cbdMD, Inc.: Form 10-Q for the period ended Mar 31, 2023

The following discussion of our financial condition and results of operations for the three and six months ended March 31, 2023 and the three and six months ended March 31, 2022 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.

cbdMD Therapeutics

In March 2021 we formed a new wholly owned subsidiary, cbdMD Therapeutics, for the purposes of isolating and quantifying our ongoing investments in science related to our existing and future products, including research and development activities for therapeutic applications and to explore potential cannabinoid-based medicines.

In August of 2022 the Company concluded a randomized, double blind, placebo controlled clinical study in dogs performed in conjunction with Colorado’s State University’s veterinary program. Preliminary results indicate that our proprietary broad spectrum hemp extract improved mobility, gait, and quality of life in dogs with osteoarthritis. These results are expected to provide claims related to our proprietary broad spectrum blend’s efficacy and drive new product development to address the needs of the nearly $2 Billion canine arthritis treatment market according to Expert Market Research.

In September of 2022 the Company concluded a multi-year randomized, double blind, placebo controlled clinical study in healthy adults utilizing its proprietary hemp extract blend which demonstrated significant benefits in many areas, including reduction of pain, reduced inflammation, improvements to several immunity markets, and improved mood, and these results are further driving the refinement of current products and the development of new products which utilize the same proprietary blend of hemp extracted cannabinoids.

We believe the results from both of the clinical studies provide us a unique and differentiated competitive marketing advantage for certain of our products and has already started creating additional B2B wholesale opportunities for our organization. In addition, these results will inform near term product development efforts, and serve as preliminary data for future clinical studies.

The formation of Therapeutics has also led to the identification of a novel cannabinoid that will be patented and utilized in future formulations for cbdMD. We believe the Company’s investments into therapeutics R&D will continue to benefit current products and dietary supplement development.

Recent Developments

During the second quarter the Company launched its third National Sanitation Foundation ("NSF") for sport product, our 1500mg broad spectrum gummy. Not only was cbdMD the first to commercialize NSF for Sport CBD product it is the only certified gummy product on the market, has the highest concentration on the market and largest portfolio of NSF for Sport offering. We believe this certification is important to a large customer based that continues to as well as build credibility with retailers.

The Company also recently launched its first products on Amazon in the UK. cbdMD is one of only a handful of companies approved to sell CBD products in the Amazon UK CBD pilot program due to its validated Novel Foods application. Brands approved to sell CBD through Amazon UK are required to pass compliance checks by Amazon and now must have a credible application for Novel Foods Authorization which has been validated by the United Kingdom's Food Standards Agency. The Company is continuing to work to expand our product listing on Amazon UK and accelerate its revenue on the platform.

In February 2023, the Company’s President resigned to pursue other interest and the Company’s CFO was named Interim CEO.

During the second fiscal quarter we continued to make headway to improve the overall operation of our business. We further reduced payroll, have sublet a portion of our warehouse, have engaged brokers to market and seek options on our corporate office lease, cut un-product services, and continuing to assess alternatives to our operating infrastructure to reduce our costs.

Since the beginning of the second quarter, we have onboard new agencies, fine-tuned go-to-market strategies and communication with customers as well as pricing, are successfully ramping profitable Meta advertising, and are encouraged with our direct-to-consumer revenue trends in March and April as a result of the steps taken. 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:

