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

The following discussion of our financial condition and results of operations for the three months ended December 31, 2023 and the three months ended December 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 hempMD. We believe that we are an industry leader producing and distributing hemp derived solution including broad spectrum CBD products and full spectrum CBD products. Our mission is to enhance our customer’s overall quality of life while bringing cannabinoid 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 and Delta 9 products contain a variety of cannabinoids and terpenes in addition to CBD while maintaining small amounts of THC that falls within the limits set in the 2018 Farm Act. 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 and Proline Global that houses some of our newer brands.

Our cbdMD brand of products includes an array of high-grade, premium every day and functional CBD products, including tinctures; gummies; topicals; capsules; drink mixes; and sleep, focus and calming aids. In addition we have clinical based claims and industry leading strength and concentrations to drive product efficacy.

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 hempMD brand is a curated line of hemp derived solutions that we believe will open up several new customer acquisition channels.

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.

Recent Developments

Management continues to be very focused on delivering positive earnings through a combination of optimizing our product portfolio, right-sizing our cost structure and investing in marketing that will provide positive return on customer acquisition. During fiscal 2023 we made significant changes to our marketing and overall operations including re-platforming our website to significantly reduce our operating costs. While revenue decreased, our cash burn has been significantly reduced.

At the end of our third quarter of fiscal 2023 we changed our e-commerce platform to focus on our customer experience and conversion rates. As part of this plan, we planned a site refresh that launched during November of 2023. We continue to focus on our site optimization to ensure we have the industry-best customer experience on our website. As part of our platform change, we concentrated on our subscription base and have seen a strong increase in subscribers year over year and this has accelerated since our platform change.

During the fourth quarter of fiscal 2023 we also attempted to convert the Series A Preferred stock to common stock through a shareholder vote to amend our Series A Preferred Stock designation. Ultimately, we were unable to get the required votes needed to approve the amendment and we canceled the shareholder meeting. We believe the combined market capitalization of both our common and Series A Preferred is being impacted due to our current capital structure. Our goal is to simplify our capital structure and we believe it will help unlock additional equity value and open up more strategic activity for the Company. The Company has a new proposal to convert all of the Company's Series A Preferred stock to be voted on by its shareholders at the Company's 2024 annual meeting.

Our Paw CBD brand won yet another Pet Innovations awards this year from Independent Innovations Awards, an independent awards association. This year our Dog Hip and Joint won the Dog Product of the Year for soft chews. In December of 2023, cbdMD products were awarded been named a bronze winner in two distinguished categories at the esteemed Best in Biz Awards. The Company’s CBD Freeze Roll-On has been recognized in the Consumer Product of the Year category, while cbdMD PM Softgel Capsules - NSF Certified for Sport® has been honored in the Best New Product of the Year consumer category.

During October 2023, the Company launched its hempMD product line of hemp-derived functional products and have begun opening up additional sales channels, including Amazon.

cbdMD recently expanded its retail reach in December 2023 by launching several products throughout Sprouts Supermarkets.

We have spent significant resources focused on state and national regulatory matters and believe lack of a clear regulatory framework has a negative impact and limits the opportunity for CBD companies that act with integrity and invest in responsible quality and safety standards. We continue to believe in the long term benefits of hemp-derived cannabinoids, but see a longer-term horizon for federal regulatory clarity. As a result, in late 2023 and into early fiscal 2024 the Company has focused on expanding into categories that do not have as many regulatory and channel hurdles.

During December 2023, the Company launched its new functional mushroom line of products with its Super Gummy under the ATRx brand on ATRxlabs.com. At our core, we believe in natural health and wellness solutions and we believe in the benefits derived from functional mushrooms in addition to hemp. We are working to open up additional channels and are in discussions with a large retailer to anchor the launch of 4 new SKUs under the ATRx brand during the balance of fiscal 2024.

Growth Strategies

We continued to pursue many strategies to grow our revenues and expand the scope of our business in fiscal 2024 and beyond:

• Product Innovation: Our goal is to provide our customers superior functional based products with greater efficacy claims and absorption. 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. During fiscal 2023 we focused on expanding some of our core line of products. This included adding to our NSF for Sport product line, as well as our line of Delta 9 gummies and microdose products. In addition, we expanded our line up by launching our proprietary hemp blend under hempMD. In November of 2023 we launched our new CBG tincture and during the first quarter of fiscal 2024 we launched our new nootropic mushroom line under the ATRx brand. We have a robust pipeline of cannabinoid and non-cannabinoid products to launch during fiscal 2024.
• Expand our revenue channels: During fiscal year 2023, our wholesale business continued to face macro industry contraction trends that we believe are tied to low-dose, high-priced products. We continued to pursue relationships with traditional retail accounts and believe our top brand awareness and effective marketing position us as a preferred CBD partner for key traditional retail accounts as this channel has continued to normalize. During the first quarter of fiscal 2024 we launched several SKUs into Sprouts retail footprint. We continue to assess our product channel fit and working with retailers and distributors alike to further grow this channel.
• International Expansion: We continue to explore sales in 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 a number of 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 (UK) by expanding onto Amazon’s platform during fiscal year 2023 and are continuing to grow this channel quarterly. In March 2021, we officially filed our Novel Food Application with the United Kingdom’s Food Standards Agency (“FSA”) and the European Union’s (“EU”) Food Safety Agency (“EFSA”) and received validation notices during 2022. The UK government has not provided clarity on the timeline to complete their FSA process.
• Cultivate Additional Brands: We continue to operate and attempt to grow the Paw CBD business. During fiscal 2024 we launched hempMD as a separate brand and in December 2023 we launched our new nootropic mushroom line under the ATRx brand. We believe there is ongoing opportunities with these brands to focus on education, cross-selling and customer retention.
• Acquisitions: We evaluate acquisitions (M&A) 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. While the Company continues to evaluate M&A opportunities, as of the date of this report we currently do not have any pending or potential acquisitions.

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 $5.4 million and $6.1 million for the three months ended December 31, 2023 and 2022, respectively, resulting in a decrease in net sales of $0.7 million or 12% quarter over quarter. This decrease is partially attributable to a decrease of $0.5 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 $0.2 million, in part due to state level restrictions that had a year over year impact to accounts in key geographic regions. In response, management has embarked on several corrective measures, including the appointment of a new Vice President of Wholesale, the introduction of new customer acquisition strategies, and the replacement of underperforming vendors and agencies. Despite the overall category facing challenges, we remain optimistic about our product's market positioning in 2024, amidst increasing global tensions and the election year.

Moreover, the management team dedicated the first fiscal quarter to pivotal initiatives that influenced this quarter's performance. These initiatives encompassed a proxy vote; exploration of mergers and acquisitions that were ultimately abandoned due to complexities in the capital structure; and the development of our new product lines, ATRx Labs and HempMD. We believe these new lines present significant growth opportunities beyond the regulatory and marketing constraints currently affecting the CBD category.

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 33.8% and 41.4% for three months ended December 31, 2023 and 2022, respectively. This overall decrease in our cost of sales quarter over quarter is primarily attributable to decreased overhead allocation of approximately $80,000 related to overall headcounts reductions quarter over quarter as well as decreased freight changes of approximately $230,000 as we switched to a more cost effective freight provider subsequent to the first quarter of fiscal year 2023, which increased margins for that quarter.

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, 2023 and 2022:

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Our overall operating expenses decreased by $3.0 million or 39.3% for the three months ended December 31, 2023 over the three months ended December 31, 2022. The year over year decrease was primarily driven by management's continued ongoing efforts to reduce our cost structure including decreases in staff related expenses ($0.9 million), advertising, marketing, sponsorships and affiliate commission expenses ($0.5 million), a reduction of ($0.9 million) related to a one time non-cash stock compensation for a terminated contractual obligation, a reduction of intangibles amortization of ($0.1 million) as a result of the intangibles impairment and change in useful life that occurred in fourth quarter of fiscal year 2023, and a reduction of approximately ($0.5 million) across all other expense areas quarter over quarter.

Corporate overhead and allocation of management fees to our segments

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, 2023 and 2022:

Our corporate operating expenses are down quarter over quarter by ($90,000) or 12.4%. This decrease in primarily related decreased headcount and non-cash stock compensation, slightly offset by increases in accounting/legal /professional outside services as we incurred expenses tied to the initial proxy statement filed for a shareholder proposal to convert our series A preferred stock as well as M&A diligence and structuring that occurred during the December 2023 quarter.

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 which are not allocated to the operating business unit, including staff related expenses and R&D and regulatory expenses. The Therapeutic operating expenses include research and development activities for therapeutic applications. Year over year’s decline is primarily driven by the finishing of our clinical studies.

The following tables provide information on our approximate corporate overhead for the three months ended December 31, 2023 and 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 $20,611 at December 31, 2023, as compared to $90,363 at September 30, 2023, respectively. The fourth and final marking period ended and the final issuance of shares occurred in January 2024.

Liquidity and Capital Resources

We had cash and cash equivalents on hand of $1.5 million and working capital of $1.4 million at December 31, 2023 as compared to cash and cash equivalents on hand of $1.8 million and working capital of $3.4 million at September 30, 2023. Our current assets decreased approximately 8.7% at December 31, 2023 from September 30,2023, which is primarily attributable to a decrease in cash used to fund operations. Our current liabilities increased by 27.9% at December 31, 2023 from September 30, 2023, and is primarily attributable to dividends on the preferred stock that have been accrued but not paid.

During the three months ended December 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 dividends at an annual rate of 8% payable monthly in arrears for the prior month to our preferred shareholders. As of September 2023, we have stopped paying this dividend in cash monthly and are accruing this dividend on a monthly basis.

