ITEM
1 –FINANCIAL STATEMENTS (unaudited)
Eastside
Distilling, Inc. and Subsidiary
Consolidated
Balance Sheets
March
31, 2017 and December 31, 2016
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|
March
31, 2017
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December
31, 2016
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|
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|
(unaudited)
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Assets
|
|
|
|
|
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Current assets:
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|
|
|
|
|
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Cash
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|
$
|
883,715
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|
|
$
|
1,088,066
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|
Trade receivables
|
|
|
360,126
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|
|
|
344,955
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|
Inventories
|
|
|
995,733
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|
|
|
780,037
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Prepaid
expenses and current assets
|
|
|
146,802
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|
|
|
187,714
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|
Total current assets
|
|
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2,386,376
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|
|
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2,400,772
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Property and equipment, net
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128,560
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|
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|
99,216
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Intangible assets, net
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|
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373,502
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|
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-
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Deposits
|
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59,400
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|
|
|
48,000
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Total
Assets
|
|
$
|
2,947,838
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$
|
2,547,988
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Liabilities and Stockholders’
Equity
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Current liabilities:
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|
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Accounts payable
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$
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476,175
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$
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457,034
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Accrued liabilities
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208,418
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523,702
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Deferred revenue
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1,458
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|
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2,126
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Current
portion of notes payable
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|
-
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|
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4,537
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Total current liabilities
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686,051
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987,399
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Notes payable
- less current portion and debt discount
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365,160
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427,756
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Total
liabilities
|
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1,051,211
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1,415,155
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Commitments and contingencies (Note
9)
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Stockholders’ equity:
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Series A convertible
preferred stock, $0.0001 par value; 3,000 shares authorized; 50 and 300 shares issued and outstanding at March 31, 2017 and
December 31, 2016, respectively (liquidation values of $125,000 and $750,000, respectively)
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49,426
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245,838
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Common stock, $0.0001
par value; 45,000,000 shares authorized; 9,010,352 and 7,627,512 shares issued and outstanding at March 31, 2017 and December
31, 2016, respectively
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901
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|
764
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Additional paid-in
capital
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15,566,199
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13,699,275
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Accumulated
deficit
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(13,719,899
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)
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(12,813,044
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)
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Total
stockholders’ equity
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1,896,627
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1,132,833
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Total
Liabilities and Stockholders’ Equity
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$
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2,947,838
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$
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2,547,988
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The
accompanying notes are an integral part of these condensed consolidated financial statements.
Eastside
Distilling, Inc. and Subsidiary
Consolidated
Statements of Operations
For
the three months ended March 31, 2017 and 2016
(unaudited)
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Three
Months Ended
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March
31, 2017
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March
31, 2016
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Sales
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$
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829,669
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$
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621,882
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Less excise taxes,
customer programs and incentives
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217,188
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167,120
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Net sales
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612,481
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454,762
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Cost of sales
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322,913
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256,169
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Gross profit
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289,568
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198,593
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Operating expenses:
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Advertising, promotional
and selling expenses
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386,132
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156,203
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General and administrative
expenses
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726,396
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886,011
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Loss
on disposal of property and equipment
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35,534
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-
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Total
operating expenses
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1,148,062
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1,042,214
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Loss from operations
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(858,494
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)
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(843,621
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)
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Other income (expense), net
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Interest expense
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(47,809
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)
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(171,054
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)
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Other
income (expense)
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4,485
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(4
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)
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Total
other expense, net
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(43,324
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)
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(171,058
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)
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Loss before income
taxes
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(901,818
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)
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(1,014,679
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)
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Provision for
income taxes
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|
|
-
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-
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Net loss
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(901,818
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)
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(1,014,679
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)
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Dividends on
convertible preferred stock
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(5,037
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)
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-
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Net
loss attributable to common shareholders
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$
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(906,855
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)
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$
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(1,014,679
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)
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Basic
and diluted net loss per common share
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$
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(0.12
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)
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$
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(0.45
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)
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Basic
and diluted weighted average common shares outstanding
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7,842,971
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2,275,625
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The
accompanying notes are an integral part of these condensed consolidated financial statements.
Eastside
Distilling, Inc. and Subsidiary
Consolidated
Statements of Cash Flows
For
the three months ended March 31, 2017 and 2016
(unaudited)
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2017
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2016
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Cash Flows From Operating
Activities:
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|
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Net
loss
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$
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(901,818
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)
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$
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(1,014,679
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)
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Adjustments to reconcile
net loss to net cash used in operating activities:
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Depreciation and
amortization
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9,006
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5,574
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Loss on disposal
of property and equipment
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35,534
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-
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Amortization of
debt issuance costs
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37,009
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11,167
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Amortization of
beneficial conversion feature
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-
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148,077
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Issuance of common
stock in exchange for services
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86,317
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89,100
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Stock-based compensation
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158,658
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105,839
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Changes in operating
assets and liabilities:
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Trade receivables
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(15,171
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)
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(40,974
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)
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Inventories
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|
(112,208
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)
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|
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61,356
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Prepaid expenses
and other assets
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29,512
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|
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64,751
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Accounts payable
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13,961
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(7,808
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)
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Accrued liabilities
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(466,335
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)
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304,739
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Deferred
revenue
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(668
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)
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1,381
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Net
cash used in operating activities
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(1,126,203
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)
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(271,477
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)
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Cash Flows From Investing
Activities:
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Cash acquired in
acquisition
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7,062
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|
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|
-
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Purchases
of property and equipment
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(39,631
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)
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(6,954
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)
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Net
cash used in investing activities
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(32,569
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)
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(6,954
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)
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Cash Flows From Financing
Activities:
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Preferred stock
deposit
|
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|
-
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151,200
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Stock issuance cost
related to acquisition
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(5,580
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)
|
|
|
-
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Payments of principal
on notes payable
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(1,716
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)
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(1,286
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)
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Proceeds from common
stock, net of issuance costs of $6,033, with detachable warrants
|
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802,467
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|
-
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Proceeds
from warrant exercise
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159,250
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|
|
-
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Net
cash provided by financing activities
|
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954,421
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|
|
|
149,914
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Net decrease in cash
|
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(204,351
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)
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|
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(128,517
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)
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Cash - beginning of period
|
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|
1,088,066
|
|
|
|
141,317
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Cash - end of
period
|
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$
|
883,715
|
|
|
$
|
12,800
|
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|
|
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|
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Supplemental Disclosure
of Cash Flow Information:
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|
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|
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Cash
paid during the period for interest
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|
$
|
10,800
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|
|
$
|
1,380
|
|
|
|
|
|
|
|
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Supplemental Disclosure
of Non-Cash Financing Activity:
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|
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|
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|
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Issuance
of common stock for the acquisition of MotherLode Craft Distillery, LLC
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$
|
377,000
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|
|
$
|
-
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Common
stock issued in exchange of notes payable
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$
|
87,500
|
|
|
$
|
-
|
|
The
accompanying notes are an integral part of these condensed consolidated financial statements.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
1.
|
Description
of Business
|
We are a Portland, Oregon-based
producer and marketer of craft spirits, founded in 2008. Our products span several alcoholic beverage categories, including bourbon,
American whiskey, vodka and rum. Unlike many, if not most distillers, we operate several retail tasting rooms in Oregon to market
our brands directly to consumers. Our growth strategy is to build on our local base in the Pacific Northwest and expand selectively
to other markets by using major spirits distributors, such as Southern Glazer Wines and Spirits, or regional distributors that
focus on craft brands. As a small company in the large, international spirits marketplace filled with massive conglomerates, we
are innovative in exploiting new trends with our products, for example our Coffee Rum with cold brew coffee and low sugar and
our gluten free potato vodka. In December of 2016 we retained Sandstrom Partners (an internationally known spirit branding firm
that branded St Germain and Bulleit Bourbon), to guide our marketing strategy and branding. They subsequently became an investor
in our Company. We seek to be both a leader in creating spirits that offer better value than comparable spirits, for example our
value priced Burnside Bourbon and Portland Potato Vodka, and an innovator in creating imaginative spirits that offer a unique
taste experience, for example our cold-brewed coffee rum, Oregon oak aged whiskeys, Marionberry Whiskey and Peppermint Bark holiday
liqueur. On May 1, 2017, we acquired Big Bottom Distillery (“BBD”) for its excellent, award winning range of super
premium gins and whiskeys, including Navy Proof Gin, Oregon Gin, Delta Rye and initial production of American Single Malt whiskey.
BBD’s super premium spirits will expand our tasting room offerings and give us a presence at the “high end”
of the market. In addition, through MotherLode Craft Distillery (“MotherLode”), our wholly-owned subsidiary acquired
on March 8, 2017, we also provide contract bottling and packaging services for existing and would be spirits producers, some of
whom contract with us to blend or distill spirits. As a publicly-traded craft spirit producers, we have access to the public capital
markets to support our long-term growth initiatives, including strategic acquisitions.
We
currently sell our products in 22 states (Oregon, California, Washington, Florida, Nevada, Texas, Virginia, Indiana, Illinois,
New York, New Jersey, Massachusetts, Connecticut, Minnesota, Georgia, Pennsylvania, Rhode Island, New Hampshire, Maine, Idaho,
Vermont and Maryland) as well as Canada and China. The Company also generates revenue from tastings, tasting room tours, private
parties, and merchandise sales from its facilities in Oregon. The Company is subject to the Oregon Liquor Control Commission (OLCC)
and the Alcohol and Tobacco Tax and Trade Bureau (TTB).
Historically,
the Company has funded its cash and liquidity needs through convertible notes, extended credit terms, and equity raisings. The
Company has incurred a net loss of approximately $901,818 and has an accumulated deficit of $13,719,889 for the three months ended
March 31, 2017. The Company has been dependent on raising capital from debt and equity financings to meet its needs for cash flow
used in operating activities. For the three months ended March 31, 2017, the Company raised $954,421 in cash flow from financing
activities to meet cash flow used in operating activities.
At
March 31, 2017, the Company has $883,715 of cash on hand with a positive working capital of $1,700,325. The Company’s ability
to meet its ongoing operating cash needs is dependent on generating positive operating cash flow, primarily through increased
sales, improved profit growth and controlling expenses. Management has taken actions to improve profitability, by reducing headcount,
rent, professional fees and increasing sales. In addition, through May 12, 2017, the Company has raised an additional $833,815
in cash through equity and debt offerings (see Note 14, Subsequent Events). Also in May 2017, the Company acquired
a small distillery business (stock purchase transaction) that is expected to improve operating results (see Note 14, Subsequent
Events). Management believes that cash on hand and the most recent equity raise and acquisition will be sufficient to meet their
operating activities to meet their near-term cash needs over the next twelve months.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
3.
|
Summary
of Significant Accounting Policies
|
Basis
of Presentation and Consolidation
The
accompanying condensed consolidated financial statements for Eastside Distilling, Inc. and Subsidiary were prepared in accordance
with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with
instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition,
results of operations, and cash flows in conformity with GAAP. However, all adjustments which are, in the opinion of management,
necessary for a fair presentation of the interim condensed consolidated financial statements have been included. All such adjustments
are of a normal recurring nature. The unaudited condensed consolidated financial statements should be read in conjunction with
the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December
31, 2016. The unaudited condensed consolidated results of operations for the three months ended March 31, 2017 are not necessarily
indicative of the results that may be expected for the entire fiscal year ending December 31, 2017. The condensed consolidated
financial statements include the accounts of Eastside Distilling, Inc.’s wholly-owned subsidiary MotherLode (beginning as
of March 8, 2017). All intercompany balances and transactions have been eliminated in consolidation.
Segment
Reporting
The
Company determined its operating segment on the same basis that it uses to evaluate its performance internally. The Company has
one business activity, producing, marketing and distributing hand-crafted spirits, and operates as one segment. The Company’s
chief operating decision makers, its chief executive officer and chief financial officer, review the Company’s operating
results on an aggregate basis for purposes of allocating resources and evaluating financial performance.
Use
of Estimates
The
preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those
estimates.
Revenue
Recognition
Net
revenue includes product sales, less excise taxes and customer programs and incentives. The Company records revenue when all four
of the following criteria are met: (i) there is persuasive evidence that an arrangement exists; (ii) delivery of the products
and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectability is reasonably assured.
The
Company recognizes sales when merchandise is shipped from a warehouse directly to wholesale customers (except in the case of a
consignment sale). For consignment sales, which include sales to the Oregon Liquor Control Commission (OLCC), the Company recognizes
sales upon the consignee’s shipment to the customer. Postage and handling charges billed to customers are also recognized
as sales upon shipment of the related merchandise. Shipping terms are generally FOB shipping point, and title passes to the customer
at the time and place of shipment or purchase by customers at a retail location. For consignment sales, title passes to the consignee
concurrent with the consignee’s shipment to the customer. The customer has no cancellation privileges after shipment or
upon purchase at retail locations, other than customary rights of return. The Company excludes sales tax collected and remitted
to various states from sales and cost of sales. Sales from items sold through the Company’s retail location are recognized
at the time of sale.
Revenue
received from online merchants who sell discounted gift certificates for the Company’s merchandise and tastings is deferred
until the customer has redeemed the discounted gift certificate or the gift certificate has expired, whichever occurs earlier.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
Customer
Programs and Incentives
Customer
programs and incentives, which include customer promotional discount programs, customer incentives and other payments, are a common
practice in the alcohol beverage industry. The Company makes these payments to customers and incurs these costs to promote sales
of products and to maintain competitive pricing. Amounts paid in connection with customer programs and incentives are recorded
as reductions to net sales or as advertising, promotional and selling expenses in accordance with ASC Topic 605-50, Revenue Recognition
- Customer Payments and Incentives, based on the nature of the expenditure. Amounts paid to customers totaled $40,772 and $8,712
for the three months ended March 31, 2017 and 2016, respectively.
