Eastside Distilling, Inc. - Annual Report: 2020 (Form 10-K)

U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2020

For the transition period from ___________ to _____________

Commission File Number 000-54959

EASTSIDE DISTILLING, INC.

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

8911 NE Marx Drive, Suite A2

Portland, Oregon 97220

(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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262 (b)) by the registered public accounting firm that prepared or issued its audit report. [  ]

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 30, 2020, the last business day of the registrant’s most recently completed second fiscal quarter was $13,994,759 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 31, 2021, 11,629,307 shares of our common stock were outstanding.

Documents Incorporated by Reference: None.

EASTSIDE DISTILLING, INC.

FORM 10-K

December 31, 2020

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 any of the following:

Forward-looking statements are based on assumptions and 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.

Item 1. BUSINESS

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, market and sell a wide variety of alcoholic beverages under recognized brands. We employ 78 people in the United States.

Our brands span several alcoholic beverage categories, including whiskey, vodka, gin, rum, tequila and Ready-to-Drink (“RTD”). We sell our products on a wholesale basis to distributors in open states, and brokers in control states, and until March 2020, we operated four retail tasting rooms in Portland, Oregon to market our brands directly to consumers. We operate a mobile craft canning and bottling business (“Craft C+B”) that primarily services the craft beer and craft cider business. Craft C+B operates 11 mobile lines in Seattle, Washington; Portland, Oregon; and Denver, Colorado.

Total company revenue in 2020 was almost split evenly between spirits and Craft Canning; yet, the Craft Canning division contributed 80% of our gross profit and spirits contributed 20%. The impact of the COVID-19 pandemic had a significant effect on each business unit. Craft Canning revenue had over 20% growth from 2019 due to the incremental demand for packaging stimulated by the shift in on-premise beer sales from kegs to cans. The spirits portfolio had approximately 20% in revenue growth from 2019 due to a full year of Azuñia Tequila sales. Overall, the U.S. craft spirits category revenue was down $2.1 billion, or 40%, in 2020 according to the Distilled Spirits Council of the United States (“DISCUS”).

Principal Spirits Brands and Products During 2020

Principal Services Provided by Craft Canning and Bottling

Canning

Bottling

We have invested heavily in the past two years expanding our business through acquisitions and making substantial investments in branding and production; however, we have not achieved profitability. The immediate task at hand is to focus on a new sustainable business strategy. Based on a complete review and analysis of our competitive position, market opportunity and assets, we have identified components of the strategy that we believe would improve operating results. Management believes the following components of the strategy are in place and working:

Areas that we need incremental work include the following:

We plan to complete our business review in 2021 and embark on the following:

Eastside Distilling is unique in several specific areas: (1) to our knowledge, we are the only craft spirits company listed on Nasdaq, (2) we do not function as a traditional craft distillery with store fronts relying on local sales, (3) we are diversified with our contract manufacturing division, and (4) we have a diversified portfolio of spirits brands. We are similar to other craft distillers in that (1) we have concentrated local volume, (2) we produce small batches and remain within the volume definition of “Craft”, and (3) our brands achieve success through differentiation, discovery and distribution.

The U.S. spirits marketplace is occupied by large multi-national conglomerates with substantially more resources than Eastside Distilling. However, we can use our small size to be fast, focused, flexible in our strategy. If we attempt to grow too quickly, we may lack the underlying strength required to build scale with loyalty via strong unaided awareness and powerfully derived attributes. Moreover, attempting to focus our “frame-of-reference” to compete with the biggest brands in the most expensive venues, is likely to fail without first establishing underlying brand equity.

We will seek to utilize our public company stature to our advantage and position our spirits portfolio as a leading tier 2 spirits provider that develops brands, expands geographic presence and positions for either a sale to the tier 1 suppliers or continued ownership with growth in revenue and cash flow. We will look to grow, and vertically integrate, our Craft Canning portfolio.

Market Opportunity – Roll-up Craft Distilleries with a Vertically Integrated Production Platform

Size of the United States for the Craft Spirits Market

The U.S. craft spirits market retail value was estimated at $3.3 billion in 2020, down 40% from $5.5 billion in 2019 due to the COVID-19 pandemic and loss of on-premise sales. The craft spirits category is estimated to continue to struggle in the 1st half of 2021, declining at 15% and then experience explosive growth in the 2^nd half as the on-premise class of trade opens, growing at 30%. Overall, we project a growth rate of 10% in 2021. The compound annual growth rate from 2020 to 2023 is forecasted to be 20%.

Estimated Craft Spirits Revenue Growth 20% CAGR through 2023

Source: DISCUS

The craft spirits category share is dominated by whiskey products, followed by gin and brandy. Overall share mix continues to remain constant as growth rates tend to be consistent across product types. The rye whiskey category is growing twice that of American whiskey. While tequila is not considered a domestically produced craft spirit as all tequila is imported from Mexico, we believe Azuñia Tequila has the potential to grow and excel as an artisanal, authentic brand in the premium and super premium tequila category.

