Cbdmd, Inc. annual report, FY2016

Filing scope and business context

This is Level Brands, Inc.’s Form 10-K for the fiscal year ended September 30, 2017—not a cbdMD filing or a 2016 fourth-quarter report. Level Brands describes a brand licensing, marketing and management business, alongside its Beauty & Pin-Ups hair-care products division. During fiscal 2017 it added the I'M1 licensing and EE1 entertainment businesses; its kathy ireland Health & Wellness brand was newly licensed and still in development.

Financial results and liquidity

• Sales increased about 120% year over year, mainly reflecting the two businesses acquired in January 2017. Segment sales were $1.794 million for Licensing, $1.710 million for Entertainment and $0.970 million for Professional Products.
• Professional Products sales fell 52.3% from fiscal 2016; management attributed the decline to dependence on one distributor and inadequate post-launch sales support. The new Licensing and Entertainment divisions generated revenue for only part of fiscal 2017.
• At September 30, 2017, cash was $284,246, working capital was $2.170 million, total assets were $7.069 million and total liabilities were $1.921 million. Shareholders’ equity was $5.149 million, including non-controlling interests.
• Cash increased from $34,258 at fiscal 2016 year-end. Financing provided $2.428 million; operating activities used $2.330 million. Operating cash flow remained negative.
• Convertible notes and a related-party line of credit were converted to equity in June 2017. The balance sheet showed no line-of-credit payable at year-end; it included $360,000 of long-term related-party liabilities, primarily associated with the Health & Wellness license payment.
• After year-end, the November 2017 IPO raised $12.0 million gross and approximately $10.9 million net. This cash was not included in September 30, 2017 cash.

Changes, outlook and material matters

• Gross margin improved sharply as the sales mix shifted toward licensing and services, which generally have lower direct costs than product sales. Professional Products’ cost of sales remained high at 90.2% of its segment sales.
• Of fiscal 2017 net sales, $1.933 million was recognized for compensation in equity securities. These non-cash receipts, and the company’s exposure to their valuation and liquidity, are notable; a $175,000 other-than-temporary securities impairment was recorded.
• Fiscal 2017 results included $500,627 of interest expense and a $446,250 non-cash debt-conversion charge. The conversion charge arose when the convertible-note conversion price was reduced. Inventory impairment was $67,226, and an accounts-receivable allowance of $50,000 was recorded.
• Related-party net sales were $1.731 million. The filing also describes significant related-party arrangements, including customer work, advisory and licensing agreements, and the Health & Wellness license. That license carries an $840,000 fee, with $480,000 due by January 2018, plus a 33⅓% share of net proceeds from sublicenses.
• Management planned to use IPO proceeds for brand development, marketing, expansion and working capital; to broaden Beauty & Pin-Ups distribution; and to develop licensing and brand-management revenue. No numerical revenue or earnings guidance was provided, and management cautioned that success was uncertain and licensing revenue timing could vary.
• Key risks include limited operating history, ongoing losses and cash use, customer and related-party concentration, dependence on Kathy Ireland Worldwide and its affiliates, competition, licensee performance, and reliance on third-party manufacturers and suppliers. Five customers each represented at least 10% of fiscal 2017 sales; together they represented 86% of year-end accounts receivable.
• Management reported ineffective internal control over financial reporting at September 30, 2017 because of a material weakness involving classification of cash-flow and shareholders’ equity items. The company said it was pursuing remediation; the auditor did not provide an opinion on internal controls. The filing reported no pending or threatened litigation.

Important facts for investors to verify

1. Confirm the issuer and period: this filing is Level Brands’ FY 2017 Form 10-K, not cbdMD’s filing or a 2016 Q4 report.
2. Review the audited statements and notes for the sales presentation, including related-party revenue and the substantial equity-based service consideration.
3. Assess whether the $10.9 million of post-year-end IPO proceeds and planned spending were sufficient to address continuing operating cash outflows.
4. Track remediation and testing of the disclosed material weakness in internal controls.
5. Examine related-party transactions, customer concentration, the Health & Wellness license payment obligations, and the collectability and realizable value of receivables and private-company securities.