cbdMD, Inc.: Form 10-Q for the period ended Dec 31, 2022

The following discussion of our financial condition and results of operations for the three months ended December 31, 2022 and the three months ended December 31, 2021 should be read in conjunction with the unaudited condensed consolidated financial statements and the notes to those statements that are included elsewhere in this report. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties such as our plans, objectives, expectations and intentions.

Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements because of several factors, including those set forth under the Part I, Item 1A, Risk Factors and Business sections in our 2022 10-K, this report, and our other filings with the Securities and Exchange Commission. We use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Such statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this report.

Our Company

General

We own and operate the nationally recognized CBD (cannabidiol) brands cbdMD, Paw CBD and cbdMD Botanicals. We believe that we are an industry leader producing and distributing broad spectrum CBD products and now full spectrum CBD products. Our mission is to enhance our customer’s overall quality of life while bringing CBD education, awareness and accessibility of high quality and effective products to all. We source cannabinoids, including CBD, which are extracted from non-GMO hemp grown on farms in the United States. Our innovative broad spectrum formula utilizes one of the purest hemp extracts, containing CBD, CBG and CBN, while eliminating the presence of tetrahydrocannabinol (THC). Non-THC is defined as below the level of detection using validated scientific analytical methods. Our full spectrum products contain a variety of cannabinoids and terpenes in addition to CBD while maintaining trace amounts of THC that falls within the limits set in the 2018 Farm Bill. In addition to our core brands, we also operate cbdMD Therapeutics, LLC to capture the Company’s ongoing investments in science related to its existing and future products, including research and development activities for therapeutic applications

Our cbdMD brand of products includes high-grade, premium CBD products, including CBD tinctures, CBD gummies, CBD topicals, CBD capsules, CBD bath bombs, and CBD sleep aids.

Our Paw CBD brand of products includes veterinarian-formulated products including tinctures, chews, topicals products in varying strengths and formulas. Paw CBD products have undergone the National Animal Safety Council’s rigorous audit and meet their Quality Seal standard.

Our cbdMD Botanicals brand of beauty and skincare products features facial oil and serum, toners, moisturizers, clear skin, facial masks, exfoliants and body care. cbdMD Botanicals is dedicated to creating clean CBD skin care products combining the best of Mother Nature with the precision of scientific innovation. All of our products are 100% cruelty-free and have no parabens, sulfates, or gluten – just pure botanical ingredients carefully crafted into gentle beauty products for all skin types.

cbdMD, Paw CBD and cbdMD Botanicals products are distributed through our e-commerce websites, third party e-commerce sites, select distributors and marketing partners as well as a variety of brick-and-mortar retailers. In addition, we operate a CBD marketplace through directcbdonline.com, our own e-commerce website.

Recent Developments

At the end of September 2022, we shifted our USA product offering to focus on higher CBD concentration levels for better consumer efficacy while eliminating a number of lower strength SKUs. These products are supported by clinical claims from our human clinical studies that we have been working on for the last two years. Prior to making this shift we were focused on selling through our legacy inventory that was at end of life as part of the product shift. We believe the promotions we ran resulted in pantry loading which impacted revenue during the first quarter of fiscal 2023.

The Company's management mandate was to achieve profitability and increase revenue by the end of the 2022 calendar year. Significant headway was made on cost controls over the last two quarter and we believe additional opportunities to improve our cost structure exist: we are working to lower our facility costs, we are taking further opportunities to improve freight rates, and we continue to reassess our marketing costs and make improvements to our product portfolio. However, declines in revenue and the corresponding loss in contribution dollars offset operational gains. As a result, we made changes to our marketing department and in late December 2022 hired a new Chief Marketing Officer that reports to our President. During January of 2023 we began working to improve our communication to customers and more effectively allocate marketing spend to stabilize and rebuild revenues. Profitability remains a paramount focus and we continue to invest in a strong pipeline of accretive revenue opportunities.

