Eastside Distilling, Inc. - Annual Report: 2019 (Form 10-K)

U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2019

For the transition period from ___________ to _____________

Commission File Number 000-54959

EASTSIDE DISTILLING, INC.

(Name of small business issuer as specified in its charter)

1001 SE Water Avenue, Suite 390

Portland, Oregon 97214

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (971) 888-4264

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act: Yes [  ] No [X]

Indicate by check mark whether the registrant(1) has filed all reports required 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 day. Yes [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes [X] No [  ]

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

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]

The aggregate market value of the voting stock held by non-affiliates of the registrant at June 28, 2019, the last business day of the registrant’s most recently completed second fiscal quarter was $37,101,492 based on the last reported sales price of the registrant’s common stock as reported by the Nasdaq Stock Market on that date.

As of March 30, 2020, 9,762,728 shares of our common stock were outstanding.

Documents Incorporated by Reference: None.

EASTSIDE DISTILLING, INC.

FORM 10-K

December 31, 2019

TABLE OF CONTENTS

PART I

Eastside Distilling, Inc., is referred to herein as “Eastside,” “EAST,” “the Company,” “us,” or “we.”

Cautionary Note Regarding Forward-Looking Statements

The statements in this section and other sections of this Form 10-K include “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995 and involve uncertainties that could significantly impact results. Forward-looking statements give current expectations or forecasts of future events about the company or our outlook. You can identify forward-looking statements by the fact they do not relate to historical or current facts and by the use of words such as “believe,” “expect,” “estimate,” “anticipate,” “will be,” “should,” “plan,” “project,” “intend,” “could” and similar words or expressions. Examples include, among others, statements about:

Forward-looking statements are based on assumptions and on known risks and uncertainties. Although we believe we have been prudent in our assumptions, any or all of our forward-looking statements may prove to be inaccurate, and we can make no guarantees about our future performance. Should known or unknown risks or uncertainties materialize, or underlying assumptions prove inaccurate, actual results could materially differ from past results and/or those anticipated, estimated or projected.

We undertake no obligation to provide updates to forward-looking statements to the public, whether as a result of new information, future events or otherwise. You should, however, consult any subsequent disclosures we make in our filings with the United States Securities and Exchange Commission (“SEC”) on Form 10-Q or Form 8-K.

You should review the “Risk Factors” set forth elsewhere in this Annual Report for a cautionary discussion of certain risks, uncertainties and assumptions that we believe are significant to our business and may effect forward looking statements.

Use of Non-GAAP Financial Information – Certain matters discussed in this report, including the information presented in Part II under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” include measures that are not measures of financial performance under U.S. Generally Accepted Accounting Principles (GAAP). These non-GAAP measures should not be considered in isolation or as a substitute for any measure derived in accordance with GAAP, and also may be inconsistent with similarly titled measures presented by other companies. In Part II under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we present the reasons we use these measures under the heading of “Non-GAAP Financial Measures,” and reconcile these measures to the most closely comparable GAAP measures under the heading “Results of Operations – Year-Over-Year Comparisons.”

Overview

Eastside Distilling, Inc. (the “Company,” “Eastside Distilling,” “we,” “us,” or “our, below) was incorporated under the laws of Nevada in 2004 under the name of Eurocan Holdings, Ltd. In December 2014, we changed our corporate name to Eastside Distilling, Inc. to reflect our acquisition of Eastside Distilling, LLC. We manufacture, acquire, blend, bottle, import, export, market and sell a wide variety of alcoholic beverages under recognized brands. We employ 89 people in the United States.

Our brands span several alcoholic beverage categories, including bourbon, American whiskey, vodka, gin, rum, tequila and Ready-to-Drink (RTD). We sell our products on a wholesale basis to distributors, and until March 2020, we operated four retail tasting rooms in Portland, Oregon to market our brands directly to consumers.

Operating as a small business in a large, international spirits marketplace occupied by large multi-national conglomerates, we seek to utilize our size and our public company stature to our advantage and position Eastside Distilling as a leading tier 2 spirits provider by acquiring and developing brands, growing them to a national presence and positioning them for sale to the tier 1 suppliers to the market. This strategy was demonstrated by the launch of our Redneck Riviera Brand (RRW) in conjunction with our branding partners, Sandstrom Partners in 2018. This demonstrated how our team can leverage its position to launch nascent or new brands and grow them more quickly than the tier 1 larger conglomerates because we are able to focus and dedicate more of our attention to developing innovative products. Our RRW brand went from idea, to market roll-out in less than nine months and achieved national distribution in 49 states in 18 months. In September 2019, we acquired the Azuñia tequila brand and have begun to distribute this brand through our national platform.

In May 2017, we used our shares to acquire 90% of Big Bottom Distilling, LLC (“BBD”), known for its award-winning, super-premium gins and whiskeys, and American Single Malt Whiskey. BBD’s super-premium spirits give us a presence at the “ultra-premium segment” of the market. In December 2018, we acquired the remaining 10% of BBD. In September 2019, we also acquired the high-end, luxury tequila brand, Azuñia, to complement our portfolio and provide us with a larger established brand in the high-growth tequila category. In addition, through MotherLode Craft Distillery (“MotherLode”), our wholly owned subsidiary acquired in March 2017 and Craft Canning + Bottling, LLC (formerly known as Craft Canning, LLC) (“Craft Canning”), which we acquired in January 2019, we provide contract bottling, canning, and packaging services for existing and emerging beer, wine and spirits producers. We have used our mobile canning operations to profit from the rapid growth in the canned beverages industry (beer, wine, spirit-based RTD’s).

Market Opportunity

Large and Growing Global and Domestic Markets

The global spirits market is very large and according to Statista, a leading business data platform, the spirit market generates total revenues in excess of $400 billion annually, growing at a moderate estimated rate of 2-4% annually.

According to the Distilled Spirits Council of the U.S. (DISCUS), distilled spirits sales in the U.S. were up 5.3% in 2019, increasing by $1.5 billion, to a new record of $29 billion. Key spirits category drivers of sales growth in 2019 included: American whiskey, up 10.8 % or $387 million to $4 billion; rye was an important component of the overall American whiskey category growth with sales up 14.7 % or $30 million, reaching $235 million; tequila/mezcal, up 12.4 % or $372 million to $3.4 billion; mezcal surpassed $100 million in sales for the first time totaling $105 million. Pre-mixed cocktails were up 7.5 % or $25 million to $351 million. Volumes rose by 3.3% to a record 239 million cases, an increase of 7.6 million cases from 2018. The trend underscored the decades long trend in market premiumization as consumers shifted their purchases toward more expensive spirits, resulting in a faster rate of growth in revenue over the rate of growth in physical shipments. According to DISCUS, in 2019, the spirits industry again gained market share over beer and wine sales. Revenues grew by half a percent to 37.8% of the total beverage alcohol market. This was the 10th year of market share gains for the spirits industry. Each percentage point gain in market share is worth $770 million in additional revenue to the industry.

Key Growth Trends that We Target

High-End and Super-Premium – The high-end and super-premium spirit products, across most categories, exhibited strong growth trends in 2019. The 2019 revenues for those price points increased 7.6% and 7.9%, respectively, and by 8.0% and 7.0% in volume.

Millennials – Generally, “Millennials” (individuals born between the early 1980s and the mid-1990s) value “authenticity” and are inspired by travel and like to try new products and seek new experiences, according to a survey by BeverageDaily.com. Millennials tend to drink a broader range of spirit types (vodka, rum, tequila, whiskey, gin) than prior generations, and Millennials consume more expensive spirits than their predecessors. These individuals are often attracted to vintage spirits and cocktails with nostalgic followings, such as throwbacks to the 1950s like rye whiskey, bourbon and the Manhattan cocktail. According to Barclays Research, millennials increasingly prefer spirits over beer and wine, and flavored spirits in particular. In addition, according to DISCUS, millennials are more willing than prior generations to purchase premium spirits and continue to gravitate toward high-end and super premium spirits.

Our Strategy

Our overall strategy is to become a “house of brands” that is designed to drive industry leading growth at the tier 2 level and shareholder value by acquiring nascent brands, rebranding them with the services of Sandstrom Partners and introducing those brands to the market on our national distribution platform. We aim to grow our brands to be an attractive acquisition candidate for the tier 1 producers in the spirits industry and ultimately sell those brands and use the proceeds of the brand sales to duplicate the process.

Our goal is to have brand representation in all classes of spirits and Ready-to-Drink (RTD) beverages, and distribution channels in both spirits and beer that crosses all classes of trade primarily focused on the off-premise trade.

To help achieve our strategy, we are focused on:

Our Strengths

We believe the following competitive strengths will help enable the implementation of our growth strategies:

Our Product Approach

Our approach to our craft spirits involves five important aspects:

Production and Supply

We achieve various complex flavor profiles through one or more of the following techniques: infusion of fruit, addition of various natural flavoring substances, and, in the case of rums and whiskeys, aging of the brands in various types of casks for extended periods of time, as well as the blending of several rums or whiskeys to achieve a unique flavor profile for each brand. After we complete the distillation, purification and flavoring processes, we bottle or can the various liquids. This involves several important stages, including bottle and label design and procurement, filling of the bottles and packaging the bottles in various configurations for shipment.

We rely on a limited number of suppliers for the sourcing of our spirit products and raw materials, including our distillate products and other ingredients. These suppliers consist of third-party producers in the U.S and Mexico. Other than our 20-year exclusive agreement with Agaveros Unidos de Amatitan, SA. de CV., we do not have long-term, written agreements with any of our suppliers. However, we believe that we have consistent and reliable third-party sources for the needed materials. We produce and bottle all our spirits for distribution, regardless of whether the distillation phase of the process was at our facility or at one of our suppliers. During 2018 and 2019, we procured a significant portion of our outside base distillate from MGP Ingredients and we intend to continue to actively rely on this supplier.

As of September 12, 2019, in conjunction with the acquisition of the Azuñia tequila brand, we assumed the 20-year exclusive purchase agreement with Agaveros Unidos de Amatitan, SA. de CV. The exclusivity is based on minimum purchase volumes, fixed pricing for each of different presentations of tequila and specific cash terms.

Distribution Network

Since 2018 with the introduction of Redneck Riviera Whiskey, we developed a national distribution network and currently have distribution and brokerage relationships with third-party distributors in 49 U.S. states.

U.S. Distribution

Producers and importers of beverage alcohol in the United States must sell their products through a three-tier distribution system. Typically, a brand is first sold to a network of distributors, or wholesalers, covering the United States, in either “open” states or “control” states. In the 33 open states, the distributors are generally large, privately-held companies. In the 17 control states, the states themselves function as the distributor, and regulate suppliers, including our company. The distributors and wholesalers in turn sell to individual retailers, such as liquor stores, restaurants, bars, supermarkets and other outlets licensed to sell alcoholic beverages. In larger states, such as New York, more than one distributor may handle a brand in separate geographical areas. In control states, importers sell their products directly to state liquor authorities, which distribute the products and either operate retail outlets or license the retail sales function to private companies, while maintaining strict control over pricing and profit.