Projected 2023 Mix of Craft Spirits

Source: Arizton

According to 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 Salient Areas We Target and Focus Our Spirits Portfolio

Spirits Aficionados that Appreciate Authentic, Hand Crafted, Batch Produced Products

The overall target for Eastside Distilling is a “psychographic target” that transcends demographics and focuses on what consumers want versus who they are.

Our Strategy

Our overall strategy is to build Eastside Distilling to a leader in the craft spirits and craft packaging marketplace. We will continue to focus our spirits portfolio on a “house of brands” architecture with Azuñia Tequila, Burnside Whiskey, Portland Potato Vodka, Hue-Hue Coffee Rum and the Eastside brand of limited edition premium spirits products. We aim to grow these brands to either be an attractive acquisition candidate for the tier 1 producers in the spirits industry or be a consistent stream of earnings for the spirits portfolio generated from scale, scope and differentiation.

In terms of strategic sequence, we are focused on initiating the turnaround and then beginning the rapid value creation phase for shareholders through the following:

To help achieve our strategy, we are focused on the following:

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

Bringing a brand to market involves several important stages, including bottle and label design, raw materials procurement, filling the bottles, and packaging the bottles in various configurations for shipment. To achieve a unique flavor profile for each brand, we use one or more of the following techniques: infusion of fruit, addition of natural flavorings, blending of products, and aging in selected casks. Once the final profile is approved and quality control standards are met, we filter the liquid as needed and bottle or can the product.

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. We are in the process of reviewing our contract with Agaveros Unidos de Amatitan, SA. de CV., which was part of the acquisition of the Azuñia Tequila assets in 2019. We do not have long-term, written agreements with any of our other suppliers for the production of raw materials. 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.

Most recently, we have consolidated all procurement, manufacturing, logistics, and warehousing under the responsibility of our Senior Vice President of Operations. We have created a “center of operational excellence” that will lead and manage the following: (1) company procurement of raw materials and finished goods from Agaveros Unidos de Amatitan, SA. de CV, (2) Craft C+B contract manufacturing, (3) craft spirits direct manufacturing, and (4) company logistics and warehousing. This initiative will decrease waste, fully utilize and deploy resources, and establish a platform for expansion.

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 three-tier distributors in 49 U.S. states. Despite the divestiture of Redneck Riviera Whiskey from our product portfolio, we continue to enjoy our relationship with a national distributor network.

U.S. Distribution

Producers and importers of beverage alcohol in the U.S. 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 U.S., 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, producers and 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. Before the onset of the COVID-19 pandemic, over 2,000 craft distillers operated in the United States. Since the COVID-19 pandemic commenced, it is estimated that the total number will be reduced to 1,200.

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 in which we conduct business.

Our inventory is maintained in offsite bonded warehouses at our producers, our bonded warehouse in Milwaukie, 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 through 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 with whom currently work 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 where 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.

Significant Customers

Sales to one customer, the Oregon Liquor Control Commission, accounted for approximately 18% and 16% of our consolidated sales for the years ended December 31, 2020 and 2019, respectively.

Sales Team

We have a total sales force of approximately 10 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, 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 provides a factoring service that we 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 the spirits category, consumers “drink the image,” so brand identity is paramount.

We have shifted our marketing model from an exclusive external partnership to internal marketing overseen by our Chief Branding Officer and Chief Executive Officer. We have focused our marketing methodology to conducting quantitative external reviews based on consumer research for all brand and product development. We have developed our fundamental strategy to “position and proof” – position brands and products through quantitative research and then market test to build a “proof of concept” prior to regional or national launch. We have partnered with the Studios of Neil Powell to create, build and produce product packaging and support material.

We are implementing a micro-guerilla marketing strategy that drives tactics to build brand equity and increase sales. We focus on “Impact Stacking” that combines advertising, price promotions, point-of-sale materials, event sponsorship, in-store and off-premise promotions, public relations, and social media marketing to deliver the biggest impact to our target audience and make the most of our limited resources. We have reduced the cost of external partnerships to manage all marketing by (a) extending research to quantitative methodology that better predicts success, (b) leveraging internal marketing expertise that is more cost effective, (c) better positioning brands to include both consumer values and product attributes, and (d) more optimal utilization of resources with focus and elimination of waste.

We now focus on building the spirits portfolio strategy and architecture to better focus and align our brands and products. We also employ a more classical approach to branding based on the capability of our new Chief Branding Officer (“CBO”) and new CEO. Our new CBO has decades of experience in building brands and transforming spirits brands working with advertising agencies and strategic brand consultants. Our CEO has extensive experience in beverage innovation, strategic brand building and micro marketing techniques with a proven track record of value creation in the beverage category.