Growth Strategies

We continued to pursue many strategies to grow our revenues and expand the scope of our business in fiscal 2023 and beyond:

• Product Innovation: Our goal is to provide our customers superior functional based products with greater efficacy, absorption and efficacy claims. We regularly assess and evaluate our product portfolio, and devote resources to ongoing research and development processes with the goal of improving our product offerings to meet consumer demands. We have a robust pipeline of products to launch during fiscal 2023, including our new clinically proven product cbdMD Max for Pain that launched during the first quarter.
• Expand our revenue channels: We believe it is important to have the right product at the right price for the right channel and worked on a bespoke line of products for the food drug and mass channel (“FDM”) that shipped to Wegmans in late fiscal 2022. In September we adjusted our wholesale offer to align with our strongest CBD, best prices consumer offer. We continue to have discussions with key retailers and have expanded our sales organization to include deep channel-specific experience, focused on developing a pipeline of opportunities we believe are strategic to the category and our brand.
• International Expansion: We continue to explore sales into markets outside of the United States. Our products are currently available in 31 countries. We generally partner with local wholesalers and local legal counsel who can help navigate the laws and regulatory requirements within their jurisdiction. We continue to pursue key wholesale accounts in several international markets and are gaining market share in Central America through our sanitary registration approvals. We are also expanding our E-commerce business to consumers in the United Kingdom (U.K.) and in March 2022, we received notice that the products we submitted have been validated in the UK as well as in the EU. We continue to work on strategies to continue to expand in the EU, Israel and other major markets which is primarily driven by the regulatory environment. In late fiscal year 2022, we registered and began selling products in Japan and we are seeing growth during the early part of fiscal 2023.
• Cultivate our Additional Brands: We believe there continues to be significant opportunities to enhance Paw CBD and cbdMD Botanicals and our marketing team has begun implementing strategy to better execute on these product lines during 2023.
• Acquisitions: We evaluate acquisitions where we believe (i) there is an accretive customer base that can lower our cost of customer acquisitions through either a complementary direct to consumer base or wholesale channels, or (ii) the target has a profitable business or easily attainable cost synergies that can quickly help contribute and accelerate profitability of our Company.

Results of operations

The following tables provide certain selected consolidated financial information for the periods presented:

We record product sales primarily through two main delivery channels, direct to consumers via our E-commerce sales and direct to wholesalers utilizing our internal sales team. The following table provides information on the contribution of net sales by type of sale to our total net sales.

Net Sales

We had total net sales of $6.1 million and $9.3 million for the three months ended December 31, 2022 and 2021, respectively, resulting in a quarter over quarter decrease in net sales of $3,.2 million or 34.7%. This decrease is attributable to a decrease of $2.2 million in e-commerce sales and a decrease of $1.0 million in wholesale sales quarter over quarter. While management is disappointed with the quarter over quarter net sales decrease, the revenue is generally in line with macro competitive trends in the overall CBD industry. As compared to the immediately preceding quarter, the Company's revenue declined 22.6%. Our E-commerce sales were impacted during the fourth quarter by (i) pantry loading of end of life lower strength SKUs as we discounted ahead of our high-strength product at the end of September 2022, (ii) marketing execution issues with certain vendors that created challenges on Meta and (iii) pull back in marketing spend. Our Wholesale declined approximately $1.0 million year over year. We believe there were two main drivers to the decline in our wholesale business: (i) our new lower sales price to wholesalers and (ii) wholesale customers focused on selling through existing inventory before bringing in our new SKUs. Further, we believe the current macro inflationary environment continues to impact discretionary spending with consumers as well as wholesale customers. We continue to work on a pipeline of opportunities both domestically and internationally and believe we will see revenue growth in the coming quarters.

Cost of sales

Our cost of sales includes costs associated with distribution, fill and labor expense, components, manufacturing overhead, third party providers, and freight for our product sales. Our cost of sales as a percentage of net sales was 41.8% and 46.4% for three months ended December 31, 2022 and 2021, respectively.

The changes made during the last quarters have eliminated significant fixed overhead and were aimed at lowering overall costs and making our cost of sale more variable in nature we believe ultimately more predictable.

