UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended March 31, 2018
[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________ to _________________

 

Commission File No.: 001-38182

 

EASTSIDE DISTILLING, INC.

(Exact name of registrant as specified in its charter)

 

Nevada		20-3937596
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

1001 SE Water Avenue, Suite 390

Portland, Oregon 97214

(Address of principal executive offices)

 

Issuer’s telephone number: (971) 888-4264

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ]		Accelerated filer [  ]
Non-accelerated filer [  ] (Do not check if a smaller reporting company)		Smaller reporting company [X]
Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

 

As of May 14, 2018, 5,195,201 shares of our common stock, $0.0001 par value, were outstanding.

 

 

 

EASTSIDE DISTILLING, INC.

 

FORM 10-Q

 

March 31, 2018

 

TABLE OF CONTENTS

 

		Page
PART I— FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017	3
	Condensed Consolidated Statements of Operations for three months ended March 31, 2018 and 2017	4
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017	5
	Notes to the Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4	Control and Procedures	34
PART II— OTHER INFORMATION
Item 1	Legal Proceedings	34
Item 1A	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34
Item 3.	Defaults Upon Senior Securities	35
Item 4.	Mine Safety Disclosures	35
Item 5.	Other Information	35
Item 6.	Exhibits	35
SIGNATURES		36

 

 

PART I: FINANCIAL INFORMATION

 

ITEM 1 –FINANCIAL STATEMENTS (unaudited)

 

Eastside Distilling, Inc. and Subsidiaries

Consolidated Balance Sheets

March 31, 2018 and December 31, 2017

 

		March 31, 2018				December 31, 2017
Assets
Current assets:
Cash		$	1,554,119			$	2,586,315
Trade receivables			405,601				315,321
Inventories			5,305,953				4,051,282
Prepaid expenses and current assets			624,299				649,749
Total current assets			7,889,972				7,602,667
Property and equipment, net			1,027,087				728,506
Intangible assets, net			323,294				325,668
Goodwill			28,182				28,182
Other assets, net			383,620				343,942
Total Assets		$	9,652,155			$	9,028,965
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	909,098			$	1,267,189
Accrued liabilities			202,247				156,163
Deferred revenue			18,704				1,579
Current portion of notes payable			297,259				38,731
Total current liabilities			1,427,308				1,463,662
Notes payable - less current portion and debt discount			3,388,237				2,416,755
Total liabilities			4,815,545				3,880,417
Commitments and contingencies (Note 10)
Stockholders’ equity:
Common stock, $0.0001 par value; 15,000,000 shares authorized; 5,044,770 and 4,889,745 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively			504				489
Additional paid-in capital			24,230,006				23,223,435
Accumulated deficit			(19,410,078	)			(18,090,961	)
Total Eastside Distilling, Inc. Stockholders’ Equity			4,820,432				5,132,963
Noncontrolling interests			16,178				15,585
Total Stockholders’ Equity			4,836,610				5,148,548
Total Liabilities and Stockholders’ Equity		$	9,652,155			$	9,028,965

 

 

Eastside Distilling, Inc. and Subsidiaries

Consolidated Statements of Operations

For the Three Months Ended March 31, 2018 and 2017

 

		2018				2017
Sales		$	1,413,182			$	829,669
Less excise taxes, customer programs and incentives			192,849				217,188
Net sales			1,220,333				612,481
Cost of sales			627,523				322,913
Gross profit			592,810				289,568
Operating expenses:
Advertising, promotional and selling expenses			642,977				386,132
General and administrative expenses			1,212,512				726,396
Loss on disposal of property and equipment			-				35,534
Total operating expenses			1,855,489				1,148,062
Loss from operations			(1,262,679	)			(858,494	)
Other income (expense), net
Interest expense			(56,638	)			(47,809	)
Other income (expense)			200				4,485
Total other expense, net			(56,438	)			(43,324	)
Loss before income taxes			(1,319,117	)			(901,818	)
Provision for income taxes			-				-
Net loss			(1,319,117	)			(901,818	)
Dividends on convertible preferred stock			-				(5,037	)
Income attributable to noncontrolling interests			593				-
Net loss attributable to Eastside Distilling, Inc. common shareholders		$	(1,318,524	)		$	(906,855	)
Basic and diluted net loss per common share		$	(0.27	)		$	(0.35	)
Basic and diluted weighted average common shares outstanding			4,920,534				2,614,324

 

 

Eastside Distilling, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the three months ended March 31, 2018 and 2017

 

		2018				2017
Cash Flows From Operating Activities:
Net loss		$	(1,319,117	)		$	(901,818	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			67,836				9,006
Loss on disposal of property and equipment			-				35,534
Amortization of debt issuance costs			13,188				37,009
Issuance of common stock in exchange for services			125,030				86,317
Stock-based compensation			276,068				158,658
Changes in operating assets and liabilities:
Trade receivables			(90,280	)			(15,171	)
Inventories			(1,254,671	)			(112,208	)
Prepaid expenses and other assets			(109,460	)			29,512
Accounts payable			(358,091	)			13,961
Accrued liabilities			85,315				(466,335	)
Deferred revenue			17,125				(668	)
Net cash used in operating activities			(2,547,057	)			(1,126,203	)
Cash Flows From Investing Activities:
Cash acquired in acquisition			-				7,062
Purchases of property and equipment			(343,722	)			(39,631	)
Net cash used in investing activities			(343,722	)			(32,569	)
Cash Flows From Financing Activities:
Stock issuance cost related to acquisitions			-				(5,580	)
Proceeds from common stock, net of issuance costs of $6,033, with detachable warrants			-				802,467
Proceeds from warrant exercise			680,400				159,250
Payments on conversion of note payable			-				(1,716	)
Payments of principal on notes payable			(71,817	)			-
Proceeds from convertible notes payable, net of issuance costs			1,250,000				-
Net cash provided by financing activities			1,858,583				954,421
Net increase in cash			(1,032,196	)			(204,351	)
Cash - beginning of period			2,586,315				1,088,066
Cash - end of period		$	1,554,119			$	883,715
Supplemental Disclosure of Cash Flow Information
Cash paid during the year for interest		$	8,917			$	10,800
Supplemental Disclosure of Non-Cash Financing Activity
Issuance of common stock for the acquisition of MotherLode Craft Distillery, LLC		$	-			$	377,000
Common stock issued in exchange of notes payable		$	-			$	87,500

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

1.	Description of Business

 

Eastside Distilling, Inc. (referred to herein as “Eastside,” “EAST,” “the Company,” “us,” or “we”) is an Oregon-based producer and marketer of craft spirits, founded in 2008. Our products span several alcoholic beverage categories, including bourbon, American whiskey, vodka, gin and rum. Unlike other distillers, we operate several retail tasting rooms in Oregon to market our brands directly to consumers. Our strategy for growth is to build on our local base in the Pacific Northwest and expand selectively to other markets, using major spirits distributors. In December 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. Sandstrom Partners subsequently became an investor in our company. During 2017, with the assistance of Sandstrom Partners and using our in-house spirits expertise, we created Redneck Riviera Whiskey (“RRW”) in collaboration with country music superstar John Rich, of the duo “Big & Rich.” Supported by John Rich’s marketing efforts, we launched RRW in the Southeastern and Gulf States primarily through Republic National Distributing Company (“RNDC”). We believe that RRW will achieve commercial success on a broad scale, and we have therefore focused our sales efforts on RRW outside Oregon. We believe RRW will be a key growth engine in 2018 and will also provide a “coattail” effect for our other brands, helping them to achieve improved national recognition and success.