Advertising,
Promotional and Selling Expenses
The
following expenses are included in advertising, promotions and selling expenses in the accompanying consolidated statements of
operations: media advertising costs, special event costs, tasting room costs, sales and marketing expenses, salary and benefit
expenses, travel and entertainment expenses for the sales, brand and sales support workforce and promotional activity expenses.
Cost
of Sales
Cost
of sales consists of the costs of ingredients utilized in the production of spirits, manufacturing labor and overhead, warehousing
rent, packaging, and in-bound freight charges. Ingredients account for the largest portion of the cost of sales, followed by packaging
and production costs.
Shipping
and Fulfillment Costs
Freight
costs incurred related to shipment of merchandise from the Company’s distribution facilities to customers are recorded in
cost of sales.
Cash
and Cash Equivalents
Cash
equivalents are considered to be highly liquid investments with maturities of three months or less at the time of the purchase.
The Company had no cash equivalents at March 31, 2017 and December 31, 2016.
Concentrations
Financial
instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables. At
March 31, 2017 and December 31, 2016, three customers represented 79% and 91% of trade receivables, respectively. Sales to three
customers accounted for approximately 57% of consolidated net sales for the three months ended March 31, 2017. Sales to one customer,
the OLCC, accounted for approximately 32% of net sales for the three months ended March 31, 2016.
Fair
Value Measurements
GAAP
defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements.
GAAP permits an entity to choose to measure many financial instruments and certain other items at fair value and contains financial
statement presentation and disclosure requirements for assets and liabilities for which the fair value option is elected. At March
31, 2017 and December 31, 2016, management has not elected to report any of the Company’s assets or liabilities at fair
value under the “fair value option” provided by GAAP.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
The
hierarchy of fair value valuation techniques under GAAP provides for three levels: Level 1 provides the most reliable measure
of fair value, whereas Level 3, if applicable, generally would require significant management judgment. The three levels for categorizing
assets and liabilities under GAAP’s fair value measurement requirements are as follows:
|
Level
1:
|
Fair
value of the asset or liability is determined using unadjusted quoted prices in active markets for identical assets or liabilities.
|
|
|
|
|
Level
2:
|
Fair
value of the asset or liability is determined using inputs other than quoted prices that are observable for the applicable
asset or liability, either directly or indirectly, such as quoted prices for similar (as opposed to identical) assets or liabilities
in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
|
|
|
|
|
Level
3:
|
Fair
value of the asset or liability is determined using unobservable inputs that are significant to the fair value measurement
and reflect management’s own assumptions regarding the applicable asset or liability.
|
None
of the Company’s assets or liabilities were measured at fair value at March 31, 2017 and December 31, 2016. However, GAAP
requires the disclosure of fair value information about financial instruments that are not measured at fair value. Financial instruments
consist principally of trade receivables, accounts payable, accrued liabilities, note payable, and convertible note payable. The
estimated fair value of trade receivables, accounts payable, and accrued liabilities approximates their carrying value due to
the short period of time to their maturities. At March 31, 2017 and December 31, 2016, the Company’s note payable and convertible
notes payable are at fixed rates and their carrying value approximates fair value.
Items
Measured at Fair Value on a Nonrecurring Basis
Certain
assets and liabilities acquired in a business acquisition are valued at fair value at the date of acquisition.
Inventories
Inventories
primarily consist of bulk and bottled liquor and merchandise and are stated at the lower of cost or market. Cost is determined
using an average costing methodology, which approximates cost under the first-in, first-out (FIFO) method. A portion of inventory
is held by certain independent distributors on consignment until it is sold to a third party. The Company regularly monitors inventory
quantities on hand and records write-downs for excess and obsolete inventories based primarily on the Company’s estimated
forecast of product demand and production requirements. Such write-downs establish a new cost basis of accounting for the related
inventory. The Company has recorded no write-downs of inventory for the three months ended March 31, 2017 and 2016.
Property
and Equipment
Property
and equipment is stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line
method over the estimated useful lives of the assets, ranging from three to seven years. Amortization of leasehold improvements
is computed using the straight-line method over the life of the lease or the useful lives of the assets, whichever is shorter.
The cost and related accumulated depreciation and amortization of property and equipment sold or otherwise disposed of are removed
from the accounts and any gain or loss is reported as current period income or expense. The costs of repairs and maintenance are
expensed as incurred.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
Long-lived
Assets
The
Company accounts for long-lived assets, including property and equipment, at amortized cost. Management reviews long-lived assets
for probable impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable.
If there is an indication of impairment, management would prepare an estimate of future cash flows (undiscounted and without interest
charges) expected to result from the use of the asset and its eventual disposition. If these estimated cash flows were less than
the carrying amount of the asset, an impairment loss would be recognized to write down the asset to its estimated fair value.
Income
Taxes
The
provision for income taxes is based on income and expenses as reported for financial statement purposes using the “asset
and liability method” for accounting for deferred taxes. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable
to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. A valuation allowance,
if needed, reduces deferred tax assets to the amount expected to be realized. At March 31, 2017 and December 31, 2016, the Company
established valuation allowances against its net deferred tax assets.
Income
tax positions that meet the “more-likely-than-not” recognition threshold are measured at the largest amount of income
tax benefit that is more than 50 percent likely to be realized upon settlement with the applicable taxing authority. The portion
of the benefits associated with income tax positions taken that exceeds the amount measured as described above would be reflected
as a liability for unrecognized income tax benefits in the accompanying consolidated balance sheets along with any associated
interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with
unrecognized income tax benefits would be classified as additional income taxes in the accompanying condensed consolidated statements
of operations. There were no unrecognized income tax benefits, nor any interest and penalties associated with unrecognized income
tax benefits, accrued or expensed at and for the three months ended March 31, 2017 and 2016.
The
Company files federal income tax returns in the U.S. and various state income tax returns. The Company is no longer subject to
examinations by the related tax authorities for the Company’s U.S. federal and state income tax returns for years prior
to 2011.
Advertising
Advertising
costs are expensed as incurred. Advertising expense was $386,132 and $156,203 for the three months ended March 31, 2017 and 2016,
respectively.
Comprehensive
Income
The
Company does not have any reconciling other comprehensive income items for the three months ended March 31, 2017 and 2016.
Excise
Taxes
The
Company is responsible for compliance with the TTB regulations, which includes making timely and accurate excise tax payments.
The Company is subject to periodic compliance audits by the TTB. Individual states also impose excise taxes on alcohol beverages
in varying amounts. The Company calculates its excise tax expense based upon units produced and on its understanding of the applicable
excise tax laws. Excise taxes totaled $176,416 and $158,408 for the three months ended March 31, 2017 and 2016, respectively.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
Stock-Based
Compensation
The
Company recognizes as compensation expense all stock-based awards issued to employees. The compensation cost is measured based
on the grant-date fair value of the related stock-based awards and is recognized over the service period of stock-based awards,
which is generally the same as the vesting period. The fair value of stock options is determined using the Black-Scholes valuation
model, which estimates the fair value of each award on the date of grant based on a variety of assumptions including expected
stock price volatility, expected terms of the awards, risk-free interest rate, and dividend rates, if applicable. Stock-based
awards issued to nonemployees are recorded at fair value on the measurement date and are subject to periodic market adjustments
at the end of each reporting period and as the underlying stock-based awards vest. Stock-based compensation was $158,658 and $105,839
for the three months ended March 31, 2017 and 2016, respectively.
Accounts
Receivable Factoring Program
We
use an accounts receivable factoring program with certain customer accounts. Under this program, we have the option to sell those
customer receivables in advance of payment for 75% of the amount due. When the customer remits payment, we then receive the remaining
25%. We are charged interest on the advanced 75% payment at a rate of 1.5% per month. Under the terms of the agreement with the
factoring provider, any factored invoices have recourse should the customer fail to pay the invoice. Thus, we record factored
amounts as a liability until the customer remits payment and we receive the remaining 25% of the non-factored amount. We did not
factor any invoices during the three months ended March 31, 2017. At March 31, 2017, we had factored invoices outstanding
of $59,547, and we incurred fees associated with the factoring program of $2,582 during the three months ended March 31, 2017.
During the three months ended March 31, 2016, we factored invoices totaling $117,933 and received total proceeds of $88,450. At
March 31, 2016, we had factored invoices outstanding of $79,120, and we incurred fees associated with the factoring program of
$4,269 during the three months ended March 31, 2016.
Recent
Accounting Pronouncements
In
March 2016, the Financial Accounting Standard Boards (the “FASB”) issued Accounting Standard Update (“ASU”)
No. 2016-09,
Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting.
” ASU 2016-09,
which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for
income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows.
ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years.
We have adopted as of March 31, 2017.
In
February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842).
Under the new guidance, lessees will be required to
recognize the following for all leases (with the exception of short-term leases) at the commencement date:
|
-
|
A
lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted
basis; and
|
|
|
|
|
-
|
A
right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified
asset for the lease term.
|
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
Under
the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor
accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The new lease guidance simplified
the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities.
Lessees will no longer be provided with a source of off-balance sheet financing. Public business entities should apply the amendments
in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e.,
January 1, 2019, for a calendar year entity). Early application is permitted for all public business entities upon issuance. Lessees
(for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified
retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period
presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases
that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition
approach. We are currently evaluating the impact ASU 2016-02 will have on the Company’s condensed consolidated financial
statements.
In
May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606).
ASU 2014-09 will supersede
virtually all existing revenue guidance. Under this update, an entity is required to recognize revenue upon transfer of promised
goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or
services. As such, an entity will need to use more judgment and make more estimates than under the current guidance. ASU 2014-09
is to be applied retrospectively either to each prior reporting period presented in the financial statements, or only to the most
current reporting period presented in the financial statements with a cumulative effect adjustment to retained earnings. The Company
will elect to apply the impact (if any) of applying ASU 2014-09 to the most current reporting period presented in the financial
statements with a cumulative effect adjustment to retained earnings. In August 2015, the FASB issued ASU No. 2015-14,
Revenue
from Contracts with Customers (Topic 606): Deferral of the Effective Date
. ASU 2015-14 defers the effective date of ASU 2014-09
for one year, making it effective for the year beginning December 31, 2017, with early adoption permitted as of January 1, 2017.
The Company currently expects to adopt ASU 2014-09 in the first quarter of 2018. The Company does not expect adoption of ASU 2014-09
to have a material impact on its consolidated financial statements.
In
August 2014, the FASB issued ASU No. 2014-15,
Presentation of Financial Statements - Going Concern
. The new guidance explicitly
requires that management assess an entity’s ability to continue as a going concern and may require additional detailed disclosures.
ASU 2014-15 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods.
We have adopted as of December 31, 2016.
In
July 2015, the FASB issued ASU No. 2015-11,
Inventory (Topic 330), Simplifying the Measurement of Inventory
. ASU 2015-11
is part of the FASB’s initiative to simplify accounting standards. The guidance requires an entity to recognize inventory
within scope of the standard at the lower of cost or net realizable value. Net realizable value is the estimated selling price
in the ordinary course of business, less reasonable predictable costs of completion, disposal and transportation. ASU 2015-11
will be effective prospectively for the year beginning January 1, 2017. We have adopted as of March 31, 2017.
In
April 2015, the FASB issued ASU 2015-03, simplifying the presentation of debt issuance costs, which requires that debt issuance
costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount
of that debt liability. ASU 2015-03 is effective for annual and interim periods beginning after December 15, 2015 and early application
is permitted. We have early adopted as of December 31, 2015.
Reclassifications
Certain
prior period amounts have been reclassified to conform to the March 31, 2017 presentation with no changes to net loss or total
stockholders’ equity previously reported.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
For
the three months ended March 31, 2017, the Company completed the following acquisition.
MotherLode Craft Distillery,
LLC
On
March 8, 2017, the Company completed the acquisition of MotherLode Craft Distillery, LLC (“MotherLode”), a small Portland,
Oregon based provider of bottling services and production support to craft distilleries. The Company’s consolidated financial
statements for the three months ended March 31, 2017 include MotherLode’s results of operations from the Acquisition date
of March 8, 2017 through March 31, 2017. The Company’s consolidated financial statements reflect the final purchase accounting
adjustments in accordance with ASC 805 “Business Combinations”, whereby the purchase price was allocated to the assets
acquired and liabilities assumed based upon their estimated fair values on the Acquisition date. The Company had approximately
$375,000 in revenues (unaudited) in 2016.
The
following allocation of the purchase price is as follows:
Consideration given:
|
|
|
|
|
260,000
shares of common stock valued at $1.45 per share
|
|
$
|
377,000
|
|
Assets and liabilities acquired:
|
|
|
|
|
Cash
|
|
|
7,062
|
|
Inventory
|
|
|
103,488
|
|
Property and equipment
|
|
|
46,250
|
|
Intangible assets
- customer list
|
|
|
376,431
|
|
Accounts payble
|
|
|
(5,180
|
)
|
Customer
deposits
|
|
|
(151,051
|
)
|
|
|
$
|
377,000
|
|
Intangible
assets are recorded at estimated fair value, as determined by management based on available information. The fair values assigned
to identifiable intangible assets were determined through the use of the income approach, specifically the relief from royalty
and the multi-period excess earning methods. The major assumptions used in arriving at the estimated identifiable intangible asset
values included management’s estimates of future cash flows, discounted at an appropriate rate of return which are based
on the weighted average cost of capital for both the Company and other market participants, projected customer attrition rates,
as well as applicable royalty rates for comparable assets. The useful lives for intangible assets were determined based upon the
remaining useful economic lives of the tangible assets that are expected to contribute directly or indirectly to future cash flows.
