Eastside Distilling, Inc.

Hi, everyone, and welcome to the East Side Distilling fourth quarter 2022 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would now like to turn the conference over to Amy Broussard, Corporate Secretary.

Please go ahead. Thank you. Good afternoon, everyone, and thank you for joining us today to discuss Eastside Distilling's financial results for the fourth quarter and year-end 2022. I'm Amy Broussard, Eastside's Corporate Secretary, and I'll be your moderator for today's call. Joining us on today's call to discuss these results are Mr. Jeffrey Gwynn, the company's Chief Executive Officer and Chief Financial Officer, Ms. Amy Lancer, Eastside's Chief Commercial Officer, Ms. Tiffany Milton, Eastside's Controller, and Mr. Bruce Wells, Crafts Controller. Following their remarks, we will open the call to your questions. Now, before we begin with prepared remarks, we submit for the record the following statement. Certain matters discussed on the conference call today by the management of Eastside Distilling may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended, Section 21E of the Securities Exchange Act of 1934 as amended, And such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements describe future expectations, plans, results, or strategies and are generally preceded by the words such as may, future, plan or planned, will or should, expected, anticipates, draft, eventually, or projected. Listeners are cautioned that such statements are subject to a multitude of risks. and uncertainties that could cause future circumstances, events, or results to differ materially from those projected in the forward-looking statements. Such matters involve risks and uncertainties that may cause actual results to differ materially include but are not limited to the company's acceptance and the company's product in the market, success in obtaining new customers, success in product development, ability to execute the business model and strategic plans, success in integrating acquired entities and assets, ability to obtain capital, ability to continue its going concerns, and all of the risks and related information described from time to time in the company's filings with the Securities and Exchange Commission, including the financial statements and related information pertaining to the company's annual report on Form 10-K for the year ended December 31st, 2022, filed with the Securities and Exchange Commission. Now, with that said, I'd like to turn the call over to Jeffrey Gwynn. Jeffrey, please proceed.

Welcome to Eastside's fourth quarter 2022 earnings conference call. I'm Jeffrey Gwynn, the interim CEO and CFO, and appreciate your interest in our company. 2022 was a transformational year for Eastside Distilling. The business we have today is very different from that of last year or the year prior. The most obvious change is at Kraft, our beverage services business. Last year, we built out and began operating a state-of-the-art digital can printing plant in Portland, Oregon. To remind everyone on the call, this is the only digital direct-to-can decorating operation in the Pacific Northwest. This new facility allows us to create extraordinary can design for the craft beverage segment that is 100% recyclable and doesn't use plastic shrink sleeves or sticker labels. The cans we are now producing are important marketing tools for our customers. I've been stating this for the past three quarters, that this technology, I believe, will transform the craft beverage space. It's a critical tool for them. And I believe we are seeing that proof now. We've converted nearly all of our existing customer base to this 100% recyclable product, and we've won many new customers. Moreover, we've watched as a number of our customers have really fully embraced the capabilities of this new technology, and they're using it successfully at retail. Now, if you've followed the company over the past few quarters and the past year, getting this investment at Kraft up and running has been a huge challenge. I mean, think about it. It's a brand-new product. It's new technology. It's a new market for us. We've had to build a new plant, install a new team, build new processes, it's been a huge undertaking. And initially, we had projected a faster ramp-up to full capacity, but we faced a steep learning curve that impacted our ability to get to scale through last year. Now, while printing performances improved in 2022, the fourth quarter was particularly challenging as we had to address the bottlenecking, among many other issues that were inhibiting our ability to achieve that full capacity that we're looking for. Seasonal slowness in the beer category, a core part of our current customer set in the fourth quarter, gave us a chance to improve our processes in printing, but it meant not achieving that full capacity in the quarter. So that had a negative impact on the gross margin in the quarter, and you can see that in the numbers. Each challenge we faced, though, during the year, we sorted out a solution for the credit of the team. We improved our processes, and we always served our customers. And we did the same thing in the fourth quarter. Now, as we sit here now on the last day of the first quarter of 2023, I can say our performance this quarter will be much better. Although coming out of the year, we started generation very low. We've seen sequential, uh, improvement in January, February, and March. And in March, we've printed well over a million cans alone this month, a record for us and mobile. We've also made a number of improvements in the fourth quarter and the first part of this year, and we expect better performance there as well. But now let me turn to our spirits business. Light Crafted had its own challenges, and in 2022, we made a very hard decision to reposition our Zunia tequila brand in retail channels where we would be able to make an adequate return on all the investment spending. This meant exiting a number of distribution deals where we were effectively losing money. So each quarter of last year, we saw volumes decline, and they continued doing that in the fourth quarter. But at the same time, we are working on improving our distribution partnerships in all our focus states. Now, walking away from this volume is hard to do, but it was critical for the long-term success of the companies. Now, we have completed this realignment of investment in Azunia with restructuring actions that took place in the first quarter of this year. And this completes a big shift from an overinvestment in Azunia to a more balanced approach that allows us to leverage the opportunity in both Portland Potato Vodka and Burnside, our other portfolio brands. In addition, you will see that we've written down a large portion of the goodwill associated with the Azunia acquisitions. We continue to look across our brand portfolio and target the most attractive segments to invest our scarce capital. And given our high cost of capital, this is exactly the disciplined approach we have lacked in the past. Let's go. We're going to stay at it. Overinvestment in Azunia has meant an underinvestment in the Oregon brand. That underinvestment is reflected in their volume performance in the fourth quarter. But rest assured, we will be increasing our investment there in the Oregon portfolio in 2023, and we expect to see significant improvements. Now, over the course of the year, I've heard from many of you expressing a general frustration of the performance of our stock, and I, too, share that frustration. I bought a lot myself early last year, and I know many of you want an immediate solution that will unlock the value of that we all believe is in this company for all stakeholders. In December, the board, along those lines, instructed the company and me to consider the potential sale of Spirit Brands, one or all, and we put every option on the table and gone through a process that's not complete to date. We do anticipate that we will be wrapping that process up shortly. And while I'm not in a position to answer any questions on that topic today, I can assure you that we will be updating you all once the process has been completed. Now, Tiffany will take you through our year-end results in a moment, but I first would like to give you some rough guidance on what to expect from us this year. We have set a goal to be even at positive for both Kraft and Spirit in the Spirit's business by the third quarter. Kraft will likely hit that mark sooner than Spirit's. We expect improving trends in SPIRITS volumes and strong growth at CRAFFT due to our digital printing investment. These goals will not be easy to achieve, but I believe we have put a thorough plan together and we have it in place. The board has approved it, and if we execute it, we will achieve these goals. With that said, I'll turn the call over to Tiffany, who will cover more details, and then we can get into some questions.