Intellectual Property

Trademarks are an important aspect of our business. We sell our products under a number of trademarks which we own. 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 in spirits, primarily due to seasonal holiday buying. Our Craft C+B business typically has peak sales mid to late summer. 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

In spirits, our industry is highly fragmented and very competitive. The threat of new entrants is high; however, the craft spirits segment in the United States is estimated to be down 40% in revenue in 2020 due to the COVID-19 pandemic. The number of craft distilleries is also down from 2,000 to an estimated 1,200. The next three years will produce significant growth for craft spirits off of a lower base.

We believe that Eastside Distilling will compete on the basis of quality, authenticity, sustainability, artisanal and experiential. Our premium brands compete with other alcoholic and nonalcoholic beverages for market share. 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 Rémy Cointreau S.A. These competitors have substantially greater resources than we do.

We believe we are a meaningful tier 2 participant that is in a prime position to build our platform and potentially partner with small-to-mid-size spirit brands as opposed to the major importers and tier 1 multinationals. 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 marketing & 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, and the downsizing of craft distilleries due to the COVID-19 pandemic are expected to create opportunities for small to mid-size wine and spirits companies to expand and increase market share.

The mobile canning and bottling industry is highly fragmented and very competitive. The threat of new entrants is high. Moreover, we compete at the hyper-local scale, where we have a few concentrated customers. One of our greatest threats associated with losing customers is the customer’s own growth and success. As new brewers grow, they are able to afford the investment in their own canning line. We believe the mobile canning industry is in the very early stages of development.

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. If 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 31, 2021, we have 78 employees, 10 of whom are in sales and marketing, 56 in production/canning/bottling, and 12 of whom are in administration. All employees are full-time with the exception of one part-time employee in sales and two part-time employees in canning. 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 Distilling currently sells its products in 49 states.

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

Internal disagreements of our Board of Directors could have materially adverse consequences

We have a dynamic board of directors consisting of independent and non-independent members. Our board seeks to stimulate the flow of ideas, identify key issues, consider alternatives, and make informed decisions through a deliberative process. Our directors have a diverse range of experiences and perspectives. In some cases, our directors have actual or possible conflicts of interests or have financial or other interests in proposed transactions with the Company. As a result of all of these factors, members of our board of directors may disagree on how to oversee the business of the Company, the Company’s long-term strategic, financial, or organizational goals, the Company’s standards and policies, or other Company matters.

These disagreements can evolve into disputes, and some of these disputes may have adverse consequences, including a reduced level of trust among board members, unresolved issues, an inability to act on corporate matters, instability on the board, and reduced management and employee morale. They can also significantly delay or prevent the achievement of our business objectives or have an adverse impact on our business performance. In some cases, if disputes cannot be resolved internally, they can result in director resignation or removal, proxy contests, litigation, or stock market delisting.

Failure to retain & recruit executive management and to build morale and performance

Eastside Distilling’s success depends upon the efforts and abilities of our executive management team, key senior management, and a high-quality employee base, as well as our ability to attract, motivate, reward, and retain them. If one of our executive officers or critical senior management terminates his or her employment, we may not be able to replace their expertise, fully integrate new personnel or replicate the prior working relationships. The loss of critical employees 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. Difficulties in hiring or retaining key executive or employee talent, or the unexpected loss of experienced employees could have an adverse impact on 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. Both our corporate controller and Vice President of Financial Planning and Analysis resigned effective December 2020 due to concerns of stability, functionality, and over-reaching Board involvement. This has been a significant set-back to the Company. We have recently recruited two new employees to fill these roles and we are currently on-boarding in the first quarter 2021.

There is substantial uncertainty relating to our acquisition of the assets of Intersect Beverage, LLC

On September 12, 2019, the Company completed the acquisition of the Azuñia Tequila brand, the direct sales team, existing product inventory, supply chain relationships and contractual agreements from Intersect Beverage, LLC, an importer and distributor of tequila and related products. We have encountered integration difficulties since the acquisition, including difficulties in assimilating the operations and products, failing to realize synergies, unanticipated costs, low profit margins, diversion of management’s attention from other business concerns, and issues relating to employee transition. Moreover, the Company has discovered a number of inappropriate and problematic trade and sales practices relating to the Company’s sales of the Azuñia Tequila brand of products. The Company has commenced an internal investigation into these trade practices and the effects, if any, such practices may have on the Company’s historical results of operation, as well as any potential violation of laws or regulations applicable to the Company. The results of the investigation could lead to one or more material adverse effects on the Company, including actions for violation of law or regulation, penalties or other monetary liability, suspension, or forfeiture of one or more licenses to operate our business. Moreover, the investigation may result in assertion of one or more claims of indemnification or other legal action arising out of the acquisition.

