,056) (1,140,603) (937,419)
Proceeds from Sale of Assets and Other, Net......... 1,813,118 1,084,932 78,525
----------- ----------- -----------

Net Cash Provided by (Used in) Investing
Activities........................................ 1,388,062 (55,671) (858,894)
----------- ----------- -----------

FINANCING ACTIVITIES
Repayments on Debt.................................. (450,000) (450,000) (2,140,608)
Repurchase of Common Stock.......................... (584,483) -- --
Officer Note Repayment and Other, Net............... -- 100,999 82,876
----------- ----------- -----------

Net Used in Financing Activities.................... (1,034,483) (349,001) (2,057,732)
----------- ----------- -----------

Increase in Cash and Cash Equivalents............... 2,024,411 2,452,331 2,118,283
Cash and Cash Equivalents:
Beginning of Year................................. 5,462,779 3,010,448 892,165
----------- ----------- -----------

End of Year....................................... $ 7,487,190 $ 5,462,779 $ 3,010,448
=========== =========== ===========

See Accompanying Notes
30
33

REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS

1. NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Redhook Ale Brewery, Incorporated (the "Company") was incorporated on May
4, 1981 for the purpose of brewing, marketing and selling craft beers. Its
operations consist of corporate headquarters and a pub in the Fremont area of
Seattle, Washington; a brewery and pub in the Seattle suburb of Woodinville,
Washington; and, a brewery and pub in Portsmouth, New Hampshire. As of December
31, 2000, the Company's products were distributed in 48 states.

In 1994, the Company signed an agreement (the "Distribution Alliance" or
the "Alliance") with Anheuser-Busch, Incorporated ("A-B"), pursuant to which the
Company utilizes A-B's national distribution network to distribute its products.
In addition, A-B purchased 1,289,872 shares of Series B convertible redeemable
preferred stock (the "Series B Preferred Stock") and 236,756 newly issued shares
of common stock in connection with the Distribution Alliance. As of December 31,
2000, A-B owned 26.1% of the Company's outstanding shares of Common Stock,
calculated on a Fully Diluted Basis.

Cash and Cash Equivalents

The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. The carrying amount
of cash equivalents approximates fair value because of the short-term maturity
of these instruments.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method.

Fixed Assets

Fixed assets are stated at cost. Significant additions and improvements are
capitalized. Maintenance and repairs are expensed as incurred. Upon disposition
of fixed assets, any gains or losses are reflected in the statement of
operations. Depreciation and amortization is computed using the straight-line
method over the following estimated useful lives:

Buildings............................ 31 - 40 years
Brewery equipment.................... 20 - 25 years
Furniture, fixtures and other
equipment.......................... 2 - 10 years
Leasehold improvements............... Lesser of lease term or useful life
Vehicles............................. 5 years

Revenue Recognition

The Company recognizes revenue from product sales when the products are
shipped to customers.

Income Taxes

The Company accounts for income taxes under the liability method, whereby
deferred taxes are provided for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities. These
deferred tax assets and liabilities are measured under the provisions of the
currently enacted tax laws.

31
34
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Advertising Expenses

Advertising costs, including production costs, are expensed as incurred.
For the years ended December 31, 2000, 1999, and 1998, advertising expenses
totaled $2,460,000, $2,753,000 and $265,000 respectively.

Segment Information

The Company operates in one principal business segment, manufacturer of
beer and ales, across domestic markets.

Earnings (Loss) per Share

Basic loss per share is calculated using the weighted-average number of
shares of common stock outstanding. The calculation of adjusted weighted-average
shares outstanding for purposes of computing diluted earnings per share includes
the dilutive effect of all outstanding convertible redeemable preferred stock
and outstanding stock options for the periods when the Company reports net
income. The convertible preferred stock and outstanding stock options have been
excluded from the calculation of diluted loss per share for the years ended
December 31, 2000, 1999 and 1998, because their effect is antidilutive. The
calculation uses the treasury stock method and the as if converted method in
determining the resulting incremental average equivalent shares outstanding as
applicable.

Use of Estimates

The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results may differ from those estimates.

Reclassifications

Certain reclassifications have been made to the prior years' financial
statements to conform to the current year presentation. The effects of the
reclassifications are not considered material.

Recently Issued Accounting Standards

In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." In June 2000, the FASB issued
SFAS No. 138, which amends certain provisions of SFAS 133 to clarify specific
areas presenting difficulties in implementation. The Company has adopted the
provisions of FAS 133/138 as of January 1, 2001. Adoption of SFAS 133/138 did
not have a material impact on the Company's results of operations, financial
position or cash flows.

In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation: an interpretation of APB
Opinion No. 25." Interpretation No. 44 provides clarification of certain issues,
such as the determination of who is an employee, the criteria for determining
whether a plan qualifies as a non-compensatory plan, the accounting consequence
of various modifications to the terms of a previously fixed stock option or
award and the accounting for an exchange of stock compensation awards in a
business combination. The Company believes that its accounting for stock-based
compensation is in conformity with this guidance, and therefore Interpretation
No. 44 did not have an impact on the Company's financial condition or results of
operations.

32
35
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

2. INVENTORIES

Inventories consist of the following:

DECEMBER 31,
------------------------
2000 1999
---------- ----------

Finished goods...................................... $ 935,229 $1,059,460
Raw materials....................................... 1,126,772 814,106
Promotional merchandise............................. 444,584 342,071
Packaging materials................................. 219,486 191,160
---------- ----------
$2,726,071 $2,406,797
========== ==========

Finished goods include beer held in fermentation prior to the filtration
and packaging process.