Operating expenses

Our principal operating expenses include staff related expenses, advertising (which includes expenses related to industry distribution and trade shows), sponsorships, affiliate commissions, merchant fees, technology, travel, rent, professional service fees, and business insurance expenses.

Consolidated Operating Expenses

The following tables provide information on our operating expenses for the three months ended December 31, 2022 and 2021:

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Our overall operating expenses decreased by $4.3 million or 36.3% three months ended December 31, 2022 over the three months ended December 31, 2021 . The quarter over quarter decrease was primarily driven by management's ongoing efforts to reduce our cost structure including decreases in staff related expenses ($1.4 million), advertising, marketing, sponsorships and affiliate commission expenses ($2.9 million), reduction in stock expense ($1 million), and R&D and regulatory spend ($0.2 million), partially offset by an increase in all other expenses ($0.5 million) and an increase of ($0.9 million) non-cash expense related to accelerated stock compensation amortization tied the termination of a contractual obligation, and an increase in intangible amortization expense.

Excluding non-cash depreciation, intangible amortization, and non-cash stock expenses, we reduced our cash adjusted operating expenses from $10.4 million to $6.2 million for the three months ended December 31, 2021 and December 31, 2022 respectively.

While we showed strong year over year improvement in our operating expense, we are very focused on our sequential performance and trends in order to get us to a profitable quarter. We continued to make headway on our cost structure, however gains in our operating costs were offset by loss in revenue during the quarter. We have continued to lower our operating costs and at the end of January 2023, staffing is down to 65 full-time team members. In addition we made changes to our marketing team starting in December 2022 and brought in new leadership as well as partners to allow us to consistently navigate Meta advertising rules, improve our messaging, customer acquisition, and rebuild our revenue. We continue to pursue all avenues that will help lower our costs while maintaining our quality, efficacy and service for our customers; position us for revenue growth; and promote a culture of performance and success. In addition we have engaged third parties to review and assess strategic alternatives for the Company.

Corporate overhead

Included in our consolidated operating expenses are expenses associated with our corporate overhead which are not allocated to the operating business unit, including (i) staff related expenses; (ii) accounting and legal expenses; (iii) professional outside services; (iv) travel and entertainment expenses; (v) rent; (vi) business insurance; and (vii) non-cash stock compensation expense.

The following tables provide information on our corporate overhead for the three months ended December 31, 2022 and 2021:

Our corporate operating expenses are down quarter over quarter and year over year as a result of our ongoing efforts to reduce our cost structure across the board.

The corporate operating expenses are primarily related to the ongoing public company related activities.

Therapeutics Overhead

Included in our consolidated operating expenses are expenses associated with Therapeutics including staff related expenses and R&D and regulatory expenses. The Therapeutic operating expenses include research and development activities for therapeutic applications.

The following tables provide information on our approximate corporate overhead for the three months ended December 31, 2022 and 2021:

The Therapeutic operating expenses include research and development activities for therapeutic applications. This division was formed during the third quarter of fiscal 2021. Our human and pet clinical studies have concluded. We started receiving initial results during the first quarter of fiscal 2023 and expect final reports during the second quarter of fiscal 2023.

Goodwill Impairment

The Company had goodwill at December 31, 2021 of $42,772,685. The Company impaired goodwill in subsequent reporting periods of fiscal 2022 and goodwill was fully impaired by September 30, 2022.

Other income and other non-operating expenses

We also record income and expenses associated with non-operating items. The material components of those are set forth below.

Realized and unrealized gain (loss) on marketable and other securities

We value investments in marketable securities at fair value and record a gain or loss upon sale at each period in realized and unrealized gain (loss) on marketable securities. For the three months ended December 31, 2022 and 2021, we recorded $0 and $(33,350), respectively. The realized loss in 2021 was a result of our shares in Isodiol being de-listed.