Negative impact of COVID-19 pandemic

Our business continues to be susceptible to disruption from any number of current and ongoing challenges brought on by the COVID-19 pandemic. The impact of consumer 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. For instance, our sales staff have had limited opportunity to interact with customers. Businesses have been closed, including establishments that sell our products, and supply chains and manufacturing have been disrupted. Consumer buying habits have shifted and may continue to shift, which may result in fewer sales of our products. These and other impacts from the COVID-19 pandemic and any other similar crisis could have a material impact on our operations and financial results.

In addition, our results and financial condition may be adversely affected by federal or state legislation (or other similar laws, regulations, orders or other governmental or regulatory actions) that would impose new or more severe restrictions on our ability to operate our business or impact the economy or our customers and suppliers, a severe downturn in the economy or financial and lending markets.

The degree to which COVID-19 may impact our results of operations and financial condition is unknown at this time and will depend on future developments, including the ultimate severity and the duration of the pandemic, and further actions that may be taken by governmental authorities or businesses or individuals on their own initiatives in response to the pandemic.

Negative impact of operating losses every quarter since our inception

We believe that we will continue to incur net losses in 2021 as we expect to make continued investment in product development, sales and marketing, brand support and to incur administrative expenses as we seek to grow our brands. We also anticipate that our cash needs will exceed our income from sales in 2021. Some of our products may not achieve widespread market acceptance and may not generate sales and profits to justify our investment in them. We expect we will continue to experience losses and negative cash flow. Results of operations will depend upon numerous factors, some of which are beyond our control, including new entrants, competitive activity, government regulations and increase in tax. We also incur substantial operating expenses at the corporate level, including costs directly related to being a reporting company with the SEC.

Failure to secure additional capital and achieve adequate liquidity to grow and compete

We will require additional capital to operate, grow and compete, and failure to obtain such additional capital could limit our operations and our growth. Unfortunately, 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 that additional financing will be available to us on acceptable terms or at all. 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.

Failure to effectively manage debt

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 assets in 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.

Failure of our brands to achieve anticipated consumer acceptance, sales, growth, or profitability.

Although 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. Our profitability depends in part on achieving scale. We will need to achieve wider market acceptance of our brands and materially increase sales to achieve profitability.

Failure to obtain satisfactory performance from our suppliers or loss of our existing suppliers

Other than our long-term exclusive agreement with Agaveros Unidos de Amatitan, SA. de CV (“Agaveros Unidos”) 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.

We have yet to assume the Intersect Beverage, LLC contract with Agaveros Unidos, which we are renegotiating. That contract runs through July 2039 and has set pricing for the tequila and bottling services Agaveros Unidos provides. The contract also 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 Tequila brand. We are currently evaluating our options relating to amending and renegotiating the contract.

Failure of our distributors to distribute our products adequately within their territories

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.

Failure of our products to 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.

Failure to maintain adequate inventory levels

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 make timely 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.

Failure to acquire additional distilleries, brands, or products that are complementary to our existing portfolio

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 Tequila 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, the following:

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.

Failure to protect our trademarks and trade secrets

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.

Failure of our key or service product information technology systems, cyber-security breach or cyber-related fraud

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.

Negative impact of litigation and litigation risks

From time to time, we become involved in various litigation matters and claims, including employment, regulatory proceedings, administrative proceedings, governmental investigations, and contract disputes. We 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. 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.

On December 15, 2020, Grover Wickersham filed a complaint in the United States District Court for the District Court of Oregon against the Company. Mr. Wickersham, the former CEO and Chairman of the Board of the Company, has asserted causes of action for fraud in the inducement, breach of contract, breach of the implied covenant of good faith and fair dealing, defamation, interference with economic advantage, elder financial abuse, and dissemination of false and misleading proxy materials The Company disputes the allegations and intends to defend the case vigorously.

RISKS RELATED TO OUR INDUSTRY

Demand for our products may be adversely affected by changes in category trends and consumer preferences

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.

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. Alaska, Arizona, California, Colorado, Illinois, Maine, Massachusetts, Michigan, Montana, Nevada, Oregon, Vermont, Washington and the District of Columbia). As a result, marijuana sales may adversely affect our sales and profitability.

We face substantial competition in our industry

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.

Class actions or other litigation relating to alcohol abuse or the misuse of alcohol

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

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 $13.34 to $2.70 per gallon.

Product liability or other related liabilities

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

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

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 if 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 common stock to satisfy obligations may impact the market price and cause substantial dilution

We 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 directors, consultants and business partners in our common stock or other securities linked to 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

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.

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

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.

On August 20, 2020, Nasdaq notified the Company that it no longer complied with Nasdaq Listing Rule 5550(b)(1) because its reported stockholder’s equity of $2.4 million as of June 30, 2020 was below the minimum stockholder’s equity of $2.5 million set forth in the Nasdaq Listing Rule by $0.1 million. The Company believes it has regained compliance with Nasdaq’s stockholders’ equity requirement based upon the specific transactions and events as of February 16, 2021. Nasdaq will continue to monitor the Company’s ongoing compliance with the stockholders’ equity requirement and, if, the Company does not evidence compliance at the time of its next periodic report, the Company may be subject to delisting.