3. FIXED ASSETS

Fixed assets consist of the following:

DECEMBER 31,
--------------------------
2000 1999
----------- -----------

Land and improvements............................. $ 4,564,080 $ 5,263,864
Buildings......................................... 35,603,761 35,454,397
Brewery equipment................................. 44,639,779 45,004,627
Furniture, fixtures and other equipment........... 3,606,512 3,903,916
Leasehold improvements............................ 176,651 171,466
Vehicles.......................................... 81,730 81,730
Other............................................. -- 12,333
----------- -----------
88,672,513 89,892,333
Less accumulated depreciation and amortization.... 15,002,265 12,152,783
----------- -----------
$73,670,248 $77,739,550
=========== ===========

4. FREMONT BREWERY

In January 1998, production at the Fremont Brewery was significantly
reduced and the brewery served as a backup facility to the Woodinville Brewery.
During the quarter ended June 30, 1998, the Company analyzed its current and
future production capacity requirements and its plans for the Fremont Brewery
production assets. Based upon that analysis, the Company decided to permanently
curtail the Fremont Brewery operations and sell substantially all of those
production assets. In accordance with FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, the
Fremont production assets were written down to an estimate of their net
realizable value in the quarter ended June 30, 1998. The write-down was recorded
through a non-cash valuation provision totaling $5.2 million. The special
valuation provision, net of the related income tax benefit, totaled $3.4
million. As of April 1998, the Company stopped depreciating these assets,
thereby reducing the Company's depreciation expense for 1998 by approximately
$330,000. The write-down was recorded in the statement of operations as a
Special Valuation Provision. As of December 31, 1999, the Company had sold
substantially all of the equipment for an amount approximately equal to its
estimated net realizable value.

33
36
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

The special valuation provision and the related assets held for sale were
recorded as follows:

Brewery equipment........................................... $ 8,577,598
Building.................................................... 1,068,824
-----------
9,646,422
Less accumulated depreciation and amortization.............. (3,389,772)
-----------
Net book value.............................................. 6,256,650
Estimated net realizable value of Assets Held for Sale...... (1,184,000)
-----------
Estimated impairment........................................ 5,072,650
Reserve for disposal related costs.......................... 100,000
-----------
Special Valuation Provision................................. 5,172,650
Income tax benefit.......................................... (1,810,428)
-----------
Special Valuation Provision, net of income tax benefit...... $ 3,362,222
===========

Adjacent to the Fremont Brewery, the Company owned a warehousing facility
and land, which was used as the keg filling, storage and shipping facility prior
to curtailing the Fremont Brewery operations. In July 2000, the Company sold the
warehouse facility and related real estate parcel for approximately $1.7 million
in cash and recorded a gain of approximately $1.0 million during the quarter
ended September 30, 2000. The gain is reflected as Other Income (Expense) -- Net
in the statement of operations.

5. DEBT

Long-term debt consists of the following:

DECEMBER 31,
------------------------
2000 1999
---------- ----------

Secured Facility, payable to bank monthly at
$37,500, plus accrued interest, interest at 7.8%
at December 31, 2000, due 2002.................... $7,425,000 $7,875,000
Current portion..................................... (450,000) (450,000)
---------- ----------
$6,975,000 $7,425,000
========== ==========

Annual principal payments required on long-term debt:

2001.............................. $ 450,000
2002.............................. 6,975,000
----------
$7,425,000
==========

In June 1997, the Company converted the $9 million outstanding balance of
its secured bank facility (the "Secured Facility") to a five-year term loan with
a 20-year amortization schedule. As of December 31, 2000, there was $7.4 million
outstanding on the Secured Facility, and the Company's one-month LIBOR-based
borrowing rate was approximately 7.8%. In addition, the Company has a $10
million revolving credit facility (the "Revolving Facility") with the same bank
through July 1, 2002, and as of December 31, 2000, there were no borrowings
outstanding on this Revolving Facility. The Company can elect to extend the
borrowing period for advances on the Revolving Facility to five years on
predetermined terms. Interest accrues at a variable rate based on the London
Inter Bank Offered Rate ("LIBOR"), plus 1.25% to 2.00% for the Secured Facility
depending on the Company's debt-to-tangible net worth ratio. The interest rate
for the Revolving Facility is the applicable LIBOR plus 1.00% to 2.00%,
depending on the Company's debt service-to-cash flow ratio. The Company has the
option to fix the applicable interest rate by selecting LIBOR for one-to
twelve-month periods as a base. The estimated fair market value of the Secured
Facility approximates its carrying value.

34
37
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

The Secured Facility and Revolving Facility are secured by substantially
all of the Company's assets. In addition, the Company was in compliance with
applicable covenants including minimum debt service ratios and a minimum
tangible net worth as of and during the year ended December 31, 2000.

The Company made interest payments totaling $594,000, $530,000 and $692,000
for the years ended December 31, 2000, 1999 and 1998, respectively.

6. CONVERTIBLE REDEEMABLE PREFERRED STOCK

Convertible redeemable preferred stock outstanding is as follows:

DECEMBER 31,
--------------------------
2000 1999
----------- -----------

Series B, par value $0.005 per share, issued and
outstanding 1,289,872 shares; net of unamortized
offering costs.................................. $16,099,455 $16,055,055
=========== ===========

There are 10,000,000 shares of preferred stock authorized. During 1993, the
Board of Directors designated 1,242,857 preferred shares as Series A Preferred
Stock. In August 1993, the Company sold all such designated shares of Series A
Preferred Stock to existing common shareholders, institutional investors and
other qualified or accredited investors for approximately $8.7 million, or $7.00
per share. All shares of Series A Preferred Stock were automatically converted
to an equal number of common shares upon the closing of the Company's initial
public offering in August 1995.

During 1994, the Board of Directors designated 1,289,872 preferred shares
as Series B Preferred Stock. In November 1994, the Company sold all shares of
Series B Preferred Stock to A-B for approximately $16.3 million, or $12.61 per
share. Prior to November 1999, A-B's ownership percentage of the Company was
limited to 25% of the outstanding Common Stock, assuming the conversion of all
outstanding Preferred Stock. The ownership percentage limitation increased to
30% for the period November 1999 through November 2001. The Company has reserved
shares of common stock to issue if these Series B Preferred Stock shares were
converted to common stock.

Each share of Series B Preferred Stock is entitled to as many votes as the
number of shares of common stock into which it is convertible. The conversion
rate is one share of common stock for each share of preferred stock, subject to
antidilution adjustment under certain circumstances. The Series B Preferred
Stock is convertible to common stock at any time by its holder and is subject to
automatic conversion under certain circumstances on December 31, 2004 or
December 31, 2014.

