Eastside Distilling, Inc. - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the transition period from ______________ to _________________

Commission File No.: 001-38182

EASTSIDE DISTILLING, INC.

(Exact name of registrant as specified in its charter)

1001 SE Water Avenue, Suite 390

Portland, Oregon 97214

(Address of principal executive offices)

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

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

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

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

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

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

As of August 13, 2020, 10,061,539 shares of our common stock, $0.0001 par value, were outstanding.

EASTSIDE DISTILLING, INC.

FORM 10-Q

June 30, 2020

TABLE OF CONTENTS

PART I: FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS (unaudited)

Eastside Distilling, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

June 30, 2020 and December 31, 2019

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

Eastside Distilling, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

For the Three and Six Months Ended June 30, 2020 and 2019

(Unaudited)

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

Eastside Distilling, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the six months ended June 30, 2020 and 2019

(Unaudited)

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

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Eastside Distilling (the “Company,” “Eastside,” “Eastside Distilling,” “we,” “us,” or “our”, below) was incorporated under the laws of Nevada in 2004 under the name of Eurocan Holdings, Ltd. In December 2014, we changed our corporate name to Eastside Distilling, Inc. to reflect our acquisition of Eastside Distilling, LLC. We manufacture, acquire, blend, bottle, import, export, market and sell a wide variety of alcoholic beverages under recognized brands. We currently employ 85 people in the United States.

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

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Our mission is to build craft inspired experiential brands and high-quality artisan products around premium spirits and Ready to Drink (“RTD”) craft cocktails. We will focus our core competency around brands, product marketing and distribution. We are building our branded spirits and mobile canning and bottling service division both organically and through acquisition to capture growth in the spirits, wine, beer, and RTD categories. Our growth in the mobile canning and bottling services is being driven through Craft Canning + Bottling, LLC (“Craft Canning”).

Our partnership capabilities were first demonstrated by our licensing and launch of our Redneck Riviera Whiskey brands (“RRW”). Our RRW brand went from idea, to market roll-out in less than nine months and achieved national distribution in 49 states within 18 months. We proved how our team could leverage its market position to successfully launch a nascent or new brand, while demonstrating our ability to focus and dedicate more of our attention to developing innovative products.

Recent Developments

COVID-19. As a result of governmental and self-imposed restrictions due to the COVID-19 pandemic, there has been a shift in on and off premise demand. On-premise business such as bars and restaurants have been closed leading to a decline in demand of the Azuñia brand which has been a predominately on-premise brand that we are actively seeking to expand wholesale. 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. However, in Oregon the Portland Potato Vodka 1.75L has shown a dramatic increase in sales. Additionally, our Craft Canning operation has seen strong sales and customer bookings for mobile canning that have extended beyond the normal peak season. We believe this is a result of the transition from the use of kegs for on premise to the preference for cans for wider off-premise usage. This trend has been dramatic and has resulted in shortages of available can stock. However, the Company believes it has sourced enough cans to supply its current business plan.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Historically, the Company has funded its cash and liquidity needs through operating cash flow convertible notes, extended credit terms, and equity financings. The Company has incurred a net loss of $5.7 million for the six months ended June 30, 2020 and has an accumulated deficit of $49.9 million as of June 30, 2020. The Company has been dependent on raising capital from debt and equity financings as well as the utilization of our inventory to meet its needs for cash flow used in operating activities. For the six months ended June 30, 2020, we raised approximately $3.6 million in additional capital through debt financing (net of repayments).

At June 30, 2020, the Company had $1.9 million of cash on hand with a positive working capital of $0.4 million. Our ability to meet our ongoing operating cash needs over the next 12 months depends on reducing our operating costs, utilizing our inventory, 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 refinancing initiatives completed in the first half of 2020. If we are unable to obtain additional financing, or additional financing is not available on acceptable terms, we may seek to sell assets, reduce operating expenses or reduce or eliminate marketing initiatives, and take other measures that could impair our ability to be successful.

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

Basis of Presentation and Consolidation

The accompanying unaudited condensed consolidated financial statements for Eastside Distilling, Inc. and subsidiaries were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements in accordance with GAAP have been condensed or eliminated as permitted under the SEC’s rules and regulations. In our opinion, the unaudited condensed consolidated financial statements include all material adjustments, all of which are of a normal and recurring nature, necessary to present fairly our financial position as of June 30, 2020, our operating results for the six months ended June 30, 2020 and 2019 and our cash flows for the six months ended June 30, 2020 and 2019. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. Interim results are not necessarily indicative of the results that may be expected for an entire fiscal year. The condensed consolidated financial statements include the accounts of Eastside Distilling, Inc.’s wholly-owned subsidiaries, including, MotherLode LLC, Big Bottom Distilling LLC, Outlandish Beverages, LLC, Redneck Riviera Whiskey Co., LLC, Craft Canning + Bottling LLC (beginning as of January 11, 2019) and the Azuñia tequila assets (beginning September 12, 2019). All intercompany balances and transactions have been eliminated on consolidation.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Segment Reporting

The Company determined its operating segment on the same basis that it uses to evaluate its performance internally. The Company has one business activity, producing, packaging, marketing and distributing alcoholic beverages and operates as one segment. The Company’s chief operating decision makers, its chief executive officer and chief financial officer, review the Company’s operating results on an aggregate basis for purposes of allocating resources and evaluating financial performance.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Revenue Recognition

Net sales include product sales, less customer programs and excise taxes. 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, other than customary rights of return. The Company excludes sales tax collected and remitted to various states from sales and cost of sales.

Customer Programs

Customer programs, which include customer promotional discount programs, customer incentives and other payments, are a common practice in the alcohol beverage industry. The Company makes these payments to customers and incurs these costs to promote sales of products and to maintain competitive pricing. Amounts paid in connection with customer programs and incentives are recorded as reductions to net sales or as 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 $0.5 million and $0.6 million for the six months ended June 30, 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 alcohol beverages in varying amounts. The Company calculates its excise tax expense based upon units produced and sold and on its understanding of the applicable excise tax laws. Excise taxes totaled $0.2 million and $0.6 million for the six months ended June 30, 2020 and 2019, respectively.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Cost of Sales

Cost of sales consists of the costs of ingredients utilized in the production of spirits, manufacturing labor and overhead, warehousing rent, packaging, and in-bound freight charges. Ingredients account for the largest portion of the cost of sales, followed by packaging and production costs.

Shipping and Fulfillment Costs

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

Sales and Marketing Expenses

The following expenses are included in sales and marketing expenses in the accompanying condensed consolidated statements of operations: media advertising costs, sales and marketing expenses, promotional costs of value-added packaging, salary and benefit expenses, travel and entertainment expenses for the sales, brand and sales support workforce and promotional activity expenses. Sales and marketing costs are expensed as incurred. Sales and marketing expense totaled $2.8 million and $2.6 million for the six months ended June 30, 2020 and 2019.

General and Administrative Expenses

The following expenses are included in general and administrative expenses in the accompanying condensed 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. General and administrative expense totaled $4.5 million and $5.4 million for the six months ended June 30, 2020 and 2019, respectively, of which $1.8 million and $1.6 million were non-cash expenses, respectively.