On January 19, 2021, our board of directors determined that one of its members, Stephanie Kilkenny, had ceased to be independent due to circumstances beyond her reasonable control resulting in our non-compliance with Nasdaq Listing Rules 5605(b), (c), and (d). The Board resolved to regain compliance and take commercially reasonable steps, including retaining an executive search firm, to fill a current vacancy on the Board with a new director who qualifies as independent under these rules as soon as possible but in no event later than the earlier of our next annual shareholder meeting or 180 days from the date of determination. On March 22, 2021, our Board of Directors unanimously consented to a new independent board member bringing us back into compliance.

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 240,278 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’ interests may conflict with the company or our smaller shareholders

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 received 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 officers, such as our CEO, Mr. Block and CFO, Mr. Gwin 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.

Issuing additional shares of common stock and shares of preferred stock could cause dilution

Our Articles of Incorporation authorize the Board to issue up to 15 million shares of common stock and up to 100 million 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 million shares of common stock outstanding or subject to warrants or other convertible securities. We are limited to issuing up to 15 million 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 adversely affect the market price and voting rights of common shareholders

Our Articles of Incorporation permit us to issue, without approval from our stockholders, a total of 100 million 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, 2020:

* Retail operations were permanently closed on March 23, 2020.

Item 3. LEGAL PROCEEDINGS

On December 15, 2020, Grover Wickersham filed a complaint in the United States District Court for the District Court of Oregon against the Company. Mr. Wickersham, the former CEO and Chairman of the Board of the Company, has asserted causes of action for fraud in the inducement, breach of contract, breach of the implied covenant of good faith and fair dealing, defamation, interference with economic advantage, elder financial abuse, and dissemination of false and misleading proxy materials The Company disputes the allegations and intends to defend the case vigorously.

We are not currently subject to any other material legal proceedings; however, 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.

Item 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

Item 5. MARKET FOR THE 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, Oregon 97214 (Telephone: (503) 227-2950).

As of March 31, 2021, there were 11,629,307 shares of our common stock outstanding, which were held by 96 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 sets 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:

The foregoing transaction did not involve 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 transaction described above because such transaction was predicated on the fact that the issuance was made only to an investor who (i) confirmed to the Registrant in writing that it is an accredited investor, or if not accredited, has such knowledge and experience in financial and business matters that it is 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 its relationship 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

Not applicable.

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, 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, market and sell a wide variety of alcoholic beverages under recognized brands. We employ 78 people in the United States.

Our brands span several alcoholic beverage categories, including whiskey, vodka, gin, rum, tequila and Ready-to-Drink (“RTD”). We sell our products on a wholesale basis to distributors in open states, and brokers in control states, and until March 2020, we operated four retail tasting rooms in Portland, Oregon to market our brands directly to consumers. We operate a mobile craft canning and bottling business (“Craft C+B”) that primarily services the craft beer and craft cider business. Craft C+B operates 11 mobile lines in Seattle, Washington; Portland, Oregon; and Denver, Colorado.

Total company revenue in 2020 was almost split evenly between spirits and Craft Canning; yet, the Craft Canning division contributed 80% of our gross profit and spirits contributed 20%. The impact of the COVID-19 pandemic had a significant effect on each business unit. Craft Canning revenue had over 20% growth from 2019 due to the incremental demand for packaging stimulated by the shift in on-premise beer sales from kegs to cans. The spirits portfolio had approximately 20% in revenue growth from 2019 due to a full year of Azuñia Tequila sales. Overall, the U.S. craft spirits category revenue was down $2.1 billion, or 40%, in 2020 according to the Distilled Spirits Council of the United States (“DISCUS”).

Principal Spirits Brands and Products During 2020

Principal Services Provided by Craft Canning and Bottling

Canning

Flexible packaging options in multiple sizes

Nitrogen dosing: Specialized equipment allowing for packaging of still products in addition to carbonated beverages

Velcorin: Specialized equipment that supports microbial control

Label application capabilities

Mobility packaging for clients at their production facility

Full-service packaging provider

Bottling

Supplies all needed packaging and has the ability to package in two primary bottle sizes

Specialized packaging and quality control equipment

We have invested heavily in the past two years expanding our business through acquisitions and making substantial investments in branding and production; however, we have not achieved profitability. The immediate task at hand is to focus on a new sustainable business strategy. Based on a complete review and analysis of our competitive position, market opportunity and assets, we have identified components of the strategy that we believe would improve operating results. Management believes the following components of the strategy are in place and working:

Areas that we need incremental work include the following:

We plan to complete our business review in 2021 and embark on the following:

Eastside Distilling is unique in several specific areas: (1) to our knowledge, we are the only craft spirits company listed on Nasdaq, (2) we do not function as a traditional craft distillery with store fronts relying on local sales, (3) we are diversified with our contract manufacturing division, and (4) we have a diversified portfolio of spirits brands. We are similar to other craft distillers in that (1) we have concentrated local volume, (2) we produce small batches and remain within the volume definition of “Craft”, and (3) our brands achieve success through differentiation, discovery and distribution.