 

Operating as a small business in a large, international spirits marketplace occupied by massive conglomerates, we seek to turn our small size from a disadvantage into an advantage. As the success of our RRW launch and Sandstrom Partners collaboration demonstrate, our team can leverage its smaller size to launch new brands more quickly than larger conglomerates because we are able to dedicate more of our attention and resources to developing innovative products. We believe that the dominance of Canadian whiskeys in the light-whiskey segment is vulnerable to a light whiskey that is 100% American, and we are exploiting that vulnerability with RRW, a product that went from idea, to celebrity collaboration, to design and formulation, to market roll-out in less than nine months. We are innovative in targeting emerging trends with our products; for example, we recently developed our Coffee Rum with cold brew coffee and low sugar, as well as our gluten-free potato vodka. We seek to be both a leader in creating spirits that offer better value than comparable spirits (for example, our value-priced Portland Potato Vodka), and an innovator in creating imaginative spirits that offer a unique taste experience, like our Coffee Rum, Oregon oak-aged whiskeys and Marionberry Whiskey.

 

As a Nasdaq-traded company, we have access to public capital markets to support our growth initiatives, including strategic acquisitions. In May 2017, we used our shares to acquire 90% of Big Bottom Distillery (“BBD”), known for its award-winning, super-premium gins and whiskeys, including The Ninety One Gin, Navy Strength Gin, Oregon Gin, Delta Rye and American Single Malt Whiskey. BBD’s super-premium spirits give us a presence at the “high end” of the market. In addition, through MotherLode Craft Distillery (“MotherLode”), our wholly-owned subsidiary acquired in March 2017, we also provide contract bottling and packaging services for existing and emerging spirits producers, some of whom contract with us to blend or distill spirits. During 2018, we intend to use our “slim line” canning equipment, newly installed at MotherLode, to profit from an emerging consumer interest in canned wine. We believe our location close to vineyards in Oregon and Washington is a competitive advantage.

 

We currently sell our products in 26 states (Oregon, Washington, California, Florida, Nevada, Texas, Virginia, Indiana, Illinois, New York, New Jersey, Massachusetts, Connecticut, Georgia, Rhode Island, Idaho, Maryland, West Virginia, Wyoming, North Carolina, Louisiana, Tennessee, Mississippi, South Dakota, Kansas and Alaska) as well as Ontario, Canada. 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).

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

2.

Liquidity

 

Historically, the Company has funded its cash and liquidity needs through the issuance of convertible notes, extended credit terms and the sale of equity. The Company has incurred a net loss of $1,319,117 and has an accumulated deficit of $19,410,078 for the three months ended March 31, 2018. The Company has been dependent on raising capital from debt and equity financings to fund its operating activities. For the three months ended March 31, 2018, the Company raised $1,858,583 in proceeds from financing activities.

 

At March 31, 2018, the Company had $1,554,119 of cash on hand with a positive working capital of $6,462,664. 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 managing expenses while increasing sales. In addition, through May 8, 2018, the Company raised an additional $1,615,156 million in cash through a debt offering and the exercise of previously issued warrants (see Note 14, Subsequent Events). Management believes that cash on hand and proceeds generated from the most recent financings, along with revenue that the Company expects to generate from operations, will be sufficient to meet the Company’s cash needs over the next twelve months. 

 

3.	Summary of Significant Accounting Policies

 

Basis of Presentation and Consolidation

 

The accompanying unaudited condensed consolidated financial statements for Eastside Distilling, Inc. and Subsidiaries 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. In our opinion, the unaudited condensed consolidated financial statements include all material adjustments, all of which are of a normal and recurring nature, necessary to present fairly our financial position as of March 31, 2018, our operating results for the three months ended March 31, 2018 and 2017 and our cash flows for the three months ended March 31, 2018 and 2017. 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, 2017. Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year ending December 31, 2018. The condensed consolidated financial statements include the accounts of Eastside Distilling, Inc.’s wholly-owned subsidiary MotherLode (beginning as of March 8, 2017), and majority-owned subsidiary BBD (beginning as of May 1, 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.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

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.

 

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 Accounting Standards Codification (“ASC”) Topic 605-50, Revenue Recognition - Customer Payments and Incentives, based on the nature of the expenditure. Amounts paid to customers totaled $47,801 and $40,772 for the three months ended March 31, 2018 and 2017, 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. Advertising, promotional and selling costs are expensed as incurred. Advertising, promotional and selling expense was $642,977 and $386,132 for the three months ended March 31, 2018 and 2017, respectively.

 

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.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

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, 2018 and December 31, 2017.

 

Concentrations

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables. At March 31, 2018, four customers represented 70% of trade receivables, and at December 31, 2017, two customers represented 79% of trade receivables. Sales to three customers accounted for approximately 59% of consolidated net sales for the three months ended March 31, 2018. Sales to three customers accounted for approximately 57% of net sales for the three months ended March 31, 2017.

 

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, 2018 and December 31, 2017, 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.

 

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, 2018 and December 31, 2017. 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, 2018 and December 31, 2017, 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.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

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, 2018 and 2017.

 

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.

 

Intangible Assets / Goodwill

 

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. At December 31, 2017, an impairment loss of $218,374 was recognized related to its acquisition of Big Bottom Distillery, LLC. At March 31, 2018, no additional impairment loss was recognized.

 

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, 2018 and December 31, 2017, the Company established valuation allowances against its net deferred tax assets.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

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, 2018 and 2017.

 

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.

 

Comprehensive Income

 

The Company does not have any reconciling other comprehensive income items for the three months ended March 31, 2018 and 2017.

 

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 $145,048 and $176,416 for the three months ended March 31, 2018 and 2017, respectively.

 

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 $276,068 and $158,658 for the three months ended March 31, 2018 and 2017, respectively.

 

Accounts Receivable Factoring Program

 

During the three months ended June 30, 2017, we terminated our previous receivable factoring program. Under the prior program, we had the option to sell certain customer account receivables in advance of payment for 75% of the amount due. When the customer remitted payment, we would receive the remaining 25%. We were 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 had recourse should the customer fail to pay the invoice. Thus, we recorded factored amounts as a liability until the customer remitted payment and we received the remaining 25% of the non-factored amount. We did not factor any invoices and did not incur any fees associated with the factoring program during the three months ended March 31, 2018. At March 31, 2018, we had no factored invoices outstanding.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

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 was effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We have adopted ASU 2016-09 as of March 31, 2017.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). 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 ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). 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 2014-09 which 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”). ASU 2015-14 deferred 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. We adopted ASU 2014-09 as of January 1, 2018. The Company does not believe the adoption of ASU 2014-09 had any material impact on its condensed consolidated financial statements.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (“ASU 2014-15”). 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 was effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods. We adopted ASU 2014-15 as of December 31, 2016. The Company does not believe the adoption of ASU 2014-15 had any material impact on its condensed consolidated financial statements.