Stock-Based Compensation

The Company recognizes as compensation expense all stock-based awards issued to employees. The compensation cost is measured based on the grant-date fair value of the related stock-based awards and is recognized over the service period of stock-based awards, which is generally the same as the vesting period. The fair value of stock options is determined using the Black-Scholes valuation model, which estimates the fair value of each award on the date of grant based on a variety of assumptions including expected stock price volatility, expected terms of the awards, risk-free interest rate, and dividend rates, if applicable. Stock-based awards issued to nonemployees are recorded at fair value on the measurement date and are subject to periodic market adjustments at the end of each reporting period and as the underlying stock-based awards vest. Stock-based compensation was $0.7 and $0.8 million for the six months ended June 30, 2020 and 2019, respectively.

Discontinued Operations

The Company reports discontinued operations by applying the following criteria in accordance with Accounting Standards Codification (“ASC”) Topic 205-20 – Presentation of Financial Statements – Discontinued Operations: (1) Component of an entity; (2) Held for sale criteria; (3) Strategic shift. During the first quarter of 2020, management made a strategic shift to focus the Company’s sale and marketing efforts on the nationally branded product platform, resulting in the decision to close / abandon all four of its retail tasting rooms in the Portland, Oregon area by March 31, 2020. This decision meets the criteria (1) - (3) for reporting discontinued operations, and as a result, the retail operations have been reported as discontinued operations in the accompanying unaudited condensed consolidated financial statements. In the current year, the income, expense and cash flows from retail 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. Additionally, the assets and liabilities from retail operations are shown on the balance sheet as assets and liabilities for discontinued operations.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Income and expense related to discontinued retail operations for the six months ended June 30 2020 and 2019:

Assets and liabilities related to discontinued retail operations

Cash and Cash Equivalents

Cash equivalents are considered to be highly liquid investments with maturities of three months or less at the time of the purchase. The Company had no cash equivalents at June 30, 2020 and December 31, 2019.

Fair Value Measurements

GAAP defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements. GAAP permits an entity to choose to measure many financial instruments and certain other items at fair value and contains financial statement presentation and disclosure requirements for assets and liabilities for which the fair value option is elected. At June 30, 2020 and December 31, 2019, management has not elected to report any of the Company’s assets or liabilities at fair value under the “fair value option” provided by GAAP.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

The hierarchy of fair value valuation techniques under GAAP provides for three levels: Level 1 provides the most reliable measure of fair value, whereas Level 3, if applicable, generally would require significant management judgment. The three levels for categorizing assets and liabilities under GAAP’s fair value measurement requirements are as follows:

None of the Company’s assets or liabilities were measured at fair value at June 30, 2020 and December 31, 2019. However, GAAP requires the disclosure of fair value information about financial instruments that are not measured at fair value. Financial instruments consist principally of trade receivables, accounts payable, accrued liabilities, notes payable, and convertible notes payable. The estimated fair value of trade receivables, accounts payable, and accrued liabilities approximates their carrying value due to the short period of time to their maturities. At June 30, 2020 and December 31, 2019, the Company’s notes payable are at fixed rates and their carrying value approximates fair value.

Items Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities acquired in a business acquisition are valued at fair value at the date of acquisition.

Inventories

Inventories primarily consist of bulk and bottled liquor, raw packaging material for bottling, raw cans for Craft Canning and merchandise and are stated at the lower of cost or market. Cost is determined using an average costing methodology, which approximates cost under the first-in, first-out (FIFO) method. A portion of inventory is held by certain independent distributors on consignment until it is sold to a third party. The Company regularly monitors inventory quantities on hand and records write-downs for excess and obsolete inventories based primarily on the Company’s estimated forecast of product demand and production requirements. Such write-downs establish a new cost basis of accounting for the related inventory. The Company recorded an inventory allowance of $0.3 million for obsolete inventory for the six months ended June 30, 2020 and no write-downs of inventory for the six months ended June 30, 2019.

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, ranging from three to seven years. Amortization of leasehold improvements is computed using the straight-line method over the life of the lease or the useful lives of the assets, whichever is shorter. The cost and related accumulated depreciation and amortization of property and equipment sold or otherwise disposed of are removed from the accounts and any gain or loss is reported as current period income or expense. The costs of repairs and maintenance are expensed as incurred.

Intangible Assets / Goodwill

The Company accounts for long-lived assets, including property and equipment and intangible assets, at amortized cost. Management reviews long-lived assets for probable impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. If there is an indication of impairment, management would prepare an estimate of future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition. If these estimated cash flows were less than the carrying amount, an impairment loss would be recognized to write down the asset to its estimated fair value. The Company performed a qualitative assessment of goodwill at June 30, 2020 and determined that goodwill was not impaired.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Long-lived Assets

The Company accounts for long-lived assets, including property and equipment, at amortized cost. Management reviews long-lived assets for probable impairment whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. If there is an indication of impairment, management would prepare an estimate of future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition. If these estimated cash flows were less than the carrying amount of the asset, an impairment loss would be recognized to write down the asset to its estimated fair value.

Income Taxes

The provision for income taxes is based on income and expenses as reported for financial statement purposes using the “asset and liability method” for accounting for deferred taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled.

As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. At June 30, 2020 and December 31, 2019, the Company established valuation allowances against its net deferred tax assets.

Income tax positions that meet the “more-likely-than-not” recognition threshold are measured at the largest amount of income tax benefit that is more than 50% likely to be realized upon settlement with the applicable taxing authority. The portion of the benefits associated with income tax positions taken that exceeds the amount measured as described above would be reflected as a liability for unrecognized income tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized income tax benefits would be classified as additional income taxes in the accompanying condensed consolidated statements of operations. There were no unrecognized income tax benefits, nor any interest and penalties associated with unrecognized income tax benefits, accrued or expensed at and for the six months ended June 30, 2020 and 2019.

The Company files federal income tax returns in the U.S. and various state income tax returns. The Company is no longer subject to examinations by the related tax authorities for the Company’s U.S. federal and state income tax returns for years prior to 2012.

Comprehensive Income

The Company does not have any reconciling other comprehensive income items for the six months ended June 30, 2020 and 2019.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Accounts Receivable Factoring Program

The Company has entered into two accounts receivable factoring programs. One for its spirits customers (the “spirits program”) and another for its co-packing customers (the “co-packing program”). Under the programs, the Company has the option to sell certain customer account receivables in advance of payment for 75% (spirits program) or 85% (co-packing program) of the amount due. When the customer remits payment, the Company receives the remaining balance. For the spirits program, interest is charged on the advanced 75% payment at a rate of 2.4% for the first 30 days plus 1.44% for each additional ten-day period. For the co-packing program, interest is charged against the greater of $500,000 or the total funds advanced at a rate of 5% plus the prime rate published in the Wall Street Journal. Under the terms of both agreements, the factoring provider has full recourse against the Company should the customer fail to pay the invoice. In accordance with ASC 860, we have concluded that these agreements have met all three conditions identified in ASC 860-10-40-5 (a) – (c) and have accounted for this activity as a sale. Given the quality of the factored accounts, the Company has not recognized a recourse obligation. In certain limited instances, the Company may provide collection services on the factored accounts but does not receive any fees for acting as the collection agent, and as such, the Company has not recognized a service obligation asset or liability. The Company factored $3.8 million of invoices and incurred $0.1 million in fees associated with the factoring programs during the six months ended June 30, 2020. At June 30, 2020, the Company had $0.9 million factored invoices outstanding.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Recently Adopted Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:

Under the new guidance, lessor accounting will be largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and ASU No. 2014-09, Revenue from Contracts with Customers. The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842). This guidance provides an additional (and optional) transition method whereby the new lease standard is applied at the adoption date and recognized as an adjustment to retained earnings. In addition, this ASU provides a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease and instead account for the lease as a single component if both the timing and pattern of transfer of the nonlease component(s) are the same, and if the lease would be classified as an operating lease. These amendments have the same effective date as ASU 2016-02. On January 1, 2019, the Company adopted the new accounting standard using the modified retrospective approach and elected to not adjust comparative periods. Upon adoption, the Company recognized right-of-use assets of $0.9 million, lease liabilities of $1.1 million, and a net adjustment to retained earnings of $0.2 million. The Company considers the impact of the adoption to be immaterial to its consolidated financial statements on an ongoing basis.

In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718) – Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”), which aligns the accounting for share-based payment awards issued to employees and nonemployees. Under ASU 2018-07, the existing employee guidance will apply to nonemployee share-based transactions (as long as the transaction is not effectively a form of financing), with the exception of specific guidance related to the attribution of compensation cost. The cost of nonemployee awards will continue to be recorded as if the grantor had paid cash for the goods or services. In addition, the contractual term will be able to be used in lieu of an expected term in the option-pricing model for nonemployee awards. The new standard became effective on January 1, 2019 and should be applied to all new awards granted after the date of adoption. The Company adopted ASU 2018-07 as of January 1, 2019. The Company does not believe the adoption of ASU 2018-07 had any material impact on its consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350) – Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 will simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Current guidance requires that companies compute the implied fair value of goodwill under Step 2 by performing procedures to determine the fair value at the impairment testing date of its assets and liabilities following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. ASU 2017-04 will require companies to perform annual or interim goodwill impairment tests by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and will be applied prospectively. Early adoption of this standard is permitted. The Company adopted ASU 2017-04 as of January 1, 2020. The Company does not believe the adoption of ASU 2017-04 had any material impact on its consolidated financial statements.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

During the fiscal year 2019, the Company completed the following acquisitions:

Craft Canning + Bottling

On January 11, 2019, the Company completed the acquisition of Craft Canning + Bottling, LLC (“Craft Canning”), a Portland, Oregon-based provider of bottling and canning services. The Company’s consolidated financial statements for the six months ended June 30, 2020 include Craft Canning’s results of operations. For the six months ended June 30, 2019, Craft Canning’s results of operations are included from the acquisition date of January 11, 2019 through June 30, 2019. The Company’s condensed consolidated financial statements reflect the final purchase accounting adjustments in accordance with ASC 805 “Business Combinations”, whereby the purchase price was allocated to the assets acquired and liabilities assumed based upon their estimated fair values on the acquisition date.

The following allocation of the purchase price is as follows:

Intangible assets are recorded at estimated fair value, as determined by management based on available information. The fair value assigned to the customer list intangible asset was determined through the use of the income approach, specifically the relief from royalty and the multi-period excess earning methods. The major assumptions used in arriving at the estimated identifiable intangible asset value included management’s estimates of future cash flows, discounted at an appropriate rate of return which is based on the weighted average cost of capital for both the Company and other market participants, projected customer attrition rates, as well as applicable royalty rates for comparable assets. The useful lives for intangible assets were determined based upon the remaining useful economic lives of the tangible assets that are expected to contribute directly or indirectly to future cash flows. The customer relationships estimated useful life is seven years.

The Company incurred acquisition costs of $0.1 million during the six months ended June 30, 2019 that have been recorded in general and administrative expenses on the consolidated statement of operations. The results of the Craft acquisition are included in our consolidated financial statements from the date of acquisition through June 30, 2020. The revenue and net profit of Craft operations included in our condensed consolidated statements of operations were $4.0 million and $0.3 million, for the six months ended June 30, 2020. The revenue and net income (including transaction costs) of Craft operations included in our condensed consolidated statements of operations were $3.8 million and $0.5 million, for the period from January 11, 2019 through June 30, 2019.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Azuñia Tequila

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. The Company’s consolidated financial statements for the six months ended June 30, 2020 include the Azuñia Tequila assets and results of operations.

The acquisition was structured as an all-stock transaction, provided that the Company may, at its election, pay a portion of the consideration in cash or by executing a three-year promissory note if the issuance of stock would require the Company to hold a vote of its stockholders under the applicable Nasdaq rules. Subject to compliance with applicable Nasdaq rules, the initial consideration, will be payable approximately 18 months following the closing and will consist of 850,000 shares of the Company’s common stock at a stipulated value of $6.00 per share, 350,000 shares of the Company’s common stock based on the Company’s stock price twelve months after the close of the transaction, and additional shares based on the Azuñia business achieving certain revenue targets and the Company’s stock price 18 months after the close of the transaction. The Company has also agreed to issue additional stock consideration (subject to compliance with applicable Nasdaq rules) of up to $1.5 million upon the Azuñia business achieving revenue of at least $9.45 million in the period commencing on the 13th month following the closing and ending on the 24th month following the closing.

The Company’s consolidated financial statements reflect the final purchase accounting adjustments in accordance with ASC 805 “Business Combinations”, whereby the purchase price was allocated to the assets acquired based upon their estimated fair values on the acquisition date. The Company estimated the purchase price based on weighted probabilities of future results and recorded deferred consideration payable of $12.8 million on the acquisition date that will be remeasured to fair value at each reporting date until the contingencies are resolved, with the changes in fair value recognized in earnings. The Company remeasured the deferred consideration payable for the period ended December 31, 2019 and increased the liability by $2.7 million to a balance of $15.5 million. No adjustment was made to the deferred consideration payable for the six month period ended June 30, 2020.

The following allocation of the purchase price is as follows:

Intangible assets are recorded at estimated fair value, as determined by management based on available information. The fair value assigned to the brand intangible asset was determined through the use of the market approach. The major assumptions used in arriving at the estimated identifiable intangible asset value included category averages for comparable acquisitions, including multiples of annual sales and dollars per case sold. The brand has an indefinite life and will not be amortized.

The results of the Azuñia Tequila asset acquisition are included in our consolidated financial statements for the six months ended June 30, 2020. The sales of Azuñia Tequila products included in our condensed consolidated statements of operations were $1.4 million for the six months ended June 30, 2020.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Pro Forma Financial Information

The following unaudited pro forma consolidated results of operations for the six months ended June 30, 2019 assume that both acquisitions of Craft Canning + Bottling and Azuñia Tequila were completed on January 1, 2019:

Pro forma sales and net loss exclude retail operations that have been classified as discontinued operations. Pro forma data does not purport to be indicative of the results that would have been obtained had these events actually occurred at the beginning of the periods presented and is not intended to be a projection of future results. The share and per share data have been retroactively reflected for the acquisitions.