The U.S. spirits marketplace is occupied by large multi-national conglomerates with substantially more resources than Eastside Distilling. However, we can use our small size to be fast, focused, flexible in our strategy. If we attempt to grow too quickly, we may lack the underlying strength required to build scale with loyalty via strong unaided awareness and powerfully derived attributes. Moreover, attempting to focus our “frame-of-reference” to compete with the biggest brands in the most expensive venues, is likely to fail without first establishing underlying brand equity.

We will seek to utilize our public company stature to our advantage and position our spirits portfolio as a leading tier 2 spirits provider that develops brands, expands geographic presence and positions for either a sale to the tier 1 suppliers or continued ownership with growth in revenue and cash flow. We will look to grow, and vertically integrate, our Craft Canning portfolio.

Recent Developments

During 2020, Craft Canning experienced an increase in demand and revenue growth as customers are continuing to prefer to fill cans for a wider off-premise usage. In order to meet this demand, we invested in additional canning lines. Throughout 2020, the canning industry has faced a shortage of aluminum cans. However, we believe we have sourced enough cans to supply our current business plan. While off-premise business has seen an increase in spirits sales, the customer focus has been on major brands and larger format bottles which we do not currently have on the national platform. Other parts of our business were negatively affected by mandated lockdowns and other related restrictions including a decrease in sales volume in on-premise accounts, where products are typically consumed immediately, such as bars and restaurants. This negative trend has continued through the year.

In response to the COVID-19 pandemic, we implemented specific measures to reduce the spread of the virus including having our employees work remotely whenever possible, screening visitors and workers before entering facilities, requiring visitors and employees to wear masks, and encouraging social distancing. These preventive measures have been effective as evidenced by the minimal number of COVID-19 cases between our workforce, vendors, and customers.

Available Information

Our executive offices are located at 8911 NE Marx Drive, Suite A2, Portland, Oregon 97220. 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

During the first quarter of 2020, Eastside Distilling focused its sales and marketing efforts on the distribution of our brands through the national platform, resulting in the decision to close all four of its retail stores in Portland, Oregon by March 31, 2020. On October 29, 2020, we announced our intent to divest the Redneck Riviera brand. We signed a non-binding term sheet between Eastside Distilling and Rich Marks, LLC, Redneck Riviera Whiskey Co, LLC, John D. Rich Tisa Trust and Redneck Spirits Group, LLC (collectively the buyers referred to as “RSG”). The retail operations and Redneck Riviera business have been reported as discontinued operations in the accompanying condensed consolidated financial statements. In the current year, the income, expense, and cash flows from retail and Redneck Riviera operations during the period they were consolidated have been classified as discontinued operations. For comparative purposes amounts in the prior periods have been reclassified to conform to current year presentation.

Consolidated Statements of Operations Data

Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019

Our sales for the year ended December 31, 2020 increased to $14.8 million, or approximately 21%, from $12.2 million for the year ended December 31, 2019. The following table compares our sales during the years ended December 31, 2020 and 2019, and excludes the retail tasting room and Redneck Riviera sales that have been classified as discontinued operations:

Our overall 2020 sales were primarily driven by increases in wholesale sales and canning sales and services. Wholesale sales increased primarily due to the acquisition of Azuñia Tequila in September 2019, which accounted for $1.7 million increase over last year as well as a $0.2 million increase in Portland Potato Vodka brand sales. Our canning and bottling revenue increased year over year, which has benefited from a shift in consumer preferences to consume alcohol at home rather than at on-premise locations. This was a result of the COVID-19 pandemic and was also offset by lower co-packing and mobile bottling sales.

Customer programs and excise taxes

Customer programs and excise taxes for the year ended December 31, 2020 increased to $1.1 million, or approximately 87%, from $0.6 million for the year ended December 31, 2019. The increase was attributable to higher excise taxes and broker commissions due to increased sales.

Cost of Sales

Cost of sales consists of the costs of ingredients utilized in the production of spirits, manufacturing and/or service labor and overhead, warehousing rent, packaging, and in-bound freight charges. During the year ended December 31, 2020, cost of sales increased to $9.2 million, or approximately 21%, from $7.6 million for the year ended December 31, 2019 in line with the increase in sales.

Gross Profit

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 for the years ended December 31, 2020 and 2019:

Gross Margin

Our gross margin of 33% of net sales for the year ended December 31, 2020 decreased from our gross margin of 35% for the year ended December 31, 2019 primarily due to a change in product and services mix, higher raw material costs, and unabsorbed manufacturing overhead related to lower wholesale production levels. Our goal is to improve our overall gross margin by increasing the efficiencies and reducing the footprint of our production facility as well as evaluate the materials in our finished goods by looking to create economies of scale by creating consistency of the dry goods across our brands.