The U.S. spirits industry has consolidated dramatically over the last ten years due to merger and acquisition activity. Eight major spirits companies currently dominate the industry, each of which owns and operates its own importing businesses. All companies, including these large companies, are required by law to sell their products through wholesale distributors in the United States. The major companies continue to exert increasing influence over the regional distributors and as a result, it has become increasingly difficult for smaller companies to get their products recognized by distributors.

Importation

We hold the federal importer and wholesaler license required by the Alcohol and Tobacco Tax and Trade Bureau of the U.S. Treasury Department and the requisite state licenses within the states we conduct business.

Our inventory is maintained in offsite bonded warehouses at our producers, our bonded warehouses in Milwaukie, Oregon and Hillsboro, Oregon and at bonded warehouses managed by Park Street, our fulfillment and logistics partner. We also typically have inventory in transit that we ship nationally by our network of licensed and bonded carriers.

Wholesalers and Distributors

In the United States, we are required by law to use state-licensed distributors or, in the control states, state-owned agencies performing this function, to sell our brands to retail outlets. As a result, we depend on distributors for sales, product placement and retail store penetration. All of the distributors that we currently work with also distribute our competitors’ products and brands. As a result, we must foster and maintain our relationships with our distributors. Through our internal sales team, we have established relationships for our brands with wholesale distributors in the forty-nine states we sell our products, and our products are sold in the U.S. by these wholesale distributors, as well as by various state beverage alcohol control agencies.

Other Sources of Revenue

Retail Stores

During 2019 we had four retail stores in the Portland, Oregon area that provided us with additional opportunities for sampling and sales of our products. In January 2020, we announced that we will be closing our retail stores. Effective March 23, 2020, all of these stores have been closed.

Significant Customers

Sales to one customer, the Oregon Liquor Control Commission, accounted for approximately 16% and 30% of our consolidated sales for the years ended December 31, 2019 and 2018, respectively.

Sales Team

We have a total sales force of approximately 24 people, with an average of over ten years of industry experience with premium beverage alcohol brands.

Our sales personnel are engaged in the day-to-day management of our distributors, which includes setting quotas, coordinating promotional plans for our brands, maintaining adequate levels of stock, brand education and training and sales calls with distributor personnel. Our sales team also maintains relationships with key chain and retail customers through independent sales calls. They also schedule promotional events, create local brand promotion plans, host in-store tastings, where permitted, and provide wait staff and bartender training and education for our brands.

In addition, we have also engaged Park Street Imports, a provider of back-office administrative, fulfillment, and logistical services for alcohol and beverage distributors, which services include state compliance, logistics planning, order processing, order fulfillment, distributor chargeback and bill-support management and certain accounting and reporting services. In addition, Park Street Imports provides a factoring service that Eastside distilling can take advantage of to improve cash flow.

Advertising, Marketing and Promotion

To build our brands, we must effectively communicate with three distinct audiences: distributors, retail trade and end consumers. Advertising, marketing and promotional activities help to establish and reinforce the image of our brands in our efforts to build substantial brand value.

In late 2016, to aid us in this strategy, we retained Sandstrom Partners, a Portland-based firm specializing in spirits branding, and tasked them with reviewing our current product portfolio, as well as our new ideas, and advising us on marketing, creation of brand awareness and product positioning, locally and nationally. We are 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. During 2017, Sandstrom Partners re-branded our key Burnside whiskey brand as well as developed the branding for “Redneck Riviera” brand. Throughout 2018-2019 Sandstrom Partners was focused on a number of new and existing (re-branded) product efforts. Some of those have now been launched including Hue Hue, Granny Rich, and the more recent Portland Mule and Howdy Dew RTD products. Sandstrom Partners is currently working on the Azuñia tequila brand.

We use a range of marketing strategies and tactics to build brand equity and increase sales, including consumer and trade advertising, price promotions, point-of-sale materials, event sponsorship, in-store and off-premise promotions and public relations, as well as a variety of other traditional and non-traditional marketing techniques, including social media marketing, to support our brands.

Besides traditional advertising, we also employ three other marketing methods to support our brands: public relations, event sponsorships and tastings. Our significant U.S. public relations efforts have helped gain editorial coverage for our brands, which increases brand awareness. Event sponsorship is an economical way for us to have influential consumers taste our brands. We actively contribute product to trend-setting events where our brand has exclusivity in the brand category. We also conduct in-store promotions at our off-premise accounts.

We support our brand marketing efforts with an assortment of point-of-sale materials. The combination of trade and consumer programs, supported by attractive point-of-sale materials, also establishes greater credibility for us with our distributors and retailers.

Intellectual Property

Trademarks are an important aspect of our business. We sell our products under a number of trademarks, which we own or use under license, including the Redneck Rivera trademark, which is owned by Rich Marks and described above under “Item 1 - Business - Our Brands”. Our brands are protected by trademark registrations or are the subject of pending applications for trademark registration in the U.S. where we distribute, or plan to distribute, our brands. The trademarks may be registered in the names of our subsidiaries. In the U.S., trademark registrations need to be renewed every ten years. We expect to register our trademarks in additional markets as we expand our distribution territories.

Seasonality

Our business has historically followed the spirits industry seasonality trends with peak sales generally occurring in the fourth calendar quarter, primarily due to seasonal holiday buying. However, as our business has evolved and as we continue to expand our footprint in the national distribution platform, our sales growth has been more dependent on the timing of successful sales efforts and shipment of product to customers, but there remains a concentration of buying and stocking our chains ahead of the holiday season.

Competition

Our industry is highly competitive. We believe that we compete on the basis of quality, price, brand recognition and distribution strength. Our premium brands compete with other alcoholic and nonalcoholic beverages for consumer purchases, retail shelf space, and wholesaler attention. We compete with numerous tier 1 multinational producers and distributors of beverage alcohol products, many of which have greater resources than us.

Over the past ten years, the U.S. wine and spirits industry has undergone dramatic consolidation and realignment of brands and brand ownership. The number of major importers in the U.S. has declined significantly. Today, we believe eight major companies dominate the market: Diageo PLC, Pernod Ricard S.A., Bacardi Limited, Brown-Forman Corporation, Beam Suntory Inc., Davide Campari Milano-S.p.A., and Remy Cointreau S.A. These competitors have substantially greater resources than we do.

We believe we are a leading tier 2 participant that is in a prime position to partner with small-to-mid-size spirit brands as opposed to the major importers and tier 1 multinationals. Despite our relative capital position and resources, we have been able to compete with these larger companies in pursuing agency distribution agreements and acquiring brands by being more responsive to private and family-owned brands, offering flexible transaction structures. Given our size relative to our major tier 1 competitors, most of which have multi-billion dollar operations, we believe that we can provide greater focus on smaller brands and tailor transaction structures based on individual brand owner preferences. However, our relative capital position and resources may limit our marketing capabilities, our ability to expand into new markets and our negotiating ability with our distributors.

By focusing on the premium and super-premium segments of the market, which typically have higher prices per case and gross profit margins, and having an established, experienced sales force, we believe we are able to gain relatively significant attention from our distributors for a company of our size. Also, the continued consolidation among the major companies is expected to create an opportunity for small to mid-size wine and spirits companies, such as Eastside to penetrate markets, as the major companies contract their portfolios to focus on fewer brands.

Government Regulation

We are subject to the jurisdiction of the Federal Alcohol Administration Act, U.S. Customs laws, and the Alcoholic Beverage Control laws of all fifty states, among many other regulations.

The U.S. Treasury Department’s Alcohol and Tobacco Tax and Trade Bureau regulates the production, blending, bottling, sales and advertising and transportation of alcohol products. Also, each state regulates the advertising, promotion, transportation, sale and distribution of alcohol products within its jurisdiction. We are also required to conduct business in the U.S. only with holders of licenses to import, warehouse, transport, distribute and sell spirits.

We are subject to U.S. regulations on the advertising, marketing and sale of beverage alcohol. These regulations range from a complete prohibition of the marketing of alcohol in some states to restrictions on advertising style, media and messages.

Labeling of spirits is also regulated in many markets, varying from health warning labels to importer identification, alcohol strength and other consumer information. All beverage alcohol products sold in the U.S. must include warning statements related to risks of drinking beverage alcohol products.

In the U.S. control states, the state liquor commissions act in place of distributors and decide which products are to be purchased and offered for sale in their respective states. Products are selected for purchase and sale through listing procedures which are generally made available to new products only at periodically scheduled listing interviews. Consumers may purchase products not selected for listings only through special orders, if at all.

The distribution of alcohol-based beverages is also subject to extensive federal and state taxation in the U.S. and internationally. Most foreign countries impose excise duties on wines and distilled spirits, although the form of such taxation varies from a simple application on units of alcohol by volume to intricate systems based on the imported or wholesale value of the product. Several countries impose additional import duty on distilled spirits, often discriminating between categories in the rate of such tariffs. Once we begin distributing our products internationally, import and excise duties could have a significant effect on our sales, both through reducing the consumption of alcohol and through encouraging consumer switching into lower-taxed categories of alcohol.

Employees

As of March 30, 2020, we have 89 employees, 23 of whom were in sales and marketing, 58 in production/canning/bottling, and 8 whom were in administration. All employees are full-time. We will continue to monitor our staffing in light of the impacts of the coronavirus and streamlining on our operations for working capital needs.

Geographic Information

Eastside currently sells its products in 49 states, as well as in Ontario, Canada.

Item 1A. RISK FACTORS

The statements in this section describe the most significant risks to our business and should be considered carefully in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the “Notes to Consolidated Financial Statements” to this Annual Report on Form 10-K, as well as our other disclosures in this Annual Report. We may have other risks that we have not yet identified or that we currently believe are immaterial but may become material.

RISKS RELATING TO OUR BUSINESS

We require additional capital, which we may not be able to obtain on acceptable terms, or at all. Our inability to access or raise such capital, as needed, on beneficial terms or at all could restrict our future growth and severely limit our operations.

We require additional capital in order to continue our operations, and failure to obtain such additional capital could limit our operations and our growth, including our ability to continue to develop, grow and maintain existing brands, service our debt and other obligations, maintain adequate inventory levels, fund potential acquisitions of new brands, maintain existing distribution relationships and retail channels, penetrate new markets, attract new customers and enter into new distribution relationships. We have not generated sufficient cash from operations to finance additional capital needs, and we will need to raise additional funds through private or public equity and/or debt financing. We cannot assure you that additional financing will be available to us on acceptable terms or at all. Because we have collateralized our assets and secured debt, our ability to obtain additional debt financing by offering security to lenders may be limited. If additional capital is either unavailable or cost prohibitive, our operations and growth may be limited, and we may need to change our business strategy to slow the rate of, or eliminate, our expansion or to reduce or curtail our operations. Also, any additional financing we undertake could impose covenants upon us that restrict our operating flexibility, and, if we issue equity securities to raise capital, our existing shareholders may experience dilution and the new securities may have rights, preferences and privileges senior to those of our common stock.