• Grow Core Revenue Channels
• Direct to Consumer: The last several quarters we pulled back on sponsorships, expensive influencers and high acquisition cost marketing spend that resulted in low lifetime value customers. As a result, overall revenues have declined, but we believe we are in a better position to improve profitability and are now investing carefully in efforts with strong measurable return on spend to drive traffic and conversion rates.
• Wholesale: We continue to focus on the right product at the right price for the right channel and adding channel specific distributors and brokers to help us scale in the food drug and mass channel (“FDM”). During the last 12 months we successfully expanded throughout GNC’s retail footprint, added Wegmans and are working with several national and regional chains. We continue to build relationships 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.
• Product Innovation: We believe innovation is key to the long-term success of any consumer brand. We invest in new product development and brand extension that we believe will (i) give us a competitive advantage in the marketplace; (ii) attract new customers; and (iii) open up additional revenue opportunities. During fiscal 2022 we launched an industry first NSF for Sport product line with World Anti-Doping Association (WADA) level assurance, a line of Delta 9 gummies and microdose products, along with a number of functional gummies and capsules. Based on customer feedback and preliminary clinicals we launched a new line of high-strength CBD products at the end of September 2022 and further launched cbdMD Max for Pain at the end of calendar 2022. We have a robust pipeline of products to launch during the second half of 2023 that we believe will open up additional distribution channels as well as grow our addressable market.
• 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.
• 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 $6.2 million and $9.6 million for the three months ended March 31, 2023 and 2022, respectively, resulting in a decrease in net sales of $3.4 million or 35.4% year over year. This decrease is attributable to a decrease of $1.7 million in e-commerce sales as we continue to reduce marketing spend as part of our continued efforts to improve profitability. Wholesale sales decrease of $1.7 million in mainly attributed to our lower price structure and some larger orders that occurred during the March 2022 quarter. Despite the year over year decrease, management is very encouraged by the sequential revenue trends. Our E-commerce business remained relatively flat while we made significant changes to our market team and infrastructure while wholesale sales increased approximately 14% for the three months ended March 31, 2023 from the three months ended December 31, 2022, resulting in a combined increase of approximately 2.5% during the same period. We believe the current macro inflationary environment continues to impact discretionary spending with consumers as well as wholesale customers. We remain cautiously optimistic 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 38.5% and 33.1% for three months ended March 31, 2023 and 2022, respectively.

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 and six months ended March 31, 2023 and 2022:

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Our overall operating expenses decreased by $6.0 million or 52.7% three months ended March 31, 2023 over the three months ended March 31, 2022. The year over year decrease was primarily driven by management's ongoing efforts to reduce our cost structure including decreases in staff related expenses ($1.5 million), advertising, marketing, sponsorships and affiliate commission expenses ($3.6 million), reduction in stock expense ($0.5 million), reduction in depreciation expense ($0.4 million) related to the closure of our lab and manufacturing facility in fiscal 2022, and R&D and regulatory spend ($0.1 million).

Excluding non-cash depreciation, intangible amortization, and non-cash stock expenses, we reduced our cash adjusted operating expenses from $10.1 million to $4.9 million for the three months ended March 31, 2022 and March 31, 2023 respectively.

Our overall operating expenses, excluding goodwill and intangibles impairment, decreased by $10.4 million or 44.4% for the six months ended March 31, 2023 over the six months ended March 31, 2022. The year over year decrease was primarily driven by management's ongoing efforts to reduce our cost structure including decreases in staff related expenses ($2.9 million), advertising, marketing, sponsorships and affiliate commission expenses ($6.5 million), reduction in stock expense ($1.5 million), reduction in depreciation expense ($0.6 million) related to the closure of our lab and manufacturing facility in fiscal 2022, and R&D and regulatory spend ($0.3 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, and we reduced our cash adjusted operating expenses, excluding goodwill and intangibles impairment, from $22.3 million to $11.1 million for the three months ended March 31, 2022 and March 31, 2023 respectively.

We continue to show strong year over year improvements operating a more disciplined SG&A cost structure. We are very focused on our sequential performance and trends as we are fixated on delivering a profitable quarter. We made significant headway on our cost structure during the second fiscal quarter and were able to stabilize our revenue base while reducing our sequential SG&A costs by $2.2 million, resulting in a sequential reduction of operating losses; from a $4.0 million operating loss in the first fiscal quarter to $1.4 million for the second fiscal quarter. We continue to fine tune our operating costs, have sublet a portion of our warehouse, have engaged brokers to market and seek options on our corporate office lease, cut un-product services, and continuing to assess alternatives to our operating infrastructure to reduce our costs. Since the beginning of the second quarter, we have onboard new agencies and, fine-tuned some go-to-market strategies, pricing and, been successful ramping profitable Meta advertising and have an exciting line up of new products in the pipeline to launch during the balance of fiscal 2023. 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 and six months ended March 31, 2023 and 2022:

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 as well as a significant reduction in the amount of non-cash stock compensation expense that has been issued year over year.

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 and six months ended March 31, 2023 and 2022:

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.