Sales and Marketing Expenses

Sales and marketing expenses for the year ended December 31, 2020 increased to $3.9 million, or approximately 20%, from $3.2 million for the year ended December 31, 2019. This increase was primarily due to a $1.2 million increase in sales and marketing compensation related to the increased headcount from the acquisition of the Azuñia tequila brand.

General and Administrative Expenses

General and administrative expenses for the year ended December 31, 2020 decreased to $9.2 million, or approximately 15%, from $10.8 million for the year ended December 31, 2019. This decrease was primarily due to a decrease in compensation and benefits, legal and professional fees and rent, insurance and other miscellaneous general and administrative costs; offset by higher non-cash expenses related to depreciation and amortization from the Craft Canning acquisition and leasehold improvements to our production facility.

Other Expenses

Total other expenses, net was $1.5 million for the year ended December 31, 2020 compared to $3.2 million for the year ended December 31, 2019, an increase of 54%. This increase was primarily due to higher interest expense on increased notes payable, a secured line of credit, and accounts receivable factoring programs; and the write-off of services for branding products in 2020; as well as a revaluation of the Azuñia Tequila acquisition in 2019.

Liquidity and Capital Resources

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, 2020 and 2019, we incurred a net loss of $9.9 million and $16.9 million, respectively, and had an accumulated deficit of approximately $54.1 million as of December 31, 2020. We have been dependent on raising capital from debt and equity financings and utilization of our inventory to meet our needs for cash flow used in operating activities. For the year ended December 31, 2020, we raised approximately $3.4 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. In addition, for the year ended December 31, 2020, we consumed $1.8 million of our inventories.

To help ensure adequate liquidity in light of uncertainties posed by the COVID-19 pandemic, we applied for and received a loan of $1.4 million under the U.S. government Paycheck Protection Program (“PPP Loan”). On January 29, 2021, the Small Business Administration (“SBA”) notified us that it approved our request for full forgiveness of the PPP loan in the principal amount of $1.4 million. As a result of the SBA’s decision to approve our request for forgiveness, the SBA paid the entire outstanding balance of the PPP loan of $1.4 million, which is now considered paid in full.

On May 13, 2020, Live Oak Banking Company (the “Lender”) notified the Company that it was in technical default under certain covenants in a loan agreement, dated January 15, 2020, between the Company, Motherlode LLC, Big Bottom Distilling, LLC, Craft Canning + Bottling LLC, Redneck Riviera Whiskey Co., LLC, Outlandish Beverages LLC, and Live Oak Bank (the “Loan Agreement”). Those technical defaults included the failure to timely deliver information and its belief that we owed certain taxes and did not relate to any failure to pay amounts owing under the Loan Agreement. The Loan Agreement provides that upon an event of default, the Lender may, at its option, declare the entire loan to be immediately due and payable. Further, a default interest rate may apply on all obligations during the existence of an event of default at a per annum rate equal to 2.00% above the applicable interstate. On June 3, 2020 the Company entered into a Second Modification to Loan Agreement (“Modification”) with the Lender agreeing to waive the technical defaults upon the satisfaction of certain conditions by September 30, 2020. The Company complied with these conditions and was compliant with the terms of the Loan Agreement and Modification as of December 31, 2020.

As of December 31, 2020, we had approximately $0.8 million of cash on hand with a negative working capital of $17.3 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, selling assets 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. See Notes 10 and 11 to our financial statements for a description of our debt and the debt financing initiatives completed during 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, 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 ended December 31, 2020 and 2019 was as follows:

Operating Activities

Total cash used from operating activities was $3.0 million in 2020 compared to $9.1 million in 2019. The decrease in cash usage can be primarily attributed to a $3.0 million decrease in marketing and administrative cash expenditures, and improved management of receivables and prepayments of $0.6 million, which was offset by $0.8 million used in reducing operating liabilities.

Investing Activities

Cash used in investing activities consists primarily of acquisitions and purchases of property and equipment. We incurred capital expenditures of $0.5 million and $2.2 million in 2020 and 2019, respectively. Proceeds from sales of fixed assets totaled $0.6 million for the year ended December 31, 2020. Net cash used in the acquisition of Craft Canning for the year ended December 31, 2019 was $1.4 million.

Financing Activities

Net cash flows provided by financing activities during the year ended December 31, 2020 primarily consisted of $6.3 million of proceeds from the establishment of a new secured credit facility, offset by $3.0 million repayment and termination of the existing secured credit facility and $1.8 million in debt repayments, $1.4 million of proceeds from the Paycheck Protection Program and $0.4 million in proceeds from borrowing on an existing line of credit with our bank. During the year ended December 31, 2019, our operating losses and working capital needs were primarily funded by issuance of common stock totaling $1.3 million.