If our brands do not achieve more widespread consumer acceptance, our sales, growth, and profitability may be limited.

Although certain of our brands continue to achieve acceptance, most of our brands are relatively new and have not achieved national brand recognition. We have not yet had success growing a brand to a sufficient level to realize profitability and be in a position to sell the brand for a profit. Also, brands we may develop and/or acquire in the future may not establish widespread brand recognition. Accordingly, if consumers do not accept our brands at scale, our sales will be limited and we will not be able to penetrate our markets.

In addition, our profitability depends in part on achieving scale. We will need to achieve wider market acceptance of our brands and materially increase sales and gain profitability.

We have incurred significant operating losses every quarter since our inception and anticipate that we will continue to incur significant operating losses in the future.

We believe that we will continue to incur net losses for the foreseeable future as we expect to make continued significant investment in product development, sales and marketing, brand support and to incur significant administrative expenses as we seek to grow our brands. We also anticipate that our cash needs will exceed our income from sales for the foreseeable future. Some of our products may never achieve widespread market acceptance and may not generate sales and profits to justify our investment in them. Also, we may find that our expansion plans are more costly than we anticipate and that they do not ultimately result in commensurate increases in our sales or profits, which would further increase our losses. We expect we will continue to experience losses and negative cash flow, some of which could be significant. Results of operations will depend upon numerous factors, some of which are beyond our control, including market acceptance of our products, new product introductions and competition. We also incur substantial operating expenses at the corporate level, including costs directly related to being a reporting company with the SEC. For the year ended December 31, 2019, we reported a net loss of $16.9 million. As of December 31, 2019, we had an accumulated deficit since inception of $44.2 million.

The success of our Redneck Riviera brand is dependent on our relationship with and on the reputation and popularity of singer and songwriter John Rich. Any adverse reactions to publicity relating to Mr. Rich, or the loss of his services and relationship, could adversely affect our revenues of the Redneck Riviera brand and results of operations as well as our ability to maintain our consumer base and brand reputation.

In October 2017, we were granted an exclusive license for the use of the Redneck Riviera brand for spirits-based products. The Redneck Riviera trademark is owned by Rich Marks, which is controlled by John Rich, a “multiple platinum” country music singer and songwriter who performs with the “Big & Rich” band. Beginning in 2020, we will be required to meet certain levels of case sales, and if such sale levels are not met, Rich Marks will have the right to terminate the license.

In addition, the success of Redneck Riviera Whiskey may be negatively impacted by a number of factors, including the reputation and popularity of Mr. Rich. Mr. Rich’s reputation may be harmed due to factors outside of our control, which could negatively impact our brand image and have a material adverse effect on our business. If we fail to maintain and enhance the Redneck Riviera brand, or if excessive expenses are incurred in an effort to do so, our business, financial condition and results of operations could be materially and adversely affected.

In addition, if our relationship with Mr. Rich deteriorates, our reputation and operating results may be adversely affected. In late 2019, we amended our license agreement related to the Redneck Riviera trademark in part because of our desire to continue to motive Mr. Rich to use exceptional efforts to promote the RRW brand and a recognition of our ongoing relationship. The license agreement generally provides, among other things, that we may not take any action which is harmful or potentially harmful to Mr. Rich’s or the brand’s reputation. The license agreement also provides for other termination rights related to our solvency, providing reports and other matters.

If we are unable to maintain our current associations with Mr. Rich at a reasonable cost, or we experience an unplanned interruption or termination of our collaboration, we could lose the benefits of this relationship and the return on our substantial investment in the brand.

We must attract new Board members to provide valuable contributions to the Company and ensure that we meet Nasdaq independence requirements. In addition, new directors will not be voted on by stockholders until our Annual Meeting in 2020.

At our Annual Meeting held on August 8, 2019, four members of our Board who were nominees resigned and/or did not get re-elected. Those directors comprised all but one of our nominated independent directors and comprised all of the members of our independent Board committees. As a result, at such time, we did not comply with the independence requirements of Nasdaq, the exchange on which we list our common stock. We appointed several new directors and re-gained compliance with the Nasdaq independence requirements in September 2019, although we again fell out of compliance on November 12, 2019 due to a director resignation and the appointment of Lawrence Firestone, a then-independent director, as our Chief Executive Officer. We promptly came back into compliance on November 18, 2019, however, future non-compliance with Nasdaq listing rules could result in our delisting. In addition, our corporate governance and risk and strategic oversight will suffer until we have a sufficient number of talented independent directors to our Board, including those with industry experience. In addition, because we added new directors after our Annual Meeting and needed to appoint additional directors to regain compliance, the new directors will serve without shareholder approval until our Annual Meeting in 2020.

Executive departures and any other failure to attract or retain key executive or employee talent, or further changes in our talent, could adversely affect our business.

Our success depends upon the efforts and abilities of our senior management team, other key employees, and a high-quality employee base, as well as our ability to attract, motivate, reward, and retain them. If we or one of our executive officers or significant employees terminates her or his employment, we may not be able to replace their expertise, fully integrate new personnel or replicate the prior working relationships, and the loss of their services might significantly delay or prevent the achievement of our business objectives. Qualified individuals with the breadth of skills and experience in our industry that we require are in high demand, and we may incur significant costs to attract them. We do not maintain and do not intend to obtain key person insurance on the life of any executive or employee. Difficulties in hiring or retaining key executive or employee talent, or the unexpected loss of experienced employees could have an adverse impact our business performance. In addition, we could experience business disruption and/or increased costs related to organizational changes, reductions in workforce, or other cost-cutting measures.

We recently experienced significant changes to our executive leadership team. In May 2019, our Chief Executive Officer announced his transition to Executive Chairperson, stepping down from his dual role as Chairman and Chief Executive Officer, and has since that time left our Board. Our Chief Financial Officer, Steven Shum, was appointed as Interim Chief Executive Officer, but resigned as Interim Chief Executive Officer effective October 7, 2019 and announced his resignation as Chief Financial Officer effective as of November 14, 2019 and G. Stuart Schreiner was appointed as Interim Chief Financial Officer, effective February 28, 2020. Effective November 12, 2019, Lawrence Firestone was appointed as our Chief Executive Officer. This executive leadership transition has the potential to disrupt our operations and relationships with employees, customers, suppliers, and investors. In addition, Mr. Firestone had no prior experience in our industry. Our future operating results depend substantially upon the continued service of our key personnel and in significant part upon our ability to attract and retain qualified management personnel. If we are unable to mitigate these or other similar risks, our business activity could be disrupted, and our financial condition and results of operations could be materially adversely affected.

We depend on a limited number of suppliers. Failure to obtain satisfactory performance from our suppliers or loss of our existing suppliers could cause us to lose sales, incur additional costs and lose credibility in the marketplace.

We depend on a limited number of third-party suppliers for the sourcing of the raw materials for all of our products, including our distillate products and other ingredients. Azuñia, in particular, is sourced from a single supplier in Mexico. Other than our long-term exclusive agreement with Agaveros Unidos de Amatitan, SA. de CV. for the Azuñia tequila brand, we do not have long-term, written agreements with any of our suppliers. The termination of our relationships or an adverse change in the terms of these arrangements (including with Agaveros Unidos) could have a negative impact on our business. If our suppliers increase their prices, we may not be able to secure alternative suppliers, and may not be able to raise the prices of our products to cover all or even a portion of the increased costs. Also, our suppliers’ failure to perform satisfactorily or handle increased orders, delays in shipments of products from suppliers or the loss of our existing suppliers, especially our key suppliers, could cause us to fail to meet orders for our products, lose sales, incur additional costs and/or expose us to product quality issues. In turn, this could cause us to lose credibility in the marketplace and damage our relationships with distributors, ultimately leading to a decline in our business and results of operations. If we are not able to renegotiate these contracts on acceptable terms or find suitable alternatives, our business, financial condition or results of operations could be negatively impacted.

Our contract with Agaveros Unidos runs through July 2039 and has set pricing for the tequila and bottling services they provide. The contract includes an exclusivity clause. We are committed to purchase 24,000 9-liter cases in 2020 and 35,000 9-liter cases in 2021. We have no expressed commitments beyond 2021. A breach of this contract, including minimum purchase commitments, could lead to a $2 million penalty and termination of the contract, and result in a failure of the Azuñia brand.

Our outstanding debt could reduce our strategic flexibility and liquidity and may have other adverse effects on our results of operations.

We have incurred significant debt under promissory notes and inventory financing lines. Much of our debt is secured by our bulk spirit inventory and other assets, including our Craft Canning business. Our ability to meet our debt service obligations depends upon our operating and financial performance, which is subject to general economic and competitive conditions and to financial, business and other factors affecting our operations, many of which are beyond our control. If we are unable to service our debt, we may need to sell inventory and other material assets, restructure or refinance our debt, or seek additional equity capital. Prevailing economic conditions and global credit markets could adversely impact our ability to do so.

Our debt agreements contain limits on our ability to, among other things, incur additional debt, grant liens, undergo certain fundamental changes, make investments, and dispose of inventory. We are also required to maintain compliance with a total leverage ratio and an interest coverage ratio and for our secured inventory to have a market value relative to our outstanding debt balance.

The amount and terms of our debt, could have important consequences, including the following:

If we breach a loan covenant or miss a payment, the lenders could accelerate the repayment of debt and foreclose on our inventory and other assets. We might not have sufficient assets to repay our debt upon acceleration. If we are unable to repay or refinance the debt upon acceleration or at maturity, the lenders could initiate a bankruptcy proceeding against us or collection proceedings with respect to our assets securing the facility, which could materially decrease the value of our common stock.

We depend on our independent wholesale distributors to distribute our products. The failure or inability of even a few of our distributors to distribute our products adequately within their territories could harm our sales and result in a decline in our results of operations.

We are required by law to use state-licensed distributors or, in 17 states known as “control states,” state-owned agencies performing this function, to sell our products to retail outlets, including liquor stores, bars, restaurants and national chains in the United States. We have established relationships for our brands with a limited number of wholesale distributors; however, failure to maintain those relationships could significantly and adversely affect our business, sales and growth. We currently distribute our products in 49 states.

Over the past decade there has been increasing consolidation, both intrastate and interstate, among distributors. As a result, many states now have only two or three significant distributors. Also, there are several distributors that now control distribution for several states. If we fail to maintain good relations with a distributor, our products could, in some instances be frozen out of one or more markets entirely. The ultimate success of our products also depends in large part on our distributors’ ability and desire to distribute our products to our desired U.S. target markets, as we rely significantly on them for product placement and retail store penetration. In addition, all of our distributors also distribute competitive brands and product lines. We cannot assure you that our U.S. distributors will continue to purchase our products, commit sufficient time and resources to promote and market our brands and product lines or that they can or will sell them to our desired or targeted markets. If they do not, our sales will be harmed, resulting in a decline in our results of operations.