The customer relationships estimated useful life is seven years.
Inventories
consist of the following at March 31, 2017 and December 31, 2016:
|
|
2017
|
|
|
2016
|
|
Raw materials
|
|
$
|
533,814
|
|
|
$
|
439,739
|
|
Finished goods
|
|
|
461,919
|
|
|
|
340,298
|
|
Total inventories
|
|
$
|
995,733
|
|
|
$
|
780,037
|
|
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
6.
|
Property
and Equipment
|
Property
and equipment consists of the following at March 31, 2017 and December 31, 2016:
|
|
2017
|
|
|
2016
|
|
Furniture and fixtures
|
|
$
|
147,721
|
|
|
$
|
70,140
|
|
Leasehold improvements
|
|
|
14,907
|
|
|
|
8,607
|
|
Vehicles
|
|
|
12,000
|
|
|
|
38,831
|
|
Construction
In-Progress
|
|
|
-
|
|
|
|
34,603
|
|
Total cost
|
|
|
174,928
|
|
|
|
152,181
|
|
Less accumulated
depreciation
|
|
|
(46,068
|
)
|
|
|
(52,965
|
)
|
Property and
equipment - net
|
|
$
|
128,560
|
|
|
$
|
99,216
|
|
Depreciation
expense totaled $6,077 and $5,574 for the three months ended March 31, 2017 and 2016, respectively.
There
were no intangible assets at December 31, 2016. At March 31, 2017, intangible assets consist of the following:
|
|
2017
|
|
Permits and licenses
|
|
$
|
25,000
|
|
Customer lists
|
|
|
351,431
|
|
Total intangible assets
|
|
|
376,431
|
|
Less accumulated
amortization
|
|
|
(2,929
|
)
|
Intangible assets
- net
|
|
$
|
373,502
|
|
Amortization
expense totaled $2,929 and nil for the three months ended March 31, 2017 and 2016, respectively.
Notes
payable consists of the following at March 31, 2017 and December
31, 2016:
|
|
2017
|
|
|
2016
|
|
Notes
payable bearing interest at 7.99%. The note is payable in monthly principal plus interest payments of $472 through December,
2020. The note is secured by a vehicle.
|
|
$
|
-
|
|
|
$
|
16,642
|
|
Notes payable
bearing interest at 8%. The notes have a 2-year maturity and are due at various dates between September 19, 2018 – October
19, 2018, and pay interest only on a monthly basis
|
|
|
460,000
|
|
|
|
547,500
|
|
Total notes payable
|
|
|
460,000
|
|
|
|
564,142
|
|
Less current portion
|
|
|
-
|
|
|
|
(4,537
|
)
|
Less debt discount
for detachable warrant
|
|
|
(94,840
|
)
|
|
|
(131,849
|
)
|
Long-term portion
of notes payable
|
|
$
|
365,160
|
|
|
$
|
427,756
|
|
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
Maturities
on notes payable as of March 31, 2017, are as follows:
Year
ending December 31:
2017
|
|
$
|
-
|
|
2018
|
|
|
460,000
|
|
Thereafter
|
|
|
-
|
|
|
|
$
|
460,000
|
|
The
provision for income taxes results in effective tax rates which are different than the federal income tax statutory rate. The
nature of the differences for the three months ended March 31, 2017 and 2016 were as follows:
|
|
2017
|
|
|
2016
|
|
Expected
federal income tax benefit
|
|
$
|
(286,381
|
)
|
|
$
|
(344,991
|
)
|
State income taxes
after credits
|
|
|
(59,520
|
)
|
|
|
(66,969
|
)
|
Change
in valuation allowance
|
|
|
345,901
|
|
|
|
411,960
|
|
Total provision
for income taxes
|
|
$
|
-
|
|
|
$
|
-
|
|
The
components of the net deferred tax assets and liabilities at March 31, 2017 and December 31, 2016 consisted of the following:
|
|
2017
|
|
|
2016
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net
operating loss carryforwards
|
|
$
|
3,843,052
|
|
|
$
|
3,557,909
|
|
Stock-based
compensation
|
|
|
277,596
|
|
|
|
213,181
|
|
Total deferred
tax assets
|
|
|
4,120,648
|
|
|
|
3,771,090
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
(74,473
|
)
|
|
|
(70,816
|
)
|
Total deferred
tax liabilities
|
|
|
(74,473
|
)
|
|
|
(70,816
|
)
|
Valuation
allowance
|
|
|
(4,046,175
|
)
|
|
|
(3,700,274
|
)
|
Net deferred
tax assets
|
|
$
|
-
|
|
|
$
|
-
|
|
At
March 31, 2017, the Company has a cumulative net operating loss carryforward (NOL) of approximately $3.8 million, to offset against
future income for federal and state tax purposes. These federal and state NOLs can be carried forward for 20 and 15 years, respectively.
The federal NOLs begins to expire in 2034, and the state NOLs begins to expire in 2029. The utilization of the net operating loss
carryforwards may be subject to substantial annual limitation due to ownership change provisions of the Internal Revenue code
of 1986 and similar state provisions. In general, if the Company experiences a greater than 50 percentage aggregate change in
ownership of certain significant stockholders over a three-year period (a “Section 382 ownership change”), utilization
of its pre-change NOL carryforwards are subject to an annual limitation under Section 382 of the Internal Revenue Code (and similar
state laws). The annual limitation generally is determined by multiplying the value of the Company’s stock at the time of
such ownership change (subject to certain adjustments) by the applicable long-term tax-exempt rate. Such limitations may result
in expiration of a portion of the NOL carryforwards before utilization and may be substantial.
In
assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion
or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon generation
of future taxable income during the periods in which those temporary differences become deductible. Due to the uncertainty of
the realizability of the deferred tax assets, management has determined a full valuation allowance is appropriate.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
10.
|
Commitments
and Contingencies
|
Operating
Leases
The
Company leases its warehouse, kiosks, and tasting room space under operating lease agreements, which expire through December 2018.
Monthly lease payments range from $1,802 to $21,000 over the terms of the leases. For operating leases which contain fixed escalations
in rental payments, the Company records the total rent expense on a straight-line basis over the lease term. The difference between
the expense computed on a straight-line basis and actual payments for rent represents deferred rent which is included within accrued
liabilities on the accompanying consolidated balance sheets. Retail spaces under lease are subject to monthly percentage rent
adjustments when gross sales exceed certain minimums.
At
March 31, 2017, future minimum lease payments required under the operating leases are approximately as follows:
2017
|
|
$
|
213,000
|
|
2018
|
|
|
90,000
|
|
2019
|
|
|
2,000
|
|
Thereafter
|
|
|
-
|
|
Total
|
|
$
|
305,000
|
|
Total
rent expense was approximately $19,000 and $74,000 for the three months ended March 31, 2017 and 2016, respectively.
On
February 7, 2017, we entered into a Lease Termination Agreement with PJM BLDG. II LLC (the “Termination Agreement”),
the landlord of our current headquarters and production facilities located at 1805 SE Martin Luther King Jr. Blvd., Portland,
Oregon. The Termination Agreement provides that the original lease agreement dated July 17, 2014 (the “Lease”) will
terminate on June 30, 2017 rather than October 30, 2020.
Legal
Matters
We
are not currently subject to any material legal proceedings, however we could be subject to legal proceedings and claims from
time to time in the ordinary course of our business. Regardless of the outcome, litigation can, among other things, be time consuming
and expensive to resolve, and divert management resources.
11.
|
Net
Loss per Common Share
|
Basic
loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the
period, without considering any dilutive items. Diluted net loss per common share is computed by dividing net loss by the sum
of the weighted average number of common shares outstanding and the potential number of any dilutive common shares outstanding
during the period. Potentially dilutive securities consist of the incremental common stock issuable upon exercise of stock options
and convertible notes. Potentially dilutive securities are excluded from the computation if their effective is anti-dilutive.
There were no dilutive common shares at March 31, 2017 and 2016. The numerators and denominators used in computing basic and diluted
net loss per common share in 2017 and 2016 are as follows:
|
|
March
31,
|
|
|
|
2017
|
|
|
2016
|
|
Net loss attributable to
common shareholders (numerator)
|
|
$
|
(906,855
|
)
|
|
$
|
(1,014,679
|
)
|
Weighted average shares (denominator)
|
|
|
7,842,971
|
|
|
|
2,275,625
|
|
Basic and diluted
net loss per common share
|
|
$
|
(0.12
|
)
|
|
$
|
(0.45
|
)
|
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
12.
|
Stockholder’s
Deficit
|
|
|
Convertible
Series A
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
|
Preferred
Stock
|
|
|
Common
Stock
|
|
|
Paid-in
|
|
|
Accumulated
|
|
|
Stockholders’
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Deficit
|
|
|
Deficit
|
|
Balance, December
31, 2016
|
|
|
300
|
|
|
|
245,838
|
|
|
|
7,627,512
|
|
|
|
764
|
|
|
|
13,699,275
|
|
|
|
(12,813,044
|
)
|
|
|
1,132,833
|
|
Issuance of common stock
|
|
|
-
|
|
|
|
-
|
|
|
|
45,000
|
|
|
|
4
|
|
|
|
58,496
|
|
|
|
|
|
|
|
58,500
|
|
Issuance of common stock, net of issuance
costs of $6,033, with detachable warrants
|
|
|
-
|
|
|
|
-
|
|
|
|
576,923
|
|
|
|
57
|
|
|
|
743,910
|
|
|
|
|
|
|
|
743,967
|
|
Issuance of common stock from warrant
exercise for cash
|
|
|
-
|
|
|
|
-
|
|
|
|
122,500
|
|
|
|
12
|
|
|
|
159,238
|
|
|
|
|
|
|
|
159,250
|
|
Issuance of common stock for services
by third parties
|
|
|
-
|
|
|
|
-
|
|
|
|
59,385
|
|
|
|
6
|
|
|
|
83,794
|
|
|
|
|
|
|
|
83,800
|
|
Issuance of common stock for services
by employees
|
|
|
-
|
|
|
|
-
|
|
|
|
1,724
|
|
|
|
-
|
|
|
|
2,517
|
|
|
|
|
|
|
|
2,517
|
|
Stock-based compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
158,658
|
|
|
|
|
|
|
|
158,658
|
|
Issuance of common stock for acquisition
of MotherLode, net of issuance costs of $5,580
|
|
|
-
|
|
|
|
-
|
|
|
|
260,000
|
|
|
|
26
|
|
|
|
371,394
|
|
|
|
|
|
|
|
371,420
|
|
Shares issued for payoff of long-term
notes
|
|
|
-
|
|
|
|
-
|
|
|
|
67,308
|
|
|
|
7
|
|
|
|
87,493
|
|
|
|
|
|
|
|
87,500
|
|
Cumulative dividend on Series A preferred
|
|
|
-
|
|
|
|
5,037
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,037
|
)
|
|
|
-
|
|
Common shares issued for preferred conversion
|
|
|
(250
|
)
|
|
|
(201,449
|
)
|
|
|
250,000
|
|
|
|
25
|
|
|
|
201,424
|
|
|
|
|
|
|
|
-
|
|
Net loss
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(901,818
|
)
|
|
|
(901,818
|
)
|
Balance, March
31, 2017
|
|
|
50
|
|
|
|
49,426
|
|
|
|
9,010,352
|
|
|
|
901
|
|
|
|
15,566,199
|
|
|
|
(13,719,899
|
)
|
|
|
1,896,627
|
|
Reverse
Stock Split
All
shares related and per share information in these financial statements has been adjusted to give effect to the 20-for-1 reverse
stock split of the Company’s common stock effected on October 18, 2016.
Issuance
of Common Stock
From
January 4, 2017 to January 22, 2017, we sold 45,000 shares of common stock to accredited investors at a price of $1.30 per share
for aggregate cash proceeds of $58,500.
On
March 31, 2017, the Company issued 576,923 shares of its common stock for $750,000 including 576,923 warrants for common stock.
This represented an initial closing of the Company’s private offering as filed in the Form 8-K on March 27, 2017.
From
January 15, 2017 through February 16, 2017, the Company received warrant exercises and subscription documents totaling $159,250
for 122,500 shares issued.
In
March 2017, the Company issued 59,385 shares of common stock to four third-party consultants in exchange for services rendered.
In
March 2017, the Company issued 1,724 shares of common stock to employees for stock-based compensation of $2,517.
On
March 8, 2017, the Company completed the acquisition of MotherLode Craft Distillery, LLC (“MotherLode”), a Portland,
Oregon based provider of bottling services and production support to craft distilleries. We issued 260,000 shares of common stock
to the owners of MotherLode as consideration for the acquisition. Based on the closing share price of our common stock of $1.45
on March 8, 2017, the value of the transaction was $377,000.
In
March 2017, the Company issued 67,308 shares of its common stock upon conversion of 8% convertible promissory notes with an aggregate
principal amount converted of $87,500.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
In
March 2017, the Company issued 250,000 shares of its common stock upon conversion of 250 shares of preferred stock.
All
shares were fully vested upon issuance.