Inventories consist of the following:

(Dollars in thousands)

Property and equipment consists of the following:

(Dollars in thousands)

Purchases of property and equipment totaled $0.2 million and $2.2 million for the six months ended June 30, 2020 and June 30, 2019, respectively. Depreciation expense totaled $1.0 million and $0.4 million for the six months ended June 30, 2020 and June 30, 2019, respectively. Gain on disposal of fixed assets totaled $0.02 for the six months ended June 30, 2020 compared to nil for the same period last year.

Intangible assets and goodwill at June 30, 2020 and December 31, 2019 consists of the following:

(Dollars in thousands)

Amortization expense totaled $0.2 million and $0.2 million for the six months ended June 30, 2020 and June 30, 2019, respectively. The permits and licenses, Azuñia brand and goodwill have all been determined to have indefinite life and will not be amortized. The customer list is being amortized over a seven-year life.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Other assets consist of the following:

(Dollars in thousands)

As of June 30, 2020, the Company had $0.9 million of capitalized costs related to services provided for the rebranding of its existing product line and branding of new product lines. This amount is being amortized over a seven-year life.

Amortization expense totaled $0.05 million and $0.09 million for the six months ended June 30, 2020 and June 30, 2019, respectively.

As of June 30, 2020, the Company had notes receivable from Wineonline.com for $127,500 which mature on August 25, 2020. The interest rate on these notes is 5% and will be payable at maturity. The Company received $322,500 from Wineonline.com in June 2020 for notes receivable that had matured and has determined the remaining note is collectible.

The deposits represent office lease deposits.

The Company has various lease agreements in place for facilities and equipment. Terms of these leases include, in some instances, scheduled rent increases, renewals, purchase options and maintenance costs, and vary by lease. These lease obligations expire at various dates through 2022. As the rate implicit in each lease is not readily determinable, the Company uses its incremental borrowing rate based on information available at commencement to determine the present value of the lease payments. Based on the present value of the lease payments for the remaining lease term of the Company’s existing leases, the Company recognized right-of-use assets of $0.9 million and lease liabilities of $1.1 million, and a net adjustment to retained earnings of $0.2 million upon adoption on January 1, 2019. Right-of-use assets and lease liabilities commencing after January 1, 2019 are recognized at commencement date based on the present value of lease payments over the lease term. As of June 30, 2020, the right-of-use assets and lease liabilities were $0.4 million and $0.5 million, respectively. Leases with an initial term of 12 months or less (“short-term leases”) are not recorded on the balance sheet and are recognized on a straight-line basis over the lease term. Aggregate lease expense for the six months ended June 30, 2020 was $0.4 million, consisting of $0.2 million in operating lease expense for lease liabilities and $0.2 million in short-term lease cost.

Maturities of lease liabilities as of June 30, 2020 are as follows:

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Notes payable consists of the following:

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

The Company paid $0.1 million and $0.08 million in interest on notes for the six months ended June 30, 2020 and 2019, respectively.

Maturities on notes payable as of June 30, 2020, are as follows:

Year ending December 31:

On January 15, 2020, the Company entered into a loan agreement (the “Loan Agreement”) between the Company which includes its wholly-owned subsidiaries MotherLode LLC, an Oregon limited liability company, Big Bottom Distilling, LLC, an Oregon limited liability company, Craft Canning + Bottling, LLC, an Oregon limited liability company, Redneck Riviera Whiskey Co., LLC, a Tennessee limited liability company, and Outlandish Beverages LLC, an Oregon limited liability company collectively, (the “Borrowers” and each a “Borrower”) and Live Oak Banking Company, a North Carolina banking corporation (the “Lender”) to refinance existing debt of the Borrowers and to provide funding for general working capital purposes. Under the Loan Agreement, the Lender has committed to make up to two loan advances to the Borrowers in an aggregate principal amount not to exceed the lesser of (i) $8,000,000 and (ii) a borrowing base equal to 85% of the appraised value of the Borrowers’ eligible inventory of whisky in barrels or totes less an amount equal to all service fees or rental payments owed by the Borrowers during the 90 day period immediately succeeding the date of determination to any warehouses or bailees holding eligible inventory (the “Loan”).

The Loan matures on January 14, 2021 (the “Maturity Date”). On the Maturity Date, all amounts outstanding under the Loan will become due and payable. The Lender may at any time demand repayment of the Loan in whole or in part, in which case the Borrowers will be obligated to repay the Loan (or portion thereof for which repayment is demanded) within 30 days following the date of demand. The Borrowers may prepay the Loan, in whole or in part, at any time without penalty or premium.

The Loan bears interest at a rate equal to the prime rate plus a spread of 2.49%, adjusted quarterly. Accrued interest is payable monthly, with the final installment of interest being due and payable on the Maturity Date. The Borrowers are also obligated to pay a servicing fee, unused commitment fee and origination fee in connection with the Loan. The Company paid $0.2 million in interest as of June 30, 2020.

The Loan Agreement contains affirmative and negative covenants that include covenants restricting each Company’s ability to, among other things, incur indebtedness, grant liens, dispose of assets, merge or consolidate, make investments, or enter into restrictive agreements, subject to certain exceptions.

The obligations of the Borrowers under the Loan Agreement are secured by substantially all of their respective assets, except for accounts receivable and certain other specified excluded property.

The Loan Agreement includes customary events of default that include among other things, non-payment defaults, covenant defaults, inaccuracy of representations and warranties, cross default to material indebtedness, bankruptcy and insolvency defaults and change in control defaults. Under certain circumstances, a default interest rate will apply on all obligations during the existence of an event of default under the Loan Agreement at a per annum rate equal to 2.00% above the applicable interest rate.

In connection with the Loan Agreement, the Company issued to the Lender a warrant to purchase up to 100,000 shares of the Company’s common stock at an initial exercise price of $3.9425 per share (the “Warrant”). The Warrant expires on January 15, 2025. In connection with the issuance of the Warrant, the Company granted the Lender piggy-back registration rights with respect to the shares of common stock issuable upon exercise of the Warrant, subject to certain exceptions.

On January 16, 2020, in connection with the Company’s consummation of the Loan Agreement, Eastside repaid in full and terminated the Secured Line of Credit Promissory Note that Eastside had issued to TQLA, LLC (“Holder”) on November 29, 2019 (the “TQLA Note”). Since Eastside repaid the TQLA Note in full prior to its maturity date, the Common Stock Purchase Warrant that Eastside had issued to Holder on November 29, 2019 is not be exercisable and is cancelled. No prepayment or early termination penalties were incurred by Eastside as a result of repaying the TQLA Note. In addition, Eastside repaid in full and terminated the $3,000,000 credit and security agreement (the “Credit and Security Agreement”), by and between the Company and The KFK Children’s Trust, Jeffrey Anderson – Trustee (the “Lender”). The Company paid $27,015 in interest on the TQLA Note and $17,117 in interest on the Credit and Security Agreement during the first quarter of 2020.

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 owe 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 interest rate. 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 June 30, 2020. The Company complied with these conditions and was compliant with the terms of the Loan Agreement and Modification as of August 13. 2020.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Legal Matters

We are not currently subject to any material legal proceedings; however, we could be subject to legal proceedings and claims from time to time in the ordinary course of our business, 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.