Under the terms of the Series B Preferred Stock purchase agreement, the
Company is required to meet various affirmative and negative covenants. These
covenants limit the Company's ability to declare dividends on, or purchase, any
of its capital stock without prior approval from the Series B Stockholders. The
holders of Series B Preferred Stock and converted Series A Preferred Stock also
are entitled to certain contractual registration rights.

Holders of Series B Preferred Stock generally are entitled to receive
dividends at a rate equal to any dividends declared on common stock, when and if
dividends are declared by the Company's Board of Directors. In addition, under
certain circumstances relating to the termination of the Distribution Alliance
by A-B, the Series B Preferred Stock would prospectively accumulate preferential
dividends until stock redemption at a fixed annual rate based on the ten-year
U.S. Treasury rate, plus 2.75%.

Holders of Series B Preferred Stock also have mandatory redemption rights
and liquidation preferences equal to $12.61 per share, plus any accumulated and
unpaid dividends, from legally available funds. The Company is required to
redeem all shares of outstanding Series B Preferred Stock on December 31, 2004,
or
35
38
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

on December 31, 2014, under certain other conditions relating to a termination
of the Distribution Alliance by A-B. Termination of the A-B Distribution
Agreement on or before December 31, 2004 under the following circumstances would
mandate the redemption of Series B Preferred Stock on December 31, 2004 at a
redemption price equal to $12.61 per share (approximately $16.3 million in the
aggregate), plus an amount equal to accumulated and unpaid dividends, from
legally available funds: (i) by either the Company or A-B without cause on or
before December 31, 2004, or (ii) by A-B upon an uncured material breach by the
Company of certain provisions of the Series B Preferred Stock, the A-B
Investment Agreement, the A-B Distribution Agreement and certain related A-B
investment documents, or upon the insolvency of the Company, (iii) by A-B upon
(a) acquisition by another large alcoholic beverage competitor of 10% or greater
equity ownership of the Company and a seat on the Company's Board of Directors
or (b) a deterioration of the Company's financial condition that results from a
change in ownership of the Company and materially adversely affects its ability
to perform under the A-B Distribution Agreement, or (iv) by A-B following (a)
any action by the Company that in A-B's sole determination damages the
reputation or image of A-B or the brewing industry (for example, production of a
high-alcohol beer, defamation of A-B or its products or contamination of the
Company's products, but not poor operating results, an unsuccessful product
introduction or competition with A-B's products), (b) any acquisition of,
agreement to acquire, or institution of a tender or exchange offer to acquire a
percentage of the Company's equity securities equal to or greater than that held
by A-B, (c) certain agreements pursuant to which the Company would merge into or
consolidate with another corporation or sell substantially all of its assets or
certain of its trademarks, or (d) the failure to appoint a successor acceptable
to A-B in the event Paul S. Shipman ceases to function as the Company's Chief
Executive Officer.

The difference between the issuance price, net of offering costs, of the
convertible redeemable preferred stock and the redemption value is accreted
periodically through the redemption date as of December 31, 2004 by a charge of
$44,000 per year to retained earnings.

7. COMMON STOCKHOLDERS' EQUITY

Note Receivable for Stock Purchase

The Company's President had an interest-bearing loan for $100,000
outstanding at December 31, 1998 related to the exercise of stock options in
1994. The loan, paid in full during 1999, was secured by Company stock held by
the officer and is included as a reduction in common stockholders' equity.
Principal payments received on the loan have been reflected in the statement of
cash flows as a financing activity and as an increase in common stockholders'
equity. The note accrued interest at 5.9% per year.

Sale of Common Stock

In August 1995, the Company completed the sale of 2,193,492 shares of
common stock through an initial public offering and 716,714 common shares in a
concurrent private placement to A-B (collectively, the "Offerings") at a price
of $17.00 per share. The net proceeds of the Offerings totaled approximately $46
million. All of the 1,242,857 shares of Series A convertible preferred stock
automatically converted to an equal number of common shares upon closing of the
Offerings.

Repurchase of Common Stock

In May 2000, the Board of Directors authorized the repurchase of up to
500,000 shares of the Company's outstanding shares of common stock. In January
2001, the Board of Directors authorized the repurchase of an additional 250,000
shares of its outstanding common stock. As of December 31, 2000, 375,000 shares
had been purchased in the open market for $584,000.

36
39
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

Stock Option Plans

In 1993, the Company's shareholders approved the 1992 Stock Incentive Plan
(the "Plan") and the Directors Stock Option Plan (the "Directors Plan"). Under
the Plan, as amended in May 1996, the approval provides for 1,270,000 shares of
common stock for options. The approval, as amended in May 1996, also provides
for 170,000 shares of common stock for options under the Directors Plan.
Employee options generally vest over a five-year period while director options
vest immediately and become exercisable six months after the grant date. Vested
options are generally exercisable for ten years from the date of grant.

In September 1990, the Company reserved 120,000 shares of common stock for
its 1990 Incentive Stock Option Plan. Options for 120,000 shares were granted at
that time with an exercise price equal to the estimated fair market value. The
exercise price increased from the original price by 5% per year until full
vesting occurred. These options vested over five years and were exercisable for
ten years from the date of grant. As of December 31, 2000, no options remained
outstanding under this plan.

Presented below is a summary of stock option plans' activity for the years
shown:

SHARES OF
COMMON WEIGHTED OPTIONS WEIGHTED
STOCK AVERAGE EXERCISABLE AVERAGE
UNDER THE EXERCISE AT EXERCISE
PLANS PRICE END OF YEAR PRICE
--------- -------- ----------- --------

Balance at January 1, 1998...................... 785,582 $13.08 346,592 $12.37
Granted....................................... 295,950 5.73
Exercised..................................... -- --
Canceled...................................... (64,880) 12.87
---------
Balance at December 31, 1998.................... 1,016,652 10.96 478,872 12.39
Granted....................................... 293,950 3.97
Exercised..................................... (300) 3.33
Canceled...................................... (47,770) 10.22
---------
Balance at December 31, 1999.................... 1,262,532 9.36 631,272 11.84
Granted....................................... 95,000 1.55
Exercised..................................... -- --
Canceled...................................... (610,780) 11.47
---------
Balance at December 31, 2000.................... 746,752 6.64 395,702 8.75
=========

During the year ended December 31, 2000, officers of the Company
voluntarily returned 567,000 options previously granted to them under the 1992
Stock Incentive Plan. No consideration or additional options were given or
promised in exchange for this forfeiture. This activity is reflected as Canceled
in the summary of plan activity above.

