Business context and reporting period
Conversion Labs, Inc. (the registrant named in this filing; not “Lifemd, Inc.”) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. Its direct-to-consumer portfolio included Shapiro MD, iNR Wellness MD, RexMD and PDF Simpli. The company reported that a June 2019 joint venture enabled prescription-drug sales nationwide through GoGoMeds. The filing describes the business as an online marketing and telemedicine company.
Financial performance and position
- Third-quarter revenue: $3.13 million, up 53% from $2.04 million. Gross profit was $2.45 million; gross margin was 78%, versus 74% a year earlier.
- Third-quarter expenses and loss: Operating expenses were $3.42 million, including $2.07 million in marketing. Operating loss was $974,000; net loss was $1.10 million, compared with $1.09 million in Q3 2018. Loss attributable to Conversion Labs was $944,000, or $0.02 per share.
- Nine-month results: Revenue was $8.52 million, up 39% from $6.14 million. Gross profit was $6.51 million and gross margin was 76%, versus 78%. Operating loss was $2.37 million; net loss was $2.80 million, compared with $542,000 in 2018. The prior period included $926,000 of income from discontinued operations, including a gain on sale. Loss attributable to Conversion Labs was $2.43 million, or $0.06 per share.
- Cash flow: Nine-month operating cash flow was positive $92,000, compared with negative $489,000 in 2018. The filing attributes 2019 operating cash generation in part to a $1.16 million increase in accounts payable and accrued expenses and noncash expenses. Investing cash outflow was $500,000, primarily LegalSimpli contingent consideration; financing inflow was $1.01 million. Cash increased $601,000 to approximately $781,000.
- Liquidity and debt: Current assets were $1.76 million and current liabilities $2.98 million at September 30, 2019, resulting in a $1.22 million working-capital deficit and a 0.59 current ratio. Net notes payable were $723,000, versus $247,000 at December 31, 2018. Total liabilities were $3.11 million; stockholders’ deficit was $568,000.
- Margins and costs: Management attributed revenue growth to LegalSimpli and increased haircare and skincare sales. Higher marketing spending was a major expense driver: $5.57 million for the nine months, up 56%. Cost of sales grew faster than nine-month sales, contributing to lower gross margin.
Material changes versus the prior comparable period
- Q3 revenue rose 53%, while net loss was broadly similar year over year. For the nine months, revenue rose 39%, but operating loss widened from $1.26 million to $2.37 million and net loss increased substantially; the 2018 comparison benefited from the discontinued-business gain.
- Cash improved from $180,000 at December 31, 2018, but current liabilities increased faster than current assets, turning working capital from a $413,000 surplus to a $1.22 million deficit.
- In April 2019, the company agreed to acquire the remaining 21.8% of Conversion Labs PR for 5 million shares valued at $900,000; the shares were issued in August. It also formed CVLB Rx, in which it holds 51%, and increased its prescription-drug and telehealth activity.
- In August, the company issued $1.292 million of convertible notes bearing 12% interest, with a one-year maturity, and warrants. The notes have conversion-price adjustment provisions, which may increase dilution. Nine-month interest expense rose to $431,000 from $205,000.
Outlook, risks and unusual items
- Going concern: Management stated there was substantial doubt about the company’s ability to continue as a going concern, citing losses, an accumulated deficit of approximately $15.9 million and the working-capital deficit. It said additional sales growth and/or financing would be needed for 2019 and beyond; financing availability and terms were not assured. Management also said available capital at the current burn rate was expected to fund operations through the balance of 2019.
- Guidance: No formal numerical revenue, earnings or margin guidance is provided. Management expressed an expectation that PDF Simpli would achieve profitability in 2019, but this was an expectation, not a quantified forecast.
- Reporting and execution risks: Management disclosed ineffective disclosure controls due to material weaknesses, including inadequate segregation of duties, limited written accounting policies, insufficient IT controls and lack of formal related-party transaction and whistleblower policies.
- Revenue recognition: The company disclosed that it lacked a process to properly defer certain product revenue when title passed on delivery rather than shipment. It also said it had not adequately implemented reporting for Shapiro MD trial offers and related inventory effects, and had not yet estimated the historical impact.
- Other risks and unusual items: Sales depend heavily on online advertising platforms; management cited competition, supply constraints, regulatory and intellectual-property risks, and the need for capital. Three credit-card processors represented 66%, 18% and 12% of accounts receivable. Related-party arrangements include CEO-linked fulfillment services and office space. The filing reported no material pending legal matter identified by management.
Most important facts for investors to verify
- Confirm the registrant’s identity: this filing is for Conversion Labs, Inc., despite the request metadata naming Lifemd, Inc.
- Review the going-concern disclosure, cash needs, financing availability and maturity/conversion terms of the August 2019 notes.
- Assess whether rising sales can translate into improved operating results given marketing costs, losses and the nine-month decline in gross margin.
- Examine the disclosed revenue-recognition and trial-offer process issues, and whether they have been remediated or could affect reported results.
- Review the material weaknesses in disclosure controls and related-party arrangements, including fulfillment costs and the share issuance to company insiders.