We rely on a few key distributors, and the loss of any one key distributor would substantially reduce our revenues.

We currently derive a significant amount of our revenues from a few major distributors. A significant decrease in business from or loss of any of our major distributors could harm our financial condition by causing a significant decline in revenues attributable to such distributors. Sales to two distributors accounted for approximately 25% and 42% of our consolidated sales for 2019 and 2018, respectively. While we believe our relationships with our major distributors are good, we do not have long-term contracts with any of them and purchases generally occur on an order-by-order basis. If we experience a significant decrease in sales to any of our major distributors and are unable to replace such sales volume with orders from other customers, our sales may decrease which would have a material adverse financial effect on our results of operations and financial condition.

The sales of our products could decrease significantly if we cannot secure and maintain listings in the control states.

In the control states, the state liquor commissions act in place of distributors and decide which products are to be purchased and offered for sale in their respective states. Products selected for listing in control states must generally reach certain volumes and/or profit levels to maintain their listings. Products in control states are selected for purchase and sale through listing procedures, which are generally made available to new products only at periodically scheduled listing interviews. Products not selected for listings can only be purchased by consumers in the applicable control state through special orders, if at all. If, in the future, we are unable to maintain our current listings in the control states, or secure and maintain listings in those states for any additional products we may develop or acquire, sales of our products could decrease significantly, which would have a material adverse financial effect on our results of operations and financial condition.

We must maintain a relatively large inventory of our products to support customer delivery requirements, and if this inventory is out of stock, lost due to foreclosure, theft, fire or other damage or becomes obsolete, our results of operations would be negatively impacted.

We maintain relatively large inventories of our product aging in barrels, as well as, to meet customer delivery requirements. We have used our barreled spirits inventory at market value as collateral in our financing. If we do not timely make payments on our financing obligations, or we breach our covenants in any financing document, including maintaining loan-to-value ratios, the lenders may foreclose and take possession of our inventory. In addition, this inventory is always at risk of loss due to theft, fire, evaporation, spoilage or other damage, and any such loss, whether insured against or not, could cause us to fail to meet our orders and harm our sales and operating results. Also, our inventory may become obsolete as we introduce new products, cease to produce old products or modify the design of our products’ packaging, which would increase our operating losses and negatively impact our results of operations.

If we are unable to identify and successfully acquire additional brands that are complementary to our existing portfolio, our growth will be limited, and, even if additional brands are acquired, we may not realize anticipated benefits, due to market acceptance, integration difficulties or other operating issues.

A component of our growth strategy may be the acquisition of additional brands that are complementary to our existing portfolio through the acquisition of such brands or their corporate owners, directly as brand acquisitions or through mergers, joint ventures, long-term exclusive distribution arrangements and/or other strategic relationships. For example, in September 2019, we acquired the high-end, luxury tequila brand, Azuñia, to complement our portfolio and provide us with a brand in the high-growth tequila category. In addition, we acquired MotherLode in March 2017, which provides contract canning, bottling and packaging services for existing and emerging spirits producers, and in January 2019, we completed the acquisition of Craft Canning, which significantly adds to our contract canning, bottling and packaging services. If we are unable to identify or have the financial ability to acquire suitable brand candidates and successfully execute our acquisition strategy, our growth will be limited. In addition, our entry into and expansion of our contract bottling, canning, and packaging services as a result of our acquisitions of MotherLode and Craft Canning may not be successful, and we may not realize the benefits of these co-packing operations and may face certain risks, including safety concerns, product contamination, and equipment malfunctions or breakdowns, among other things associated with our manufacturing operations. In addition, if our bottling, canning, or packaging services fail to meet our customers’ expectations, or there is an overall decline in demand for bottling, canning, or packaging services, our reputation, business, results of operations and financial condition could be adversely affected.

If we are successful in acquiring additional brands or related service businesses, we may still fail to achieve our target margins or maintain profitability levels that would justify our investment in those additional brands or services or fail to realize operating and economic efficiencies or other planned benefits with respect to those additional brands or services. For Craft Canning, we will need to provide increased capital to expand operations and for Azuñia we will need to increase our gross profit margins substantially, grow sales, reduce cost and leverage distribution to become cash flow positive.

The addition of new products or businesses entails numerous risks with respect to integration and other operating issues, any of which could have a detrimental effect on our results of operations and/or the value of our equity. These risks include, but are not limited to:

Our ability to grow through the acquisition of additional brands is also dependent upon identifying acceptable acquisition targets and opportunities, our ability to consummate prospective transactions on favorable terms, or at all, and the availability of capital to complete the necessary acquisition arrangements. We intend to finance our brand acquisitions through a combination of our available cash resources, third-party financing and, in appropriate circumstances, the further issuance of equity and/or debt securities. Acquiring additional brands could have a significant effect on our financial position and could cause substantial fluctuations in our quarterly and yearly operating results. Also, acquisitions could result in the recording of significant goodwill and intangible assets on our financial statements, the amortization or impairment of which would reduce reported earnings in subsequent years.

Our failure to protect our trademarks and trade secrets could compromise our competitive position and decrease the value of our brand portfolio.

Our business and prospects depend in part on our ability to develop favorable consumer recognition of our brands and trademarks. Although we apply for registration of our brands and trademarks, they could be imitated in ways that we cannot prevent. Also, we rely on trade secrets and proprietary know-how, concepts and formulas. Our methods of protecting this information may not be adequate. Moreover, we may face claims of misappropriation or infringement of third parties’ rights that could interfere with our use of this information. Defending these claims may be costly and, if unsuccessful, may prevent us from continuing to use this proprietary information in the future and result in a judgment or monetary damages being levied against us. We do not maintain non-competition agreements with all of our key personnel or with some of our key suppliers. If competitors independently develop or otherwise obtain access to our trade secrets, proprietary know-how or recipes, the appeal, and thus the value, of our brand portfolio could be reduced, negatively impacting our sales and growth potential.

A failure of one or more of our key or service product information technology systems, cyber-security breach or cyber-related fraud could have a material adverse impact on our business.

We rely on information technology (“IT”) systems, networks, and services, including internet sites, data hosting and processing facilities and tools, hardware (including laptops and mobile devices), and software and technical applications and platforms, some of which are managed, hosted, provided and/or used by third-parties or their vendors, to assist us in the management of our business.

Increased IT security threats and more sophisticated cyber-crime pose a potential risk to the security of our IT systems, networks, and services, as well as to the confidentiality, availability, and integrity of our data. If the IT systems, networks, or service providers we rely upon fail to function properly, or if we suffer a loss or disclosure of business or other sensitive information, due to any number of causes, ranging from catastrophic events to power outages to security breaches, and our business continuity plans do not effectively address these failures on a timely basis, we may suffer interruptions in our ability to manage operations and reputational, competitive and/or business harm, which may adversely affect our business operations and/or financial condition. In addition, such events could result in unauthorized disclosure of material confidential information, and we may suffer financial and reputational damage because of lost or misappropriated confidential information belonging to us or to our partners, our employees, customers, suppliers or consumers. In any of these events, we could also be required to spend significant financial and other resources to remedy the damage caused by a security breach or to repair or replace networks and IT systems.

We may not be able to collect on notes receivable.

We currently have secured notes receivables from a Canadian online seller of spirits that mature in 2020. If the debtor fails to pay the note receivable on the maturity date we may incur costs related to collections, foreclosure and ultimately declare the debt uncollectable.

We are subject to litigation risks.

From time to time, we may become involved in various litigation matters and claims, including employment, regulatory proceedings, administrative proceedings, governmental investigations, and contract disputes. We may face potential claims or liability for, among other things, breach of contract, defamation, libel, fraud, or negligence. We may also face employment-related litigation, including claims of age discrimination, sexual harassment, gender discrimination, immigration violations, or other local, state, and federal labor law violations. For instance, two former employees have made claims that our current and former management engaged in gender discrimination and sexually harassing manner. Because of the uncertain nature of litigation and insurance coverage decisions, the outcome of such actions and proceedings cannot be predicted with certainty and an unfavorable resolution of one or more of them could have a material adverse effect on our business, financial condition, results of operations, cash flows, reputation, brand identity and the trading price of our securities. Any such litigation, with or without merit, could also result in substantial expenditures of time and money, and divert attention of our management team from other tasks important to the success of our business.

If we fail to manage growth effectively or prepare for product scalability, it could have an adverse effect on our employee efficiency, product quality, working capital levels and results of operations.

Any significant growth in the market for our products or our entry into new markets may require an expansion of our employee base for managerial, operational, financial, and other purposes. During any period of growth, we may face problems related to our operational and financial systems and controls, including quality control and delivery and service capacities. We would also need to continue to expand, train and manage our employee base. Continued future growth will impose significant added responsibilities upon the members of management to identify, recruit, maintain, integrate, and motivate new employees. Aside from increased difficulties in the management of human resources, we may also encounter working capital issues, as we will need increased liquidity to finance the marketing of the products we sell, and the hiring of additional employees. For effective growth management, we will be required to continue improving our operations, management, and financial systems and controls. Our failure to manage growth effectively may lead to operational and financial inefficiencies that will have a negative effect on our profitability. We cannot assure investors that we will be able to timely and effectively meet that demand and maintain the quality standards required by our existing and potential customers.

RISKS RELATED TO OUR INDUSTRY

Demand for our products may be adversely affected by many factors, including changes in consumer preferences and trends.

Consumer preferences may shift due to a variety of factors, including changes in demographic and social trends, public health initiatives, product innovations, changes in vacation or leisure, dining and beverage consumption patterns and a downturn in economic conditions, any or all of which may reduce consumers’ willingness to purchase distilled spirits or cause a shift in consumer preferences toward beer, wine or non-alcoholic beverages or other products. Our success depends in part on fulfilling available opportunities to meet consumer needs and anticipating changes in consumer preferences with successful new products and product innovations.

A limited or general decline in consumption in one or more of our product categories could occur in the future due to a variety of factors, including:

In addition, our continued success depends, in part, on our ability to develop new products to meet consumer needs and anticipate changes in consumer preferences. The launch and ongoing success of new products are inherently uncertain, especially with regard to their appeal to consumers. The launch of a new product can give rise to a variety of costs, and an unsuccessful launch, among other things, can affect consumer perception of existing brands and our reputation. Unsuccessful implementation or short-lived popularity of our product innovations may result in inventory write-offs and other costs.

In addition, the legalization of marijuana in any of the jurisdictions in which we sell our products may result in a reduction in sales. Studies have shown that sales of alcohol may decrease in jurisdictions where marijuana has been legalized (e.g. California, Colorado, Washington, Nevada, Alaska, Illinois, Vermont, Massachusetts, Maine, Michigan and Oregon). As a result, marijuana sales may adversely affect our sales and profitability.

We face substantial competition in our industry and many factors may prevent us from competing successfully.