Decrease in contingent liability

As described in Note 6 to the notes to the consolidated financial statements appearing elsewhere in this report, the earn-out provision for the Earnout Shares is accounted for and recorded as a contingent liability with increases in the liability recorded as non-cash other expense and decreases in the liability recorded as non- cash other income. The value of the non-cash contingent liability was $215,000 at December 31, 2022, as compared to $276,000 at September 30, 2022, respectively. We expect to continue to record changes in the non-cash contingent liability through the balance of the earnout period.

As described in Note 6 to the notes to the consolidated financial statements appearing elsewhere in the report, the requirement for the earn-out provision for the Twenty Two Earnout Shares was never met and at September 30, 2022 the balance of this obligation was zero.

Liquidity and Capital Resources

We had cash and cash equivalents on hand of $3.4 million and working capital of $6.0 million at December 31, 2022 as compared to cash and cash equivalents on hand of $6.7 million and working capital of $10.7 million at September 30, 2022. Our current assets decreased approximately 20.0% at December 31, 2022 from September 30, 2022, which is primarily attributable to a decrease in cash used to fund operations as well as a one-time non-cash expenses of approximately $885,000 related to previously un-expensed stock amortization related to an terminated contractual obligation. Our current liabilities increased by 5.0% at December 31, 2022 from September 30, 2022, and is primarily attributable to increases in accrued expenses, partially offset by a decrease in accounts payable.

During the three months ended December 31, 2022 we used cash primarily to fund our operations.

We do not have any commitments for capital expenditures. We have a commitment for cumulative cash dividends at an annual rate of 8% payable monthly in arrears for the prior month to our preferred shareholders. We have one endorsement agreement that runs through February 2025 that provides for financial commitments from the Company based on performance/participation (see Note 11 Commitments and Contingencies).

While the Company is taking strong action and believes that it can execute it's strategy and path to profitability within it's balance sheet and its ability to raise additional funds, there can be no assurances to that effect. The Company’s working capital position may not be sufficient to support the Company’s daily operations for the twelve months subsequent to the issuance of these quarterly financial statements. The Company’s ability to continue as a going concern is dependent upon its ability to improve profitability and the ability to acquire additional funding. These and other factors raise potential concern about the Company’s ability to continue as a going concern within twelve months after the date that the quarterly financial statements are issued. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result in the Company not being able to continue as a going concern.

Our goal from a liquidity perspective is to use operating cash flows to fund day to day operations and we have not met this goal as cash flow from operations has been a net use of $2.1 million and $5.5 million for the three months ended December 31, 2022 and 2021, respectively. Management believes the quarterly cash consumption will continue to improve in subsequent quarters.

Critical accounting policies

The preparation of financial statements and related disclosures in conformity with US GAAP and our discussion and analysis of our financial condition and operating results require our management to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Note 1, “Organization and Summary of Significant Accounting Policies,” of the Notes to our consolidated financial statements appearing elsewhere in this report describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates, and such differences may be material.

Please see Part II, Item 7 – Critical Accounting Policies appearing in our 2022 10-K for the critical accounting policies we believe involve the more significant judgments and estimates used in the preparation of our consolidated financial statements and are the most critical to aid you in fully understanding and evaluating our reported financial results. Management considers these policies critical because they are both important to the portrayal of our financial condition and operating results, and they require management to make judgments and estimates about inherently uncertain matters.

Recent accounting pronouncements

Please see Note 1 – Organization and Summary of Significant Accounting Policies appearing in the consolidated financial statements included in this report for information on accounting pronouncements.

Off balance sheet arrangements

As of the date of this report, we have no undisclosed off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off-balance sheet arrangement” generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have any obligation arising under a guarantee contract, derivative instrument or variable interest or a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.

Evaluation of Disclosure Controls and Procedures. We maintain “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934. In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation as of the end of the period covered by this report, our interim principal executive officer and Chief Financial Officer has concluded that our disclosure controls and procedures were effective to ensure that the information relating to our company, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our interim principal executive officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Accordingly, we incorporate by reference the risk factors disclosed in Part I, Item 1A of our 2022 10-K.