37
40
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

The following table summarizes information for options currently
outstanding and exercisable at December 31, 2000:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE (YRS) PRICE EXERCISABLE PRICE
- ------------------------- ----------- ----------- -------- ----------- --------

$ 1.49 to $ 3.33......... 147,500 6.79 $ 2.18 78,750 $ 2.72
3.97 to 3.97......... 275,400 8.38 3.97 74,880 3.97
5.73 to 5.73......... 126,740 7.38 5.73 66,020 5.73
7.00 to 12.61......... 137,862 5.06 10.34 119,302 10.37
13.00 to 22.75......... 38,000 5.66 22.34 35,600 22.32
25.50 to 25.50......... 21,250 4.91 25.50 21,150 25.50
------- -------
$ 1.49 to $25.50......... 746,752 7.05 $ 6.64 395,702 $ 8.75
======= =======

Under the terms of the Company's incentive stock option plans, employees
and directors may be granted options to purchase the Company's common stock at
the market price on the date the option is granted. At December 31, 2000, 1999
and 1998, a total of 565,601, 67,821 and 314,001 options, respectively, were
available for future grants under the plans.

The Company has reserved approximately 2.6 million shares of common stock
for future issuance related to potential stock option exercises and conversion
of the Series B Preferred Stock.

Shareholder Rights Agreement

In September 1995, the Company's Board of Directors adopted a shareholder
rights agreement (the "Rights Agreement"). Pursuant to the Rights Agreement,
holders of common stock have certain rights to purchase common stock that are
exercisable only in certain circumstances (the "Rights"). The Rights trade
together with the common stock until the Distribution Date. The "Distribution
Date" shall occur on the earlier of: (i) ten days following the date that the
Company learns that a person or group of affiliated or associated persons (an
"Acquiring Person") has acquired beneficial ownership of 20% or more of the
outstanding common stock and (ii) such date as may be designated by the
Company's Board following the commencement of, or announcement of an intention
to make, a tender or exchange offer, the consummation of which would result in
the beneficial ownership by a person or group of 20% or more of such outstanding
common stock. Each Right will not be exercisable until the Distribution Date. If
any person becomes an Acquiring Person, the Rights will entitle each holder of a
Right (other than those held by an Acquiring Person (or any affiliate or
associate of any Acquiring Person)) to purchase, for $120 per Right (the
"Purchase Price"), that number of shares of common stock which at the time of
the transaction would have a market value of twice the Purchase Price. The
Rights Agreement provides certain exceptions for beneficial ownership by A-B for
up to 30% of the Company's common stock. The Rights, which are not currently
exercisable, expire on September 22, 2005, but may be redeemed at any time by
the Company for $0.001 per Right.

Pro Forma Fair Value Disclosures

In October 1995, the Financial Accounting Standards Board issued Statement
No. 123, Accounting for Stock-Based Compensation ("Statement 123"), which
established accounting and reporting standards for stock-based employee
compensation plans. Statement 123 defines a fair value-based method of
accounting for these equity instruments. This method measures compensation cost
based on the value of the award and recognizes that cost over the service
period. As permitted under Statement 123, the Company has elected to

38
41
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

continue accounting for stock-based compensation in accordance with APB Opinion
No. 25, Accounting for Stock Issued to Employees ("Opinion 25"). Accordingly,
because the grant price equals the market price on the date of grant, no
compensation expense is recognized for stock options issued to employees. Had
compensation cost for the Company's stock options been recognized based upon the
estimated fair value on the grant date under the fair value methodology
prescribed by Statement 123, the Company's net income (loss) and earnings (loss)
per share for the years ended December 31, 2000, 1999 and 1998 would have been
impacted as indicated in the following table. Pursuant to the provisions of
Statement 123, the pro forma results shown below only reflect the impact of
options granted subsequent to 1994.

YEAR ENDED DECEMBER 31,
---------------------------------------
2000 1999 1998
--------- ----------- -----------

Reported net income (loss)................... $(728,207) $(1,523,434) $(4,011,180)
Pro forma net income (loss).................. (963,456) (2,083,754) (4,570,357)
Reported basic and diluted earnings
(loss) per share........................... $ (0.10) $ (0.20) $ (0.52)
Pro forma basic and diluted earnings
(loss) per share........................... $ (0.13) $ (0.27) $ (0.59)

The fair value of options granted (which is amortized to expense over the
option vesting period in determining the pro forma impact) is estimated on the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:

2000 1999 1998
------ ------ ------

Expected life of option..................................... 5 yrs. 5 yrs. 5 yrs.
Risk-free interest rate..................................... 6.75% 5.25% 4.73%
Volatility of the Company's stock........................... 82.3% 50.0% 50.0%
Dividend yield on the Company's stock....................... 0.0% 0.0% 0.0%

The weighted average estimated fair value of options granted during the
years ended December 31, is as follows:

2000 1999 1998
-------- -------- --------

Total number of options granted.................... 95,000 293,950 295,950
Estimated fair value of each option granted........ $ 1.06 $ 1.69 $ 2.97
Total estimated fair value of all options
granted.......................................... $100,700 $496,776 $878,971

In accordance with Statement 123, the weighted average estimated fair value
of stock options granted is required to be based on a theoretical statistical
model using the preceding Black-Scholes assumptions. In actuality, because
Company stock options do not trade on a secondary exchange, employees can
receive no value nor derive any benefit from holding stock options under these
plans without an increase, above the grant price, in the market price of the
Company's stock. Such an increase in stock price would benefit all stockholders
commensurately. Refer to the table of options currently outstanding for the
weighted average grant price for options granted during 2000, 1999 and 1998.