We compete on the basis of product taste and quality, brand image, price, service and ability to innovate in response to consumer preferences. The global spirits industry is highly competitive and is dominated by several large, well-funded international companies. Many of our current and potential competitors have longer operating histories and have substantially greater financial, sales, marketing and other resources than we do, as well as larger installed customer bases, greater name recognition and broader product offerings. Some of these competitors can devote greater resources to the development, promotion, sale and support of their products. As a result, it is possible that our competitors may either respond to industry conditions or consumer trends more rapidly or effectively or resort to price competition to sustain market share, which could adversely affect our sales and profitability.

Our business may be disrupted by crisis such as the Covid-19 pandemic.

Our business is suspectable to disruption from any number of possible crisis. The impact of business and government responses to the Covid-19 pandemic has had a significant impact on the operations and financial condition of many businesses. Those include employees being required to work remotely, not travel and otherwise alter their normal working conditions. Businesses have been closed, including establishments that sell our products, and supply chains and manufacturing have been disrupted. Consumers buying habits have shifted to buying larger package of spirits (e.g. 1.75 liter) sized packages, which we do not sell in our mainstream brands. These and other impacts from the Covid-19 and any other similar crisis could have a material impact on our operations and financial results.

Class actions or other litigation relating to alcohol abuse or the misuse of alcohol could adversely affect our business.

Our industry faces the possibility of class action or similar litigation alleging that the continued excessive use or abuse of beverage alcohol has caused death or serious health problems or related to the labelling of our products. It is also possible that governments could assert that the use of alcohol has significantly increased government-funded healthcare costs. Litigation or assertions of this type have adversely affected companies in the tobacco industry, and it is possible that we, as well as our suppliers, could be named in litigation of this type.

Also, lawsuits have been brought in a number of states alleging that beverage alcohol manufacturers and marketers have improperly targeted underage consumers in their advertising. Plaintiffs in these cases allege that the defendants’ advertisements, marketing and promotions violate the consumer protection or deceptive trade practices statutes in each of these states and seek repayment of the family funds expended by the underage consumers. While we have not been named in these lawsuits, we could be named in similar lawsuits in the future. Any class action or other litigation asserted against us could be expensive and time-consuming to defend against, depleting our cash and diverting our personnel resources and, if the plaintiffs in such actions were to prevail, our business could be harmed significantly.

Regulatory decisions and legal, regulatory and tax changes could limit our business activities, increase our operating costs and reduce our margins.

Our business is subject to extensive government regulation. This may include regulations regarding production, distribution, marketing, advertising and labeling of beverage alcohol products. We are required to comply with these regulations and to maintain various permits and licenses. We are also required to conduct business only with holders of licenses to import, warehouse, transport, distribute and sell beverage alcohol products. We cannot assure you that these and other governmental regulations applicable to our industry will not change or become more stringent. Moreover, because these laws and regulations are subject to interpretation, we may not be able to predict when and to what extent liability may arise. Additionally, due to increasing public concern over alcohol-related societal problems, including driving while intoxicated, underage drinking, alcoholism and health consequences from the abuse of alcohol, various levels of government may seek to impose additional restrictions or limits on advertising or other marketing activities promoting beverage alcohol products. Failure to comply with any of the current or future regulations and requirements relating to our industry and products could result in monetary penalties, suspension or even revocation of our licenses and permits. Costs of compliance with changes in regulations could be significant and could harm our business, as we could find it necessary to raise our prices in order to maintain profit margins, which could lower the demand for our products and reduce our sales and profit potential.

Also, the distribution of beverage alcohol products is subject to extensive taxation (at both the federal and state government levels), and beverage alcohol products themselves are the subject of national import and excise duties in most countries around the world. An increase in taxation or in import or excise duties could also significantly harm our sales revenue and margins, both through the reduction of overall consumption and by encouraging consumers to switch to lower-taxed categories of beverage alcohol. Although we expect a significantly positive impact on our operating results from the enactment of the Craft Modernization and Tax Reform Act of 2017, which was part of the 2017 federal tax legislation that went into effect on January 1, 2018, resulting from the lowering of the federal excise tax on spirits for the first 100,000 proof gallons per year from $13.50 to $2.70 per gallon, there can be no assurance this revised tax rate will remain in effect after the extension period ending December 31, 2020.

We could face product liability or other related liabilities that increase our costs of operations and harm our reputation. In addition, our insurance coverage might not be adequate.

Although we maintain liability insurance and will attempt to limit contractually our liability for damages arising from our products, these measures may not be sufficient for us to successfully avoid or limit product liability or other related liabilities. Our product liability insurance coverage is limited to $2 million per occurrence and $5 million in the aggregate and our general liability umbrella policy is capped at $2 million, which may be insufficient. Further, any contractual indemnification and insurance coverage we have from parties supplying our products is limited, as a practical matter, to the creditworthiness of the indemnifying party and the insured limits of any insurance provided by these suppliers. In any event, extensive product liability claims could be costly to defend and/or costly to resolve and could harm our reputation or business.

Contamination of our products and/or counterfeit or confusingly similar products could harm the image and integrity of, or decrease customer support for, our brands and decrease our sales.

The success of our brands depends upon the positive image that consumers have of them. Contamination, whether arising accidentally or through deliberate third-party action, or other events that harm the integrity or consumer support for our brands, could affect the demand for our products. Contaminants in raw materials purchased from third parties and used in the production of our products or defects in the distillation and fermentation processes could lead to low beverage quality, as well as illness among, or injury to, consumers of our products and could result in reduced sales of the affected brand or all of our brands and potentially serious damage to our reputation for product quality, as well as product liability claims. Also, to the extent that third parties sell products that are either counterfeit versions of our brands or brands that look like our brands, consumers of our brands could confuse our products with products that they consider inferior. This could cause them to refrain from purchasing our brands in the future and in turn could impair our brand equity and adversely affect our sales and operations.

In addition, we also provide contract bottling, canning, and packaging services for existing and emerging beer, wine and spirits producers through our subsidiaries MotherLode and Craft Canning. Beer and wine products produced by third parties may be more susceptible to contamination than the distilled products that we produce, due to the lower alcohol content.

Adverse public opinion about alcohol could reduce demand for our products.

Anti-alcohol groups have, in the past, advocated successfully for more stringent labeling requirements, higher taxes and other regulations designed to discourage alcohol consumption. In addition, recent developments in the industry may compel us to identify the source and location of our distillate products and notify the consumer of whether the product was distilled by us. More restrictive regulations, negative publicity regarding alcohol consumption and/or changes in consumer perceptions of the relative healthfulness or safety of beverage alcohol could decrease sales and consumption of alcohol and thus the demand for our products. This could, in turn, significantly decrease both our revenues and our revenue growth, causing a decline in our results of operations.

RISKS RELATED TO OUR COMMON STOCK

Our common stock is thinly traded, and investors may be unable to sell some or all of their shares at the price they would like, or at all, and sales of large blocks of shares may depress the price of our common stock.

Our common stock has historically been sporadically or “thinly-traded,” meaning that the number of persons interested in purchasing shares of our common stock at prevailing prices at any given time may be relatively small or non-existent. As a consequence, there may be periods of several days or more when trading activity in shares of our common stock is minimal or non-existent, as compared to a seasoned issuer that has a large and steady volume of trading activity that will generally support continuous sales without an adverse effect on share price. This could lead to wide fluctuations in our share price. Investors may be unable to sell their common stock at or above their purchase price, which may result in substantial losses. Also, as a consequence of this lack of liquidity, the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of shares of our common stock in either direction. The price of shares of our common stock could, for example, decline precipitously in the event a large number of shares of our common stock is sold on the market without commensurate demand, as compared to a seasoned issuer that could better absorb such sales without adverse impact on its share price.

Sales of our stock or use of our stock to satisfy obligations may impact the market price of our common stock and cause substantial dilution.

We likely will need to raise additional capital, which might be in the form of an equity offering. Future sales of substantial amounts of our common or preferred stock, including shares that we may issue upon exercise of warrants or conversion of preferred stock, could adversely affect the market price of our common stock. Further, if we raise additional funds through the issuance of equity, the percentage ownership of our stockholders will be reduced and cause substantial dilution to current stockholders.

We pay certain of our consultants and business partners in our common stock, and sometimes settle debts with common stock. We also pay executive compensation in the form of equity. These payments are based on the dollar value of what is owed, rather than a fixed number of shares. Continued use of our stock in this manner, especially if our stock price is trading at a low price, may cause dilution to our shareholders and could adversely affect the market price of our common stock.

A decline in the price of our common stock could affect our ability to raise working capital and adversely impact our ability to continue operations.

A further decline in the price of our common stock could result in a reduction in the liquidity of our common stock and a reduction in our ability to raise capital. A decline in the price of our common stock could be especially detrimental to our liquidity and our operations. Such reductions may force us to reallocate funds from other planned uses and may have a significant negative effect on our business plans and operations, including our ability to develop new services and continue our current operations. If our common stock price further declines, we can offer no assurance that we will be able to raise additional capital or generate funds from operations sufficient to meet our obligations. If we are unable to raise sufficient capital in the future, we may not be able to have the resources to continue our normal operations.

If we are unable to continue as a going concern, our securities will have little or no value.

We have incurred operating losses since our inception, and we expect to continue to incur significant expenses and operating losses for the foreseeable future. Our financial statements have been prepared under the assumption that we will continue as a going concern. Our independent registered public accounting firm included in its opinion for the years ended December 31, 2019 and 2018 an explanatory paragraph referring to our net loss from operations and net capital deficiency and expressing substantial doubt in our ability to continue as a going concern without additional capital becoming available. If we are unable to generate sufficient cash from operations or obtain additional financing in the future, we might not be able to continue as a going concern. There are no assurances that such financing, if necessary, will be available to us at all or will be available in sufficient amounts or on reasonable terms. Our financial statements do not include any adjustments that may result from the outcome of this uncertainty. If we are unable to generate additional funds in the future through financings, sales of our products or from other sources or transactions, we will exhaust our resources and will be unable to continue operations. If we cannot continue as a going concern, our stockholders would likely lose most or all of their investment in us.

Our failure to meet the continued listing requirements of the Nasdaq Capital Market could result in a delisting of our common stock.

In August 2017, our shares of common stock began trading on the Nasdaq Capital Market. If we fail to satisfy the continued listing requirements of the Nasdaq Capital Market, such as the corporate governance requirements or the minimum closing bid price requirement, Nasdaq may take steps to delist our common stock. Such a delisting would likely have a negative effect on the price of our common stock and would impair your ability to sell or purchase our common stock when you wish to do so. In the event of a delisting, we would expect to take actions to restore our compliance with Nasdaq’s listing requirements, but we can provide no assurance that any such action taken by us would allow our common stock to become listed again, stabilize the market price or improve the liquidity of our common stock, prevent our common stock from dropping below the Nasdaq minimum bid price requirement or prevent future non-compliance with Nasdaq’s listing requirements. As of August 8, 2019, we failed to comply with Nasdaq’s requirement to have a majority independent Board and independent audit and compensation committees. Although we regained compliance with the Nasdaq listing requirements in September 2019, we again fell out of compliance on November 12, 2019 due to a director resignation and the appointment of Lawrence Firestone, a then-independent director, as our Chief Executive Officer. We promptly came back into compliance on November 18, 2019.