 

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330), Simplifying the Measurement of Inventory (“ASU 2015-11”). 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 was effective prospectively for the year beginning January 1, 2017. We adopted ASU 2015-11 as of March 31, 2017. The Company does not believe the adoption of ASU 2015-11 had any material impact on its condensed consolidated financial statements.

 

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 was effective for annual and interim periods beginning after December 15, 2015 and early application was permitted. We early adopted ASU 2015-03 as of December 31, 2015. The Company does not believe the adoption of ASU 2015-03 had any material impact on its condensed consolidated financial statements.

 

4.	Business Acquisitions

 

During the fiscal year 2017, the Company completed the following acquisitions:

 

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 condensed consolidated financial statements for the three months ended March 31, 2018 include MotherLode’s results of operations. For the three months ended March 31, 2017, MotherLode’s results of operations are included from the acquisition date of March 8, 2017 through March 31, 2017. The Company’s condensed 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. MotherLode had approximately $375,000 in revenues (unaudited) in 2016.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

The following allocation of the purchase price is as follows:

 

Consideration given:
86,667 shares of common stock valued at $4.35 per share		$	377,000
Assets and liabilities acquired:
Cash			7,062
Inventory			103,488
Property and equipment			46,250
Intangible assets - customer list and license			376,431
Goodwill			28,182
Accounts payable			(5,180	)
Customer deposits			(179,233	)
		$	377,000

 

Intangible assets are recorded at estimated fair value, as determined by management based on available information. The fair value assigned to the customer list intangible asset was 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 value included management’s estimates of future cash flows, discounted at an appropriate rate of return which is 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. The fair values assigned to the license intangible asset were determined through the use of the cost approach. The license has an indefinite life and will not be amortized.

 

Big Bottom Distillery, LLC

 

On May 1, 2017, the Company acquired 90% of the ownership of Big Bottom Distillery, LLC (“BBD”), a Hillsboro, Oregon-based distiller of super premium spirits. The Company’s condensed consolidated financial statements for the three months ended March 31, 2018 include BBD’s results of operations. The Company’s condensed 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. BBD had approximately $201,000 in revenues (unaudited) in 2016.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

The following allocation of the purchase price is as follows:

 

Consideration given:
28,096 shares of common stock valued at $4.80 per share for 90%		$	134,858
Noncontrolling interests			14,984
Total value of acquisition		$	149,842
Assets and liabilities acquired:
Cash (overdraft)		$	(2,521	)
Accounts receivable			6,224
Inventory			129,922
Property and equipment			22,717
Intangible assets - license			25,000
Goodwill			193,374
Accrued liabilities			(52,841	)
Notes payable			(172,033	)
Total		$	149,842

 

Intangible assets are recorded at estimated fair value, as determined by management based on available information. The fair value assigned to the license intangible asset was determined through the use of the cost approach. The license has an indefinite life and will not be amortized. For the year ended December 31, 2017, the Company recognized an impairment of $218,374 for the intangible asset – license and the goodwill originally recorded as part of the purchase price allocation for BBD.

 

5.	Inventories

 

Inventories consist of the following:

 

		March 31, 2018				December 31, 2017
Raw materials		$	4,666,678			$	3,755,477
Finished goods			639,275				295,805
Total inventories		$	5,305,953			$	4,051,282

 

6.	Property and Equipment

 

Property and equipment consists of the following:

 

		March 31, 2018				December 31, 2017
Furniture and fixtures		$	665,303			$	326,088
Leasehold improvements			436,943				56,410
Vehicles			49,483				49,483
Construction in progress			-				372,667
Total cost			1,151,729				804,648
Less accumulated depreciation			(124,642	)			(76,142	)
Property and equipment - net		$	1,027,087			$	728,506

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

Purchases of property and equipment totaled $343,722 and $39,631 for the three months ended March 31, 2018 and March 31, 2017, respectively. Depreciation and amortization expense totaled $50,873 and $41,253 for the three months ended March 31, 2018 and March 31, 2017, respectively.

 

7.	Intangible Assets and Goodwill

 

Intangible assets and goodwill at March 31, 2018 and December 31, 2017 consists of the following:

 

		March 31, 2018				December 31, 2017
Permits and licenses		$	25,000			$	25,000
Customer lists			323,249				351,432
Goodwill			28,182				28,182
Total intangible assets and goodwill			376,431				404,614
Less accumulated amortization			(53,137	)			(50,764	)
Intangible assets and goodwill - net		$	323,294				353,850

 

Amortization expense totaled $2,370 and $2,929 for the three months ended March 31, 2018 and March 31, 2017, respectively.

 

8.	Other Assets

 

Other assets consist of the following:

 

		March 31, 2018				December 31, 2017
Product branding		$	285,000			$	285,000
Deposits			118,942				53,942
Less accumulated amortization			(20,322	)			-
Other assets		$	383,620			$	343,942

 

As of March 31, 2018, the Company had $285,000 of capitalized costs related to services provided for the rebranding of its Burnside product line. This amount is being amortized over a seven year life. Additionally, there was $60,000 in deposits for the branding services related to the future release of other product lines. The remaining deposits of $13,942 represent office and retail space lease deposits.

 

 

9.	Notes Payable

 

Notes payable consists of the following:

 

		March 31, 2018				December 31, 2017
Notes payable bearing interest at 8%. The notes have a 2-year maturity, are due either June 30, 2018 or June 30, 2019 and pay interest-only on a monthly basis.			407,500				407,500
Note payable bearing interest at 2.74%. The note is payable in monthly principal plus interest payments of $100 through December 2019			2,608				2,608
Note payable bearing interest at 4.00%. The note is payable in quarterly principal plus interest payments of $9,614 through March 2019.			37,152				56,341
Convertible notes payable bearing interest at 4.00%. The notes principal plus accrued interest is due in full at various dates between April 3, 2020 – September 30, 2020. The notes have 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 $7.50. The outstanding principal and unpaid accrued interest on the notes will 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 $6.00, whichever is lower, provided, however, that in no event will the conversion price be less than $6.00. The note has a voluntary conversion feature where the investor may convert, in whole or in part, at any time at the conversion price of $6.00.			938,288				927,192
Promissory notes payable bearing interest at 8.00%. The notes’ principal is due on June 30, 2019. Interest is paid monthly.			419,585				1,101,840
Notes payable bearing interest at 5.00%. The notes’ principal, plus any accrued and unpaid interest is due May 1, 2021.			1,906,870				-
Total notes payable			3,712,001				2,495,179
Less current portion			(297,259	)			(293,726	)
Less debt discount for detachable warrant			(26,505	)			(39,693	)
Long-term portion of notes payable		$	3,388,237			$	2,161,760

 

Maturities on notes payable as of March 31, 2018, are as follows:

 

Year ending December 31:

 

2018		$	257,500
2019			609,343
2020			938,288
2021			1,906,870
Thereafter			-
		$	3,712,001

 

10.	Commitments and Contingencies

 

Operating Leases

 

The Company leases its corporate office, warehouse, kiosks, and tasting room space under operating lease agreements which expire at various dates through March 2021. Monthly lease payments range from $1,857 to $6,400 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.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

At March 31, 2018, future minimum lease payments required under the operating leases are approximately as follows:

 

2018		$	213,631
2019			253,586
2020			167,303
2021			19,200
2022			-
Thereafter			-
Total		$	653,720

 

Total rent expense was $101,631 and $19,000 for the three months ended March 31, 2018 and 2017, respectively.