While the Company is taking strong action and believes that it can execute its strategy and path to profitability within its balance sheet, and in 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 this report. The Company’s ability to continue as a going concern is dependent upon its ability to improve profitability and cash flow and the ability to acquire additional funding. These and other factors raise substantial doubt about the Company’s ability to continue as a going concern within twelve months after the date that our annual 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 $0.1 million and $12.1 million for the three months ended December 31, 2023 and 2022, respectively. Management believes the quarterly cash consumption should continue to improve in subsequent quarters.

Subsequent to the period covered by this report, as disclosed under note 16 to the unaudited financial statements included in this report, the Company entered into a Purchase Agreement dated January 30, 2024 with five Investors whereby the Investors advanced the Company an aggregate of $1,250,000 gross proceeds and the Company issued each Investor an 8% Senior Secured Original Issue 20% Discount Convertible Promissory Note, in the aggregate principal amount of $1,541,666. The Company intends to use the proceeds from the issuance of the Notes for working capital and general corporate purposes, including, but not limited to inventory investment to assist with orders and funding proxy expenses.

Also subsequent to the period covered by the report, on January 11, 2024, we issued Keystone 64,218 shares of common stock for an aggregate purchase price of $50,000 or $0.7786 per share.

Adjusted EBITDA

To supplement the Company's unaudited interim consolidated financial statements presented in accordance with U.S. GAAP, the Company uses certain non-GAAP measures of financial performance. Non-GAAP financial measures are not prepared in accordance with, or as an alternative to U.S. GAAP. Generally, a non-GAAP financial measure is a numerical measure of a company's performance that either excludes or includes amounts, or is subject to adjustment that have such an effect, that are not normally excluded or included in the most directly comparable financial measure that is calculated and presented in accordance with U.S. GAAP. Adjusted EBITDA as presented below is a non-GAAP measure.

cbdMD defines Adjusted EBITDA as Earnings Before Interest, Taxes, Depreciation and Amortization excluding (1) stock based compensation; (2) one time inventory adjustments; (3) impairment of goodwill and other intangible items; (4) one-time severance accruals; (5) non-cash trade credits; and (6) accruals/expenses for discretionary bonuses, and (7) other one-time expenses related to M&A or other corporate actions.

Our management uses and relies on Adjusted EBITDA, which is a non-GAAP financial measure. We believe that management, analysts and shareholders benefit from referring to the following non-GAAP financial measure to evaluate and assess our core operating results from period-to-period after removing the impact of items that affect comparability. Our management recognizes that the non-GAAP financial measures have inherent limitations because of the excluded items described below.

We have included a reconciliation of our non-GAAP financial measure to the most comparable financial measures calculated in accordance with GAAP. We believe that providing the non-GAAP financial measures, together with the reconciliation to GAAP, helps investors make comparisons between cbdMD and other companies. In making any comparisons to other companies, investors need to be aware that companies use different non-GAAP measures to evaluate their financial performance. Investors should pay close attention to the specific definition being used and to the reconciliation between such measure and the corresponding GAAP measure provided by each company under applicable rules of the Securities and Exchange Commission.

The following table presents a reconciliation of GAAP loss from operations to Adjusted EBITDA.

Adjusted EBITDA for the three months ended December 31, 2023 and December 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 expenses incurred in relation to M&A and financing activities during the quarter ended December 31, 2023.

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, in addition to the disclosure below, we incorporate by reference the risk factors disclosed in Part I, Item 1A of our 2023 10-K. See also "Liquidity and Capital Resources" above.

The issuance of shares upon exercise of our outstanding options, restricted stock awards and warrants, or the conversion of the Notes or Series A Convertible Preferred Stock may cause immediate and substantial dilution to our existing shareholders.

We presently have options, unvested restricted stock awards and warrants that if exercised would result in the issuance of an additional 93,222 shares of our common stock, and our Series A Convertible Preferred Stock is presently convertible into an additional 185,223 shares of common stock. In addition, our outstanding Notes are presently convertible into approximately 2,253,900 shares of common stock (although currently limited to 608,714 shares until such time as the Company has received shareholder approval in accordance with NYSE American Rules 713(a) for the issuance of such number of shares in excess of 20% of the Company’s outstanding common stock as of January 30, 2024). Furthermore, the Company is currently seeking shareholder approval to amend its articles of incorporation, as amended, to provide for the automatic conversion of all outstanding shares of Series A Preferred Stock on a 1 to 6 basis, which in the event such amendment is approved, would result in the issuance of an additional 30,000,000 shares of common stock. The number of shares issuable upon conversion of the Notes may increase in the event the conversion price is adjusted. The issuance of shares upon exercise of warrants and options and/or the conversion of our Notes and Series A Convertible Preferred Stock will result in dilution to the interests of other shareholders.