Basic loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period, without considering any dilutive items. Diluted net loss per common share is computed by dividing net loss by the sum of the weighted average number of common shares outstanding and the potential number of any dilutive common shares outstanding during the period. Potentially dilutive securities consist of the incremental common stock issuable upon exercise of stock options and convertible notes. Potentially dilutive securities are excluded from the computation if their effect is anti-dilutive. There were no dilutive common shares at June 30, 2020 and 2019. The numerators and denominators used in computing basic and diluted net loss per common share in 2020 and 2019 are as follows:

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

Issuance of Common Stock

In January 2020, the Company issued 90,798 shares of common stock to directors, employees and consultants for stock-based compensation of $290,547. The shares were valued using the closing share price of our common stock on the date of grant of $3.20 per share.

On April 6, 2020, the Company issued 216,363 shares of common stock under the 2016 Equity Incentive Plan to directors, employees and consultants for stock-based compensation of $238,800. The shares were valued using the closing share price of the Company’s common stock on the date of the grant, $1.10 per share.

On May 22, 2020, the Company issued 45,553 shares of common stock to consultants for stock-based compensation of $72,885. The shares were valued using the closing share price of our common stock on the date of grant of $1.60 per share.

On May 28, 2020, 10,704 shares of common stock were retired that had previously been issued to an employee. The shares were valued at the cost at the time of issuance, ranging from $3.20 to $7.94.

Stock-Based Compensation

On September 8, 2016, the Company adopted the 2016 Equity Incentive Plan (the “2016 Plan”). Pursuant to the terms of the plan, on January 1, 2020, the number of shares available for grant under the 2016 Plan reset to 2,887,005 shares, equal to 8% of the number of outstanding shares of the Company’s capital stock, calculated on an as-converted basis, on December 31 of the preceding calendar year, and then added to the prior year plan amount. As of June 30, 2020, there have been 640,825 options and 886,869 restricted stock units (“RSUs”) issued under the 2016 Plan, with vesting schedules varying between immediate and five (5) years from the grant date.

On January 29, 2015, the Company adopted the 2015 Stock Incentive Plan (the 2015 Plan). The total number of shares available for the grant of either stock options or compensation stock under the 2015 Plan is 50,000 shares, subject to adjustment. The exercise price per share of each stock option will not be less than 20 percent of the fair market value of the Company’s common stock on the date of grant. At June 30, 2020, there were 5,417 options issued under the Plan outstanding, which options vest at the rate of at least 25 percent in the first year, starting 6-months after the grant date, and 75% in year two.

The Company also issues, from time to time, options that are not registered under a formal option plan. At June 30, 2020, there were no options outstanding that were not issued under the Plans.

A summary of all stock option activity at and for the six months ended June 30, 2020 is presented below:

The aggregate intrinsic value of options outstanding at June 30, 2020 was $0.

At June 30, 2020, there were 148,375 unvested options with an aggregate grant date fair value of $367,362. The unvested options will vest in accordance with the vesting schedule in each respective option agreement, which varies between immediate and five (5) years from the grant date. The aggregate intrinsic value of unvested options at June 30, 2020 was $0. During the six months ended June 30, 2020, 34,889 options became vested.

The Company uses the Black-Scholes valuation model to measure the grant-date fair value of stock options. The grant-date fair value of stock options issued to employees is recognized on a straight-line basis over the requisite service period. Stock-based awards issued to nonemployees are recorded at fair value on the measurement date and are subject to periodic market adjustments as the underlying stock-based awards vest.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

To determine the fair value of stock options using the Black-Scholes valuation model, the calculation takes into consideration the effect of the following:

The calculation includes several assumptions that require management’s judgment. The expected term of the options is calculated using the simplified method described in GAAP. The simplified method defines the expected term as the average of the contractual term and the vesting period. Estimated volatility is derived from volatility calculated using historical closing prices of common shares of similar entities whose share prices are publicly available for the expected term of the options. The risk-free interest rate is based on the U.S. Treasury constant maturities in effect at the time of grant for the expected term of the options.

The Company did not issue any additional options during the six months ended June 30, 2020.

For the six months ended June 30, 2020 and 2019, total stock compensation expense related to stock options was $149,074 and $596,852, respectively. At June 30, 2020, the total compensation cost related to stock options not yet recognized is approximately $367,362, which is expected to be recognized over a weighted-average period of approximately 1.62 years.

Warrants

During the six months ended June 30, 2020, the Company issued an aggregate of 100,000 common stock warrants in connection with the Secured Credit Facility from Live Oak Bank. The estimated fair value of the warrants of $97,800 was recorded as debt issuance cost and will be amortized to interest expense over the maturity period of the secured credit facility, with $48,900 recorded in the six months ended June 30, 2020. Warrants issued to three shareholders during 2017 and 2018 vest quarterly for 3 years and resulted in $13,383 worth of amortization expense for the six months ending June 30, 2020.

The estimated fair value of the warrants at issuance was based on a combination of closing market trading price on the date of issuance for the warrants, and the Black-Scholes option-pricing model using the weighted-average assumptions below:

No warrants were exercised during the six months ended June 30, 2020.

A summary of activity in warrants is as follows:

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

The following is a description of transactions since January 1, 2019 as to which the amount involved exceeds the lesser of $120,000 or one percent (1%) of the average of our total assets at year-end for the last two completed fiscal years which was $311,118 and in which any related person has or will have a direct or indirect material interest, other than equity, compensation, termination and other arrangements.

On June 11, 2019, our Board appointed Owen Lingley to the Board to fill an existing vacancy on the Board effective immediately. Owen Lingley is the founder of Craft Canning, LLC, which was acquired by the Company on January 11, 2019 and subsequently changed its name to Craft Canning + Bottling LLC. In connection with the acquisition of Craft Canning, Mr. Lingley received $1,843,200 in cash, 338,212 shares of common stock of the Company and a promissory note in the aggregate principal amount of $731,211, which bears interest at a rate of 5% per annum and matures on January 11, 2022. The shares acquired by Mr. Lingley in connection with the acquisition of Craft Canning are subject to a one-year lock-up restriction and have “piggyback” registration rights effective after the one-year lock-up. Mr. Lingley resigned from the Board on November 18, 2019.

In addition, the Company also issued to Mr. Lingley a warrant to purchase 146,262 shares of common stock of the Company at $7.80 per share and an exercise period of three years. The shares of common stock issuable upon exercise of the warrant will be subject to the same “piggyback” registration rights as the shares received in connection with the acquisition of Craft Canning, described above.

Following the acquisition of Craft Canning, Mr. Lingley became non-executive Chairman of Craft Canning and was party to a consulting agreement with the Company. Under his consulting agreement with the Company, Mr. Lingley was to receive annual cash compensation of $75,000 per year. Mr. Lingley resigned as non-executive Chairman of Craft Canning in January 2020, and under the terms of his consulting agreement 146,262 warrants were cancelled.

