Cbdmd, Inc. quarterly report, Q3 FY2019

Business context and reporting period

Period clarification: The supplied filing is cbdMD, Inc.’s Form 10-Q for the quarter ended June 30, 2020 (fiscal 2020 Q3), not 2019 Q3 as indicated in the request metadata. The nine-month period is the nine months ended June 30, 2020. Amounts are in U.S. dollars.

cbdMD sells hemp-derived CBD products through consumer e-commerce and wholesale channels, including products under its Paw CBD brand. The company has shifted its focus to CBD and classified several legacy subsidiaries as discontinued operations.

Financial performance and position

• Quarterly net sales increased 32.9% year over year; nine-month sales increased 114.0%. In Q3, consumer sales rose to $8.23 million from $4.64 million, while wholesale sales declined to $2.41 million from $3.37 million. Management attributed wholesale weakness to COVID-related store closures and said e-commerce growth offset it.
• Gross margin improved in both comparison periods. Management said it expected product cost of sales to remain 30%–37% of net sales.
• Quarterly operating expenses fell 28.7% year over year, including lower marketing, sponsorship, and other costs. Nine-month operating expenses rose 76.9%, reflecting the CBD business build-out and increased staffing, advertising, sponsorship, technology, and sales activity.
• Reported nine-month net income does not represent operating profitability: it includes a $30.58 million reduction in the merger-related contingent liability, while Q3 included a $7.58 million increase in that liability. The Q3 increase was principally driven by the share price rising from $0.93 at March 31 to $1.91 at June 30. The adjustments are non-cash and materially affect reported earnings.
• Cash used in operating activities was $10.28 million for the nine months, versus $9.06 million a year earlier. Investing activities used $1.85 million, chiefly for property and equipment; financing provided $22.45 million, including equity proceeds and a PPP loan. Ending cash was $15.01 million, up from $4.69 million at September 30, 2019.
• At June 30, 2020, current assets were $24.11 million and current liabilities $4.39 million; working capital was $19.73 million. Total assets were $111.31 million and total liabilities $27.73 million.
• Borrowings included $237,434 of equipment notes and a $1.456 million PPP loan. Separately, operating lease liabilities totaled $7.42 million. The balance sheet also reported a $15.40 million contingent liability for potential earnout shares.
• Common shares outstanding increased from 27.72 million at September 30, 2019 to 51.35 million at June 30, 2020, following equity issuance and earnout shares. The filing reports 52.11 million shares outstanding on August 1, 2020. Preferred dividends are cumulative at 8% annually; 500,000 preferred shares were outstanding.

Material changes, outlook, risks, and unusual items

• In January 2020, the company raised approximately $16.93 million net from a common-stock offering; its October 2019 preferred-stock offering generated approximately $4.53 million net. It received a $1.456 million PPP loan in April, bearing 1% interest. The company intended to use proceeds for eligible expenses and apply for forgiveness; forgiveness was not assured in this filing.
• COVID-19 disrupted retail and events. Management reported reduced wholesale sales from store closures, increased e-commerce marketing, no supply-chain impact to date, and a return to work under revised safety procedures. It warned that the pandemic’s future financial and liquidity effects were uncertain.
• Management cited growth priorities including product development, expanding online, wholesale and international channels, developing Paw CBD, and targeted marketing. It reported a goal of achieving positive operating cash flow, but provided no specific revenue, earnings, or cash-flow forecast.
• COVID-related suspensions, terminations, or renegotiations affected sponsorship commitments. The company terminated its Feld Motor Sports agreement and suspended or reconsidered other sponsorship arrangements. A July 1, 2020 athlete agreement replaced the prior contract and included 700,000 shares issued after quarter-end, valued at $1.337 million, plus potential future stock or cash payments and scheduled cash payments through 2022.
• The merger earnout may require up to 15.25 million additional shares, depending on revenue targets within the specified period; the remaining liability was valued using significant Level 3 assumptions. Further equity issuance, preferred-stock conversion, options, and warrants may dilute common shareholders.
• Other notable matters include a $233,372 inventory-scrapping charge in Q3 and a collection lawsuit filed in April 2020 concerning discontinued-operations receivable from Sandbox Properties LLC. The company reported $700,884 of discontinued-operations receivables at June 30, including $666,668 from that customer, and stated it believed that amount would be collected in full.
• The company disclosed no material changes to internal control over financial reporting and said disclosure controls were effective. It reported no material off-balance-sheet arrangements. The filing’s legal proceedings section says “None,” although the receivable-collection lawsuit is described in the notes.

Important facts for investors to verify

1. Confirm the filing period: this is Q3 2020, not Q3 2019, and assess comparisons in light of business changes and discontinued operations.
2. Reconcile earnings to operating performance, especially the non-cash contingent-liability remeasurement; assess recurring operating losses and cash burn.
3. Track e-commerce growth against wholesale weakness, gross-margin sustainability, and progress toward positive operating cash flow.
4. Review liquidity needs, PPP loan forgiveness and repayment status, and the cash requirements of leases, preferred dividends, and sponsorship or endorsement agreements.
5. Assess potential dilution from earnout shares, the July 2020 athlete share issuance, preferred conversion, options, and warrants.
6. Verify collection of the Sandbox Properties receivable and the outcome of the related lawsuit, as well as the carrying values of inventory, goodwill, and intangible assets.