39
42
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

8. EARNINGS (LOSS) PER SHARE

The following table sets forth the computation of basic and diluted
earnings (loss) per common share:

YEAR ENDED DECEMBER 31,
----------------------------------------
2000 1999 1998
---------- ----------- -----------

Basic and diluted earnings (loss) per share
computation:
Numerator:
Net income (loss)....................... $ (728,207) $(1,523,434) $(4,011,180)
---------- ----------- -----------
Denominator:
Weighted-average common shares.......... 7,632,628 7,687,687 7,687,486
---------- ----------- -----------
Basic and diluted earnings
(loss) per share................. $ (0.10) $ (0.20) $ (0.52)
========== =========== ===========

9. INCOME TAXES

The components of income tax expense (benefit) are as follows:

YEAR ENDED DECEMBER 31,
-------------------------------------
2000 1999 1998
--------- --------- -----------

Current........................................ $ 22,792 $ 11,364 $ (493,864)
Deferred....................................... (350,918) (778,822) (1,581,630)
--------- --------- -----------
$(328,126) $(767,458) $(2,075,494)
========= ========= ===========

The Company's effective income tax rate was 31.1%, 33.5% and 34.1% for the
years ended December 31, 2000, 1999 and 1998, respectively. In 2000, the
effective rate was lower than the federal statutory rate due primarily to lower
pre-tax results relative to other components of the tax provision calculation,
such as the exclusion of a portion of meals and entertainment expenses from tax
return deductions.

Current tax expense in 2000 and 1999 is attributable to state tax
liabilities. Deferred income taxes reflect the net tax effects of temporary
differences between the bases of assets and liabilities for financial reporting
purposes and the bases used for income tax return purposes. Significant
components of the Company's deferred tax liabilities and assets are as follows:

DECEMBER 31,
-------------------------
2000 1999
----------- ----------

Deferred tax liabilities:
Tax-over-book depreciation............................... $10,192,182 $9,239,665
Other.................................................... 272,650 377,173
----------- ----------
10,464,832 9,616,838
Deferred tax assets:
NOL and AMT credit carryforwards......................... 9,162,201 7,815,813
Other.................................................... 26,482 173,958
----------- ----------
9,188,683 7,989,771
----------- ----------
Net deferred tax liability................................. $ 1,276,149 $1,627,067
=========== ==========

40
43
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

As of December 31, 2000, the Company had net operating loss carryforwards
of $23.5 million and alternative minimum tax credit carryforwards of $184,000
which can be utilized to offset regular tax liabilities in future years. The
alternative minimum tax credit carryforwards, which have no expiration date, and
the tax benefit of the net operating loss carryforwards, substantially all of
which expire from 2012 through 2020, are the primary components of the Company's
deferred tax asset presented above.

10. COMMITMENTS

In 2000 and 1999, the Company had an operating lease for its Fremont
Brewery facility, occupied by the Trolleyman Pub and the corporate offices.
Terms of the lease include annual rental payment adjustments to reflect changes
in the Consumer Price Index. In 1997, the Company exercised its option to extend
the lease through October 2002. The Company has an option to extend the lease
for one additional five-year period.

Prior to 1999, the Company leased office space near the Fremont Brewery.
The Company exercised its option to terminate the lease in 1998 and moved its
corporate offices to the Fremont Brewery building.

In May 1995, the Company entered into an agreement to lease the land on
which the New Hampshire Brewery was constructed. The initial lease period runs
through April 2047 and may be extended at the Company's option for two
additional seven-year terms. The lease also provides the Company with the first
right of refusal to purchase the premises should the lessor receive an offer to
sell the property to a third party. The monthly rent commenced upon the
completion of the facility, and can escalate up to 5% at the end of every
five-year period.

Rent expense for the years ended December 31, 2000, 1999 and 1998 totaled
$553,000, $536,000 and $862,000, respectively. For a portion of 1998, rent
expense included a fee in lieu of property taxes on the New Hampshire Brewery.

Minimum aggregate future lease payments under noncancelable operating
leases as of December 31, 2000 are as follows:

2001................................... $ 532,613
2002................................... 487,377
2003................................... 261,197
2004................................... 260,277
2005................................... 253,978
Thereafter............................. 10,346,375
-----------
$12,141,817
===========

The Company periodically enters into commitments to purchase certain
natural gas and raw materials in the normal course of business. Furthermore, the
Company has entered into purchase commitments to ensure it has the necessary
supply of hops to meet future production requirements. Hop commitments are for
crop years through 2003. The Company believes that hop commitments in excess of
future requirements, if any, will not materially affect its financial condition
or results of operations.

41
44
REDHOOK ALE BREWERY, INCORPORATED

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

11. EMPLOYEE BENEFIT PLAN

The Company maintains a 401(k) savings plan for employees age 21 years or
older with at least six months of service. The maximum employee contribution is
15% of the participant's compensation. The Company matches 100% of each dollar
contributed by a participant, with a maximum matching contribution of 4% of a
participant's compensation. The Company's contributions to the plan vest at
varying rates up to five years depending upon the employee's years of service
and totaled $186,000, $178,000 and $189,000 in 2000, 1999 and 1998,
respectively.

12. FINANCIAL INSTRUMENTS, MAJOR CUSTOMERS, AND RELATED-PARTY TRANSACTIONS

Financial instruments that potentially subject the Company to credit risk
consist principally of trade receivables and interest-bearing deposits. The
Company's interest-bearing deposits are placed with major financial
institutions. Wholesale distributors and A-B account for substantially all
accounts receivable; therefore, this concentration risk is limited due to the
number of distributors, their geographic dispersion, and state laws regulating
the financial affairs of distributors of alcoholic beverages.