On October 24, 2019, our Board appointed Stephanie Kilkenny to the Board to fill an existing vacancy on the Board effective immediately. Mrs. Kilkenny was the former managing director of Azuñia Tequila, and 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 is entitled to receive up to 93.88% of the aggregate consideration payable under the asset purchase agreement. Subject to compliance with applicable Nasdaq rules, the aggregate initial consideration will be payable approximately 18 months following the closing and will consist of 850,000 shares of Company common stock at a stipulated value of $6.00 per share, 350,000 shares of Company common stock based on the Company’s stock price twelve months after the close of the transaction, and additional shares based on the Azuñia business achieving certain revenue targets and the Company’s stock price 18 months after the close of the transaction. The Company has also agreed to issue additional stock consideration (subject to compliance with applicable Nasdaq rules) of up to $1.5 million upon the Azuñia business achieving revenue of at least $9.45 million in the period commencing on the 13th month following the closing and ending on the 24th month following the closing.

In addition, on September 16, 2019, the Company entered into a Subscription Agreement with Stephanie Kilkenny’s spouse, Patrick J. Kilkenny as Trustee For Patrick J. Kilkenny Revocable Trust (the “Kilkenny Trust”), in reliance on the exemption from registration afforded by Section 4(a)(2) of the Securities Act and Rule 506(b) promulgated thereunder, pursuant to which the Company agreed to issue and sell to the Kilkenny Trust an aggregate of 55,555 units at a per unit price of $4.50. Each unit consists of one share of the Company’s common stock and a three-year warrant to acquire 0.5 shares of common stock at an exercise price of $5.50 per share.

Effective November 29, 2019, the Company issued to TQLA, LLC, a California limited liability company (“Holder”), a Secured Line of Credit Promissory Note (the “Note”) for a revolving line of credit in the aggregate principal amount of $2,000,000. The Note matures on April 15, 2020 and may be prepaid in whole or in part at any time without penalty or premium. Repayment of the Note is subject to acceleration in the event of an event of default. The Company may use the proceeds to purchase tequila for its Azuñia product line and for general corporate purposes, as approved by the Holder. As of December 31, 2019, the Company has borrowed $946,640 on the Note. Stephanie Kilkenny, a director of the Company, owns and controls TQLA, LLC with her spouse. The Company’s Audit Committee approved the transaction. The Note was paid in full in January 2020.

Eastside Distilling, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

June 30, 2020

(Unaudited)

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

On July 18, 2020, the Company issued 44,501 shares of common stock under the 2016 Plan to directors, employees and consultants for stock-based compensation of $86,500. The shares were valued using the closing share price of the Company’s common stock on the date of the grant, $1.18 per share.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes. This section of the Quarterly Report includes “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:

You should not place undue certainty on these forward-looking statements which speak only as of the date made, and except as required by law, we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Factors that could cause differences include, but are not limited to, customer acceptance risks for current and new brands, reliance on external sources on financing, development risks for new products and brands, dependence on wholesale distributors, inventory carrying issues, fluctuations in market demand and customer preferences, as well as general conditions of the alcohol and beverage industry, and other factors discussed in Item 1A of Part I of our annual report on Form 10-K for the year ended December 31, 2019 entitled “Risk Factors,” similar discussions in subsequently filed Quarterly Reports on Form 10-Q, including this Form 10-Q, as applicable, and those contained from time to time in our other filings with the Securities and Exchange Commission.

Use of Non-GAAP Financial Information – Certain matters discussed in this report, including the information presented in Part I under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” include measures that are not measures of financial performance under U.S. Generally Accepted Accounting Principles (GAAP). These non-GAAP measures should not be considered in isolation or as a substitute for any measure derived in accordance with GAAP, and also may be inconsistent with similarly titled measures presented by other companies. In Part I under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we present the reasons we use these measures under the heading of “Non-GAAP Financial Measures,” and reconcile these measures to the most closely comparable GAAP measures under the heading “Results of Operations – Year-Over-Year Comparisons.”

Business Overview

Eastside Distilling (the “Company,” “Eastside Distilling,” “we,” “us,” or “our, below) was incorporated under the laws of Nevada in 2004 under the name of Eurocan Holdings, Ltd. In December 2014, we changed our corporate name to Eastside Distilling, Inc. to reflect our acquisition of Eastside Distilling, LLC. We manufacture, acquire, blend, bottle, import, export, market and sell a wide variety of alcoholic beverages under recognized brands. We currently employ 85 people in the United States.

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

Our mission is to build craft inspired experiential brands and high-quality artisan products around premium spirits and Ready to Drink (“RTD”) craft cocktails. We are focusing our core competency around brands, products marketing and distribution. We will build our branded spirits and mobile canning and bottling service division both organically and through acquisition to capture growth in the spirits, wine, beer, and RTD categories. Our growth in the mobile canning and bottling services is being driven through Craft Canning + Bottling, LLC (“Craft Canning”).

Our partnership capabilities were first demonstrated by our licensing and launch of our Redneck Riviera Whiskey brands (“RRW”). Our RRW brand went from idea, to market roll-out in less than nine months and achieved national distribution in 49 states within 18 months. We proved how our team could leverage its market position to successfully launch a nascent or new brand, while demonstrating our ability to focus and dedicate more of our attention to developing innovative products.

In May 2017, we used our shares to acquire 90% of Big Bottom Distilling, LLC (“BBD”), known for its award-winning, super-premium gins and whiskeys, and American Single Malt Whiskey. BBD’s super-premium spirits give us a presence at the “ultra-premium segment” of the market. In December 2018, we acquired the remaining 10% of BBD. In September 2019, we also acquired the high-end, luxury tequila brand, Azuñia, to complement our portfolio and provide us with a larger established brand in the high-growth tequila category. In addition, through MotherLode Craft Distillery (“MotherLode”), our wholly-owned subsidiary acquired in March 2017 and Craft Canning + Bottling, LLC (formerly known as Craft Canning, LLC) (“Craft Canning”), which we acquired in January 2019, we provide contract bottling, canning, and packaging services for existing and emerging beer, wine and spirits producers. We intend to use our mobile canning operations to profit from the rapid growth in the canned beverages industry. As the COVID-19 pandemic developed, craft brewers turned to mobile canning to support their operations as the market transitioned from kegged beer to canned beer.

Recent Developments

COVID-19. As a result of governmental and self-imposed restrictions due to the COVID-19 pandemic, there has been a shift in on and off-premise demand. On-premise business such as bars and restaurants have been closed leading to a decline in demand of the Azuñia brand which has been a predominately on-premise brand that we are actively seeking to expand wholesale. 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. However, in Oregon the Portland Potato Vodka 1.75L has shown a dramatic increase in sales. Additionally, our Craft Canning operation has seen strong sales and customer bookings for mobile canning that have extended beyond the normal peak season. We believe this is a result of the transition from the use of kegs for on premise to the preference for cans for wider off-premise usage. This trend has been dramatic and has resulted in shortages of available can stock. However, the Company believes it has sourced enough cans to supply its current business plan.

Available Information

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

Results of Operations

Overview

Since 2018, Eastside Distilling has transformed from a small regional craft distiller serving the northwest, principally Oregon, to a nationally recognized purveyor of high quality above premium spirit brands throughout the United States. We have grown organically as well as through brand licensing and acquisitions. In 2019 we acquired Craft Canning + Bottling, LLC (“Craft Canning”), a mobile canning and bottling company driving growth in our non-spirits and service revenue. Additionally, we introduced three brand extensions acquired the Azuñia tequila brand, fueling growth in spirits sales.