 

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 effect is anti-dilutive. There were no dilutive common shares at March 31, 2018 and 2017. The numerators and denominators used in computing basic and diluted net loss per common share in 2018 and 2017 are as follows:

 

		Three months ended March 31,
		2018				2017
Net loss attributable to Eastside Distilling, Inc. common shareholders (numerator)		$	(1,318,524	)		$	(906,855	)
Weighted average shares (denominator)			4,920,534				2,614,324
Basic and diluted net loss per common share		$	(0.26	)		$	(0.35	)

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

12.	Stockholder’s Equity

 

		Common Stock								Paid-in				Accumulated				Total Stockholders’				Non-controlling interest in consolidated				Total
		Shares				Amount				Capital				Deficit				Equity				Entities				Equity
Balance, December 31, 2017			4,889,745			$	489			$	23,223,435			$	(18,090,961	)		$	5,132,963			$	15,585			$	5,148,548
Issuance of common stock from warrant exercise for cash			126,000				13				680,387				-				680,400				-				680,400
Issuance of common stock for services by third parties			12,525				1				60,931				-				60,932				-				60,932
Issuance of common stock for services by employees			16,500				1				90,509				-				90,510				-				90,510
Stock-based compensation			-				-				174,744				-				174,744				-				174,744
Net profit attributable to noncontrolling interests			-				-				-				-				-				593				593
Net loss attributable to common shareholders			-				-				-				(1,319,117	)			(1,319,117	)			-				(1,319,117	)
Balance, March 31, 2018			5,044,770			$	504			$	24,230,006			$	(19,410,078	)		$	4,836,610			$	16,178			$	4,836,610

 

Reverse Stock Splits

 

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, and the 3-for-1 reverse stock split of the Company’s common stock effected on June 15, 2017.

 

Issuance of Common Stock

 

During the first quarter of 2018, the Company issued 126,000 shares of common stock at $5.40 per share in connection with the exercise of warrants for cash proceeds of $680,400.

 

In January and February 2018, the Company issued 16,500 shares of common stock to directors and employees for stock-based compensation of $90,510. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $3.99 - $5.11 per share.

 

During the first quarter of 2018, the Company issued 12,525 shares of common stock to a consultant in exchange for services. The shares were valued using the closing share price of our common stock on the date of grant, with a range of $3.99 - $5.11 per share, for a total value of $50,118.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

In December 2017, the Company issued 18,371 shares of common stock to directors and employees for stock-based compensation of $79,351. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $3.78 - $4.33 per share.

 

In December 2017, the Company issued 32,000 shares of common stock to a consultant in exchange for services, which were subject to a claw-back provision tied to specific performance. The shares were valued using the closing share price of our common stock on the date of grant, $4.54 per share.

 

In December 2017, the Company issued 14,384 shares of its common stock upon conversion of 8% convertible promissory notes with an aggregate principal amount converted of $52,500. No gain or loss recorded on the transactions.

 

In September 2017, the Company issued 14,760 shares of common stock to directors and employees for stock-based compensation of $56,221. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $3.78 - $4.38 per share.

 

In August 2017, the Company issued 83,334 shares of its common stock upon conversion of a 6% convertible promissory note with an aggregate principal amount converted of $500,000. No gain or loss recorded on the transactions.

 

In August 2017, the Company issued 5,209 shares of common stock to a third-party consultant in exchange for services rendered. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $3.40 - $3.50 per share.

 

In August 2017, the Company completed an underwritten public offering of 1,200,000 units consisting of 1,200,000 shares of its common stock and warrants to purchase up to an aggregate of 1,200,000 shares of its common stock (each, a “Unit”) at a public offering price of $4.50 per Unit. The warrants have a per share exercise price of $5.40, are exercisable immediately, and will expire five years from the date of issuance. The gross proceeds to the Company from this offering were $5.4 million, before deducting underwriting discounts and commissions and other estimated offering expenses. On August 24, 2017, the underwriters exercised their option to purchase an additional 180,000 Units to cover over-allotments, that resulted in additional gross proceeds to the Company of $810,000, before deducting offering expenses.

 

In June 2017, the Company issued 2,716 shares of common stock to employees for stock-based compensation of $15,943, all of which were fully vested upon issuance. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $4.38 - $6.00 per share.

 

In May 2017, the Company completed the acquisition of a majority stake in BBD. We issued 28,096 shares of common stock to the owners of BBD as consideration for 90% of the BBD LLC units. Based on the closing share price of our common stock of $4.80 on May 1, 2017, the value of the transaction was $134,858. Issuance costs incurred were $14,400.

 

In April 2017, the independent directors, Messrs. Trent Davis and Michael Fleming, respectively, each exercised 4,630 stock options to purchase common stock at $5.40 per share.

 

In April 2017, the Company issued 50,335 shares of common stock to three third-party consultants in exchange for services rendered. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $4.35 - $4.50 per share.

 

In April 2017, the Company approved a restricted stock unit grant of 33,334 shares of common stock to the Company’s Chief Executive Officer, Grover Wickersham. The grant vested on April 5, 2017, of which 10,218 shares were withheld in order to satisfy Mr. Wickersham’s personal tax withholding responsibility. The shares were valued using the $4.80 closing share price of our common stock on the date of grant.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

In April 2017, the Company issued 16,667 shares of its common stock upon conversion of 50 shares of preferred stock.

 

In March 2017, the Company issued 83,334 shares of its common stock upon conversion of 250 shares of preferred stock.

 

In March 2017, the Company issued 22,436 shares of its common stock upon conversion of 8% convertible promissory notes with an aggregate principal amount converted of $87,500. No gain or loss recorded on the transactions.

 

On March 8, 2017, the Company completed the acquisition of MotherLode. We issued 86,667 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 $4.35 on March 8, 2017, the value of the transaction was $377,000. Issuance costs incurred were $5,580.

 

In March 2017, the Company issued 575 shares of common stock to employees for stock-based compensation of $2,517. The shares were valued using the $4.38 closing share price of our common stock on the date of grant.

 

In March 2017, the Company issued 19,796 shares of common stock to four third-party consultants in exchange for services rendered. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $3.90 - $4.35 per share.

 

From March 31, 2017 to June 2, 2017, the Company issued 400,019 shares of its common stock for aggregate cash proceeds of $1,560,000, including 400,019 warrants for common stock.

 

From January 15, 2017 through February 16, 2017, the Company received warrant exercises and common stock subscriptions for 40,834 shares for aggregate cash proceeds of $159,250.

 

From January 4, 2017 to January 22, 2017, the Company sold 15,001 shares of common stock to accredited investors at a price of $3.90 per share for aggregate cash proceeds of $58,500.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

Issuance of Convertible Preferred Stock

 

Each share of Series A Preferred has a stated value of $1,000, which is convertible into shares of the Company’s common stock at a fixed conversion price equal to $4.50 per share. The Series A 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 is 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 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 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 vote separately a class to change any of the rights, preferences and privileges of the Series A Preferred.