The Company's most significant non-Alliance wholesaler, K&L Distributors,
Inc., an independent A-B distributor, accounted for approximately 16%, 17% and
17% of total sales in 2000, 1999 and 1998, respectively. The sales to A-B
through the Distribution Alliance represented 60%, 58% and 58% of total sales,
or $22,582,000, $20,712,000 and $20,878,000 (net of an approximate 2% alliance
fee), in 2000, 1999 and 1998, respectively. Additional fees incurred by the
Company for A-B administrative and handling charges totaled $216,000, $188,000
and $183,000 in 2000, 1999 and 1998, respectively. The Company purchased certain
materials through A-B totaling $3,989,000, $3,999,000 and $4,462,000 in 2000,
1999, and 1998, respectively. Net amount due to A-B was $120,000 and $415,000,
as of December 31, 2000 and December 31, 1999, respectively.

13. QUARTERLY FINANCIAL DATA (UNAUDITED)

2000 QUARTER ENDED 1999 QUARTER ENDED
-------------------------------------- --------------------------------------
DEC. 31 SEPT. 30 JUNE 30 MAR. 31 DEC. 31 SEPT. 30 JUNE 30 MAR. 31
------- -------- ------- ------- ------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

Sales..................................... $ 8,960 $10,313 $10,408 $8,156 $8,853 $9,623 $9,309 $7,675
Less Excise Taxes......................... 754 922 984 764 803 894 866 703
------- ------- ------- ------ ------ ------ ------ ------
Net Sales................................. 8,206 9,391 9,424 7,392 8,050 8,729 8,443 6,972
Cost of Sales............................. 6,259 6,388 6,506 5,428 5,878 5,850 5,785 5,100
------- ------- ------- ------ ------ ------ ------ ------
Gross Profit.............................. 1,947 3,003 2,918 1,964 2,172 2,879 2,658 1,872
Selling, General and Administrative
Expenses................................ 3,238 3,160 2,707 2,642 2,976 3,058 3,085 2,172
------- ------- ------- ------ ------ ------ ------ ------
Operating Income (Loss)................... (1,291) (157) 211 (678) (804) (179) (427) (300)
Interest Expense and Other Income,
Net(1).................................. 10 990 (63) (77) (78) (328) (80) (95)
------- ------- ------- ------ ------ ------ ------ ------
Income (Loss) Before Taxes................ (1,281) 833 148 (755) (882) (507) (507) (395)
Income Tax Provision (Benefit)............ (439) 306 59 (253) (274) (177) (178) (138)
------- ------- ------- ------ ------ ------ ------ ------
Net Income (Loss)......................... $ (842) $ 527 $ 89 $ (502) $ (608) $ (330) $ (329) $ (257)
======= ======= ======= ====== ====== ====== ====== ======
Basic Earnings (Loss) per Share........... $ (0.11) $ 0.07 $ 0.01 $(0.07) $(0.08) $(0.04) $(0.04) $(0.03)
======= ======= ======= ====== ====== ====== ====== ======
Diluted Earnings (Loss) per Share......... $ (0.11) $ 0.06 $ 0.01 $(0.07) $(0.08) $(0.04) $(0.04) $(0.03)
======= ======= ======= ====== ====== ====== ====== ======
Barrels Shipped........................... 50.5 56.9 58.7 46.4 49.6 53.5 51.4 43.1

- ---------------
(1) In July 2000, the Company sold a warehousing facility and real estate parcel
for approximately $1.7 million in cash and recorded a gain of approximately
$1.0 million.

42
45

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES

None.

PART III.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding the Company's directors and executive officers is
incorporated by reference from the Company's definitive proxy statement for its
2001 Annual Meeting of Stockholders (the "2001 Proxy Statement") under the
captions "Board of Directors" or "Executive Compensation."

ITEM 11. EXECUTIVE COMPENSATION

Information regarding executive compensation is incorporated by reference
from the 2001 Proxy Statement caption "Executive Compensation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information regarding security ownership of certain beneficial owners and
management is incorporated by reference from the 2001 Proxy Statement under the
caption "Security Ownership of Certain Beneficial Owners and Management."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and related transactions is
incorporated by reference from the 2001 Proxy Statement under the caption
"Certain Transactions."

PART IV.

ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K

The following documents are filed as part of this report under Item 8:

1. Audited Financial Statements and Financial Statement Schedules

PAGE
----

Report of Ernst & Young LLP, Independent Auditors........... 26
Balance Sheets as of December 31, 2000 and 1999............. 27
Statements of Operations for the Years Ended
December 31, 2000, 1999 and 1998.......................... 28
Statements of Common Stockholders' Equity for the Years
Ended
December 31, 2000, 1999 and 1998.......................... 29
Statements of Cash Flows for the Years Ended
December 31, 2000, 1999 and 1998.......................... 30
Notes to Financial Statements............................... 31

All other financial statement schedules are omitted because they were
not required or the required information is included in the Financial
Statements or Notes thereto.

43
46

2. Exhibits

The following exhibits are filed or incorporated by reference pursuant
to Item 601 of Regulation S-K:

3.1(1) Articles of Amendment to and Second Restatement of Articles
of Incorporation of Registrant dated November 15, 1994;
Articles of Amendment, dated November 15, 1994; and Articles
of Amendment dated June 15, 1995
3.2 Amended and Restated Bylaws of Registrant, dated February
16, 2001;
10.1(1) Securities Purchase Agreement dated as of July 21, 1993,
between the Registrant and GE Capital Redhook Investment
Corp.
10.2(1) Securities Purchase Agreement dated as of July 21, 1993,
among Registrant and certain investors
10.3(1) Amendment No. 2 dated as of October 18, 1994, to Securities
Purchase Agreement dated as of July 21, 1993 (see Exhibits
10.1 and 10.2)
10.4(1) Investment Agreement dated as of October 18, 1994, between
the Registrant and Anheuser-Busch, Incorporated
10.5(1) Registration Rights Agreement dated as of August 9, 1993,
between the Registrant and Purchasers (as defined therein)
10.6(1) Amendment No. 1 dated as of October 18, 1994, to
Registration Rights Agreement dated as of August 9, 1993
10.7(1) Registration Rights Agreement dated as of October 18, 1994,
between Registrant and Anheuser-Busch, Incorporated
10.8(1) Employment Agreement between Registrant and Paul Shipman,
dated October 18, 1994
10.9(1) Multi-Tenant Lease between the Quadrant Corporation and
Registrant, dated June 1, 1987, as amended, November 5,
1987, February 1, 1988, March 29, 1988, June 27, 1988,
October 27, 1988, June 18, 1991, October 1, 1991, December
22, 1992 and March 31, 1993
10.11(1) Sublease between Pease Development Authority as Sublessor
and Registrant as Sublessee, dated May 30, 1995
10.14(1) Amended and Restated Registrant's Directors Stock Option
Plan
10.15(1) Registrant's Incentive Stock Option Plan, dated September
12, 1990
10.16(1) 1992 Stock Incentive Plan, approved October 20, 1992, as
amended, October 11, 1994 and May 25, 1995
10.18(1) Amended and Restated Credit Agreement between U.S. Bank of
Washington, National Association and Registrant, dated June
5, 1995
10.21(1)(9) Master Distributor Agreement between Registrant and
Anheuser-Busch, Incorporated, dated October 18, 1994
10.22(1) Amendment No. 3 dated as of July 27, 1995, to Securities
Purchase Agreement dated as of July 21, 1993 (see Exhibits
10.1 and 10.2)
10.23(1) Amendment dated as of July 25, 1995, between the Registrant
and GE Capital Redhook Investment Corp.
10.24(1) Assignment of Sublease and Assumption Agreement dated as of
July 1, 1995, between Registrant and Redhook of New
Hampshire, Inc. (see Exhibit 10.11)
10.25(1) Letter Agreement dated as of July 31, 1995, between
Registrant and Anheuser-Busch, Incorporated

44
47

10.26(7) Employment Agreement between Registrant and Bradley A. Berg,
dated December 20, 1999
10.27(8) Employment Agreement between Registrant and David J.
Mickelson, dated December 20, 1999
10.28(8) Employment Agreement between Registrant and Allen L
Triplett, dated December 20, 1999
10.29(8) Employment Agreement between Registrant and Pamela J.
Hinckley, dated December 20, 1999
10.30(2) Amendment No. 1 dated as of June 26, 1996, to Master
Distribution Agreement between Registrant and
Anheuser-Busch, Incorporated, dated October 18, 1994
10.31(2) Amendment dated as of February 27, 1996, to Registrant's
1992 Stock Incentive Plan, as amended
10.32(2) Amendment dated as of February 27, 1996, to Amended and
Restated Registrant's Directors Stock Option Plan
10.33(2) Amendment dated as of July 25, 1996, to Registrant's 1992
Stock Incentive Plan, as amended
10.34(3) First Amendment dated as of July 25, 1996, to Amended and
Restated Credit Agreement between U.S. Bank of Washington,
National Association and Registrant, dated June 5, 1995
10.35(4) Second Amendment to Amended and Restated Credit Agreement
between U.S. Bank of Washington, National Association and
Registrant, dated September 15, 1997
10.36(4) Consent, Waiver and Amendment, dated September 19, 1997, to
Master Distributor Agreement between Registrant and
Anheuser-Busch, Incorporated, dated October 18, 1994
10.37(5)(9) Purchasing Agreement dated as of March 27, 1998, between and
Anheuser-Busch, Incorporated
10.38(6) Third Amendment to Amended and Restated Credit Agreement
between U.S. Bank of Washington, National Association and
Registrant, dated February 22, 1999
10.39(6) Amended and Restated Rights Agreement between Registrant and
ChaseMellon Shareholder Services, LLC, dated as of May 12,
1999
10.40(6) First Amendment to Employment Agreement between Registrant
and Paul Shipman, dated May 6, 1999
10.41(8) Employment Agreement between Registrant and Greg Marquina,
dated August 1, 2000
10.42(8) Fourth Amendment to Amended and Restated Credit Agreement
between U.S. Bank National Association and Registrant, dated
August 10, 2000
10.43 Employment Agreement between Registrant and Paul Shipman,
dated November 1, 2000
21.1(1) Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors

- ---------------
(1) Incorporated by reference to same exhibit number as in the
Company's Registration Statement on Form S-1, Registrant No.
33-94166.

(2) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended June 30, 1996.

45
48

(3) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended September 30, 1996.

(4) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended September 30, 1997.

(5) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended March 31, 1998.

(6) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended March 31, 1999.

(7) Incorporated by reference to same exhibit number as in the
Company's Form 10-K for the year ended December 31, 1999.

(8) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended September 30, 2000.

(9) Confidential treatment has been granted for portions of this
document.

46
49

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Seattle, State of Washington, on March 30, 2001.

REDHOOK ALE BREWERY, INCORPORATED

By /s/ DAVID J. MICKELSON
------------------------------------
David J. Mickelson
Executive Vice President,
Chief Financial Officer and
Chief Operating Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
--------- ----- ----

/s/ PAUL S. SHIPMAN President, Chief Executive March 30, 2001
- ----------------------------------------------------- Officer and Chairman of the
Paul S. Shipman Board (Principal Executive
Officer)

/s/ DAVID J. MICKELSON Executive Vice President, March 30, 2001
- ----------------------------------------------------- Chief Financial Officer and
David J. Mickelson Chief Operating Officer
(Principal Financial Officer)

/s/ ANNE M. MUELLER Controller and Treasurer March 30, 2001
- ----------------------------------------------------- (Principal Accounting Officer)
Anne M. Mueller

/s/ M. COLLEEN BECKEMEYER Director March 30, 2001
- -----------------------------------------------------
M. Colleen Beckemeyer

/s/ FRANK H. CLEMENT Director March 30, 2001
- -----------------------------------------------------
Frank H. Clement

/s/ JERRY D. JONES Director March 30, 2001
- -----------------------------------------------------
Jerry D. Jones

/s/ ANTHONY J. SHORT Director March 30, 2001
- -----------------------------------------------------
Anthony J. Short

/s/ WALTER F. WALKER Director March 30, 2001
- -----------------------------------------------------
Walter F. Walker