Issuance
of Convertible Preferred Stock
From
April 4, 2016 to June 17, 2016, the Company sold 972 shares of its series A convertible preferred stock (“Series A Preferred”)
for an aggregate purchase price of $972,000, of which (i) 499 Units were purchased for $499,000 in cash (ii) 423 Units were purchased
by certain of our officers in consideration of $423,000 accrued and unpaid salary and (iii) 50 Units were purchased in consideration
of cancellation of $50,000 of outstanding indebtedness net of issuance costs of $69,528.
Each
share of Series A Convertible Preferred has a stated value of $1,000, which is convertible into shares of the Company’s
common stock (the “Common Stock”) at a fixed conversion price equal to $1.50 per share. The Series A Convertible Preferred
accrue dividends at a rate of 8% per annum, cumulative. Dividends are payable quarterly in arrears at the Company’s option
either in cash or “in kind” in shares of Common Stock; provided, however that dividends may only be paid in cash following
the fiscal year in which the Company has net income (as shown in its audited financial statements contained in its Annual Report
on Form 10-K for such year) of at least $500,000, to the extent permitted under applicable law out of funds legally available
therefore. For ‘in-kind” dividends, holders will receive that number of shares of Common Stock equal to (i) the amount
of the dividend payment due such stockholder divided by (ii) 90% of the average of the per share market values during the twenty
(20) trading days immediately preceding a dividend date.
In
the event of any voluntary or involuntary liquidation, dissolution or winding up, or sale of the Company, each holder of Series
A Preferred shall be entitled to receive its pro rata portion of an aggregate payment equal to: (i) $1,000 multiplied by (ii)
the total number of shares of Series A Preferred Stock issued under the Series A Certificate of Designation multiplied by (iii)
2.5.
For
all matters submitted to a vote of the Company’s stockholders, the holders of the Series A Preferred as a class shall have
an aggregate number of votes equal to the product of (x) the number of shares of Common Stock (rounded to the nearest whole number)
into which the total shares of Series A Preferred Stock issued under the Series A Certificate of Designation on such date of determination
are convertible multiplied by (y) 2.5 (the “Total Series A Votes”), with each holder of Series A Preferred entitled
to vote its pro rata portion of the Total Series A Votes. Holders of Common Stock do not have cumulative voting rights. In addition,
the holders of Series A Preferred shall vote separately a class to change any of the rights, preferences and privileges of the
Series A Preferred.
|
|
Shares
|
|
|
Shares Issued and
|
|
|
Net
|
|
|
Conversion
|
|
|
Number of shares of common
stock
|
|
|
Liquidation
|
|
|
Liquidation
|
|
|
|
Authorized
|
|
|
Outstanding
|
|
|
Proceeds
|
|
|
Price/Share
|
|
|
Equivalents
|
|
|
Preference
|
|
|
Value/Share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series A
|
|
|
3,000
|
|
|
|
50
|
|
|
$
|
49,426
|
|
|
$
|
1.50
|
|
|
|
33,333
|
|
|
$
|
125,000
|
|
|
$
|
2,500
|
|
Stock-Based
Compensation
On
September 8, 2016, the Company adopted the 2016 Equity Incentive Plan (the 2016 Plan). The total number of shares available for
the grant of either stock options or compensation stock under the 2016 Plan is 500,000 shares, subject to adjustment. On January
1, 2017, the number of shares available for grant under the 2016 Plan reset to 869,125 shares, equal to 8% of the number of outstanding
shares of the Company’s capital stock, calculated on an as-converted basis, on December 31 of the preceding calendar year.
On May 11, 2017, the Board of Directors approved an amendment to the 2016 Plan to increase the number of shares of common
stock reserved thereunder to a new total of 1,169,125 shares, contingent upon shareholder adoption and approval of this
amendment at the next annual meeting of stockholders. The exercise price per share of each stock option shall not be less than
100 percent of the fair market value of the Company’s common stock on the date of grant. At March 31, 2017, there were 762,500
options and 68,540 RSU’s issued under the Plan, with vesting schedules varying between immediate and
five (5) years from the grant date.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
On
January 29, 2015, the Company adopted the 2015 Stock Incentive Plan (the 2015 Plan). The total number of shares available for
the grant of either stock options or compensation stock under the 2015 Plan is 150,000 shares, subject to adjustment. The exercise
price per share of each stock option shall not be less than 20 percent of the fair market value of the Company’s common
stock on the date of grant. At March 31, 2017, there were 43,750 options issued under the Plan outstanding, which options vest
at the rate of at least 25 percent in the first year, starting 6-months after the grant date, and 75% in year two.
The
Company also issues, from time to time, options which are not registered under a formal option plan. At March 31, 2017, there
were 50,000 options outstanding that were not issued under the Plan.
A
summary of all stock option activity at and for the three months ended March 31, 2017 is presented below:
|
|
#
of Options
|
|
|
Weighted-
Average Exercise Price
|
|
Outstanding
at December 31, 2016
|
|
|
521,250
|
|
|
$
|
3.08
|
|
Options granted
|
|
|
335,000
|
(1)
|
|
|
1.57
|
|
Options exercised
|
|
|
-
|
|
|
|
-
|
|
Options
canceled
|
|
|
-
|
|
|
|
-
|
|
Outstanding
at March 31, 2017
|
|
|
856,250
|
|
|
$
|
2.49
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at March 31, 2017
|
|
|
258,854
|
|
|
$
|
3.93
|
|
(1)
options granted under 2016 Stock Incentive Plan;
The
aggregate intrinsic value of options outstanding at March 31, 2017 was $0.
At
March 31, 2017, there were 597,396 unvested options with an aggregate grant date fair value of $691,042. The unvested options
will vest in accordance with the vesting schedule in each respective option agreement, which varies between immediate and five
(5) years from the grant date. The aggregate intrinsic value of unvested options at March 31, 2017 was $0. During the three months
ended March 31, 2017, 113,881 options became vested.
The
Company uses the Black-Scholes valuation model to measure the grant-date fair value of stock options. The grant-date fair value
of stock options issued to employees is recognized on a straight-line basis over the requisite service period. Stock-based awards
issued to nonemployees are recorded at fair value on the measurement date and are subject to periodic market adjustments as the
underlying stock-based awards vest. To determine the fair value of stock options using the Black-Scholes valuation model, the
calculation takes into consideration the effect of the following:
|
●
|
Exercise
price of the option
|
|
●
|
Fair
value of the Company’s common stock on the date of grant
|
|
●
|
Expected
term of the option
|
|
●
|
Expected
volatility over the expected term of the option
|
|
●
|
Risk-free
interest rate for the expected term of the option
|
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
The
calculation includes several assumptions that require management’s judgment. The expected term of the options is calculated
using the simplified method described in GAAP. The simplified method defines the expected term as the average of the contractual
term and the vesting period. Estimated volatility is derived from volatility calculated using historical closing prices of common
shares of similar entities whose share prices are publicly available for the expected term of the options. The risk-free interest
rate is based on the U.S. Treasury constant maturities in effect at the time of grant for the expected term of the options.
The
following weighted-average assumptions were used in the Black-Scholes valuation model for options granted during the three months
ended March 31, 2017:
Risk-free interest rate
|
|
|
1.60
|
%
|
Expected term (in years)
|
|
|
7.25
|
|
Dividend yield
|
|
|
-
|
|
Expected volatility
|
|
|
75
|
%
|
The
weighted-average grant-date fair value per share of stock options granted during the three months ended March 31, 2017 was $1.11.
The aggregate grant date fair value of the 335,000 options granted during the three months ended March 31, 2017 was $371,865.
For
the three months ended March 31, 2017 and 2016, total stock option expense related to stock options was $158,658 and $51,569 respectively.
At March 31, 2017, the total compensation cost related to stock options not yet recognized is approximately $666,286, which is
expected to be recognized over a weighted-average period of approximately 3.41 years.
Warrants
During the three months ended March
31, 2017, the Company issued 576,923 detachable warrants in connection with the purchase of 576,923 shares of common stock. The
Company has determined the Warrants are classified as equity on the condensed consolidated balance sheet as of March 31, 2017.
The estimated fair value of the warrants at issuance was $301,731, based on the Black-Scholes option-pricing model using the weighted-average
assumptions below:
Volatility
|
|
|
75
|
%
|
Risk-free interest rate
|
|
|
1.50
|
%
|
Expected term (in years)
|
|
|
3.0
|
|
Expected dividend yield
|
|
|
-
|
|
Fair value of common stock
|
|
$
|
1.46
|
|
A
total of 122,500 warrants were exercised during the three months ended March 31, 2017 for cash proceeds of $159,250.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
A
summary of activity in warrants is as follows:
|
|
Warrants
|
|
|
Weighted
Average Remaining Life
|
|
|
Weighted
Average Exercise Price
|
|
|
Aggregate
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December
31, 2016
|
|
|
2,540,295
|
|
|
|
2.77
years
|
|
|
$
|
2.16
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
576,923
|
|
|
|
3.00
years
|
|
|
$
|
2.50
|
|
|
$
|
0
|
|
Exercised
|
|
|
(122,500
|
)
|
|
|
2.00
years
|
|
|
$
|
1.30
|
|
|
|
|
|
Forfeited
and cancelled
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2017
|
|
|
2,994,718
|
|
|
|
2.61
years
|
|
|
$
|
2.25
|
|
|
$
|
0
|
|
13.
|
Related
Party Transactions
|
There
were no related party transactions during the three months ended March 31, 2017. During the three months ended March 31, 2016,
the Company’s chief executive officer paid expenses on behalf of the Company on his personal credit card. These related
party advances do not bear interest and are payable on demand. At March 31, 2016, the balance due to the chief executive officer
was approximately $95,000, and is included in accounts payable on the accompanying condensed consolidated balance sheets.
On
May 12, 2017, the Company filed a revised S-1 registration statement for the proposed sale common stock of up to $6.9 million.
On
May 1, 2017, the Company announced the acquisition of a majority stake in Big Bottom Distilling, LLC (“BBD”), a Hillsboro,
Oregon-based distiller of award winning and super premium gins, whiskeys, brandies, rum, and vodka. The transaction is structured
as an exchange of 84,286 Eastside shares for 90% of the BBD LLC units, and will maintain the independence of BBD as a separate
entity underneath the operational umbrella of Eastside Distilling. BBD and Eastside will benefit from brand synergies because
of the limited overlap with Eastside products. Eastside will devote sales, marketing, financial capital and production resources
to expanding BBDs business, which in 2016 had total revenues of approximately $201,000.
On
April 24, 2017, the Company issued 50,000 shares of its common stock upon conversion of 50 shares of preferred stock. As of April
24, 2017, the Company has zero shares of preferred stock outstanding.
On
April 21, 2017, the Company completed a $500,000 convertible note purchase agreement with an accredited investor. The note has
a maturity date of April 3, 2020, and bears interest at the rate of five percent (5%) per annum. The note has an automatic conversion
feature upon the closing (or first in a series of closings) of the next equity financing in which the Company sells shares of
its equity securities for an aggregate consideration of at least $4,000,000 at a purchase price of at least $2.50. The outstanding
principal and unpaid accrued interest on the Note shall be automatically converted into equity securities at a price equal to
80% of the price paid per share by the investors in the next equity financing or $2.00, whichever is lower, provided, however,
that in no event shall the conversion price be less than $2.00. The note has a voluntary conversion feature where the investor
may convert, in whole or in part, at any time at the conversion rate of $2.00.
Eastside
Distilling, Inc. and Subsidiary
Notes
to Condensed Consolidated Financial Statements
March
31, 2017
(unaudited)
On
April 5, 2017, the board approved an incentive option grant to messr Grover Wickersham totaling 100,000 shares with an exercise
price of $1.60. In addition, the board approved a restricted stock unit grant of 100,000 shares of common stock that vested on
April 5, 2017. 30,650 shares were not issued in order to satisfy messr Wickersham’s personal tax withholding responsibility.
On
April 3, 2017, the Company issued 25,000 shares of common stock to a third-party consultant in exchange for services rendered.
From
April 3, 2017 to May 4, 2017, the Company issued 256,781 shares of its common stock for $333,815, including 256,781 warrants for
common stock. This represented the remaining closings of the Company’s private offering as filed in the Form 8-K on March
27, 2017. The private offering was completed on May 4, 2017.
On
April 2, 2017 and April 18, 2017, 13, 2016, the independent directors, messrs Trent Davis and Michael Fleming, respectively, each
exercised 13,888 stock options to purchase common stock at $1.80 per share.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The
following discussion should be read in conjunction with the condensed consolidated financial statements and notes. This section
of the Quarterly Report includes a number of forward-looking statements within the meaning of Section 27A of the Securities Act
of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended that reflect our current views with respect
to future events and financial performance. Forward-looking statements are often identified by words like believe, expect, estimate,
anticipate, intend, project and similar expressions, or words which, by their nature, refer to future events. You should not place
undue certainty on these forward-looking statements which speak only as of the date made, and except as required by law, we undertake
no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. These
forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially
from these forward-looking statements. Factors that could cause differences include, but are not limited to, customer acceptance
risks for current and new brands, reliance on external sources on financing, development risks for new products and brands, dependence
on wholesale distributors, inventory carrying issues, fluctuations in market demand and customer preferences, as well as general
conditions of the alcohol and beverage industry, and other factors discussed in Item 1A of Part I of our annual report on Form
10-K for the year ended December 31, 2016 entitled “Risk Factors,” similar discussions in subsequently filed Quarterly
Reports on Form 10-Q, including this Form 10-Q, as applicable, and those contained from time to time in our other filings with
the Securities Exchange Commission.