 

As of March 31, 2018, the Company has zero shares of preferred stock outstanding.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

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 166,667 shares, subject to adjustment. On January 1, 2017, the number of shares available for grant under the 2016 Plan reset to 307,139 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 October 18, 2017, the Board of Directors (the “Board”) approved amendments to the 2016 Plan to (i) increase the number of shares of the common stock that may be issued under the 2016 Plan (the “Aggregate Limit”) by an additional 192,861 shares of common stock, for a total of 500,000 shares of common stock, (ii) increase the number of shares of common stock that may be granted to any participant pursuant to options to purchase common stock and stock appreciation rights under the 2016 Plan in any one year period (the “Individual Option Limit”) from 8,333 shares to 200,000 shares, (iii) increase the number of shares of common stock that may be granted to any participant pursuant to other awards (the “Individual Award Limit”) under the 2016 Plan in any one year period from 8,333 shares to 200,000 shares and (iv) increase the number of shares of common stock that may be paid to any one participant under the 2016 Plan for a performance period pursuant to performance compensation awards under the 2016 Plan (the “Individual Performance Award Limit”) from 8,333 shares to 200,000 shares, which amendments were adopted and approved at the December 2017 meeting of stockholders. The exercise price per share of each stock option will not be less than 100 percent of the fair market value of the Company’s common stock on the date of grant. On January 1, 2018, the number of shares available for grant under the 2016 Plan reset to 1,131,880 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, added to the prior year plan amount. At March 31, 2018, there were 709,422 options and 145,146 restricted stock units (“RSUs”) issued under the 2016 Plan, with vesting schedules varying between immediate and five (5) years from the grant date.

 

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 50,000 shares, subject to adjustment. The exercise price per share of each stock option will 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, 2018, there were 14,584 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, 2018, there were no options outstanding that were not issued under the Plans.

 

A summary of all stock option activity at and for the three months ended March 31, 2018 is presented below:

 

		# of Options				Weighted- Average Exercise Price
Outstanding at December 31, 2017			369,006			$	6.47
Options granted			355,000			$	3.97
Options exercised			-
Options canceled			-
Outstanding at March 31, 2018			724,006			$	4.84
Exercisable at March 31, 2018			198,448			$	6.55

 

The aggregate intrinsic value of options outstanding at March 31, 2018 was $1,579,436.

 

At March 31, 2018, there were 525,558 unvested options with an aggregate grant date fair value of $1,467,798. 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, 2018 was $1,475,574. During the three months ended March 31, 2018, 47,166 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:

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(unaudited)

 

	●	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

 

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, 2018:

 

Risk-free interest rate			2.36	%
Expected term (in years)			6.11
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, 2018 was $2.66. The aggregate grant date fair value of the 355,000 options granted during the three months ended March 31, 2018 was $942,837.

 

For the three months ended March 31, 2018 and 2017, total stock option expense related to stock options was $174,744 and $158,658 respectively. At March 31, 2018, the total compensation cost related to stock options not yet recognized is approximately $1,565,148, which is expected to be recognized over a weighted-average period of approximately 2.55 years.

 

Warrants

 

During the three months ended March 31, 2018, the Company issued an aggregate of 217,298 common stock warrants in connection with the purchase of $2.2 million in promissory notes. $1.25 million was purchased with new cash proceeds and $922,980 was purchased from the conversion of prior existing notes. The Company has determined the warrants should be classified as equity on the condensed consolidated balance sheet as of March 31, 2018. The estimated fair value of the warrants at issuance was $988,923, based on a combination of closing market trading price on the date of issuance for the public offering warrants, and the Black-Scholes option-pricing model using the weighted-average assumptions below:

 

Volatility			75	%
Risk-free interest rate			2.475	%
Expected term (in years)			4.5
Expected dividend yield			-
Fair value of common stock		$	4.74

 

A total of 126,000 warrants were exercised during the three months ended March 31, 2018 for cash proceeds of $680,400.

 

 

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

March 31, 2018

(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, 2017			2,623,077				3.62 years			$	5.96			$	54,880
Three months ended March 31, 2018:
Granted			217,298				4.5 years			$	5.40			$	347,677
Exercised			(126,000	)			4.5 years			$	5.40				-
Forfeited and cancelled			-				-			$	-				-
Outstanding at March 31, 2018			2,714,375				3.67 years			$	5.94			$	2,877,238

 

13.	Related Party Transactions

 

The following is a description of transactions since January 1, 2016 as to which the amount involved exceeds the lesser of $120,000 or one percent (1%) of the average of our total assets at year-end for the last two completed fiscal years and in which any related person has or will have a direct or indirect material interest, other than equity, compensation, termination and other arrangements.

 

On June 2, 2017, Mr. Wickersham purchased 15,189 units at $3.90 per unit, with each unit consisting of one share of common stock and one three-year common stock purchase warrant exercisable at $7.50 per share (subject to adjustment), for total proceeds of $59,237 in cash.

 

On August 10, 2017, Mr. Wickersham and his affiliates purchased 55,555 units at $4.50 per unit, with each unit consisting of one share of common stock and one Public Warrant, for total proceeds of approximately $250,000 in cash.

 

 

On August 23, 2017, our Board appointed Jack Peterson to the Board to fill an existing vacancy on the Board effective immediately. Mr. Peterson is also the President of Sandstrom Partners. In late 2016, with the goal of increasing its brand value and accelerating sales, the Company retained Sandstrom and tasked them with reviewing the Company’s current product portfolio, as well as its new ideas, and advising it with respect to marketing, creation of brand awareness and product positioning, locally and nationally. The Company is using Sandstrom’s full range of brand development services, including research, strategy, brand identity, package design, environments, advertising as well as digital design and development. The Company paid $140,000 in cash, issued 33,334 shares of stock valued at $145,000 (at the time of issuance), and issued 42,000 warrants with an exercise price of $3.50 valued at $43,596 (using a Black-Scholes value at the time of issuance) to Sandstrom Partners in 2017 for services rendered by Sandstrom under its agreement with the Company. We have also issued an additional 10,025 shares valued at $40,000 (at the time of issuance) to Sandstrom in 2018.

 

On December 29, 2017, the Grover T. Wickersham Employees’ Profit Sharing Plan (“PSP”) purchased from us a promissory note bearing interest at the rate of 8% per annum (a “Promissory Note”) for aggregate consideration of $464,750. Interest is paid monthly. The note is due on June 30, 2019 or in the event the Company completes a private or public offering of its equity or debt securities in which the gross amount raised in such financing is at least $2.0 million (a “Future Financing”), all amount due under this Note shall become due and payable within five (5) business days of the final closing of such Future Financing. In lieu of receiving the cash repayment of amounts due under this Note in connection with a Future Financing, at the option of Payee, the principal amount due and payable may be used to purchase the securities offered in the Future Financing. The payee used a balance of $379,750 to purchase the Company’s new private offering of notes with warrants. The remaining principal balance of $85,000 was paid in April 2018. The new promissory notes bear interest at 8% per annum, payable monthly on the last day of the month. The entire amount of principal and any accrued and unpaid interest is due and payable on May 1, 2021. In conjunction with this new offering, the Payee was issued 37,975 warrants, exercisable at $5.40 per share.