While our warrants are outstanding, it may be more difficult to raise additional equity capital.

We currently have non-trading, privately issued common stock warrants to purchase 736,559 shares of common stock. During the term that our warrants are outstanding, the holders of the warrants will be given the opportunity to profit from a rise in the market price of our common stock. We may find it more difficult to raise additional equity capital while we have warrants outstanding. We might issue additional warrants along with a future financing.

We do not expect to pay dividends for the foreseeable future.

For the foreseeable future, it is anticipated that earnings, if any, that may be generated from our operations will be used to finance our operations and that cash dividends will not be paid to holders of common stock.

Our largest stockholders have the power to significantly influence our decisions and their interests may conflict with ours or yours in the future.

We have several stockholders owning near or over 5% of our outstanding common stock, according to public filings. In addition, Stephanie Kilkenny, a member of our Board of Directors together with her spouse, owns and controls TQLA, LLC (“TQLA”), the majority owner of Intersect Beverage, LLC. In connection with the acquisition of Azuñia Tequila from Intersect Beverage, LLC, TQLA may receive a substantial number of shares payable under the asset purchase agreement in 2021, subject to a limitation under Nasdaq rules if the share issuance would require a shareholder vote (e.g., we anticipate that the share issuance will be limited 19.99% of our outstanding). Certain of our officers and directors, such as our CEO Mr. Firestone, and our Director Jack Peterson (through his relationship with Sandstrom Partners), may become significant stockholders through the payment of equity compensation.

Accordingly, as a result of their direct and indirect beneficial ownership, the foregoing stockholders may be able to exercise substantial control and more directly influence our affairs and business, including any determination with respect to a change in control, future issuances of common stock or other securities, declaration of dividends on the common stock and the election of directors. The stockholders may have interests that differ from the interests of other stockholders.

We have the ability to issue additional shares of our common stock and shares of preferred stock without asking for stockholder approval, which could cause your investment to be diluted. However, if we fail to obtain shareholder approval for additional authorized common stock, our financing alternatives will be limited.

Our Articles of Incorporation authorize the Board to issue up to 15,000,000 shares of common stock and up to 100,000,000 shares of preferred stock. The power of the Board to issue shares of common stock, preferred stock or warrants or options to purchase shares of common stock or preferred stock is generally not subject to stockholder approval. Accordingly, any additional issuances of our common stock, or preferred stock that may be convertible into common stock, may have the effect of diluting your investment, and the new securities may have rights, preferences and privileges senior to those of our common stock.

We have over 11,000,000 shares of common stock outstanding or subject to warrants or other convertible securities. We are limited to issuing up to 15,000,0000 shares of common stock. The limited number of available shares of common stock constrains our ability to conduct equity offerings or engage in financing transactions that may have an equity component. In addition, this limitation will constrain our ability to grant equity incentives, which could result in a failure to align management to shareholder objectives or to be able to retain and motivate key personnel.

By issuing preferred stock, we may be able to delay, defer, or prevent a change of control.

Our Articles of Incorporation permit us to issue, without approval from our stockholders, a total of 100,000,000 shares of preferred stock. Our Board may determine the rights, preferences, privileges and restrictions granted to, or imposed upon, the shares of preferred stock and to fix the number of shares constituting any series and the designation of such series. It is possible that our Board, in determining the rights, preferences and privileges to be granted when the preferred stock is issued, may include provisions that have the effect of delaying, deferring or preventing a change in control, discouraging bids for our common stock at a premium over the market price, or that adversely affect the market price of and the voting and other rights of the holders of our common stock.

We face risks related to compliance with corporate governance laws and financial reporting standards.

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), as well as related rules and regulations implemented by the SEC and the Public Company Accounting Oversight Board, require compliance with certain corporate governance practices and financial reporting standards for public companies. These laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002 relating to internal control over financial reporting (“SOX 404”), has materially increased our legal and financial compliance costs and made some activities more time-consuming, burdensome and expensive. Although we currently believe our internal control over financial reporting is effective, the effectiveness of our internal controls in future periods is subject to the risk that our controls may become inadequate or may not operate effectively. Any failure to comply with the requirements of SOX 404, our ability to remediate any material weaknesses that we may identify during our compliance program, or difficulties encountered in their implementation, could harm our operating results, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of the periodic management evaluations of our internal controls and, in the case of a failure to remediate any material weaknesses that we may identify, would adversely affect the annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting that are required under SOX 404. Inadequate internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock, and we could be subject to regulatory sanctions or investigations by the SEC or other regulatory authorities, which would require additional financial and management resources.

Item 1B. UNRESOLVED STAFF COMMENTS

None.

Item 2. PROPERTIES

We leased the following properties as of December 31, 2019:

* Retail operations were permanently closed on March 23, 2020. Leases scheduled to expire after operations cease will either be bought out with a termination fee or will remain empty until a sub-lease arrangement can be completed.

** Distilling operations are scheduled to move to the Milwaukie, Oregon production facility in the second quarter of 2020, and the lease is expected to terminate on June 30, 2020.

*** The lease at Water Avenue has been to be extended to December 31, 2020.

Item 3. LEGAL PROCEEDINGS

We are party to the legal proceeding described below. In addition, we could be subject to legal proceedings and claims from time to time in the ordinary course of our business, or legal proceedings we considered immaterial may in the future become material. Regardless of the outcome, litigation can, among other things, be time consuming and expensive to resolve, and divert management resources.

On October 22, 2019, a complaint was filed against the Company in the Circuit Court of Oregon, County of Multnomah by two former employees, Laurie Branch and Justina Thoreson. The complaint also named as defendants certain current and former officers and employees of the Company. The complaint is captioned Branch et al. v. Eastside Distilling, Inc. et al., case number 19-CV-45716, and alleged, among other things, that the Company and certain current and former officers and employees engaged in sex discrimination, retaliation for reporting sexual discrimination, sexual harassment, and aiding and abetting unlawful discrimination. As relief, the complaint sought among other things, monetary damages of up to $560,000 and attorneys and experts’ fees. This litigation was successfully mediated on March 20, 2020 and is in final stages of settlement. The Company’s insurer accepted initial defense of this matter, with a reservation of rights. The Company is responsible for $100,000 retention per claim.

Item 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on the Nasdaq Capital Market (“Nasdaq”) under the symbol “EAST.”

Shareholders

Our shares of common stock are issued in registered form. The registrar and transfer agent for our shares of common stock is Transfer Online, Inc. 512 SE Salmon Street, Portland, OR 97214 (Telephone: (503) 227-2950).

As of March 30, 2020, there were 9,762,728 shares of our common stock outstanding, which were held by approximately 95 record stockholders. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of shares of common stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies.

Dividend Policy

We have not paid cash dividends on our common stock since our inception, and we do not contemplate paying dividends in the foreseeable future.

Recent Sales of Unregistered Securities

The following lists set forth information regarding all securities sold or granted by us within the past year that were not registered under the Securities Act of 1933, as amended (the “Securities Act”), and the consideration, if any, received by us for such securities:

None of the foregoing transactions involved any underwriters, underwriting discounts or commissions, general solicitation or any public offering, and the Registrant believes each transaction was exempt from the registration requirements of the Securities Act, as stated above. The Registrant believes that the Section 4(a)(2) or Rule 506(b) of Regulation D exemption applies to the transactions described above because such transactions were predicated on the fact that the issuances were made only to investors who (i) confirmed to the Registrant in writing that they are accredited investors, or if not accredited, have such knowledge and experience in financial and business matters that they are capable of evaluating the merits and risks of their investment; and (ii) either received adequate business and financial information about the Registrant or had access, through their relationships with the Registrant, to such information. Furthermore, the Registrant affixed appropriate legends to the share certificates and instruments issued in each foregoing transaction setting forth that the securities had not been registered and the applicable restrictions on transfer.

Repurchase of Securities

None.

Item 6. SELECTED FINANCIAL DATA

This selected financial data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation” and our Consolidated Financial Statements and the accompanying Notes contained in “Item 8. Financial Statements and Supplementary Data.”

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this Form 10-K and in other documents incorporated herein, as well as in oral statements made by the Company, statements that are prefaced with the words “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,” “project,” “intend,” “designed,” and similar expressions, are intended to identify forward-looking statements regarding events, conditions, and financial trends that may affect the Company’s future plans of operations, business strategy, results of operations, and financial position. Examples include those statements set forth above prior to “Item 1. Business - Cautionary Note Regarding Forward-Looking Statements.” These statements are based on the Company’s current expectations and estimates as to prospective events and circumstances about which the Company can give no assurance. Further, any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement to reflect future events or circumstances. Forward-looking statements should not be relied upon as a prediction of actual future financial condition or results. These forward-looking statements, like any forward-looking statements, involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include the factors set forth above and the other information set forth in this Form 10-K.

Overview

Eastside Distilling (the “Company,” “Eastside Distilling,” “we,” “us,” or “our, below) was incorporated under the laws of Nevada in 2004 under the name of Eurocan Holdings, Ltd. In December 2014, we changed our corporate name to Eastside Distilling, Inc. to reflect our acquisition of Eastside Distilling, LLC. We manufacture, acquire, blend, bottle, import, export, market and sell a wide variety of alcoholic beverages under recognized brands. We currently employ 89 people in the United States.

Our brands span several alcoholic beverage categories, including bourbon, American whiskey, vodka, gin, rum, tequila and Ready-to-Drink (RTD). We sell our products on a wholesale basis to distributors, and until March 2020, we operated four retail tasting rooms in Portland, Oregon to market our brands directly to consumers.

Operating as a small business in a large, international spirits marketplace occupied by large multi-national conglomerates, we seek to utilize our size and our public company stature to our advantage and position Eastside Distilling as a leading tier 2 spirits provider by acquiring and developing brands, growing them to a national presence and positioning them for sale to the tier 1 suppliers to the market. This strategy was demonstrated by the launch of our Redneck Riviera Brand (RRW) in conjunction with our branding partners, Sandstrom Partners in 2018. This demonstrated how our team can leverage its position to launch nascent or new brands and grow them more quickly than the tier 1 larger conglomerates because we are able to focus and dedicate more of our attention to developing innovative products. Our RRW brand went from idea, to market roll-out in less than nine months and achieved national distribution in 49 states in 18 months. In September 2019, we acquired the Azuñia tequila brand and have begun to distribute this brand through our national platform.