Thank you, Jeff, and thank you all again for joining our call today. Let's review the fourth quarter. On a consolidated basis, our growth sales were over 2 million for the fourth quarter of 22 compared to almost 3 million for the fourth quarter of 21. Spirit sales were 1.1 million for 22 compared to 1.4 million for 21 due to volume softness in Azunia as we reduced discounting and had soft holiday sales. Craft sales were 1.2 million for 22 and $1.4 million for 2021, reflecting our continued challenges in mobile canning, and we experienced some unexpected seasonality in can printing during the holidays. Our consolidated gross profit was negative $148,000 for Q4 2022, compared to positive $598,000 for Q4 2021. Our consolidated gross margins were negative 6% for 2022 and positive 23% for 2021, Spirits margins were 13% for 22 and 38% for 21, and craft had margins of negative 23% for 22 and positive 10% for 21. Craft margins are expected to continue to improve as we build volume of printed cans, as Jeff mentioned earlier. Adjusted EBITDA was negative 1.6 million for 22 and negative 1.5 million for 21 due to the continued softness in both businesses. In addition, we recorded an impairment loss related to our Zunia brand of $7.5 million. Turning to the balance sheet, we raised a net of almost $2 million during the fourth quarter of 2022, ending with cash of $700,000 as we continued to pay down debt, which we've fully repaid all loans at Kraft. These financial results were not what we expected to deliver, but we believe we are now better positioned in spirit as we've eliminated unprofitable volume and reestablished ourselves with our distributors, At Kraft, we printed a million cans during March, and we are focusing only on profitable mobile customers. We are excited about the outstanding growth of the printer for the remainder of the year. As Jeff said, we are also expecting better results from the continued restructuring of both businesses, which will be more apparent in coming quarters. We will now open the floor for questions. Operator?

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster.

Our first question comes from James Watson, a private investor.

Please go ahead.

Hi, Geoffrey. I was looking at a full year's adjusted EBITDA margin. It's roughly a negative of 30%. And if I heard you correctly, we are targeting a positive EBITDA by quarter three, if I'm not wrong. So the swing will be quite to be a break-even level, what gives us the confidence that we will reach there?