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50

2. Exhibits

The following exhibits are filed or incorporated by reference pursuant
to Item 601 of Regulation S-K:

3.1(1) Articles of Amendment to and Second Restatement of Articles
of Incorporation of Registrant dated November 15, 1994;
Articles of Amendment, dated November 15, 1994; and Articles
of Amendment dated June 15, 1995
3.2 Amended and Restated Bylaws of Registrant, dated February
16, 2001;
10.1(1) Securities Purchase Agreement dated as of July 21, 1993,
between the Registrant and GE Capital Redhook Investment
Corp.
10.2(1) Securities Purchase Agreement dated as of July 21, 1993,
among Registrant and certain investors
10.3(1) Amendment No. 2 dated as of October 18, 1994, to Securities
Purchase Agreement dated as of July 21, 1993 (see Exhibits
10.1 and 10.2)
10.4(1) Investment Agreement dated as of October 18, 1994, between
the Registrant and Anheuser-Busch, Incorporated
10.5(1) Registration Rights Agreement dated as of August 9, 1993,
between the Registrant and Purchasers (as defined therein)
10.6(1) Amendment No. 1 dated as of October 18, 1994, to
Registration Rights Agreement dated as of August 9, 1993
10.7(1) Registration Rights Agreement dated as of October 18, 1994,
between Registrant and Anheuser-Busch, Incorporated
10.8(1) Employment Agreement between Registrant and Paul Shipman,
dated October 18, 1994
10.9(1) Multi-Tenant Lease between the Quadrant Corporation and
Registrant, dated June 1, 1987, as amended, November 5,
1987, February 1, 1988, March 29, 1988, June 27, 1988,
October 27, 1988, June 18, 1991, October 1, 1991, December
22, 1992 and March 31, 1993
10.11(1) Sublease between Pease Development Authority as Sublessor
and Registrant as Sublessee, dated May 30, 1995
10.14(1) Amended and Restated Registrant's Directors Stock Option
Plan
10.15(1) Registrant's Incentive Stock Option Plan, dated September
12, 1990
10.16(1) 1992 Stock Incentive Plan, approved October 20, 1992, as
amended, October 11, 1994 and May 25, 1995
10.18(1) Amended and Restated Credit Agreement between U.S. Bank of
Washington, National Association and Registrant, dated June
5, 1995
10.21(1)(9) Master Distributor Agreement between Registrant and
Anheuser-Busch, Incorporated, dated October 18, 1994
10.22(1) Amendment No. 3 dated as of July 27, 1995, to Securities
Purchase Agreement dated as of July 21, 1993 (see Exhibits
10.1 and 10.2)
10.23(1) Amendment dated as of July 25, 1995, between the Registrant
and GE Capital Redhook Investment Corp.
10.24(1) Assignment of Sublease and Assumption Agreement dated as of
July 1, 1995, between Registrant and Redhook of New
Hampshire, Inc. (see Exhibit 10.11)
10.25(1) Letter Agreement dated as of July 31, 1995, between
Registrant and Anheuser-Busch, Incorporated

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51

10.26(7) Employment Agreement between Registrant and Bradley A. Berg,
dated December 20, 1999
10.27(8) Employment Agreement between Registrant and David J.
Mickelson, dated December 20, 1999
10.28(8) Employment Agreement between Registrant and Allen L
Triplett, dated December 20, 1999
10.29(8) Employment Agreement between Registrant and Pamela J.
Hinckley, dated December 20, 1999
10.30(2) Amendment No. 1 dated as of June 26, 1996, to Master
Distribution Agreement between Registrant and
Anheuser-Busch, Incorporated, dated October 18, 1994
10.31(2) Amendment dated as of February 27, 1996, to Registrant's
1992 Stock Incentive Plan, as amended
10.32(2) Amendment dated as of February 27, 1996, to Amended and
Restated Registrant's Directors Stock Option Plan
10.33(2) Amendment dated as of July 25, 1996, to Registrant's 1992
Stock Incentive Plan, as amended
10.34(3) First Amendment dated as of July 25, 1996, to Amended and
Restated Credit Agreement between U.S. Bank of Washington,
National Association and Registrant, dated June 5, 1995
10.35(4) Second Amendment to Amended and Restated Credit Agreement
between U.S. Bank of Washington, National Association and
Registrant, dated September 15, 1997
10.36(4) Consent, Waiver and Amendment, dated September 19, 1997, to
Master Distributor Agreement between Registrant and
Anheuser-Busch, Incorporated, dated October 18, 1994
10.37(5)(9) Purchasing Agreement dated as of March 27, 1998, between and
Anheuser-Busch, Incorporated
10.38(6) Third Amendment to Amended and Restated Credit Agreement
between U.S. Bank of Washington, National Association and
Registrant, dated February 22, 1999
10.39(6) Amended and Restated Rights Agreement between Registrant and
ChaseMellon Shareholder Services, LLC, dated as of May 12,
1999
10.40(6) First Amendment to Employment Agreement between Registrant
and Paul Shipman, dated May 6, 1999
10.41(8) Employment Agreement between Registrant and Greg Marquina,
dated August 1, 2000
10.42(8) Fourth Amendment to Amended and Restated Credit Agreement
between U.S. Bank National Association and Registrant, dated
August 10, 2000
10.43 Employment Agreement between Registrant and Paul Shipman,
dated November 1, 2000
21.1(1) Subsidiaries of the Registrant
23.1 Consent of Ernst & Young LLP, Independent Auditors

- ---------------
(1) Incorporated by reference to same exhibit number as in the
Company's Registration Statement on Form S-1, Registrant No.
33-94166.

(2) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended June 30, 1996.

45
52

(3) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended September 30, 1996.

(4) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended September 30, 1997.

(5) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended March 31, 1998.

(6) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended March 31, 1999.

(7) Incorporated by reference to same exhibit number as in the
Company's Form 10-K for the year ended December 31, 1999.

(8) Incorporated by reference to same exhibit number as in the
Company's Form 10-Q for the quarter ended September 30, 2000.

(9) Confidential treatment has been granted for portions of this
document.

46