In May 2017, we used our shares to acquire 90% of Big Bottom Distilling, LLC (“BBD”), known for its award-winning, super-premium gins and whiskeys, and American Single Malt Whiskey. BBD’s super-premium spirits give us a presence at the “ultra-premium segment” of the market. In December 2018, we acquired the remaining 10% of BBD. In September 2019, we also acquired the high-end, luxury tequila brand, Azuñia, to complement our portfolio and provide us with a larger established brand in the high-growth tequila category. In addition, through MotherLode Craft Distillery (“MotherLode”), our wholly-owned subsidiary acquired in March 2017 and Craft Canning + Bottling, LLC (formerly known as Craft Canning, LLC) (“Craft Canning”), which we acquired in January 2019, we provide contract bottling, canning, and packaging services for existing and emerging beer, wine and spirits producers. We intend to use our mobile canning operations to profit from the rapid growth in the canned beverages industry (beer, wine, spirit-based RTD’s).

Recent Developments

Introduction of new Redneck Riviera Whiskey “Granny Rich Reserve”. In February 2019, we announced the introduction of its newest product under the Redneck Riviera trademark - Redneck Riviera Whiskey “Granny Rich Reserve”. Representing the first line extension with the Redneck Riviera Brand, Granny Rich Reserve is a premium priced blend of traditional corn whiskey, aged three years or more, blended with American single malt aged at least four years.

Introduction of new Portland Mule Ready-to-Drink (RTD) Cocktail. In January 2019, we announced our landmark entry into the fast growing Ready-to-Drink (RTD) market with the introduction of the Portland Mule Ready-to-Drink Cocktail. Portland Mule comes in a 250ml, or 8.4 oz can, designed by the award-winning design team at Sandstrom Partners, and has a 10.5% alcohol by volume. In August 2019, we announced the Portland Mule – Marionberry flavor Ready-to-Drink Cocktail.

Acquisition of Craft Canning & Bottling – creates significant increase in canning operations. In January 2019, we completed the acquisition of Portland-based Craft Canning + Bottling (“Craft Canning”) a leading provider of mobile canning and bottling services in Oregon, Washington and Colorado. Craft Canning will combine operations with Eastside’s MotherLode co-packing subsidiary, positioning the combined business unit to be a preeminent local provider to the fast-growing wine and Ready-to-Drink (RTD) cocktail segments.

Acquisition of the high-end, luxury tequila brand, Azuñia. In September 2019, we completed the acquisition of Azuñia Tequila from Intersect Beverage. Azuñia Tequila offers four premium tequila products; Blanco Organic Tequila, Reposado Organic Tequila, Añejo Tequila, and Azuñia Black Tequila. Primarily sold into on-premise locations throughout the western and southeastern United States. The Azuñia tequila brand provides Eastside Distilling with a second national anchor brand, along with Eastside’s Redneck Riviera Whiskey portfolio.

Introduction of new Redneck Riviera “Howdy Dew!” In October 2019, we announced the Redneck Riviera Ready-to-Drink Cocktail “Howdy Dew!”. Representing the second line extension with the Redneck Riviera Brand, Howdy Dew! comes in a 12 oz can, designed by the award-winning design team at Sandstrom Partners, and has a 5.5% alcohol by volume.

Available Information

Our executive offices are located at 1001 SE Water Ave, Suite 390, Portland, Oregon 97214. Our telephone number is (971) 888-4264 and our internet address is www.eastsidedistilling.com. The information on, or that may be, accessed from our website is not part of this annual report.

Results of Operations

Overview

Throughout 2018 and 2019, Eastside Distilling has transformed from a small regional craft distiller serving the northwest, principally Oregon, to a tier 2 nationally recognized purveyor of high quality above premium spirit brands throughout the United States with distribution in the major chains and retail outlets covering 49 states. We grew both organically and through acquisitions as we grew Redneck Riviera Whiskey from zero at the beginning of 2018 to approximately 27,000 cases for 2019 in less than two years. Additionally, we introduced three brand extensions and completed two acquisitions in 2019, as we acquired the business of Craft Canning and the Azuñia tequila brand, adding growth in spirits and non-spirits sales during 2019.

We continue to expand our points of distribution to drive continued growth as we now have over 10,000 points of distribution for Redneck Riviera Whiskey alone, which we consider to be our gateway to grow our other brands on a national platform. We believe we are also positioned to simplify our business model and manage both an in-house and outsourced scalable production model and outsourced fulfillment and logistics to keep up with demand. Our mission is to become “the” tier 2 house of national brands in the spirits industry with national distribution and a host of brands growing from near zero to in the range of 100,000 cases annually, leading to potential opportunities to sell our most mature brands to the tier 1 spirits houses.

On December 9, 2019, Redneck Riviera Whiskey Co., LLC, a Tennessee limited liability company (“Licensee”) and a wholly-owned subsidiary of Eastside Distilling, Inc., executed a First Amendment (the “First Amendment”) to the Amended and Restated License Agreement (the “License Agreement”), among Rich Marks, LLC, a Delaware limited liability company (“Licensor”), Licensee, John D. Rich tisa Trust u/a/d March 27, 2018, Dwight P. Wiles, Trustee, and Eastside Distilling, Inc. (the “Company). Under the License Agreement, the Licensor is required to reimburse the Licensee for 50% of the designated marketing expenses incurred. The reimbursement is payable upon the sale of the brand within the term of the agreement, which is 10 years, with a renewable option for any additional 10 years, by the licensor, and is thus deemed to be a contingent asset. For the years ended December 31, 2019 and 2018, the 50% Redneck Riviera marketing expense reimbursement was $2.4 million and $1.2 million, respectively.

(Dollars in thousands)

On December 31, 2019, management made a strategic shift to focus the Company’s sale and marketing efforts on the nationally branded product platform, resulting in the decision to close all four of its retail stores in the Portland, Oregon area. This decision does not meet the criteria for reporting discontinued operations until the retail stores are closed / abandoned, which is planned to occur by March 31, 2020. As a result, the retail operations will not be reported as discontinued operations as of December 31, 2019. The table below show results of retail operations compared to total company operations for 2019 and 2018.

(Dollars in thousands)

Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018

Our sales for the year ended December 31, 2019 increased to $17.0 million, or approximately 136%, from $7.2 million for the year ended December 31, 2018.

Our overall 2019 sales was primarily driven by increases in wholesale sales and co-packing. Wholesale sales increased primarily due to increased points of distribution of the Redneck Riviera Whiskey products, which drove brand sales to $3.8 million in 2019 from $2.3 million in 2018, the acquisition Azuñia tequila brand, which accounted for a $1.1 million increase over last year, as well as continued growth within the Pacific Northwest, which increased to $3.5 million in 2019 from $3.1 million in 2018. Our private label sales increased due to the acquisition of Craft Canning and also benefited from our periodic bulk spirit sales during the year. Finally, our retail operations experienced a decline due to the decision to discontinue event activities outside our retail stores during 2019, with the plan to discontinue all remaining retail store operations by the end of the first quarter of 2020.

Excise taxes, customer programs and incentives for the year ended December 31, 2019 increased to $1.4 million, or approximately 32%, from $1.1 million for the comparable 2018 period. The increase is attributable to the higher federal excise taxes as a result of the increase in spirit shipments from our production facility above 100,000 proof gallons, as well as an increase in customer programs and incentives due to increased distribution. The customer programs and incentives for Redneck Riviera Whiskey in 2019 was $0.4 million compared to $0.1 million in 2018 for which 50% of these charges are expected to be reimbursed upon the eventual sale of the brand by the licensor if the licensing agreement remains in force.

Cost of sales consists of the costs of ingredients utilized in the production of spirits, manufacturing labor and overhead, warehousing rent, packaging, and inbound freight charges. During the year ended December 31, 2019, cost of sales increased to $10.1 million, or approximately 166%, from $3.8 million for the year ended December 31, 2018. The increase is attributable to the costs associated with our increased sales in the period, as well as higher manufacturing overhead related to increased facilities costs. In addition, during 2019 we wrote-off $0.3 million of obsolete inventory. The cost of sales we reported in both 2019 and 2018, are based on small production lots. Our objective is to achieve economies of scale as we continue to scale our operations and therefore drive improvement in our per unit cost of sales, which is likely to include expanding our outsourced production.

Gross profit is calculated by subtracting the cost of products sold from net sales. Gross margin is gross profits stated as a percentage of net sales.

The following table compares our gross profit and gross margin in the years ended December 31, 2019 and 2018:

Our gross margin of 35% of net sales in the year ended December 31, 2019 decreased from our gross margin of 38% for the year ended December 31, 2018 primarily due to a change in product and services mix, higher raw material costs, higher facilities costs due to the manufacturing footprint relative to current volume, and obsolete inventory write-off. The gross margin of the Azuñia tequila products in the fourth quarter was significantly lower than our corporate average for the spirits products and therefore accounts for 2% of the decline in gross margin from 2018 to 2019. Our goal is to improve our overall gross margin by increasing the efficiencies of our production facility and evaluate outsourced production as a means to lower cost of goods sold. As we generate increased volumes, our margins may continue to fluctuate as a result of other key factors: raw material costs which tend to fluctuate, product and service sales mix and the related customer programs and incentives, which are subject to seasonal fluctuations and the competitive environments.

Advertising, promotional and selling expenses for the year ended December 31, 2019 increased to $7.5 million or approximately 72% from $4.3 million for the year ended December 31, 2018. This increase is primarily due to our increased sales compensation of $2.9 million in 2019 from $1.5 million in 2018 as we increased our national sales force and as a result of the Azuñia acquisition. The advertising, promotional and selling expenses for Redneck Riviera Whiskey in 2019 was $4.0 million compared to $2.3 in 2018 for which 50% of these charges are expected to be reimbursed upon the eventual sale of the brand by the licensor if the licensing agreement remains in force.

(Dollars in thousands)

General and administrative expenses for the year ended December 31, 2019 increased to $11.5 million, or approximately 85%, from $6.2 million for the year ended December 31, 2018. This increase is primarily due to increased headcount from the acquisitions and the associated compensation and benefits, higher depreciation and amortization from the Craft Canning and Azuñia acquisitions, and certain one-time costs related to bonuses paid, legal expenses, and acquisition-related expenses.

Total other expense, net was $3.2 million for the year ended December 31, 2019, compared to $0.8 million for the year ended December 31, 2018, an increase of 306%. This increase was due to revaluation of the Azuñia acquisition partially offset by a decrease in interest expense.

Net loss available to common shareholders during the year ended December 31, 2019 was $16.9 million as compared to a loss of $9.0 million for the year ended December 31, 2018. The increase in our net loss was primarily attributable to our greater operating expenses as advertising, promotional and selling expenses grew 72% from the prior year as the promotional expenses to support Redneck Riviera grew in connection with the growth in national distribution, and general and administrative expenses grew in both cash and non-cash expenses as the Azuñia acquisition added amortization of intangibles added to the non-cash expenses and professional fees added to the cash expenses in 2019. The growth in operating expenses was partially offset by an increase in gross profit.

Liquidity and Capital Resources

Year Ended December 31, 2019

Our primary capital requirements are for cash used in operating activities, the financing of inventories, and financing acquisitions. Funds for our 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 years ended December 31, 2019 and 2018, we incurred net losses of approximately $16.9 million and $9.0 million respectively and as of December 31, 2019, we had an accumulated deficit of approximately $44.2 million. We have been dependent on raising capital from debt and equity financings to meet our needs for cash flow used in operating activities. For the year ended December 31, 2019, we raised approximately $2.5 million in additional capital through equity and debt financing (net of repayments). See Notes 10 and 11 to our financial statements for a description of our debt.