Overview
We
are a Portland, Oregon-based producer and marketer of craft spirits, founded in 2008. Our products span several alcoholic beverage
categories, including bourbon, American whiskey, vodka and rum. Unlike many, if not most distillers, we operate several retail
tasting rooms in Oregon to market our brands directly to consumers. Our growth strategy is to build on our local base in the Pacific
Northwest and expand selectively to other markets by using major spirits distributors, such as Southern Glazer Wines and Spirits,
or regional distributors that focus on craft brands. As a small company in the large, international spirits marketplace filled
with massive conglomerates, we are innovative in exploiting new trends with our products, for example our Coffee Rum with
cold brew coffee and low sugar and our gluten free potato vodka. In December of 2016 we retained Sandstrom Partners (an internationally
known spirit branding firm that branded St Germain and Bulleit Bourbon), to guide our marketing strategy and branding. They subsequently
became an investor in our Company. We seek to be both
a leader
in creating spirits that offer better value than comparable
spirits, for example our value priced Burnside Bourbon and Portland Potato Vodka, and
an innovator
in creating imaginative
spirits that offer a unique taste experience, for example our cold-brewed coffee rum, Oregon oak aged whiskeys, Marionberry Whiskey
and Peppermint Bark holiday liqueur. On May 1, 2017, we acquired Big Bottom Distillery (“BBD”) for its excellent,
award winning range of super premium gins and whiskeys, including Navy Proof Gin, Oregon Gin, Delta Rye and initial production
of American Single Malt whiskey. BBD’s super premium spirits will expand our tasting room offerings and give us a presence
at the “high end” of the market. In addition, through MotherLode Craft Distillery (“MotherLode”), our
wholly-owned subsidiary acquired on March 8, 2017, we also provide contract bottling and packaging services for existing and would
be spirits producers, some of whom contract with us to blend or distill spirits. As a publicly-traded craft spirit producers,
we have access to the public capital markets to support our long-term growth initiatives, including
strategic acquisitions.
First
quarter sales increased 33% over the prior year, primarily due to three factors: 1) increased wholesale sales traction within
the Pacific Northwest; 2) the acquisition of MotherLode and the expansion of our private label business; and 3) the addition of
a new retail location. The Oregon market continues to experience strong year-over-year growth. During the first quarter of this
year, Oregon represented approximately 78% of sales, compared to 2016 where Oregon represented approximately 58% of sales. National
distribution sales were flat quarter-over-quarter, but we anticipate the new markets to make strong sales progress and become
a larger percentage of our overall sales.
We
have also invested heavily in our infrastructure (facilities, people, and marketing programs) in order to support our planned
expansion and believe we are well positioned to experience further improved performance throughout the balance of 2017.
Market
Opportunity
Large
and Growing Global and Domestic Markets
The
global spirits market generated total revenues of $316 billion in 2013, representing a compound average growth rate (CAGR)
of 3.4% between 2009 and 2013, according to MarketLine. The performance of the market is forecasted to accelerate with an anticipated
CAGR of 4.2% for the five year period 2013-2018, which is expected to increase revenues generated by this market to approximately
$388 billion by the end of 2018.
The
U.S. spirits market had total revenues of $24.1 billion in 2015, representing a 25% increase since 2010, according to the Distilled
Spirits Council of the United States (DISCUS). The domestic market share of spirits compared to beer and wine was at a record
35.4% in 2015 according to DISCUS, representing more than a 2% gain over beer and wine in terms of market share since 2010.
Key
Growth Trends That we Target
Craft
– The market share of “craft” distillers (defined as any producer that bottles less than 100,000 cases annually)
has doubled over the last two years, and is projected to reach 8% by 2020, according to BNP Paribas.
Women
– The United States Alcohol and Tobacco Tax and Trade Bureau (the “TTB”), Park Street Imports,
LLC (“Park Street”) and the US Census Bureau estimate that 37% of all U.S. whiskey drinkers are women.
Millennials
– Generally, millennials (individuals born between the early 1980s and the mid-1990s) value “authenticity”
and are inspired by travel, like to try new products and seek new experiences, according to a survey by BeverageDaily.com. Millennials
tend to drink a broader range of spirit types (vodka, rum, tequila, whiskey, gin) than prior generations. Millennials consume
more expensive spirits than their predecessors and are attracted to vintage spirits and cocktails with nostalgic followings, such
as throwbacks to the 1950’s like rye whiskey, bourbon, and the Manhattan cocktail. According to
Barclays Research
,
millennials increasingly prefer spirits over beer and wine, and flavored spirits, in particular. In addition, according to DISCUS
,
millennials are more willing than prior generations to purchase premium spirits.
Flavored
– According to DISCUS, flavored spirits continue to grow faster than the overall spirits market,
and flavored whiskey, which is especially appealing to younger drinkers and women, is the fastest growing flavored spirit
category.
International
– The demand for U.S.-produced spirits abroad is increasing significantly. U.S. spirit exports nearly doubled over the past
decade to $1.56 billion in 2015, and whiskey exports were up approximately 5.4% in 2015 compared to 2014. The largest export
markets for U.S. spirits include the United Kingdom, Canada, Germany, Australia and Japan.
Our
Strategy
Our
objective is to build Eastside Distilling into a profitable spirits company, with a distinctive portfolio of premium and high-end
spirits brands that have national, and even international, consumer appeal and following. To help achieve this, we expect to:
●
Target
Industry Growth Trends.
Demand for U.S.-produced premium and high-end
craft spirits, particularly whiskeys, has been increasing among millennials and women. We endeavor to capitalize
on these trends by developing products that appeal to changing demographics, as typified by our Master Distiller, Melissa Heim,
whom we believe is the first female commercial master distiller and blender west of the Mississippi River.
●
Be
Experimental.
We are not afraid to take chances with innovative
product offerings that the larger and more bureaucratic companies that populate the industry cannot easily launch. We want
to produce and deliver quality products that offer consumers “something different,” as to value or uniqueness, and
we want to convey that message with new packaging devloped by our spirits branding firm, Sandstrom Partners.
●
Be
Local
. Be true to our Oregon and Pacific Northwest “roots” by shunning artificial additives, using locally
sourced ingredients such as our high-quality water and Oregon oak, and relying on skilled local artisans.
●
Expand
Geographically and Online.
We are building brand awareness and driving sales in
multiple geographic markets, with the use of social media (Twitter, Facebook, YouTube). We are partnering with retailers that
market heavily online and investing resources into e-commerce and digital marketing.
●
Provide
Value
. We target the high-growth premium ($12-20 per bottle) and high-end ($20-30 per bottle) market segments with premium
quality at attractive pricing. In the super premium category (above $50 per bottle), we intend to have limited
production offerings that we believe also deliver exceptional value.
●
Use
Sales Networks of Major U.S. Spirits Distributors
. We have established and will continue to build relationships with the major
wine and spirit wholesalers to distribute our products into the largest spirits markets in the United States.
●
Increase
Production
. We expect our production of cases to increase each year for the next three years. We believe our increased
production capacity will make us more attractive to distribution partners and will also facilitate additional revenues,
cost savings and profits.
●
Leverage
Access to Public Capital Markets.
The public capital markets facilitates funding access for
our long-term growth initiatives, including potential strategic acquisitions.
Our
Strengths
We
believe the following competitive strengths will help enable the implementation of our growth strategies:
●
Award
Winning Diverse Product Line:
We have a diverse product line currently offering 14 premium craft spirits, many of which have
won awards for taste and/or product design. According to a study by the American Craft Spirits Association, the U.S.
craft spirits volume of cases sold experienced a compound annual growth rate of 27.4% between 2010 and 2015, and
saw an increase in market share from 0.8% to 2.2% during that period. Our sales of premium brands have increased over 1,000%
since 2010. We believe our diverse, recognized product line in this growing market will enable us to establish a presence in new
geographic markets and enable us to procure additional distributors for our products.
●
Key
Relationships
: We have distribution arrangements with several of the largest wine and spirits distributors in the United
States, such as Southern Glazer. We have also engaged Park Street, a provider of back-office administrative and logistical services
for alcohol and beverage distributors. We believe these relationships will help accomplish our goal of having our premium
spirits sold and distributed nationwide.
●
Experienced
Master Distiller.
Our master distiller, Melissa “Mel” Heim, whom we believe is the first female commercial
master distiller and blender west of the Mississippi River, is an important factor in distinguishing our brands. We believe
that Ms. Heim’s highly regarded “palate” is important to us in maintaining a high quality artisanal character
to our products as well as adding to our consumer appeal.
Our
Product Approach
Our
approach to our craft spirits involves five important aspects:
●
Commitment
to Quality
: We create and deliver high-quality, innovative products targeted at growing markets.
●
Authentic
Yet Scalable
: We believe our approach to production allows us to produce our products at scale while keeping flavor profiles
consistent.
●
Unique
Talent and Experience
: Every spirit reflects the creativity of our entire team.
●
14
Spirit Portfolio
: Many craft distillers have only one to three products; we have 14, which we believe affords us the opportunity
to target a broader range of consumers with our brands.
●
Generate
Customer Loyalty
: These factors attract loyal and enthusiastic customers and major distributors for our products.
Our
Brands
We
develop, produce and
market the premium brands listed below.
Burnside
Bourbon
. We develop, market and produce two premium, barrel–aged bourbons: Burnside Bourbon and Oregon Oak Burnside
Bourbon. Our Burnside Bourbon is aged in oak barrels, is 96 proof and won a Gold Medal in the MicroLiquor Spirit Awards in 2014,
and another from Beverage Tasting Institute. Our Oregon Oak Burnside Bourbon is produced in limited quantities and aged for an
additional 90 days in heavily charred Oregon oak barrels, and we consider it an “ultra-premium” brand. Our
Burnside Bourbon brands accounted for approximately 40%, 35% and 40% of our revenues for years 2016, 2015 and 2014, respectively.
Barrel
Hitch American Whiskey
. We develop, market and produce two premium whiskeys: Barrel Hitch American Whiskey and Barrel Hitch
Oregon Oaked Whiskey. Our whiskey is 80 proof and won a triple-Gold Medal and best of show in the MicroLiquor Spirit Awards in
2015. Our Oregon Oak version is produced in limited quantities and aged for an additional 90 days in heavily charred Oregon
oak barrels, and we consider it an “ultra-premium” brand. Our Whiskey brand was introduced in July 2015 and
accounted for approximately 17% and 7% of our revenues for years 2016 and 2015, respectively.
Premium
Vodka.
We develop, market and produce a premium potato vodka under the brand name Portland Potato Vodka which is distilled
from potatoes rather than grain and as such is gluten free. Eastside Portland Potato Vodka was awarded a silver medal from the
American Wine Society as well as a gold medal from the Beverage Tasting Institute which also gave it a “Best Buy”
rating. Our Portland Premium Vodka accounted for approximately 13%, 14% and 30% of our revenues for years 2016, 2015 and 2014,
respectively.
Distinctive
Specialty Whiskeys
. We develop, market and produce two distinctive specialty whiskeys: Cherry Bomb Whiskey and Marionberry
Whiskey. Our Cherry Bomb Whiskey combines handcrafted small batch whiskey with a blast of real Oregon cherries. Our Cherry Bomb
Whiskey won a gold medal from the American Wine Society and was also awarded a gold medal for taste and a silver medal for package
design in the MicroLiquor Spirit Awards. Our Marionberry whiskey combines Oregon marionberries (a hybrid blackberry) with
premium aged whiskey and was awarded two silver medals in the MicroLiquor Spirit Awards for taste and package design. Our distinctive
whiskeys accounted for approximately 12%, 15% and 10% of our revenues for years 2016, 2015 and 2014, respectively.
Below
Deck Rums
. We develop, market and produce four rums under the Below Deck brand name: Below Deck Silver Rum, Below Deck
Spiced Rum, Below Deck Coffee Rum and Below Deck Ginger Rum. Below Deck’s Silver Rum is our original rum. Below Deck Spiced
Rum is double-distilled from molasses and infused with exotic spices and won a triple gold medal for taste and a bronze medal
for package design in the MicroLiquor Spirit Awards. Our Below Deck Coffee Rum is double-distilled and infused with coffee flavors
from Arabica bean and won a silver medal at the San Francisco World Spirits Competition. Below Deck Ginger Rum is infused with
natural ginger. Our Below Deck Rums accounted for approximately 10%, 12% and 10% of our revenues for years 2016, 2015 and 2014,
respectively.
Seasonal/Limited
Edition Spirits. In addition to our premium bourbons, whiskeys, rum and vodka, we create seasonal and limited-edition handmade
products such as Advocaat (eggnog) Liqueur, Peppermint Bark Liqueur, Bier Schnapps and Holiday Spiced Liqueur. Our Seasonal/Limited
Edition Spirits accounted for approximately 6%, 10% and 10% of our revenues for years 2016, 2015 and 2014, respectively.
MotherLode
Acquisition
On
March 8, 2017, we acquired Motherlode
,
a Portland, Oregon based provider of bottling services and production support to craft distilleries. Since its founding in 2014
by Allen Barteld, the mission of MotherLode has been to enable craft distillers to increase their production and extend their
product lines, reducing cost and increasing efficiency, thereby freeing them to focus on their craft. The typical MotherLode customer
is a distillery of small batch, hand-crafted spirits, or a premium craft spirit sold as a private label.
We
plan to relocate much of our own operations to MotherLode’s facility and expand our manufacturing resources. Plans are in
place for a pneumatic bottling line, which we anticipate could result in a five-times increase in bottling rate and provide us
with an opportunity for large-volume spirit handling capability.