Goodwill Impairment

The Company had goodwill at March 31, 2022 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.

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 $167,000 at March 31, 2023, 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 $1.7 million and working capital of $5.5 million at March 31, 2023 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 12.0% at March 31, 2023 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, in addition to receiving our $1.0 million investment in Adara back in full. Our current liabilities decreased by 15.7% at March 31, 2023 from September 30, 2022, and is primarily attributable to decreases in accrued expenses and accounts payable.

On March 2, 2023, we entered into a purchase agreement with Keystone Capital Partners, LLC, which provides that subject to the terms and conditions set forth therein, we may sell to Keystone up to 281,934 shares of our common stock, from time to time during the term of the purchase agreement. Under the terms and subject to the satisfaction of the conditions set forth in the purchase agreement for a period of 12 months, subject to a blackout period from April 30, 2023 through July 14, 2023 under the terms of our recent underwritten public offering. the Company has the right, but not the obligation, to sell to Keystone, and Keystone is obligated to purchase, up to 281,934 shares of common stock. Upon entering into the Purchase Agreement the Company agreed to issue to Keystone 392,282 shares of common stock of the Company as the Commitment Shares as consideration for Keystone’s commitment to purchase shares of common stock upon the Company’s direction under the purchase agreement. Subsequent to the period covered by this report, commencing on April 19, 2023 and through April 25, 2023, we received gross proceeds of approximately $36,000 from sales of 8,888 shares of our common stock to Keystone. In addition, subsequent to the period covered by this report, on May 3, 2023 we closed an underwritten public offering of 30,000 shares of our common stock at a public offering price of $2.10 per share. Net proceeds from the offering after deducting underwriting discounts and commissions and offering expenses were approximately $2.5 million.

As of May 11, 2023, the Company had approximately $4.2 million of cash. The Company has nominal debt. As of May 12, 2023, the Company also has up to 273,044 shares available to be sold under its agreement with Keystone, which it may drawdown on such agreement, subject to trading volume requirements of our common stock and further subject to the blackout period referenced above.

Management has concluded that substantial doubt exists about our ability to continue as a going concern for the next twelve months from the date hereof. Our current capital resources, including our equity line of credit with Keystone may not be sufficient to support our planned operations for the next twelve months from the date hereof. We believe that upon receipt of approximately $2.5 million in net proceeds pursuant to the underwritten public offering completed on May 3, 2023 (see Note 16 of the accompanying financials statement for more information), after deducting the underwriting fees and estimated offering expenses payable by us, that our cash and cash equivalents on hand should be sufficient to fund operations through the end of the fiscal year if not longer. However, depending upon our operating results and cash burn over the next four months, we may be required to raise additional capital to fund operations or scale back our operations or dividends. We expect to continue to incur losses for the foreseeable future as we continue our efforts to increase sales, develop additional products, seek acquisitions and mergers, continue research and development, reduce operating expenses and attempt to achieve profitability. Furthermore, in the event we identify an acquisition candidate, such acquisition may require immediate capital to close such acquisition. These factors, individually and collectively, raise substantial doubt about our ability to continue as a going concern, and therefore, could materially limit our ability to raise additional funds through an issuance of debt or equity securities or otherwise.

During the three and six months ended March 31, 2023 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).

The Company is taking strong action and believes that it can execute its strategy and path to profitability as well as its ability to raise additional funds, but 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 through the end of fiscal 2023. 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 $1.7 million and $5.3 million for the six months ended March 31, 2023 and 2022, respectively. Management believes the quarterly cash consumption should continue to improve in subsequent quarters.

Adjusted EBITDA

Adjusted EBITDA for the three and six months ended March 31, 2023 and March 31, 2022 is as follows:

(Unaudited)

(1) Represents non-cash expense related to options, warrants, restricted stock expenses that have been amortized during the period.

(2) Represents non-cash expense related to options, warrants, restricted stock expenses that have been amortized during the period.

(3) Represents an operating expense related to inventory loss related to regulatory changes impacting labels and packaging and obsolete/expired inventory.

(4) Represents non-cash goodwill impairment of $13,898,285 and impairment of the cbdMD trademark of $4,285,000.

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.