Our mission is to build craft inspired experiential brands and high-quality artisan products around premium spirits and Ready to Drink (“RTD”) craft cocktails. We will focus our core competency around brands, product marketing and distribution. We are building our branded spirits and mobile canning and bottling service division both organically and through acquisition to capture growth in the spirits, wine, beer, and RTD categories. Our growth in the mobile canning and bottling services is being driven through Craft Canning.

Our partnership capabilities were first demonstrated by our licensing and launch of our Redneck Riviera Whiskey brands (“RRW”). Our RRW brand went from idea, to market roll-out in less than nine months and achieved national distribution in 49 states within 18 months. We grew RRW from zero at the beginning of 2018 to approximately 27,000 cases for 2019 in less than two years. We proved how our team could leverage its market position to successfully launch a nascent or new brand, while demonstrating our ability to focus and dedicate more of our attention to developing innovative products.

We have expanded distribution to approximately 10,000 points of distribution for Redneck Riviera Whiskey, which we consider to be our gateway to grow our other brands regionally through our national platform. We believe we are also positioned to simplify our business model and manage both an in-house and outsourced scalable production model and outsourced fulfilment and logistics to keep up with demand.

During the first quarter of 2020, the Company 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. The retail operations have been reported as discontinued operations in the accompanying unaudited condensed consolidated financial statements. In the current year, the income, expense and cash flows from retail 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.

Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30, 2019

Sales

Our sales for the three months ended June 30, 2020 increased to $4.3 million, or approximately 7%, from $4 million for the three months ended June 30, 2019. The following table compares our sales in the three months ended June 30, 2020 and 2019, and excludes the retail tasting room sales that have been classified as discontinued operations:

(Dollars in thousands)

The increase in sales in the three months ended June 30, 2020 is primarily driven by increases in wholesale sales. Wholesale sales increased primarily due to the acquisition of the Azuñia tequila brand in September 2019, which accounted for $0.5 million increase over last year as well as a $0.1 million increase in sales of the Portland Potato Vodka brand which was partially offset by a $0.2 million decrease in Redneck Riviera brand sales. Canning and bottling revenue increased $0.1 million year over year primarily due to the shift in demand for craft beer in cans rather than kegs during the second quarter as customers adapted to changing consumer preferences due to the COVID-19 pandemic, which accounted for a $0.9 million increase in mobile canning revenue which was partially offset a $0.2 million decrease in mobile bottling revenue and a $0.6 million decrease in co-packing revenue.

Customer programs and excise taxes

Customer programs and excise taxes for the three months ended June 30, 2020 remained flat at $0.3 compared to the same 2019 period.

Cost of Sales

Cost of sales consists of the costs of ingredients utilized in the production of spirits, manufacturing labor and overhead, warehousing rent, packaging, and in-bound freight charges. During the three months ended June 30, 2020, cost of sales increased to $2.4 million, or approximately 5%, from $2.3 million for the three months ended June 30, 2019. The increase is attributable to the costs associated with our increased sales in the period. The cost of sales we reported in both the first half of 2020 and 2019 are based on small production lots. Our objective is to achieve economies of scale as we continue to focus on our operations and with the objective to drive improvement in our per unit cost of sales, which is likely to include expanding our outsourced production.

Gross Profit

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

The following table compares our gross profit and gross margin in the three months ended June 30, 2020 and 2019:

(Dollars in thousands)

Gross Margin

Our gross margin of 39% of net sales in the three months ended June 30, 2020 increased from our gross margin of 38% for the three months ended June 30, 2019 primarily due to a change in product and services mix. Our goal is to improve our overall gross margin by increasing the efficiencies of our production facility and evaluate outsourced production as a means to lower cost of goods sold. As we generate increased volumes, our margins may continue to fluctuate as a result of other key factors: raw material costs which tend to fluctuate, product and service sales mix and the related customer programs, which are subject to seasonal fluctuations and the competitive environments.

Sales and Marketing Expenses

Sales and marketing expenses for the three months ended June 30, 2020 decreased to $1.1 million, or approximately 14%, from $1.3 million for the three months ended June 30, 2019. This decrease is primarily due to a $0.4 million decrease in tactical marketing spend over the same period last year as well as a $0.1 million decrease in travel and entertainment due to COVID-19 travel restrictions and was partially offset by a $0.3 million increase in sales and marketing compensation.

General and Administrative Expenses

(Dollars in thousands)

General and administrative expenses for the three months ended June 30, 2020 decreased to $2.3 million, or approximately 17%, from $2.8 million for the three months ended June 30, 2019. This decrease is primarily due to a decrease in legal and professional fees and rent, insurance and other miscellaneous general and administrative costs and is 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 expense, net was $0.3 million for the three months ended June 30, 2020, compared to $0.1 million for the three months ended June 30, 2019, an increase of 176%. This increase was primarily due to higher interest expense on increased notes payable, secured line of credit and accounts receivable factoring programs in 2020.

Net Loss

Net loss attributable to common shareholders during the three months ended June 30, 2020 was $2.2 million as compared to a loss of $2.9 million for the three months ended June 30, 2019. The decrease in our net loss was primarily attributable to an $0.4 million increase in canning and bottling service revenue as well as a $0.5 million decrease in general and administrative expense and $0.2 million decrease in selling and marketing expenses.

Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019

Sales

Our sales for the six months ended June 30, 2020 increased to $8.0 million, or approximately 7%, from $7.5 million for the six months ended June 30, 2019. The following table compares our sales in the six months ended June 30, 2020 and 2019, and excludes the retail tasting room sales that have been classified as Discontinued Operations:

(Dollars in thousands)

The increase in sales in the six months ended June 30, 2020 is primarily driven by increases in wholesale sales. Wholesale sales increased primarily due to the acquisition of the Azuñia tequila brand in September 2019, which accounted for $1.4 million increase over last year as well as a $0.1 million increase in Portland Potato Vodka brand sales which was partially offset by a decrease of $0.5 million in sales of Redneck Riviera Whiskey over the same period last year. Our canning and bottling revenue decreased year over year due to slowdowns in co-packing and mobile bottling sales which was offset by an increase in mobile canning driven by the shift in demand for craft beer in cans vs. kegs due to COVID-19 exiting the first quarter and continuing through the second quarter.

Customer programs and excise taxes

Customer programs and excise taxes for the six months ended June 30, 2020 increased to $0.6, or approximately 73%, from $0.4 for the comparable 2019 period. The increase was attributable to higher federal excise tax expense, as well as an increase in customer programs due to increased distribution.

Cost of Sales

Cost of sales consists of the costs of ingredients utilized in the production of spirits, manufacturing labor and overhead, warehousing rent, packaging, and in-bound freight charges. During the six months ended June 30, 2020, cost of sales increased to $5.0 million, or approximately 8%, from $4.6 million for the six months ended June 30, 2019. The increase is attributable to the costs associated with our increased sales in the period as well as a change in product mix with increased sales of goods that carry a higher cost of sales and decreased sales of services that carry a lower cost of sales. The cost of sales we reported in both the first quarter of 2020 and 2019 are based on small production lots. Our objective is to achieve economies of scale as we continue to focus on our operations and with the objective to drive improvement in our per unit cost of sales, which is likely to include expanding our outsourced production.