In
addition to bottling services for distillers and other producers of spirits, MotherLode bottles “private label” craft
spirits for customers who have on-premise or off-premise licenses, including retail and liquor stores, bars, restaurants, events,
and businesses who want to take advantage of the benefits that come from having their brand clearly printed on a label. MotherLode’s
craft spirits can also be private labeled for corporate gifts, wedding, birthdays and other personal events.
Production
and Supply
There
are several steps in the production and supply process for beverage alcohol products. First, all of our spirits products are distilled.
This is a multi-stage process that converts basic ingredients, such as grain, sugar cane or agave, into alcohol. Next, the alcohol
is processed and/or aged in various ways depending on the requirements of the specific brand. For our vodka, this processing is
designed to remove all other chemicals, so that the resulting liquid will be odorless and colorless, and have a smooth quality
with minimal harshness. Achieving a high level of purity involves a series of distillations and filtration processes. For our
large production products, we currently source full strength and barrel strength (barrel strength has a lower alcohol by volume
(ABV) due to evaporation) that we further process (such as aging in Oregon Oak, or adding ingredients) and bottle at our premises.
For
our spirits brands, rather than removing flavor, various complex flavor profiles are achieved through one or more of the following
techniques: infusion of fruit, addition of various flavoring substances, and, in the case of rums and whiskeys, aging of the brands
in various types of casks for extended periods of time, and the blending of several rums or whiskeys to achieve a unique flavor
profile for each brand. After the distillation, purification and flavoring processes are completed, the various liquids are bottled.
This involves several important stages, including bottle and label design and procurement, filling of the bottles and packaging
the bottles in various configurations for shipment.
Distribution
Network
We
believe that the distribution network that we have developed with our sales team and our independent distributors and brokers
is one of our key strengths. We currently have distribution and brokerage relationships with third-party distributors in 22 U.S.
states.
U.S.
Distribution
Producers
of beverage alcohol products in the U.S., such as
us, must sell their products through a three-tier distribution system. Producers of alcohol produce the product then sell
it to a network of distributors, or wholesalers, covering the U.S., in either “open” states or “control”
states. In the 33 open states, the distributors are generally large, privately-held companies. In the 18 control states, the states
themselves function as the distributor, and regulate producers such as us. The distributors and wholesalers in turn sell
to individual retailers, such as liquor stores, restaurants, bars, supermarkets and other outlets licensed to sell beverage alcohol.
In larger states, such as New York, more than one distributor may handle a brand in separate geographical areas. In control states,
importers sell their products directly to state liquor authorities, which distribute the products and either operate retail outlets
or license the retail sales function to private companies, while maintaining strict control over pricing and profit.
The
U.S. spirits industry has consolidated dramatically over the last ten years due to merger and acquisition activity. There are
currently eight major spirits companies, each of which own and operate their own importing businesses. All companies, including
these large companies, are required by law to sell their products through wholesale distributors in the U.S. The major companies
are exerting increasing influence over the regional distributors and as a result, it has become more difficult for smaller companies
to get their products recognized by the distributors.
Importation
We
hold the federal importer and wholesaler license required by the Alcohol and Tobacco Tax and Trade Bureau of the U.S. Treasury
Department, and the requisite state licenses within the states we conduct business.
Our
inventory is maintained in our warehouse and shipped nationally by our network of licensed and bonded carriers.
Wholesalers
and Distributors
In
the U.S., we are required by law to use state-licensed distributors or, in the control states, state-owned agencies performing
this function, to sell our brands to retail outlets. As a result, we depend on distributors for sales, for product placement and
for retail store penetration. We have no distribution agreements or minimum sales requirements with any of our U.S. alcohol distributors,
and they are under no obligation to place our products or market our brands. All of the distributors also distribute our competitors’
products and brands. As a result, we must foster and maintain our relationships with our distributors. Through our internal sales
team, we have established relationships for our brands with wholesale distributors in the 22 states we sell our products,
and our products are sold in the U.S. by seven wholesale distributors, as well as by various state beverage alcohol control agencies.
Other
Sources of Revenue
Special
Events
We
also generate revenues from participating in special events (such as farmer’s markets, trade shows, hosting private tastings,
etc.). We offer tastings as well as sell merchandise and bottle sales and have generated as much as $95,000 in revenues from these
special events in a single month during the holiday season (November/December). In addition to the revenues these events generate,
we value the immediate customer feedback during these activities which is instrumental in creating better products and testing
new flavors.
Retail
Stores and Kiosks
We
have three retail stores in shopping centers in the Portland, Oregon area that provide us with additional
revenue from sales of our products. In December 2014, we opened a 1,200 square foot retail store in Clackamas Town Center (Happy
Valley Town Center) and in January 2015, entered into a lease for 3,100 square feet of retail space in the Washington Square Center
in Portland. We also had two additional holiday season retail locations within high-traffic shopping malls in the Portland metro
region during 2015. For the 2016 holiday season, we replaced the Washington Square Mall storefront with a kiosk location.
We intend to maintain these retail stores and kiosks to build local brand awareness and direct-to-consumer retail sales. Some
of these stores will contain in-store tastings, which we believe will lead to additional product purchases.
Sales
Team
Our
sales force has
an average of over ten years of industry experience with premium beverage alcohol brands.
Our
sales personnel are engaged in the day-to-day management of our distributors, which includes setting quotas, coordinating promotional
plans for our brands, maintaining adequate levels of stock, brand education and training and sales calls with distributor personnel.
Our sales team also maintains relationships with key retail customers through independent sales calls. They also schedule promotional
events, create local brand promotion plans, host in-store tastings, where permitted, and provide wait staff and bartender training
and education for our brands.
In
addition, we have also engaged Park Street Imports, a provider of back-office administrative and logistical services for alcohol
and beverage distributors, which services include state compliance, logistics planning, order processing, distributor chargeback
and bill-support management and certain accounting and reporting services.
Advertising,
Marketing and Promotion
To
build our brands, we must effectively communicate with three distinct audiences: our distributors, the retail trade and the end
consumer. Advertising, marketing and promotional activities help to establish and reinforce the image of our brands in our efforts
to build substantial brand value. We intend to stay true to our roots as a local Portland-based craft spirit company, while
identifying and capitalizing on trends within the booming craft spirits industry.
In
late 2016, with the goal of increasing our brand value and accelerating sales, we retained Sandstrom Partners, a Portland-based
firm specializing in spirits branding, to review our current product portfolio, as well as our new ideas, and advise
us on marketing, creation of brand awareness and product positioning, locally and nationally. We intend to use Sandstrom’s
full range of brand development services, including research, strategy, brand identity, package design, environments, advertising
as well as digital design and development. We intend to use Sandstorm’s full range of brand development services, including
research, strategy, brand Identity, package design, environments, advertising, digital design and development. Sandstrom Partners
is recognized as preeminent in spirits brand development and their work appears in every national and international design competition.
Some of Sandstrom Partners current and past spirit branding clients include St-Germain, Brown-Forman, Brown Forman/Chambord, Old
Forester, Stillhouse Distilling, Aviation Gin, Diageo, Bulleit Bourbon, Miller Brewing, Pernod Ricard, Bacardi Oakheart. Sandstrom’s
approach to spirits marketing always involves telling a compelling story whose plot is transmitted in every consumer communication:
from the name, to the package, point-of-sale, web, and advertising.
We
use a range of marketing strategies and tactics to build brand equity and increase sales, including consumer and trade advertising,
price promotions, point-of-sale materials, event sponsorship, in-store and on-premise promotions and public relations, as well
as a variety of other traditional and non-traditional marketing techniques, including social media marketing, to support our brands.
Besides
traditional advertising, we also employ other marketing methods to support our brands: public relations, event sponsorships and
tastings. Our U.S. public relations efforts have helped gain editorial coverage for our brands, which increases brand awareness.
Event sponsorship is an economical way for us to have influential consumers taste our brands. We actively contribute product to
trend-setting events where our brand has exclusivity in the brand category. We also conduct hundreds of in-store and on-premise
promotions each year.
Intellectual
Property
Trademarks
are an important aspect of our business. We sell our products under a number of trademarks, which we own or use under license.
Our brands are protected by trademark registrations or are the subject of pending applications for trademark registration in the
U.S where we distribute, or plan to distribute, our brands. The trademarks may be registered in the names of our subsidiaries.
In the U.S., trademark registrations need to be renewed every ten years. We expect to register our trademarks in additional markets
as we expand our distribution territories.
Seasonality
Our
industry is subject to seasonality with peak retail sales generally occurring in the fourth calendar quarter, primarily due to
seasonal holiday buying. Historically, this holiday demand typically resulted in higher sales for us in our second and/or
third fiscal quarters.
Competition
The
beverage alcohol industry is highly competitive. We believe that we compete on the basis of quality, price, brand recognition
and distribution strength. Our premium brands compete with other alcoholic and nonalcoholic beverages for consumer purchases,
retail shelf space, restaurant presence and wholesaler attention. We compete with numerous multinational producers and distributors
of beverage alcohol products. Many of our current and potential competitors have longer operating histories and have substantially
greater financial, sales, marketing and other resources than we do, as well as larger installed customer bases, greater name recognition
and broader product offerings. Some of these competitors can devote greater resources to the development, promotion,
sale and support of their products. As a result, it is possible that our competitors may either respond to industry conditions
or consumer trends more rapidly or effectively or resort to price competition to sustain market share, which could adversely affect
our sales and profitability.
Over
the past ten years, the U.S. wine and spirits industry has undergone dramatic consolidation and realignment of brands and brand
ownership. The number of major importers in the U.S. has declined significantly. Today there are eight major importers:
Diageo PLC, Pernod Ricard S.A., Bacardi Limited, Brown-Forman Corporation, Beam Suntory Inc., Davide Campari Milano-S.p.A., and
Remy Cointreau S.A.
We
believe that we are sometimes in a better position to partner with small to mid-size brands than the major importers. Despite
our relative capital position and resources, we have been able to compete with these larger companies in pursuing agency distribution
agreements and acquiring brands, offering flexible transaction structures and providing brand owners the option to retain local
production and “home” market sales. This flexibility is attractive to private and family-owned brands who are more
interested in retaining local production and sales. Given our size relative to our major competitors, most of which have multi-billion
dollar operations, we believe that we can provide greater focus on smaller brands and tailor transaction structures based on individual
brand owner preferences. However, our relative capital position and resources may limit our marketing capabilities, limit our
ability to expand into new markets and limit our negotiating ability with our distributors.
By
focusing on the premium and super-premium segments of the market, which typically have higher margins, and having an established,
experienced sales force, we believe we are able to gain relatively significant attention from our distributors for a company of
our size. Also, the continued consolidation among the major companies is expected to create an opportunity for small to mid-size
wine and spirits companies, such as ourselves, as the major companies contract their portfolios to focus on fewer brands.
Government
Regulation
We
are subject to the jurisdiction of the Federal Alcohol Administration Act, U.S. Customs Laws, Internal Revenue Code of 1986 and
the Alcoholic Beverage Control laws of all fifty states.
The
U.S. Treasury Department’s Alcohol and Tobacco Tax and Trade Bureau regulates the production, blending, bottling, sales
and advertising and transportation of alcohol products. Also, each state regulates the advertising, promotion, transportation,
sale and distribution of alcohol products within its jurisdiction. We are also required to conduct business in the U.S. only with
holders of licenses to import, warehouse, transport, distribute and sell spirits.
We
are subject to U.S. regulations on the advertising, marketing and sale of beverage alcohol. These regulations range from a complete
prohibition of the marketing of alcohol in some states to restrictions on the advertising style, media and messages used.
Labeling
of spirits is also regulated in many markets, varying from health warning labels to importer identification, alcohol strength
and other consumer information. All beverage alcohol products sold in the U.S. must include warning statements related to risks
of drinking beverage alcohol products.
In
the U.S. control states, the state liquor commissions act in place of distributors and decide which products are to be purchased
and offered for sale in their respective states. Products are selected for purchase and sale through listing procedures which
are generally made available to new products only at periodically scheduled listing interviews. Consumers may purchase products
not selected for listings only through special orders, if at all.
The
distribution of alcohol-based beverages is also subject to extensive federal and state taxation in the U.S. and internationally.
Most foreign countries impose excise duties on wines and distilled spirits, although the form of such taxation varies from a simple
application on units of alcohol by volume to intricate systems based on the imported or wholesale value of the product. Several
countries impose additional import duty on distilled spirits, often discriminating between categories in the rate of such tariffs.
Once we begin distributing our products internationally, import and excise duties could have a significant effect on our sales,
both through reducing the consumption of alcohol and through encouraging consumer switching into lower-taxed categories of alcohol.
We
believe that we are in material compliance with applicable federal, state and other regulations. However, we operate in a highly
regulated industry which may be subject to more stringent interpretations of existing regulations. Future compliance costs due
to regulatory changes could be significant.
Employees
As
of May 1, 2017, we had 20 full-time employees, 10 of whom were in sales and marketing and three of
whom were in management and seven in administration and production.
Geographic
Information
We
operate
in one business
segment – premium beverage alcohol. Our product categories are rum, whiskey, vodka and specialty liquors,
with an intent to sell gin and private label tequila in the future. We currently sell our products in 22 states
(Oregon, California, Washington, Florida, Nevada, Texas, Virginia, Indiana, Illinois, New York, New Jersey, Massachusetts, Connecticut,
Minnesota, Georgia, Pennsylvania, Rhode Island, New Hampshire, Maine, Idaho, Vermont and Maryland) and are authorized to distribute
our products in Ontario, Canada as well.