Sure. So the way I think you need to look at this business, as I referenced in my remarks, is it's really a completely different business than what you've seen before the company. I mean, in the past, we've had a mobile canning operation, which for the people that are new on the call, that's a business where you basically pick a small mini canning line to a brewery and you fill cans there. And we've transitioned to a big plant that does high quality, super high end digital graphic printing. And then we can also do the mobile filling too. But the point there is, is that In the fourth quarter, you saw a pretty big gross margin missed by Kraft, and that's a function of the fact that we didn't get enough ramp up of cans in the fourth quarter. We went from not having any digital printing to having the only plant in the Pacific Northwest in less than a year, and we converted 100% of our customers in less than a year. Now, beyond that, you have to ramp up and add a lot more customers who are going from you know, buying a few million cans a year. And now we're in a, you know, a different game. We're in a game where we're buying, you know, 20 plus million cans a year. So what will get us to that EBITDA positive number is three things. It's getting the mobile, I'm sorry, the digital printing business to a point where we're doing over a million and a half cans a month. And just to correct the number, it was actually this month. I think we're close to 1.2. Now, that number is not a number that's written in stone because it depends on what cans and the margins and how we've sourced cans and what customer base it's going to. But suffice it to say, we hit that number and we're moving through that number and heading north of that number. We're generating positive EBITDA at Kraft. And then in spirits, you're going to see something else happen in there. You'll see we've done quite a bit of restructuring in spirits. We've reduced the workforce significantly, really focused our sales on this core portfolio brand, and we believe that that business with some production restructuring is going to also turn around and generate even that. And then in corporate, we've shrunk our corporate headcount pretty significantly by half. And that's going to be the last piece. So I have a lot of confidence we're going to get there. This is a complicated business for the size it is, since it is multiple businesses. But the teams are focused, the plans in place. We have a couple things left to do in spirits, and then we're fully locked in. But I have every confidence that we're on our way to a much better year this year.

Yeah, I just want to do a follow-up because if we look at the gross profit margin for Kraft Canning, I think it's been a negative gross profit margin for quarter four as well. So when we talk about wanting to be break even, right, how is that going to happen? Because we're not even seeing any positive cross margins at this point.

It's because you have a fixed expense In the Argyle facility, you have large lease payment. You have a team that we didn't have before, a printing team, support staff, right? And the losses that you saw in the year at Kraft are a function of putting that in place. And then it's a scramble to get that machine up and going, right? Get us to a point where you have enough customers on that machine that we're generating enough customers. you know, margin dollars to absorb that fixed cost. So, you know, once you sell a customer, right, and he's taken his supply chain away from traditional labels, that can decoration, he's going to come back for more unless he goes out of business, right? Or you disappoint and he goes back to the old label. We haven't had any of that happen. So the slowly building, adding customer's onboarding new customers to craft just means we're loading the volume on that machine, getting the utilization up. And as the gross margin dollars start to grow there, absorb the overhead, and then you see the margins change. So looking at the margins statically in the rear window is going to be way off where this is going to be going forward.

Got it. And also, I think it's a great thing to know that we are achieving EBITDA positive this year. My question is, how are we going to self-finance ourselves until we get to that level? Because assuming we are losing about 1 to 2 million per quarter, we kind of need about 3 to 4 million perhaps to tide us through until we become very even. So what are your thoughts around it?

Well, there's a couple of interesting things that we have going for us. On the one hand, Diva Dye is not the same as free cash flow. We have a large barrel inventory and we have more barrels today than we need. And so when we sell a bottle of vodka, we don't go and we have to rebuild that raw material. But in the case of bourbon, we're selling it and we're not actually able to place it. So Free cash flow is a bigger number in spirits than EBITDA, unless we turn on the spigot and spend a lot of money on CapEx, which we're not doing. So that helps the company. And the other thing that you have to think about is how we survive today. We've rationalized things that really are high value, not reflected on the balance sheet. And we did that throughout last year with taking advantage of you know, very high whiskey prices and funded the company as we, you know, executed our build out of craft. So I think those are some ways we can do it. Now, having said that, I'll be the first to admit, last year I was hoping that we would be in a position that we could accelerate growth at another machine, move faster, and equity markets obviously haven't, you know, helped us get there. You know, microcaps are not the beloved thing investment opportunities as they once were just a few years ago. So that window feels like it's closed to some degree. But, you know, this is a situation where I really believe that if we perform here in the first and second quarter, and I want to be crystal clear, the second quarter is going to be better than the first quarter. But if we perform, then I'm hopeful that we're going to have multiple avenues to pursue growing the company.

Again, if you have a question, please press star then 1 to be joined into the queue.

This concludes our question and answer session. I would like to turn the conference back over to Jeffrey Quinn for any closing remarks.

Yes, so thank you. I am looking ahead and seeing both of our businesses heading in a much improved direction. I'm super excited about the team and what they've accomplished at Kraft. But I also am really excited to see how Spirits is going to perform this year because I think we've made a tremendous amount of investment in architecting a plan that's going to take us to a much better place on both sides of our businesses here, both the craft services, beverage, can printing business, and our spirits business in Oregon. So thank you for your time today, and we look forward to talking to you here shortly in the first quarter.

The conference is now concluded. Thank you for attending today's presentation. You may all now disconnect.