Gross Profit

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

The following table compares our gross profit and gross margin in the six months ended June 30, 2020 and 2019:

Gross Margin

Our gross margin of 33% of net sales in the six months ended June 30, 2020 decreased from our gross margin of 35% for the six months ended June 30, 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 of our production facility and evaluate outsourced production as a means to lower cost of goods sold. As we generate increased volumes, our margins may continue to fluctuate as a result of other key factors: raw material costs which tend to fluctuate, product and service sales mix and the related customer programs, which are subject to seasonal fluctuations and the competitive environments.

Sales and Marketing Expenses

Sales and marketing expenses for the six months ended June 30, 2020 increased to $2.8 million, or approximately 11%, from $2.6 million for the six months ended June 30, 2019. This increase is primarily due to a $0.7 million increase in sales and marketing compensation related to the increased headcount from the acquisition of the Azuñia tequila brand which was partially offset by a $0.3 million decrease in tactical marketing spend as well a $0.2 million decrease in travel and entertainment due to COVID-19 travel restrictions.

General and Administrative Expenses

(Dollars in thousands)

General and administrative expenses for the six months ended June 30, 2020 decreased to $4.5 million, or approximately 17%, from $5.4 million for the six months ended June 30, 2019. This decrease is primarily due to a decrease in compensation and benefits, legal and professional fees and rent, insurance and other miscellaneous general and administrative costs and is 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 expense, net was $0.6 million for the six months ended June 30, 2020, compared to $0.2 million for the six months ended June 30, 2019, an increase of 179%. This increase was primarily due to higher interest expense on increased notes payable, secured line of credit and accounts receivable factoring programs in 2020.

Net Loss

Net loss attributable to common shareholders during the six months ended June 30, 2020 was $5.7 million as compared to a loss of $5.9 million for the six months ended June 30, 2019. The decrease in our net loss was primarily attributable to a $0.9 million reduction in general and administrative expense partially offset by a $0.4 increase in interest expense and a $0.3 increase in sales and marketing expense.

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 six months ended June 30, 2020 and 2019, we incurred a net loss of approximately $5.7 million and $5.9 million, respectively, and had an accumulated deficit of approximately $49.9 million as of June 30, 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 six months ended June 30, 2020, we raised approximately $3.6 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 six months ended June 30, 2020, we consumed $1.6 million of our inventories.

To help ensure adequate liquidity in light of uncertainties posed by the COVID-19 pandemic, the Company applied for and has received a loan of $1.4 million under the U.S. government Paycheck Protection Program (“PPP Loan”). On April 23, 2020, the Small Business Administration issued new guidance that questioned whether a public company with substantial market value and access to capital markets would qualify to participate in the Paycheck Protection Program. Should we be audited or reviewed by the U.S. Department of the Treasury as a result of filing an application for forgiveness or otherwise, such audit or review could result in the diversion of management’s time and attention and legal and reputational costs. If we were to be audited and receive an adverse finding in such audit, we could be required to return the full amount of the Paycheck Protection Program loan, which could reduce our liquidity, and potentially subject us to fines and penalties.

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 owe 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 interest rate. 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 June 30, 2020. The Company complied with these conditions and was compliant with the terms of the Loan Agreement and Modification as of August 13. 2020.

At June 30, 2020, we had approximately $1.9 million of cash on hand with a positive working capital of $0.4 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, 11 and 16 to our financial statements for a description of our debt and the debt financing initiatives completed in the first half of 2020. If we are unable to obtain additional financing, or additional financing is not available on acceptable terms, we may seek to sell assets, reduce operating expenses or reduce or eliminate marketing initiatives, and take other measures that could impair our ability to be successful.

Our cash flow related information for the six months ended June 30, 2020 and 2019 are as follows:

(Dollars in thousands)

Operating Activities

Total cash used from operating activities was $2.1 million compared to $6.2 million during the six months ended June 30, 2019. The decrease in cash usage can primarily be attributed to a decrease in cash expenses and an increase in non-cash operating expenses, including depreciation and amortization from acquisitions and leasehold improvements and stock issued for services. The $1.6 million reduction in inventory during the six months ended June 30, 2020 was partially offset by a $0.8 million decrease in accounts payable. Additionally, $0.2 million less cash was used in discontinued operations in 2020 compared to 2019.

Investing Activities

Cash used in investing activities consists primarily of acquisitions and purchases of property and equipment. We incurred capital expenditures of $0.1 million and $2.1 million in the six months ended June 30, 2020 and 2019, respectively. Proceeds from sales of fixed assets totaled $0.2 million for the six months ending June 30, 2020. Net cash used in the acquisition of Craft Canning in the six months ended June 30, 2019 was $1.4 million.

Financing Activities

Net cash flows provided by financing activities during the six months ended June 30, 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, $1.4 million of proceeds from the Paycheck Protection Program and $0.1 million in proceeds from debt borrowing on an existing line of credit with our bank. During the six months ended June 30, 2019, our operating losses and working capital needs were primarily funded by existing cash on hand.

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.

Management believes that there have been no significant changes to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on form 10-K for the fiscal year ended December 31, 2019.

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 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4 – CONTROLS AND PROCEDURES

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

We conducted an evaluation (pursuant to Rule 13a-15(b) of the Exchange Act)), under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officers, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e)) as of the end of the period covered by this report. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of June 30, 2020.

As of the end of the period covered by this report, there have been no changes in internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the quarter ended June 30, 2020, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

We are not currently subject to any material legal proceedings; however, we could be subject to legal proceedings and claims from time to time in the ordinary course of our business, 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 1A – RISK FACTORS

There have been no material changes in our risk factors from those previously disclosed in our annual report on Form 10-K for the year ended December 31, 2019 and incorporated therein by reference.

The impacts of the COVID-19 pandemic could adversely affect our business, and other similar crises could result in similar or other harms.

Our business is susceptible to disruption from any number of possible crisis. 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. Consumers 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 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 or best practices) 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 financials and lending markets, a requirement by the government that we repay our PPP Loan if it determines we did not act in good faith, or other matters.

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.

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

In January 2020, the Company issued 87,700 shares of common stock to directors, employees and consultants for stock-based compensation of $280,633. The shares were valued using the closing share price of our common stock on the date of grant of $3.20 per share.

On April 6, 2020, the Company issued 216,363 shares of common stock under the 2016 Equity Incentive Plan to directors, employees and consultants for stock-based compensation of $238,800. The shares were valued using the closing share price of the Company’s common stock on the date of the grant, $1.10 per share.

On May 22, 2020, the Company issued 45,553 shares of common stock to consultants for stock-based compensation of $72,885. The shares were valued using the closing share price of our common stock on the date of grant of $1.60 per share.

On May 28, 2020, 10,704 shares of common stock were retired that had previously been issued to an employee. The shares were valued at the cost at the time of issuance, ranging from $3.20 to $7.94.

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

ITEM 3 – DEFAULT UPON SENIOR SECURITIES

None.

ITEM 4 – MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5 – OTHER INFORMATION

ITEM 6 – EXHIBITS

SIGNATURES

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