Facilities
Our
corporate headquarters are currently located in Portland, Oregon, where we lease and occupy 41,000 square feet of office and industrial
space pursuant to a lease that commenced on November 1, 2014 and was recently amended to a revised expiration date of June
30, 2017. On February 17, 2017, the Company entered into a Commercial Sublease Agreement with Motherlode, LLC which we subsequently
acquired. We intend to consolidate our production operations into the Motherlode facility. The Company anticipates relocating
to new corporate offices that will be sufficient to maintain its current operations.
Legal
Proceedings
We
are not currently subject to any material legal proceedings, however we could be subject to legal proceedings and claims from
time to time in the ordinary course of our business. Regardless of the outcome, litigation can, among other things, be time consuming
and expensive to resolve, and divert management resources.
Corporate
History
We
were incorporated in Nevada in February 2004 under the name Eurocan Holdings, Ltd. Until the closing of the Eastside Distilling,
LLC acquisition (described below), Eurocan operated solely as an online marketing and media solutions firm specializing in digital
interactive media, which business was conducted through Eurocan’s wholly-owned subsidiary, Michael Williams Web Design Inc.
of New York, New York (“MWW”).
The
Acquisition of Eastside Distilling, LLC
In
October 2014, Eurocan Holdings Ltd. consummated the acquisition (the “Acquisition”) of Eastside Distilling, LLC (“Eastside”)
pursuant to an Agreement and Plan of Merger (the “Merger Agreement”) by and among the Eurocan, Eastside and Eastside
Distilling, Inc., our wholly-owned subsidiary. Pursuant to the Merger Agreement, Eastside merged with and into Eastside Distilling,
Inc. The merger consideration for the Acquisition consisted of 1,600,000 shares (the “Shares”) of our common stock.
In addition, certain of our stockholders cancelled an aggregate of 1,245,500 shares of our common stock held by them. As a result,
upon consummation of the Merger Agreement on October 31, 2014, we had 2,000,000 shares of our common stock issued and outstanding,
of which 1,600,000 shares were held by the former members of Eastside.
Following
the Acquisition, we conduct the business of Eastside as our primary business.
Spin-Off
of MWW
Following
consummation of the Acquisition, our new management conducted an evaluation of the MWW business and an analysis of the business
going forward. Management determined that due to MWW’s operating and net losses in each of the last two fiscal years preceding
the Acquisition, its working capital deficit as of the end of the latest fiscal year and as of the latest fiscal quarter preceding
the Acquisition, and its accumulated deficit, it was not in the best interest of the Company and its stockholders to continue
the operation of MWW going forward. Accordingly, in February 2015, we transferred all of the outstanding shares of MWW held by
us, along with all assets and liabilities related to MWW, to Michael Williams in consideration of MWW’s and Mr. Williams’
full release of all claims and liabilities related to MWW and the MWW business. Mr. Williams was the sole officer, director and
employee of MWW at the time of the transaction. The spinoff of MWW resulted in the impairment of goodwill related to the Acquisition
of approximately $3.2 million in December 2014. Additionally, as a result of the spin-off, we recorded a net gain of approximately
$52,890 on February 3, 2015. This gain is primarily the result of the transfer of net liabilities to Mr. Williams, which is reflected
in our consolidated financial statements for the year ending on December 31, 2015.
Motherlode
Acquisition Agreement
On
March 8, 2017, we entered into a Purchase and Assignment of Membership Interests, Assumption of Obligations, Agreement to be Bound
by Limited Liability Company Agreement and Admission of Substituted Member (the “Motherlode Acquisition Agreement”),
with Allen Barteld, the sole member and the manager of Motherlode, LLC, an Oregon limited liability company (“Motherlode”)
and Motherlode. Under the terms of the Motherlode Acquisition Agreement, the Company agreed to acquire from Mr. Barteld all of
the membership interests in Motherlode in exchange for 260,000 shares of the Company’s common stock (the “Motherlode
Acquisition”). The Motherlode Acquisition Agreement does not provide for any post-closing adjustments of the consideration
paid. The Motherlode Acquisition was closed concurrently with the execution of the Acquisition Agreement on March 8, 2017. In
connection with the Motherlode Acquisition, the Company entered into a three-year employment agreement with Mr. Barteld as described
in the “Management” section below under the heading “Employment Agreements.”
The
Motherlode Acquisition Agreement contains customary representations and warranties as to, among other things: the organization,
good standing, and qualifications to conduct the business of the Company, Mr. Barteld’s power and authority to transfer
the membership interests; the valid and marketable title of the membership interests free and clear of all liens; the Company’s
authorization to issue the common stock; and compliance with applicable laws, as well as cross-indemnification provisions for
losses (as defined in the Motherlode Acquisition Agreement) arising out of, resulting from, or in connection with any breach of
any representation, warranty, covenant or obligation made by the party in the Motherlode Acquisition Agreement or other documents
entered into or delivered in connection with the transactions contemplated by the Motherlode Acquisition Agreement. Neither the
Company nor Mr. Barteld may unilaterally terminate the Motherlode Acquisition Agreement other than in the event the other party
is in material breach of the representations, warranties, covenants or obligations set forth in the Motherlode Acquisition Agreement,
subject to a 20-day cure period. The Motherlode Acquisition Agreement may be terminated by mutual consent of the parties.
The
description of the transactions contemplated by the Motherlode Acquisition Agreement set forth herein does not purport to be complete
and is qualified in its entirety by reference to the full text of the Motherlode Acquisition Agreement filed as an exhibit to
the registration statement of which this prospectus is a part.
Big
Bottom Distilling Acquisition Agreement
On
May 1, 2017 we acquired 90% of the ownership of Big Bottom Distilling (“BBD”), a Hillsboro, Oregon-based distiller and
producer of super premium gins, whiskeys, brandies, rum, and vodka. Pursuant to the agreement governing the acquisition of BBD,
we agreed to exchange 84,286 shares of our common stock for 90% of the outstanding limited liability company units of BBD. Following
the acquisition of BBD, we will maintain the independence of BBD as a separate entity underneath the operational umbrella of the
Company.
Results
of Operations
Overview
First
quarter sales increased 33% over the prior year, primarily due to three factors: 1) Increased wholesale sales traction within
the Pacific Northwest; 2) the acquisition of MotherLode and the expansion of our private label business; and 3) the addition of
a new retail location. The Oregon market continues to experience strong year-over-year growth. During the first quarter of this
year, Oregon represented approximately 78% of sales, compared to 2016 where Oregon represented approximately 58% of sales. National
distribution sales were flat quarter-over-quarter, but we anticipate the new markets to make strong sales progress and become
a larger percentage of our overall sales.
We
have also invested heavily in our infrastructure (facilities, people, and marketing programs) in order to support our planned
expansion and believe we are well positioned to experience further improved performance throughout the balance of 2017.
RESULTS
OF OPERATIONS
Three
Months Ended March 31, 2017 Compared to the Three Months Ended March 31, 2016
Our
sales for the three months ended March 31, 2017 increased to $829,669, or approximately 33%, from $621,882 for the three months
ended March 31, 2016. The following table compares our sales in the three months ended March 31, 2017 and 2016:
|
|
Three
Months Ended March 31,
|
|
|
|
|
|
|
2017
|
|
|
|
|
|
2016
|
|
|
|
|
Wholesale
|
|
$
|
429,902
|
|
|
|
52
|
%
|
|
$
|
384,493
|
|
|
|
62
|
%
|
Private Label
|
|
|
115,870
|
|
|
|
14
|
%
|
|
|
—
|
|
|
|
—
|
|
Retail / Special
Events
|
|
|
283,897
|
|
|
|
34
|
%
|
|
|
237,329
|
|
|
|
38
|
%
|
Total
|
|
$
|
829,669
|
|
|
|
100
|
%
|
|
$
|
621,882
|
|
|
|
100
|
%
|
The
increase in sales in the three months ended March 31, 2017 is primarily attributable to three factors: 1) Increased wholesale
sales traction within the Pacific Northwest; 2) the expansion of our private label business; and 3) the addition of a new retail
location.
Excise
taxes, customer programs and incentives for the three months ended March 31, 2017 increased to $217,188, or approximately 30%,
from $167,120 for the comparable 2016 period. The increase is attributable to the increase in liquor sales due to our increased
distribution and sales traction during the period.
During
the three months ended March 31, 2017, cost of sales increased to $322,913, or approximately 26%, from $256,169 for the three
months ended March 31, 2016. The increase is primarily attributable to the costs associated with our increased liquor sales in
the period. The cost of sales we reported in both 2017 and 2016 are not typical of our expected future results because the product
costs in both periods are based on smaller production lots, and do not reflect the economies of scale that we anticipate as we
move into our new production facility later in 2017 and continue to scale our operations.
Gross
profit is calculated by subtracting the cost of products sold from net sales. Cost of sales consists of the costs of ingredients
utilized in the production of spirits, manufacturing labor and overhead, warehousing rent, packaging, and in-bound freight charges.
Ingredients account for the largest portion of the cost of sales, followed by packaging and production costs. Gross margin is
gross profits stated as a percentage of net sales.
The
following table compares our gross profit and gross margin in the three months ended March 31, 2017 and 2016:
|
|
Three
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
289,568
|
|
|
$
|
198,593
|
|
Gross margin
|
|
|
47
|
%
|
|
|
44
|
%
|
Our
gross margin of 47% of net sales in the three months ended March 31, 2017 increased from our gross margin of 44% for the three
months ended March 31, 2016 primarily due to product mix, as the private label products typically have a higher gross margin.
Advertising,
promotional and selling expenses for the three months ended March 31, 2017 increased to $386,132 or approximately 147% from $156,203
for the three months ended March 31, 2016. This increase is primarily due to our efforts to expand our product sales both regionally
in the Pacific Northwest as well as target national markets.
General
and administrative expenses for the three months ended March 31, 2017 decreased to $726,396, or approximately 18%, from $886,011
for the three months ended March 31, 2016. This decrease is primarily due to decreased management headcount and tighter expense
controls, offset by $52,819 higher stock-based compensation expense in 2017.
In
the three months ended March 31, 2107, we had a $35,534 loss on disposal of property and equipment, primarily related to the write-off
of construction-in-process on our MLK facility due to the early lease termination agreement we were able to execute in February
2017.
Total
other expense, net was $43,324 for the three months ended March 31, 2017, compared to $171,058 for the three months ended
March 31, 2016, a decrease of 75%. This decrease was primarily due to lower interest expense that started with the conversion
of outstanding debt into common stock in December 2016 and continued in the three months ended March 31, 2017.
Net
loss attributable to common shareholders during the three months ended March 31, 2017 was $906,855 as compared to a loss of $1,014,679
for the three months ended March 31, 2016. The reduction in our net loss was primarily attributable to our increased sales and
gross margin, as well as decreased general and administrative expenses and interest expense during 2017, which amounts were offset
by higher advertising, promotional and selling expenses and a one-time loss on the disposal of property and equipment.
Liquidity
and Capital Resources
Three
Months Ended March 31, 2017
The
Company’s primary capital requirements are for the financing of inventories, and cash used in operating activities. Funds
for such purposes have historically not been generated from operations but rather from short-term credit in the form of extended
payment terms from suppliers, convertible debt and equity financings.
Historically,
the Company has funded its cash and liquidity needs through convertible notes, extended credit terms, and equity raisings. For
the three months ended March 31, 2017 and 2016, the Company incurred a net loss of approximately $0.9 and $1.0 million in 2017
and 2016, respectively, and has an accumulated deficit of approximately $13.7 million as of March 31, 2017. The Company has been
dependent on raising capital from debt and equity financings to meet its needs for cash flow used in operating activities. For
the three months ended March 31, 2017, the Company raised approximately $1.0 million from cash flow from financing activities
to meet cash flows used in operating activities.
At
March 31, 2017, the Company has approximately $0.9 million of cash on hand with a positive working capital of $1.7 million. The
Company’s ability to meet their ongoing operating cash needs is dependent on generating positive operating cash flow, primarily
through increased sales, improved profit growth and controlling expenses. Management has taken actions to improve profitability,
reduce headcount, reduce rent and increase sales. In addition, through May 12, 2017, the Company has raised an additional $833,815
in cash through equity and debt offerings (see Note 14, Subsequent Events). Also in May 2017, the Company acquired a small distillery
(its second acquisition of 2017) that is expected to improve operating results (see Note 14, Subsequent Events). Management believes
that cash on hand and the most recent equity raise and two acquisitions will be sufficient to meet their operating activities
to meet their near-term cash needs over the next twelve months.
The
Company’s cash flow related information for the three months ended March 31, 2017 and 2016 are as follows:
|
|
Three
Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Net cash flows provided by (used
in):
|
|
|
|
|
|
|
|
|
Operating
activities
|
|
$
|
(1,126,203
|
)
|
|
$
|
(271,477
|
)
|
Investing activities
|
|
|
(32,569
|
)
|
|
|
(6,954
|
)
|
Financing activities
|
|
|
954,421
|
|
|
|
149,914
|
|
Operating
Activities
In
the three months ended March 31, 2017, the net loss plus non-cash adjustments used was approximately $0.6 million compared to
using $0.7 million in 2016. The decrease in cash usage can be primarily attributed to the smaller net loss incurred in 2017 as
compared to 2016. Non-cash adjustments in the aggregate were about $33,000 lower in 2017. In addition, there was a $0.1 million
inventory build and a $0.5 million reduction accrued liabilities in 2017. In 2016, there was a $0.1 million inventory decrease,
a $0.1 million decrease in prepaid expenses and $0.3 million increase in accrued liabilities.