Deposit

In August 2020, we entered into discussions with Intersect Beverage, LLC (“Intersect”) and TQLA, LLC (“TQLA”) to address potential changes to the deferred consideration for the Azuñia Tequila acquisition and received a deposit of $0.3 million in cash. In the fourth quarter of 2020, Intersect and TQLA sent us an additional deposit bringing the total outstanding amount deposited to $0.7 million. Subsequent to December 31, 2020, the full deposit of $0.7 million was repaid. Eastside Distilling has not reached agreement with Intersect and TQLA to make any substantial changes to the deferred consideration for the Azuñia Tequila acquisition.

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 $3.8 million of invoices during the year ended December 31, 2020. As of December 31, 2020, the Company had $0.1 million factored invoices outstanding.

Since 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 $4.1 million of invoices during the year ended December 31, 2020. As of December 31, 2020, 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) $8.0 million and (ii) a borrowing base of up 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 assets 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 $3.94 per share. The proceeds of the Live Oak Loan were 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 December 31, 2020, the balance of the Live Oak Loan was $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

Customer programs, which include customer promotional discount programs, customer incentives, and broker commissions, 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 sales and marketing expenses in accordance with ASC 606 - Revenue from Contracts with Customers, based on the nature of the expenditure. Amounts paid to customers totaled $1.0 million and $0.6 million for the years ended December 31, 2020 and 2019, respectively.

Excise Taxes

The Company is responsible for compliance with the Alcohol and Tobacco Tax and Trade Bureau (“TTB”) regulations, which includes making timely and accurate excise tax payments. The Company is subject to periodic compliance audits by the TTB. Individual states also impose excise taxes on 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 $0.1 million and $0 million for the years ended December 31, 2020 and 2019, respectively.

Cost of Sales

Cost of sales consists 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.

Sales and Marketing Expenses

The following expenses are included in sales and marketing expenses in the accompanying consolidated statements of operations: media advertising costs, 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.

General and Administrative Expenses

The following expenses are included in general and administrative expenses in the accompanying consolidated statements of operations: salary and benefit expenses, travel and entertainment expenses for executive and administrative staff, rent and utilities, professional fees, insurance, and amortization and depreciation expense. General and administrative costs are expensed as incurred.

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 as of December 31, 2020 and 2019.

Concentrations

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of trade receivables. As of December 31, 2020, one distributor represented 14% of trade receivables. As of December 31, 2019, two distributors represented 40% of trade receivables. Sales to one distributor accounted for 18% of consolidated sales for the year ended December 31, 2020. Sales to one distributor accounted for 16% of consolidated sales for the year ended December 31, 2019.

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.

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 $1.3 million and $0.7 million in 2020 and 2019, respectively.

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 AND SUPPLEMENTARY DATA

Table of Contents

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, 2020 and 2019, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the years in the two-year period ended December 31, 2020, and the related notes (collectively referred to as the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated 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 consolidated 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 consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Evaluation of Intangible Assets

As discussed in Note 4, the Company acquired two entities during 2019 accounted for as business combinations, which required assets and liabilities assumed to be measured at their acquisition date fair values. At each reporting period, certain intangible assets are required to be assessed annually for impairment based on the facts and circumstances at that time. Auditing management’s evaluation of intangible assets can be a significant judgment given the fact that the Company uses management estimates on future revenues and expenses which are not easily able to be substantiated.

Given these factors and due to significant judgements made by management, the related audit effort in evaluating management’s judgments in evaluation of intangible assets required a high degree of auditor judgment.

The procedures performed included evaluation of the methods and assumptions used by the Company, tests of the data used and an evaluation of the findings. We evaluated and tested the Company’s significant judgments that determine the impairment evaluation of goodwill and intangible assets.

Lack of Going Concern Paragraph

Due to the net loss and negative cash flows from operations for the year, the Company evaluated the need for a going concern.

Auditing management’s evaluation of a going concern can be a significant judgment given the fact that the Company uses management estimates on future revenues and expenses which are not able to be easily substantiated.

To evaluate the appropriateness of the lack of going concern paragraph in our audit opinion, we examined and evaluated the financial information that was the initial cause for this consideration along with management’s plans to mitigate the going concern.

Eastside Distilling, Inc. and Subsidiaries

Consolidated Balance Sheets

December 31, 2020 and 2019

(Dollars in thousands, except share and per share)

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, 2020 and 2019

(Dollars and shares in thousands, except per share)

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

Eastside Distilling, Inc. and Subsidiaries

Consolidated Statements of Stockholder’s Equity (Deficit)

Years Ended December 31, 2020 and 2019

(Dollars and shares in thousands)

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

Eastside Distilling, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Years Ended December 31, 2020 and 2019

(Dollars in thousands)