 

On December 29, 2017, the Grover T. and Jill Z. Wickersham 2000 Charitable Remainder Trust (the “Wickersham Trust”) purchased from us a promissory note bearing interest at the rate of 8% per annum (a “Promissory Note”) for aggregate consideration of $179,300. Interest is paid monthly. The note is due on June 30, 2019 or in the event the Company completes a private or public offering of its equity or debt securities in which the gross amount raised in such financing is at least $2.0 million (a “Future Financing”), all amount due under this Note shall become due and payable within five (5) business days of the final closing of such Future Financing. In lieu of receiving the cash repayment of amounts due under this Note in connection with a Future Financing, at the option of Payee, the principal amount due and payable may be used to purchase the securities offered in the Future Financing. During the first quarter of 2018, the payee used the balance to purchase the Company’s new private offering of notes with warrants. The new promissory notes bear interest at 8% per annum, payable monthly on the last day of the month. The entire amount of principal and any accrued and unpaid interest is due and payable on May 1, 2021. In conjunction with this new offering, the Payee was issued 37,975 warrants, exercisable at $5.40 per share.

 

We believe that the foregoing transactions were in our best interests. Consistent with Section 78.140 of the Nevada Revised Statutes, it is our current policy that all transactions between us and our officers, directors and their affiliates will be entered into only if such transactions are approved by a majority of the disinterested directors, are approved by vote of the stockholders, or are fair to us as a corporation as of the time it is authorized, approved or ratified by the board. We will continue to conduct an appropriate review of all related party transactions and potential conflicts of interest on an ongoing basis. Our audit committee has the authority and responsibility to review, approve and oversee any transaction between the Company and any related person and any other potential conflict of interest situation on an ongoing basis, in accordance with Company policies and procedures in effect from time to time.

 

14.	Subsequent Events

 

Between April 3, 2018 and May 8, 2018, the Company issued 9,291 shares of common stock to directors and employees for stock-based compensation of $66,367. The shares were valued using the closing share price of our common stock on the date of grant, with the range of $7.00 - $7.19 per share.

 

On April 6, 2018, the Company raised an additional $880,000 under its private offering of promissory notes and accompanying warrants. The promissory notes bear interest at 8% per annum, payable monthly on the last day of the month. The entire amount of principal and any accrued and unpaid interest is due and payable on May 1, 2021. For every $100,000 in principal, the Company issued to the investor 10,000 common stock purchase warrants, for a total of 88,000 warrants. The warrants, which are identical to the warrants that were issued in the Company’s public offering that was consummated in August 2017, are exercisable through August 10, 2022, unless earlier redeemed, at an exercise price of $5.40, subject to adjustment for stock splits, reverse splits and other similar recapitalization events. The Company will have the option to redeem all or a part of the outstanding warrants at any time after the closing price of the Company’s common stock exceeds $7.65 for five consecutive trading days. In electing to redeem the warrants, the Company will provide 30 days’ notice of the redemption date, during which time the holders of outstanding warrants will have the opportunity to exercise their warrants at the exercise price then in effect. Any warrants remaining outstanding at the close of business on the 30th day of the notice period will be redeemed at a price of $0.15 per warrant, after which, the warrants will be cancelled.

 

Between April 3, 2018 and May 8, 2018, the Company received an aggregate of $735,156 upon exercise of a total of 136,140 common stock purchase warrants that were sold in the Company’s August 2017 public offering. As of May 8, 2018, there remains outstanding 1,117,860 warrants sold in the public offering, in addition to a total of 305,298 identical warrants sold in the private placement noted above. We also received $30,000 upon the exercise of a total of 5,000 common stock purchase warrants that were sold in a prior private offering.

 

 

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, 2017 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 and Exchange Commission.

 

Business Overview

 

We are an Oregon-based producer and marketer of craft spirits, founded in 2008. Our products span several alcoholic beverage categories, including bourbon, American whiskey, vodka, gin and rum. Unlike other distillers, we operate several retail tasting rooms in Oregon to market our brands directly to consumers. Our strategy for growth is to build on our local base in the Pacific Northwest and expand selectively to other markets, using major spirits distributors. In December 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. Sandstrom Partners subsequently became an investor in our company. During 2017, with the assistance of Sandstrom Partners and using our in-house spirits expertise, we created Redneck Riviera Whiskey (“RRW”) in collaboration with country music superstar John Rich, of the duo “Big & Rich.” Supported by John Rich’s marketing efforts, we launched RRW in the Southeastern and Gulf States primarily through Republic National Distributing Company (“RNDC”). We believe that RRW will achieve commercial success on a broad scale, and we have therefore focused our sales efforts on RRW outside Oregon. We believe RRW will be a key growth engine in 2018 and will also provide a “coattail” effect for our other brands, helping them to achieve improved national recognition and success.

 

 

Operating as a small business in a large, international spirits marketplace occupied by massive conglomerates, we seek to turn our small size from a disadvantage into an advantage. As the success of our RRW launch and Sandstrom Partners collaboration demonstrate, our team can leverage its smaller size to launch new brands more quickly than larger conglomerates because we are able to dedicate more of our attention and resources to developing innovative products. We believe that the dominance of Canadian whiskeys in the light-whiskey segment is vulnerable to a light whiskey that is 100% American, and we are exploiting that vulnerability with RRW, a product that went from idea, to celebrity collaboration, to design and formulation, to market roll-out in less than nine months. We are innovative in targeting emerging trends with our products; for example, we recently developed our Coffee Rum with cold brew coffee and low sugar, as well as our gluten-free potato vodka. We seek to be both a leader in creating spirits that offer better value than comparable spirits (for example, our value-priced Portland Potato Vodka), and an innovator in creating imaginative spirits that offer a unique taste experience, like our Coffee Rum, Oregon oak-aged whiskeys and Marionberry Whiskey.

 

As a Nasdaq-traded company, we have access to public capital markets to support our growth initiatives, including strategic acquisitions. In May 2017, we used our shares to acquire 90% of Big Bottom Distillery (“BBD”), known for its award-winning, super-premium gins and whiskeys, including The Ninety One Gin, Navy Strength Gin, Oregon Gin, Delta Rye and American Single Malt Whiskey. BBD’s super-premium spirits give us a presence at the “high end” of the market. In addition, through MotherLode Craft Distillery (“MotherLode”), our wholly-owned subsidiary acquired in March 2017, we also provide contract bottling and packaging services for existing and emerging spirits producers, some of whom contract with us to blend or distill spirits. During 2018, we intend to use our “slim line” canning equipment, newly installed at MotherLode, to profit from an emerging consumer interest in canned wine. We believe our location close to vineyards in Oregon and Washington is a competitive advantage.

 

RESULTS OF OPERATIONS

 

Overview

 

First quarter 2018 results benefitted from the impact of several key initiatives the Company started in 2017. Gross sales increased 70% over the prior year, primarily due to five key factors: 1) the newly launched Redneck Riviera whiskey product, which experienced very strong sales with its initial market launch, 2) increased wholesale sales traction within the Pacific Northwest, especially with our vodka product as we strategically invested in programs to promote the vodka product, 3) the re-launch of our new Burnside Bourbon packaging, which began in late 2017, and its corresponding growth in the first quarter, 4) the acquisitions of MotherLode and BBD, and the expansion of our private label business with our new canning abilities; and 5) the addition of retail locations within Oregon.