Investing
Activities
Cash
used in investing activities consists primarily of purchases of property and equipment. Capital expenditures of $39,631 and $6,954
were incurred in the three months ended March 31, 2017 and 2016 respectively.
Financing
Activities
During
the three months ended March 31, 2017, operating losses and working capital needs discussed above were met by raising equity financing
from common stock of $0.8 million and warrant exercises of $0.2 million. Net cash flows provided by financing activities in the
three months ended March 31, 2016 primarily consisted of $0.2 million in deposits for our preferred stock offering.
Rece
nt
Issuances
of Common
Stock
We
recently concluded an equity financing of 833,704 units at $1.30 per unit, each unit consisting one share of common stock and
one three-year common stock purchase warrant exercisable at $2.50 per share (subject to adjustment), for total proceeds of $1,083,815
in cash. The closing of this financing occurred on March 31, 2017, on which date the Company issued 576,923 shares of its common
stock for $750,000 in cash and warrants to purchase 576,923 shares of common stock, and on several dates between April 3, 2017
and May 4, 2017, during which period the Company issued 256,781 shares of its common stock for $333,815 in cash and warrants to
purchase 256,781 shares of common stock.
In
March 2017, we issued 59,385 shares of common stock to four third-party consultants in exchange for services rendered.
In
March 2017, we issued 1,724 shares of common stock to employees for stock-based compensation of $2,517.
On
March 8, 2017, we completed the acquisition of MotherLode. We issued 260,000 shares of common stock to the owners of MotherLode
as consideration for the acquisition. Based on the closing share price of our common stock of $1.45 on March 8, 2017, the value
of the transaction was $377,000.
In
March 2017, we issued 67,308 shares of common stock upon conversion of 8% convertible promissory notes with an aggregate
principal amount converted of $87,500.
In
March 2017, we issued 250,000 shares of common stock upon conversion of 250 shares of preferred stock.
From
January 15, 2017 through February 16, 2017, we received warrant exercises and subscription documents totaling $159,250 for 122,500
shares issued.
From
January 4, 2017 to January 22, 2017, we sold 45,000 shares of common stock to accredited investors at a price of $1.30 per share
for aggregate cash proceeds of $58,500.
Critical
Accounting Policies
The
discussion and analysis of our financial condition and results of operations is based upon its consolidated financial statements,
which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial
statements requires us to make significant estimates and judgments that affect the reported amounts of assets,
liabilities,
revenues and expenses, and related disclosure of contingent assets and liabilities. These items are monitored and analyzed by
management for changes in facts and circumstances, and material changes in these estimates could occur in the future. The more
judgmental estimates are summarized below. Changes in estimates are recorded in the period in which they become known. We base
our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances.
Actual results may differ from the Company’s estimates if past experience or other assumptions do not turn out to be substantially
accurate.
Revenue
Recognition
Net
sales includes product sales, less excise taxes, customer programs and incentives. we
record revenue when all four of the following criteria are met: (i) there is persuasive evidence that an arrangement exists; (ii)
delivery of the products and/or services has occurred; (iii) the selling price is fixed or determinable; and (iv) collectability
is reasonably assured.
We
recognize sales when merchandise is shipped from a warehouse directly to wholesale customers (except in the case of a consignment
sale). For consignment sales, which include sales to the Oregon Liquor Control Commission (OLCC), the Company recognizes
sales upon the consignee’s shipment to the customer. Postage and handling charges billed to customers are also recognized
as sales upon shipment of the related merchandise. Shipping terms are generally FOB shipping point, and title passes to the customer
at the time and place of shipment or purchase by customers at a retail location. For consignment sales, title passes to the consignee
concurrent with the consignee’s shipment to the customer. The customer has no cancellation privileges after shipment or
upon purchase at retail locations, other than customary rights of return. We exclude sales tax collected and remitted to various
states from sales and cost of sales. Sales from items sold through the Company’s retail location are recognized at
the time of sale.
Sales
received from online merchants who sell discounted gift certificates
for our merchandise and tastings is deferred until the customer has redeemed the discounted gift certificate or the gift certificate
has expired, whichever occurs earlier.
Customer
Programs and Incentives
Customer
programs and incentives, which include customer promotional discount programs, customer incentives and other payments, are a common
practice in the alcohol beverage industry. The Company makes these payments to customers and incurs these costs to promote sales
of products and to maintain competitive pricing. Amounts paid in connection with customer programs and incentives are recorded
as reductions to net revenue or as advertising, promotional and selling expenses in accordance with ASC Topic 605-50,
Revenue
Recognition- Customer Payments and Incentives
, based on the nature of the expenditure. Amounts paid to customers totaled $40,772
and $8,712 for the three months ended March 31, 2017 and 2016, respectively.
Shipping
and Fulfillment Costs
Freight
costs incurred related to shipment of merchandise from our distribution facilities to customers are recorded in cost of
sales.
Concentrations
Financial
instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables. At
March 31, 2017, three distributors represented 79% of trade receivables. At December 31, 2016, three distributors represented
91% of trade receivables. Sales to three customers accounted for approximately 57% of consolidated sales for the three months
ended March 31, 2017. Sales to one distributor, the OLCC, accounted for approximately 32% of consolidated sales for the three
months ended March 31, 2016.
Inventories
Inventories
primarily consist of bulk and bottled liquor and merchandise and are stated at the lower of cost or market. Cost is determined
using an average costing methodology, which approximates cost under the first-in, first-out (FIFO) method. A portion of inventory
is held by the OLCC on consignment until it is sold to a third party. Eastside regularly monitors inventory quantities on hand
and records write-downs for excess and obsolete inventories based primarily on the Company’s estimated forecast of
product demand and production requirements. Such write-downs establish a new cost basis of accounting for the related inventory.
We have recorded no write-downs of inventory for the three months ended March 31, 2017 and 2016.
Advertising
Advertising
costs are expensed as incurred and are included in advertising, promotional and selling expenses in the accompanying statements
of operations. Advertising expenses were $386,132 and $156,203 for the three months ended March 31, 2017 and 2016, respectively.
Excise
Taxes
The
Company is responsible for compliance with the TTB regulations which includes making timely and accurate excise tax payments.
Eastside is subject to periodic compliance audits by the TTB. Individual states also impose excise taxes on alcohol beverages
in varying amounts. The Company calculates its excise tax expense based upon units produced and on its understanding of the applicable
excise tax laws. Excise taxes totaled $176,416 and $158,408 in the three months ended March 31, 2017 and 2016, respectively.
Stock-Based
Compensation
The
Company recognizes as compensation expense all stock-based awards issued to employees in accordance with the fair value recognition
provisions of Accounting Standards Codification Topic 718,
Compensation - Stock Compensation
. The compensation cost is
measured based on the grant-date fair value of the related stock-based awards and is recognized over the service period of stock-based
awards, which is generally the same as the vesting period. The fair value of stock options is determined using the Black-Scholes
valuation model, which estimates the fair value of each award on the date of grant based on a variety of assumptions including
expected stock price volatility, expected terms of the awards, risk-free interest rate, and dividend rates, if applicable. Stock-based
awards issued to nonemployees are recorded at fair value on the measurement date and are subject to periodic market adjustments
as the underlying stock-based awards vest. Stock-based compensation was $374,687 and $140,370 in 2016 and 2015, respectively,
and $158,658 and $105,839 in the three months ended March 31, 2017 and 2016, respectively.
Off-Balance
Sheet Arrangements
We
have no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our
financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures
or capital resources that are material.
Related
Party Transactions
We
had no related party transactions during the three months ended March 31, 2017. During the three months ended March 31, 2016,
the Company’s chief executive officer paid expenses on behalf of the Company on his personal credit card. These related
party advances do not bear interest and are payable on demand. At March 31, 2016, the balance due to the chief executive officer
was approximately $95,000, and is included in accounts payable on the accompanying condensed consolidated balance sheets.
Subsequent
Events
On
May 1, 2017, we announced the acquisition of a majority stake in BBD.
Pursuant to the agreement
governing the acquisition of BBD, we agreed to exchange 84,286 shares of our common stock for 90% of the outstanding limited liability
company units of BBD. Following the acquisition of BBD, we will maintain the independence of BBD as a separate entity underneath
the operational umbrella of the Company.
We and BBD will benefit from brand synergies because of the limited overlap with our products. We will
devote sales, marketing, financial capital and production resources to expanding BBD’s business, which in 2016 had total
revenues of approximately $201,000.
On
April 24, 2017, we issued 50,000 shares of its common stock upon conversion of 50 shares of preferred stock. As of April 24, 2017,
we have zero shares of preferred stock outstanding.
On
April 21, 2017, we completed a $500,000 convertible note purchase agreement with an accredited investor. The note has a maturity
date of April 3, 2020, and bears interest at the rate of five percent (5%) per annum. The note has an automatic conversion feature
upon the closing (or first in a series of closings) of the next equity financing in which we sell shares of its equity securities
for an aggregate consideration of at least $4,000,000 at a purchase price of at least $2.50. The outstanding principal and unpaid
accrued interest on the note shall be automatically converted into equity securities at a price equal to 80% of the price paid
per share by the investors in the next equity financing or $2.00, whichever is lower, provided, however, that in no event shall
the conversion price be less than $2.00. The note has a voluntary conversion feature where the investor may convert, in whole
or in part, at any time at the conversion rate of $2.00.
On
April 5, 2017, our board approved an incentive option grant to Mr. Grover Wickersham totaling 100,000 shares with an exercise
price of $1.60. In addition, the board approved a restricted stock unit grant of 100,000 shares of common stock that vested on
April 5, 2017. 30,650 shares were not issued in order to satisfy Mr. Wickersham’s personal tax withholding responsibility.
On
April 3, 2017, we issued 25,000 shares of common stock to a third-party consultant in exchange for services rendered.
From
April 3, 2017 to May 4, 2017, we issued 256,781 shares of its common stock for $333,815 in cash, including warrants to purchase
256,781 shares of common stock. This represented the remaining closings of our private offering as described in the Form 8-K we
filed on March 27, 2017. The private offering was completed on May 4, 2017.
On
April 2, 2017 and April 18, 2017, 13, 2016, the independent directors, Messrs. Trent Davis and Michael Fleming, respectively,
each exercised 13,888 stock options to purchase common stock at $1.80 per share.
Recent
Accounting Pronouncements
In
March 2016, the Financial Accounting Standard Boards (the “FASB”) issued Accounting Standard Update (“ASU”)
No. 2016-09,
Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting.
” ASU 2016-09,
which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for
income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows.
ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years.
We have adopted as of March 31, 2017.
In
February 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842).
Under the new guidance, lessees will be required to
recognize the following for all leases (with the exception of short-term leases) at the commencement date:
|
●
|
A
lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted
basis; and
|
|
|
|
|
●
|
A
right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified
asset for the lease term.
|
Under
the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor
accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The new lease guidance simplified
the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities.
Lessees will no longer be provided with a source of off-balance sheet financing. Public business entities should apply the amendments
in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e.,
January 1, 2019, for a calendar year entity). Early application is permitted for all public business entities upon issuance. Lessees
(for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified
retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period
presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases
that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition
approach. We are currently evaluating the impact ASU 2016-02 will have on the Company’s condensed consolidated financial statements.
In
May 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606).
ASU 2014-09 will supersede
virtually all existing revenue guidance. Under this update, an entity is required to recognize revenue upon transfer of promised
goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or
services. As such, an entity will need to use more judgment and make more estimates than under the current guidance. ASU 2014-09
is to be applied retrospectively either to each prior reporting period presented in the financial statements, or only to the most
current reporting period presented in the financial statements with a cumulative effect adjustment to retained earnings. The Company
will elect to apply the impact (if any) of applying ASU 2014-09 to the most current reporting period presented in the financial
statements with a cumulative effect adjustment to retained earnings. In August 2015, the FASB issued ASU No. 2015-14,
Revenue
from Contracts with Customers (Topic 606): Deferral of the Effective Date
. ASU 2015-14 defers the effective date of ASU 2014-09
for one year, making it effective for the year beginning December 31, 2017, with early adoption permitted as of January 1,
2017. The Company currently expects to adopt ASU 2014-09 in the first quarter of 2018. The Company does not expect adoption of
ASU 2014-09 to have a material impact on its consolidated financial statements.
In
August 2014, the FASB issued ASU No. 2014-15,
Presentation of Financial Statements - Going Concern
. The new guidance explicitly
requires that management assess an entity’s ability to continue as a going concern and may require additional detailed disclosures.
ASU 2014-15 is effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods.
We have adopted as of December 31, 2016.
In
July 2015, the FASB issued ASU No. 2015-11,
Inventory (Topic 330), Simplifying the Measurement of Inventory
. ASU 2015-11
is part of the FASB’s initiative to simplify accounting standards. The guidance requires an entity to recognize inventory
within scope of the standard at the lower of cost or net realizable value. Net realizable value is the estimated selling price
in the ordinary course of business, less reasonable predictable costs of completion, disposal and transportation. ASU 2015-11
will be effective prospectively for the year beginning January 1, 2017. We have adopted as of March 31, 2017.
In
April 2015, the FASB issued ASU 2015-03, simplifying the presentation of debt issuance costs, which requires that debt issuance
costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount
of that debt liability. ASU 2015-03 is effective for annual and interim periods beginning after December 15, 2015 and early application
is permitted. We have early adopted as of December 31, 2015.
Off-Balance
Sheet Arrangements
We
have no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our
financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures
or capital resources that are material.