At December 31, 2019, we had $0.3 million of cash on hand with a positive working capital of $8.3 million. Our ability to meet our ongoing operating cash needs over the next 12 months depends on reducing our operating costs, raising additional debt or equity capital and generating positive operating cash flow, primarily through increased sales, improved profit growth and controlling expenses. We intend to implement actions to improve profitability, by managing expenses while continuing to increase sales. Additionally, we are seeking to leverage our large inventory balances and our accounts receivable balance to help satisfy its working capital needs over the next 12 months. See Notes 10, 11 and 18 to our financial statements for a description of our debt and the debt refinancing initiatives completed in the first quarter of 2020. If we are unable to obtain additional financing, or additional financing is not available on acceptable terms, we may seek to sell assets, reduce operating expenses or reduce or eliminate marketing initiatives, and take other measures that could impair our ability to be successful.

Our cash flow related information for the years 2019 and 2018 is as follows:

Operating Activities

Total cash used from operating activities was $9.1 million compared to $13.9 million in 2018. The decrease in cash usage can be primarily attributed to a $0.3 million decrease in accounts receivable, and a $1.2 million increase in accounts payable and accrued liabilities, partially offset by a $0.4 million inventory build which consisted of an increase of $2.3 million of finished goods inventory, with $1.1 million of that increase resulting from the Azuñia acquisition, and $1.1 million from our inventory build up to support Redneck Riviera.

In 2018, the inventory build was $7.0 million which was principally raw spirit inventory. Accounts receivable increased $0.2 million and a $0.2 million increase in accrued liabilities was partially offset by a $0.7 million increase in accounts payable.

Investing Activities

Cash used in investing activities consists primarily of acquisitions and purchases of property and equipment. We incurred capital expenditures of $3.6 million and $1.3 million in 2019 and 2018, respectively. The increase in cash usage can largely be attributed to the $1.5 million Craft Canning acquisition, net of cash acquired, in January 2019, and the further buildout and equipment additions to our primary production facility in Milwaukie, Oregon.

Financing Activities

Our operating losses and working capital needs were primarily funded by existing cash on hand and $2.5 million in proceeds from the issuance of common stock and debt (net of repayments). Net cash flows provided by financing activities during 2018 were from $8.7 million in proceeds from the sale of common stock, $3.6 million in proceeds from the issuance of notes, $2.9 million net proceeds from the secured credit facility and warrant exercises of $8 million, partially offset by principal payments on notes of $0.5 million.

Common Stock Financings

In September 2019, the Company issued 280,555 units (the “Units”) in a private offering at a per Unit price of $4.50 per share, resulting in net cash proceeds of $1.3 million. Each Unit consists of one share of the Company’s common stock and a three-year warrant to acquire 0.5 shares of common stock at an exercise price of $5.50 per share.

Promissory Notes

During 2019, we executed two promissory notes totaling $0.6 million with a financial institution. The promissory notes bear interest at 3.91% - 3.96% per annum. The notes have 60-month terms with maturities in August 2024 – November 2024. Principal and accrued interest are paid in accordance with monthly amortization schedules. The notes are secured by the assets of Craft Canning.

During 2019, we executed a promissory note for $0.25 million with a private investor. The promissory note bears interest at 5.0% per annum. The note matured on December 31, 2019 and is in default. We anticipate the note to be extended until December 31, 2020.

During 2019, we issued to TQLA a Secured Line of Credit Promissory Note (the “TQLA Note”) for a revolving line of credit in the aggregate principal amount of $2.0 million. The TQLA Note was scheduled to mature on April 15, 2020 and may be prepaid in whole or in part at any time without penalty or premium. As of December 31, 2019, the Company had borrowed $0.9 million on the TQLA Note. The TQLA Note was repaid in its entirety on January 16, 2019.

Lines of Credit

During 2019, we entered into a Factoring Agreement with ENGS Commercial Capital, LLC that provides for a minimum of $0.5 million purchased accounts receivable and a maximum of $2.0 million purchased accounts receivable. The advance rate is 85%, and interest is charged against the greater of $0.5 million or the total funds advanced at a rate of 5% plus the prime rate published in the Wall Street Journal. The Company factored $0.7 million of invoices during the year ended December 31, 2019. At December 31, 2019, the Company had $0.4 million factored invoices outstanding.

During 2019, we utilized an existing accounts receivable factoring line of credit with Park Street Financial Services, LLC. The advance rate is 75%, and interest is charged at a rate of 2.4% for the first 30 days plus 1.44% for each additional ten-day period. The Company factored $1.5 million of invoices during the year ended December 31, 2019. At December 31, 2019, the Company had $0.1 million factored invoices outstanding.

Inventory Line

In January 2020 we and our subsidiaries entered into a loan agreement with Live Oak Banking Company (“Live Oak”) for a loan in an aggregate principal amount not to exceed the lesser of (i) $8,000,000 and (ii) a borrowing base equal to 85% of the appraised value of the borrowers’ eligible inventory of whisky in barrels or totes less an amount equal to all service fees or rental payments owed by borrowers during the 90 day period immediately succeeding the date of determination to any warehouses or bailees holding eligible inventory (the “Live Oak Loan”). The Live Oak Loan is secured by all asset of the Company excluding accounts receivable and certain other specified excluded property. The Live Oak Loan bears interest at a variable rate of interest equal to (i) two and 49/100ths percent (2.49%) per annum plus (ii) the Prime Rate as published in The Wall Street Journal, adjusted on a calendar quarterly basis. Interest is payable monthly. Additionally, the Company issued to Live Oak 100,000 warrants to purchase common stock at an initial exercise price of $3.9425 per share. The proceeds of the Live Oak Loan have been used to pay off all principal and accrued interest under the TQLA Note of $0.9 million and all principal and interest under loan issued pursuant to that Credit and Security Agreement, by and between the Company and The KFK Children’s Trust, Jeffrey Anderson – Trustee of $3.0 million. As of March 30, 2020, the balance of the Live Oak Loan is $6.5 million and has been fully drawn upon.

Critical Accounting Policies

The discussion and analysis of the Company’s financial condition and results of operations is based upon its consolidated financial statements, which have been prepared in accordance with United States. generally accepted accounting principles. The preparation of these financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. The more judgmental estimates are summarized below. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our 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 and customer programs and incentives. The Company recognizes revenue by applying the following steps in accordance with Accounting Standards Codification (“ASC”) Topic 606 – Revenue from Contracts with Customers: (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to each performance obligation in the contract; and (5) recognize revenue when each performance obligation is satisfied.

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 locations are recognized at the time of sale.

Sales 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 alcoholic beverage industry. The Company makes these payments to customers and incurs these costs to promote sales of products and to maintain competitive pricing. Amounts paid in connection with customer programs and incentives are recorded as reductions to net sales or as advertising, promotional and selling expenses in accordance with ASC 606 - Revenue from Contracts with Customers, based on the nature of the expenditure. Amounts paid to customers totaled $0.6 million and $0.4 million in 2019 and 2018, respectively. The customer programs and incentives for Redneck Riviera Whiskey in 2019 were $0.4 million, compared to $0.1 million in 2018, for which 50% of these charges are expected to be reimbursed upon the eventual sale of the brand by the licensor while the licensing agreement is in effect.

Cost of Sales

Cost of sales consists of the finished spirits imported from Mexico for the Azuñia tequila brand, 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.

Advertising, Promotional and Selling Expenses

The following expenses are included in advertising, promotional and selling expenses in the accompanying consolidated statements of operations: media advertising costs, special event costs, tasting room costs, sales and marketing expenses, promotional costs of value added packaging, 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 $7.5 million and $4.3 million in 2019 and 2018, respectively. The advertising, promotional and selling expense for Redneck Riviera Whiskey in 2019 was $4.0 million compared to $2.3 in 2018 for which 50% of these charges are expected to be reimbursed upon the eventual sale of the brand by the licensor while the licensing agreement is in effect.

Shipping and Fulfillment Costs

Freight costs incurred related to shipment of merchandise from the Company’s distribution facilities to customers are recorded in cost of sales.

Cash and Cash Equivalents

Cash equivalents are considered to be highly liquid investments with maturities of three months or less at the time of the purchase. The Company had no cash equivalents at December 31, 2019 and December 31, 2018.

Concentrations

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables. At December 31, 2019, two distributors represented 40% of trade receivables. At December 31, 2018, two distributors represented 37% of trade receivables. Sales to one distributor accounted for 16% of consolidated sales for the year ended December 31, 2019. Sales to two distributors accounted for 42% of consolidated sales for the year ended December 31, 2018.

Inventories

Inventories primarily consist of bulk spirits, packaging supplies, and finished goods which 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 our finished goods 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 write-downs of inventory of $0.3 million and $Nil for the years ended December 31, 2019 and 2018, respectively.

Excise Taxes

The Company is responsible for compliance with the Alcohol, 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 alcoholic 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 $0.8 million and $0.7 million in 2019 and 2018, 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. Net stock-based compensation was $0.7 million and $0.7 million in 2019 and 2018, respectively.

Going Concern

Although our audited financial statements for the year ended December 31, 2019 were prepared under the assumption that we would continue our operations as a going concern, the report of our independent registered public accounting firm that accompanies our financial statements for the year ended December 31, 2019 contains a going concern qualification in which such firm expressed substantial doubt about our ability to continue as a going concern, based on the financial statements at that time. Specifically, as noted above, we have incurred operating losses since our inception, and even though we have reduced our operating expenses and increased our available capacity under our lines of credit, and have large inventory balances to drawn from, we expect to continue to incur significant expenses and operating losses for the foreseeable future. These prior losses and expected future losses have had, and will continue to have, an adverse effect on our financial condition. If we cannot continue as a going concern, our stockholders would likely lose most or all of their investment in us.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

Item 8. FINANCIAL STATEMENTS SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Stockholders of Eastside Distilling, Inc.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Eastside Distilling, Inc. (the Company) as of December 31, 2019 and 2018, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2019, and the related notes and schedules (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company suffered a net loss from operations and has a net capital deficiency, which raises substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this.

/s/ M&K CPAS, PLLC

We have served as the Company’s auditor since 2017.

Houston, TX

March 30, 2020

Eastside Distilling, Inc. and Subsidiaries

Consolidated Balance Sheets

December 31, 2019 and 2018

The accompanying notes are an integral part of these consolidated financial statements.

Eastside Distilling, Inc. and Subsidiaries

Consolidated Statements of Operations

Years ended December 31, 2019 and 2018

The accompanying notes are an integral part of these consolidated financial statements.

Eastside Distilling, Inc. and Subsidiaries

Consolidated Statements of Stockholder’s Equity

Years ended December 31, 2019 and 2018