 

In order to support our planned growth, we invested heavily in our infrastructure (facilities, people, and marketing programs) during 2017. We believe we are now well positioned from a capacity and infrastructure standpoint to leverage those investments made and thus experience improved performance throughout 2018.

 

Three Months Ended March 31, 2018 Compared to the Three Months Ended March 31, 2017

 

Our sales for the three months ended March 31, 2018 increased to $1,413,182, or approximately 70%, from $829,669 for the three months ended March 31, 2017. The following table compares our sales in the three months ended March 31, 2018 and 2017:

 

		Three Months Ended March 31,
		2018								2017
Wholesale		$	755,714				53	%		$	429,902				52	%
Private Label			351,658				24	%			115,870				14	%
Retail / Special Events			305,810				23	%			283,897				34	%
Total		$	1,413,182				100	%		$	829,669				100	%

 

The increase in sales in the three months ended March 31, 2018 is primarily attributable to: the newly launched Redneck Riviera Whiskey product, increased wholesale sales traction within the Pacific Northwest, our acquisitions of MotherLode and BBD and related expansion of our private label business and canning abilities, and the addition of new retail locations.

 

Excise taxes, customer programs and incentives for the three months ended March 31, 2018 decreased to $192,849, or approximately 11%, from $217,188 for the comparable 2017 period. The decrease is entirely attributable to the lower federal excise tax rates that went into effect this year, partially offset by increased Oregon excise taxes (from our retail operations) and higher customer programs during the period.

 

 

During the three months ended March 31, 2018, cost of sales increased to $627,523, or approximately 94%, from $322,913 for the three months ended March 31, 2017. The increase is attributable to the costs associated with our increased liquor sales in the period as well as higher facilities costs.

 

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, 2018 and 2017:

 

		Three Months Ended March 31,
		2018				2017
Gross profit		$	592,810			$	289,568
Gross margin			49	%			47	%

 

Our gross margin of 49% of net sales in the three months ended March 31, 2018 increased from our gross margin of 47% for the three months ended March 31, 2017 primarily due to the combination of our new products which have higher margins than prior legacy products as well as the new, lower federal excise tax. While our goal is to ultimately improve our overall gross margin, it may fluctuate around the current level due to the impact of two key factors: product sales mix and the related customer programs and incentives, both of which are subject to seasonal fluctuations and the competitive environment.

 

Advertising, promotional and selling expenses for the three months ended March 31, 2018 increased to $642,977, or approximately 67%, from $386,132 for the three months ended March 31, 2017. 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, particularly with the new Redneck Riviera product launch.

 

General and administrative expenses for the three months ended March 31, 2018 increased to $1,212,512, or approximately 64%, from $726,396 for the three months ended March 31, 2017. This increase is primarily due to increased headcount and the associated compensation and benefits in addition to $117,410 higher stock-based compensation expense in 2018.

 

Total other expense, net was $56,438 for the three months ended March 31, 2018, compared to $43,324 for the three months ended March 31, 2017, an increase of 30%. This increase was primarily due to higher interest expense on an increased notes payable balance in 2018.

 

Net loss attributable to common shareholders during the three months ended March 31, 2018 was $1,318,524 as compared to a loss of $906,855 for the three months ended March 31, 2017. The increase in our net loss was primarily attributable to our higher general and administrative expenses and advertising, promotional and selling expenses during 2018, partially offset by an increase in gross profit.

 

Liquidity and Capital Resources

 

Three Months Ended March 31, 2018

 

The Company’s primary capital requirements are for the financing of inventories, and cash used in operating activities. Funds for the Company’s cash and liquidity needs have historically not been generated from operations but rather from short-term credit in the form of extended payment terms from suppliers as well as from convertible debt and equity financings.

 

 

For the three months ended March 31, 2018 and 2017, the Company incurred a net loss of approximately $1.3 million and $0.9 million, respectively, and has an accumulated deficit of approximately $19.4 million as of March 31, 2018. 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, 2018, the Company raised approximately $1.9 million from financing activities to meet cash flows used in operating activities.

 

At March 31, 2018, the Company had approximately $1.6 million of cash on hand with a positive working capital of $6.5 million. 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 and increase sales. Management believes that cash on hand and proceeds generated from the most recent financings, along with revenue that the Company expects to generate from operations, will be sufficient to meet the Company’s cash needs over the next twelve months.

 

The Company’s cash flows for the three months ended March 31, 2018 and 2017 are as follows:

 

		Three Months Ended March 31,
		2018				2017
Net cash flows provided by (used in):
Operating activities		$	(2,547,047	)		$	(1,126,203	)
Investing activities		$	(343,722	)		$	(32,569	)
Financing activities		$	1,858,583			$	954,421

 

Operating Activities

 

During the three months ended March 31, 2018, our net loss plus non-cash adjustments used was approximately $0.8 million compared to using $0.6 million in 2017. The increase in cash usage can be primarily attributed to the larger net loss incurred in 2018 as compared to 2017. In addition, there was an increase of $1.3 million in inventory, a $0.1 million increase in trade receivables and a $0.3 million net reduction in accounts payable and accrued liabilities in 2018. In 2017, there was a $0.1 million increase in inventory and $0.5 million net reduction accounts payable and accrued liabilities.

 

Investing Activities

 

Cash used in investing activities consists primarily of purchases of property and equipment. Capital expenditures of $343,722 and $39,631 were incurred in the three months ended March 31, 2018 and 2017, respectively.

 

Financing Activities

 

During the three months ended March 31, 2018, the Company’s operating losses and working capital needs were primarily funded by $0.7 million in proceeds from warrant exercises and $1.25 million in proceeds from the issuance of promissory notes. Net cash flows provided by financing activities during the three months ended March 31, 2017 primarily consisted of $0.8 million in proceeds from the sale of common stock and $0.2 million in proceeds from warrant exercises.

 

Critical Accounting Policies

 

The discussion and analysis of our financial condition and results of operations is based upon its condensed 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. Our critical accounting policies, summarized below, are highly dependent upon subjective or complex judgements, assumptions and estimates. 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 $47,801 and $40,772 for the three months ended March 31, 2018 and 2017, 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, 2018, four customers represented 70% of trade receivables, and at December 31, 2017, two customers represented 79% of trade receivables. Sales to three customers accounted for approximately 59% of consolidated net sales for the three months ended March 31, 2018. Sales to three customers accounted for approximately 57% of net sales for the three months ended March 31, 2017.

 

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. 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. We have recorded no write-downs of inventory for the three months ended March 31, 2018 and 2017.

 

 

Advertising

 

Advertising costs are expensed as incurred. Advertising expense was $642,977 and $386,132 for the three months ended March 31, 2018 and 2017, respectively.

 

Excise Taxes

 

The Company is responsible for compliance with Alcohol and Tobacco Tax and Trade Bureau (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 $145,048 and $176,416 for the three months ended March 31, 2018 and 2017, 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 $276,068 and $156,658 for the three months ended March 31, 2018 and 2017, 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.

 

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”). 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 was effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We have adopted ASU 2016-09 as of March 31, 2017.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). 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”). 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 deferred 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. We adopted ASU 2014-09 as of January 1, 2018. The Company does not believe the adoption of ASU 2014-09 had any material impact on its condensed consolidated financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (“ASU 2014-15”). 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 was effective for annual periods beginning after December 15, 2016 and interim periods within those annual periods. We adopted ASU 2014-15 as of December 31, 2016. The Company does not believe the adoption of ASU 2014-15 had any material impact on its condensed consolidated financial statements.

 

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330), Simplifying the Measurement of Inventory (“ASU 2015-11”). 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 was effective prospectively for the year beginning January 1, 2017. We have adopted ASU 2015-11 as of March 31, 2017. The Company does not believe the adoption of ASU 2015-11 had any material impact on its condensed consolidated financial statements.

 

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 was effective for annual and interim periods beginning after December 15, 2015 and early application was permitted. We early adopted ASU 2015-03 as of December 31, 2015. The Company does not believe the adoption of ASU 2015-03 had any material impact on its condensed consolidated financial statements.

 

 

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, we are not required to provide information required by this item.

 

ITEM 4 – CONTROLS AND PROCEDURES

 

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”) that are designed to provide reasonable assurances that the information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

 

In connection with the preparation of this quarterly report on Form 10-Q, an evaluation was carried out by our management, with the participation of the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

 

As of the end of the period covered by this report, there have been no changes in internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the quarter ended March 31, 2018, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II: OTHER INFORMATION

 

ITEM 1 – 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 is time consuming and expensive to resolve, and it diverts management resources.

 

ITEM 1A – RISK FACTORS

 

There have been no material changes in our risk factors from those previously disclosed in our annual report on Form 10-K for the year ended December 31, 2017, and incorporated therein by reference.

 

ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

The following list sets forth information regarding all securities sold or granted by us during the period covered by this report that were not registered under the Securities Act, and the consideration, if any, received by us for such securities, which proceeds has been or will be used by us for general working capital purposes. The securities were offered and sold in reliance on the exemption from registration afforded by Section 4(a)(2) or Rule 506(b) of Regulation D promulgated under the Securities Act, which exempt transactions by an issuer not involving any public offering. The purchasers were “accredited investors” as such term is defined in Regulation D. The securities are non-transferable in the absence of an effective registration statement under the Act or an available exemption therefrom, and all certificates are imprinted with a restrictive legend to that effect.

 

On March 15, 2018, the Company completed a private offering of promissory notes and accompanying warrants in which it raised $1,250,000 in gross proceeds. The promissory notes bear interest at 8% per annum, payable monthly on the last day of the month. The entire amount of principal and any accrued and unpaid interest is due and payable on May 1, 2021. For every $100,000 in principal, the Company issued to the investor 10,000 common stock purchase warrants, for a total of 125,000 warrants. The warrants, which are identical to the warrants that were issued in the Company’s public offering that was consummated in August 2017, are exercisable through August 10, 2022, unless earlier redeemed, at an exercise price of $5.40, subject to adjustment for stock splits, reverse splits and other similar recapitalization events. The Company will have the option to redeem all or a part of the outstanding warrants at any time after the closing price of the Company’s common stock exceeds $7.65 for five consecutive trading days. In electing to redeem the warrants, the Company will provide 30 days’ notice of the redemption date, during which time the holders of outstanding warrants will have the opportunity to exercise their warrants at the exercise price then in effect. Any warrants remaining outstanding at the close of business on the 30th day of the notice period will be redeemed at a price of $0.15 per warrant, after which, the warrants will be cancelled.

 

During the first quarter of 2018, we issued 10,025 shares to our partner, Sandstrom Partners, as part of their branding work on our products, and 2,500 shares to two different service providers for services rendered.

 

 

ITEM 3 – DEFAULT UPON SENIOR SECURITIES

 

None

 

ITEM 4 – MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5 – OTHER INFORMATION

 

On May 10, 2018, Eastside Distilling, Inc. (the “Company”) entered into a credit and security agreement (the “Credit and Security Agreement”), by and between the Company and The KFK Children’s Trust, Jeffrey Anderson – Trustee (the “Lender”). Pursuant to the Credit and Security Agreement, the Lender will make loans to the Company in an aggregate principal amount not to exceed $3,000,000 (the “Loans”). The proceeds of the Loans are to be used by the Company to purchase bulk whiskey, bourbon and rye inventory for use in distilling and producing its spirits products, and for no other purpose.

 

The Loans have an annual interest rate of 7.00%. The Company will pay accrued and unpaid interest on the Loans, for the period commencing on the date each such Loan is made, and continuing until each such Loan is paid in full. The Company will pay the outstanding principal amount of the Loans: (i) in a one-time payment on the termination date of the Credit and Security Agreement, which shall take place 37 months from the effective date thereof, or earlier pursuant to other provisions thereof; and (ii) the Company may prepay the Loans or any portion thereof at any time, and from time to time, without premium or penalty.

 

On May 11, 2018, Eastside Distilling, Inc. terminated the employment and the related employment agreement of Allen Barteld, who had served as President and CEO of MotherLode, LLC, a wholly-owned subsidiary of Eastside since the acquisition of MotherLode by Eastside in March of 2017. MotherLode will continue to provide contract bottling and packaging services for existing and emerging spirits producers and to utilize its newly-installed, “slim line” canning equipment to profit from an emerging consumer interest in canned wine.

 

ITEM 6 – EXHIBITS

 

Exhibit No.		Description
3.1		Amended and Restated Articles of Incorporation of the Company, as presently in effect, filed as Exhibit 3.1 to the Registration Statement on Form S-1 filed on November 14, 2011 (File No. 333-177918) and incorporated by reference herein.
3.2		Certificate of Designation – Series A Preferred Stock, filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K dated March 9, 2016 and filed on March 11, 2016 and incorporated by reference herein.
3.3		Amendment to Certificate of Designation After Issuance of Class or Series, filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K dated June 1, 2016 and filed on June 9, 2016 and incorporated by reference herein.
3.4		Certificate of Change, filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K dated October 6, 2016 and filed on October 11, 2016 and incorporated by reference herein.
3.5		Certificate of Change, filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K dated June 14, 2017 and filed on June 15, 2017 and incorporated by reference herein.
3.6		Amended and Restated Bylaws of the Company, as presently in effect, filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K dated October 13, 2016 and filed on October 19, 2016 and incorporated by reference herein.
10.1		Credit and Security Agreement, dated May 10, 2018, between the Company and The KFK Children’s Trust, Jeffrey Anderson – Trustee.
31.1		Certification of Grover Wickersham pursuant to Rule 13a-14(a).
31.2		Certification of Steven Shum pursuant to Rule 13a-14(a).
32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C Section 1350.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C Section 1350.
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Schema Linkbase Document
101.CAL		XBRL Taxonomy Calculation Linkbase Document
101.DEF		XBRL Taxonomy Definition Linkbase Document
101.LAB		XBRL Taxonomy Labels Linkbase Document
101.PRE		XBRL Taxonomy Presentation Linkbase Document

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	EASTSIDE DISTILLING, INC.
	By:	/s/ Grover Wickersham
		Grover Wickersham
		Chief Executive Officer, Director
		(Principal Executive Officer)
		Date: May 14, 2018
	By:	/s/ Steve Shum
		Steve Shum
		Chief Financial Officer
		(Principal Financial and Accounting Officer)
		Date: May 14, 2018